The draft Direct Taxes Code Bill and a Discussion Paper on the subject have been made available by the Government, in keeping with the Finance Minister’s promise in the budget speech. Initial reports suggest that experts have welcomed the proposed Bill. Here are the links to a CNBC report, and ET report, and a Mint report. The general tenor of these reports is positive, though the Mint mentions that “The scope and extent of what is sought to be considered as tax avoidance is wide and can be a cause of concern as it could place significant onus on taxpayers to defend the bona fides of a suspect transaction.” That the provisions are a “cause of concern” appears to be a massive understatement.
Typically, tax avoidance is considered to be legal; tax evasion is illegal (Azadi Bachao Andolan v. Union of India). The draft Bill radically changes this position. The Discussion Paper released by the Government echoes the philosophy that “Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues…” The philosophy has been sought to be put in practice by the draft Section 112. The fact that it might actually be desirable in policy to maintain the avoidance-evasion distinction appears to be a point which is lost on the Government. Here is what the proposed Section says:
112. (1) Any arrangement entered into by a person may be declared as an impermissible avoidance arrangement and the consequences, under this Code, of the arrangement may be determined by,-
(a) disregarding, combining or re-characterising any step in, or a part or whole of, the impermissible avoidance arrangement;
(b) treating the impermissible avoidance arrangement-
(i) as if it had not been entered into or carried out; or
(ii) in such other manner as in the circumstances of the case the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit.
(c) treating parties who are connected persons in relation to each other as one and the same person; or
(d) disregarding any accommodating party or treating any accommodating party and any other party as one and the same person;
(e) deeming persons who are connected persons in relation to each other to be one and the same person;
(f) re-allocating, amongst the parties to the arrangement,-
(i) any accrual, or receipt, of a capital or revenue nature; or
(ii) any expenditure, deduction, relief or rebate;
(i) any equity into debt or vice-versa;
(ii) any accrual, or receipt, of a capital or revenue nature; or
(iii) any expenditure, deduction, relief or rebate
So what exactly does the Section mean? Any arrangement can be treated as an impermissible avoidance arrangement. In so treating the arrangement, the Revenue can practically do whatever it wants to do. Effectively, the Government can lift the corporate veil as and when it wants to. It can look at the “substance” of the transaction as and when it wants to. The only guideline is provided in the fact that “impermissible avoidance arrangement” is defined in Section 113, clause 14:
impermissible avoidance arrangement means a step in, or a part or whole of, an arrangement, whose main purpose is to obtain a tax benefit and it,-
(a) creates rights, or obligations, which would not normally be created between persons dealing at arm's length;
b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Code;
(c) lacks commercial substance, in whole or in part; or
(d) is entered into, or carried out, by means, or in a manner, which would not
normally be employed for bonafide purposes;
First, if “impermissible avoidance arrangement” is defined, how can Section 112 possibly say that “any arrangement” may be declared as an impermissible one? Let us assume for a moment that “any arrangement” in Section 112 only refers to those covered by the definition in Section 113. The definition in Section 113 is, nonetheless, extremely broad. To take just one instance, what does “lacks commercial substance” mean? Again, the Discussion Paper provides some guidance; as does clause 17 of Section 113:
The lack of commercial substance, in the context of an arrangement, shall be determined, but not limited to, by the following indicators:
(i) The arrangement results in a significant tax benefit for a party but does not have a significant effect upon either the business risks or the net cash flows of that party other than the effect attributable to the tax benefit.
(ii) The substance or effect of the arrangement as a whole differs from the legal form of its individual steps .
(iii) The arrangement includes or involves:
(a) round trip financing;
(b) an 'accommodating party', as defined;
(c) elements that have the effect of offsetting or cancelling each other;
(d) a transaction which is conducted through one or more persons and disguises the nature, location, source, ownership or control of funds; or
(e) an expectation of pre-tax profit which is insignificant in comparison to the amount of the expected tax benefit.
The Government seems to be labouring under the illusion that commerce is carried on solely to increase the government’s revenue. For, if there is something which confers a tax benefit, that – according to the Government – lacks commercial substance…
The Government might as well have enacted a law saying “Whatever the Revenue demands, the assessee must pay.” The General Anti-Avoidance Rule in Section 112 is bound – if enacted – to result in great uncertainty. It will be impossible for businesses to know what their tax liability is; what legal transactions are impermissible. It is based on the premise that any legal means to reduce tax liability is unconscionable. Undoubtedly, it is for legislative policy to provide the lead in looking at the substance over the form – this particular legislative policy, however, seems to render form totally redundant.
This much is bad; but the worst is yet to come. Here is what Section 114, clause 1 says:
An arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit unless the person obtaining the tax benefit proves that obtaining the tax benefit was not the main purpose of the arrangement.
So not only is an assessee not allowed to reduce his tax burden, he is also expected to prove that he is not reducing his tax burden. The Discussion Paper also suggests that the provisions are in line with international trends. Soviet Russia seems to be a prime example.