ANTI AVOIDANCE MEASURES
(Project Report)
Submitted by:
Submitted To:
Name: Rajat Chopra
Dr. Archana Gharote
Roll no.: 113
Faculty : Principles of Taxation Law
Sec: A
Submitted On- 18/08/2018
Semester- V
Hidayatullah National Law University, Post- Uparwara,
Naya Raipur – 492002 (Chhattisgarh)
DECLARATION
I, Rajat Chopra, hereby declare that, the project work titled “Anti Avoidance Measures”
submitted to H.N.L.U., Raipur is record of an original work done by me under the abled
guidance of Dr. Archana Gharote, Faculty, H.N.L.U., Raipur.
Rajat Chopra
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Semester - V
Roll no. - 113
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ACKNOWLEDGEMENTS
I, Rajat Chopra take genuine pride and pleasure in presenting this project with the grace of the
almighty to Dr. Archana Gharote. I would first of all like to express my most sincere gratitude
to Dr. Archana Gharote for her paramount support and encouragement. I am thankful for
being given the honour of making this project on “Anti Avoidance Measures” I am thankful to
the library staff and committee members for all the conveniences which played a major role in
the completion of t his project. I would like to thank my family for their perpetual support
and encouragement. I would also like to thank my friends for their support and advice. Last
but the most important, I would like to thank God for keeping me in good health and senses to
complete this project. I am thankful to my seniors for all their boundless support,
encouragement and valuable advice whenever needed. I present this project with a humble
heart.
RAJAT CHOPRA
(Semester - V)
CONTENTS
1. Introduction...............................................................................................…5
2. RESEARCH METHODOLOGY…………………………………………7
3. RESEARCH PROBLEM………………………………………………….7
4. RATIONALE……………………………………………………………....7
5. Objectives……………………………………………………………..….8
6. LITERATURE REVIEW……………………………………………..…..8
7. NATURE AND TYPE OF STUDY…………………………………...…..9
8. LIMITATION OF THE STUDY……………………………………...….9
9. Sources Of Anti Avoidance Measures.....................................................10
10. Judicial Anti Avoidance Measures...........................................................11
11. Legislative Anti Avoidance Measures......................................................14
12. Administrative Anti Avoidance Measures………………………...17
13. Conclusion................................................................................….……….18
14. SUGGESTION…………………………………………………………...19
15. References......................................................................................……… 20
INTRODUCTION
Tax avoidance has various definitions in legal rulings and academic literature:-
a) Justice Reddy1 calls it the “art of dodging tax without breaking the law”;
b) Black’s Law Dictionary states that tax avoidance is the “minimization of one’s tax liability
by taking advantage of legally available tax planning opportunities”;
c) The Organization for Economic Co-operation & Development (OECD), terms “tax
avoidance as an arrangement of a taxpayer’s affairs that is intended to reduce his liability
and that although the arrangement could be strictly legal is usually in contradiction with the
intent of the law it purports to follow”;2
d) The European Court of Justice (ECJ) views tax avoidance as “artificial arrangements aimed
at circumventing law”;
e) The Carter Commission Report (Canada, 1966) states that tax avoidance is “every attempt
by legal means to reduce tax liability which would otherwise be incurred by taking
advantage of some provision or lack of provision in the law”;3
f) The landmark Helvering v. Gregory4 judgment says “any one may arrange his affairs that
his taxes shall be as low as possible; he is not bound to choose that pattern which will best
pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
The common theme amongst all the definitions of tax avoidance is that it is a “grey area” of
exploiting, albeit legally, the tax laws of countries to maximum benefit. There is often a thin
line between acceptable tax avoidance, also known as tax planning and unacceptable tax
avoidance.
There are four basic tax avoidance techniques practiced, 5 though numerous variations and
1
McDowell v. Commercial Tax Officer, (1985) 154 ITR 148.
2
Glossary of Tax Terms, http://www.oecd.org/document/29/0,3343,en_2649_34897_
33933853_1_1_1_1,00&&en-USS_01DBC.html.
3
Royal Commission on Taxation (Carter Commission), 1966, Canada.
4
Helvering v. Gregory, 69 F.2d. 809 (2nd Cir. 1934).
5
R. Rohatgi, Anti-Avoidance Measures, in BASIC INTERNATIONAL TAXATION VOLUME II: PRACTICE OF
INTERNATIONAL TAXATION 141 (2000).
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subtleties exist:
a) Deferred payment of tax liability
b) Re-characterization of an item or income or expense to tax at a lower or nil rate
c) Permanent elimination of tax liability
d) Shifting of income from a high-taxed to a low-taxed person
In practice these techniques are carried out using the following methods:
a) Use of tax Treaties for related-party transactions (i.e., “Treaty Shopping”)
b) Use of international tax shelters through artificial intermediary companies (i.e., “CFC”)
c) Excessive use of debt over equity (i.e., “Thin capitalization”)
d) Non-arm’s length transactions (i.e., “Transfer Pricing manipulation”)
e) Transfer of residence
f) Branch entities
g) Use of Tax Havens
The bottom line is that all tax avoidance techniques take advantage of inconsistencies and
discontinuities in the tax systems through various tax arbitrage techniques.
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RESEARCH METHODOLGY
The objective of this research is to study anti avoidance measures. It also studies its
shortcomings and suggests ways to overcome it. This research is descriptive and analytical
in nature. Secondary and electronic resources have been used extensively to gather data
about the topic. Books and other reference as guided by faculty of principles of taxation
law have been primarily helpful in structuring the project. Websites, dictionaries and
articles have also been referred to. Footnotes have been provided wherever needed to
acknowledge the sources.
RESEARCH PROBLEM
Tax evasion often entails taxpayers deliberately misrepresenting the true state of their
affairs to the tax authorities to reduce their tax liability and includes dishonest tax reporting,
such as declaring less income, profits or gains than the amounts actually earned, or
overstating deductions. This project deals with anti avoidance measure of tax evasion.
There are several judicial, legislative and administrative measures of anti avoidance, which
play a vital to curb the problem.
RATIONALE
An anti-avoidance measure is a rule that prevents the reduction of tax by legal arrangements,
where those arrangements are put in place purely to reduce tax, and would not otherwise be
regarded as a reasonable course of action. The rationale behind the project is to discuss the anti
avoidance measures which are helpful in curbing the problem of tax evasion.
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OBJECTIVES
To study the sources of anti avoidance measures
To study the judicial anti avoidance measures
To study the legislative anti avoidance measures
To study the administrative anti avoidance measures
LITERATURE REVIEW
Tax Competition: A Literature Review
Do tax payers actually shift assets and activities across borders in response to differences in
taxation? The main message of the literature is that the scope for tax arbitrage depends
crucially on the legal rules governing the taxation of cross-border activities and that the
intensity of tax arbitrage varies greatly across different taxes. The final step is to analyze
government reactions to tax arbitrage.6
Tax avoidance and tax expenditures in developing countries: Clemens Fuest and Nadine
Riedel Oxford University Centre for Business Taxation
6
https://www.researchgate.net/publication/275321884_Tax_Competition_A_Literature_Review [accessed Aug
16 2018].
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Tax avoidance and tax evasion are widely believed to be important factors limiting revenue
mobilisation. This study reviews existing empirical estimates of tax gaps, i.e. tax revenue
losses due to tax avoidance and tax evasion, in developing countries, and discusses the role of
tax expenditures and other determinants of revenue mobilisation. Existing empirical studies on
tax revenue losses due to tax avoidance and tax evasion in developing countries distinguish
between a domestic component and an international component. The domestic component
includes tax evasion which occurs due to the domestic shadow economy. The international
component includes profit shifting by corporations and offshore holdings of financial assets by
private individuals.
NATURE AND TYPE OF STUDY
The nature of the study is Doctrinal, which means that it is based upon the doctrines, rules or
laws which already exists in the works by different authors, statutes, precedents, rules and
regulations made by government instrumentalities. It is descriptive in nature. It is a non-
empirical study. No survey or collection of statistics is done by author.
SOURCES OF DATA
Primary sources such as statutes, rules and regulations related to taxation law are used in the
present research work. Apart from that, secondary and electronic resources have been used to
gather information and related data. Books and other related articles as guided by the faculty
have been primarily helpful in giving this project a firm structure. Websites, dictionaries and
journals have also been widely used.
LIMITATIONS OF THE STUDY
The project deals with “Anti Avoidance Measures”. Though there are several measures to
eradicate tax evasion, but this project only deals with judicial, legislative and administrative
measures. The project is limited to sources of measures and measures above stated.
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SOURCES OF ANTI AVOIDANCE MEASURES
Given the tax avoidance techniques, it is illustrative to see how governments around the
world react to this problem.
a) Legislative solutions: Most governments seem to rely on anti-avoidance statutes which
are passed by their legislatures. Such legislations can be broken down into two
categories and their distinction is very important as we will see in later sections of this
paper:
1. Specific anti-avoidance rules targeted at specific tax avoidance measures [hereinafter
“SAAR”]
2. General anti-avoidance rules which are, as the name suggests a catch- call system for tax
avoidance [hereinafter “GAAR”]
3. Bilateral measures are also pursued through treaties or Double Taxation Agreements
[hereinafter “DTAAs”]
b) Judicial solutions: The Courts across the world have been instrumental in evolving and
developing various judicial doctrines to curb tax avoidance.
c) Administrative solutions: To figure out tax avoidance has taken place and to get
information on such practice is paramount; administrative measures are a useful tool for
governments to both curb and detect tax avoidance practice.
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JUDICIAL ANTI AVOIDANCE MEASURES
The Courts may take either a literal, i.e., strict view or purposive view towards statutory
interpretation. Dozens of Courts the world over have played an important role in developing
SAAR and GAAR principles and laws. The two guiding principles 6 in judicial anti-avoidance
are:
a) Business purpose rule (motive test)
b) Substance over form rule (artificiality test)
(i) The “Business Purpose” rule
The “business purpose rule” is simple; it says that a transaction must serve a business purpose,
i.e., commercial justification, other than tax avoidance. Mere tax advantage cannot be the sole
or main business purpose. In the landmark judgment Gregory v. Helvering7 the U.S. Supreme
Court held that a corporate reorganization under the law solely for tax purposes did not qualify
for tax benefits.
It should be mentioned that business purpose is seldom defined in the statutes; Courts simply
adopt a common-sense view. There are several dozen U.K. rulings which have attempted to
define “business purpose”.
There are some interesting questions one can ask when it comes to business purpose; should
the business purpose always be financial? Is defence from a takeover a justified business
purpose? Another question is, is the motive distinct from purpose; does the purpose refer to
the ultimate objective or aim or does it mean the subjective motive of the taxpayer? The
answer to these questions is left as a puzzle for the reader to solve; suffice to say one could
refer to Inland Revenue Commissioner v. Brebner8 and Mallelieu v. Drummond 9 7 8 9 10
(ii)
“Substance v. Form”
a) a) The substance versus form principle is wider in scope than the business purpose rule;
the 1987 OECD report defines it as “the prevalence of economic or social reality over the
literal wording of legal provisions. ”Substance versus form makes for fascinating debate;
7
Frederik Zimmer, Form and Substance in Tax Law (IFA Cahiers, Vol 87A, General Report 2002); See also supra
note 7; IFA Online, http://www.ifa.nl.
8
Helvering v. Gregory, 69 F.2d 809 (2nd Cir. 1934).
9
Inland Revenue Commissioner v. Brebner, [1967] 2 A.C. 182 (H.L.) (U.K.).
10
Mallelieu v. Drummond, [1983] S.T.C. 665 (H.L.) (U.K.).
when does one stop literally interpreting and start piercing the veil? There is no easy answer
for this. Whatever be the case, it would be wise for any legal student or practitioner to
understand the various faces of “substance v. form” as listed below:
b) a) Legal v. Economic Substance
c) This applies to situations where due to the legal form used for the transaction a taxpayer
has the real economic power over the taxable income without the tax liability. A famous case
in this regard is the Duke of Westminster case. In this case the taxpayer executed tax-
deductible deeds of covenants to pay selected employees without affecting their non-
deductible wage entitlements. Under separate non-contractual agreements with the
employees, it was assumed that they would not expect to be paid their existing wages but be
content with payment under the covenant plus such additional amount as required to increase
their income to their current salary. The House of Lords held that they must be regarded as
covenanted payments and that they were entitled to deduct them. In short, the Court accepted
the legal form of covenanted payments although they could be treated in substance as the
economic equivalent of wage.
d) b) Sham Transactions
e) In a sham transaction, they (the ‘tax avoiders’) give effect to a transaction, which they do
not carry out, or do not intend to carry out or is a cover up for another transaction or
relationship. A sham transaction essentially conceals the true nature or reality of a
transaction that exists in form only. In short, the legal form is retained but the underlying
substance is not genuine in law.
f) A landmark judgment regarding sham transactions is the Knetsch case. In this case, the
taxpayer borrowed money at 3.5% to make a return of 2.5% from an investment in annuity
issued by insurance company. Investment income was taxed at lower capital gains rate and
the interest payments were fully deductible for tax purposes. The US Supreme Court treated
the transaction as a sham and disallowed the interest paid on the loan. It was held that there
was “nothing of substance to be realized beyond a tax deduction. Doctrine of the Label
(wrong characterization)
In this method, parties use incorrect labels to classify or characterize a transaction or
relationship for tax purposes.
A relevant case in this regard is the Ridge Securities case,11 where the Court rejected a loan
with interest at over 400% per annum as a loan transaction.
g) Step-transaction doctrine
Certain countries (like USA, UK, Japan and Canada) regard a series of connected transactions
as a single transaction under the “substance v. form” principle.
In a “step transaction”, the intermediate steps in a chain of preordained, even if bona fide,
transactions may be disregarded and several related transactions may be treated as a single
composite transaction. Alternatively, a single transaction may be broken into distinct steps too
to determine its tax acceptance.
It was observed in McDonald’s case12 13 that “purely formal distinctions cannot obscure the
substance of the transaction.”
h) Piercing the Corporate Veil
The piercing of the corporate veil is one of the most debated topics today in corporate circles.
The classic case for veil piercing is Salomon v. Salomon14 where Salomon converted the
business to a limited liability corporation when it was doing well. The business then
floundered and went into liquidation. The question was ‘what was the true intent behind the
conversion of the business?’ The House of Lords ruled that the company had been validly
formed and in the famous words of Lord Macnaghten, “The company is at law a different
person altogether from the subscribers to the memorandum of association...” On this basis, the
court upheld the conversion of business as bona fide.
11
Ridge Securities v. IRC, (1962) 44 T.C. 373 (Ch.D) (U.K.).
12
Mcdonald's Restaurant of Illinois v. Commissioner, 688 F.2d 520 (7th Cir. 1982).
13
Salomon v. Salomon & Co., [1897] A.C. 22 (H.L.) (U.K.).
LEGISLATIVE ANTI AVOIDANCE MEASURES
(i) SAAR & GAAR
Two kinds of statutory anti-avoidance measures exist: GAAR and SAAR. The GAAR as its
name implies is a set of general anti-avoidance rules; think of it as a “catch-all” for tax
avoidance. The SAAR is a specific anti-avoidance rule and is targeted at curbing a specific
avoidance practice or technique.
a. What is the rationale behind GAAR ?
It is easy to understand the need for SAARs and their source of evolution - typically by
judicial rulings or as a reaction to a commonly used avoidance technique in the marketplace.
However what is the rationale for having GAAR provisions? Justice Murphy said it best in
Federal Commissioner of Taxation v. Hancock, “The resource of ingenious minds to avoid
revenue laws has always proved inexhaustible and for that reason it is neither possible nor safe
to say in advance what must be found...” 14
The advantages of GAAR are that given tax avoidance schemes are becoming increasingly
complex and tough to anticipate via SAARs, governments across the world want to stop losing
what they perceive as billions of dollars of revenue and so implement GAAR provisions as a
‘catch-all’ scheme for tax avoidance in general. On the downside, the real problem with
GAAR is that it can end up promoting uncertainty. It is a good time to recollect what Adam
Smith said about taxes - that certainty is valued more than fairness and simplicity. The GAAR
may also be construed as contrary to the rule of law principle, i.e., laws are meant to be
reasonably certain or predictable.
In fact, the Canadian GAAR when introduced was challenged as unconstitutional on these
grounds but the Canadian Supreme Court held that broad, purposive interpretation of GAAR
is appropriate; refer Canada Trustco Mortgage case.15
14
Federal Commissioner of Taxation v. Hancock, (1961) 8 ATR 328, 333.
15
Canada Trustco Mortgage Co v. Canada, 2005 2 S.C.R. 601 (Supreme Court of Canada).
A GAAR is basically an attempt to strike down avoidance that is not understood at the time of
drafting. The difficulty with having such a broad scheme has been heavily debated in various
countries as and when they grappled with the thought of introducing GAAR. For example the
Taxation Review Committee, 1975, Australia debated:
In framing legislation sufficiently all-embracing to deter tax avoidance, there is always the
danger of penalizing those who have a genuine reason for entering into a bona fide transaction,
which, if carried out by others, has the objective that ought to be prevented. There is
frequently such a very fine line to be drawn between the transaction which offends and the one
which merits no condemnation.
(b) SAAR
There are many examples of SAARs around the world enacted by various countries. Some
examples are thin capitalization rules and CFC (controlled foreign corporation) rules which
are passed to curb specific tax avoidance techniques; suffice to say these are elaborated upon
in the later section on tax avoidance and counter measures. Typically SAARs are prospective;
however they can retrospective too and the increasing use of retrospective SAARs is a cause
of concern for taxpayers.
(c) Treaty anti-avoidance provisions
Tax treaties (DTAAs) have evolved over time to include a plethora of anti- avoidance
provisions in them. Some of the examples are: Arm’s-length definition for related party
transactions (Article 9) to defeat transfer pricing manipulation,
- Limitation on Benefit (LOB) clauses to counter treaty shopping,
- The concept of “beneficial ownership” applied to Interests, Dividends & Royalties
(Article 10, 11 and 12) and
Specific provisions against transactions with tax havens.
All the above measures are dealt with in later sections of this paper when tax avoidance
techniques and counter measures are elaborately discussed. Hence, we do not wish to
duplicate the same content here but wish to point out that tax treaties are evolving documents
and are good weapons in the hands of both Governments (in case of bilateral treaties) to sit
down and come up with ways and means to curb tax avoidance. It must be noted that the
continuing contribution by academic and legal experts at OECD (and the UN), whose Model
Conventions16 most countries follow is critical in this regard.
One anti-avoidance measure which we need to mention and which is not discussed elsewhere
in this paper is the Exchange of Information Articles in the treaties. Article 26 of the OECD
Model Convention is a widely accepted legal basis for bilateral exchange of information for
tax purposes. It creates an obligation to exchange information that is foreseeably relevant to
correct application of a tax convention as well as for the purposes of administration and
enforcement of domestic laws of the Contracting States. This Article serves as an important
tool to detect and gather information on tax avoidance.
A related development is that of Taxation Information Exchange Agreements. The OECD has
developed a process that enables certain non-OECD offshore financial centre jurisdictions to
commit to eliminating harmful international tax avoidance and evasion practices. These
jurisdictions can do this by committing to a program of exchange of information agreements
with OECD member countries.
ADMINISTRATIVE ANTI AVOIDANCE
16
OECD Model Tax Convention on Income and on Capital, January 2003; Canada
Trustco Mortgage Co v. Canada, 2005 2 S.C.R. 601 (Supreme Court of Canada).
MEASURES
Administrative measures are mainly to ensure compliance and/or to detect tax avoidance.
They are usually carried out in the following ways:
a) By use of investigative powers when a GAAR exists
b) By use of administrative powers to build a common law avoidance case, in
jurisdictions where no GAAR exists (example: New South Wales, Australia)
c) By use of taxpayer alerts & rulings - these typically discuss how an administration
intends to apply statutory GAAR
d) By appointing GAAR panels to decide GAAR issues.
Exchange controls & tax clearances are also used by countries as anti- avoidance measures;
these transactions are subject to either prior government approvals or to posttransaction
reporting of income or capital flows. For example, Canada requires its residents to report all
foreign investments in excess of 100,000 Canadian dollars to tax authorities. Many countries,
especially developing, still have partial or full exchange controls on current and/or capital
account that monitor tax issues on cross-border transactions.
CONCLUSION
We have seen from our detailed tour of the world of tax avoidance and its counter measures
that tax avoidance is a complex and evolving game and to counter this we can see that there
are a plethora of techniques practiced by governments around the world ranging from judicial
doctrines, SAAR and GAAR and administrative measures. It seems to one that various
countries are trying to constantly play catch-up with the evolving tax avoidance techniques in
a never-ending cat & mouse game. Coming to the proposed Indian GAAR in the DTC, it is an
expected, but nevertheless significant step. The opening up of our economy, our high growth
rate, the tremendous growth of foreign interest in Indian shores, the huge cross- border
transactions and flows and the growth of our “intangible” economy has opened up a gift box
for the investor but a Pandora’s box as far as the Revenue is concerned, with aggressive tax
planning and structuring being the order of the day. The Indian Revenue no doubt feels there
is a huge loss to the Revenue due to the practice of various tax avoidance techniques and a
GAAR is needed to cast a wide net in order to prevent to bring tax avoiders under their
scanner.The key issue is not so much that India is evolving a GAAR but more so the
unfortunately frightening certainty of there being uncertainty and unpredictability for the
taxpayers in the GAAR implementation by the Indian Revenue authorities. After all, the devil
is in the details when it comes to GAAR due to its sweeping reach. The unanswered questions
on the back of everyone’s mind are no doubt:
a) Whether GAAR will be misused as a catch-all mechanism by the Indian Revenue
authorities. The past and current behaviour of the Revenue authorities will probably lead to
sleepless nights for the taxpayer once the GAAR provisions are in place!
b) How will the Indian Courts interpret the GAAR provisions? Historically they have been
favourable to tax payer when it comes to things like treaty shopping (Azadi Bachao
Andolan). But will there be a seismic shift?
An even more fundamental question is whether India really needs a GAAR and why the
current system of a combination of judicial rulings and SAARs will not suffice? We hope that
the Indian DTC GAAR is not a case of “calm before the storm”.
SUGGESTIONS
There is a need of clarity in laws, rules and regulations related to taxation law. The
law shall be specific, clear and not ambiguious so as to give tax payers no chance to
misuse them and do tax evasion. Tax results depend on definitions of legal terms
which are usually vague. For example, vagueness of the distinction between "business
expenses" and "personal expenses" is of much concern for taxpayers and tax
authorities. More generally, any term of tax law has a vague penumbra, and is a
potential source of tax avoidance. Also, there is a need of proper agency who shall
scrutinize the loopholes of taxation law, so as to bring necessary amendments and
changes. There is also a need of change in regular tax structure with the change in
time, so that is a tax payer friendly taxation laws and at the same time beneficial for
the government.
REFERENCES
1. www.international-tax-law.at/prospective-students/.../anti-avoidance-measures/
2. ec.europa.eu/taxation_customs/taxation/company.../anti...avoidance/index_en.htm
3. www.armstrongwatson.co.uk/anti-avoidance-measures-0
4. www.kluwerlawonline.com/document.php?id=TAXI1997080
5. www.jstor.com
6. www.businesstoday.com
7. Dyreng SD, Hanlon M, Maydew EL. (2008). Long-run corporate tax avoidance. The
Accounting Review.
8. Lawrence, Felicity (2011-10-11). "Quarter of FTSE 100 subsidiaries located in tax havens".
The Guardian. London.
