India: GAAR Provisions Cannot Be Applied Retrospectively

Background

As a deterrent to tax avoidance, Indian tax law incorporated General Anti-Avoidance Rules (GAAR) provisions, effective for transactions entered from fiscal year 2017-18. (Please click here to read our Publication on GAAR). With the introduction of GAAR provisions, each transaction will attract detailed scrutiny from the Tax Officer. While GAAR had been introduced on prospective basis, recently, Kolkata Tax Tribunal¹ had an occasion to delve on a transaction where the First Appellate Authority had applied GAAR retrospectively, even though the scheme of amalgamation was approved by the Punjab & Haryana High Court and Delhi High Court. We, at BDO in India, have summarised the ruling of the Kolkata Tribunal and provided our comments on the impact of this decision.  

Facts of the case

Taxpayer, a public limited company, is engaged in the business of manufacturing and selling of textiles, yarns, readymade garments etc. Its Wholly Owned Subsidiary (WOS) earned income by selling its investments and rent and had no other substantial business activity. During the Fiscal Year (FY) 2010-11, WOS was amalgamated with the taxpayer w.e.f. 01 April 2010 under the scheme of amalgamation approved by the High Courts. Before the scheme could be approved by the High Courts, WOS sold off the freehold land for a consideration of INR 1200mn. This property was acquired in 1966 as leasehold land. However, in light of the government's decision to convert the property to freehold, the WOS converted the leasehold property to freehold property after paying conversion charges. The key dates pertaining to the instant case is tabulated hereunder:

The gains earned from the sale of property was treated as long term capital gains. Post amalgamation, the said gains were set off against the brought forward unabsorbed depreciation of the taxpayer. Further, for MAT computation, the said gain was set off against the brought forward loss / depreciation as per books while computing book profit for determining Minimum Alternate Tax (MAT) liability.             

However, the tax officer treated the gain on sale of land as short term capital gains. When the matter was referred to the First Appellate Authority, the First-Appellate Authority was of the view that the entire process of amalgamation was a colourable device to avoid payment of tax. Accordingly, he pierced through the corporate veil and looked through the entire transaction, solely on substance, other than the form. Further, acknowledging the fact that GAAR provisions are not applicable in relevant FY, he drew strength from this 'future proposed' provisions and held that amalgamation was done to avoid payment of capital gains tax on sale of land. Hence, the First-Appellate Authority denied set off of losses against capital gains earned from sale of property – both under normal as well as MAT provisions. Aggrieved, the taxpayer filed an appeal before the Kolkata Tax Tribunal.              

Tribunal Ruling

Before the Tax Tribunal, various issues were raised, one of them being denial of set off of losses against the capital gains from sale of freehold property. After hearing the taxpayer and the Revenue Authority, the Tax Tribunal held that invoking GAAR provisions, when they are not applicable for the impugned assessment year is bad in law. While coming to this conclusion, the Tax Tribunal made following observations:

• The High Courts had specifically ordered that all incomes and profits of the WOS for all purposes would be treated as the income, profits, costs etc. of the taxpayer. It stated that the First-Appellate Authority cannot take a contrary view against the court approved amalgamation 
• Relying on co-ordinate bench ruling in case of Electrocast Sales India Ltd², wherein it was observed that the High Court would approve the scheme of amalgamation after ensuring the same is not prejudicial to the public interests. Hence, the revenue authorities cannot disturb this merely because the taxpayer is not entitled for benefits under section 72A of the IT Act;
• The conclusion of First Appellate Authority that the amalgamation scheme is a colourable device was illegal and without any factual or legal basis. It further stated that invoking GAAR provisions when they are not applicable in the relevant FY was bad in law. The dichotomy in the order of the First Appellate Authority is clear from the fact that he chooses to tax capital gains in question, in the hands of the taxpayer company, though he holds that the merger is a sham transaction.

BDO Comments

The Kolkata Tribunal ruling supports that the GAAR provisions cannot be applied retrospectively. It is pertinent to note that the Central Board of Direct Taxes had issued clarification on Applicability and implementation of GAAR³ wherein it was stated that in case where an arrangement has been held as permissible by the Authority for Advance Ruling (AAR) or sanctioned by a Court, National Company Law Tribunal (NCLT) after explicitly dealing with tax implications then GAAR will not apply to such an arrangement. This Ruling is a welcome ruling.

However, it is imperative to observe that from the order it is not clear whether the High Courts, while approving the scheme of arrangement, had specifically dealt with the tax implications. Furthermore, all the facts are not clear and commercial rationale for entering into such scheme would be crucial. While the principle that GAAR cannot be applied retrospectively have been duly recognised by the Tribunal, it would be important to observe how the aspects such as substance over form, business purpose test, etc. are considered and examined at higher forums.

Footnotes