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GAAR – Tale of Two Rulings

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  • 2025-09-24

Introduction

The General Anti-Avoidance Rule ('GAAR') empowers the tax authorities to counter those schemes/arrangements that are designed for tax avoidance. GAAR was first introduced in the Direct Taxes Code 2010, but was eventually dropped. Later, the Finance Act 2012, along with a host of significant amendments, introduced GAAR provisions into the Income-tax Act, 1961('the Act') under Chapter X-A and draft guidelines were notified. However, the implementation of provisions was deferred by a year. On July 13, 2012, the Prime Minister constituted an expert committee for obtaining stakeholder consultation and finalisation of guidelines. The Committee submitted its final report ('Shome Committee Report') on September 30, 2012.

The Central Government had considered the report of the Committee and accepted major recommendations of the Committee with some modifications[1]. The Government also decided to defer GAAR to April 01 2016. Later, the Finance Bill 2015 deferred GAAR by one more year, and it was applicable from April 01 2017 (AY 2017-18). In the memorandum, the Government also expressed that the Base Erosion Profit Shifting ('BEPS') project and its recommendations in the form of reports are awaited; therefore, it is appropriate to implement GAAR as part of a comprehensive regime to deal with BEPS and aggressive tax avoidance.

GAAR Provisions in Brief

Section 95 of the Act has an overriding effect over other provisions of the Act[2] to declare an arrangement[3] entered into by the Assessee to be an impermissible avoidance arrangement ('IAA') and to empower assessing officer ('AO') to determine the consequence thereon.

Section 96(1) provides that an agreement shall be regarded as IAA if the main purpose of the arrangement is to obtain a tax benefit[4] and it satisfies any one of the tainted elements mentioned therein.

Section 97 provides a situation where an arrangement shall be deemed to lack commercial substance, and Section 98 provides for the determination of consequences by the AO as it deems appropriate to the circumstances[5].

Section 99 provides a situation where the AO has power to consider certain aspects for determination of tax benefits. The powers under this section are limited to determining the threshold of tax benefit for Section 96 and not for determination of any tax consequences.

Section 101 provided powers to provide guidelines and the rules were framed along with the procedure to be adopted by the tax authorities. Rule 10U provides a situation where the GAAR provisions shall not be applicable more particularly in respect of income arising from transfer of investment made on or before April 01 2017. Further, the Central Board of Direct Taxes ('CBDT') has issued a circular[6] clarifying various aspects of implementation of GAAR

Section 144BA provides a detailed mechanism that has to be adopted by the AO during assessment or reassessment. More safeguards have been prescribed for the invocation of GAAR, including issuance of a show cause by the AO and by the Commissioner of Income Tax ('CIT'), and if the case is fit, then the CIT has to refer the matter to the approving panel. The approving panel then issues directions[7] that are deemed fit in respect of the declaration of arrangement as IAA. The final order passed pursuant to the directions is subject to appeal before the Tribunal.

Challenges to Arrangement

In the course of giving their no objection to the scheme of arrangement filed by Companies under 231-233 of the Companies Act, 2013, the revenue sought to raise objections on GAAR and succeeded in National Company Law Tribunal ('NCLT'), rejecting the scheme[8], and there are instances where the NCLT granted a scheme despite an allegation of GAAR[9]. Recent experience indicates that the NCLT approves the scheme, subject to a caveat that it does not grant exemption under the Income Tax, and tax authorities can very well scrutinise the scheme at a later stage.

Recently, the Telangana High Court had an occasion to look at the provisions of Chapter XA in the context of certain transactions and rendered a ruling regarding the application of GAAR by the tax authorities. 

Ayodhya Rama Reddi Alla[10]

This is a case where a writ petition challenging the proceedings initiated by the CIT under Section 144BA of the Act. The Assessee was a shareholder in Ramkay Estates and Farm Limited ('REFL'). REFL issued bonus shares in the ratio of 5:1, and pursuant to the bonus shares, the Assessee sold the original shares of REFL to a related party, namely Advisory Service Pvt. Ltd ('ADR'), resulting in a short-term capital loss that was offset with his other long-term capital gain made in Ramky Enviro Engineers Limited ('REEL').

The transaction was evident from the arguments of ASG. The Assessee, along with Oxford Ayyappa Consulting Services Private Limited ('OACSPL '), had invested in REFL through private placement. Later, the Assessee acquired the entire holdings from OACSPL. Consequently, the value of shares works out to INR 19.20/share as against the pre-bonus value of INR 115/share. OACSPL funded ADR for acquisition of original shares from the Assessee, resulting in a loss of INR 462 Crores to the Assessee. Further, it was alleged that an inter-corporate deposit of INR 350 Crores was disbursed in February and March 2019; however, a sum of INR 288.50 Crores was reflected as written off in March 2019[11], which resulted in business loss to set off against capital gains. The Commissioner initiated GAAR proceedings and issued a notice under Rule 10UB, which was challenged before the High Court.

The Critical argument of the Assessee is that, at the time the transaction was consummated, Section 94(8), which dealt with bonus stripping, was applicable only to units, and the same was extended to shares at a later point in time. Since Section 94(8) specifically addresses curbing bonus stripping and transactions of shares not covered by this section, the Assessee has passed the test of specific SAAR. Hence, GAAR cannot be invoked for those transactions that have passed the test of SAAR. Reference was also made to the Shome Committee Report, which recommended that if SAAR applies to a particular transaction, then GAAR cannot be invoked.

The Revenue argued that the Assessee routed the funds through various entities[12] and created the entire transaction without economic rationale or substance, solely to create a loss and avoid tax payment by setting it off.

The High Court has observed as follows:

  • Several Courts have observed that when specific provisions are enacted, then general provisions of the law cannot be invoked. However, in the case of GAAR, it was legislated in 2013 and became effective from 01.04.2016. Hence, GAAR cannot be invoked when transactions fall within the four corners of SAAR, which is not acceptable. Furthermore, the Section 94(8) does not apply to shares during the relevant year.
  • Chapter X-A has an overriding effect on all other provisions of the law.
  • Prior to 2018, the judiciary followed substance over form ('Judicial GAAR') to counter abusive transactions that lacked commercial substance and escape tax obligations through legal loopholes. These are codified in terms of Chapter X-A under the Act.
  • Section 100 emphasises that the chapter is applicable in addition to or as a substitute for any other existing method of determining tax liability. It provides that GAAR should act as safety net to capture all illicit transactions.
  • Section 94(8) is relevant only in the case of an isolated situation of a bonus issue and cannot apply to an evident artificial arrangement that lacks a logical and commercial situation, like the one on hand.
  • Shome Committee Recommendation on SAAR related to international arrangement and not to domestic arrangement. The Finance Minister clarified that the application of SAAR or GAAR would be determined on a case-by-case basis. The CBDT vide its circular[13] provided clarity on the application of SAAR vs GAAR.
  • The transaction is devoid of commercial substance under Section 97 and constitutes a deliberate misuse of the law, thereby creating extraordinary rights and obligations that are not conducted in good faith or fair dealing, leading to a conclusion that it is an IAA under Section 96.
  • There is clear and convincing evidence to suggest that the entire arrangement was designed with the sole intent of evading tax. The petitioner could not counter this claim.

The GAAR provisions had contained multiple safeguards before the arrangement could be regarded as IAA (refer to provisions in brief section). However, the Court at the threshold declared the transaction as IAA and directed the lower authorities to proceed with further process, i.e., in this case, referring the case to the approving panel. Ideally, the situation should have been such that the Court could have dismissed the writ without declaring the transaction to IAA and could have directed the Assessee to follow due process. Now, given that the transaction is declared as IAA, the approving panel merely has to give directions and AO to determine the consequences. There will be no scope for assessee to argue that the transaction is not an IAA.

Smt. Anvida Bandi[14]

The Assessee challenged the directions of the Approving Panel under Section 144B(6) before the High Court. The Assessee was regularly investing in shares and securities and held investments totalling INR 80 Crores (Approx.)[15]. During the year, the Assessee earned long-term capital gains on shares amounting to INR 44 Crores (Approx). The Assessee invested in shares of HCL Technologies Ltd ('HCL') and other mutual funds. In the same year, HCL's shares, valued at INR 17.35 Crores in the open market, resulted in a loss of INR 17.65 Crores. This loss was set off against the earlier gain made by the Assessee.

The Tax Authorities alleged that the transaction of purchase and sale of HCL shares was IAA and referred the case to the Approving Panel. The Approving Panel issued directions treating the transactions as IAA.

The High Court quashed the directions by making following observations:

  • The department is unable to prove that purchases and sales are made through known parties or concerns, and no evidence was placed to show that the Assessee entered into any arrangement. This was a case of pure trading by the Assessee without knowing purchase and sale.
  • The investments in shares and units are regular transactions and not isolated transactions.
  • The transactions are carried through a Demat Account, and sales are made through stock exchange.
  • There is no material to substantiate the transaction as IAA, except for timing of the transactions.
  • The Shome Committee Report recommended that transactions of sale and purchase through the stock exchange would not come under GAAR[16].
  • Department unable to show which tainted element under Section 96(1) was satisfied to declare the arrangement as IAA

 Key Inferences from the judgements

  1. Misuse or Abuse of the Provisions

The Act does not define either of these terms. The clause envisages a situation where the spirit or intent of the provisions is circumvented[17]. The Supreme Court in Walfort Shares[18], in the context of application of Section 14A to dividend stripping transactions, held that the use of provisions cannot be called an abuse of law. The intent of the relevant clause in 96(1) is to consider the end result of the arrangement, whether it resulted in abuse or misuse. Therefore, in my view, every use of provisions without artificiality being present should not be regarded as abuse or misuse.

In Ayodhya Rama ruling, the Court observed that 94(8) as it existed during the year does not cover bonus stripping of shares[19]. A question arises when there is no provision of the Act, whether an arrangement could be regarded as an abuse or misuse of the provisions? In Walfort Shares (supra), the observation of 'use of provisions of law' was made in the context of dividend income being exempt under 10(33), and the assessee used it to earn tax-free dividend. Hence, in the absence of applicability of Section 94(8) to shares, it cannot be said that the assessee has misused or abused the provision.

  1. Tainted Elements

Section 96(1) envisages cumulative satisfaction of three aspects for an arrangement to be regarded as IAA, and they are (i) Main Purpose (ii) Obtaining Tax Benefit and (iii) Presence of one of the tainted elements.

In Anvida ruling, the Court observed that the tax authorities failed to provide any of the tainted elements. At this juncture, it is pertinent to note that the Writ was against the challenge to directions of the Approving Panel and the Commissioner in terms of Rule 10UB r.w. Form 3CEI required the documentation of detailed reasoning as to which clause of 96(1) i.e., the tainted element satisfied in the arrangement. However, these aspects are not available in order.

In Ayodhya Rama ruling, the Court discussed three tainted elements (i) misuse or abuse (already discussed earlier), and (ii) rights or obligations and (iii) commercial substance.

  • Rights or obligations aspect - The clause aims to compare the rights or obligations of parties acting independently with those of the transaction subject matter of GAAR. On comparison, if such rights are not normal, then it may satisfy the contours of tainted element. The Court observed that the arrangement resulted in unusual rights or obligations that are not in line with general principles of fair dealing. However, the Court had not elaborated on the nature of rights or obligations that are created from the arrangement. One may infer that the Court considered the aspect of this clause because the transactions are between related parties, which created a significant loss.
  • Commercial Substance aspectThe Court observed that arrangement is devoid of commercial substance under Section 97. It is pertinent to note that Section 97 deals with situations of deemed lack of commercial substance, and the Court has not discussed which clause of Section 97 triggered in the case of the Assessee. At this juncture, the department argued that the Assessee was involved in the round-tripping of funds to generate capital loss. 
  1. SAAR vs GAAR

In Ayodhya Rama ruling, the Court observed that the SAAR under Section 94 overrides GAAR is unacceptable and drew reference to the Finance Minister's Statement and CBDT clarification on GAAR. The FM mentioned in a press release that either SAAR or GAAR would be applied if both are in force, and guidelines would be issued accordingly. However, the CBDT Circular on GAAR clarified that both GAAR and SAAR can co-exist. It is to be noted that the Court noted that at point in time 94(8) does not cover shares, hence the question of SAAR being in place does not arise.

The Court observed that the Committee Report on SAAR generally supersedes GAAR, applying only to international agreements and not to domestic transactions. However, no specific observations were made in the Report[20]. I believe the Court was clouded by the observations made in the report in the context of a treaty having a limitation of benefit clause ('LOB'), and application of GAAR therein may be regarded as a treaty override[21]

The SAAR, as introduced under domestic laws, is designed to address specific issues and may or may not have artificiality or lack commerciality. Therefore, in the absence of tainted elements, they may not be covered under GAAR. It is empirical to note the language of Section 100, which the Court also pointed out that GAAR is in lieu of or in addition to existing provisions for determination of tax liability. This aspect highlights that GAAR can co-exist with SAAR, subject to the satisfaction of contours of Section 96(1). However, whether these aspects are sacrosanct when it comes to treaty LOB-related conditions (e.g. India-US DTAA or India–Singapore DTAA), only time will tell.

  1. Relevance of Shome Committee Report

In both rulings, the committee's report was used for interpreting certain aspects of GAAR, and a view was taken one way or another. In Ayodhya Rama, the Court interpreted the SAAR vs GAAR recommendations from the Report. In Anvida, the Court cited the example from the report to exonerate the case from the ambit of GAAR. It is to be noted that some of the committee's recommendations were considered in a modified form, as evident from the press release (supra). The Constitutional Court in R.S. Nayak v. A.R. Antulay[22] held that committee reports can be used as an external aid for interpretation. In other words, when the words of the statute are ambiguous, then such reports could be used as external aid to interpret the provision. However, in the instant case, the Court picked up an example quoted in the Report as an interpretation to decide that GAAR cannot be applied to a transaction consummated on the stock exchange.

  1. Timing of Transactions

Section 97(4)(i) provides that the period or time for which the arrangement exists may be relevant but sufficient for the determination of commercial substance. In Anvida, the Court was concerned with the timing of a transaction. Though Walfort's ruling (supra) was a pre-GAAR era, it sheds some light on the pre-ordained transactions. The Court observed that provisions could be used in certain situations, irrespective of whether the transactions were pre-planned, and there is nothing to impeach the genuineness of the transactions. The Apex Court held that not every planning of a transaction within the four corners of law can be frowned upon as a colourable device. While timing could be left to the taxpayer's discretion, the presence of artificiality or contrivance aspects can be tested by the tax authorities.

  1. Burden of Proof

In both cases, the Courts discussed the aspect of Section 96(2), and in Ayodhya, the Court was categorical that the Assessee failed to disprove the presumption of tax avoidance[23]. Section 96(2) provides that if a main purpose of a step in or part of an arrangement is to obtain a tax benefit, then a presumption shall be made that the main purpose of entire arrangement is to obtain a tax benefit. This presumption is made even when the main purpose of entire arrangement is not to obtain a tax benefit. Once the presumption is made, the burden to prove that the main purpose of a step or part is not to obtain a tax benefit is on the Assessee. Through this presumption, the colour of the step or part spills over the entire arrangement. Therefore, this is not a complete shift in burden; instead, it is limited to the purpose test, and the tainted element test still has to be proved by the tax authorities.

Taken together, these aspects show how the judiciary is still shaping the contours of GAAR.

Conclusion

This tale of two judgments highlights a central truth: GAAR’s reach will not be defined solely by statutory text but by how courts balance legislative purpose, committee reports, and evolving notions of abuse or misuse. For taxpayers, the lesson is that even legitimate planning within the four corners of law may be vulnerable if the arrangement is perceived to have artificiality and lacks substance. For tax authorities, the challenge lies in consistently evidencing tainted elements and applying GAAR with restraint to avoid overreach. As more cases are litigated, jurisprudence will gradually bring clarity. Until then, uncertainty remains an inherent feature of GAAR, with each case offering a new thread in the evolving fabric of interpretation.

[1] https://www.pib.gov.in/newsite/PrintRelease.aspx?relid=91556 dated 14 January 2013

[2] Section 100 provided that GAAR is in lieu of, or in addition to, existing provisions for determination of tax liability

[3] Defined under Section 102(1)

[4] Defined under Section 102 (10)

[5] The aspects provided under Section 98 are illustrative and hence the consequences cannot be limited to the one listed in the section.

[6] Circular 7 of 2017 dated 27 January 2017

[7] 144BA(6) directions cannot be challenged before the ITAT, hence any challenge is only by way of a writ under Article 226 before the jurisdictional High Court.

[8] Gabs Investment and Ajanta Pharma (CSP No.995 and 996 of 2017 and CSA No.791 and 792 of 2017) ; NCLAT’s decision in Wiki Kids Ltd. and Ors. Vs. Regional Director, South East Region and Ors. in Company Appeal (AT) No.285 of 2017 decided on 21.12.2017

[9]  Panasonic India Private Limited and Panasonic Life Solutions India Private Limited, CP (CAA) No.8/Chd/Hry/2021

[10] Ayodhya Rami Reddi Alla v PCIT [TS-398-HC-2024(TEL)]

[11] It was not clear as to which entity was the recipient of ICD i.e, whether REFL (As per Para 20) or Ramkay Infrastructure Limited (Para 24)

[12] (i) The Assessee acquired shares from OACSPL. (ii) OACSPL funded ADR, which was used by ADR to acquire the shares of REFL from the Assessee.

[13] FAQ No 1 of Circular 7 of 2017

[14] Anvida Bandi vs. DCIT [TS-1110-HC-2025(TEL)]

[15] Many facts are not available in the rulings

[16] Example 9 of the Final Report

[17] It implies cases where the law is followed in letter or form but not in spirit or substance, or where the arrangement results in consequences which are not intended by the legislation, revealing an intent to misuse or abuse the law (Page 26 of Shome Committee Report)

[18]  CIT v. Walfort Share & Stock Brokers (P.) Ltd (2010) 326 ITR 1 (SC) – The Apex was dealing in a batch of cases where the dividends stripping was done before the introduction of Section 94(7) of the Act.

[19] The Court has not mentioned which provisions of the Act was misused or abused

[20] Page 7 of the Final Report

[21] Page 45 of the Final Report

[22] [1984] 2 SCC 183

[23] In both rulings, there is no discussion on which part of the step or which part led to such presumption from the department.

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