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  • Ena Kapur

The Codification of GAAR: A Step Backwards?

Tax evasion and tax planning are at the two extreme ends for reducing tax liability, whereas tax avoidance is the middle-ground. The only acceptable legal method is tax planning wherein tax payers skilfully use the law in their favour while sticking to the legal framework for availing benefits. The use of exemptions and deductions as provided underSection 80C of the Income Tax Act, 1961 (“IT ACT”) is an example of tax planning. Tax evasion, in its literal sense, means escaping taxes and is illegal as per the law. The third method is tax avoidance, considered more harmful and complicated than the other two methods. It is often described as the art of dodging taxes, under the refuge of loopholes in the law.

The Need for Codification

In 1936, the UK Court in IRC v. Duke of Westminister[i] laid down the cardinal principle that “every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.” Post World-War II, in 1968, in Commissioner of Income-Tax v. A Raman & Co., the Court similarly held that the avoidance of tax liability by efficiently arranging commercial affairs, such that the charge of tax is distributed, is not prohibited under the law. However, with huge amounts of profiteering and racketing that took place, the judicial attitude slowly began to shift in India. The Supreme Court in Mcdowell & Co. Ltd. v. Commercial Tax Officer[ii] stated that tax avoidance is not permitted under the law and held “Colourable devices cannot be a part of tax planning and it is wrong to encourage avoidance of tax payments by resorting to dubious means, as it is the duty of every citizen to pay taxes.” Thus, the courts became concerned not only with the genuineness of a transaction, but also with its effect with respect to fiscal purposes. Merely being legal was considered insufficient to permit tax avoidance.

The differences in the schools of thought existed because every judge was applying their own interpretation to the law. There was another diversion in the law as both, Union of India v.Azadi Bachao Andolan in 2003, and Vodafone International Holdings v. Union of India in 2013, diverted from the Mcdowell judgment and permitted tax avoidance in India. As is evident, the lack of uniformity in the judiciary’s understanding of tax avoidance became a cause of concern due to the absence of a legislation on the contentious matter. The rationale provided in the Azadi Bachao and Vodafone Case for not following the Mcdowell judgment was that as judges, they could not make the law since it was the role of the legislature which has the power of formulating new laws. However, on various occasions, judges have taken a proactive approach in the past and stepped in when there has been a legal vacuum. The Mcdowell case is an example of judicial General Anti-Avoidance Rules (“GAAR”) or judge-made Anti-Avoidance Law. As the judges became more proactive, a major issue that arose was the excessive discretion being given to judges that had the potential to lead to arbitrary and biased decisions. It was in such a situation that the codification of GAAR became the need of the hour, which was subsequently launched on April 1st, 2017 after much hue and cry.

The Creation of GAAR

GAAR was inserted in Chapter 10A of the IT Act and comprises Sections 95 to 102. The law deals with impermissible avoidance arrangements where the main purpose is to solely obtain tax benefits. It was structured in a manner that clearly marked the thin line of difference between acceptable tax planning/mitigation and illegal tax avoidance. The Courts were to give effect to the provisions if an arrangement lacked commercial substance, created non-ordinary rights and obligations, or was for a mala fide purpose, amongst others. At the outset, the classification of GAAR was perceived to be a welcoming step for addressing the pre-existing problems regarding the permissibility of tax avoidance and for ensuring that the judiciary does not encroach upon the duties of the legislature. However, the purpose behind the rules was disrupted as the loopholes in the legislation allowed for vagueness and inconsistency in its application, thus, defeating the purpose of its codification.

The Anomalies in the Law

The biggest obstacle remains is Section 96 that lays down the criteria for impermissible avoidance agreements. Since the Section is worded widely, it broadens the scope of the definition, which can have far-reaching consequences.Sub-Section 1(a) of Section 96 does not clearly state which rights and obligations are created ordinarily and which are not. It is possible that the creation of non-ordinary rights may be for bona-fide reasons and would not necessarily abuse the law but due to this provision, even such lawful rights would attract GAAR. Subsection 1(b) is undoubtedly the most treacherous part of the Section. The phrase, “indirect and direct abuse” in the provision has an extremely open-ended meaning as anything can be easily argued to indirectly abuse or misuse the law, resulting in genuine transactions incorrectly being considered within the ambit of the Section and being subjected to GAAR. Subsection 1(d) requires a distinction to be made between mala-fide and bona-fide purposes in commercial transactions which are difficult to implement as no grounds for ascertaining this have been established. Further, Subsection 2 is unusually framed as there is a rebuttable presumption against the assessee. As a general rule, the presumption is always in favour of the party against whom the case is filed. This is problematic as the Section is framed broadly, which makes it difficult for the assessee to adduce evidence to the contrary.

Additionally, Section 97 deals with what constitutes a lack of commercial substance. Although, this Section is written substantially to correctly identify the commercial substance, but it still remains a subjective matter that requires an objective test. For instance, a merger formed for smooth and better functioning of companies may constitute a commercial substance for some and may not for others. This gives an increased discretion to the authority in-charge of deciding these matters. Moreover, Section 101 that proposed for the guidelines to be framed was meant to be a saving grace for the proper implementation of the GAAR. However, it has failed to provide any relief since the inception of the Chapter in 2018. Four years down the line, no guidelines have been issued. The provisions in the Chapter are faulty and have left gaps in the law that have allowed for unbridled uncertainty. Further, due to stakeholder’s complaints about the change being burdensome, GAAR reporting has been deferred thrice from 2018; once till 2019 then 2020 and due to the pandemic, till 2021.

The Shome Committee Report on GAAR (“Shome Committee”) as well as CBDT Circular no. 7 of 2017 FAQ 10(“FAQ 10”) both have eloquently laid down the procedure for recognizing the cases that can attract the application of GAAR law. Shome Committee laid down a three-step process to engage with abusive, artificial and contrived arrangements. Whereas, FAQ 10 states that the cases need to be first approved by a Principal Commissioner and subsequently, by an Approving Panel. However, both of these are only external aids of interpretation and do not find mention in the legislation, leaving it open to judges’ discretion.


GAAR has already been incorporated by most countries in their legal systems. In India, the codification of GAAR was certainly a change for the better. It focuses on the substance approach over the form approach that tests the genuineness of transactions, unlike both Azadi Bachao Andolan and Vodafone Holdings that stuck to form over substance. These judgments only allowed tax avoidance because of the judges’ decision to not take up the role of the legislature for framing the law. Had the law been codified earlier, the judiciary might have taken a different stand. Thus, the codification of GAAR was viewed as a great starting point to ensure tax avoidance. Nonetheless, the lacunae in the law led to its failure in removing the discrepancies. The obscurity in the provisions has also increased the scope for tax litigation, giving unrestrained discretion to the judiciary to interpret the provisions as they deem fit. GAAR has been stretched beyond the contours of the initial spirit of the law. Although, there have been no reported instances under GAAR till date, but the need of the hour now is to amend the law to narrow down its scope, explicitly lay down certain parameters to be followed and raise the threshold under Section 96 to attract only the rarest of the rare cases.


[i] Inland Revenue Commissioners v. Duke of Westminster (1936) A.C. 1; 19 TC 490.

[ii] McDowell & Co. Ltd. v. CTO (1985) 3 SCC 23.

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