Chapters PDF

Facets of Tax Avoidance: A Comprehensive Study
CHAPTER-I
INTRODUCTION
Tax is a compulsory levy imposed by an organ of government for public
purposes. It has three basic features:
Compulsion: The legal essence of definition lies in compulsion.
Authority
Purpose: Political essence.
The origin of taxation begins from the very beginning of the concept called State
Financial Management. But from the ancient time to the modern age, the concept
has witnessed multi-pronged transformation. In its origin, taxation was a means
to sustain the survival of the state. In the current financial management, it is a
means to vitalize economic development.
Yatha phalen yujeta raja kartta ca karmanam
Tatha Veksya nrpo raster kalpayetsatatm karan
These verses of Manusmriti throw adequate light on the canon of justice in
taxation, particularly in the Indian perspective. The essence of the above verses
clarify that just as fruits are gathered from a garden as and when they ripe, so
revenue should be collected as and when it ripes. To be more clear the element
of time was given a significant place, particularly in the management of state
finances.1
The primary purpose of taxation is to raise revenue for government
expenditure. Government can raise revenue by borrowing, by printing money,
and by selling things, but in practice it is unavoidable that taxation should raise
most of the governments fiscal requirements. The government spends part of
the money on services which private enterprises cannot provide, such as
defence, law and order, social security, education.
1
S. M. Jha, Taxation and The Indian Economy, (New Delhi: Deep and Deep Publications), 1990,
p. 27
With regard to these primary functions of government the economists put

forth as follows: if that were all that was required of taxation, a benevolent
government would abolish taxation and finance all its expenditure by printing
money and borrowing it. Since this is likely to be inflationary, the basic function
of taxation is to reduce private expenditure in order to allow governments to
spend without causing inflation. Thus taxation is basically a deflationary device.
There are of course subsidiary objectives: to redistribute income and wealth, to
influence the balance of payment, to encourage Exports and discourage imports,
to promote long-term economic growth etc.2
Another purpose of taxation is redistribution of wealth and income. Income
tax should be progressive and tax revenue should be spent on welfare
measures. Taxes control the economy. Changes in taxation can and do affect
the economy, but control is also exercised by adjusting money supply and credit.
Taxes may also be used as a kind of social control. Many of the products such as
tobacco and alcohol are taxed more. They are considered as social evil and by
fixing high taxes to these goods state discourages its people from consuming it.
There are some fundamental features that a tax legislation should have.
Adam Smith in the Wealth of Nations, set out four canons that lead to better
taxes. The four axioms are:
People should contribute taxes in proportion to their incomes and wealth.
Taxes should be certain and not arbitrary
Taxes should be levied in the most convenient way
The costs of imposing and collecting taxes should be kept minimal.3
In taxing system there are two principle involved: Horizontal equity and Vertical
equity.
Hepkar Michad, Modern Apprach to tax law, 1973, p.7

th
Geoffrey Morse and David Williams, Davies: Principles of Tax law, 6 edn., (London: Sweet and
Maxwell), 2008, p. 6.
Horizontal equity: it is the idea that people in equal circumstances should pay an
equal amount of tax. Vertical equity: it means that people in different
circumstances should pay an appropriately different amount of tax.
Horizontal equity is disturbed because of tax evasion and tax avoidance
strategies.
Tax avoidance and tax evasion are neither new nor peculiar to India. In
fact, they are universal and are as old as taxes themselves, although the
magnitude of the problem differs from country to country. In the early days of the
operation of income tax in India, the rates of taxes were comparatively low and
the temptation to conceal income was, therefore, limited. However, later period
the clever and wealthy taxpayer started adopting ingenious methods of
understanding their incomes.
Every person has a right to enjoy the fruit of ones labour by using all legal
means. There are three methods available in the taxation laws to avoid the tax
on income. They are: tax planning, tax avoidance and tax evasion. But nowhere
in the laws, these concepts, have been defined. This is due to the fact that it
provides the taxpayers wider privilege to enjoy their income. In short, it is
beneficial to the taxpayers
This Dissertation contains nine chapters and six research questions
which are answered in these chapters. The first chapter introduces the topic
Facets of Tax Avoidance: A Comprehensive Study. In second chapter, the
concept of tax avoidance, tax evasion and tax planning is dealt and tax
avoidance is distinguished from tax evasion and tax mitigation. In the next
chapter the causes and consequences of tax avoidance are examined and
through this enquiry a justification is brought out for judicial interference on an
arrangement which do not cross the legal boundaries. Different techniques, from
traditional to sophisticated methods, to avoid tax are described in chapter four.
The fifth chapter is the core chapter which deals with measures to combat tax
avoidance arrangements. Legislative and judicial measures are analyzed in this
3
chapter with the help of UK and US cases. Next three chapters deal with three
different issues relating to tax avoidance. Sixth chapter deals with General AntiAvoidance Rules, whether essential in India and whether it is against the values
of rule of law, if so, what is the possible justification. In the following chapter Role
of Double Taxation Avoidance Agreement coupled with Tax havens in tax
avoidance is examined and impact of these agreement on developing Nations
are also looked into. In the eight chapter an attempt is made to bring a link
between Corporate Social Responsibility and tax avoidance so that corporations
can adopt anti-avoidance measures in their culture and voluntarily come up to
pay taxes. Lastly the researcher concludes the study with the comparing initial
hypothesis with ideas emerged after the entire study.
CHAPTER-II
TAX PLANNING, TAX AVOIDANCE AND TAX EVASION
To understand the concept of tax avoidance, the terms tax planning, tax
evasion and tax avoidance should be differentiated. Tax evasion is illegal where
as tax planning and tax avoidance are legal. There are many decisions especially
in U.K. and USA which have rendered some idea in differentiating these
concepts. In this chapter the issue of how to determine the boundary between
acceptable tax avoidance and unacceptable tax avoidance is dealt.
1. CONCEPTUAL ANALYSIS
1.1. Tax Planning
Tax planning is considered to be a refined form of tax avoidance and
implies arrangement of a persons financial affairs in such a way that it reduces
the tax burden without violating any of the provisions of law. Full advantage is
taken of all the tax exemptions, deductions, concessions, rebates, allowances
and other benefits permitted under the tax laws so that the incidence of tax is
reduced to the minimum. Tax planning is done by staying within the ambit of law,
without any prevarication, dodging or misrepresentation of accounts.4
1.2. Tax Avoidance
Tax avoidance is arranging ones transaction being under legal
boundaries. Blacks Law Dictionary defines tax avoidance as the minimization of
ones tax liability by taking advantage of legally available tax planning
opportunities. One of the clearest definitions of tax avoidance was provided by
Lord Templeman in the Challenge Corporation5 case, where he noted that:
Income tax is avoided and a tax advantage is derived from an
arrangement when the taxpayer reduces his liability to tax without
4
5
Anushree Agrawal, Tax Avoidance- A Social Evil or Individuals Need, 200 T AXMAN 109, 2011
CIR (NZ) v. Challenge Corporation Ltd. (1987) AC 155.
involving him in the loss or expenditure which entitles him to that

reduction. The taxpayer engages in tax avoidance does not reduce
his income or suffer a loss or incur expenditure but nevertheless
obtains a reduction in his liability to tax as if he had.
Getting to the essence of tax avoidance perhaps requires an
understanding of its goals - what tax avoidance sets out to achieve. Clearly the
end game is a reduction of tax liability, but that can take a number of forms. It is
possible to identify four possible goals that underpin tax avoidance activity:
deferral; re-characterization; elimination; and/or shifting.
There are two kinds of tax avoidance: Endogenous and Exogenous tax
avoidance
Exogenous tax avoidance refers to avoidance of tax by resorting to
transactions or structures for their own sake, that is, to transactions and
structures that are independent of other economic activity of the taxpayer.
Exogenous avoidance typically involves taxpayers participating in tax shelters
that generate losses to set off against ordinary income or that otherwise produce
fiscal effects that reduce tax payable on such income. A notorious example is
Cridland v. Federal Commissioner of Taxation 6 , which involved a scheme
designed to take advantage of a rule that allowed primary producers to average
their incomes over a number of years and to pay tax on that average. The rule
was intended to make the tax system fairer for farmers, whose income often
varies from one year to the next. Pursuant to the scheme, Cridland, a university
student, bought a share in a unit trust. The trust was a primary producer.
Cridlands interest as a beneficiary of the trust amounted to only one dollar a
year. The years in which he was a beneficiary straddled his time as a student
and his time as a salaried graduate, when his income was much higher. He
claimed to average his income as a primary producer. The High Court of
Australia upheld the claim.
Cridland v. Federal Commissioner of Taxation [1977] HCA 61
Endogenous tax avoidance refers to avoidance, that is effected by

adjusting transactions and structures that the taxpayer was proposing to enter, or
has already entered, in any event. In some circumstances, endogenous
avoidance might be, or might appear to be, a by-product of ordinary transactions
that are otherwise unexceptionable. Endogenous avoidance ordinarily involves
avoidance in the context of some other transaction or structure, most commonly
a business or estate planning structure. An example of the latter has been
mentioned: income splitting that comes about as a result of transferring incomeproducing assets to the ownership of others. Examples of business structures
adjusted to obtain fiscal benefits abound. Treaty shopping to reduce tax on
cross-border income lows in the context of international financing is one. That is,
endogenous avoidance entails transactions that endeavour to stay on the
right side of tests like economic substance, business purpose, substance
over form, sham, commerciality, and so on.7
Taxonomy of tax-avoidance behavior that consists of five general types:
1. Changes in real behavior;
2. Transactional substitution;
3. Creation of tax attributes;
4. Transfer of tax attributes; and
5. Tax evasion.8
In its broadest sense, the term tax avoidance refers to any change in
behavior that occurs as a response to the change in price of particular activities,
assets, or transactions occasioned by the imposition of taxation.
1.3. Tax Evasion
The Shorter Oxford English dictionary defines evasion as an "act of
evading or escaping as by artifice or contrivance, dodging, prevarication,
7
Zoe M. Prebble, John Prebble, The Morality of Tax Avoidance, available at:
th
http://ssrn.com/abstract=1650363 last visited on 10 April, 2014.
8
Tim Edgar, Building A Better GAAR, Vol. 27, VIRGINIA TAX REVIEW, available at
http://heionline.org, last visited on 18/05/2014 p. 841
shuffling excuse or subterfuge." Tax evasion means not paying taxes as per the
provisions of the law or saving of tax by illegitimate means. Tax evasion could be
done by concealment of income or inflation of expenses or falsification of
accounts or by conscious violation of rules, etc.
2. DIFFERENCE BETWEEN:
2.1. Tax evasion and tax avoidance
According to a briefing by Richard Murphy of Tax Research UK, where he
tackles the Language of defining these terms, the following definitions have been
outlined:
Tax Evasion: tax Evasion is the illegal non-payment or underpayment of taxes, usually resulting from the making of false
declaration or no declaration at all of taxes due to the relevant tax
authorities, resulting in legal penalties (which may be civil or
criminal) if the perpetrator of tax evasion is caught.
Tax Avoidance: Tax avoidance is seeking to minimize a tax bill
without deliberate deception (which would be tax evasion) but
contrary to the spirit of the law. It therefore involves the exploitation
of loopholes and gaps in tax and other legislation in ways not
anticipated by the law9
The classic distinction between avoidance and evasion is due to Oliver
Wendell Holmes, who wrote
we do not speak of evasion, because, when the law draws a line, a
case is on one side of it or the other, and if on the safe side is none
the worse legally that a party has availed himself to the full of what
9
Richard Murphy, Tax Research UK, Tax Briefing: Tax Avoidance, evasion, compliance and
planning, accessed at: http://www.taxresearch.org.uk/Documents/TaxLanguage.pdf, last visited
on 03/05/2014.
the law permits. When an act is condemned as evasion, what is

meant is that it is on the wrong side of the line.10
Tax avoidance implies a situation in which the taxpayer reduces his tax
liability by taking advantage of the loop-holes and ambiguities in the legal
provisions, in the case of tax evasion, facts are deliberately misinterpreted and
the tax liability is understated. Tax evasion is illegal and, therefore, carries with it
the risk of penalties and prosecution under the tax laws.
The legal right of a taxpayer to decrease the amount of what otherwise
would be the amount of his taxes, or altogether avoid them, by means which the
law permits, cannot be doubted.11 Any one may so 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 ones
taxes.12 It means that tax avoidance through tax planning is legal and hence
should not be bad in law.
In Duke of Westminster v. Commissioners,13 Lord Atkin said:
It was not, I think, denied-at any rate it is incontrovertible- that the
deeds were brought into existence as a device by which the
respondent might avoid some of the burden of surtax. I do not use
the word device in any sinister sense, for it has to be recognized
that the subject, whether poor and humble or wealthy and noble, has
the legal right so to dispose of his capital and income as to attract
upon himself the least amount of tax.
It is not easy to see the distinction between evasion and
avoidance- if needed, evasion involves some crime where
avoidance involves no crime. Two factors blur this distinction in
practice. First, some quite honourable people think that a tax crime
10
Bullen v. Wisconsin (1916), 240. U.S. 625, p. 630

Gregory v. Helvering, 293 U. S. 465, 469 (1935)
12
Gregory v. Helvering, 293 U. S. 465, 469 (1935)
13
Duke of Westminster v. Commissioners (1936) A.C.
11
is not really a crime at all. What is really wrong with omitting to

mention in a tax return some jobbing gardening or book reviewing
done at weekends? We tend to think that what we do ourselves is
not really criminal at all. What others do is always bigger and
badder. The second factor is that crime versus no crime is not the
last word on the subject. Elaborate schemes of tax avoidance that
have no other purpose may not be criminal, but they are distasteful
to many taxpayers and to some judges.14
Tax evasion and tax avoidance involve similar taxpayer behavior and are
each undertaken in pursuit of the same broad aim: to minimize or to eliminate tax
liability. They are factually similar, but legally distinct. Tax evasion is illegal. It
consists in the willful violation or circumvention of applicable tax laws in order to
minimize tax liability.
Tax evasion generally involves either deliberate under-reporting or non
reporting of receipts, or false claims to deductions. This conduct is legally
straightforward to identify; a taxpayer has committed tax evasion only if he or she
has breached a relevant law. Indeed, evasion ordinarily involves criminal fraud.
Tax avoidance is a problem for every country. Avoidance is not evasion.
Evasion means dishonestly reporting ones income. For example, a cash
business may understate its takings or fail to file any tax return at all. Avoidance
is also not mitigation. Mitigation is not a term of art, but in this article and
generally in the present context, it means reducing ones tax in ways that a
governing statute clearly encourages or permits; for example, taking a deduction
for a gift to charity.
Avoidance exists somewhere between evasion and mitigation. Avoidance
means, approximately, contriving transactions typically but not necessarily
14
th
Geoffrey Morse and David Williams, Davies: Principles of Tax law, 6 edn., (London: Sweet
and Maxwell), 2008, p. 8.
10
artificial in nature, to reduce tax that would otherwise be payable according to

what appears to be the policy of the taxing provision in question.
As a general rule, the law does not require people to arrange their affairs
so that they incur the greatest possible tax liability. When faced with two possible
legal ways in which to organize their money, taxpayers are legitimately entitled to
choose the option that requires them to pay the lesser amount of tax. There
comes a point, however, when governments begin to think that taxpayers are
going too far in their attempts to decrease their tax liability. At this point,
taxpayers cease to engage in legitimate tax mitigation and embark on
unacceptable tax avoidance.
To help to recognize
Revenue Commissioners
Kingdom
avoidance, an example may be referred, Inland

Bowater
Property
Developments 15 , a
United
case that the House of Lords decided in 1988.That case involved
development land tax, a kind of capital gains tax that applied to land sales
if
the development
value
component
of
the
sale
was
greater
than
50,000.In a transaction potentially caught by the tax, Bowater proposed to

sell land for more than 250,000 to a company called Milton Pipes Limited.
Instead of selling the land as one parcel, Bowater segmented the land into five
undivided shares. It sold one share to each of five sibling companies in the
Bowater group for 36,000 per share. Land in each of the undivided shares
looked just like land; there was no sub-divisional survey or separate titles.
The five Bowater companies owned the land under one title, just as a married
couple owns their home in one title. The Bowater companies resembled a
modern marriage between five spouses. These five sales had no effect on the
beneficial ownership of the land. Both before and after the sales, the ultimate
owners were the shareholders in the Bowater group.
15
Inland Revenue Commissioners v Bowater Property Developments [1985] STC 783
11
The five companies then sold their undivided shares to Milton Pipes for
52,000 each.16.
See Challenge Corp 16 . The court held that Challenge
Corporation took advantage of rules that allowed it to consolidate the affairs of its
members and to pay tax only on the resulting net profit. That is, each company
bought for 36,000 and sold for 52,000, earning a profit of 16,000, well
under the capital gains tax threshold of 50,000.
Legally, there were five separate sales from Bowater to the sibling
companies and five more sales to Milton Pipes. Economically, there was just one
sale from Bowater to Milton Pipes. Ignoring this economic reality, however, the
House of Lords treated the transactions as genuine. Bowater accordingly
escaped development land tax.
2.2.
Acceptable tax avoidance and unacceptable tax avoidance

Acceptable tax avoidance can also be termed as tax mitigation. "Tax
mitigation" refers to cases where the reduction of tax is the result of the taxpayer
adopting a course of action that is clearly (and, ordinarily, expressly) encouraged
by the relevant legislation. "Tax mitigation" is a label for a conclusion: that a
scheme under examination that reduces tax is valid under relevant legislation
(including relevant specific anti-avoidance rules), and not vulnerable to a GAAR,
either statutory or judge-made. That is, "mitigation" does not inform us about the
rules or processes of reasoning that led us to this conclusion. Nevertheless, it is
a useful term, serving as a label for a concept that must be distinguished from
avoidance. It does not tell us where the line between avoidance and acceptable
reduction of tax is drawn, but it gives a name to the territory on the acceptable
side of that line.17
The definition given in Lord Nolans judgment in the Willoughby case,
draw the line between tax avoidance (unacceptable tax avoidance) and tax
mitigation (acceptable tax avoidance). Lord Nolan stated: The hall mark of tax
16
CIR (NZ) v. Challenge Corporation Ltd, [1986] 2 NZLR at 559

Zoe M. Prebble, John Prebble, The Morality of Tax Avoidance, available at:
th
http://ssrn.com/abstract=1650363 last visited on 10 April, 2014, p. 706
17
12
avoidance is that the taxpayer reduces his liability to tax without incurring the
economic consequences that Parliament intended to be suffered by any taxpayer
qualifying for such reduction in his tax liability. The hall mark of mitigation, on the
other hand, is that the taxpayer takes advantage of a fiscally attractive option
afforded to him by the legislation, and genuinely suffers the economic
consequences that Parliament intended to be suffered by those taking advantage
of the option.
The line between evasion and avoidance may not be straightforward but it
is considerably more so than that between different types of avoidance. The
attempt to divide acceptable avoidance, tax planning or mitigation on the one
hand, and unacceptable avoidance on the other, in any general sense has been
argued already here to be unhelpful. The judicial law has not developed in such a
way as to indicate clearly to taxpayers what will or will not be acceptable. The
problem should not be exaggeratedit arises only at the boundaries. But at
those boundaries, activities which utilize the strict wording of the legislation to
achieve a tax saving may or may not succeed. At one point the case law might
have been thought to invoke a general principle which overrode the detailed
rules: the so-called Ramsay 18 principle which looked at whether a transaction
forming part of a pre-ordained, circular or self-cancelling transaction was
undertaken for no commercial purpose other than obtaining the tax advantage in
question. If so, the scheme could be looked at as a whole and the legislation
might then not apply to achieve the effect the taxpayer was hoping for. The
Ramsay 19 principle subsisted alongside, and did not overrule, the Duke of
Westminster20 principle that every taxpayer is entitled to arrange his affairs so
that the tax attaching to them is less than it otherwise would be. Principles have
the potential to conflict and need to be weighed against each other.
18
W. T. Ramsay Ltd. v. Inland Revenue Commissioners, [1982] AC 300

W. T. Ramsay Ltd. v. Inland Revenue Commissioners, [1982] AC 300
20
Duke of Westminster v. Commissioners (1936) A.C.
19
13
Lord Goff in Ensign Tankers 21 case, said, unacceptable tax avoidance

typically involves the creation of complex structures by which the taxpayer
conjures out of the air a loss, or a gain or expenditure, or whatever it may be,
which otherwise would have existed The line between unacceptable tax
avoidance and acceptable tax mitigation or tax planning is by no means as
simple to draw as that quotation might suggest. All taxing jurisdiction have
significant bodies of legislative, as well significant bodies of litigations that can
attest to the difficulty of knowing where and how to draw that line. And it is a line,
or distinction, that is by no means constant- the boundaries will inevitably change
in the light of ever-changing social, legal and economic circumstances. Not only
is the border line between tax avoidance and tax mitigation ever-changing, but so
are the participants who contest that border. There is an obvious and on-going
tension between the taxpayer and the national revenue Authorities, and those
are ever the principal combatants.
Unacceptable Tax Avoidance typically includes any or all of the following
features:
The lack of economic substance (usually resulting from pre-arranged

circular or self-cancelling arrangements), with the result that an apparently
significant investment proves ultimately to be illusory, and, through various
devices, the taxpayer remains insulated from virtually all economic risk,
while creating a carefully crafted impression to the contrary;
The use of tax-indifferent accommodating parties or special purpose

entities, often referred to in the jargon as washing machines;
Unnecessary steps and complexity, often inserted to pop up a claim of

business purpose, or to disguise the true nature of a scheme or as a
device to cloak the tax shelter transaction from detection;
21
Inconsistent treatment for tax and financial accounting purposes;
High transaction costs;
Fee variation clauses or contingent fee provisions;
Ensign Tankers (Leasing) Ltd. v. Stokes (1992) STC 226
14
The use of new, complex financial instruments such as derivatives,

hybrids and synthetic instruments which have made it possible for
promoter to mimic almost perfectly the risks and returns attributable to
more traditional financial instruments such as equity shares or plain
vanilla debt without incurring, at least in theory, the tax consequences
typically associated with them; and
The use of tax havens, particularly in the context of captive insurance

companies, captive finance subsidiaries and intangible property holding
companies.22
Examination of transaction should enquire for these features to decide whether

avoidance is permissible avoidance or is done through aggressive tax planning
and is unacceptable. Every case has to be determined separately to bring out
above features of unacceptable tax avoidance. Its not possible to have
exhaustive list saying transactions as unacceptable tax avoidance.
Tax avoidance, tax evasion and tax planning are three different terms
which are used synonymously by lay man but in legal parlance it has distinct
meaning which have been brought out in this chapter. It is not difficult to
differentiate between these three terms. Tax avoidance can be segregated into
acceptable tax avoidance and unacceptable tax avoidance. Tax avoidance is
within legal boundaries unlike tax evasion, judicial doctrines are now targeting at
unacceptable tax arrangement done with sole intent to avoid tax. Differentiating
between these is very tedious work and there are chances of misapplication of
doctrines. Since intent cannot be manifestly seen it is not always possible to
identify transaction with sole intent to avoid tax. Drawing the line between
acceptable and unacceptable tax avoidance is at most important as it forms the
basis for application of legal rules.
22
Chris Evans, Barriers to Avoidance: Recent Legislative and Judicial Developments in Common
Law jurisdictions, 37 HONG KONG L.J. 103, 2007, p.116
15
CHAPTER-III
TAX AVOIDANCE: CAUSES AND CONSEQUENCES
Every patriotic citizen has a desire to strengthen one's society. It is their
public duty to make tax payment and they also try to fulfill their desires by making
tax payments to the government because taxes are the major sources of income
for government and government use this money to provide services to general
public such as defense, public utilities, transportation, education, roads etc.
There must be some reasons for non-payment of tax. This chapter deals with the
cause for avoiding tax by assessee and its consequences. By examining the
causes and consequences we can justify as to why there is an attempt to draw
boundary line between accepted tax avoidance and unaccepted tax avoidance.
1. CAUSES
Since tax, by definition, is a payment without direct quid pro quo, it
involves some type of compulsion because the taxpayer derive no direct benefit
in paying taxes except the negative advantage that they would not be punished
for violating the taxation laws of the states. Since taxpayers are required to make
tax payments fixed by the government regardless of their individual disposition in
the matter, every taxpayer wants to pay the minimum of taxes.23
The Second World War created condition that gave tremendous impetus
to tax avoidance and evasion. The war proved to be a golden era for tax dodgers
and poured fortunes into the laps of skilful tax evaders. Tax avoiders look for
loopholes in law. These loopholes or tax gaps also forms the major causes which
provokes the taxpayers to avoid tax taking shelter under those loopholes. An
example of loophole in tax law can be seen here. In Hindu undivided families
there is option of partial partition. Since an HUF can be divided and subdivided
into smaller units of HUF- each such unit comprising a separate taxable entity in
23
Anil Kumar Jain, Tax Avoidance and Tax Evasion: The Indian Case, Vol.21, No. 2, Modern
Asian Studies (1987), pp. 233-255, available at http://www.jstor.org/stable/312646, last visited on
14/3/2014.
16
addition to the main HUF the incidence of the higher rates proposed can in fact
be avoided quite easily, particularly if the main HUF has not been divided earlier
into the maximum permissible number of HUFs. This provides an opportunity to
avoid taxes by entering partial partition.
Globalization, increasing deregulation and changes in market forces are
principal causes. There are various reasons for tax avoidance. These underlying
reasons should be understood so that solution can be found out.
These reasons can be filed in two categories. The first category
comprises factors that negatively affect taxpayers compliance with tax
legislation. These factors can be subsumed either contributing to a low
willingness to pay taxes (low tax morale) or to high costs to comply with tax laws.
The second category contains reasons for the low ability of tax administration
and fiscal courts to enforce tax liabilities. These factors can be summarized as
resulting from insufficiencies in the administration and collection of taxes as well
as weak capacity in auditing and monitoring tax payments which limit the
possibility to detect and prosecute violators.24
a. Low Level of voluntary tax compliance
Low tax morale
The willingness to pay tax differs widely across world. Risk-averse
individuals tend to pay more taxes attempting to avoid the risk of detection and
punishment. The willingness to pay of the taxpayer is influence by following
factors:
Low quality of the service in return for taxes: in general, citizens expect
some kind of service or benefit in return for the taxes paid. If the government fails
to provide basic public goods and services or provides them insufficiently,
24
GIZ Sector Programme Public Finance, Administrative Reform, Addressing tax evasion and tax
avoidance in developing countries, http://www.taxcompact.net/documents/2011-0909_GTZ_Addressing-tax-evasion-and-avoidance.pdf last visited on 03/05/2014.
17
citizens may not be willing to pay taxes and tax avoidance will be the
consequence
Tax system and perception of fairness: high tax rates increases the tax
burden and, hence, lower the disposable income of the taxpayer. However, the
level of the tax rate may not be the only factor influencing peoples decision
about paying taxes. in fact, the structure of the overall tax system has an impact
as well.
Low transparency and accountability of public institutions: lack of
transparency and accountability in the use of public funds contribute to public
distrust both with respect to the tax system as well as the government.
High level of corruption: If due to high levels of corruption, citizens cannot
be certain whether their paid taxes are used to finance public goods and services
their willingness to pay suffers and it becomes more likely that they evade their
tax liabilities. A taxpayer might consider avoiding taxes if the cost of bribing a tax
auditor is lower than the potential benefit from tax evasion.
Lack of rule of law and weak fiscal jurisdiction: Strong fiscal courts are
essential to protect taxpayers rights and safeguard them from arbitrariness. If the
legal system does not operate in accordance with the rule of law, citizens have to
fear arbitrariness, discrimination, unequal attendance in court, etc. The lack of
rule of law reduces transparency of public action and fosters distrust among
citizens. As a result, citizens may not be willing to finance the state through
taxes, and decide to evade these liabilities.
High compliance costs
High compliance costs, that are the costs the taxpayer has to bear to
gather the necessary information, fill out tax forms etc, can be an additional
reason for tax evasion and avoidance
b. Weak enforcement of tax laws
18
There exist several circumstances that restrain tax administrations from

performing their functions properly thereby increasing the possibility of tax
avoidance. these circumstances include:
Insufficiencies in tax collection:
tax administration and tax policy are
intertwined spheres. Tax policy directly affects the costs and the organization of
the tax administration. There are two approaches for the organizational set up of
tax administration. The first option is where the ministry of finance itself assumes
the tax administration function and departments within the ministry of finance
collect taxes. The second option is a semi-autonomous revenue authority where
tax administration is moved out the ministry of finance into a separate entity.25
Weak capacity in detecting and prosecuting inappropriate tax practices: A
well-functioning body of tax investigation is essential for the detection and
prosecution of cases of tax fraud. The lack of sufficient capacities in tax
administrations reduce the probability of detection that again influences the
decision of a taxpayer as to whether evade or not.
2. CONSEQUENCES
In the first place, and perhaps most importantly, it impacts negatively on
the capacity of national tax jurisdictions to collect the revenue needed for the
proper discharge of governmental functions. Revenue collection is the primary
function of any tax system, and systematic and widespread avoidance activity will
clearly have an adverse impact on that function. Revenue lost due to tax
avoidance activities amounts to huge amount in any given tax year. The
reduction in revenues due to tax avoidance could lead to a variety of detrimental
effects. For example, if government budget is constant then this gap must be
plugged by other means, implying higher taxes on those who do not avoid taxes,
25
GIZ Sector Programme Public Finance, Administrative Reform, Addressing tax evasion and tax
avoidance in developing countries, http://www.taxcompact.net/documents/2011-0909_GTZ_Addressing-tax-evasion-and-avoidance.pdf last visited on 03/05/2014.
19
an externalized cost. In contrast, if government budget is shrunk because of tax

avoidance then at least some government programs must be cut back, leading to
a welfare transfer from those who rely on these programs. The tax planning
activities are non-productive in the sense that they do not generate net social
benefits.
But the harmful effects of tax avoidance activity go well beyond their
impact on revenue collections. They also significantly affect the efficiency and
equity of tax systems. These impacts are neatly encapsulated by Joseph
Bankman where he notes that "tax shelters siphon off resources from more
productive ventures, redistribute the tax burden and threaten to undermine
compliance". As the OECD has also noted, any "proliferation of arbitrary and
contrived schemes ... leads to a perception that the system is unfair which can
discourage compliance, even by taxpayers that had not previously engaged in ...
tax avoidance".26
An MNC's use of tax havens can cause harm to third parties. Tax havens
have been charged with "undermining the international financial regulatory
environment and taxation policies" of these countries while "skewing the
allocation of costs and benefits of globalization." In fact, one of the biggest
difficulties in effecting anti avoidance regulations is the fact that MNCs can avoid
such restrictions by simply relocating to countries with more lenient tax
regulations. This choice to relocate in order to avoid regulations is especially
easy for corporations that transact in intangible goods, such as finance or
technology
Economic development is essential factor for every country in the world
and government services and public infrastructure are also required for economic
development. Lacking in public service provisions subverts the efforts to increase
people living standard especially in developing countries and slow down the
economic growth. It has also observed that governments of many developing
26
Law jurisdictions, 37 Hong Kong L.J. 103, 2007, p. 112
20
countries have failed to provide adequate public services due to many reasons.
The most important of them is the lack of tax revenue. Tax revenue in a country
serves as life blood for the government. Hence, law not only targets tax evasion
but also the transactions which are within legal boundaries but done with sole
purpose to avoid tax. After examining the Consequences of tax avoidance, we
may now feel it justified to draw the line between acceptable tax avoidance and
unacceptable tax avoidance.
21
CHAPTER-IV
TAX AVOIDANCE TECHNIQUES
Taxes are compulsory payments to the Government. It depends on the
income of the assessee, more a person earns, the more taxes the he has to pay.
That is, tax is proportional to income. No person pays taxes willingly, but
because of the penalty it is backed by. To avoid tax people try to segregate
income by entering into complex transactions. Involving into different techniques
to avoid tax is been followed since long. The methods vary from time to time and
presently more sophisticated techniques are adopted. This chapter deals with the
traditional methods which were used earlier especially in case of Individual
income and in case of Hindu undivided family to avoid taxes and the modern
methods used by the corporations, Multi National Companies to save huge
money from being paid to tax.
1. Principles of Tax Avoidance
There are three basic principles of tax avoidance within an income tax:
Postponement of taxes: The present discounted value of a postponed tax

is much less than that of a tax currently paid.
Tax arbitrage across individuals facing different tax brackets (or the same
individual facing different marginal tax rates at different times). This is a
particularly effective method of educing tax liabilities within a family; but
differential tax rates may also induce transactions among individuals in
different brackets which substantially reduces the aggregate tax liability;
the availability of such opportunities leads to what may be referred to as
tax induced transactions.
Tax arbitrage across income streams facing different tax treatment. Under
the current law, long term capital gains are taxed at lower rates than are
other forms of income from capita. This provides an inducement to
convert the returns to capital into long-term capital gains. Similarly,
22
special treatment is afforded to the return to capital in the form of housing,

pensions, IRAs etc.27
Many tax avoidance devices involve a combination of these three.
Stiglitz provides four basic methods of Tax Avoidance in his work The
General Theory of Tax Avoidance:
Method 1. Postponement of capital gains: the first method is a

modification of the familiar technique of postponing the realization of capital
gains, which gives rise to the locked-in effect. It is based on two aspects of the
tax code: capital gains are taxed only upon realization, and there is a step up in
basis at death. the usual discussion err, however, in not taking into account the
fact that the riskiness of an individuals portfolio will change if an individual holds
on to an asset longer than he otherwise would simply avoid taxes. To avoid taxes
and any change in the pattern of risk bearing or consumption, the individual sells
short a perfectly correlated security, at precisely the same moment that he would
have, in the absence of taxation, sold the given security. The individuals net
portfolio positions and income flows are then identical to what they would have
otherwise been; but because no capital gain has been realized, no capital gain
tax liability has been incurred. It is thus apparent how an individual can risklessly
avoid paying capital gains taxes.
Method 2. Arbitrage between short-term and long-term capital gains rates:
The previous method of tax avoidance took advantage of the fact that capital
gains are only taxed upon realization; it did not take advantage of the lower rates
which are afforded capital gains. the second method does. But while optimal
portfolio strategies in the previous method exhibited the locked-in effect, with
this method they do not.
Method 3. Indebtedness: The third method takes advantage of the
differential treatment afforded long-term capital gains and interest. From an
27
Joseph E. Stiglitz, The General Theory of Tax Avoidance, Vol. XXXVIII, No. 3, NATIONAL TAX
JOURNAL, pp. 325,326.
23
economic point of view, interest and capital gains are simply two alternative
forms of return on capital; there would be no reason to differentiate among them.
Assume that there were no uncertainties about changes in the price of gold. An
exhaustible natural resource like gold should have its price rise at the rate of
interest. All of the returns, however, are realized in the form of capital gains. if an
individual borrows to purchase gold, then his interest would be deductible against
ordinary income, his capital gains taxed at favorable rates. With a perfect capital
market, there would be no reason that the bank would not lend to the individual:
he could simply put up the gold as collateral, and there would thus be no risk to
either party.
Method 4: Rollovers: this method takes advantage of the arbitrariness of
the unit of time over which taxes are levied. It does not, however, require that
there be differential tax rates on long-term and short-term capital gains.
Lord Walker of Gestingthorpe, in an unpublished papers, identified "seven types
of tax avoidance", proceeding from the simplest case to the increasingly complex
(and to most observers, increasingly objectionable). These were:
1. using a relief;
2. finding a gap;
3. exploiting (or abusing) a relief;
4. anti-avoidance karate (by which he meant the capacity for taxpayers to
turn to their own advantage statutory provisions designed to prevent tax
avoidance);
5. unnatural assets or transactions;
6. pre-ordained transactions; and
7. dodgy offshore schemes.28
28
Law jurisdictions, 37 HONG KONG L.J. 103, 2007, p.113.
24
2. Techniques of tax Avoidance

2.1. Creation of trust and will
Drafting of wills and trust were developed into a practice concerned
primarily with taxes. Even if they are not deliberately designed to nullify the
progressive element in the tax structure, intricacies in settlements leave a trail of
confusion in their wake. A will may create complex settlements. One document
may provide for various strata of interest; and a multiplicity of trusts providing for
diverse interests may compound the difficulty for the revenue authorities. where
the same donor sets up several trusts, the trustees of a particular trust may often
become beneficiaries in other trusts and similarly the beneficiaries of the trust
may become trustees in others. A network of checks and counter balances is a
safeguard against trustees who may be vindictive or indifferent: all the
beneficiaries have a built-in guarantee of even treatment.
An example of trust: A lady set up three trusts in 1957, each for the
exclusive benefit of one of her sons. Since there was only one beneficiary in
each trust, the only reason for resorting to the medium of a trust was apparently
to cause complication, and she did succeed in her design. The fact that each of
the sons had separate properties and that he would be liable to the wealth tax it
the value of the trust property was added to the value of the rest of his properties,
escaped the attention of the revenue authorities. it is significant that revocable
transfers of certain shares had also been made by the same lady to her father-inlaw and mother-in-law, and these were also not declared by her as part of her
wealth.29
This in not just true in case of individuals but even large industrial house
escaped substantial wealth tax by holding unquoted equity shares of some
companies under its control in a number of firms in which private family trusts
were partners through their trustees. The firms and the trusts served as conduits
for storage of valuable shares of the close companies.
29
C & A G, 1973-74, pp.140, 143 and144.
25
In Tulsidas Kilachand and Others v. CIT30, the Court held that love and
affection as the consideration for declaring a trust for the settlers wife might be
good enough to support a contract but not adequate to avoid tax.
In Dharma Vijaya Agency v. CIT Bombay City,31 both the J. K. Trust and
Dharma Vijaya Agency were found to be public charitable trust. As for the
doctrine of lifting the veil in tax matters relating to companies, the following is the
Supreme Courts observation:
it is true that from the juristic point of view the company is a legal personality
entirely distinct from its members and the company is capable of enjoying rights
and being subjected to duties which are not the same as those enjoyed or borne
by its members. But in exceptional cases, the court is entitled to lift the veil of
corporate entity and to pay regard to the economic realities behind the legal
faade
2.2.
Treaty Shopping
Treaty shopping is generally considered to be an improper use of tax
treaties. The main purpose of tax treaty is to mitigate double taxation by reducing
rates of withholding tax imposed on income and capital earned across national
borders. To promote international trade and investment, countries maintain
extensive and complex treaty network. Treaty shopping is defined as the routing
of income arising in one country to a person in another country through an
intermediary country to obtain an unintended tax advantage of tax treaties.32
Treaty shopping connotes a premeditated effort to take advantage of the
international tax treaty network, and careful selection of the most favorable treaty
30
Tulsidas Kilachand and Others v. CIT (1961) 42 ITR 1 SC

Dharma Vijaya Agency v. CIT Bombay City (1960) 38 ITR 392 (Bom.)
32
nd
Roy Rohatgi, Basic International Taxation, 2 edn. Vol. II, (New Delhi: Taxmann Allied
Services (P) Ltd.),2007, p. 165.
31
26
for a specific purpose 33 . Treaty shopping necessarily involves deliberate

measures by individuals and entities to affect their residence for treaty purposes.
Treaty shopping can be described as: the situation where a person who is
not a resident of either country a party to treaty seeks certain benefits under the
income tax treaty between the two countries. Under certain circumstances, the
nonresident is able to secure these benefits by establishing a corporation (or
other entity) in one of the countries which, as a resident of that country, is entitled
to the benefits under the treaty. Additionally, it may be possible for the thirdcountry resident to repatriate funds to the third country from the entity under
favorable conditions (i.e., it may be possible to reduce or eliminate taxes on the
repatriation) either through relaxed tax provisions in the distributing country or by
passing the funds through other treaty countries (essentially, continuing to treat
shop) until the funds can be repatriated under favorable terms. 34 There are
different structures of treaty shopping.
Direct Conduit:
In this the taxpayer interposes an intermediary entity with a
favourable tax treaty usually to reduce the tax rate in the source State. The
structure involves a intermediary step of no commercial significance, coupled
with a series of preordained transaction resulting in a tax advantage.
Stepping stone conduit: This structure uses counterbalancing expense in the
conduit company to reduce its tax base. The income is fully taxable but the tax is
levied on a margin or spread only.
Apart from these two methods there are other conduit is which may be hybrid of
two or some other new technique.
Treaty shopping primarily affects source States and intermediary or
conduit jurisdiction that provide the location as a treaty haven. It enables
33
David G. Duff, Responses to Tax Treaty Shopping: A Comparative Evaluation, available at:
rd
http://ssrn.com/abstract=1688689 last visited on 3 may 2014, p. 3
34
Kenneth A. Grady, Income Tax Treaty Shopping: An Overview of Prevention Techniques,
available at http://scholarlycommons.law.northwestern.edu/njilb last visited on 3rd may 2014, p.
627.
27
nonresident taxpayers to avoid or reduce source country taxes through a thirdcountry treaty.
Example: Indo-Mauritius Treaty.
In India 40% of the total FDI comes through Mauritius, because according to the
Indo Mauritius DTAA, tax levied on capital gain as per the law of the country of
the residence of the assessee. But according to the tax law on Mauritius there is
no tax imposed on capital gains; because of which all the investment in India
from the different country comes through the Mauritius.
India has no anti-abuse rules to preventing tax avoidance through treaty
shopping. In the famous case Union of India v. Azadi Bachao 35 , the Court
observed that: Overall, countries need to take, and do take, holistic view. The
developing countries allow treaty shopping to encourage capital and technology
inflows, which developed countries are keen to provide to them. The loss of tax
revenues could be insignificant compared to the other non-tax benefits to their
economy. Many of them do not appear to be too concerned to the other non-tax
benefits to their economy. Many of them do not appear to be too concerned
unless the revenue losses are significant compared to the other tax and non-tax
benefits from the treaty, or the treaty shopping leads to other tax abuses.
Whether it should continue, and, if so, for how long, is a matter which is best left
to the discretion of the executive as it is depended upon several economic and
political consideration. It was further held that if the aim of the DTAA was not to
include a person of third country and restricts him/her from taking the benefit out
of the favourable terms, then there should be an another provision about it.
Parliament has a duty to take care of it in this regard; and if there is no specific
provision and limitation mentioning DTAA; then no one can be denied benefit of
the favourable tax provision in the belief that treaty shopping is prohibited.
2.3.
35
Tax havens
Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706
28
Governments face enormous difficulty taxing MNCs in a global market

characterized by cross-border activity and involving intangible assets and
transfers accomplished at the push of a button. Several of the methods that
modern MNCs use to avoid taxes have a common denominator - the tax haven.
The use of tax havens is a common way to evade taxes. Tax havens are
naturally a common site for tax avoidance activities, as well. In fact, the vast
majority of international tax avoidance involves tax havens. Though there is no
authoritative definition of what constitutes a "tax haven," they are fairly described
as "financial conduits that, in exchange for a fee, use their one principal asset their sovereignty to serve a nonresident constituency of accountants
and
lawyers, bankers and financiers, who bring a demand for the privileges that
tax havens can supply." Not to be confused with the broader avoidance activity
known as "tax sheltering," tax havens are distinct locales characterized by
extremely low tax rates for nonresidents and banking secrecy laws. Promoters in
tax havens openly advertise tax "minimization," as well as the quick and
anonymous purchase of offshore shell corporations and bank accounts. Although
the term conjures up images of "sun-kissed exotic islands reminiscent of the
Garden of Eden where a few billionaires, mafiosi and corrupt autocrats hide
their ill-gotten gains," not all tax havens are so paradisiacal. Many tax havens
are developing nations, where a lack of centralized taxation prevents the
formation of a beneficial tax infrastructure and paralyzes growth efforts.36
The OECD initially defined tax havens in terms of countries or territories
that have the following features37:
Zero or low taxes
Lack of effective exchange of information or lack of tax information

exchange with other countries (even if there is exchange for fraud
and money laundering)
Lack of transparency
36
Jasmine M. Fisher, Faire Shores: Tax Havens, Tax Avoidance, And Corporate Social
Responsibility, vo. 94, Boston UNIVERSITY LAW REVIEW, 2014, p. 338
37
Sankhanath Bandyopadhyay, Tax Dodging: An Overview, CBGA, 2013, p. 10
29
A high degree of bank secrecy
Lack of real economic activity associated with the income

generated
2.4.
Tax havens are small countries
Population is less than one million
Tax havens are generally more affluent than other countries.
Controlled Foreign Corporations

Foreign-sourced income is taxed after it is accrued as income in the
country of residence of the recipient; thus it becomes possible to defer or avoid

tax on foreign dividend income until it is repatriated. Several countries prevent
their residents from accumulating funds abroad through exchange control
restrictions. As countries increasingly ease their exchange control rules many of
them have enacted Controlled Foreign Corporation rules to ensure there is no
deferral of taxes on the foreign income. Under the CFC rules, the domestic law
effectively extends the residence tax rules to the income. It requires that the tax
due on foreign profits, whether distributed or not, be paid currently at home by
tax residents. These rules are normally applied in cases where the resident
shareholders, individually or collectively, have substantial influence or control
over a foreign corporation.38
2.5.
Thin Capitalization
According to the 1987 OECD Report, the term thin capitalization is
commonly use to describe, hidden equity capitalization through excessive

loans.39 The tax advantage of loan capital usually encourages the taxpayer to
use more debt than equity in cross-border investments. However, the use of debt
for a tax motive may be regarded as a form of tax avoidance by many source
38
T.P. Ostwal, Vikram Vijaraghavan, Anti-Avoidance Measures, available at:

th
http://manupatra.com last visited on 4 April, 2014, p. 86
39
nd
Roy Rohatgi, Basic International Taxation, 2 edn. Vol. II, (New Delhi: Taxmann Allied
Services (P) Ltd.),2007, p. 215.
30
jurisdictions. Generally, interest expense is tax-deductible, and is subject to lower

withholding tax rates.
Thin Capitalization is the artificial use of interest-bearing debt instead of
equity by shareholders with the sole or primary motive to benefit from its tax
advantages. The loan may be provided on a market rate of interest but the size
of the loan cannot be justified on bona fide business considerations. Such
excessive interest payments constitute hidden distributions that should properly
be treated as dividends on equity capital.40
2.6.
Transfer Pricing
Transfer pricing refers to manipulation of price in intra-firm exchange. The basic

objective in this method is to maximize the companys overall after-tax profit
rather than profit of individual subsidiaries.41 The manipulation of prices between
the companies concerned shifts the profit from one region to the other region.
The motivation behind the manipulation of prices is not only the shifting of profit
but also to avoid payment of duties, protection against exchange fluctuation and
capitalization.42
Transfer price is the price at which goods and services between related
companies are transacted. The main branch of a company is called the parent
company and a number of associated units spread in different countries are
called subsidiaries. Companies often manipulate the transfer price to escape
taxes.
The concept and practice of transfer price is not illegal. The idea
underlying transfer pricing is optimal allocation of a firms resources by
minimizing costs. The practice can be accepted if transactions between the
40
Ibid
st
Prof, K.C. Gopalkrishnan, Textbook on International Taxation, 1 edn., (Mumbai: Snow White
Publications Pvt. Ltd), 2002 p. 115
42
K. R. Sekar, Transfer Pricing Law and Practice, (Mumbai: Snow White Publications Pvt. Ltd.),
2001p.3
41
31
parent company and its subsidiaries or between subsidiary firms can be done at
the market price.
2.7.
Transfer of Residence
There are two basic rules that enable the country of residence as well as
the country where the source of income exits to impose tax, namely: Source rule:
the source rule holds that income is to be taxed in the country in which it
originates irrespective of whether the income accrues to a resident or a
nonresident and Residence rule: the residence rule stipulates that the power to
tax should rest with the country in which the taxpayer resides.
In jurisdiction with worldwide tax regimes, taxpayers when they become
non-residents are no longer liable to pay taxes on their foreign source income.
2.8.
Branch Entities
Under a classical tax system, host country taxes the corporate profits
twice- at company level and again when company pays dividend. Most countries
do not tax remittances of after-tax branch profits to non-residents. A branch entity
therefore avoids this economic double taxation. Several jurisdictions regard the
use of a branch as an unjustified loss of tax revenue that would have been due to
them as dividend withholding taxes from a subsidiary. Thus, an additional tax
either on branch profits or on remittances to head office is levied.43
These techniques are not exhaustive. There can be new ways which may
be combination of any these techniques. These techniques develop because of
the inconsistencies and gaps in the legislations. The assessee tries to utilize the
gap in his favour to take advantage by avoiding tax. legislature while drafting
might not have intended such advantages because of the gray area in the law.
Drafters cannot foresee all the situation that can come under its drafted law.
43
T.P. Ostwal, Vikram Vijaraghavan, Anti-Avoidance Measures, available at:

th
http://manupatra.com last visited on 4 April, 2014, p.93
32
Some of the above mentioned techniques are very complex in nature and it is
very hard for judiciary to determine the nature of transaction and its purpose.
33
CHAPTER-V
ANTI- AVOIDANCE MEASURES
As seen in the earlier chapter the consequences of tax avoidance on the
community is more, it affects the society and destroys the horizontal equity. The
growth of anti- avoidance measure and its judicial analysis raise a question as to
how the tax statute should be interpreted. In interpreting tax statute the judges
should not go beyond the text. Purposive interpretation cannot be done in case of
taxation.
In this chapter, the measures adopted by countries to tackle the problem
of unaccepted tax avoidance through legislative measures and judicial doctrines,
is dealt. The Legislative measures under Income Tax Act, 1961, specific antiavoidance rules and General Anti-Avoidance Rules. Judicial doctrines of
Commercial Purpose doctrine and Substance and form doctrines, that are used
to decide the nature of transaction through its intent, so that unaccepted tax
avoidance strategies are traced and nullify the resultant effect. The chapter also
provides for analysis of few cases in this area and traces the development in the
judicial approach.
The Carter Commission Report defined Tax avoidance as 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 law44. It then grouped the
various anti-avoidance provisions into four categories, as follows:
1. Sniper approach- the enactment of specific provisions that identify with
precision the type of transaction to be dealt with and prescribe against the
tax consequences of such treatment.
2. Shotgun Method- the enactment of general provisions to hit broad types of
avoidance practices in specific areas
44
Report of the Royal Commission on Taxation (Canada 1966)
34
3. Administrative approach- the responsibility to control tax avoidance is left

to the discretion of the tax authorities.
4. Arms-length approach- the transactions between related parties should
be similar to transactions between independent parties.45
This is stated in the report of Canadian Royal Commissions, however, it is
true even in the case of other tax regimes. In India if the measures at present are
examined, it relates to same four approaches taken by the legislators.
There are three fundamental requirements of the graduated income tax:
a. It must produce revenue;
b. It must accomplice fairness and equality by laying the burden in
accordance with the relative ability of the various classes of taxpayers to
pay; and
c. It must constitute a chart by which it may be determined with as great a
degree of accuracy as possible whether the individual is liable to pay tax,
and if so, how much, or whether he is not subject to tax. The entire
accomplishment of all these three major aims certainly is extremely
difficult and probably impossible. We cannot hope for a perfectly drawn
statute. Perhaps the solution is weighing the relative importance of the
three major aims in the various and different fields of the statute, and so
strike a reasonable balance depending on the needs.46
The reason for extending measures against tax avoidance is two-fold.
First, the government of every country needs more and more money; second, the
feeling of international solidarity is constantly increasing, particularly in clubs like
the EEC. In other words, it appears more and more a violation of international
45
Ibid
Montgomery B. Angell, Tax Evasion and Tax Avoidance, Vo. 38, No. 1, Columbia Law Review,
1938, pp 80-97, available at http://www.jstor.org/stable/1116551, last visited on 23/12/2013.
46
35
rules that any country may apply unduly low taxes, thus permitting or
encouraging tax avoidance in other countries.47
1. LEGISLATIVE MEASURES
Section 92 to 94 deals with anti-avoidance measures. Two types of tax
avoidance are dealt with:
Avoidance by transfer pricing income-yielding assets to a non-resident

while retaining the power to enjoy the income, and
Avoidance by transactions in securities know as bond-washing

transactions.
With the view to provide a statutory framework which can lead to
computation of reasonable, fair and equitable profits and tax in India, in case of
multinational enterprises, transfer pricing provisions have been introduced in the
Income tax Act, 1961.
According to section 92:
i.
Any income;
ii.
Allowance for any expense or interest.
Arising from an international transaction shall be determined having regard to the

arms length price.48
Clause two explain the situation as follows:
(2) Where in an international transaction or specified domestic transaction two or
more associated enterprises49 enter into a mutual agreement or arrangement for
47
J.F. Avery Jones, Tax Heavens and Measures against Tax Evasion and Avoidance in the EEC,
(London: Associated Business Programmes), 1974, p. 11
48
Section 92(1) r/w Explanation to sec. 92 of Income Tax Act, 1961.
49
Associated Enterprises is defined under section 92A
Associated enterprise in relation to another enterprise means an enterprise-
36
the allocation or apportionment of, or any contribution to, any cost or expense
incurred or to be incurred in connection with a benefit, service or facility provided
or to be provided to any one or more off such enterprises, the cost or expense
allocated or apportionment to, or, as the case may be, contributed by, any such
a. Which participate, directly or indirectly, or through one or more intermediaries, in the

management or control or capital of the other enterprise; or
b. In respect of which one or more persons who participates, direct or indirectly, or through
one or more intermediaries, in its management or control or capital, are the same
persons who participate, directly or indirectly, or through one or more intermediaries, in
the management or control or capital of the other enterprises.
(2) For the purpose of sub-section (1), two enterprise shall be deemed to be associated
enterprises if, at any time during the previous yeara. One enterprise holds, directly or indirectly, shares carrying not less than twenty-six per
cent of the voting power in the other enterprise; or
b. Any person or enterprise holds, directly or indirectly, shares carrying not less than twentysix per cent of the voting power in each of such enterprises; or
c. A loan advanced by one enterprises to the other enterprises constitutes not less than
fifty-one per cent of the book value of the total assets of the other enterprise; or
d. One enterprise guarantees not less than ten per cent of the total borrowing of the other
enterprise; or
e. More than half of the board of directors or members of the governing board, or one or
more executive directors or executive members of the governing board of one enterprise,
are appointed by the other enterprise; or
f. More than half of the directors or members of the governing board, or one or more of the
executive directors or members of the governing board, of each of the two enterprises
are appointed by the same person or persons; or
g. The manufacture or processing of goods or articles or business carried out by one
enterprises is wholly depended on the use of knowhow, patents, copyrights, trade-marks,
licences, franchise or any other business or commercial rights or similar nature, or any
data, documentation, drawing or specification relating to any patent, invention, model,
design, secret formula other process, of which the other enterprises is the owner or in
respect of which other enterprise has exclusive rights; or
h. Ninety per cent or more of the raw materials and consumable required for the
manufacture or processing of goods or articles carried out by one enterprises, are
supplied by the other enterprise, or by persons specified by the other enterprises; or
i. The goods or articles manufactured or processed by one enterprise, are sold to the other
enterprise or to persons specified by the other enterprise, and the prices and other
conditions relating thereto are influenced by such other enterprise; or
j. Where one enterprise is controlled by an individual, the other enterprise is also controlled
by such individual or his relative or jointly by such individual and relative of such
individual; or
k. Where one enterprise is controlled by a Hindu undivided family, the other enterprise is
controlled by a member of such Hindu undivided family or by a relative of a member of
such Hindu undivided family or jointly by such members and his relative; or
l. Where one enterprise is a firm, association of persons or body of individuals, the other
enterprise holds not less than ten per cent interest in such firm, association of persons or
body of individuals; or
m. There exists between the two enterprises, any relationship of mutual interest, as may be
prescribed.
37
enterprise shall be determined having regard to the arms length price of such
benefit, service or facility, as the case may be.
In Multi- National enterprises (MNEs), that have various entities set up in
various tax jurisdictions, especially where the MNEs are highly integrated, the
prices paid for these goods and services might be fixed such that the tax liability
of the enterprise in one or more jurisdiction is reduced. To combat this, tax laws
around the world have introduced the concept of transfer pricing. The transfer
pricing provisions are aimed at ensuring that profits that ought to have been
earned in India are not shifted to other jurisdictions either by reducing the income
or inflating the expenditure in transactions between various entities belonging to
a multi-national group. Therefore, the object is to determine the likely profits that
would have been earned in India if the transaction was on the basis of an arms
length price between independent entities.
The Blacks Law Dictionary understands the term to be the charge
assigned to an exchange of goods or services between corporations
organizational units.50
According to Ramanatha Aiyer, the term transfer price has been defined
from two aspects; one, finance- the price changed (or value assigned) to a
product or service which is transferred within an enterprise from one segment or
division to another and two, business- within a group of companies, the price at
which goods or services are sold by one subsidiary to another.51
Let us say a company situated in the US, X Inc. has an Indian subsidiary,
X India Ltd., provides certain services to its parent at a charge of Rs. 100 per
hour. This is called the transfer price. It is found that if X Inc. were to get these
services done by an unrelated person, it would have to pay Rs. 120 per hour.
This is the arms length price. In the absence of transfer pricing regulation, X
India Ltd. would pay tax only on the profits on Rs. 100 per hour in India, while X
50
51
th
Garner, Blacks Law Dictionary, 7 edn. 1999, p. 1536

P. Ramanatha Aiyars, Advance Law Lexicon, 4th ed., 2010, p. 6890
38
Inc. would be entitled to claim expenditure of Rs. 100 per hour in US.
Accordingly, the US profits are higher by Rs. 20. If the tax rate in India is higher,
the enterprise may endeavour to structure the transaction in such a manner.
However, under the transfer pricing regulations, authorities in India will
determine the arms length price, in this case, at Rs. 120 per hour, and make an
adjustment of Rs. 20 per hour in the assessment of X India Ltd. In other words,
the transfer pricing provisions allow the department to deem that the price for the
transaction is Rs. 120 and tax it on that basis.
Now, if X India Ltd. buys certain goods to provide these services from
another related Singaporean company, X Singapore Ltd., for Rs. 1000, whereas
the arms length price of these goods is only Rs. 600, it will gain a tax
advantage in India since it can claim higher expenditure on buying these goods.
The department, under the relevant transfer pricing laws, can make on this
expenditure as well.52
It is worth noting here that Section 92 (1) provides that any income arising
from an international transaction shall be computed having regard to arms length
price. The word having regards may be interpreted in a manner that income
arising from international transaction need not arising from the necessarily be
Arms Length Price always. Therefore, other peculiarities like third party
uncontrolled revenue can also be kept in mind while determining the income
arising from the international transaction.53
It must be noted that the transfer pricing provisions are not a license to the
assessing authorities to rewrite the contractual relationship between parties. The
Delhi High Court 54 has held that international best practices (as found in the
OECD Guidelines) are helpful in interpreting the applicable sections of the Indian
52
th
Arvind P. Datar, Kanga & Palkhivalas The Law and Practice of Income Tax, 10 edn., Vol. II,
(Haryana: Lexis Nexis), 2014, p.1737
53
Sunil M. Lala, Shailvi Singhal, Transfer Pricing- Controversies arising out of the provisions
relating to transfer Pricing under the Income Tax Act, 1961, International Taxation Inmprtant
Aspects and Issues, All Inia Federation of Tax Practitioners, 2012 p. 149
54
CIT v. EKL Appliances 345 ITR 241- following Eastern Investment Ltd. v. CIT 20 ITR 1 (SC)
39
Act. Thus, Business dealings between parties ought not be rewritten by tax
authorities, except wherei. the economic substance of a transaction differs from its form and
ii. The form and substance if the transactions are the same but
arrangements made in relation to the transaction, viewed in their
totality, differ from those which would have been adopted by
independent enterprises behaving in a commercially rational
manner
Section 92 was amended in 2001 and 2002 which replaced the primitive form of
transfer pricing.
The Board Circular explains the reason for re-casting these provisions:
The increasing participation of multi-national groups in economic
activities in the country has given rise to new and complex issues
emerging from transactions entered into between two or more
enterprises belonging to the same multi-national group. The profits
derived by such enterprises carrying on business in India can be
controlled by the multi-national group, by manipulating the prices
charged and paid in such intra-group transactions, thereby leading
to erosion of tax revenues.55
With regard to sec. 92 (3), the intention underlying the provision is to
prevent avoidance of tax by shifting taxable income to a jurisdiction outside India,
through abuse of transfer pricing.56 The idea that tax avoidance is necessary
before invoking transfer pricing provisions is also implicit from s. 92(3), which
states that the section will not apply if the transfer pricing adjustment has the
effect of reducing the chargeable income. This shows that the intention of the
exercise is not to apply it to all international transactions, or specified domestic
transactions, but only to transactions that lead to the erosion of the tax base.
55
56
Circular No. 14, December 12, 2001, 252 ITR (St.) 65, 103.
Memorandum to Finance Bill, 2002
40
Similarly, if the transfer price for an expenditure in the hands of a resident is

lesser that the arms length price, then no adjustment will be made under this
Chapter. This implies that the exercise is only to curb tax avoidance, and not to
determine the correct income that is chargeable to tax in India.57
This section is applicable in respect of international transaction and
specified domestic transaction. These two phrases are defined under sections
92B and 92BA respectively.
International Transaction: International transaction means transaction between
two or more associated persons, either or both of whom are nonresident.
If the there is transaction not between associated persons, then they will be
deemed to be associated persons if there exists a prior agreement under subsection 2 of section 92B.
The explanation to section provides what international transaction includes:
a. The purchase, sale, transfer, lease or use of tangible property including
building, transportation vehicle, machinery, equipment, tools, plant,
furniture, commodity or any other article, product or thing;
b. The purchase, sale, transfer, lease or use of intangible property 58 ,
including the transfer of ownership or the provision of use of rights
57
th
Arvind P. Datar, Kanga & Palkhivalas The Law and Practice of Income Tax, 10 edn., Vol. II,
(Haryana: Lexis Nexis), 2014, p.1740.
58
Explanation ii of Section 92B provides for what the expression intangible property include:
a. Marketing related intangible assets, such as, trademarks, trade names, brand names,
logos;
b. Technology related intangible assets, such as, process patents, patent applications,
technical documentation such as laboratory notebooks, technical know-how;
c. Artistic related intangible assets, such as , literary words and copyrights, musical
compositions, copyrights, maps, engravings;
d. Data processing related intangible assets, such as, proprietary computer software,
software copyrights, automated databases, and integrated circuit masks and masters;
e. Engineering related intangible assets, such as, industrial designs, product patents, trade
secrets, engineering drawing and schematics, blueprints, proprietary documentation;
f. Customer related intangible assets, such as, customer lists, customer contracts,
customer relationship, open purchase order;
g. Contract related intangible assets, such as, favourable supplies, contracts, licence
agreements, franchise agreements, non-compete agreements;
41
regarding land use, copyrights, patents, trademarks, licences, franchises,

customer list, marketing channel, brand, commercial secret, know-how,
industrial property right, exterior design or practical new design or any
other business or commercial rights of similar nature;
c. Capital financing, including any type of long-term or short-term borrowing,
lending or guarantee, purchase or sale of marketable securities or any
type of advance, payments or deferred payment or receivable or any other
debt arising during the course of business;
d. Provision of services, including provision of market research, market
development, marketing management, administration, technical service,
repairs, design, consultation, agency, scientific research, legal or
accounting service;
e. A transaction of business restructuring or reorganization, entered into by
an enterprise with an associated enterprise, irrespective of the fact that it
has bearing on the profit, income, losses or assets of such enterprises at
the time of the transaction or at any future date;
Specified domestic transaction means following transactions:
i.
Any expenditure in respect of which payment has been made or is to be

made to a person referred to in clause (b) of sub-section (2) of section
40A
ii.
Any transaction referred to in section 80A
iii.
Any transfer of goods or services referred to in sub-section (8) of section

80-IA
h. Human capital related intangible assets, such as, trained and organized work force,
employment agreements, union contracts;
i. Located related intangible assets, such as, leasehold interest, mineral exploitation rights,
easements, air rights, water rights;
j. Goodwill related intangible assets, such as, institutional goodwill, profession practice
goodwill, personal goodwill of professional, celebrity goodwill, general business going
concern value;
k. Methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts,
estimates, customer lists, or technical data;
l. Any other similar item that derives its value from its intellectual content rather than its
physical attributes.
42
iv.
Any business transacted between the assessee and other person as

referred to in sub-section (10) of section 80-IA
v.
Any transaction, referred to in any other section under Chapter VI-A or

section 10AA, to which provisions of sub-section (8) or sub-section (10) of
section 80-IA are applicable; or
Any other transaction as may be prescribed59
vi.
Various methods of determining Arms Length Price

1. Comparable uncontrolled price method (CUP)
2. Resale Price Method (RPM) see income tax rules
3. Cost plus method
4. Profit split method
5. Transactional net margin method
6. Such other measure as may be prescribed by the Board.60
The Income Tax Rules provides for steps in each of the above methods.
Section 92 CA says that if Assessing Officer deems fit then with the
permission of Commissioner can refer the international transaction to Transfer
Pricing Office for computation of arms length price. This section also provides for
procedural aspects that has to carried after the reference.
Safe harbor rules are applicable in case of section 92C and 92CA. Safe
harbour means circumstances in which the income-tax authorities shall accept
the transfer price declared by the assessee.61
Sections 93 and 94, deals with avoidance of income-tax by transactions resulting
in transfer of income to non-residents and Avoidance of tax by certain
transactions securities, respectively. Both the provisions are deeming provisions,
where income is deemed to be of first mentioned persona and of owner. Section
59
Section 92BA of Income Tax Act, 1961.

Section 92 C, Income Tax Act, 1961
61
Explanation to section 92CB of Income Tax Act, 1961.
60
43
94A makes special provisions in respect of transactions with persons located in

notified jurisdictional area.
While interpreting provisions of taxing statutes, the courts keep certain
principles in mind. These statutes are very strictly construed and no implied
effects are given. Regarding interpretation of taxing statutes certain examination
of courts observations are apt here.
In Partington v. Att.-Gen.62, it is this: If a person sought to be taxed comes
within the letter of the law he must be taxed, however great the hardships may
appear to the judicial mind to be. On the other hand, if the Crown, seeking to
recover the tax, cannot bring the subject within the letter of the law, the subject is
free, however apparently within the spirit of the law the case might otherwise
appear to be. This judgment is very old but even today its relevant to consider
because the nature of statute remains same and nothing can be implied.
Inrandy Syndicate v. IRC63, Rowlatt J. a masterly Revenue Judge, gave
this approach its classic expression: in a taxing Act one has to look merely at
what is clearly said. There is no room for any intendment. There is no equity
about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing
is to be implied. One can only fairly at the language used.
tax avoidance is an evil, but it would be the beginning of much greater evils if the
courts were to overstretch the language of the statute in order to subject to
taxation people of whom they disapproved.
The tradition of literalism has given rise year by year to what Lord Morton
once called a game of chess between Parliament and taxpayers advisers.
Parliament imposes a charge, the advisers find ways to avoid it; Parliament
enacts specific anti-avoidance legislation, the advisers device a more elaborate
avoidance techniques; and so it goes on. It becomes tempting to widen the
scope of anti-avoidance measures- with only one shot a year, a shotgun seems
62
63
Partington v. Att.-Gen (1869) L.R. 4 H.L. 100, p. 122

Inrandy Syndicate v. IRC (1921) 1 K.B. 64, p. 71
44
more useful than a rifle. The danger of a shotgun is that it may hit innocent
bystanders as well as its intended victims.64
Certain ways and means may be devised which may go a long way to
reduce these problems. The measures consist of closing loopholes in tax laws to
minimize tax avoidance, devising suitable administrative processes to detect
unacceptable tax avoidance, raising standards of administration publicity and
arousing social conscience against unacceptable tax avoidance.
Apart from these provisions there are also Specific anti avoidance rules
and also General anti avoidance rules. GAAR is not in force now, but it is the
most debated issue. Next chapter of Dissertation deals with GAAR and the
ongoing controversies.
2. JUDICIAL MEASURES
The Judicial responses to tax avoidance strategies can be seen through the
doctrines it has propounded to identify and nullify the effect of a unaccepted tax
avoidance arrangement. Two guiding principles are followed by judiciary:
i.
Business Purpose test- Motive Test
ii.
The Substance over Form Principle- Artificiality Test
Business Purpose Test

Tax avoidance transaction should be identified as any transaction that:
Results in a tax benefit;
Cannot be considered to have been undertaken for a bona fide business

purpose.
The business purpose rule attacks tax avoidance schemes that do not have a
business purpose. It makes a distinction between transactions with a valid or
64
Hepker Michad, A Modern approach to tax law,1973,p.39
45
bona fide commercial purpose and those designed primarily to avoid tax. the
focus is on business or non-tax reasons for entering into the transactions.
In Gregory v. Helvering, the US Supreme Court held that a corporate
reorganization under the law solely for tax purposes did not qualify for tax
benefits. The reorganization must be done for a legitimate business purpose
other than tax avoidance. It was held that in construing words of a statute which
describe commercial or industrial transactions, we are to understand them to
refer to transactions entered upon for commercial or industrial reasons and not to
include transactions entered for no other motive but to escape taxation.65
The scope of this rule has not been defined. It can be interpreted in
narrower and also in broader sense. The judiciary would be at its discretion to
adopt the interpretation if legislature does not define the ambit. In United
Kingdoms decisions an attempt to define business purpose rule can be seen.
For example:
The commercial or business purpose need not be financial, e.g. defence

from a takeover is a justified business purpose. The advantage needs to
be weighed against the commercial benefits that may or may not be
quantifiable.66
The main purpose must be a genuine commercial purpose and not a tax
advantage. However, obtaining a tax advantage can also be a bona fide
commercial purpose.67
The motive is distinct from purpose. The purpose does not mean the
subjective motive or intention in the mind of the taxpayer by the objective
result of the transaction is the ultimate objective or aim.68
Substance over Form Principle
65
Gregory v. Helvering 293 US 465 (1935) (US)

IRC v. Brebner (1967) 2 AC 182 (UK)
67
IRC v. Plummer (1979) STC 793 (UK)
68
Mallelieu v. Drummond (1983) STC 124 (UK)
66
46
The substance over form rule is broader than the business purpose rule. Th
eOECD report defines it as the prevalence of economic or social reality over the
literal wording of legal provisons.69
At least three levels of meaning exist:
The incident of taxation must be made to depend upon the economic

substance of the transaction. To permit the true nature of a transaction to
be disguised by mere formalisms which exist solely to alter tax liabilities
would seriously impair the effective administration of the tax policies. In
this sense and context, the doctrine of substance-over-form serves a high
purpose. It is a search for the essential reality, seeking to uncover the
economic substance in order to allow the tax burden to fall with he exact
weight which the legislature intended.
The phrase substance-over-form is a label. Like most labels, it is

frequently not the determining reason for the tax result, but instead is
pasted on the fact situation afterward as a shorthand description of the
conclusion. The competitive generalization- that a taxpayer is entitled
under the law to so order his affairs as to incur the least tax-is likewise an
over-simplification. Generalizations are blunt tools in attempting to
uncover essence in particularized factual transactions. To the extent these
labels are used as substitutes for painstaking analysis, each is an
impediment and not an aiding hand in the task of reaching results based
on substance.
A considerable body of thought exists that the doctrine of substance is a

sword available in the hands of tax authorities, but that it may not be used
as a shield by the taxpayer. The rationalization supporting this view si that,
since the taxpayer is originally free to choose the form, the tax authorities
may appropriately be heard to say that the form does not comport with
69
T.P. Ostwal, Vikram Vijayaraghavan, Anti-Avoidance Measures, available at:

th
http://manupatra.com last visited on 10 April 2014.
47
substance, but the taxpayer may not be heard to deny on hindsight the
freely chosen form.70
Legal v. Economic Substance.

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.
In Duke of Westminster
71
, Duke of Westminster had made an
arrangement that he would pay his gardener an annuity, in which case, a tax
deduction could be claimed. Wages of household services were not deductible
expenses in computing the taxable income therefore, duke of Westminster was
advised by the tax experts that if such an agreement was employed, Duke would
get tax exemption. Under the Tax Legislation then in force, if it was shown as
gardeners wages, then the wages paid would not be deductible. Inland Revenue
contended that the form of the transaction was not acceptable to it the Duke was
taxed on the substance of the transaction, which was that payment of annuity
was treated as a payment of salary or wages. Crowns claim of substance
doctrine was, however, rejected by the House of Lords. Lord Tomlins stated as
follows:
Every man is entitled if he can order his affairs so that the tax attaching under
the appropriate Acts is less than it otherwise would be. If he succeeds in ordering
them
so as to secure this result, then however unappreciative the
Commissioners of Inland Revenue or his fellow taxpayers may be of his

ingenuity, he cannot be compelled to pay an increased tax. This so called
doctrine of the substance seems to me to be nothing more than an attempt to
70
J. Bruce Donaldson, When Substance-Over-Form Argument is available to the Taxpayer,

Available at: http://scholarship.law.marquette.edu/mulr/vol48/iss1/4 last visited on 03/05/2014.
71
Duke of Westminster v. Commissioner of Inland Revenue, (1936) 1 A.C. 19 (H.L.)
48
make a man pay notwithstanding that he has so ordered his affairs that the
amount of tax sought from him is not legally claimable.
Lord Atkin, however, dissented and stated that the substance of the transactions
was that what was being paid was remuneration.
Three principles emerged from this judgment:
i.
A legislation is to receive a strict or literal interpretation;
ii.
An arrangement is to be looked at not in by its economic or commercial

substance but by its legal form; and
iii.
An arrangement is effective for tax purposes even if it has in business

purpose and has been entered into to avoid tax.
The Westminster Principle: given that a document or transaction is genuine, the

Court cannot go behind it to some supposed underlying substance has been reiterated in the subsequent English Courts judgments as the cardinal principle.
The House of Lords, during 1980s began to attach a purposive interpretation
approach and gradually began to emphasize on economic substance doctrine.
In Aiken Industries v. Commissioner, Mechanical Products Inc. raised debt from
an Ecuadorian corporation and issued promissory notes; the Ecuadorian
corporation then exchanged these promissory notes for new promissory notes
issued by Industries, a Honduran company. Aiken repaid the debt and interest to
Industries, which in turn repaid its debt along with interest to the Ecuadorian
corporation. Revenue contended that the entire structure was devised solely to
avoid tax since interest payments to Industrias would not be eligible to tax
withholding under US-Honduras Treaty (DTAA). The Court agreed with Revenue
and held that Aiken, the successor of Mechanical Products, was liable for
withholding taxes on interest paid.
Sham Transactions
Sham transaction can be defined as a situation whereby acts have been taken
which are intended by the involved parties to give to third partied the appearance
49
of creating between the involved parties legal rights and obligations different from
the actual legal rights and obligations which the parties intended to create.72
In sham transaction the parties conceal the true nature of transaction, they say
one thing but intend other. In Knetsch v. US73, a taxpayer borrowed money at
3.5% to make a return of 2.5% from an investment in an annuity issued by an
insurance company. The investment income was taxed at a lower capital gains
rate and the interest payments were fully deductible for tax purposes. The net
result after tax, therefore, provided a tax benefit. The US Supreme Court treated
the transaction as a sham and disallowed the interest paid on the loan. It held
that there was nothing of substance to be realized from his transaction 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. Unlike sham transaction, the
transaction are real and do create legal rights an liabilities which do exist or
which are not different from those that actually do exist.
Step Transaction Doctrine

In a step transaction, the intermediate steps in a chain of preordained, even if
bona fide, transaction may be disregarded and several related transactions may
be treated as a single composite transaction.
In Gregory v. Helvering74, the taxpayer attempted to avoid dividend tax through a
taxfree corporate reorganization. She owned a company, United Mortgage, which
held shares of Monitor Securities. A direct sale of these shares would have
72
Snook v. London and West Riding Investments Ltd. (1967) AII ER 518, 5201 (UK)
Knetsch v. US 364 US 361 (1960)
74
Gregory v. Helvering, 293 465 (1935) (US)
73
50
resulted in a capital gains tax in United Mortgage and an income tax on the
dividend when the proceeds were subsequently paid to the taxpayer. She was
prepared to pay the capital gains tax but not the income tax. United Mortgage st
up a shell company, Averill, and transferred to it all its shares in Monitor
Securities in exchange for Averill shares. It then distributed Averill shares to the
taxpayer under a tax-free corporate spin-off. She subsequently liquidated Averill
and the liquidation proceeds, i.e. the shares , now by the taxpayer were then
sold.
Another example of step transaction can be seen in Ramsay case 75 ,
Ramsay was a case of sale-lease back transaction in which gain was sought to
be counteracted, so as to avoid tax, by establishing an allowable loss. The
method chosen was to buy from a company a readymade scheme, whose object
was to create a neutral situation. The decreasing asset was to be sold as to
create an artificial loss and the increasing asset was to yield a gain which would
be exempt from tax. The Crown challenged the whole scheme saying that it was
an artificial scheme and, therefore, fiscally in-effective. It was held that
Westminster did not compel the Court to look at a document or a transaction,
isolated from the context to which it properly belonged. It is the task of the Court
to ascertain the legal nature of the transaction and while doing so it has to look at
the entire transaction as a whole and not to adopt a dissecting approach. In the
present case, the Revenue has adopted a dissecting approach at the
Department level.
Ramsay did not discard Westminster bit read it in the proper context by which
device which was colourable in nature had to be ignored as fiscal nullity. Thus,
Ramsay lays down the principle of statutory interpretation rather than an overarching anti-avoidance doctrine imposed upon tax laws.
In Dawson76, two operating companies decided to sell their entire shareholdings
to Wood Bastow Holding Ltd. Acting on advice, to escape capital gain tax,
75
76
W. T. Ramsay Ltd. IRC (HL 1981, 54 TC 101) UK

Furniss v. Dawson, (1984) 1 AII ER 530, 532 (HL)
51
Dawsons decided not to sell directly to Wood Bastow, rather arranged to

exchange their shares for shares in an investment company to be incorporated in
the Isle of Man. Greejacket Investments Ltd. was then incorporated in the Isle of
Man on 16th December, 1971 and two arrangements were finalized:
i.
Greenjacket would purchase Dawsons shares in the operating company

for 152,000 to be satisfied by the issue of shares of Greenjacket and
ii.
An agreement for Greenjacket to sell the shares in the operating company

to Wood Bastow for 152,000.
The High Court and the Court of appeal ruled that Ramsay principle applied only
where steps forming part of the scheme were self-canceling and they considered
that it did not allow share exchange and sale agreements to be distributed as
steps in the scheme, because they had an enduring legal effect. The House of
Lords, however, held that steps inserted in a preordained series of transactions
with no commercial purpose other than tax avoidance should be disregarded for
tax purposes, notwithstanding that the inserted step had a business effect. Lord
Brightman stated that inserted step had no business purpose apart from the
deferment of tax, although it had a business effect.
whatever may be the personal sympathies of a judge who tries a revenue case,
his decision has to be based on purely legal and technical grounds, and
Parliament can expect no discretion or elasticity from the courts in enforcing
taxation law. Even though case law has been moving away from the strict and
literal approach found in some of those early cases to the new approach in
Ramsay, as developed by Furniss v Dawson, the latest pronouncements of the
House of Lords suggest that the judges do not see themselves as having
authority to create a judicial anti-avoidance rule or to impose an overlay upon tax
legislation but only to interpret parliamentary intention.77
77
Lord Hoffmann in MacNiven v Westmoreland Investments, [2001] STC 237 at 248
52
In Craven v. White78, the shareholders in a family company, Queenferry, wished

to dispose their interest through either a merger or an outright sale. They were
negotiating for merger with a grocery chain, Cee-N-Cee, or purchase by another
company, Oriel. In the meanwhile, they set up an Isle of Man subsidiary, Millor,
and exchanged their shares in Queenferry on a tax-free basis for shares in Millor.
The negotiations for the merger subsequently broke down, and Millor eas sold to
an Oriels subsidiary. The House of Lord held that the series of transactions were
not preordained and not without a business purpose.
Following the decision in BMBF79, Lord Hoffmann commented that:
The primacy of the construction of the particular taxing provision and the
illegitimacy of rules of general application has been reaffirmed by the recent
decision of the House in [BMBF]. Indeed it may be said that this case has killed
off the Ramsay doctrine as a special theory of revenue law and subsumed it
within the general theory of the interpretation of statutes ...
Coming to India position, prior to MacDowell80, it is relevant to look to the
observations of Shah, J. in the cases of CIT v. A. Raman & Co81 and CIT v.
B.M. Kharwar 82 . The observation from the latter case reads as follows "The
taxing authority is entitled and is indeed bound to determine the true legal
relation resulting from a transaction. If the parties have chosen to conceal by a
device the legal relation, it is open to the taxing authorities to unravel the device
and to determine the true character of the relationship. But the legal effect of a
transaction cannot be displaced by probing into the substance of the
transaction."
In MacDowell case, Under the A.P. Excise Act and Rules, the manufacturer was
to remove the liquor from the distillery only upon payment of excise duty.
However, the buyers of liquor from the assessee themselves paid the excise duty
78
Craven v. White, (1988) 3 WLR 423 (HL) (UK)

Barclays Mercantile Business Finance Ltd v Mawson[2004] UKHL 51
80
MacDowell and Company Ltd. (1985) 3 SCC 230
81
CIT v. A. Raman & Co. [1968] 67 ITR 11
82
CIT v. B.M. Kharwar [1969] 72 ITR 603 (SC)
79
53
before the removal of the goods. The price of the liquor was collected by the
assessee from the buyer but the excise duty paid by the buyer to the Excise
Department was not shown as a part of the price received by it from the buyer.
The assessee continued to sell liquor in this manner and paid sales tax under the
A.P. Sales Tax Act on the turnover returned by him which did not, as mentioned,
include the amount of the excise duty. However, the assessing authority took the
view and held that the assessee had failed to include in its turnover, the amount
of excise duty paid by its buyers to the Excise Department. The assessee
challenged that view but the High Court agreed with the assessing authority. The
assessee appealed to the Supreme Court.
A Division Bench of the Supreme Court examined the excise laws as well as the
sales tax laws. The Court took the view that:
(i)The buyer was also legally responsible to pay the excise duty; and
(ii)The amount of excise duty never went into the till of the assessee.
On this view of the law, the Supreme Court held that the excise duty,
which had been directly paid by the buyers to the Excise Department, was not
includible in the turnover of the assessee. This was in 1977, the first judgment of
the Supreme Court on the issue. Consequent upon this judgment, the Rules
were amended. The new Rule provided for payment of excise duty by the
manufacturers, including the assessee, but the excise duty continued to be paid
directly by the buyers as was done earlier. On the basis of the amendment in the
Rules, the assessing authority again added the sum of excise duty to the
assessees turnover. The assessee again moved the High Court for quashing the
notice. The High Court held that "the turnover related to liquor; excise duty, which
was payable by the assessee but, by an arrangement, had been paid by the
buyer, was actually a part of the turnover of the assessee and was, therefore,
liable to be so included (in the turnover) for determining the assessees liability
for sales tax".
54
The assessee appealed to the Supreme Court wherein the validity of the earlier
judgment in the assessees case was doubted and the matter was referred to a
Constitution Bench of five Judges.
There were only two basic issues before the Constitution Bench. One,
whether the liability to pay excise duty was that of the assessee. And, the other,
even if the liability to pay excise duty was of the assessee, whether the amount
of excise duty, directly paid by the buyer, was includible in the turnover of the
assessee for payment of sales tax.
Referring to several earlier precedents wherein the concept of excise duty
had been elaborated, the Constitution Bench held that "the incidence of excise
duty is directly relatable to manufacture" and its payment "is the primary and
exclusive obligation of the manufacturer ... but (only) its collection can be
deferred to a later stage as a measure of convenience or expediency". On a
fresh appraisal of the law, the highest court found fault with and overruled its own
decision rendered in 1977 in the same assessees case.
As to the other issue relating to turnover also, the Supreme Court referred
to various Indian and English decisions and held that excise duty is a part of the
consideration which a buyer pays to purchase liquor and is includible in the
turnover of the assessee (manufacturer) although the buyer had directly paid it to
the Excise Department. Thus, on this issue also, the Supreme Court differed
from its own earlier view.
The assessee, thus, lost the case in the Supreme Court. There was no scope for
discussing tax avoidance or tax evasion in the case of the assessee.
The decision in McDowell & Co. Ltd.s case (supra) by a Constitution
Bench of the Supreme Court so widened the net under different taxing statutes
that several innocent commercial and financial acts and transactions of the
assessee which were till then neither treated nor supposed to be treated as
taxable suddenly found themselves threatened with being dragged within the
pale of taxability and even penalization. The observations in the judgment,
particularly in the opinion rendered by Chinnappa Reddy, J., against tax
55
avoidance have so emboldened the assessing and taxing authorities that it

results in a lot of unreasonableness and high-handedness towards the
assessees.
In particular, McDowell & Co. Ltd.s case (supra) judgment has blurred the
line of distinction between reduction of tax liability by an assessee on account of
legally permissible, honest and justified means, on the one hand, and reduction
due to some colourable device, design or subterfuge, on the other hand. For that
reason, it has given rise to sufficient confusion and misunderstanding. Hence,
there is the need to undertake a critical study of McDowell & Co. Ltd.s case
(supra).
Lifting of Veil:
In Vodafone83 case, the court held that lifting of corporate veil doctrine is
readily applied in the cases coming within the Company Law, Law of Contract
and Law of taxation. Once the transaction is shown to be fraudulent, sham,
circuitous or a device designed to defeat the interests of the shareholders,
investors, parties to the contract and also for tax evasion, the Court can always
lift the corporate veil and examine the substance of the transactions.
Presently the measures provided under the statute i.e., Income Tax Act,
1961, is not adequate to handle modern tax avoidance techniques. That is why
judicial doctrines are developed to substantiate to the effectiveness. General anti
avoidance rules are giving statutory effect to the these judicial doctrines.
83
Vodafone Internations Holdings B.V. v. Union of India and Anr, MANU/SC/0051/2012
56
CHAPTER-VI
GENERAL ANTI-AVOIDANCE RULES
General Anti-Avoidance Rule, as the phrase suggest, is the general rules
to prevent tax avoidance strategies. These rules are included in taxing regimes.
Tax avoidance tactics carried on by the individuals and especially by corporation
and Multi-National Enterprises are varied. These strategies are formulated for the
sole purpose of avoiding tax. Judiciary through its activism is segregating the
transactions which are solely entered to avoid tax form other transactions done
for commercial purposes. The aggressive tax planning by huge corporation will
drastically effect on the economy of the nation, hence many regimes have come
forward to give a legislative framework for what is now done through judicial
activism. This legislative framework is the General Anti- Avoidance Rules. In
number of countries, like New Zealand and Canada etc. have included these
rules in their tax statutes. Debates have been taking place whether India also
needs the General Anti-Avoidance Rules to combat tax avoidance. It if felt that
the Specific Rules and Judicial Doctrines are not effective to handle the present
situations of tax avoidance. Through an amendment these rules have been
included in Income Tax Act, 1961, but will come into force on 1st April, 2016.
In this chapter, the researcher has dealt with the two major issues. First,
whether India needs General Anti-Avoidance Rules to combat tax avoidance or
the present scenario is sufficiently handles the tax avoidance strategies. Second,
whether these rules are in consonance with Rule of Law, if not can they be
justified on any grounds in taxing statutes. This chapter also gives an overview of
the rules.
1. NEED OF GAAR
General Anti-Avoidance Rules are whether required or not is depended on
the effectiveness of the present tax regime to prevent unacceptable tax
57
avoidance transactions. Prevention, identification and nullifying the effect of

transaction are the three main functions that are required to be carried. The
present specific ant-avoidance rules in the statute and the judicial doctrine is not
effective enough to do these three functions. Revenue is utmost important to the
country for various purposes. Tax not only accumulates revenue also does other
functions social functions. The need for GAAR was expressed by Government of
India in following words:
Tax avoidance, like tax evasion, seriously undermines the
achievements of the public finance objective of collecting revenues
in an efficient, equitable and effective manner. Sectors that provide
a greater opportunity for tax avoidance tend to cause distortion in
the allocation of resources. Since the better-off sections are more
endowed to resort to such practices, tax avoidance also leads to
cross-subsidization of the rich. Therefore, there is a strong general
presumption in the literature on tax policy that all tax avoidance, like
tax evasion, is economically undesirable and inequitable. On
considerations of economic and fiscal justice, a taxpayer should not
be allowed to use legal constructions or transactions to violate
horizontal equity.
In the past, the response to tax avoidance has been the
introduction of legislative amendments to deal with specific
instances of tax avoidance. Since the liberalization of the Indian
economy, increasingly sophisticated forms of tax avoidance are
being adopted by the taxpayers and their advisers. The problem
has been further compounded by tax avoidance arrangements
spanning across several tax jurisdictions. This has led to severe
erosion of the tax base. Further, appellate authorities and courts
have been placing a heavy onus on the Revenue when dealing with
matters of tax avoidance even though the relevant facts are in the
58
exclusive knowledge of the taxpayer and he choose not to reveal

them.
In view of the above, it is necessary and desirable to
introduce a general anti-avoidance rule which will serve as a
deterrent against such practices. This is also consistent with the
international trend.84
Again need of the General Anti-Avoidance Rules, were described in the
Memorandum to the Finance Bill, 2012 in the following words:
The question of substance over form has consistently arisen
in the implementation of taxation laws. In the India context, judicial
decisions have varied. While some courts in certain circumstances
have held that legal form of transactions can be dispensed with and
the real substance of transaction can be considered while applying
the taxation laws, others have held that the form is to be given
sanctity. The existence of anti-avoidance principles are based on
various judicial pronouncements. There are some specific antiavoidance provisions but general anti-avoidance has been dealt
only through judicial decisions in specific cases.
In an environment of moderate rate of tax, it is necessary
that the correct tax base be subject to tax in the face of aggressive
tax planning and use of opaque low tax jurisdictions for residences
as well as for sourcing capita. Most countries have codified the
substance over form doctrine in the form of General Anti
Avoidance Rules (GAAR).
In the above background and keeping in view the aggressive
tax planning with the use of sophisticated structures, there is a
84
Discussion Paper accompanying the Direct Taxes Code, Department of Revenue, Ministry of
Finance, Government of India, August 2009, para 24.1, available at
http://www.itatonline.org/info/?dl_id=98 last visited on 10/05/2014.
59
need for statutory provisions so as to codify the doctrine of

substance over form where the real intention of the parties and
effect of transactions and purpose of an arrangement is taken into
account for determining the tax consequences, irrespective of the
legal structure that has been superimposed to camouflage the real
intent
and
purpose.
Internationally
several
countries
have
introduced, and are administering statutory General Anti-Avoidance

Provisions. It is, therefore, important that Indian taxation law also
incorporate a statutory General Anti Avoidance Provisions to deal
with aggressive tax planning.85
Judiciary does not have tools that are adequate for the identification of
impermissible tax-avoidance transactions as the outcome of an exercise in
statutory interpretation.86 The principal difference between judicial anti-avoidance
doctrines and GAARs is one of form rather than the content of the tax law. In taxavoidance cases, this content is the outcome of three analytical tasks that the
judiciary is seen to discharge in identifying prohibited transactions.
i.
The first task is to characterize the legal relationships created by the

parties to the relevant transactions. This task is conventionally
discharged by characterizing the legal substance or private-law
relationship created by the parties as distinct from the perceived
economic substance.
ii.
The second task is to characterize the purpose of the transaction or

transactions. This task is conventionally discharged by constructing two
or more transactions as a series and determining the existence of a tax
benefit that is accessed by the transaction or transactions. The
transaction or series is then characterized as tax-driven or not, with only
the former considered a tax-avoidance transaction.
85
Memorandum to Finance Bill, 2012, available at http://indiabudget.nic.in/ub201213/mem/mem1.pdf, last visited on 19/05/2014, p. 28.
86
Judith Freedman, Interpreting Tax Statutes: Tax Avoidance and the Intention of Parliament,
123 LAW QUARTERLY REVIEW 53 (2007)
60
iii.
The third task is to interpret and apply the relevant statutory provisions
that supposedly provide the tax benefit accessed by a transaction or
series that is characterized as tax motivated.87
GAAR tends to be adopted in those countries in which the judiciary is
reluctant to discharge its responsibility to control tax avoidance and retreats into
a literalist or textualist approach to the statutory interpretation exercise as
rationalization. In India though judicial activism is tremendous in this are still it
cannot go beyond what act says. Though transactions, with sole intent to avoid
tax, are identified but if those transactions do not come within the purview of the
intended transactions in the statute then the hands of judiciary is bound. Hence
the scenario requires an effective law and mechanism to tackle tax avoidance.
2. GENERAL ANTI-AVOIDANCE RULES: AN ANALYSIS

The General Anti-Avoidance Rules are provided under chapter X-A. This
chapter deals with four main areas: tax consequences of entering into
arrangement considering partly impermissible avoidance arrangement; Detailed
procedure for administration of statutory GAAR, mainly to limit routine use of
statutory GAAR; Providing timelines for the completion of statutory GAAR
examination at the level of Commissioner; and, safe harbour; instances where
statutory GAAR will not be invoked and clarification related thereto.
This chapter contains section 95 to 102. Sections 100, 101 and 102 deals
with the applicability of the chapter, which says that this chapter shall be applied
in accordance to, or in lieu of, any other basis for determination of tax liability,
framing of guidelines and compliance with the same and definitions for the
purpose of this chapter only respectively.
Applicability of General Anti-Avoidance Rules
87
Tm Edgar, Building A Better GAAR, Vol. 27, VIRGINIA TAX REVIEW, available at
http://heionline.org, last visited on 18/05/2014, pp. 876,877
61
General Anti-Avoidance Rules are applicable to an arrangement entered by an

assessee is declared as an impermissible avoidance arrangement
88
Impermissible avoidance arrangement is defined under section 96 as follows:

An impermissible avoidance arrangement means an arrangement, the main
purpose of which is to obtain a tax benefit, and ita. Creates rights, or obligations, which are not ordinarily created between
persons dealing at arms length;
b. Results, directly or indirectly, in the misuse, or abuse, of the provisions of
this Act;
c. Lacks commercial substances or is deemed to lack commercial
substance under section 97, in whole or in part; or
d. Is entered into, or carried out, by means, or in a manner, which are not
ordinarily employed for bona fide purposes.89
An arrangement shall be presumed unless it is proved to the contrary by the
assessee, to have been entered into, or carried out, for the main purpose of
obtaining a tax benefit if the main purpose of a step in, a part of, the arrangement
is to obtain a tax benefit, notwithstanding the fact that the main purpose of the
whole arrangement is not to be obtained a tax benefit.90
This clause had ferocious reaction from corporate as it shifts the burden of
proof on the assessee. After debate Mukherjee, then finance minister,
announced the amendment of GAAR in Parliament on 7 May 2012. The italicized
words in the above clause were deleted. The effect was the onus of proof entirely
shifted from the taxpayer to the revenue department before any action can be
initiated. Even after amendment, this section has an element of burden of the
taxpayer while the initial burden is on the tax department. The department has to
first prove that a part of the arrangement is to obtain a tax benefit, while the
presumption will follow that the whole arrangement is for obtaining a tax benefit.
88
Section 95, Income Tax Act, 1961

Section 96 (1), Income Tax Act, 1961
90
(2) of Section 96, Income Tax Act, 1961
89
62
This presumption will have to be disproved by the tax payer. So the burden of
proof comes back to the tax payer.91
To serve as a guideline both for tax-administration in identifying and for
the judiciary in sustaining the objection of the tax-administration, the substanceover-form test has been enacted by a general rule that an arrangement shall be
deemed to lack commercial substance if the substance or effect of the
arrangement as a whole, is inconsistent with, or differs significantly from, the
form of its individual steps or a part.92 Supplementing this general rule, specific
instances have been identified where the arrangements will be deemed to be
lacking commercial substance. These are where the transactions involve or
include:
i.
Round trip financing93;
ii.
An accommodating party94;
iii.
Elements that have effect of offsetting or cancelling each other; ot
iv.
A transaction which is conducted through one or more persons and

disguise the value, location, source, ownership or control of funds
which is the subject matter of such transaction,95
91
Sukumar Mukhopadhyay, General Anti-Avoidance Rule in Income Tax Law, Vol. XLVII, No. 2,
ECONOMIC AND POLITICAL W EEKLY, , June 2012.
92
Section 97 (1)(a), Income Tax Act, 1961
93
Sub-section 2 of section 97 provides for what round trip financing includes. It includes any
arrangement in which, through a series of transactionsa. Funds are transferred among the parties to the arrangement; and
b. Such transactions do not have any substantial commercial purpose other than obtaining
the tax benefit (but for the provision of this chapter),
Without having any regard toA. Whether or not the funds involved in the round trip financing can be traced to any funds
transferred to, or received by, any party in connection with the arrangement;
B. The time, or sequence, in which the funds involved in the round trip financing are
transferred or received; or
C. The means by, or manner in, or mode through, which funds involved in the round trip
financing are transferred or received.
94
Sub-section 3 of section 97 provides as follows: for the purposes of this chapter, a party to an
arrangement shall be an accommodating party, if the main of the direct or indirect participation of
that party in the arrangement, in which or in part, is to obtain, directly or indirectly, a tax benefit
(but for the provisions of this chapter) for the assessee whether or not the party is a connected
person in relation to any party to the arrangement.
95
Section 97 (1)(b), Income Tax Act, 1961.
63
The underlying idea of invoking GAAR is to undo the form and structure of the
transaction intended to avoid tax by reconstructing it in a manner in which
normally would have been. With this idea, the rules provide for the consequences
of impermissible avoidance arrangement. if an arrangement is declared to be an
impermissible avoidance arrangement, then, the consequences, in relation to tax,
of the arrangement, including denial of tax benefit or a benefit under a tax treaty,
shall be determined, in such manner as is deemed appropriate, in the
circumstances of the case, including by way of but not limited to the following,
namely
a. Disregarding, combining or recharacterising any step in, or a part or whole
of, the impermissible avoidance agreement;
b. Treating the impermissible avoidance arrangement as if it had not been
entered into or carried out;
c. Disregarding any accommodating party or treating any accommodating
party and any other party as one and the same person;
d. Deeming persons who are connected persons in relation to each other to
be one and the same person for the purposes of determining tax treatment
of any amount;
e. Reallocating amongst the parties to the arrangementi.
Any accrual, or receipt, of a capital nature or revenue nature; or
ii.
Any expenditure, deduction, relief or rebate;
f. Treatingi.
The place of residence of any party to the arrangement; or
ii.
The situs of an asset or of a transaction,
At a place other than the place of residence, location of the asset or

location of the transaction as provided under the arrangement; or
g. Considering or looking through any arrangement by disregarding any
corporate structure.
(2). For the purpose of sub-section 1
i.
Any equity may be treated as debt or vice versa;

64
ii.
Any accrual, or receipt, of a capital nature may be treated as of revenue

nature or vice versa; or
iii.
Any expenditure, deduction, relief or rebate may be recharacterised.96

The list in the above section is not exhaustive. Too much discretion in the
hands of tax department brought extreme responses by the corporations. By

aligning to few recommendation an independent member was introduced in
GAAR approving panel to ensure objectivity and transparency. One member of
the panel now will be an officer of the level of joint secretary or above from the
Ministry of Law. It is also provided that taxpayer can approach the Authority for
Advance Ruling for a ruling on whether an arrangement to be undertaken by him
or her is permissible or not under the GAAR provisions. To provide greater clarity
and certainty in matters relating to GAAR, a committee has been constituted
under the chairmanship of he Director General of Income Tax to make
recommendation on formulating the rules and guidelines for implementing the
GAAR provisions and to suggest safeguards so that these provisions are not
applied indiscriminately.97
To ensure that the application of these rules if undertaken on a fair and
rationale basis, the applicability of these rules have been deferred by Finance
Act, 2013 to 1st April, 2016 and certain suggestions of the Expert Committee
constituted to advice on GAAR have also been incorporated by making suitable
amendments in the Act.
98
The basic reasoning for postponing the
implementation of GAAR is that:
the tax administration lacks the specialized knowledge needed to

administer GAAR and it should have access to intensive training to be
able to specialize in various aspects of international taxation,
the tax expenditure by postponing the tax is very little, and
96
Section 98, Income Tax Act, 1961.

Sukumar Mukhopadhyay, General Anti-Avoidance Rule in Income Tax Law, Vol. XLVII, No. 2,
ECONOMIC AND POLITICAL W EEKLY, June 2012.
98
Tarun Jain, GAAR and Rule of Law: Mutually Incompatible?, available at:
http://www.manupatrafast.in/pers/Personalized.aspx last visited on 14th April, 2014.
97
65
Pre-announcement is a common practice and, therefore, the intention to

implement GAAR should be expressed three years before the event.99
3. GAAR AND RULE OF LAW

A.V. Diceys formulation held that the rule of law requires the absolute
supremacy or predominance of regular law as opposed to the influence of
arbitrary power. 100 Theorists writing, since Dicey, have supplemented Diceys
basic formulation with a number of additional requirements that the basic
formulation logically must entail if it is to be of value.
In India the theory of basic structure was propounded in Kesavananda
Bharati 101 case, where concepts such as supremacy of the Constitution,
republican and democratic form of Government, secular character of the
Constitution, separation of power between the legislature, executive and the
judiciary, federal structure of the constitution, etc were said to be part of basic
structure and hence declared to be inviolable. In I. R. Coelho,102 Supreme Court
declared that rule of law is part of basic structure in following terms:
equality, rule of law, judicial review and separation of powers from
parts of the basic structure of the Constitution. Each of these
concepts are intimately connected. There can be no rule of law, if
there is no equality before the law. These would be meaningless if
the violation was not subject to the judicial review. All these would
be redundant if the legislative, executive and judicial powers are
vested in one organ. Therefore, the duty to decide whether the limits
have been transgressed has been placed on the judiciary.
99
M. Govinda Rao, R Kavita Rao, Taxes and Death Are Inevitable, but GAAR Is Avoidable, Vol.
XLVII, No. 43, ECONOMIC AND POLITICAL W EEKLY, October 2012, p. 11
100
Rebecca Prebble, John Prebble, Does the Use of General Anti-Avoidance Rules to Combat
Tax Avoidance Breach Principles of the Rule of Law? A Comparative Study, available at
http://www.victoria.ac.nz/law/research/default.aspx last visited on 10/05/2014,
101
Kesavananda Bharati Sripadagalvaru v. State of Kerala, AIR 1975 SC 2299.
102
I. R. Coelho v. State of Tamil Nadu, (2007) 2 SCC 1.
66
Even before this, in Golak Nath103 case, stress was laid on rule of law. It
was observed that, having regard to the past history of our country, it could not
implicitly believe the representatives of the people, for uncontrolled and
unrestricted power might lead to an authoritarian State. It therefore, preserves
the natural rights against the State encroachment and constitutes the higher
judiciary of the State as the sentinel of the said rights and the balancing wheel
between the rights, subject to social control.
The Direct Taxes Code Bill, 2010, after its introduction in the Parliament,
was referred to the Standing Committee on Finance of the Parliament. In its
Report evaluating the nuances of the Bill the Committee noted various fallouts of
GAAR being invoked, both on equitable as also pragmatic consideration. These
were:
The provisions to deter tax avoidance should not end up penalizing taxpayers, who have genuine reasons for entering into a bonafide
transactions;
The proposals should not lead to any fiscal uncertainty or ambiguity; and
It should be ensured that any of the proposals does not pave the way for
avoidable litigation, which is already at a very high level in tax matters.104
Examination of provisions of GAAR would provide an idea that it is not
compatible with the values of rule of law.

Certainty: As for as certainty is concerned, there is near unanimity: most,
and probably all, legal philosophers consider that law must be relative certain in
order to conform to the principles of the rule of law. It is this requirement of
certainty that general anti-avoidance rules offend. The legislation adds little to the
common understanding of what constitutes tax avoidance. There is uncertainty
as to which transactions fall inside the general anti- avoidance rule. The
uncertainty surrounding tax avoidance stems from the fine line that separate
103
104
Golak Nath v. State of Punjab, (1967) 2 SCR 762.

(2012) 342 ITR (St.) 305, p. 98.
67
unacceptable tax avoidance from acceptable tax mitigation. Although it is

generally accepted that general anti-avoidance rules apply to tax avoidance and
not to tax mitigation, drawing the line between the two is often problematic. A
literal application of general anti-avoidance rules would improperly include many
legitimate transactions. General anti-avoidance rules, therefore, mean something
more than their words.
Certainty is clearly an important rule of law value. Usually certainty is
important for both the law-follower and the law-maker. Most laws are more
effective when people can be certain what they are meant to do or not do. That
is, in most cases the rule of law helps to promote effective law. General antiavoidance rules are, therefore, an aberration: It is their very vagueness that
makes them effective. If they were not vague, they would not be effective.
Drafters of the laws cannot foresee all relevant fact situations. As Hart pointed
out, all laws admit of core situations, where the law will definitely apply, and
penumbra, where it is less certain whether the law will apply. General antiavoidance rules because of their application is unclear in some situations appear
to subject them to a higher standard than we demand of law in general. The
difference is that general anti-avoidance rules have far larger penumbras than
most laws. Arguably, general anti-avoidance rules are nothing but penumbras.
The reason why legislators decide that they need general anti-avoidance rules is
that all situations where the rules may be needed cannot be defined in advance.
If legislators could foresee all varieties of tax avoidance, they would pass
specifically targeted rules to frustrate those endeavors. No doubt, most tax policy
makers could give examples of the sorts of arrangements that might be caught
by general anti-avoidance rules, but these examples would be cases that have
been found to constitute avoidance in the pat. The fact that general antiavoidance rules exist at all is evidence that policy makers and legislators
themselves cannot predict what structures taxpayers will eventually contrive.105
105
http://www.victoria.ac.nz/law/research/default.aspx last visited on 10/05/2014
68
The words of Adam Smith: The tax which every individual is bound to pay
ought to be certain, and not arbitrary. The time of payment, the manner of
payment, the quantity to be paid, ought to be clear and plain to the contributor,
and to every other person. Where it is otherwise, every person subject to the tax
is put more or less in the power of the tax gatherer, who can either aggravate the
tax upon any abnoxious contributor, or extort, by means of terror of such
aggravation, come present or perquisite to himself. The uncertainty of taxation
encourages the insolence and favours the corruption of an order of men who are
naturally unpopular, even where they are neither insolent nor corrupt. The
certainty of what each individual ought to pay is, in taxation, a manner of so great
importance, that a very considerable degree of inequality, is not near so great an
evil as a very small degree of uncertainty.106
Guidance: The rule of law requires that the law be certain so that it can
provide guidance. Generally, laws that are as vague as general anti-avoidance
rules attract considerable criticism, because they fail to provide people with
sufficient information about what is an dis not permitted to allow them to plan
their lives.
Liberty: According to Rawls, people must know exactly what legal rights
they can claim because if the bases of these claims are unsure, so are the
boundaries of mens liberties. 107 An essential part of being free is knowing
exactly how free one is. General Anti-Avoidance Rules does not provide any clue
as to how far their reach extends to. People are prevented from taking action that
might be allowed, the argument continues, because they do not want to take the
risk of their action being disallowed.
Non- Arbitrary: The General Ant-Avoidance Rule confers wide powers with
the tax-administration not just to disregard the actions of the taxpayers but also
to extrapolate or recast them in the manner which according to the taxadministration should yield the highest tax-revenue. This exercise would be
106
107
Adam Smith, The Wealth of Nations, vol. 5, Oxford University Press, 1977.
John Rawls, A Theory of Justice, p. 235
69
undertaken subsequent to the transactions having taken place and with the taxadministration antedating them post facto has a bearing on the principle of
certainty firmly embedded in the application of fiscal statutes.
Supreme Court has categorically held that fairness and reasonableness
must be the pivotal touchstones to check exercise of wide discretion vested with
administrative authorities- a lest which squarely applies to tax-administration in
the wake of wide powers conferred by the statutory GAAR. The law is to this
effect was declared by the Supreme Court in Rash Lal Yadav108 case in following
terms:
If the statute confers drastic powers it goes without saying that
such powers must be exercised in a proper and fair manner.
Drastic substantive laws can be suffered only if they are fairly and
reasonably applied. In order to ensure fair and reasonable
application of such laws courts have, over a period of time, devised
rules of fair procedure to avoid arbitrary exercise of such powers.
True it is, the rules of natural justice operate as checks on the
freedom of administrative action and often prove time-consuming
but that is the price one has to pay to ensure fairness in
administrative action. And this fairness can be ensured by
adherence to the expanded notion of rule of natural justice.
Therefore,
where
statute
confers
wide
powers
on
an
administrative authority coupled with wide discretion, the possibility

of its arbitrary use can be controlled or checked by insisting on their
being exercised in a manner which can be said to be procedurally
fair.
Justification: Typically, Governments combat avoidance by adding specific
and often very detailed rules to tax legislation rules that frustrate one kind of
avoidance transaction or another. For instance, jurisdiction might allow taxpayer
108
Rash Lal Yadav v. State of Bihar, (1994) 5 SCC 267.
70
companies to carry losses forward and to set them off against the profits of future
years. As an anti-avoidance measure, such jurisdiction tends to support these
rules with requirements of certain minimum continuity of ownership between the
loss year and the profit year. Tax statutes are replete with such rules. However,
specific anti-avoidance rules cannot combat the more creative forms of tax
avoidance that employ transactions governments cannot predict. Consequently,
many tax systems features general anti-avoidance rules in addition to specific
ones.109
General anti-avoidance rules allow tax authorities to disregard schemes
that would otherwise reduce tax liability. The transactions to which they apply are
void for tax purposes. For a transaction being void, the tax lies where it falls,
although modern general anti-avoidance rules often allow tax authorities to
reconstruct a transaction to reflect the economic reality of the circumstances and
to tax the taxpayer on the basis of the reconstructed transaction.
In the absence of General Anti-Avoidance rules, the alternative will be a
system with may specific rules that detail exactly what is and is not subject to
income tax. Presently India has specific rules and general anti-avoidance rules
are not in force. The specific and detailed a systems rules become, the more
ways people find to circumvent those rules.
Tax law is unusual in two key respects:
There are very few other areas of law that people so aggressively try to
avoid
The nature of tax law means that tax legislation contains a large number
of potential loopholes.
109
http://www.victoria.ac.nz/law/research/default.aspx last visited on 10/05/2014,
71
The result is that in the absence of a general anti-avoidance rule, there is apt to
be a great deal of tax avoidance that the government is powerless to stop as we
are presently witnessing in India and many other countries.
Tax avoidance undermines two key purposes of tax system. First, the
principle of horizontal equity states that people in the same economic position
should be taxed at the same rate. Tax avoidance makes horizontal equity difficult
to achieve, because successful tax avoidance results in some people being
taxed less than others who are in the same economic position. This result in
arbitrary applicability of tax laws. Second, tax avoidance makes it more difficult
for tax systems to be economically neutral. Economic neutrality demands that tax
systems should not distort the normal working of the market. people should not
make decisions for purely tax reasons.
The aims of the tax system are related to the more general point about the
purpose of tax systems. Governments do not tax people only to amass wealth.
Rather, tax is necessary to keep states functioning. Governments must provide
public services such as defense and education. Furthermore, most societies use
tax to redistribute wealth to some extent. Tax avoidance reduces the
effectiveness of welfare systems, a matter that is particularly important in the light
of the public perception that most tax avoidance is perpetrated by the rich or by
people who are relative well off.
This balancing exercise reveals much about the nature of the rule of law
and its values. Adherence to the rule of law can often interfere with a societys
other goals. When it comes to tax avoidance, the benefits to society of legal
certainty are outweighed by its detriments.
General anti-avoidance rules demonstrate that the rule of law is not an
unqualified good. As with all principles, the rule of law can be outweighed by
competing considerations. General anti-avoidance rules give an example of what
those competing considerations might be.
Furthermore, while general anti-
avoidance rules themselves are justified, they also are useful in showing exactly
72
why we value the rule of law. Most societies with developed legal systems tend
not to breach the rule of law very often. As a rare example of a breach, general
anti-avoidance rules are a useful reminder of why values such as certainty are
important.
The legislature has to provide detailed rules discerning fairness and
controlling the discretion of field formations entrusted with the authority to
administer GAAR. Failure to provide such restriction may evince violation of
constitutional norms with a high degree of probability of being declared arbitrary
and thus unenforceable.110
In Earl Lipson v. Queen,111 Speaking for the majority, LeBel J. observed,
The GAAR is neither a penal provision nor a hammer to pound taxpayers into
submission. It is designed, in the complex context of the ITA, to restrain abusive
tax avoidance and to make sure that the fairness of the tax system is preserved.
A desire to avoid uncertainty cannot justify ignoring a provision of the ITA that is
clearly intended to apply to transactions that would otherwise be valid on their
face.
From the above examination of provisions and ethos of rule of law, it is
very clear that General Anti-Avoidance Rules are incompatible with the values of
Rule of Law. However, an enquiry as to the need of GAAR also brought out its
importance in India. Attempts to justify GAAR on the various grounds were
carried on. The problem faced by many regimes is of Tax avoidance. To solve
this problem a shotgun approach is being taken by not only India but also many
other countries. The repercussions of this approach will definitely vitiate the
fundamental
norms.
GAAR
is
not
implemented
in
India
yet,
before
implementation the law has to become certain. The reach of these rules has to
be defined.
110
Khemka & Co. (Agencies) Pvt. Ltd. v. State of Maharastra, (1975) 2 SCC 22
Earl Lipson v. Queen (2009) 1 SCR 3
111
73
CHAPTER-VII
DOUBLE TAXATION AVOIDANCE AGREEMENT AND TAX
AVOIDANCE
In the current era of cross-border transactions across the world, due to
unique growth in international trade and commerce and increasing interaction
among the nations, residents of one country extend their sphere of business
operations to other countries where income is earned. One of the most significant
results of globalization is the noticeable impact of one countrys domestic tax
policies on the economy of another country. This has led to the need for
incessantly assessing the tax regimes of various countries and bringing about in
dispensable reforms. Therefore, the consequence of taxation is one of the
important considerations for any trade and investment decision in any other
countries. Where a taxpayer is resident in one country but has a source of
income situated in another country, it gives rise to possible double taxation. This
arises from two basic rules that enable the country of residence as well as the
country where the source of income exits to impose tax, namely: Source rule: the
source rule holds that income is to be taxed in the country in which it originates
irrespective of whether the income accrues to a resident or a nonresident and
Residence rule: the residence rule stipulates that the power to tax should rest
with the country in which the taxpayer resides.
Double taxation has adverse effects on the trade and services and on
movement of capital and people. It constitutes prohibitive burden on the taxpayer. Relief against double taxation is provided by unilateral measure or by way
of bilateral measures. Agreements entered by countries to avoid the double
taxation. These agreements are now becoming a way for avoiding tax. The very
purpose double taxation avoidance agreement is vitiated by taking advantages of
it with tax havens. The chapter concentrates on the above issue and also on
impact of double taxation avoidance agreements on developing countries.
74
1.
DOUBLE TAXATION
OECD Draft Convention defines double taxation as the imposition of

comparable taxes in two or more States on the same taxpayer in respect of the
same subject matter and for identical periods. International double taxation will
have following characteristics: assessment by various independent bodies having
powers of taxation whose superior organization are states or belonging to various
states; assessment of the same entity in respect of the same object of taxation
for the same tax period with the imposition of comparable taxes; taxation of the
same income or capital in the hands of taxpayers who are legally two separate
entities, although identical or at least associated from an economic point of view.
Double taxation may arise in same jurisdiction of competing jurisdictions.
Double taxation arises in the same jurisdiction when a single governmental unit,
such as a country attempts to tax the same property twice under different names.
Double taxation arises chiefly when wealth and the evidences or representatives
of wealth are taxed at the same time. Double taxation by competing jurisdictions
arises when two or more states or countries attempt to tax the same property,
income, or inheritance. It may arise as a result of confusion among the various
states in making precise legal distinction between real and personal property, or
because of the confusion on the part of the various states in regard to the situs of
tangible personal property, or failure to distinguish between wealth and property,
or in an attempt to tax same incomes in two competing jurisdictions.112
Competence of the states in matters of taxation was considered in the
Report on Double Taxation which was submitted to the Financial Committee of
the League of Nations in 1923, the report propounded four general principles in
accordance with which States are accustomed to impose taxes113:
a. Political allegiance, or nationality
112
Cornelius J. Gregg, Double Taxation, available at http://www.jstor.org/stable/743096, as

visited on Nov. 20, 2013, pp. 82,83.
113
R. F. Bailey, Double Taxation in Regard to Death Duties, available at www.heinonline.com as
visited onNov. 30, 2013, p. 48
75
b. Temporary residence,
c. Domicile, or permanent residence, and
d. Location of wealth, or situs.
It was pointed out in the Report that the reason why States waver between
these principles is that they may be regarded as elements in the broader modern
doctrine of economic allegiance.
2. DOUBLE TAXATION AVOIDANCE AGREEMENT
The Organization for Economic Co-operation and Development (OECD)

has noted that the purpose of double taxation conventions is to promote, by
eliminating international double taxation, exchanges of goods and services, and
the movement of capital and persons and that the phenomenon of international
juridical double taxation and its harm effect on the exchange of goods and
services and movement of capital, technology, and persons are so well known
that is scarcely necessary to stress the importance of removing the obstacles
that double taxation presents to the development of economic relations between
countries.114
Double Taxation avoidance agreements may be classified into:
Comprehensive Agreements: These types of agreements provides for

taxes on income, capital gains and capital investments and ensure that
the taxpayer in both the countries would be treated on equitable manner in
respect of the issue relating to double taxation.
Limited Agreements: These agreements denote income from shipping and

air transport or legacy and gifts.
There are several models of Double taxation Avoidance Agreement but
prominent among them are OECD, US and UK model. These model tax treaties
attempt to resolve some of the problems of overlapping tax jurisdictions through
114
Tsilly Dagan, The Tax Treaties Myths, 32 N.Y.U.J. INTL & POL. 939 (2000), p.6
76
internationally accepted tax rules. They recognize that each State is entitled to
exercise its sovereign taxing rights within its fiscal jurisdiction. To avoid double
taxation, the State must agree to limit their domestic tax rules under the tax
treaty. These treaties comprises the standard clauses which can be amended by
the negotiations between the Contracting States
Model tax treaties are relieving in nature. Most of its provisions are
designed to create rights and benefits for taxpayers where none would otherwise
exist. They allocate taxing rights but do not make the tax rules, which are based
solely on domestic laws. They do not require that the allocated taxing rights must
be exercised by a State or dictate how they must be exercised. The use of
treaties is also optional since the taxpayer can choose in many countries to apply
the domestic tax law if it is more beneficial. The Model treaties may reduce but
normally do not increase the taxing rights under the domestic law of each State.
When we see Indian position regarding double taxation and double
taxation avoidance agreements then we come to know that unlike many
countries like U.S.A India also permits double taxation. Double taxation is
permitted in certain matters only. When it comes to cross border transactions
India also has entered into number of DTAA with foreign countries and availing
the benefits of these agreements.
In Laxmipath Singhania v. CIT115, Supreme Court made it clear it is a
fundamental rule of the law of taxation that unless otherwise expressly provided
income cannot be taxed twice. Again it was not open to the Income Tax Officer, if
the income has accrued to the assessee and is liable to be included in the total
income of a particular year, to ignore the accrual and thereafter to tax it as the
income of a another year on the basis of receipt. This principle is also been
given statutory effect in the Income Tax Act through Explanation 2 to section 5
which provides that for the removal of doubts it is hereby declared that income
which has been included in the total income of a person on the basis that it has
115
Laxmipath Singhania v. CIT, (1969)72 ITR 291 SC
77
accrued or arisen or is deemed to have accrued or arisen to him shall not again
be so included on the basis that it is received by him in India. S.C. in Jain
Brothers v. Union of India116 has observed that, there can be double taxation if
the legislature has distinctly enacted it. It is only when there are general words of
taxation and they have to be interpreted, they, cannot be so interpreted as to tax
the subject twice over to the same tax. The Constitution does not contain any
prohibition against double taxation even if it is to be assumed that such taxation
is involved in the case of a firm or its partners. Nor is there any other
enactment which interdicts such taxation.117 Under entry 14 of list I in Schedule
VII to the Constitution of India, the union of India has power to enter into treaties
and agreements with foreign countries and implementation of such treaties,
agreements and conventions with foreign countries.
The Indian Income Tax Act, 1961 administrates the taxation of income
accrued in India. As per Section 5 of the Income Tax Act, 1961 residents of India
are liable to tax on their global income and non-residents are taxed only on
income that has its source in India. The Provisions of DTAA override the general
provisions of taxing statute of a particular country. It is now well settled that
in India the provisions of the DTAA override the provisions of the domestic
statute. Moreover, with the insertion of Sec.90 (2) in the Indian Income
Tax Act, it is clear that assessee have an option of choosing to be
governed either by the provisions of particular DTAA or the provisions of
the Income Tax Act, whichever are more beneficial. Further if Income tax Act
itself does not levy any tax on some income then Tax Treaty has no power to
levy any tax on such income. Section 90(2) of the Income Tax Act recognizes
this principle.
116
Jain Brothers v. Union of India (1970) 77 ITR 107 SC

R, Santanam, Double Taxation Avoidance Agreements, (Delhi: Commercial Law Publishers
(India) Pvt. Ltd.), 2004, p. 550.
117
78
3. DOUBLE TAXATION AGREEMENTS AND TAX AVOIDANCE

An important problem in the international fiscal commons is the
emergence of third countries that have found ways to tap tax base by
manipulating existing international tax laws. This typically results in the erosion of
both source and residence country tax bases. Most such third countries have
come to be known as tax havens and offshore financial centres (OFCs). Tax
havens are countries or autonomous jurisdictions having low tax regimes for nonresidents. Low tax regimes are often coupled with secrecy laws or practices
which result in limited information provision about non-residents to fiscal and
financial regulators, possibly opaque and discretionary tax and financial
regulations, and lenient laws for incorporation of business by foreigners. Tax
havens themselves benefit from being havens. what is less clear is the impact of
this avoidance on the economies of countries with high tax rates.118 Serious
problems associated with OFCs and some tax havens, with greater ramifications
than just avoidance, relate to unidentified cross-border capital flows for terrorism,
drug trafficking and other criminal activities.119
Tax avoidance opportunities, inter alia, arise from residence country tax
provisions in treaties. The incentives arising from tax systems to shift income
from high-tax to low-tax jurisdiction exist if the home country exempts foreignsource income. This incentives is absent only if income is repatriated by a firm
resident in a country that taxes worldwide income if, furthermore, the firm is
unable to claim sufficient foreign tax credits to attain zero tax status. Due to the
interaction of Double taxation Avoidance Agreements and tax havens, countries
claim to lose a large amount of revenue on cross-border transactions. Common
entities can engage in a variety of tax avoidance strategies to reduce taxes.
Hence, DTAAs and tax laws for non-resident income have to incorporate
defense measures to pre-empt tax base capture by such jurisdictions.
118
Arindam Das-Gupta, Economic Analysis of Indias Double Tax Avoidance Agreements, 2010,
available at: http://ssrn.com/abstract=1632939 last visited on 03/05/2014, p. 7
119
Ibid
79
The more experiences of double tax burdens, the greater will be the
incentives to them to look for and to employ new ways and means of avoiding
such burdens. For example; an enterprise establishing business abroad usually
avoids tax in stages, comprising exports of its own products to dependent or
independent sales companies, granting production licences to third parties,
establishment of operating companies abroad. Tax planning runs parallel to each
stage. With the increasing transfer of functions abroad, the scope available to
these enterprises for organizing their various operations so as to minimize the tax
burden is also broadened. A typical multinational enterprise is made up of a large
number of legally independent companies engaged in production, trading and
providing services in a great many countries under the management of a parent
company. These subsidiary companies cooperate with one another, exchange
licences and know-how, pool their profits and raise funds on international capital
markets. This is not only the source of their particular economic strength, but also
of their potential for shifting profits. However, enterprises of this king are favoured
not only by their organizational set-up, but also by the fact that there is no
possibility on an overall check on taxation by any one state. With relation to this
the countries need to address three problem areas to seek the solution: how to
ensure a greater degree of consistency in the practice of governments and of
companies in establishing profits levels based upon the principle of arms length
pricing; how to facilitate the task of national tax administrations in identifying
reported profits which need to be adjusted; and how to improve, in a manner
conducive to the avoidance of double taxation, arrangement for adjusting and
readjusting profits of affiliated companies in different countries.
The benefit of tax avoidance is taken through treaty shopping. Indian
Supreme Court dealt with the issue of treaty shopping in Azadi Bachao
Andolan120 case, it was argued by the respondent that the offshore companies
incorporated in Mauritius were shell companies, carrying on no business in
Mauritius, and were incorporated only with the motive of taking undue advantage
120
Union of India v. Azadi Bachao Andolan and Anr. (2003) 263 ITR 706
80
of the favourable tax treaty between India and Mauritius. The Supreme Court
rejected this argument. It held that if it were intended that a national of a thir
State should be precluded from the benefits of the treaty, then a suitable
Limitation on Benefits clause have been incorporated therein. Therefore, where
such a clause does not exist in a Treaty, it cannot be read into it.
The court further observed that Overall, countries need to take, and do
take, holistic view. The developing countries allow treaty shopping to encourage
capital and technology inflows, which developed countries are keen to provide to
them. The loss of tax revenues could be insignificant compared to the non-tax
benefits to their economy. Many of them do not appear to be too concerned
unless the revenue losses are significant compared to the other tax and non-tax
benefits from the treaty, or the treaty shopping leads to other tax abuses.
Whether it should continue, and, if so, for how long, is a matter which is best left
to the discretion of the executive as it is depended upon several economic and
political considerations.121
Anti-avoidance initiatives
To counter avoidance strategies, countries have taken a variety of
measures. The OECD has taken the lead in this through its Harmful Tax
Practices (HTP) initiative and various information sharing, coordination and
transparency conventions to counter OFCs and tax havens.
The OECDs Harmful Tax Initiative: This was initiated in 1998 in response
to several countries, whose rights to exploit the fiscal commons were not
accepted by the OECD, that were eroding OECD member countries tax bases
using what they considered illegitimate means. Some commentators perceive
this initiative as the use of strong-arm tactics by the rich and powerful members
of the OECD to deprive smaller nations of their sovereign rights to tax. For
example, the following quote from Langer (2000) is of interest:
121
Union of India v. Azadi Bachao Andolan and Anr. (2003) 263 ITR 706
81
"Mitchell says that this OECD effortcontradicts international norms

and threatens the ability of sovereign countries to determine their
own fiscal affairs.' He adds that the OECD proposal..would create
a cartel by eliminating or substantially reducing the competition
these high-tax nations face from low-tax regimes.122
Under this initiative, the OECD (see OECD, 1998) defined four key factors
to identify tax havens and harmful preferential tax regimes in non-haven
jurisdictions.
Low, nominal or zero special tax rates for mobile income is the first
criterion which, however, needs to be combined with one or more of the
other three factors for a countrys tax regime to be regarded as harmful.
The second criterion is existence of ring-fencing whereby the domestic

economy is partially or fully isolated insulated from the tax regime for
foreign taxable entities. In tax havens with limited domestic economic
activity, ring-fencing is replaced by the criterion of absence of substantial
economic activity. A common example of ring-fencing is a restriction of
special tax benefits to non-residents.
The third criterion is lack of effective information exchange on taxpayers

benefiting from low tax regimes in a jurisdiction.
The fourth criterion is lack of transparency in legislative or administrative

tax provisions giving on tax administrations latitude in interpretation of tax
laws and room for negotiated taxes due from favoured entities.
4. EFFECT OF DTAA ON DEVELOPING COUNTRIES
Jurisdiction to tax income is most frequently based upon either the
principle of residence or the principle of source.123 Under either principle, extra-
122
Arindam Das-Gupta, Economic Analysis of Indias Double Tax Avoidance Agreements, 2010,
available at: http://ssrn.com/abstract=1632939 last visited on 03/05/2014, p. 7
123
Under the principle of residence, all income of persons domiciled or normally resident in a
country is subject to that countrys income tax; under the principle of source, all income
82
territorial taxing jurisdiction is asserted, as jurisdiction is extended to foreign

source income under the residence principle and to nonresident aliens under
the source principle. To the extent one country asserts such extra-territorial
taxing jurisdiction there arise the possibility of conflict with the internal tax
systems of other countries as against the purpose of double taxation
agreements. The primary purpose of double taxation agreements is to facilitate
the international flow of capital, technology, and services by eliminating double
taxation of income through bilateral resolutions of the conflicts between
overlapping tax jurisdictions.
The present system of tax agreements creates the anomaly of aid in
reverse- from poor to rich countries. The reason for this anomaly is that the tax
agreements currently in force generally give the country of a taxpayers
residence either the exclusive or more substantial right to tax income as against
the country in which the income arose and in income generating transaction
between developed and developing countries the former is invariably the country
of residence and the latter the country of source. Whatever the merits of the
present system of double taxation agreements in apportioning income between
developed countries, it is clear that this system is inappropriate as means of
allocating income between developing and developed countries. The present
system generally operates to the considerable disadvantage of developing
countries because of the preference most double taxation agreements have for
the residence country and the concomitant contraction in income such
preferences cause in the source country. When contracting states are at greatly
different levels of economic development, the income flows in substantially only
on direction- out of the developing country, as source country, into the developed
country, as residence country.
The history of double taxation agreements has shown that they were
developed in the light of the economic and social policies important to the
originating in a country, regardless of to whom such income accrues, is subject to that countrys
income tax.
83
contracting countries and it is possible that the desire of developed countries to

have their extraterritorial tax jurisdiction determined in a manner consistent with
the fundamental structures of their domestic tax systems played a significant role
in the formulation of the double taxation agreements presently in force. Since
most of the domestic tax systems of developed countries are based upon a
combination of the residence and source principles- that is, developed countries
generally tax residents on their world-wide income and foreigners on all income
with its source within the country.124
The disadvantages of the present system of double taxation agreements
for developing countries have long been recognized by developed countries and
some developing countries. At least since the early 1940s, developing countries
have actively tried to gain greater use of the source principle in double taxation
agreements. At that time there were regional conferences in Mexico City
attended by representatives of the United States, Canada and the Latin
American countries. These conferences were greatly influenced by the views of
the developing countries and resulted in model income tax convention predicated
almost exclusively on the principle of source.125 However, a substantial majority
of the double taxation agreements presently in force between developed and
developing countries continue to give primacy to the residence principle and to
shift revenues from developing and developed countries. A great number to the
disadvantageous double taxation agreements presently in force were assumed
by newly independent countries as part of the general assumption of rights and
obligations from the former colonial powers.
There are numerous reasons, why unfavourable double taxation
agreements with an emphasis on residence are assumed by developing
countries on independence or executed between developing and developed
countries. The main reasons are as follows:
124
Charles R. Irish, International Double Taxation Agreements and Income Taxation at Source,
23 INTL & COMP. L.Q. 292, 1974,p. 295
125
Charles R. Irish, International Double Taxation Agreements and Income Taxation at Source,
23 INTL & COMP. L.Q. 292, 1974,p. 298
84
Developing countries are unaware of the spurious or overemphasized

nature of many of the reasons propounded for the predilection for
residence;
As a condition precedent to the ready availability of the capital, technology

and services of such countries, developing countries are under pressure
to accept any agreement which provides for exemption of foreign source
income or grants full credit against domestic taxes for foreign income
taxes;
Developing countries are unaware of the disadvantages of double taxation

agreements with a predilection for residence and that inroads into the
primacy of residence can be made in particular areas or with certain
countries;
Developing countries have or believe they have a relatively weak bargaining

power and developing countries take advantage over it.
Double taxation hinders the economic growth by preventing the
investments into the countries. Double Taxation Avoidance Agreements are not
the sole measures to mitigate the double taxations. There are several other
methods which a country takes into account to mitigate. These other methods
may be more effective than Double Taxation Avoidance Agreement. Under
Double Taxation Avoidance Agreements the Contracting parties arrive at a
mutually consenting provisions by giving away some of its rights to tax the
income. Since every clauses of agreement are the results of negotiation, no two
agreements are similar.
Double Taxation Avoidance Agreements benefits the parties of the
Agreements as well as the subjects of the Agreement. It benefits the individuals
or the entities by providing the certainty of tax on their income or profits. The
contracting States are also benefited as they get investments into their countries
on the basis of the rate of tax and applicability of tax. However it is not that the
Agreements are always beneficial. They can even result in causing ill effects.
This is mainly because of the economic interdependency and unequal bargaining
85
power of the States. One state tend to dominate other when it finds itself in better
bargaining position. Double taxation agreements do not employ uniform principle
of taxing. It employs source or residence principle. A country can employ source
principle in one DTAA and same country employs residence principle in another
DTAA with another country. Many of the developed countries are doing this. This
gives the tax from residents as well as the tax from foreigners. To this extents the
other contracting states jurisdiction to tax is limited by the DTAA. DTAA and tax
heavens are increasing the tax avoidance strategies and even creating
opportunities to MNCs to avoid tax. an agreement which is entered to bring
certainty in law is now aiding to vitiate the taxing structure.
86
CHAPTER-VIII
CORPORATE SOCIAL RESPONSIBILITY AND TAX AVOIDANCE
Corporations and Multi-National Enterprises are the major groups
responsible for huge revenue loss to government because of tax avoidance
strategies. The concept of tax implies a compulsory duty. Any compulsory duty
will not be voluntary. Avoidance strategies are carried by the corporations
because they are not willing to pay taxes as they think paying taxes will reduce
their profit share.
Corporations are a necessary institution, with the growth of commerce, the
role of corporation is increasing and the impact they have on society is also
immense. Corporations should be made responsible towards society just like a
citizen. They assume an artificial citizens status in the place of residence. Just
as in case of environment and human rights, how the judiciary has developed
doctrines where corporations are made responsible, similar way they must also
be made responsible towards society by making them to pay taxes.
Corporate Social Responsibility is most debated issue. The debate first
pertains to whether corporations have social responsibility, because the only
objective of business is to make profit. However, this chapter does not address
above debate and it is presumed that corporations have social responsibility. The
issues raised in this chapter are two-fold: whether tax avoidance can be treated
as an issue relating to corporate social responsibility and whether by linking
corporate social responsibility and tax avoidance, can corporation be encouraged
to include anti-avoidance measures in its culture.
1. Corporate Social Responsibility and its ambit
In the words of Keith Davis and Robert Blomstroom (1975), Social
responsibility refers to a persons obligation to evaluate in the decision making
process the effects of both his personal and institutional decisions and action on
the whole social system. According to them, corporate social responsibilities
87
mean the obligation of decision-makers to take actions which protect and

improve the welfare of society as a whole along with their own interest. 126
According to Joseph Mc Guire (1963), the idea of social responsibilities
supposes that the corporation has not only economic and legal obligations, but
also certain responsibilities to society which extend beyond these obligations.127
Corporate Social Responsibility generally refers to the obligations and
inclinations, if any, of corporations organized for profit, voluntarily to pursue
social ends that conflict with the presumptive shareholder desire to maximize
profit.128
The term corporate Social Responsibility refers to the assumption of
responsibilities by companies, whether voluntarily or by virtue of statute, in
discharging socio-economic obligations in society. No identifiable and acceptable
definition of Corporate Social Responsibility is found. Consequently, the
contents, dimensions and the nature of the concept remain unclear, although its
role in the corporate world and the business world at large cannot be denied.
There seems to be a broad consensus among many commentators that a
definition of Corporate Social Responsibilities contains two main principles: the
philanthropic and the trusteeship principles. When a company discharges a
social service role it is then concerned with corporate philanthropy. In such
circumstances, companies participate in society by engaging in social activities
themselves and by encouraging philanthropic activities in the form of resolution
of chosen social problems of the community without any direct monetary
benefits. The trusteeship principle, on the other hand, perceives directors as
trustees for shareholders, creditors, employees, consumers and the wider
community. However, there seems to exist an apparent hierarchy between these
126
Z.U. Khairoowla, Nawab Ali Khan, Corporate Social Responsibility: The Need of the Hour,
Corporatization And Corporate Social Responsibility, (New Delhi: SBS Publishers and
Distributors Pvt. Ltd.), 2011, p.5
127
128
David L. Engel, An Approach to Corporate Social Responsibility, 32 STAN. L. REV. 1, 1979.
88
groups of creditors of the company primarily relate to be protection of their

monetary interest. 129 Corporate philanthropy is, therefore, concerned with the
companys role in society. The trusteeship principle is however, more concerned
with the awareness of a sense of responsibility on the part of directors towards
the various groups of people with whom they are directly concerned.
Henry H. Albers (1972) has explained the concept of social responsibility of
business asi.
Justice and fair play in all its dealings;
ii.
Making of serious attempts at growth and development of all the factors of

constituents of business from owners to consumers;
iii.
Utilization of surplus, if at all left over, for any other social purpose
deemed fit for assistance such as education and health. The surplus may
further be utilized for the purposes which should not be controversial and
for which no new values should be setup by the society itself, through
there might be slight difference of opinion here and there in regard to the
emphasis to be placed on certain values. The following may be some such
non-controversial purposes: elimination of poverty in certain, areas,
providing employment, control of pollution and population, establishment
of industrial peace, disposal of waste, provision of housing and transport
facilities, making good water, food and power shortage, contribution of
defence effort and many such others.130
The responsibilities of the business should be related to the changing social

expectations, which are depended upon the social, political and other
environmental factors, which are dynamic too.
Broad components of CSR
129
Dr. Saleem Sheik, Corporate Social Responsibilities Law and Practice, (Great Britain: Biddles
Ltd., Guildfordand Kings Lynn), 1996, p.15
130
89
Employees Welfare: these include right to organize, child welfare, right to

collective bargaining, abolition of child labour, living wages for social
security training, safety, health and well being, life-long learning,
empowerment of employees, empowerment of women in rural and urban
areas.
Human Rights: the business practices can profoundly affect the rights and
dignity of employees and communities. Developing workplaces free from
discrimination where creative and learning can flourish
Consumer rights: steps for consumer protection, practicing and giving

proper weightage to Right to Information, proper hearing their grievances
and
effective
redressal
mechanisms
and
creating
corporate
Ombudsman.
Environmental
Protection:
responsibilities
i.e.
respect
CSR
for
also
includes
environment,
environmental
environment
friendly
technologies, use of conservation and discharge of energy, material and

water in an eco-friendly manner, adopting preventing and precautionary
measures for environmental pollution and control; rectifying environmental
damage at source; treating waste before disposing it; preservation of bidiversity; promoting and implementing an environmental
policy for
sustainable energy and environment.
Community
Development:
sharing
resources
with
unprivileged
communities, investing in social development programmes for the

community at large.
Business
Responsibilities:
compliance
with
Tax
laws
and
other
regulations, investing in developing science and technology, fostering

ethical trade practices to all authorities, customer groups, business
partners and external influences.
90
2. Linking Corporate Social Responsibility and Tax

Avoidance
The company does not exist solely to maximize profits for the
shareholders, but also to serve the society on which it depends for its existence.
Though the theory of Friedman did not favor social responsibility of corporations
still few insights of social side of corporation can be seen in his theory. Friedman
expounds that the corporate executives responsibility is to conduct the business
in accordance with the shareholders desire, which generally will be to make as
much money as possible while conforming to the basic rules of the society, both
those embodied in the law and those embodied in ethical customs.131
Four social responsibilities that any company has to society: economic,
legal, ethical, and philanthropic. The corporations ultimately have to survive in
the society. It cannot be argued that corporation has no role towards society as
the actions of the corporations heavily impact on the society. If society is harmed
or destroyed there will not be any scope for corporation. Business depends upon
the mutual will of buyer and seller. According to Dahl .Every large corporation
should be thought of as a social enterprise; that is, an entity whose existence and
decisions can be justified only insofar as they serve public or social purposes.132
Since corporations are perceived as social enterprises, it is permissible for
them to take account of the social welfare considerations which affect society.
Companies should, therefore, discharge their social obligations for the benefit of
society and in the public interest. The purpose why tax obligation is imposed is to
consolidate fund from those who can bear the burden to serve the country and its
need. Tax avoidance hinders this objective and horizontal equity is destroyed.
In his writings, Berle believed that corporate social responsibility had
revolutionalized the modern company. Management provided a social service
131
Colin Marks and Paul S. Miller, Plato, THE PRINCE and Corporate Virtue: Philosophical
Approaches to Corporate Social Responsibility, available at: ssrn.com/abstract=1616903 last
visited on 03/05/2014.
132
91
and a good life for the community. Corporate social responsibilities require the
management of a company to have an orientation which contributes to a
corporations philanthropic activities and those based on the trusteeship principle.
Indeed,
Howard Bowen emphasized
that
voluntary commitment
by
corporations to pursuing social objectives is essential. The spill-over effects of

such a commitment should automatically improve the quality of management and
thereby contribute to the welfare of the society. This voluntary assumption of
responsibilities include corporate involvement in charitable contributions,
community service, employee welfare, charging reasonable prices, improving
existing products and introducing new ones, locating plants according to
community needs, providing for conservation of natural resources and promoting
fundamental scientific research.133 However, the list is not exhaustive.
The
arguments
in
support
of
business
assumptions
of
social
responsibilities are based on two key facts1. Business operation causes serious social problem and so business has a
moral responsibility to solve them or at least ameliorate them.
2. Even in problem areas where business is not guilty of causing them
directly, business should do something in its own enlightened self-interest
to promote social welfare.
In National Textile Workers Union v. P. R. Ramakrishnan and Others134,
the Honble Supreme Court by Mjority: P. Bhagwati, Chinnppa Reddy and
Baharul Islam, JJ. Observed that:
The concept of a company has undergone radical transformation
in the last few decades. The old nineteenth century view which
regarded a company merely as a legal device adopted by
shareholders for carrying on trade or business as proprietors has
been discard a company is now looked upon as a socioeconomic
133
134
National Textile Workers Union v. P. R. Ramakrishnan and Others 1983 AIR 750
92
institution wielding economic power and influencing the life of the

people. The view that a company is the property of the
shareholders can no longer be regarded as valid. Apart from capital
and labour there are other factors which contributes to the
production of national wealth; the financial institutions and
depositors who provide the additional finance required for
production and the consumers and the rest of the members of the
community who are vitally interested in the product manufactured.
A company, according to the new socio-economic thinking, is a
social institution having duties and responsibilities towards the
community in which it functions and one of its paramount objectives
is to bring about maximization of social welfare and common good.
This necessarily involves reorientation of thinking in regard to the
duties and obligations of the company not only vis--vis the
shareholders but also vis--vis the rest of the community affected
by its operations
"Taxes are what we pay for civilized society", Oliver Wendell Holmes - Jr,
in the case of Compan I ia General de Tabacos de Filipinas v. Collector of
Internal Revenue, 1904.
Paying taxes is perhaps the most fundamental way in which private and
corporate citizens engage with broader society. Tax revenues are the lifeblood of
the social contract, vital to the development and maintenance of physical
infrastructure and to the sustenance of the infrastructure of justice that underpins
liberty and the market economy. It is therefore curious that tax minimization
through elaborate and frequently aggressive tax-avoidance6 strategies is
regarded as one of the prime duties that directors are required to perform on
behalf of their shareholders. It is more curious still that the debate about
Corporate Social Responsibility (CSR), which has touched on virtually every
other area of corporate engagement with broader society has scarcely begun to
93
question companies in the area where their corporate citizenship is most tangible
and most important - the payment of tax.
Corporate social responsibility is a shared belief within a firm. It is the
belief about the right course of actions that takes into account not only economic
but also social, environmental and other externalized impacts of company
actions. it follows that irresponsible CSR activities are inconsistent with CSR.
Likewise, aggressive tax avoidance practices are costly to society and they are
widely viewed as unethical and irresponsible by the public and the popular
press; it follows that overly aggressive tax avoidance is also likely to be viewed
as inconsistent with CSR. Accordingly, aggressive tax avoidance practices
should be positively, or at least non-negatively, associated with irresponsible
CSR activities.135
A study was carried in U.S.A. to establish the link. Using a large sample of
U.S. public firms over the period 2003-2009, the researchers tried to find that
firms with more irresponsible CSR activities, particularly those with excessive
irresponsible activities in a given year, have a higher probability of engaging in
tax sheltering, greater discretionary book-tax difference and a lower cash
effective tax rate, after controlling for firm performance, earnings quality,
corporate governance, industry effect, year effect, and other factors influencing
tax avoidance.136 The outcome of the study was positive and thus it can be said
that a link can be established between CSR and Tax avoidance.
3. Shareholders benefits and reputational costs
Tax planning to minimize the obligation to pay taxes increases financial
and organizational complexity. And, to the extent that this greater complexity
cannot be adequately communicated to outside parties, such as equity investors,
135
Chung-Keung Hoi, Is Corporate Social Responsibility (CSR) Associated with Tax Avoidance?
Evidence from Irresponsible CSR Activities, available at: www.ssrn.com, last visited on
3/05/2014.
136
Chung-Keung Hoi, Is Corporate Social Responsibility (CSR) Associated with Tax Avoidance?
Evidence from Irresponsible CSR Activities, available at: www.ssrn.com, last visited on
3/05/2014.
94
creditors, and analyst transparency problems can arise. Bhushman, Chen, Engel
and Smith described this transparency potential problem as follows:
Operational complexities can arise as firms act to arbitrage institutional
restrictions such as tax codes and financial restrictions. For example, firms may
employ complex transfer pricing schemes to shift profits to low tax jurisdictions
that can complicate efforts by shareholders and board members to understand
firms foreign operations.137
Corporate social responsibility activities can be viewed as a risk
management strategy that a firm uses to enhance its corporate social
responsibility reputation, which, in turn, protects the firm against the risk of
adverse political, regulatory and social sanctions/penalties in the case of
negative corporate events. Aggressive tax avoidance practices may lead to
severe negative sanctions such as loss of firm/executive reputation, increased
political or media pressure, penalties and even consumers boycotts. Consumers
become aware of tax avoidance when firms are identified by other sources, most
often the financial press, but also through protests and the work of advocacy
groups, for instance Citizens for Tax Justice. Irresponsible CSR activities will
then be reduced to enhance their CSR reputation, so as to lessen the expected
costs associated with aggressive tax avoidance practices.
4. Morality and Tax Avoidance
Ethics deals with values, with good and bad, with right and wrong.
We cannot avoid involvement in ethics for what we do- and what
we dont do- is always a possible subject of ethical evaluation.
Anyone who thinks about what he or she ought to do is,
consciously or unconsciously, involved in ethics138.
-
Peter Singer
137
Karthik Balakrishnan, Does Tax Aggressiveness Reduce Corporate Transparency?, available

th
at: http://ssrn.com/abstract=1792783 last visited on 10 may 2014.
138
Jean Jacques du Plessis, James Mcconvill, Mirko Bagario, Principles of Contemporary
Corporate Governance, (Cambridge: Cambridge University Press), 2005, p. 343
95
The moral status of tax avoidance is contentious. A number of cases hold that
people have the right to arrange their affairs so as to pay as little tax as possible;
some even hold that there is nothing immoral about tax avoidance. Relying on
such decisions, lawyers tend to assume that as a matter of law tax avoidance is
morally unimpeachable. However, it is a logical error to say that because tax
avoidance is not immoral as a matter of law it is not immoral in any sense.
Whether a certain act is moral must be determined according to principles of
ethics, not by reference to statements in judgments. What is the moral status of
tax avoidance according to basic principles of ethics? As a matter of morality
untainted by law, people know that they have a duty to pay tax, so seeking to pay
less tax might appear to be shirking that duty.
It is possible that judges who say that there is nothing immoral about tax
avoidance are correct, but if that is so, it must be because tax avoidance is moral
according to ethical principles. As a matter of logic, a judge saying that a
particular act is moral as a matter of law cannot determine whether the act is in
fact moral.
Morality alone, without legal backing, does indeed seem inadequate as a
guide to the duty to pay tax. A leading legal philosopher has used tax as an
example of an area where morality cannot provide adequate guidance without
legal content. Professor Honor has explained that in complex societies morality
is dependent on law. Morality is like an outline from which details are missing.
Laws, along with conventions, fill many of these in. In his view, taxation affords a
good example of this point:
According to most peoples moral outlook members of a community
should make a contribution to the expense of meeting collective
needs. . . .So members of a community have in principle a moral
obligation to pay taxes. But this obligation is incomplete or, if one
prefers inchoate, apart from law. It has no real content until the
amount or rate of tax is fixed by an institutional decision, by law.
What amounts to a reasonable contribution is not otherwise
96
determinable, since what is required is a co-ordinated scheme which

can be defended as fair not merely in the aggregate amount it raises
but in its distribution. Taxpayers cannot settle it for themselves, as
people can within limits settle for themselves, say, the proper way of
showing respect for the feelings of others. Apart from law no one
has a moral obligation to pay any particular amount of tax. An
obligation to pay an indeterminate amount is not an effective
obligation; it requires only a disposition, not an action. So, apart from
law no one has an effective obligation to pay tax.139
The surface nature of moral language suggests that moral principle is applicable
to all forms of human conduct, whether public or private. There is moral crisis in
India today. Taxpayers are not conscious of their responsibilities towards the
society and the country in which they are living. People blame the government for
the difficulties and shortages. However, when it comes to the payment of taxes,
they feel as if it is their moral duty to avoid tax. This is probably because there is
no system in India whereby people may know that they should pay proper taxes.
In the USA even the school-going children are made conscious about the
payment of proper taxes. In recent years, special efforts have been made in the
UK to help young people coming into the tax system for the first time to
understand how it works, and how they can get advice if they encounter tax
problems.140
Multinational companies should adopt clear CSR standards in the area of
taxation, including requirements to publish all necessary accounting information
and to refrain from the use of profits laundering vehicles created without
substantial economic purpose. CSR reports should list the countries in which the
company trades, how much profit is derived from activities in each of these
countries, and where these profits are booked for tax purposes, indicating any
139
Judith Freedman, Defining Taxpayer Responsibility: In Support of a General Anti-Avoidance

Principle, No. 4, BRITISH TAX REVIEW, 2004, p. 338
140
Anil Kumar Jain, Tax Avoidance and Tax Evasion: The Indian Case, Vol.21, No. 2, Modern
Asian Studies (1987), pp. 233-255, available at http://www.jstor.org/stable/312646, last visited on
14/3/2014.
97
special purpose vehicles that are used, and the extent of tax avoidance arising
from the use of novel tax planning ideas. Only in this way can the relevant
stakeholders, including Governments, shareholders, employees and the general
public obtain the data they need to determine whether the organizations that
dominate the globalized economy are acting as good corporate citizens.141
Tax avoidance enables the companies to become economic free-riders,
enjoying the benefits of corporate citizenship without accepting the costs, while
also causing harmful market distortions and transferring a larger share of the tax
burden onto individual taxpayers and consumers. Hence by connecting issue of
tax avoidance to corporate social responsibility, the corporations can be
encouraged to adopt anti-avoidance measures in their corporate cultures, which,
intern builds their reputation and helps in long term to the shareholders. This
concept is developing in U.S. because of the increase in the scale of avoidance
and consequent loss to revenue. In India, the concept has not been addressed.
The corporate social responsibilities are more seen in the area of environment
and human rights through judicial efforts. Taking a lesson from U.S. the
corporation can come up with anti-avoidance culture and have some positive
impact on the society.
141
Anushree Agrawal, Tax Avoidance- A Social Evil or Individuals Need, (2011) 200 T AXMAN 109
(MAG)
98
CHAPTER-Ix
CONCLUSION
Tax is a financial charge levied by the government or its department
concerned upon a person, such that failure to pay is punishable under law.
Person can be individual, company or a legal entity. Constitution of every
country empowers the government to levy tax. It levies tax because of the role it
assumes. Tax is paid by all of us knowingly and unknowingly. When a person
sees money going out of hand to government his only aim will be to save that
money for himself. The very nature of human being is such that they preserve
things for themselves. In a country like India where people are not educated, they
do not understand the importance of paying tax. It is a duty of every individual to
pay tax to government for its functions and to make better society for himself.
People should be educated about the role of government and for whom
government exists.
Then the avoidance of taxation should be performed in a manner that it
will fulfill its responsibilities towards the society and should not act in an
irresponsible way. The reason behind this contention is that the Government
collects the revenue from the State in order to use it for the welfare of the society,
i.e., to facilitate its people with the basic necessities to lead a better standard of
life. Therefore, it becomes the liability of the person, whether an individual or a
corporate body, to perform its social act towards the society and should not do
anything which is in contravention of the public policy or cause any harm to the
society or hampers the growth and development of the society. The growth can
be hampered in a manner that the reduction in the amount of revenue collected
by the Government disturbs the budget of the financial year and will hamper the
development of the country by disturbing the revenue of the State. Thus, the
avoidance done in a legalized manner with all liabilities fulfilled will make the
concept as a need of individual and will not turn into the evil for the society.
Multi-National Corporations, big company avoid taxes to increase their
profit share. If one observes the judicial doctrines such as business purpose,
99
substance-over-form, and Lifting of corporate veil are developed to trap the

arrangements or transactions of the corporations to avoid the duty of paying
taxes. Individuals may not affect the government finance to greater extent but
corporations do. In todays world where there in globalization, cross-border
transactions taking place, the corporations has to comply with the laws of more
than one jurisdiction and may be had to pay double tax. To avoid such double tax
burden on the business entities, governments enter into double taxation
avoidance agreements, through which the taxpayer can be taxed only ones
according to his choice. These treaties are also now miss-used by moving to tax
havens. Tax havens benefit themselves by keeping low or zero tax but its impact
on the country having high rate tax great.
Corporate Social Responsibility is taken up by the corporation for the
betterment of society. If tax is considered as a social responsibility then, the
corporation will voluntarily pay tax and effective law will not be needed. But there
are many theorists who say that the only aim and duty of business man is to
make profits. Making profits and paying high dividends is the moral duty of the
management or directors. The researcher deviates from these theorists, because
corporations assume various roles which were first performed by the State. With
expansion of the functions and role which will have effect on the society,
corporations
should
be
responsible
towards
society.
Corporate
Social
responsibility when linked with tax avoidance will bring a culture of voluntariness
and willingness. Even, if the duty of corporation to make profits is taken into
consideration, having anti avoidance measures will build the reputation of
corporation and benefit it in long run.
Due to the Tax Avoidance strategies using tax havens etc. many countries
like New Zealand, Canada, have introduced General Anti Avoidance Rules. UK
and India were debating on the issue of whether GAAR is needed in their tax
regimes. Recently India has inserted GAAR provisions in Income Tax Act, 1961,
but their enforcement is postponed to three year to train the administrator to
handle the General Anti-Avoidance Rules. India has judicial doctrines and
100
specific anti avoidance rules to tackle. These rules have the element of
uncertainty. Tax laws have to be clear and definite. The General anti-avoidance
rules provide discretionary power to the tax authorities to bring a transaction into
the scope of unacceptable tax avoidance. It is true that India needs legislation to
curb avoidance strategies but this legislation at any cost should not hamper the
fundamentals of governance. The impact can only be seen fully once General
Anti-Avoidance Rules are in force.
101
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Facets of Tax Avoidance: A Comprehensive Study

Compulsion: The legal essence of definition lies in compulsion.

Purpose: Political essence.

Facets of Tax Avoidance: A Comprehensive Study

With regard to these primary functions of government the economists put

People should contribute taxes in proportion to their incomes and wealth.

Taxes should be certain and not arbitrary

Taxes should be levied in the most convenient way

The costs of imposing and collecting taxes should be kept minimal.3

Hepkar Michad, Modern Apprach to tax law, 1973, p.7

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

involving him in the loss or expenditure which entitles him to that

Cridland v. Federal Commissioner of Taxation [1977] HCA 61

Facets of Tax Avoidance: A Comprehensive Study

Endogenous tax avoidance refers to avoidance, that is effected by

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

the law permits. When an act is condemned as evasion, what is

Bullen v. Wisconsin (1916), 240. U.S. 625, p. 630

Facets of Tax Avoidance: A Comprehensive Study

is not really a crime at all. What is really wrong with omitting to

Facets of Tax Avoidance: A Comprehensive Study

artificial in nature, to reduce tax that would otherwise be payable according to

avoidance, an example may be referred, Inland

case that the House of Lords decided in 1988.That case involved

50,000.In a transaction potentially caught by the tax, Bowater proposed to

Inland Revenue Commissioners v Bowater Property Developments [1985] STC 783

Facets of Tax Avoidance: A Comprehensive Study

See Challenge Corp 16 . The court held that Challenge

Acceptable tax avoidance and unacceptable tax avoidance

CIR (NZ) v. Challenge Corporation Ltd, [1986] 2 NZLR at 559

Facets of Tax Avoidance: A Comprehensive Study

W. T. Ramsay Ltd. v. Inland Revenue Commissioners, [1982] AC 300

Facets of Tax Avoidance: A Comprehensive Study

Lord Goff in Ensign Tankers 21 case, said, unacceptable tax avoidance

The lack of economic substance (usually resulting from pre-arranged

The use of tax-indifferent accommodating parties or special purpose

Unnecessary steps and complexity, often inserted to pop up a claim of

Inconsistent treatment for tax and financial accounting purposes;

High transaction costs;

Fee variation clauses or contingent fee provisions;

Ensign Tankers (Leasing) Ltd. v. Stokes (1992) STC 226

Facets of Tax Avoidance: A Comprehensive Study

The use of new, complex financial instruments such as derivatives,

The use of tax havens, particularly in the context of captive insurance

Examination of transaction should enquire for these features to decide whether

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

There exist several circumstances that restrain tax administrations from

tax administration and tax policy are

Facets of Tax Avoidance: A Comprehensive Study

an externalized cost. In contrast, if government budget is shrunk because of tax

Facets of Tax Avoidance: A Comprehensive Study

Facets of Tax Avoidance: A Comprehensive Study

Postponement of taxes: The present discounted value of a postponed tax

Facets of Tax Avoidance: A Comprehensive Study

special treatment is afforded to the return to capital in the form of housing,