India’s incoming GAAR disputes: in conversation with Sanjay Sanghvi

A wave of Indian litigation related to new general anti-avoidance rules is on its way, Sanjay Sanghvi, a partner at local law firm Khaitan & Co, predicts in an interview with ITR.

GAAR rules are designed to eradicate tax evasion practices, giving authorities the power to deny certain tax benefits to taxpayers.

India’s GAAR rules became effective in April 2017, after first being proposed as part of the country’s Direct Tax Code Bill 2009.

“Since this is relatively new legislation, there are very few reported decisions which have examined the GAAR and its implications,” Sanghvi tells ITR.

However, he highlights one case, which began in 2022 and saw a judgment in June 2024, which he says provides a useful analysis of how India’s courts may approach GAAR issues.

In Ayodhya Rami Reddy Alla v Principal Commissioner of Income Tax at the Telangana High Court, the applicant, Alla, issued bonus shares to a shareholder firm called Ramky Estate and Farms (REF). The shares were then sold to a company named Advisory Services.

Due to the issued bonus shares, the value of each share that REF received was reduced to one-sixth of its previous value, resulting in a short-term capital loss to the applicant.

The applicant attempted to offset the losses against long-term gains made on a separate sale of shares and to file the income under ‘capital gains’ for the 2019/2020 assessment year. This led to the dispute with India’s income tax authority.

“The High Court upheld the tax authority’s action in invoking GAAR provisions on ‘bonus-stripping’ transactions on shares,” Sanghvi says.

“The court observed that the specific anti-avoidance rules (SAAR) for bonus stripping, as provided in the Indian Income Tax Act for the applicable assessment year, do not cover cases of bonus stripping on securities,” he adds.

“Therefore, the taxpayer’s argument that SAAR would override GAAR provisions was held to be incorrect.

“The court also noted that there was clear and convincing evidence to suggest that the entire arrangement was designed with the sole intent of avoiding taxes and hence the tax authorities were justified in invoking GAAR,” Sanghvi says.

Sanghvi predicts that this case represents the tip of the iceberg when it comes to future GAAR-related disputes in India.

“It is widely expected that one will see an increased number of GAAR-related disputes, given the high-stake transactions and commercial and regulatory complications and a desire for tax efficiency, as well as a sometimes-aggressive approach from tax authorities.”

With India’s tax authorities seemingly intent on using new GAAR powers to clamp down on tax evasion, Sanghvi says, the concept of “tax planning” has all but diminished.

“To a great extent, the era of tax planning has come to an end,” he states.

“With the introduction of GAAR…there has been an increase in scrutiny and the assessment of transactions by the tax administration to improve tax buoyancy. Practically it’s becoming more and more challenging for taxpayers to do effective tax planning.”

This is especially true given recent transfer pricing (TP) dispute trends, says Sanghvi.

He argues that the Indian tax authorities are “recharacterising” advertising, marketing and promotion expenses as a TP issue, where Indian subsidiaries of foreign parent entities are being compensated on a “cost plus” mark-up basis.

Despite this aggressive attitude from the tax authorities, Sanghvi notes, taxpayers have scored some key wins in India in recent years.

In Blackstone Capital Partners (Singapore) v ACIT, a much-watched case from 2023, the High Court of Delhi ruled that a tax residency certificate was sufficient for a foreign investor to claim tax benefits based on the India-Singapore tax treaty.

The case provides significant reassurance for foreign investors looking to do business in India, Sanghvi says. However, he notes that the Supreme Court of India has since stayed the judgment, which will cause some uncertainties until a further ruling on the matter.

Sanghvi is due to discuss GAAR-related issues at ITR’s Managing Tax Disputes Summit, which is scheduled to take place in Amsterdam on September 10.

To register for ITR’s Managing Tax Disputes Summit, click here.