Judicial Anti-Avoidance Doctrines (JAAD) - Income Tax - Ready Reckoner - Income Tax

Judicial Anti-Avoidance Doctrines (JAAD) History of judicial anti avoidance could be found in the decisions rendered in US and English cases, which have been relied upon extensively by the Indian Judiciary, from time to time. The two guiding principles in judicial anti-avoidance doctrines are: Business Purpose Rule (motive test) Substance over form Rule (artificiality test) Other Civil Doctrine Business Purpose Rule The business purpose rule says that a transaction must serve or test a business purpose. It requires justification of a transaction from commercial point of view, other than serving a purpose of tax avoidance. Mere tax advantage cannot be the sole or main business purpose. U.S. Supreme Court in the landmark decision Gregory v. Helvering held that existence of a corporate organization under the law solely for tax purposes did not qualify for tax benefits. Business purpose test is not seldom defined in the statutes and Courts have taken a common-sense view. While issuing a general anti-avoidance Regulation, Indian Parliament has tried to define the business purpose test objectively which we will discuss under GAAR Chapter. Substance over form Rule The principle substance over form is wider in scope than business purpose rule. 1987 OECD report defines it as the prevalence of economic or social reality over the literal wording of legal provisions. Although substance test is being used very frequently, the true meaning of this test has remained unravelled. Though various countries have tried to define it by introducing GAAR provision or similar provision, it is rather impossible to codify it in its complete form as it being a very fact specific exercise. There are various faces of substance v. form as listed below: Legal v. Economic Substance Sham transactions Label Doctrine ( wrong characterization ) Step-transactions doctrine Piercing the Corporate Veil Legal V. Economic Substance This applies to situations where due to the legal form used for the transactions a taxpayer has the real economic power over taxable income without the tax liability. Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure that 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 principle at the heart of the tax evasion- tax avoidance impasse, also called the Westminster principle, was a landmark decision in IRC vs. Duke of Westminster which provided legitimacy to tax planning, even if its sole motive was to save tax. In substance, this judgment indicated that legal form would govern the tax consequences and that the taxpayer could arrange his affairs for tax savings. The doctrine set forth in this case has been relied upon in several cases and has been the base of various decisions on questions whether the transactions fall within the four corners of tax planning or in the realm of tax avoidance . Sham Transactions In a sham transaction, tax avoiders give effect to a transaction, which they do not carry out, or do not intend to carry out or is a cover up for another transaction or relationship. A sham transaction essentially conceals the true nature or reality of a transaction that exists in form only. In short, the legal form is retained but the underlying substance is not genuine in law. Doctrine of the Label ( wrong characterization ) ​​​​​​​​​​​​​​ In this method, parties use incorrect labels to classify or characterize a transaction or relationship for tax purposes. Step-transaction doctrine ​​​​​​​ In a step transaction , the intermediate steps in a chain of preordained, even if bona fide, transactions may be disregarded and several related transactions may be treated as a single composite transaction. Alternatively, a single transaction may be broken into distinct steps too to determine its tax acceptance. Piercing the Corporate Veil ​​​​​​​ The piercing of the corporate veil is one of the most debated topics today incorporate circles. Under the corporate law, a company is having a separate and independent status as compared to its shareholder. Lifting of corporate veil refers to disregarding such separate and independent status of a corporate and to consequently tax the shareholder thereof.