Statutory backbone of India's General Anti-Avoidance Rule (GAAR) : 180 of the Income Tax Bill, 2025 Vs. Section 97 of the Income-tax Act, 1961

Clause 180 Arrangement to lack commercial substance.

Income Tax Bill, 2025

Introduction

Clause 180 of the Income Tax Bill, 2025 and Section 97 of the Income-tax Act, 1961 both articulate the principle that certain arrangements, despite their legal form, may be disregarded for tax purposes if they lack "commercial substance." These provisions are the statutory backbone of India's General Anti-Avoidance Rule (GAAR) regime-a legislative response to increasingly sophisticated tax avoidance strategies that exploit legal form over economic reality. Their inclusion marks a significant shift from a strictly form-based approach to one that prioritizes substance and intent, aligning Indian tax law with international standards. This commentary provides an in-depth analysis of Clause 180 in the context of the 2025 Bill, examines its objectives and practical implications, and undertakes a clause-by-clause comparison with Section 97 as currently enacted under the Income-tax Act, 1961. The analysis highlights both the continuity and evolution of anti-avoidance law in India, emphasizing the legal, practical, and policy dimensions of these provisions.

Objective and Purpose

The legislative intent behind both Clause 180 and Section 97 is clear: to empower tax authorities to disregard arrangements that, while technically compliant with the letter of the law, are primarily or solely designed to secure a tax benefit without genuine commercial purpose. This objective is rooted in several policy considerations:

• Protecting the Tax Base: By targeting arrangements that lack commercial substance, these provisions aim to safeguard government revenues from aggressive tax planning schemes that erode the tax base.
• Ensuring Equity and Fairness: They promote fairness by preventing taxpayers from gaining an undue advantage through artificial or contrived transactions that are unavailable to the general body of taxpayers.
• Aligning with International Norms: The adoption of substance-over-form principles is consistent with global trends, particularly the OECD's Base Erosion and Profit Shifting (BEPS) project, which encourages member countries to strengthen their anti-avoidance regimes.
• Providing Certainty and Predictability: By codifying the circumstances under which arrangements may be disregarded, the provisions aim to provide greater certainty to taxpayers and minimize protracted litigation.

Detailed Analysis

1. The Core Test: What Constitutes "Lack of Commercial Substance"?

Both Clause 180(1) and Section 97(1) enumerate the circumstances under which an arrangement is deemed to lack commercial substance. The structure and language of both provisions are nearly identical, indicating a strong continuity in legislative approach. Each enumerated clause is analyzed below:

• (a) Substance Over Form:
  The provision states that an arrangement lacks 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." This embodies the classic "substance over form" doctrine, empowering authorities to look beyond the superficial legal structure of a transaction and consider its real economic effect. The focus is on the overall effect rather than isolated steps, ensuring that taxpayers cannot fragment a tax-motivated scheme into innocuous parts to escape scrutiny.
• (b) Specific Indicators of Artificiality:
  Both provisions provide four specific indicators that, if present, may lead to a finding of lack of commercial substance:
  • (i) Round Trip Financing: This refers to arrangements where funds are circulated among parties, often returning to the original party, with no real commercial purpose except to secure a tax benefit. The definition is expanded in sub-section (2) of both provisions (see below).
  • (ii) Accommodating Party: This involves the participation of a party whose involvement is primarily to facilitate a tax benefit, rather than for any genuine commercial reason. Section 97(3) elaborates on the definition of an accommodating party, a detail absent in Clause 180.
  • (iii) Offsetting or Cancelling Elements: Arrangements where steps or elements neutralize each other, indicating a lack of real economic activity or risk transfer.
  • (iv) Disguising Transactions: Transactions structured to conceal the true value, location, source, ownership, or control of funds, suggesting an intent to obfuscate and avoid tax liability.
• (c) Location or Residency Without Commercial Purpose:
  The provision targets arrangements involving the location of assets, transactions, or the residence of any party, where such choices lack substantial commercial purpose other than obtaining a tax benefit. This is aimed at countering treaty shopping, artificial relocation of assets, or shifting of tax residence to low-tax jurisdictions.
• (d) No Significant Effect on Business Risks or Cash Flows:
  If an arrangement does not materially affect the business risks or net cash flows of any party, apart from the tax benefit, it may be deemed to lack commercial substance. This targets "paper" transactions that have no real-world impact except reducing tax liability.

2. Round Trip Financing: Expanded Definition

Clause 180(2) and Section 97(2) provide a detailed explanation of "round trip financing." The essential elements are:

• Funds are transferred among parties through a series of transactions.
• These transactions lack any substantial commercial purpose other than obtaining a tax benefit.
• Three factors are explicitly stated as irrelevant:
  • Whether the funds can be traced to particular transactions or parties.
  • The timing or sequence of the transfers.
  • The means, manner, or mode of the transfers.

This expansive definition is designed to prevent taxpayers from circumventing the rule by introducing complexity or opacity in the flow of funds. By disregarding tracing, timing, and manner, the law focuses on substance and intent, closing potential loopholes.

3. Accommodating Party: A Point of Divergence

A significant difference emerges here. Section 97(3) provides a specific definition:

"For the purposes of this Chapter, a party to an arrangement shall be an accommodating party, if the main purpose of the direct or indirect participation of that party in the arrangement, in whole 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."

This clarifies that the mere presence of a party whose main role is to secure a tax benefit for another, regardless of their connection, can render the arrangement suspect. Clause 180 of the 2025 Bill omits this explicit clarification, potentially introducing ambiguity in interpretation. The omission may reflect an intent to streamline the provision, but it could also lead to uncertainty regarding the threshold for designating an "accommodating party."

4. Factors Not Sufficient to Establish Lack of Commercial Substance

Both provisions, in Clause 180(3) and Section 97(4), list factors that may be relevant but are not sufficient in themselves to determine lack of commercial substance:

• The duration of the arrangement.
• The fact that taxes have been paid under the arrangement.
• The provision of an exit route (e.g., transfer of business or operations).

By clarifying that these factors are not determinative, the law prevents taxpayers from relying on superficial characteristics (such as longevity or tax payment) to legitimize an otherwise artificial arrangement. This reflects a sophisticated understanding that tax-motivated arrangements can be structured to mimic genuine transactions on the surface.

5. Structural and Drafting Differences

While the substantive content of Clause 180 and Section 97 is largely congruent, there are notable drafting and structural differences:

• Absence of Definition for Accommodating Party in Clause 180: As discussed, Clause 180 omits the explicit definition found in Section 97(3).
• Removal of "For the Removal of Doubts" Language: Section 97(4) explicitly states that certain factors are "clarified" as not sufficient, while Clause 180 simply lists them. This may have implications for interpretive certainty.
• Minor Linguistic Updates: The 2025 Bill uses more streamlined language, possibly to enhance readability and modernize the statute.

Practical Implications

The practical impact of these provisions is profound, affecting taxpayers, tax authorities, and advisors alike:

• For Taxpayers:
  Taxpayers must ensure that their transactions have genuine commercial rationale beyond mere tax savings. Documentation, business purpose, and economic substance become critical. Aggressive tax planning involving circular transactions, artificial parties, or paper arrangements is likely to attract scrutiny under GAAR.
• For Tax Authorities:
  These provisions provide a robust legal framework to challenge and disregard tax avoidance schemes. However, authorities must exercise this power judiciously, substantiating their claims with evidence of lack of commercial substance. The risk of litigation and the need for detailed analysis of facts and intent remain high.
• For Advisors and Planners:
  Legal and tax advisors must reassess the risk profile of complex arrangements, focusing on their economic rationale. The threshold for what constitutes acceptable tax planning versus impermissible avoidance is now determined by substance, not mere compliance with legal form.

The provisions also raise compliance costs, as taxpayers may need to seek advance rulings or maintain extensive documentation to demonstrate commercial substance.

Comparative Analysis: Clause 180 of the Income Tax Bill, 2025 and Section 97 of the Income-tax Act, 1961

1. Substantive Parity

At their core, both provisions are substantially identical. They enshrine the same legal tests and indicators for determining lack of commercial substance and reflect a unified policy approach. This continuity ensures that judicial interpretations and administrative guidance developed u/s 97 will remain relevant under Clause 180.

2. Key Differences

• Omission of Definition for Accommodating Party:
  The explicit definition of "accommodating party" in Section 97(3) is not carried forward in Clause 180. This could create interpretive uncertainty, as the test for identifying such a party is less clearly articulated. In practice, this may require recourse to judicial interpretation or administrative guidance.
• Drafting Simplifications:
  Clause 180 adopts a more streamlined drafting style. For example, it omits "for the removal of doubts, it is hereby clarified that..." and simply lists the factors that are not sufficient. While this may make the provision more readable, it could also reduce the force of the clarification, potentially inviting litigation over whether such factors can ever be sufficient.
• Potential for Judicial Evolution:
  The move to a new statute provides an opportunity for courts to revisit and refine the interpretation of these provisions, especially where drafting changes introduce ambiguity.

3. International Context

Both provisions are consistent with international best practices, as seen in the UK's "substance over form" doctrine, the US "economic substance" doctrine, and the OECD's recommendations under BEPS Action 6 and 14. The focus on round trip financing, accommodating parties, and artificial arrangements is a hallmark of modern anti-avoidance legislation globally.

4. Judicial and Administrative Interpretation

u/s 97, Indian courts and tribunals have begun to develop jurisprudence around the meaning of "commercial substance," often referencing international case law and principles. The continuity in language ensures that this body of interpretation can be carried forward under Clause 180, though the omission of certain definitions may necessitate judicial clarification.

5. Prospective Application and Transitional Issues

The transition from Section 97 to Clause 180 (assuming passage of the 2025 Bill) raises questions about the treatment of pre-existing arrangements and the application of judicial precedents. Generally, unless the new provision is expressly retrospective, it will apply prospectively. However, the similarity in language should facilitate a smooth transition in both administration and adjudication.

Practical Implications

(A) For Taxpayers

• Taxpayers must ensure that their arrangements have a genuine, demonstrable commercial purpose beyond tax savings.
• Structures involving round tripping, accommodating parties, or artificial layering are likely to attract scrutiny.
• Documentation and evidence of business rationale, risk assumption, and economic effect are critical to withstand GAAR challenges.

(B) For Tax Authorities

• These provisions provide a robust tool to challenge aggressive tax planning, but also impose an obligation to thoroughly investigate the facts and not to invoke GAAR mechanically.
• The absence of a definition for "accommodating party" in Clause 180 may require reliance on administrative guidance or judicial precedents.

(C) For Regulators and Policy Makers

• The alignment of Clause 180 with Section 97 reflects policy continuity, but the minor changes may require clarification through rules or circulars to ensure consistent application.

(D) Compliance Requirements

• Taxpayers engaging in complex or cross-border transactions must undertake GAAR risk assessments and seek advance rulings where necessary.
• Enhanced disclosure and documentation are essential to demonstrate commercial substance.

Conclusion

Clause 180 of the Income Tax Bill, 2025, closely mirrors Section 97 of the Income-tax Act, 1961, reaffirming India's commitment to robust anti-avoidance measures based on the principle of commercial substance. By empowering tax authorities to disregard arrangements lacking genuine economic rationale, these provisions serve as a bulwark against sophisticated tax avoidance strategies. While the 2025 Bill streamlines the language and omits certain clarifications, the core tests and policy objectives remain unchanged. The practical implications are significant, requiring taxpayers to prioritize economic substance in structuring transactions and maintain comprehensive documentation. The omission of the explicit definition of "accommodating party" in Clause 180 may invite judicial scrutiny and necessitate further clarification, but the overall continuity ensures that established principles and interpretations will guide future application. The evolution from Section 97 to Clause 180 reflects both the maturity and adaptability of India's tax law, aligning domestic practice with international standards while responding to the ever-changing landscape of tax planning and avoidance.

Alternative Titles for the Commentary

1. Examining Commercial Substance under India's GAAR: A Comparative Study of Clause 180 (2025 Bill) and Section 97 (1961 Act)
2. Substance Over Form in Indian Tax Law: Analyzing the Evolution from Section 97 to Clause 180
3. GAAR and the Test of Commercial Substance: Legislative Continuity and Change in Indian Income Tax Law
4. Disregarding Artificial Arrangements: Legal and Practical Implications of Clause 180 versus Section 97

 

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Full Text:

Clause 180 Arrangement to lack commercial substance.

 

Dated: 28-4-2025