Is GAAR Curtailing Abusive Tax Arrangements?

Are you a foreign entity doing business in Nepal? Have you made investments in Nepal but you aren’t clear about the country’s tax regime? Are you a tax payer who has found acceptable measures to reduce your taxes? Are you certain whether you’re avoiding taxes within the prescribed legal framework or have you crossed the line? Or are you camouflaging tax avoidance as a business driven transaction? All smart businesses plan their taxes to reduce their tax burden. Businesses have found numerous loopholes in the tax provisions and utilised those to their benefit but to the dismay of the tax authorities. Corporations are mostly one step ahead of the tax department and it is impossible for the government to enact a foolproof legislation. Treaty shopping, tax evasion and planning solely for not paying taxes have become common practice. Thus, the government has incorporated the concept of General Anti Avoidance Rules (GAAR) into the Income Tax Act of Nepal 2058. If you are planning your taxes you should be aware if your transaction is hit by GAAR provision. An otherwise legal scheme to reduce your tax burden becomes illegal if it attracts GAAR as laid down by section 35 of the Income Tax Act. GAAR is an anti-tax avoidance rule which means it’s a law that has come in place to curtail abusive tax arrangements. GAAR empowers tax authorities to deny tax benefits to arrangements or transactions which do not have any commercial substance but is done with an intent to gain tax benefit out of such arrangements. Tax avoidance is the use of legal opportunities to gain a tax benefit by taking advantage of the tax provisions. Thus, GAAR is a provision that allows tax authorities to look through a transaction to determine if the transaction is abusive tax avoidance which do not have any commercial substance. Internationally too the concern of tax avoidance has risen which is why countries like UK, Germany and this year India have enacted GAAR provisions. Section 35 of Nepal’s Income Tax Act talks about the general rule against tax avoidance. It states that to ascertain tax liability, the tax department may recharacterise any arrangement made as a part of the tax avoidance scheme. It also states the department can disregard arrangements that do not show any substantial effect. Thus, this provision allows the department to look through a transaction to determine whether the transaction was done with the intent to avoid taxes or was it just a part of the business scheme. GAAR gets triggered if a transaction was done only with the intent to avoid taxes and had no business motive independently. GAAR is invoked to deter unacceptable and abusive tax avoidance schemes which otherwise would fall under the grey area of law and wouldn’t per say be illegal. The provision bars a person or a corporation to abuse the law and take undue advantage of the loopholes in the law. The section does this by giving the tax department the power to cancel claimed tax benefits so that the taxpayer is not driven just by their desire to obtain tax benefits. This section should be applied by the Tax Department in such a manner that it doesn’t hamper the normal business transaction of a company. Any business transaction which provides a legal tax advantage to the taxpayer and falls within the normal course of business should not be hit by GAAR. The department should be aware that there are limitations to GAAR and it cannot be invoked for any tax planning scheme, but only to abusive tax avoidance schemes. One example of the government invoking the GAAR provision is the recent Ncell deal. Ncell is a leading telecom operator in Nepal that landed in trouble with the government for not paying capital gains tax. There are varying opinions on the stand that the government took and some commend it while others state that the government went beyond its jurisdiction and the provisions of the Nepal’s Income Tax Act. As the transaction happened offshore, it was debated whether Nepal’s Tax authorities would have jurisdiction in the matter. TeliaSonera, a company registered in Sweden has its presence in Europe and Asia, Nepal being one of them. TeliaSonera Sweden has its subsidiary in Finland which then has subsidiary in Netherland which had invested in a number of companies. One of its subsidiaries has further invested in TeliaSonera Asia Holdings which holds 100% of the shares of TeliaSonera Norway. Reynolds holding is one of the subsidiaries of TS Norway and held 80% of the shares of Ncell Nepal. Axiata made a 100% acquisition of Reynolds holdings and in effect owned 80% of its shares. The tax department invoked GAAR provisions to look through this structure and Ncell was asked to pay its taxes. A section on GAAR has been introduced in our Income Tax Act to look into abusive tax avoidance schemes. It is pertinent that the Tax Department looks into the intent of the transaction and if it shows that the transaction was entered into only to avoid taxes then GAAR hits them. If we look into the Ncell structure, there are numerous layers of subsidiaries before the government can reach TeliaSonera, Sweden the parent company. Furthermore, all of these subsidiary companies have been conducting business in their area and have made investments in numerous companies thus it would be difficult to argue that the intent of the structure was just to avoid taxes. Nepal lacks case law precedence on the concept of GAAR and thus it would have been fascinating to see the courts interpret the applicability of GAAR in a scenario like the Ncell deal. It would have cleared the air regarding the interpretation of section 35 of the Income Tax Act. The Ncell tax fiasco is very similar to that of the Vodafone case in India. Vodafone International holdings BV bought out Hutchison Essar. Its subsidiary bought out the share and the entire transaction happened offshore. The Income Tax Department demanded the payment of the capital gains tax but the Supreme Court Ruled in 2012 that Vodafone’s actions were legal and asked to look at the transaction and not look through it. Thereafter, India has recently come up with a comprehensive GAAR provisions. In Nepal’s scenario, the Tax Department needs to be careful while invoking GAAR provision so as not to deter foreign investments into the country. With ambiguity in the implementation of the section, Nepal becomes a risky market for foreign investors. Thus, it is important that the Tax Department cuts through dubious tax avoidance schemes but at the same time the department should not deny tax benefit if the transaction has commercial substance.

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Shraddha Bhattarai, Head of Tax Practice, Gandhi and Associates.