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Four decades ago in the landmark case, the Supreme Court observed that it is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the court to determine the nature of new and sophisticated legal devices to avoid tax, to expose them for what they really are and to refuse to give them judicial approval.

In a classic example of “good facts make good law”, the Telangana High Court in made stinging observations about the factual matrix of the case and upheld the revenue’s invocation of the General Anti-Avoidance Rules (GAARs), holding that questions of law should not be decided without looking at the facts. The court also made a passing observation on the intentions of the taxpayer in approaching the court when it had an alternate route available.

The taxpayer claimed losses of more than INR4.5 billion (USD54 million) to offset capital gains. The losses were the result of a series of intra-group transactions of issuing bonus shares and buying and selling the shares at pre- and post-bonus issue rates, respectively.

This practice is known as bonus-stripping. Indian tax laws have a specific anti-avoidance provision disallowing losses on such actions. When tax laws make provisions to clamp down on specific loopholes, such provisions are known as Special Anti-Avoidance Rules (SAAR). In the year in which these transactions took place, the SAAR for bonus-stripping did not extend to mutual funds. The taxpayer claimed that even though an SAAR existed it did not extend to securities and the tax authorities were expanding the scope of the SAAR by invoking the GAARs, which was not permissible. The court rejected this proposition as being fundamentally flawed.

The court ruled that the SAAR existed before the GAARs were introduced in law, and thus the long-standing jurisprudence in India that specific provisions superceded general provisions would not be relevant. The court went on to observe that because the GAARs contained a notwithstanding clause, they would override other provisions.

The SAAR on bonus-stripping was modified by the Finance Bill, 2022, to include securities. The memorandum explaining such amendments clearly stated that the scope was being expanded to clamp down on tax evasion through bonus stripping.

The court examined the judicial anti-avoidance rules (JAAR) in India. The court held that even before the GAARs, the judicial system in India had established such rules. JAARs are carefully crafted tools that direct courts to uphold substance over form. The court observed that the legal amendments introducing the GAARs were driven by the judiciary’s firm commitment to uphold these anti-avoidance principles, using judicial power to enforce them.

International GAAR jurisprudence is less consistent. Earlier this year, an Australian court ruled that whatever may have been the subjective intent of the taxpayer, its objective action did not conclusively demonstrate sufficient cause to invoke the GAARs. A UK court disallowed interest on an intra-group loan, arising out of a reorganisation designed to accelerate the use of tax losses. In another development reported this year, the Supreme Court in the Netherlands requested a preliminary ruling from the European Court of Justice as to whether its general anti-abuse provisions conflicted with the freedom of business principle enshrined in article 49 of the Treaty on the Functioning of the EU (TFEU). The Advocate General found that the Dutch anti-avoidance rule in article 10a was both justified, appropriate and necessary, and was therefore not in conflict with article 49 of the TFEU. Thus, effectively implying that business decisions should be independent of tax considerations such as anti-avoidance rules prevalent in a country.

Ayodhya Rami Reddy Alla appears to be the first case involving the purpose and effect of the GAARs since their 2017 introduction. It confirms the resolve of the administration and the judiciary to dismantle what they perceive to be abusive tax structures. Businesses should not only look at their existing arrangements but also view future transactions through the prism of tax abuse. Tax costs may not hurt the business as much as the loss of reputation and confidentiality because of the detailed reporting of facts in judgments.

Seema Kejriwal is a partner at BMR Legal.