PROVISIONS relating to General Anti-Avoidance Rules though first introduced in the Indian legislation way back in 2012, were actually effectuated only in 2017. In jurisdictions that have put in place statutory GAAR, it has been observed that litigations start surfacing about a decade or so after the introduction of the legislation. In India even if the final legislation was put in place in 2017, the structure of the approving panel was finalised sometime later and we find litigations already surfacing even without the full procedure contemplated in the legislation being completed.

Briefly, the procedure for the invocation of the GAAR in India is as follows: As a first step, the AO must apply his mind and consider that it is necessary for him to declare an arrangement as an impermissible avoidance arrangement and thereafter he may refer the case to the principal Commissioner/Commissioner, who, in turn, has to form an opinion that the 'arrangement' indeed was an impermissible one as defined in the legislation. Thereafter, the PCIT/CIT has to form an opinion about the applicability of the GAAR provisions to the particular case referred by the A.O. If he forms such an opinion then he has to invite objections from the taxpayer and after considering the same, if he still believes that the GAAR provisions have to be invoked, he has to make a reference to an Approving Panel in a particular format.

The Approving Panel headed by a serving or retired judge of a High Court and an outside academic and an officer of the rank of Chief Commissioner of Income tax or above then apply their mind and after hearing both the AO and the party involved, they conclude as to whether the GAAR provisions apply to the particular case in question. No appeal by either party is provided in the statute against the order of the Approving Panel. However, appeal will lie before the ITAT when the AO passes the assessment order incorporating the directions of the panel. Normal appeals remedy is therefore available in cases involving application of GAAR.

The most important definition in the context of the cases involving the application of GAAR is the definition of impermissible avoidance arrangement in section 96 of the ITA,1961. (corresponding Section 179 of the IT Act, 2025)

"1) An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax benefit, and it:

(a) creates rights, or obligations, which are not ordinarily created between persons dealing at arm's length;

(b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;

(c) lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part;

(d) is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

(2) An arrangement shall be presumed, unless it is proved to the contrary by the assessee, to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit." (Emphasis added)

Thus, there must be an arrangement and the department must show that the main purpose of that arrangement is to obtain a tax benefit. In other words, an IAA is one whose main purpose (and not merely one of the main purposes) is to obtain a tax benefit and it must also satisfy one of the four tainted elements mentioned in section 96 of ITA 1961.

Section 97 (Section 180 of ITA 2023) then list out the circumstances in which an arrangement is deemed to lack commercial substance.

An arrangement is deemed to lack commercial substance under Section 97 if: 

(a) Its overall substance or effect is inconsistent with the form of its individual steps or parts.

(b) It involves or includes either round-trip financing, an accommodating party, or have effect of offsetting or cancelling each other, or transactions that disguise the value or ownership or control of funds.

(c) The location of assets, transactions, or parties serving no substantial commercial purpose other than gaining a tax benefit.

(d) It does not significantly affect the business risks or cash flows of any party, except for the impact of the tax benefit obtained. 

'Arrangement' for the purpose of the GAAR rules is defined in section 102(1) to mean- "any step in, or part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding." (Emphasis added)

Although there were some cases involving company reorganisations before the NCLT where the tax department alleged that the scheme of arrangement submitted for approval was impermissible in terms of the GAAR legislation, the first proper Court case involving the interpretation of GAAR provisions was the one pronounced by the Telangana High Court in a writ proceeding in the case of Ayodhya Rami Reddy Alla, that we had the occasion to discuss in an earlier column.

That case related to the disallowance of a claim for set off of losses from a transaction in shares involving bonus stripping against capital gains from another transaction. The case was decided by the High Court on a writ at the stage of issuance of notice by the CIT even before it could reach the Adjudicating panel for determining the applicability or otherwise of the GAAR provisions. The Additional Solicitor General did make an argument about the admissibility of a writ at that stage of the proceedings but there was no observation of the Court on that aspect.

In that case, the taxpayer had argued that anti bonus stripping provision in section 94(8) was a special anti- avoidance rule (SAAR) and SAAR being a special rule would override the General Anti-Avoidance Rules. The High Court however, did not accept this contention and found that the transaction generating the loss was entered into with a related party and no satisfactory rationale of such a transaction was available. Hence the tax department's invocation of the GAAR provision was approved by the Court.

However, a second case, (Anvida Bandi v DCIT), again involving set-off of capital loss from a transaction entered into by the taxpayer through purchase of cum-bonus and sale of ex-bonus shares to capital gains from another transaction of alienation of shares of an unlisted company again cropped up before the same Telangana High Court. But this time the result was different.

The brief facts as narrated by the High Court in its order states that the taxpayer is a regular investor in shares and securities and apparently held shares worth more than 30 crores and mutual investments of more than 47 crores at the relevant time. It seems that the taxpayer had sold her holdings in an unlisted company that resulted in a long-term capital gain of more than 44 crores. No details are available about the nature of this unlisted company and the relationship, if any, of the taxpayer with the said company. The High Court order mentions that with so much funds at her disposal, the taxpayer decided to purchase shares of HCL Technologies Pvt Ltd apparently "with an intention of earning short-term gains and thereafter to make long-term gains from subsequent disposal of investments." The total quantity of shares purchased or the value of investment in HCL Technologies is not known. However, it is mentioned that the cumulative effect of purchase of shares of M/s. HCL Technologies Pvt. Ltd. in the open market and sale of shares thereafter resulted in loss of Rs.17.65 crores to the taxpayer for the same Financial Year 2019-20.

Although throughout the order of the High Court, the name of the company is mentioned as HCL Technologies Pvt Ltd, it should perhaps be HCL Technologies limited as it is mentioned that the purchase and sale took place in the open market through a stock exchange and private Ltd companies are prohibited from offering their shares to the general public.

The High Court's order does not mention the date of acquisition of the shares of HCL as also the date of sale of the said shares. Google search however tells us that HCL announced a 1:1 bonus share in October 2019 and the record date was December 7, 2019 and that 1.35 billion new shares were allotted as fully paid bonus shares. It is possible that the shares were acquired cum-bonus and sold ex-bonus thereby resulting in an assured loss in the transaction which is then set off against the profit from the transaction in the disposal of the shares in the unlisted company. But, none of these details about the issue of bonus shares as also the dates of the purchase and sale of the shares are available in the order of the High Court.

It is mentioned in the High Court's order is that the tax department found that the transactions in purchase and sale of the shares of the aforementioned company was an impermissible avoidance agreement thereby triggering the application of GAAR under chapter-X-A of the ITA,1961.It is mentioned that the Approving panel passed the impugned order on 21.03.2023 holding that the transactions so far as purchase and sale of shares of HCL Technologies Pvt. Ltd., particularly taking into consideration the period of time during which the sale and purchase was made, amounted to an impermissible avoidance arrangement..

No further details are available. It is apparently a case of bonus stripping and there is also a SAAR in section 94(8). There is no discussion about its applicability in the facts of the case.

Before the High Court while the taxpayer argued that she was a regular investor and the loss occurred in the ordinary course of her investment activities, the department's representative apparently drew attention of the court primarily to the timing of the purchase and sale of shares for applying the GAAR provisions. The department also submitted that the tax authorities looked into the entire transaction to reach the conclusion as to whether it was a normal routine purchase and sale of shares, or was, strategically a tax planning mechanism with an intention of tax avoidance and off-set the gain.

However, it seems that on a specific query by the Court about any material collected by the tax department apart from timing, the counsel could not produce any other material.

The High Court referred to the definition of IAA as reproduced earlier and concluded that in order to hold a transaction of purchase and sale of shares to be impermissible avoidance arrangement, first of all there has to be an arrangement arrived at between two or more parties and secondly, the said arrangement has the four ingredients envisaged in clauses (a) to (d) of Sub-Section (1) of Section 96.

According to the High Court, the four ingredients which would constitute an impermissible avoidance arrangement are: -

"a) The arrangement creating rights or obligations which are otherwise not ordinarily created between persons dealing at an arm's length;

b) There has to be cogent proof of misuse or abuse of the provisions of the Income Tax Act either directly or indirectly;

c) The transaction should either lack a commercial substance or it leads to a deemed lack of commercial substance in whole or in part; and

d) The arrangement entered into would reflect on the face of it to have been not ordinarily employed for bona fide purposes."

In this regard, the High Court observed that:

1) The Department has not been able to show or has collected any material to prove that the purchase and sale of shares made by the taxpayer was with any of their known persons or entity ;

2) There was no nexus which could be established between purchase and sale of shares of M/s.HCL Technologies Pvt. Ltd.

3) All the shares have been sold through stock exchange

4) The petitioner is an investor and has been carrying on the sale and purchase of shares continuously which would establish that the so-called transaction of sale of M/s. HCL Technologies Pvt. Ltd. shares by the petitioner was not one of the isolated transactions specifically made to save tax;

5) All the transactions i.e. the purchase and sale of shares have been made through the DMAT account;

6) These transactions are part of the investment portfolio and all the information were part of the IT returns and that there was no new material available with the Department so as to hold that the so-called arrangement is hit by the provisions of Chapter X-A; and

7) There is also no material to hold the transactions to be an impermissible avoidance arrangement except for the timing of the transactions.

As for the timing, "which perhaps was the strong point on which the authority concerned has passed the impugned order," the High Court referred to the Shome Committee report and according to the court the said report "has categorically held that sale and purchase through stock market transactions would not come under the GAAR provisions. It was held that timing of a transaction or a taxpayer would not be questioned under the GAAR provisions on sale and purchase of shares made by the assessee."

In that view of the matter, the High Court allowed the writ and set aside the order of the Approving panel.

It seems that the case has not been properly presented and there seems to be a gap in the understanding of certain issues. The same judge has also issued the judgement in the Ayodhya Rami Reddy case where also it was essentially a case of adjustment of loss from bonus stripping against capital gains in certain other transactions. There was of course clear indication in that case that the loss was generated through transactions between related parties.

The High Court seems to have put particular emphasis on the arm's length aspect of a transaction that presupposes the existence of transaction between related parties. But GAAR need not be confined to related party transactions alone. The presence of any of the four tainted elements may make the transaction impermissible. This is also evident from Form 3CEI read with Rule 10UB.

That apart, the reliance on the Shome Committee Report about the exclusion of transactions routed through stock exchange from the purview of GAAR is also problematic. It is not as if all the recommendations of the Committee were accepted. Besides, there is no express provision in this regard in the Act, Rules, or Circulars of the CBDT.

It has been reported that in the Reddy case, SLP has already been admitted in the Supreme Court. It is also unlikely that the tax department will not approach the Supreme Court in this case.

In the meantime, the details of a third GAAR case was widely reported in recent days involving Hinduja Global Solutions Ltd (HGSL). The said company offered services in three verticals, health care, digital and customer experience. In 2021, its Board approved the sale of its healthcare services vertical to its wholly owned subsidiary- Betadine BV resulting in an inflow of approximately Rs 8000 crores to HGSL.

Subsequently, the digital, media and communications business of a related party Next Digital Limited (NDL) was demerged and was acquired by HGSL. NDL had substantial carried forward loss and unabsorbed depreciation that wiped off the capital gains.

It was reported in the press that there was a search proceeding by the income-tax department in 2023 that revealed from internal communications that the main purpose of the convoluted demerger and re-merger was purely for the purpose of obtaining tax benefits under section 72A read with section 2(19AA) of the ITA, 1961 and the tax department invoked the provisions of GAAR to deny the benefits even if the schemes of arrangement were approved by the NCLT. The PCIT apparently considered that there was no synergy between the business of the merged entities and the arrangement lacked commercial substance and referred the matter to the Approving Panel.

Through an order dated October 30, 2025, the Approving Panel agreed with the tax department and characterised the demerger of Next Digital into HGSL as an impermissible avoidance arrangement and directed the AO to disregard the set-off of the brought forward losses of Next Digital with the income of the resulting company HGSL. We will, of course, have to wait for the final outcome of possible legal challenges in the future.