Library / Income-tax Act, 2025: The Professional's Master Guide

34. Anti-Avoidance Rules

34.1 Specific anti-avoidance provisions

Provision	New	Old	In simple words
Transfer of income to non-residents	174	93	Income that remains with a non-resident through a transfer of assets is taxed in the resident transferor's hands
Bond washing and dividend stripping	175	94	Losses from buying just before record date and selling after are disregarded
Notified jurisdictional areas	176	94A	Transactions with parties in notified non-cooperative jurisdictions: TP applies, higher TDS, strict documentation
Limitation of interest deduction (thin capitalisation)	177	94B	Interest to non-resident AEs capped at 30% of EBITDA

34.2 Thin capitalisation (section 177)

Where an Indian company or a PE of a foreign company pays interest exceeding Rs. 1 crore to a non-resident associated enterprise (or on a loan guaranteed by an AE), the deduction is limited to 30% of EBITDA. The excess is carried forward for 8 years. Banks, insurance companies, specified NBFCs and certain IFSC finance companies are excluded.

Illustration 129: Interest cap

Zenith India Pvt. Ltd. pays interest of Rs. 5 crore on a loan from its Singapore parent. EBITDA is Rs. 12 crore. Allowable = 30% x 12 crore = Rs. 3.6 crore. Disallowed = Rs. 1.4 crore, carried forward and allowed in later years within the 30% limit.

34.3 General Anti-Avoidance Rule (GAAR)

GAAR (old Chapter X-A, sections 95 to 102) is retained in the 2025 Act; section 181 sets out the consequences of an impermissible avoidance arrangement. It applies where the tax benefit from an arrangement in a year exceeds Rs. 3 crore.

An arrangement is an impermissible avoidance arrangement if its main purpose is a tax benefit and it has at least one of these features:

It creates rights or obligations that would not normally be created between parties dealing at arm's length.
It results in misuse or abuse of the provisions of the Act.
It lacks commercial substance, in whole or in part (for example, round tripping, accommodating parties, or elements that offset each other).
It is carried out in a manner not normally used for bona fide purposes.

Consequences: the tax authority may disregard or recharacterise the arrangement, ignore an entity, treat parties as one, reallocate income, or deny treaty benefits. GAAR is invoked only after approval by an Approving Panel. Arrangements grandfathered from before 1 April 2017 (investments made before that date) are outside GAAR.

Illustration 130: Treaty shopping through a shell

An investor sets up a company in a treaty country with no staff, no office and no other business, only to hold shares of an Indian company and claim a treaty exemption on capital gains. The tax benefit is Rs. 12 crore. Since the main purpose is tax and the entity lacks commercial substance, the treaty benefit can be denied under GAAR, and also under the Principal Purpose Test of the MLI.

Practice note

For any structure with foreign holding entities, keep board minutes, staff and office records, and a written note of the commercial reasons for the location. Substance is decided on facts, not on paper.

34.4 GAAR procedure

Judicial view: Dividend stripping before the specific rule

CIT v. Walfort Share and Stock Brokers (P) Ltd. (Supreme Court, 2010): a loss from buying units before the record date and selling them after receiving exempt dividends was allowed for years before the specific provision applied, since the transactions were genuine. The specific rule (now section 175) was enacted to deal with such dividend and bonus stripping.

Step	Who	What happens
1	Assessing Officer	Identifies an arrangement that may be impermissible and makes a reference to the Principal Commissioner or Commissioner
2	Commissioner	Hears the taxpayer; if not satisfied, refers the matter to the Approving Panel
3	Approving Panel	Headed by a retired High Court judge; issues binding directions within 6 months
4	Assessing Officer	Completes the assessment as per the directions, with the consequences in section 181

34.5 GAAR and treaties

GAAR can override a treaty where the arrangement is impermissible. In addition, the Principal Purpose Test (PPT) under the MLI, which applies to many of India's treaties, denies treaty benefits where obtaining the benefit was one of the principal purposes of the arrangement, unless granting the benefit is in line with the object and purpose of the treaty. The PPT has a lower threshold than GAAR (one of the principal purposes versus the main purpose), no monetary threshold, and no Approving Panel.

34.6 GAAR versus specific anti-avoidance rules

Where a specific rule (transfer pricing, thin capitalisation, clubbing, deemed dividends) already addresses an arrangement, the CBDT has indicated that GAAR should generally not be invoked for the same element, unless the arrangement is designed to get around the specific rule. Also, GAAR is not applied to the choice of a legitimate option available in the law (for example, choosing between buyback and dividend, or between a branch and a subsidiary), unless it involves a colourable device.

Illustration 131: Round tripping

Indian promoters remit funds to a newly formed Mauritius company through LRS, which then invests back into the promoters' Indian company as FDI and later sells the shares, claiming the grandfathered treaty exemption. The funds originated in India, the Mauritius entity has no substance, and the arrangement returns the money to India. This is a classic round tripping arrangement that can be treated as impermissible, with the gain taxed in the promoters' hands.

Chapter summary

• Specific rules: transfer to non-residents, bond washing, NJA, thin capitalisation.

• GAAR applies above a Rs. 3 crore tax benefit with an Approving Panel.

• The MLI PPT has a lower threshold and applies to treaty benefits.

PART G: COMPLIANCE, ASSESSMENT AND DISPUTES

TDS and TCS, advance tax, returns, assessment, appeals, penalties and forms

Most of a tax professional's time goes into compliance and dispute handling. This part covers TDS and TCS in detail, salary TDS, advance tax, returns, tax audit, notices, assessment and reassessment, search and survey, appeals, recovery and refunds, penalties and prosecution, and the renumbered forms.