Rules of engagement

Nations play by different rulebooks when applying GAAR, which can cause additional uncertainty for global businesses.

Countries that grapple with austere budgets while worrying about their business tax bases eroding are sharpening an enforcement tool often reserved for the most egregious cases of tax avoidance. The tool, known as the general anti-avoidance rule (GAAR), allows tax authorities to deny tax benefits in transactions or arrangements that they believe have inadequate commercial substance or purpose.

Even tax authorities in countries without a formal GAAR are challenging business arrangements that lack substance.

GAAR is designed to counteract perceived tax avoidance that might otherwise be legal under the broad rules and principles of a country’s tax code.

While around since 1915, GAAR has become more popular as a tax enforcement tool in the past five years. Many countries have either introduced or considered implementing the rule, including Australia, Canada, Germany, China, India and the UK. Emerging market countries, such as Chile, China and India, are making headlines by widening their tax net to include cross-border transactions that may be accepted as common by some other countries. In 2011, for example, China concluded 207 GAAR cases, collecting an additional US$3.81b in tax for that year which would seem to indicate that their investment in developing GAAR is justified.

Companies have good reason to be worried: while judges in several GAAR cases have defended businesses against overly broad application of the rule, countries such as India that have lost high-profile tax cases have either pursued other cases or sought tax authorities in countries without a formal GAAR are challenging business arrangements that they feel lack substance, even if they comply with applicable laws. The uncertainty for companies operating in an interconnected and interdependent market is amplified by the enthusiasm that leading economies have shown for bringing their anti-avoidance rules to bear more regularly.

Another concern for businesses is that all countries approach GAAR differently. Their interpretation of potentially abusive transactions rarely align, nor does the form of business purpose test applied to each transaction. Some countries have built-in safeguards to protect business from overzealous enforcement, while others do not. As an example, Australia, Canada and France all have a review panel to determine whether the GAAR applies to a particular transaction; Brazil, Japan and the Netherlands do not.

How countries identify and quantify tax benefits is as varied as how they determine whether GAAR should be applied to certain transactions or arrangements. Businesses that are operating in multiple countries would benefit from a common definition of GAAR, which could be advanced through multilateral organizations such as the European Commission, the Organization for Economic Cooperation and Development (OECD), or the United Nations. The operation of GAAR in the context of tax treaties should be agreed bilaterally and reflected in the treaty itself. Whether these things can happen remains to be seen.

Few question that countries – particularly those classified as emerging markets – must address tax evasion. The hard line approach to fighting evasion, however, is not appropriate when it comes to applying GAAR. Indeed, companies are wary of governments that adopt an inconsistent position on avoidance, rather than taking a more balanced approach. To operate effectively together, taxpayers and governments need to find a workable balance between taxpayers’ efforts to minimize tax costs and tax administrators’ efforts to put in place anti-avoidance regimes that might affect commercial, substance-driven decisions.

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