Impermissible Avoidance Arrangement — How Consequences Are Determined for Partial Arrangements

When an arrangement is declared to be an impermissible avoidance arrangement, the consequences can be significant. Section 178(2) of the Income Tax Act, 2025 empowers authorities to apply GAAR provisions to any step in, or a part of, an arrangement . Understanding how consequences are determined, particularly for partial arrangements, is essential for taxpayers.

Definition of Impermissible Avoidance Arrangement

An impermissible avoidance arrangement means an arrangement where the main purpose is to obtain a tax benefit and it satisfies at least one of four conditions :

1. Creates rights or obligations not ordinarily created between persons dealing at arm's length
2. Results in misuse or abuse of the provisions of the Act
3. Lacks commercial substance
4. Is entered into by means or in a manner not ordinarily employed for bona fide purposes

Consequences of Declaration

Denial of Tax Benefit

The primary consequence is denial of tax benefit or a benefit under a tax treaty . This means the taxpayer cannot claim the tax advantages that the arrangement was designed to achieve.

Comprehensive Consequences

The consequences may include :

• Disregarding, combining, or recharacterising any step in, or a part or whole of, the arrangement
• Treating the arrangement as if it had not been entered into
• Disregarding any accommodating party
• Deeming connected persons to be one and the same person
• Reallocating accruals, receipts, expenditure, deductions, relief, or rebates
• Treating the place of residence or situs of an asset at a place other than as provided under the arrangement

Partial Arrangements

Application to Steps or Parts

The provisions may be applied to any step in, or a part of, the arrangement as they are applicable to the arrangement . This means even a single step in a multi-step arrangement can be scrutinised and declared impermissible.

Partial Consequences

Where a part of an arrangement is declared to be an impermissible avoidance arrangement, the consequences in relation to tax shall be determined with reference to such part only. This ensures that the entire arrangement is not invalidated merely because one part is problematic.

Factors in Determining Partial Consequences

• Whether the part is severable from the rest of the arrangement
• Whether the tax benefit is attributable to that part
• Whether the part has independent commercial substance
• Whether the part was integral to the overall arrangement

Determining Consequences

Step-by-Step Approach

1. Identify the Arrangement: Determine the scope of the arrangement
2. Identify the Impermissible Part: Determine which step or part is impermissible
3. Determine the Tax Benefit: Calculate the tax benefit attributable to that part
4. Apply Consequences: Apply appropriate consequences to that part only

Severability

If the impermissible part is severable from the rest of the arrangement, only that part is affected. If it is integral to the whole, the entire arrangement may be affected.

Practical Implications

For Taxpayers

• Complex multi-step arrangements are at greater risk
• Each step should have independent commercial substance
• Documentation should demonstrate severability where possible
• Tax planning should avoid arrangements where one part is vulnerable

For Tax Practitioners

• Advise clients on the risks of multi-step arrangements
• Document the commercial substance of each step
• Consider severability when structuring transactions
• Plan exit strategies if a part is challenged

Expert Legal Guidance

Understanding the consequences of impermissible avoidance arrangements is essential for tax planning. Anuj Desai & Associates provides expert advisory services on anti-avoidance compliance, helping taxpayers structure arrangements that withstand GAAR scrutiny.

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