General Anti-Avoidance Rule (GAAR) and Tax Treaties

GAAR (General Anti-Avoidance Rule) is a set of rules that allows a tax authority to deny tax benefits from arrangements that are technically legal but are primarily designed to obtain an impermissible tax advantage. GAAR can also be relevant where an arrangement involves a tax treaty.

For example, a taxpayer may attempt to structure an arrangement through a particular jurisdiction mainly to obtain treaty benefits.

However, treaty benefits are not automatically denied merely because a treaty route is used. The relevant GAAR conditions and applicable provisions have to be examined.

In India, Chapter XI of the Income Tax Act, 2025 contains GAAR provisions. Broadly, an arrangement can be treated as an impermissible avoidance arrangement (IAA) where its main purpose is obtaining a tax benefit and it also satisfies specified conditions, such as creating rights or obligations that are not ordinarily created between independent parties, lacking commercial substance, or being carried out in an improper or abusive manner.

Indian law expressly provides that GAAR can apply to an arrangement even if the arrangement is permissible under a tax treaty, subject to the statutory framework and applicable safeguards.

EXAMPLE

Suppose :

Indian Company → Shell Company in Country B → Investment in Country C

Country B has a favourable treaty with India, so the intermediary company claims a reduced withholding-tax rate. If the Country B company :

§  has no meaningful employees or operations,

§  exists primarily to obtain the treaty rate,

§  immediately passes the income to another jurisdiction, and

§  has little or no commercial justification,

Indian tax authorities may examine whether the structure is an impermissible avoidance arrangement and potentially deny the treaty benefit under GAAR.

 GAAR and treaty benefits

 GAAR becomes particularly important in international taxation. Consider :

India → Foreign subsidiary → Treaty jurisdiction → Investor

Suppose an investor routes an investment through a treaty jurisdiction primarily to obtain a treaty benefit, despite having no meaningful commercial connection with that jurisdiction. The question becomes whether the treaty structure is genuine or merely an artificial arrangement. GAAR therefore interacts with :

§  Double Taxation Avoidance Agreements (DTAAs);

§  treaty-shopping concerns;

§  Limitation of Benefits (LoB) provisions;

§  beneficial ownership concepts;

§  Specific Anti-Avoidance Rules.

Core Concept 

§  TAX TREATIES : Bilateral or multilateral agreements designed to prevent double taxation, promote cross-border trade, and allocate taxing rights between Contracting States.

§  GAAR : A broad, principle-based statutory framework empowering tax authorities to look past the legal form of a transaction, identify lack of commercial substance or artificiality, and recharacterize or deny tax benefits.

GAAR can override tax treaties (DTAA)

The General Anti-Avoidance Rule (GAAR) contains non-obstante provisions that allow tax authorities to override beneficial treaty provisions {Double Taxation Avoidance Agreement (DTAA)} if an arrangement is classified as an impermissible avoidance agreement designed primarily to exploit treaty shopping

Statutory Subordination

Section 159(6) of the Income Tax Act, 2025, explicitly states that the provisions of Chapter XI (containing GAAR : Treaty Override Rider) apply even if they are inconsistent with or less beneficial than a DTAA.

Section 159(6) of the Income Tax Act, 12025 states, “Irrespective of  anything contained in sub-section (4), the provisions of Chapter XI of the Act shall apply to the assessee even if such provisions are not beneficial to him.”

In other words, this sub-section (6) in section 159, suggests that in case of an inconsistency between the DTAA and the provisions of Chapter XI, containing GAAR provisions, the statute shall override the treaty. Consequently, the assessee may be denied tax benefits of the DTAA.

NOTE

Section 159(4) preserves the beneficial treaty rule, while section 159(6) provides that the provisions of Chapter XI shall apply notwithstanding section 159(4). Thus, Parliament has expressly recognised the overriding operation of GAAR where the substantive requirements of Chapter XI are satisfied.

However, section 159(6) does not provide that every treaty anti-avoidance provision, including an LOB clause, shall stand displaced whenever a taxpayer derives a tax benefit under a DTAA. It establishes the relationship between the treaty-benefit rule in section 159(4) and Chapter XI; it does not dispense with the substantive statutory conditions prescribed for an “impermissible avoidance arrangement”.

Supreme Court Precedent : The Tiger Global International Holdings Ruling :

The Supreme Court in the case of Authority for Advance Rulings (Income-tax) v. Tiger Global International II Holdings (2026) 485 ITR 214 : 182 taxmann.com 375 (SC) affirmed that GAAR and domestic anti-abuse provisions take precedence over treaty protections and Tax Residency Certificate (TRC) reliance when structures are used primarily for tax avoidance. The key principles emerging from the Supreme Court’s detailed ruling are as below:

§  AAR EMPOWERED TO REJECT APPLICATIONS ON PRIMA FACIE TAX AVOIDANCE GROUNDS : Where an initial examination of the documents indicates that an arrangement is structured for tax avoidance, the AAR is empowered to dismiss the application on grounds of maintainability without adjudicating the matter on its merits.

 

§  TRC IS NECESSARY BUT NOT SUFFICIENT; AUTHORITIES CAN ‘LOOK BEHIND IT’: A TRC is an eligibility document under the Act for claiming DTAA benefits. However, pursuant to the amendments to Section 90 and the introduction of GAAR, a TRC, by itself, does not establish residency or beneficial entitlement. In cases involving potential abuse, including treaty abuse through conduit structures, the IRA may deny DTAA benefits. The same principle would apply even to shares that are grandfathered. Circulars issued by the CBDT prior to the introduction of GAAR would not hold good in the post-GAAR environment. 

§  GAAR OVERRIDES DTAA – FOCUSES ON TAX BENEFITS, NOT INVESTMENT TIMING: GAAR applies to any arrangement that yields a tax benefit on or after April 1, 2017, even if the underlying investment predates that date. Grandfathering under the DTAA safeguards genuine investments but does not protect abusive structures. Rule 10U of the Income-tax Rules, 1962, ensures that the scrutiny focuses on the arrangement producing the tax benefit rather than on the timing of the investment.

§  DOMESTIC SOURCE RULE CONTROLS INDIRECT TRANSFERS IN ABUSE CASES: The indirect transfer provisions under Section 9 of the Act, which seek to tax transactions where the underlying value is derived from Indian assets, would have primacy over DTAA relief where anti-abuse provisions apply.

§  EFFECTIVE MANAGEMENT DETERMINES COMPANY’S RESIDENCY: If the real control and decision-making of a company occur outside the country in which it claims to be resident, entitlement to treaty benefits may fail. The Supreme Court has emphasised that mere incorporation or formal compliance cannot substitute for genuine residence.

 

§  BURDEN OF PROOF ON THE TAXPAYER TO NEGATE AN IMPERMISSIBLE AVOIDANCE ARRANGEMENT : The Supreme Court reiterated that, under the GAAR provisions, an Impermissible Avoidance Arrangement may be presumed where the facts indicate that the arrangement was designed to obtain a tax benefit. The taxpayer must rebut such presumption with strong evidence demonstrating a bona fide commercial purpose.

§  GRANDFATHERING AND LIMITATION OF BENEFITS LIMITED TO DIRECT TRANSFERS: The Supreme Court clarified that Article 13(3A) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA), {Article 13(3A) deals with capital gains from the sale/transfer of shares}, which provides for grandfathering and the related LoB clause, applies only to direct transfers of Indian shares. Indirect transfers fall under the residuary Article 13(4) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA) and, therefore, do not enjoy the protection of the LoB clause or grandfathering provisions.

§  JUDICIAL ANTI-AVOIDANCE RULES (JAAR) EXPOSURE, DESPITE GAAR NON-APPLICABILITY: The Supreme Court clarified that, in respect of certain arrangements, even where it may technically be argued that GAAR does not apply, the provisions relating to JAAR could nevertheless apply.

Revenue may invoke GAAR where there is an independent abuse irrespective of Limitation of Benefits (LoB clause)

The assessee does not submit that satisfaction of LoB immunises an arrangement from all forms of GAAR.

FOR EXAMPLE

If the Revenue establishes that :

(a) the arrangement is a sham or colourable device;

(b) the interposed entity lacks commercial substance;

(c) accommodating parties have been inserted;

(d) artificial steps have been introduced solely to obtain a tax benefit;

(e) the arrangement misuses or abuses the provisions of the Act; or

(f) another statutory condition of an impermissible avoidance arrangement is independently satisfied,

GAAR may remain available notwithstanding satisfaction of the LoB.

Treaty-Level GAAR : The Principal Purpose Test (PPT)

Following BEPS Action 6 and the Multilateral Instrument (MLI), anti-avoidance mechanisms were integrated directly into bilateral tax treaties themselves:

§  Article 29(9) of the OECD Model / MLI Article 7 : Introduces the Principal Purpose Test (PPT).

§  The Standard : Treaty benefits are denied if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of the arrangement or transaction.

§  Exception : Benefits are still granted if establishing that granting the benefit accords with the object and purpose of the relevant provisions of the treaty.

Comparing Domestic GAAR and Treaty-Level PPT 

Attribute	Domestic GAAR	Treaty Principal Purpose Test (PPT)
Source	Domestic income tax legislation.	Bilateral tax treaty / MLI.
Threshold	Often requires “main purpose” plus additional statutory “tainted elements” (e.g., misuse/abuse of law, non-arm's length terms, lack of commercial substance).	“One of the principal purposes” test; lower threshold than pure main purpose.
Consequences	Recharacterization of income, disregard of entities, adjustment of tax liability.	Specific denial of the treaty benefit claimed.
Safeguards	Usually governed by internal administrative panels and threshold limits (e.g., monetary limits).	Subject to Mutual Agreement Procedure (MAP) and international treaty interpretation.

Treaty benefits are not unconditional

A taxpayer may technically qualify for a treaty benefit while using an arrangement that has been deliberately structured to obtain a tax advantage without genuine commercial substance.

Therefore, a treaty must be interpreted and applied in accordance with its object and purpose, and not as an instrument for facilitating artificial arrangements designed solely to escape taxation.

GAAR should be invoked where the facts demonstrate artificiality, abuse, lack of commercial substance, or deliberate manipulation of the treaty framework.

For instance :

Genuine investment structure	Potentially abusive structure
Substantial employees	No employees
Genuine office	Mere registered address
Independent management	Nominee directors
Genuine commercial risks	Risks borne elsewhere
Substantial business activity	Conduit activity
Investment rationale	Treaty benefit as principal motivation
Income retained/reinvested commercially	Immediate pass-through
Long-term commercial presence	Entity created immediately before transaction

 Treaty shopping is a legitimate target of anti-avoidance principles

Suppose an investor from Country A wants to invest in India. Instead of investing directly, it establishes a shell entity in Country B because India has a favourable DTAA with Country B.

The structure becomes : Country A investor → Shell entity in Country B → India

If the Country B entity has no substantial commercial purpose other than accessing the India - Country B treaty, the Revenue can argue that the treaty benefit is being obtained by an entity that was not the genuine economic investor contemplated by the treaty framework. From the Revenue's perspective, allowing such arrangements would:

§  erode India’s tax base;

§  permit non-residents to obtain benefits never intended for them;

§  encourage artificial corporate structures;

§  discriminate against genuine taxpayers who conduct business directly; and

§  undermine the object and effectiveness of domestic tax legislation.

Treaty interpretation should not encourage abuse

Tax treaties should not be interpreted in a manner that facilitates abuse of treaty provisions. A treaty allocates taxing rights between sovereign states. It is not ordinarily intended to enable a person with no genuine economic connection to a treaty jurisdiction to manufacture entitlement to treaty benefits.

Treaty must be interpreted in light of its object, purpose and the need to prevent abusive exploitation of its provisions

This is particularly persuasive in cases involving:

§  treaty shopping;

§  conduit companies;

§  circular transactions;

§  artificial holding structures;

§  round-tripping;

§  shell entities;

§  arrangements lacking commercial substance.

It reflects the balance established under Article 31(1) of the Vienna Convention on the Law of Treaties (VCLT), which dictates that a treaty must be interpreted in good faith, in accordance with the ordinary meaning of its terms in their context, and in the light of its object and purpose.

A DTAA grants treaty benefits; it does not grant immunity from GAAR

A taxpayer cannot claim an unrestricted entitlement to treaty benefits merely by satisfying the formal conditions of a DTAA. Where an arrangement has been deliberately structured to obtain a tax benefit and falls within the statutory definition of an impermissible avoidance arrangement, Chapter XI permits the Revenue to disregard or recharacterise the arrangement in accordance with law. Section 159(4) cannot be invoked as an absolute shield against GAAR, particularly in view of Section 159(6). The availability of treaty protection must therefore be examined in conjunction with the domestic anti-avoidance provisions.