"Commercial substance means GAAR can't apply": what ITA 2025 Section 179 actually says

India's General Anti-Avoidance Rule (GAAR) does not require your transaction to be a sham. Under Section 179, Income-tax Act 2025 (Section 96, Income-tax Act 1961), an arrangement is an impermissible avoidance arrangement when its main purpose is a tax benefit and it meets even one of four alternate conditions. Lack of commercial substance is only one of them. Treaty residency, payment of taxes abroad and a genuine business purpose each help, but none of them on its own shuts out all four conditions.

Legal basis: Sections 178–184, Income-tax Act 2025, Chapter XI (General Anti-Avoidance Rule); corresponding provisions: Sections 95–102, Income-tax Act 1961, Chapter X-A. Procedure: Section 274, ITA 2025 (Section 144BA, ITA 1961). Threshold and grandfathering: Rule 128, Income-tax Rules 2026 (G.S.R. 198(E), 20 March 2026, in force 1 April 2026). Under the 1961 Act, Chapter X-A applied from Assessment Year 2018-19 (Section 95(2), ITA 1961).

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What is GAAR, and when was it switched on?

GAAR lets the tax authorities look past the legal form of a transaction to its substance. Under the 1961 Act, Chapter X-A applied "in respect of any assessment year beginning on or after the 1st day of April, 2018" (Section 95(2), ITA 1961), that is, from Assessment Year 2018-19. With the Income-tax Act 2025 in force from 1 April 2026, the GAAR provisions sit in Chapter XI, Sections 178–184, with the same text renumbered: Section 95 → 178, Section 96 → 179, Section 97 → 180, Section 98 → 181, Section 99 → 182, Sections 100–101 → 183, Section 102 → 184.

GAAR works alongside the rest of the Act. Section 183(a) of ITA 2025 says the Chapter applies "in addition to, or in lieu of, any other basis for determination of tax liability."

For HNI tax planning involving layered structures, offshore entities or trust arrangements, GAAR therefore needs to be tested before any plan is finalised.

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The two-part trigger: main purpose and one of four conditions

Section 179(1) of ITA 2025 sets a conjunctive test. Both parts must be satisfied:

Part A — main purpose test: The main purpose of the arrangement must be to obtain a tax benefit. Section 184(11) defines tax benefit to include a reduction, avoidance or deferral of tax, an increase in a refund, a reduction in total income or an increase in loss, including where the result comes from a tax treaty.

Part B — at least one of the following four:

Source: Section 179(1), ITA 2025 (Section 96(1), ITA 1961).

The critical point: conditions (a), (b) and (d) operate independently of commercial substance. An arrangement with genuine operations can still be caught under (a), (b) or (d) if its main purpose is a tax benefit.

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The commercial substance test in detail (Section 180)

Section 180(1) of ITA 2025 (Section 97, ITA 1961) deems an arrangement to lack commercial substance if any of the following apply:

• Substance differs from form — the substance or effect of the arrangement as a whole is inconsistent with, or differs significantly from, the form of its individual steps or a part.
• Round-trip financing — funds are transferred among the parties through a series of transactions with no substantial commercial purpose other than the tax benefit. Under Section 180(2), this applies whether or not the funds can be traced, whatever the time or sequence of the transfers, and whatever the means or mode used. Routing through multiple intermediaries does not sanitise the arrangement.
• Accommodating party — a party whose main purpose in participating is to obtain a tax benefit for the assessee (definition in Section 184(1)).
• Offsetting or disguising elements — elements that offset or cancel each other, or a transaction routed through one or more persons that disguises the value, location, source, ownership or control of funds.
• Location without purpose — the location of an asset, a transaction or a party's place of residence has no substantial commercial purpose other than a tax benefit.
• No real commercial effect — the arrangement does not significantly affect the business risks or net cash flows of any party apart from the tax benefit.

Section 180(3) adds that the period for which the arrangement has existed, the fact that taxes have been paid (directly or indirectly) under it, and the availability of an exit route "may be relevant but shall not be sufficient" to decide whether it lacks commercial substance. Paying taxes in the treaty jurisdiction does not, on its own, immunise a structure.

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The Rs 3 crore threshold: your first GAAR filter

Rule 128(1)(a) of the Income-tax Rules 2026 provides that Chapter XI does not apply to "an arrangement, where the aggregate tax benefit in the relevant tax year, to all the parties to the arrangement does not exceed a sum of three crore rupees."

The threshold is tested at the arrangement level, for each tax year, across all parties together. If an arrangement involves three entities that together save Rs 4 crore in tax, the Rs 3 crore limit is crossed even if each entity individually saves under Rs 1.5 crore.

For tax years before 1 April 2026, Chapter X-A of the 1961 Act and Rule 10U of the Income-tax Rules 1962 govern.

For tax planning at the HNI or family-office level, where the tax benefit from a structure can exceed Rs 3 crore a year, this filter offers no protection.

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How GAAR is invoked: the Approving Panel process

Section 274 of ITA 2025 (Section 144BA, ITA 1961) sets out the procedure:

Stage 1 — Assessing Officer reference: Before referring the matter, the Assessing Officer must issue a notice to the assessee seeking objections on whether Chapter XI applies (Rule 129(1), Income-tax Rules 2026). The Assessing Officer may then refer the matter to the Principal Commissioner or Commissioner at any stage of assessment or reassessment (Section 274(1)).

Stage 2 — Commissioner's notice and hearing: If the Principal Commissioner or Commissioner considers Chapter XI should be invoked, he issues a notice setting out the reasons and basis, and gives the assessee a hearing within the period specified in the notice, not exceeding sixty days (Section 274(2)). If the assessee files no objection in time, the Commissioner issues directions himself (Section 274(3)).

Stage 3 — Approving Panel: If the assessee objects and the Commissioner is not satisfied with the explanation, the matter goes to the Approving Panel (Section 274(4)). The Panel has three members: a Chairperson who is or has been a High Court judge, a member of the Indian Revenue Service not below the rank of Principal Chief Commissioner or Chief Commissioner, and an academic or scholar with special knowledge of matters such as direct taxes, business accounts and international trade (Section 274(18)–(19)). No direction prejudicial to the assessee can be issued without giving the assessee an opportunity of being heard (Section 274(7)). The Panel's directions bind the assessee and the tax authorities (Section 274(16)).

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GAAR and tax treaties: why treaty residency is not a complete defence

A common view among NRI clients is that genuine treaty residency — living in the UAE or Singapore with bona fide local operations — gives complete protection against GAAR.

It does not. Section 181(1) of ITA 2025 (Section 98(1), ITA 1961) states that once an arrangement is declared impermissible, its tax consequences are determined "including denial of tax benefit or a benefit under a tax treaty." The definition of tax benefit in Section 184(11)(c) and (d) expressly covers tax reductions and refund increases obtained as a result of a tax treaty.

Section 179(2) adds a presumption: if the main purpose of a single step or part of an arrangement is to obtain a tax benefit, the whole arrangement is presumed to have that main purpose, unless the assessee proves otherwise — even if the main purpose of the whole arrangement is not a tax benefit.

Any treaty-level anti-abuse test in the relevant tax treaty is a separate analysis and needs to be run on its own.

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Grandfathering of pre-April 2017 investments

Rule 128(1)(d) of the Income-tax Rules 2026 provides that Chapter XI does not apply to income from the transfer of investments made before 1 April 2017. Rule 128(2) then states that, without prejudice to that exclusion, Chapter XI applies to any arrangement, "irrespective of the date on which it has been entered into", in respect of the tax benefit obtained on or after 1 April 2017.

If you hold a pre-2017 investment, document the investment date and the chain of ownership carefully. The exclusion covers income from transferring those investments, not every later tax benefit drawn from an older structure.

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Practical steps for NRIs, HNIs and their advisors

• Map every step in the structure against the four conditions. For each holding entity or intermediate step, ask: (a) is this arm's length? (b) does it use a provision for a result the provision was not meant to give? (c) does the entity carry real risk and operations? (d) would a third-party observer recognise this as bona fide?
• Document commercial substance as it happens. Board minutes, economic risk, payroll, local bank accounts and signed contracts should exist when the arrangement operates, not be assembled after a notice arrives.
• Check the Rs 3 crore threshold at the arrangement level, not per entity. Rule 128(1)(a) counts the aggregate tax benefit to all parties.
• Keep GAAR and treaty analyses separate. Satisfying a treaty's own anti-abuse test does not settle GAAR, because Section 181(1) allows denial of a treaty benefit. Run both analyses.
• Respond to notices within the time they specify. Object to the Assessing Officer's notice under Rule 129(1), and to the Commissioner's notice within the period (not exceeding sixty days) set under Section 274(2); failing to object lets the Commissioner issue directions without a Panel reference (Section 274(3)).
• Review pre-2017 structures against Rule 128(1)(d) and (2). Confirm your investment-date documentation is in order.

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FAQ

Q1. Can GAAR be applied even if I have paid taxes in the foreign country?
Yes. Under Section 180(3) of ITA 2025, payment of taxes, directly or indirectly, under the arrangement "may be relevant but shall not be sufficient" to decide whether it lacks commercial substance. It is one factor, not a standalone defence.

Q2. Does GAAR apply to a transaction that saves Rs 2 crore in taxes?
Under Rule 128(1)(a) of the Income-tax Rules 2026, Chapter XI does not apply where the aggregate tax benefit to all parties in the relevant tax year does not exceed Rs 3 crore. A Rs 2 crore aggregate saving for the arrangement falls within that exclusion.

Q3. Can GAAR override a tax treaty benefit?
Yes. Section 181(1) of ITA 2025 provides that the consequences of an impermissible avoidance arrangement include "denial of tax benefit or a benefit under a tax treaty."

Q4. Can I appeal against the Approving Panel's directions?
No appeal under the Act lies against the Approving Panel's directions (Section 274(17), ITA 2025), and the directions bind both the assessee and the tax authorities (Section 274(16)). Before the Panel issues prejudicial directions, the assessee must be given an opportunity of being heard (Section 274(7)).

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Sources

• Income-tax Act 2025 (30 of 2025), Chapter XI, Sections 178–184, and Section 274.
• Income-tax Act 1961, Chapter X-A, Sections 95–102, and Section 144BA.
• Income-tax Rules 2026 (G.S.R. 198(E), 20 March 2026), Rules 127–129.

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To discuss how GAAR applies to an existing structure, contact Harun Raaj & Associates.

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