Section 96 of the Income-tax Act, 1961: Impermissible Avoidance Arrangement

What is an impermissible avoidance arrangement?

Under Section 96(1), an arrangement is impermissible when its main purpose is to obtain a tax benefit and it satisfies any one of the conditions in clauses (a) to (d). The main-purpose requirement and at least one specified characteristic must both be considered; obtaining a tax advantage alone does not automatically establish an impermissible avoidance arrangement.

GAAR is a substance-focused anti-avoidance framework. It allows tax authorities, subject to statutory safeguards and prescribed conditions, to examine arrangements that exploit legal form to secure inappropriate tax advantages.

Section 96(1): Four statutory conditions

Clause (a): Non-arm's-length rights or obligations

The arrangement creates rights or obligations not ordinarily created between persons dealing at arm's length. This asks whether independent parties acting on commercially ordinary terms would typically agree to comparable rights and responsibilities.

Clause (b): Misuse or abuse of the Act

The arrangement directly or indirectly results in misuse or abuse of provisions of the Income-tax Act. The inquiry considers whether a claimed tax outcome defeats the purpose of the provisions relied upon.

Clause (c): Lack of commercial substance

The arrangement lacks commercial substance, in whole or in part, or is deemed to lack it under Section 97. Indicators can include round-trip financing, accommodating parties, offsetting transactions and arrangements without meaningful non-tax effects on business risk or cash flow.

Clause (d): Means not ordinarily used for bona fide purposes

The arrangement is entered into or carried out through means, or in a manner, not ordinarily employed for genuine purposes. Bona fide means genuine or in good faith; the actual commercial purpose and conduct matter more than labels used in documentation.

Section 96(2): Presumption where a step seeks a tax benefit

If the main purpose of a step or part of an arrangement is to obtain a tax benefit, the arrangement is presumed to have been entered into or carried out for that main purpose, unless the assessee proves otherwise. This may apply even when the overall arrangement has a different stated main purpose.

This is a rebuttable statutory presumption, not an automatic final finding of GAAR liability. The other statutory requirements, exceptions and procedural protections still matter.

How Section 96 fits within GAAR

Section 95 permits an arrangement to be declared impermissible subject to Chapter X-A. Section 96 supplies the definition; Section 97 explains lack of commercial substance; and Section 98 addresses tax consequences, potentially including denial of tax or treaty benefits, recharacterisation or disregard of steps, and reallocation of income or deductions.

Other related provisions include Section 99 (connected persons and accommodating parties), Section 100 (application of Chapter X-A), and Section 102 (statutory definitions). GAAR is also subject to prescribed thresholds, exclusions and procedural safeguards; the provisions should be read together rather than in isolation.

Corresponding provisions under the Income-tax Act, 2025

Under Chapter XI of the 2025 Act, Section 178 addresses GAAR applicability, Section 179 defines impermissible avoidance arrangement, and Section 180 concerns lack of commercial substance. The four tests and rebuttable presumption in Section 179 substantially follow Section 96. The assessment procedure is addressed separately, including Section 274 of the 2025 Act.

Practical illustrations

Example 1: Circular funding without genuine economic change

Company A routes funds through several connected entities, with the funds ultimately returning to the original economic owner. If the main purpose is a tax benefit and the steps lack commercial substance, the arrangement may attract scrutiny under GAAR. The result depends on all relevant facts and safeguards.

Example 2: Genuine commercial restructuring

A business reorganises operations to reduce costs, integrate staff and improve logistics, with documented commercial reasons and real operational changes. A consequential tax saving does not, by itself, establish that the arrangement is impermissible.

Records and compliance

Businesses should preserve contemporaneous board papers, valuation reports, commercial analyses, contracts, cash-flow evidence and records explaining the non-tax rationale for significant arrangements. Where GAAR risk is material, specialist advice is advisable before implementation.

Official legislation and reference material

• Income Tax Department: Section 96, Income-tax Act, 1961
• Official consolidated Income-tax Act, 1961 (Finance Act, 2025)
• Income-tax Act, 2025, as amended by Finance Act, 2026
• Income Tax Department: Income-tax Act, 2025 and transition resources

This article explains the law for general information and is not a substitute for advice based on particular facts, assessment years and applicable notifications.