Section 97: Arrangement to Lack Commercial Substance - GAAR Explained

Section 97 of the Income-tax Act, 1961 explained when an arrangement was deemed to lack commercial substance for purposes of the General Anti-Avoidance Rule (GAAR). From 1 April 2026, the corresponding provision is section 180 of the Income-tax Act, 2025. The principle is that a transaction's actual commercial effect matters, not merely its legal form.

Meaning of lack of commercial substance

An arrangement lacks commercial substance when its structure or operation does not reflect a genuine commercial purpose or effect, according to the statutory tests. It is one of the conditions relevant to identifying an impermissible avoidance arrangement under section 96 of the 1961 Act (corresponding section 179 of the 2025 Act). Lack of commercial substance alone should not be confused with an automatic GAAR determination: the other statutory requirements, exceptions and procedures must also be considered.

Statutory tests under section 97(1) and section 180(1)

1. Substance differs from legal 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 any part of it. For example, a purported independent sale that economically functions as a secured financing may call for a substance-over-form examination.

2. Specified artificial features

The arrangement involves or includes any of these features:

• Round trip financing: movement of funds among parties through a series of transactions without substantial commercial purpose other than a tax benefit.
• Accommodating party: a party interposed mainly to secure a tax benefit for the assessee.
• Offsetting or cancelling elements: steps that neutralise each other's economic effects.
• Disguised funds: transactions through one or more persons that disguise the value, location, source, ownership or control of funds.

3. Artificial location or residence

An asset, transaction or party is located in a particular place without substantial commercial purpose other than securing a tax benefit. The presence of an overseas entity is not, by itself, proof of an impermissible arrangement; its functions, assets, risks and commercial rationale matter.

4. No significant non-tax economic effect

The arrangement has no significant effect on the business risks or net cash flows of any party apart from the tax benefit that would otherwise be obtained.

Round trip financing - section 97(2)

Round trip financing includes a series of transfers of funds among parties where the transactions have no substantial commercial purpose other than obtaining a tax benefit. The statutory test does not depend on tracing the exact funds, the order or timing of transfers, or the payment mechanism. A circular flow of money may therefore be examined as a whole.

Accommodating party - section 97(3) of the 1961 Act

Under the 1961 Act, an accommodating party is one whose main purpose in participating, directly or indirectly, in the arrangement, wholly or partly, is to obtain a tax benefit for the assessee. The party need not be a connected person. Under the 2025 Act, the definition and treatment of accommodating parties must be read with the relevant GAAR provisions, including section 182; section 180 itself has been reorganised.

Facts that are relevant but not conclusive

Under section 97(4) of the 1961 Act and section 180(3) of the 2025 Act, these facts may be relevant but are not sufficient by themselves to establish commercial substance:

• The length of time for which the arrangement or its operations exist.
• The fact that taxes have been paid, directly or indirectly.
• The availability of an exit route, including transfer of business or operations.

Illustrative example

Suppose an Indian business routes funds through two entities that immediately return substantially the same funds under offsetting agreements. If the entities perform no meaningful commercial functions and the principal result is a tax deduction, the arrangement may raise concerns about round trip financing, offsetting steps and lack of significant economic effect. Whether GAAR applies depends on the full facts and statutory requirements; the example is not a determination of liability.

How GAAR applies in practice

Under the 1961 Act, section 95 addresses applicability, section 96 defines an impermissible avoidance arrangement, section 97 deals with commercial substance, and section 98 provides consequences. Under the 2025 Act, consult sections 178 to 184 together with the applicable rules and safeguards. GAAR involves a statutory process and cannot be inferred from a single feature without considering the whole arrangement.

Official legislation and further reading

• Income Tax Department: section 97, Income-tax Act, 1961
• Income Tax Department: Income-tax Act, 2025 (as amended by Finance Act, 2026), section 180
• Income Tax Department: 2025 Act, rules and correspondence utilities
• Income-tax Act, 1961 as amended by Finance Act, 2025 (official PDF)

Frequently asked questions

Does every tax-efficient transaction lack commercial substance?

No. Tax efficiency alone is not the statutory test. The transaction must be examined against the relevant GAAR provisions and its genuine economic effects.

What replaced section 97 of the 1961 Act?

Section 180 of the Income-tax Act, 2025 is the corresponding provision, effective from 1 April 2026.

Is a short holding period conclusive?

No. The duration of an arrangement can be relevant, but is not sufficient by itself to decide whether commercial substance exists.

This article is general legal information. The law applicable to a particular year and transaction, together with the applicable rules, notifications and procedural safeguards, should be verified before acting.