What Is Section 96 of the Income Tax Act & Why Should You Care?
In the world of tax planning, there's a fine line between smart saving & illegal avoidance. Section 96 of the Income Tax Act draws that line — in bold. Introduced under the General Anti-Avoidance Rules (GAAR), this section empowers the Income Tax Department to ignore any arrangement that’s made solely for obtaining a tax benefit, even if it looks legal on paper.
Many think, “If it’s technically within the law, I’m safe.” But that’s where Section 96 flips the script. It allows authorities to look beyond the structure & focus on the substance of a deal.
What Makes an Arrangement "Impermissible"?
Section 96 says that an arrangement is considered impermissible if:
- Its main purpose is to obtain a tax benefit, &
- It creates rights or obligations not normally created between persons dealing at arm’s length, or
- It results in the misuse or abuse of tax provisions, or
- It lacks commercial substance, or
- It’s carried out in a manner not ordinarily employed for genuine transactions.
You don’t need to tick all boxes — even one of these can make the entire arrangement void for tax purposes."
Let’s Make It Simple: A Quick Example
Imagine a company in India routes investments through a shell entity in a tax haven, just to enjoy tax treaty benefits. The entity exists only on paper, has no employees & no real business activity. The sole intention? Avoid taxes.
Even if everything appears legal, Section 96 can kick in. The arrangement lacks commercial substance, is structured only to obtain a tax benefit, & may be declared impermissible.
What Happens If an Arrangement Is Declared Impermissible?
The tax department can disregard the entire structure & recompute income as if the transaction never happened that way. It’s like peeling back a disguise to expose the real transaction underneath.
They can:
- Deny tax treaty benefits
- Ignore intermediary companies
- Recharacterize debt as equity
- Combine or split entities as needed
Whatever it takes to undo the tax advantage.
But Isn’t That Harsh? What About Legal Agreements?
That’s exactly why GAAR under Section 96 is applied cautiously & only to aggressive tax avoidance, not regular tax planning. You can still claim exemptions & deductions — but if your deal exists only for a tax benefit, you’re in dangerous territory.
Is GAAR Already Applicable?
Yes. GAAR, along with Section 96, applies to:
- Arrangements entered into on or after April 1, 2017
- Where the tax benefit exceeds ₹3 crore
So, not every small investor or routine corporate deal is affected. But high-value transactions & international structures should be reviewed carefully."
Section 96: Common Mistakes to Avoid
✅ Don’t enter into back-to-back contracts that lack business logic.
✅ Avoid shell entities with no real operations.
✅ Ensure substance in transactions — physical presence, staff, control, & functions.
✅ Don’t rely solely on legal form — the department will test intent & outcome.
The Real Message of Section 96
This section isn’t anti-business. It’s anti-fake business. The law isn’t against you planning your taxes efficiently, but if your plan is a mirage with no commercial reality, it won’t stand the scrutiny.
Taxpayers, especially corporates & high-net-worth individuals, must review structures carefully. Don’t fall for shady advice promising zero tax — if the taxman finds no substance, Section 96 can burn the whole arrangement to ashes.
What If You’re Already Involved in Such a Structure?
Don’t panic — not everything will be automatically declared void. But it's best to consult a Chartered Accountant or tax advisor immediately. Be transparent in disclosures & maintain documentation to prove real business intent.
Final Thoughts: Don’t Just Look Legal — Be Genuine
In today’s world, tax transparency matters more than ever. Regulators are smarter, tech-driven, & better equipped to trace every digital footprint.
So, before entering that new partnership, overseas investment, or holding company setup, ask yourself:
“Does this make commercial sense — or just save me tax?”
Because if it’s only the latter, Section 96 might come knocking.
💡 Need help reviewing your transactions for GAAR compliance or building tax-smart but legal structures? Our expert Chartered Accountants at Callmyca.com can guide you every step of the way, so you save tax without crossing the line.
