Entering Troy: The Government’s Battle between Tax Policy and Investment Commitments
In today’s globalized era where multinationals are on a boom, India has emerged as a potential hub of investment. With a view to improve India’s image at the global level and boost its investment market, the new -
|government has made certain investor-friendly changes in the existing tax regime but a detailed analysis of them confirms that the element of uncertainty continues to remain write Anmol Awasthi and Neelasha Nemani.
With the dawn of globalization and the economic reforms undertaken by India in the 1990s, the Indian economy has emerged as the fastest growing competitive force in the global economy. Incidentally, since there had been a shift in business practices all over the world – from being confined to the domestic territory of one country to transcending borders and bringing together the global market as a whole, India became one of the world’s largest and most desired hubs of investment. While this foreign investment in India was strongly encouraged, the integration of the domestic market with the global market posed unimaginable challenges to the existing tax structure in India.
As a developing economy, India undeniably requires a good inflow of foreign investment. But in the process, the existing tax structure is faced with the difficulty of integrating itself with international standards and global tax regimes. On one hand, the primary focus of a tax structure is to collect revenue from taxes levied by the government but on the other hand, the same structure must be integrated in such a manner so as to be favourable to foreign investments as well. It is this balancing act that has and continues to pose a challenge to the tax authorities of India.
Surprising as it may be, India is, unfortunately, considered one of the most aggressive tax regimes in the world. Much to the dismay of the investors, India’s tax reforms to bring its structure in line with global practices has not produced desirable results; and who is to blame? Popular opinion holds that there is great inconsistency between the legislation, interpretation and enforcement of taxation laws and the Indian administration is accused of being extremely arbitrary. International business reports have evidenced that the enforcement Surprising as it may be, India is, unfortunately, considered one of the most aggressive tax regimes in the world. Much to the dismay of the investors, India’s tax reforms to bring its structure in line with global practices has not produced desirable results; and who is to blame? Popular opinion holds that there is great inconsistency between the legislation, interpretation and enforcement of taxation laws and the Indian administration is accused of being extremely arbitrary. International business reports have evidenced that the enforcement agencies distrust taxpayers and are consequently more rigid in enforcing tax payments.1 It is this aggressiveness of tax practices that has earned India a negative reputation and has resulted in the creation of an unfavourable investment climate.
Through this article, the authors seek to delve into the specific instances responsible for India’s tarnished image of being an uncertain and unstable tax jurisdiction. The article also critically discusses the efforts put in by the Indian government to purge India of its negative reputation.
II. AGGRESSIVE TAX REGIME VERSUS A COMPELLING NEED FOR INVESTMENT: PATH OF RECONCILIATION
In the process of integrating its domestic practices with international standards, the past decade has witnessed the Indian government’s persistent efforts at revenue generation inasmuch as its tax policies have become so aggressive that it has resulted in fundamentally questioning India’s ability to be a prime investment destination. Several instances suggest arbitrary and whimsical behaviour on part of tax authorities giving investors reason to withdraw investment from India. But what the government cannot turn a blind eye to is that India, as a matter of fact is still a developing economy and in order to progress on the economic front, it requires a lot of investment – both domestic as well as foreign. In an attempt to accelerate economic growth and development, tax law and its implementation has become more aggressive with a view to put more transactions to tax and increase revenue; however, the same aggressiveness is discouraging investors from actually investing.
III. Chasing Vodafone
While looking at instances which evidence the aggressiveness of Indian tax regime, the Vodafone-Hutchinson2 tax saga is perhaps the most noteworthy of all. This is a case concerning an ‘indirect transfer’ of shares wherein Vodafone B.V. had made a 100% acquisition of CGP Holdings from Hutchinson Telecommunications International Ltd. (HTIL) and CGP Holdings controlled 67% of the stake in Hutchinson Essar Ltd. (HEL), which was an Indian joint venture.
1. R.R Singh & Neetika Kaushal Nagpal, India Investment Climate: Addressing Concerns About Tax Policy, Indian Council for Research on International Economic Relations 2014, available at http://www.bmradvisors.com/pdf/India-Investment-Climate_Addressing-Concerns-About-Tax-Policy.pdf, last seen on 28/07/2015.
2. Vodafone International Holdings B.V. v. Union of India & Anr., (2012) 6 SCC 613.
In a battle that lasted five years, the fundamental issue before the Court was whether an offshore transfer of shares between two foreign companies that resulted in indirect transfer of shares of an Indian company could be taxed in India, given the fact that the foreign buyer (Vodafone B.V.) had acquired economic control over the Indian shares.
In its landmark ruling, the Supreme Court ruled that profits arising out of such transfer of shares could not be taxed in India since it did not result in the transfer of a capital asset situated India. Interpreting Section 9(1) (i) of the Income Tax Act, 1961 (Act), the Court categorically held that the provision was not a ‘look through’ provision and hence, did not encompass ‘indirect transfers’. Further, it was observed that in order to determine the true nature of a transaction, the tax authorities must ordinarily take the ‘look at’ approach3 and should resort to the ‘substance over form’ rule only when it is established that the transaction is a sham.4
Notably, while delivering the judgment, the Apex Court unequivocally admitted that certainty and stability in fiscal policy were indispensable for the investor community to make rational economic choices in the most efficient manner.5 However, in a haste to tax Vodafone, the Indian government amended Section 2(47) of the Act through Section 36 of the Finance Act, 2012 with retrospective effect, thereby rendering the verdict nugatory and making Vodafone B.V. liable to pay tax. This harshness of the Indian government was severely criticized by investors and tax experts from all across the globe. Although the legislature through its amendment to the term ‘transfer’ sought to tax all indirect transfers, it did not provide for the meaning or definition of what ‘indirect’ would encompass. Disguised as ‘clarificatory’ and only to ‘remove doubts’, this amendment has not only floundered the established principle of ‘certainty’ in the rule of law but has also given a severe blow to foreign investment.7
3. WT Ramsay Ltd. v. IRC, (1982) AC 300 HL.
4. N.S Nigam, Vodafone Amendment is More Than a Retrospective Issue, Business Standard (21/07/2014), available at http://www.business-standard.com/article/opinion/n-s-nigam-the-vodafone-amendment-is-more-than-a-retrospective-issue-114072101195_1.html, last seen on 28/07/2015.
5. Supra 2, at 91.
6. S. 3, Finance Act, 2012: “in clause (47), the Explanation shall be numbered as Explanation 1 thereof and after Explanation 1 as so numbered, the following Explanation shall be inserted and shall be deemed to have been inserted with effect from the 1st day of April, 1962, namely: — ‘Explanation 2. —For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India...”.
7. Editorial Staff, Why the Vodafone Retrospective Law Will Ruin India: Harish Salve, ITATonline, available at http://www.itatonline.org/articles_new/why-the-vodafone-retrospective-law-will-ruin-india-harish-salve/, last seen on 28/07/2015.
At present, the Income Tax department has served a notice upon Vodafone B.V. in respect of seizure of its assets upon non-payment of its tax liability which has now been doubled to include penalty and interest as well. Quoting Narendra Modi as having said, “We will not resort to retrospective taxation. And I repeat this commitment once again. We are also swiftly working towards making our tax regime transparent, stable and predictable”,8 such a move on part of the tax authorities reflects the complete disconnect between the policy makers and the implementers, thereby increasing the uncertainty surrounding the issue. The matter has thus been taken across the border and Vodafone has decided to pursue the same in arbitration against the Indian government.9
IV. General Anti-Avoidance Rules: Smoothening out the creases
“Taxation is the art of plucking the goose so as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” - Jean Baptiste Colbert. In other words, tax policies are designed to extract the largest possible amount of revenue from Multi-National Corporations (MNCs) with the least bit of economic and political change. Needless to say, with the growing number of MNCs, the hissing is only growing louder.10
One such tax policy which reflects the traditional debate between tax avoidance and tax evasion is that of the implementation of the General Anti Avoidance Rules (GAAR) in the Act.11 In essence, the GAAR is a set of statutory rules which are designed to scrutinize such transactions and arrangements, which are entered into by the taxpayers with the sole objective to circumvent their tax liabilities.12 The application of these rules by the Revenue authorities results in the denial of benefits arising out of such transactions to the taxpayers. In the Indian context, the GAAR proposed by the government give the Revenue authorities wide and unfettered powers to declare as ‘impermissible’13 any arrangement or part of it, if the main or
8. PTI, Vodafone Gets I-T Reminder to Pay Up Rs. 14, 200 Crore Tax Dues, Indian Express (16/02/2016), available at http://indianexpress.com/article/india/india-news-india/vodafone-income-tax-department-modi/, last seen on 27/03/2016.
9. Remya Nair, Vodafone Initiates Investment Arbitration against India, Livemint (07/04/2014), available at http://www.livemint.com/Industry/TwgSr8xoHzU3EcbIjqyIzH/Vodafone-begins-arbitration-in-India-tax-dispute.html, last seen on 27/03/2016.
10. Plucking the Geese: Traditional Ways of Raising Tax Do Not Work Well in a Globalized World, The Economist (22/02/2014), available at http://www.economist.com/news/special-report/21596672-traditional-ways-raising-tax-do-not-work-well-globalised-world-plucking-geese, last seen on 23/07/ 2015.
11. Ss. 95 to 102, Income Tax Act, 1961.
12. Sukumar Mukhopadhyay, General Anti-Avoidance Rule in Income Tax Law, Vol. 47 (Issue No. 22) Economic and Political Weekly, 1 (2012) http://www.epw.in/journal/2012/22/commentary/general-anti-avoidance-rule-income-tax-law.html, last seen on 30/04/2016.
13. S. 95, Income Tax Act, 1961.
one of the main purposes of entering into such arrangement is to obtain tax benefit.14 Thus, these rules are usually used as a last resort mechanism in foreign jurisdictions but are used nonetheless if no other tool is as efficient in striking down unlawful tax practices which undermine the very intention and purpose of the ordinary tax law.
However, as far as India is concerned, the rules are so highly ambiguous that since its inception, India has received a lot of condemnation for it despite its global acceptance especially because it was introduced immediately after the controversial Vodafone-linked retrospective amendment in 201216 and it was seen as an attempt on part of the Indian policymakers to deliberately counter the Supreme Court’s decision and assume control over the situation. Further, these rules were introduced without holding consultations with stakeholders and were therefore perceived as the government’s ploy to increase its revenue on the pretext of aggressive tax planning.
Having said that, the importance of such an instrument to crackdown on cases of widespread money laundering cannot be ignored. Recognizing this, the Shome committee gave its recommendations on how the said rules should be implemented and for the same it consulted various stakeholders to incorporate their concerns as well.
The government accepted the recommendation that the application of the GAAR must be deferred on administrative grounds as it is a complex mechanism and requires intensive training of tax officers in international taxation before it can be efficiently implemented.17 The government has agreed to defer it until the Financial Year (FY) beginning April 1st, 2017 (Assessment Year 2018-19) and such implementation will be prospective in nature, thereby allowing investors sufficient time to plan their taxes.19
Further, the government has also agreed to amend Section 9620 of the Act to bring under the
14. S. 96, Income Tax Act, 1961.
15. Christophe Waerzeggers & I Cory Hillier, Introducing a General Anti-Avoidance Rule (GAAR), Vol. 1, Tax Law IMF Technical Note, Jan 2016, available at https://www.imf.org/external/pubs/ft/tltn/2016/tltn1601.pdf, last seen on 16/04/2016.
16. Vikas Dhoot, Budget 2015: GAAR on Hold for Two Years, DTC Abandoned, The Economic Times (01/03/2015), available at http://articles.economictimes.indiatimes.com/2015-03-01/news/59642324_1_general-anti-avoidance-rules-general-anti-avoidance-rules-gaar, last seen on 14/07/ 2015.
17. Ministry of Finance, Government of India, Final Report on General Anti Avoidance Rules (GAAR) in Income Tax Act, 1961, available at finmin.nic.in/reports/report_gaar_itact1961.pdf, last seen on 28/07/2015.
18. PTI, GAAR deferred for 2 years: Jaitley, The Hindu (28/02/2015), available at http://www.thehindu.com/business/budget/gaar-deferred-for-2-years-jaitley/article6945067.ece, last seen on 14/07/2015.
19. Supra 16.
20. Supra 14.
purview of the GAAR only such arrangements whose main purpose is to obtain a tax benefit. Therefore, arrangements of commercial substance which incidentally also seek to mitigate tax will be excluded from the application of these rules. For a large part, the government’s accepting of this recommendation goes a long way in preventing abuse and indiscriminate application of the GAAR by eliminating the possible element of subjectivity.
What the government has also agreed to is that in a situation wherein only a part of the arrangement has been declared ‘impermissible’, consequences arising from the same will apply only to such part and not the whole arrangement.21 Also, only such arrangements that involve the obtaining of a benefit of more than Rs. 3 crores, arising to the assesse in question in the assessment year in question will be subjected to the GAAR.22 Further, the government has also clarified that transactions subjected to SAAR will be exempted from the GAAR.
The Union Budget of 2015-16 had been most favourable to Foreign Institutional Investors (FIIs) in as much as the government has announced that the GAAR provisions will not be attracted, should an arrangement be entered into without taking the benefit of Section 90A of the Act. If benefit is taken, the GAAR may become applicable, but non-resident FIIs would be excluded from its ambit.23
Determining whether a transaction must be brought within the ambit of the GAAR will always be a delicate decision and a universally acceptable objective criterion cannot possibly be evolved. This is essentially because, for instance, terms such as “tax avoidance” have different meanings in different jurisdictions.24 Therefore, the success of the GAAR in each jurisdiction will specifically be determined by its legal design and drafting and its administrative efficiency and infrastructure to be able to impose it properly.
While the Union Budget of 2016-17 is all set to implement the GAAR from FY 2017-18,25 the skepticism surrounding the success of the same is not unwarranted. Is India truly equipped to implement such a strong and presumptive anti-avoidance code or will the complexities of the same result in indiscriminate abuse of power by tax authorities, giving
21. Press Information Bureau, Government of India, Major Recommendations of Expert Committee on GAAR Accepted (14/01/2013), available at http://pib.nic.in/newsite/erelease.aspx?relid=91556, last seen on 14/07/2015.
22. Supra 16, at 47.
23. GAAR Rising: Mapping Tax Enforcement’s Evolution, Ernst & Young (02/2013), available at www.ey.com/Publication/...rising/.../GAAR_rising_1%20Feb_2013.pdf, last seen on 28/07/2015.
24. Supra 15.
25. Key Features of Budget 2016-2017, available at http://indiabudget.nic.in/ub2016-17/bh/bh1.pdf, last seen on 27/03/2016.
them unfettered powers to target enterprises and without a doubt, stifle the quantum of investment? Do Indian tax policies in this regard need a complete overhaul or are the same required to only be dynamically refined? Only time will tell.
V. Safe Harbour Rules: Not as Much a ‘Sigh of Relief’ for Fund Raisers
In a quest to address the issue of double taxation, several taxing jurisdictions entered into DTAAs whereby the most pertinent concept of Permanent Establishment (PE) was introduced. In essence, PE is a legal tool which is used to settle the right of a source country to levy tax on profits of an enterprise which is a resident of another country. It refers to a fixed place of business26 through which the business of an enterprise is wholly or partly carried out and assumes great significance under tax treaties due to the multi-jurisdictional operations of MNCs.27
Until the Union Budget of 2015-16, the Indian-based investment advisors of foreign investment funds would often run the risk of being categorized as a PE of the offshore fund thereby attracting additional tax liability on the profits that could be attributed to such PE. As a consequence, offshore funds interested in investing in India often took assistance of fund managers based outside India. However, with a view to improve India’s fund management operations and overall investment climate, the Union Budget of 2015-16 clarified that on fulfillment of certain preconditions, fund management activities carried out in India by an eligible fund manager on behalf of an eligible investment fund shall not be categorized as ‘business connection’ 28 in India. That is, an Indian-based investment advisor who either acts as an independent person or is sufficiently connected with the offshore fund will not be categorized as a PE.
To fulfill this aim, the Finance Act of 2015 introduced safe harbor provisions in the form of Section 9A29 which exempts fund managers and their offshore funds from tax liability if certain onerous conditions are satisfied. For instance, the concerned fund can neither carry out nor have any control or management in any business in India. Second, the fund must have at least twenty five members who are not connected with the fund either directly or indirectly, which is highly improbable in private equity or venture capital funds where the number of
26. CIT v. Vishakhapatnam Port Trust, (1983) 144 ITR 146 (AP).
27. Art. 5, OECD Model Tax Convention on Income and Capital, OECD document (22/07/2010), available at http://www.oecd.org/tax/treaties/47213736.pdf, last seen on 28/07/2015.
28. Explanation 2, S. 9, Income Tax Act, 1961.
29. Notes on Clauses, The Finance Bill, 2012 at 90.
investors is very small. For instance, a sovereign fund or large institutional funds mostly have a single investor.30 Further, the Indian-based fund manager cannot be an employee of the fund or be connected with the fund in any manner whatsoever. This seems highly implausible because owing to the requirements of consistency and confidentiality, funds do not prefer independent advisors/managers. Furthermore, the investor-commitment ceilings such as less than 50% aggregate participation of 10 or less members of the fund or maximum 10% participation of individual members along with persons connected with the fund will only hinder greater investor participation and impact the overall growth of the fund management industry.
It is inferable from the aforesaid conditions that primarily, only Foreign Portfolio Investors (FPIs) or hedge funds can avail of the exemption successfully since other funds such as private equity or venture capital funds fail to meet such stringent conditions. It is also pertinent to note that despite the recommendations made by the N.R. Narayana Murthy Committee31 to ease the eligibility conditions and streamline them with global practices, no proactive steps have been taken by the Government in the Union Budget of 2016-17.
32 While the rules33 for implementing the safe harbor provisions are enforceable from April 1, 2016, the onerous eligibility conditions have still not been addressed.34
The authors are of the view that the safe harbor provisions can be made more effective by first, extending their benefits to offshore investment funds incorporated in countries with which India has not signed any tax treaty.
Second, the minimum requirement of 25 members in the offshore fund must be relaxed as many of them, particularly pension and sovereign funds usually have one or few major investors who hold up to 51% of the fund’s stake. Thus, the minimum limit being commercially unfeasible must be reduced to encourage small and mid-sized offshore funds to invest in India or, in the alternative, indirect investors must be included while calculating the
30. Sachin Dave, Fund Managers May Soon Get Clarity on Permanent Establishment Rules, The Economic Times, available at http://articles.economictimes.indiatimes.com/2015-07-16/news/64495335_1_sovereign-fund-tax-rules-clarifications, last seen on 28/07/2015.
31. Securities and Exchange Board of India, The Alternative Investment Policy Advisory Committee Report (20/01/2016), available at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1453278327759.pdf, last seen on 27/03/2016.
32. The Finance Bill, 2016 (Bill No. 18 of 2016).
33. Ministry of Finance, Government of India, The Income Tax (5th Amendment) Rules, 2016 (15/03/2016), available at http://www.incometaxindia.gov.in/news/notification-no-14-of-2016.pdf, last seen on 27/03/2016.
34. The CBDT notifies the Rules in relation to the Safe Harbor Provisions for Offshore Funds, KPMG (18/03/2016), available at https://www.kpmg.com/IN/en/services/Tax/FlashNews/KPMG-Flash-News-Safe-Harbour-rules-for-Offshore-Funds-2.pdf, last seen on 27/03/2016.
minimum number of investors. In addition, the minimum corpus requirement of 100 crores must also be rationally relaxed to ensure foreign investment by mid-sized overseas investment funds.
Third, given the operational strategies of certain funds wherein they invest a majority stake in the investee company with a goal to either make it an associate entity or with a provision of subsequent buyout, it becomes relevant to rationalize the investment conditions pertaining to an investment limit of 20% in single portfolio companies.
Fourth, a minimum threshold of control must be allowed to overseas funds in their investments in India to assist them in ensuring that their investments are rightfully directed to meet their goals. Lastly, the recommendations made by the N.R. Narayana Murthy Committee35 must be incorporated to rationalize the eligibility conditions and to foster an effective onshore fund management environment.
VI. The Elusiveness of Minimum Alternate Tax
Another contentious issue in India’s tax arena pertains to the applicability of Minimum Alternate Tax (MAT)36 on FIIs. Generally, a company’s liability to pay tax in an assessment year is computed on the basis of its total income in the previous year and the same is determined in accordance with the provisions of the Act.37 In order to avoid tax liability, there emerged a growing practice amongst companies with soaring book profits to declare and distribute significantly high dividends to their shareholders. As a result, these companies could avail of several exemptions, deductions and depreciations at high rates under the Act which considerably reduced their taxable income, thereby resulting in payment of little or no tax.38
Commonly referred to as ‘zero tax’ companies, the concept of MAT was introduced in the Act39 with an aim to levy minimum tax on such companies by deeming a certain percentage of their book profits, computed under the Companies Act40, as taxable income.41 Thus, where
35. Supra 30.
36. S. 115JB, Income Tax Act, 1961.
37. S. 4, Income Tax Act, 1961.
38. S. 115J, Income Tax Act, 1961 (inserted by the Finance Act, 1987).
39. Supra 36.
40. The Companies Act, 2013.
41. Ministry of Finance, Government of India, Report on Applicability of Minimum Alternate Tax (MAT) on FIIs / FPIs for the Period Prior to 01.04.2015 (25/08/2015), available at http://finmin.nic.in/reports/ReportonApplicabilityofMinimumAlternateTax%20onFIIsFPIs.pdf, last seen on 27/03/2016.
the tax payable on the total income of a company (assessee) in a given previous year (commencing on or after April 1, 2001) is less than 18.5% of its book profits,42 then such book profits shall be deemed to be the total income of the company on which tax at a flat rate of 18.5% would be payable.43
With respect to the applicability of MAT on FIIs, the Authority for Advance Rulings (AAR) had categorically ruled that MAT was not applicable on foreign companies which did not have a PE in India.44 However, controversy arose in 2012 when in the case of Castleton Investment Ltd.,45 the AAR deviated from its earlier rulings and ambitiously held that MAT was applicable on foreign companies even if they did not have PE in India. Sending shock waves across the entire foreign investor community, this ruling affirmed the aggressiveness of Indian tax authorities on non-resident tax payers as the direct implication of this ruling was that FIIs could be liable to pay MAT.
This was followed by another erroneous clarification in the Finance Act of 2015 that MAT would not be levied on FPIs’ long term capital gains from securities, royalty, technical fees and interest income from April 1, 2015 onwards, completely overlooking the deep-seated issue of whether MAT was applicable to non-resident investors or not. In the absence of any explanation concerning the fate of sixty eight cases where tax notices had been already served before April 1, 2015,46 and the mounting writ petitions challenging the tax notices in the High Courts, the Government was compelled to constitute a three-member panel headed by retired Justice A.P. Shah to assess the applicability of MAT on foreign companies and institutional investors and its overriding effect over the provisions of double taxation avoidance agreements (DTAA).
While the legislative intent behind the levy of MAT was to target domestic companies, that is, companies which conduct business operations in India, it is pertinent to note that the decision making functions of FIIs and FPIs are carried outside India, thereby ensuring that they do not have sufficient business presence in India.47 This ensures that only fund managers
42. Explanation 1, S. 115JB, Income Tax Act, 1961.
43. Arvind Datar, The Law and Practice of Income Tax, 1872 (10th ed., 2014).
44. In Re: The Timken Company,  326 ITR 193 (AAR); In Re: Praxair Pacific Limited,  326 ITR 276 (AAR).
45. In Re: Castleton Investment Ltd.,  348 ITR 537 (AAR).
46. Sachin Dave, AP Shah Panel Seeks Recommendations; to Meet Revenue Officials, FPIs & Analysts, The Economic Times (01/06/2015), available at http://economictimes.indiatimes.com/articleshow/47494886.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst, last seen on 28/07/2015.
47. Supra 29.
of such FIIs and FPIs operate in India and the overseas fund as a whole can enjoy the tax concessions granted to them with an aim to promote an investor-friendly environment.
Significantly, even the A.P. Shah Committee49 opined that MAT could not be levied on FIIs and its provisions under the Income Tax Act, 1961 did not have an overriding effect on the benefits ensured under DTAAs. In addition to accepting the recommendations of the committee, the Government finally clarified before the Apex Court that MAT would not be levied on FIIs and FPIs which did not have a business presence in India, thereby putting to rest the Castleton controversy.50
It is worth noting that such elusiveness on the part of the Government does more harm than boosting India’s investment climate. At the heart of this uncertainty was the flawed reasoning of the Income Tax department that, FPIs must pay MAT since they are supposed to maintain books in India.51 In light of the recommendations made by the A.P. Shah Committee, the authors are of the view that the scope of MAT’s exemption must be categorically defined as one which takes into its ambit all foreign investors who claim exemption under treaties, who do not have a Permanent Establishment in India and who are not required to maintain books under the Indian Companies Act, 2013.
VII. Transfer Pricing: Attempting to tax Share Subscriptions
With the advent of globalization, cross border transactions between MNCs have proliferated considerably, resulting in increased transfer of goods, services and assets amongst nations. Evidently, tax concerns pertaining to such cross border transactions52 also came to the forefront of which the most contentious has been the issue of transfer pricing as a tool for tax avoidance. In essence, transfer pricing refers to setting or fixing of the prices by MNCs for goods and services which are sold from one legal entity to another within an umbrella enterprise or between associated or related enterprises53 with the sole object of reducing the overall tax liability of the MNC. The structure typically consists of a parent company
48. S. 9A, Income Tax Act, 1961.
49. Supra 41.
50. Government Accepts the Recommendation of the A.P. Shah Committee to Clarify the Inapplicability of MAT to FIIs/FPIs, KPMG, (03/09/2015), available at http://www.kpmg.com/IN/en/services/Tax/TaxDocuments/KPMG-Flash-News-Applicability-of-MAT-to-FPIs-2.pdf, last seen on 27/03/2016.
51. Sachin Dave, I-T Department Issues Fresh MAT Notices to Foreign Investors, The Economic Times, available at http://articles.economictimes.indiatimes.com/2015-04-07/news/60902664_1_fpis-capital-gains-mat, last seen on 28/07/2015.
52. S. 92 B, Income Tax Act, 1961.
53. S. 92A, Income Tax Act, 1961.
incorporated in one country and its numerous subsidiaries in different jurisdictions. So when business is carried out within the structure of an MNC, the market standard of Arm’s Length Price54 (ALP) is disregarded and the income is shifted arbitrarily in such a manner that profit figures are lowered in a high tax jurisdiction and are raised in a country that levies low or no taxes. Such a price is said to be a manipulated transfer price and it entails misuse of the tax policies of jurisdictions.
The Indian transfer pricing regulations are as recent as 2001 and though the underlying rationale behind regulating transfer pricing is to bring in coherence and uniformity in the manner in which tax is imposed on cross border transactions between associated enterprises, there are numerous instances wherein Indian tax authorities have faltered in applying the same. What makes India an overtly aggressive tax jurisdiction, particularly with reference to its transfer pricing law is the fact that India is perhaps the only country in the world to have even attempted at taxing share subscriptions, by tailoring the scope of the term ‘income’ as defined under section 2(24) of the Act to its needs.
The first and foremost precondition of interpreting a fiscal statute is to avoid making any assumptions as to the intention of the legislature from a plainly constructed provision55. Should there arise any ambiguity in specifying the three components of a tax provision i.e, the subject of the tax, person liable to pay tax and the rate of tax to be paid, there is no tax in law. 56
In the recent landmark Vodafone case, Vodafone57 India issued a certain number of equity shares to its non-resident parent company at a price computed under the Capital Issues (Control) Act.58 However, the income tax authorities recomputed the same and accused Vodafone India of having issued the shares not in accordance with the ALP so determined and asserted that the difference between the ALP and the price at which the petitioner issued its shares would be treated as a ‘loan’, the income arising from which would be subject to tax. What makes this assertion absurd is that the Act does not provide for the creation of a legal fiction to treat such a shortfall in capital receipts as ‘income’. Section 2(24)(vi) specifies that capital gains chargeable under Section 45 of the Act would be construed as income for
54. S. 92C, Income Tax Act, 1961.
55. A.V. Fernandes v. State of Kerala, AIR 1957 SC 657.
56. Mathuram v. State of Madhya Pradesh, (1999) 8 SCC 667.
57. Vodafone India Services Pvt. Ltd. v. Union of India, (2014) 271 CTR (Bom) 488.
58. Capital Issues Control Act, 1947.
the purposes of taxing a transaction under this Act. However, the transaction in question does not fall within the ambit of Section 45 either since it involves the issue of shares and not merely a transfer, both of which are distinguishable in law.59 This transaction resulted in the generation of capital receipts which does not find a mention in the inclusive definition of ‘income’ and therefore cannot be subjected to tax. In light of the fact that the generation of income is a prerequisite for attracting transfer pricing provisions, the Court in this case held that the transaction would not be taxable. Further, that unless and until there is a charging section specifically bringing a transaction to tax, tax cannot be levied.60
Reaffirming its decision in the Vodafone India case, the Bombay High Court in the case of Shell India61 upheld two important principles. Firstly, that equity infusion by a foreign parent company into an Indian subsidiary cannot be construed as income for the reason that it results in the generation of capital receipts.62 And secondly, that the above does not attract the provisions of transfer pricing as under the Act since the same is applied only when income, interest or expense are involved.63
Clearly, the tax authorities were overstepping their jurisdiction by attempting to tax capital receipts by over-widening the scope of the concerned provision which is against the basic rule of interpretation of fiscal statutes. Being the first and the only country so far to have attempted to tax share subscriptions, India has rightly earned itself the reputation of being an overtly aggressive tax regime, giving reason to investors to believe that tax authorities in India take a leap at any ambiguity in the law to wrongfully bring transactions to tax.
It is indisputable that India being a developing economy, the Government has a twofold obligation to fulfill. First, as an emerging player in the international investment market, it has to ensure that Indian laws are constructive and approving of foreign investment in the Indian
59. Khoday Distilleries v. CIT, (2009) 1 SCC 256.
60. Amitabh Kant, India Sending Right Messages on Non-Adversarial Tax Policy, The Economic Times, available at http://economictimes.indiatimes.com/news/economy/policy/india-sending-right-messages-on-non-adversarial-tax-policy-amitabh-kant-dipp-secretary/articleshow/46566424.cms, last seen on 05/04/2015.
61. Shell India Markets Pvt. Ltd. v. Assistant Commissioner of Income Tax, (2015) 273 CTR (Bom) 161.
62. BS Reporter, Shell Wins Transfer Pricing Tax Dispute in Bombay HC, Business Standard, available at http://www.business-standard.com/article/companies/bombay-hc-rules-in-favour-of-shell-in-transfer-pricing-case-114111800735_1.html, last seen on 28/07/2015.
63. Our Bureau, Shell India Wins Transfer Pricing Case, The Hindu Businessline, available at http://www.thehindubusinessline.com/companies/shell-india-wins-17920crore-transfer-pricing-case/article6612053.ece, last seen on 28/07/2015.
market and second, it must provide for a stable and predictable tax regime to ensure efficient revenue collection and certainty of law from the standpoint of investors. Once these obligations are understood, it is then necessary to ensure their execution within the boundaries of law so that any form of arbitrariness and inconsistency does not percolate.
This is imperative since the whimsical attitude of the government and the tax authorities showcasing their distrust in investors or laying bare the instability of the tax regime will result in systemic risks in India’s investment market. That is, it will not only make investors excessively cautious about doing business in India but will also significantly increase the very risk of doing business in India. Evidently, this will have a profound impact on the economic goals that a developing country like India aims to achieve.
The instances discussed in the article reveal that the underlying reason behind India’s being categorized as an unstable and aggressive tax regime is the anxiety and abruptness with which its tax laws are ‘rationalized’. The inability in balancing investment needs against efficient revenue collection can only be mitigated if and when the various stakeholders are involved in the decision-making process. The A.P. Shah Committee, constituted to address the vagueness surrounding MAT provisions has wisely involved representatives from the foreign investor community as well the Income Tax Department to resolve the ambiguity. Even in the case of GAAR, the Shome Committee submitted recommendations to the government after consulting stakeholders as to what was agreeable to them.
It is praiseworthy that the new government is determined to encourage India’s investment climate and is agreeable to making changes in the existing tax regime to regain the confidence of investors after acknowledging the fact that in a developing economy, policies of such nature cannot be successful without making the two ends meet.
| ANMOL AWASTHI and NEELASHA NEMANI are students pursuing B.A. LL.B. (Hons.) from National Law University Odisha, Cuttack and may be reached at email@example.com and firstname.lastname@example.org respectively.