THE Finance Ministry under Mr Chidambaram toiled hard for the introduction of a new Direct Taxes Code. Leaving aside the minutiae, from the perspective of fiscal policy, it was predicated upon a lowering of tax rates, removal/ restriction of tax breaks including those on savings and closing the loopholes in the tax regime. A significant reduction in tax rate can happen only when there is better compliance. With that end in view, for the first time, the DTC Bill 2009 proposed to bring in a General Anti Avoidance Rule (GAAR) to put a stop to the prevalent practice of the blatant abuse of tax laws by the various players.
It is now very well known that foreign companies investing in India through Mauritius do not have to pay any income tax on capital gains in India whether at the time of exit or otherwise. What is not that well known is the fact that the Mauritius treaty is beneficial even in respect of other streams of income. Take for example, business - by far the most important source of income. A company, through the services of its employees, would normally carry business in India. The maximum risk for a business will hence be when there is the possibility of creating a service PE in India. The treaty with Mauritius does not have provision for a service PE, thereby restricting the PE exposure. Moreover, unlike the usual practice of India in having a clause relating to fee for technical services in its treaties, there is no FTS clause in the treaty with Mauritius. A big chunk of the income of a Mauritius based foreign company will therefore be out of the ambit of income taxation in India. As for taxation of dividend income, the same is relevant when the foreign company does business in India through a subsidiary. Dividends can be deferred indefinitely and if time comes, the holding company can buy back shares, which then can be claimed to be exempt from taxation in India.
The short point of the discussion so far is that it is possible for a Mauritius based foreign company to do business and earn income in India without paying any tax at all. Tax treaties contain a non-discrimination clause that guarantees that the foreign company is not discriminated against as compared to a domestic company. But, the way treaties in conjunction with the domestic law operate in India, most of the times it will be the Indian companies that will be discriminated against when compared to a foreign company. The higher headline rate of tax applicable to a foreign company till now is an eye-wash. The effective tax rate for such companies is much less. The domestic companies, on the other hand, cannot escape the burden of taxation. The last time corporate tax rate was lowered in India was in 1997 also during the time of Mr. Chidambaram. Corporate tax represents a disproportionate share of the total tax kitty and it is the domestic companies that must bear most of the tax burden and it must be revenue consideration that prevented a reduction of tax rate on domestic companies for over a decade now.
In such circumstances, it is therefore advantageous to be a foreign company preferably registered in Mauritius. Incorporation of a company in a jurisdiction like Mauritius, being a child’s play, many Indian companies have also started to become foreign. In our data base of case laws relating to international taxation, we very often find that the judgement starts with a statement that ABC Ltd is a Mauritius registered company which has invested in India when ABC could be any one of the well-known Indian corporate names. The way things are, it pays to be foreign in India. Why be Indian and pay taxes when one can equally be foreign and pay no taxes?
When the original DTC Bill was introduced, it promised a lowering of corporate tax rate to 25%. There was also a mouth-watering proposal for individual income tax rate of 10% for income up to ten lakhs. Leaving aside the hullaballoo over shifting from EEE to EET, most of the protests at that time also revolved around measures taken to streamline non-resident taxation. The GAAR proposal, in particular faced most trenchant criticism even from our trade and industry associations. With many Indian companies becoming foreign, such reaction is not unexpected. As an aside, when the Finance Act, 2012 actually brought in GAAR and the Voda amendments, the then Revenue secretary wondered why the Indian companies and Indian chambers were so exercised about certain amendments which were aimed at foreign players who did not wish to play by the rules of the game.
The DTC Bill having undergone many changes was finally introduced in the Parliament in 2010 and was referred to the standing committee on August 30, 2010. The Standing committee discussed the contentious issues threadbare with various ‘stakeholders’ for over a year and gave its report incorporating its suggestions on March 9, 2012. In the meantime, cornered over the allegation of inaction on the front of tackling black money, the then Finance Minister decided to fast track certain anti-abuse measures including the GAAR. It is true that the provision as incorporated in the Finance Bill, 2012 differed in some aspects from the original DTC Bill as also from what was suggested by the Standing committee. Responding to criticisms, however, assurances were given and certain changes were also made already diluting the original provision. It was also decided to defer the implementation of GAAR by one year to 2013 and to issue suitable guidelines by constituting a committee headed by the Director General of Income Tax (International Taxation).
After the passage of the Bill, followed a media blitzkrieg that painted a very bleak scene about the impending withdrawal of all foreign investments from India. Not a day passed without some experts or other not coming to the TV and deprecating the move. In short, hype was successfully created that the GAAR proposal was responsible for the dismal economic situation of the country.
Meanwhile there was a change in the Ministry and for about a month, the PM also held the Finance Ministry portfolio. It has been widely reported that the PM was uncomfortable with the stance of the Finance Ministry and was of the view that foreign investments should not suffer at any cost. This is in sharp contrast to the ‘we were not eating lizards’ statement of the erstwhile FM. The then FM having moved to the Presidential Palace, the first thing that the PM did was to appoint Dr Parthasarathy Shome to head a committee ‘to undertake stakeholder consultation and finalise the guidelines for the draft GAAR guidelines’. Reading between the lines, it was obvious that the proposal for GAAR was to be killed or diluted and deferred. It was just a matter of finding sufficient intellectual justification for the step.
Dr Shome has obliged by proposing to defer the implementation of GAAR by three years. In order to sound reasonable, he however, proposes to immediately announce the implementation of his suitably diluted GAAR from the year 2016-17. “Pre announcement is a common practice internationally, in today’s environment of freely flowing capital” says the report. This statement is meaningless, particularly when one considers the fact that GAAR is part of the Finance Act, 2012, having been duly passed by the Parliament and supposed to come into effect from 2013. It is the property of the Parliament. Yet, the government wants to make major changes and further postpone its implementation. Nothing prevents the government in 2017 to completely junk the same or make further concessions to various interests in the name of foreign investment.
And what is the justification given for the deferment? This is supposed to be on ‘administrative grounds’. “It needs to be realized that GAAR is an extremely advanced instrument of tax administration - one of deterrence, rather than for revenue generation - for which intensive training of tax officers, who would specialize in the finer aspects on international taxation, is needed.” This is one of the lamest excuses that one could think of. The committee ignores the fact that GAAR is not restricted to international transactions. It is relevant in domestic transactions as well. Moreover, what is the purpose of deterrence if it does not lead to revenue augmentation? Mere existence of deterrence is often times sufficient for revenue augmentation.
It is true that officers need to be trained. But training is an ongoing process, particularly for the officers of the tax department. Many new features come in the law at periodic intervals. Today, there is no CFC legislation in India. If and when it comes, again as a measure, of deterrence, should we again postpone its implementation? The same can be said for thin cap regulations. Taxation is a dynamic subject. Issues would arise at regular intervals. They have to be met by the administration as and when they arise through training and through other means of communication. In the USA and the UK, detailed guidelines are issued. There is no reason to assume that the tax administration in India is incapable of doing that. The probationers in NADT, Nagpur are now a days being routinely exposed to various aspects of international taxation. They have to do projects with NALSAR as part of the training programme and are awarded Masters in Business Law and Taxation. This has been going on for the last 3-4 years and these young officers are certainly better prepared than officers of earlier generations to deal with such challenges.
Moreover, even assuming that all the officers are untrained and they are able to detect only 20 out of 100 cases where GAAR should be applied, that is much better than a situation where all the 100 are allowed to escape. The excuse of not introducing an anti-avoidance legislation on the pretext of inadequate training therefore seems hollow.
The committee, of course, says that the experience with transfer pricing was not good. Now, it is not known whether the ‘experience’ the committee is talking about is that of the tax administration or of the tax professionals. The ‘stakeholders’ whom the committee met and whose list is given in the annex to the report are mostly practitioners who normally take every opportunity to paint the tax department in bad light. A goggle search of the articles written by some of them will prove the point. One of such stakeholders, Mr. Satya Poddar, of Ernst &Young, in an article in the Business Standard titled "Shome Committee sends out positive signal’ gushes: “The Shome Committee report is a triumph of democracy over tax bureaucracy…”
The expert committee should have taken the viewpoint of the tax administration as well before coming out with such a statement. After all, in ordinary parlance, the tax administration is also a ‘stakeholder’. The details of the consultation as given in the committee’s report do not show any consultation, leave alone ‘intense consultation’ with such an important stakeholder. As far as the tax administration is concerned, transfer-pricing regulations seem to be a huge success. The government, in answer to many parliament questions has repeatedly asserted the revenue gains through transfer pricing adjustments. Sure, there are litigations and there might have been some initial hiccups, but that does not mean that the Transfer Pricing provisions should not have been introduced when they were. The excuse dished out by the committee for the deferment of GAAR therefore is a lame one indeed.
The committee report mentions: “In India, introduction of GAAR through Finance Act 2012 has been taken as a shock by the stakeholders although GAAR has been in public domain for discussion since 2009. Probably, it was due to the challenging economic environment. The market has also not prepared itself for such a measure…” The expectation was that with the announcement of the postponement of GAAR the market will zoom. In fact, the market actually came down a few points. The market went up on the news of some resolution of the debt crisis in Europe. It seems that the market has already discounted the GAAR factor and any announcement one way or the other is not going to make any difference.
Even as I write this, there is a news item: “House sale Cap gains Clause under Review [ET 11/9/2012]. In a bid to encourage investment in small-scale industries, Budget, 2012, at the instance of the Commerce and Industry Ministry proposed to exempt house sales from capital gains if the same was invested in small business enterprises. According to the news report, there is a rethink of the proposal as it is likely to be abused for avoiding capital gains. While it is good that the Ministry should worry about exemptions capable of being misused, one wonders why such worries do not manifest themselves when it comes to rampant abuse of the tax treaties.
Also See:
The GAAR War?
Who Is Afraid of GAAR? |
