No country is free of tax controversies and challenges. But the nature and complexity of such disputes, as well as the ways of addressing these, evolve with time. The Indian economy is now going through an interesting phase with the promise of the new government to promote a stable, transparent and non-adversarial tax regime instilling confidence, hope and a positive sentiment among taxpayers. However, since there will always be some amount of friction between the taxpayer and the tax authorities due to the natural contradiction in the interests involved, the dream nation, free from tax litigation, is unlikely to become a reality.
A tax dispute in India is seen as a time consuming and expensive exercise with an uncertain outcome. It can potentially have serious long term ramifications for both the profitability of the relevant business and the reputation of the taxpayer. There has been an upsurge in tax disputes in the past few years with a number of high profile cases now being contested at various levels of the judiciary and the administration. Tax litigation trends highlight the importance of a preventive and proactive approach and also the importance of strategising right from the first step when planning a transaction.
Forums available for tax dispute resolution
Under Indian Income-tax Act, 1961 (Act), the following forums could be used to facilitate the speedy resolution of tax disputes:
Authority for Advance Rulings (AAR)
This forum is primarily available to non-residents / foreign companies. A key advantage of this forum is that the AAR is required to pronounce its ruling in a time-bound manner and such ruling is binding both on the tax authorities as well as the applicant who sought the ruling in connection with the concerned transaction. This approach can be adopted for either a completed transaction or a proposed transaction but not for a 'hypothetical transaction'. This increases the level of certainty in tax matters and helps non-residents / foreign companies to ascertain their tax exposure in India.
Recently, as a measure to reduce tax litigation, the government had announced that the opportunity to approach the AAR would also be available to resident taxpayers (who have entered into one or more transactions valuing INR 10 million ($150,000) or more). Further, it has been proposed that additional benches of the AAR would also be set up.
It must be noted that a prerequisite for filing an application before the AAR is that a 'question' raised by the applicant must not be pending before any income tax authority / appellate tribunal or any court. In certain rulings pronounced by the AAR, it was held that an application for an AAR filed after filing of return of income will be invalid as the question will then be treated as pending before the tax authorities and therefore outside the ambit of the AAR.
If effectively used and implemented, the AAR could prove to be one of the most efficient ways to mitigate tax litigation in India.
Though a ruling by the AAR is binding on both the tax authorities and the applicant and is non-appealable under the Act, in exceptional circumstances the Supreme Court of India (SC) and the jurisdictional High Courts do exercise their discretion to admit constitutional special leave petitions (SLPs) or writ petitions (respectively) challenging AAR rulings.
Dispute Resolution Panel (DRP):
This is another forum which was set up to facilitate the speedy resolution of tax disputes. The DRP comprises a panel of three commissioners of income-tax who adjudicate matters concerning adjustments proposed by a tax officer in tax assessments of foreign companies and cases involving transfer pricing adjustments.
In case the taxpayer has objections to the proposed adjustments in its tax assessment, it can approach the DRP and submit these objections. The DRP then considers the objections and, after hearing both sides, it gives the necessary directions to the tax officer. Thereafter, the tax officer is obliged to frame the tax assessment based on the directions of the DRP. The DRP is required to provide its directions in a time-bound manner for the speedy disposal of disputes.
Income Tax Settlement Commission (ITSC):
The ITSC provides speedy resolution of tax disputes in complicated matters involving tax demands exceeding certain prescribed amounts (INR 1 million or INR 5 million depending on the relevant criteria). A 'case' can be filed with the ITSC for settlement if it involves a proceeding for tax assessment in respect of any year which is pending before a tax officer on the date on which an application is made to the ITSC. The ITSC has been vested with wide powers to settle a tax dispute taking an overall practical view of the case based on the facts and circumstances. Settlement orders passed by the ITSC are final and binding and cannot be appealed against before any court of law, except by way of writ petition before a jurisdictional high court under the Constitution of India. The ITSC also has powers to grant immunity from penalty and prosecution in certain deserving cases.
Withholding tax authorisation:
Section 195 of the Act requires tax to be deducted from payments made to non-residents which are chargeable to tax in India. If the payer believes that a proposed payment to a non-resident is not liable to tax in India, it may approach the tax authorities for their authorisation, by way of a lower/nil tax withholding certificate, to make such payment without deducting tax or deducting tax at a lower rate. This mechanism could reduce the possibility of disputes at a later stage as the tax is deducted (or not deducted) after agreement with the tax authorities. However, it should be kept in mind that a lower/nil tax withholding certificate is not a conclusive determination of the tax liability of the payee. The tax authorities usually reserve their right to make a final determination of the tax liability at the time of the actual assessment of the taxpayer. The opportunity is also available to the payee, in certain specified circumstances, to approach the tax authorities for an authorisation to receive payments without withholding of taxes or after a lower withholding of taxes.
Mutual agreement procedure (MAP) under tax treaties:
This is a special mechanism provided under double taxation avoidance agreements (DTAAs) which India has entered into with various countries. MAP applies to cases where an action or a proposed action leads to double taxation of income, which is not in accordance with the DTAA in question. On receipt of an application for MAP made by a taxpayer, the competent authority of the taxpayer's country will take up the disputed matter with the competent authority of India to discuss the issues and try to arrive at a resolution.
Advance pricing agreements (APA):
The APA mechanism enables an agreement between the Central Board of Direct Taxes and any taxable entity, which determines, in advance, the arm's-length price or specifies the manner of determination of the arm's-length price (or both), in relation to an international transaction. An APA scheme has been notified by the Ministry of Finance detailing the process and compliances in this regard. This is a fairly recent addition to the dispute resolution landscape in India.
Income Tax Appellate Tribunal (ITAT):
The ITAT is the final fact-finding authority under the Act. The ITAT has benches all across India which have jurisdiction over specified regions. The ruling of the ITAT is binding on all tax authorities within its jurisdiction. An appeal to the ITAT would stem from the orders of the first appellate authority under the Act (that is, from the Commissioner of Income-tax (Appeals)) and from orders of the DRP.
The High Court usually has jurisdiction over a particular state. The high courts, in addition to their appellate jurisdiction, also enjoy constitutional writ jurisdiction used most often for the enforcement of fundamental rights and to control administrative excesses, apart from enforcing legal rights. The high courts do not indulge in any fact-finding exercises, instead deciding on the questions of law posed before them.
India's independent judicial system is headed by the Supreme Court (SC). The SC hears appeals from the orders of the High Court and constitutional SLPs filed against the orders of any authority, court or tribunal. Like the high courts, the SC is only required to consider questions of law.
Importance of proper strategies for effective handling of tax litigation
Identifying and adopting an appropriate strategy is crucial in the effective and efficient handling of tax litigation. Some of the key factors that could avoid or reduce tax litigation are:
- Scrutinising transactions from a legal perspective to ensure compliance with all applicable laws. Proper counselling goes a long way to resolving tax litigation in a timely manner;
- Laying strong foundation for a strong defence:
- A taxpayer should make appropriate disclosures in tax returns; bring relevant facts and legal documents on record with the tax authorities upfront in order to lay the foundation for a strong case. This would also help in defending against any levy of penalty;
- When undertaking transactions with related parties, a taxpayer should ensure a transfer pricing study is undertaken before entering the transaction, as opposed to this being an afterthought. This will help the taxpayer in structuring such transactions in an appropriate fashion, and reducing, to some degree, the possibility of the transaction's pricing being called into question;
- Transactions – documentation and back up:
- While undertaking transactions such as acquisitions, mergers, slump sales, share sales, and so on, taxpayers must ensure all relevant documents and evidence are preserved, including supporting evidence with respect to the valuation of the assets involved;
- Drafting or vetting of the transaction documents to ensure the intended tax structure is appropriately captured in the documents and is aligned with the commercials, which will strengthen the taxpayer's position in case of a challenge;
- Strategy to address a challenge:
- Taking a proactive approach and making the best use of the forums available for litigation, for example approaching the AAR for the determination of taxability of a transaction, and so on. An advantage of approaching the AAR is that potential proceedings before a tax officer stay in abeyance from the date of application until the date of ruling and subsequently the applicant has the option to directly approach the High Court / SC on merits. The benefits of this are twofold:
- If the AAR does not find in favour of the applicant, he can jump the queue and directly approach the High Court / SC on merits. In contrast an appeal against the decision of a tax officer lies with a superior tax officer, that is, the Commissioner of Income Tax (Appeals), and thereafter with the ITAT. The High Court can be approached only after the decision of the ITAT; and
- Since the assessment proceedings are in abeyance, it negates the possibility of the tax authorities raising demands and following up for the recovery thereof;
- It is critical that the taxpayer has effective representation before the tax and appellate authorities, and all key facts, arguments, supporting evidence and relevant documentation are put forth in a comprehensive fashion before the aforementioned authorities. It should be noted that the High Court and the SC decide on questions of law and do not go into questions of fact. Further, they do not routinely permit the introduction of additional evidence in matters before them; and
- Timely follow-up and a push for speedy disposal of disputes is essential. This can be achieved by effective representation before the tax authorities and timely compliance with official procedures and paperwork requirements.
Recent tax controversies in India
Some of the recent and much talked about disputes and controversies in India include:
- Nokia, involving the taxation of royalty payments by Nokia India to its Finnish parent company. The tax authorities had slapped a notice on Nokia's subsidiary in India, freezing its assets in pursuance of an alleged default of withholding norms while making the royalty payments. This had stalled the transfer of Nokia units in India to Microsoft being undertaken as a part of its global deal;
- IBM, wherein the tax authorities declined to give the benefit of rebates to IBM under the Software Technology Parks of India Scheme. The company is now contesting a INR 1,090 crore tax demand raised by the tax department;
- Shell India and Vodafone, involving additions to tax liability on account of transfer pricing provisions applied to share issue involving alleged undervaluation of shares to avoid tax in India. However, the High Court has ruled that these transactions would not be subject to transfer pricing provisions and the government has accepted the ruling of the High Court;
- The Aditya Birla-AT&T deal, involving a question of indirect transfer of Indian assets and applicability of the India-Mauritius DTAA. This matter is pending before the SC;
- A number of cases involving the question of whether minimum alternate tax (MAT – tax payable at the rate of 18.5% plus surcharge and education cess. The levy only applies when the tax paid on normal income is less than 18.5% of the book profits) is due. However, the government, in its Budget for the year 2015-2016, has announced that MAT will not be applicable to foreign companies having income in the form of capital gains. Since this amendment is effective only prospectively, the dispute in relation to past years is awaiting a decision from the SC;
- Certain cases are pending before the AAR seeking a ruling on the applicability and availability of the India-Mauritius DTAA, commonly used as part of tax structuring for foreign investors looking to enter or expand operations in India, and by Indian companies seeking to make moves into Africa.
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