Friday, May 25, 2007

Taxing Communication (Law Street in The Economic Times for May 2007)

Hi Readers,

Global warming has taken its toll, in more ways than one. Believe it or not, globalisation also has its repurcussions in tax land. So read on for the latest column. For the url click here

As always, the column is also cut and pasted here from the online edition of The Economic Times for your convenience.

Taxing communication

Global warming is the hottest topic these days. But please do not bring up this subject if conversing with Zenobia Aunty. She has returned from her vacation, badly sunburned, and vows not to step out of the house for days to come. Slathered in calamine lotion, she is not attending the tonnes of networking events which she is addicted to, yet she is still inundated with requests for her views. In fact, her email-inbox overflows each day with tirades against a recent Mumbai Tribunal decision, where it was held that the payment of the arm’s length price to the dependent agent does not extinguish the tax liability of the foreign company in India. In this case, the assessee was a telecasting company, which was a Singapore tax resident. It had an agent in India for marketing airtime slots; this agent was considered to be a dependent agent and hence constituted a permanent establishment in India.

If a permanent establishment of a foreign entity exits in the other country, tax treaties prescribe that such other country has the right to tax the foreign entity. However, the foreign entity can be taxed only in respect of the profits attributable to the permanent establishment. Based on past judicial precedent and also based on two circulars issued by the Central Board of Direct Taxes (CBDT), one of which had clarified the tax position in cases where outsourcing activities were carried out from India, the Singapore company held that there was no tax incidence in India. The Singapore company argued that as it remunerated its dependent agent at an arm’s length price, nothing further would be attributable to it in India and hence it would not be subject to Indian taxes. However, the Tribunal held otherwise.

Perhaps for the first time, the Tribunal explicitly held that the foreign entity and the dependent agent are two different tax payers. In other words, the tax liability of the foreign entity was not subsumed in the arm’s length price paid to the dependent agent in India. This ruling, has led to some degree of unease. It is true that a dual tax payer approach is advocated by the Organisation for Economic Co-operation and Development (Oecd) - a think tank comprising largely of developed economies. Back home, the unease lies in the subjectivity which may arise during the course of tax assessments in determining whether or not a permanent establishment exists in India and also the manner of attribution of profits.

It is one thing to say that mere business operations in India through a subsidiary will not always create a permanent establishment. Further, even if such a permanent establishment exits, it is not essential that there would be a profit attribution. However, tax authorities especially at the lower levels may take a different view, resulting in an endless bout of litigation. Oecd in its paper has clearly specified that there cannot be an automatic attribution profit trigger merely because a permanent establishment exits. It should be examined whether or not there is an actual undertaking of risks and economic ownership of assets by the dependent agent, only then in certain circumstances can there be any attribution to the foreign principle over and above the arm’s length price already paid to the dependent agent. This, in essence brings us back to transfer pricing and the need for advance pricing mechanisms. Something that Zenobia Aunty is now tired of advocating.

With tax uncertainties on the rise, tax risk management has become the need of the hour. An annual survey of CFOs and finance professionals carried out by the firm where this columnist currently work, shows that tax risk management is gaining importance. With cross-border impact of taxes, this should not come as a surprise. Companies must have in place tax risk management strategies approved at the highest levels. While tax risk management has been recognised and is being increasingly put into practice, by identifying the tax risk points - be it cross-border transactions or transfer pricing, tax reporting is something which CFOs and finance professionals need to equip themselves with much better. In this era of corporate governance, as tax incidence has an impact on stake holders, it is essential to get the right message across, including the next steps that are proposed to be taken by the company concerned. Further, this needs to be done in simple terms so that it can be understood by a cross section of stakeholders who may not be tax experts. It is true that tax uncertainties can act as a hurdle to effective communication. For once Zenobia Aunty is asking for your views. Any thoughts on the best way to report tax uncertainties?

(The author is a CA. Views are personal.)

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