Friday, December 31, 2010

Law Street - Economic Times (Dec 2010) -Rounding up 2010

Dear Readers,

Zenobia Aunty has completed a decade, writing her columns in The Economic Times and has immensely enjoyed interacting with you. In the December 2010 column, she asks whether things do change in tax land? Old problems do continue, even as new challenges arise. But, here is looking forward to 2011.

Do click on the online edition of the newspaper or else scroll below.

Happy New Year.
Warm regards,

Ring out the old!
• Greater clarity on royalty payments is required
• Clearer guidelines are required for determining permanent establishment
• Cloud computing will create more tax challenges

Happy 2011, dear Readers. As Zenobia Aunty begins to type this column, she realizes that she has completed a decade of interacting with her loyal readers. She raises her cup of tulsi tea to toast them. This is a time for reflection. While a decade may have passed since this column first rolled out, there are so many issues in tax land that remains unresolved.

For instance, litigation in the tax arena as regards the classification of payments on import of shrink wrapped software continues. At the judicial level, the tax orders are largely in favour of the foreign recipient as the judiciary seeks to distinguish between a copyrighted article and exploitation of a copyright. Software licensing to the Indian payer is treated as a transaction of a copyrighted article and thus not a royalty payment.

However, at the lower levels, the going is tough for the foreign recipient or even the Indian payer. Faced with the prospect of being treated in default, the Indian payer seeks to withhold tax at source, even when it is technically not subject to tax under the tax treaty. To compound the problem, if the foreign recipient does not have a Permanent Account Number (PAN), tax has to be withheld at the higher rate of 20%. It is also likely that the home country of the foreign recipient may not allow a foreign tax credit on the ground that the tax was wrongfully withheld in India.
Recently, professionals were a bit taken aback with a ruling given by the Delhi Income tax Tribunal, in the widely published case of Microsoft. While holding that the payments made by the Indian payer would be subject to withholding tax as the payment for license of the software was royalty, the Tribunal also went ahead to observe that reliance cannot be placed on the OECD commentary in interpreting a tax treaty and that a later provision in domestic laws would override tax treaty provisions. Thankfully, the Mumbai Income tax Tribunal followed suit with a few favourable decisions, upholding the distinction between a copyright and a copyrighted article. Yet uncertainty continues to loom large.

Let us take another instance. Indian companies are often sub-contracted work by their foreign parent and other overseas group entities. The Delhi Income tax Tribunal in another instance has held that the relationship of the US entities with its Indian subsidiary to which it had subcontracted or assigned software development or call centre services resulted in a permanent establishment in India.

Moreso, since the Indian subsidiary had not been remunerated on an arm’s length basis, the Delhi Income tax Tribunal largely upheld the approach adopted by the tax department of attributing profits to such permanent establishment of the US entities based on a proportion of Indian assets to global assets.

Looks like foreign entities wanting to do business with India, need to pay more detailed attention to these ongoing issues. While it may be time to ring out the old, in tax land, the existing issues never seem to die.

But one must also look forward at emerging business scenarios, for instance e-commerce or the even more nascent cloud computing. A prominent feature of business activities conducted via the internet is that it is impossible to pin-point where that activity is taking place. The physical location of the business activity has traditionally been the crucial factor in determining where the permanent establishment is located and thus in which country the profits can get taxed.

In the context of a computer server, the OECD in its commentary has made several observations. If an enterprise which carries on a business through a website has the server (in another country) at its own disposal – it owns or leases and operates the server, it could result in a permanent establishment exposure in such other country. In most cases, it is likely, especially given the lack of usage of personnel manning the server that the all substantial assets and risks would be at the head office level and negligible profits alone could be attributed to the server created permanent establishment. But yes, attribution of profits would be a tricky matter.
If this were not enough, cloud computing will blur the boundaries further. However, it is likely that a cloud computing solution may help reduce the tax exposure arising through permanent establishment creation, as in essence it would mean that a foreign entity is merely using the services of the cloud computing provider and the cloud computing provider is not its dependent agent so as to constitute a permanent establishment.

As Zenobia Aunty looks back on the existing tax issues and foresees some new tax issues emerging she exclaims: There is never a dull moment in tax land.

Saturday, November 27, 2010

Law Street - Economic Times (Nov 2010) -GAAR

Dear Readers,
How do I describe GAAR? My greatest fear is that commercial business transactions backed by proper substance, may also fall foul of the GAAR provisions owing to ambiguity and wide sweeping powers. For views from Zenobia Aunty read further. Please click here.
As always the column is also cut and pasted below. Have a nice weekend.
Best regards,

The sting in the GAAR tale

• Specific anti avoidance rules are preferable
• If GAAR is a must, grandfathering clause is vital
• Times limits must be imposed for invoking GAAR

When was the last time you received a hand-written letter? Recently, the post man knocked at our door and handed Zenobia Aunty a hand-written letter. Zenobia Aunty hastened to open the envelope. But, it was no gushing fan-mail. Instead, it was a letter from an eminent advocate and her reader, criticizing her for calling attention only to the Controlled Foreign Corporation Rules in the Direct Tax Code (DTC), 2010, and not the “draconian” General Anti-Avoidance Rules (GAAR).

Well, touched by this advocate’s zeal to spare some time and pen a letter, a long spell of research and dictation to her long suffering niece (yes, this columnist) began. The advocated lamented how scams had taken over our country. Scams he explained often arise because of wide discretionary powers and their intended or unintended misuse. Finally, he came back to tax laws, stating that wide discretionary powers even in tax land can resulted in unwanted scenarios.

If the powers given are wide and there are no specific guidelines in place, often even a hardworking honest tax official also finds himself standing at the cross roads, not knowing which way to turn. He stands at the cross roads knowing any action will lead him into the non enviable situation of: Damned if you do, and damned if you don’t!”

The letter was referring to the GAAR proposals. GAAR as contained in the DTC gives wide discretionary powers to a Tax Commissioner to invoke these provisions and to declare any transaction as an “impermissible tax avoidance arrangement”. It is possible that tax authorities could look not at the transaction in its entirety but only at certain aspects of the entire transaction and scream: Foul! As things stand at present, even transactions or arrangements approved by the Courts can be subjected to the wide sweeping powers of the Commissioner.

Zenobia Aunty is all in favour of plugging tax abuse. But at the same time, she does not favour a climate of uncertainty. Specific anti-avoidance rules, such as thin-capitalisation rules, which kick in to prevent misuse of related party debt, are a better option as they deter tax abuse without creating a climate of uncertainty, she explains.

At present, the DTC provides for only the following safeguards in invoking GAAR: (i) The Central Board of Direct Taxes (CBDT) will issue guidelines to govern when GAAR should/could be invoked (ii) A safe harbor, possibly a monetary one, may be included only beyond which the GAAR provisions would be invoked and (iii) Tax payers can approach the Dispute Resolution Panel, if GAAR provisions are sought to be applied to the tax payer.

Are these safeguards adequate? Zenobia Aunty could not help but chanting this ditty (with due apologies to William Shakespeare) under her breath as she went about doing more research on this subject: For a charm of powerful trouble; like a hell broth boil and bubble, GAAR doth bring toil and trouble, Fire burn and DTC caldron bubble.
True certain safeguards have been mentioned. However, it is essential that the proposed guidelines providing for the circumstances in which GAAR could be invoked are objective and remove all traces of uncertainty. The GAAR provisions should not interfere with legitimate and commercial transactions. Further, a monetary threshold for invoking GAAR should be set and this must be reasonable.

It would be ideal if GAAR is dropped and specific anti-avoidance measures are introduced. However, if the powers that be, wish to continue on the path of GAAR certain additional provisions must be built in.

While the DTC prescribes that tax payers can approach the Dispute Resolution Panel if GAAR is sought to be applied, prevention is better than cure. Thus creation of an authority which would give a clean chit to a proposed transaction – on the lines of the Authority for Advance Rulings would create a sense of comfort among the investors, especially the foreign investors. The only fair way to administer a GAAR mechanism would be to introduce a clearing service where the tax authorities would review a proposed transaction or a transaction and give their opinion on the tax position.

The DTC should provide grandfathering provisions under GAAR and ensure transactions entered into only during after the DTC has come into effect can be subject to GAAR. Further, there should be a time limit within which tax authorities can invoke GAAR in respect of any transaction. The Damocles sword cannot hang over the heads of the tax payers in perpetuity. The onus of proof that there has been tax avoidance should lie on the revenue and not the tax payer.

Such additional precautions are necessary to ensure that GAAR does not become a weapon to meet tax revenue targets. Zenobia Aunty hopes that the eminent advocate and indeed her other readers are satisfied that she had done some justice to the complex proposed GAAR mechanism.

Friday, October 15, 2010

Law Street - Economic Times (Oct 2010) -CSR issues

Dear Readers,

Wishing you a happy Diwali. Zenobia Aunty and I hope that you will also be spreading the light by donating whether in cash or in kind. For the October column of Law Street: Charity begins at India Inc, please click here for the online edition of The Economic Times.

Else as always, scroll below.

Best regards,


Most non-profits which Zenobia Aunty is associated with would call her a good soul. She, in turn, admires a host of companies (editorial etiquette will prevent her from naming these companies) who voluntarily give back to society. In one of her earlier columns, she had advocated the need for uniform reporting guidelines for CSR activities, perhaps a CSR index. This would ensure that market forces could take into cognisance the contributions of such companies and would directly or indirectly boost their market value and profits.

However, the concept of a ‘mandatory CSR regime’ has taken her a bit aback and she decided to seek views from a cross section of her friends. The Standing Committee has approved of a provision contained in the Companies Bill, 2009, that mandates every company having a net worth of more than . 500 crore or turnover higher than Rs 1,000 crore; or a net profit of Rs 5 crore or more during a year to formulate a CSR policy to ensure that every year at least 2% of its average net profits during the three immediately preceding financial years is spent on CSR activities as may be approved and specified by the company.

In addition, directors are required to make suitable disclosures in the annual reports. In case any such company does not have adequate profits or is not in a position to spend prescribed amount on CSR activities, the directors are required to provide an explanation.

The intention seems laudable, but is it the right approach? After all, corporate entities do pay taxes. Zenobia Aunty’s friend, Ravichandar, a Bangalore-based consultant, doesn’t think it is a good idea. He explains: “It just reaffirms that the compact between business and government is broken. The role of the corporate sector is to create jobs, generate income and pay taxes. The government was required to take care of law and order, security and social infrastructure provisioning . This machinery has failed and now there are plans to mandate CSR on business. My concern is that ‘fudge’ will be the order of the day on conforming to specified CSR percentage requirements that are to be met. A more sustainable solution will evolve only when business entities realise that getting engaged on social issues is good for business success, this trend is slowly emerging.”

Dave Mason, a businessman from the US, seems to agree. He says: “The devil is in the details and what constitutes a CSR activity is a pretty big detail to have not defined prior to any passage of the Bill. I don't believe I could support such a measure without knowing ‘the what’ and ‘where’ of the money flow.” In case you are wondering, there is no defined mandatory regulation requiring companies to engage in CSR in the US.

Others point out that a few businessmen use the corporate vehicle to fund the so-called CSR activities for their own personal gratification or glory, whereas they should actually be using their own personal money for this purpose.

Zenobia Aunty agrees that there is scope for ‘fudging’ results. Further, what constitutes CSR is in itself quite subjective. Could a landscaping of a workplace campus be CSR? After all, they are ‘making the environment greener’ !

The line between a business activity and a CSR activity could be blurred. At times, CSR can be truly linked to business needs and yet be a worthy cause, such as providing free education to the children of their shop floor workers by setting up a good school near the factory complex which, in turn, could lower attrition or deter strikes.

Yet at other times, CSR activities could be totally delinked to business objectives such as donating to known organisations including government funds especially during natural calamities. There could even be a hybrid model wherein goods or services of the company are used for CSR activities, such as a pharma company donating drugs to a government-aided hospital.

Another issue would arise, some CSR activities could be a business expenditure and deductible, others may benefit from a tax deduction (such as cash donations to recognised organisations), but there may be others which would not get any benefit at all.

However, a few are more optimistic. Dilip sir, a former army personnel and now a management professor, says: “We do have examples of corporate leaders who believe that a ‘profits only’ approach is much too short-sighted . Profit is important for survival and growth but must not the only reason for existence. It is in such companies that CSR emanates as a natural byproduct. The government making it mandatory to earmark at least 2% average net profit during the previous three years will help increase awareness and is a positive step.”

Zenobia Aunty sums it up by saying: “It is better than a CSR cess, for instance as regards education cess, it is impossible for us to know where the money went. At least the power will now be with the shareholders to ensure that the money is put to its rightful use.” The need of the hour is: mature shareholders. Are we ready for that?

Source of the Photograph.

Friday, September 24, 2010

Law Street - Economic Times (Sept 2010) -DTC - Change for the better

Dear Readers,

The cup can be half full or half empty, depending on how one sees it. As a lot had been written and published about the "harsh" provisions in the DTC and moreso, since "Zenobia Aunty" was in a good mood she decided to see the DTC in a good light. As always, you can read it online on The Economic Times' website. It is also cut and pasted below.
Have a nice weekend.
Best regards,

Change for the better
• Cascading impact of DDT is resolved for domestic multi-tiered groups
• Dispute resolution expanded to cover GAAR cases
• Advance pricing mechanisms introduced for international transactions

Zenobia Aunty recently read an amazing book, “Leaving Microsoft to change the world”. Written by John Wood, founder of the global NGO, “Room To Read” which facilitates education for girls in developing countries including India, it shows that change for the better is always possible, if one is committed to the cause.

Our new tax law was supposed to be a change for the better – in essence it sought to achieve stability, simplicity, minimize litigation and also prevent abuse of tax laws. Thus, at first glance, Zenobia Aunty was taken aback to see that the Direct Tax Code, 2010 (DTC) ran into something like 400 pages.

Some of her friends have outright pooh-poohed the DTC mainly because the radical low rates of tax spoken about in the 2009 draft could not be introduced. However, basking in the aftermath of having contributed her mite towards girl’s education and being in a very generous mood, Zenobia Aunty decided to concentrate on what was good in the DTC.

For long, India Inc has been complaining about the double whammy when it comes to dividend distribution tax (DDT). The Finance Act, 2008, alleviated this grievance partly by providing that the domestic holding company will not have to pay DDT on dividends paid to its shareholders to the extent it received dividends from its subsidiary company on which DDT has been paid by such subsidiary. However, this reduction benefit was available only up to one level. Once the DTC comes into force, this restrictive provision will be abolished enabling multi-tiered domestic companies to get the reduction benefit up to the last level of the corporate chain.

It is true that the wide provisions of the General Anti-Avoidance Rules (GAAR) continue to exist, the CBDT has been empowered to lay down the conditions for application of GAAR and Zenobia Aunty hopes powers will be judiciously exercised. That said the DTC provides that taxpayers in whose case GAAR is invoked can approach the Dispute Resolution Panel (DRP).

An assessing officer, who has received a direction from the tax commissioner for applying GAAR in relation to a particular case, is required to prepare a draft assessment order and serve it on this tax payer. The tax payer can then directly approach the Dispute Resolution Panel (DRP) against this order for resolution of the matter. Zenobia Aunty points out: “Currently, DRP is a mechanism used in the arena of transfer pricing, hopefully the mechanism when extended to GAAR cases will be equally effective and mitigate long winded protracted litigation.”

The mechanism of advance pricing agreements has at last been introduced. The arm’s length price for international transactions can be decided upfront for a maximum of up to five years and this will go a long way in mitigating transfer pricing litigation. Even as SEZ developers and units will now fall under MAT levy, the profit linked exemptions have been suitably grandfathered. R&D expenditure (other than land and building) will carry a weighted deduction of 200% against the existing 150% and more so will be expanded to the non-manufacturing sector also. The practical realities facing the Not for Profit (NPO) segment have also been factored in. Further, donors will continue to get a tax benefit for their deduction to approved and registered NPOs

True there are certain uncalled for changes. Instead of the wide sweeping GAAR provisions, the government could have introduced specific anti avoidance provisions. The government has sought to bring into the tax ambit cross border acquisitions, if: the target foreign company holds directly/indirectly assets in India that are valued at more than 50 per cent of the fair market value of all assets held by such company, at any time, within the twelve months prior to such transfer. Perhaps an extra territorial move? Controlled foreign corporation rules have been defined and exemptions carved out, but sadly underlying tax credit norms are not introduced. While profit linked incentives for SEZs are grandfathered, they find themselves in the MAT net.

Coming to individuals, there has been some minor tinkering in tax slabs, but not much. The silver linings are many. The existing EEE mechanism continues and various perquisites such as HRA continue to enjoy tax benefits.

Zenobia Aunty has always lamented about two things, both of which have been favourably resolved. Medical reimbursement is now exempt up to Rs. 50,000 in a year (as compared to the measly Rs. 15,000 under current tax provisions). Further, the DTC provides that there will be no provision for presumptive rent where properties have not been let out during the financial year. Currently presumptive rent provisions apply and tax is payable on notional income.

Zenobia Aunty signs off on the note that: The FM cannot please everyone, but some of the changes are for the better. Hopefully, the jarring changes will also be streamlined.

Photograph: This photograph was taken at the Lalbaugh Flower Show in Bangalore, India.

Saturday, August 28, 2010

Law Street - Economic Times (Aug 2010) -New Tax Code on the anvil

Dear Readers,
Even as this column had been sent for publication, on Thus, August 26, 2010, the Cabinet Committee gave its nod to the New Tax Code Bill. It will now be placed before the Parliament this month. Then it will be placed before a committee and hopefull it will be finally passed in the Winter Session.
Through media reports, we know of a few snippets, such as:
1) Corporate tax rate continues at 30% (Perhaps there will be no surcharge and cess, if so then it will be better than the prevailing rate which works out to close to 34%)
2) MAT is now pegged at 20% (Currently it is 18% on adjusted book profits)
3) There is minor tinkering in slab rates for individuals
4) EEE regime largely continues
Well, we need to see the fine print once the Tax Code Bill is made available to the public.
I do hope this Bill offers clarity. The August column points out at the need for simplification and clarity.
You can view it online by clicking here.
Alternatively, as always, the column is also cut and pasted below.
Have a nice weekend.
Best regards,

Monsoon musings
• Both BPT and MAT clarity must be provided in new tax laws
• A urban cost of living adjustment could be considered in tax rates
• Tax must be attuned to real needs of the tax payers

It has been raining cats and dogs here in Mumbai. It is perhaps, just the right season for Zenobia Aunty to sit on her favourite chair and surf the internet for tax news or to connect with all her friends across the globe to chat on latest happenings in the tax arena.

Yes, it is pouring tax news. Let us start with home base, India. Soon after the revised discussion paper on the Direct Tax Code (DTC) was issued, came the report of the Takeover Regulations Advisory Commentary followed by announcements on the GST front and then suddenly some States had second thoughts about the constitutional amendment for introducing a GST regime. It has sure has been one busy season and never a dull moment.

It beats me why it always pours over the weekends. Or perhaps on weekdays, unless we are scurrying for meetings, one doesn’t have time to look out of the window, even if it offers a sea view. A spate of grey days makes one appreciate the sunbeams.
Likewise, two recent rulings relating to applicability of MAT on foreign companies have gladdened many. The Authority of Advance (AAR) Rulings in two cases has ruled that a foreign company that has not established a place of business or permanent establishment in India would not be subject to the MAT regime. Unfortunately, the Income tax Act itself does not provide any specific clause stating that a foreign company is exempt from MAT. While AAR rulings are binding only that particular transaction in relation to which the ruling was sought, they do have a persuasive effect in assessments dealing with a similar issue. Thus, these rulings are much welcome.

These favourable rulings, prompt Zenobia Aunty to raise questions as regards the Branch Profit Tax (BPT) provisions contained in the DTC. While sipping a strong cup of masala tea she says: “It should be clarified by the government that the levy of BPT is restricted to a foreign company that has a fixed place of business in India by virtue of a branch office or project office. Further the BPT should only be levied on actual remittance of profits. In the context of MAT if tax laws itself had provided for such clarity foreign companies would not have faced ambiguity, at least now, in the context of BPT and MAT clarity must be ensured in the new Income tax Act.”

While I was in Bengaluru I really thought it was no longer a garden-city but a Mall city. When we left Mumbai, eight years ago, perhaps there were only one or two Malls. Now, while on a drive from South to suburban Mall all you see are signs screaming: SALE!!! Malls have, overrun Mumbai as well.

Kay Bell, a famous tax blogger from the US points out that in August, States in the US are having what is typically referred to as back-to-school sales tax holidays. These last for two-ten days and during this period shoppers don’t have to pay state sales taxes and sometimes they also avoid local levies, on selected items.
Zenobia Aunty quotes from her blog: The most popular tax exempt products are clothing and footwear where the bill is below a certain limit. Some US States also exempt school supplies, with a few including computers and PC peripherals in the no-tax category. Wish we had something similar back home, but well, perhaps we shall settle for the monsoon discounts offered by Malls, over this weekend.

Mumbai is an expensive city, so are various others cities across the globe, such as New York. This bit of news, gladdened Zenobia Aunty’s heart: Six Congressmen from New York are pushing a tax cut for people who live in high-income areas. The idea is to index everyone's income tax brackets to the cost of living, giving a big tax break to everyone who lives in the nation's most expensive areas. It other words, what they are pressing for is regional cost-of-living adjustments for tax rates.

I agree, for example: a salary of Rs 20 lakh in Mumbai does not go as far as a similar salary in say Bengaluru or Hyderabad. Rentals or property prices are just too steep in amachi Mumbai. After all if agricultural income can be tax exempt because understandably farmers do face a lot of hardship, shouldn’t the hardship faced by those in expensive Indian cities also be considered? Perhaps cities can be classified as Class A, B and C and a cost of living adjustment built into the tax rate? Or is this just wishful thinking?

It is pouring again, there go my plans of strolling along Colaba Causeway. Maybe I shall go join Zenobia Aunty in her quest for tax news in cyberspace.

Photograph: This photograph was taken at Lalbaugh Garden, Bangalore, Karnataka

Friday, July 30, 2010

Law Street - Economic Times (July 2010) -CFC Rules, Keep it simple

Dear Readers,
It appears that India is gearing up to introduce CFC Regime. However, introduction of these without measures such as underlying tax credit, participation exemption or even parent-subsidiary directives will not augur well for Indian companies having overseas subsidiaries. Practical safe harbours must be introduced and an underlying tax credit mechanism assured to Indian companies prior to introduction of the CFC Regime.

You can read this in the online edition of The Economic Times.

This photograph was taken in July 2010 off the Worli Sea Face. If CFC is implemented in a hurry without much thought, the dreams of Indian companies planning overseas expansions will be "ON THE ROCKS"

Alternatively scroll down below.
Best regards,

CFC Rules: Keep it simple!

Alternative measures would do away with the need for CFC rules

If introduced, exemptions must be carved in CFC rules

Underlying tax credit must be introduced

Thick heavy clouds hung over a stormy Arabian Sea. Flashes of lighting streaked across the sky. The scene could be regarded either as spectacular or gloomy, depending on how one chose to see it. Much like the revised discussion paper (RDP) on the proposed direct tax code - one could say that the Central Board of Direct Taxes (CBDT) had ironed out many difficulties or one could say it had only added to the problems of the corporate tax payer.

Zenobia Aunty, down with a few niggling ailments, was not her cheerful self and preferred to see the glass half empty, so to speak. A paragraph tucked away in the RDP proposing the Ministry of Finance intent to introduce Controlled Foreign Corporation (CFC) provisions in India, caught her eye.

This proposal is viewed as an anti-avoidance measure and provides that passive income earned by a foreign company which is directly or indirectly controlled by an Indian resident, shall be subject to CFC provisions. In other words, even where such passive income is not distributed to the Indian shareholders it shall be treated as having been distributed and shall be subject to tax in India in the hands of the Indian shareholders as dividend income.

Mind you, dividend received in India is taxed at the full corporate rate (currently 30%) plus applicable surcharge and cess. It is only dividend that is declared by an Indian company, on which dividend distribution tax has been paid, that is exempt from Indian income tax in the hands of its shareholders be they Indian or foreign shareholders.

“Why introduce something which was not there in the draft direct tax code?” muttered Zenobia Aunty. “Why can’t they go to the root of the problem?” she added and stomped her foot in anger taking a slumbering Spot by surprise.

Dear readers, please bear with her while she repeats herself: If only, India would exempt dividend repatriated from overseas there would be no need for Indian companies making overseas forays to set up intermediary holding companies to park overseas profits and no need for introduction of complicated CFC provisions. True, the Indian corporate tax rate has steadily declined, but if one compares it with the tax rates in some developed regimes, such as neighbouring Singapore which is now 17% we still have a long way to go. Thus bringing back dividends into India and subjecting such income to 30% doesn’t make economical sense, it seems more feasible to keep it overseas and use it for further overseas growth. The best solution, to attract dividend repatriation, is either a full exemption to foreign dividends repatriated to India or if this is not possible, a reduced rate of tax.

“Further, how could the intention of introducing CFC provisions be announced without a parallel intent to introduce underlying tax credit rules? In the absence of underlying tax credit rules, the Indian multinational will be subject to multiple taxation of the same income” exclaims, Zenobia Aunty. An underlying tax credit is a credit for any tax on the underlying profits, out of which the dividend is paid.
Perhaps it was the Vijay Mathur Committee, which in its report in January 2003, first made mention of the need for introduction of CFC provisions. However, the very same report also spoke of the need to introduce underlying tax credit. This report provided illustrations of various exemptions from the CFC regime (in other words instances where the undistributed profits would not be taxed in the hands of the Indian shareholder as dividend income in India). The exemptions covered: a CFC that would distribute a certain percentage of income in a year; was engaged in genuine business activities; was not established for the purpose of avoiding domestic tax; was listed on a stock exchange; or even a de-minimis exemption if the total income of the CFCs did not exceed a particular threshold amount.

In addition, the Vijay Mathur Committee accepted that since CFC regime attributes income to the shareholders before actual distribution of income, relief provisions are ordinarily built in to prevent double taxation of CFCs income which is subsequently distributed. It provided illustrations for inclusion of relief provisions such as: relief on account of foreign taxes paid; relief on account of dividend paid out of the previous attributed income; relief in respect of losses incurred and relief from double taxation on subsequent capital gains arising from disposition of shares arising out of CFC by the shareholder, where the shareholders have been previously taxed on the undistributed income of the CFC.

It would have been simpler to encourage repatriation of foreign dividend into India, but now that the intent to introduce CFC is made clear, care must be taken to ensure it does not sound the death knell for Indian companies. Perhaps, some sensible measures will cheer up Zenobia Aunty.

Sunday, June 13, 2010

Law Street - Economic Times (June 2010) -Towards a greener world

Dear Readers,

We celebrated environment week, this month. But, are we ready to turn towards the more expensive green products? Appears not! It is time the government subsidized the purchas of these products through tax credits, as have several other countries. Looking forward to a greener world. Read this column online in The Economic Times, by clicking here.

As always, the column is also cut and pasted below.

Have a nice weekend.


Towards a greener cleaner world
• Tax sops must be at the consumer level
• Tax carrots rather than sticks will work
• Monetary sops will be an added advantage
We celebrated Environment Week this month. Various organizations as part of their Corporate Social Responsibility (CSR) initiatives got their act together, conducted workshops to sensitize their employees, planted trees, et al. A few friends participated in “cycle to work” initiatives which were understandably short lived.
Short spurts of efforts, while they do contribute in a way, are not adequate to save the planet. We need long term efforts which provide lasting results and it is here that the government can really help. Zenobia Aunty has been reading a lot about green investments. She says: “A recent international survey undertaken by Regus states that: Governments worldwide must introduce new tax breaks to increase the uptake of green investment.”

Eco-friendly measures seem attractive on paper, but they do entail a higher cost, at least initially. No wonder then that 46% of companies surveyed have declared that they will only invest in low-carbon equipment if the running costs are the same or lower than those of conventional equipment. A mere 40% have invested in low-carbon equipment and only 38% have a company policy to do so.

Governments world over have down the years, devised various forms of green taxes to save the environment. Such taxes have been as varied as a ‘plastic tax’ on use of plastic bags in Ireland, to a ‘flight tax’ in the UK which airlines had to cough up if they did not fly at full capacity.

While Zenobia Aunty was in Bangalore (Bengaluru) there were talks of permitting cars with odd numbered license plates to drive on one day and those with even numbers on another day. Would this have helped in reducing carbon emission? “Not really, with an inefficient public transport mechanism, families were really thinking of buying yet another car, as car pooling was not always an option,” explains Zenobia Aunty.
If spreading the tax net wide, pays dividends, so does spreading of tax sops. Perhaps, it would make better sense to provide sops for green investments at the consumer level. It would help spread the movement make the world greener.
United States for instance, with its green tax sops covers the consumers. Tax credits as distinct from tax deductions are available for purchase of hybrid cars or battery, electrical or alternate fuel vehicles; heating and air conditioning systems that are ‘energy star rated’; renewable energy systems; solar and wind energy systems and even something as simple as insulation such as new doors, windows or roofing that meet set criteria and help save on electricity bills.

How is a tax credit different from a tax deduction? A tax credit is a ‘rupee-for-rupee’ reduction in your total tax bill. For instance, your tax bill works out to Rs. 2.50 lakh. Let us assume that a tax provision states that for each solar panel that you install in your house you get a deduction of 20% of the purchase price subject to a cap of Rs. 50,000 per solar panel. Assuming you purchase three solar panels and can claim Rs. 1.5 lakh through such purchase. Your tax bill will then be just Rs. One lakh.

On the other hand, a tax deduction is expenditure or a prescribed amount (such as depreciation) which is allowed as a deduction from your total income to arrive at the net taxable income, which is then subject to tax at the applicable rate. While both reduce your tax bill, in pure monetary terms a tax credit is more beneficial.
It is the consumer who can propel a demand for environmental friendly products. With prices for such products being higher, tax sops alone can provide the much needed spending boost in the right direction.

In India we have seen a few sporadic attempts such as wind farms being eligible for 100 per cent depreciation or higher depreciation rates for pollution control equipment. However, till date attempts have not been made to start at the consumer level.

Imagine the potential that we have to use solar energy, especially in the rural areas of India, which are prone to power cuts, or for that matter, even small scale industries in urban areas. To boost demand for use of solar energy, start at the consumer level, enabling him to get a tax credit. This would mean that the manufacturer of solar panels does not have to face hardships to convert people towards a more friendly power source and can make fair profits. After all, even a green manufacturer needs to survive. Moreover, provision of softer loans for purchase of green products by households, farmers, small scale enterprises and certain other segments would be an added advantage.

It is true that the government is considering abolition of tax holidays, however, tax credits to the individual for purchase of green products, is something which needs to be seriously contemplated. Drat, the power just went off, now where is that candle?

Source of the photograph.

Saturday, May 29, 2010

Law Street - Economic Times (May 2010) - PANs Prickly Pains

Dear Readers,
Sometimes laws can be shortsighted. Take the instance of everyone being required to have a PAN or else suffer a higher withholding, on payments due to them. This includes senior citizens, who perhaps are not tax payers, or even foreign entities doing a one off transaction with India. To hear Zenobia Aunty, rave and rant, click here. Else as always, if the link doesn't work, it is cut and pasted below.
Have a nice weekend.
Best regards,

PANs prickly pains

Sweeping all encompassing amendments cause problems
Exceptions must be carved out in tax laws
Practical regulations are required

These days, owing to the heat and humidity, Zenobia Aunty spends her evenings, sitting on the bench outside her colony, people watching and catching the breeze. In fact, she is soon joined by some friends, all of who sit quietly, at peace with each other and the world as they observe other people go about their tasks. I am sure one day; this group will surprise us with a book on human psychology or something equally profound.

Thus, this little group of senior citizens was taken aback, when Jingoo Uncle was spotting angrily waving his walking stick at all and sundry and muttering at random. He sure spoiled their peace and quiet.

However, one can empathize with Jingoo Uncle. The main reason for his anguish was that he had sold an antique table and tax had been withheld by the buyer at 20%, just because Jingoo Uncle, a retired person, did not have a PAN card.

Let us not even get into the argument of whether tax ought to have been withheld on such transaction or not. For now, let us solely concentrate on this new amendment, which came into effect from April 1, this year and requires tax to be withheld at 20% or the rate in force, whichever is higher, if PAN is not furnished by the payee (recipient of the income).

Perhaps the tax authorities can argue that Jingoo Uncle’s case is a rare exception. Jingoo Uncle retired at least two decades ago and is well looked after by his children. He is no longer a tax payer and does not have a PAN card, or rather does not remember whether he once had a PAN card and where it is. So couldn’t he be exempt from this new provision?

If you think the situation cannot get any more absurd, there is more to come. India is today a global player. Foreign entities carry out business with Indian parties even if they are not physically present in India. Let us take another illustration.
EasyDesign PLC has supplied an industrial design to another company in India. Such payment is in the nature of fees for technical services and under the relevant tax treaty, tax is to be withheld only at 10%.

EasyDesign PLC has never carried out any operations in India, this is its first transaction with an Indian buyer and everything seems to be smooth sailing, till such time that the Indian party insists on withholding tax at 20%.

An argument ensues. EasyDesign PLC is thunderstruck by the absurdity of Indian tax laws that require it to obtain a PAN to ensure that tax is withheld at the correct rate of 10 per cent and not 20 per cent. Moreso, if tax is incorrectly withheld in India, it would result in complexities in its assessments in its home country. The Indian buyer, on the other hand, wants to protect itself from any legal hassles.
Tax laws which are not practical have dented a good business relationship. Based on these designs, the Indian company would have been able to sell its final products to EasyDesign’s contacts overseas. It is true that withholding taxes ensure that the tax authorities get their share of the tax pie immediately and effortlessly. However, this rigid rule has complicated business matters.

Exceptions must be carved out to make laws practical. As regards obtaining a PAN number, certain categories must be exempt, such as senior citizens or foreign entities that do not have a fixed place of business in India. If there is a commercial branch in India, it is perfectly fine to expect the foreign entity to apply for and obtain a PAN and indeed to file its tax return and comply with other relevant tax obligations.

In the realm of withholding taxes, the larger issue still remains, of whether tax ought to be withheld at source in India irrespective of whether or not the payment made to the non resident is chargeable to tax in India.

It was the decision of the Karnataka High Court in the case of Samsung Electronics, which sparked off this debate. However, lately a decision by the Delhi High Court in the case of Van Oord ACZ, followed by that of the special bench of the Chennai Tribunal in the case of Prasad Productions have rightly concluded that an Indian payer need not withhold taxes on making payments if such payments are not liable to tax in the hands of the recipient. Yet, this has certainly dealt a blow to those in Karnataka and left others confused. Perhaps in the coming days, a decision by India’s apex court – The Supreme Court of India, will resolve this matter.

It is fair to expect any country to protect its share of the tax pie, however, as Zenobia Aunty always says: One must never miss the woods for the trees.

Courtesy: Image.

Friday, April 30, 2010

Law Street - Economic Times (April 2010) - Overseas acquisitions

Dear Readers,

The days are getting warmer, the sun beats down mercilessly, this prompts Zenobia Aunty to stay indoors, even as she dreams of a visit to Iceland (volcanic eruptions, notwithstanding). But it seems that India Inc is truly leaving its footprints behind on foreign soil. Tax laws, if amended with this growing need in mind, could really put India Inc on the global map. To read more, click here.

In case, you can't access the above link, or the summer heat is making you lazy, the article is also pasted below. Have a nice weekend.

Best regards,

Source of the photograph

Globetrotting anew
Overseas M&As must be encouraged
Reforms for overseas M&As must be progressive
Singapore has introduced a M&A write-off
Travel writer, Pico Iyer is known to have said: “…Travel for me is an act of discovery and of responsibility as well a grand adventure and a constant liberation.” India Inc which is once again confidently striding overseas and engaging not only in setting up shop overseas but boldly acquiring companies overseas would no doubt agree.

After all, in a flat world and one which is only getting flatter, inorganic growth, especially cross-border growth is essential to emerge as a leader or at least find a firm footing on the global map. We do have astute business leaders who are willing to embark on the overseas expansion road trip, keeping in view their stakeholder’s interests. However, the much desired change in regulations to spur outbound growth remains largely elusive.

Indian Companies are expanding their operations worldwide – either through acquisitions or by setting-up new companies. A corresponding trend that has emerged is that more and more Indian companies use their overseas subsidiaries to hold offshore investments. One of the principal reasons in doing so is that repatriating funds to India is extremely inefficient from a taxation point of view – foreign dividends when received by the Indian investor company in India are taxed at the normal corporate rate (current of 30%) plus applicable surcharge and cess.

In addition there is economic double taxation, because Indian companies are taxed on dividends received from its overseas subsidiaries without receiving any credit for foreign taxes that were paid by the dividend paying subsidiary (only a few tax treaties entered into by India, such as those with Mauritius and Singapore provide for underlying tax credit). Developed tax regimes avoid this issue through either providing a tax credit for foreign taxes or by totally exempting the dividend from tax in the recipient jurisdiction. For instance, UK and Japan last year, introduced legislative changes whereby dividend income received from an overseas subsidiary is not taxed.

In fact, globally there are constant developments in the realm of taxation, to encourage outbound growth. Zenobia Aunt’s Singapore attorney friend provided some interesting details. He dropped in last weekend to meet Zenobia Aunty who is currently recuperating and is housebound.
While he was sipping a cup of Darjeeling tea, he happened to look at this paper and the headlines relating to an overseas acquisition. This sparked off a debate on whether India was really friendly to its overseas investors (domestic companies investing overseas). Our friend, the Singapore attorney, felt India still had a lot to do to catch up.

Jet lagged, he wasn’t at this diplomatic best. “The Bandra-Worli sea-link, isn’t enough”, he quipped. This invited glares from all of us and a growl from Spot. Zenobia Aunty was more realistic. While she acknowledges the liberalisation reforms carried out, she still thinks that there is a lot more we can do, or rather must do.
Singapore recently announced its budget proposals which contain some interesting features. A merger and acquisition (M&A) allowance will be available in respect of transactions that qualify during the five year period commencing from April 1, 2010. The quantum of the M&A allowance is 5 per cent of the value of the acquisition
subject to a cap of Singapore dollars 5 million. This M&A allowance is to be written off by the Singapore company equally over a five year period. Further stamp duties on transfer of unlisted shares in respect of such qualified M&As will also be remitted subject to the stipulated caps.

The Singapore government has recognised that M&As are a necessary tool for strategic growth and globalisation. The M&A allowance, in the form of a tax write-off helps defray a portion of the costs of acquisitions. It is simple, because it does not distinguish between interest costs and other costs and hence is neutral between debt and equity financing in the M&A deal.

Zenobia Aunty is quick to point out that the RBI has over the years liberalised the provisions relating to outbound investments. The overall limit for outbound investments by Indian companies now stands at 400 per cent of its net-worth. However, our tax laws have not been as progressive.

While anti-avoidance provisions are sure to be introduced when the Direct Tax Code (DTC) comes into play, progressive tax laws must not be ignored. Perhaps a cue can be taken from Singapore, and also from Japan and UK, which have now exempt foreign dividends repatriated back to the home country. And if we could introduce an M&A write-off, nothing like it.

Recent statistics released by ‘Business Monitor International’ show that the outbound foreign direct investment as a percentage of GDP in developed countries is 33 per cent. In the BRIC countries it is as follows: Russia (20 per cent); Brazil (10 per cent), China (3 per cent) and India (2.6 per cent). For India to catch up, supportive domestic legislations, especially on the tax front hold the key.

Friday, March 26, 2010

Law Street - Economic Times (March 2010) - Post budget column

Dear Readers,

Click here for the online version of Zenobia Aunty's budget analysis, or else as always scroll down.

Best regards,

Saral or not?

Practical tax laws alone the purpose
Retrospective amendments cast more burdens
Simplicity and stability is the key to success

Zenobia Aunty lives in what the real-estate brokers call ‘towers’. Now Zenobia Aunt’s apartment is tucked away in the last tower in the residential complex, away from the din and noise and on a lower floor, even as the preference perhaps may have been for apartments on higher floors which offer a sea view. All around her neighborhood mill complexes are giving way to residential complexes. Real estate brokers are a busy lot, towing potential customers across to see the model flat as are perhaps Vastu consultants.

Yes some flats do command a premium – such as a flat overlooking a park or having a sea view or even one which is on a higher floor. Our Finance Minister has now sought to bring into the service tax net: “special services provided by a builder to the prospective buyers such as providing a preferential location or external or internal development”.

Zenobia Aunty scratches her head. “Is this practical, how will they ever implement it?,” she wonders. A Google search shows that in 1696, a tax was placed on British homes based on the number of windows the home had. Previously the tax was levied per household, no matter the size of the house or the number of residents. The law changed, however, to levy higher taxes on larger homes with, presumably, more windows. Instead of paying the higher taxes, people just bricked up the windows that they found to be extraneous. An astute visitor to Britain can still see evidence of this law today in the scores of walled up windows in older buildings throughout the country! This columnist wonders what Mumbai apartment dwellers having a sea view will do, buy thick curtains perhaps?

Zenobia Aunty was really expecting that the tax exemption available for medical expenses would go a bit higher from the current limit of Rs. 15,000. Alas, while this did not happen, payment for treatment made by insurance companies directly to hospitals is now under the service tax net. The past few weeks, we have been seeing headlines on how third party insurance intermediaries are trying to dictate terms as to how much doctors in hospitals should charge. Even as the battle between insurance companies and the patients is hotting up, up comes this whammy. Zenobia Aunty can sense that HR departments, where employees are covered by health insurance plans will have their hands full. And it is quite possible, that the employee covered by the insurance scheme will have to bear this tax for which he cannot take any tax credit.
There is also a retrospective amendment dating back to July 1, 2003 to cover commercial training and coaching services. Once again, the litigation and administrative costs involved thanks to such a retrospective amendment may not be worth the recovery in the form of service tax.

Ah, well, there are some things that the hoi-polloi like you, this columnist, or Zenobia Aunty will never understand. Minimum Alternative Tax is one such thing. Last year, we saw a hike in MAT from 10% to 15%. This year, there is another hike to 18%. On the other hand, the normal tax rate, with the slight decline in surcharge to 7.5% is now 33.22% (for large companies). If one considers the various tax sops including tax depreciation available, the normal effective tax for a company could be slightly lower, say around 25%.

MAT was introduced as a solution to bridge the difference between book profits and taxable profits – to bring into the tax net companies which were paying heavy dividends but owing to tax sops were not paying tax. This bridge or gap has been narrowed down the years through a reduction in depreciation rates and phasing of various exemptions. Reduction in tax depreciation for plant and machinery from a high of 25% to 15% by the Finance Act, 2005 significantly narrowed the disparity between book profits and taxable profits. Thus, Zenobia Aunty really wonders, why MAT still exits.

MAT takes back what was lawfully intended to be given as tax breaks and tax sops. And hiking MAT rates adds insult to the injury. Further, if it is to exist, MAT should be applicable, when there is actual profit after deducting both the carry forward loss and unabsorbed depreciation from the book profit and not the lower of the two. Else, companies where depreciation element is low, but who are making consistent losses – owing to business environment, will have to pay MAT despite heavy carry forward losses. Likewise, companies that are making nominal profit or loss before depreciation but the depreciation charge being very heavy will be liable for MAT.

Zenobia Aunty also hopes that there is some rethink on, as regards levy of MAT on the gross value of the assets which was proposed in the draft Direct Tax Code. Abolish MAT in toto, is what she advocates.

Hopefully once the Direct Tax Code is in place, it will ensure greater simplicity and stability in tax laws, like Saral-II. Let us wait and watch.

(Photograph for illustration purpose only: Planet Godrej, a well known residential tower in Mumbai)

Friday, February 19, 2010

Law Street in The Economic Times (Feb 2010) Pre budget

PS: This is the sea off Marine Drive. The funny shaped concrete blocks are sea breakers meant to weaken the strength of the strong waves as they lash against the Mumbai coastline. This photograph was taken much later in July 2010, but I thought I would add it here.

Dear Readers,

Sometimes,the right procedural amendments without a change in tax rates can also cheer up the tax payers. Zenobia Aunty suggests a few such amendments in the run-up to the Finance Bill, 2010-11 which will be tabled in the Parliament in India on Friday, February 26. For more, click here or scroll down below.

Law Street/ Lubna Kably
Dear Finance Minister, simplify taxation

• Small procedural changes can help the aaam admi
• ESOP taxation needs to be practical
• Savings must be encouraged

Expectations are mounting and the fiscal deficit is looming overhead. Yes, our FM is not to be envied during these tough times. Just last year, he offered us some respite. There was no change in the number of slabs or the tax rate for each slab, however the basic threshold exemption limit was marginally raised and also the surcharge of 10% was abolished. Tax rate cuts may not see the light of the day, this year, yet without adversely denting the Treasury coffers, the FM can help some of us smile.

Zenobia Aunty’s favourite pastime is to view a kaleidoscope and people watching she claims is no different. A walk along Marine Drive and a quick chat with Mumbaikars from various backgrounds and with varying needs itself threw up clues on what can be easily done.

Jogging a few paces with Mohan, helped Zenobia Aunty understand the practical problems of ESOP taxation. Today, Mohan is taxed on the notional perquisite value (the difference between the fair market value as on the date of exercise of the option by him, as reduced by the amount contributed by him). Payment of tax at the time of exercise is an uncalled for burden, as employees have to cough up cash even before they have sold their ESOPS (which has a lock in period post exercise). Then there is yet another incidence of tax on sale, which is the price obtained minus the fair market value as on the date of exercise.

ESOP taxation has been subjected to various amendments over the years. Perhaps the tried and tested regulation which existed prior to introduction of FBT (now abolished), must be reintroduced. Employees must be subject to tax only on sale of the shares which they obtained under an ESOP scheme, provided the ESOP scheme fulfils certain criteria. This will put them on a better footing to bear their tax liability, instead of paying their dues when they are cash strapped.
Tax on notional perquisite value, impacts their purchasing power by denting, sometimes badly their take home pay. An added sore point is that at the time of sale of the shares, the prices may have fallen – after all the market ain’t booming yet. Thus they would have not only paid perquisite tax at the time of exercise but are saddled with a capital loss.

Spot and Zenobia Aunty were soon out of breath and sat down to enjoy the sea breeze. Soon enough, Freny joined them. She walked daily between Nariman Point to Churchgate, it saved her from the hassle of joining a bus or taxi queue or even a gym.

Freny was upset that contributions by her employer to superannuation, in excess of Rs one lakh, were taxed in her hands. In fact, superannuation benefits are contingent - such as the requirement of having served a certain number of years etc and Freny may not even get that benefit, but for now she will be taxed first in the year of contribution to the extent it exceeds Rs one lakh and secondly at the time of receipt of annuity. Yes, she was aware that the concept of EET is the subject of much debate, but for now she wants this immediate issue to be sorted out.

It was never a dull moment for Zenobia Aunty, even as Freny rushed off to catch the local train, Dilip came by. Dilip loved to save money and invest for a rainy day. “Long term savings, such as pensions, could be mobilized for infrastructure needs and this is not effectively done,” he complained.

Zenobia Aunty agrees our much touted National Pension Scheme turned out to be a damp squib, because the tax sop ceiling was clubbed with various other savings to stand at a cumulative of Rs one lakh. Not to mention that it is one of the schemes that falls under EET mechanism. Perhaps by increasing the eligible limit upward or carving out a separate eligibility category it will help the government to pump savings into the needed sectors.

In the previous column Zenobia Aunty spoke about the perils of making payments to non-residents owing to the lack of clarity on withholding of tax. There is an additional procedural problem associated with TDS. The tax laws mandate that if PAN is not furnished by the payee, the withholding tax will be 20% or the applicable rate, whichever is more. Senior citizens may not have applied for a PAN card because they do not fall within the taxable limit, so also foreign companies which merely export goods to India and do not have a place of business in India. Thus, some safe harbours must be built in. We all know the process of obtaining a refund is time consuming, even as direct refunds to bank accounts have made things easier.
Yes, the folks at the MoF just need to put on their thinking caps and they can make life a bit easier for you and for me.

Friday, January 29, 2010

Law Street - Economic Times (January 2010) - Should all payments to non residents be subject to tax withholding in India?

Dear Readers,

As you will learn on reading this column, Zenobia Aunty thinks she doesn't understand tax anymore. A fall out of a recent High Court decision appears to indicate that tax needs to be withheld at source on all payments made to non-residents, unless a certificate stating otherwise is obtained from the tax authorities. Yes, the tax-men need to meet their revenue targets, but what happened to the good old concept that only income chargeable to tax in India can be subject to tax by India?

Some clarification would be welcome. Read on by clicking here.

Or else, as always, feel free to scroll below.

PS: The next column will be related to pre-budget issues and will be published not on the last Friday of next month but earlier. Zenobia Aunty shall keep you all posted.

Best regards,

A tax spanner for international trade

• A recent High Court decision has raised doubts on tax withholding in India
• It appears tax has to be withheld on all imports or payments to non residents
• A clarification is urgently required to resolve doubts

Zenobia Aunty was spotted the other day, staring dismally at the crashing waves off Marine Drive. She just doesn’t seem to understand tax anymore or so she thinks. Her niece; this columnist decided to approach a friendly tax expert to find out the root cause of her Aunt’s gloom. “If you want to pay a non-resident, just deduct tax at source,” he snapped and booted her out.

The cause of this turmoil, faced by everyone in India and everyone who does business with India, appears to be a recent decision of the Karnataka High Court, in the case of Samsung Electronics Ltd. The High Court has held that on import of shrink-wrapped software tax has to be deducted at source in India. Earlier, Tax Tribunals in umpteen cases have held that payments made for import of shrink-wrapped software is akin to purchase of goods (a copyrighted article) and is not ‘royalty’ and no tax is to be withheld in India.

Interestingly, the High Court did not answer the issue of nature of payment for import of shrink-wrapped software question but said that all payments for imports into India are subject to tax deduction at source.

Tax authorities asked for a lemon, but they have got a melon. The judgement has very wide ramifications. The implication of the Karnataka High Court’s decision seems to be, that in all instances of import of any goods, irrespective of its chargeability to tax in India, tax must be withheld and paid to the Indian government and only the balance can be remitted to the foreign supplier.

The only scenario under which the payer (Indian importer in this case) shall be not be under an obligation to withhold tax in India or may withhold tax at a lower rate, is when the payer obtains prior approval from the assessing officer by making an application under section 195(2) of the Income tax Act (Act).

The Karnataka High Court apparently has relied on the Supreme Court decision in the case of Transmission Corporation of A.P. However, tax experts point out that the implications of the Supreme Court decision are quite different.

The tax expert called back to grumpily explain that the Supreme Court in the case of Transmission Corporation had held that: Tax is to be deducted at source only on the sum on which income tax is leviable and which income could be assessed to tax under the Act. Thus, in his view, the payer has to determine whether or not the payment is subject to tax in the hands of the foreign recipient or supplier of goods or services. If income is not chargeable to tax in India, where is the question of deducting tax when making payment to the foreign supplier? There are CBDT circulars which the payer can still rely on and not deduct tax at source, if the income is not taxable in India, he stresses.

However, if one does not wish to take this stand, as suggested by the tax expert, it does appear that in all instances of payments, the tax payer will have to approach the tax authorities for obtaining a dispensation order under section 195(2), an additional administrative burden! If the Indian payer does not do so, the payer will bear the consequences of non-withholding.

For example, an Indian company imports equipment, if tax is not withheld at source, the entire expense will be disallowed, even if in the view of the Indian company, there is no tax to be withheld in India as the foreign supplier does not have a permanent establishment (fixed place of business in India) and such payment is not royalty or fees for technical services, which mandate a tax withholding. Plus, the home country of the foreign supplier may not give a foreign tax credit for taxes ‘wrongfully’ withheld in India. It sure puts a spanner in the wheels of international trade and commerce.

One can also visualize scenarios where the implications of this judgement stretch beyond import of goods. A Mauritius company, sells its shareholding in ABC Ltd, an Indian company to XYZ Ltd, another Indian company. Sale of shares of an Indian company by a Mauritius resident, under the “Capital Gains’ clause of the tax treaty, does not trigger a tax incidence in India.

However, will XYZ Ltd, as per the ‘letter’ of this High Court decision, have to deduct tax at source, before remitting money to the Mauritius seller of shares? If this be the case, global restructuring will get a beating.

Even as Zenobia Aunty was dictating this column, a single member bench of the Mumbai Tax Tribunal has relied on the Samsung decision, however, this was done presumably without considering a favourable view of the Mumbai Tribunal’s Special Bench. Zenobia Aunty learns that a similar issue will now come up before a Special Tribunal Bench in Chennai.

It may be some time before the Supreme Court can clarify this issue. Thus, the MoF must quell the doubts arising in the minds of global players. Else who would want to do business with India?

Source of the photograph