Friday, June 29, 2012
Our newspapers continue to report about the menace of black money. Zenobia Aunty wonders why India is hesitant to enter into revenue sharing agreements with Switzerland. After all, if there is tax imposed on Swiss bank accounts, there would be less inclination to hoard money there, plus the disclosure norms that have just kicked in will also act as a deterrent. For her views, read Law Street online, by clicking here or scroll down.
Black isn’t beautiful
• Revenue sharing agreements can help in tax recovery
• Tighter disclosure norms will provide transparency
• Special courts must be suitably equipped
When this columnist was a school-kid, Ten-rupee notes were black in colour and she thought these notes were black money. Notes have given way to shiny coins, but black money continues to plague our economy. The MoF has decided not to leave the definition to a child’s imagination and its recent White Paper, defines black money as: ‘Assets or resources that have neither been reported to the public authorities at the time of generation nor disclosed at any point of time during their possession’.
Recent years have witnessed more pro-active measures by the government to tackle the problem, with exchange information being introduced in tax treaties and ‘tax information exchange agreements’ being signed.
A very recent move, introduced by the Finance Act, 2012, has been the disclosure requirements in tax returns. The White Paper also covers this move: ‘Reporting mechanisms for those operating assets and banking accounts abroad is strengthened by making filing of return of income mandatory for every resident (excluding a person who is not ordinarily resident in India) having any assets or banking accounts located outside India even if such person does not have taxable income’. Any false information or withholding of information will result in prosecution.
‘Tut-tut’ says Zenobia Aunty. She thinks that those who stash black money abroad are not deterred. For once, the MoF seems to agree with her. In the White Paper it admits: ‘Sometimes taxpayers may be willing to take a calculated risk of tax evasion and may even justify it as a 'commercial risk', which can be deterred by effective prosecution. The prosecution calls for rigorous imprisonment of up to seven years and a fine. However, the actual state of criminal prosecution in tax matters in India is somewhat dismal. In very few cases, do the tax authorities opt for prosecution and subsequent conviction in tax evasion cases is rare and cannot be found even in high-profile search cases. The absence of a specialized prosecution wing and the cumbersome procedure contribute to this state of affairs’.
The Government is taking measures to remedy this situation. A separate Directorate of Criminal Investigation has been established to deal with tax offences and special courts are to be set up. One hopes that the Directorate and Special Courts will be adequately staffed with the right people; else this plan will just remain on paper. ‘Time is of the essence,’ comments Zenobia Aunty and examines the tax revenue sharing agreements that Switzerland has entered into with UK, Germany and Austria. It has plans to enter into such agreements with several other countries.
While the agreement with UK was entered into last year, it was recently modified. From January 1, 2013, investment income earned by UK residents in Swiss financial institutions will be subject to 48 per cent withholding tax; while dividends at 40 per cent and capital gains at 27 per cent. There will also be a first time one off tax imposed to make up for tax lost in the past years. This will vary between 21 to 41 per cent, depending on the value of the account and period for which it was held. The taxes withheld will flow into the UK treasury. However, an option is provided to the UK residents. Both the future and retrospective withholding tax provisions will not apply to anyone who authorises their Swiss financial institution to disclose their accounts to the UK revenue and declares and pays tax in their UK tax return. This agreement is a win-win situation, as Switzerland gets to keep its prized banking secrecy and UK their share of taxes. The agreements with Germany and Austria are based on almost the same norms.
Our Government is well aware of such agreements, but the White Paper adds: India will have to take a decision first as to whether these will meet its national objective. The main concern is that while India will get its tax revenue, Switzerland under the agreement will not part with the identity of the banking customer. The Indian government has proposed further discussions and debate.
Do we really need another endless bout of discussion? Haven’t countless Bills being stuck up because the Parliament is not functioning as it ought to? Let us sign such agreements, let us continue with the requirement of disclosure in tax returns and let us strengthen the arms of the prosecution department and set up special courts. To begin with, we will get our much needed funds, at the same time domestic disclosure norms coupled with the fact that tax will get withheld on money stashed in Switzerland may prompt many Indian residents to come clean. The option of coming clean should exist as has been done in the UK. We need to make headway. Black is no longer beautiful.
Source of the photograph: Downloaded from Flickr and used as per the terms of the Creative Commons License.
Posted by Lubna at 10:57 AM
Friday, April 27, 2012
Dear Readers, Newspapers are filled with analysis of how draconian the Finance Bill really is and the fears of investors in India. Zenobia Aunty agrees. For the online version of Law Street in The Economic Times, click here, else please scroll below. Owing to certain circumstances, Zenobia Aunty will be taking a break and is unlikely to publish her monthly column in May. But she will be back, soon after the Finance Bill is enacted with her views. So stay tuned. Best regards, Lubna
A stretch too far
• Knowing the source of income of your shareholder is difficult
• Terms in tax treaties can be defined by Indian tax authorities
• Tax withholding provisions have been widened
Zenobia Aunty is proceeding on a short sabbatical to an undisclosed address. The tedious, convoluted provisions of the Finance Bill are making her head spin. While the retrospective amendments relating to indirect transfer of a capital asset (where one can immediately relate to the long drawn out Vodafone battle) have been much spoken about, this isn’t the only provision that is causing strife to taxpayers.
Certain things have been stretched too far. Let us take a few illustrations.
(i) Stretching the ‘know your shareholder’ rules too far: Not only do closely held companies have to know their shareholder, but they also have to know the source of funds of such shareholder. If the closely held company fails to discharge this additional onus, the sum contributed as share capital will be treated as income of the company (and of course taxed!). This proposed amendment comes into force from April 1, 2013 (It is applicable to the FY 2013-14) onwards. By doing so, the Finance Bill has overturned several court decisions including the one of the Supreme Court (SC) in the case of Stellar Investments Limited. Here, it was held that if the shareholders are not genuine, the amount received as share capital cannot be taxed in the hands of the company.
(ii) Tax to be withheld on import of computer software as the payments will be characterised as royalty: This amendment is effective retrospectively from June 1, 1976. Why this date? Because, as Soli Uncle the tax guru, explained, the provisions relating to Royalty were introduced in this year in the Indian Income-tax Act. “Else perhaps this provision also would have been introduced with retrospective effect from April 1, 1962 when the current draft of Indian Income tax Act, first came into being”, adds Zenobia Aunty, wryly. Several courts had said the right to use software is akin to reading a book, it is the use of a copyrighted article instead of a copyright and cannot be treated as royalty. It may be possible to argue that exporters from treaty countries could take protection under the narrow definition under the tax treaty to argue that it is not royalty and is not subject to tax in India. However, it is likely that the Indian importer may want to withhold tax at source to avoid litigation and avoid any disallowance or penalties in its hand. The end result – the exporter will suffer, as its home country is unlikely to give a tax credit for tax wrongly deducted in India. It is true, that our country is growing and is a major market, but do we want to arm-twist those wanting to do business with us?
(iii): Tax treaty? We define it: Through a notification a term in the tax treaty can be defined (provided the definition is not contained in the tax treaty), this interpretation would date back to the date the tax treaty entered into force. India has entered into tax treaties with as many as 80 countries. One can only wonder about what can be unleashed on residents of such treaty countries, through issue of deadly notifications.
The requirement of obtaining a Tax Residency Certificate (TRC) for claiming tax treaty benefits has been much spoken about. Everyone is rightfully upset. Not all countries issue such a certificate. For instance: Indian tax laws itself do not contain any provision empowering its tax authorities to issue a TRC. Yet, obtaining a TRC containing the prescribed details, by a person doing business with India, is now mandatory. Further the TRC, even if obtained, will not act as sufficient proof and inquiries can be made to determine tax residency of the other country. The SC in the case of Azadi Bachao had upheld circular 786, issued by The Central Board of Direct Taxes (CBDT) which provided that: Obtaining a Mauritius tax residency certificate was sufficient proof to avail the benefits under the India-Mauritius tax treaty. The only saving grace is that this non-practical provision is not retrospective.
There are yet other provisions that require a class of persons or cases (to be notified by the CBDT) to apply to the tax officer to determine the proportion of sum chargeable to tax in India. It was a set rule that there is no obligation to deduct tax at source when making payment to a non-resident if such sum is not chargeable to tax in India. It sure looks like anything and everything will be chargeable to tax in India.
Both Zenobia Aunty and her niece, this columnist, are seriously considering a change of career, to a less taxing one. We are seriously contemplating learning how to cultivate mushrooms, herbs and strawberries. After all agricultural income will never be taxed in India.
Source of the photograph: http://www.flickr.com/photos/64818595@N02/5902541250/ (Creative Commons License)
Posted by Lubna at 9:58 AM
Friday, March 30, 2012
The Finance Bill, which contains tax proposals was tabled in India in the lower house of the Parliament on March 16. We all knew that the Direct Tax Code - DTC (which would provide a new tax code) would not be introduced in this budgetary session owing to delays by the Parliamentary Standing Committee in giving their comments on the DTC. Yet, everyone was waiting and watching whether certain provisions, especially those that would enable more tax revenue to be garnered would be introduced. This is precisely what happened. Among several other amendments, General Anti Avoidance Rules were introduced.
As the Parliamentary Standing Committee in its report on the Direct Tax Code had called for caution when introducing GAAR, stakeholders were breathing easy. However, none of their suggestions have been taken into consideration.
As the provisions of the Finance Bill stands today, the onus of proof continues to be on the tax payer, the provisions continue to be wide-sweeping, and the orders of the Commissioner invoking the GAAR provisions continue to be subject to the approval of a panel of tax commissioners and above. One hopes rationality will prevail and the provisions that are enacted will be fair and just.
You can read Zenobia Aunty sharing her woes in today's edition of The Economic Times. If the link doesn't work, scroll down below.
Have a nice weekend.
Aaargh: GAAR is here
• The recommendations of the Parliamentary Standing Committee (PSC) have been ignored
• Current wording may cover genuine transactions
• It isn’t a fair mechanism as the advisory panel is not independent
After reading the Finance Bill (Bill) and the Explanatory Memorandum, Zenobia Aunty picked out this quote from Hamlet: “O woe is me, to have seen what I have seen, see what I see.”
The Bill is riddled with several retrospective amendments, it has sought to overturn several court decisions, including those of the Supreme Court, it has turned the Dispute Resolution Mechanism available for transfer pricing cases into another farce with the tax department being allowed to file an appeal against its orders and above all without paying any heed to the comments of the Parliamentary Standing Committee or the voice of various stakeholders, it has introduced a wide sweeping GAAR.
Soli Uncle, the famous personality in tax-land, speaking to an assembled group CAs at an event organised by the BCAS, agreed that “the most obnoxious part of the Direct Tax Code (DTC) has been implemented.”
Let us look at one clause of the GAAR provisions. It states: It shall be ‘presumed’ that obtaining of tax benefit is the main purpose of an arrangement unless otherwise proved by the tax payer.
Four alternative additional tests have been laid down to determine whether or not a transaction could be covered by the GAAR provisions. These are: (i) the arrangement creates rights and obligations which are not normally created between parties dealing at arm’s length; (ii) it results in misuse or abuse of provisions of tax law (iii) it lacks commercial substance or is ‘deemed’ to lack commercial substance (which is further defined), or (iv) it is carried out in a manner which is normally not employed for bona-fide purpose.
As per the Bill, even if one part of the arrangement is found to obtain a tax benefit then the entire arrangement will be declared as impermissible. GAAR also has an over-riding effect over tax treaties.
Soli Uncle narrated many illustrations to elucidate the absurdity of these provisions. Let’s take two. An entrepreneur sets up an undertaking in a backward area to claim tax benefit. The provisions, as they exist, give the right to the tax authorities to disallow the tax benefit saying there was no commercial substance, as the sole purpose of such a location was to claim a tax benefit.
Take another example: A person makes a capital gain and makes investments in bonds eligible under section 54EC, owing to which he does not pay capital gains tax. The tax authority can argue that the main purpose of investment in such bonds (which incidentally have a lower rate of interest) as opposed to investments in more lucrative securities which did not carry a tax benefit was devoid of commercial substance. Enter GAAR!
Tax authorities have been given the widest powers imaginable. They can disregard or combine steps or parties in the transaction; they can reallocate expenses and income between parties; they can relocate place of residence of a party or location of a transaction or situs of an asset to a place other than provided in the transaction; they can re-characterize equity into debt, capital into revenue etc; they can even look through the arrangement by disregarding any corporate structure. Thus Mr. A of Country A, can be told that he is now Mr. B and that he is a resident of Country C. Anything is possible by a wave of the GAAR sword.
On another note, the Bill makes it vital to obtain a tax residency certificate, in the form prescribed by India, to obtain tax benefits falling under a particular treaty (say between Country A and India). Now why will tax authorities of another country, issue such a certificate in a format prescribed by India?
There is an additional twist. Even if such certificate is obtained, it will not be a ‘sufficient’ condition for claiming treaty benefits. Why then call for such certificate?
In its report, the Parliamentary Standing Committee (PSC) examining the DTC recognised the gravity of a wide sweeping GAAR and had said it must not impact bona-fide transactions entered into for genuine reasons. Further, it stated the onus of proving tax avoidance should rest with the tax department and not with the tax payer. It had also called for an independent body (rather than a panel set up from within the tax department) for approving the order of the Commissioner invoking the GAAR provisions. This would be fair and just to the tax payers.
The Explanatory Memorandum to the Bill agrees that the wide discretion and authority to the tax administration which at times is prone to be misused, is the foundation for criticism of GAAR provisions worldwide. Yet it does nothing about it!
As the Bill stands today, the onus of proof continues to be on the tax payer, the provisions continue to be wide-sweeping, and the orders of the Commissioner invoking the GAAR provisions continue to be subject to the approval of a panel of tax commissioners and above.
Thus, is it fair for the tax payer to presume that revenue collection is the main purpose of such wide sweeping powers to the tax department? One hopes that rationality will prevail.
Source of the photograph: http://2.bp.blogspot.com/_d_czO70DFC0/SniVqS9mkXI/AAAAAAAAAIg/E73sr_unqEA/s320/Puzzled.jpg
Posted by Lubna at 7:01 AM
Friday, February 24, 2012
Just when we had thought that the Supreme Court's verdict in Vodafone's case had brought about clarity on India's right to tax in instances of indirect transfer, a review petion filed by the tax authorities has once again created an element of uncertainity.
The Economic Times has reported a few days ago: The Income-Tax Department has filed a review petition in the Supreme Court asking it to reconsider its verdict dismissing the government's $2.2-billion tax claim on telecom company Vodafone, but the UK-based group appeared unfazed.The department has sought the review on the grounds the judgement suffered from errors, failed to consider its submissions, and that certain provisions in the income-tax law had not been correctly interpreted.
Meanwhile in the February column of Law Street, Zenobia Aunty looks ahead at the provisions contained in the draft Direct Tax Code and wonders whether the government will cherry pick some of the provisions, especially those relating tax in India on indirect transfer of shares and introduce them in the Finance Bill in the coming month. The column is available online here, and as always it is also cut and pasted below.
Taxing indirect transfers
Tax provisions on indirect transfers must be clear
Exemptions must be granted for intra group transfers
Valuation comparisons should be date specific
Lately Zenobia Aunty has been very busy. Seminars, lunches and dinners, to discuss the landmark Vodafone judgement are still going strong. Understandably tax practitioners are jubilant with the Supreme Court’s verdict. As we wait for the Finance Bill, 2012, to be unfolded the question uppermost in everyone’s mind is whether this joy of the tax practitioners will be short-lived.
It is well known that in 2009, China introduced a legislation to tax an indirect transfer of a capital asset situated in China. It is believed that the Chinese authorities borrowed a leaf from the Indian tax authorities’ action in Vodafone’s case. Circular Number 698 requires non-resident transferors to report their share transfer transactions, together with the relevant supporting documentation, including share transfer agreements, after they indirectly transfer their equity interests in Chinese resident companies, via disposal of intermediate holding company. This is required to be done if the resultant tax on the transaction through the use of the intermediate holding company is less than 12.5 per cent.
Chinese tax authorities then examine the transaction. If it is found that the intermediate holding company has no business substance and was set up only for tax avoidance, the transaction is regarded as transfer of shares of the Chinese resident company (and not that of the intermediate company) and is subject to tax in China. Since issue of this circular, in a number of cases, the Chinese tax authorities have ‘looked-through’ the intermediary companies and taxed the transaction in China.
From a technical legal perspective, the provisions of Circular 698 or even Chinese General Anti Avoidance Provisions (GAAR) apply only to corporate tax payers and are governed by the framework of corporate tax laws. However, in recent months, a case has been reported on the collection of individual income tax of close to USD 2.1 mn on the capital gain arising from an indirect transfer of an equity interest in a Chinese company through an offshore transfer of its Hong Kong parent by a Hong Kong resident individual. The fear among the business community is that this case could be used as a guiding principle when dealing with non-resident individuals and not just corporate tax payers.
At one point of time, when grey clouds shrouded the tax frontier in India, global tax payers had felt that at least the Chinese tax laws provided some clarity on tax incidence as regards indirect transfer of capital assets. But with the wide interpretation now given to this circular by the Chinese tax authorities, which has roped in even individual tax payers, there is understandably a sense of apprehension.
Coming back to perhaps what the future holds in India. Section 5 (1) (d) of the Direct Tax Code (DTC) seeks to bring within the tax ambit direct or indirect transfer of a capital asset situated in India. Section 5(4) (g) adds that: The capital gains would not be deemed to arise in India from such transactions unless at any time in twelve months preceding the transfer, the fair market value of the assets in India, owned, directly or indirectly, by the company, represent at least fifty per cent of the fair market value of all assets owned by the company.
The intent of introducing the above provision seems to be to cover cases where ‘controlling interest’ in an Indian company is sought to be transferred outside India, by transferring shares of the foreign company which holds shares in the Indian company. Considering the unintended consequences that could arise owing to ambiguity in the language, the coverage of indirect transfer may be restricted to cases where: (i)The foreign company whose shares are transferred owns, directly or indirectly, more than 50% of the share capital of an Indian company and (ii) The shareholder transferring the shares of the foreign company, should own more than 50% of the share capital of the foreign company.
Further the window period of twelve months referred to in valuation could lead to practical difficulties. For the purpose of comparison of the values, the comparison should be should be restricted to the balance sheet date immediately preceding the date of transfer. A merger of two foreign companies should also not result in tax implications in the hands of the shareholder on account of indirect transfer of capital asset. Additionally, an exemption should be granted for intra-group transfers. Indian tax laws do provide for tax incidence in the hands of the representative assessee. From a practical perspective, a representative assessee must be one who has possessed the non-residents money in the course of the transaction.
Be it China or India, tax authorities are keen to gain a bigger slice of the tax pie, but ambiguity hurts. Investor confidence is now riding high as far as India is concerned, appropriate amendments in the DTC will be of an added help.
Source of the photograph
Posted by Lubna at 9:32 AM
Sunday, January 29, 2012
As the press had a rare holiday on India's Republic Day, viz January 26, we did not get a printed copy of the newspaper the next day. However, my column was duly uploaded on the website.
It is likely that the Companies Bill, when reintroduced, will continue with its proposition to make CSR disclosures mandatory. That said, shouldn't the tax laws be in synch so as to propel the corporate sector towards CSR activities? Perhaps a weighted deduction for CSR activities would be a blessing. It would also reduce the litigation on whether a CSR expense is a business expenditure or a CSR expenditure. Click here to read the online edition of The Economic Times, or scroll below.
CSR activities may be mandatory
Appropriate tax deductions should be introduced
The Finance Bill and Cos Bill must be in synch
Zenobia Aunty firmly believes in Karma, little wonder then, that Spot is forced to share his biscuit treats with the alley cat. In an ideal world, if a Company contributed towards the society, it would be amply rewarded by its various stakeholders in myriad ways. However, without expecting anything in return, many companies do contribute by building townships, providing funds or assets for schools, hospitals and the like. Yet, there are others who firmly believe that this is not their role and the taxes paid by them should cover take care of their social obligations.
Perhaps, it is only a matter of time before contribution towards Corporate Social Responsibility (CSR) will be mandatory. The Companies Bill, 2011, at the insistence of the opposition was withdrawn from the Parliament in the winter session, but it is likely to be reintroduced in the budget session in March. This Bill called upon corporate entities meeting certain parameters to engage CSR activities. In the budget session, the Finance Bill, 2012 will also be tabled and perhaps also the Direct Tax Code. Thus, here is an opportunity for our draftsmen to ensure that the tax laws cover the treatment of CSR expenditure.
The Companies Bill had prescribed that every Company having a net worth of Rs 500 crore or more; or a turnover of Rs one thousand crore or more; or a net profit of Rs 5 crore or more; during any financial year shall set up a CSR Committee, which would guide and monitor the company’s CSR agenda and expenditure. Companies meeting this criterion were required to spend at least 2 % of their average net profits made during the three previous financial years towards CSR activities. Proper disclosure of the CSR policy including reasons for not meeting the required expenditure was called for.
Schedule VII prescribed the various activities that would fit into the CSR policy agenda. Besides contribution to the PM’s National Relief Fund and certain other funds of the Central and State governments, the CSR activities covered those relating to eradicating hunger, promoting education or health, ensuring environmental sustainability and everything that could fall in the definition of social business projects.
Let us assume that the Companies Bill, containing mandatory CSR spend in some form or the other gets passed in the budget session. To ensure that the corporate sector gets its due recognition for such activities the Finance Bill should also contain suitable provisions providing for tax deductions for CSR activities.
At present tax exemption for cash donations can be broken up into various categories: donations which entitle the donor to a 100 % or 50 % tax exemption without any qualifying limit such as the PM’s National Relief Fund and PM’s Drought Relief Fund respectively; and donations which are subject to 100 % or 50 % deduction subject to a cap of 10 % of the adjusted gross total income. In such cases, even if you make a donation larger than 10 % of the adjusted gross total income the total donation amount eligible for a tax deduction would be capped at this 10 %limit.
The Companies Bill, by defining CSR activities has widened the field. Currently, it may be possible for a Company to treat a particular CSR related activity as a bondfide business deduction, say installation of solar panels in its office premise (which helps environment sustainability) against which it claims a tax depreciation. But, claiming expenses for a medical camp in a nearby rural district as a business deduction may result in litigation.
To avoid any further litigation on the issue, any expenditure that qualifies as a CSR expenditure, whether it be capital or revenue in nature, should be entitled to a separate tax treatment. A deduction, for tax purposes of 120-150 per cent of the CSR expenditure should be permitted with a prescribed cap. As, the Companies Bill calls for a minimum spend of 2% of the average net profits during the previous three years, perhaps a cap of 5% of this amount should be set for the purpose of claiming a tax deduction. Any excess expenditure beyond 5% should not be permitted, as this would ensure that scrupulous companies do not overspend under the CSR banner just for the sake of a tax claim.
Several companies have set up their own trusts or foundations for CSR activities. Perhaps companies may need to move these activities within the corporate fold so as to take the tax benefit. However, it would be best for the tax laws to provide that a contribution to the trust or foundation is also regarded as a CSR expenditure, provided the trust or foundation has spent that money fully during a financial year.
While internal CSR committees would bear the responsibility of ensuring that the prescribed funds are used for genuine CSR activities, appropriate tax policies would ensure clarity and also prompt India Inc to fully support this initiative.
Source of the photograph
Posted by Lubna at 11:14 PM