Friday, March 30, 2012

Law Street (The Economic Times: March 30, 2012)

Dear Readers,

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.

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