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India: cracking down on international tax avoidance

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The prospect of new mega power plants is tempting foreign direct investment into India. But beware vigilant tax authorities, cautions Samir Kanabar.

Foreign Direct Investment (FDI) in India is on the rise, with a 25% increase in the number of FDI projects in the 11 months to November 2011 compared with 201014. There is also record growth in power generation, including 14 planned ultra mega power plants in the Twelfth Five-Year Plan (2012-17).

However, for power and utility companies and engineering, procurement and construction services, the tax system can prove a trap for the unwary. Indian tax laws, governing direct and indirect taxes are very complex – with multiple rates and duties or levies, incentives and exemptions to achieve specific social and developmental goals, and elaborate procedures requiring a great deal of documentation.

To add more fuel to the ongoing fire, the recent Finance Bill 2012 introduced anti-avoidance regulations and more than 30 amendments that overturn judicial pronouncements in favor of tax payers and domestic transfer pricing regulations.

Many provisions in the laws are also subject to more than one interpretation, frequent disputes and litigation arise. These complexities prove fertile ground for tax evasion as they provide with greater discretionary powers to tax collectors.

Increased focus on multinationals

Recently, the authorities have targeted multinationals with cross-border activities. In the last two financial years, the Directorate of Transfer Pricing has detected mispricing to the value of INR 341.45 billion (US$6.8 billion), compared with just INR 146.55 billion (US$2.9 billion) over the last five tax years.

The Finance Bill 2012 has widened the definition of international transactions that fall within the purview of TP, and done so retrospectively. Under the Finance Bill, the law now brings such transactions within the remit of domestic tax law, making them taxable. This said, treaty benefits (which are more beneficial than domestic tax law) could continue to apply, if the tax payer is able to overcome anti-avoidance regulations.

In one of India's biggest tax controversies, Vodafone Group recently won a US$2.5 billion battle against the Indian tax office.

The Supreme Court set aside the Bombay High Court's decision on the taxability of gains arising to a foreign company from the transfer of shares of a foreign holding company indirectly holding shares in an Indian operating company.

The unanimous judgment in Vodafone's favour is significant, with implications for international transactions, tax avoidance and enforcement in territories beyond India.

Nearly US$70 billion tied up in appeals

Given the rising number of disputes, especially in international taxation, there is an urgent need to strengthen India's dispute resolution mechanism. The Comptroller and Auditor General of India, in a recent report on direct taxes, estimated that nearly US$50 billion was tied up in appeal cases in 2009–10. A further US$20 billion was locked up in appeals at higher levels.

The Government set up dispute resolution panels (DRP) to address this. However, the DRP's structure and functioning has a lot to be desired. Steps are underway to make it more independent and accountable.

Tax benefits being reassessed

Effective tax structuring is vital to make sure power generation, transmission and distribution projects are attractive to investors. One of the biggest benefits available has been tax holidays, which allow an operation to choose which 10 years out of 15 its operations will be tax-free.

This benefit was due to expire for the power and infrastructure sectors on 31 March 2012, but is expected to be extended for another year.

The Government withdrew the Deemed Export Drawback benefit for supplies made to non-mega power plants, with effect from 28 December 2011. Deemed Exports are transactions in which the supply of goods made in India are seen to have been exported out of the country for tax purposes.

For example, supply to non-mega power projects was considered a deemed export and therefore eligible for certain indirect tax benefits subject to specific conditions. This policy change could have a significant impact on returns and cash flows.

Conclusion

International companies looking to operate in India must get informed tax advice so they can:

  • Determine their optimal structure for tax purposes
  • Demonstrate substance and rationale for this structure to the tax authorities
  • Obtain an advance ruling on whether a transaction is taxable, where possible
  • Keep up-to-date with implications of new regulatory developments, such as the recently released Finance Bill 2012, which introduced retrospective amendments
  • Carry out a detailed transfer pricing study to defend intra-group transactions

We have successfully advised a number of companies in these areas, advocated for multinationals and made representations to the tax authorities. Given the high incidence of disputes and litigation, and the likely 12-15 year timeframe to resolve issues, foreign players are advised to look before they leap into the many opportunities India presents.

For more information


India a new dawnIndia, a new dawn

Read our report on tax in India, published in 2011.


Ready for the transition: EY's 2012 India attractiveness surveyReady for the transition: EY's 2012 Indian Attractiveness Survey

Read our report on foreign direct investment in India.



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14Ready for the transition, EY's 2012 Indian Attractiveness Survey. 2012.

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Samir Kanabar Samir Kanabar

Samir is Tax Leader for the cleantech sector in India, advising clients on issues like structuring investments, tax aspects of their business models, cross-border lease models and complex tax issues related to tax holidays and accelerated depreciation. He focuses on clients in the cleantech, infrastructure, real estate, defense and oil and gas sectors.
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