Jaitley Should Address Retrospective Tax, Defer GAAR
Tax Partner, EY
The Indian economy today is in urgent need of measures to restore growth. A stable, clear and transparent tax regime would go a long way in improving sentiments and investor confidence. Building such a tax regime would require an integrated effort including legislative changes to bring in clarity, operational changes to improve tax administration and investment in strengthening dispute resolution mechanisms. While legislative changes can be immediately introduced through the upcoming budget, the operational changes would need sustained on-the-ground reform efforts.
To begin with, the retrospective amendments which introduced in the backdrop of the Vodafone case must be first addressed. The fact that these amendments were introduced with retrospective effect, overriding the Supreme Court's judgement in the Vodafone case has rattled investor confidence in the fairness and stability of the Indian tax regime. Removing the retrospective effect of these amendments can help restore investor confidence. Further, the "indirect transfer" provisions as they stand today lack clarity on substantial aspects. The expert committee headed by Dr Parthasarathi Shome has made a number of suggestions to clarify the tax law on this matter. Implementing these recommendations in the upcoming budget would help bring in certainty in the application of these provisions.
General Anti-Avoidance Rules (GAAR) which are slated to come into effect from 1 April 2015 would grant tax officers unprecedented powers, to counteract arrangements which they judge as being carried out with the main purpose of obtaining a tax benefit. The sweeping powers granted to tax officers, coupled with the subjectivity involved in application, makes GAAR especially worrisome for taxpayers. Further, the tax treatment of transactions would no longer be certain, since there would always be a threat of GAAR being applied to rewrite their tax implications. GAAR will thus introduce fresh uncertainty into the tax system - an additional risk which investors would not find palatable. Given this there are strong arguments to do away with the GAAR provisions entirely. If the government sees compelling reasons for retaining GAAR, it would be best if its implementation is deferred till such time India is able to build a mature, non-adversarial and transparent tax administration. Alternatively, the government can consider introducing prescriptive anti-avoidance rules, under which taxpayers can objectively identify specific arrangements which would be covered.
The manufacturing sector needs support if the decline of recent years is to be reversed. Presently, an investment allowance of 15 per cent is available for investments of more than Rs. 100 crore made by manufacturing concerns. This incentive should be made more broad-based such that SMEs also benefit. Introducing other export and investment incentives would be of much help.
Transfer pricing has been an area where there has been substantial litigation. Advance pricing arrangements (APAs), under which taxpayers can agree upon a transfer price in advance with the tax authorities, have shown a promising start. The APA body must be strengthened to speed up the process of closing APAs, such that the momentum built up till now is maintained. Under the "safe harbour" provisions which were operationalized last year, taxpayers whose transfer prices meet certain specified thresholds would not be subjected to a transfer pricing scrutiny. The Safe Harbour mechanism has only seen a lukewarm response till now, due to high transfer pricing thresholds. Rationalising the safe harbour thresholds would help in more widespread adoption, and consequently help reduce litigation. For example, the safe harbour threshold for software services should be reduced from an operating margin of 20-22 per cent to 15 per cent. Reducing transfer pricing litigation will be an impetus for increasing investment into India.
The Dispute Resolution Panel (DRP) scheme has not met the intended objectives - practically, the DRP has become a formality with most DRP orders being appealed before the Income Tax Appellate Tribunal. For the DRP mechanism to yield tangible results its independence must be strengthened; it must be given powers to settle cases as well.
The advance ruling mechanism was originally mooted to provide non-resident taxpayers an opportunity to obtain certainty of tax treatment before entering into a transaction. However, the Authority for Advance Rulings ("AAR") today has a massive backlog of cases; applications filed before the AAR now take 2 -3 years to be resolved. If the AAR's intended objective of providing tax certainty in advance is to be met, the AAR must be expanded and strengthened further.
Lastly, the tax administration needs a complete overhaul, to make it more taxpayer friendly and to increase transparency. Effecting organizational change is always a challenge, especially in the government sector. Setting up the Tax Administration Reform Commission (TARC) is a step in the right direction. The government must rise up to the challenge and push for speedy implementation of the TARC's recommendations for administration reform. This will help address what has been the weakest link in India's tax system - the on-the-ground implementation of tax policy.
Some of the suggestions outlined above may be revenue negative in the short term. However, the government can push forward with the implementation of these measures keeping in mind its larger responsibility for encouraging economic growth.