India Tax Insights – eighth edition
Is the stage set for next generation tax reforms?
Sudhir Kapadia, National Tax Leader, EY India
Elections in India tend to center around a number of noisy and boisterous issues, and it is rare for tax policy to find a meaningful place in the manifestos of political parties. However, in the 2014 elections, the current Government’s political manifesto in particular made pointed references to the prevalence of what it called “tax terrorism” and the urgent need for tax certainty and a non-adversarial tax regime. The context of these manifesto points was of course the much-criticized slew of retrospective amendments brought about by the previous government in the 2012 Budget and the general prevailing atmosphere of suspicion and aggressiveness on the part of the tax administration in relation to assessments and collection of taxes.
With more than two years of governance behind the Modi Government, it is the right time to analyze the progress of several aspects of its tax policy reforms. The scene was set by the maiden Budget1 presented by the finance minister outlining the new Government’s tax policy and vision; however, it was thought to be short of bold and decisive measures (for example, the retrospective provisions of taxation of indirect transfers were left untouched, and still continue on the statute book, though some other mitigating measures were introduced). However, since then the Government has shown remarkable resolve and progress toward its objectives of tax certainty and non-adversarial tax regime, as outlined below:
- Tax simplification and certainty: The Central Board of Direct Taxes (CBDT) has issued a number of much-needed clarifications on quite a few simmering tax issues. Examples include providing certainty on the characterization of the investment portfolio of taxpayer as capital gains instead of business income (rather than leaving it to the discretion of the assessing officer)2; clarifying the non-applicability of the Association of Persons status in case of executing engineering, procurement and construction (EPC) contracts3; automatic stay of the tax demanded on assessment upon payment of 15% of the demand if the taxpayer prefers an appeal against the assessment4; substitution of low threshold for the selection of cases for transfer pricing scrutiny with a risk based evaluation with greater emphasis on qualitative rather than quantitative factors; rules for special taxation regime to facilitate the location of fund managers of offshore funds in India5; and notifying amendments to the GAAR rules clarifying the grandfathering of income from transfer of investments made before 1 April 2017 from the application of GAAR. In general, it is observed that there is a willingness and strong intent to provide clarity and certainty on a variety of contentious issues.
- Non adversarial tax regime: The most notable feature of the current tax regime is that there has been no serious attempt to rake up fresh issues based on “creative interpretation,” which was the order of the day in the past. However, a notable exception was an attempt to levy minimum alternate tax (MAT) on foreign institutional investors (FIIs), which created a great deal of anxiety and uncertainty but was very quickly resolved in a time-bound manner through legislative intervention in the Budget that followed6. Similarly, the Government took cabinet approval not to appeal against a favorable order passed by the Bombay High Court7, ruling against the transfer pricing adjustments carried out by the tax administration in respect of fresh issue of shares by a subsidiary of a foreign company in India.
There are instances both in direct and indirect tax administration where high-handed measures are still resorted to, including unreasonable demands and summoning of senior executives and directors of companies even if the issue is one of difference of interpretation of law rather than concealment or fraud. Similarly, timely grant of tax refunds is still an issue, with many tax officers attempting to make adjustments in subsequent years to offset the refunds due for prior years. Timely grant of lower or nil tax deduction at source (TDS) certificates is still a challenge, as is the case of timely grant of appeal effects in case of favorable rulings by higher authorities Dispute resolution mechanism: The Authority for Advance Rulings (AAR) was established way back in the 1990s to provide certainty in respect of proposed transactions to be carried out by foreign investors in India. The AAR has a checkered history and has seen periods when it has been quite inactive, resulting in pendency of several cases. The AAR has made tremendous progress in recent times under the chairmanship of the current justice. However, there is an urgent need to put in place a mechanism where unnecessary delays are avoided both by the tax administration as well as applicants of the rulings. In particular, it has been observed with unfailing regularity that the counsels for tax administration routinely request for adjournments on the basis of necessary paper work not being ready or provided to them. This attitude remains unchallenged despite specific counsel provided by the CBDT in a recent circular to help expedite cases at the AAR. There is also a dire need to grant continuity of tenure to the sitting judge to ensure seamless functioning of the AAR. It has often been seen that after the tenure of the sitting judge concludes, it takes several months for a new incumbent to be appointed and take charge, leading to more delays and pendency of applications. The announcement of additional benches of the AAR has also remained on paper as the necessary members have not yet been notified. In short, time has now come to further enhance the effectiveness of the AAR and encourage taxpayers to avail of this opportunity to seek advance rulings of proposed transactions, which will result in greater certainty and avoidance of litigation in future. Similarly, the Advance Pricing Authority (APA) has done a commendable job in concluding APA agreements on a variety of issues and providing certainty on transfer pricing issues. Here too, there is a need to have continuity in the team members comprising the APA and to ensure that future members have the right competencies and mind set toward helping conclude pricing arrangements rather than have a challenging revenue mind-set that scares away potential applicants from approaching the APA.
- Simplification of tax laws: The finance minister has provided a clear roadmap for the rationalization of corporate tax rates from 30% to 25% in lieu of the gradual removal of various incentives in the next 3—4 years. However, legacy surcharges, which add 3%—4% to the tax burden, still continue. Similarly, the dividend distribution tax (DDT) has seen a gradual increase to nearly 20%, significantly enhancing the effective corporate tax rate for dividend paying companies. It may now be time to revisit the classical system of dividend taxation: taxing shareholders at applicable slab rates above the minimum threshold so as not to burden small shareholders. MAT has also increased to nearly 20% over the years. Therefore, a clear clarification of the phased removal of MAT, along with reduction of corporate tax rate to 25% and phasing out of incentives, is required to make the corporate tax system simpler, attractive and efficient.
- Base Erosion and Profit Shifting measures: India has played a pivotal role in the development of Base Erosion and Profit Shifting (BEPS) action points at the OECD. India has already introduced minimum stands prescribed under BEPS by way of common CbCR and master filing documentation and an equalization levy for advertising revenues earned by foreign websites8. Going forward, there are a number of recommendations pertaining to interest cost disallowance, tax avoidance measures, transfer pricing—based on value contributions etc., which India would likely consider to incorporate in the Indian tax law. However, India would do well to avoid over-complicating an already complex law, which may in turn trigger an onset of future tax controversies even as the past controversies are being addressed. India should also consider balancing the need of attracting investments in the Indian economy versus introducing more detailed rules recommended by the BEPS action agenda.
- Capital gains tax: Exemption of short term capital gains in the hands of foreign investors investing through Mauritius and availing of the Mauritius–India Treaty has been a contentious issue for more than two decades. No government in the past was willing to touch this issue for fear of spooking the capital markets. This Government has shown courage and vision to resolve this long-pending uncertainty by providing for a phased withdrawal of capital gains exemption and yet grandfathering past investments9. There are reports indicating similar re-visiting of capital gains tax exemption provision in some other treaties, including with Singapore and the Netherlands. By introducing these amendments, the Government has made its intent clear to provide a level playing field to all foreign investors, whichever country they come from, in respect of their capital gains taxation in India.
- Goods and Service Tax (GST): The passage of the Constitution (Amendment) Bill for GST implementation by the Rajya Sabha is a remarkable achievement and marks a new era of cooperative fiscal federalism in India. In the spirit that the Government has demonstrated earlier, it should now engage constructively with the stakeholders on the significant matters relating to the tax base and rates. The current draft of the proposed GST law does not inspire much confidence and has a plethora of issues that need to be immediately addressed. An open and regular dialogue with the industry would help in settling these issues.
The Chief Economic Advisor to the Government, Arvind Subramanian, has rightly stated that the Modi Government has successfully followed “persistent, creative and encompassing incrementalism in its economic policy.” The same description could well apply to the Modi Government‘s tax policy. While this approach has ensured that tax policy is moved positively in the right direction, it also means that considerable hard work lies in the areas of effective implementation of some well-intended and well-designed policy measures.
- EY’s E-Budget Analysis in Budget Connect + 2014 at http://www.ey.com/IN/en/Services/Tax/EY-budget-connect-2014
- CBDT Circular 6 of 2016 dated 29 February 2016 and CBDT Clarification F.No. 225/12/2016/ITA.II dated 2 May 2016
- CBDT Circular 7 of 2016 dated 7 March 2016 and EY Tax Alert dated 9 March 2016
- CBDT (Office Memorandum) F.No. 404/72/93-ITCC dated 29 February 2016
- EY Tax Alert on Key international tax proposals of India Budget 2016 (dated 1 March 2016) and of FB 2015 (dated 28 February 2015)
- EY Tax Alert on Key international tax proposals of FB 2015 (dated 28 February 2015)
- EY Global Tax Alert dated 15 October 2014
- EY Tax Alert on Key international tax proposals of India Budget 2016 (dated 1 March 2016)
- EY Global Tax Alert dated 11 May 2016