Lecture Meeting

1. On 16th
March 2012, Indian Finance Minister, Pranab Mukherjee presented the
Indian Budget for the Fiscal Year 2012-13.

“The life of a finance
minister is not easy and I must be cruel only to be kind” Mr. Mukherjee
lamented in his 8th budget speech. The tax provisions contained therein
have indeed proved him right. A few days after the Bill was announced,
Mr. S. E. Dastur, ‘the’ Senior Tax Counsel shared his views on the
implications and the fine print of the Finance Bill, 2012.

 2. Vodafone —
Wherever you go, the tax net(work) follows!

The budget this year seems
focussed on garnering as much revenue as possible by way of various
retrospective amendments. While the budget took care of several issues,
plugged many loopholes and gave a few benefits to the taxpayer, the most
discussed aspect of the Finance Bill was the Vodafone case.

The issue
in the Vodafone case was that the Tax Department had issued a notice to
Vodafone for not withholding tax while making payment to Hutchison for
purchasing 1 share of a Cayman Island Company. The Supreme Court (‘SC’)
held that the tax officer did not have jurisdiction in matters relating
to tax withholding in case of offshore transaction of sale of shares of a
foreign company between two non-residents as it was not chargeable to
tax in India. To counter this decision, the Government retrospectively
amended sections 2, 9 and 195 of the Income-tax Act, 1961 (‘Act’).

The
question which arises now is whether the Government is justified in
making these retrospective amendments and what is the consequence of
these retrospective amendments?

Mr. Dastur opined that there was no bar
on making retrospective amendments. However, whether the Government
could rely on this amendment, which was made after the decision in
Vodafone’s case was pronounced to collect taxes from Vodafone itself?
The review petition filed by the Government challenging the Vodafone
decision was dismissed by the SC. This was rightly so, as on the date of
dismissal, there was no enactment on the basis of which the SC could
accept it.

A review lies because of the change in law, while presently,
the amendments are still at the Bill stage. The question now is whether,
once the provisions are enacted into a law, the Government could once
again approach the SC to review its Vodafone decision in light of the
change in law? If the answer to this is yes, would it mean that two
review petitions could be filed to the SC against the same decision?
Perhaps the better course of action for the Government would have been
to wait till the provisions were enacted and then to file the review
petition asking for condonation of delay.

3. Retrospective perspective

 It is possible to take a view that if a retrospective amendment is
passed, it means that there is an error in the Court’s judgment and
hence, the judgment could be reviewed by the Court. However, in the case
of Kauvery Water Disputes Tribunal [1993 SCC Supl. (1) 96], the SC has
held that a change of law cannot per se set aside a SC decision.

In the
case of Raja Shatrunji v. Mohammad Azmat Azim Khan, (2 SCC 200), the SC
held that a review was possible when there was a change in the law.
However, Mr. Dastur observed that it would be unjust and contrary to the
principle of equity to ask Vodafone to deduct tax at source, after the
SC has decided in favour of Vodafone on the issue, only in view of the
retrospective amendment to law. The liability of deducting tax at source
on Vodafone is only as a statutory agent of the Government. The
Government cannot say that Vodafone, having acted as per the law then
existing, ought to now deduct tax at source and pay it to the Government
only on the basis of the retrospective amendment of law. It would be
contrary to Article 14 of the Constitution of India as harsh,
unreasonable and arbitrary.

4. Curing the Vodafone indigestion

There are
two actions that the Government has undertaken to overcome the effects
of the Vodafone decision of the SC:

(i) Amendment to sections 2(14) and
2(47) which now provide that if rights in India are transferred owing to
a transfer of shares of a company registered or incorporated outside
India, then those rights are deemed to be a capital asset giving rise to
capital gains. However, if the asset is confined to rights such as
transfer of ‘right to vote’, ‘right to control’, etc., the question
arises as to how to determine the value of the ‘right’. These rights are
as a result of the shares in the offshore entity held and it is not
possible to apportion the cost of such rights from the cost of the
shares. In the case of B. C. Srinivasa Setty (128 ITR 294), the SC held
that if the cost of acquisition of the asset cannot be determined, there
cannot be a capital gains tax liability.

(ii) However, Explanations 4
& 5 to section 9(1) (i) resolve the above by deeming that if any
right in India is transferred on account of transfer of shares of an
offshore company, the shares of offshore company would be an asset
situated in India and section 9(1)(i) would apply to income arising from
its transfer.

5. Loyalty to royalty

In the case of Ericsson, the Delhi
High Court (‘HC’) held that a copyrighted article is different from the
use of a copyright. Explanation 4 is inserted in section 9(1)(vi) to
include as Royalty, the use of a computer software, thereby overcoming
the above HC decision.

In the Asia Satellite’s case (332 ITR 340), the
Delhi HC took a view that use of space on transponder for beaming
programmes to India would not amount to use of a process and thus,
consideration paid for the same is not royalty. This decision is now
brought to a naught by insertion of Explanation 6 to section 9(1)(vi).

6. The domestic transfer pricing bomb

Shielding itself by the SC remark
in the case of CIT v. GlaxoSmithKline Asia (P) Ltd., the Finance Bill
has introduced the concept of transfer pricing in relation specified
domestic related party transactions. The transfer pricing provisions
till now applicable to specified international transactions would be now
made applicable to domestic transactions as well by amendment to
section 92CA. The arm’s-length price (‘ALP’) would be determined in
accordance with the most appropriate method laid down in section 92C.
Further, these domestic entities will be required to maintain adequate
documentation supporting the transfer price on an annual basis as per
Rule 10D of the Income Tax Rules.

The sections of the Act affected by
domestic transfer pricing are:

(i) Section 40A(2) — In case of an entity
making a payment to another related entity, especially where paying
entity is posting a loss and thereby, paying lower taxes. However,
proviso to section 40A(2)(a) states that no adjustment would be made on
account of the expenditure being excessive having regard to the fair
market value (‘FMV’), if such expenditure is at ALP, thereby making a
distinction between the FMV and the ALP.

(ii) Sections 80A/80IA — if an
assessee has an 80A/80IA eligible unit and a transaction is effected
between the 80A/80IA unit and an 80A/80IA ineligible unit belonging to
the same assessee, transfer pricing provisions would be attracted. No
distinction is made between the FMV and the ALP.

(iii) Section 10AA —
Similar applicability as for sections 80A/80IA.

 7. Penalising the
honest?

Section 92CA(1) states that a reference to a Transfer Pricing Officer to determine the fair value of a transaction should be made only after consent of the Commissioner of Income-tax and if he feels that it is necessary or expedient to make the reference. However, it seems that today, reference is made only based on the monetary value of the transaction. Mr. Dastur said that such an action can be taken to the Courts by the assessee, if there appears to be no valid reason for the reference. The Bombay HC in the case of Coca Cola has favoured this position.

8.    GAAR — General Anti-Assessee Rules!

Till date, the view taken by the Courts was that there is no duty on the assessee to pay the maximum tax so far as he stays within the four corners of the law. Mr. Dastur remarked that while the GAAR provisions were introduced in the Direct Tax Code, the Code is put on hold as there were certain ambiguities in it. Nevertheless, the Finance Bill, 2012 has proposed to implement what was perhaps the most obnoxious part of the Code!

The GAAR defines ‘impermissible avoidance arrangements’ as arrangements which meet certain criteria laid down in the provisions and provide tax benefits to the assessee. In such a case, the tax officer has been given powers to disregard/ignore the transaction or steps in the transaction and rewrite the entire transaction and foist tax liability on the transaction.

Mr. Dastur opined that these are perhaps the widest and unguided powers given to tax officers and that despite the Supreme Court holding that a transaction could only be looked at and not looked through, the GAAR seeks to do just that.

Some examples of the likely consequences of the GAAR provisions pointed out by Mr. Dastur are:

•     Setting up industries/units in backward areas to avail the tax benefits/exemptions granted to such areas could result in GAAR being invoked on the basis that no rational person would set up industry in backward areas except to obtain tax benefit.

•     Investing of capital gains in low return securities granting exemption to the capital gains u/s.54EC of the Act could be characterised as an impermissible avoidance arrangement as it provides tax benefit to the assessee and no rational person would have invested in such low-return securities in normal circumstances.

•     A demerger transaction could be disregarded and GAAR invoked by the tax officer claiming that the main intention of the demerger was to sell the undertaking and demerger route, which was commercially unnecessary, was adopted only to avail tax benefit.

•     Sale and lease back transactions could be ignored stating that these were only for tax purposes.

All these consequences would be contrary to all the Supreme Court decisions till date.

9. Safeguards

The safeguards introduced to prevent misuse of the GAAR provisions by the tax officers are approval of the Commissioner of Income-tax and of a three-member Approving Panel consisting of three Income-tax Officials.

Attention was drawn to a letter from the Chairman of the Central Board of Direct Taxes dated 17th February 2012 sent out to tax officials sought to give the highest weightage to the tax revenue collections while deciding on the promotions and postings of the Commissioners.

Mr. Dastur expressed serious doubts on the independence of the Commissioner and the Approving Panel and questioned the adequacy of the safeguards.

10.    Implications on DTAAs

New section 98 gives the tax officer the power to deny DTAA benefits or modify the DTAA applicability including the power to decide which treaty should apply to the case, irrespective of the actual place of residence of the assessee. Mr. Dastur observed that while it may be permissible by a section in the Act to override a treaty, which is an agreement between two countries, GAAR gives the tax officer the power to override that treaty.

Circular 789, dated 13th April 2000 states that if an assessee provides a Tax Residency Certificate (TRC) issued by the Mauritian Government stating that he is a Mauritian resident, he shall be treated as such, and benefits for the Indo-Mauritian DTAA would be available to him. Now, in view of the above provisions, the validity of the Circular is also in question.

Mr. Dastur pointed out that the Explanatory Memo-randum to the Bill states that while obtaining the TRC is now a necessary condition u/s.90(4) for avail-ing treaty benefit, it is not the only condition.

Explanation 3 inserted in section 90 gives the Tax Department the power to retrospectively define a ‘term’ for the purposes of the DTAAs.

11.    Dispute Resolution Panel (DRP)

The DRP is now given powers to enhance the additions made by the Assessing Officer. Further, the Order of the DRP is made appealable by the Tax Department. These amendments defeat the purpose of the Panel which was to reduce the amount of tax litigation.

12.    Other amendments
Mr. Dastur, briefly dwelled upon taxation of charitable institutions, introduction of alternate minimum tax for all assessees, amendments relating to taxability of share application money u/s.68, amendments to section 2(19AA) dealing with demerger, new section 50D, extension of time limits for re-opening of assessments.

Mr. Dastur, concluded the session with the remark that the Finance Bill, 2012 has inserted approximately 31 Explanations of which 22 are with retrospective effect with most Explanations using the words ‘for removal of doubts’! Mr. Dastur, with his vast knowledge and wit, kept the audience hanging on to his every word.