By Rutvik R. Sanghvi, Jinal Shah
Chartered Accountants
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Subject :
Recent Controversies in Cross Border Taxation
Speaker : Pinakin Desai, Chartered Accountant
Date : 11-7-2012
Venue : Indian Merchant Chambers, Mumbai
The first Lecture Meeting of BCAS for the year 2012- 13 was addressed by Pinakin Desai on the topic ‘Issues in Cross-Border Taxation’ on 11th July 2012. Deepak Shah, Society’s newly elected President, welcomed everyone on behalf of BCAS. He shared with the august gathering the focus areas of BCAS for the upcoming year — to expand and enrich membership experience, to enhance and strengthen relationships and to provide mentorship — and invited whole-hearted involvement and participation of all BCAS members.
After an overwhelming introduction by the President, Mr. Desai took the stage to do full justice to it. Given the recent upheaval in the tax world, many new controversies have added themselves to an already long list. Mr. Desai, in his talk, discussed some of the most controversial ones. These are briefly discussed below:
1. Overview of General Anti-Avoidance Rules (‘GAAR’)
As per the current GAAR provisions, an arrangement would be termed as ‘impermissible avoidance agreement’ if its main purpose is obtaining tax benefit and it satisfies any of the four conditions specified in section 96(1) of the Income-tax Act, 1961 (‘Act’). The speaker opined that the condition that the main purpose be obtaining tax benefit was necessary to be provided and is provided by most countries globally. However, presently, the term tax benefit is very loosely worded and could lead to unreasonable conclusions.
Section 96(2) provides that while the objective of an arrangement as a whole may not be to obtain tax benefit, if a step in or a part of the arrangement has been inserted only to obtain tax benefit, the entire arrangement shall be presumed to obtain tax benefit.
GAAR can be used in addition to or in conjunction with other specified anti-avoidance rules already forming part of the Act. Benefit of the tax treaties would be subject to GAAR applicability.
2. Consequences of GAAR
Consequences of invoking GAAR have been laid down in section 98. Draft guidelines on GAAR have been released on 28th June 2012 giving examples of cases where GAAR is invoked. The speaker opined that there appeared to be no co-relation between the transactions and the consequences that followed. There were no principles laid down in the draft guidelines for reading the transactions and applying the appropriate consequence to it.
Further, the consequences per section 98 are not exhaustive; the Assessing Officers have been given wide powers to take appropriate actions where GAAR gets invoked. This is a dangerous tool in the hands of the officers as there is no saying as to how it will be used.
Lastly, it is not clear as to who will GAAR apply to — would it be limited to the parties carrying out the impermissible arrangement or could it be extended to a person who may be only liable to deduct tax at source?
3. Draft GAAR Guidelines:
Examples The draft guidelines on GAAR have been released for public consultation. The speaker urged all present to actively contribute to the same.
The guidelines would have the same force as the statute to the extent that they are not inconsistent with the statute. The guidelines lay down monetary thresholds for invoking GAAR. GAAR is made effective to income accruing or arising on or after 1st April 2013, which is in sync with international practices. However, there are no grandfathering provisions for existing structures/transactions which may result in income accruing or arising post GAAR becoming applicable.
Key take-away of guidelines:
- GAAR provisions codify substance over form doctrine.
- Onus of proof is on tax authority.
- Special Anti-Avoidance Rules (‘SAAR’) usually override GAAR; exception being abusive behaviour that defeats a SAAR.
- If arrangement is only partly impermissible, GAAR is applicable to the part, not the whole.
The speaker, thereafter, briefly dealt with examples in the guidelines which seek to clarify the applicability of GAAR.
He observed that while the guidelines explained tax evasion and tax planning, they failed to bring out the distinction between tax evasion and tax mitigation, thereby leaving ambiguity for borderline cases. Thus, the guidelines still leave ambiguity on what qualifies as tax avoidance. Further, the examples are not exhaustive in any case and do not address the various peculiar transactions.
With respect to FIIs, the guidelines clarify that GAAR will not be applicable to FIIs if the FII opts not to claim treaty benefits. GAAR would also not extend to non-resident investors in FIIs. However, presently, there is no legal provision for this, but only the guidelines.
While SAAR overrides GAAR, one of the questions left open by the guidelines was whether the limitation of benefit clause in a double tax avoidance treaty would qualify as SAAR? Likewise, while guidelines gave examples demonstrating that treaty shopping is impermissible if without commercial substance, they also opened a Pandora’s Box of unaddressed challenges. Some of these issues were discussed by the learned speaker.
The guidelines have recognised the ‘choice principle’ in some examples, i.e., if a person undertakes a transaction purely as a matter of commercial choice, without the motive of tax evasion, GAAR would not apply. However, the speaker opined, that a number of other examples in the guidelines are inconsistent with this principle.
The guidelines should further clarify the following:
- GAAR is not a revenue earning measure; GAAR deals with abuse. l Respect business decisions and choice principle.
- Notional taxation is not permitted. l Claim of expenses to be evaluated on tax provisions. GAAR covers only artificial claims; not real expenditure.
- Co-relative adjustment: a natural hedge to protect reasonable business choice?
- Citing of a counterfactual (alternative/nonabusive) arrangement by the tax officer should be required.
4. Indirect transfer of assets in India — Section 9
Transfer outside India of shares of a company set up outside India by a non-resident of India to another non-resident have been made taxable in India of the company whose shares are being transferred derives its value substantially from Indian assets.
Meaning of the term ‘deriving value substantially’ used in the statute is not clear. This has thrown up a variety of issues. For example, say, A holds shares of Company X listed on the New York Stock Exchange (‘NYSE’). Company X holds Company Y which is located outside India and has operations in India and China. In this case, would sale of shares of Company X by A on the NYSE attract capital gains tax in India?
Some of the effects, perhaps intended, of these provisions are:
- Merger of a foreign company having operations in India with its sister concern located outside India could now lead to capital gains tax in India for the holding company of the merging entities. Such transactions were till date outside the scope of Indian tax laws.
- Issues with respect to what would be the cost of acquisition and what would be the period of holding of the ‘deemed Indian assets’ in some situations are as yet unanswered.
- Indirect transfers may get treaty protection if the actual asset being transferred is located in a beneficial treaty country.
Reassessment of income for foreign assets
Whether the extended time limit of 16 years for assessees having undisclosed foreign assets would apply to cases of indirect transfer of Indian assets? Likewise, the time limit for reassessment of representative assessees has been extended to 6 years. While ideally, these limits should not apply to indirect transfers; it is difficult to be confident of this under the reigns of the Indian Tax Department.
5. Other provisions
(i) Software payments: The purpose of amendment to section 9(1)(vi) appears to bring into tax net ‘shrinkwrapped software’. However, there is no change in treaty position and hence, if treaty provisions made a transaction non-taxable, it will continue to be not taxable. The amendment will, however, apply to non-treaty and domestic transactions.
(ii) Domestic transfer pricing: While international transfer pricing applies to foreign company holding more than 26% shares of Indian company, domestic transfer pricing may apply to foreign company holding more than 20% shares of Indian company. Disconnect in domestic transfer pricing provision could capture director’s fees, managerial remuneration allocated to Indian PE of a foreign company and paid by the foreign company.
(iii) Taxation of foreign dividends at concessional rate (section 115BBD): This section does not cover deemed dividend u/s.2(22)(e). Further, section 115BBD does not allow deduction of expenses incurred. In many cases, the expenditure incurred, which is disallowed by section 115BBD, may be higher than the benefit offered by the concessional tax rate of section 115BBD. Further, MAT provisions still apply to this income.
(iv) Foreign currency borrowings (section 115A r.w.s. 194LC): If loan agreement is executed prior to 1st July 2012 but monies are actually borrowed after that date, section 115A benefits would apply. While section 115A requires approval of Central Government, External Commercial Borrowing (‘ECB’) is permitted under general FEMA approval and does not require a specific Central Government approval. Clarifications/instructions clarifying this issue may be expected.
(v) Issues arising out of amendments to section 195(7), concessional tax rate on LTCG from sale of unlisted securities by non-residents, requirement of tax residency certificate, section 90(3), annual statement requirement in respect of Liaison Offices were also lightly touched upon.
