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Budget 2014: Fixing Tax Litigation

Published on Tue, Jul 01,2014 | 22:00, Updated at Wed, Jul 02 at 18:25Source : 

By: Rajan Vora, Tax Partner - EY

India has been viewed as a preferred jurisdiction by foreign investors because of its rapidly growing economy and the Government of India’s (GOI) decision to allow foreign direct investments in various sectors.

Before investing in any venture, every investor would like to understand its cost structure and return on investment. In India, tax being as high as 40% on the profits earned from business, it is one of the important factor for the investor to consider before setting up a business in India.

After considering all the factors, once the investor decides to invest in India, if the GOI, subsequently, decides to change the tax laws with retrospective effect to bring transactions which were initially not chargeable to tax into the tax net, it would not only affect the sentiments of existing investors, its cost of doing business in India and also affect potential investments.    

Investors who decide to invest in India would be interested not only in doing business in India but also enhancing investments in India. At present, the biggest road block for the investment community is the litigation process for tax matters in India. Excessive litigation in India is mainly because various issues that are raised by Tax Authorities and also because of the number of years it takes for a matter to attain finality.

Some of the investors, who opted for getting advanced ruling, were also shocked on account of delays in the Ruling as well as extreme views taken by Authority for Advanced Ruling.

At present, on a conservative side, if any issue goes in litigation, till it gets resolved at the Supreme Court of India (SC), it takes a minimum of 12-15years. The impact of the same would be that the tax amount in dispute gets blocked.
Additionally, the cost of litigation in terms of money as well as efforts and money, is also very high due to the enormous efforts required to be put in to support an investor’s case.

Most investors, may not have factored in, all costs before investing in India. This leaves the investor community discouraged, which, in the long term, is detrimental to the development of the country.

A major setback to the investor community was due to the Finance Act, 2012, particularly  the various retrospective amendments made by the GOI to the Income Tax Act, 1961 (ITA), which were on the following issues:

Amendments pertaining to international taxation

  • Retrospective amendments (applicable from 1976) were made to the ITA to treat tax payments towards shrink-wrapped software, connectivity charges, transponder hire charges etc., as “royalty”. This implied that the transfer of all or any right to use computer software, including licensing, would be treated as “royalty”, irrespective of the transfer medium.
  • Another retrospective amendment (applicable from 1976) was made to the definition of “royalty” to include any consideration with respect to right/property/information, irrespective of whether the recipient controls or uses it, or, whether it is located in or outside India.
  • The definition of the term “process” was also broadened to include transmission by satellite, cable, optic fibre and so on.
  • Retrospective amendments (applicable from 1961) were also made to the ITA to include indirect transfers within the ambit of taxation.  

Amendments pertaining to transfer pricing

  • Retrospective amendments were also made to transfer pricing laws to widen the definition of the term “international transaction”, to bring into its ambit, transactions in connection with tangible/intangible property, capital financing activities etc.

The rationale behind these amendments was said to be, to clarify and or to reiterate the legislative intent of the source rule of taxation for non-residents in India. It was strongly felt that some of these amendments were made to overrule the SCs decision in the case of Vodafone International Holdings BV.

Most investors had not factored in the cost of taxes which are levied by the Income Tax Authority.  To add to this is the cost of litigation to protect against the tax demand raised by the Income Tax Authority; Also, if the dispute is decided in favour of the investor by the Courts (including SC), tribunals etc., the retrospective amendments are made to the ITA to overrule the these decision. Such events that affected the interests and confidence, of investors in the Indian market, due to negative message sent to the overall investor community across the world.   

Such amendments directly impact Indian consumers for the reason that, now, whenever any Indian company enters into a transaction with a foreign company, a tax protection clause is inserted into the agreement. This results in the transfer of tax costs to Indian companies, which, in turn, results in additional costs for the ultimate Indian consumer.
Furthermore, the pendency of several cases in litigation on transfer pricing issues, such as adjustment on account of marketing intangible, corporate guarantee, investments in foreign subsidiary, advancement of loan to associated enterprises, payment of royalty etc. and add to it, due to retrospective amendments, has created considerable uncertainty in the minds of investors, as to whether they should continue their investments in India. Under such circumstances, investors seek opportunities to move to more tax-friendly and stable jurisdictions.

In the case of Nokia India, due to undue litigation in India, a tax demand of INR 21,000 crores was raised on the taxpayer as withholding tax on royalty payment made to the parent company, where the transaction of payment of royalty had taken place eight years ago.   This undue litigation has stalled the process of sale of Nokia India’s business to Microsoft, as the Delhi High Court has ordered the India unit of Nokia to be kept out of the ambit of the global transaction of sale of Nokia’s business to Microsoft.

This scenario of prolonged litigation and undue harassment to taxpayers by the Income Tax Authority is having a negative impact on existing and potential investors.  

However, in the General Elections 2014 that concluded recently, one single party received a clear mandate, which is viewed as a new dawn for India. Provision of a favourable tax regime and overhauling the dispute resolution mechanisms are priorities of the new Government, on the basis of which India Inc. is hoping for increased transparency from the Income Tax Authority.  In view of the same, Budget 2014 has to be seen as an expectation budget, not only for the investor community, but also for MNCs in India.

(Views expressed are personal)


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