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Old Goals, New Year: Budget 2016 Expectations

Published on Mon, Jan 11,2016 | 22:29, Updated at Mon, Jan 11 at 22:29Source : 

By: CA Ritu Shaktawat and Advocate Aditi Mukundan

A certain, fair and stable tax regime has long been on the wish-list of tax administrators and taxpayers world over. With each passing year, as the announcement of the Union Budget draws near, tax controversies faced in India, both new and old, are critically analysed and efforts are made to enact changes to the Income Tax Act, 1961 (Act) that would make it more beneficial for the administrator and the taxpayer alike. Below are a few important considerations – substantial as well as procedural changes that could assist in attaining that much desired beneficial tax regime.

Indirect transfers of Indian assets – Devil in the details

While the prior amendments (effected through the Finance Act, 2015) to Section 9 of the Act clarifying the rules to tax (indirect) transfers of Indian assets among non-residents are  welcome, there still exist some intrinsic issues that foreign M&A players face while (indirectly) dealing with Indian assets. Presently, the Act contains objective tests and thresholds to ascertain whether Indian assets contribute ‘substantial value’ to the foreign target company whose shares are being transferred. However, such tests are best-suited for transactions wherein the foreign target company is an investment holding company or a special purpose vehicle and not an operating company. Specific reference can be made to the usage of the term ‘assets’ in the provision which causes much speculation on the application of the provision to tax transfers in cases where the companies are operating entities which derive their value or revenue from not any particular asset but from the business as a whole (more so in case of the services sector). Applying the ‘assets’ focused test to such entities may result in satisfaction of the ‘substantial value’ test where the Indian ‘assets’ owned by the target directly or indirectly are ‘substantial’ in value in comparison to the total ‘assets’ owned by the foreign target company despite the fact that Indian assets may be contributing far lesser value to the business of the foreign target company. Furthermore, no particular valuation method has been prescribed for the purposes of this provision. It comes as no surprise that, uncertain implications of Indian capital gains taxation destabilizes investor confidence and adversely impacts the M&A world.

Withholding tax worries – Here to stay?

A recent, noticeable trend in M&A deals, across the board, regardless of the industry, parties to the transaction or the quantum of the deal, is the time spent in negotiating the tax clauses and commensurate indemnity provisions. Withholding tax woes haunt the buyer as well as the seller in light of certain in-principle issues. For instance, at the time of the sale / purchase of the asset, if the Act allows the seller to benefit from a lower tax rate under a double tax avoidance treaty, and the buyer on the basis of a fair and reasonable assessment believes that the seller is entitled to avail such benefits, the buyer should be allowed some leeway for such a ‘good faith’ determination. This is particularly important when the only other recourse to the buyer is a not-so-conclusive nil withholding certificate granted by the tax authorities who may vary their assessment subsequently resulting in the buyer being treated as an ‘assessee in default’. Seemingly, the buyer is left with no alternative but to litigate the tax demand in order to successfully recover the tax amount.

It is critical to remedy this situation by adopting a two-pronged approach by being cognizant of the buyer’s acts of complying with legal obligation of procuring the seller’s tax residency certificate etc. as well as grant a withholding certificate in a timely manner if the parties have made such a request. Furthermore, while the tax authorities under law may change their position at the time of detailed assessment, due regard should be given to the withholding certificate issued in order to dissuade adopting inconsistent approaches to tax transactions when all the relevant facts were considered at that time. This will greatly facilitate the smooth completion of M&A deals that boost investor confidence and India’s positioning as a jurisdiction offering ease of doing business.  

Warming up to the new tax rule - POEM

Recently the Central Board of Direct Taxes (CBDT) has issued the guidelines (as was specified in the Memorandum to the Finance Bill, 2015) to determine the Place of Effective Management (POEM) of a company. The guidelines seek to clarify the new rule of tax residence introduced in the Act for companies. Presently, the CBDT has invited comments from the public on the same. It is important for the tax authorities to ensure the fair administration of the new rule and specify key strategies on how they intend to implement the rule. The success of scaling-up Indian businesses by allowing them to set up subsidiaries abroad hinges on equitable and transparent implementation of aforesaid rule.

Access to advance rulings

It is never enough to reiterate the need to ensure substantial as well as procedural fairness in a tax regime. The advance rulings mechanism which allows non-residents to understand the Indian tax ramifications and provides certainty has of late lost its effectiveness because of the pendency of matters thereby causing a long wait for obtaining a ruling. . Thus, scaling up the number of benches that pronounce such rulings and catalysing the process shall go a long way in ensuring the very objective of establishing such a mechanism is achieved in its entirety.

Catching up with the digital economy

India being one of the largest consumer markets, its tax regime must keep up with the evolving business models. The challenges faced by world over due to the growing scale of e-commerce must be carefully discussed at a larger policy level to ensure that the tax measures are in tune with established and recognised international principles. Any high level committee report that studies the models of business, objective of the parties involved and the revenue generated as a result of engaging in the e-commerce space is welcome.

Identifying tax controversies

In cases where several similarly situated tax payers are embroiled in tax litigations on an issue of law, it is beneficial for the tax administration to refer the dispute to a committee or team of highly qualified and experienced individuals familiar with the issue in order to resolve the same at a policy level. This measure, not only allows taxpayers to comprehend the legislative intention behind tax provisions but also enables a lesser adversarial regime by clarifying tax policy and thereby reducing litigation.

On the whole, it is essential to accept that the primary goal of the Indian tax regime must be to ensure a stable and certain tax regime rather than adopt a short term approach of bolstering revenue collection. One hopes that the Finance Act, 2016 shall inch towards the ideal and robust tax regime.
This column is sourced from the year end series of Bombay Chartered Accountants' Society

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