Budget 2012: Tax Verdict
By all measure this is a tax negative budget! Industry will bear a higher burden due to the hike in excise & service tax rates from 10 to 12%. A sea-change for the service sector, as all services now come under service tax save a negative list of 17 categories. But all that was, to a large extent, anticipated and hence has not hurt much. What has shocked are a series of retrospective amendments in the finance bill - that hurt M&A and software. Joining CNBC TV18’s Menaka Doshi to deliver the tax verdict are Dinesh Vyas, Senior Tax Counsel, Rohan Shah of ELP and Sudhir Kapadia of EY.
Menaka: Rohan, I will start with what I am calling the “Vodafone jhatka” - that are the changes or the proposed amendments to Sections 2,9 and 195 that have a retrospective effect dating back to 1962. Can you explain to me the substantive changes that these proposals or amendments make to the existing law and how it will impact M&A?
Shah: Since you started with Vodafone, what Vodafone effectively said is under our current charging provisions India couldn’t tax indirect transfers outside of India. So, what the amendments do and they start by saying we are restating the legislative intent because some judgments have not got this right and they do four things. So, one is the definitions are restated, the definition of property, the definition of transfer. Section 9 is now again amended to enable us to tax these transactions i.e.: transfers outside of India, and section 195 is amended to ensure that in relation to such transfers you also effectively pay your withholding taxes upfront. So the whole scheme is now in a way to say that whatever said by Vodafone, in that matter, stands neutralized.
Doshi: And whatever was judged by the Supreme Court (SC) as an argument that won in court now no longer stands?
Shah: Yes, that is true. So SC pointed out a lacuna and this is clearly a provision to meet that lacuna.
Doshi: Not only is it a provision to meet that lacuna, it is a provision that meets that lacuna with retrospective effect from 1962. Mr. Vyas based on precedent, do you think such amendments would stand up in a court of law? For instance if Vodafone or any of the other parties whose transactions would come under this now were to challenge it?
Vyas: The cases can fall in two compartments. One is Vodafone itself and the others are non-Vodafone cases. As far as the Vodafone case is concerned it has a very strong ground. The reason is, what is the justification of all these changes, what is the fundamental feature of the changes - that there was a doubt and that we want to clarify. With respect, there is no doubt, there is no clarification needed after the SC has decided the matter. SC whatever it decides under Article 141 is the law of the land.
Doshi: So are you saying that Vodafone has a strong chance of success if it were to challenge this in court but not the other transacting parties, why is that?
Vyas: This is not for the first time this has happened. In the past, whenever the retrospective amendment was brought in to deal with a SC judgment, that particular SC matter which was decided, was excluded specifically.
Doshi: But it (amendment) was applied to all the other transactions?
Vyas: Absolutely. But here not only it applies to all but also Vodafone and that is on account of the validation clause which is the last.
Doshi: Okay I am going to come to validation clause in a bit. But Sudhir Kapadia - Earlier transactions and future M&A transaction all get impacted now by these proposed amendments if they go through and if the finance bill go through. How many years back can they (Revenue) go to be able to start scrutinizing or reassessing M&A transactions and how will the M&A sector be impacted? One government source says they anticipate revenue from these amendments could amount to Rs 40,000 crore – I am guessing that is ex-Vodafone.
Kapadia: Rs 40,000 crore you can collect through an M&A surcharge, that will be much better! It will make all our lives much easier! But to your question on re-opening transactions, the law allows upto 7 years from the end of the relevant financial year for the tax authorities to reopen.
Doshi: So everything in the last seven years can come back under this scanner?
Kapadia: Absolutely because they will say that we have the powers to reopen, this was the law as it always stood. So they potentially all those transactions can be subject to reopening.
Doshi: A corollary to that question - The DTC (Direct Tax Code) had an asset clause (indirect transfers clause) that was going to impact M&A transactions prospectively. Now if these amendments go through, what happens to that asset clause?
Kapadia: What they have done is they have fast-forwarded that and that too with a retrospective effect. If you go to the standing committee report (Parliamentary Standing Committee) on the DTC, they have very wisely put in some checks and balances on the indirect transfer clause as well. So you have not taken into account those and you have fast-forwarded these with retrospective effect. So the question is indirect transfer in the DTC now has no meaning left because we have brought all those indirect transfers as if this was the law as it always stood from 1962. Just one point if I may take Mr Vyas’ view, in the past when you said retrospective amendment, what I remember is you had capital employed 80J, you had dividends 80M – those were challenged but they were not successful?
Vyas: There was no SC decision.
Vyas: SC’s decision in case of Vodafone makes the difference. On this point about the reopening six years, in this bill there is a provision widening the powers for reopening taking it back to 16 years.
Doshi: But that is only in the case of, as the FM (Finance Minister) put it, checking black money flows and it seems to have to do with assets abroad. So would that same clause be applicable to reassessments under section 9 or section 2 amendments.
Shah: He uses some language saying ‘financial interest abroad’.
Doshi: So you are saying they could potentially open cases going all the way back to 16 years?
Shah: The general perception is 6 years but if you read that clause very carefully, it talks of ‘financial interest’ also.
Vyas: Yes, in entity…which is Vodafone!
Doshi: Mr. Vyas can you explain to me - what is this validation clause, which is item 113 in the finance bill? What is the impact of what they are trying to do with that?
Vyas: The impact as I said is to bring in retrospectively not only the cases which are decided by the SC but also the SC case itself. And in the past whenever SC decision was superseded, it used to be excluded specifically. So this is the change for the first time.
Doshi: So, if this comes into effect that means even Vodafone may not have strong grounds to challenge.
Vyas: Absolutely, intention is exactly the same. The validation clause is to take care of Vodafone case itself.
Doshi: Vodafone has said it has ‘full faith in the Indian judicial system’ in its response to the events of today. And it says we don’t think ‘it should have any impact on the final judgement handed out by the SC in our tax case’ - but I guess we will only know in the days to come. I want to get to the second important point and that is General Anti-Avoidance Rules (GAAR), now we had certain safeguards laid out by the SC or parameters or tests to understand whether a transaction has substance or not. The Parliamentary Standing Committee came back with its report (on DTC) last Friday with its opinion on how GAAR should be applied. But we now have GAAR fast-forwarded in this finance bill. Rohan is this a better version of GAAR, is it a worse version of GAAR than what was anticipated, does it keep the SC and the Parliamentary Standing Committee’s recommendations or parameters in mind?
Shah: I don’t know if we can have a better version on GAAR!
Doshi: Or a milder version?
Shah: Yes, some of the things which are noteworthy here is - ultimately it says we are trying to address this whole form and substance issue. Now SC made this distinction between investment for the purposes of participation and a pre-ordained in transaction - it drew that distinction. This now lays down certain types of transactions where either because of form, the nature of rights, because they think it lacks in substance etc… as transactions that can be more closely scrutinized. And then you go through a process in terms of saying do the GAAR provisions apply or not? The situation which sometimes is worrying and they recognize it - they say one of the criticisms of GAAR is that its scope is too wide. But one of the issues here is firstly this is non-obstante, so in a way, it prevails over all other provisions. The second situation is it talks of a limited treaty override but to the extent that there is a treaty override, the situation is you don’t know how far that is going to go. And non-obstante combined with treaty override… what does it do to section 90 and the various treaties? The other critical issue is the moment they feel that they can initiate a case here, the onus to defend immediately shifts to the assessee. So in a lot of provisions where you begin this sort of an enquiry, the onus before you start the enquiry is at a very high threshold, here once they initiate, the situation is the onus shifts.
Doshi: Your reaction to what they have attempted to do with GAAR in this finance bill?
Vyas: They have gone too wide and as far as the implication is concerned, it will create litigation, the extent of which you cannot even imagine. It is going too far, it is going to apply to almost one and all. Even without GAAR, in reality, on the field we know what the problems are. With GAAR it is going to be worse. Litigation will increase.
Doshi: If I was to try and understand what GAAR meant for my company, if I was running one, what kind of transactions would come under the purview of GAAR, this GAAR that has gone too wide and this GAAR that puts the onus on the assessee?
Kapadia: I think there are two aspects, one is the first question, to say it a bit light heartedly it is almost like the tax department telling businesses that the onus is on you, please demonstrate to us that you have organized your affairs in a manner that you are paying the maximum possible tax. Not the minimal tax, which is payable under the law….. (Interrupted by anchor)
Doshi: This applies to all transactions?
Kapadia: This applies to all transactions, it is not only international or cross border, it is virtually saying that. And I think that is obviously not good for business. The other aspect, I can think of atleast 4 or 5 very healthy recommendations again contained in the Parliamentary Standing Committee Report, which have been ignored completely. To talk about atleast two of them, one is they have clearly stated, the point which Rohan Shah was trying to make, that the onus should be on the revenue. They are the ones who are alleging that we have done something wrong.
Doshi: I think SC says that in the Vodafone judgement as well. So they (Revenue) have ignored several of the safeguards that were put in, so it is a wide GAAR and a harsh GAAR at that. Sorry to interrupt you but I am going to move on to the next point because the next point I want to come to you on is with regards to the retrospective amendment on software which I now understand will tax software as royalty, it will kill all the crazy litigation that has been going on in this space but I am told it is very negative for the software sector, correct?
Kapadia: It is negative because if you see international precedents, if you see the OECD commentary on this, the principle is very simple. What they are saying is in today’s world when you are buying a readymade computer software, it is as good as buying a ‘good’ and it is not buying any ‘rights’. So when you buy a book, you buy a music CD, you buy any productized software, you are basically buying a ‘good’, you are not taking a copyright for exploitation - so it should not be royalty. What you have now done, we as one country in the comity of nations will treat this as royalty and we will deviate from the OECD principles - that is what it means.
Vyas: I would like to make one very important point. An amendment retrospective in nature of this magnitude finds no mention in the speech of the finance bill.
Doshi: Neither of these things got a mention.
Vyas: Leave apart the speech, it does not find mention even in the memorandum explaining the provisions of the bill. This, frankly speaking, is totally in a bad taste.
Doshi: He wanted to surprise you I guess! Rohan a quick question on the kind of software that will get impacted - so if I was to try and understand this as a lay person, is it the Microsofts of the world and the Oracles of the world that will get impacted or the Infosys’ of the world will get impacted as well? Who gets impacted by this?
Shah: If you see the amendments that they have made, they are very wide because they talk of all nature of medium, situations where property is transferred, not transferred, no matter how it is downloaded. But the issue effectively is, is it a copyrighted article vis-à-vis is it a transference of some sort of technology. So the issue is we have deviated completely from that and only through a deeming provision of law. It is our deeming provisions, which recharacterise what the whole world says is a transaction in relation to a copyright in article.
Doshi: I get that - which companies, who will get impacted.
Shah: The way it looks right now, whether you are talking of package or whether you are talking of anything else, as long as they deviate from saying it is not copyrighted article, you are going to have this problem.
Doshi: So if I was to put it this way – anyone from a Microsoft to an Infosys would get impacted?
Shah: Packaged software for sure.
Doshi: Maybe even software development would get impacted.
Shah: Yes. This whole thing on retrospective, the worst part is they may get away with it for the reason that if you see the law on the retrospective amendments, it says that if an amendment directly seeks to overrule SC, it is not sustainable. But if SC pointed out a lacuna and that lacuna is sought to be filled and that means that the judgement is rendered ineffective, that is permissible.
Doshi: Okay. I am going to come to the wrap-up comments and in those wrap-up comments I have questions because there are two-three other key areas that we want to cover - that is the impact of the widening of the service tax net, what happens to DTC now and what kind of burden does this impose on industry at large because excise and service tax rates have also gone up. Service tax negative list, Rohan, what impact is this going to have on service sector?
Shah: Very large impact because constitutionally we should have only been able to tax services. Now we have defined service to say ‘any activity for consideration’. So any commercial transaction can be taxed, save and except what is in the negative list. So to that extent, the one cardinal principle that people should have certainty on tax is lost because they by interpretation can say any nature of commercial transaction, whether or not common-sensically is a service, is now liable to service tax. Which means uncertain tax burdens, multiplicity and duplicity of tax because even if you are charged as goods or as manufacture for a transaction of sale, this tax could come in because it is on any activity for consideration. So again lots of uncertainty and lots of litigation because you have cast the net very wide and literally on a day-to-day basis by interpretation you will evolve the law.
Doshi: Give me an example of a transaction that may not common-sensically qualify as a service but under this will now be taxed.
Shah: If you see their whole concept of what they call declared services, all nature of contracts not to do something… so therefore a non-compete, a right of first refusal, a license, an option… all of that being activities for consideration could come now into the tax net.
Doshi: Moving ahead from just service tax, what impact will all of these fasttrack provisions that he has brought into the finance bill have on both the implementation of DTC and GST, both of which we have no specific timeline on?
Vyas: Frankly speaking as far as DTC is concerned, I doubt whether this government will be able to push it through before 2014 because the purpose is achieved by bringing the GAAR changes, the slab changes and also the taxation of what they call ‘undisclosed assets outside of India’. So the real meat of the matter has gone away. It will take time because the Standing Committee has required them to redraft the law and put it up before the Parliament once again. So it is going to be a long drawn out process. I don’t see it happen.
Doshi: GST is anyone’s guess. Impact on industry which is reeling under a bad year, now the hike in excise, service tax rates and all these controversies that we have discussed.
Kapadia: I would only put it this way that the industry perhaps would not mind the known impacts and the expected impacts because to an extent they were known that they would come. What the industry is reeling under the shock from is the unknown and the surprise impact like the retrospective amendments. So I think it is obviously negative from a business point of view. All the numbers you mentioned in terms of the retrospective amendments, they may reduce the fiscal deficit in the near-term but if they impact business sentiment then the country is a loser.