MUMBAI: The unbridled freedom and powers given to tax authorities in this year’s Budget could spark a furious face-off in the coming months between companies determined to protect their profits in a slowing economy and an equally resolute tax department eager to wrest every last bit of revenue, experts warn.
Last Friday’s Union Budget, which increased taxes and gave almost limitless powers to the tax department to check evasion and increase tax collection, has been widely criticised for its excessive focus on increasing revenue and ignoring the damaging aftereffects, higher litigation and messy court room battles.
Tax officials, once the Budget is passed, will have powers to check all transactions between companies and its subsidiaries, affiliates, investors and foreign partners for tax eligibility. The result, experts warn, will be a sharp increase in costs, compliance and litigation.
“It is a back door entry to anarchy,” rued Daksha Baxi, executive director at Khaitan & Co, a law firm that represents many business conglomerates in India. “The tax department can now open all deals that have happened in the past six years. Why a buyer should be penalised because you (government) were not sure. There are so many transactions,” she added.
Some Budget proposals will empower tax officials to revive tax demands on marquee deals of the past six years, routine transactions such as purchase of computer software and inter-corporate transactions for purchase of raw materials within business houses. It will ignite a sprawl of litigation as taxmen draw up conclusions to earn additional tax revenue that corporates will naturally challenge at various legal forums made available to them.
Under the new amendments proposed in the Budget, the assessing officer will now be armed with powers to question the value of inter-group transactions, but the fear is that it could be done in an arbitrary manner, mostly at the discretion of the assessing officer.
An immediate result of the new law is that the companies are now bound to maintain proper documentation in support of the transaction value they claim in their returns. In short, there will be an increase in compliance burden.
“The reason for this provision is understandable, but this will increase the compliance and administrative burden of the tax payer as well as the tax authorities,” said Samir Gandhi, partner, Deloitte.
With the extension of transfer pricing norms, all domestic transactions between related resident parties for computation of income, would come under the taxman’s lens. “While earlier transactions between an Indian parent and an international subsidiary were probed for transfer pricing, this is the first time that domestic deals between related parties of a conglomerate will also be added,” said the CFO of one of India’s largest companies.
The income tax department, in its eternal quest to increase collections, had recently included corporate guarantees issued by an Indian parent to a foreign subsidiary and advertising for an overseas unit, as part of transfer pricing.
“Most of the sales in such transactions are done at arms length. If the income tax department has reasons to believe that the pricing was not at market value, it can examine the transaction under transfer pricing,” said Sunirmal Talukdar, a former CFO at Hindalco Industries.
Typically, transfer pricing refers to the amount used when accounting for transfer of goods or services from one company to another in the same business group. Corporate guarantees have so far not been included in TP calculations. Companies had also liberally made use of them, especially when buying a large asset or a company overseas. Another contentious proposal is the amendment of transfer pricing rules to now include domestic transactions that exceeds .`5 crore. This will make it difficult for companies to explain expenditure incurred between related parties.
The companies would also find it difficult to transfer the group profits to subsidiaries having units in areas specified for tax holidays or tax-exempted locations like SEZs.
The amendment would also enable Transfer Pricing Officers to examine the inflated income posted by group companies having facilities in tax-exempted zones. The amendment empowers the Transfer Pricing Officer (TPO) to look into the transactions between related parties and ask for supporting documents that can substantiate claims of expenditure.
“Hypothetically speaking, under the new transfer pricing regulations, the assessing officer can question why marketing or train-ing expenses have not been taken into account while calculating the profits from an SEZ. The same can apply to expense related to, say the CEO or CFO salary,” said N Venkatraman, CFO, Sonata Software.
Nasscom president Som Mittal said while the advance pricing agreement will help in reducing litigation, including domestic transactions within the ambit of transfer, pricing would increase complexity even if IT companies were doing transactions at arm’s length. Multinational IT firms, which were primarily affected by transfer pricing in cross-border transactions, would now have to take into account pricing of transactions between two or more domestic arms – if they operate through multiple entities in the country. Contrary to perceptions, not only foreign direct investments, but Indian companies in all such transactions will be impacted.
For example, in the Birla AT&T case, the Birlas got approval for nil withholding tax from the income tax department to effect the transaction to purchase AT&T’s shares. Indian Rayon, on behalf of the Aditya Birla Group, applied to the tax authorities for obtaining a certificate to determine the withholding tax for making remittance of $150 million to AT&T Mauritius. The tax authorities issued a nil withholding certificate to Indian Rayon and the Birla Group company made the remittance to AT&T Mauritius on the basis of the certificate.
Now with the proposal to amend cases for six assessment years, this telecom case can come under the tax lens. “What will happen to all such Indian companies,” asked Sudhir Kapadia, tax head at Ernst & Young. “Not only is that transaction taxable, the government now implies that the Indian company should have known about the tax liability six years ago.”
This will give rise to broader commercial and legal issues on the unexpected discharge of tax. “The foreign company might have changed hands and it will be difficult for the Indian company to pursue the matter,” Kapadia added.Some of the other deals that may be dusted and picked up for taxation include transactions that defined trends in India Inc in the past six years including that between Foster and SAB Miller (2011), GEGenpact (2011) and Sanofi-Medicare (2011).
There are also companies which have got favourable rulings from the AAR. The status of such cases is uncertain. Vedanta’s buyout of 51% of Mitsui in Sesa Goa is another transaction that would be ripe for re-interpretation by the tax authorities, by virtue of the new budget proposal.
In 2008, Vedanta Resources paid $981 million to buy a controlling 51% stake in Mitsui’s Sesa Goa. Today it is one of the cash cows for the London-listed resources giant which recently made Sesa Goa the vehicle for creating a grandiose mining monolith. “That (deal) seems very expensive now,” said a senior official close to the mining major. “Because a retrospective charge could create a high tax outgo while the Budget’s other proposal to levy a cess on oil explorers, would affect Cairn India, where Sesa owns a 20% stake.
In his budget speech, finance minister Pranab Mukherjee suggested the “need to provide retrospective amendment to restate the legislative intent” for certain sections of the Income Tax Act. The government’s focus was on transactions relating to sale of capital assets situated in India, after having lost about .`11,000 crore in tax revenue in the sale of Hutchison Essar to Vodafone. The closely-fought legal batter culminated after the Supreme Court ruled that the government had no jurisdiction to tax the share sale.
Within two months of the order that was touted globally as one of the finest examples of the rule of law inIndia, the Budget proposal has dashed all hopes. The Finance Bill seeks to amend the Income Tax Act with retrospective effect from 1962 (the Income Tax Act was formed in April 1961).
“You cannot change the rules of the game midway,” said Dinesh KaInnabar, KPMG deputy CEO and one of the key persons who advised on the Vodafone matter. “Unlike China, India prides on a good functioning judiciary. But you cannot amend a law retrospectively to create a new charge,” he added. If this was not enough there are other contentious proposals in the Budget that make corporates see red.
The proposal to retrospectively amend royalty from 1976 will bring many Indian companies to cough up tax on past purchase of computer software to manage their businesses.
The Budget proposes that the purchase of software would not be seen as purchase of goods and services but royalty. A lot of companies would have made payment for software. How will they implement the proposal, wonders a tax practitioner. “Will they only catch the big fish?” asked Baxi who is agitated by the sweeping move to make some laws retrospective.
In that case, it would be unfair on them, she added. “This is a kind of sweeping law that comes from a country that is worse than a banana republic,” Baxi rued.
Another Budget proposal emboldening tax authorities is the power to interpret corporate restructuring when companies or subsidiaries merge to create new entities. “The tax authorities will assume it (mergers) is done for tax purposes.
“Why will they (businessmen) open all our cards. These are business strategies that they cannot put in the open domain as competition can use it to their benefit,” the official affiliated to a leading business said.
“There is a level to how much you mistrust your population. This is certainly not democracy,” Baxi said.
If you drive a car, I’ll tax the street, If you try to sit, I’ll tax your seat. If you get too cold I’ll tax the heat, If you take a walk, I’ll tax your feet. India Inc must be hoping that the Beatles George Harrison’s words in 1966 do not come true.