Some of the recent high profile tax disputes in India have fetched considerable attention from investors across the world. One of these has been the Vodafone-Hutch tax issue. The case pertains to Vodafone acquiring majority stake in mobile phone operator Hutchison Essar in 2007.
It is being opined that the various loopholes and numerous uncertainties surrounding tax laws in India led to the adverse judgment in the case. Many investors consider that it was amid lack of clarity and of specific provisions in the tax laws to cover tax issues in the fast growing global business transactions that Vodafone was held not liable to pay Rs 11,218 crore in taxes.
In the judgment, the SC held that the offshore transaction was a bona-fide “structured FDI investment into India which fell outside India’s territorial tax jurisdiction, hence not taxable”. The judgment created an immediate impression on the multi-national companies that they could enter into shell or layered structure of takeovers to gain advantage of vague Indian tax laws. The apex court verdict in this case also prompted the think-tanks of the Finance Ministry to amend the Finance Act. They were also forced to consider introducing anti-avoidance provisions rules in the tax laws as part of the Direct Tax Code (DTC).
The setback in the Vodafone case also alerted revenue authorities to closely monitor the transaction of Nokia-Microsoft deal and put a stake in the big ticket worth of around Rs 6000 crore tax default. The Nokia case is similar to the layered structural transaction. Herein, Nokia-India has been avoiding the tax to be paid on the royalities passed on to its parent company – – Nokia Finland. However, this transaction is slightly different from the Vodafone issue wherein — if the deal is studied closely and thoroughly — it can be inferred as taxing be made on the capital gain by the Vodafone. In the case of Nokia, on the other hand, it is the transfer of technology from one company to another.
The vagueness that surrounds the tax laws is not just limited to income tax but extends itself to service tax as well. The Service Tax Voluntary Compliance Encouragement Scheme, 2013 (VCES,2013), as brought by the Finance Act, 2013, , for instance, has put numerous service industry workers wondering whether it was introduced for their benefit or as a punishment for voluntarily declaring their taxes.
In its detailed guidelines (under chapter VI of the Finance Act, 2013) outlined by theMinistry, the defaulter of service tax opting for the scheme will have to deposit at least half the pending dues by December 2013 and the remaining amount by June 30, 2014 without interest. The guidelines specify that full and final payment will have to made by December 31, 2014 with interest from July 1, 2014 on the remaining amount.
The profusion of seemingly irresolvable tax rows is now deterring foreign groups from investing in India. I feel bad saying this as a citizen, but I am party to several discussions involving foreign companies who say that, if we have a choice, we will expand outside India, because there is no certainty over tax.”
The VCES Scheme was announced under the Finance Act, 2013 with a view to encourage compliance by those registered (as well as unregistered) service providers. In his Budget Speech before Parliament, Finance Minister P. Chidambaram had categorically stated that there are a vast number of assesses who have registered but are not filing returns (non-filers are as much as 85% or above of the registered assesses). The above-mentioned schemerequired the defaulters / non-filers to make a declaration before 31.12.2013 in the prescribed form and give a true disclosure of the ST liability covering a specified period.
The declaration is in respect of the taxes due for the period specified. Both the declaration and the payment of taxes are covered in Section 107 of the Finance Act. Section 107(3) specifies that not less than 50 % of taxes due as per the declaration shall be paid on or before 31.12.2013. The balance payment of the taxes due is covered in Section 107(4) and the proviso below Section 107(4).
The proviso also stated that in the event the declarant fails to pay the taxes due, the same shall be paid by 31.12.2014 along with interest as prescribed. On a combined reading of 107(3) and 107(4) and the proviso it appears that the full payment can be made by 31.03.2014 even though 50% payment by 31.03.2014 is not made. This ambiguity has opened the gates for litigation in various high courts by members of the service sector.
The Vodafone case involved the acquisition by Netherlands-based Vodafone International Holdings BV (and controlled by Vodafone UK) of shares and controlling interest of CGP Investments Holdings Limited from Hutchinson Telecommunications International Ltd. It clearly included the transaction of the acquisition by the Vodafone of the shares of the holding company of Hutch but one which was located offshore.
In such a scenario, the issue before the apex court was whether the Indian tax authorities have the jurisdiction to claim tax under the then existing tax provisions. This was for the capital gain on the transaction between two foreign entities i.e. non-resident Indian entities. Even though the transaction pertained to the sale of the business of Hutch in India, it was structured to show only transfer of shares between the two foreign companies.
In such transactions, however, there is no provision in the existing taxation laws which can “go through” the transactionrather than just watching it. It may not be out of place to mention here that Section 5(6) of the proposed DTC can usher in a change. It specifically provides the imposition of capital gains tax on the overseas acquisition if the acquired company holds over 50 per cent assets in India.
The Nokia case, on the other hand, is slightly different from the Vodafone case. In fact, it differs as much as that we can say Nokia is sheer unlucky for not being able to escape the demands of the tax department. It is a royalty dispute.
The present taxation is equipped suitably with the provision of Section 115A of the Income-tax Act, 1961. It stipulates that an Indian resident is required to deduct 10% tax from royalty payments to a foreign company. Based on this, India had liberalized the royalty paying rules in 2010. Since then royalty payments by Indian companies has been considerably increased. However, revenue from such royalty payments has been always a major concern.
In the Nokia case, the Indian tax authority was not required to establish the local business connection in order to tax the foreign entity. Since no import of goods was involved, it was the import of mere technology. Hence, the royalty paid to import the technology, which in turn is being used to manufacture the marketable product, is taxable regardless of the residence or location of the company from where the technology is passed on to the Indian entity. In the era of advance technology, one wonders if such a tax provision for import of technology is really tenable.
However, this taxation method is based on the universally accepted UN model of taxation.
While the Vodafone case was initiated in 2007, the apex court interpreted the provision of tax laws after a lapse of 5 years. This prompted the Indian government to amend the laws retrospectively.
This retrospective amendment in turn has again triggered a series of litigation between Vodafone and the IT department.
The action by the government has also created uncertainty and apprehension in the minds of the investors. To meet their concerns, the government had appointed the committee to review the retrospective amendments. However, there is no clarity on the report of the committee till now. Even though the Indian tax laws and provisions are in line with most of international tax countries, their implementation has been a major struggle and not in tune with the best international tax practices.
No clarity on fiscal laws, including the taxation and retrospective amendments in the taxation, will certainly shake the confidence of the foreign investors in the regulatory framework of India. Added to the retrospective taxation, the authorities bombarded the Vodafone with another issue of tax demand of around Rs 37,000 crore on transfer pricing. The transfer pricing disputes and ambiguity of interpretation of double taxation treaties will certainly put the country on the bottom of preference list of investors.
The biggest issue before the nation now is “credibility”, i.e. credibility of regulatory framework. The country regularly announces policies and objectives but their flawed implementation and execution steer foreign investors away. On one hand, the issue of Vodafone or retrospective taxation signals to the world that India is not a taxhaven or low-tax country, on the other it gives enormous power to the tax authority to determine which overseas investment should be taxed, thus undermining the confidence in other investment policies.
Not only India, many developed nations too face the manipulative skills and often get carried away with the non-clarity tax provisions. This became the public outrage over the MNCs not paying tax, but, it is the common man who bears the social expenditure cost.
The Summit of the G20 leaders mandated the world’s most influential tax-rules setting body, “Organisation for Economic Co-operation and Development (OECD)” toprovide a roadmap to address these issues. OECD published 15-point action plan on “Addressing Base Erosion and Profit Shifting” (BEPS). BEPS mainly refers to the “tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low resulting in little or no overall corporate tax being paid”.
Let us hope that new government which comes into power later this month will deal with these issues keeping in mind the interest of both the investors and common public. The concerns demand that they be dealt with on priority basis and with full attention so that the long outstanding concern to promote India’s image globally as investor-friendly country is resolved.
It is beyond doubt that the new government is required to promote and encourage foreign investment in India. The common sentiment now prevailing globally that India is anti-MNCs and a difficult place to do business — evident from the sharp dip in foreign investments at present — needs to be dispelled to encourage investors from across the world.
Various factors might have contributed towards the slowdown in investments, but the major issue always centres around the hefty demand by taxing authority on the companies like Vodafone, Nokia, Siemensetc on issues ranging from capital gains, royalties and transfer pricing. Specifically, this happens in the retrospective taxation to open the cases back from 1962. Therefore, the new government will have to rack its brains on gaining higher tax revenue without disturbing the business climate in India, along with full cooperation of the MNCs.
“Top global companies including Vodafone, Nokia, IbM and royal Dutch Shell Plc are facing increasing scrutiny from Indian tax authorities as the government seeks to boost revenue at a time when economic growth has slowed down. the aggressive tax collection may, however, deter foreign investments that are critical for the country to boost economic growth and cover the nation’s large current account gap. to be frank, India’s lingering tax disputes with foreign investors will only further tarnish its image as an attractive business destination and increase uncertainity among existing foreign investors in Asia’s third-largest economy.”
Whatever the case may be, the sooner one arrives at a good and structured tax legal framework, the well understood and received it is by MNCs globally and in turn more investments are likely to be expected. The abrupt actions taken by the tax authorities until now signaled to the global investors the lack of trust between tax payers and the administration.
This trust can be rebuilt with a more communicative and compliance approach by the administration.
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