Better Late Than Never: Shome Committee bats for certainty in tax laws

In Depth

Better Late Than Never: Shome Committee bats for certainty in tax laws

Aseem Chawla | November 2012

The tax proposals for the year 2012, introducing proposals with the ostensible intent to mitigate tax evasion and some having retrospective tax application, India came across as an Investor unfriendly nation even for the most intrepid overseas investors.

The scheme of General Anti Avoidance Rules (‘GAAR’), which provided wide discretionary power to tax authorities resulting in excessive tax and compliance burden on the taxpayer and the retrospective amendments on taxation of indirect transfers, did become a subject of intense debate and hugely criticised.

Considering the importance of favourable investment climate and all round criticism of tax proposals, the govt. soon after deferred implementation of GAAR was by one year.

THE SHOME COMMITTEE

The government of India constituted an expert committee under the chairmanship of Dr. Parthasarathi Shome, noted economist to undertake consultations and suggestions from stakeholders and general public on the first draft guidelines for GAAR. The committee after considering suggestions from various stakeholders issued second draft guidelines for GAAR.

The draft report submitted by Shome committee has suggested deferring the implementation of GAAR by a period of three years on the administrative ground, as it would require trained tax officers. The tax officers would be required to have specific knowledge since GAAR requiresdeterrence of avoidance arrangement rather than revenue generation.

Further, the committee in its draft report has emphasised on “investment approach” by suggesting abolishment of tax on gains arising from transfer of listed securities and tax on business income of foreign investors in India. In order to make good of tax loss, the committee has also recommended increasing the rate of security transaction tax.

THE RECOMMENDATIONS

It recommended that the tax officer would be required to give a detailed reasoning before invoking GAAR, as such the onus of proving shall be on tax authorities.

As initially spelled, the provisions of GAAR envisaged provision of wide discretion andauthority to tax authorities, as such it has been constantly feared that it might result in tax exploitation.

In order to avoid ambiguity and uncertainty, the committee has further recommended that until the tax is abolished, as mentioned in the above paragraph, in case a Tax Residency Certificate is issued by the government of Mauritius, GAAR provisions shall not apply to examine the genuineness of the residency of an entity set up in Mauritius.

Similarly, where the treaty itself has anti avoidance provisions, for instance under Indo – Singapore tax treaty, the treaty provisions ought not to be substituted by GAAR provisions under the treaty override provisions.

It was also felt that tax avoidance should be distinguished from tax mitigation. An exhaustive negative list for the purposes of GAAR should also be specified.

INTRODUCTION OF A NEGATIVE LIST, NOT EXHAUSTIVE, WHICH INCLUDES :

Amalgamations and demergers (as defined in the Act) as approved by the High Court.
Intra-group transactions (i.e. transactions between associated persons or enterprises) which may result in tax benefit to oneperson but overall tax revenue is not affected either by actual loss of revenue or deferral of revenue.
Selection of one option out of two or more options offered by law should not be considered to be tax avoidance. For instance: – payment of dividend or buy back of shares by a company, – setting up of a branch or subsidiary, – setting up of a business unit in SEZ or any other place, – funding through debt or equity, and – purchase or lease of a capital.
Timing of a transaction, for instance, sale of property in loss while having profit in other transactions. To bring more clarity and fairness, the committee in its report has recommended that the investment made by residents or non-residents, which are existing as on the date of commencement of GAAR, should not be brought under the scrutiny of GAAR provisions.

OTHER SALIENT RECOMMENDATIONS

Monetary threshold of Rs. 3 crores (equivalent to USD 5,00,000 approximately) of tax benefit to check the applicability of GAAR provisions.
GAAR to cover only those arrangements, which have the main purpose of obtaining tax benefit and not those whose main objective is to obtain tax benefit.
An arrangement lacking “commercial substance” shall be deemed to include arrangement not having significant business risks or net cash flows apart from tax benefit.
In order to ensure high level of independence, the approving panel for the purposes of GAAR should have 5 members including chairman. The Chairman should be a retired judge of the High Court, two members from outside government and persons of eminence from the fields of accountancy, economics or business, two chief commissioner of income tax.
As per the existing legislated provisionsof GAAR under Finance Act, 2012, whilst determining the commercial substance of an arrangement following factors are considered irrelevant:

Time period of existence of an arrangement,
Fact of payment of taxes, directly or indirectly, under the arrangement,
Fact that an exit route is provided by the arrangement.

The committee has recommended that these tests should not be discarded as totally irrelevant and may be considered in addition to the other aspects while evaluating the commercial substance of an arrangement.

GAAR provisions would not be invoked while processing application for lower tax deduction at source where the taxpayer gives an undertaking to pay taxes in case it is found that GAAR provisions are applicable in relation to remittance during the course of assessment proceedings.

Apart from the above, the committee has also recommended that tax avoidance schemes to be considered for reporting purposes as more likely than not as impermissible avoidance arrangement and be reported in the voluntary tax filing done by the taxpayer.

By and large, the Industry and all the stakeholders have hailed the recommendations of the Shome Committee as a welcome relief.

The Shome Committee has suggested that amendments made to source rule should have prospective application and not retrospective. Retrospective amendments, which widen the tax base, would lead to apprehensions about the certainty, predictability and stability of tax laws in India and should occur in exceptional or rarest of rare cases.

The committee further suggested that an amendment should have retrospective application when it has the effect of correcting apparent mistakes/anomalies in the statue, or it is genuinely clarificatory in nature or for protecting the tax base from highly abusive tax planning schemeshaving main purpose of avoiding tax.

The amendments made to section 9 of the Income Tax Act, 1961 (’Act’) are not “genuinely clarificatory” in nature and should not accordingly be applied retrospectively. In case such amendments are retained, interest for default / delay in payment of tax deducted at source or interest payment in terms of section 234A/B/C of the Act should not be levied. Also, no penalty for concealment of income or failure to deduct to tax should be levied.

The committee also recommended that in a scenario where amendments are applied retrospectively in relation to indirect transfers, liability to pay tax should be in the hands of the person making capital gains.

CONCLUSION

The Shome Committee recommendations have given a much needed interim respite. It acts like a beacon, which paves the way for the government to ensure course correction, lest the positive vibes have a momentary impact. In the coming days, the resolve of government to achieve this balancing act would be put to test. Till such time, let us hope the positive vibes do not get outlived.