This year’s Budget presentation on March 16 has acquired added significance because less than two months ago, the Supreme Court (SC) delivered a landmark ruling in the Vodafone case, which was not in favour of the government. The key issue then was whether investors based outside India can use offshore holding companies to avoid paying taxes in India. The government argued such transactions are subject to tax, but the SC ruled otherwise. The tax fraternity and the investor community that awaited the SC’s verdict with bated breath back then, are again equally anxious, to see if March 16 would see a government reaction to the Vodafone case verdict.
Further, with the Direct Taxes Code Bill (DTC Bill) unlikely to take effect from the scheduled date of April 1, 2012, it will be all the more interesting to know what is in store in the upcoming Budget to tackle Vodafone-like situations. For instance, would it be a specific introduction of provisions that propose to tax Vodafone-like transactions? Or, will the government introduce the General Anti-Avoidance Rules (GAAR) in the existing Income-Tax Act, 1961 (the Act)?
Interestingly, even the SC has emphasised the need for the express provisions in the taxing law to achieve the government’s objective of collecting corporate taxes.
At the outset, if past finance bills are any indication, it cannot be ruled out that the finance ministry may seek to widen the ambit of the charging provisions of the Act, given that the SC held that the present provisions of Section 9 read with Section 5 do not permit “looking through” overseas transactions similar to Vodafone’s.
The SC also held that the scope of Section 9 is restricted to direct transfer of capital assets situated in India and does not cover indirect transfer of overseas assets deriving their value from underlying assets situated in India. In such an event, it would be interesting to see if this amendment would come as an amendment to the charging provisions themselves, or as a clarification by way of an explanation of the charging provisions.
Another hotly debated issue is whether such an amendment would be made effective prospectively or retrospectively.
The SC, by majority, also held in the Vodafone case that the withholding tax provisions under Section 195 do not apply to non-residents not having a presence in India. Again, it is possible that government, with a view to cast the net wide, may use the finance bill to try and bring either all non-residents within the ambit of Section 195 or those non-residents that have a tax presence in India.
Interestingly, with a view to tax Vodafone-like transactions, the government had already inserted specific provisions in the charging provisions of the DTC Bill, whereby overseas companies deriving 50% or more value from underlying assets in India, would be liable to income tax in India in respect of transfer of shares of the intermediate overseas holding company. The present form of the DTC Bill was introduced in 2010 — that is, long before the SC ruling in the Vodafone case. With the final verdict now out, this provision is likely to find its way into the Budget proposals.
Also, one would not be surprised if the government introduces GAAR provisions in the existing tax law as this issue is very important to the government. The GAAR provisions in the DTC Bill are extremely wide in coverage, giving sweeping powers to the tax authorities in handling cases of tax avoidance and tax evasion. It presumes all transactions are designed for tax avoidance unless proven otherwise by the taxpayer. The said provisions give unfettered powers to the tax authorities to consider any transaction or a part of it as impermissible and disregard the same for income tax purposes.
Introduction of the said GAAR provisions in their current form could lead to a lot of uncertainty and anxiety amongst the taxpayer and investor community. It would be a positive move, however, if the government first assesses the need to introduce the GAAR provisions at this stage. For, internationally, such provisions have been debated and discussed amongst the stakeholders much in detail before their introduction.
While drafting the Budget proposals, the finance ministry will need to be mindful of the reactions of various stakeholders, particularly domestic and international investors and the industry at large. It is critical to ensure that the investor community continues to have faith and confidence in the Indian judiciary. At the same time, the government should be able to achieve the economic objective of tax collections.
The government would, thus, have to do a fine balancing act, considering the implications of the Vodafone ruling and the overall investor sentiment. As the SC has itself pointed out in the Vodafone ruling, foreign direct investment inflows are important to India and if India were to continue as a desired investment destination, it would be necessary to assure the investors about certainty on tax and legal fronts.
— The writer is executive director — tax and regulatory services, PwC India. His colleague Amit G Jain contributed to this article. Views expressed here are personal