Untangling the complex web of tax laws

Notwithstanding the NDA’s election promise to end tax terrorism the dynamics on the ground belie easy fixes

The National Democratic Alliance (NDA) government is seeking to prepare a road map to reduce existing tax litigation and look into increasing pecuniary threshold limits to discourage tax departments from launching new cases.

The move follows the constitution of a committee headed by former judge R.V. Easwar to reform tax laws to reduce the potential for disputes caused by ambiguity in the Income Tax Act 1961, and streamline existing complex provisions to increase predictability and certainty (mintne.ws/1k3R1MU).

Notwithstanding the promise to end tax terrorism, which was part of the current government’s election manifesto and clearly a pro-business move, the dynamics on the ground belie easy fixes.

Nevertheless, the kinks in the complicated mesh of tax laws are gradually getting hammered out by the often frustrating legal system.

The tax woes of Vodafone Group Plc.’s Indian arm is a case in point. One company has arguably had it worse than most and has become a shorthand for Indian tax troubles in the process. But in the last year or so, Vodafone has won several important high court decisions (though not for lack of resistance from government lawyers).

On 8 October, the Bombay high court overruled a Rs.8,500 crore transfer pricing order against Vodafone by the Income Tax Appellate Tribunal (ITAT), relating to the 2007 sale of a call centre unit in Ahmedabad that ITAT claimed had been structured to circumvent transfer tax. The full high court judgment exonerating Vodafone has still not been published and whether the government will appeal is not yet known.

DMD Advocates’ senior partner Fereshte D. Sethna, who has been representing Vodafone in this and other tax matters, says subject to the wording of the full judgment and whether there is an appeal, the case would likely be settled and help clarify transfer pricing jurisprudence.

On 10 October 2014, the high court had ruled in Vodafone’s favour in a separate Rs.3,200 crore transfer pricing case relating to its Pune-based outsourcing arm issuing shares to its parent company.

That judgment was a boon to more than 20 other companies facing the income tax department on a similar issue (Royal Dutch Shell Plc. won two transfer-pricing cases worth Rs.18,000 crore in November 2014 on the back of it in the high court).

And then, in January in a long-absent stroke of luck for Vodafone and others, communications minister Ravi Shankar Prasad promised the government would not appeal the judgment in the Supreme Court.

“That was a very important case as well on matters concerning transfer pricing,” comments Sethna. “That has by a stroke of the pen weeded out a significant amount of issue that were otherwise going to languish for some time to come.”

However, the mother of all tax disputes is hard to just forget and a bitter taste will still linger for Vodafone and foreign investors. Vodafone lost its writ petition in the Bombay high court against the tax department’s 2007 show-cause notice.

While the company ultimately prevailed at the Supreme Court in 2012, the then governing United Progressive Alliance quickly turned around and changed the tax law with retrospective effect to ensure Vodafone would be on the hook again for the Rs.20,000 crore tax bill arising out of its $11 billion purchase of Hutchison Essar Ltd in 2007 (bit.ly/1X25yEM).

The government and Vodafone have since been in arbitration, which has shown little signs of accelerating; the government most recently appointed Costa Rican international lawyer Rodrigo Oreamuno as its arbitrator in July after the previous arbitrator, former chief justice of India R.C. Lahoti, recused himself.

Revenue secretary Hasmukh Adhia has said the arbitration would continue according to its own rules and pace, while the retrospective amendment would not be re-examined by the panel.

“The problem with the retrospective amendment is that it’s a legacy issue,” says Anuradha Dutt, senior partner at DMD who also advised Vodafone with Sethna. “You need a lot of guts to say: ‘We are not going to implement the retrospective amendment’. Cairn India (Ltd) is a glaring example.”

DMD is also representing Cairn, which faces a $1.6 billion Indian tax bill—according to Cairn unfairly—for an entirely internal intra-group restructuring. The company has also started international arbitration proceedings with the Indian government.

“There are two ways to look at this problem, whether you look at it positively or pessimistically,” says BMR Legal managing partner Mukesh Butani, who acted for Shell in the earlier Bombay high court matter that benefited from the 2014 Vodafone judgment, and for several other companies facing similar tax troubles. “If you look at it positively, I would say that you are dealing with a leadership which is responsive.”

Other than the appointment of a law commission panel to examine an overhaul of tax laws, Butani particularly lauds the “unprecedented decision” in January not to appeal against the high court order. On the other hand, he added, “a negative way to look at it is there’s very little that’s changed at the ground level”.

“Transformational changes take time,” he says. “These are deep-rooted administrative reforms you’ve got to undertake”, spanning deeper issues such as the use of technology, staffing, training and remuneration evaluation.

Other tax lawyers spoken with broadly agree that the basic structure of the tax office is not necessarily conducive to commerce, with high recovery targets for tax officers sometimes encouraging and rewarding creativity in chasing multinationals.

“They think that multinationals are just sitting ducks and they can do whatever; whatever is their shortfall they can go after the multinationals,” complains one tax lawyer, noting that multinationals have often been less likely to push back. However, it would not be “fair to say that there is an unwarranted level of aggression” from tax officers.

“We find them extremely cognizant of the issues we are facing, and we don’t know at what level decisions on these large assessments get taken,” the lawyer said on condition of anonymity.

At the end of the day, the Indian system simply does not leave much room for dialogue or negotiation with tax officers, unlike many other jurisdictions. The underlying perception that dealings with the bureaucracy in India can be managed off-the-book makes it hard for tax officers to exercise discretion when it could sometimes be more useful than fighting an assessee tooth-and-nail.

Even initiatives such as a dispute resolution panel with high-ranking officers aiming to solve tax disputes before they clog up the judicial system are often ineffective, as few bureaucrats are willing to stick their neck out and take decisions for which they might be questioned later.

Arun Giri, editor of the portal Taxsutra, says many areas of tax laws are also complicated and tax litigation is a natural fallout with the tax department having to ensure that India gets the taxes it is due from multinationals doing business in the country.

“The solution really ought to be the Central Board of Direct Taxes ensuring a lot more consistency from the tax officers by way of circulars and guidance. In fact, of late we are seeing that with increasing frequency. You have thousands of tax officers; if each of them interprets the same Income Tax Act in a different manner, then that’s surely a disservice, and creates avoidable litigation.”

Sethna says he wouldn’t brand the revenue department’s officers “tax terrorists under any circumstances”.

“They’re just doing their job as they must, for the benefit of the exchequer, and there are a host of exceptionally bright officers in our revenue system. One respects their work product in the form of their orders.

Of course we may not agree with them, on occasion, because we believe the law is capable of being interpreted differently, and thus the assessee ultimately has to deal with going through the travails of litigation,” Sethna says.

The travails of litigation, while often being described as a punishment in their own right, also give rise to the feeling that the courts are slowly but surely untangling the tax mess despite the large values attached to some of the tax claims.

“Big numbers are not going to deter the judiciary, that’s what’s important,” muses Dutt. “There’s a signal to foreign investors, there is a vision of law, a consistency, and the judiciary is not going to be scared of the numbers. “That’s something very positive.”

What’s less positive, as in most facets of the judicial system, is the mountain of tax cases that are piling up.

“If you look at amounts locked up in litigation, these sums are growing and growing,” says Butani. “The other struggle is that disposals for appeals are not picking up.”

The numbers

As of December 2011, an estimated 65,998 income tax appeals worth Rs.1.84 trillion were pending at tax appellate tribunals, high courts and the Supreme Court, according to data supplied to the Lok Sabha by the then junior finance minister S.S. Palanimanickam.

According to finance minister Arun Jaitley, that number in 2015 stood at 77,448 cases involving Rs.1.87 trillion at dispute. (see table)

As of November 2012, an additional 76,652 indirect tax appeals at tribunal, high court or apex court level were pending. They involved a combined amount of Rs.95,734 crore.

The rates of success of the government in tax litigation and appeals have been abysmally low: between 2008 and 2012, the government lost more than 80% of indirect tax tribunal cases, according to finance ministry data disclosed to the Lok Sabha in 2012 (bit.ly/1Mx6rjG).

At the next stage, the high court, the government’s success rate in indirect tax cases was slightly better; it won between 28% and 35% of cases, but this nosedived at the final stage, the Supreme Court level, to a success rate of only between 5.5% and 10.6%.

In other words, the government would lose as many as nearly 19 out of 20 indirect tax appeals at the Supreme Court, which is a good indication that many of these legal challenges should never have been filed in the first place.

The grassroots of tax terrorism, systemic and deeply-entrenched, can only be stamp out with bold reform and action to effect change. The latest steps by the government in that direction are the right ones.

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