Budget 2014 should bring clarity on transfer pricing, retrospective amendments and tax targets

As the new government gets to work, one key item on the agenda would be the revival of growth. The key to that objective is the revival of the investment climate in India for renewed flow of overseas investments.

One aspect that has vitiated the investment climate is the tax regime and this needs to be addressed immediately if we have to provide confidence to investors about India. Over the last three years, several things have shaken up investors. One, we have rampant transfer-pricing disputes in India.

Issues ranging from markup to be charged by captives to marketing intangibles have become all pervasive. An estimate suggests that 70% of all transfer-pricing disputes globally are in India. This in a country that accounts for less than 2% of global trade.

Taxing Front Page

We have had a retrospective amendment clarifying a position in law after it has been interpreted by the Supreme Court. This caught global attention. We have had a global transaction held up because tax issues have held up the issue of a no-objection certificate for transfer of India assets. Both are now likely to be in international arbitration. Tax demands make it to the front pages of newspapers everyday.

Precedent shows that most demands get knocked off in appeals. Yet, there are issues relating to account payments, coercive recovery measures and so on. Tax administration is viewed as being adversarial and the trust necessary between the administration and taxpayers has broken down. We have mounting tax arrears and delays in disposal of tax appeals. This result is loss of revenue for the government, and frustration amongst assessees.

Rethink Gaar

There is no clarity on tax policy. The position on the Mauritius tax treaty is ambivalent. The way forward on general anti-avoidance rule (Gaar) is blurred and fraught with uncertainties. We are on the brink of a Direct Taxes Code (DTC): is this legislation necessary or are we heading for more uncertainty? The important goods and services tax (GST) has been held up and is awaiting implementation.

Finally, we have a parallel economy and this issue of Indian money overseas, which erodes the tax base and is absent from all GDP computations. Here is what the government should do. First, we need to send out a strong signal that India respects the rule of law.

The retrospective amendments on overseas transfers should be made prospective. This will inspire confidence that the government means business. Similarly, we need to reconsider the retrospective amendments taxing royalties and the like.

In the new government’s first Budget, we need to see some important changes: we need mandatory timelines for disposal of appeals or rectifications; we need a time-bound, more pervasive advance rulings mechanism that works and is effective; and we need to empower the government to settle tax disputes and evolve a framework around that. These three measures provide certainty to the taxpaying community and provide a framework for resolution of disputed tax matters.

We need to push back the implementation of Gaar. There is a need for a greater debate on the subject, prescription of rules and evolution of a framework that is acceptable to all. Over the next two years, once a relationship based on trust is effective, Gaar can find a place on the statute.

Overambitious Targets

We need a performance evaluation mechanism for officials. High-pitched assessments that get repeatedly knocked off in appeals need to have negative markings. Accountability of bureaucracy is imperative. Forcing a tax official to achieve artificially high revenue collection targets fixed by the Central Board of Direct Taxes, by making high-pitched assessments, cannot be the basis of tax administration.

For foreign investments to flow in, we need a clear policy on interpretation of tax treaties and a stand on the India-Mauritius tax treaty. We do not need to give sops. What we need is a clearly-spelt-out stand so that we do not have gaps between stated policy and implementation. Finally, while we continue to pursue the exchange of information with Switzerland, we need to consider entering into a treaty of the type entered into by the UK where account holder who does not agree to names being provided to the government of India would suffer a tax on the accumulated balance and on ongoing income.

Indeed, if the estimates of the large amount of money abroad are true, we will have robust tax collections to show. GST must be passed once Centrestate relationships are set. The implementation and working on these suggestions will set the stage for a conducive tax environment.

It will enhance collections and, if at all there is a loss of tax collections on some of the aspects, the economic impetus and enhanced credibility of the government will more than make up for the loss. I am waiting with bated breath to see how the new government will solve the tax conundrum.