Restore sanctity of I-T Act, scrap double-taxation avoidance pacts

“A government that robs Peter to pay Paul, can always count on the support of Paul”– George Bernard Shaw.

Well, the UPA government certainly did a Peter to multinational companies operating in India by hiking withholding taxes from 10% to a good 25% in the 2013 budget. Who is the Paul that has benefited is still a mystery, given the virtually empty coffers that the Narendra Modi-led government inherited this year.

Speaking of MNCs, ‘transfer pricing’, is at the heart of most controversies that a Vodafone, Shell, Nokia, Samsung and Microsoft have found themselves in, within the Indian context.

Transfer pricing is the value at which companies trade products, services or assets between units across borders, which is a regular way of doing business for an MNC.

However, what is not regular is the fact that very often, what is passed off as routine ‘tax planning’ by some MNCs is more akin to ‘tax chori’. Again, to compound matters, welfare states like India have in some cases been accused of ‘tax terrorism’ and bullying MNCs to cough up seemingly unfair tax pay-outs. Thus continues a raging cross continental global debate; the more recent example being the $11.2 billion Vodafone-Hutch deal.

To my mind, however, there was never any ‘debate’ to start with, and this is why.

Vodafone’s contention that the deal involved sale of shares of a company not domiciled in India but out of Cayman Islands and hence it not being liable to pay the said Indian taxes, has been outright ignorance of the Indian Income Tax Act of 1961 or absolute disrespect for the same or worse still, a mix of both on the part of Vodafone.

For taxation, what is relevant is the place from which or the source from which the profits or gains have generated or have accrued or arisen to the seller, irrespective of the domicile nature of the seller, (Hutch in this case). Undoubtedly, the source of profits in this case has been India and primarily the Indian operations of Hutch, which Vodafone bought out, by buying a controlling stake in the target company, HEL, Hutchison Essar Ltd.

The transaction pertained to Hutch’s Indian business and that is material; not the fact that the transaction was routed via one of Hutch’s Cayman Islands’ based entities, with which India has a DTAA, Double Taxation Avoidance Agreement. But the moot point here is that if indeed it is all so crystal clear, then why is the whole deal still entangled in a legal quagmire? The culprit here is the DTAA agreement between India and Cayman Islands.

India today, has DTAAs with more than 60 countries. While the benefits of DTAAs are debatable, what is not debatable is the fact that these agreements are the source of unwanted confusion and stress for the administrative machinery, entailing obscene litigation related expenses; are inequitable by their very territorial and discriminatory nature as they give undue preference to some countries over many others for no viable logic; and in tax parlance, what is inequitable can never be fair.

Foreign capital requires a facilitative and transparent environment but an agreement like the DTAA is neither about ‘tax concessions’, nor about ‘tax morality’, simply because, it is technically unsound to start with, as it does not even address basic issues like who is a ‘beneficial owner’ or under what specific circumstances, a contracting party is put to a ‘tax dis-advantage’.

When DTAA guidelines themselves are so flimsy, how can countries like India that enter into such agreements ever stand to benefit from them, not to mention the added reputational damage that comes with the ‘package’?

This budget should therefore restore the diluted sanctity if any, of the Income Tax Act of 1961, which categorically states that rules governing non-residents with respect to income received, deemed to be received, income accrued or arisen or deemed to be accrued or arisen, apply to foreign companies operating in India too.

If this entails scrapping one sided agreements like the DTAA in a phased time-bound manner, so be it; even if this means introducing incremental legislative changes that will resolve with greater clarity, complex ‘transfer pricing’ related issues, by limiting the scope for subjective interpretation.

For GAAR, Anti Avoidance Rules (Gaar), to be meaningfully effective from the proposed date in April 2016, DTAA has to go by then. Most foreign investors who would otherwise be taxed under Gaar, will get immunity under DTAA through various existing tax loopholes and there are simply too many to be plugged.

True, this will be a dramatically radical step; however, radicalism in some sense is the clarion call of the hour; more so when it is believed that the losses to the Indian exchequer through tax evasion from tax havens like Mauritius alone tantamount to a staggering $55 billion, which is more than Rs 3 crore; enough to largely wipe out the subsidy burden on fuel, food, power and fertilisers that gobble up a shameful 3% of GDP and more.