How India’s finance minister aims to use his forthcoming Budget to position India as an attractive investment destination

By: Hitesh Sharma, Tax Partner & National Leader, Ernst & Young, India

With the annual Budget around the corner, India’s Finance Minister Palaniappan Chidambaram has announced that the primary objective will be to re-instill the confidence of all stakeholders, have a stable tax regime and find fair and reasonable solutions to pending and likely disputes. Taxpayers are once again hoping the Finance Minister will take concrete steps to address issues surrounding international taxation.

With a large number of retrospective and contentious amendments in Budget 2012, there is a widespread expectation that Budget 2013 will seek to rationalize some of those amendments as well.

As readers may recall, the Indian tax authorities had sought to levy tax on Vodafone for failure to withhold tax on alleged capital gains in the hands of Hutch on the sale of shares of the Cayman Island company that ultimately held shares in Hutch India. Vodafone had contested this position and the Supreme Court vide its judgment reported in 341 ITR 1, had ruled in its favor. Immediately thereafter, in Budget 2012, a retrospective amendment was brought in to tax indirect transfers deriving “substantial value” from India.

As widely debated and suggested, such an amendment should only be made prospective and a clear definition of what would constitute “substantial value” should be given. In any case, penalties and interest should be waived in situations where transactions are completed prior to the date of introduction of the amendment.

A similar recommendation was made by an expert committee set up by the Government of India on provisions relating to indirect transfers. It is suggested that committee recommendations should be followed to provide a fair and reasonable basis of taxation.

Treaty relief: in search of clarity

After the Supreme Court judgment in the case of Azadi Bachao Andolan (263 ITR 706), it is a settled principle that a tax residency certificate (TRC) should entitle a taxpayer to claim treaty relief. However, there have been cases where the tax authorities seek to deny treaty benefit despite a valid TRC.

There may be arguments to deny treaty relief in some circumstances (for example, where there is actual or alleged tax evasion or where the powers can be drawn from specific legislation such as the upcoming General Anti-Avoidance Rules). In other cases, it is essential that tax treaties signed between two sovereign countries are respected by the tax authorities.

Amendments in Budget 2012 require that the TRC is issued by tax authorities of other countries in a prescribed format. It may not be possible for every country to follow norms unilaterally issued by India, which could result in denial of treaty benefits.

This is likely to cause hardships to taxpayers. It is expected that the amended TRC be made optional or, at minimum, should be made applicable only to specified jurisdictions.

Transfer pricing: easing the burden

On the transfer pricing (TP) front, the Government of India should issue safe harbor guidelines and benchmarks soon – this should help a number of taxpayers who are faced with a huge TP adjustments burden. In July 2012, the Government set up an expert committee to provide recommendations on possible mechanisms to bring certainty on

TP margins and models for specific industries, including IT and R&D. The Government should accelerate the process of submission and consideration of the committee recommendations. This would be a welcome move to limit ongoing disputes with tax authorities on TP.

Another welcome step taken by the tax authorities has been to introduce the much-needed alternative to the time-consuming dispute mechanism, i.e., Advance Pricing agreements (APAs). However, current guidelines do not provide for the rollback of APAs, i.e., applicability to past open litigation and abeyance of ongoing TP proceedings until the conclusion of an APA, to reduce duplication of effort of tax authorities and taxpayers. This should be considered by the Government.

Currently, cases selected for TP assessment are solely based on the quantum of international transactions, i.e., where the value exceeds INR150m (approximately US$3m), which may not be an ideal basis. The criteria for the selection of cases should also include qualitative factors. Further, the monetary threshold for selection needs revision as it was set five years ago.

Upping accountability

On a more general note, the tax administrative functions should look at bringing in a higher level of accountability and introducing measures that curtail making unjustified adjustments to income by lower level tax authorities while framing assessments.

It is anticipated that all the recent activities and statements by the Finance Minster to showcase India as an attractive investment jurisdiction will be realized in the form of fair and stable provisions in the Budget. Specifically, it is hoped that the trend of nullifying court rulings by amending legislation and bringing in retrospective amendments should be significantly curtailed.

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