Budget 2012: An Overview

Finance Minister Pranab Mukherjee presented the Union Budget, 2012 on the 16th of March, 2012. This post will discuss briefly  the tax aspects of the budget, focussing of course on the direct taxation implications. The delay is regretted. This year’s budget has been attacked by corporates as being anti-investment, promoting uncertainty and doing nothing to assist India’s now not-so-shining economy. Nevertheless, it did have some appreciated measures, which I intend to address first:

1. The Government has shown its benevolent side by relaxing restrictions on External Commercial Borrowings (ECBs) in certain sectors, which most agree are key sectors for reviving the Indian economy, viz. Power, Airlines and Roads & Highways, together constituting a fillip to the otherwise sagging infrastructure sector. These borrowings are otherwise subjected to rather stringent regulations by the RBI. ECB’s are essentially one of the primary sources of forex for Indian businesses and PSUs.

2. This provision moves India towards the much-awaited GST regime. For now, the negative list is being criticised as too broad, harsh, etc. but the fact remains that it does in many ways lead to a more transparent and clear service tax regime, something that most craved earlier. The negative list essentially means that instead of earlier, where a specific service had to be mentioned particularly for it to be taxable, we now have a role-reversal, whereby every single service is taxable unless it finds specific mention as being exempted vide inclusion in the “negative list”. The relevant provision is Section 143 (F) of the Finance Bill and it reads as follows:

(…)66B. There shall be levied a tax (hereinafter referred to as the service tax) at the rate of twelve per cent. on the value of all services, other than those services specified in the negative list, provided or agreed to be provided in the taxable territory by one person to another and collected in such manner as may be prescribed.

3. Apart from the negative list, this Budget has also taken another step in the direction of transparency, with an amendment to Section 139, that mandates who has to file a return of income tax. It now includes residents who have any asset located outside India or signing authority in any account located outside India. This is presumably the Government’s baby steps towards tackling the black money menace. The relevant provision reads as follows:

56. In section 139 of the Income-tax Act, in sub-section (1),—
(a) after the third proviso, the following proviso shall be inserted, namely:— “Provided also that a person, being a resident, who is not required to furnish a return under this sub-section and who during the previous year has any asset (including any financial interest in any entity) located outside India or signing authority in any account located outside India, shall furnish, on or before the due date, a return in respect of his income or loss for the previous year in such form and verified in such manner and setting forth such other particulars as may be prescribed.”

4. There have been significant reforms as far as India’s transfer pricing regime goes. We now have provisions that allow for Advance Pricing Arrangements (APAs), that assessee’s may enter into with the Revenue to ascertain their tax liability for a specific transaction and freeze it, subject of course to caveats pertaining to misrepresentation, fraud, etc. These arrangements shall bind both the Commissioner and the assessee. Section 39 is the relevant provision, that states:

39. After section 92CB of the Income-tax Act, the following sections shall be inserted with effect from the 1st day of July, 2012, namely:—
‘92CC. (1) The Board, with the approval of the Central Government, may enter into an advance
pricing agreement with any person, determining the arm’s length price or specifying the manner in
which arm’s length price is to be determined, in relation to an international transaction to be entered into by that person.

Of equal importance, perhaps, is the introduction of a domestic transfer pricing regime, for a range of “specified domestic transactions”, enumerated in Section 92BA of the Act.

5. The last aspect I shall discuss is that of the removal of the cascading effect of the Dividend Distribution Tax (DDT) levied in Section 115-0. Earlier, complex holding structures were discouraged due to the neccessity of having to pay tax at each stage, a situation modified three years ago by the addition of sub-section (1A) that granted an exemption to subsidiaries. That amendment has been now taken forward, with further deletions in (1A), that now allow holding structures since tax would be payable only on one occasion.

Further, several further amendments to the Income Tax Act, 1961 have been made, most of which are retrospective in nature, and a lot of which seem to aim at overcoming the decision of the Supreme Court of India in the recently decided Vodafone  matter. There has also been the (anticipated) introduction of the General Anti – Avoidance Rule (GAAR) into Indian fiscal jurisprudence, with the addition of a Chapter X-A to the Act. These amendments include:

1. A GAAR, which one thought would arrive only with the DTC, seems to have inserted with the intention of testing its validity (and its validity is indeed sure to be tested before the Courts soon enough). An entire chapter has been added to the Act, with the first of the provisions declaring:

95. Notwithstanding anything contained in the Act, an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement and the consequence in relation to tax arising therefrom may be determined subject to the provisions of this Chapter.
Explanation.—For the removal of doubts, it is hereby declared that the provisions of this Chapter may be applied to any step in, or a part of, the arrangement as they are applicable to the arrangement

It must be noted that the Chapter is set to apply in derogation to all other provisions, and this would technically include Section 90(2) as well, which is the statutory authority under which the State enters into DTAAs with other countries. Resolving this conflict will be a duty soon to be cast upon the Courts.

2. The most shocking amendment to my mind was that of the addition of Explanations to Section 9(1)(vi), dealing with royalty. There had been controversies pertaining to several aspects of royalty, especially as to whether the transfer of copyrighted items (off the shelf software products, books, etc.) could be equated to a transfer of copyright itself. Similar disputes regarding royalties payable by satellite TV providers too had surfaced.  The new amendment pre-empts any further adjudication sans a constitutional challenge to the provision, by declaring retrospectively that:

(…)in clause (vi), after Explanation 3, the following Explanations shall be inserted and shall be deemed to have been inserted with effect from the 1st day of June, 1976, namely:—
‘Explanation 4.—For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred.
Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not—(a) the possession or control of such right, property or information is with the payer; (b) such right, property or information is used directly by the payer; (c) the location of such right, property or information is in India.
Explanation 6.—For the removal of doubts, it is hereby clarified that the expression “process” includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret.

3. The last issue is one I shall address in an independent post, that of the amendments to Section 2 and 9 of the Act. Section 2, the definitions clause, saw sub-sections 2(14) and 2(47) amended, the two dealing with the definitions of “capital asset” and “transfer” respectively. To overcome the SC decision, the term “capital asset” has been amended to include any rights of management and the term “transfer” to include:

Explanation 2: For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed always to have included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company incorporated outside India.”

Section 9 (1)(i) has been modified more severely, with a clear eye on the words of the learned Chief Justice in Vodafone, the amendments stating:

Explanation 4: For the removal of doubts, it is hereby clarified that the expression “through” shall mean and include and shall be deemed to have always meant and included “by means of”, “in consequence of” or “by reason of”.

Explanation 5: For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share of the interest derives, directly or indirectly, its value substantially from the assets located in India.

And so, another budget comes to pass, and the spate of retrospective and purportedly clarificatory amendments continues unabated. The Revenue muscles on, and with the law on its side, continues its usury.

Mr. Soli Dastur provides an interesting take on how, perhaps the retrospective amendments may not have the desired effect on the Vodafone decision – a video of his analysis of the Finance Bill, 2012, is available over here (the analysis starts from 6 minutes 30 seconds).

A copy of the Finance Bill, 2012 itself is accessible over here.

The Explanatory Memorandum may be read over here.

Informative posts with far more erudite analyses on the budget, by  Nishith Desai Associates (NDA) Hotline may be accessed over here (for a corporate perspective), and by V. Niranjan on the Indian Corporate Law Blog may be accessed over here and here (for an erudite, yet detached, academic perspective).

Azadi no more?

Some four score years ago, in the Duke of Westminster’s case (1936) AC 1, Lord Tomlin proclaimed:

Every man is entitled, if he can, to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.

This principle, at the heart of the tax evasion – tax avoidance impasse, can be called the Westminster principle. It, at least as understood by later decisions, allows for individuals and corporations to structure financial arrangements so as to minimise tax liability, as long as these structures are within the four corners of the black letter law. It must be seen in contrast to the modern Ramsay Principle. Laid down in the famous WT Ramsay v. IRC decision of the House of Lords, (1982) AC 300, it is best stated as:

It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions intended to operate as such, it is the series or combination which may be regarded.

This principle can be placed in contradistinction to the one in Westminster, adopting a seemingly purposive construction method to unravel the ‘true nature’ of transactions entered into with the sole intention of avoiding ones legitimate tax liability. The doctrine emerged in light of the increasingly common practice of self-cancelling transactions being entered into that had no real legal effect except to change the apparent nature of a certain loss, gain or appropriation. It was further affirmed in IRC v. Burmah Shell, (1982) STC 30 and in many ways extended in Furniss v. Dawson, (1984) AC 474.

Nevertheless, in later cases such as Macniven v. Westmoreland Investments 2001 UKHL 6 and Craven v. White, [1988] 3 All ER 495, the two seemingly deviant lines of reasoning and judicial approach were reconciled to retain Tomlin’s dictum while providing for a parallel rule of statutory construction to unravel the true nature of a transaction, but only for the purpose of the relevant statute and to assess whether the transaction fell into the category what the statute intended to tax. This position makes for interesting analysis in the context of the principles of statutory interpretation applicable to fiscal statutes, exemplified by Rowlatt J’s famed dictum in Cape Brandy Syndicate [1921] 1 K.B. 64. This must be taken as the meaning of these cases, given their understanding in later decisions and in the Indian context, Justice Srikrishna’s observations in Azadi Bachao. Palkhivala, in his stimulating work, We The Nation, assumes the same position.

In India, tax avoidance has always been a sticky subject, with the recent apex court decision in Azadi Bachao Andolan v. Union of India, 263 ITR 706 providing some respite by clarifying the position. In Azadi, the Revenue was aggrieved by the Delhi High Court decision to quash a circular 789 of the Central Board of Direct Taxes issued on April 13, 2000, that simply reinforced the anomalous situation whereby the Indo-Mauritian DTAA had prescribed that the country of residence was to tax capital gains and since Mauritius did not levy any capital gains tax, companies were investing in India through colourable devices like shell companies, etc. The Court overruled the decision and upheld the validity of the circular, interpreting the previous Constitution Bench decision (he disregarded O Chinappa Reddy’s concurring judgment, labelling it on coherent legal grounds, a far cry from the majority decision of Ranganatha Mishra) in McDowells 154 ITR 148 to hold that in India, the Westminster principle neccessarily operates to prevent judicial unravelling of such anomalous situations. Being squarely on the point of the avoidance-evasion debate, the decision represents a watershed in the Indian jurisprudence on international taxation.

However, the draft Direct Taxes Code, likely to be enacted next year, now includes within it a specific provision that introduces into Indian direct tax jurisprudence for the first time, what is internationally called a General Anti-Avoidance Rule (GAAR). The provision allows Courts to look through superficial companies and transactions, to assess their true nature and impose a tax liability. This would neccessarily imply an overruling of the seminal decisions on the evasion-avoidance debate in both India and England, ie. Westminster and Azadi Bachao. I intend to thoroughly analyse the nature, worth and scope of such a GAAR in a later post, but suffice it to say that the introduction of such a rule will compromise several colourable transactions and structures that have anyway taken a beating post-Vodafone.

A taxing wait

The Indian public in general and the legal and accountancy professions in particular await with bated breath the passage of the Direct Taxes Code, slated for passage in April 2012. The Code brings with it the promise of a sea change in the Indian taxation law regime, with highlights including a new, sweeping General Anti – Avoidance Rule (GAAR) that intends to make tax evasion rules far stricter than before; a higher threshold exemption at Rs. 2 lakh; a marginally reduced rate of corporate taxation, etc.

As far as the GAAR goes, several have said that this would necessarily involve a re-negotiation of several of India’s Double Taxation Avoidance Treaties (DTAAs), as the terms on which such treaties were inked were based on the relatively lax Section 90 of the Income Tax Act, 1961 and its corresponding provisions, which following the decision of the Supreme Court in Azadi Bachao Andolan’s case, made life a lot easier for would-be ‘tax evaders’. Several legal issues will emerge from this move. Watch this space for more.

The flipside of the Code is that it no longer caters to the socialist political agenda of the 1960s and is now aimed at cashing on the growing nouveau riche. Equity Mutual Funds, Term deposits, NSC (National Savings certificates), house loan principal repayment, stamp duty and registration fees on purchase of house property will consequently loose tax benefits. A wealth tax now visits anyone with wealth over Rs. 1 crore. Furthermore, NRIs will now fall into the tax net even if they spend only 60 days in the country, a marked departure from the 182 day rule earlier.

This post is an extremely cursory summary of the DTC provisions, and has not ventured into the murkier depths of Indian fiscal policy, but it can be safely expected that several more posts will follow in this space; on taxation and allied issues in the near future.