The dynamic nature of Indian tax laws witnessed in recent years would easily mark an inflection point for multinationals doing business in India, given th resolve and pledge to overhaul tax regime by ushering the twin new legislations of Direct taxes Code (DTC) expected to be made effective from April 2012 and Goods & Services Tax (GST). Whilst, the DTC would replace the five decade old law, GST is anticipated to bring a fundamental shift in taxation of trade of goods and services. With several veratax policy changes slated to occur in less than 12 months headquarters of , multinationals are scrambling with a robust strategy for transition to the new tax regimes. The last mile in the transition process could well be more stressful for MNCs with India’s promise to G20 towards International Financial reporting Standards (IFRS) convergence.
DTC – a paradigm shift and challenge
The purported objective of the new legislation is to simplify taxation of income and provide enhanced certainty to taxpayers by minimizing tax disputes. Yet, a close look into the fine-print of the DTC reveals that the new legislation is far from a simplified tax Cod in the opinion of experts. Proposals to introduce certain anti-avoidance measures into DTC, which hitherto are partly enshrined in judicial doctrines only, would only blur the fine lines dissecting legitimate tax planning from tax avoidance.
Some of the anti-avoidance legislation that the new law would usher in are – General Anti-avoidance Rules (“GAAR”); Controlled Foreign Corporation (“CFC”) rules; Treaty override; and ‘Place of effective management’ test for residence of multinationals in India. One can not dispute the noble intent underlying the introduction of anti-avoidance measures, yet in the Indian context the relevance and preparedness for such internationally accepted rules can be argued. For instance, GAAR proposal envisages tax administrations power to declare an arrangement entailing a mere ‘tax benefit’ as ‘impermissible avoidance arrangement’ if the Revenue alleges that the arrangement lacks commercial substance, or results in abuse of provisions of the DTC. The onus to prove that the arrangement does not result into ‘abuse’ of provisions of DTC is on the taxpayer, and not on the Revenue. By invoking GAAR in such instance, the Revenue may re-characterize the nature of arrangement and re-allocate the income accruals amongst parties involved in such arrangement.
Anti-avoidance rules – Pandora’s box!
Clearly, the ‘subjective’ fundamentals of Indian GAAR are not in line with the international best practices; for instance, Canadian GAAR envisages that for GAAR to be invoked, a transactionmust entail a ‘tax benefit’ and must result in ‘misuse’ or ‘abuse’ of the Code. The onus to prove that a transaction resulted into abuse of laws is on the Canadian Revenue. Indian GAAR to this extent is diametrically opposite, as the burden to disprove ‘abuse’ of the tax code rests with the taxpayer. India choose to adopt the South African model, which in my view is a recipe for litigation.
Towards broader alignment with internationally accepted practice, DTC proposes to shift the basis for determining the residential status (of foreign companies) from the test of ‘control and management ’ to ‘Place of effective management’ (POEM). POEM test suggests that a foreign company shall become resident if the POEM is situated in India at any time during the year. POEM is defined as a place where – a) the board of directors of the company or its executive directors take decisions; or b) place where the board routinely approve the commercial and strategic decisions made by the executive directors and, the place where such executive directors or officers of the company perform their functions
POEM test under the DTC is fraught with ambiguities; for one, it is not clear whether one split board meeting could constitute a POEM. Further, POEM test is at varience to OECD test which emphasizes upon key ‘management and commercial decisions’ necessary for the conduct of the business as a whole. The divergence from OECD definition, to this extent, broadens the contours of POEM test which could well turn out to be nightmare for MNC’s, having regional offices or place of management in India. Besides, it would discourage MNC’s to set up regional base in India.
Skeptic in me would believe a subjective anti avoidance legislation followed by a subordinate legislation giving discretion to the tax administration will have multinationals gasping for breath.
DTC will also introduce a limited Treaty override rule; simply defined, the ‘Treaty override’ rule shall come into effect in cases where the GAAR has been invoked, or the CFC law is applicable to Indian resident companies for taxing passive income of overseas subsidiary.
Whereas, I am not opposed to anti- avoidance law aligned to international best practices, however, these noble pieces of impending legislation may blur the thin line of difference between tax avoidance and tax planning. The result could well add to taxpayers’ woes in the form of prolonged disputes with the Revenue, and thus beat the fundamental edifice of the Government’s tax reform agenda.
Preparedness is the key
Looking at some of the unique provisions enshrined in the new legislation, I have no hesitation in believing that transition to DTC would be a herculean task in itself. The transition could spell gigantic task with impeding GST roll out and IFRS convergence beckoning within the same timeframe.
To me, the key lies in adequate preparadness and robust subordinate legislation.. The transitionr equires attitudinal shift on taxpayers’ part as much as for the Revenue. From the Revenue’s standpoint, it would be critical to walk that extra mile in allaying unfounded fears and skepticism borne out of transition pain, lest the tax reform agenda of the Government is given a thumb-down by taxpayers.
I am hopeful that the tax administration is gradually gearing up to the reality of new legislation, and would soon come out with sound implementation guidelines /subordinated legislations, allowing adequate time to get set for the new era.
The author is Partner, BMR Legal and was assisted by Sumit Singhania. Views are entirely personal
