The long-awaited simplification of the Indian income-tax law has been triggered by the finance minister’s introduction of the Direct Taxes Code. The Code is to come into force from April 1, 2010, to aim at unifying all Indian direct taxes, and establishing an economically efficient, effective and equitable direct tax system that facilitates voluntary compliance and minimises litigation.
To provide certainty of tax liability with regard to international transactions, the finance ministry has introduced the concept of Advance Pricing Arrangement (APA). APA decisions will be valid up to five consecutive years and will be binding on the taxpayer as well as the revenue authorities. APAs will not be binding in case of changes in law/facts that form the basis on which the APA was initially concluded. Detailed procedures relating to the application process, etc., are yet to be formulated.
Recent introduction of Safe Harbour rules and Dispute Resolution Panel coupled with the proposed APA regime are welcome moves to achieve certainty for taxpayers.
As an additional anti-avoidance measure, the Code has introduced the concept of ‘Impermissible avoidance arrangements’ which would serve as a deterrent against tax base erosion. Impermissible avoidance arrangements are arrangements where the main purpose of the arrangement is to obtain tax benefits and to create rights/obligations not created between people dealing at arm’s length. Such arrangements may be scrutinised with a view to disregard its “form” and consider the underlying “substance” of the arrangement for taxation. As part of such anti-avoidance measures, certain debt transactions may also be re-characterised as equity in a manner akin to Thin Capitalisation regulations.
Establishment of economic and commercial substance and robust documentation will be necessary to reduce the likelihood of application of such anti-avoidance measures.
The Code, inter alia, seeks to widen the criteria for enterprises to be considered as associated enterprises by reducing the threshold shareholding norm. For instance, the shareholding relationship amongst enterprises has been reduced from 26 per cent to 10 per cent. This would widen the base for transfer pricing compliance.
The proposed threshold of 10 per cent seems too low for defining “control”. It may be prudent to take cognizance of international tax practices while finalising the Code.
Further, the Code proposes a risk management strategy (not to be revealed to the taxpayer or to the general public) that would be framed by the revenue for selection of cases for scrutiny. This risk-based strategy will replace the current value-based assessment process.
Also, to support a strong deterrence programme in a moderate tax regime, penalties on non-conformance are sought to be equalised by this Code. This will result in reduction of the penalty incidence. For instance, in case of failure to maintain documentation, the penalty has been reduced to a maximum of Rs 2 lakh from a penalty of 2 per cent of the transaction value. The upper limit of income adjustment penalty range has reduced from 300 per cent to 200 per cent of tax on adjustment.
Implementation of the above changes will mark the maturity of the transfer pricing regime in India. Amendments like introduction of APAs, Dispute Resolution Panel and rationalisation of penalties are sure signs of an equitable transfer pricing regime. These measures would meet the desired results if discretionary powers under the anti-avoidance measures are substituted with objective guidelines to the revenue.
Also assisted by Shuchi Ray, senior manager, PricewaterhouseCoopers
(Views presented herein are personal and do not necessarily reflect those of the firm)
