India’s tax regime needs to be prudent

The Hindu Business Line, June 12, 2015

By Pradeep S Mehta
The Finance Minister must ensure that, by simplifying laws to make the country attractive for investors of all hues

After pulling out significant funds from the economy during the last few months, foreign institutional investors finally turned into net buyers in the beginning of June 2015, and the trend is expected to continue.

During the first week of June, net inflows of around Rs. 1,600 crore were recorded. There are lessons for India in this, which should guide us to get rid of the ‘tax terrorist’ label.

This would not have been possible without the damage control act initiated by Finance Minister Arun Jaitley. The way he handled the issues ranging from retrospective levy of minimum alternate tax (MAT), complication in tax return forms, and such similar faux pas is worth applauding.

However, all these efforts were made after initial damage was done. Jaitley must make a quick transition from being reactive to pro-active, to prevent such occurrences in future.

This would shield the economy from any unforeseen shocks and avoid the taxation regime from being labelled as uncertain.

To understand the gravity of matter, let’s stocktake the damage done on account of late or insufficient reactions of the government on tax related matters

Retrospective MAT

Not so long ago, Indian revenue authorities slapped around Rs. 602.83 crore demand notices in 68 cases of overseas funds to pay MAT for past years on the ‘capital gains’ made by them in Indian markets. This resulted in steep withdrawal of funds by foreign portfolio investors, from Rs. 33,688 crore at the beginning of the year to Rs. 15,266 crore in April.

The applicability of MAT to foreign companies which do not have a ‘place of business’ in India, and not required to maintain books of accounts in India, has long been debated.

In the case of non-residents without permanent establishment (PE), the courts have traditionally held that the MAT is not applicable on them. But a ruling from the Authority of Advance Ruling (AAR) in the case of Castleton Investment Ltd reversed this trend in 2012.

After representations from various foreign investor’s groups, the Finance Act, 2015, amended the MAT provisions to exclude any income accruing or arising to a foreign company by way of capital gains on securities, interest, royalty or fee for technical services (FTS) from the ambit of MAT.

But these provisions were made effective from April 2015, giving space to the Indian revenue taxing FPIs on the income accrued or earned up to March 2015, i.e. retrospectively, despite repeated assurances from Jaitley against such levies. The government quickly offered relief by exempting FIIs from countries with tax treaties with India.

However, uncertainty continues with respect to taxability of funds coming from countries such as the US, the UK and Luxembourg which do not offer such treaty benefits.

To settle the issue, the government constituted a high-level committee, headed by Justice AP Shah to examine the matters relating to levy of MAT on FIIs.

Such uncertain regulatory governance and belated efforts have the potential to dent India’s image as an investment destination.

Foreign investors would perceive that despite several assurances and promises by the government, tax remains the most vulnerable subject, impeding investment inflows in India.

Transfer pricing tussle

The uncertainty around tax issues is not limited to MAT. Another is linked to the transfer pricing scrimmage between the Indian revenue and multi-nationals.

Transfer pricing is the practice of pricing for transactions between related entities based in different jurisdictions, in a manner that the transactions would have entered amongst unrelated parties, to ensure a fair price.

Recent experience suggests that a large number of transfer pricing disputes are hurting India. Dispute resolution on transfer pricing adjustments including determination of mark-up has been a major area of discomfort amongst multi-nationals doing business in India.

While initiating reforms in transfer pricing, the government announced measures such as advance pricing agreements (APAs) with larger number of multi-nationals and a ‘roll back’ provision in APAs, but gaps remain.

For instance, the regulations require making comparisons with nine comparables to determine the relevant price. This may be difficult in all cases. Also, there is no guidance on selection of comparables. This could create uncertainty and increase disputes.

While the government was successful in getting the GST Constitutional Amendment Bill passed in the Lower House of Parliament, with no consensus in sight and the government facing a number crunch in the Upper House, the Bill was referred to a select committee.

Even after seeing the light of the day, the proposed tax would be effective only if it allows the markets to function smoothly, and enable the economy to grow. At present, there are significant obstacles that could act as roadblocks to the proposed tax and could lessen its effectiveness.

The way to go

These include unnecessary exemptions, possibility of high GST rate, additional 1 per cent, origin- based levy, and trust deficit between States and the centre. These issues must be quickly and pro-actively settled for good, without resorting to temporary quick-fixes.

It is important to build an integrated and seamless national market that on its own can add at least couple of digits to the country’s growth rate. This will require the implementation of the National Competition Policy (NCP) and Article 307 of the Constitution that calls for an inter-state trade and commerce commission. We have repeatedly stressed the need to both adopt the NCP and constitute the Commission, wherein the above issues could be discussed.

In nutshell, tax regime needs to be simplified for attracting rest of the world to invest in India and also make it easier for our own investors.

The Union Budget makes some efforts by slashing corporate tax rates and royalty, but much more needs to be done. India must send out the message that its tax regime is rationale and prudent.

If Jaitley is unsuccessful in quickly addressing these issues in a proactive manner, he may end up upholding the long recognised idiom: only things certain in life are death and taxes.

Putting it simply, during one’s life, one can be assured of paying taxes, and at the end of life, one can be assured of being dead!

The writer is secretary general of CUTS International. With inputs from Jitin Asudani

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