Tax systems are fundamental to society. Stability, certainty and consistency in application of tax laws are cornerstones of a sound tax policy. A simpler tax system contributes to economic growth; complexity in tax systems distorts the economy, diverting energies into non-productive administration and litigation.

Tax systems are fundamental to society. Stability, certainty and consistency in application of tax laws are cornerstones of a sound tax policy. A simpler tax system contributes to economic growth; complexity in tax systems distorts the economy, diverting energies into non-productive administration and litigation.

India’s image as an aggressive tax jurisdiction peaked after the 2012 Budget, when the government responded with a retrospective change in tax law to undo the Supreme Court ruling in the case of Vodafone. In one stroke, it eroded global confidence in fairness of governance in India. Investment began to dry up between 2012 and 2014, caused at least partly by these tax developments.

The new government in 2014, promised to end ‘tax terrorism’ and provide certainty in tax policy to boost investment. Since then, the government & the CBDT have made a sincere attempt to revive India’s image as a tax-certain jurisdiction. In the context of capital markets, clarity on tax issues of FPIs, PE funds and domestic VC Funds have contributed towards fostering a positive business climate. Renegotiation of some of India’s popular tax treaties as well as grandfathering of existing investments under GAAR demonstrates the government’s decisiveness and commitment to bring changes in tax policy that help reduce uncertainty.

One disruptive event during this period has been the controversy relating to MAT on FPIs, which seemed to send a signal to global investors that India had once again moved the goalpost. The government, however, intervened swiftly and contained the damage through administrative/legislative action.

A similar situation has now arisen with the issuance of circular No 41 by CBDT, on December 21, on indirect transfer provisions to FPIs and other foreign funds. Like MAT, this is also a case of conflict between the letter of the law and its perceived intent.

FPIs are liable to tax when they transfer Indian securities and there should not be double taxation when the FPI upstreams cash to investors either directly or via feeder funds through redemptions/buy backs. The circular provided straight-jacketed answers to various questions and confirmed that double or even multiple taxation is a possibility. Ironically, the circular penalised funds that commit a significant portion of their capital to India as compared to those that don’t. Besides, it put at risk the taxation of historical transactions, where investors may have long exited.

Basically, the circular threatened to undo the good work done by the CBDT and the government over the past two years. As expected, the issuance of the circular evoked strong reactions from the fund industry. The government, sensing the alarming nature of the situation, issued a press release keeping the operation of the circular in abeyance pending the review of representations received from stakeholders.

While this action of the government deserves appreciation, a key takeaway from this incidence is that investors demand stability in tax policy and such instances tend to create noise in the international arena about India being a hostile tax jurisdiction. What is required is a pragmatic approach to the issue if the letter of the law gives rise to such unreasonable consequences. The government should clarify its intention by way of an amendment to Income-tax Act in the Budget, like it did to resolve the MAT controversy, to bring finality to this simmering issue.

Another area of the tax law where the government needs to take a big-picture and pragmatic approach is the safe harbour regime for domestically managed offshore funds introduced in 2015 vide section 9A of the I-T Act. Section 9A provides that an offshore fund will not face any taxation which is worse off than what is provided in the I-T Act simply because the fund is managed by an Indian asset manager. The lack of this simple rule had prevented the domestic fund management industry from managing foreign pools of capital. Sebi itself has recognised this as a significant opportunity for Indian asset management industry. While the government introduced section 9A to enable this, it came with a long list of 17 conditions which the fund/fund manager have to comply to avail of the safe harbour. Some of the conditions are practically difficult to satisfy for most funds & their managers. After two years of its introduction, this regime has yet to find takers and the opportunity to incentivise the fund management industry, generate employment and garner more taxes remains unexploited.
With GAAR expected to become effective from April 1, 2017, the government still needs to release practical guidance for its application. Investors’ expectations on this relate to clarity on application of LOB in treaties and domestic SAAR over GAAR, and examples of situations where GAAR would or would not apply. It is important that CBDT issues GAAR guidelines quickly.

There has been speculation that the government may seek to impose tax on long term capital gains on listed securities, which is currently exempt. A combination of STT together with exemption/reduced rate on capital gains has served us well for past 12 years. Any move to modify this regime should weigh the aspect of simplicity that may have to be compromised.

For Budget 2017, while the government will have in mind some big-bang tax reforms post demonetisation, it should equally focus on providing the desired clarity on issues which continue to be a source of anxiety and impede business decision-making. From a capital markets perspective, if these issues are resolved, it will have a profound effect on the daily lives of funds, fund managers, investors and the entire ecosystem of financial services market participants, ultimately leading to more participants, increased volumes and buoyancy in tax revenues

Hence, the notice by itself is not an implication nor the beginning of an investigation. In most cases, the Income Tax notice could be just a request for disclosing the source of cash. Usually, the notice should come to only those people whose deposit may not match their income prima facie as per tax authorities’ assessment.

If you have relevant documents to explain the deposit and its source, you have no cause for worry. Moreover, if you haven’t done anything illegal and all your money is ‘white’, you don’t have to worry at all irrespective of how much you earn or deposit.

If you get an I-T notice, read it carefully. This could be simply asking you to provide the source of income for the cash deposited in the bank. The source of income should be supported by documentary proof. If the tax authorities are satisfied by your response, you get a clean chit and the matter gets closed.

If you are not able to explain the source of income or the answer is not satisfactory, there will be further proceedings. The outcome of this will depend on your responses and how valid they are found by the investigating authorities.

In the recent demonetization drive, the government has also made it mandatory to quote PAN number in case the deposit exceeds Rs. 50,000. If you haven’t filed returns for years and your deposit exceeds Rs 2.5 lakh, you may get a notice asking to explain the source and subsequent demand to file the returns. This will require detailed investigation.

What happens when you don’t respond?

Ideally, you should not abstain from responding. However, if you don’t respond, you may get a follow-up communication from the I-T Department. Additionally, the tax authorities will assess your income based on the deposit data and other available details and come out with the tax liability, and you may have to pay the difference.

Remember that a lack of response from your side may lead the tax authorities to believe or assume that you have no explanation for the source of your deposit or income, and you do have illicit wealth in your possession.

If required or in doubt, consult a practising chartered accountant or tax consultant for the optimal course of action. In addition, use oodles of practical sense in order to take a decision and make it a habit to preserve all documentation related to your finances. Also, follow up with the case officer or the I-T team until the matter is resolved. Do not allow any pending issue to fester.

Finally, cooperate with the tax authorities if you get a notice. Avoiding it, concealing relevant information, or trying to give wrong details in order to misdirect the authorities will only go against you. If you have played it by the book, you have nothing to worry. If you haven’t, it would be wise to get on the straight and narrow, pay your dues, and clear yourself.