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Tax reforms: Past, present and future
February, 19th 2016

The Narendra Modi-led National Democratic Alliance government promised a stable, fair and predictable tax regime to investors after coming to power in May 2014. Since then, the government has initiated some steps to reduce tax disputes between the income tax department and investors. It has also sought to effect some much-needed reforms in tax administration to reduce litigation and frivolous tax demands.

Still, it has not yet been able to resolve some of the legacy issues (nor does it seem inclined to, taking refuge behind “due process”) and bring in key tax reforms such as the goods and services tax that require legislative passage. Ahead of the 2016-17 budget, Mint looks at what remains to be done by the government.

The legacy problem that remains unresolved

Despite promising investors a stable and predictable tax regime, the Modi-led NDA government did not address the main issue that had earned India the tag of “tax terrorism”.

It did not scrap or repeal retrospective amendments to tax laws that required investors to pay capital gains tax on transactions involving transfer of shares overseas with underlying assets in India. And although it promised adequate safeguards before any fresh tax demands are raised under this law brought in by the previous Congress-led United Progressive Alliance government, it did not do anything to address existing tax disputes involving companies such as Vodafone Plc and Cairn Energy Plc. In fact, the government has not even tried to keep the tax demands in abeyance till the matter is settled either in domestic courts or in international arbitration.

Vodafone has initiated international arbitration proceedings against the government under the Bilateral Investment Promotion and Protection Agreement. However, it has also started the process of exploring conciliation options with the government. But with the tax department pressing ahead with its recovery process and threatening seizure of assets, it remains to be seen how the conciliation talks progress.

Cairn Energy and its erstwhile subsidiary Cairn India are also involved in a long-drawn tax tangle in India. The issue relates to Cairn UK Holdings Ltd, a subsidiary of Cairn Energy, transferring shares of Cairn India Holdings to Cairn India as part of an internal group reorganization in 2006-07, resulting in R10,246 crore of capital gains, according to the tax department. Cairn Energy has initiated international arbitration under the India-UK Bilateral Investment Protection Agreement. The tax department also recently extended the freeze on UK’s Cairn Energy selling its remaining 9.8% stake in Cairn India till 31 March, keeping the dispute alive. Demand also raised on Cairn India for Rs.20,495 crore.

What has been addressed so far

1. The government has managed to resolve a host of transfer pricing disputes since taking over.

• It put the whole controversy involving under-pricing of share transfers between the parent and subsidiary to rest by deciding not to appeal against an adverse high court ruling. While the government was of the view that such transactions come under the transfer pricing ambit, the companies argued that these are capital transactions and not liable under the transfer pricing net. The government’s decision not to appeal against the high court ruling provided relief to more than 26 companies, including Vodafone India Services Pvt. Ltd and Shell India Markets Pvt. Ltd, which were contesting notices issued by the income tax department.

• The government has also managed to resolve 100 transfer pricing disputes with US-based multinational companies under the mutual agreement procedure under the India-US double taxation avoidance agreement.

Total disputes solved: 180

Amount involved: Rs.5,000 crore

•Introduction of Advance Pricing Agreements (APAs) has brought in certainty in the transfer pricing regime, with 41 APAs signed.

2. Over the past few months, the income tax department has announced a host of measures to reduce litigation, including clarifying on some key litigious issues like tax deducted at source, levy of penalty, claiming tax deduction for expenditure and the refund process.

Agenda for 2016-17 budget

1. Phasing out corporate tax exemptions

The budget will kick-start the process of phasing out corporate tax exemptions as well as a corresponding gradual decrease in corporate tax rates aimed at reducing litigation and making India more competitive.

2. Implementation of the recommendations of the R.V. Easwar committee

The Easwar committee, in its report presented last month, proposed many amendments to tax laws to reduce disputes relating to tax deducted at source, claiming of expenditure deduction and delay in refunds. Some of these will be part of the upcoming budget.

3. Acting on the report of the tax administration reforms commission

The tax administration reforms commission, headed by Parthasarathi Shome, has suggested a string of recommendations to improve tax administration in India.

4. Moving towards implementing OECD’s base erosion and profit shifting (BEPS) mandate

The budget will introduce provisions to implement country-by-country reporting as per the BEPS mandate. These will require multinational firms to make detailed disclosures about the operations of the parent as well as subsidiaries.

5. Laying to rest the minimum alternate tax (MAT) controversy

The government has assured investors that it will bring in necessary amendments to ensure that foreign investors with no permanent establishment in India will not be required to pay MAT in India. The government will bring in the necessary amendments to tax laws, but wording of the amendment could be crucial to settling the matter.

6. Making masala bonds attractive

The government has promised to announce more tax benefits for making rupee issuances by Indian companies more attractive for foreign investors. These include a lower withholding tax of 5% on interest income accruing to non-resident investors of these bonds as well as exemption from capital gains tax on gains accruing from a possible appreciation of the rupee between the date of issue and redemption against the foreign currency in which the investment is made.

7. Incentivizing offshore fund managers to move to India

Though the previous budget announced a number of steps to attract such offshore fund managers to move to India, some of the pre-conditions were viewed to be very strict by investors. It is likely that the government may relax some of these criteria.

8. Convergence towards goods and services tax (GST)

The government is expected to announce a number of steps to aid in the transition of the indirect tax regime towards GST. This includes possibly increasing the service tax rate, bringing down the excise exemptions list to less than 100 from more than 300 at present and reducing the size of the so-called negative list of service tax.

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