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Advance rulings help foreign investors decode tax
March, 29th 2010

Improved global sentiments and strong industrial output numbers are increasingly attracting foreign investors towards India. There has been a steady increase in the foreign investment that India has been attracting, especially since October 2009. As per a United Nations Conference on Trade and Development (Unctad) report on World Investment Prospects Survey 2009-11, India would continue to remain among the top five attractive destinations for foreign investors during the next two years. Significant foreign investment proposals have been cleared by the government recently. All these are positive signs for India.

Recognising the importance of tax as a decision point in doing business in India, the Indian income-tax law as well as the excise, customs and service tax laws have an advance ruling mechanism that permits non residents to seek an advance determination of tax liabilities, arising from transactions they propose to undertake or (in some cases) have undertaken.

Set-up in 1993 under the finance ministry, the income-tax Authority for Advance Rulings (AAR) has ruled on important cross-border tax aspects that have provided guidance to foreign investors in the past. The role of the AAR would be all the more pronounced when the proposed direct tax code and the goods and service tax are introduced.

In this column, we take a look at some of the important AAR rulings in the recent past. In a ruling related to mergers of foreign companies with Indian firms (STAR case), the AAR confirmed the tax neutrality of the merger, dismissing arguments of the tax department that the same would be prejudicial to the interests of the Indian revenue. This ruling is expected to pave way for many such mergers of foreign companies into Indian companies.

In two rulings dealing with internal group reorganisation involving India investments, the AAR held (Amiantit International Holding case) that in the absence of any consideration flowing from the transferee group company into which the holdings are transferred, no tax can be levied on the transferring group company. A similar ruling held well in the case of bankruptcy proceedings in the US (Dana Corporation case). An amendment in the income-tax law (proposed from June 1, 2010) may, however, bring to tax share transfers without consideration or at a consideration less than the fair market value, subject to the protection available under tax treaties.

With the Samsung ruling of the Karanataka High Court adding to the misery of software companies, the AAR passed a ruling (Dassault Systems case) that overseas software vendors are not liable to pay tax in India on the sale of off-the-shelf software in India. This ruling analyses in detail several legal aspects related to the licensing and sale of software, and should serve as a useful benchmark in settling this long pending tax controversy.

In another recent ruling, the AAR also clarified beneficial ownership principles (KSPG the Netherlands case). This ruling assumes importance in the backdrop of the Vodafone issue. The Indian tax authorities are vehemently pursuing a tax demand from an overseas Vodafone company based in the British Virgin Islands on the basis that it failed to withhold tax at source when it bought the erstwhile Hutch business in India. While this all important matter may ultimately be decided by the Supreme Court, the AAR seems to have done its bit in clarifying the first principles on beneficial ownership, when it comes to capital gains tax.

In the context of a multinational business group, it is a common phenomenon that costs incurred by the parent company are shared among all other group companies, which use such common facilities, especially when it comes to sharing the fruits of R&D activities. In one such recent ruling (ABB case), the AAR clarified that when a parent company incurs certain R&D costs and other international group companies contribute their share of the common costs, the parent company cannot be seen as earning any income and therefore, cannot be taxed in India on such cost contributions. This ruling again assumes lot of significance as similar cost contribution or cost sharing arrangements exist amongst lot of multinational groups.

One theme that is consistent and most important in the recent AAR rulings is clarifying that if there is no taxable income in India in the hands of a non-resident then the Indian companies are not required to withhold any taxes at source. This is a welcome clarification as this supports the stand of the Indian companies that they cannot be asked to cough up the taxes payable by non-residents (over whom the Indian tax department has relatively lesser control and thus demand is made from Indian companies) if they can prove that no taxes are payable in India by the non-residents.

While this question on the requirement to withhold taxes at source on payments made to non-residents (whether or not the payments are ultimately taxable in India in the hands of the non-resident) is currently before the Supreme Court and would be decided shortly, the AAR rulings definitely add much-needed armor to deal with demand notices being issued by the revenue. Several of the above rulings deal with very nuanced aspects of international tax and with the pace of frantic activity of cross border trade, we should expect several more interesting rulings from the AAR.

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