The tremendous backlog of pending direct tax litigation has been a bane for the government and taxpayers alike—the locking-up of precious tax revenue for the government and unrelenting uncertainty on the tax front for the taxpayers. The finance minister stated in his Budget speech that reducing litigation and providing certainty in taxation would be one of the “nine pillars” of his tax proposals for FY17. This thought process is enshrined in the various amendments proposed to the Income-tax Act, 1961.

The minister said that the objective of Income Declaration Scheme (IDS) 2016 is to provide a final opportunity to non-compliant domestic taxpayers to clear their past income-tax transgressions and become compliant. This is sought to be achieved by the payment of tax at the rate of 30% on income declared to have not been offered to tax; and a surcharge of 25% (termed as Krishi Kalyan Cess) and a penalty at 25% on the amount of tax computed above.

This culminates into an effective tax rate of 45% on undisclosed income which needs to be discharged by date to be prescribed by the central government. IDS will be operative from June 1, 2016, to September 30, 2016, and can be availed for years up to FY17.

However, IDS cannot be resorted by the taxpayers for years in which there are pending assessment, reassessment or survey proceedings. In addition, IDS cannot be availed in relation to any undisclosed income or asset chargeable under the Black Money Act of 2015 or in respect of persons covered under specified legislations. IDS has a mechanism to prevent its abuse in the form of invalidation of immunity if there is any misrepresentation or suppression of facts by the taxpayer.

The primary advantage offered under IDS is a sovereign promise of immunity with regard to income disclosed from scrutiny, enquiry and prosecution under the Act as well as the Wealth Tax Act, 1957, and specified circumstances under the Benami Transactions (Prohibition) Act, 1998.

The Direct Tax Dispute Resolution Scheme (DRS) aims at reducing the backlog of pending litigation before Commissioner (Appeals)—first appellate authority—as on February 29, 2016, as well as settle the litigation arising out of any retrospective amendments to the Act.

Under DRS, the appeals pending at Commissioner (Appeals) can be resolved by the taxpayers on payment of tax and interest computed till the date of the assessment order; and payment of penalty up to 25% in cases where tax exceeds Rs 10 lakh.

A pending penalty appeal can be resolved by the taxpayer on payment of 25% of the minimum penalty leviable, provided that tax and interest payable as per the original assessment or reassessment order is paid.

Litigation arising out of retrospective amendments and pending at any level can be resolved on payment of only the tax involved—thus the interest or penalty (if any) is waived. But the taxpayer has to withdraw any pending appeal or arbitration, conciliation or mediation proceedings, and furnish a declaration he will not pursue further remedy before being able to avail the benefit under DRS.

DRS requires the taxpayers to file an application to the prescribed tax authorities, who shall then evaluate the same and issue a certificate within 60 days determining tax liability. This needs to be discharged within 30 days, upon which pending appeals shall be deemed to have been withdrawn.

There are certain exclusions and invalidations prescribed under DRS which are similar to those prescribed under IDS.

The advantage offered by DRS is that litigating taxpayers can buy peace by paying tax upfront and saving on the potential interest, penalty and litigation costs, which are to be reckoned not only in terms of legal fees but also in terms of sheer man hours lost in engaging in litigation. However, DRS could have been sweetened by excluding interest and penalty.

It is proposed that Revenue shall not have a right to appeal against the directions issued by Dispute Resolution Panel (DRP). While this amendment is aligned with the philosophy behind the introduction of DRP as a fast-track dispute resolution scheme, it remains to be seen whether DRP becomes conservative in deciding in favour of the taxpayers, since Revenue would not have further right of appeal before higher appellate forums.

The existing penal provisions under the Act have been the subject-matter of heavy litigation, primarily due to the large discretion conferred upon Revenue to determine the gravity of default and the associated penalty. These provisions are proposed to be replaced by graded penalties (50% on under-reporting of income and 200% on misrepresentation) for reducing uncertainty and bringing objectivity. It is worth noting that a transfer pricing adjustment is specifically excluded from the scope of under-reporting if the taxpayer has maintained and disclosed information as required under the Act.

Given the difference in the quantum of penalties, one may envisage that the next generation of litigation on tax penalties would revolve around characterising the default into under-reporting or misrepresentation of income.
Additional interest is proposed at 3% on refund delayed beyond 3 months from the date of appeal order. This may encourage faster processing of refunds. Similarly, reducing the time limit for rectifying the orders of the tribunal from 4 years to 6 months will ensure faster resolution of apparent errors in tribunal orders without the taxpayers having to resort to the appeal mechanism.

While there is always scope for improvement, the steps taken by the government are illustrative of the bold and unconventional approach adopted to tackle contemporary tax issues, although only time will reveal the success thereof.