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CAG raises concerns on direct tax code
May, 26th 2010

The Comptroller and Auditor General (CAG) has raised several concerns over some provisions of the proposed direct tax code (DTC), the draft of which was unveiled by the finance?ministry in 2009.

The countrys statutory auditor pointed out in a communication in March that some key provisions of the code, such as the ones on international taxation, could prove problematic. Other concerns relate to changes in taxation for the voluntary sector.

The note, which hasnt been made public, was reviewed by Mint.

While CAG generally doesnt comment on proposed legislation, a senior official at the agency said: Audit need not necessarily be adversarial. Why should we not be pre-empting issues and advising the government?

CAG said the codes treaty override proposal could prove problematic as it violates the Vienna Convention on the Law of Treaties and may lead to disputes between India and its treaty partners. The code allows domestic law to take precedence over treaties with foreign governments on areas such as avoidance of double taxation.

Industry chambers had expressed concern over the provision during public meetings on the code in 2009 and the finance ministry had said it would be one of the areas that would be revisited.

A revised version of the code is expected to be unveiled as early as next month. Finance minister Pranab Mukherjee has said the government intends to lay it before Parliament in the monsoon session.

The Vienna convention makes it clear each member-state applies the treaty in good faith, said Sudhir Kapadia, partner at Ernst and Young. Good faith would mean a country should not override a treaty unilaterally, he added.

India has treaties to avoid double taxation with a number of countries, Mauritius being the most prominent example as a lot of foreign investment into the country originates from there. The Mauritius tax treaty was unsuccessfully challenged in the Supreme Court.

Under the code, in the event of a conflict, the later law will prevail. This may nullify older tax treaties unless new protocols are signed after the enactment of DTC.

CAG pointed out the provisions could cut both ways. Treaties are based on the principle of reciprocity and partners could withdraw benefits to Indian companies. It has recommended that a cost-benefit analysis be carried out on treaty override before the code is finalized.

In the mid 1980s, the US made a similar change in its domestic tax laws, allowing it to prevail over treaties in the event of a conflict, according to Kapadia. The controversy generated in the wake of the move eventually led to a clarification that detailed the circumstances under which such an override could take place, he said.

The DTC proposal is characterized by sweeping powers, Kapadia said. It may have been more acceptable if the code had been nuanced by providing it with safe-harbour rules, he added.

CAG has also suggested that the finance ministry examine some other areas where implementation can be challenging, among them the proposal to tax charitable trusts.

The finance ministrys bid to remove or rationalize exemptions given to charitable trusts of companies isnt aligned with the governments policy of engaging businesses in welfare activities.

CAG says there are around 1.2 million voluntary organizations as per independent estimates. Total receipts of organizations carrying out non-profit activities in India in 2008-09 amounted to Rs9,094 crore, of which 90% was raised from within the country.

The DTC provisions stipulate that if the entire grant is not used by non-profit organizations in the year of receipt, tax would have to be paid on the residual amount. This could lead to a fresh set of disputes as most receipts flow into non-profit organizations in the last two quarters of the year, CAG said.

Other concerns relate to the extent of disputesinvolving revenue to the tune of Rs1.99 trillionunder the existing Act. CAG suggests that the ministry consider introducing a scheme to allow plea bargaining to settle disputed demands.

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