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Global move on tax planning limits
May, 03rd 2010

In April last year, leaders of G20 summit in London increased the reach and authority of OECD to crack the whip on tax planning ideas that fell in the realm of policy makers and other intermediaries such as banking and offshore institutions. Although, the issue of transparency in tax administration did not take centrestage, leaders made stern observations on questionable tax planning structures resulting in a loss of revenue to the exchequer.

The two major outcomes of the summit followed by OECD communiqu on tax havens underpins emphasis on tax information exchange and imposition of a greater degree of compliance by jurisdictions offering low tax rate. Evidently, in a year since the summit, a host of efforts have been channelled by G20 economies to align their governance standards. Notable evidence is unprecedented increase in conclusion and signing of tax cooperation agreements and international information exchange agreements, revisiting the role of banking institutions and secrecy laws in relation thereto. Recently, India notified 10 non-sovereign jurisdictions (including Hong Kong, Bermuda, British Virgin Islands and Cayman islands) as special territories with whom India is expected to enter into limited treaties and it is clear that information exchange would be on top of the policy makers agenda. Last week, the FM concluding the passage of 2010 Finance Bill intimated to the house that India has sent communication to 65 tax treaty partners in relation to exchange of information and Swit-zerland, Bahamas and Bermuda have agreed to act.

Such developments effectively put tax transparency firmly on the Boards agenda given the integration of tax function alongside day to day operations of multinational companies engaged in cross border transactions. Though, this may just be a modest beginning, more important actions are likely to follow. The question in my mind is how coordinated are those actions! I guess, the overarching objective should be to ensure that such standards are upheld; countries dont cherry pick gold standards and choose to legis-late country specific solutions to deal with a global phenomenon. It would otherwise cause chaos for businesses dealing with Tax administration in multiple jurisdictions. This con-tinues to be a concern for multi-nationals operating outside the OECD countries.

Indian landscape varnished
It is imperative to understand the Indian landscape on tax planning and transparency standards for forecasting the impact of changes it is likely to have on tax payers. The overhang of OECD Communiqu appears to have played on the minds of Indian tax administration and I clearly notice higher vigilance and interrogative approach in questioning tax structures that lead to potential savings. Absence of General Anti-avoidance rules (GAAR) has not prevented the Tax administration from questioning legitimate treaty benefit claim or applying form over substance test. Recent Court decisions and Advance Auth-ority rulings though seem to be veering on the tax payers side and upholding age old principle articula-ted in the landmark case of Duke of Westminster. The said decision essentially gave a stamp of approval and freedom to tax payers for organising their operations in the manner they choose to and avail of tax savings. In other words, it restricted tax administrations right to question tax payers tax planning schemes. To what extent would Westminster principles apply in the current context would be tested in recent times.

Recent revelations on tax structures of franchisees for sports extravaganza, Indian Premier League has only added credence to my skepticism in the administrations approach. Tightening noose by way of uncomfortable scrutiny, given maze of complex issues IPL is mired into may seem justified and in line with mandate for ensuring transparency, the question is its implementation and tools to achieve the objectives. In such situations, axe falls on bona fide tax planning structures and all are (taint) painted with the same brush!

Lately, several tax planning structures have come under the Revenues scanner. Whilst the approach deployed to ensure tax transparency is proactive, there is scope for concrete and legal basis to replace random investigation. Even more disturbing is the divide between the Revenues approach and ratio espoused by judicial and quasi-judicial authorities.

In a recent instance (E*Trade case), the Revenue denied capital gains tax exemption to Mauritius investors available under the India-Mauritius tax treaty holding that the transaction was sham and devised for tax avoidance purpose. However, the Authority for Advance Ruling later restored the treaty exemption holding the transaction as genuine, even though the objective was to achieve tax efficiency. Similarly, it was held that investment made by a German parent via a Netherlands subsidiary is eligible for benefits under the India- Dutch treaty and that tax administration cant allege treaty shopping given the absence of limitation of benefits clause under the treaty.

I see a clear need for aligning the approach of tax administration with framework of an evolving global policy and jurisprudence to uphold standards for legitimate tax planning. Tax payers should be spared from the agony of investigative approach and rigor of traversing multiple layers of appeals to achieve finality on the structure. Lets not forget that the global (gold) standards on tax transparency are evolving and it takes time for even most sophisticated jurisdictions to perfect the art of implementation. A case in point is the US.

Apposite timing for anti-abuse rules
Balancing the two important elements of effective tax planning i.e. tax optimization and governance will require greater transparency and disclosure by tax payers before implementation. Though, US has recently tightened the economic substance rules, what constitutes substantial economic substance is not defined leaving a wake of confusion that is likely to raise tax cases for foreign businesses operating in the US. Recent endeavor by Indias apex tax administration CBDT to establish a task force for advising on prevention of treaty shopping is a step in the right direction. It however has to be followed by legislation and administrative guidance to effectively administer them.

Though, I have personally not been in favor of timing for the legislation as proposed in the Direct Taxes Code, besides the vagueness in drafting, I may perhaps be forced to change my view in this emerging era of global move for tax transparency. If indeed the Government chooses to legislate regulations, we can learn from experiences in other jurisdictions, particularly Canada. Canada took 4 years to legislate GAAR given limitation of its judicial processes in setting out anti-avoidance rules. In almost 2 decades of GAAR regime, three conflicting decisions have been rendered by the Canadian Supreme Court and as expected, the law makers believe that GAAR deserves a relook. One aspect is clear; the Canadian Revenue believes that it has to work with its Tax treaty partners to effectively administer anti avoidance rules.

Legislature should chart the path
A challenging task for our legislature would be to ensure that India does not scare away tax planning

ideas and at the same time maintain check on aggressive tax structures designed to defraud the exchequer.

A definitive and specific GAAR legislation could perhaps be in the long term interest of tax payers. Clear articulation of instances of tax-avoidance /abusive transactions, defining powers of tax administration to deal with and question such tra-nsactions is of paramount importance. The final decision making to invoke GAAR should be prerogative of the apex administration. In the interim and for dealing with present cases, it is equally important to define the tone, tenor and rules of the game in the absence of a legislated anti-abuse regime.

While one cant take for granted effectiveness from the word go, regardless of who the winner is, it is imperative that India works as a team with its tax treaty Partners and the tax administration takes on board concerns of the tax payers!

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