The tax authorities are scrambling to keep up with corporate Indias recent overseas buying spree and Budget 2008-09s big story is expected to be taxation of cross-border capital gains, particularly mergers & acquisitions. Early warning signals are hard to miss and top officials said much more in terms of beefing up policies on international taxation and transfer pricing rules are in the works.

For starters, to ensure that the Morgan Stanley case does not set a precedent, the ministry will change the legal definition of permanent establishment in the Finance Bill. We do not have an option as the Supreme Court has turned down our powers to tax the BPO establishments of foreign companies under existing laws, lamented a senior official. A new definition would also help the department progressively amend double-tax avoidance agreements with different countries.

The department has also decided to treat the tax notice on Vodafone-Hutch as a test case. We have no issues with the company, but there is a clear capital gains tax trail, the official said. The objective is to understand the tax implication of such deals, he added. While the matter is pending with the Bombay High Court, sources said the department is hoping that the deal will not set an example for others to route M&As through overseas shell companies.

Taxing the movement of cross-border capital will, therefore, be key to the revenue departments exercise in the run up to the next Budget. The department has also decided to increase technically equipped staff to man the transfer pricing cells. This is crucial if we have to keep pace with the tax implications of the new trends in capital flows, the official said.