|
March of the Professional |
|
Speech of Hon’ble Mr. Justice S. B. Sinha1 on NTC at Jamshedpur held on 29-30 August, 2009 |
I am grateful to the All India Federation of Tax Practitioners to given me an opportunity to share my views in this august gathering and in particular with the experts on taxation laws.
With the advent of new economy and onset of globalization, privatization and liberalization, taxation laws in the context of foreign direct investment in India assumes great importance. Foreign direct investment has become all the more necessary in view of the period of recession we had. A new area of competition amongst the countries having more or less similar political and economic conditions is being witnessed inasmuch as each one of them tries to have an edge over the other. Any foreign direct investors would like to understand the different tax structure of the developed countries as in their opinion they are sometimes uneven and arbitrary.
It is now beyond all controversy that India needs to be involved with global business. It cannot remain isolated. It is in the aforementioned context, study of lego-economics has become imperative for the members of the taxation bar. It is almost indispensable.
India cannot achieve the status of a fully developed country unless ‘certainty’ in some areas of law is achieved. An entrepreneur intending to make substantial investment in the country must know what would be its corporate tax liabilities towards direct and indirect taxes.
It is only with that intent the Central Government had introduced the system of advance ruling on taxation. The countries have come up with their own regional organizations to promote healthy tax component and encourage tax reforms. The small market economies are strengthening their fight for inflow of capital.
In today’s world, everybody talks of good governance. Recently, taxation has been held to be a part of good governance2.
Movement of the economy towards a market model envisages greater contractual relationship between the parties. The licence and permit-raj is sought to be abolished. Litigations in view of the economic growth would increase for clarifying the mutual rights and obligations of the contracting parties. Ascertainment of the tax components arising out of a contract plays an important role in tax litigations.
We may refer to a recent case of the Supreme Court in Ishikawajma – Harima Heavy Industries Ltd. vs. Director of Income Tax, Mumbai3 where despite the fact that the contract provided for a turnkey project, the Supreme Court held that for the purpose of taxability, it need not be an integrated one opining that a taxation statute deserves strict construction. It was further held:
“52. Tax under the Act has to be assessed under different heads. Income under one head may be subject to exemption; under same head, deductions may be claimed; yet under another, no tax may be payable at all. Whether a part of the income of the assessee would be taxable or not depends upon the fact of each case. Even there is nothing to prevent the income accruing or arising at the sources.”
The Court laid down the law not only in regard to construction of contract but also how and in what circumstances the taxation statute vis-à-vis the permanent establishment of a foreign entity in the light of double taxation treaties would be attracted, stating:
92. Global income of a resident although is subjected to tax, global income of a non-resident may not be. The answer to the question would depend upon the nature of the contract and the provisions of DTAA.
93. What is relevant is receipt or accrual of income, as would be evident from a plain reading of Section 5(2) of the Act. The legal fiction created although in a given case may be held to be of wide import, but it is trite that the terms of a contract are required to be construed having regard to the international covenants and conventions. In a case of this nature, interpretation with reference to the nexus to tax territories will also assume significance. Territorial nexus for the purpose of determining the tax liability is an internationally accepted principle. An endeavour should, thus, be made to construe the taxability of a non-resident in respect of income derived by it. Having regard to the internationally accepted principle and DTAA, it may not be possible to give an extended meaning to the words “income deemed to accrue or arise in India” as expressed in Section 9 of the Act. Section 9 incorporated various heads of income on which tax is sought to be levied by the Republic of India. Whatever is payable by a resident to a non-resident by way of fees for technical services, thus, would not always come within the purview of Section 9(1)(vii) of the Act. It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax. Whereas a resident would come within the purview of Section 9(1)(vii) of the Act, a non-resident would not, as services of a non-resident to a resident utilised in India may not have much relevance in determining whether the income of the non-resident accrues or arises in India. It must have a direct live link between the services rendered in India, when such a link is established, the same may again be subjected to any relief under DTAA. A distinction may also be made between rendition of services and utilisation thereof.
It was held that off-shore supply and off-shore services would not attract liabilities.
Reform of ‘Direct Taxation’ has also the potential to further improve growth. Nonetheless, the tax system bears some traces of past interventionism, extensive loopholes and exemptions which introduce distortions and complexity, facilitating tax evasion. Here, I propose to discuss a few issues as regards the IT Act which the court is facing.
With rapid globalisation, multinationals see national boundaries as increasingly less relevant to how they conduct business. Revenue authorities, on the other hand, do not see things in quite the same way and zealously guard the tax base of their respective countries. As a result transfer pricing has become one of the most important and complex tax issues facing modern businesses today. The law on the subject of transfer pricing is at nascent stage, the next few years are likely to witness a lot of developments and disputes in this area.
In India, the void in the Income- tax Act, 1961 (‘the Act’) relating to detailed transfer pricing regulations was finally filled with Finance Act, 2001 introducing detailed transfer pricing provisions as an anti-avoidance measure into Chapter X of the Act with effect from 1 April 2001 under Section 92A to 92F.
Transfer pricing is a method of evaluation of transactions between associated enterprises. It is governed by AL Principle. Price under the said principle is called as AL Price. Arm’s Length price is the price applied to a transaction between two unrelated entities engaged in similar transactions, which are not associated enterprises, in uncontrolled conditions. Section 92(1) deals with AL Price and provides that any income arising from international transaction shall be computed having regard to AL Price. Therefore, Transfer Price in international transaction shall be determined as if it is a transaction between two enterprises, other than associated enterprises, in uncontrolled conditions. Transfer price, therefore, is not an agreed price between contracting parties till it is found that such price is similar to those charged by unrelated parties in uncontrolled conditions. Under Section 92, AL price is not only applicable to incomes, it also applies to allowances for expenditure/ interest arising from international transaction.
The arm’s length principle means the transaction should be valued at prices which a company would have charged another unrelated company based on market considerations only. This principle is reflected in Section 92 of the Income-tax Act, 1961.
The object behind enactment of Sections 92A to 92F, is to provide statutory framework to compute reasonable, fair and equitable profits, taxable in India, in the case of MNEs, having regard to AL Price. It also gives meaning of AE, meaning of international transaction, computation of AL Price, maintenance of documents by persons entering into international transactions. The said ‘Sections’ relate to computation of income from international transactions having regard to AL Price. Tax treaties have important role in dealing with transfer pricing cases and examination of the transactions of MNE and the AEs.
Within a short span of time, a number of controversies were raised as regards the implementation of these provisions.
In DIT (International Taxation), Mumbai vs. ReMorgan Stanley and Co. Inc.,4 the the Supreme Court was concerned with the articles in Double Tax Avoidance Agreement ("DTAA") between India and United States which have implication on transfer pricing legislation. The said Treaty either advocates application of arm's length principle or provides a mechanism for avoiding double taxation on income. Double Taxation is also a raging debate in India as it has given rise to instances where an income escapes tax in one country on account of the DTAA and in the other on account of its local tax laws.
The following principles emerge from the above judgment of the Supreme Court in Morgan Stanley:
i) There is no need for attribution of further profits to the PE of MSCo (foreign company) where the transaction between the foreign company and MSAS was at arm’s length, but this principle is subject to a proviso, namely, that the associated enterprise (that constituted a PE) was remunerated at arm’s length basis taking into account all the risk taking functions of MSCo (MNE). The situation would be different if transfer pricing analyses did not reflect the functions performed and the risks assumed by the enterprise. In the latter case, there would be a need to attribute profits to the PE for those functions and risks that have not been considered. The entire exercise is to ascertain whether the service charges payable to the service provider (MSAS) fully represented the value of the profit attributable to its service. It is the duty of the Department, therefore, to examine whether the PE had obtained services from the multi-national enterprise at lower than the arm’s length cost.
ii) There is a difference between the taxability of the PE in respect of its income earned by it in India under the 1961 Act and the taxability of MSCo through its PE in India under Article 7 of the DTAA. In the case of MSCo, the taxable unit is the foreign company.
iii) Section 92F(iiia) of the 1961 Act provides that the PE would include a fixed place where the business of multi-national enterprise is wholly or partly carried on.
Thus, the entire exercise is based on factual analysis of each case. There is no straight-jacket formula which would apply to each and every international transaction.
Further, the Finance Minister in his budget speech in 2007 had taken up the issue of reviewing the DTAA treaties and had said the government is in favour of relooking at some provisions of the DTAA with Mauritius, as some Indian Companies were involved in round-tripping of funds. India's controversial double taxation avoidance agreement (DTAA) with Mauritius may be up for review soon. The finance ministry is in favour of reviewing such treaties that India has with over a 100 countries, in view of the country's changing economic scenario. The treaties should be such that they are more suitable for Indian investments abroad as much as it is for incoming capital.5
The concept of Fringe Benefit Tax (FBT)6 was introduced by the Government in the year 2005 and has now become a part of the tax structure in operation in the country. FBT is a tax which is levied upon the expenditure of the company or employer towards the various benefits which are provided to the employees. According to the objective behind this new concept, it is the tax which will be levied on the many benefits which are enjoyed by the employees collectively and therefore cannot be taxed in the hands of individual employees. Since it is impossible to impose this tax during the assessment of every individual employee, this tax shall be calculated in the assessment of the employer.7
With the introduction of this FBT a number of arguments and theories have been raised about it, both supporting and decrying it. The objective according to the Finance Minister to introduce the FBT is to penalize those companies and corporate employers who seek to escape the corporate duty by paying a large chunk of the salary of the employees in the form of benefits. Since these benefits are of a considerable value, it bodes well to the revenue department to tax these benefits, which are in fact the remuneration accorded to employees, in disguise.8
The argument against FBT are:–
1. One of the principal arguments against the imposition of FBT is that the Union Legislature does not have competence to do so. The Union legislature has authority to tax income other than agricultural income and the area sought to be taxed by FBT is not income in any sense of the word. Income by definition is something that comes in, something that is accrued. The area sought to be covered by FBT is expenditure.9
2. Also, the FBT scheme is in violation of the right to equality under Article 14 of the Constitution. The objective of FBT was to penalize those corporate employers who sought to escape corporate duty liability by paying employee in kind and beneficial services instead of cash. The scheme as it is in operation imposes FBT on all persons engaged in trade or business who have persons in their employ. This is unfair on those who have been honest taxpayers. Therefore the FBT scheme is in violation of Article 14 for unreasonable classification. Further, the FBT scheme makes an unfair distinction between Government enterprises and private enterprises. Private enterprises have to bear the brunt of this scheme whereas all government enterprises are exempt.
3. The provision is also highly presumptive because it presumes that expenditure on the listed items necessarily benefit the employee, whereas in reality most of the listed may not have any relation whatsoever with employee benefits. The presumptive provisions violate natural justice principles. The scheme presumes that any expenditure towards the heads listed in the chapter would accrue as benefits to the employees and a fixed slab is imposed. The scheme does not provide an opportunity to the assessee to make a case as to the expenditures which actually accrued as benefits to the employees and those that did not. This is against the principle of audi alteram partem.10
This has already been challenged in the Punjab and Haryana High Court by the Haryana Vidyut Prasaran Nigam (HVPN) Ltd, a successor company of the Haryana State Electricity Board (HSEB). What needs to be seen now is the consequences that would follow by way of challenges on its constitutionality.
One of the issues which probably would require an authoritative pronouncement of the Supreme Court is with regard to the automatic imposition of penalty and automatic imposition of interest.
In Union of India vs. Dharmendra Textile Processors and Others11, penalty has been equated with civil wrong and, thus, existence of mens rea was found not to be a requisite ingredient for levy thereof. However, conceptually, it may not be correct when a penalty is imposed, existence of mens rea keeping in view the purpose of levy thereof should be held to be a pre-requisite as it is a well-settled principle of law that in case of any doubt the statute should be interpreted in favour of the assessee and not in favour of the revenue. This salient aspect of the matter has not been considered in Dharamendra Textile Processors.
We may also notice that recently in P.R. Metrani vs. Commissioner of Income Tax, Bangalore12, the principle that a person’s fundamental right of privacy as envisaged under Article 21 of the Constitution of India was invoked for the purpose of construction of Section 132 of the Income Tax Act wherein it was clearly held that the same requires strict construction and only for the purpose of finding out evasion of tax and not for any other purpose.
Proper tax administration also assumes importance in the matter of grant of relief by way of exemption to an entrepreneur keeping in view the circulars issued by the CBDT and the principle that an assessee arranges his business affairs relying thereupon and, thus, the subordinate officers cannot contend that any circular is erroneous and not binding on them having been issued under Section 119(1) of the Income Tax Act, 196113.
The introduction of the recent direct tax code is one of the measures undertaken by the Central Government towards tax reforms.
• The new draft code’s intended objectives are:
– To simplify the provisions of the existing tax code
– To reduce litigation
– To enable the Indian economy to be competitive globally• It’s salient features are:
– Anti-avoidance measures: Belief among practitioners that where a transaction is not regarded as a bonafide transaction, the same could be subject to intense scrutiny by the taxing authorities, due to grant of wide powers for interpretation of the code to them. This may result, among other things, in an adverse effect upon the domestic Mergers and Acquisitions.
• It’s concerns are:
1. Reduced revenue
2. Lack of Vision
3. Inadequately deals with evasion• Other salient features are:
1. Code, brings finality
2. Removes exemptions
3. Relief given more to the individual over commercial entities.o Introduction of the Goods and Services Tax (GST):
– What is it? GST is a simple broad based form of taxation, where business pay taxes on the total value of their sales and receive credit for the taxes paid by their suppliers.
– The consequences of introduction of GST are as under:
• May be the single most important fiscal initiative in India.
• It could also prove to be a stimulus to the economy. In certain countries when GST was introduced it has yielded revenues higher than anticipated largely due to improved compliance.
• The benefits are dependant on the design of the GST. As the decisions made while finalizing the GST model would not be reversible in the near future, it is important that there is considerable research and analysis, balancing of conflicting interests and commitment to reform.14
o Changes in non-resident taxation provision :
– At present: both the tax code and the tax treaties have parity
– The reform: Domestic tax code to override the tax treaties – Would this be conducive to international investment is a big question.
– Change in the concept of residence of companies wherein any simple control on management in India could make a company resident India: . Therefore it means that as long as any part of the control and management is in India, it becomes a resident in India exposing it to worldwide corporate taxation. Therefore, this significantly risks the exposure of the MNCs and increases the territorial reach of the Income Tax Act.
– This is a policy issue and needs to be further debated.
It is of great significance that this august body is going to deliberate upon several important developments of law including service tax, works contract, share, securities and derivates transaction under the Income Tax Act, new Direct Tax Code and Cenvat credit in service tax on indirect expenses.
I may shortly deal with some of them.
The aspect theory involved in works contract, as was propounded in Federation of Hotel & Restaurant Assn. of India vs. Union of India [(1989) 3 SCC 634], has recently been taken into consideration in Imagic Creative (P) Ltd. vs. CCT [(2008) 2 SCC 614] wherein it was held:
“29. If the submission of Mr Hegde is accepted in its entirety, whereas on the one hand, the Central Government would be deprived of obtaining any tax whatsoever under the Finance Act, 1994, it is possible to arrive at a conclusion that no tax at all would be payable as the tax has been held to be an indivisible one. A distinction must be borne in mind between an indivisible contract and a composite contract. If in a contract, an element to provide service is contained, the purport and object for which the Constitution had to be amended and Clause (29-A) had to be inserted in Article 366, must be kept in mind.”
In that case, it was categorically held that if sales tax is payable on transfer of goods, the service tax would not be payable being mutually exclusive.
The difficulty faced by the Bench and the Bar in the matter of fixing the entitlement of sales tax in relation to various inter-State sales was recognized in Ashok Lanka vs. Rishi Dixit and Others15 wherein requirements to constitute a new tribunal where the respective claims of the concerned states could be gone into was highlighted.
In relation to service tax, another important aspect which would come up for consideration before the court of law in near future is imposition of service tax in respect of the matters which the State considers to be the Res Extra Commercium.
In Union of India vs. Martin Lottery Agencies Ltd.16 it has been held:
“14. This gives rise to a question, i.e., Does the State in organizing lottery render any service and, if so, to whom.
The learned Additional Solicitor General submits that service is being rendered to the general public as revenue is generated therefrom. We fail to persuade ourselves to agree with the aforementioned submission. The law, as it stands today (although it is possible that this Court in future may take a different view), recognizes lottery to be gambling. Gambling is res extra commercium as has been held by this Court in The State of Bombay vs. R.M.D. Chamarbaugwala and B.R. Enterprises vs. State of U.P. and Ors.
15. Contention of Mr. Salve is that where the State involves itself in an illegal activity, it cannot render a service as dealing in lottery is illegal being res extra commercium, no services can be rendered. We, as at present advised, do not intend to go into the said issue which is a complex one, in view of the fact that in this case we are primarily required to consider the effect of the explanation appended to Clause (19) of Section 65 of the Act. It is also not otherwise necessary to be determined.
We must, however, proceed to determine the said question keeping in view the aforementioned decisions of this Court that holding of lottery being gambling comes within the purview of the doctrine of res extra commercium.
16. Organizing lottery by the State is tolerated being an economic activity on its part so as to enable it to raise revenue. Raising of revenue by the State, in our opinion, by itself cannot amount to rendition of any service. It may be true that for the purpose of invoking the provisions of taxing statute, the morality aspect may not be of much consequence but such a question assumes significance for the purpose of ascertaining as to whether the same amounts to rendition of service within the meaning of the aforementioned sub-clause. The word `service' has not been defined in the Act. Its dictionary or etymological meaning may or may not be appropriate. We would, however, notice its dictionary meaning:
Work done or duty performed for another or others; a serving; as, professional services, repair service, a life devoted to public service.
An activity carried on to provide people with the use of something, as electric power, water, transportation, mail delivery, telephones, etc.
Anything useful, as maintenance, supplies, installation, repairs, etc., provided by a dealer or manufacturer for people who have bought things from him.”
The Supreme Court of India, however, recently has hinted that the doctrine of res extra commercium has wrongly been applied in relation to education, lottery, gambling, liquor, etc. [See Martin Lottery Agencies Ltd. (supra), Action Committee Un-Aided Pvt. Schools and Ors. vs. Director of Education, Delhi and Ors17.
Apart from direct tax code, the issues which require deep deliberation are:
(i) Inbound service taxation;
(ii) Anti DTA Regulations;
(iii) How to tax financial services and
(iv) Goods and Service Tax.
1 Justice S.B. Sinha, Former Judge, Supreme Court of India
2 [See Aashirwad Films vs. Union of India and Ors. [(2007) 6 SCC 624].
5 “Double taxation treaties in for review to suit the Indian economy”, The Financial Express dated December 6, 2007 available at http://www.financialexpress.com/news/Double-taxation-treaties-in-for-review-to-suit-economy/247454/.
6 Although the Fringe Benefit Tax has been abolished in the Budget of 2009, it will apply to assessment years prior thereto.
7 S. Mishra et al, “Fringe Benefit Tax: A Phenomenon Uncovered”, 278 ITR (2005) 33-48.
8 G. Srinivasan, “Constitutional Validity of Fringe Benefit Tax”, 148 Taxman (2005) 60-64.
9 Kothari, “Constitutional Validity of FBT”, 199 CTR (2005) 91-104.
13 [See State of Kerala v. Kurian Abraham (P) Ltd. (2008) 3 SCC 582]
14 [Source: Goods and Services Reform: A highly awaited tax reform ( Economic Times, 3rd July, 2009) By Harishanker Subramaniam , Patner, Ernst & Young.]