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Advance Rulings: Time For a Reality Check

India
16 Sep 2012

This article was first published in the Business Standard, 17 September 2012.

It's important to introspect why India has earned a reputation of having clogged judicial system with a significant rise in tax litigation cases leading to an agonisingly slow pace of dispute resolution. This, coupled with the tax administration's approach to appeal against almost all matters right till the Apex Court, has led businesses to clamor for forums of dispute resolution, which can provide clarity and more importantly, consistency in a defined time frame. Coming on the heels of the opening up of the Indian economy for foreign investment in 1991, the move to set up the Authority for Advance Rulings (AAR) by none other than the present PM as an independent quasi-judicial body aimed at ushering certainty on tax positions was seen as a bold move in a nation generally guarded against the concept of private rulings. Almost two decades after it was established and having seen several complex and high profile cases go through the annals of AAR, it's time to pause and introspect.

Legislative framework
The current framework enables non-residents and residents entering into cross-border transactions to approach the AAR for determination of tax liability on a specified transaction or a proposed transaction. The law envisages that the AAR shall pass its orders within 6 months from the application and such ruling shall be binding on the applicant and the Revenue. The AAR has been a popular forum for non-resident investors seeking certainty on complex issues concerning tax treaties, withholding tax obligations, permanent establishment issues, characterisation of income, etc. Under its charter, AAR cannot rule on tax avoidance scheme and on matters requiring determination of an arm's length price. Hence, a large constituency of disputes for foreign investors has been effectively left out from the ambit of AAR. However, the recent Advance pricing mechanism introduced by the Finance Act, 2012 is expected to address certainty on transfer pricing.

Challenges to the binding nature of the rulings
For most part of the 90s, rulings given by the AAR were not appealed by invoking the writ jurisdiction, either by the taxpayers or by the Revenue. This changed with the landmark Morgan Stanley ruling with the Revenue challenging the ruling of the AAR before the Supreme Court. The trend has only exacerbated with both sides now seeking intervention of the SC almost routinely.

While no doubt this is a worrying trend and raises issues on the very purpose of the institution of the AAR, it has thrown up several procedural and legal questions.

To deal comprehensively with these matters, recently, the Supreme Court in the case of the Columbia Sportswear held that the AAR is a body exercising judicial power conferred by the Income-tax law and therefore, it shall have the status of a 'Tribunal' under the Constitutional provisions.

It also held that the binding nature of the rulings did not take away the jurisdiction of the Supreme Court or High Courts under the constitution to entertain a challenge against a ruling pronounced by the AAR.

More importantly, the Apex Court affirmed adherence to the principles of consistency and persuasive value of precedents; emphasising the twin crucial principles in the context of recent spate of inconsistent rulings. Though not evidenced in recent cases of inconsistent rulings by the AAR, the SC verdict could now make AAR more circumspect in deviating from its earlier decision on 'principles of law'.

Similar to Tribunal rulings, it would be allowed to deviate if there are distinguishing factual aspects in a taxpayer's case. On the flip side, the SC ruling will delay outcome of appellate remedy as the SC has directed that the appeals against an adverse AAR order should be filed before the jurisdictional HC. In my view, the SC missed an opportunity to clarify that the AAR cannot rule on transactions where it has prima facie formed a view that it is in the nature of tax avoidance. This is particularly relevant given tax administrations exuberance to argue against most applicants alleging tax avoidance.

Time to re-engineer
On an average, cases before the AAR are now taking disposal time between 12 to 18 months. Such delays have raised questions in the minds of the taxpayers on whether the forum is really an option for predetermination of tax liability for proposed transactions given that deal closures work in shorter timeframes. Uncertainty due to ambiguity from conflicting judgments poses a grave challenge to the fundamental objective of establishing AAR and is forcing applicants to re-look at their options.

With close to 200 applications pending for disposal and with growing complexity on international tax matters, applicants are merely expected to rise.

There is a pressing need to increase the capacity of the institution by considering multiple benches to deal with cases.

In the wake of recent amendments to Finance Act 2012, additional onus has now been placed on AAR to adjudicate on whether an arrangement qualifies as an 'impermissible avoidance agreement' in the context of GAAR provisions, should be implemented.

Without doubt, this is a welcome move, but it will merely add to the burden and unless drastic measures are taken to ensure consistency and speedy disposal, the AAR institution could become another cog in the wheel of India's overburdened legal system.

Mukesh Butani, Chairman, Taxand India

For further information please contact:
Abigail Tarren, COO
T. +44 (0)207715 5243
E. atarren@taxand.com

This article was first published in the Business Standard, 17 September 2012.

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