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India Braces for International Tax Jurisprudence

17 Jul 2011

Softer a State, greater would be the unholy nexus between the law makers, the law keepers, and the law breakers - observed the Supreme Court (SC) in a strongly worded order laced with anxiety. Passing an interim order appointing a Special Investigation Team (SIT) to pursue investigation into the issue of black money, the court expressed concern, not only on the quantum of monies stashed away in offshore banks, but also on the audacious manner in which such monies have been off-shored. Taxand India explores tax avoidance and tax evasion, and looks at the implemented 'toolbox of counter measures.'

The Supreme Court ordered that all organs of the nation, at central and state level, should extend cooperation necessary for the functioning of SIT and that the government can't seek protection under the tax treaty secrecy clause in situations of tax evasion.

The menace of unaccounted money has been well documented and understood by Governments of the World, International agencies, Organisation for Economic Cooperation and Development ("OECD"). Governments in various jurisdictions are attempting different measures to combat the menace through a slew of measures besides following guidance from G20 group and the OECD with respect to entering into international conventions for information exchange.

The US enacted laws as early as 1970 requiring financial institutions to keep records of cash transactions and report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. More recently, it announced an amnesty for US citizens to declare monies lying in offshore bank accounts. Germany amended its tax laws in 2009 providing for disallowance of payments made by German taxpayers to companies incorporated in specified jurisdictions that shield money from disclosure rules. Similar provisions were introduced by India called "toolbox of counter measures" in 2011 budget and made applicable from June 1, 2011. The Indian law is similar to Germany and directed to discourage transaction's with countries which do not cooperate (with India) in exchange of information. The Direct Tax Code (DTC) seeks to enact General Anti-Avoidance Rules (GAAR) which would empower the tax administration to declare a transaction as an 'impermissible avoidance arrangement' if it is not at arm's length and lacks commercial substance.

Whilst the toolbox of counter measures could help in a limited way in ensuring that funds do not flow to jurisdictions that don't cooperate with India on exchange of information, it is certainly not a game changing measure to prevent flight of unaccounted money. Such measures at best could trace flow of accounted money, but not unaccounted ones. Similarly, GAAR provisions deal with denying tax benefits enjoyed due to arrangements that lack commercial substance, but does nothing to deal with unaccounted money. Governments affidavits in the SC on legislating GAAR or enforcing transfer pricing principles to deal with black money is a misplaced notion. Transfer pricing and new enacted laws can trace the trail of accounted monies from India and into India which can transform into unaccounted monies in such tax havens, through use of complex instruments and intercompany holding structures. It still does not resolve the issue of bringing the accumulated unaccounted wealth.

An issue that often gets mixed up is the role, importance of tax treaties, its usage and misuse and the purpose it serves for development of cross border investments and trade. Lately, treaty structures have come under the scanner of the tax administration for its role in facilitating tax avoidance. The unending debate on future of India's treaty with Mauritius continues to cause anxiety in minds of the investors with inconsistent approach by the law makers. While it is well understood that the treaty exempts foreign companies (who are residents of Mauritius) from capital gains tax arising from sale of shares in India, can this be labelled as tax evasion? The jury is open, particularly given Friday's development in the Bombay High Court on availability of Mauritius treaty benefit. Over several decades, legal sophistry has well established this spectre of division between tax evasion and tax avoidance. While tax avoidance is legal, evasion is not. Tax administration assumes statutory right to decipher the true meaning of a transaction, but cannot substitute its legal effect by a perceived substance without concomitant anti-avoidance provisions. This has been a consistent position of Indian Courts unless of course there are cases of fraud where the Courts have pierced the corporate veil.

The Mauritius issue is being litigated by the tax administration despite the Supreme Court upholding the capital gains benefit in the Azadi Bachao Andholan (ABA) judgment of 2004. This ruling has not deterred the Revenue to file a special leave petition before the Supreme Court challenging a ruling of the Authority for advance rulings ("AAR") in the case of e-Trade Mauritius, wherein the AAR reaffirmed the capital gains benefit. Last week, Bombay HC in the case of Aditya Birla Nuvo took a view that capital gains arising from sale of shares held by Mauritius company (specific to the facts of the case) should be treated as arising to the ultimate US parent (and not to the Mauritius shareholder). Essentially, the HC has affirmed administration's stance to apply see through' provision despite there being none in law. This ruling has come as a shot in the arm for the tax administration and vindicates their position to continue with its pursuit to challenge the Mauritius shareholding structure.

However, when such vigour is shown by the Revenue on the Mauritius treaty despite the ABA ruling, there should be equal vigour in pursuing Liechtenstein bank account issue involving tax evasion. In that case, the Government sought to take shelter under the Treaty and its binding nature, which in the view of the Government, prohibits disclosure of information obtained from Germany. This argument was negated by the SC holding that the Tax Treaty with Germany does not proscribe the disclosure of documents, that the treaty had nothing to do with information received from Liechtenstein and that anyways the treaty allows the information to be used for public proceedings. It is important to note the difference in the approach of the Government on these issues. While an arrangement such as the Mauritius Tax Treaty already upheld by the SC is pursued and litigated, on the more critical aspect of pursuit of the black money, the Government has been found wanting by the SC.

Undoubtedly, India has not been a mute spectator and has aggressively pursued entering into agreements for exchange of information with several jurisdictions including tax havens such as British Virginia Islands, Bahamas and so on. The department of revenue has also undertaken measures to build robust information infrastructure by establishing overseas units and seconding senior IRS officers to such units and to the OECD.

Taxand's Take

These are important steps, but by no means a giant leap to deal with the evil of parallel economy. Would India be able to persuade tax havens to open their chamber of secrets? Efficacy of the SIT and oversight of the Apex Court would be the determining factor. Another clearer aspect is that the Apex Court will have to intervene in articulating principles on an important arm of tax law dealing with tax treaties, having regard to international conventions.

*First published in the India Business Standard Column, 18 July 2011.

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