- Capital Gains Tax (CGT)
- Direct Tax Code (DTC)
- Tax Avoidance and GAAR
- What is Transfer Pricing?
- What is Arm’s Length Price?
- Advance ruling
Sidenote: Madhya Pradesh MPPSC prelim hallticket uploaded click me.
After Budget 2014, six terms in news:
- Transfer Pricing
- Advanced Pricing agreements (APA), roll back provision
- Arm’s length price
- Advance Tax Ruling
- Direct tax code
- GAAR, Shome Panel
All of them aim to reduce tax litigation, have direct-indirect connection with Vodafone case. So let’s refresh those old concepts.
- is a direct tax
- Levied on profit, when you sell capital assets (shares, gold etc)
- Matter falls under IT department, because it’s a direct tax.
|applies to||doesn’t apply to|
More given in the appendix, about short term vs long term CGT.
- Assume Kishor Biyani wants to sell Pantaloon company to Kumar Mangalam Birla at profit of 1000 crore and has to pay 100 crore CGT to income tax department.
- In real life, seller (Kishor) himself doesn’t need to pay 100 Crore CGT to Government.
- Buyer (Birla) will have to keep aside 100 crore for government, and pay only 1000-100=900 crores to Biyani. Observe following photo
This is called withholding norms or Tax deduction at source (TDS).
Question: If income tax department doesn’t get the tax, then whom should they send notice- Buyer or Seller?
Ans. Buyer. Birla in Pantaloon deal and Vodafone in Hutch deal.
- Hutchison (Hongkong) own a company called CGP investment Holding ltd, (Cayman Island)
- CGP owns 67% shares of Hutch-Essar India.
- Vodafone (HQ London), tells its subsidiary in Netherland, to purchase Cayman Island Company from Hutch (Hongkong) for the price of 11 billion dollars (~55k crore rupee that time)
- Now Vodafone owns CGP, therefore, and thus indirectly owns Hutch-Essar India also. Because CGP owned 67% shares of Hutch Essar India.
Ok so what’s happening?
- A buyer (Vodafone) has (indirectly) purchased shares (of an Indian company) from a seller (Hutch).
- So, does Buyer (Vodafone) have to pay Capital Gains Tax, in India?
|Vodafone’s version||Income Tax Department says|
Matter goes to Income tax Appellate tribunal (ITAT) and then to court:
Then Finance Minister Pranab doesn’t like it. Not one bit. So, he issues a clarification in IT act.
- We can demand Capital gains Tax, when a foreign company is sold. IF that foreign company’s value is derived from Indian Assets. (e.g. CGP valued at 55k crore, because it owned HutchEssar India’s shares).
- Then, for tax purpose, we’ll consider them Indian companies, and demand capital gains tax.
- This provision will apply to all deals from 1962 onwards (hence called “Retrospective”.)
So, even after winning case in Supreme court, Vodafone’ trouble did not end.
Income tax department again sends notice for the same Capital gains tax.
Direct Tax Code aims to replace the Income Tax Act of 1961
|2010||DTC Bill introduced. Sent to Parliament’s standing Committee on Finance. Committee proposed changed.|
|2014, March||Chindu uploads revised (draft) Direct Tax Code 2013 on Finance ministry website, to seek juntaa’s opinion on it.|
|2014, May||Direct Tax bill lapses with “THE END” of 15th Lok Sabha.|
Then, should we prepare DTC for exams?
- Economic survey 2013: recommended implementing DTC.
- Budget 2014: Jaitley said “we’ll implement DTC, after reviewing juntaa’s comments and consulting with experts.”
DTC aims to fix discrepancies in Income Tax Act, so that Vodafone like cases, do not happen again. Under DTC:
- “Indirect (asset) transfers” will be taxed in India, IF the companies involved, have at least 50 percent of their assets located in India.
- For example, Vodafone bought CGP investment ltd for ~55k crore rupees, because CGP owned 67% shares of Hutch-Essar India.
- Therefore, income tax department can demand Capital gains tax from Vodafone. (recall: Buyer pays CGT)
Limitation: what if they create three separate post box companies each owning 30-30-30%!
DTC also provided tax on “software Royalties” (with respect to that Nokia case click me)
|taxable income||Budget 2014||DTC proposed|
|2.5 lakh to 5 lakh||10||2 lakh to 5 lakh slab: 10%|
|>5 lakh-upto 10 lakh||20||20%|
|dividend >1 crore||—||additional 10%|
|1% Wealth Tax,For assets above 30 lakhs||Yes, but only on physical assets.||Wealth tax on both:
- DTC also provide plus higher slabs to senior citizens, and many other technical reforms.
- More on budget 2014’s direct-indirect taxes in separate articles. So far we’ve learned; what is CGT, How Vodafone avoided CGT, What’s the provisions in DTC to prevent such cases in future?
Moving to next topic
|Tax Evasion||Tax Avoidance|
|Income, sell-purchase is hidden from tax authorities.||all deals open- mentioned in their account books and shareholder meetings.|
|Example: builder sells a property for 10 lakh, but accept only 1 lakh via cheque, remaining 9 lakh via cash. (to evade stamp duty).||Example: this Vodafone case. They purchased an Indian company (Hutch-Essar) via purchasing an intermediary company (CGP) in a tax haven.|
|Income tax act already has clear cut penalties for this.||
Vodafone isn’t the only company that has avoided tax.
|MNC giant||Bought Indian Company||Via intermediary in|
|Vodafone||Hutch Essay||Cayman Island|
|Sanofi Aventis||Shantha biotech||French|
|General Electric||GenPact India.||Luxemburg|
- Like ^this, MNC giants have avoided ~40,000 crore rupees of capital gains Tax from India. This money could have been used for financing fiscal deficit, inflation control, and Sarkaari schemes!
- Therefore, Government decided to make new rules to stop this menace.
And, thus we come to next topic:
- General Anti Avoidance Rules.
- Originally mentioned in Budget 2012. They were to be implemented from 1/4/2014.
- IT commissioner take action against business deal made outside India, to avoid taxes.
- He can send notice to Indian Citizen, NRI, Foreigners, to recover such money:
- Even if they’re living outside India.
- Even for retrospective deals i.e. deals happened before GAAR was implemented
- Even if deals protected under any Double taxation avoidance agreement treaty.
- Burden of proof lies with the party and not IT commissioner i.e. Company has to explain their deal is genuine.
- IT commissioner has to decide the case within 12 months. Aggrieved party can approach Dispute resolution Panel (DRP) => Income Tax Appellate Tribunal (ITAT) => HC and finally Supreme Court.
- GAAR not a completely new invention. China, Australia, Canada, New Zealand, Germany, France, S.America etc already have similar concepts.
Obviously MNCs wouldn’t like it. Not one bit. They lobbied hard, finally government setup a panel under Parthsarthi Shome Panel to review the GAAR rules.
- IT commissioner should send notices only in rare cases- where he can recover more than 3 crore rupees.
- GAAR should not be used for filling revenue shortfalls. Revenue shortfall occurs when government’s revenue collection is less than expected because of inflation, policy paralysis, global slowdown etc. So in such cases, GAAR should not be used for extracting more money from corporates to finance Bogus Sarkaari schemes.
- For retrospective cases- only recover tax dues. Don’t demand additional penalty and interest rate on such retrospective cases.
- Exempt the buying/selling of company shares from Capital gains tax. Better just increase the Securities Transaction Tax (STT) on buying/selling of such shares. Then, there is no litigation about “CGT evasion via post box company”. Problem permanently solved.
- Don’t implement GAAR from 2014. Implement it from April 2016.
For more GAAR features, pro and anti arguments click me
|Budget 2013||Chindu says we’ll implement GAAR from 1/4/2016|
|Sept 2013||Chindu says following
|Budget 2014||Jaitley silent on GAAR|
So far, we learned
- CGT, Vodafone Hutch deal.
- DTC, GAAR to prevent Vodafone like cases in future.
Now next two topics: Transfer pricing and advance ruling. These are also in context of Vodafone
Recall the original concept of CGT & TDS:
- When a capital asset (shares) are transferred from seller (Kishor Biyani) to Buyer (K.M.Birla) => then Buyer has to withhold / deduct the capital gains tax for government.
- Biyani and Birla are two unique businessmen / promoters. So, when share transferred from one person to another, we can hope the share price are decided by market forces of supply, demand and speculation.
- BUT WHAT IF two subsidiary companies transfer shares to each other, and play mischief.
Vodafone London has two subsidiaries:
- Mauritius: Vodafone Teleservices India Holding Mauritius.
- India: (Call center) Vodafone India Services (VISPL)
|What Vodafone says?||What IT Dept. says|
- Vodafone transferred its call centre shares from India to Mauritius at an undervalued price
- this was one type of hidden loan / secret transfer of profit.
- IT dept wants capital gains tax on this.
That’s the Vodafone Transfer Pricing issue. Case pending in Income Tax Appellate Tribunal (ITAT).
Shell India, also caught in similar controversy.
Jaitley made new reforms in Budget 2014, to reduce the transfer pricing related litigations, and enhance MNC confidence to invest in India.
Advance pricing agreement (APA) is an agreement between:
- Tax payer (Vodafone)
- Tax authority (IT department)
For deciding transfer price OR arm’s length price in advance.
|IT Commissioner||Yes, but Only if __ bottles of desi liquor are provided to our staff.|
|Vodafone CEO||But I’m a foreigner, I do not know any local dens! I can get you finest Vodka, Cognac and Champaign!|
|IT commissioner||That’s not my problem. We only prefer Swadeshi. IF you want to operate in India, then you have to respect our culture (GS1) and tradition.|
Enough cheap jokes back to topic:
- APA concept introduced in Income Tax Act from 2012.
- Ok then what is Jaitley’s innovation in 2014?
Means, If Vodafone and IT Dept. sign an APA agreement right now, its (share pricing) methodology can be applied for solving pending cases upto last four years.
|before||after budget 2014|
|Only previous one year’s data could be used for deciding the price.||Jailed permitted use of multi-year data for better comparative analysis. (so that pending litigations upto last 4 years can be decided)|
on a related topic:
- Arm’s length price, is the price at which two unrelated parties will make a deal. (Say Kishor selling shares to Birla at 1000 crores).
- Since these two parties are unrelated, hence market forces of supply-demand will work, the (share) price will be rational.
- So, government will get the full tax it deserves.
- When MNC giant’s one subsidiary company makes deal with another subsidiary company- they’re related with each other (because main boss is the MNC).
- In this case, deal pricing may not be rational.
- Government may not get full tax it deserves.
Therefore, government wants to ensure that following two prices are same. For example:
|Inter-company price / Transfer price||Arm’s length price|
|when Vodafone’s Mauritius arm sells its Indian call centre shares to Vodafone’s Netherlands arm||Price at which Kishore would trade his Vodafone callcentre shares with Birla?|
Let’s try a Mains questions:
Q. Discuss advance pricing agreements, and their role in promoting foreign investment in India. (200 words)
- When two subsidiary companies of the same MNC giant, make a deal, there are chances of price manipulation to reduce tax liability, as it allegedly happened when Vodafone’s Indian arm transferred the shares to Mauritius arm. Resulting into a lengthy litigation between Vodafone and Income tax department of India.
- 2012: Government provided for advance pricing agreement in Income tax Act.
- APA is an agreement between tax payers and tax authorities.
- It validates the transfer pricing between two interrelated companies and ensures that it is equivalent to an arm’s length price.
- 2014: Government further reformed APA system, to provide “roll back“ in APA agreements. Now APA agreements can sort out pending litigations up to past four years using multi-year data analysis for share pricing.
- Thus, APA is a win-win situation for both parties- tax authorities get their legitimate dues and companies become immune to future litigations. This clarity and continuity in tax policies will aid in bringing more foreign investment in India.
- Jaitley also discussed this in budget-2014.
- This topic not directly related to Vodafone.
- But it’s easy to make silly mistakes between APA vs advance ruling. so let’s check it out:
What is Advance Tax Ruling?
- Suppose a foreign company enters India via Joint Venture / Subsidiary / etc.
- But India has a complex tax structure, the foreign company may need clarification in advance, on the Taxes that may apply to its business.
To help foreign companies, Government setup a body called….
- It’s a statutory body Under IT Act. Started from 1993.
- composition: Retired SC judge and two government officials (of Addl.Secretary rank)
- Foreign company can file application to AAR, to seek clarification on its tax liabilities.(Fees: 2500 rupees.)
- Timeframe: AAR has to reply within 6 months.
- AAR ruling binding on both company (Tax payer) and Income tax department. IT officials cannot send notices/raids if AAR already rules in advance that xyz matter is exempted. (Although IT officials can approach HC and SC to challange AAR rulings)
- Thus, AAR provides clarity on tax structure in India. Promotes “Ease of Doing business”.
- Speedy decisions, Avoids lengthy court litigations.
Ok then what’s new?
|BEFORE||After budget 2014|
|only (nonresident) Foreign companies could approach AAR to seek coaching clarification.||Even Indian companies can approach AAR.|
|Committee 4 Tax clarity||High level Committee under CBDT|
- Apart from this, Economic Survey and Jaitley mentioned many bodies such as productivity commission, Expenditure Management commission etc. But we’ll see them in future articles because they’re not directly related with tax litigations like Vodafone.
- More than 4 lakh crore worth tax money cases stuck in litigations. In this article, my purpose was to cover the bodies/reform that’ll aid in that regard.
Some side topics:
How much CGT do you have to pay? That depends on “Duration”.
|Suppose I bought a gold-bar, diamond, house, Picasso’s painting or DEBT-mutual fund today, and sell It in less than three years (with profit)||
|same case, but I sell after three years (with profit)||Long term capital gains tax (20%)|
- Meaning, two CGT rates depend on duration for which, you own the asset.
- But there is slight change, if you buy/sell shares and (Equity) mutual funds:
|SHORT TERM||LONG TERM|
|within 1 year||after 1 year|
- Equity mutual funds: people pool their money, and mutual fund manager invests it in shares.
- Debt mutual funds: people poor their money, and mutual fund manager invests it in bonds.
Q. Does 3% education cess apply?
Yes education cess applies.
So far Vodafone is caught up in two cases
|Hutch Essar CGT||Transfer pricing of call centre|
- In August 2013, Chindu offered “Conciliation” (e.g no need to pay 20k crore, just pay ___ crore in ___ installments, and IT dept will free you from this case.)
- Initially Vodafone agreed, but then demanded conciliation “Discount” for both Hutch case + call centre transfer pricing case.
|Vodafone||Then I want both dispute to be settled outside India, under UNICITRAL law.|
|Chindu||Sorry, can’t accept. (thus, conciliation talks collapsed)|
|Vodafone||Then I want this dispute be handled under India-Netherlands Bilateral Investment Protection and Promotion Agreement. (BIPA)|
|Chindu||That agreement will not protect you on that call centre case. You’ve deliberately undervalued share prices.|
|Vodafone||Only time will tell.|
- April 2014: Vodafone Sends notice to government in April, 2014, wanting the case handled by an International arbitrator at London, as per the provisions of Netherland BIPA.
- June 2014: Government appointed former Chief Justice of India R. C. Lahoti as arbitrator. He’ll look only at Hutch CGT case. And NOT at the call centre transfer pricing (Because that matter still pending.)
I’ll set Mock MCQS later. My first priority is to cover the “Content” of budget + economic Survey.