AAR versus tax authorities

Written by Milan Shah | Updated: Feb 28 2014, 08:29am hrs
Certainty and clarity are cornerstones of a good law, especially income tax law. In recent times, one has seen how this desired element of income tax law significantly influences flow of foreign direct investment decisions globally, including in India.

The Indian income tax law has created forums like the authority of advance ruling (AAR) and, most recently, advanced pricing agreements with a view to provide foreign companies and non-residents certainty and clarity on the taxability or otherwise of any transaction undertaken or proposed to be undertaken in India. Since the rulings given by AAR are binding on the Indian tax authority as well as the taxpayer seeking the ruling, the AAR forum was also intended to reduce long-drawn litigations in India.

AAR is an alternative forum available to foreign investors to get fast-track adjudication on any issue as against the normal course of filling tax returns before the tax authority. Considering the possible overlap in exercising jurisdiction on the same issue, the Indian income tax law provides a bar on AAR from admitting any application seeking advance ruling, if any issue or question raised in such application is already pending for adjudication before the tax authorities.

Under what circumstance one can consider that an issue already pending before the income tax authorities has been a matter of controversy Would mere filing of a tax return before filing of an application before AAR trigger this bar on AAR or only where the tax authorities have initiated tax assessment on the basis of such tax return filed, the bar on AAR applies

The tax office has been opposing admission of an application before AAR in cases where a tax return has been filed before filling of AAR application, arguing that by doing so the applicant has opted for adjudication before the tax authorities instead of AAR. It was argued that, in such cases, the issue is already pending before the tax officer and, thus, such cases cannot be decided by AAR. Substantial number of applications before AAR were caught in such controversies, creating an atmosphere of uncertainty and confusion.

AAR has delivered divergent rulings on this controversy. In some rulings, AAR has held that only in circumstances where a tax officer has already acted on any tax return filed by a foreign company or a non-resident (before filing of the AAR application) by initiating tax assessment proceeding, the bar against AARs jurisdiction on deciding an issue already pending before tax authorities gets triggered. In certain other cases, AAR held that by filling of a tax return before approaching AAR, the applicant is inviting the tax officer to exercise his jurisdiction, which makes the issue raised before AAR already pending before the income tax authority and hence AAR cannot decide on such applications.

Due to divergent rulings from AAR, the foreign investor community were caught in a catch-22 situation. It was expected that the higher courts would provide the required clarity on this issue or the government would bring the required clarification in income tax law itself. The Delhi High Court, in a particular case, decided the issue in favour of tax authorities, holding that once a taxpayer proceeds to consciously file a tax return before approaching AAR, the jurisdiction of AAR to entertain such an application for advance ruling is taken away.

As expected, this Delhi High Court decision was challenged before the Supreme Court, which has recently delivered its decision, and has decided to set aside the Delhi High Court decision and restored the matter back to AAR for a fresh ruling considering recent favourable ruling of AAR on this subject. The Supreme Court has not expressly laid down the law, which could have been the ideal situation to lay the controversy to rest. Nevertheless, one will have to now wait and see how AAR decides in this case, in light of the Supreme Courts directions. Interestingly, subsequent to this Supreme Court decision, AAR in a recent ruling (but in a different case) has held this issue in favour the taxpayer upholding the position that filling of a tax return prior to the AAR application does not act as a bar on AARs jurisdiction, unless the tax officer has already initiated tax assessment proceedings.

In the above case, where Supreme Court has given directions to AAR to decide the matter afresh in accordance with the law, it is likely that AAR may decide this issue in favour of the taxpayer by following its recent favourable rulings. One also hopes that once AAR comes out with favourable ruling, the tax authority would also accept it and would not challenge further in a court of law, which will help in settling the long-standing controversy to rest on this issue. Alternatively, the government should bring out the required clarification on this issue by amending the Indian income tax law, to set this controversy to rest once and for all.

(With inputs from Darshan Shah, associate, PwC India)

The author is associate director, Tax & Regulatory Services, PwC India. Views are personal