The Modi govt has made some efforts to ensure tax certainty, but legacy issues will take time to clear up
In 1991, Manmohan Singh, the then finance minister, concluded the Union Budget speech by quoting Victor Hugo—“No power on earth can stop an idea whose time has come”. This quote was meant to signify the idea of India emerging as a major economic power. In 2016, India celebrates 25 years of its first major economic reforms, those that came in 1991. While we look back at the contours of the evolution of India’s tax regime, it is pertinent to mention that tax policies have not only been a measure for collecting revenues but have simultaneously been a stimulus for increasing investments into capital markets, attracting investments through fiscal incentives and also a measure to improve technological and scientific capabilities of the country.
After the 1991 liberalisation, India had to ensure a competitive environment in order to attract MNCs. The country saw the first set of direct tax reforms in 1991, when the Tax Reforms Committee (TRC) was setup. As the very first step, progressive taxation for non-corporate taxpayers was adopted. Domestic corporates were taxed at 40%; the rate was subsequently brought down to 35% and later to 30%. In Budget 2015, finance minister Arun Jaitley, proposed that the rate be reduced to 25% in four years.
India has seen several proposals that have turned around the entire construct of direct tax policy. Somethat have proved to be game-changers include the introduction of Tax Deduction at Source (TDS) provisions—which helped widening the tax base and ensured a regular stream of income for the government—presumptive taxation, shifting of dividend tax levy from investors to the companies, introduction of transfer-pricing norms and integration of fair market value concept to counter generation of unaccounted money. Another worthwhile mention would be the reintroduction of the minimum alternate tax (MAT) in 1996-97. MAT provisions have been successful in curbing the so-called ‘zero-tax’ companies; however, it simultaneously gave rise to one of the most vexing tax controversies, i.e., its applicability on foreign companies. Undoubtedly, this hit India’s image as a tax-friendly nation. However, in September 2015, the MAT controversy was laid to rest when the government accepted the recommendations of Justice AP Shah Committee and scrapped its applicability on FIIs.
With MNCs’ participation in the Indian economy increasing, cross-border transactions increased rapidly. To counter and prevent erosion of the tax base, India introduced the international transfer-pricing (TP) norms in FY02—these were supposed to ensure cross-border transactions between associated enterprises were undertaken only at arm’s-length pricing. Government reports show that the cumulative value of TP adjustments was R 2,700 billion till FY15. Recognising the increase in TP adjustments and consequent litigation, the government, in 2012, introduced the provision of Advance Pricing Agreement (APA), thereby giving taxpayers an opportunity to mitigate tax controversies. Initially, this was only limited to unilateral relief. Starting 2015, the wall around unilateral APAs was finally broken and conversations began for executing bilateral APAs, with roll-backs.
As we recapitulate the Indian direct tax reforms, the Finance Act of 2012 deserves a mention because it introduced several retrospective amendments on indirect transfer taxation and software taxation. These were made to counter the Supreme Court (SC) judgment on the tax demand raised by the government on the Hutch-Vodafone transactions and high court rulings upholding the view that the payment for sharing-wrapped software do not constitute royalty under the Indian tax laws. The government, however, had other concerns. The tax department estimated it would lose about R40,000 crore in revenue from Vodafone-type deals following the SC decision. The government, looking for revenues to meet mounting expenses, introduced tax on indirect transactions. This action was roundly criticised by industry captains around the globe.
The Modi government, elected with an unprecedented mandate, faced the uphill task of providing a certain, stable and non-adversarial tax regime. While it has given repeated assurances of a stable and predictable tax reforms, there is still some time before India fully recovers from the legacy uncertainties. Tax litigation, on the one hand, is yet to see any major reform—this is primarily dependent on structural and functional efficiencies of the executive. Data revealed by the Tax Administrative Reforms Committee (TARC) report shows staggering statistics with respect to outstanding disputes, with approximately 2.6 lakh cases pending at several levels in FY13. To be sure, the government has adapted several alternate dispute resolution mechanisms such as the Dispute Resolution Panel (DRP) and Settlement Commissions for speedy resolution of disputes—however, they have not turned out to be effective so far. On the other hand, the generation and circulation of unaccounted money has remained a concern, even prior to liberalisation. There have been several initiatives and policies to counter the parallel economy, but very few have been effective. Though it is too early to tell, the black money law introduced in 2015 hopefully should bring some discipline.
Is the Indian tax law (as it exists today) well-equipped to deal with the complexities of the modern-day business environment? Certain efforts were made on this account, notably the 2013 introduction of the Direct Taxes Code which was, however, withdrawn subsequently by the government. The country is also looking at the OECD’s framework (BEPS) to prevent tax-base erosion. With the introduction of the General Anti-Avoidance Rules (GAAR)—scheduled for implementation in FY18—alongwith the recent amendments in the 33-year-old tax treaty between India and Mauritius, India has sent a strong message of its commitment towards a source-based taxation policy.
Undoubtedly, going forward, as Indian transforms into a developed economy, tax policy are likely to be significantly influenced by the international community in comparison to what existed prior to liberalisation. Indian tax evolution, in the coming years, should usher in a progressive regime, and for this, tax administration reforms are essential.
With inputs from Puneet Gupta, associate director, and Vignesh Iyer, associate, BMR & Associates LLP
The author is leader (direct tax), BMR & Associates LLP. Views are personal