TAX JOURNAL 2012 Low Resolution

A compilation of our published thought leadership

Taxation in India 2011-12

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9 | An important step to revamp complex structure of DTC Sudhir Kapadia looks forward to an efficient tax regime in India as he discusses the recommendation of the Standing Committee.

11 A ‘retrospective’ play on words The word ‘retrospective’ played ploy in the recent budget. Rajiv Memani elaborates on the proposed change in the definition of capital asset, transfer and scope of income with retrospective effect.

14 | Ensure GAAR doesn’t cause hardship to taxpayers General Anti-Avoidance Rules (GAAR), though introduced with an aim to counter tax avoidance schemes and codify the concept of “substance over form” in law, Hitesh Sharma stresses that the government must ensure such widely-scoped provision does not cause undue hardship to taxpayer and bona fide tax-planning is not challenged.

16 | Budget 2012-2013: An analysis According to Ganesh Raj, Budget 2012 though promises that reforms will be continued and fiscal numbers will be kept in check; still non-tax revenue can again fall short due to uncertainties around disinvestment and telecom spectrum sale.

Personal Tax

21 | Of death and taxes Amitabh Singh gets into a conversation about the repercussions of inheritance taxes.

24 | DTC to widen wealth tax net While looking forward to an efficient tax regime with DTC, Mayur Shah dwells into the fact how wider asset coverage for wealth tax, may eat up the savings.

26 | How much tax is payable on global income? Liberalisation opened up a world of investment opportunities for Indians, but these are not tax-free luxuries writes Shalini Jain.

29 | Will court rulings on PF affect you? Sonu Iyer analyses the change in calculation of PF and take home salary with Madhya Pradesh & Madras high court ruling to include conveyance allowance and special allowance to the basic wages.

32 | Weigh DTC provisions while choosing tax saving instruments DTC has suggested some major changes in the way tax saving instruments are positioned, Amarpal Chadha lists down some of the key proposals under the DTC which could impact your investment decisions.

Feature articles

Contents

Indirect tax35 | Advance ruling under indirect tax

Saloni Roy emphasizes that the Central Government should reconsider aligning the provisions relating to advance ruling under indirect tax laws with the scheme prevailing under income tax.

38 | A better goods and services tax Harishanker Subramaniam (Hari) elaborates on how negative list of services and place of supply rules are a precursor and an interim step towards implementing the GST in the near future.

40 | Burden of fiscal consolidation falls on tax system, again In Budget 2012, the only measure which could be viewed as a significant stepping stone to the GST is the Goods and Service Tax Network (GSTN), feels Satya Poddar.

43 | Budget takes India inc closer to GST Vivek Pachisia fears that the increase in tax rates and the widening the tax base through the negative list based taxation would increase the cost of living for the common man.

46 | Pluses in the negative list Budget 2012 has proposed a paradigm shift in the way services are to be taxed in India and if the proposals are accepted then all kinds of activities, except those in the negative list, would become taxable, suggests Bipin Sapra.

International tax

49 | Importance of transfer pricing documentation Vijay Iyer stresses on the need for a robust Transfer Pricing documentation in order to win TP controversies within time.

52 | Transfer Pricing and intangibles Ernst & Young report highlights the increased focus of audits to the transfer of intangibles, Vijay Iyer outlines the key points from OECD scoping paper on the subject that can help resolve the issue.

54 | Reducing cross-border tax disputes It has become crucial to effectively unlock the key to lengthened tax disputes and evolve new juristic standard for their speedy resolution says Prashant Khatore.

57 | Going back in time is no good Though retrospective amendments proposed in the Budget 2012 clouded much of the industry discussion, Jayesh Sanghvi dwelled deeper and elaborated on positive amendments like Advance Pricing Agreements (APA) and transfer pricing.

60 | Pause before P-Notes Hiresh Wadhwani is of the view that uncertainties in tax positions could deter FIIs from issuing P-Notes, which could adversely impact foreign fund inflow to the Indian capital market; thus clarity and certainty on the issue of P-Note taxation is the need of the hour.

62 | Mauritius structures — gazing through a crystal ball The India-Mauritius Tax Treaty which had underpinned the emergence of Mauritius as the dominant channel for FDI into India, Vidya Nagarajan feels that the country has been under constant scrutiny by Indian tax authorities as a result of alleged abuse by investors.

Transaction tax65 | New ring to tax tale

Amrish Shah debates that taxation of Cross-border transactions may result in a temporary spurt in revenue for the Government, but it could also have an adverse impact on investor sentiments and hamper future FDI flows into India.

69 | Options that change investment status Amrish applauds DIPP on the revise of its earlier provision that sought to define equity investment as debt, if it was accompanied by in-built options, while also emphasize that the other regulators should follow suit.

71 | The new M&A horizon Narendra Rohira feels that with the new Companies Bill 2011, cross-border mergers will only be allowed with companies situated in jurisdictions notified by the Central Government.

Tax and regulatory policy

75 | Is grip tightening on black money? The issue of tax evasion, or black money, continues to occupy centre stage in the country. Sudhir Kapadia, discusses recent steps taken by various countries, including India, to tackle tax evasion in general and offshore tax evasion in particular.

78 | New regulatory framework for private investment vehicles The proposed framework by SEBI for private funds is restrictive as per Prakash Shah & Chaitrali Kamat, since its wide to cover offshore funds investing in India, while and on the other hand the intent is to regulate the domestic funds.

82 | Alternative investment funds: hits and misses SEBI’s proposal to introduce, Alternative Investment Funds (AIF) will be useful only if it enables them to compete with their global peers, say Sudhir Kapadia and Subramaniam Krishnan in their exclusive review.

84 | One-time amnesty for swiss stash Government often toy with the idea of introducing one-time amnesty to bring back the Swiss stash, Sudhir Kapadia dwells in if it would that be an effective idea to implement?

87 | Tax transparency is the new reality Pranav Sayta lists down the fine points of the amended protocol to the India-Swiss DTAA.

90 | New SEBI takeover code finally notified The new takeover code notified is a revolutionary legislation, feels Amrish Shah as it is likely to change the landscape for M&As of listed Indian entities in the near future.

94 | The big push for big retail India’s retail market promises to be among the top retail destinations in the world, undoubtedly FDI in the sector garner much of interest. Paresh Parekh briefs on the possible impact of the proposed change in FDI in retail.

97 | 3G of tax reforms Satya Poddar elaborates on the third-generation tax reforms that are rationalisation of the direct and indirect taxes levied by the Centre, broadening of their bases, and lowering of the statutory rates.

Specials101 | The path to globalisation compliance and reporting

Rahul Kashikar draws that a more rationally organised, efficient and controlled compliance and reporting function is required on a global front, which would help in combating regulatory risks and unexpected costs.

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Sudhir Kapadia

Rajendra Nayak

Prashant Khatore

Bipin Sapra

Editorial board

Rahul Kashikar

Shalini Mathur

Rahul Patni

Subramaniam Krishnan

Ashwin Vishwanathan

Chaitrali Kamat

Tejas Mody

Cynthia Dalmeida

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dThe world has changed dramatically in the space of just a few years. The effect on tax policy has been startling, overshadowing longer-term tax trends. Tax authorities have become significantly more assertive in examining cross-border activities. Tax administrators and legislators, under pressure to generate more revenue to balance debt-laden budgets and fund infrastructure and social programs, acknowledge that they are more committed than ever to enforcing existing tax law and creating new enforcement mechanisms.

From an Indian perspective, the fiscal year 2011-12 began with signs that indicated that the Indian economy has emerged with remarkable rapidity from the slowdown caused by the global financial crisis of 2007-09. However, recent macroeconomic data indicates that some clouds continue to linger. Managing growth and price stability are the major challenges of macroeconomic policymaking. In 2011-12, India found itself in the heart of these conflicting demands.

Tax executives, tax administrators and tax policy-makers have perhaps never been in such agreement: converging trends have created the riskiest environment for tax controversy the world has experienced in years. The next five years will likely be every bit as volatile and evolutionary as the last half-decade.

Sudhir Kapadia National Tax Leader Ernst & Young, India

To enable a deeper understanding of some noteworthy tax and regulatory developments in the year gone by, we are glad to bring forth to you Taxation in India 2011-12. It is a select compilation of analysis that our thought leaders and experts shared with the market in some of the leading tax and business publications on the developments between July 2011 and May 2012. The publication contains a compilation of articles ranging from personal taxation, indirect tax, transfer pricing, tax & regulatory policy, taxation of cross-border transactions and M&A taxation.

The past year has witnessed a dizzying array of tax legislation, reforms and stepped up tax enforcement efforts. The pace of change may only accelerate as Governments and businesses reflect on lessons learned from the global economic crisis. With the scale of the changes that are underway, we hope this publication stimulates your thoughts, helps you prepare for the dynamic future ahead of us.

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Corporate taxThe Indian corporate tax arena has witnessed several developments in the last fiscal year, the highlight of which appears to be the significant changes brought in by the Finance Minister as part of the Union Budget 2012 (Budget) proposals. A plethora of amendments, some of which are introduced with retrospective effect have not gone well with various stakeholders.

This section analysis these as also the report of the Standing Committee on Finance on major aspects of the direct taxes code (DTC), that seeks to comprehensively replace the present tax law. The Budget also proposed to introduce a general anti-avoidance rule (GAAR) to address aggressive tax planning. Thankfully, the start date for application of GAAR has been deferred by a year, and would now apply from 1 April 2013 (i.e. tax year 2013-14 onwards).

9 | An important step to revamp complex structure of DTC11 | A “retrospective” play on words14 | Ensure GAAR doesn’t cause hardship to taxpayers16 | Budget 2012-2013 - An Analysis

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An important step to revamp complex structure of DTC

Sudhir KapadiaEconomic Times, 10 March 2012

The Standing Committee has finally spoken on major aspects of the direct taxes code, or

DTC, including a direct critique on its very structure. The Committee notes, the overarching objectives of the DTC to make tax laws simple and comprehensible yet the structure of the DTC whereby large number of schedules containing detailed provisions are relegated at the end of the main body of the Bill would only create more confusion than clarity.

The Committee has, therefore, recommended a complete relook at the structure of the DTC to make it more user friendly. (One wonders whether this recommendation alone would ensure that the duly revised DTC cannot see the light of the day in time for its immediate implementation.)

The other heartening recommendation of the Committee is to note the unfettered discretion sought to be granted through the rule making provisions in the DTC to the Tax authorities. For instance, in relation to the General Avoidance Agreement Rules ( GAAR),

the Committee has specifically recommended that the onus of proof of tax avoidance should rest with the tax authorities and not the tax payer.

The Committee has recommended that suitable grandfathering provisions should be made to protect the interest of the taxpayers who have entered into structures and arrangements under the existing law.

Another welcome aspect of the Committee’s report is affirmation of the Corporate tax rate of 30% and a thumbs up to ‘investment linked’ incentives as opposed to ‘profit linked’ incentives. Interestingly, the Committee has gone on to suggest provisions which are presently missing in the DTC for eg, the aspect of accountability of Assessing Officers and the exaggerated assessments and additional demands without sufficient grounds raised by the Assessing Officers has been noted by the Committee.

The Committee has made a radical suggestion of taking disciplinary action against those Assessing Officers who have raised unreasonable tax demands

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Sudhir has functional specialization in International Tax and over 20 years of varied experience in advising companies. Sudhir also leads the client relationship management agenda for our tax practice and is the senior tax advisory partner for a number of firms’ leading clients. He is a regular speaker at key national and international events and actively contributes to thought leadership in the areas of international taxation. He is based in our Mumbai office.

You can write to Sudhir at: [email protected]

Sudhir KapadiaNational Tax Leader Ernst & Young, India

The Finance Bill, 2012, had included provisions to introduce GAAR. However, based on representations made by various stakeholders and the recommendations of the Standing Committee, the GAAR provisions have been deferred by a year and will now apply from 1 April 2013. Further, as recommended by the Standing Committee, the primary onus of proving that the arrangement is an impermissible avoidance arrangement now vests with the tax authority and not the taxpayer. In addition, while the Finance Bill, 2012 had proposed that the GAAR Approving Panel will comprise not less than three members consisting of officers of Commissioner rank and above, an amendment has been made to provide that the panel will also include an officer of the Indian legal service, at least of the rank of the Joint Secretary to the Government of India.

based The Committee has made a radical suggestion of taking disciplinary action against those Assessing Officers who have raised unreasonable tax demands based on irrational tax assessments which is perhaps of the first of its kind ever in the history of parliamentary recommendations in India.

Another important recommendation of the Committee is to allow for tax consolidation of group entities to eliminate multiple levels of taxation of income generated within the group and reduce compliance costs.

This is a far reaching suggestion which should be duly incorporated in the DTC. Finally, the Committee has recommended setting up of special fast track courts comprising of experts to dispose of the plethora of pending cases. It is not clear as to whether this is to be a one-time mechanism or a sustainable solution to reduce the time taken in litigation.

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Reprinted with the permission of Economic Times © 2012. All rights reserved throughout the world.

An important step to revamp complex

structure of DTC

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A “retrospective” play on words

Rajiv MemaniMint, 17 March 2012

I must be cruel only to be kind”—when finance minister Pranab Mukherjee quoted these words

from Hamlet in his budget speech on Friday, little did we realize that he would be so true to these words.

One of the provisions in the budget that has taken industry by surprise is the proposed change in the definition of capital asset, transfer and scope of income with retrospective effect. The Bill clarifies that an asset or capital asset being any share or interest in a company or entity outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.

While the government’s intent to tax transactions similar to those in the Vodafone case involving indirect transfer of Indian assets is understandable, it puts a question mark on several other judicial pronouncements in tax cases. Further, the finance Bill contains a validation clause that would operate irrespective of any judgement or decision on the matter. This proposal will have an impact on attracting foreign investment into India.

As if this was not enough, a plethora of retrospective changes has been proposed in the Bill. For instance, the expansion in the scope of royalty for right to use property is effective from 1976, whereby the right to use computer software has been covered (including granting of a licence), irrespective of the medium. Being a retrospective change, it will have the effect of overruling many favourable judgements on software taxation, where sale of standard software supplied by non-resident vendors has been considered as out of the ambit of royalty taxation. Further, the definition of process has been modified to include transmission by satellite, and hence, covered under royalty.

Extensive GAAR (General Anti-Avoidance Rules) provisions have been introduced, which shall result in declaring a transaction as “impermissible avoidance arrangement” where the transaction lacks commercial substance. The scope of these provisions is even wider than that suggested in the direct taxes code. Woefully, the pragmatic suggestions of the parliamentary standing committee have also been ignored. While the

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fine print of the provisions remains to be seen, broadly the provisions shall have impact on the classification of equity and debt, classification of capital and revenue transactions and recharacterization of any expenditure.

A welcome feature has been the announcement related to the introduction of the advance pricing mechanism. This has been a long-standing demand of the industry and would be conducive in providing greater certainty and unanimity of approach in the transfer pricing methodology.

Two other positives offered by the Bill are the removal of the cascading effect of the dividend distribution tax and reduction in the securities transactions tax by 20% from 0.125% to 0.1%. With a view to providing a thrust to infrastructure, the finance Bill extends the profit-linked tax holiday for power sector projects starting before 31 March 2013. Further, additional depreciation of 20% for the power sector would provide a boost to the sector. The Bill also provides a lower withholding tax of 5% on external commercial borrowings for three years in certain specified infrastructure sectors, compared with the normal rate of 20%.

The budget provides a positive thrust to infrastructure by, for instance, providing enhanced investment-linked deduction of 150% for specified businesses, extension of 200% weighted deduction for investment


in research and development and extension of the sunset clause for the power sector by one year. The proposal to remove the restriction on venture capital funds from investing in nine specified sectors is a very positive move.

The government has taken proactive steps to tackle the issue of unaccounted for funds parked abroad. Its resolve to curb black money is also reflected in the imposition of 1% tax deducted at source on the transfer of immovable property above a specified threshold and 1% tax on the sale of bullion and jewellery if the consideration exceeds Rs. 2 lakh and the sale is in cash.

On indirect taxes, the move to a negative list of services and the rise in the central excise and service tax rates has been along expected lines. Though the tax rate hike may have an inflationary effect, in view of the fiscal constraints, a hike in the rates was unavoidable. Moreover, 12% excise duty will still be in line with the anticipated goods and services tax rate, especially given that the latter would apply to the full retail price as against the factory gate price. However, the finance minister could have resisted increasing the lower rate of 1% to 2% at the current juncture.

Finally, fiscal consolidation was the most significant challenge that Mukherjee faced in preparing this budget. His proposal to reduce the

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Rajiv Memani took over as the Country Managing Partner of Ernst & Young in 2004. He has been with the firm for almost 20 years now. A qualified Chartered Accountant, Rajiv has successfully advised several leading multinational corporations on their entry in India and has worked with some of India’s largest companies, both in the private and public sector. His areas of expertise include M&A advisory, valuations and restructuring.

Affiliated with prominent business and industry associations, Rajiv is a member of the National Council of Confederation of Indian Industry (CII). He has been selected on the World Economic Forum’s New Asian Leaders, a network of 100 young leaders in business and politics to develop programs for the development of Asia.

You can write to Rajiv at: [email protected]

Rajiv MemaniCountry Managing Partner Ernst & Young, India

This article was written based on Budget 2012 proposals announced in March 2012. Since then, there have been changes made to some of these proposals and clarifications provided on others. Illustratively, GAAR provisions have been deferred by a year to apply from 1 April 2013, the proposal of imposing a withholding tax rate on transfer of immovable property has been withdrawn, the threshold limit for withholding tax in respect of cash sale of jewels has been enhanced to Rs 5 lakh, the 5% withholding tax on ECBs has been extended to other taxpayers as well. Further, the Indian administrative authority has also recently clarified that retrospective amendments would not be used to open new cases where a regular tax assessment has already been completed before 1 April 2012.

fiscal deficit to 5.1% in 2012-13 raises questions about how realistic it would be, given the tough economic conditions. Moreover, the finance minister expects an ambitious revenue growth of more than 19%, with no expenditure reductions announced other than keeping subsidies to less than 2% of gross domestic product—a promise he may find difficult to deliver in the present political landscape. What must also be considered is that the budget would be inflationary as the burden of garnering a larger chunk of revenue has been shifted onto indirect taxes. The question mark on fiscal consolidation belies any hopes of the easing of monetary policy.

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Reprinted with the permission of Mint © 2012. All rights reserved throughout the world.

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Ensure GAAR doesn’t cause hardship to taxpayers

Hitesh SharmaDNA - DNA Money, 28 March 2012

The finance minister has introduced anti-abuse provisions called ‘General Anti-

Avoidance Rules’ (GAAR) in the Indian tax laws during the announcement of the Union Budget for the next fiscal.

The aim is to counter tax avoidance schemes and codify the concept of ‘substance over form’ in law.

Since the time of announcement, these provisions have created a furore and anxiety in corporate circles.

The primary reason is the wide ambit of transactions which can be considered as tax avoidance schemes and powers conferred on the tax authorities for invoking GAAR provisions.

GAAR provisions can be invoked if the main purpose of an arrangement is to obtain a tax benefit and one of the other conditions is satisfied — these are creation of rights or obligations which would not usually be created between independent third parties, where whole or part of the arrangement lacks or is considered to be lacking commercial substance, misuse or abuse of the Indian tax laws or is not for bona fide purpose.

Where the substance or impact of individual step varies from that of the arrangement as a whole or the arrangement involves locating an asset or being tax resident of a place without any substantial commercial purpose, the arrangement will be deemed to lack commercial substance.

There are no restrictions to applying GAAR only to transactions with or between non-residents or where tax treaty benefit is sought; these provisions would extend to all classes of tax payers, including individuals and partnership firms.

“Government must ensure that GAAR that is aimed to counter tax avoidance scheme and codify the concept of substance over form in law, does not cause undue hardship to taxpayers.”

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Ensure GAAR doesn’t cause hardship to taxpayers

GAAR also places the burden of proof on the taxpayer to demonstrate that the intention of a transaction is not to obtain tax benefit. Considering that the Indian criminal law also presumes innocence until proven guilty, this provision appears to be far too onerous.

In order to safeguard the taxpayer from arbitrary invocation of GAAR provisions, the tax officer will have to seek approval from the Commissioner of Income Tax (CIT) as well as Approval Panel, consisting of three CITs. Given that the approvers will also be a part of the tax administration, can one be optimistic about the objectivity in decision-making?

The GAAR provisions will apply from April 1, 2012; however, there is no clarity on their applicability to consequences arising on or after April 1, 2012 from structures implemented prior to that date. While the government has come out

The Indian Government has stated that the burden of proof will lie on the tax authorities and that an independent member from the Law Ministry will form part of the Approval Panel. The implementation of GAAR provisions has been deferred to 1 April 2013.

Hitesh with over 22 years of exeprience specialises in International Tax and Transfer Pricing, and has worked on several international acquisitions, investment structuring assignments and cross-border structures, including IPR/brand issues, international taxation, particularly transfer pricing and investment structuring. Hitesh also leads the Life Science Industry for Ernst & Young in India and is based in our Mumbai office.

You can write to Hitesh at: [email protected]

Partner & National Leader, International Tax Services Ernst & Young, India

Hitesh Sharma

with some clarifications to appease foreign investors, the proof will lie in implementation when the actual cases are placedfor scrutiny before income tax officers in next few months.

While one can’t deny the need of having an anti-avoidance law in India, the government must ensure such widely-scoped provision does not cause undue hardship to taxpayer and bona fide tax-planning is not challenged.

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Reprinted with the permission of DNA - DNA Money © 2012. All rights reserved throughout the world.

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Budget 2012-2013—An analysis

Ganesh RajCFO Connect, 1 April 2012

The industry did not really have high expectations from the Budget this year as the multiple challenges before the Finance Minister (FM) on political, economic and fiscal fronts, were well known to all. However, what the industry did look forward to was that the Budget would be bold on reforms and would deliver a clear roadmap for fiscal consolidation. The FM’s proposals have attempted to combine pragmatism with the promise that reforms would be continued and fiscal numbers would be kept in check. However, how he would deliver on these promises is the big question.

The revised estimates for fiscal deficit at 5.9% of the GDP turned out to be even higher than what was being anticipated. Though the FM has assured that this would be brought down to 5.1% next year and that the subsidies would be restricted to les than 2% of the GDP, a clear roadmap for how this would be done is missing. The government is obviously counting on an ambitious GDP growth rate of 7.6% that could help deliver a tax revenue growth of about 19%. The FM is also hopeful of keeping the inflation rate down to 6.4%.

The government seeks to raise additional Rs 40,000 crores through tax revenue and on non tax revenue front it has planned for disinvestment proceeds worth Rs 30,000 crores as also additional Rs 40,000 crores from the sale of telecom spectrum. However, the non tax revenues could again fall short, given the uncertainties surrounding both disinvestment and telecom spectrum sale.

The main concern arises on the expenditure front. The subsidies burden for 2011-12 was as high as 2.4% of the GDP, despite the fact that payments to oil and fertilizer companies were deferred. Bringing the burden down to under 2% would clearly require a huge price increase in the petroleum and urea prices – a step that the government can ill afford, given the political pressures it continues to face. Reports indicate that at the current levels of global crude oil prices and the prevalent domestic retail prices of controlled products, the losses of the oil marketing companies could be a whopping Rs 2.13 lakh crores. As against this, the FM has provided only Rs 40,000 crores for compensating these companies.

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Budget 2012-2013An analysis

Given the above, the promise to reign in the fiscal deficit at 5.1% of GDP is not very convincing.

The taxation issues

The Budget has many positives to offer for the individual and corporate taxpayers. However, some of the provisions introduced, particularly on international taxation, have truly turned the Finance Bill to the Shakespearean tragedy that the FM referred to. Many of the provisions have been introduced with retrospective effect, a step which goes against the principle of stability and certainty in taxation.

The euphoria over the Supreme Court judgement in the Vodafone case has rudely ended with the draconian provision introduced by the Finance Bill that seeks to capture transactions of indirect transfer of capital assets through offshore transfer of shares in a foreign company, by making legislative provisions with retrospective effect since the inception of the Act. Not only this, for the first time and going to the extreme level, the Finance Bill contains a ‘validation’ clause that would operate irrespective of any judgement or decision on the matter.

It is noteworthy that many such similar offshore transactions are currently under the scanner of tax authorities. The proposed amendments would have serious negative impact on investor sentiment and taxpayer confidence and raise questions about the closure provided by judicial forums on tax issues. Retrospective amendment of

such nature will be prone to challenge on grounds of constitutional validity.

Besides the above, many other retrospective changes have been proposed in the Bill. For instance, the expansion in the scope of Royalty for right to use property is effective from 1976 whereby the right for use or right to use the computer software will now be treated as royalty irrespective of the medium through which such right is transferred. Consideration for transactions involving satellite transmission or lease of transponder capacity in the satellite will also be characterized as royalty, bringing to rest the controversy on this issue. This would be so whether or not the ‘process’ is secret. The proposal to amend the provisions retrospectively is a cause of concern and results in substantial uncertainty. It will also have to be seen whether the amendment in domestic law can impact the DTAA benefits available to taxpayers in this respect.

It was widely expected that pending the DTC, GAAR provisions would be brought in advance by the government with a view to check international tax avoidance. However, it is disappointing that the concerns of the industry have not been considered and extensive GAAR provisions have been introduced, which shall result in declaring a transaction as ‘impermissible avoidance arrangement’ where the transaction lacks commercial substance. The scope of these provisions is even wider than that suggested in the DTC and even

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the pragmatic suggestions of the Parliamentary Standing Committee have been ignored. While the fine print of the provisions remains to be seen, broadly the provisions shall have impact on the classification of equity and debt, classification of capital and revenue transactions and recharacterization of any expenditure.

The positive features of the Budget include the announcement about the introduction of the Advance Pricing Mechanism. This has been a long standing demand of the industry and would help provide greater certainty in the transfer pricing methodology.

In removing the cascading effect of the dividend distribution tax, the government has finally accepted the industry’s suggestion of bringing rationality in these provisions. Reduction in the securities transactions tax by 20% from 0.125% to 0.1% has also come as a relief for the taxpayers.

With a view to provide a thrust to the infrastructure, the finance Bill extends the profit linked tax holiday for power sector projects starting till March 31, 2013. Further, additional depreciation of 20% for power sector would provide a boost to the sector. The Bill also provides a lower withholding tax of 5% on external commercial borrowings for 3 years in certain specified infrastructure sector in comparison to normal rate of 20%.

That the government continues to do its bit for the infrastructure is evident from the positive thrust given to the

sector. Enhanced investment linked deduction of 150% for specified businesses, extension of 200% weighted deduction for investment in R&D, extension of sunset clause for the power sector by one year and the proposal to remove restriction on venture capital funds to invest only in nine specified sectors is a very positive move.

For the individual taxpayers, the FM has provided marginal relief by raising the exemption threshold to Rs 2 lakhs and enhancing the income tax slab from Rs 8 lakhs to Rs 10 lakhs.


“Budget 2012 though promises that reforms will be continued and fiscal numbers will be kept in check; still non-tax revenue can again fall short due to uncertainties around disinvestment and telecom spectrum sale”

The government has taken determined measures to tackle the issue of unaccounted funds parked abroad as also address the areas back home where black money transactions are most rampant. The imposition of 1% TDS on transfer of immovable property above the prescribed threshold of Rs 50 lakhs and Rs 20 lakhs in urban agglomerations and other areas, and 1% tax on the sale of bullion and jewellery if the consideration exceeds Rs 2 lakh and the sale is in cash are welcome.

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Ganesh Heads the firm’s policy & advisory group as one of his multiple leadership roles. His functional experience includes corporate tax planning, structuring cross-border investments and transactions, and joint venture negotiations. He is based in our Noida office.

You can write to Ganesh at: [email protected]

Ganesh RajPartner & National Leader — Policy Advisory Group Ernst & Young, India

On the indirect taxes front, the government’s proposal to harmonize Central Excise and Service Tax laws is commendable. The assurance about the GST Network, that would provide services through a common technology enabled portal for registration of dealers, filing and processing of tax returns and payment of taxes to be operational by August 2012 provides hope that the GST may see the light of the day sooner than later.

The introduction of the Settlement Commission and Revision Application Authority for service tax is a positive move. Rampant litigation is a vexatious issue both for the industry and government and one can look forward to expeditious resolution of disputes in indirect taxes.

The move to negative list of services and the rise in the central excise and service tax rates from 10% to 12% has been on expected lines. Though the tax rate hike may have


an inflationary effect, in view of the fiscal constraints, a hike in the rates was unavoidable. However, the FM could have resisted from increasing the lower rate of 1% to 2% at the current juncture.

Finally, the Finance Minister has tried to present a realistic budget in view of the limitations he was faced with - industry hopes that the credibility of the budget is maintained by achieving the promised fiscal consolidation. Most significantly, the government must provide an environment of trust, certainty and stability in taxation to make India an attractive destination for the investors.

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Reprinted with the permission of CFO Connect © 2012. All rights reserved throughout the world.

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Personal TaxIn India, income tax is levied on progressive tax rates for individuals; where income is taxed on the basis of residence of the taxpayer and source of income.

The Indian Government has endeavored to widen the tax base by aiming to push through important legislation in the form of the Direct Taxes Code, which aims to generate additional tax revenue by introducing moderate levels of taxation and easing administrative burden by reducing cost on the one hand and ushering in a new tax regime of transparency by eliminating distortions in the tax structure and improving tax compliance through simplifying regulations on the other.

In this section you can read about the concept of inheritance tax and whether it applies in India; how much tax is payable on global income; impact of recent decisions on computation of basic salary for provident fund purposes; impact of the proposed DTC on future investment strategy.

21 | Of death and taxes 24 | DTC to widen wealth tax net 26 | How much tax is payable on global income? 29 | Will court rulings on PF affect you? 32 | Weigh DTC provisions while choosing tax saving

instrumentsIn th

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Of death and taxes

Amitabh SinghHindu Business Line, 10 July 2011

As I lazed around one late afternoon in Delhi’s intense summer, the doorbell rang. My

maid opened the door and the sweet voice of Mrs Basu reached my ears. I hastily hid the movie magazine I was reading and picked up the latest copy of the Wall Street Journal. Mrs Basu had a great regard for me as an “intellectual” and I did not want to break the truth to her just yet.

“Mr Seengh,” she said in her lilting Bengali accent, “how nice to see you.” Then her eyes caught the WSJ and she said, “Eeesh, I am so sorry to have disturbed you.” “Not at all,” I said, I have been reading it for the whole day and you indeed provide me with a welcome break.”

“You are so generous,” she said. “You see, Mr. Basu is again travelling and I wanted some urgent advice.” Saying so, she opened the newspaper she was carrying and pointed to a news item that talked about the Government considering the possibility of introducing inheritance tax as a means of raising more revenues.

She continued, “You know, my father has a lot of ancestral property that he has willed to me. Similarly, we

wanted to settle our assets in such a manner that it gets distributed evenly to our children. Is the Government now thinking of imposing tax on inheritance?”

“There is no need to panic,” I said. “What has been said in the newspaper is just a thought and a lot more needs to be done before it becomes reality. There is no doubt that the Government is looking at ways to garner more revenues and it will continue to explore fresh sources. Strangely, nobody talks about taxing agricultural income and even the richest farmers do not pay tax.”

“India has taxed inheritance in the past by way of Estate Duty Act, 1953. This Act remained in force till 1985 when it was removed by Mr V.P.Singh, the then Finance Minister. In his budget speech for 1985-86, he alluded to the fact that the total tax collected by the Estate Duty Act was no more than Rs 20 crores and it had failed in both its objectives – neither did it reduce unequal distribution of wealth nor did it assist the states in financing their development schemes. He also felt that Wealth Tax and Estate Tax should not co-exist as both, in some way, were taxes on

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a person’s wealth and property. As a result, as we stand today, we have wealth tax but no estate taxes.”

“My goodness, you know so much Mr Seengh. I am so impressed!” said Mrs Basu. I tried to look modest as I offered tulsi chai to her.

Emboldened by her remark, I continued, “Many developed countries have had some form of “death duty” as it is often called since it gets triggered upon a person’s death. In some countries it is called “estate taxes” where the tax is levied on the estate of the deceased or “inheritance taxes” where it is levied on the beneficiaries though the distinctions have got blurred over time. Japan, US, UK, France have very high rates of estate taxes with Japan tax rates going as high as 70per cent. Australia, Malaysia and some other countries do not have estate taxes. The presence of these taxes have spawned a very lucrative practice of estate tax planning that the rich and famous pay enormous sums of money for.”

“That will be so good for tax advisers like you,” Mrs. Basu said, “but do you think this tax is advisable in the Indian context?”

I replied, “These taxes are not very popular in the countries where they are levied. However, since they aim to tax the very wealthy by keeping the exemption limit to a very high level, the opposition against these taxes have been muted. Many wealthy people have sought to shift their domiciles and nationality just to avoid these taxes but countries have followed with tighter laws as countermeasures.”

“When Estate Duty was in force in India, it gave rise to many evasionary tactics. The most rampant was ‘benaami holdings’ - wealth and estate being broken into smaller pieces and being held by proxy owners while the real owners continued to enjoy the benefits. It also led to concealment of assets and income and probably sowed the seeds for the thriving parallel economy we see now.

Since estate taxes take away a large chunk of one’s wealth, it is often seen as a disincentive for wealth, capital formation and entrepreneurship. Would you really save and scrounge to buy a house and other assets if the Government were to take half of it away on your death?

There is no doubt that India has a large number of wealthy people and those numbers are growing each year.

Of death and taxes

“Estate taxes take away a large chunk of one’s wealth, it is often seen as a disincentive for wealth, capital formation and entrepreneurship”

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However, there is also no doubt that the data gathering and enforcement mechanism is very weak and full of holes. Enacting a taxing law is the easiest part. The tough part is enforcing it and punishing evaders. As it is, we have not done a good job with our good old Income Tax, what great work we can do with Estate Tax? On the other hand, if we really beefed our current enforcement, rooted out corruption in the ranks and started punishing the offenders; our tax kitty would swell of its own without having to think of death duties etc.”

“Mr Seengh, your mind is as clear as Rabindra Nath Tagore!” Said Mrs Basu.

Amitabh was a Tax Partner with Ernst & Young’s Human capital services. His functional expertise included compensation structuring, payroll outsourcing, stock based incentive plans, social security, personal income tax and immigration matters. In the past he has served as the Chairman of Amcham’s Tax, Tariff and Regulatory Affairs Committee.

Amitabh was associated with Ernst & Young since 1984 and was based at the Noida Office.

You can write to us on this article at: [email protected]

Amitabh Singh Retired Partner, Human Capital Services Ernst & Young, India

Amitabh Singh

Of death and taxes

I sipped my tea in contentment for there could be no greater compliment from Mrs Basu than that.

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Reprinted with the permission of Hindu Business Line © 2012. All rights reserved throughout the world.

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DTC to widen wealth tax net

Mayur ShahFinancial Express, 9 August 2011

The DTC Bill which was introduced in Parliament in 2009 and the revision last year

has proposed to levy wealth tax on the specified unproductive assets of all taxpayers, except for non-profit organisations. While, the threshold limit to trigger wealth tax has been raised significantly from R30 lakh to R1 crore, the tax rate continues to be 1%, resulting in savings of R70,000. The critical point to be noted is the extended coverage of the ‘assets’ on which wealth tax is payable, could negate this saving.

Similar to the present provisions, assets like land, building, cars, yachts, boats, aircraft, jewellery, bullion, furniture, utensils or other articles made of precious metals continue to be considered wealth even under DTC. While the taxable wealth definition under DTC has been extended to specifically cover assets such as archeological collections, drawings, paintings, sculptures, similar works of art, expensive watches (value more than R50,000), helicopters. The most crucial inclusions are deposits in banks located outside India, beneficial interest in foreign trust or other entities outside India and investments

in equity or preference shares in a controlled foreign company (essentially foreign companies not engaged in active business activities).

Further, the DTC also continues with concept of “clubbing” and thus, any transfer of assets or gifting to your spouse, minor children, daughter-in-law, revocable trusts and own HUFs; will not help in getting away from wealth-tax.

Given the number of cross-border scams, hawala transactions, disproportionate asset cases, unaccounted income/wealth and others, the above inclusions clearly seem to further government’s concerted laudable intent to track down black money parked overseas and bring the culprits to justice. These measures also seem to be an interim result of the study commissioned by the finance ministry on unaccounted income and wealth held within and outside the country, and also is in line with the five-fold strategy announced by the finance minister in the last Budget speech.

Another important implementation measure undertaken by the government already (ahead of the DTC) is the quick finalisation/ signing

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of various Tax Information Exchange Agreements (‘TIEAs’) with various countries, and revision of existing tax treaties to specifically include information exchange clauses. It is also learnt that a dedicated cell for exchange of information is being set up in the CBDT to expedite the actual implementation and effective gather of information from other countries.

Therefore, while the stage is set under the DTC regime to trap unreported overseas investments and drill out cases with disproportionate assets vis-à-vis income earned, it remains to be seen how effectively the tax authorities utilise the tools laid down by the finance ministry as a part of combating tax evasion. Thus, the time in your “expensive watch” will speak whether the DTC wealth-tax provisions achieves this objective.

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Reprinted with the permission of Financial Express © 2012. All rights reserved throughout the world.

While implementation of DTC has been deferred to April 2013, some of the changes brought in by Finance Act 2012 are in line with the directions of the draft DTC legislation.

Mayur heads the specialized practice discipline, Human Capital, Global Mobility in Ernst & Young Mumbai. He has over 10 years of work experience and has worked extensively in the area of human capital; specializing in global mobility and employment taxation. He is based in our Mumbai office.

You can write to Mayur at: [email protected]

Director, Human Capital Practice Ernst & Young, India

Mayur Shah

DTC to widen wealth tax net

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How much tax is payable on global income?

Shalini JainEconomic Times - Wealth, 29 August 2011

When the RBI liberalised global investment norms, it literally opened up a world of choices

for wealthy Indians. They could invest in immoveable property, shares, bonds, debentures, mutual funds, listed and unlisted debt securities, and other financial instruments outside India. The new norms and the urge for geographical diversification has led many Indians to invest in foreign markets.

However, there are no tax-free luxuries from such investments for these may invite tax both in India and abroad. In fact, the tax implications in some cases can be quite complex. In addition, tax implications in the foreign country where the investment is to be made should also be analysed.

Tax on capital gains

Under the Indian tax laws, a resident and ordinarily resident of India is taxed on his worldwide income. This includes capital gains, rental income and income from other sources. If the transaction involves sale of shares listed on the overseas stock exchanges or other assets (gold, property) outside India, the income is treated as capital gains.

These can be either short-term or long-term gains, depending on the period of holding.

If the asset is held for more than 12 months (in the case of shares or units) or 36 months (in any other case), the income is classified as a long-term capital gain. If the holding period is shorter, the gains are treated as short term.

Types of incomes and tax liability

Interest on bonds, deposits

Dividend from stocks, funds

Short-term capital gains

Long-term capital gains

Rental income from property

Added to income and taxed at normal rate 20.6% Added to income after 30% standard deduction and taxed at normal rate

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How much tax is payable on global income?

While most types of incomes from foreign investments are treated in the same way as those from domestic investments, the crucial difference is in the way long-term capital gains from stocks and equity funds are taxed. If an investor holds domestic equities for over a year, there is no tax on the capital gains if the stocks were bought through a recognised stock exchange. However, there is no exemption on profits from foreign equities and an investor will have to pay 20.6% tax on the gains.

Carrying forward losses

The good part is that these long-term capital gains from foreign equities can be adjusted against long-term capital losses. There’s a caveat here: long-term capital losses can be set off only against long-term capital gains. In case of short-term losses, they can be set off against both short-term and long-term gains.

If the loss cannot be completely set off, it can be carried forward.

The tax laws allow carrying forward of losses incurred in overseas investments, including long-term losses from equities, for up to eight consecutive years. What’s more, the cost of acquisition can also be adjusted for indexation to account for inflation during the period of holding. The same rules of indexation that govern domestic assets are applicable to foreign investments.

Saving capital gains tax

Global investments can also be a source of saving tax. Under Section 54, one can claim exemption from tax on capital gains earned from

the sale of a residential property by reinvesting the proceeds in another house within a specified period. This can be a house in a foreign country as well.

Investors can deposit the proceeds in the capital gains account scheme before the due date of filing the income tax return for that year, provided the money is re-invested in another property within three years of the date of sale of the original property. Any money lying unutilised in the capital gains account at the end of three years would become taxable.

Tax on rental income

The rental income from overseas property gets the same treatment as that from domestic real estate. After a 30% standard deduction and municipal taxes paid for the property, the rental income is added to the income of the owner and taxed at the normal rate. Deduction can also be claimed for interest paid on housing loan during the financial year.

The rules don’t change much when it comes to income from other sources as well. The dividends from mutual funds and stocks are also fully taxable, along with the interest income earned on bonds and deposits.

These tax provisions in India are set for a big change with the Direct Taxes Code (DTC) likely to be introduced from 1 April 2012. The DTC proposes to remove the distinction between long-term and short-term assets and change the way the holding period is calculated for indexation benefits. The standard deduction for rental income will also be reduced from the present 30% to 20%.

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Avoiding double taxation

The taxability of foreign investment also depends on the tax laws of that country. There is some relief for the investor if there is a tax agreement between India and the other country. In the case of double taxation, the investor can seek relief under the Double Taxation Avoidance Agreement (DTAA) between India and the country concerned.

However, this could vary and depends on the nature of income, tax laws in the overseas country and the provisions of the agreement between India and that country. India currently has DTAA with more than 80 countries, including the US, the UK, France, Greece, Brazil, Canada, Germany, Israel, Italy, Mauritius, Thailand, Spain, Malaysia, Russia, China, Bangladesh and Australia.

If one satisfies the conditions mentioned in the respective DTAA, credit can be claimed for the taxes paid overseas on such income against the Indian tax liability. The tax credits are calculated as being lower of the actual taxes paid overseas and the Indian tax liability, and should be claimed in the income tax return form under ‘Relief under Section 90.’

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Reprinted with the permission of Economic Times - Wealth © 2012. All rights reserved throughout the world.

How much tax is payable on global

income?

Shalini has over 11 years of work experience and her specific competence areas are tax and regulatory issues relating to globally mobile individuals, structuring of assignments for globally mobile employees, compensation structuring, interpretation of double tax avoidance agreements, design and implementation of stock based incentive plans, tax litigation and social security advisory. She is based in our Delhi office.

You can write to Shalini at: [email protected]

Shalini JainAssociate Director, Human Capital Practice Ernst & Young, India

“While implementation of DTC has been deferred to April 2013, some of the changes brought in by Finance Act 2012 are in line with the directions of the draft DTC legislation”.

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Will court rulings on PF affect you?

Sonu IyerMint, 13 September 2011

Are you a member of the Indian Provident Fund (PF)? Do you contribute 12% of your

basic salary every month into the PF? Is your CTC (cost to company) divided into basic salary and various allowances such as conveyance allowance, asset allowance, education allowance and special allowance? Are you an HR manager in a company where you handle the above set of employees? If your answer is yes for any of these questions, then you may find this article useful.

After the specific inclusion of international workers in the Provident Fund Scheme in October 2008 and then further amendments in September 2010, the recent Madhya Pradesh and Madras high court rulings are the latest to add to the woes of employees and HR directors/chief financial officers of many companies.

Very briefly, the high courts have held that various allowances such as conveyance allowance and special allowance form part of basic wages for calculation of PF contribution.

Reinforcing existing law

What needs to be considered here is whether the high court rulings have laid down some new principles or are these more a way of reinforcement the existing law. To understand this, let us discuss the concept of PF contribution and basic wages in greater detail.

Under the Provident Fund Act, an employer is required to contribute 12% of the basic wages, dearness allowance and retaining allowance (if any) paid to the employees to the Provident Fund and Pension Scheme. The employee is required to match the contribution made by the employer.

Basic wages are defined to mean all emoluments in accordance with the terms of the contract of employment and which are paid or payable in cash, but does not include cash value of any food concession, dearness allowance, house rent allowance, overtime allowance, bonus, commission or any other similar allowance and presents made by the employer.

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Thus, the definition of basic wages in the Provident Fund Act seems to suggest the intention of including all cash emoluments unless the same is specifically excluded.

On this topic, the Supreme Court of India has ruled that any payment, which is universally, necessarily and ordinarily paid to all across the board is included in basic wages.

The Supreme Court has also mentioned that a payment that is specifically made to those who avail of an opportunity such as an overtime allowance is not to be included in basic wages. Also, any payment by way of special incentive or work or which is based upon contingencies is excluded.

Therefore, it is fair to say that the high court rulings only serve to reinforce the above principles laid down by the Supreme Court earlier. Subsequent to the high court rulings, the PF head office has issued internal directions to regional offices (available in the public domain) that the rulings of high courts may be utilized by the regional offices as per the merits of the case as and when similar situations arise in the field offices.

The concerns

This has caused apprehension among the employer community. Whether this would lead to increased PF audit activity? Whether employers would

be asked to pay contribution on such allowances retrospectively? Whether this would lead to increased cost of PF in case of international workers and have an impact on their business plan?

The major concern here is of the employees who are worried since this would reduce their take-home salary drastically. In the current CTC structure which is generally followed in most companies, if both the employer’s and the employee’s share of additional contribution is deducted from the CTC, there will be a major impact on the employee’s take-home salary. While there will be some tax saving on the employer’s portion of contribution as the same is non-taxable, the deduction of the employee’s contribution under section 80C of the Income-tax Act will be limited to Rs1 lakh annually.

The way out: But the situation does not seem to be so bleak. Particularly, in case of local employees, the Provident Fund Scheme does provide a cap. There is merit in saying that employer’s and employee’s contribution to the Provident Fund Scheme can be limited to the base of Rs6,500 per month. However, if the employee so chooses, he may opt to make an additional contribution. Therefore, in respect of local employees, the employer can still take a position of limiting monthly contribution to the base of Rs6,500.

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Still to be examined

Also, the generally accepted principle of not contributing on special allowance and certain other allowance on the basis of certain old PF circulars may also be examined. The argument that the earlier PF audits did not impose any requirement to contribute on such allowance may also be brought up.

For international workers, this needs to be examined differently as the limit of Rs6,500 per month does not apply to them. For international workers, what needs to be analysed is whether the test of universality needs to be applied for the company as a whole (including local employees) or for the international worker population only. Also, what needs an analysis is whether it can be argued that allowances paid to expatriate employees during the period of assignment can be considered as contingent as these are paid only while they are away from their home country and thus excluded from the scope of basic wages.

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Reprinted with the permission of Mint © 2012. All rights reserved throughout the world.

On 2 December 2011, the Employees Provident Fund Organisation (‘EPFO’) has issued directions to its regional offices that its earlier circular dated 23 May 2011 regarding allowances to be considered for the purpose of PF contribution is to be kept in abeyance in view of the Punjab & Haryana High Court ruling in the matter of “Assistant Provident Fund Commissioner, Gurgaon vs. M/s G4S Security Services (India) Ltd. and another”. In its ruling, the Punjab & Haryana High Court has held that the exclusion of certain allowances while calculating PF contributions cannot be said to be “unjustified” unless such exclusion is in complete deviation of the concept of allowances sought to be under the ‘basic wages’ exclusion clause. The EFPO has filed and the Supreme Court has admitted an appeal against the Punjab and Haryana High Court ruling.

Sonu has over 16 years of experience in the area of Human Capital — Global Mobility covering employee taxation and advisory with key focus on global mobility risk advisory services and Accidental Expatriates. She is based in our Delhi office.

You can write to Sonu at: [email protected]

Partner & National Leader, Human Capital Practice Ernst & Young, India

Sonu Iyer


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Weigh DTC provisions while choosing tax saving instruments

Amarpal S ChadhaEconomic Times, 3 January 2012

As an investor, when you think about investments, you have to keep in mind that

the existing tax laws will undergo a major change by April 2013, with the implementation of the Direct Tax Code (DTC). DTC has suggested some major changes in the way tax saving instruments are positioned. One has to ensure that the investments which are eligible for ‘tax saving’ under the existing tax laws would also continue to reap benefits under the DTC.

The avenues available for tax saving investments are less under the DTC compared to the existing tax laws. Following are some of the key proposals under the DTC which could impact your investment decisions.

Deductions: Under the existing tax laws, the umbrella limit of Rs 1,00,000 is available as a deduction for a host of investments which includes payment of life insurance premium, ELSS, unit-linked insurance plans (Ulips), tuition fees of children, five-year bank deposits, and provident fund contributions etc.

The revised discussion paper on DTC has proposed to provide EEE (Exempt-Exempt-Exempt) method of taxation on the following investment instruments:• Government provident fund• Public provident fund• Recognised provident funds

• Pension schemes (administered by the Pension Fund Regulatory and Development Authority)

• Approved pure life insurance and annuity schemes

Under the DTC, the deduction of Rs 1,00,000 is restricted to Government Provident Fund, Public Provident Fund, recognised provident funds and pension schemes. Investments made before the commencement of the DTC, which enjoy EEE method of taxation under the existing tax laws, would continue to be eligible for the EEE method of taxation for full duration of the instruments.

An additional deduction of 50,000 has been proposed to cover payments such as life insurance premium (annual premium shall not exceed 5% of capital sum assured), tuition fees for children and contribution to health insurance, which are currently under the limit of Rs 1,00,000.

National Saving Certificates, five-year term deposits with banks or post offices or deposits in senior citizen savings scheme and non-pure life insurance premiums will no longer be a choice of tax saving investments under the DTC. Also, repayment of housing loan principal amount and contribution to long-term infrastructure bonds will no longer yield tax saving under the DTC.

Capital gains: Listed equity shares or units of equity-oriented funds held for a year or less would be taxed after

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Weigh DTC provisions while choosing tax saving instruments

allowing 50% of capital gains as notional deduction. The main object of the computation of adjusted capital gains is to benefit the lower and middle income group taxpayers, as the effective tax rate would be lesser in case of taxpayers falling under the lower tax rate.

Listed equity shares or units of equity-oriented funds held for more than a year, would be taxed after allowing 100% of capital gains as notional deduction.

In the case of non-equity shares or non equity-oriented mutual funds, period of holding will be considered from the end of the financial year in which they are acquired; where as, the holding period is calculated from the date of purchase of investments under the existing tax laws.

A snapshot of some of the key positive, negative and neutral proposals from a tax saving perspective under the DTC is given below:

Positive: An additional deduction of 50,000 is available for life insurance, tuition fees for children and health insurance premium.

Neutral: Contribution to employee provident fund, PPF, superannuation fund, pension schemes are subject to deduction with a maximum ceiling of 1 lakh: a) Continuance of NIL tax on capital gains from sale of equity shares/equity-oriented units held for more than a year b) Continuation of EEE method of taxation

Negative: The following investments will not be eligible for tax saving - ELSS, national savings certificate,

five-year bank fixed deposits, Senior Citizens’ Savings Scheme, post-office time-deposits, principal component of home loan repayment, contribution to long-term infrastructure bonds : a) In the case of non-equity shares or non equity-oriented mutual funds, period of holding will be considered from the end of the financial year in which they are acquired

To conclude, diversification always reduces risk and may increase returns, too. So, one could balance his/her portfolio and maintain a fair balance of investments in both government and private securities. The focus for investors will need to move towards investments that provide for a ‘real’ wealth accumulation and not only a tax savings play. Let’s keep our fingers crossed for the DTC to be implemented by April 2012 as it will provide more clarity and a long-term view on the investment horizons.

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Reprinted with the permission of Economic Times, © 2012. All rights reserved throughout the world.

Amarpal S. Chadha is a partner at Ernst & Young India in the Tax Human Capital practice. He possesses 15 years of experience and has done extensive work in the area of global mobility and employee taxation, from inbound as well as outbound perspective, with experience in dealing with tax, social security and other regulatory authorities. He is based in our Bangalore office.

You can write to Amarpal at: [email protected]

Amarpal S ChadhaPartner, Human Capital Practice Ernst & Young, India

While implementation of DTC has been deferred to April 2013, some of the changes brought in by Finance Act 2012 are in line with the directions of the draft DTC legislation.

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Indirect taxThe indirect tax system in India is currently undergoing a significant transition from a multiple tax regime to a common GST. The Government had taken one important step by introducing Constitutional Amendment Bill last year in the Parliament. Given that the new tax system requires Central and State Governments to strip their constitutional powers and join hands for a common tax system, implementation of GST regime is expected to throw economic and political challenges ahead of its implementation. Stakeholders understand the need to carefully implement changes in the current laws, and keep a close vigil on the likely structure to ensure a smooth shift to GST when it is implemented.

The Government is rightly attempting to make the current laws GST friendly, with the introduction of the Negative list concept in the Service tax law from 1 July 2012 being a step in this direction. The negative list concept is a paradigm shift in manner of taxing services from a positive list to negative list and this is expected to help service providers for a smoother transition into the GST regime.

This section provides a detailed analysis of the issues being deliberated in the purview of GST, among other developments that may impact your business.

35| Advance ruling under Indirect tax38 | A better goods and Services Tax40 | Burden of fiscal consolidation falls on tax system, again43 | Budget takes India Inc closer to GST46| Pluses in the negative list

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Advance ruling under indirect tax

Saloni RoyHindu Business Line, 12 December 2011

The Central Government should reconsider aligning the provisions relating to advance

ruling under indirect tax laws with the scheme prevailing under income tax.

Authoritative and binding advance rulings allow traders and investors to make business decisions regarding taxes and duties, in a stable and predictable environment. Advance rulings lend transparency and predictability to the tax environment, and have thus emerged as a valuable tool for achieving certainty in tax positions.

While in many countries, the concept of advance ruling has been introduced for existing tax payers, the idea was first pioneered in India in 1993, to offer a forum to non-residents for resolving questions pertaining to proposed transactions, and was limited to direct taxes only. It was only in 1999, that the concept of advance rulings was extended to Central Excise and Customs, and, in 2003, to Service Tax.

Tax categories

Since inception, the ambit of advance rulings, as applicable to indirect taxes, has been widened with the years, and the categories of persons who can seek an advance ruling (as it stands today), under both the direct and indirect tax regimes, is as follows. It is clear that a far more expansive category of persons is eligible to seek advance rulings under direct tax vis-à-vis indirect tax.

Categories under direct tax regime:

i. A non-resident

ii. A resident in relation to a transaction with a non-resident

iii. Residents notified by the Central Government

iv. Public sector companies, where notified

Categories under indirect tax regime:

i. A non-resident setting up a joint venture in India in collaboration with a non-resident or a resident

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ii. A resident setting up a joint venture in India in collaboration with a non-resident

iii. A wholly-owned subsidiary Indian company, of which the holding company is a foreign company

iv. A joint venture in India

v. Residents notified by the Central Government

vi. Public sector companies, where notified

However, despite the fact that the category of eligible applicants for advance rulings has been expanded from time to time, the response of the trade and industry has been, to say the least, ‘lukewarm’. This is evident by the fact that the Authority for Advance Ruling set up for indirect tax matters has received only 146 applications, since its inception till March this year.

Direct and indirect tax

It is interesting to note that in complete contrast to the above, the Authority for Advance Ruling set up to look into direct tax matters has been much more successful, in terms of the number of applications received and the general perception in the trade and industry. One of the biggest reasons for this disparity apart from the eligibility criteria is the difference of scope of Advance Rulings, as available under direct tax vis-à-vis the indirect tax regime.

Questions pertaining to direct tax:

1. No specific provisions specifying the nature of questions that may be raised

2. Advance ruling can be sought on a question of law or fact relating to a transaction which the applicant has undertaken or proposes to undertake

3. Specific prohibitions in the case of questions already pending before other authorities

Questions pertaining to indirect tax:

1. Can be sought only on questions relating to classification, valuation, applicability of notifications, admissibility of CenVAT credit, and determination of liability to pay tax.

2. No other questions covered.

3. Can be sought only for transactions proposed to be undertaken.


“The Central Government should reconsider aligning the provisions relating to advance ruling under indirect tax laws with the scheme prevailing under income tax”

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Every year, the Central Government introduces amendments to the various indirect tax laws in the annual budget. Some of these amendments have, in the recent past, specifically under the service tax regulations, stirred huge debates, and have led to litigation at multiple levels, primarily due to the difference in interpretation by the tax payer and the revenue authorities.

If the scope of the advance ruling mechanism included within its ambit applications in relation to ongoing transactions, some of this litigation could have been limited, specifically in cases of classification of services, applicability of notifications, and issues pertaining to dual taxation under Service Tax, as well as Value Added Tax.

Saloni has over 17 years of experience in indirect tax consultancy. Her areas of expertise are service tax, customs and international trade, VAT and excise duty. She is based in our Gurgaon office.

You can write to Saloni at: [email protected]

Partner, Indirect Tax Services Ernst & Young, India

Saloni Roy

Given the increased litigation in indirect taxes, the Central Government, in the coming budget, should sincerely reconsider the recommendation of aligning the provisions relating to advance ruling under indirect tax laws, with the scheme prevailing under income tax. This would go a long way in not only reviving the confidence of the taxpayers, but also in realising the full potential of the system.

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A better goods and services tax

Harishanker SubramaniamEconomic Times, 19 January 2012

The Empowered Committee of State Finance Ministers’ endorsement to the concept

of a negative list for services, albeit with some riders, paves the way for its possible introduction in the coming Budget. With the widening fiscal deficit and the urgent need to generate revenues, the Centre has released two concept papers, signalling its intent to widen the service tax base.

The papers reckon that the concept of a negative list - services that would be exempt from tax - is a precursor and an interim step towards implementing the goods and services tax (GST) in the near future. Although a negative list would enable a simplified GST design, its timing has led to apprehensions over double taxation.

States have endorsed the negative list, but with a contentious rider -- the Centre should refrain from taxing areas that are within states domain such as construction, entertainment, meals in air-conditioned restaurants and so on. It will be interesting to see the Centre’s reaction when the concept is finally unveiled.

However, it underlines the serious issue of overlap of taxation powers between the Centre and states. This

has led to many areas of double taxation (telecom, construction and so on), resulting in litigation, harassment and uncertainty for the industry.

Going by the concept papers, the negative list will only compound the issue of double taxation. However, both the Centre and the state are equally responsible as their aggressive actions in the recent past have led to the vexed issue of double taxation. So, an early implementation of GST seems to be the only solution.

This is one of the key reasons why industry believes that the concept of a negative list would be in order it is aligned with GST implementation. One only hopes that the concept is introduced as an interim step to GST.

The introduction of a negative list should also desirably bring along with it equitable changes in many other areas of service tax law. These include a clear definition of “service”, place of supply rules and credit rules. Service tax law, since its evolution, has been a victim of misinterpretation, partly on account of lack of clarity in law making and understanding the business of intangibles.

This has led to plethora of litigation and uncertainty for the industry, raise

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compliance cost for the taxpayer and the cost of doing business. With the experience of over a decade, the hope is this time round is that policy and law makers come out with a concept that is fairly unambiguous in its intent and language. This will provide some degree of certainty about taxes.

A negative list will increase the tax base, but it is equally important for policy makers to take a closer look at credit rules. Efforts should be to provide a fair credit chain in the system to avoid the cascading of taxes and increasing cost of business. Over the last few years, far too much of tinkering has happened in this area. Some of it was welcome, but several of them were highly debatable, increasing areas of cascading of taxes. The negative list offers a chance for policy makers to have a holistic relook and provide more equitable Cenvat credit in the chain.

Place of supply rules is another key area of drafting. Here again, the hope is that policy makers use all their past experience to bring out clear and unambiguous rules that provide a fair degree of certainty. We all are

well aware of issues relating to export of service rules that the industry has faced in the recent past. It has led to unnecessary and prolonged litigation and also stalled service tax refunds, hurting cash flows of the industry. The issue generally is never about taxability, but its certainty and an expeditious resolution of refunds.

Conceptually, a negative list is welcome, but what is debatable is the timing of its introduction. We still live in an indirect tax environment where the aggressive stance of Centre and State has created a serious issue of overlap, leading to double taxation and impacting the competitiveness of Indian industry in these uncertain times.

.................


A better goods and services tax

Hari is a qualified licenced customs broker and has over 25 years of experience in industry and consulting. His areas of expertise are customs and international trade, and service tax, VAT and excise duty. He is also currently involved in assisting companies for the impending introduction of Goods and Services Tax in India. He is based in our Gurgaon office.

You can write to Harishanker (Hari) at: [email protected]

Partner & National Leader, Indirect Tax Services Ernst & Young, India

Harishanker Subramaniam

1. Negative list has been announced to be implemented by 1 July 2012

2. Some of the concerns of the empowered committee were addressed in the Negative list framework announced with Budget 2012

3. Draft place of Provision of Services rules have been notified

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Burden of fiscal consolidation falls on tax system, again

Satya PoddarEconomic Times, 19 March 2012

The finance minister went into the budget with his hands tied and came out with his

hands tied. On the fiscal side he had little elbow room to announce new spending initiatives or tax cuts.

On the social and economic policy fronts, given the emerging divisions within the UPA coalition, he had little hope of getting the support needed for any major reform. In these circumstances, he has resisted the temptation to announce populist measures and shied away from a concrete roadmap for fiscal consolidation.

Fiscal consolidation was the most significant challenge that the FM faced in preparing this budget. The fiscal deficit of 5.9% of GDP turned out to be higher than anticipated. His plan to reduce the fiscal deficit to 5.1% next fiscal, while reasonable, begs the question whether it is realistic.

No expenditure reductions were announced other than the policy objective of keeping subsidies within the cap of 2% of GDP. It is unlikely that the government will have the political strength to cut back on subsidies in the remaining two years of its mandate.

The achievement of these targets will thus depend entirely on market forces such as the prices of crude oil. In the absence of a tangible reduction in international oil prices, the fiscal woes will continue to compound in 2012-13.

The burden of fiscal consolidation in the budget has fallen entirely on the tax system and there again on indirect taxes, which are being raised to provide an additional Rs 45,940 crore. Leaving aside the significant and dramatic changes in international taxation arena, the direct tax proposals are modest and populist, resulting in a revenue loss of Rs 4,500 crore.

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This is consistent with international trends, whereby most countries in need of fiscal consolidation have resorted to indirect tax increases. Governments are increasingly constrained in increasing direct tax rates for fear of adverse impact on investment and economic growth.

Other tax changes are largely in the nature of housekeeping. Having missed his targets before, the FM was wise not to provide a concrete roadmap for major structural reforms such as the Direct Taxes Code and the Goods and Services Tax (GST).

beyond. And, they are retroactive, as far back as 1962-63. It remains to be seen whether the government will invoke these amendments to defend the assessments already raised for the transactions concluded prior to the budget.

The move to change the approach to taxation of services from a positive list to a negative list appears to be too little too late. With major consumer services such as healthcare, education, residential rentals and public transportation either in the negative or exempt list, there is no tangible broadening of the tax base. The proposal to harmonise central excise and service tax laws may also not be worth the effort if the GST were to be implemented in the near future.

The only measure which could be viewed as a significant stepping stone to the GST is the Goods and Service Tax Network (GSTN). It will provide services through a common technology-enabled portal for registration of dealers, filing and processing of tax returns, payment of taxes and refunds, and taxpayer management including account management, notifications, information and status tracking.

Burden of fiscal consolidation falls on tax system, again

“Goods & Services Tax Network is a significant stepping stone to the GST”

The changes in the taxation of capital gains from indirect transfers of capital property (linked to the Vodafone transaction), while anticipated, are draconian and vindictive. The amendments proposed close all the legislative gaps identified by the Supreme Court in the taxation of indirect transfers of property and go

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In spite of dissension about the GST, all state governments have agreed to the launch of the GSTN and pilot tests have already commenced for migration of some of the front-end processes to the common portal. Successful launch of the GSTN will constitute third generation of tax reforms, after the first generation of reforms of the central direct and indirect taxes under the leadership of the then finance minister Manmohan Singh, and the second generation reform of state sales taxes in 2005.

Satya has over three decades of experience in advising clients on tax policies, VAT and international taxes, he has been the Advisor to the Gulf Cooperation Council on issues relating to tax policy matters and Director of the Tax Analysis and Commodity Tax Division in the Canadian Ministry of Finance.

He has also served as tax policy advisor to governments around the world, including Russia, China, European Union, New Zealand, Syria, Korea, and Gulf Cooperation Council. He is based in our Gurgaon office.

You can write to Satya at: [email protected]

Satya PoddarPartner, Policy Advisory Group Ernst & Young, India

Burden of fiscal consolidation falls on

tax system, again

It will simplify tax processes, reduce leakages, facilitate voluntary compliance and can yield significant fiscal dividends to governments. It’s a win-win for both taxpayers and governments.

.................


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Budget takes India Inc closer to GST

Vivek PachisiaHindu Business Line, 19 March 2012

The Budget was expected to be of a different kind compared to the previous Budgets due

to the political, social and economic upheaval the country has been through in the previous year. The highlight of this Budget is the introduction of ‘Negative List of Services’ which would bring about a paradigm shift in the manner in which provision and consumption of services would be taxed going forward. Any activity qualifying the characteristics of ‘service’ or the ‘ declared services’ would be taxable unless found in the negative list. The negative list comprises 17 services which broadly includes, subject to exceptions and conditions:

• Services provided by the Government or local authorities, Reserve Bank and foreign diplomatic missions;

• Services relating to agriculture;

• Trading in goods;

• Manufacture;

• Renting of residential dwellings, entertainment and amusement services;

• Specified public transportation.

The declared services contain renting of immovable property, temporary transfer of intellectual property, service portion in a works contract, information technology software services etc. among others.

The negative list approach would come into effect from the date which would be notified in due course of time and consequently the provisions pertaining to the positive list approach would cease to exist from such notified date.

Exempted services

The Budget has also proposed a list of exempted services in addition to the negative list of services. The exemption list, subject to exceptions and conditions, primarily includes services such as (i) health care, (ii) services provided by charities, religious persons, sportspersons

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etc. (iii) specific services provided to Government or local authorities, (iv) individual advocates providing services to non-business entities, independent journalists, (iv) construction services relating to specified infrastructure, canals, irrigation works, residential dwelling etc.

The additional list of exemption provides relief from service tax to services that are essentially intended towards the larger benefit of the society.

Further, the Budget has proposed to introduce the ‘Place of Provision of Services Rules, 2012’ which would identify the taxing jurisdiction of a service and will replace the existing export and import of service rules.

Place of provision of service rule is critical to determine the taxable jurisdiction on import and export of services and potentially provides guidance on taxability of inter-State exchange of services under GST.

The draft rules have been released for comments and feedback, from the stakeholders, for the time being.

Easy refund

Refund of service tax has always been a subject matter of concern given the cumbersome procedure and voluminous documentation involved in the process.

To mitigate the hardship, the Budget has replaced the existing refund provision with a much simplified provision that intends to allow the benefit of refund based on a simple formulary approach.

If implemented in its true spirit, eligible CENVAT credit would simply be entitled for refund in the ratio of the export turnover to total turnover.

Further, the Budget also contains amendment to the Point of Taxable Rules, 2012 to bring in greater clarity on the subject, harmonisation of service tax and central excise by bringing about a common platform for registration and filing of returns,

“The additional list of exemption provides relief from service tax to services that are essentially intended towards the larger benefit of the society. “

increase in rate of service tax and excise duty from the existing 10 per cent to 12 per cent, and specific changes to rates of duties of customs and excise across different industry sectors.

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However, it is also evident from the proposals in the Budget that the Government has aimed at sweeping reforms on indirect taxation and has taken a wide variety of measures such as broadening of the tax base, mitigating tax cascading, simplifying tax refund procedures, harmonisation of compliances, and so on, to rationalise the existing indirect tax statues and prepare the ground for introduction of GST in the longer-term.

Vivek is leading the Indirect Tax practice in Bangalore. He possesses over 13 years of experience in advising clients on Indirect tax matters in the areas of supply chain structuring, mergers and acquisitions, project and EPC contract structuring, business tax operations, litigation and tax controversy management.

You can write to Vivek at: [email protected]


Vivek Pachisia

If the changes are effectively implemented and all irritants are removed, the dream of achieving the GST regime could soon be a reality which would, no doubt, be the biggest blockbuster reform in the history of indirect taxation.

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Pluses in the negative list

Bipin SapraHindu Business Line, 16 April 2012

Negative list of services, which existed as a mere concept until sometime ago, is finally

seeing the light of day. Budget 2012 has proposed a paradigm shift in the way services are to be taxed in India. Currently, service tax is levied only on a positive list of services, which are specified in the service tax legislation. However, if the budget proposals are accepted then all kinds of activities, except those in the negative list, would become taxable.

Definition of ‘service’

But what exactly is ‘service’?. The Finance Bill broadly defines service as any activity carried out by one person for another for consideration, but does not include sale of goods or immovable property, transaction in money or actionable claim, service provided by employee to employer in course of employment and fee taken by court or tribunal.

Accordingly, all services that were not taxable earlier have now been brought within the purview of service tax. For example, if you provide translation services for a consideration, it would now attract service tax. Similarly, if you are an actor, magician or a non-classical musician, your services would attract service tax.

The definition of service also includes certain declared services. Although most of the declared services are taxable under the present positive-list regime, they have been so declared in order to remove ambiguity and ensure uniform application of law all over the country.

Some important declared services include renting of immovable property, customisation and upgradation of information technology software, and agreeing to refrain from an act or tolerating an act.

With all services, except those in the negative list, attracting service tax, the list itself assumes great importance. The negative list has been drafted after ensuring that certain services that assume social, economic and political relevance remain outside the ambit of service tax. Services provided by the Government and RBI, agricultural services, educational services, transportation of passengers in stage carriage and railways (other than first class or air-conditioned coach), and other essential services such as funeral, burial and crematorium services, have been included in the negative list.

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Bundled services

An interesting aspect of the negative list is the bundled services. What is the taxability of bundled services wherein some services are in the negative list while others are not? The Finance Bill states that where different services are naturally bundled in the ordinary course of business, the bundle shall be treated as provision of a single service that gives the bundle its essential character. In other cases, the bundle shall be treated as provision of a single service that results in highest liability of service tax.

There is no doubt that taxation of services under the existing positive-list regime has made the law lengthy and litigious. The option of including additional items in the positive list makes the tax structure even more complex. Therefore, the shift to taxation of services based on negative list is certainly a positive development.

However, the new regime still fails to address the issue of double taxation, where State taxes are also liable on some of the transactions. The inclusion of ‘temporary transfer or permitting the use or enjoyment of any intellectual property right’ within the definition of declared services could result in double taxation, as several VAT legislations treat the same as ‘goods’ subject to VAT.

Similarly, providing licence to use software may continue to suffer both service tax and VAT. Further, with an involved definition of services including declared services, a long negative list and mega exemption list, it must be ensured that the new tax regime does not result in another complex tax structure that is difficult to interpret and implement.

.................


Bipin anchors Indirect Tax for our technology, communications and entertainment industry practice for the national capital region. An ex. Additional Commissioner with the Department of Revenue, Ministry of Finance in India, he has been part of various committees in the Indian Government for drafting legislations on Indirect tax policy in India. He is based in our Gurgaon office.

You can write to Bipin at: [email protected]


Bipin Sapra

Pluses in the negative list

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Feature articles

International taxWith economic growth and globalization, matters such as arriving at the correct arm’s length price on cross-border payments between associated enterprises, valuation of intangibles, assumes a key challenge as the Indian tax authorities ramp up their enforcement efforts on the Transfer Pricing front.

A welcome feature in the Budget has been the introduction of the advance pricing mechanism.

This section on International Tax covers topics such as the importance of transfer pricing (TP) documentation, TP and intangibles and reducing cross border disputes. Insights on taxability of P-Notes and the continuity of the Mauritius structure are also discussed here.

49| Importance of Transfer Pricing Documentation52 | Transfer pricing and intangibles54 | Reducing cross-border tax disputes57 | Going back in time is no good60 | Pause before P-Notes62 | Mauritius structures - gazing through a crystal ballIn

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Importance of transfer pricing documentation

Vijay IyerCFO Connect, 1 July 2011

In Ernst & Young’s Global Transfer Pricing Survey 2010, three quarters of the respondents considered

transfer pricing documentation as being more important than it was two years ago. Commonly recognised as one of the most pressing issues, transfer pricing indeed dominates tax agendas around the world. India is no exception insofar as the transfer pricing legislation, though only a decade old, has seen considerable controversy. It is estimated that approximately Rs. 30,000 crores is locked up in transfer pricing disputes alone in India.

Six rounds of transfer pricing audit examination by the Indian tax authorities have witnessed scrutiny of various inter-company transactions. There is a sustained increase in quantum of transfer pricing adjustments cutting across various industries. Cases have travelled through the appellate chain and are pending adjudication at various levels. Dispute resolution has been a time consuming process. Many issues of divergence between the tax authorities and the taxpayers are still

to be settled. However, a common theme underlying the judicial precedence that is currently evolving in the country is the need for robust transfer pricing documentation.

The Income Tax Appellate Tribunal (ITAT), which is the ultimate fact finding authority in the Indian dispute resolution framework, has repeatedly emphasized on the need for the taxpayer to possess documentation supporting the positions adopted in a transfer pricing analysis. Wherever the ITAT has eventually ruled in favour of the taxpayer, the case has been supported with extensive documentary proof. A cue can be taken from the recent case of Symantec Software Solutions Private Limited, which dealt with issues relating to use of single year versus multiple year data, application of turnover filters, and adjustment for functional and risk differences. In allowing the tax authorities to use only data for the year under consideration, the ITAT held that multiple year data cannot be used as a rule and the taxpayer has to make a case out for how prior year

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data influences the prices of the year under review to justify its usage. On the turnover filter, it was mentioned that the taxpayer did not demonstrate how turnover impacts the profitability thereby, negating its application. Even in case of economic adjustments, the ITAT cited the lack of documentation to prove how functional and risk differences affected the margins of comparable companies in order to be undertaken. This ruling therefore underscores the importance which the ITAT attaches to documentation of facts and rationale.

The advantages of preparing and maintaining prescribed documentation are manifold. It captures the terms and conditions of inter-company arrangements, helps identify the functional attributes of the parties to transactions and the risks allocation entailed in such arrangements thereby, giving a better insight into the business. A proper description of the industry in which the taxpayer operates, aids in spotting trends which have a bearing on profitability. A correlation of these trends to actual financial performance can often help in substantiating specific business strategies or defending against losses. These aspects then feed into the comparability analysis where description of the search methodology, the screens applied to filter companies, the computation of financial ratios of comparable companies, reasons necessitating economic adjustments and a

quantification of such adjustments demonstrate the due diligence undertaken by the taxpayer. Detailed documentation also serves as a tool to explain the business purpose and economic substance of controlled transactions to protect against tax authority disregarding the form of the transaction and re-characterizing it during audits.

We observe a trend towards the tax authorities requesting for a greater level of detail around related party transactions specifically intra-group services. Last year, in many instances, Indian taxpayers paying for management services availed from group companies suffered disallowances of these charges on the grounds that adequate documentation was not available to evidence actual availing of services or benefits received from them. Additionally, the basis of arriving at the service charge encompassing the cost elements of the service charge and the allocation keys was scrutinized. Tax authorities are increasingly investigating the value chain to understand the contribution of the Indian taxpayer to the overall product or service offering of the group. Inadequate or inconsistent documentation opens the taxpayer to allegations of intangible creation and a demand for higher compensation or attribution of a portion of the global profits to tax in India. Documentation plays a very critical role in addressing these questions and enables the taxpayer to enter an audit situation from a position of strength.


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With the sustained pressure on raising revenues, the tax department is seeking to levy penalties in almost all cases. Suitable documentation facilitates penalty protection in case of a dispute and reduces the risk of additional financial costs to the company. The global economic crisis has triggered off a need to relook business operations to achieve efficiency, synergy, and competitiveness. The transfer pricing documentation process provides a useful framework to discover opportunities for supply chain optimization, streamlining global policies and reconfiguring functions and risks to derive maximum benefit. The legislative and regulatory landscape is rapidly altering. Contemporaneous documentation endows companies the benefit of taking into account these changes, anticipating potential implications thereof and tackling them appropriately to stay ahead of the curve.

Heightened scrutiny by the tax department and the augmented levels of disclosure expected from taxpayers significantly inflates the transfer pricing risks confronting companies. Transfer pricing documentation globally is motivated by risk mitigation and audit defense factors. In the Indian context, robust documentation is a key ingredient for success in controversy and will continue shaping the views of the judicial authorities in future transfer pricing judgments. Greater rigour in preparing and maintaining documentation will keep corporate taxpayers in good stead to face the challenges of the new world.

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Vijay possesses over 15 years of experience in advising clients on transfer pricing and international tax, including outbound investment from India to overseas. Vijay has been rated as one of the World’s Leading Transfer Pricing Advisors for India by the Legal Media Group and by International Tax Review. He is based in our Delhi office.

You can write to Vijay at: [email protected]

Partner and National Leader, Transfer Pricing Practice Ernst & Young, India

Vijay Iyer

The seventh round of TP audits got concluded in October 2011 and has resulted in proposed TP adjustments of approx Rs. 45,000 crores.


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Transfer pricing and intangibles

Vijay IyerHindu Business Line, 19 September 2011

Transfer Pricing, simply put, refers to pricing of transactions between group companies in

different countries. The increasing complexity in this area can be gauged from the 2010 Global Transfer Pricing Survey, conducted by Ernst & Young, where more than 74 per cent of the multi-national enterprises (MNEs), believed that transfer pricing will be absolutely critical to their organisations during the next two years. Further, one third of the MNEs surveyed identified transfer pricing as one of the most important tax challenges facing their group.

Indian tax authorities, like several others, have tightened transfer pricing laws, improved vigilance, enhanced enforcement and armed its tax officials with greater powers of investigation. The Director General of Income Tax (DGIT) communicated at a public conference, that transfer pricing cases will be scrutinised by the Comptroller and Auditor General of India (CAG), since they have revenue implications for the exchequer. Taxpayers may therefore brace themselves for greater audit activity in the coming days.

Focus of audits

Recent audits have seen increased focus on transactions pertaining to use or transfer of intangible property. In this regard, tax authorities have sought detailed information on the description of intangible property received, its uniqueness, details of the process, product, covered by the intangible property, agreement rights to receive upgrades / modifications, useful life of the intangible, information on the availability of such intangibles in the open market and prices and the cost of development of the intangibles. They have also been challenging taxpayers on the cost-benefit analysis of the receipt / use of intangibles, quantification of the benefits and the comparison of profits before and after the use of the intangible.

As the name suggests, intangibles are subtle, elusive, and mobile, thereby complicating questions of pricing and ownership. In the absence of specific guidance on definition, identification, and valuation of intangibles for transfer pricing purpose, issues pertaining to intangibles have been a significant bone of contention between taxpayers and tax administrations.

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OECD project

The Organisation for Economic Cooperation and Development (OECD) is attempting to bridge this gap and has released a scoping paper for a project that will examine various issues related to transfer pricing for intangible property.

The scope of the above project will include work on a framework for analysis of intangible-related transfer pricing issues.

The OECD guidelines currently do not contain any universal definition of intangibles. The project intends to address issues pertaining to definition of intangibles, including the relevance of definitions of intangibles used in accounting, valuation, and legal standards.

The Working Party for the project intends to review specific categories of intangibles, such as the pricing of R&D services, and when a cost-plus method or a method other than cost-plus may be acceptable for pricing of R&D services.

Indian tax authorities, in recent transfer pricing audit proceedings, have raised the issue of ‘arm’s length return’ to entities that aren’t legal

owners of intellectual property, but are seen to have economic ownership. The notion of economic ownership, as opposed to legal ownership, will also be examined in the OECD Project, along with the valuation of the intangibles.

Useful paradigm

Though the OECD Guidelines are not binding on the Indian tax administration (since India isn’t a part of the OECD), the results of this project, in the absence of any guidelines in the Indian regulations, would serve as a useful paradigm while analysing various aspects of transfer pricing, at least for the taxpayers. However, the primary responsibility for ensuring appropriate transfer pricing analysis and documentation lies with the taxpayer only.

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On 6 June 2012, the OECD has released an interim discussion draft on the revision of the special considerations for intangibles in Chapter VI of the OECD transfer pricing guidelines and related provisions

Vijay possesses over 15 years of experience in advising clients on transfer pricing and international tax, including outbound investment from India to overseas. Vijay has been rated as one of the World’s Leading Transfer Pricing Advisors for India by the Legal Media Group and by International Tax Review. He is based in our Delhi office.

You can write to Vijay at: [email protected]

Partner and National Leader, Transfer Pricing Practice Ernst & Young, India

Vijay Iyer

Transfer pricing and intangibles

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Reducing cross-border tax disputes

Prashant KhatoreHindu Business Line, 13 February 2012

Justice delayed is justice denied, a proverb conceived in the realm of law has become the

defiant voice of India Inc due to long pending tax disputes with portion of it attributable to complex tax regime, effectiveness of administrative processes, manifold appellate layers.

Multinationals operating in India have to deal with complex issues with fundamentals of international taxation being tested on regular basis. Phenomenal rise in cross border tax disputes leading to huge tax demands and delay in their dispensation has given rise to concerns in multinationals’ confidence and may impact the future of investments.

Given the above, it would not be an understatement to say that tax disputes have assumed the centre stage! It has become crucial to effectively unlock the key to lengthened tax disputes and evolve new juristic standard for their speedy resolution.

Dispute resolution panels

Finance Act 2009 introduced DRP as an alternate dispute resolution mechanism to facilitate expeditious resolution of disputes on a fast-track basis.

Under the traditional mechanism, an assessing officer’s order can be appealed before Commissioner (Appeals), and thereafter, the Tribunal, High Court and Supreme Court - a process that can take a couple of decades to attain finality!

DRP serves as an alternate to the Commissioner (Appeals) process in cases involving transfer pricing or international tax adjustments. The draft order passed by the assessing officer is litigated before the panel of three Commissioners (the DRP panel) which is required to adjudicate the matter within 9 months. The DRP’s directive is binding on the tax department; however the taxpayer may appeal before the Tribunal.

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The highlight of the mechanism is the automatic stay of demand till the final decision by DRP, disposal of cases on fast-track i.e. 9 months vis-à-vis Commissioner (Appeals) with no mandatory statutory limit disposal of cases and certainty that the tax department will not litigate further.

DRP panel is 2 years old and while the intent for speedy disposal is creditable, the experience has not been cheering. A joint EY–CII report ‘India, a new dawn’ quoting a recent study by E&Y on the performance of DRPs for a period of two years notes that out of the total cases decided by the DRPs, 63 per cent were rejected and only partial relief was provided in 21 per cent cases. Given the above, it is vital to address the challenges being faced by the forum, in order to make it effective and enable it to meet its objectives:

Independence: With the three commissioners on the DRP panel wearing dual hats of panel members as well as Commissioners, the forum is faced with the fundamental issue of independence leading to conflict of interest. Central Board of Direct Taxes (CBDT) decision that Commissioners associated with transfer pricing orders will not be a part of DRP collegium is indeed a right step towards reinforcing DRP’s independence.

However, to ensure effective functioning of the forum to its intent it is crucial to constitute an independent body to function as DRP.

Work allocation: The panel members having an additional charge as DRP members have perceptibly divided attention. Accordingly, the CBDT must exercise its discretion to establish additional benches.

The Union Budget 2005 proposed to replace the appeal to High Court by the NTT with the objective of speedy adjudication of disputes.

The proposal of NTT was supposed to be followed by formation of 15 Tribunals with decision of NTT appealable only before the Supreme Court. The implementation of NTT would avoid conflicting decisions on the same issue thereby significantly reducing litigation. The NTT needs to become operational at the earliest.

Safe harbour

In addition to the introduction of the DRP, Finance Act 2009 empowered the CBDT to formulate safe harbour rules i.e. circumstances in which the income-tax authorities shall accept transfer price declared by the taxpayer.


“MNCs in India have to deal with complex issues, with fundamentals of international taxation being tested on a regular basis.”

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Introduction of safe harbour rules came as a cheer-up for the multinationals as the same intended to provide certainty on pricing of international transactions/determination of arm’s length margins thereby resulting in significant reduction of transfer pricing litigation. Though the CBDT established a Committee to finalise the details of the provision, the rules are yet to see the light of the day. These rules should be issued at the earliest.

The Direct Tax Code had proposed the introduction of APAs which shall be valid up to 5 financial years.

Conceptually, APA is a mechanism to provide an opportunity to the taxpayer to reach an agreement with the revenue authorities on

the future application of the arm’s length principle in their international transactions. It works as an assurance by the revenue authorities not to make any adjustments to the transfer price as long as the taxpayer adheres to the principles agreed in the arrangement.

Introduction of APAs is a welcome measure and should provide a fair degree of certainty to the business transactions.

.................


“APAs have been introduced in the Income tax law in the recent budget.”

A corporate tax specialist, Prashant has extensive experience in tax planning and structuring. He also actively contributes to thought leadership in the areas of direct taxation. He is based in our Noida office.

You can write to Prashant at: [email protected]

Prashant KhatorePartner, Tax & Regulatory Services Ernst & Young, India


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Going back in time is no good

Jayesh SanghviHindu Business Line, 19 March 2012

Across the globe, the tremors of the crisis continue to pose new and serious challenges.

Governments are increasing the focus on consolidating their public finances and designing tax structures that are growth-oriented.

The opening statement of the Finance Minister, “I need to be cruel at present to be kind in the future”, was clearly meant to be more of a statement of intent than a headliner. One would ask — was the insignificant relief granted by the Finance Minister in personal taxation (pale in the backdrop of crippling inflation), not cruelty enough?

Was it necessary to launch retrospective attack and annihilate credibility?

A passing glance on the proposed amendments of the Budget throw up a plethora of amendments, which are proposed to be retrospective, seeking to negate judicial precedents, across various appellate levels, which have provided some certainty. In this regard to highlight a few retrospective amendments:

In direct negation of the Supreme Court judgment in Vodafone retrospective amendments have been proposed to provide that a share or interest in a foreign company which directly or indirectly derives its value substantially from assets located in India would be deemed to be an asset situated in India.

The definition of the term ‘Royalty’ has been suitably amended to restate the legislative intent and to subject software licence, transponder lease revenue streams of non-residents into the net of the tax authorities.

The definition of the terms ‘international transaction’ and ‘intangible property’ have been amended for providing certainty in law.

Section 92C(2) has been amended to clarify that the tolerance band of five per cent is not taken to be a standard deduction while computing Arm’s Length Price and to ensure that due to such retrospective amendment already completed assessments or proceedings are not reopened only on this ground. It has also been

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proposed that this amendment shall be applicable to all proceedings which were pending as on 1 October 2009.

At a time when business houses and tax practitioners crave for certain and stable tax legislation, such retrospective amendments throwing business strategies and plans into disarray are hardly welcome.

Transfer pricing

In contrast, credit where it’s due, it is to be noted that the Finance Minister’s proposed amendments also include the introduction of the highly anticipated Advance Pricing Agreements (APA) and other transfer pricing related amendments. APA is very welcome in providing certainty and unanimity of approach.

Transfer pricing remains the most litigated subject today and it is hoped that the APA mechanism would foster some certainty. Other transfer pricing related amendments, including but not exhaustive (as is generally in tax law!)

Powers have been granted to the Transfer Pricing Officer (TPO) to determine the Arms Length Price (ALP) of an international transaction even if the said transaction was not referred to him by the Assessing Officer (AO), provided the same was not reported in the Transfer Pricing Report (TPR).

Penalties are now leviable for failure to (a) maintain prescribed documents or information; or (b)

report any international transaction which was required to be reported, or (c) maintain or furnish correct information or documents. Such penalty is to be levied at two per cent of the value of the international transaction.

TP regulations (procedure and penalty) extended to domestic related party transactions under Section 40A, 80IA, 10AA, 80A. Applicable effective AY 2013-14 for transactions aggregating to Rs 5 crore.

No range in lieu of five per cent was prescribed by the Government but the Budget has proposed an upper ceiling of three per cent for the same.

Again here, as mentioned earlier, definition of ‘international transaction’ has been significantly expanded for clarification retrospectively. Therefore, a taxpayer, who is not bestowed with the psychic powers of what an international transaction ‘always’ meant may have omitted including some transactions in its disclosure and documentation. He may now wait to be visited with penal provisions?

There are some provisions laid out to widen the tax base, that is, introducing tax deduction at source to immovable property transactions between residents (other than agricultural land at one per cent on urban land or other land exceeding Rs 50 lakh or Rs 25 lakh, respectively), as also tax collection at source on cash sale of bullion and jewellery in excess of Rs 2 lakh.


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New avatar

Despite the counsel of the Parliamentary Standing Committee on Finance to introduce General Anti-Avoidance Rules (GAAR), only after due consideration of some very valid recommendations, the FM has proposed to introduce GAAR in its most virulent “avatar”.

Unfortunately, it is the honest tax payer who is most scared in this country, at the prospect of being handed out a bigger tax bill. It is only hoped that the GAAR will be invoked sparingly and to address issues of clear tax evasion.

In the end, one is bewildered at how the present day legislature so vividly knows the intentions behind the legislation framed in 1962! It seems that our current legislature is gifted with superhuman prowess which the Judiciary is incapable of.

Law is truly blind. Certainty may be some distance away as some of the retrospective amendments will very likely be resisted in post-Budget parleys and, if legislated, challenged in the courts.

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1. Omitted in the Finance Act 2012, enacted on 28 May 2012

2. The Finance Act 2012 has provided relaxations to the proposed provisions by excluding coins and articles weighing less that 10 grams from “bullion” and enhancing the threshold limit for sale of jewelry to Rs. 5 lacs

3. While the GAAR provisions have been enacted vide the Finance Act 2012, their impact has been deferred by a year, i.e. the provisions are to be inserted w.e.f. 1 April 2014

Jayesh has over 19 years of experience in the field of corporate taxation, transfer pricing , regulatory matters, transaction structuring, due diligence related tax and advisory support for a number of multinational and domestic clients across various industries. Planning appropriate holding and financing structures for companies in case of reorganizations, mergers and acquisitions, advising global companies on smooth and tax efficient exit and repatriation strategies from the Indian tax perspective. He is based in our Hyderabad Office.

You can write to Jayesh at: [email protected]

Partner, Tax & Regulatory Services Ernst & Young, India

Jayesh Sanghvi


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Feature articles

Pause before P-Notes

Hiresh WadhwaniHindu Business Line, 16 April 2012

The post-budget uncertainty over taxation of participatory notes (P-Notes) remains unresolved.

In the past few days the market may have breathed a bit easier after the Finance Minister told the media that there could be no question of tax liability in India for the P-Note holder. However, the implications of the budget proposals are far-reaching and greater clarity is required.

An offshore contract

P-Notes are ‘offshore derivative instruments’ that signify a contractual arrangement executed outside India between the P-Note holder and the FII issuing it.

They are meant for investors looking for exposure to the Indian capital market. The FII is contractually obliged to provide a return that is linked to the performance of the specified security.

This financial instrument is especially useful for a significant number of investors who are not registered as FIIs with the Securities and Exchange Board of India; it gives them access to such superior returns that these Indian securities may generate.

Typically, the P-Note holder has no ownership rights in the specified security. Though the performance of the P-Note is linked to the

performance of the specified security, the FII issuing it is not obliged to hold the security.

Where the FII holds the security, it is on its own account and in accordance with its risk-taking ability. Further, in some cases the return to the P-Note holder is net of taxes incurred, if any, by the FII from hedging .

Taxing assets in India

The understanding all along has been that as a foreign asset, the gains on transfer of P-Notes are not liable to be taxed in India. However, now an uncertainty has arisen due to the proposed amendments to the Income-tax Act, 1961 (Act) on two counts.

First, in an attempt to amend the Act retrospectively to tax Vodafone-like transactions, certain amendments have been proposed to significantly widen the ‘source’ rule. These inter alia include amendment of section 9 of the Act, deeming any asset or capital asset that forms a share or interest in a company or entity incorporated outside India, as Indian if the share or interest derives its value substantially from the assets located in India. This raises worry as the return on P-Notes is linked to the performance of specified Indian securities, which are assets located in India and taxable here.

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‘Impermissible avoidance’

The second area of worry is the introduction of the General Anti-Avoidance Rule (GAAR), which empowers the tax officer to declare as “impermissible avoidance arrangement” any arrangement whose main purpose is to obtain tax benefit and inter alia lacking in commercial substance. The P-Note holder may be affected, especially where the hedging entity of the issuing FII is located in a jurisdiction that has a favourable tax treaty with India for capital gains. GAAR proposes to override the tax treaties India has entered into with other sovereign nations. The proposed provisions are widely worded and onerous.

Further, the onus is on the taxpayer to prove that the provisions do not apply. This leaves the application of GAAR to the judgment of the tax officers. Further, the applicability would be determined only at the assessment stage, which typically creates a time lag. This results in uncertainty over the tax position for these instruments.

Wary foreign funds

Such uncertainties in tax positions could deter FIIs from issuing P-Notes

and even lead to the unwinding of existing issuances, which could adversely impact foreign capital inflow to the Indian capital market.

It is worth noting that P-Notes are not unique to India and are prevalent in economies where direct access to the market is restricted; for instance, the Qualified Foreign Institutional Investor (QFII) regime in China, the Foreign Institutional Investor (FINI) regime in Taiwan, and the Investor Identification regime in Korea. Even as emerging market economies are vying for a share of the same pie, clarity and certainty on the issue of P-Note taxation will go a long way in reassuring the FII community and prevent an exodus of foreign capital from India.

.................


Pause before P-Notes

The proposed introduction of GAAR has been deferred by one year and will now be effective for income earned after April 1, 2013. Also, pursuant to significant concerns raised by various stakeholders, the burden of proof to show that an arrangement is not an impermissible avoidance arrangement is no longer that of the tax payer.

Hiresh’s experience in tax, regulatory and inbound structuring projects spans over 20 years. He has worked with variety of international financial institutions, including banks, brokerage houses, investment banks, asset management companies and PE funds. He is based in our Mumbai office.

You can write to Hiresh at: [email protected]

Hiresh WadhwaniTax Partner & National Director, Financial Services Ernst & Young, India

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Mauritius structures — gazing through a crystal ball

Vidya NagarajanHindu Business Line, 14 May 2012

Mauritius has been a popular location for intermediary holding companies for

multinationals and others investing in India. This popularity is due to several factors including the capital gains tax exemption available under the India-Mauritius Tax Treaty. The treaty, which had underpinned the emergence of Mauritius as the dominant channel for foreign direct investment into India, has been under constant scrutiny by Indian tax authorities as a result of alleged abuse by investors.

Relief in reverse?

In the past, a circular issued by the Central Board of Direct Taxes that allows tax treaty benefits based on a valid Tax Residency Certificate (TRC) of Mauritius, and the Supreme Court ruling (in the case of Azadi Bachao Andolan 263 ITR 706) upholding the validity of the circular, had provided a reasonable level of certainty to taxpayers. With a series of high-profile court rulings, including one from the Authority for Advance Rulings (in the case of E*Trade Mauritius Ltd 324 ITR 1, where it

was observed that the legal structure of the Mauritius company cannot be disregarded and legitimate tax planning was permissible), it seemed as if the status quo was restored on the use of the tax treaty.

However, recent developments indicate a renewed attempt by the tax authority to challenge the use of Mauritius structures. The authority’s approach has been to make a detailed inquiry into the facts, documentation and conduct of the parties to question the legal/ beneficial ownership of the shares by the Mauritius company, and thereafter determine the availability of the benefits under the tax treaty. Further, in a recent ruling, the Authority for Advance Rulings held that the buy-back of shares held by a Mauritius company was a tax avoidance device, as the buy-back by the Indian company was in lieu of distribution of dividends. The buy-back was disregarded and treated as distribution of dividend chargeable to dividend distribution tax (DDT) in India, both under Indian tax law as well as the tax treaty. Media reports on the possible renegotiation of the

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tax treaty and the introduction of a General Anti-Avoidance Rule (GAAR) have aggravated the challenges and risks. These have collectively caused a lot of uncertainty.

The road ahead

Over the last few years, according to media reports, the Government has sought to review the tax treaty. Tax authorities are hoping that Mauritius would stiffen the requirement for tax exemption under the treaty. Interestingly, Mauritius had added to its treaty with China a protocol (in force from January 2007) under which capital gains arising in Mauritius on the sale of Chinese assets are subject to tax in China in some circumstances.

While one can only guess what lies ahead in the use of the India-Mauritius tax treaty, drawing from media reports, it would appear that the treaty could be brought on par with the tax treaty with Singapore.

The India-Singapore tax treaty had additional clauses to check treaty abuse. It is interesting to note that the capital gains tax exemption available under the India-Singapore tax treaty is linked to the India-Mauritius tax treaty, and is available only so long as the India-Mauritius tax treaty provides that exemption.

It almost appears as if tax professionals and taxpayers will have to gaze into a crystal ball to make predictions on the future of Mauritius structures in India! Here many find themselves in deeper waters, and they look forward to greater clarity and certainty on the issue.

.................


Vidhya is a part of our Business Tax Services practice. Over the past 15 years, she has advised clients in the areas of corporate restructuring, divestments, foreign investment consulting, joint ventures, international and corporate tax. She is based in our Chennai office.

You can write to Vidya at: [email protected]

Vidya NagarajanPartner, Tax & Regulatory Services Ernst & Young, India

Mauritius structures — gazing through a crystal ball

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Feature articles

Transaction taxThis new phase of economic and corporate revival has arrived with a lot of changes in the regulations governing Mergers & Acquisitions. The Government has proposed to introduce the new Companies Bill 2011 which permits cross-border mergers and amalgamations between Indian and foreign companies, situated in notified jurisdictions. Further, the new SEBI Takeover Code reflects a fine balance of SEBI’s preference to take care of considerations of all the stakeholders - the acquirer, the target company and the minority shareholders.

All this and more is discussed in the section on Transaction tax.

65 | New ring to tax tale69 | Options that change investment status71 | The new M&A horizon

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New ring to tax tale

Amrish ShahFinancial Express, 23 September 2011

The territorial jurisdiction of Indian tax authorities to tax cross-border transactions

involving indirect transfer of shares of an Indian company has been a matter of controversy. It was generally understood that such transactions should not be taxed in India, since the situs of the shares sold are outside India and in the absence of any specific ‘look-through’ provisions. However, recently, Indian tax authorities have attempted to challenge this interpretation, which appears to steer against the accepted jurisprudence and seeks to lift the corporate veil, having far-reaching implications on international transactions.

In the era of evolving financial markets, structures put in place to channel legitimate investments across borders are perfectly acceptable, including multi-tier structures put in place for commercial reasons, such as leveraged buyouts. They provide exit flexibility to investors. These structures should not be subjected to the lifting of the corporate veil merely

because it results in tax savings. Taxing such transactions on the basis of non-existing provisions would result in uncertainties amongst the existing investors.

In the past, similar transactions have been left untouched. Taxing similar transactions now would result in an unfair advantage to those past transactions.

Though such an approach might result in a temporary spurt in revenue for the Government, it could also have an adverse impact on investor sentiments and hamper future FDI flows into India. The ‘preferred investment destination’ image of India may take a beating in the case of such an approach being adopted by the tax authorities.

If other countries also start adopting the same approach, taking a cue from the arguments of Indian tax authorities, this would create a fair chance of affecting outbound structures of Indian corporates and hinder their global expansion plans. This, in turn, would hinder the overall growth of Indian corporates and, therefore, India itself.

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Such a position would raise some practical issues as well. The parties involved would be foreign entities unaware of Indian tax laws. How would they withhold taxes and deposit in India? For instance, in the case of a listed foreign entity having an Indian subsidiary, there could be numerous transactions where withholding tax implications may arise to public shareholders, which seems to be an absurd position. How would the cost of the acquisition of such shares be computed and capital gains apportioned, if the foreign company whose shares are being sold also holds shares of companies other than Indian companies? Also, if a similar transaction results in a capital loss, would the tax authorities be willing to allow a set-off of such a capital loss? In the case of a multi-layered structure involving multiple countries, the tax impact would need to be examined in each country in the structure and the transaction could be subject to tax in multiple countries. This lack of clarity would result in enhancing litigation and consequential uncertainties. Resolution of the issues may result in a delay in the closure of deals. Also, the transaction documentation, especially the representations, warranties and indemnification clauses, are likely to get a lot more complex and elaborate.

If at all such transactions are to be taxed, a prospective amendment in the existing tax laws with a specific provision to tax such transactions

would be a reasonable path forward, in order to provide prospective investors a better chance to plan their structures. Interestingly, the Direct Taxes Code—which is likely to come into effect on April 1, 2012—specifically spells out conditions under which such indirect transfer will be subject to tax in India. Since there are various instances of pending litigations in Indian courts (including the apex court), a better picture and a clear view forward would be available only after such litigations are settled.

The right of a State to tax a non-resident arises from the existence of a nexus between him and that State. International law recognises a State’s right to tax income having its source in its jurisdiction. The Bombay High Court’s ruling in the Vodafone case has stirred a hornet’s nest mainly on account of the perception that there was no such nexus, as the transaction was entered between two foreign companies—outside India, and for shares of another foreign company. It is, therefore, argued that Revenue is stretching the concept of nexus by bringing in the issue of the foreign company’s underlying Indian assets.

Actually, the case revolves around a complex catena of facts, briefly stated here. The Hutchison Group of Hong Kong was controlling certain companies in India in joint ventures with others. It held a majority stake in an Indian company, Hutchison Essar Limited (HEL), through Hutchison Telecommunication International Ltd (HTIL) of Cayman Islands. HEL had


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interests in several telecom circles in India through a web of subsidiaries. In February 2007, HTIL agreed to procure and transfer to Vodafone International Holdings BV the entire share capital of an investment company in Cayman Islands called CGP Investments Holdings Ltd, which was controlling the Indian interests of the Hutch group. Pursuant to this, Vodafone took approval of FIPB. It also entered into a covenant with HTIL indemnifying it for certain tax liabilities and allowing it to retain $352 million out of the sale consideration. Thereafter, Vodafone

The Revenue contended that this was, in reality, a composite transaction for the transfer of all rights in HEL by HTIL, resulting in Vodafone stepping into the shoes of HTIL. It argued that the transaction gave rise to capital gains taxable in India, as, in effect, the controlling interest in the Indian assets of HEL got transferred, and Vodafone ought to have deducted tax. The central argument on behalf of Vodafone remained that as the transaction was of a share of CGP Cayman Islands—situated outside India—no income can be deemed to have accrued or arisen in India. It took the matter to the Bombay High Court in a writ against a Show Cause Notice issued by Revenue even before the tax liability was determined.

The Court held that it will be simplistic to assume that the transaction was only for the transfer of one share of CGP Cayman Islands. The price of $11 billion factored in a panoply of rights and entitlements including control premium, right to the Hutch brand in India, a non-compete agreement, the value of non-voting preference shares and entitlement to acquire further 15% interest in HEL. The transaction prima facie amounts to a transfer of a capital assets and not merely a transfer simplicitor of controlling interest—especially as it confers a right to enter the telecom business in India with a control premium.


“If other countries take their cue from the arguments of Indian tax authorities, this could effect outbound structures of Indian corporates and really hinder their global expansion plans.”

paid the balance consideration and the share certificate of CGP was delivered to it in Cayman Islands. The transaction was accompanied with several other enabling agreements.

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Relying on the doctrine of substance versus form, the Court held that the label which parties ascribe to a transaction cannot be conclusive in determining its character. This has to be ascertained from the covenants and surrounding circumstances. A colourable device in which parties, while seeking to clothe the transaction with a legal form, actually engage in a different transaction which serve no business purpose except avoidance of tax, can be disregarded. It held that once the nexus between a non-resident and the country seeking to tax him is shown to exist based on a business connection or situs of assets within the State, taxability can arise.

“The Finance Act, 2012, introduced retrospective provisions ,effective from 1st April, 1962, to tax indirect transfers of shares in situations where the shares derive, directly or indirectly, their substantial value from assets located in India.”

An all-India rank holder in Chartered Accountancy, Amrish has over two decades of experience in the areas of mergers and acquisitions, divestments, corporate restructuring, foreign investment consulting, and establishment of joint ventures. He is based in our Mumbai office.

You can write to Amrish at: [email protected]

Amrish ShahPartner & National Leader — Transaction Tax Services Ernst & Young, India


The ruling has been given on the basis of facts indicating that the transaction was a colourable tax avoidance device. Therefore, Revenue will be ill-advised in invoking it in genuine business cases. Incidentally, the Direct Taxes Code codifies the anti-avoidance Rules under which a transaction can be declared as lacking commercial substance.

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Reprinted with the permission of Financial Express © 2012. All rights reserved throughout the world.

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Options that change investment status

Amrish ShahEconomic Times, 4 November 2011

It took just a month for the Department of Industrial Policy and Promotion to revise its earlier

provision that sought to define equity investment as debt if it was accompanied by in-built options. For the private equity industry, which was most affected by this directive, the subsequent revision has come as a welcome shot in the arm. But other regulatory bodies will need to follow suit if the current buoyancy in PE inflow into India is to continue.

The Department of Industrial Policy and Promotion (DIPP) in its mid-year review of Foreign Direct Investment (FDI) policy on October 1, 2011 had inserted a specific provision, which stated that any equity instrument when issued or transferred to a non-resident, will be deemed as ‘debt’ if it includes in-built options or is supported by third party options of any type. Such instruments would need to comply with extant External Commercial Borrowings (ECB) guidelines in respect of various caps, compliances, restrictions and limitations.

This inclusion saw vehement opposition from the industry, more particularly from private

equity investors. The cardinal principle of any PE investment is to simultaneously think about the exit at the time of entry itself. Limiting their options to structure their investment, especially their exit options, obviously did not go down well with the industry.

Even if the provisions were introduced by DIPP to curb investments made by foreign players (especially in real estate sector) who acting as lenders brought in money under the garb of FDI compliant instruments, painting all FDI investors with the same brush and limiting their structuring options would have had a significant effect on FDI into India.

The hue and cry and the various representations made to the government authorities have borne fruit. The DIPP has reacted swiftly and within one month of introduction of the said regulation has withdrawn the entire provision by issuing a clarificatory circular dated October 31, 2011. In doing so, the DIPP has displayed a flexible approach and an ability to ensure that India’s attractiveness as an FDI destination remains intact.

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While DIPP has taken the necessary amending steps, it needs to be seen whether other regulators follow suit. For example, even prior to introduction of the said provision by DIPP, in certain cases, RBI has been questioning investment agreements which involved options and classifying them as an ECB, irrespective of whether such an option was exercisable by the Company or by its shareholders, or whether it was exercisable to the shareholder pursuant to a breach of a condition or upon failure to provide exit to the investor.

Similarly even Sebi in the recent past has held that Put/ Call Options in private agreement amongst shareholders is invalid since as per the provisions of Securities Contracts (Regulation) Act, 1956, only spot delivery contracts or derivative contracts entered into through a stock exchange are legally enforceable.

The options being exercisable on a future date can neither be regarded as spot delivery contracts nor be

considered as a legal/ valid derivative contract entered on a stock exchange, since they are exclusively entered between two parties independent of the stock exchange.

Considering that DIPP has given a green signal to use of Options, one can only hope that a similar approach would be adopted by the other Regulators as well. The industry is open to apt regulations, which would curb debt masquerading as equity and other such abusive practices; however, a blanket attack on all option structures even in case of genuine equity investments is something which is extremely undesirable.

The other regulatory authorities should take a clue from DIPP and come out with clear clarifications so that there is no negative impact on FDI investments.

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Amrish Shah is a partner at Ernst & Young India and leads our Transaction Tax practice*. Over the past 18 years he has advised clients in the areas of acquisitions, divestments, mergers, demergers, corporate restructuring, re-organizations, foreign investment consulting, and establishment of joint ventures, international/corporate tax and business reorganization. He is based in our Mumbai office.


Amrish ShahPartner & National Leader — Transaction Tax Services Ernst & Young, India

Options that change investment status

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The new M&A horizon

Narendra RohiraHindu Business Line, 26 December 2011

Last week saw the arrival of the latest product of the current spree of legislative reform

directed at India Inc – the Companies Bill 2011 (‘the new Bill’). Aiming to consolidate over 50 years of practical and legislative history is no easy task, and while it is evident that the new Bill has attempted to balance out the needs of the Indian corporate sector on one hand, the rights of the minority shareholder, greater discloser and greater accountability are also obvious keystones desired to be addressed by the legislature.

Cross-border mergers

Leading the charge of iconic changes attempted by the new Bill are the provisions governing cross-border mergers and amalgamations between Indian and foreign companies. At first, this appears a bold and progressive move with the legislation finally opening up India’s borders to previously outlawed outbound mergers.

However, like the great impressionist paintings of Renoir and Van Gogh, a closer inspection reveals a far fuzzier picture. While the provisions do allow inbound and outbound cross-border mergers, such cross-border mergers

will only be allowed with companies situated in jurisdictions notified by the Central Government.

Given that the provisions governing cross-border mergers apply to both inbound and outbound mergers, this qualification could actually result in a metaphorical step back as under the existing laws, inbound mergers are not only permissible, but are permissible with foreign companies from any jurisdiction. The provisions could therefore result in India Inc finding their hands tied as they would be only able to merge with companies in specific countries instead of being able to play in the entire global market as they do now.

Prior approval

Another potentially unwished-for-change is the requirement of seeking prior RBI approval for any and all cross-border M&A activity. The inherent paperwork and lengthy timelines surrounding regulatory approval could prove practically onerous for Indian corporates, should such a process be required for each and every cross-border transaction.

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However, qualifications such as Government notification and mandatory prior RBI approval might significantly reduce the potential benefits for India Inc. In recent times, the government’s focus on disclosure and transparency when dealing with the corporate sector has come to the forefront with high profile cases highlighting the regulatory authorities’ determination to question corporate structures and transactions that seem to have been put in place solely to take advantage of loopholes in the existing laws.

In line with this spirit, the new Bill provides that going forward, pure investment holding companies may only make investments through a maximum of two layers. However, this could prove rather unfriendly for India Inc as existing multiple investment layers have most often been put in place to allow efficient tax planning, greater investment and capital infusion flexibility and alternative holding structures that are compliant with existing laws but still allow a promoter/majority shareholder to retain control – directly or indirectly.

Under the provisions of the new Bill, holding treasury stock i.e. stock held

in the name of the issuing company itself, is no longer permissible, in or out of a trust structure.

Treasury stock has historically been held as an instrument that could provide access to liquidity should the company require it in the future, while still allowing the promoters/majority shareholders to retain a controlling stake over the company.

The loss of such an option could require many Indian corporate houses to look for alternative funding and retention of control options.

“Under the new bill, cross-border mergers will only be allowed with companies situated in jurisdictions notified by the Central Government.”

The new M&A horizon

Balancing needs

The new Bill’s desire to balance out the needs of all its stakeholders is evident in its attempt to provide procedural simplicity and clarity in situations that were only dealt with in practical jurisprudence until now. A testament to this desire is the new Bill’s provisions with regard to mergers and/or amalgamations between small companies and those between parent companies and their subsidiaries.

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Instead of the entire regulatory process involving the courts, mergers involving such companies have been given the option of a simpler process involving only the relevant Registrar and the Official Liquidator. For mergers between wholly-owned subsidiaries and their parent companies, the logic of a simpler process was upheld by the courts in cases such as Mahaamba Investments Ltd vs. IDI Limited and the codification of this principle by the new Bill will provide welcome certainty to companies who until now were sure of successfully applying this principle in selected courts only.

The new M&A horizon

A partner with our Transaction Tax practice, Narendra focusses on conceptualizing, structuring and implementation of M&As. He has assisted various Private Equity players with acquisitions in India involving cross border structuring, funding and corporate tax optimization. He is based in our Mumbai office.

You can write to Narendra at: [email protected]

Narendra RohiraPartner, Transaction Tax Services Ernst & Young, India

Amidst the heated debate on FDI limits and the glamorous morality of the Lokpal Bill, the Companies Bill is a perhaps a quiet giant but a giant nonetheless, on whose shoulders has fallen the task of bringing Indian’s corporate laws into the 21st century. How well it manages its responsibilities, only time will tell.

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Tax & regulatory policyThe current economic situation continues to be of concern. Though inflation has momentarily stabilized, it is still hovering above the tolerance level. Issues such as the sliding rupee, black money play an important role in shaping the investment environment in India. The Government needs to take measures to boost the business environment and keep the confidence of domestic and foreign investors intact.

While the Government appears cautious about permitting FDI in Retail and sensitive sectors like Defense & Civil aviation, there have also been challenges on the introduction of GST. Measures such as streamlining the FDI policy and reducing red-tape are expected to result in boosting investor confidence.

From a tax and regulatory policy perspective, it appears that the Government dished out a safe budget that merely pledges reforms. A dynamic environment like this demands a sharp analytical focus on the policies and concrete shape must be given at the earliest to control the ballooning fiscal deficit.

The articles in this section bring to the fore the significant dimensions of the regulatory policy environment in India.

75 | Is grip tightening on black money?78 | New regulatory framework for private investment vehicles82 | Alternative investment funds: hits and misses84 | One-time amnesty for swiss stash87 | Tax transparency is the new reality90 | New SEBI takeover code finally notified94 | The Big Push for Big Retail97 | 3G of Tax ReformsIn

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Is grip tightening on black money?

Sudhir KapadiaEconomic Times, 11 August 2011

The issue of tax evasion, or black money, continues to occupy centre stage in the country.

According to a 2006 report of the Swiss Banking Association, Indian nationals hold $1,456 billion in Swiss bank deposits.

A Global Financial Integrity study estimates the flight of gross illicit assets from India during 1948-2008 at a staggering $462 billion. This article discusses recent steps taken by various countries, including India, to tackle tax evasion in general and offshore tax evasion in particular.

The US: The US Internal Revenue Service (IRS) has introduced the Offshore Voluntary Disclosure Initiative, 2011, for taxpayers with undisclosed offshore accounts and assets to bring them into compliance with US tax laws. Voluntary disclosure is a practice of the IRS criminal investigation whereby it takes timely, accurate and complete voluntary disclosures into account to decide whether to recommend to the Department of Justice that a taxpayer be criminally prosecuted.

The taxpayers are encouraged to make voluntary disclosures and become compliant to avoid substantial penalties, including fraud penalty and foreign information return penalties, and the risk of criminal prosecution. Voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues.

The IRS ferrets out the identities of those with undisclosed foreign accounts. This information is available under tax treaties through submissions by whistle-blowers, and will become more available as the Foreign Account Tax Compliance Act (FATCA) and Foreign Financial Asset Reporting become effective.

The UK: Her Majesty’s Revenue & Customs (HMRC) deals seriously with cases of tax defaults using civil or criminal powers to penalise or prosecute evaders. From April 2010, in addition to recovering due tax, interest and a penalty up to 100% of the tax lost, HMRC is empowered to publish details of persons caught deliberately evading over ?25,000.

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Besides this, to tackle offshore non-compliance, the Finance Act, 2010, introduced a new penalty framework applicable to income tax and capital gains tax for failure to notify or inaccuracy on a return or failure to file a return on time. The legislation provides for enhanced penalties where the non-compliance arises in a jurisdiction that does not automatically share tax information with the UK.

For example, for territories in categories 2 (exchange of information on request) and 3 (no/insufficient information sharing), the penalties will be up to 150% and 200% of tax respectively.

India: The government has notified ‘specified territories’ to be able to initiate and negotiate Tax Information Exchange Agreements (TIEA) for prevention of tax evasion or avoidance and assistance in collection of income tax.

In April 2010, nine jurisdictions - Bermuda, British Virgin Islands (BVI), Cayman Islands, Gibraltar, Guernsey, Isle of Man, Jersey, Netherlands Antilles and Macau - were notified with the intent to enter into a TIEA. Till date, India has signed TIEAs with Bahamas, BVI, Isle of Man and Cayman Islands. Hong Kong has been also notified as a specified territory for entering into a tax treaty by the government.

Along the lines of OECD Model Article on ‘Exchange of Information’, the government has signed a protocol amending its treaty with Singapore to add standards on exchange of information on request in tax matters for the administration and enforcement of domestic tax law.

The Finance Act, 2011, introduced an anti-avoidance measure - section 94A, effective from June 1, 2011 - to curb round-tripping, etc. The government shall notify a country or territory with lack of effective exchange by it with India as a Notified Jurisdictional Area (NJA).

A transaction between the taxpayer and a person located in an NJA will be deemed to be an international transaction subject to transfer pricing provisions. All parties to such international transaction would be deemed to be associated enterprises.

No deduction will be allowed for any expenditure or allowance (including depreciation) unless taxpayer maintains proper documentation and furnishes prescribed information. Any sum received by a person located in an NJA on which tax is deductible would invite tax at ahigher punitive value.


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Besides these, the government has commissioned a study for estimating unaccounted income and wealth within and outside India and instituted the directorate of income tax, criminal investigations, under the CBDT to investigate criminal matters having financial implications punishable as an offence under any direct tax law, similar to steps undertaken by the US and UK.

Further, a high-level committee on black money has been constituted under the CBDT chairman, now to be overseen by a special investigating team as per a Supreme Court directive. As in everything else, the key will be effective implementation and relentless pursuit of tax offenders in specific cases. Bringing those offenders to book will be critical to the future direction of India’s efforts of tackling this cancerous menace in the Indian economy.

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• The Ministry of Finance has in May 2012, released a ‘White Paper on Black Money’, which identifies different kinds of manipulations of financial statements resulting in tax evasion and the generation of black money, these include: Land and Real Estate Transactions, Bullion and Jewellery Transactions and Financial Market Transactions. The White Paper also outlines various policy options that could be pursued by the Central and State Governments to tackle the menace of black money.

• Providing a perspective on black money held by Indians in Swiss Bank accounts, the White Paper states that this figure has decline by 60% from INR 23, 373 crore in 2006 to INR 9, 295 crore in 2010.

• The Finance Act, 2012, has introduced various measures to improve better disclosures and tackle the issue of black money. These include: (i) Production of a Tax Residency Certificate for availing the beneficial provisions of a tax treaty; (ii) Strengthening reporting mechanism wherein every resident (other than not ordinarily resident) having any asset (including including financial interest in any entity) located outside India or signing authority in any account located outside India has to file a tax return containing the required disclosures such as details of foreign bank accounts, financial interests, immovable properties or other assets held outside India; (iii) Introducing provisions of tax collection at source (TCS). In instances of cash sale of jewellery or bullion in excess of INR 0.5 mn and 0.2 mn the seller needs to collect tax from the buyer at the rate of 1 per cent; (iv) The time limit for reopening of assessments where income in relation to any asset located outside India has escaped assessment has been extended from six to sixteen years.



Sudhir KapadiaNational Tax Leader Ernst & Young, India


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Feature articles

New regulatory framework for private investment vehicles

Prakash ShahCFO Connect, 1 September 2011

The Securities and Exchange Board of India (SEBI) has recently released a concept

paper proposing introduction of SEBI (Alternative Investment Funds) Regulations, 2011 (‘AIF Regulations’) and containing draft AIF Regulations. The same is open for public comments up to 30 August 2011. The proposed structure is, inter alia, aimed at providing a regulatory framework for all types of private pool of capital or investment vehicles so that such funds are channelised in the desired space in a regulated manner without posing a systemic risk. The proposed framework also classifies the funds into separate categories such that concessions/ relaxations can be tied to investment restrictions for special kind of funds such as venture capital funds, social venture funds, private equity funds etc.

Once the AIF Regulations come into effect, the SEBI (Venture Capital Fund) Regulations, 1996, the current regulation governing domestic venture capital funds will be repealed and the new AIF Regulations will then govern VCFs. The SEBI (Foreign Venture Capital Investor) Regulations, 2000, under which a SEBI registered FVCI can invest in venture capital

undertakings (VCUs) in India without the pricing restrictions for making investments in India (that are applicable to investments made under the Foreign Direct Investment route) will continue.

Registration

An Alternative Investment Fund means pooling or raising of private capital from institutional or High Net Worth Investors (HNI) with a view to investing in accordance with a defined investment policy for the benefit of the investors; and includes one of the prescribed categories of funds indicated below and such other funds which are not covered under the SEBI (Mutual Funds) Regulation, 1996 or SEBI (Collective Investment Schemes) Regulations, 1999. A HNI is defined to mean an individual or corporate or any other legal entity located in India or overseas who invests in AIFs for a value of not less than Rs. 100 million.

All AIFs would be required to obtain a certificate of registration under the proposed AFI Regulations. While the language used in the concept paper is very wide to cover even offshore funds investing in India, the intent is to regulate the domestic funds.

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The Funds could be formed as companies, trust or body corporate including Limited Liability Partnerships (LLPs). The application will be in one of the following categories:

1. Venture capital fund - for providing equity seed capital to unlisted start-up or new ventures or early-stage or emerging companies primarily involved in new or unproven technology

2. Private Investment in Public Enterprises (PIPE fund) – for investments into small size listed companies

3. Private Equity fund – for making investments primarily in unlisted equity or unlisted debt securities of companies

4. Debt fund – for making investments primarily in debt instruments of unlisted companies

5. Infrastructure fund – for investments in infrastructure funds

6. Real estate fund – for investing in real estate projects or in special purpose vehicles investing in real estate projects

7. Social venture fund – for investors willing to accept muted returns (10% - 12%) to invest in social ventures such as micro finance institutions (MFIs).

8. Small and Medium Enterprises (SMEs) fund – for investors willing to invest in unlisted equity of companies in manufacturing and services sector and companies providing infrastructure support

While considering the application for registration of an AIF, the SEBI will take into account all matters relating to investment objective of the fund, the target investors, size of the fund, investment style or strategy, professional qualification of the managers, necessary infrastrustructure, past experience etc.

The registration would be valid for the lower of three years or the tenure of fund.

Unlike the current VCF Regulations where the trust secures a VCF registration and can then launch several schemes, under the AIF regulations each scheme will require a separate registration. This requirement could significantly increase the time and costs as for each scheme a separate registration would have to be sought.

All funds already registered as VCF under SEBI (VCF) Regulations, 1996 shall continue to be regulated by the said regulations till the existing fund or scheme managed by the fund is wound up. An AIF acting as such before the commencement of these regulations may continue to do so

Any applications made as of date, SEBI should be considering the same under the current VCF regulations.


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Key conditions

The investment manager /sponsor of the fund is required to have a minimum interest of 5% of the fund which should not be contributed through waiver of management fees. Such investment of the investment manager/sponsor will not be transferable during the life of the fund. This requirement of mandatory contribution is onerous and is much higher than the standard international practice where the commitments range between1% to 2%.

Such Funds can operate as closed ended funds with a specified target size (not less than Rs. 200 million), life cycle (minimum maturity of 5 years) and target investors under the proposed framework. The minimum investment amount should be the higher of 0.1 per cent of the fund size or Rs. 100 million. The funds formed as companies or LLPs can at the maximum have 50 investors and the minimum size of the units issued is Rs. 1 million. The investors would have a lock-in period of three years.

The AIF can invest only in instruments specified for each category of investments. As is currently the case for VCF, an AIF cannot invest more than 25% of the corpus of the fund in one investee company. Similarly, the AIF Regulations also prohibit investment of AIF in Non Banking

Financial Companies (NBFCs) (except in prescribed cases), Gold Financing, activities not permitted under the Industrial Policy of the Government of India or any other activity specified by SEBI. Further, AIFs granted registration under one category is not permitted to change its category subsequent to the registration.

The AIF Regulations also lay additional restrictions on each of the categories of funds.

The AIF Regulations require disclosure of the terms and conditions of subscription to the funds, the mechanism of payment to the investment manager as well as the method adopted while distribution of monies to the investors. The responsibility of the investment manager should be clearly defined. These requirements should form part of the Private Placement Memorandum issued by the fund to its investors.

It may be noteworthy that the venture capital fund registration currently used for registration of all funds that adhere to the investment restrictions/ conditions prescribed under the SEBI VCF Regulations would under the AIF Regulations be available to only funds which have the objective to promote new ventures using new technology or with innovative business ideas at early / start up stage and where the fund size is not more than Rs. 2.5

New regulatory framework for private

investment vehicles

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billion. Further such funds would be precluded from investing in any company that is promoted directly or indirectly by any of the top 500 listed companies by market capital capitalization or by their promoter.

The introduction of the AIF Regulations is a step in the right direction and should go a long way in steering the growth of the industry while at the same time balancing the need for managing risks to the investors and the stability of the financial system.

Some of the conditions that are prescribed in the concept paper are quite restrictive and may hinder the participation by certain players for eg. the maximum size of VCF funds being Rs. 2.5 billion, the restriction on investment by VCF

funds into companies promoted by top 500 listed companies by market capitalization, investments by PIPE funds only into small sized listed companies etc. It would be advisable that some of these restrictions are eliminated in the final regulations as the same would go a long way in the efficacy of the guidelines and its implementation.

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‘SEBI has released the final guidelines on Alternative Investment Fund regulations in May, 2012’.

Prakash Shah is an Associate Director at Ernst & Young India in the Financial Services - tax and regulatory practice. He possesses over 13 years of experience and has done extensive work in the area of tax and regulatory matters of financial services entities such as banks, insurance companies, securities broking, private equity etc. He is based in our Mumbai office.

You can write to Prakash at: [email protected]

Prakash ShahAssociate Director, Tax & Regulatory Services Ernst & Young, India


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Alternative investment funds: hits and misses

Sudhir KapadiaEconomic Times, 9 September 2011

Market regulator SEBI is proposing a new set of regulations for all Alternative

Investment Funds (AIF). However, this new framework will be useful only if it enables AIFs in India to compete with their global peers, say the authors in this exclusive review.

Venture capital (VC) and private equity (PE) funds play a crucial role in India’s economic development by filling the gaps in availability of capital. As of September 2010, Sebi-registered VC funds and foreign VC investors cumulatively invested approximately $12 billion across several industries.

Separately, public data indicates that PE funds as an investor class (including both Sebi-registered and other overseas funds) have invested more than $45 billion in the last five years.

Recognising the growing importance of this industry and with a view to maintaining the stability of the financial system, Sebi has proposed to introduce Alternative Investment Funds (AIF) Regulations.

It appears from the Regulations that foreign PE/VC funds, which collect funds from institutional investors/

HNIs in India will also be bound by the Regulations and will be subject to Sebi’s oversight.

If that is indeed Sebi’s intent, it may be more prudent to frame specific regulations for such funds given that it may be commercially impractical for a foreign PE/VC fund to design its product in accordance with the Regulations.

The Regulations categorises all AIFs into nine distinct categories including VC funds, PE funds, debt funds, real estate funds, social venture funds and strategy funds. Viewed in the context of the prevailing Sebi VC Fund Regulations, this is a welcome move as funds can diversify product offerings based on investors’ risk appetite and investment objectives.

However, it certainly merits consideration whether industry must compartmentalise itself into nine distinct product offerings to gain concessions. Benefits can similarly be defined for an AIF making an early stage investment, investment in infrastructure sector, social sector, etc without necessarily categorising the AIF under the Regulations.

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Alternative investment funds: hits and misses

Sebi’s objectives would be equally achieved by prescribing a framework for mandatory registration and oversight of AIF Managers coupled with a system of reporting particulars of the various AIFs launched by registered AIF Managers.

This would also be consistent with the recent approach of most developed market regulators that now require (or are in the process of mandatorily requiring) most AIF Managers to register and comply with significant reporting and record keeping obligations to facilitate the management of systemic risk by the country’s securities market regulator.

Other concerns that the industry would have from the Regulations is the high threshold of Rs 1 crore that has been prescribed for minimum investment in an AIF.

This represents a significant increase from the present minimum investment amount of Rs 5 lakhs that applies to investment in a registered VC fund and is likely to have a significant impact on fund raising by AIFs.

Sebi could consider specifying a minimum investment threshold that is in line with that applicable to Portfolio Management Schemes, which the concept paper states is likely to be revised from Rs 5-25 lakh. Lastly, a review of the taxation framework for AIFs would immensely benefit the industry.

The domestic AIF industry is set to grow exponentially. It is now upto Sebi and the Government to decide whether to let them flourish by providing them a platform to compete with their global peers.

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“The Securities and Exchange Board of India has on 21 May 2012 notified the SEBI (Alternative Investment Funds) Regulations, 2012 incorporating substantial changes to the draft regulations originally circulated for public comments in August 2011.”



Sudhir KapadiaPartner, National Tax Leader Ernst & Young, India

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Feature articles

One-time amnesty for swiss stash

Sudhir KapadiaEconomic Times, 29 September 2011

Of late, the tale of the elusive Swiss accounts has resurfaced with the proposed

treaty between the UK and Swiss governments, where Switzerland has agreed to repatriate to the UK an anonymous tax amount calculated on the aggregate income of UK tax residents, in their Swiss bank accounts. The tradeoff is that the names of the individual UK taxpayers shall not be revealed by the Swiss government in return for this lump sum munificence.

The UK government is obviously motivated by the opportunity to shore up its treasury by the one-time payment, and for the Swiss government, it may come as a pressure to avoid yet another instance of further diluting its much-vaunted banking secrecy. From an EU and tax policy perspective, this may not be the most optimal result as it goes against the grain of ensuring transparency and naming and shaming of tax evaders.

This approach adopted by the UK government is in sharp contrast to the one favoured by the US government, where the US

government extracted the names of US tax residents illegally holding bank accounts in UBS, for example, and a simultaneous announcement of tax amnesty for US tax residents under which payment of evaded taxes and reduced penalty would ensure closure of all other proceedings against US tax residents. This, of course, was accompanied by a shrill campaign by the US Internal Revenue Service to warn the tax citizenry at large about more dire consequences, including prosecution, if US tax residents do not come forth to declare their secret deposits in offshore accounts.

In the light of the continuous debate in India about the methodology by which the country should endeavour to recover the lost billions in tax revenues due to alleged siphoning of Indian money to offshore locations, a question arises for Indian policymakers to ponder over the approach that should be taken, vis--vis the Swiss government in the light of the above international developments, vis-vis the US and the UK.

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At one level, it can be argued that there is no need for any incentive mechanism to coax reluctant Indian taxpayers to declare their undisclosed income as recent initiatives such as sharing of information including on bank accounts maintained with Swiss banks should enable Indian government, in specific instances, to ask for the relevant information from the Swiss authorities and take further action based on that information. In other words, it can be argued that time has come for the Indian government to start utilising tools such as exchange of information, agreements that have been entered into with various offshore countries and sharpen the revenue knife to cut into the undisclosed wealth outside India and get its fair pound of flesh.

This, of course, is easier said than done as it will be a long and arduous process that Indian authorities will have to go through, before they get to the much-coveted and highly-fancied offshore bank deposits and other wealth. It is also a moot point how legally successful Indian tax authorities will emerge in tracing the alleged undisclosed wealth outside

India to Indian beneficiaries. Viewed from this angle, the pact like the one UK has entered into with Switzerland would look attractive. It immediately garners an entire one-time revenue payment that can fund the societal obligations for the Indian government and, hopefully, make a clean slate going forward to deter tax evaders from similar action in future.

However,in this approach, Indian government may have to rely on the Swiss governments definition of money belonging to Indian tax residents based on which they will calculate India’s share of taxes. For example, there may be a maze of intermediary companies or

trusts or other such entities, where the final beneficiary may not be immediately visible and the Swiss government may choose to keep out of this formula of any interest paid to such account holders from Swiss bank accounts. Against this, the US approach seems superior in as much as it compels US tax residents to come forth and declare their undisclosed offshore income under the amnesty and, thereby, collect much-needed revenue and, at the


“The Indian Government may want to consider a combination of effectively utilising the recent agreement for exchange of information including bank accounts, as well as a onetime window for Indian taxpayers to come forth and anonymously declare their offshore accounts.”

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Feature articles

same time, instill enough fear in the minds of US taxpayers, that going forward, the deterrent measures will be so strong against tax evaders that they would be ill-advised to continue the practice of non-disclosure of offshore income.

On balance, therefore, the Indian government may want to consider a combination of effectively utilising the recent agreement for exchange of information including bank accounts, as well as a onetime window for Indian taxpayers to come forth and anonymously declare their offshore accounts, on which taxes as well as penalties can be imposed as a one-time revenue-raising measure;



Sudhir KapadiaPartner, National Tax Leader Ernst & Young, india

and also to serve as a deterrent for potential future tax evaders.

Of course, any such initiative will have to be carefully planned and executed in a way that it remains legally tenable and practically implementable. More importantly, appropriate communication strategy should be adopted to make taxpayers aware about the serious repercussions that will befall them for any such tax evasive action by them in future.

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Tax transparency is the new reality

Pranav SaytaHindu Business Line, 1 November 2011

Tax transparency is the new reality for India, as the government has realised the

urgent need to tackle black money. Internationally, the move towards tax transparency began in early 2000 and OECD’s Global Forum Working Group on Effective Exchange of Information released an ‘Agreement on exchange of information on tax matters’ in April 2002.

Tackling black money

On the legislative front, India has adopted a three-pronged approach to tackle black money. First, it has completed negotiation of Tax Information Exchange Agreements (TIEAs) with 16 tax havens. Second, it has initiated the process of negotiation with 75 countries to broaden the scope of the ‘Exchange of Information’ Article in Double Tax Avoidance Agreements (DTAAs), either by way of protocols to existing DTAAs or new DTAAs.

As of September, negotiations/renegotiations with 40 countries were completed. Third, section 94-A of the Income-tax Act, 1961, now empowers the Government to notify any territory outside India, having regard to lack of effective exchange of information, as a notified jurisdictional area. In simple terms, transactions with residents of such territories are subject to higher withholding, certain disallowances and also subject to transfer pricing regulations. Several countries have pressurized Switzerland to be more tax transparent. According to OCED’s statistics, Switzerland has signed 91 DTAAs providing for the exchange of information. The protocol amending the India-Swiss DTAA was signed on August 30 last year and approved by the Swiss Parliament on June 17, 2011. The 100-day waiting period for ratification has recently ended. This enables India to obtain information from Switzerland in specific cases, for a period starting from April 1, 2011.

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Overview in the Swiss context

For long Switzerland did not accept a full exchange of information clause. However, international pressure and the need to upgrade to OECD’s G-20 white list led to a rethink. Its Federal Council on March 13, 2009, made the historic announcement that Switzerland intends to adopt the OECD standard on administrative assistance in tax matters. This decision permitted the exchange of information with other countries in individual cases, where a specific and justified request was made and Switzerland began negotiations on revising its DTAAs.

Protocol to the DTAA

The amending protocol to the India-Swiss DTAA has replaced Article 26 and has introduced a new paragraph 10 to the protocol. The India-Swiss

to the widest possible extent, it does not allow fishing expeditions or request for information that is unlikely to be relevant to the tax affairs of a given tax payer. India’s Competent Authority needs to provide various information to the Swiss competent authorities when making such requests, which include the name of the person/s under examination, the period for which the information is required, a statement of information sought including the nature and format in which it is sought, the tax purpose for which the information is sought and also the name of any person believed to be in possession of such information.

The India-Swiss DTAA expressly provides that the administrative procedure rules regarding taxpayers’ rights remain applicable before information is transmitted. The Swiss domestic law also provides for procedural rights for protecting the interest of the tax payers. Thus, before any information can be exchanged, the tax payer will first be informed of, then has the right to be heard on and finally has the right to object to (and eventually appeal before the Swiss Federal Administrative Court) on the decision made by the Swiss Federal Tax Administration to exchange information. Further the India-Swiss DTAA does not commit Switzerland to exchange information on an automatic or spontaneous basis.

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“India-Swiss DTAA does not commit Switzerland to exchange information on an automatic or spontaneous basis.”

DTAA now enables India to obtain information that is foreseeably relevant to the administration and enforcement of Indian Income taxes. India can now approach Switzerland for information, but only after it has exhausted all normal procedures under its domestic law to obtain such information. While it is intended to provide for exchange of information

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• The Ministry of Finance has in May 2012, released a ‘White Paper on Black Money’, according to which black money in bank accounts in Switzerland has reduced from INR 23, 373 crore in 2006 to INR 9,295 crore in 2010.

• The ‘White Paper ‘also refers to the revenue sharing agreements entered into by Switzerland with U.K, Germany and Austria. In simple terms, Switzerland protects the identity of the bank account holder but withholds tax at source (a one-time tax and a tax on future income) and remits such tax withheld to the treasury of the other country. The White Paper calls for further debate on whether entering into a similar agreement with Switzerland would be in India’s best national interest.

Pranav leads the Technology, Communication & Entertainment business unit for Tax service line. With over twenty years of experience in the practice of Direct Tax Laws, he specializes in advising on various international tax matters, inbound and outbound transactions, cross border and domestic mergers, acquisitions & joint ventures, group financial and corporate restructuring.

Pranav has been consistently rated as one of the leading tax advisors in India by International Tax Review & by the Legal Media Group Guide to the World’s Leading Tax Advisers. He is based in our Mumbai office.

You can write to Pranav at: [email protected]

Pranav SaytaTax Partner, Technology, Communication & Entertainment Ernst & Young, India


• In a bid to gather information, The Finance Act, 2012, has amended section 139 of the Income tax Act, 1961 (w.e.f AY 2012-13), to provide for mandatory filing of tax return by every resident (other than not ordinarily resident) having any asset (including including financial interest in any entity) located outside India or signing authority in any account located outside India. Such a tax return is required to be filed even if the person does not have any taxable income. Details of foreign bank accounts, financial interests, immovable properties or other assets outside India are required to be disclosed in the tax returns.

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Feature articles

The Indian tax and regulatory laws are undergoing a period of change and one such

change is the evolution of the new takeover code.

On September 23, 2011, SEBI had notified Substantial Acquisition of Shares and Takeover Regulations, 2011,which are effective from October 22, 2011. The new regulations clarify that all the transactions where public announcement had already been made under the old regulations shall continue to be governed by that regulation, i.e. without considering the new regulation. It is indeed a revolutionary legislation which is likely to change the landscape of M&A for listed Indian entities in the near future. Some of the key amendments in the new code are as under:

Increase in open offer size

One of the most significant amendments in the new regulations is increase in statutory open offer size from 20% to 26% of the total shareholding of the target company. Takeover Regulations

Advisory Committee’s (TRAC) recommendation to increase the open offer size to 100% of remaining shareholders was not accepted primarily due to the lack of proper bank funding options available in India, resulting in the international buyers with better leveraging abilities getting an advantage. This would have also reduced the overall size of the M&A market due to lack of Indian acquirer’s ability to raise resources and lead to public investor not being able to get benefits of higher price, due to an increased level of interest in their companies. At the same time, 100% would have been sweeter for the MNCs as it would tantamount to automatic delisting of shares.

Delisting

Coming to the delisting aspect, the TRAC in its earlier proposal, had suggested a proposal of “auto delisting” where, pursuant to open offer, the acquirer acquires stake in excess of the “delisting threshold”, the target could automatically be delisted. It is noticed that apart from

New SEBI takeover code finally notified

Amrish ShahCFO Connect, 1 November 2011

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removing the possibility of automatic delisting, the new regulations actually make it impossible to launch a delisting offer where the promoter shareholding goes beyond the maximum permissible non-public shareholding, for a period of 12 months.

Accordingly, limiting the open offer size to 26% seems to be a good balancing act and will help the M & A landscape significantly, as we move forward.

Increase in initial trigger limit

The initial threshold limit provided for open offer obligations has been increased from 15% to 25% of the shares or voting rights of the target company. In today’s high interest era, the higher threshold would greatly enhance the ability of Indian listed companies to raise equity capital from financial investors without triggering the open offer requirements. It will also benefit private equity investors who can go up much higher without shelling out money for an open offer.

For the economy, one can expect more investment from PE or foreign partners in the coming months, which would propel the FDI numbers which have not been encouraging in the recent past.

From a strategic acquirer’s perspective, the above changes would enable an acquirer to potentially acquire a minimum 51% stake (25% initial threshold plus 26% open offer) of the target company, as compared to 35% (15% initial threshold plus 20% open offer) under the old regulations. To an acquirer, this helps bring stability by achieving a definite controlling stake instead of de facto control.

Abolition of non-compete fees

Inclusion of non-compete fees in the offer price is a fine balancing act as it would lead to an open offer being made to all the public shareholders at a uniform price. This is a very bold step and would encourage larger participation of retail investors and it does remove any advantage the

promoters of target companies may have. At the same time, promoters may feel aggrieved given the fact that a significant stake sale by promoter

would ordinarily carry a control premium for the additional efforts of the promoter to drive the company as compared to the public shareholders.

“It is indeed a revolutionary legislation which is likely to change the landscape of M&A for listed Indian entities in the near future”.

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Specific provision for voluntary open offer

Under the old regulations, there is no distinct category as a voluntary open offer. Therefore, nothing prevented any non-promoter, with or without a shareholding, from making an unsolicited open offer to public shareholders. The new regulations provide for voluntary open offer for an acquirer holding 25% or more voting rights in a target company to consolidate their shareholding with a minimum offer size of 10% of voting rights, subject to the total shareholding post open offer not exceeding the maximum permissible non-public shareholding. Even these shareholders cannot make voluntary offers if they had purchased shares from the market in the preceding one year. Further, such shareholders shall not be entitled to acquire any shares of the target company for a period of six months after completion of the open offer, except pursuant to another voluntary open offer.

The aforesaid provision, while offering the benefit to the promoters to consolidate their holdings, puts in place, time and shareholding restrictions on such offers; and enabling the promoters to shore up their stake to levels that can ward off attempts from any unwarranted investors acquiring substantial stake in the company.

Creeping acquisitions

Creeping acquisitions of 5% can be made per financial year by acquirers holding more than 25% of voting capital of the target company without triggering the mandatory open offer, so long as the maximum permissible non-public shareholding limit is not breached. This is a welcome change for promoters holding more than 55% but less than 75% shareholding in the target company as it provides them a window of increasing their stake by 5% per financial year, vis-à-vis 5% in the lifetime of the company in the old regulations.

Other significant amendments

In an era of global acquisitions, the provisions under the new regulations with respect to compliance with the takeover regulations in case of indirect acquisitions are a welcome step instead of the materiality and intention based criteria laid down in past cases. It lays out specific tests that if company derives more than 80% of net worth, turnover or market cap from investment in listed company, then acquisition of such a company beyond thresholds automatically makes it a direct acquisition and the provisions of new regulations shall apply accordingly. The new takeover regulations impose an obligation on independent directors of the target company, to give their recommendations to shareholders on the open offer.

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Further, certain exemptions from making a public offer pertaining to change in control with a shareholders resolution and exemption requiring disclosing the names forming part of the “group” in the annual report has been withdrawn, and some new exemptions have been provided in the new regulations such as, increase in voting rights pursuant to buy-back, acquisition of preference shares carrying voting rights, and acquisition of shares of target company not involving change in control pursuant to a Corporate Debt Restructuring Scheme.

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An all-India rank holder in Chartered Accountancy, Amrish has over two decades of experience in the areas of mergers and acquisitions, divestments, corporate restructuring, foreign investment consulting, and establishment of joint ventures. He is based in our Mumbai office.


Amrish ShahPartner & National Leader-Transaction Tax Services Ernst & Young, India


ConclusionOverall, the new takeover regulations appear to be tuned towards today’s overall corporate standards of a big developing economy and should have a positive impact on capital markets activities. The changes highlighted in the new takeover code reflect a fine balance of SEBI’s preference to take care of considerations of all the stakeholders - the acquirer, the target company and the minority shareholders.

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The big push for big retail

Paresh ParekhEconomic Times, 26 November 2011

India’s retail market promises to be among the top retail destinations in the world, thanks to rising

consumption.

International brands and retailers will gain access to a substantial market, following Cabinet’s decision to allow up to 51% foreign direct investment (FDI) in multi-brand retail sector and 100% FDI in single-brand retail.

FDI in single-brand retail currently is 0.03% of cumulative FDI of around $149 billion from April 2000 to September 2011. The relaxation is likely to result in an increase in FDI in retail sector, especially in greenfield and brownfield investments.

Indian retail market, which was around $220 billion in 2005, is now expected to hit $700 billion by 2015, with a CAGR of about 12%.

Within retail, modern, or organised, retail is growing at a fast clip, with CAGR of about 21%. Though the industry was expected to grow at a much faster rate 5-7 years ago, the actual growth rate was much lower. Lack of retail expertise and experience has been the main reason for this subdued growth.

FDI in retail will pave the way for inflow of technical expertise and knowledge and this, in turn, can boost the overall growth of the industry. The announcement is expected to generate 10 million jobs over three years, without impacting smaller and domestic retailers.

The sophisticated front-end that international players are likely to bring will boost investment in infrastructure by retail players, third-party supply-chain companies and the government. This will improve efficiencies in the supply chain, cut wastage, increase efficiency and bring down consumer prices.

Fact is, farming community in India has shown one of the lowest efficiencies in terms of production. Our productivity in food and agriculture is among the lowest in the world and there is a significant opportunity to raise output, with investment in better farming practices.

FDI in retail will provide the farming community a new support group with a common interest that is expected to give a big push to productivity.

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Foreign multi-brand retailers, who did not want to enter India through cash-and-carry route, may now explore Indian presence, as they would be able to directly own stake in multi-brand retailing. Foreign retailers such as Sainsbury’s, Lawson and others may now explore Indian retail market.

Multi-brand foreign retailers that have already invested in India under cash-and-carry arrangements, such as Walmart, Metro, Carrefour, Tesco, and Woolworths, now have an option to invest in Indian companies undertaking direct retailing.

In existing single-brand retail joint ventures, the foreign multinational joint-venture partner would have the flexibility to raise its stake in the venture beyond 51%. For existing Indian retail players, such as Reliance, Trent, Shoppers Stop and the Future Group, this could provide further options to raise long-term capital for expansion and to attract partnerships with some global players.

This will help bring capital as well as global best practices and retail expertise to the Indian businesses.

Single-brand foreign retail players, who have so far restrained themselves from entering the country for reasons such as wanting the entire stake or ownership in an Indian single-brand retail entity, may now want to explore the Indian market.

One may also potentially see present licensing, distributor or franchise arrangements being converted to either joint ventures with respective

foreign retailer or brands, or foreign retailers completely buying out the Indian licensee, franchisee or distributor.

In multi-brand retailing, as the foreign retailer can own a maximum stake of 51%, the retailer would have to scout for an Indian partner to enter Indian multi-brand retail sector.

Further, one will have to wait for clarification on whether the entire amount of minimum capitalization of $100 million is to be invested upfront or over a period of time. Also, would such a condition be too onerous for certain categories of multi-brand retailing such as sport goods, watches, stationery, apparel and electronics.

Also, to comply with the norm of minimum 50% investment in back-end infrastructure, retailers would need to have a precise interpretation


“MNC retailers will assess market dynamics and select partners with suitable capabilities.”

of the term back-end infrastructure. Another key condition is that foreign retailers should source certain minimum percentage from micro, small and medium enterprises. This could provide an impetus to the growth of the small-scale sector.

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With this relaxation of FDI in multi-brand retailing, it remains to be seen whether the government will also relax the restriction on cash-and-carry companies that are barred from supplying more than 25% of their turnover to group companies.

While FDI in retail sector has been relaxed with conditions, potential foreign retailers would assess customer dynamics, competition, supply chain, infrastructure and import regulations.

They would also typically want to select a partner with complementing capabilities and cultural fitment, adapt products for the diverse Indian

“While the Indian Government has allowed up to 100% FDI in Single Brand retailing, post this article the Indian Government has kept the decision to allow 51% FDI in Multi Brand retailing on hold for further deliberations”

Paresh Parekh is a Partner at Ernst & Young India in the Tax & Regulatory Services Practice. Paresh is focusing on Retail, Consumer, Infrastructure and Industrial sector. Over past 12 years he has advised clients in the areas of India entry, complex domestic and international tax matters, litigation, foreign direct investment regulations, cash repatriation, merger and acquisitions, divestments, corporate restructuring, outbound investments and business reorganization. He is based in our Mumbai office.

You can write to Paresh at: [email protected]

Paresh ParekhPartner, Tax & Regulatory Services Ernst & Young, India


micro-markets, use appropriate sourcing models to manage costs and appeal to the Indian customer, and understand the tax and regulatory landscape in India.

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3G of tax reforms

Satya PoddarEconomic Times, 1 March 2012

In preparing his Budget 2012, the finance minister faces a difficult challenge of fiscal consolidation

without stifling investment and economic growth.

Given the limited elbow room to raise revenues through higher tax rates, the government should focus on the third-generation (3G) tax reforms that can yield a fiscal bonanza similar to that from 3G spectrum auctions. These would be reforms that modernise tax administration.

The first-generation reforms consisted of rationalisation of the direct and indirect taxes levied by the Centre, broadening of their bases, and lowering of the statutory rates. The second-generation reforms were the replacement of state sales taxes by the value-added tax (VAT).

While these reforms resulted in improvement in tax compliance and provided a significant boost to tax revenues, they were limited to legislative changes and the rich dividends that could be reaped by having a modern, IT-savvy and taxpayer-friendly tax administration remain unrealised.

A facilitative tax administration is dependent on simplicity of the tax laws, infrastructure for tax administration, harmonisation and integration of laws and procedures across the country.

The reforms for achieving simplicity in tax laws and their harmonisation are an ongoing process and the goods and services tax (GST) is aimed at addressing this objective. The GST, if based on the flawless design recommended by the 13th Finance Commission, could well be the 4G reform. Pending its implementation, governments should focus on archaic, inefficient and ineffective tax administration.

Critical ingredients of a modern tax administration are automation and standardisation, quality taxpayers’ services, avoidance of tax disputes and their quick resolution. The most pivotal reform among these is a more effective use of information technology. While India has made considerable progress in terms of computerisation, it is still very basic.

3G of tax reforms

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3G of tax reforms

The significant role that IT can play in comprehensive automation and integration of processes, minimising discretion by officials, data capturing and analysis for guiding policy decisions and for enhancing taxpayer services, has not been tapped in full measure.

The current business processes, systems and facilities lack in transparency, which encourages rent-seeking behaviour and reduces the willingness of taxpayers to voluntarily pay taxes. At the state-level, particularly, the use of IT in VAT administration and for monitoring inter-state trade leaves a vast scope for improvement. As one senior official put it recently, “revenues their governments collect is not because of the effort by officials, but in spite of it”.

The latest World Bank study on Doing Business ranks India at a dismal low of 147 out of 183 countries in terms of ‘ease of paying taxes’. Investors lament aggressive interpretation of tax laws by assessing officers, which can lead to protracted litigation for decades.

The resulting costs and uncertainty hinder business. So, the finance minister’s recent statement that the government aims to provide citizen-centric governance to improve taxpayer services and redressal of public grievances could not have been more timely.

The decisions and actions of tax administrations are guided by the assumption that the taxpayer is naturally inclined to avoid paying taxes.

This attitude must be replaced by a more cooperative and communicative approach. Modern tax jurisdictions like in the US and UK adopt a customer-oriented and outcome-based approach for taxpayers.

While setting organisational objectives, establishing targets and evaluating performance, the emphasis is on parameters of ‘customer’ satisfaction

along with business results.

An open, communicative approach towards taxpayers can be instrumental in bringing greater certainty in tax liability and quicker resolution of tax issues, which helps reduce litigation.

India is sitting on a blocked amount of more than 3 lakh crore on account of tax litigation, of which 2.2 lakh crore is stuck at the Commissioner (Appeal) level. These sums could be much lower if there was a more open and communicative environment.

Studies in Australia show that reduced disputes lead to better compliance and more revenues. In UK, the Advance Agreement Unit comprising of a team of specialists work with businesses to provide some

“The Government must leverage IT to modernise tax administration and improve quality of taxpayer services.”

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Satya has over three decades of experience in advising clients on tax policies, VAT and international taxes, he has been the Advisor to the Gulf Cooperation Council on issues relating to tax policy matters and Director of the Tax Analysis and Commodity Tax Division in the Canadian Ministry of Finance.

He has also served as tax policy advisor to governments around the world, including Russia, China, European Union, New Zealand, Syria, Korea, and Gulf Cooperation Council. He is based in our Gurgaon office.

You can write to Satya at: [email protected]

Satya PoddarPartner, Policy Advisory Group Ernst & Young, India

3G of tax reforms

certainty for future tax payments. Also, customer relations managers provide a single-point contact and take a lead role in engaging companies on open cases and draw up an action plan for case resolution.

The HMRC has established customer contact centres that focus on alleviating doubts of taxpayers and create an environment of customer friendliness.

At a time when governments worldwide are grappling with the burgeoning debts and fiscal constraints due to the global financial crisis, ‘working smarter’ has become a necessity for tax administrators. India too must lend absolute commitment to reengineering its administrative framework and implement it in the right earnest.

The multiplier effect of this 3G reform could have the potential to surpass the rich haul reaped from

the 3G spectrum auctions - a win-win situation for taxpayers, the revenue department and the economy. A stable and efficient tax administrative environment would also spur foreign investments, crucial for India’s economic growth.

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101 | The path to globalisation compliance and reporting

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The path to globalisation compliance and reporting

Rahul KashikarCFO Connect, 1 October 2011

Over the last decade, Indian companies have rapidly globalised their operations

and there seems to be an ever increasing appetite to grow overseas inorganically. Due to this, the role of the CFO at the Indian headquarter level has substantially evolved to oversee multi country finance operations.

One of the important responsibilities of the CFO is statutory compliance and reporting, which could have inherent risks attached to it, given its statutory nature. Many companies are currently distributing responsibility for compliance & reporting processes throughout their organisations, which may not be resulting in the most optimal efficiency, control and value.

Ernst & Young Survey on compliance and reporting

Recently Ernst & Young conducted a survey on more than 200 finance and tax executives from Fortune Global 500 and Forbes Global 2000 companies, which gave rise to some interesting findings. The key elements of compliance and reporting that the survey pertains to is statutory financial and tax filings as required in countries around the world. These

include:

• Income tax compliance

• Indirect tax compliance

• Statutory accounting and reporting

• Tax accounting and provisions

Some of the findings of the survey are very insightful:

1. We are at a tipping point for compliance and reporting:

Almost two-thirds of the respondents say that changes in regulatory requirements will impose significant challenges on compliance and reporting processes. A more rationally organised, efficient and controlled compliance and reporting function globally can help mitigate these risks and unexpected costs.

The fact that local jurisdictions are rewriting regulations, focusing more intently on the collection of tax revenues and sharing more tax information across borders makes this even more important.

In the past 12 months, percentage of companies from Fortune 500 experiencing:

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64% Unplanned tax audits

45% Unexpected tax assessments

42% Penalties

17% Business interruption due to lack of compliance

2. Local expertise is key to a successful GCR model:

Compliance and reporting processes result in inherently local in-country filings and submissions. Between 64% and 78% of survey respondents indicated that local-country resources are vital to successful compliance with tax and regulatory requirements. Yet the trend in finance has been to reduce or redeploy to

global or regional centers the in-country finance resources, which traditionally supported local compliance and reporting processes. Often, the level of start-up business activity doesn’t readily support investment in local finance teams.

3. Leading companies blend internal resources and external providers to optimise compliance and reporting:

More than 80% of respondents that use outside providers consider it an effective means of accessing local expertise

4. Effective compliance and reporting models require a strong governance structure:

More than 40% of respondents indicated a lack of global governance over statutory financial filings, and more than 60% indicated no global governance over direct and indirect tax filings required by their companies.

Note: Companies assessing outsourcing as an effective means of chieving business benefits

The path to globalisation compliance

and reporting

83%

72%

59% 56%46% 43%

0%

20%

40%

60%

80%

100%

Ability to employ people with appropriate level of local expertise

Leveraging methodolo-gies, expertise, etc., of service partner

Ensuring flexibility and scalability of sourcing solution

Reducing costs and increasing predictability of costs

Reducing head count and full-time equivalents

Diversify-ing and sharing of operational and execution risk

Perc

enta

ge

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These survey results point to a need for a greater level of control, visibility and accountability within compliance and reporting. Strong corporate governance reduces the likelihood of unplanned audits and is a prerequisite for simplification, standardisation, automation and centralisation of key processes. It is also a vital ingredient for most successful transformations.

How are leading global companies dealing with compliance and reporting across borders?

Leading global companies today are increasingly procuring some or all of their compliance and reporting services on a regional or global basis. Just as companies are finding benefit in regionalising and standardising their in-house finance functions, they are taking a similar approach to the procurement of compliance and reporting service providers.

Requiring the service provider to include a governance framework to manage the centrally procured compliance and reporting processes provides such companies a robust infrastructure to monitor and gain visibility of the compliance process.

Often, this means replacing a patchwork of local service providers with a globally or regionally engaged provider, who has cutting edge technical capabilities in a multi-country environment with a robust technology infrastructure to manage the process.

Our experience indicates that companies are increasingly leveraging in-house procurement experts to achieve a greater level of quality and consistency in the service they receive from such global service providers. This is often done through the adoption of contracts that cover multiple countries and through the adoption of global SLAs (service level agreements). Such an approach, when aligned with standardisation, can help a company achieve an improved balance of efficiency, control and value throughout the compliance and reporting processes.

Need for Indian companies to adapt global compliance and reporting (GCR) methodologies

Given the rapid pace at which Indian companies are multiplying its operations overseas, it is all the more reason that they must transform GCR processes to deliver greater efficiency, control and value; and to mitigate risk in an increasingly global and sometimes hostile tax and regulatory environment. The benefits are clear. There is no longer any question that GCR processes must change. The only questions are when and how.


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Following are some of the key benefits of adapting to GCR methodologies

• ► Rapid overseas expansion – Manage compliance and reporting risks

• ► Reduced resource deployment overseas

• ► Enhance visibility and control over processes

• ► Centralise global compliance and reporting governance

• ► Deal with developments such as IFRS

• ► Management can focus on core business

Key factors in GCR transformation

Transforming the GCR model presents many challenges. Companies are reducing the number of experienced finance and tax resources available in-country. Yet, local authorities are becoming more focused on increasing revenues through enhanced enforcement. Access to skilled and experienced local resources is vital.

Leading companies mustrecognise that by having the right core skills internally, along with standardised processes and information, they can take maximum advantage by using external providers that operate globally. New GCR models incorporate clear global accountability, transparency and control. This is very different from the historical patchwork of GCR responsibilities spread across different departments and geographies.

The new GCR model ushers in an era where processes are optimised to deliver efficiency, control and value. Structured, standardised, reliable, scalable, sustainable and value-focused GCR models will soon transcend the patchwork upon which most Indian companies rely today. Successful results will require effort. But as the Ernst &Young report demonstrates, the benefits and risks demand that companies begin the journey.

With regard to GCR requirements, finance executives must define, inventorise and rationalise the filings or submissions that are required.

“A more rationally organised and controlled compliance and reporting function globally, can help mitigate regulatory risks and unexpected costs.”

Companies that have addressed GCR opportunities within their finance transformations are reaping the benefits. For others, whether their transformation is completed or contemplated, now is the time to make a change. Companies need to assess the gaps in their current approach along with the benefits available from a new GCR model.

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and reporting

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The requirements definition should include responsibility and accountability, timing and key metrics for the related activities. Also, finance and tax executives should ensure that their model anticipates and manages accelerating changes — regulatory, legal entity, finance and business — that affect GCR requirements.

The importance of having a governance framework developed and implemented to manage GCR processes on a global basis cannot be undermined. This will ensure control

Rahul Kashikar is an Associate Director at Ernst & Young India. Rahul is focussing on the Global Compliance Reporting initiative in India. With over 15 years of exeprience is closely working with the Indian telecom and advertising industry sector clients advising on tax and regulatory matters. He is based in our Mumbai office.

You can write to Rahul at: [email protected]

Rahul KashikarAssociate Director, Tax & Regulatory Services Ernst & Young, India

and stakeholder confidence and set a foundation for sustainable cost advantages through standardisation, automation and centralisation.

...............



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Fore more information, visit www.ey.com/India

Connect with us

Assurance, Tax, Transactions, Advisory A comprehensive range of high-quality services to help you navigate your next phase of growth

Read more on www.ey.com/India/Services

Our services

Centers of excellence for key sectors Our sector practices ensure our work with you is tuned in to the realities of your industry

Read about our sector knowledge at ey.com/India/industries

Sector focus

Easy access to our knowledge publications. Any time.

http://webcast.ey.com/thoughtcenter/

Webcasts and podcasts

www.ey.com/subscription-form

Follow us @EY_India Join the Business network from Ernst & Young

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