The NDA government needs to do more and get rid of the UPA’s extortionist tax regime

This year in February, Vodafone shot off an angry press statement — launching a veiled attack on the government — after it received a notice from the income tax department to pay Rs 14,200 crore tax due or face seizure of assets.

In the statement, the company expressed its exasperation saying that “When PM Modi is promoting a taxfriendly environment for foreign investors, this seems a complete disconnect between government and tax department.” Though the statement was directed towards the tax department, it’s clearly aimed at the government.

The tax demand pertains to the company’s acquisition of Hutchison’s 67 per cent stake for about $11 billion in 2007. Though Vodafone had won the case against the tax demand in the Supreme Court in 2012, the then UPA government had changed the law retrospectively to ensure that Vodafone did not escape paying the tax.

The retrospective change in the Income Tax Act led to a kerfuffle with both international as well as domestic media accusing Indian government of resorting to tax terrorism. This decision apparently spooked international investors and earned India a bad name.

The Bharatiya Janta Party (BJP), which was then in the opposition, made tax terrorism a political issue and promised in its election manifesto that it would not resort to such extortion tactics if it came to power.

And now that it is in power, companies such as Vodafone were hoping for an amicable solution to the issue. But that did not happen. Cairn Energy, another multinational company that was hit by the 2012 retrospective change in the tax law, also received similar notice from tax authorities in 2015 and 2016. It owes the government almost Rs 30,000 crore in tax.

Priorities and pressures

Has the government gone back on its prepoll promise of providing an amicable tax regime to businesses? Did the businesses attach too much importance to a political party’s election promise? Or is the government’s policy in line with the changing global tax landscape?

While Prime Minister Narendra Modi, who is known to be business friendly and can be seen hobnobbing with domestic as well as global business leaders, had promised non-adversarial tax policies to businesses (for which he has received a lot of cheers), he had also promised (to his core supporters) an all-out war against black money.

To keep both promises, the government would need to adopt contrasting policies — you can’t fight the menace of black money by having amicable tax policies. And for some reason, the government has decided to pursue the battle against the menace of black money more seriously than the promise of an easier tax regime.

Its first biggest move on the tax front was that of bringing the black money law that was aimed at unearthing unaccounted assets abroad. The law has provision of a 60 per cent tax on assets disclosed, and in case of willful non-disclosure, a jail term of up to 10 years. The stringent law has not gone down well with many, so much so that even the sympathisers of the government and Prime Minister Narendra Modi have called it a big joke.

Further intensifying its fight against black money, the government brought a provision in the income tax law that requires taxpayers with annual taxable income of Rs 50 lakh and above to provide the value of assets and liabilities in the income tax return. The government again received severe criticism for the move, although it tried to brush off the criticism by saying that only 1.5 lakh taxpayers would get affected by the new rule. However, critics have called it another round of tax terrorism even insinuating that such moves may force rich taxpayers leaving the country.

GAAR, PoEM and Equalisation levy

There are many more such steps taken by the government that signals a stricter tax regime ahead.

The General Anti-Avoidance Rule (GAAR), which was deferred by the new government in 2015, would now come into force from April 2017. GAAR has a provision that gives the tax department the authority to go after an assessee if it is convinced that the latter has used the tax treaty with a country to avoid tax. In such cases, the domestic laws would override treaty provisions. GAAR provisions have the potential to create a lot of litigations and tax disputes.

Another contentious tax rule that comes into force from April 2017 is the place of effective management (PoEM). PoEM is a set of rules that determine the tax residency of an entity. It says that a company would be treated as resident in India if its place of effective management in the previous year was in India. This should impact foreign companies with India subsidiaries, Indian companies with foreign subsidiaries. Though the government has come out with a comprehensive rule on PoEM, there are many ambiguities and doubts. These again would lead to more tax litigations and harassment of taxpayers.

In this year’s Budget, the government has mooted a new tax on payments made to overseas digital companies — the likes of Google, Facebook, and so on — which do not have permanent establishment in India and hence escape paying tax despite earning substantial revenues here. The new tax is called Equalisation Levy and would be levied on payment made towards advertisements on a non-resident online entity. Residents paying for such advertisements have to withhold the tax. The levy has been kept out of the ambit of Income Tax Act and, therefore, foreign companies would not be able to claim credit for such a tax. They, therefore, would increase the rates of advertisement by 6 per cent to negate the impact of Equalisation levy on their revenues.

The Mauritius treaty

Recently, the India-Mauritius tax treaty was changed to enable the Indian authorities to tax capital gains made by companies based in Mauritius from selling equity in Indian companies. This ends the decades of double non-taxation of capital gains by companies based out of Mauritius. The change in treaty structure would impact Mauritius-based foreign portfolio investors, private equity and venture capital funds.

The change in Mauritius treaty would also necessitate change in Singapore treaty. The two countries account for 50 per cent of the foreign direct investments (FDI) in India. In future the government may also change the treaty with Cyprus and the Netherlands, therefore, making it impossible for FPIs and shell companies to avoid paying taxes in India.

Though the government has taken many steps to clear ambiguities and bringing more certainty in tax laws over the past two years, it has certainly not kept its promise of amicable tax policies.

While many of the tax policies have been guided by the overall change in global attitude towards tax avoidance and were in the making over a long period, many of the changes in tax laws bore out of the government’s over exuberance in fighting the menace of black money.

The only problem in going all out against the so-called tax evaders and avoiders is that it may damage the business-friendly environment in the country.