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The Budget 2012 - Some thoughts

By Gayatri Sridharan

The Budget of 2012 is finally out. The expected changes have been brought about. A few changes appear controversial no doubt but may be essential to plug evasion of tax. This is not to state that the measures need to be harsh.  How does one seek a balance between necessity and harsh measures?    

The first Budget Speech was brought in by Shri R. K. Shanmukham Chetty on 26th of November 1947. India was caught in the throes of partition and the aftermath of the World War. There had been an almost total breakdown of the economy of the East and West Punjabs. While Government was doing everything possible to relieve immediate distress and suffering of the refugees, formulation of long-range plans for their rehabilitation raised formidable issues both in the financial and administrative fields. The food scarcity continued to cause grave anxiety both to the Provincial Governments and the Central Government. In spite of that the then Finance Minister declared

    “I have carefully considered if any part of the deficit for this year should be covered by additional taxation and I have come to the conclusion that it should be left largely uncovered.”

 That was a humane budget. This year however despite the escalating prices the Finance Minister was not in such a benevolent mood. He felt that he must be cruel to be kind. Some of the chief measures in the field of Direct Taxes are introduction of General Anti Avoidance Rules and amendments to enlarge the scope of accrual and receipt of income to overcome the verdict of the Apex Court in the Vodafone case.              

The GAAR which is introduced as Chapter X- A in the Income Tax Act, 1961 is thankfully not retrospective. It bestows wide powers on the Income Tax Authorities to rearrange by disregarding, ignoring, reallocating, reconsidering or looking through any arrangement or part of an arrangement or any step in any arrangement which they feel is an ‘impermissible avoidance arrangement’. The Bill lays down four tests to determine an impermissible avoidance arrangement. They are:

(1)  An arrangement creating rights and obligations not normally created between parties at arm’s length
(2)  Abuse or misuse of provisions of tax laws
(3)  The arrangement lacks commercial substance
(4)  It is carried out in a manner not employed for a bona fide purpose.

An arrangement will be deemed to lack commercial substance if
(1)  If the substance or effect of the arrangement as a whole is  inconsistent  with or differs significantly from, the form of its individual steps
(2)  It involves round trip financing
(3)  It involves an accommodating party
(4)  It involves elements that have the effect of offsetting or cancelling each other or a transaction which disguises the value, location, source, ownership or control of fund which is subject matter of such transaction.
(5)  It involves the location of an asset, transaction or place of residence of any party which would not have been so located for any substantial commercial purpose other than obtaining tax benefit for a party.              

By these amendments it seeks to emphasise substance over form in the implementation of tax laws. In India, hitherto anti-avoidance principles were based mostly on judicial pronouncements. This has now been codified. The provisions of this chapter will enjoy precedence over Double Taxation Avoidance Agreements entered into by India with other countries. The treaty override will render many benefits conferred by treaty nugatory. There will be no certainty in the treaty obligations for citizens of either country.  

Another significant anti-avoidance amendment is the extension of application of transfer pricing regulations to domestic transactions between related parties the value of which exceeds Rs. 5 Crores in a year. Domestic transactions between related parties are already subject to scrutiny under the existing provisions like Sections 40 A, 80 A , 80 IA etc., But there are no specific methods to determine reasonableness of the expenditure or fair market value to recompute the income in such related transactions. This amendment is the offshoot of the suggestion of the Supreme Court in the case of CIT v. Glaxo Smith Kline Asia (P) Ltd. reported in (2010) 47 DTR 65, 236 CTR 113 (SC) to consider appropriate provisions in law to make transfer pricing regulations applicable to such related party domestic transactions.            

Now let us come to the changes triggered by the Supreme Court decision in the case of Vodafone. The main stumbling block for the Income Tax Department was the language of Section 9 of the Income tax Act. Section 9 creates a legal fiction to tax income which may or may not arise in India and would not have been taxable but for the deeming provision. This deeming provision is now proposed to be expanded retrospectively in keeping with “source based taxation” to include transfers through, by means of , in consequence of or by reason of  a capital asset situated in India. Further Section 9(1) (i) has been amended to clarify that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be situated in India if the share or interest derives directly or indirectly, its value substantially from the assets located in India. Lest you should have any doubts about the “share or interest in a company”, it has been clarified by amendment to Section 2(14) that property includes any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.              

One is reminded of Lord Asquith’s remarks in his famous passage in East End Dwellings Co. Ltd. v. Finsbury Borough Council (1952] AC 109 at p. 132. He said:           
" If you are bidden to treat an imaginary state of affairs as real, you must also imagine as real the consequences and incidents which, if the putative state of affairs had in fact existed, must inevitably have flowed from or accompanied it; and if the statute says that you must imagine certain state of affairs, it cannot be interpreted to mean that having done so, you must cause or permit your imagination to boggle when it comes to the inevitable corollaries of that state of affairs."    

As if that is not enough the Bill has not spared the definition of ‘royalty’ which is being expanded to include consideration for transfer of computer software which will now include transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through such right is transferred whether or not the possession or control of such right, property or information is with the payer; is used directly by the payer or the location of which is in India. Further the expression “process” in Section 9 (1)(vi) has been clarified to include  transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret.    

In Craies on Statute Law, p. 90 and also Maxwell on The Interpretation of Statutes, Tenth Edn., pp. 236-237, Lord Dunedin in Whitney v. Commissioners of Inland Revenue [1925] 10 Tax Cas. 88, 110), observed as follows  
"A statute is designed, to be workable, and the interpretation thereof by a court should be to secure that object, unless crucial omission or clear direction makes that end unattainable.”  

In a series of lectures delivered  before the Law School of Yale University as Storrs Lectures in the school year 1921-22, Roscoe Pound cited the following passage from John Chapman Gray’s work in ‘Nature and Sources of the Law ‘which was published in 1909,  
“The fact is, that the difficulties of so called interpretation arise when the legislature has had no meaning at all; when the question which is raised on the statute never occurred to it; when what the judges have to do is, not to determine what the legislature did mean on a point  not present to its mind, but to guess what it would have intended on a point not present to its mind but to guess what it would have intended on a point not present to its mind had the point been present.”
What does one do when every time the object of legislation is determined the legislation itself is promptly amended? There can never be any closure and assessees have to live in constant paranoia. If the judiciary interprets a provision of the Income Tax law in a beneficial manner you may be rest assured that the Income Tax Department will in one-up-manship promptly amend the provision retrospectively clarifying what was supposed to be intended. This problem is further compounded when the legislature continually changes its mind; or is it the executive limb of the government which decides what is in the mind of the legislature? More questions are thrown up when we look at the national policy on cross border relations. What messages are we sending across globally? Has anyone thought of the snowballing effect of such legislation? In logic this is often referred to as the fallacy of irrelevant conclusion (Ignoratio Elenchi). The fallacy of ignorantio elenchi is committed when an argument purporting to establish a particular conclusion is instead directed to proving a different conclusion thus bypassing serious questions by obscuring the issue with attractive generalizations about some larger or different end. Source based taxation and substance over form are not sufficient to remedy what ails our nation.    

[The author is Principal Associate, Direct Tax, Lakshmikumaran & Sridharan, Bangalore]

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