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3 All rights reserved ISBN : ???-? Price : ` 250 Published by : Taxmann Publications (P.) Ltd. Sales & Marketing : 59/32, New Rohtak Road, New Delhi India Phone : Fax : Regd. Office : 21/35, West Punjabi Bagh, New Delhi India Website : sales@taxmann.com Printed at : Tan Prints (India) Pvt. Ltd. 44 Km. Mile Stone, National Highway, Rohtak Road Village Rohad, Distt. Jhajjar (Haryana) India sales@tanprints.com Every effort has been made to avoid errors or omissions in this publication. In spite of this, errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in the next edition. It is notified that neither the publisher nor the author or seller will be responsible for any damage or loss of action to any one, of any kind, in any manner, therefrom. It is suggested that to avoid any doubt the reader should cross-check all the facts, law and contents of the publication with original Government publication or notifications. No part of this book may be reproduced or copied in any form or by any means [graphic, electronic or mechanical, including photocopying, recording, taping, or information retrieval systems] or reproduced on any disc, tape, perforated media or other information storage device, etc., without the written permission of the publishers. Breach of this condition is liable for legal action. For binding mistake, misprints or for missing pages, etc., the publisher s liability is limited to replacement within one month of purchase by similar edition. All expenses in this connection are to be borne by the purchaser. All disputes are subject to Delhi jurisdiction only.

4 TAXMANN S GUIDE TO BUDGET

5 CHAPTER-HEADS PAGE CHAPTER 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA 1 CHAPTER 2 : TAX TREATIES & TAX RESIDENCY CERTIFICATE 11 CHAPTER 3 : TRANSFER PRICING 15 CHAPTER 4 : GENERAL ANTI-AVOIDANCE RULES (GAAR) 24 CHAPTER 5 : DEDUCTION OF TAX AT SOURCE 34 CHAPTER 6 : TAX COLLECTED AT SOURCE 45 CHAPTER 7 : ALTERNATE MINIMUM TAX (AMT) 48 CHAPTER 8 : DIVIDEND DISTRIBUTION TAX (DDT) 51 CHAPTER 9 : DEDUCTIONS 53 CHAPTER 10 : BUSINESS INCOME 61 CHAPTER 11 : CAPITAL GAINS 68 CHAPTER 12 : CASH CREDITS 79 CHAPTER 13 : TAXATION OF GIFTS 82 CHAPTER 14 : EXEMPTIONS 84 CHAPTER 15 : RETURN AND ASSESSMENT 90 CHAPTER 16 : CHARITABLE TRUST 94 CHAPTER 17 : AMENDMENT TO PENALTY PROVISIONS 96 I-5

6 I-6 CHAPTER-HEADS PAGE CHAPTER 18 : COMPUTATION OF T ONNAGE INCOME - REVISED SCHEME 99 CHAPTER 19 : WEALTH-TAX 101 CHAPTER 20 : INCOME TAX RATES 103 CHAPTER 21 : SERVICE TAX, EXCISE AND CUSTOMS 105

7 CHAPTER 1 INCOME DEEMED TO ACCRUE OR ARISE IN INDIA Vodafone Ruling & Proposed Amendment to section 9 Present situation in view of Vodafone ruling Presently, indirect transfer of an asset in India is not taxable under the Income-tax Act, 1961 (hereinafter referred to as ITA ). This was subject to huge litigation since Tax Authorities tried to tax the gains arising to a foreign company from transfer of shares of a foreign holding company, which indirectly held underlying Indian assets (indirect transfer). However, the Hon ble Supreme Court ( SC ) settled the long fought litigation in its landmark judgment in the case of Vodafone International Holdings B.V. v. Union of India [2012] 204 Taxman 408. The SC held that the source rule provisions under the ITA needs to be strictly construed and, accordingly, in the absence of a look through provision, an indirect transfer would not be taxable in India. The SC analysed various provisions and gave specific comments as below: Applicability of Section 9 of the ITA on transfer of capital assets not situated in India The SC quoted the provisions of section 9 of the ITA which is reiterated below: Income deemed to accrue or arise in India. The following incomes shall be deemed to accrue or arise in India: (i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, 1

8 2 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. Based on the above, the essential condition for triggering capital gains taxation under these source rules is that the capital asset must be situated in India. In this regard, the SC held the following three elements should exist in order to tax capital gains in India: i. transfer; ii. existence of a capital asset; and iii. situation of such asset in India. Thus, in case of a foreign company, income from capital gains accruing or arising outside India would be fictionally deemed to accrue or arise in India, when the capital asset is situated in India. The SC ruled that Section 9(1)(i) of the ITA cannot be extended to cover indirect transfers of capital assets/property situated in India. For a gain on transfer of a capital asset to be taxable in India, applicability of the last limb of Section 9(1)(i) of the ITA is required i.e. the capital asset must be situated in India. The words directly or indirectly in Section 9(1)(i) of the ITA go with the income and not with the transfer of a capital asset (property). The SC held that to do so, would amount to changing the content and ambit of Section 9. Look through provisions of the ITA The SC held that Section 9 of the ITA is not a look through section. Section 9, being a legal fiction has a limited scope and cannot be expanded by giving purposive interpretation. The question of providing look through in the ITA or in the tax treaty is a matter of policy. It is to be expressly provided for in the ITA or in the tax treaty. The SC observed that the proposed Direct Taxes Code Bill, 2010 expressly provides for taxation of transfer of shares of a

9 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA 3 foreign company by a non-resident, which represents at least 50% of the fair market value ( FMV ) of assets in India. Such proposal indicate that the word indirect cannot be read on the basis of a purposive construction and indirect transfers are not covered by the existing Section 9(1)(i) of the ITA. Property rights The argument laid down by the Tax Authorities was that under the share purchase agreement, the foreign company had directly extinguished its property rights viz rights of control and management of immediate subsidiary and its further subsidiaries. Since these property rights constitute capital assets situated in India, its extinguishment results into a transfer of capital assets (as evidenced by the share purchase agreement) which is a taxable event in India. On these facts, the SC held that the holding company had no legal rights over subsidiaries action and de facto control conveys a state of being in control without any legal right to such state. As regards the right of parent to direct a downstream subsidiary as to the manner in which it should vote, the SC observed that this right, if at all it is a right, fell in the category of a persuasive position/influence rather than having a power over the subsidiary. Further, the SC held that a share is a bundle of intangible rights against the company. A share-sale transaction cannot be broken into separate individual components, assets or rights such as right to vote, right to participate in company meetings, management rights, controlling rights, control premium, brand licenses and so on and split consideration to each item. Amendment proposed (with retrospective effect from 1 April 1962) and impact analysis Finance Bill, 2012 laid down before the Parliament seeks to tax indirect transfer of capital assets in India by inserting clarificatory explanations to Sections 2(14), 2(47), 9(1) and 195 of the ITA.

10 4 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA Definition of capital assets - Explanation to Section 2(14) of the ITA The Bill proposes to insert an explanation in Section 2(14) of the ITA in order to clarify that property includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever. The insertion of the explanation widens the definition of capital asset and clarifies that the term property includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any rights whatsoever. This amendment is also directed to overrule observation in the case of Vodafone (supra), wherein it has been held that the capital asset transferred were the shares of a foreign company and transfer of controlling interest is not a capital asset in itself but is incidental to transfer of shares. After the amendment, transfer of shares (at any level) which result in transfer of controlling interest of an Indian Company could give rise to a taxable event in India. Definition of transfer - Explanation to Section 2(47) of the ITA It has been clarified by way of an amendment that transfer includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India. The amendment clarifies that transfer in relation to capital assets includes disposing or parting of an asset or interest therein provided such transfer of rights is effected or depen-

11 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA 5 dent upon the transfer of a shares of a company (whether registered or incorporated outside India). Thus, transfer would include indirect transfer of shares if rights in such shares are effected and dependent upon transfer of shares even of a foreign company. Clarification of through in Section 9(1) - Explanation 4 to Section 9(1) The Bill further proposes to clarify that the expression through shall mean and include and shall be deemed to have always meant and included by means of, in consequence of or by reason of. As a result of the amendment, the bill proposes to clarify that income deemed to accrue or arise in India by means of/ in consequence of/ by reason of a capital asset situated in India would also be taxable in India. Thus, the amendment seeks to side-step the observation of the SC in the case of Vodafone (supra) where the SC had ruled that income from capital gains accruing or arising outside India would be deemed to accrue or arise in India only when the capital asset is situated in India Applicability of Section 9 of the ITA on transfer of capital assets situated in India- Explanation 5 to Section 9(1) The Bill proposes to insert a clarificatory amendment in Section 9 of the ITA whereby it is clarified 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 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. Accordingly, the amendment seeks to widen the scope of income under Section 9 of the ITA and bring into tax net, the gains derived from transfer of share or interest if such share or interest derives either directly or indirectly its value substantially from assets located in India Applicability of Section 195 of the ITA - Explanation 2 to Section 195

12 6 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA A related amendment has been proposed in Section 195 of the ITA, whereby it is proposed to clarify by way of an explanation that the obligation to comply with withholding tax provisions under Section 195 of the ITA and to make deduction thereunder applies and shall be deemed to have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident, whether or not the non-resident person hasi. a residence or place of business or business connection in India; or ii. any other presence in any manner whatsoever in India; The amendment widens the withholding tax provisions of Section 195 of the ITA by applying it to all persons whether resident or non- resident. It is further clarified that such nonresident may or may not have a residence or place of business or business connection or any other presence in India. Applicability of clarificatory retrospective amendment Applicability of retrospective amendment depends upon the status of the assessment. For pending assessments, the amended provisions would apply. A completed assessment may be re-opened under Section 147 of the ITA, if the relevant provisions of the law are amended with retrospective effect. However, such re-assessment proceeding cannot be initiated where the prescribed period of limitation has lapsed. Further, based on various judicial precedents 1, a case should not be reopened under the proviso to Section 147 of the ITA i.e. after expiry of four years from the end of the relevant assessment year since the assessee would not have failed to disclose fully and truly all material facts necessary for the assessment. 1. CIT v. Sil Investments Ltd. [2010] 9 Taxman 143, CIT v. M/s K Mohan & Co (Exports) I.T.A. No. 1307/Mum/2008

13 It is pertinent to note that the case of Vodafone (supra) may not be reopened for the relevant financial year since it has obtained finality at the SC level and no further appeal can be made against the ruling. The global scenario The proposed amendment reflects an international trend by governments to expand their taxing jurisdiction to include indirect transfers of local shares by non- resident entities. Several countries such as China, Peru and Indonesia have introduced provisions to enable taxation of such indirect transfers of investments made in these countries. It seems India also has gone the global way in taxing indirect transfer of assets in India. Taxation of Royalty Introduction CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA 7 Section 9 of the Income-tax Act, 1961 ( ITA ) provides for cases where the income shall be deemed to accrue or arise in India. Explanation 2 to Section 9(1)(vi) of the ITA defines Royalty for the purposes of the ITA. Definition of Royalty has been a subject matter of litigation with conflicting judgments delivered by the judiciary. Finance Bill 2012 intends to amend Section 9(1) of the Act to clear ambiguities surrounding definition of Royalty. Existing Provisions Royalty as defined under Explanation 2 to Section 9(1)(vi), means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head Capital gains ) for (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ;

14 8 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA (ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property ; (iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ; (iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ; (v) the transfer of all or any rights (including the granting of a license) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or (vi) the rendering of any services in connection with the aforementioned activities. Proposed Amendments The Memorandum annexed to the Finance Bill 2012 specifies that some judicial decisions have interpreted the definition in a manner which has raised doubts as to whether consideration for use of computer software is royalty or not; whether the right, property or information has to be used directly by the payer or is to be located in India or control or possession of it has to be with the payer. Similarly, doubts have been raised regarding the meaning of the term processed. In order to avoid such series of litigation and establish synergy, the Finance Bill, 2012 has inserted explanations to remove ambiguity that have arisen. The amendments have been discussed as under: Explanation 4 to Section 9(1)(vi) of the ITA and its impact It has been clarified, by way of proposed insertion of Explanation 4 to Section 9(1)(vi) of the ITA, that the transfer of all or any rights in respect of any right, property or information in-

15 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA 9 cludes and has always included 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 which such right is transferred. The amendment is proposed to take effect from 1 June Thus, transfer of all or any rights includes transfer of all or any rights for use or right to use computer software. The medium through which such software is provided has been termed irrelevant. The amendment thus confirms the observations made in the case of Gracemac Corporation v. Assistant Director of Incometax [2010] 42 SOT 550 wherein it was held that the payments made by end users for granting of license in copy right and other intellectual property rights was payment of royalty. It was also held that by way of a copyrighted article, the end users had not purchased copy of software product, but a license to use such software products. Explanation 5 to Section 9(1)(vi) of the ITA and its impact Explanation 5 to Section 9(1)(vi) of the ITA clarifies that royalty includes and has always included consideration in respect of any right, property or information, whether or not (a) the possession or control of such right, property or information is with the payer; (b) such right, property or information is used directly by the payer; (c) the location of such right, property or information is in India. The amendment is proposed to be effective retrospectively from 1st June The explanation seems to be directed to counter the position adopted by the tax payers, based on various judicial precedents, to treat income in respect of a right, property or information as business income on the reasoning that: (a) The possession or control of such right, property or information is not with the assessee;

16 10 CH. 1 : INCOME DEEMED TO ACCRUE OR ARISE IN INDIA (b) such right, property or information is not directly used by the assessee; (c) such right, property or information is located outside of India; (d) however, the explanation now brings to rest the uncertainty by clarifying that payment for use of such right, property or information shall be trated as Royalty irrespective of control, use or location of such right, property or information. Explanation 6 to Section 9(1)(vi) of the ITA and its impact Explanation 6 to Section 9(1)(vi) is proposed to be inserted whereby it has been clarified that expression process includes and shall be deemed to have always included 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. The amendment is proposed to take effect from 1 June The amendment seeks to ensure that payment made in the event of uplinking of signal by TV would be now included in the definition of process. This happens specifically in case of uplinking of signals by satellite transponders. The amendment seems to side- step the ruling of the Delhi High Court in the case of Asia Satellite Telecommunication Co. Ltd. v. DIT [2011] 197 Taxman 263 wherein it was held that the assessee had given the transponder on lease to its customer and not the technology within it and, therefore, the leasing of its transponder did not tantamount to the making available the secret process in the transponder. The amendment comes may result in tax implications for companies providing services through satellite transmission even though they do not have any physical presence in India.

17 CHAPTER 2 TAX TREATIES & TAX RESIDENCY CERTIFICATE Existing Provisions Section 90 of the ITA empowers the Government of India to enter into an agreement (DTAA or treaty) with a Government of any foreign country or specified territory outside India for the purpose of avoidance of double taxation or for the exchange of information. Further, Section 90A of the ITA empowers the Central Government to adopt any agreement between specified associations for relief of double taxation. By virtue of these sections it has been provided that the provisions of the ITA or provisions of the DTAA, whichever are more beneficial, shall apply to a non-resident taxpayer Under the present provisions, there was no specific requirement to obtain a tax residency certificate ( TRC ) to claim benefits under the DTAA except in the case of Mauritius. The requirement of TRC with respect to Mauritius emanated from Circular No. 789 dated 13th April, 2000 issued by CBDT wherein it was clarified that: It is hereby clarified that wherever a Certificate of Residence is issued by the Mauritian Authorities, such Certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly. 11

18 12 CH. 2 : TAX TREATIES & TAX RESIDENCY CERTIFICATE Various judicial precedents 1 have subsequently recognised TRC as sufficient proof of tax residency of a tax payer resident in Mauritius. Proposed Amendment Sections 90 and 90A of the ITA are proposed to be amended by Finance Bill 2012 in order to provide that the tax payers shall be entitled to be governed by the provisions of DTAA only when they obtain a certificate (containing particulars as may be prescribed) from the Government of the country of residence of such nonresident tax payer. The memorandum explaining the Finance Bill provides that: It is noticed that in many instances the tax payers who are not tax resident of contracting country do claim benefits under the DTAA entered into by the Government with that country. Thereby even third party residents claim unintended treaty benefits. Therefore, it is proposed to amend Section 90 and Section 90A of the Act to make submission of Tax Residency Certificate containing prescribed particulars, as a necessary but not sufficient condition for availing benefits of the agreements referred to in these Sections. The amendment shall be applicable from 1 April Further, it is proposed that the provisions of treaty shall not apply where the provisions of Chapter-X (General Anti Avoidance Rules popularly referred to as GAAR) are invoked in respect of the tax payer. In other words, where the provisions of GAAR have been invoked in case of the assessee, the assessee would not be entitled to take shelter under the beneficial provisions of a DTAA. In addition, it is proposed to insert Explanation 3 to Section 90 and Section 90A of the ITA to clarify that where any term is used in any DTAA or agreement entered into under sub-section (1) of Section 90A and not defined under the said agreement or the ITA, but is assigned a meaning to it in the notification issued under sub- 1. Union of India and Anr v. Azadi Bachao Andolan and Anr [2003] 132 Taxman 373 (SC).

19 CH. 2 : TAX TREATIES & TAX RESIDENCY CERTIFICATE 13 section (3) of said Sections and the notification issued thereunder being in force, then, the meaning assigned to such term shall be deemed to have effect from the date on which the said agreement came into force. Impact of the amendment This amendment has been brought to curb the practice whereby benefits under DTAAs were being claimed even by the residents of third party countries. The amendment proposes that the treaty benefits shall be available only where the tax payer is able to obtain a certificate issued by the Government of the country of residence of the tax payer containing the particulars as may be prescribed. It has been further clarified that TRC is a necessary but not sufficient condition to claim treaty benefits. In our view, practically, the impact of this amendment would depend upon the extent of information required by the Indian Government (by way of particulars prescribed). In case the information is onerous, the issue would percolate down to whether the Government of country of residence would be comfortable to issue a certificate containing particulars prescribed by Indian Government. Where the Government of country of residence of tax payer does not issue a certificate as may be required, it may result in undue hardship to the tax payers in terms of denial of benefits under the treaty. In line with the global practice it has been provided that where the provisions of GAAR have been invoked in case of the assessee, it would not be entitled to take shelter under the beneficial provisions of the treaty. The manner in which this provision is implemented could have far reaching implications for structuring of investments into India in order to take advantage of beneficial treaties that India has entered into with specific countries. A common structure adopted is for global corporations to set-up a holding company in an intermediate country (for example, Mauritius or Singapore) which then

20 14 CH. 2 : TAX TREATIES & TAX RESIDENCY CERTIFICATE invests in an Indian entity. The extent to which this structure is prevalent is indicated by the fact that over 40 per cent of all foreign investment into India is routed through Mauritius. Where the proposed TRC requires the Government of the intermediate country to certify that the global corporation has significant operations or value in that country, such Government may be unable to issue the TRC. This will effectively nullify any benefits that the DTAA that India has with the Intermediate country and could have significant tax implications for not only proposed investments but also existing structures. Explanation 3 to Section 90 and Section 90A of the ITA proposed to be inserted by Finance Bill, 2012, enable the Indian Government to notify definition of the terms used in the DTAA from a retrospective effect (from the date on which the DTAA came into force).

21 15 CHAPTER 3 TRANSFER PRICING Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill Advance No such existing provision. Pricing Agreement The APAs were proposed to (APA) be introduced in the DTC 2010, however given the delay in introducing the DTC, the same has been proposed in the Finance Bill, The Finance Bill proposes to insert new sections 92CC and 92CD in the ITA to provide a framework for Advance Pricing Agreement (APA) under the ITA. An APA is an agreement between a taxpayer and a taxing authority to determine the arm s length price or specify the manner/ methodology in which arm s length price shall be determined for a set of transactions over a fixed period of time in future. The proposed APA framework would encapsulate the following: - APA shall be valid for not more than 5 years. - The APA shall be binding only on the taxpayer and the Income tax Commis- Given the litigation backdrop of the TP assessments for AY , which resulted in a total adjustment of Rs. 44,000 crores, the APA is a welcome measure and is important progressive option of dispute resolution. With the MNCs facing terrific Transfer Pricing Litigation pressure, we foresee many MNCs having high value international transactions opting for certainty in form of APAs. However, the taxpayer would look forward for more clarity in terms of the following in the scheme:

22 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill 2012 Considering the given scenario, the prospective nature of APAs would lessen the burden of comsioner (including income-tax authorities subordinate to him) - An APA will be held void ab initio, if it finds that the agreement has been obtained by fraud or misrepresentation of facts. - A modified return within a period of three months from the end of the month in which the said APA was entered into would have to be furnished. - In case of pending assessment proceedings, the AO would consider the modified return and the normal period of limitation of completion of proceedings shall be extended by one year. The board may prescribe a Scheme providing for the manner, form, procedure and any other matter generally in respect of the APA. Notification of the Rules is likely in June The proposed amendments will take effect from 1st July, Type of APAs i.e Unilateral, Bilateral or Multilateral - Amount of Pre-filing fees - Time frame to conclude an APA - Rollback and Renewal of APAs Further the Standing Committee on Finance has submitted its 49th Report on the Direct Tax Code 2010 to Parliament on 9th March On APAs, the Committee has recommended that the CBDT should appoint an independent agency consisting of technical and judicial members to advice the Board on APAs. It is also pointed out that the APAs should be completed within a given time frame and that the Double Taxation Avoidance Agreements already inforce should be suitably amended to include APAs. 16 CH. 3 : TRANSFER PRICING

23 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill 2012 pliance by giving taxpayers greater certainty regarding their transfer pricing methods and promote the principled resolution of the issues in advance. 2 International Presently international Transaction/ transaction means a tran- Intangibles saction between two or more associated enterprises, either or both of whom are non-residents. This transaction maybe in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises. Finance Bill, 2012 proposes to amend the definition of international transaction to elaborately explain the tangible/ intangible property, services, financing transactions. It also covers transactions of business restructuring or reorganization, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date. The expression intangible property is defined in detail to include marketing, technology, artistic, data processing, engineering, customer, contract, human capital, location, goodwill related intangible assets and also includes methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data or any other similar item that derives its This amendment will have far reaching consequences, as it expands the scope of transfer pricing by including specified domestic transactions within its ambit. Further, it also provides a list of intangible assets which was not earlier covered expressly in the ITA. Further, the term intangible has been defined broadly to include any item which derives its value from intellectual content. This kind of a broad definition leaves the tax authority to construe significant items as intangibles and this could have a major impact on the characterization of entities when conducting a function, asset and risk analysis of the international transaction. CH. 3 : TRANSFER PRICING 17

24 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill Specified Presently transfer pricing Domestic provisions are applicable transaction only in case of transactions between two or more associated enterprises, either or both of whom are non-residents. value from its intellectual content rather than its physical attributes. The revised definition of international transaction proposes to cover domestic transactions between related parties by including the term specified domestic transaction. The Finance Bill 2012 proposes inclusion of specified domestic transactions within the transfer pricing provision. The specified domestic transactions which the proposed amendment intends to cover are transactions referred to in Section 40A, Section 80A, sub-section (8) of section 80-IA, sub-section (10) of Section 80-IA of the ITA. The finance ministry has taken notice of the suggestion of the Supreme Court in the case of CIT Vs. Glaxo SmithKline Asia (P) Ltd. [2010] 195 Taxman 35 (SC) wherein the Court held that domestic transactions between related parties should be covered under the ambit of transfer pricing. Manipulation of prices could result in shifting of profits between a loss making entity and a profit making entity so as to achieve an overall reduced tax rate. Similarly profit shifting to an entity enjoying tax concessions under an incentive scheme could also be achieved through pricing of transactions of such entity with an- 18 CH. 3 : TRANSFER PRICING

25 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill 2012 other related company. The proposed amendment desires to curb such tax leakages. 4 5% variation Presently in case the variareduced and tion between the arm s not available length price and transfer as standard price does not exceed 5% of deduction the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm s length price. Prior to October % available as a standard deduction as the proviso read as follows: Provided that where more than one price is deter- The Finance Bill 2012 has substituted the five per cent with three per cent with effect from the 1st day of April, The above amendment is applicable to all assessment or reassessment proceedings pending before an Assessing Officer as on the 1st day of October, The amendment of law to introduce documentation requirements even for domestic transactions between related parties would not be unique to India, though will put onerous burden on the tax payer. This move will reduce the variation to 3% from the earlier 5%. This will lead to more cases undergoing adjustment at the TPO level consequently leading to increased litigation. Numerous judicial pronouncements have held that 5% be regarded as a standard deduction in respect of proceedings pending before an Assessing Officer as on the 1st day of October, CH. 3 : TRANSFER PRICING 19

26 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill 2012 mined by the most appropriate method, the arm s length price shall be taken to be the arithmetical mean of such prices, or, at the option of the asse-ssee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean. 5 Appeal against The direction of the DRP is the directions binding on the Income Tax of the Dispute Department and the depart- Resolution ment cannot appeal before Panel (DRP) the ITAT. The taxpayer has the right to appeal in the ITAT against the DRP order. The Finance Bill proposes to amend the provisions of section 253 and section 254 of the ITA. The revised provision will now provide the Income Tax Department the right to appeal against the directions given by the DRP. This would be applicable for objections filed on or after 1st July, This amendment removes the benefit of standard deduction applicable to the assessee. This amendment will have effect only for pending cases before the tax authorities. Till date the department could not appeal before the ITAT and hence we did not see any positive traction in the DRP directions. Therefore, we can now expect to see some speaking orders from the DRP. However, one of the interesting fact to be considered is that DRP and CIT(A) would be on same footing with the only difference being that if the taxpayer opts for the DRP route then the demand would be stayed upfront and it is also a fast track to ITAT. 20 CH. 3 : TRANSFER PRICING

27 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill 2012 The disadvantage could be that the DRP directions are given by a panel of 3 commissioners and therefore it may have a greater bearing on the ITAT. 6 Power of the The existing provision speci- DRP to fied that the DRP may conenhance firm, reduce or enhance the variations variations proposed in the draft order. 7 Transfer Earlier provision provided Pricing Officer that the TPO to analyse has legal juris- those transactions that prudence in were referred to him by the case of tran- AO The Finance Bill proposes to insert an Explanation in the provisions of section 144C to clarify that the power of DRP is restricted not only to the issues raised in the draft assessment order but it can also enhance the variation proposed in the order as a result of any new issue. This amendment will be effective retrospectively from the 1st day of April, 2009 and will accordingly apply to assessment year and subsequent assessment years. The Transfer Pricing Officer has been given the powers to analyse even those cases where the assessee has not furnished the accountant report during the course of the proceeding before him, this The ambiguity on the power of the DRP was on account of judgments like Dredging International NV v. ADIT [2011] 48 SOT 430 (ITAT Mumbai), GE India Technology Centre v. DRP [2011] 201 Taxman 191(Karnataka High Court) wherein it was held that DRP can enhance the variation which is only confined to issues raised in draft assessment order. The proposed explanation in the Finance Bill has given clarity on the powers of DRP and therefore it is likely that the above judgments would be void. This provisions aims to cover even cases where the assessee has not filed accountant s report due to which a reference has not been made by the AO to the TPO. CH. 3 : TRANSFER PRICING 21

28 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill 2012 sactions that have not been reported in accountants report 8 Penalty for The existing provision profailure to vides for penalty at the rate report inter- of 2% for failure to keep and national tran- maintain information and saction or fur- document in respect of nishing International Transaction. incorrect information and documents. 9 Completion of Under the provisions of secassessment in tion 144C of the Income-tax search cases Act where an eligible asse- will have effect from the 1st day of June, The Assessing Officer cannot under section 147 or section 154 enhance the assessment or reduce a refund in respect of proceedings which have been completed before the 1st day of July, The TPO can use the power under section 147 for non-filing or non-inclusion of transaction in accountants report with effect from July 2012 The finance bill extends the levy of penalty to also include cases wherein the assessee (i) fails to report any international transaction which is required to be reported, or; (ii) maintains or furnishes any incorrect information or documents. This amendment will take effect from 1st July, A similar provision is proposed to be made where assessments are framed as a result of search and seizure to provide Scope increased to provide penalty on failure to report international transactions and furnishing of incorrect information/documents. Will act as an effective deterrent to enforce compliance with Transfer Pricing regulations and ensure that correct particulars are reported. With this provision, the time limit for issuing the final order by the AO in case of search and seizure 22 CH. 3 : TRANSFER PRICING

29 Sl Particulars Existing provision Amendment proposed by Impact of the amendment No. Finance Bill 2012 referred to DRP ssee files an objection against the draft assessment order before the Dispute Resolution Panel (DRP), then, the time limit for completion of assessments are as provided in section 144C (one month from receipt of direction from DRP) notwithstanding anything in section 153. that for such assessments, time limit specified in section 144C will apply, notwithstanding anything in section 153B (two years from the end of the financial year in which the last authorization was executed). These amendments in the provisions of the ITA will take effect retrospectively from the 1st day of October, assessment would be one month from the receipt of direction from DRP. This provision will enable to expedite resolution in case of search and seizure cases. CH. 3 : TRANSFER PRICING 23

30 CHAPTER 4 GENERAL ANTI- AVOIDANCE RULES (GAAR) Introduction to GAAR - Proposed amendment It is common practice amongst taxpayers to arrange their affairs in a manner such that it would result in tax benefits. Such measures however, have often raised the eyebrows of revenue authorities who have not only questioned the legitimacy of such transactions, but have even tried to look through them. The issue as to whether reduction in tax liability through a transaction or a series of transactions is tax planning or tax avoidance has been the subject matter of debate both in India and overseas for the past several decades. Although, the Judiciary has attempted to define the principles for determining tax avoidance, the most recent being in the case of Vodafone B.V., however considering the mindset of revenue authorities, the introduction of and the powers prescribed under the proposed anti-avoidance provisions are likely to have significant implications, both positive and negative. The tax authorities have time and again expressed their desire to introduce reforms that would act as a deterrent to the use of sophisticated weapons of tax avoidance spanning across various jurisdictions. Further, the question of substance over form has consistently arisen in the course of implementation of tax laws. At present, India has specific anti-avoidance provisions engraved both in the domestic tax laws and in some of the tax treaties through the limitation of benefits clauses. However, in a bid to curb tax avoidance and enforce the concept of substance over form, the Indian revenue policymakers propose the introduction of one of the most significant contemporary tax reforms - the General Anti Avoidance Rules ( GAAR ). Although originally forming a part of 24

31 CH. 4 : GENERAL ANTI-AVOIDANCE RULES (GAAR) 25 the Direct Taxes Code ( DTC ) 2010, however, given the postponement of DTC, GAAR as a part of the tax reforms proposed to be introduced through the Finance Bill, The scope and language of the proposed GAAR provisions under the Finance Bill 2012 are very similar to the GAAR provisions specified in the DTC. The Revenue authorities will be bestowed with widespread powers to disregard and re-characterize any tax avoiding transaction and income accruing therefrom. Further, the Finance Bill 2012 proposes introduction of sub-section (2A) to section 90 which would enable the provisions of GAAR (proposed to be introduced through Chapter X-A in the ITA) to override the provisions of the tax treaties signed by India. While the revenue authorities may be viewing GAAR as a means to checking tax leakages, one could criticize the sweeping nature of the provision as it provides wide discretion to the tax authorities and is likely to be prone to misuse. The Indian lawmakers have taken due care in creating a law that is broadly in line with the internationally accepted standards of anti-avoidance measures. However, it may be noted that some of the important recommendations of the Standard Committee on Finance (as mentioned below) on DTC have not been taken into account while introducing the GAAR provisions: Suitable grandfathering provisions to protect the interest of the tax payers who have entered into structures/arrangements under the existing law; Uncertainties with regard to applicability of tax treaty provisions to be removed so that India s credibility as a reliable treaty partner is not affected; The proposals should not lead to any fiscal uncertainty or ambiguity; It should be ensured that any of the proposals do not pave the way for increased and avoidable litigation. GAAR v. Treaty provisions It has been proposed that the GAAR provisions would apply to a taxpayer irrespective of the fact that the treaty provisions are more

32 26 CH. 4 : GENERAL ANTI-AVOIDANCE RULES (GAAR) beneficial for him. It may be noted that a unilateral enactment of a new domestic tax law which is contrary to an existing treaty, without an amendment in treaty could possibly be regarded as violation of international law and is generally known as treaty override. It may be relevant to note that according to rules of legislative interpretation, specific legislation overrides general legislation. Therefore, an argument may be taken that change of a domestic law generally, which could be the case with GAAR, may not affect the treaty. However, in the absence of an anti-avoidance provision under the treaty, the reaction of India s treaty partner countries needs to be observed. Salient features of GAAR The Indian tax law has always had specific anti avoidance rules to target known arrangements of tax avoidance, whereas GAAR seeks to completely redefine this concept. GAAR as envisaged under the Finance Bill 2012 is a broad set of provisions which seek to tax an impermissible avoidance arrangement (which may be a step, a part or whole of an arrangement and hereinafter referred to as Transaction ) whose main purpose is to obtain a tax benefit by: (a) creating rights or obligation which wouldn t arise between persons dealing at arm s length, or (b) result in the misuse or abuse of the provisions of the Act in any way, or (c) lacks commercial substance either wholly or in part, or (d) entered or carried out in a manner which would not be employed for bona fide purposes. While, the principle condition for invalidating a transaction might be triggered at the assessment stage itself, the burden to refute the same shall rest with the tax payer. Further, once the tax benefit test is satisfied, the arrangement also has to satisfy at least one out of four additional tests discussed above. The tax authorities upon satisfaction of aforesaid conditions shall seek to:

33 CH. 4 : GENERAL ANTI-AVOIDANCE RULES (GAAR) 27 (a) disregard, combine or recharacterise any step, part or whole of a transaction; (b) treat the transaction as if it had not been entered into; (c) disregard any accommodating party or treating any accommodating party and any other party as one and the same person; (d) deeming connected persons in relation to each other as one; (e) reallocating, amongst the parties to the arrangement any accrual, or receipt, of a capital or revenue nature; or any expenditure, deduction, relief or rebate; or (f) relocating place of residence of a party or location of a transaction or situs of an asset to a place other than provided in the arrangement; and (g) considering or looking through an arrangement by disregarding any corporate structure. For the above purposes, following re-characterization may be done any equity into debt or vice versa; any accrual, or receipt, of a capital or revenue nature; or any expenditure, deduction, relief or rebate. Meaning of some of the terms used 1. Accommodating Party Accommodating party means a party to an arrangement whose main purpose for direct or indirect participation in an arrangement (in whole or in part) is to secure benefits whether directly or indirectly to a person to whom it may be connected or not. 2. An arrangement means any step in or a part or whole of any transaction, operation, scheme, agreement or understanding,

34 28 CH. 4 : GENERAL ANTI-AVOIDANCE RULES (GAAR) whether enforceable or not, and includes any of the above involving the alienation of property. 3. Tax benefit means a reduction, avoidance or deferral of, or an increase in a refund of tax under the ITA. a reduction, avoidance or deferral of, or an increase in a refund of tax for a Tax Treaty. a reduction in tax bases including increase in loss. 4. Arm s length price means a price applied or proposed to be applied in a transaction between persons or enterprises other than associated enterprises in uncontrolled, unrelated or independent conditions. 5. Associated Enterprises has been given meaning as defined in section 92A of the ITA. 6. Lacks commercial substance A step in, or a part or whole of, an arrangement shall be deemed to be lacking commercial substance, if The substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; or it includes, or involves (i) round trip financing without regard to, (a) whether or not the round tripped amounts can be traced to funds transferred or received; (b) the time, or sequence, in which round tripped amounts are transferred or received; or (c) the means by, or manner in, which round tripped amounts are transferred or received; (ii) an accommodating or tax indifferent party; (iii) any elements that have the effect of offsetting each other; or (iv) a transaction which is conducted through one or more persons and disguises the nature, location, source, ownership, or control, of the fund.

35 CH. 4 : GENERAL ANTI-AVOIDANCE RULES (GAAR) 29 The description given above renders GAAR subjective and open to interpretation. With regard to the above, it is extremely important to introduce guiding principles so as to make the above test objective, definitive and useful. 7. Round trip financing includes financing in which- Funds are transferred among the parties to the arrangement in a manner which would: result, directly or indirectly, in a tax benefit; or significantly reduce, offset or eliminate any business risk incurred by any party to the arrangement. GAAR Jurisdictional analysis Some of the key provisions of the Indian GAAR can be analysed with respect to the anti-avoidance rules existing in other international jurisdictions. The complexity of GAAR varies depending on the economic growth, infrastructure and the complexity of domestic tax statute of a particular jurisdiction. Some jurisdictions which have evolved anti-avoidance measures in the form of GAAR are Australia, France, Germany, Spain, Italy, Canada, South Africa and the United States of America. We have analysed hereunder the provisions of Indian GAAR in the light of provisions existing in South Africa and Canada. Comparison between India-South Africa Meaning of main purpose The Indian GAAR is broadly based on the principles laid down in the South African GAAR (introduced in the year 2006) which envisages principles for establishing the presence of tax avoidance in an arrangement. The application of South African GAAR ( SA GAAR ) provisions requires fulfilment of the following four requirements 1 : Existence of an arrangement; 1. Section 80A of South Africa Income Tax Act.