Mrunal Budget 2014 - CGT, APA, DTC, GAAR, Transfer Pricing Cases

7/29/2014 Mrunal Budget 2014: CGT, APA, DTC, GAAR, Transfer Pricing cases
http://mrunal.org/2014/07/budget-advance-pricing-agreement-arms-length-vodafone-transfer-pricing-dtc-gaar-advance-tax-ruling-explained.html/print/ 1/13
[Budget] Advance Pricing Agreement, Arms Length, Vodafone Transfer Pricing, DTC,
GAAR, Advance Tax ruling explained
1. Prologue
2. Capital Gains Tax (CGT)
1. CGT & Withholding norms (TDS)
2. Vodafone CGT
3. IT Act 1961: Clarification (2012)
3. Direct Tax Code (DTC)
1. DTC and Indirect transfers
2. Direct taxes: DTC vs. Budget-2014
4. Tax Avoidance and GAAR
1. What is GAAR?
2. Shome Panel on GAAR
5. What is Transfer Pricing?
1. Vodafone Transfer Pricing Issue
2. Budget 2014: transfer pricing reforms
3. What is Advance Pricing Agreement?
4. Roll back provision
6. What is Arms Length Price?
7. Advance ruling
1. Authority for Advance Ruling (AAR)
2. Other Tax reform bodies under Budget 2014
8. Appendix
1. A1: CGT: Short term vs Long term
2. A2: What happened to Vodafone case?
Prologue
Sidenote: Madhya Pradesh MPPSC prelim hallticket uploaded click me.
After Budget 2014, six terms in news:
1. Transfer Pricing
2. Advanced Pricing agreements (APA), roll back provision
3. Arms length price
4. Advance Tax Ruling
5. Direct tax code
6. GAAR, Shome Panel
All of them aim to reduce tax litigation, have direct-indirect connection with Vodafone case. So
lets refresh those old concepts.
What is Capital Gains Tax (CGT)?
is a direct tax
Levied on profit, when you sell capital assets (shares, gold etc)
Matter falls under IT department, because its a direct tax.
Capital gains Tax Application:
applies to doesnt apply to
1. shares, bonds, Mutual fund etc. financial
assets
2. land, house, office, building, factory,
machinery
3. gold, diamond, jewelry, precious stones
and metals.
4. archaeological collection, drawings,
paintings, sculptures etc.
1. Agricultural land
2. Personal articles such as furniture, cloths,
belt, shoes, wallet etc.
More given in the appendix, about short term vs long term CGT.
CGT & Withholding norms (TDS)
Assume Kishor Biyani wants to sell Pantaloon company to Kumar Mangalam Birla at profit
of 1000 crore and has to pay 100 crore CGT to income tax department.
In real life, seller (Kishor) himself doesnt need to pay 100 Crore CGT to Government.
Buyer (Birla) will have to keep aside 100 crore for government, and pay only 1000-
100=900 crores to Biyani. Observe following photo
This is called withholding norms or Tax deduction at source (TDS).
Question: If income tax department doesnt get the tax, then whom should they send notice-
Buyer or Seller?
Ans. Buyer. Birla in Pantaloon deal and Vodafone in Hutch deal.
Vodafone CGT
Hutchison (Hongkong) own a company called CGP investment Holding ltd, (Cayman Island)
CGP owns 67% shares of Hutch-Essar India.
Vodafone (HQ London), tells its subsidiary in Netherland, to purchase Cayman Island
Company from Hutch (Hongkong) for the price of 11 billion dollars (~55k crore rupee that
time)
Now Vodafone owns CGP, therefore, and thus indirectly owns Hutch-Essar India also.
Because CGP owned 67% shares of Hutch Essar India.
Ok so whats happening?
A buyer (Vodafone) has (indirectly) purchased shares (of an Indian company) from a seller
(Hutch).
So, does Buyer (Vodafone) have to pay Capital Gains Tax, in India?
CGT applies or not?
Vodafones version Income Tax Department says
Weve not purchased
Hutch Essar, we
purchased CGP.
CGP is not an Indian
company, so you cannot
demand any tax from us.
CGP is a post box company in a tax haven. It doesnt
produce any mobile phones or desi-liquor bottles, then
why have you given 55k crores for it?
Obviously, to control those 67% shares in Hutch-Essar
India!
therefore, CGPs valuation is based on an Indian asset
(shares of Hutch-Essar)
Therefore, we can, and we will demand capital gains tax.
Matter goes to Income tax Appellate tribunal (ITAT) and then to court:
Taarikh Pe Taarikh
Year court judgment
2010
Bombay Highcourt says government right, Vodafone wrong.
orders Vodafone to pay the taxes
2012
Supreme Court says government wrong, Vodafone right.
Under the current Income Tax act 1961, Income tax Department has NO
jurisdiction in this matter, when companies trading assets outside India (CGP ltd in
Cayman Islands).
Then Finance Minister Pranab doesnt like it. Not one bit. So, he issues a clarification in IT act.
IT Act 1961: Clarification (2012)
We can demand Capital gains Tax, when a foreign company is sold. IF that foreign
companys value is derived from Indian Assets. (e.g. CGP valued at 55k crore, because it
owned HutchEssar Indias shares).
Then, for tax purpose, well consider them Indian companies, and demand capital gains tax.
This provision will apply to all deals from 1962 onwards (hence called Retrospective.)
So, even after winning case in Supreme court, Vodafone trouble did not end.
Income tax department again sends notice for the same Capital gains tax.
Direct Tax Code (DTC)
Direct Tax Code aims to replace the Income Tax Act of 1961
Timeline of Direct Tax Code
2010
DTC Bill introduced. Sent to Parliaments standing Committee on Finance.
Committee proposed changed.
2014,
March
Chindu uploads revised (draft) Direct Tax Code 2013 on Finance ministry website, to
seek juntaas opinion on it.
2014,
May
Direct Tax bill lapses with THE END of 15
th
Lok Sabha.
Then, should we prepare DTC for exams?
Yes, because
1. Economic survey 2013: recommended implementing DTC.
2. Budget 2014: Jaitley said well implement DTC, after reviewing juntaas comments and
consulting with experts.
DTC and Indirect transfers
DTC aims to fix discrepancies in Income Tax Act, so that Vodafone like cases, do not happen
again. Under DTC:
Indirect (asset) transfers will be taxed in India, IF the companies involved, have at least 50
percent of their assets located in India.
For example, Vodafone bought CGP investment ltd for ~55k crore rupees, because CGP
owned 67% shares of Hutch-Essar India.
Therefore, income tax department can demand Capital gains tax from Vodafone. (recall:
Buyer pays CGT)
Limitation: what if they create three separate post box companies each owning 30-30-30%!
DTC also provided tax on software Royalties (with respect to that Nokia case click me)
Direct taxes: DTC vs. Budget-2014
Comparision: Budget provisions vs DTC proposals
taxable income Budget 2014 DTC proposed
2.5 lakh to 5 lakh 10 2 lakh to 5 lakh slab: 10%
>5 lakh-upto 10 lakh 20 20%
>10 lakh 30 30%
>10 crore 35%
dividend >1 crore additional 10%
1% Wealth Tax,For assets
above 30 lakhs
Yes, but only on
physical assets.
Wealth tax on both:
1. physical assets (gold, real
estate etc)
2. financial assets (shares,
bonds, MF etc)
DTC also provide plus higher slabs to senior citizens, and many other technical reforms.
More on budget 2014s direct-indirect taxes in separate articles. So far weve learned; what
is CGT, How Vodafone avoided CGT, Whats the provisions in DTC to prevent such cases in
future?
Moving to next topic
Tax Avoidance and GAAR
Whats the difference?
Tax Evasion Tax Avoidance
Income, sell-purchase is hidden from tax
authorities.
all deals open- mentioned in their account books
and shareholder meetings.
Example: builder sells a property for 10
lakh, but accept only 1 lakh via cheque,
remaining 9 lakh via cash. (to evade stamp
duty).
Example: this Vodafone case. They purchased an
Indian company (Hutch-Essar) via purchasing an
intermediary company (CGP) in a tax haven.
Income tax act already has clear cut
penalties for this.
Income tax Act has grey areas, loopholes
for this.
Recall Supreme court ruled in favor of
Vodafone because matter outside IT depts
jurisdiction.
Vodafone isnt the only company that has avoided tax.
More cases of (alleged) Tax Avoidance
MNC giant Bought Indian CompanyVia intermediary in
Vodafone Hutch Essay Cayman Island
Sanofi Aventis Shantha biotech French
General Electric GenPact India. Luxemburg
Vedanta Sesa Goa Cyprus
Like ^this, MNC giants have avoided ~40,000 crore rupees of capital gains Tax from India.
This money could have been used for financing fiscal deficit, inflation control, and Sarkaari
schemes!
Therefore, Government decided to make new rules to stop this menace.
And, thus we come to next topic:
What is GAAR?
General Anti Avoidance Rules.
Originally mentioned in Budget 2012. They were to be implemented from 1/4/2014.
IT commissioner take action against business deal made outside India, to avoid taxes.
He can send notice to Indian Citizen, NRI, Foreigners, to recover such money:
Even if theyre living outside India.
Even for retrospective deals i.e. deals happened before GAAR was implemented
Even if deals protected under any Double taxation avoidance agreement treaty.
Burden of proof lies with the party and not IT commissioner i.e. Company has to explain
their deal is genuine.
IT commissioner has to decide the case within 12 months. Aggrieved party can approach
Dispute resolution Panel (DRP) => Income Tax Appellate Tribunal (ITAT) => HC and
finally Supreme Court.
GAAR not a completely new invention. China, Australia, Canada, New Zealand, Germany,
France, S.America etc already have similar concepts.
Obviously MNCs wouldnt like it. Not one bit. They lobbied hard, finally government setup a panel
under Parthsarthi Shome Panel to review the GAAR rules.
Shome Panel on GAAR
Recommended following:
1. IT commissioner should send notices only in rare cases- where he can recover more than 3
crore rupees.
2. GAAR should not be used for filling revenue shortfalls. Revenue shortfall occurs when
governments revenue collection is less than expected because of inflation, policy paralysis,
global slowdown etc. So in such cases, GAAR should not be used for extracting more money
from corporates to finance Bogus Sarkaari schemes.
3. For retrospective cases- only recover tax dues. Dont demand additional penalty and interest
rate on such retrospective cases.
4. Exempt the buying/selling of company shares from Capital gains tax. Better just increase the
Securities Transaction Tax (STT) on buying/selling of such shares. Then, there is no
litigation about CGT evasion via post box company. Problem permanently solved.
5. Dont implement GAAR from 2014. Implement it from April 2016.
For more GAAR features, pro and anti arguments click me
What would General Dong (Amrish Puri) sing for this gentleman?
What happened after Shome?
Budget
2013
Chindu says well implement GAAR from 1/4/2016
Sept 2013
Chindu says following
GAAR notices only for deals after 31
st
august 2010
GAAR notices, only if benefit more than 3 crores.
GAAR will be effective from 1
st
April 2015
IT officials will have to first send show cause notice and person will be given
opportunity to present his side.
Budget
2014
Jaitley silent on GAAR
Nirmala
Sitharaman
Minister of State for Finance.
After budget, she replied in parliament, GAAR will be applicable from 1
st
April 2015.
Investors get scared, BSE-SENSEX collapses by ~350 points.
Shaktikanta
Das
Revenue Secretary
To calm down the market, he said please donot interpreted that GAAR will
be implemented from 1
st
April 2015. New government yet to look at the
issue in detail!
So far, we learned
1. CGT, Vodafone Hutch deal.
2. DTC, GAAR to prevent Vodafone like cases in future.
Now next two topics: Transfer pricing and advance ruling. These are also in context of Vodafone
What is Transfer Pricing?
Recall the original concept of CGT & TDS:
When a capital asset (shares) are transferred from seller (Kishor Biyani) to Buyer
(K.M.Birla) => then Buyer has to withhold / deduct the capital gains tax for government.
Biyani and Birla are two unique businessmen / promoters. So, when share transferred from
one person to another, we can hope the share price are decided by market forces of supply,
demand and speculation.
BUT WHAT IF two subsidiary companies transfer shares to each other, and play mischief.
Vodafone Transfer Pricing Issue
Vodafone London has two subsidiaries:
1. Mauritius: Vodafone Teleservices India Holding Mauritius.
2. India: (Call center) Vodafone India Services (VISPL)
Two version
What Vodafone says? What IT Dept. says
2008: Indian arm sells its shares
to Mauritius for ~Rs. 250 crores
Mauritius arm says we bought
shares to infuse new capital in
the Indian arm.
Real Market price of those shares = ~1550
crores.
Vodafones Indian arm deliberately sold its shares
at a lower price of ~250 cr. (undervaluation of
~1300 crore.)
This is one type of hidden loan or secret profit
transfer from Indian arm to Mauritius arm.
HOW? Well Mauritius arm could sell those
shares again to a third party at market price and
make profit.
So in a way, Mauritius will make GAINS (in
future), and we want capital GAINS Tax on it!
Thus CGT + penalty + interest = ~Rs.3700
demanded.
In short,
1. Vodafone transferred its call centre shares from India to Mauritius at an undervalued price
2. this was one type of hidden loan / secret transfer of profit.
3. IT dept wants capital gains tax on this.
Thats the Vodafone Transfer Pricing issue. Case pending in Income Tax Appellate Tribunal
(ITAT).
Shell India, also caught in similar controversy.
Budget 2014: transfer pricing reforms
Jaitley made new reforms in Budget 2014, to reduce the transfer pricing related litigations, and
enhance MNC confidence to invest in India.
What is Advance Pricing Agreement?
Advance pricing agreement (APA) is an agreement between:
1. Tax payer (Vodafone)
2. Tax authority (IT department)
For deciding transfer price OR arms length price in advance.
For example:
Vodafone
CEO
Hello IT commissioner sir, I wish to transfer ___ no. of shares of Indian
call centre to Mauritius arm @___ Rs. per share on ___ date.
Weve decided this transfer price, by taking arithmetic mean of share
prices at BSE for last one year.
So, are you OK with this pricing (and the consequent tax)?
IT
Commissioner
Yes, but Only if __ bottles of desi liquor are provided to our staff.
Vodafone
CEO
But Im a foreigner, I do not know any local dens! I can get you finest Vodka,
Cognac and Champaign!
IT
commissioner
Thats not my problem. We only prefer Swadeshi. IF you want to operate in
India, then you have to respect our culture (GS1) and tradition.
Enough cheap jokes back to topic:
APA concept introduced in Income Tax Act from 2012.
Ok then what is Jaitleys innovation in 2014?
Roll back provision
Means, If Vodafone and IT Dept. sign an APA agreement right now, its (share pricing)
methodology can be applied for solving pending cases upto last four years.
APA: Rollback
before after budget 2014
Only previous one years data Jailed permitted use of multi-year data for better comparative
could be used for deciding the
price.
analysis. (so that pending litigations upto last 4 years can be
decided)
on a related topic:
What is Arms Length Price?
Arms length price, is the price at which two unrelated parties will make a deal. (Say Kishor
selling shares to Birla at 1000 crores).
Since these two parties are unrelated, hence market forces of supply-demand will work, the
(share) price will be rational.
So, government will get the full tax it deserves.
BUT
When MNC giants one subsidiary company makes deal with another subsidiary company-
theyre related with each other (because main boss is the MNC).
In this case, deal pricing may not be rational.
Government may not get full tax it deserves.
Therefore, government wants to ensure that following two prices are same. For example:
Inter-company price / Transfer price Arms length price
when Vodafones Mauritius arm sells its Indian call
centre shares to Vodafones Netherlands arm
Price at which Kishore would trade his
Vodafone callcentre shares with Birla?
Lets try a Mains questions:
Q. Discuss advance pricing agreements, and their role in promoting foreign investment in
India. (200 words)
1. When two subsidiary companies of the same MNC giant, make a deal, there are chances of
price manipulation to reduce tax liability, as it allegedly happened when Vodafones Indian
arm transferred the shares to Mauritius arm. Resulting into a lengthy litigation between
Vodafone and Income tax department of India.
2. 2012: Government provided for advance pricing agreement in Income tax Act.
3. APA is an agreement between tax payers and tax authorities.
4. It validates the transfer pricing between two interrelated companies and ensures that it is
equivalent to an arms length price.
5. 2014: Government further reformed APA system, to provide roll back in APA agreements.
Now APA agreements can sort out pending litigations up to past four years using multi-year
data analysis for share pricing.
6. Thus, APA is a win-win situation for both parties- tax authorities get their legitimate dues
and companies become immune to future litigations. This clarity and continuity in tax
policies will aid in bringing more foreign investment in India.
(~170 words)
Advance Tax ruling
Jaitley also discussed this in budget-2014.
This topic not directly related to Vodafone.
But its easy to make silly mistakes between APA vs advance ruling. so lets check it out:
What is Advance Tax Ruling?
Suppose a foreign company enters India via Joint Venture / Subsidiary / etc.
But India has a complex tax structure, the foreign company may need clarification in
advance, on the Taxes that may apply to its business.
To help foreign companies, Government setup a body called.
Authority for Advance Ruling (AAR)
Its a statutory body Under IT Act. Started from 1993.
composition: Retired SC judge and two government officials (of Addl.Secretary rank)
Foreign company can file application to AAR, to seek clarification on its tax liabilities.
(Fees: 2500 rupees.)
Timeframe: AAR has to reply within 6 months.
AAR ruling binding on both company (Tax payer) and Income tax department. IT officials
cannot send notices/raids if AAR already rules in advance that xyz matter is exempted.
(Although IT officials can approach HC and SC to challange AAR rulings)
Thus, AAR provides clarity on tax structure in India. Promotes Ease of Doing business.
Speedy decisions, Avoids lengthy court litigations.
Ok then whats new?
Reform: Advance Ruling
BEFORE After budget 2014
only (nonresident) Foreign companies could approach AAR to
seek coaching clarification.
Even Indian companies can
approach AAR.
Other Tax reform bodies under Budget 2014
Committee 4 Tax clarity High level Committee under CBDT
High Level Committee to interact with
trade and industry on a regular basis.
to find out which tax laws require further
clarification.
Based on the recommendations of the
Committee, CBDT and CBEC shall issue
appropriate clarifications. Timeframe:
within 2 months.
before IT officials launch any fresh
cases for retrospective tax demands,
theyll have to seek permission from
this Committee.
Apart from this, Economic Survey and Jaitley mentioned many bodies such as productivity
commission, Expenditure Management commission etc. But well see them in future
articles because theyre not directly related with tax litigations like Vodafone.
More than 4 lakh crore worth tax money cases stuck in litigations. In this article, my
purpose was to cover the bodies/reform thatll aid in that regard.
Appendix
Some side topics:
A1: CGT: Short term vs Long term
How much CGT do you have to pay? That depends on Duration.
condition CGT rate
Short term capital
gains tax.
Suppose I bought a gold-bar, diamond, house, Picassos painting
or DEBT-mutual fund today, and sell It in less than three years
(with profit)
it is added to your
income
So then tax depending
on income tax slab
(10, 20, 30%)
same case, but I sell after three years (with profit)
Long term capital gains tax
(20%)
Meaning, two CGT rates depend on duration for which, you own the asset.
But there is slight change, if you buy/sell shares and (Equity) mutual funds:
SHORT TERMLONG TERM
within 1 year after 1 year
CGT: 15% exempted
Side note:
Equity mutual funds: people pool their money, and mutual fund manager invests it in shares.
Debt mutual funds: people poor their money, and mutual fund manager invests it in bonds.
Q. Does 3% education cess apply?
Yes education cess applies.
A2: What happened to Vodafone case?
So far Vodafone is caught up in two cases
Hutch Essar CGT Transfer pricing of call centre
Government demanding ~20k crore in CGT+interest+
penalty
SC ruled in favor of Vodafone but Government brought
clarification in IT act, to give retrospective notice.
Government demanding
~3700 crore rupees
In Dec 2013, ITAT gave
stay order for six months.
In August 2013, Chindu offered Conciliation (e.g no need to pay 20k crore, just pay ___
crore in ___ installments, and IT dept will free you from this case.)
Initially Vodafone agreed, but then demanded conciliation Discount for both Hutch case +
call centre transfer pricing case.
Chindu
we can give you discount for Hutch case (because SC in your favor),
But in the transfer pricing case well not give you any discount, because
youre completely at fault.
Vodafone Then I want both dispute to be settled outside India, under UNICITRAL law.
Chindu Sorry, cant accept. (thus, conciliation talks collapsed)
Vodafone
Then I want this dispute be handled under India-Netherlands Bilateral Investment
Protection and Promotion Agreement. (BIPA)
Chindu
That agreement will not protect you on that call centre case. Youve deliberately
undervalued share prices.
Vodafone Only time will tell.
April 2014: Vodafone Sends notice to government in April, 2014, wanting the case handled
by an International arbitrator at London, as per the provisions of Netherland BIPA.
June 2014: Government appointed former Chief Justice of India R. C. Lahoti as arbitrator.
Hell look only at Hutch CGT case. And NOT at the call centre transfer pricing (Because
that matter still pending.)
Ill set Mock MCQS later. My first priority is to cover the Content of budget +
economic Survey.
URL to article: http://mrunal.org/2014/07/budget-advance-pricing-agreement-arms-length-
vodafone-transfer-pricing-dtc-gaar-advance-tax-ruling-explained.html
Posted By Mrunal On 23/07/2014 @ 02:20 In the category Economy

Mrunal Budget 2014 - CGT, APA, DTC, GAAR, Transfer Pricing Cases

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