BUDGET 2012 has set the ball rolling towards DTC - in line with international best practices. Introduction of GAAR, Advance Pricing Agreements, removing cascading effect of DDT in multi–tier structures, continuing lower taxes on dividends received from foreign companies are welcome moves by the FM.
The GAAR provision in the Budget is trying to test the thin line of difference between ‘tax planning' and ‘tax avoidance'. The concept of GAAR proposes to curb aggressive tax planning and codifies the doctrine of ‘substance over form' where intentions of parties determine tax consequences. However, provisions are open-ended with widest discretion to authorities to look through structures, disregard entities and override treaties which may result in hardships to assessees. The circumstances and extent to which GAAR is applicable could become a point of debate going forward.
The proposed amendment to tax an offshore transaction deriving ‘substantial' value from Indian assets, overriding Supreme Court's Vodafone judgment, was expected but a retrospective amendment from April 1, 1962 was unanticipated. Additionally, determining the meaning of ‘substantial' has been left to the discretion of tax authorities. The draft DTC specified the limit of 50% to determine whether indirect transfers are taxable in India, which is missing here. Further, the buyer may need to apply to the AO to determine the proportion of consideration chargeable to tax in India.
Majority foreign investments in India come through tax efficient countries. The Finance Bill clarifies that submission of Tax Residency Certificate in the prescribed form is necessary but not conclusive for availing benefit under DTAAs. Binding authorities of other countries to give a Tax Residency Certificate in a specified form could be challenging.
Another spanner thrown by the legislators is taxing issue of shares to residents, at a price exceeding the fair market value (or FMV), in the hands of a closely held investee company. FMV is based on rules, yet to be prescribed, or the value that can be substantiated to the AO. It would be critical to know what method of valuation would be prescribed under the rules. Genuine transactions at a value higher than that prescribed under the rules may have to be justified to the AO leading to litigations.
What needs to be seen now is whether some of the amendments stand the test of constitutional validity and how well it is received by the global investment community considering that even a Supreme Court judgment can be overruled through retrospective amendments. It is likely to have far reaching effects on the investment climate in India. Having said this, significant structural changes may be required for smooth and effective implementation of budget proposals.
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