Plugging tax leakages in tough times

A slowdown in the Indian economy, coupled with recessionary times in Europe and America, has made it imperative for Indian companies to reduce unnecessary costs through prudent investments. One such measure is investment in tax compliance to guard against tax leakages. Indian tax law has been amended several times over the years to ensure strict compliance, and the Finance Act 2012 has enhanced penalties and introduced newer ones.

Tax penalties and interest expenses can significantly affect a company’s financial performance, especially in a difficult economy. Paying a penalty of Rs 100 actually entails a cost of Rs 130 for a company, as penalties are not allowable expenses when computing taxable profits. Therefore, tightening compliance to prevent interest and penalty costs are of paramount importance.

Generally, the accounting team of a company takes on the responsibility for the deduction of tax at source (TDS). This includes deducting tax at the appropriate rate, depositing it with the Government, filing the TDS statement every quarter, and issuing the TDS certificate to the payee. Failure to comply can lead to interest, penalties, and even prosecution. Any shortfall in deduction of taxes will attract interest at the rate of 1 per cent a month up to the date of deduction, whereas non-depositing of taxes deducted will attract interest at 1.5 per cent a month up to the date of deposit. Failure to file TDS statements could result in a penalty of up to Rs one lakh. Hence, it will be worthwhile to put in place an external review mechanism to infuse checks and balances and avoid additional costs.

Similarly, the positions taken in income tax returns should be carefully examined, deliberated and documented in order to substantiate the claims made. The filing of inaccurate particulars, or claims that cannot be substantiated later, can result in penalties extending up to three times the tax impact of any additions made by the tax officer, apart from the resulting interest.

It is also essential not to miss out on any of the claims, deductions, incentives or benefits conferred by the law. A CFO often has to weigh the benefits of outsourcing tax functions against keeping them in-house. While outsourcing may increase costs, keeping them in-house could cause a lack of continuity and data loss due to employee attrition, which may result in a loss to the company. Generally, companies choose to outsource their tax functions in order to ensure continuity, consistency and security. This is especially important where claims/deductions are deferred to future years due to the provisions of the income tax law — continuity helps avoid losing out on these claims.

Also, when a company acquires another, or is itself acquired, the incoming management may face severe challenges locating sub-schedules or details to audited accounts or tax returns, supporting evidence for capital receipts, revenues, addition to assets, expenses in profit-and-loss accounts such as bills in relation to activities pre-acquisition. This evidence may be required for assessment proceedings, which could take place almost two years after filing the relevant tax return — and non-submission of the evidence could result in additional costs in the form of tax, interest and penalties. Capturing and maintaining adequate supporting documentation for assessment should be high priority. This warrants investment in appropriate systems with the help of tax experts to ensure documents are organised effectively.

Managing tax compliance becomes all the more complicated for an Indian multinational with presence in multiple countries. Working directly with local tax experts can help keep compliance and tax costs to a minimum. However, lack of coordination between units in different countries could result in double taxation of the same income, or inadvertent non-compliance with certain provisions resulting in excess tax and penalties. The CFO of a domestic MNC should put in place a global compliance mechanism with a single point of contact in the local office to mitigate tax leakage.

Thus, in the current economic scenario, a CFO will have the tough task of evaluating the costs versus benefits of outsourcing certain tax functions. Prudent investments to ensure continuity and consistency, use of technology, adequate controls and review by relevant experts would save the company from unwanted tax, interest and penalty leakage.

(M.G. Ramachandran is Associate Director — Tax and Regulatory Services, PwC India)