When the proposed Direct Taxes Code (DTC) Bill was presented in Parliament in August 2010, it was widely expected that the DTC would come into effect from April 1, 2012. However, with the Governments' priorities focused on maintaining growth momentum in the current uncertain global environment, the general sense is that the DTC may not come into effect immediately. Nevertheless, the Government may consider bringing in certain key aspects of the DTC in the current Income-tax Act, 1961 by way of an amendment in the forthcoming Finance Bill.

One of the key aspects proposed by the DTC relates to indirect transfer of shares in an Indian company by a non-resident. DTC provides that income arising to a non-resident from sale of shares of a foreign company would be taxable in India, if such foreign company holds shares in an Indian company, either directly or indirectly, which constitute more than 50 per cent of the fair value of the assets of the foreign company.

Amendment in Finance Bill

Taxability of transfer of shares indirectly held by a non-resident in an Indian company is admittedly the ‘most followed' tax issue today among corporates, tax consultants and the taxman themselves. With the recent Supreme Court (SC) decision in favour of Vodafone and the increasing trend of Revenue Authorities disputing such transactions, an amendment in the Finance Bill on the lines proposed in the DTC could be on the priority list of the Government. Such an amendment could provide much needed clarity to the tax payers on the subject and will be a welcome measure if the amendment is applicable prospectively. Conversely, if such amendment is proposed with retrospective application to overcome the judicial thinking, it could only result in uncertainty in the minds of the international investors.

The other much debated issue is the discussion on tax planning vs tax avoidance. Tax planning leads to mitigation of tax costs within the permitted framework of law, while tax avoidance involves deploying colourable devices to evade tax. The SC has on several occasions, like Azadi Bachao Andolan, McDowell and the recent Vodafone ruling, tried to reconcile the concept of tax planning with tax avoidance. The extensive discussion on the ‘look through' (substance over form) principle and the ‘look at' principle in the Vodafone judgement indicates that the issue is one that is vexed.

‘Look through' approach

DTC Bill proposes to introduce the General Anti-Avoidance Rules (GAAR) as a deterrent and a tool against tax avoidance. GAAR is a broad set of provisions that has the effect of invalidating an arrangement that has been entered into by a taxpayer with the main objective of obtaining a tax benefit. DTC further provides that the benefits of the Double Taxation Avoidance Agreements (DTAA) would not be available if GAAR is invoked. The burden of proof vests with the taxpayer to establish that the tax benefit was not the main purpose of the arrangement. In effect, GAAR provides ammunition to the revenue authority to ‘look through' a transaction to determine if it was carried out to avoid taxes in India.

For example, with the introduction of GAAR, if a foreign company interposes Mauritius as an intermediate jurisdiction without any commercial substance but merely to avoid Indian taxes, it is possible that the Revenue Authorities may disregard the Mauritius entity and seek to tax the ultimate shareholders. The benefits of the India-Mauritius DTAA would not be available in a scenario if GAAR is invoked.

The possible introduction of taxation of indirect transfers and GAAR, in the current income-tax regime could potentially impact a number of domestic and global transactions. Any amendment which adds to needless uncertainty could affect India's desired image of being a stable, investment-friendly jurisdiction. If the amendments bestow undeterred powers on the Revenue Authorities to disregard every bona fide commercial transaction, it could exasperate interested investors and impact the investment inflows into India.

While the ruling of the Supreme Court in the case of Vodafone may not settle the debate of tax planning and tax avoidance, it should definitely have a bearing on the manner in which the above provisions would be drafted and implemented in the income-tax regime. One hopes that the amendments are rationale, clear, do not cause undue hardships to the taxpayers and are not retrospective in nature!

(The author is Associate Director — Tax practice, Ernst & Young. P. Bharath, senior tax professional, Ernst & Young has also contributed to the article. The views are personal.)

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