During acquisitions, the due diligence process is designed to ensure that there are no post-acquisition surprises. However, on a couple of occasions, tax departments have turned into unlikely villains after an acquisition.
Jet Airways and Air Sahara had to renegotiate the terms of their merger due to a service tax dispute two years after they merged. Vodafone could have expected millions of friends when it acquired the operations of Hutchison Essar in India but it would certainly not have expected that the tax department could turn into its foe.
Apart from the marquee capital gains case which forced the Government to rewrite the Income-Tax Act to go against the Supreme Court, Vodafone has been facing other niggling tax issues.
Last week, the Bombay High Court asked the company to knock on the doors of the Dispute Resolution Panel (DRP). This was to resolve its tiff with the tax department over the assessment made for the year 2008-09 which resulted in a liability of Rs 1,400 crore.
Vodafone India issued shares to a Mauritius-based group company for Rs 246 crore at a fair market value of Rs 8,519 per share.
However, the tax department determined the value of the shares at Rs 53,775 per share. The differential amount is being sought to be taxed by the authorities as income in the hands of Vodafone India. The latter maintains that this is a capital transaction which the department should not lose much sleep over.
Fix the law There is no dearth of forums for the tax payer to escalate a tax issue relating to international transactions and transfer pricing. To start with, he could seek an Advance Ruling from the Authority for Advance Rulings (AAR) to ensure that tiffs with the Department are minimised. Once the warring parties enter the war zone, they could seek assistance from the Commissioner of Income Tax (Appeals), DRP or the Income-Tax Appellate Tribunal. In case they want lasting peace for a few years at least, they can enter into Advance Pricing Agreements with the tax department.
Some tax-payers also have the added benefit of having Safe Harbour Rules which provide guidance on transaction values.
Transfer Pricing and international taxation laws seem to suffer from a strange paradox — there is an overdose of authorities passing judgements on a law which itself is extremely judgemental and thereby renders itself to multiple interpretations.
The Government should ensure that the law answers some basic questions, such as whether capital transactions would be covered; if so, what types of transactions are covered and are exempt. This would prevent the tax-payer from applying to every appellate tax authority in the country seeking an answer to a question that could have been answered by the Income-Tax Act.
Dispute Resolution With a view to expedite the time consuming litigation process in transfer pricing, the Finance Act 2009 introduced an alternative dispute resolution mechanism to facilitate resolution of disputes on a fast track basis.
Initially, the orders passed by the DRP stunned everyone — they were poorly thought out and trashed by various Tribunals. In most cases, the DRP had been conservative in its directions by just upholding the (assessing officer) AO’s/TPO’s (transfer pricing officer) stand without adding any value.
However, the DRP has slowly evolved and the orders passed recently have been more detailed and provided significant relief to taxpayers.
The Finance Act 2012 brought about an amendment giving the department the authority to appeal against the DRP order. While this may improve the quality of thee verdict, the resolution mechanism itself becomes a protracted affair. And, it looks like Vodafone will continue to make missed calls to the tax department.
(The author is Director, Finance, Ellucian)