Tax by means fair or foul

“We are reasonable, so for the future I have waived it. But the tax demand after winning the case, if I waive off, we will be like a tax haven… how would I be answerable to Parliament that after the case I just waive ₹40,000 crore”. That was Finance Minister Arun Jaitley talking to a TV channel, recently. He wants to know how he can answer Parliament if he were to waive off ₹40,000 crore due from Foreign Institutional Investors (FIIs).

Even without the benefit of any expert knowledge on income tax law, but armed with nothing more than robust common sense, that is a question easily answered. After all, if a certain future conduct is regarded as reasonable on certain moral/legal principles, it must be equally so for the past as well. He says the government ought not to demand in future that FIIs pay tax on their capital gains because that is the reasonable thing to do. But FIIs can easily turn around and ask the question: So, how it is reasonable to subject our incomes to tax if what we have been doing in the past was no different from what we are going to be doing in the future?

Evidently, the Finance Minister has taken shelter behind the fact that the process of recovery of back taxes duly initiated by the tax authorities on whatever legal ground cannot be annulled. Surely, the government has the authority to stop any executive action that it deems oppressive in nature and born out of an overzealous approach to the interpretation of the provisions of law, or is not in the broader national interest? Of course, it does.

A closer analysis of the circumstances leading up to this series of tax demands amounting to ₹40,000 crore the Finance Minister referred to would reveal that this is a fit case of oppressive tax demands born out of overzealousness and in utter disregard of due process.

The department’s action springs from a ruling of the Authority for Advance Ruling (AAR) on a specific case referred to it by a prospective foreign investor in the Indian market.(The AAR is a quasi-judicial body constituted under the income tax law to give a ruling on the tax implication of a transaction that an overseas investor proposed to undertake.)

It had ruled that even the FIIs, who enjoyed a tax-exempt status with regard to any source of income in India under the provisions of a Double Taxation Avoidance Agreement (DTAA) with another country, are nevertheless subject to the operations of Minimum Alternate Tax (MAT) — a section of the law that seeks to impose a quantum of tax as the bare minimum, should the operation of other provisions of the income tax law result in a ‘zero’ tax liability. The tax authorities have reopened the assessment of incomes already completed for a number of FIIs seeking to impose a MAT levy on their past incomes.

It is a well-recognised principle of taxation that there ought to be finality to assessment where a taxpayer has not falsified any record or otherwise concealed any income. The only exception to this principle is where the authority realises there has been a mistake that is ‘very apparent’, and is evident on the face of the record that it warrants the reopening of a completed assessment.

The tax authority would have us believe there has been such an erroneous application of the law (omitting to impose tax levy under MAT) that is so basic that it is a fit case for reopening even completed assessments.

The ruling of AAR is in the nature of a tax opinion that is meant to operate prospectively on a transaction of an individual investor. At best it can also be sought to be applied prospectively to a set of other investors who are similarly placed. Given this factual position, is AAR the appropriate judicial forum for laying down the law on applicability of MAT on FIIs? No doubt, opinions of AAR bear the stamp of judicial application of mind to a question of fact or law or both. But appending to it a character and effect similar to that of findings of an appellate tribunal under the income tax law or the higher judiciary, is to vest it with a responsibility that is far beyond what had been intended by the legislature.

The AAR ruling suffered from an incorrect appreciation of the true nature and scope of MAT, and additionally, in concluding that it can override the benefits granted to foreign investors under tax treaties that India has entered into with other countries.

The MAT as it exists today has evolved through many legislative attempts in the past. The common theme, which can be gleaned from the budget speeches of finance ministers and memorandum explaining various provisions of Finance Bills before being enacted by Parliament, is that there are a number of companies which have legitimately earned the right not to be burdened with a tax demand. They can’t even be accused of employing colourable devices to escape taxes.

Nevertheless they can be seen as having sizeable disposable incomes. It is only fair that they be called upon to pay some tax at this point in time but the same can be adjusted against their legitimate tax dues in later years where such dues have been arrived at by the proper application of various provisions of the income tax law. In other words, MAT was meant to be nothing more than an advance tax against legitimate future levies. Such adjustments (against legitimate future levies) may well be at some distant point in time. But there should be a reasonable expectation that profits computed in accordance with the provisions of the income tax law must, at some point of time, converge with profits that have been recognised by adopting conventional principles of accounting. In the absence of this convergence, the levy by way of MAT exceeds the legislative mandate.

In the case of FIIs incorporated in countries with whom India has a tax treaty, one can be sure that the former would elect themselves to be subject to the tax jurisdiction of treaty countries. In other words, the tax for purposes of Indian income tax law will always be zero. The imposition of levy under MAT thus fails the ‘convergence’ test (between book profits and tax profits) which is fundamental to the structure of law on MAT.

The department has also drawn comfort from the fact that AAR had based its ruling on the fact that the section imposing MAT has enacted that it applies, “notwithstanding anything contained in any other provision of this Act”. But the section (Sec 90) which confers on foreign investor the right to invoke the beneficial features of a DTAA has this to say: “in relation to the assessee (FII) to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee”.

The Vienna Convention on Law of Treaties enjoins upon signatory nations not to unilaterally abrogate or amend specific clauses in bilateral tax treaties. No doubt, India is not a signatory to the Vienna Convention. But there is no reason not to recognise the salutary principle of no unilateral amendment. There is even less case for such abrogation with retrospective effect as the tax department has sought to do.

In an atmosphere vitiated by scams in allocation of 2G spectrum and coal mine blocks it is difficult for the political authority to override executive initiatives. But that is no excuse for not doing the right thing when arms of the government exceed their brief.