When the tax bill is unreasonable

One of the catch-22 situations that corporate India faces when a huge tax demand visits them is whether to pay and litigate, or ask for a stay order and fight.

The issue is more complex than it seems since it is not merely a tax decision but a treasury management call.

The first question that a nervous director would ask is: What are the chances of winning before the appellate authorities? Should we be providing for the liabilities in the accounts? Hours are spent by the CEO, CFO, auditor and tax consultants discussing the pros and cons of which approach to take.

With reference to all the technical discussions and the innumerable case laws on the subject, the modern day cynic would remark: Better to toss the coin and decide. There is no certainty as to how a tax law would be interpreted from the origin; from the assessing officer to the Supreme Court will take minimum of 10 years after the order has been passed.

Any tax demand generally has to be paid within 30 days from the date of service of the demand. If it is not paid, a 12 per cent per annum interest has to be paid, which is non-tax deductible.

This is notwithstanding the fact of filing an appeal before the appellate authorities.

Also, in case of a stay, the interest implications on default and deferment in payment of advance taxes need to be considered as additional factors. Further, there is the possibility of maximum penalty equivalent of the tax in arrears that can be levied.

On the other hand, if the amount demanded is paid and the appeal filed after that, the funds otherwise available get locked up with the Government. If the issue is won on appeal, the assessee is entitled to interest at 6 per cent per annum which is taxable.

A further twist to this decision-making process is should we provide for such liability in the accounts or indicate the same as contingent liabilities in the notes on accounts? The latter is usually the preferred option since it does not create a dent in the profits of the company and improves the financial ratios. But if the issue is not resolved for years can this remain contingent till the cows come home?

The distinction between a contingent liability and provision is based on the probability of the outflow of resources which may be required to settle the obligation. Demands that may, but probably will not, require an outflow of resources are recorded as contingent liabilities, while those that probably will result in an outflow of resources are recognised as provision.

Assessment has to be done on a year-to-year basis. Management responses typically are that there are legal opinions and favourable judicial rulings on the same issue and hence can continue as contingent liability.

A cursory glance at the contingent liability list of various companies covering direct and indirect taxes can be unnerving to independent directors who can, at best, look at these issues from a distance and rely on the explanations of the management.

After the implementation of the Companies Act, 2013, independent directors have greater responsibility. Uncertainty helps nobody’s cause.

The decision to pay or ask for a stay order has to be fact specific and a factor of the policy of the company or the group. Components of demands that have a good chance of success versus the ones with less than half the chance have to be dealt with differently. One also has to consider the risk of further proceedings such as penalties and prosecution, not to mention the image of the company.

Foreign investors are baffled by the way tax demands are dealt with in our system. At the end of the day it is an evaluation of “liquidity” and “alternate use of deployment” that drives the decision on pay versus stay. It also depends on the quantum of demand. A Vodafone-like situation of a ₹20,000 crore demand is a no- brainer. The lasting solution is to fix an outer time limit for the settlement of all tax disputes — and that’s easier said than done.

The writer is a tax partner at Ernst and Young. The views are personal