The Finance Minister is all set to present his budget for the financial year 2012-2013 on March 16, 2012, delayed due to elections in various Indian States. With the Direct Taxes Code Bill, 2010 (DTC') still under scrutiny by the Parliamentary Standing Committee and unlikely to be implemented in April 2012, as proposed, there is an expectation that Budget 2012 could incorporate key provisions of the DTC into the current Income-tax Act, 1961 (IT Act) itself.

The DTC seeks to revamp existing tax legislation by codifying the law on indirect transfers, introducing ‘General Anti-Avoidance Rules' (‘GAAR') to serve as a deterrent against tax avoidance schemes and proposing provisions with regard to ‘Controlled Foreign Companies' to bring into the tax net the undistributed passive income of foreign subsidiaries of Indian companies.

Tax trends

Prior to delving into the proposed DTC legislation that could find a place in Budget 2012, it is important to note the recent trend in legislating tax policy in India. In 2011, the Government focused on ways to bring back tax-evaded moneys stashed abroad.

The fallout was that India has negotiated Tax Information Exchange Agreements with many of the identified non-cooperative jurisdictions, including the Isle of Man, Bermuda and the Cayman Islands.

Recently, India also signed and ratified a Convention on Mutual Administrative Assistance in Tax Matters that seeks to develop a broader multilateral approach to improve cooperation between countries in the assessment and collection of taxes with a view to combating tax evasion.

It is a coordinated approach by the signatories, which include the US, the UK, France, Germany, Russia, Norway to render assistance to each other in the field of information exchange, recovery of taxes, simultaneous tax examinations and participation in tax examinations abroad.

Introduction of GAAR

In this backdrop, the introduction of GAAR in Budget 2012 seems imminent.

Under the GAAR provisions of the DTC, the Indian tax authorities would be empowered to declare any ‘arrangement' as an ‘impermissible avoidance arrangement', if a part or whole of the structure has been set up with the main purpose of obtaining a tax benefit. An ‘arrangement' would be presumed to be for obtaining tax benefit, unless the tax payer demonstrates that obtaining a tax benefit was not the main objective of the arrangement.

The introduction of GAAR provisions, as it is currently drafted, could also impact tax structures with jurisdictions used as a platform for investments into India, where India's tax treaty with such jurisdictions do not have any in-built substance requirements to prevent abuse. As per GAAR, commercial substance and bona fide business purpose would be the key requirements for availing of benefits under Double Taxation Avoidance Agreements (‘DTAA') entered into by India.

Countries such as Singapore which provide tax benefits (albeit available only till such time the concession is available to Mauritius) may be preferred as the India- Singapore DTAA already has a Limitation of Benefits clause which provides for certain substance requirements. Similar commercial substance and bona fide business purpose test would become a prerequisite under a GAAR regime.

Thin capitalisation rules, which would empower tax authorities in reclassifying some of the interest paid on debt as dividend and deduct tax on it, could also be introduced as part of GAAR. Thin capitalisation rules seek to check the practice by companies of infusing capital by way of debt and seeking tax deductions on corresponding interest payments.

Transfer pricing

With the direct tax realisations across the country witnessing a flat or negative growth and the Supreme Court ruling in favour of Vodafone, Budget 2012 could also seek to specifically codify in the current IT Act, taxation of indirect transfers of underlying assets situated in India, to bring into the tax net Vodafone-like transactions.

The Supreme Court, in acquitting Vodafone, had ruled that the word ‘indirect' cannot be read into the current IT Act on the basis of a purposive construction. The DTC had also proposed the introduction of an Advance Pricing Agreement (APA) mechanism to reduce transfer pricing audits and litigation.

The introduction of APAs to check transfer pricing disputes would be welcome in Budget 2012. The APA mechanism would allow companies to enter into agreements with tax authorities to prevent future disputes with regard to pricing of products and services for the purpose of cross-border trade between related entities.

In a nutshell, Budget 2012 could serve as a stop gap arrangement until DTC and its provisions in entirety are introduced.

(The author, an Executive Director, heads the South India tax practice for PwC.)

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