The advent of the goods and services tax (GST) regime has led to a paradigm shift in the Indian tax regime. The element of uncertainty, which has always been a part of taxation in India, has emerged in an altogether new dimension in the GST regime. Apart from the issues being faced by the assessees in relation to compliance and technical processes, many provisions under the GST laws are open to myriad interpretations, each of which remain untested.
Given this backdrop, a holistic and more proactive approach to tax controversy management is needed. In fact, best-practices apropos tax controversy management now ought to be firmly entrenched in the realm of corporate governance. This article aims to shed light on a few key aspects of tax controversy management specific to India that would be relevant for multinational companies that are operating in India or are even exploring opportunities/finalising business plans for investment into India.
Tax controversy may broadly arise out of three areas: (i) tax authorities disagreeing with tax positions adopted by a company on legal grounds; (ii) tax authorities disagreeing with tax positions adopted by a company on account of erroneous contract drafting that does not reflect the intended tax positions; and (iii) difference in interpretation of tax clauses in a contract.
I. Controversies arising out of tax authorities disagreeing on legal grounds with tax positions adopted by a company
In India, under the GST regime, where every tax position remains unprecedented, there is a high possibility that tax positions which may not literally emerge from the language of the statute would be disputed by the authorities.
In this regard, the following steps may be adopted from a tax controversy management best-practice perspective.
A. Document The Rationale Behind Every Tax Position
The first step towards sound tax controversy management is to document the rationale behind every tax position. For any tax position that does not seem to be supported by a simple literal interpretation of the relevant tax statute, a legal opinion ought to be obtained explaining the legal basis behind such a position. These opinions help to establish the bona fides of a taxpayer, should litigation be initiated by the tax authorities (referred to hereinafter as “Revenue”). In addition, assessees should consider making detailed disclosures to the relevant tax authorities about any such tax position, along with reference to a supporting legal opinion.
The fact that a legal opinion has been obtained should be disclosed to the tax authorities even if the opinion is not actually provided. These steps help establish the bona fides of the taxpayer which would go a long way inpreventing penalties (which are equivalent to the demand of tax) which may be invoked by the Revenue alleging an intention to evade taxes.
B. Obtaining Advance Confirmations On Key Tax Positions
Having taken care to establish bona fides, the second step is to try to obtain confirmation of the tax position adopted. The following options are generally available under most tax statutes.
i) Obtaining Advance Rulings
Contrary to the previous regime, where advance rulings could only be obtained by a new company or an existing company setting up a new venture, under the GST regime, the alternative to explore an advance ruling is open to every company on a number of issues including classification of goods/services, valuation, time of supply, requirement to register, whether a particular thing done amounts to being a supply of goods or service.
However, the main USP of advance rulings in the pre-GST era was certainty, since there was no statutory appeal against such ruling; that stands diluted in GST as there is a remedy of statutory appeal available against such rulings before the Appellate Advance Ruling Authority. Nonetheless, from the Appellate Advance Ruling Authority, there is no further statutory appeal – resultant, an aggrieved party can directly approach the High Court on a writ.
Thus, while this dilution may be a deterrent, from a practical standpoint, this option is still a quicker remedy to overcome the ambiguity prevalent in this regime and should definitely be exercised with regard to applicability and/or interpretation of any provision of law.
However, that being said, it will not be a prudent idea to seek such a ruling in cases where the interpretation is clear and unambiguous. A negative ruling in such cases could cause more hardship than any benefit to the applicant.
ii) Obtaining formal clarifications from the Revenue
Given that GST is a new law which brings with it a number of teething issues, an effective and efficient way of overcoming such issues is to seek a written “clarification” from the Revenue. If the issues being addressed are industry wide, it may also be a good idea to make a representation on behalf of the entire industry to create more effective impact, while knowing the wide scale ramifications of the issue.
Such clarifications are binding on the Revenue, though not on the quasi-judicial/judicial authorities and the taxpayer. That is to say, once clarification has been obtained, the Revenue cannot take a view contrary to the clarification to the detriment of the taxpayer concerned (subject to such clarification not being against the law).
Strategically, seeking such a clarification also serves two additional purposes.
First, if a clarification issued by the Revenue is patently erroneous in law and against the taxpayer’s interest, a writ petition can be filed before the High Court and a quick and out-of-turn resolution to the tax issues can be expected in the same manner as advance rulings (discussed above). However, if no such clarification was ever obtained, the taxpayer would have had to exhaust all alternate remedies available under the tax statutes, such as tax assessment, departmental appeal, and tax tribunal, before it is permitted to approach the High Court.
Second, even if a clarification is not provided by the Revenue (for any reason) despite the taxpayer having approached them, the efforts undertaken in obtaining such a clarification helps to establish the bona fides of the taxpayer before a tribunal/court and thereby shields it against any penal implications at a later date. In recent times such clarifications have been very effective in resolving certain anomalies and interpretative issues under the GST regime.
iii) Payment of tax under protest
Payment of tax/duty under protest is another option which can be exercised under indirect tax laws. By opting to pay the tax under protest the taxpayer can mitigate the interest and penalty implications that may arise if the tax position adopted by the taxpayer is subsequently overruled by the appellate bodies.
C. Best Practices To Manage Tax Litigation Optimally
If efforts to obtain advance confirmation of a tax position fail and tax litigation becomes unavoidable, some of the best practices during litigation areas follows:
i) Capturing factual subtleties comprehensively at the first adjudication stage
Tax litigation in India typically commences through a show cause notice from the tax authorities. In response to the show cause notice it is important to set forth all the factual nuances of the matter, including relevant references to underlying documents like contract clauses, invoices, tax payment receipts, and books of accounts. The probability of success in tax litigation depends on how clearly the facts have been presented before the tax authorities/adjudicating forums. If all the facts have not been introduced at the lower adjudicatory level, it is generally impermissible/very difficult to introduce such facts at the higher appellate stage.
ii) Effective usage of writ remedy as a tax controversy management tool
State High Courts in India are vested with the power to issue writs and directions to any person or authority, including any Government within their territorial jurisdiction. Unlike the Supreme Court of India, High Courts are not limited to enforcement of fundamental human rights guaranteed under the Constitution. The writ jurisdiction of the High Courts extend to “any other purpose” as set forth in Article 226 of the Constitution. Similarly, under Article 227, High Courts have been granted a power of superintendence over “all courts and tribunals” in their territorial jurisdiction.
Thus, Article 226 read with 227 of the Constitution of India grants wide powers to the High Courts, and taxpayers can use this avenue effectively for tax controversy management. Typically High Courts are reluctant to interfere in tax matters under Article 226 and 227 because of the existence of alternative remedies. However, in certain cases such as lack of jurisdiction or violation of natural justice, where an alternative remedy would not serve any purpose, the Courts usually exercise their jurisdiction.
Occasionally, clarifying circulars/instructions are issued by tax authorities that are patently against the statutory provisions – Statutory appellate proceedings will not remedy such clarifying circulars and aggrieved taxpayers should not hesitate to explore writ remedies to challenge them.
The High Courts’ power of superintendence over lower courtsunder Article 227 also opens up avenues for remedy if faced with an adversel order from a tribunal under the relevant High Court’s territorial jurisdiction.
II. TAX CONTROVERSIES ARISING OUT OF TAX AUTHORITIES DISAGREEING WITH TAX POSITIONS ADOPTED BY A COMPANY ON ACCOUNT OF ERRONEOUS CONTRACT DRAFTING
Tax controversies of this nature are common and arise wherever the tax and legal departments in companies work in silos. While the legal departmentis in charge of finalising the contract and the tax team is in charge ofthe tax positions, often, tax nuances that ought to have been incorporated in the contract slip through the cracks and later get challenged by the tax authorities. It is important, therefore, that the tax team articulates the key imperatives of the tax positions/planning options factored by them to the legal team, who in turn should ensure that such imperatives are duly articulated in the contract documents.
III. TAX CONTROVERSIES BETWEEN PRIVATE PARTIES ARISING OUT OF DIFFERENCES IN INTERPRETATION OF TAX CLAUSES IN A CONTRACT
Tax controversies between private parties arising out of different contractual interpretations are common and often lead to significant time and cost expenditures in negotiations, arbitration proceedings, and court proceedings. While these proceedings may not be completely avoidable, effective mitigation is possible to a large extent by comprehensive documentation of tax planning options and a commercial understanding between the parties on key tax points. These days the biggest areas of dispute arise out of interpretation of clauses dealing with change in tax laws/statutory variations. This assumed criticality during the period of transition as most contracts were operating under both regimes – pre GST and post GST – and hence was invoked for reimbursement of taxes. In this context, the following key points are critical to be documented in a lucid and comprehensive manner to avoid future disputes:
i) What are the taxes to be borne by each party?
ii) If the contract price is to include all taxes, does it also include taxes which are statutorily payable by the customer? If yes, that should be clearly specified along with the necessary modus operandi (for example,would customs duty or GST paid on a reverse charge basis by a customer be deducted from future payments to be made to the contractor);
iii) For taxes/cesses such as a building cess which can evoke statutory liability of either the customer or the contractor depending on various factors, who bears the responsibility?
iv) For taxes that would be reimbursed by the customer, what would be the basis for such reimbursement? What sort of documentary proof would be required?
v) For availment of credits which are contingent upon the supplier being compliant with the law, who bears the risk of such non-compliance which may in turn lead to non-availability of credit and also penal liability? In general, who bears the risk of the tax positions?
vi) The scope and extent of the clause dealing with impact of change in tax laws ought to be comprehensively documented:
a. The contract should clearly indicate whether it includes change in taxes only for direct transactions between the contracting parties or whether sub-contract level change in taxes would also be covered;
b. Ideally, for the critical taxes in a high-value contract, there ought to be a detailed price schedule specifying the quantum and rate of such taxes factored on the date of the contract, so that calculation of impact of change in tax laws is easier;
c. What constitutes a ‘change in tax laws’ needs to be very clearly discussed and documented to avoid future disputes.
In the context of clauses dealing with change in tax laws, it is pertinent to note that Section 64A of the Sale of Goods Act 1930 provides for indemnification of the affected party on imposition/remission or increase/decrease of customs/excise duty and tax on sale/purchase of goods, subject to a contract to the contrary. In fact, in the case of Pearey Lal Bhawan Association (2011-TIOL-114-HC-DEL-ST), the Delhi High Court inter alia relied upon Section 64A to decide a civil money suit for claim of service tax not originally envisaged under the contract and overruled a specific contractual clause mandating the lessor (i.e. the service provider) to bear all the “municipal, local and other taxes”. By doing so, the Delhi High Court effectively extended the concept of Section 64A to service transactions as well – this judgment has also been upheld on appeal by the division bench of the Delhi High Court. Thus, failing to clearly document the impact of ‘change in tax laws’ may lead to unforeseen consequences in a litigation/arbitration.
While complete mitigation of tax controversies would not be possible in today’s dynamic regulatory environment, the best practices outlined above would help optimise tax controversy management in India. What is required is an integrated and proactive approach to crystallise the concepts and best-practices of tax controversy management as a part of the overall corporate governance framework.
*Assisted by Mannat Waraich,
Managing Associate, Advaita Legal