In the growing participation of global companies in the Indian economy as well as the participation of Indian companies in the international economy, what Rajendra Nayak, Tax Director, Ernst & Young, sees is an increasing pressure on the Indian international tax system. There is an urgent need, therefore, for the Government to consider reforms to address a number of cross-border tax issues faced by taxpayers, he reasons, during the course of a recent pre-Budget email interaction with Business Line.
“The Government should give due consideration to reforming the international tax system in the upcoming Budget. The need for adopting global best practices would be of utmost importance,” urges Nayak.
Excerpts from the interview.
On foreign tax credits .
A major challenge that Indian outbound investors face is the difficulty in claiming credits for foreign taxes. Tax treaties provide a general rule that taxes paid by a resident in the other country, in accordance with treaty provisions, should be eligible for foreign tax credits (FTC). But, specific rules for applying this principle are left to the domestic tax legislation.
In the absence of specific provisions in the tax laws, a number of technical and practical issues arise. The lack of a well-defined FTC system results in uncertainty and risk of double taxation on income arising from outbound investment.
Further, the unavailability of underlying tax credit (UTC) for dividends received from foreign subsidiaries leads to economic double taxation. This issue is more glaring as dividend income from domestic companies are presently tax-exempt in the hands of shareholders.
The concept of UTC requires the local jurisdiction to grant credit for the corporate tax paid in the foreign jurisdiction by the company paying such dividends. Introduction of UTC provisions could encourage Indian companies to repatriate profits back to India for productive re-investment.
The Vijay Mathur Committee on Non-resident Taxation, in 2003, had highlighted the need for introducing comprehensive FTC guidelines. It also proposed UTC provisions. Introduction of these provisions will prove to be an impetus to outbound investments.
On transfer pricing, ADR and APA .
A recent global survey by Ernst & Young indicates that transfer pricing (TP) is the most important international tax issue that multinational companies face. Therefore, multinational companies would also consider speedy resolution of TP disputes as equally important.
In recognition of this, the Government recently established an alternative dispute resolution (ADR) mechanism for TP disputes. However, multinational enterprises also look for upfront certainty, which can be achieved only through an Advance Pricing Agreement (APA) mechanism.
Under an APA regime taxpayers and the tax authority agree upfront on the appropriate TP approach. APAs would help in addressing any TP issue before it develops into a dispute. It would provide a basis of resolving issues in a manner that is fair and impartial.
The draft Direct Tax Code, 2009 does contain a provision for APAs. However, in view of the benefits offered by APAs, the Government should consider introducing the provision in the current law.
Additionally, there is also a need to improve the current environment for dispute resolution by improving the effectiveness of Mutual Agreement Procedure (MAP) provided in tax treaties and expanding the scope of the advance ruling authority.
On withholding tax .
An area where there has been recent controversy is the issue of application of withholding tax on payments to non-residents, in light of a recent Karnataka High Court ruling. According to the ruling all payments which are in the nature of income should attract withholding tax, unless a certificate for lower withholding tax is obtained from the tax authorities.
This decision is likely to have onerous consequences and has not appreciated that the mandate for applying withholding tax arises only where the payment includes a sum that is chargeable to tax in India. The Government should seek to clarify this aspect by making appropriate amendments in the tax law.
