Stage set for next-gen tax reforms; will India move with the times?

It remains to be seen if India will reconsider its stand on international arbitration in tax treaties

Source: Financial Express

Since its advent in 1991, globalisation has entrenched itself deep in Indian economic landscape. Cumulative FDI statistics corroborate this assertion, as total FDI climbed to $52 billion (in April 2016) from a meagre $2.46 billion in 2000. There is no denying, India’s prominence in the global economic order has risen phenomenally over the past quarter century. While economic policies have undergone multiple transitions under successive regimes, tax policy reforms have held centrestage, too.

In 1991, the Tax Reforms Committee laid out a framework for direct and indirect tax regimes as a part of the structural reform process, ushering a paradigm shift by lowering maximum marginal tax rates, implementing measures to broaden and deepen the tax base and reducing rate differentiation to simplify tax administration. The levy of minimum alternate tax (MAT) was introduced in 1996 to bring zero-tax companies into the tax net. Most of the bilateral tax treaties signed before 2000 were revised, and that was the singularly significant policy achievement of the first decade after liberalisation. From an indirect-tax-policy standpoint, the 1990s were marred by a highly complex tariff structure, cascading effect of the excise and sales tax regimes, and quantitative restrictions on cross-border trades. Introduction of the service tax legislation in 1994 marked a significant step forward in rationalising the services-consumption-based taxation regime.

The subsequent decade was witness to the evolution from a high tax-/duty-rate regime to a moderate-rate regime, as rates across direct and indirect taxes were systematically brought down and quantitative restrictions on cross-border trade were eased, given the focus shifted to broadening of tax base through efficient administration. Tax legislations were also calibrated to incentivise exports and infrastructure development; investments in sunrise industries and promoting economically backward areas for indigenous value-addition were notable examples. India’s tax regime begun embracing global best practices, beginning with the introduction of the transfer pricing legislation in 2001 to prevent erosion of tax base through sophisticated tax and transfer-pricing planning strategies. The OECD’s Project on ‘Prevention of Harmful Tax Practices’ raised global concerns surrounding treaty shopping and abusive tax practices; India, though not even an ‘observer status’ country, did well in paying heed to the global movement against tax avoidance which was to take shape in the subsequent years in more politically-endorsed movement in the form of ‘base erosion and profit-shifting’ projects. Incremental policy measures during 2000 to 2010 led to material contribution of direct taxes into total tax collections with growth from 22% to 35%. The indirect tax regime underwent a structural shift in FY05 as the country embraced the value-added tax (VAT) regime moving away from archaic state sale tax regime; the VAT regime,indeed, did well in mitigating the cascading effect of state indirect taxes, albeit, the credit interlay of central and state indirect taxes remained a significant constraint for businesses.

The success of the VAT regime ignited the debate for a nationwide GST.

Since 2010, India’s tax policies have been more proactive. Several consultative processes were initiated to deal with major tax controversies emerging from time to time, some of which earned us the flak of global investors. Taxation of indirect transfers was introduced by Finance Act 2012, to deal with growing practices of tax treaty sparing through offshore investment holding structures, even though the retrospective nature of this legislation has been a question before investors. India adopted the Advance Pricing Agreement (APA) regime in 2012, to deal with rapidly mounting transfer-pricing disputes as volumes of disputed tax liabilities soared to $9.4 billion in the seven rounds of transfer-pricing audits since 2005. Evidently, APA regime has showed phenomenal outcome as more than 500 cases have been presented to the government for amicable resolution in less than three years since the framework was institutionalised.

India’s ascent in the global tax policies arena has been transformational in nature. While, historically, India has been an observer on OECD’s committees, participation as an associate member in the ongoing OECD-G20-led BEPS project is an evidence of growing closer association with multilateral forums tasked with evolving future tax policy landscape. It is likely that the future architecture of domestic tax policies in the medium- to long-term would be constructed around convergence with best practices as borne out in the form of BEPS Action Plans, 15 action points of which will be rolled out in the next 3-4 years. There are a number of anti-avoidance measures which have been either already been legislated, or are impending, e.g., general anti-avoidance rules (GAAR), place of effective management (PoEM) rules, treaty override and taxation of the digital economy (equalisation levy). The evolution of the BEPS package through continuous consultative process will accelerate the pace of domestic tax law reforms.

With some crystal-ball-gazing, I reckon India’s existing dispute resolution mechanism is set to undergo a policy shift as the focus moves from traditional forums to alternate and more transparent dispute resolution for domestic and cross-border cases, wherein the interplay of tax treaties become relevant. While the merit of historical appellate forums cannot be undermined, speedy and effective resolution of tax disputes necessitate far more sophisticated institutions such as negotiation, conciliation and/or arbitration with equal focus on administrative practices such as advance rulings and advance pricing to avoid disputes in the first place. The BEPS Action Plan 14 advocates promoting mutual agreement procedure (MAP) as a preferred forum for resolution of disputes arising on account of misapplication of bilateral tax treaties. Besides APA and MAP, I strongly believe that international arbitration is one of the most sophisticated and effective forums for resolving high stake cross-border tax disputes and not just investment-related disputes. It will be interesting to see if India would reconsider its hard stance on permitting arbitration in tax treaties.

Finally, the present tax administration practices call for an overhaul in line with Modi government’s overarching intent to broaden tax base by evolving a taxpayer-focused administration. Useful insights from global practices have emerged in recommendations submitted by successive expert committees, which would help guide the way. Clearly, the stage is set for the government to usher in next-generation reforms in matters of tax policies and ideal administrative practices.