May 26, 2011

In the defence of revenue

In a recent article in Canada-based Financial Post, academician Vern Krishna argues that the Indian Revenue Service - the IRS - 'does not enjoy the reputation for being as untarnished as it should be'. In the very next sentence he states that IRS is also zealous to the extreme; which basically means the IRS is heavily pro-revenue.

Now I see that the two statements are contradictory. On one hand the author states that IRS has a bad reputation when it comes to probity in public life; on the other hand it states that IRS is a zealous tax collector.

I think when he talks about the bad reputation of IRS he basically implies the refund issues. Recently an NGO also highlighted that corruption in granting IT refund is one of the primary avenues of corruption in Indian bureaucracy. Unfortunately Vern Krishna lacks enough insight into the fact that the corruption in issuing refunds was rampant in the system because the clerks enjoyed greater say in issuing refunds. This is true for any department infested with clerks who effect the movement of files, be it excise duty or state secretariat. Often much of the bad name given to bureaucracy is because of clerks who are responsible for movement of files.

This problem is being fast mitigated because of the establishment of Centralised Processing Centre (CPC). CPC has effectively computerised the process of processing of returns and issue of refunds. The introduction of electronic clearing of refunds further reduces the role of clerks in effecting refunds.

Unfortunately the bad reputation gained by IT department over the years owing to its short-sighted work culture at the bottom of hierarchy tarnishes the image of IT department, and by extension the IRS.

Zealous taxmen: The Vodafone case

When Vern Krishna argues that the IRS is zealous to the extreme, he gives the example of the vodafone case. To quote him:

"The Indian Revenue Service is also zealous in the extreme. For example, it recently assessed a British company, Vodafone Group PLC, US$2.6-billion taxes on capital gains that the company triggered on a share sale of a non-resident company between two non-residents on some tenuous theory that there were corporate assets in India."

The problem with summarising tax issues is that most of the issues are lost in translation. The devil of taxation lies in the detail. By giving the above summary Krishna has basically shown his ignorance of the Vodafone case (Rahul Navin sir, the man behind the Vodafone case, was my teacher at the academy - hence I profess a better idea of the real issue). Krishna has failed to realise that Cayman based shell company of Vodafone had purchased Hutchinson's Cayman Island based shell company (a company with thin capitalisation) which was the holding company of the holding company which owned the holding company of Hutchinson India.

There were about 15 shell companies based in various tax havens which formed a chain of holding companies that ultimately held the rights over Hutchinson India. Krishna is right when he observes that the payment was effected in Cayman Islands and both the shell companies were registered in Cayman Islands. But the mobile towers of Hutch are all located in India. All other assets of Hutch are located in India. Heck, the Hutch pug shown in its ads is also a copyright asset on Indian soil.

If a capital asset is located in India, the transfer of this capital asset should be taxed in India. The apex court has stated in numerous previous judgments that if colourable devices are used to avoid taxes it is not tax planning but tax evasion. The deal was signed in Cayman Islands to fool the IRS. A complex network of shell intermediaries were inserted to make it difficult for IRS officials to unmesh it. There is clearly an intention to evade.

It amazes me to see the number of sympathizers for the assessee in this case. International taxation is an emerging field and law is still extremely fluid. However, it cannot be denied that in an increasingly networked and globalised world many problems of taxation will arise. The major issue is with Supra National Companies (SNCs ?) which pose as Multi-National Companies (MNCs) and take benefits of markets of multiple nations but are inclined not to pay for it.

Basically a SNC is a company that does not have a country of source or destination. It is based in some tax haven and has a single-minded objective of making profits. It taps into various local markets but does not want to pay taxes as per local norms. This creates a problem of equity. Domestic companies are bound by Indian tax laws. MNCs are bound by tax laws of both India and the country of source. Tax-haven-based SNCs try to exploit the complexity of accounting webs to evade tax laws. In my opinion the GAAR proposed in DTC will go a long way in mitigating these issues.

Coming back to the Vodafone case, recently an Indian ambassador to a bunch of European countries opined in Business Standard that issues such as the Vodafone tax case do not go down well with India's image as an investment destination. Without raising aspersions about his Excellency's insights into tax laws and French wines, it is pertinent to note that if SNCs are not taxed in 'country of source' or 'country of residence' then who is going to pay for the expenditures of Indian embassies in Europe and European embassies in India?

More than anything else taxation is an issue of equity. Tax evasion is not just an injustice to the treasury but also to the taxpayers - in this case the domestic companies and MNCs that follow bilateral DTAA norms. When India is set to lose $ 2.6 billion in legitimate taxes from Vodafone, I think 'image' as an investment destination should not worry us. As it is India is fast becoming the biggest market for global firms having managed to build up an affluent middle class. Outsiders are desperate to mop up on Indian mine resources. POSCO had said many times that it would leave India if legal issues are not resolved soon - but it still hangs on. We don't have to please those who are investing in India on their own.

Coming back to IRS, yes we are a zealous group of sleuths. Vern Krishna has aptly remarked this, but unfortunately the work done by these zealous taxmen does not get appreciated in national fora. Rahul Navin has brought benefits of $ 2.6 billion to Indian government by tracing out vodafone tax evasion. Alas, not a single award of national repute was given to him for the hard work he put in.

11 comments:

nitin said...

nice the blog is really insightful....

Anoop said...

Great post Smarak. In depth analysis and an apt reply for shallow observations. Keep it up dude.

Anonymous said...

Excellent! Vern Krishna has definitely reveled his ignorance of the real issues in his article.

mayank said...

Excellent reply to Vern Krishna.........

sehar said...

what an in depth n straight reply
someone is defending IRS very passionately

sehar said...

what an in depth n straight reply
someone is defending IRS very passionately

red said...

very insightful. i am fortunate to find ur blog.

rammohan said...

Hi Smarak,

Nice post and a very nice blog.

My name is Ram: B.Tech from IIT M and Masters from Texas A&M, and presently working as Assistant Project Engineer with California Department of Transportation. These days I am seriously contemplating about attempting Civil Services, and I could see myself in many of your posts, mainly the ones you posted before your selection into the services. I am sure that a brief talk with you would be of immense help for me to make some crucial career decisions.

Please let me know if I can contact you through email or phone. You can reply here or mail me to rammohanreddy.b@gmail.com

Thanks
Ram

Anonymous said...

Smarak,

What about your earlier comments in view of the new Supreme Court ruling on the illegitimacy of the IRS's position on Vodafone? Is the IRS still a 'can-do-no-wrong organization'? You were waxing of the need for national awards for wasting the time, money and energies of a nation on a non-est cause!

Smarak said...

@ Anonymous, read the Supreme Court judgment closely. SC has appreciated the fact that the judgment is ahead of its times; that we need specific laws to counter the use of colourable devices to evade taxes. Basically the SC has harped on the fact that till General Anti Avoidance Rules (GAAR) come we can not reach out to extra territorial attempts at tax evasion.

I also state this with anxiety that SC judgment puts severe impairments on the government's ability to catch the "big fish" tax evaders whereas we keep catching the smaller tax evaders (who do not have the means to do treaty shopping). By giving this judgment the Hon'ble SC preferred to restrict itself to the LETTER OF STATUTE than get into SPIRIT OF LAW. I guess this heralds the time when legislation needs to sit down and encode GAARs into tax laws

TuSKeR said...

clerk's role is known to all but assertion of the point "corruption related to issuing refunds" is more in interest of authority(officer) than a clerk.