India’s annual budget included a mixed bag of tax measures, but not the hoped-for repeal of retrospective tax amendments.

The finance minister’s presentation of India’s annual budget generally draws an extraordinary level of industry and media attention. This is because the budget announces the tax policies, provisions, tax rates and tax concessions for the year, and also serves as a platform to announce policy initiatives impacting investment opportunities in various sectors.

This year’s budget – presented by Arun Jaitley on 10 July – drew an exceptionally high level of interest as it was touted to be the first test of the reform and investment agenda of the recently elected government.

The promise of “acche din” (good days) and a resounding mandate in the elections had led to unrealistic expectations of what would be delivered in this budget. The finance minister would have had to walk on water to fulfil the expectations that had built up. In his speech, Jaitley made the point that one budget could not address everything and systemic changes would have to be made in the next few years to achieve India’s economic aspirations. The challenge for the minister was to balance the unduly

high expectations built up pre-budget with the prevailing economic realities, with a view to reshaping investment sentiment both domestically and internationally.

That said, it is disappointing that some of the major issues impacting investment sentiment – retrospective tax amendments on indirect transfers, goods and services tax (GST) and the Direct Taxes Code (DTC) – were not dealt with as decisively as was anticipated. More defining signals on these issues during the coming fiscal year will be keenly followed.

Companies in India and global companies with any interest in India need to understand the implications and potential impact of India’s budget. For the assistance of the in-house legal teams of such companies, the key taxrelated announcements made by the finance minister, and the critical amendments which would impact businesses in India, are analysed below.

GST and DTC

Arguably, GST as a concept has received widespread endorsement and is perceived as a major milestone for indirect tax reforms. In spite of the previous government’s persistent efforts over the years, the fate of GST was kept hanging in the balance owing to the lack of consensus between the central and the state governments on certain critical issues of jurisdiction of states, compensation to states for loss of central sales tax revenue, etc.

Much was expected from the budget in terms of a framework and timeline for the introduction of GST. Instead, the finance minister announced that he had discussed the crucial question of the compensation to be paid to the states with the states and hoped to find a solution in the course of this year. He is also hopeful of resolving the issue of the constitutional amendments and the legislative scheme which would enable the introduction of GST.

Although the budget does not contain significant pronouncements on the implementation of GST, the next six months should more clearly signal the launch date. On DTC, the government chose to buy some more time to review it in its present shape and consider the comments received from stakeholders.

Retrospective amendments

A disconcerting trend during the tenure of the previous government was using the budget as a means to amend tax provisions retrospectively, specifically with a view to overturning court rulings which were favourable to the taxpayers. A case in point has been the Vodafone tax issue, which arose when the government, through the Finance Act, 2012, retrospectively amended provisions relating to indirect transfers thereby overcoming a Supreme Court decision in favour of Vodafone. This has negatively impacted the industry and investment sentiment. In the run-up to the budget, it was expected that the new government, with its stated objective of improving the overall investment climate and in the interest of providing a predictable tax regime, would repeal the retrospective amendments made via the Finance Act, 2012. However, the government has not done this.

While reaffirming the sovereign right to legislate retrospectively, the new government has stated that this power would be exercised with extreme caution and judiciousness, keeping in mind the impact of each such amendment on the economy and the overall investment climate, and that the government will not ordinarily bring about any change retrospectively which creates a fresh liability. The government’s resolve in this regard can only be put to the test of action in the coming years.

The government has further stated that fresh cases arising out of the retrospective amendments of 2012 will be scrutinized by a high-level committee to be constituted by the Central Board of Direct Taxes (CBDT) before any action is initiated in such cases.

The initiation of tax demands under these retrospective amendments is seen as the most adverse development impacting India’s credibility as an investment destination, and the finance minister was expected to take some positive and definitive action on this issue. Instead, he has left all the demands pending in litigation on this issue to their own destiny before the courts. An opportunity to restore India’s credibility on this contentious issue has been irretrievably lost.

Transfer pricing

The budget announced several amendments to the tax provisions. Among the key ones are changes to rationalize the transfer pricing provisions which would offer greater comfort for taxpayers. India has seen a high level of transfer pricing adjustments year-on-year with adjustment amounts totalling around `700 billion (US$11.6 billion) in 2012-13. In light of this the budget proposals are a welcome move.

It is proposed to provide a “roll back” mechanism in the advance pricing agreement (APA) scheme, in relation to the methodology for determining the arm’s length price (ALP), or the ALP, to be applied to international transactions during any period not exceeding four previous years preceding the first of the previous years for which the APA is applied. This amendment is to take effect from 1 October.

The APA regime has received an encouraging response from taxpayers and the proposed amendments, which are in line with provisions in some other jurisdictions, can be an effective way of achieving certainty for a certain number of past and future years in a single process.

The budget also proposes to introduce the “range concept” for determination of ALP to align the transfer pricing regulations with international leading practices. However, the concept of arithmetic mean would continue to apply where the number of available comparables is inadequate.

It was further announced that the regulations would be modified to allow use of multiple year data for comparability analysis instead of the current practice of generally using one year data for such analysis. The main purpose of using multiple year data is to ensure that the outcomes for the relevant year are not unduly influenced by abnormal factors.

Excise duty

Central excise duty is levied on goods manufactured in India, based on their assessable value as determined by provisions of the Central Excise Act, read with the Central Excise Valuation Rules (except in respect of certain specified goods where duty is based on the maximum retail price). In respect of goods sold to unrelated parties, and where the price paid for the goods is the “sole consideration” which the manufacturer receives for the sale, the transaction value is to be the assessable value.

However, the Supreme Court in 2012, in the case of Commissioner of Central Excise, Mumbai v Fiat India, rejected the transaction value, holding that as the manufacturer charged distributors a price that was lower than the manufacturing cost (with the aim of increasing market penetration), the price was “not the sole consideration for sale”.

As a result of this decision, the tax authorities raised demands by rejecting transaction value in cases where manufacturers were selling goods at prices below the cost and profit, on the basis that duty had to be paid on the price after considering the cost plus profit. This adversely impacted several manufacturers which used the sale of goods at prices below the cost plus profit as a marketing strategy and did not receive any additional money from such sales. The budget proposes to amend the Central Excise Valuation Rules to provide that in cases where goods are sold at a price below the manufacturing cost and profit, and where no additional consideration flows to the taxpayer, the transaction value is to be accepted for the assessment of duty. This amendment would be a positive change as manufacturers would not be required to pay excise duty on a value that is greater than the price they charged.

The same day as the budget, the government also issued a circular clarifying that the principle laid down by the Supreme Court in the Fiat case would not apply to fertilizer manufacturers that sell their goods at a previously fixed price and receive a subsidy from the government.

Clarity and rationalization

The budget includes some measures aimed at achieving clarity in certain provisions and other measures aimed at rationalizing certain tax provisions to bring certainty and clarity in tax laws and reduce tax litigation.

To achieve clarity, one proposal is to amend the definition of “capital asset” to include any securities held by a foreign institutional investor (FII). This provision would be effective from 1 April 2015. Controversy over whether the income in the hands of an FII was taxable as a capital gain or as business income is sought to be settled by this amendment, which provides that the income in the hands of an FII would be taxable as a capital gain.

A welcome measure aimed at rationalization is the proposal to extend the advance rulings scheme to resident private limited companies. The scheme, which helps taxpayers obtain clarity on tax positions in relation to proposed transactions, previously was available only to non-residents and domestic public limited companies.

Similarly, the central excise and service tax settlement commissions previously could be approached only where a taxpayer had filed its statutory returns. It is now proposed to also cover situations in which the taxpayer, for reasonable cause, has not filed the prescribed returns.

To help identify problem areas in tax laws, the government has proposed to set up a high-level committee to interact with trade and industry on a regular basis. Based on the committee’s recommendations, the CBDT and the Central Board of Excise and Customs – the top administrative bodies for direct and indirect taxes, respectively – would issue clarifications on tax issues within two months.

Appeal process

In a bid to curtail the pendency of cases before the indirect tax appellate authorities, the process for appeals before the Commissioner (Appeals) and the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) is to be significantly revamped. Appeals currently have two stages: the stay stage and the final hearing stage. On filing an appeal, the appellant is generally required to deposit the entire disputed amounts. At the stay stage, a hearing is conducted to determine whether the appellant deserves a complete or partial waiver of pre-deposit of the disputed amounts. This determination is based on various factors including the appellate authority’s prima facie view of the appeal.

An amendment proposed in the budget would effectively do away with the stay stage proceedings. Instead of applying for a waiver of pre-deposit, the appellants would be required to make a mandatory pre-deposit for filing of appeals, which would be 7.5% of the duty demanded or penalty imposed or both for appeal to the Commissioner (Appeals) or a first-stage appeal before CESTAT, and 10% of the same amounts for a second-stage appeal before CESTAT, with all such pre-deposits being subject to an

upper limit of `100 million.

This amendment could significantly reduce the turnaround time of the Commissioner (Appeals) and CESTAT in deciding appeals. However, the requirement to make a fixed pre-deposit could be adverse and onerous, especially in cases where proceedings have been initiated by tax authorities by adopting aggressive and/or arbitrary interpretations.

CSR expenditure

An amendment has been proposed under section 37 of the Income-tax Act which provides that any expenditure incurred by a company on corporate social responsibility (CSR) activities will not be expenditure for the purposes of a business or profession and a deduction will not be allowed while computing profits. The amendment comes as a dampener for companies as it follows the mandatory prescription for CSR expenditure under the Companies Act, 2013, which applies to all companies that meet specified criteria.

Tax credit scheme

Rationalizing the central value-added tax (CENVAT) credit scheme is an important move towards the introduction of GST, which requires a comprehensive credit mechanism.

However, the budget proposes some restrictions in the CENVAT credit scheme.

In the past, several judgments have held that obtaining CENVAT credit is an indefeasible right. An amendment seeks to negate these judgments by introducing a time limit within which the right is required to be exercised. Under the amendment, the CENVAT credit for duties paid on inputs and input services will have to be claimed within six months from the date of issuing an invoice.

The government provides separate tax offices with certain facilitation for large taxpayers that opt for its Large Taxpayer Unit (LTU) scheme. One of the driving factors for companies to register under the LTU scheme has been the transferability of CENVAT credit between different units of the company. Under an amendment, such transfers would be prohibited, adversely impacting companies that have opted for the LTU scheme.

Final thoughts

The budget has sent out several positive signals through its detailed coverage of several measures to encourage investment, manufacture, employment and social facilitation. This has relegated the tax provisions to a near secondary position under the budget.

Restoring the credibility of India’s tax administration system is crucial to creating a better investment environment. The new government’s focus on better governance in every aspect of taxation augurs well for the future. If this focus on good governance carries through, there is hope that India will emerge to a point where quality governance on an ongoing basis shapes the future and an exercise like the budget becomes less relevant as a statement of the government’s policy and intent.  Disclaimer: This article was first published in the July/August 2014 issue of the India Business Law Journal magazine. It has been authored by Rohan, who is the Managing Partner and Anay Banhatti, who is a Senior Associate at Economic Laws Practice (ELP), Advocates & Solicitors. They can be reached at rohanshah@elp-in.com  or anaybanhatti@elp-in.com for any comment or query. The information provided in the article is intended for informational purposes only and does not constitute legal opinion or advice. The contents of this article/update are intended for informational purposes only and do not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.