Navigating Complexity in India’s Evolving Taxation Landscape

India’s taxation system has seen remarkable advancements over the years, evolving in tandem with the country’s economic growth. However, this increasing sophistication has introduced a layer of complexity across several areas, including tax treaty benefits, permanent establishments, transfer pricing, and general anti-avoidance measures, according to Sanjay Sanghvi and Ujjval Gangwal of Khaitan & Co.

The Indian economy has expanded significantly in recent years, driven by various factors, including a surge in cross-border transactions and foreign direct investments. Recognizing the need for a modernized tax framework, the Indian government has implemented significant reforms, such as the faceless assessments and appeals regime. While these reforms aim to enhance transparency and streamline processes, persistent challenges remain due to frequent legislative changes and judicial developments that continue to reshape the interpretation of tax laws.

India’s tax treaties with Mauritius and Singapore have been instrumental in fostering cross-border investments by offering capital gains tax exemptions to residents of these countries for investments made in Indian company shares prior to April 1, 2017. Despite this, the applicability of these benefits has been a contentious issue. The Indian income tax authorities have often challenged claims on grounds such as the taxpayer being a ‘conduit’ entity, lacking control and management in Mauritius or Singapore, not being the beneficial owner of income, or lacking substance in these jurisdictions.

Courts have consistently upheld that holding a valid tax residency certificate (TRC) should entitle an entity to the treaty benefits unless the arrangement is a sham. Recently, the Delhi High Court overturned a ruling by the Authority for Advance Rulings (AAR) in the case of Tiger Global International III Holdings vs. Authority for Advance Rulings. The AAR had denied treaty benefits to the Tiger Global entity regarding capital gains from the sale of shares in a Singapore company with substantial Indian operations. Citing principles established by the Supreme Court in Union of India vs. Azadi Bachao Andolan, the Delhi High Court held that a TRC issued by Mauritius authorities constituted valid proof of tax residency and beneficial ownership. It emphasized that a TRC could only be disregarded in cases of fraud or sham structures, with the burden of proof on the tax authorities.

Nevertheless, the issue remains contentious. For instance, in January 2024, the Supreme Court stayed a Delhi High Court ruling in Blackstone Capital Partners, which relied on a TRC issued by Singapore authorities to grant capital gains exemption.

Attribution of profits to permanent establishments (PE) in India has also been fraught with controversy, particularly when global losses are incurred by the main entity. The Delhi High Court offered conflicting views in this regard. In the Nokia Solutions and Networks OY case, the court ruled that an Indian PE would not be liable for income tax in the event of a global loss. Conversely, in Hyatt International Southwest Asia Ltd, a Full Bench held that a PE must pay tax on profits attributable to its operations in India, regardless of the global losses of the enterprise. This approach aligns with OECD principles, which emphasize taxing profits at the source country based on local operations, thus addressing concerns related to Base Erosion and Profit Shifting (BEPS).

Transfer pricing disputes have also surfaced, particularly concerning the characterization of compulsorily convertible debentures (CCDs). Tax authorities have sought to recharacterize CCDs as equity instruments to disallow interest deductions, citing Indian exchange control regulations that classify CCDs as equity. However, tribunals have often sided with taxpayers, ruling that CCDs should be treated as debt until conversion. Courts have further clarified that transfer pricing proceedings should focus on benchmarking international transactions and determining arm’s-length prices rather than recharacterizing transactions.

The introduction of India’s General Anti-Avoidance Rule (GAAR) has provided tax authorities with extensive powers to address tax avoidance arrangements. In a recent ruling in Ayodhya Rami Reddy Alla vs. PCIT, the Telangana High Court upheld GAAR’s applicability in a case involving bonus stripping, despite the taxpayer’s argument that specific anti-abuse rules (SAAR) should prevail. The court ruled that GAAR could apply if SAAR provisions were inapplicable due to technicalities. This ruling, now pending before the Supreme Court, remains one of the few reported cases on GAAR application.

The faceless tax assessment and appeal regime, introduced to promote transparency, has not been without challenges. Taxpayers have faced issues such as insufficient response times, with notices often sent at night, allowing less than three days to reply. High-pitched assessment orders, unreasoned decisions, and non-consideration of written responses have further complicated the process. Backlogs at the appellate level have also exacerbated taxpayer grievances.

To reduce disputes, the Indian government introduced the Direct Tax Vivad Se Viswas Scheme, 2024, effective from October 2024. This scheme offers taxpayers an opportunity to resolve pending disputes, subject to conditions, while obtaining immunity from penalties and prosecution.

India’s taxation landscape continues to evolve rapidly, driven by reforms aimed at improving compliance and transparency. However, the growing complexity of the system underscores the need for taxpayers to remain vigilant and proactive in addressing disputes. Filing precise and persuasive submissions, presenting complete facts, and requesting personal hearings when needed are essential strategies for effectively navigating the system.

In high-stakes disputes involving tax treaties or contentious matters, involving senior officers during assessments and preparing strong initial submissions can prevent cases from being remanded for fresh consideration. As India refines its tax policies, businesses must adopt a strategic approach to manage the demands of a dynamic and increasingly sophisticated taxation environment.

By fLEXI tEAM