From Yatin’s Desk: MAT credit dilemma under 25% corporate tax rate option

In light of last week’s historical reduction in the corporate tax rates applicable during FY 2019-20, existing domestic companies (not availing tax exemptions/specified deductions) have the option to avail reduced corporate tax rate of ≈25%. Such companies have also been exempted from applicability of Minimum Alternate Tax (MAT). Companies not opting for such scheme will continue to be taxed at the current rate (≈29%/35%) and subject to MAT, albeit at the reduced rate of ≈ 17.5% vis-a-vis 21.5%.

In absence of MAT application to such companies or any change in MAT credit provisions specifically permitting set-off of MAT credit against 25% liability, the debate will continue for the next few days on the entitlement to set of unutilized MAT credit. However, if the view emerges against the set-off, it will be vital for companies to consider their MAT credit position before jumping into the perceptibly lucrative 25% tax regime. As a big picture, so long the companies have sufficient MAT credit, the liability can be restricted to 17.5% (MAT liability) by setting off excess liability computed (at general rate of 29%/35%) against MAT credit entitlement. Accordingly, it may be beneficial for companies to continue with the existing regime till the MAT credit is completely absorbed. There is always the option to exercise the 25% regime in future.

While the taxpayers do their math, it will be worthy if the government clarifies its position.

From Yatin’s Desk: Withholding tax (TDS) default, no more business as usual

Indian tax laws mandate payers to withhold taxes at source on payments to residents (in case of specified payments) and also non-residents (where their income is taxable in India). Non-compliance has penal consequences. While failure to withhold tax has interest and penalty implications (i.e. financial costs), consequences are severe in case of non-deposit or late deposit of tax collected leading to additional prosecution implications (financial+ criminal implications). Given the humongous amount of data collated by the Revenue Authorities and use of data analytic, it is not unusual to find show cause notices being issued to defaulter now days. However what should raise alarm for the defaulters is the fact that where the default relates to non/delayed deposit of taxes leading to prosecution proceedings, the Magistrate Courts are taking a serious view on the matter with defaulters being sentenced to imprisonment.

One recent case before the Ballard Pier Magistrate Court (Mumbai), related to a delayed payments of approx. INR 850K, which was paid with interest and also penalty. The Magistrate Court disregarded the plea of financial constraint and proceeded to convict the defaulter sentencing to 3 months imprisonment. Though, the decision is appealable before higher Appellate Courts, one needs to take note that such proceedings are highly complex, time consuming and financially expensive. Take for instance this specific matter – it related to withholding default in financial year 2009-10, criminal complaint before Magistrate Court was filed in 2004 and after almost 30 odd hearings/adjournments before the Magistrate Court, the proceedings concluded in April 2019; a 10 year saga, which will further continue for years before higher Courts.

It is also relevant to take note that where the defaulter is a Company, the direct impact is on the directors, who generally are proceeded against leaving it for them to defend their innocence. A clear message – by no means delay or fail to deposit taxes deducted if you want to be on the right side of law, else don’t complain of government action!!

From Yatin’s Desk: Changes proposed to the rules for attribution of income to Permanent Establishment

Attribution of profits to a Permanent Establishment (PE) of a Multinational Enterprises (MNE) in India has been a commonly ligated matter and marred with uncertainty. The Indian tax administration has placed for public comments report of the Committee constituted to examine the existing scheme of profit attribution to PE, with the intent of framing guidelines for profit attribution, bringing certainty and transparency. While the debate on the proposals will surely continue for long, the document is a valuable read for India’s position which highlight India reservation to the authorized OECD approach for PE income attribution.

The Committee in its report emphasizes the fact that the Indian tax treaties are predominantly based on UN Model Convection which under Article 7 legitimizes attribution of profits to a PE on the basis of apportionment of the total profits of the enterprise to its various parts. Such methods is adoptable where profits cannot be determined through a direct method i.e. based on verifiable books of accounts prepared as per acceptable accounting standards. In contrast, Article 7 of OECD model convention post 2010 advocates the approach of allocation taking into account the functions performed, assets used and risks assumed (FAR analysis) by the enterprise through the permanent establishment and through the other parts of the enterprise.

The Committee has observed that business profits are contributed by both demand and supply of the goods. Article 7 of the OECD Model Tax Convention and approach recommended by OECD (based on FAR) is purely supply side approach towards profit attribution and disregards the role of demand in contributing to profits attributable to PE. Further, the Indian tax treaties have not included the concept of Income attribution based on FAR as advocated by OECD model convention, thereby permitting attribution of profits in a manner different from the authorized OECD approach i.e. by resorting to the direct accounting method and where that may not be possible, by apportionment of profits.

Accordingly, the Committee has suggested PE profit attribution based on a combination of (i) profits derived from Indian operations and (ii) three factor method based on equal weight accorded to sales (representing demand), manpower and assets (representing supply including marketing activities). In other words, profits of the multinational enterprise will first be apportioned for India sales (amount arrived at by multiplying the revenue derived from India x Global operational profit margin). As a second step, such profits will be attributed proportionately to (a) sales within and outside India; (b) employees and wages within and outside India; and (c) assets deployed within and outside India for Indian operations, each with 33% weightage. Further to address a situation whether the multinational enterprise suffers losses or has profit margin less than 2%, a margin of 2% of revenue derived from India sale is proposed to be regarded as deemed profit for India operation, thereby recommending minimum base level taxation. With regard to digital economy, where nexus to taxation is attributed to the concept of significant economic presence, considering the role of users, a fourth factor (i.e. user intensity) needs to be further built into the income attribution formulae.

The OECD approach for income attribution based on FAR analysis, which the Committee regards as factoring only supply side attributes (and not demand) finds favour with the Committee where no sales takes place in India. For instance, where a multinational enterprise constitutes a PE in India and compensates the PE at arm’s length basis FAR analysis and further such enterprise does not have any sales in India, no further income will be attributable to India (in absence of any play of demand side factor). However, where sales are made in India, the reading of the Committee report suggests formulae based attribution would become the rule and additional income attributable would become taxable in India (post allowance of income apportioned to supply factors and offered to tax in India).

Given the development, there will be a significant transformation to the concept and impact on income attribution to permanent establishments in India, should the proposed recommendation be formulated into mandatory rules. The demand side factors which the Committee consider as an important consideration would seemingly lead to attribution of 33 percent of the profits derived from sale in India even if no further attribution is required to be made in absence of other factors. It will be interesting to see how the courts view the principles around income attribution in light of the divergence in OECD approach and Indian tax administration position.

From Yatin’s Desk: Non tax filing prosecution risk

The Indian tax administration is taking strict action for non compliance under the India tax laws. The authorities have been launching penalty & prosecution proceedings for failure to file a tax return within the due date. While the tax provisions provide for an extended period for filing a belated return (till the end of the assessment year), the tax authorities have been identifying non filers and late filers and initiating penalty & prosecution proceedings, even if filed within the prescribed belated period.

Where prosecution proceedings are launched, the taxpayers may unfortunately have to go through the rigour of long drawn criminal proceedings before the Criminal Court to establish that the failure was not willful and absence of culpable mental state. Tax payers impacted by such action typically attempt as a first recourse quashing of prosecution proceedings through petition before the High Court. This unfortunately is unlikely to have much success considering the courts in such matters do not dwell into fact finding to establish bonafide of the taxpayer, (a domain of the criminal court) established through evaluation of facts and examination of witnesses.

Where penalty proceedings are simultaneously launched, which would ordinarily be the case, a favourable outcome before the Appellate Tribunal, on merits, would have a direct bearing on the prosecution proceedings before the trial court. The Appellate Tribunal being a final fact finding authority, if on appreciation of facts does decided that the tax payer had bonafide reasons for not being able to comply with the filing obligation, such determination would be a significant finding for discharge from criminal proceedings or alternatively quashing of prosecution proceedings through application to the High Court. A tax payer will be better off establishing the facts and circumstance before the Tax Tribunal than the Criminal Court. Proceedings before Criminal Court can rather be intimidating for an ordinary tax payer who may just be overwhelmed by the sheer thought of seeking a bail, examination and cross-examination of witness, the longevity of proceedings, etc.

Given the serious implications of prosecution proceedings, it will be extremely important for the impacted tax payers to have a well thought through strategy to address the challenges of such proceedings.