The Interconnect

India’s Attempt at Litigation Management: an Entry to the Avalon?

Ketan Dalal (Managing Partner, Katalyst Advisors LLP)
Apr 17, 2019

Backdrop

India is a curious mix of laws, some aligned to global standards, and some not, but an administration that leads to a very different picture in terms of on-ground implementation. Traditionally having had a reputation of a difficult tax regime, efforts are being taken to showcase India’s progress in improved ranking in Ease of Doing Business (EoDB). However, with India’s overall ranking in the 2019 EoDB World Bank report escalating to 77 (from 100 in 2018), its ranking in the specific category of “Paying taxes” has, in fact, seen a marginal drop to 121 (from 119 in 2018). While steps such as implementing GST, introducing e-assessments, etc are reflective of the commitment to becoming a “non-adversarial” tax administration, there is still a long road to be traversed. Considering the growth story that India is expecting, facilitating businesses becomes very crucial and a robust tax administration is one of the key determinants of the efficiency of doing business in the country.

It is clear that India, being one of the largest economies, needs to align with International Good Practices on the tax front. This also seems to have been recognised by the CBDT, as is borne out by setting up of a specific Committee “to examine International Good Practices on Tax Litigation Management” vide an internal memorandum of February 2019. The Committee has been tasked to analyse some of the best tax litigation practices followed globally and their applicability in the Indian context. The report of the Committee is expected by May, 2019.

In the above context, this article intends to highlight the correlation between the tax litigation environment and business functioning.

Litigation scenario and impact on business

For businesses to flourish, it is imperative for the tax environment to be conducive. One of the fears that haunts business entities doing business in/with India is the rampant litigation and the amount of time taken for litigation to conclude. This is on account of fundamental issues such as complexity of laws, consequential deviating interpretations and lack of certainty, in addition to administrative issues and no time limits for appellate processes. The approach of the revenue authorities has also been one of suspicion and confrontation and while matters are improving somewhat, there is significant unease as a result of such an approach.  One of the dimensions that the revenue authorities have unfortunately not recognised is that a variety of factors have led to businesses per force becoming more compliant; these factors include enhancement of corporate governance standards, inability to recruit and retain good professionals in absence thereof, pressure of institutional investors and financers, and indeed advent of GST.  Whilst the number of entities becoming substantially compliant may be less in percentage, they constitute an overwhelming percentage in terms of value of economic activity.

Given the above broader context, there are some specific dimensions, with significant business fallouts, arising out of tax litigation and tax uncertainty, and some of these are as follows:

Transactions often get stuck because of tax uncertainties; a whole host of issues crop up, including endless negotiations on tax indemnities, deposits of disputed amounts in escrow, exploring taking out tax insurance, none of which are easy issues to resolve and often take months of negotiation, and many times, have resulted in a sub-optimal outcomes for the buyer and seller both, and sometimes, even result in collapse of the intended transaction.

Prolonged tax litigation has significantly increased the legal costs, as was recently reported in the case of Cairn Energy.

Factoring the tax demand contingency in the books by the company would lead to a hit on the EPS and can have a cascading effect on the share price/ valuation of the company;

Litigations involving huge amounts encompass an outflow of cash; even though only some portion of the present demand is to be paid upfront (at least at the stage of first appeal); it involves blockage of working capital thereby translating into an opportunity cost of sorts. It is important to note that beyond the first appeal stage, the “facility” of 20% payment as per internal instruction dated 31 July, 2017, does not apply, and very often, the entire payment has to be paid if the first appeal is adverse to the tax payer, as is often the case.  This kind of cashflow upheaval which very often happens for high pitched and unjustified tax demands, can upset business equilibrium completely.

Any negative reports in the media concerning a tax demand, even if the case is eventually decided in favour of the company, is likely to create an undesirable sentiment amongst the investor community. Companies facing tax litigation tend to suffer reputational damage that follows such news (at a broader level, this also impacts the reputation of the country and deters foreign investors).

Current status of litigation in India and some good practices

Based on news reports, pendency of tax cases amounts to around 4.5 lakh cases at the appellate levels as on 31 March 2018. Despite such a huge pendency, statistics reveal that only 0.2% cases constituted 56% of the total demand, (which makes it very likely that a very small number of the cases constitute 80-90% of the value). If appropriate steps are to be taken to avoid unwarranted litigation, a lot of resources can be saved at both ends. 

Considering the very tangible impact that unnecessary and prolonged litigation has on bona fide businesses, let us take a look at some practices that are followed internationally as well as by other regulatory bodies in India that can be emulated for improving the present scenario in the context of the committee formed. As such, while litigation management is undeniably crucial, it is believed that preventing litigation is an equally vital dimension and the ensuing paragraphs cover some practices that can help in mitigating litigation.

Ecosystem for dealing with emerging issues

Significant litigation arises from issues that are relatively new, possibly owing to global developments in relation to different models of doing business (digital transactions/e-commerce is an important example). Putting in place an ecosystem, (say, by setting up a committee) to proactively analyse and address the issues surrounding upcoming developments and tackle the issues in close consultation with the stakeholders would go a long way to avoid unnecessary litigation.  However, it is imperative to avoid the pitfalls that past initiatives have faced; an example regarding the same is that of the Emerging Issues Task Force (“EITF”) for cross border taxation. Given the composition of the committee (tilted in favour of revenue officials), the ability to take calls (even if backed clearly by international precedents) was simply missing on issues perceived as “favourable” to the tax payer and this ultimately resulted in the EITF becoming totally ineffective. This kind of issue needs to be addressed by putting in place a meaningful architecture; one possible solution is to have non-revenue members on the committee, such members being persons of high integrity and who do not have a vested interest, so that meaningful calls can be taken (without always being hampered by revenue considerations, regardless of the merit of the issue at hand).

Certainty through circulars and manuals

Upfront certainty is an enormous help and even on matters which have been settled by courts, there is a fear that litigation will continue unabated.  In this context, issuance of circulars by the CBDT on well-settled matters would help in bringing clarity on several issues, which would otherwise take up significant amount of time, energy and resources of the taxpayers. Some examples in this context would be non-taxability of waiver of loans, non-applicability of deemed income provisions (section 56(2)) to bona fide transactions, disallowances under section 14A, etc. 

A variation of such practice exists in countries like USA, Australia, Belgium and Portugal, which have the concept of an Internal Revenue Manual, which contains revenue department’s own interpretation of tax laws, taking into consideration court rulings. Incidentally, some regulatory bodies in India have an ecosystem to help facilitate interpretation of regulations; for example, the Reserve Bank of India (RBI) issues Master Directions on some regulations (updated annually).

Creating pre-assessment filters 

It is a commonly known fact that once an assessment order is passed, even in a draft form, it is very difficult to address an issue, even if there is a re-thought from the tax department. Therefore, creating filters at the pre-assessment stage itself is likely to reduce litigation. Amongst various options, one consideration for high-value cases where the proposed adjustment is likely to be substantial could be introduction of an anonymous peer review by other senior officers to consider a second opinion before the order is finalised. Germany follows a similar approach whereby the tax authorities get a chance to reconsider their decision.

Private rulings and other alternative dispute resolution methods

The existing regime of AAR, although based on the concept of private rulings, has not been functional, defeating the purpose of obtaining an “advance” ruling. Countries such as Singapore, USA, UK, Australia, Belgium, Poland, Brazil have such private ruling mechanisms. The key to success of such a regime is to setting up a forum with adequate resources to ensure timely adjudication.

In addition to Advance Rulings, establishing a system of issuing Private Rulings or other Alternative Dispute Resolution mechanism (such as mediation and arbitration) should be introduced.

Settlement of Disputes

There could be a framework for settling cases where the taxpayer wants to conclude the litigation without necessarily agreeing to the position adopted by the tax authorities. A similar approach already is being followed by the SEBI in the form of Consent Proceedings and by the RBI in the form of Compounding mechanism. Such a framework could run parallel to the existing judicial system.

Conclusion

As discussed earlier in the article, one of the fundamental issues causing so much litigation is the complexity of laws. While one awaits the New Direct Tax Code, it can only be hoped that issues in the law itself are addressed, such that the legislation is not drafted keeping outlier cases in mind.

Lastly, the overall tax ecosystem in India should be evaluated and, if necessary, revamped keeping in view the following four canons of taxation laid out by Adam Smith, the renowned economist:

Equality - If everyone is asked to pay taxes according to his ability, then sacrifices of all taxpayers become equal.   

Certainty - The tax which an individual has to pay should be certain and not arbitrary. 

Economy - This canon implies that the cost of collecting a tax should be as minimum as possible. Any tax that involves high administrative cost and unusual delay in assessment and high collection of taxes should be avoided altogether.

Convenience - Taxes should be levied and collected in such a manner that it provides the greatest convenience to the taxpayer as well as the government.

The above hold good even today but, in an Indian context, the one which stands out is the need for certainty; to this one can add timeliness in the context of the adage “justice delayed is justice denied”. If India is to become an even more important player on the global arena, it is critical that the tax litigation system builds in timelines that are relevant to today’s scenario, so that there can be closure of litigation within significantly shorter timelines, than what has been the situation till now.

This article has been co-authored by Minita Khanchandani with inputs from Tanvi Shah.

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