By Sujit Ghosh and Sudipta Bhattacharjee
In 1789, Benjamin Franklin wrote to Jean-Baptiste Leroy that “…in this world nothing can be said to be certain, except death and taxes.” At that time, he would scarcely have realized how much of an anachronism his comment about the certainty of taxes would become in years to come. With the economic downturn in the recent years and the consequent aggressive attitude of tax administra-tors, particularly in emerging economies like India, it would not be an exaggeration to state that the only thing certain about taxes today is the uncertainty of its application.
Given this backdrop, a holistic and more pro-active approach to tax controversy management becomes necessary. In fact, the concepts of tax controversy management now ought to be firmly entrenched in the realm of corporate governance. This article aims to shed light on few key aspects of tax controversy management specific to India that would be relevant for multinational companies that are operating in India or are even exploring opportunities or finalizing business plans for investment into India.
Tax controversy may broadly arise out of three areas: (i) tax authorities disagreeing with tax posi-tions adopted by a company on legal grounds; (ii) tax authorities disagreeing with tax positions adopted by a company on account of erroneous contract drafting that does not reflect the intended tax positions; and (iii) difference in interpretation of tax clauses in a contract.
I.CONTROVERSIES ARISING OUT OF TAX AUTHORITIES DISAGREEING ON LEGAL GROUNDS WITH TAX POSITIONS ADOPTED BY A COMPANY
In a country like India, with an increasingly aggressive tax administration, any tax position that does not literally emerge from the language of the statute tends to be disputed by the authorities. Given the multiplicity of taxes, this problem gets magnified manifold in the realm of indirect taxes in India (e.g., there are federal taxes like the customs duty, excise duty and service tax that are regulated by the Central Government, state-level taxes like VAT and entry taxes, and federal taxes/cesses like Central Sales Tax and Building Cess, which are administered by the respective State Governments). Given the large number of tax-jurisdictions, tax controversy management is essential.
1.Document The Rationale Behind Every Tax Position
The first step towards sound tax controversy management is to document the rationale behind every tax position. For any tax position that does not seem to be supported by a simple literal interpretation of the relevant tax statute, a legal opinion ought to be obtained explaining the legal basis behind such a position. These opinions help to establish the bona fides of a taxpayer, should litigation be initiated by the various State/Central Government tax authorities (referred to hereinafter as “Revenue”). In addition, detailed disclosures should be made to the relevant tax authorities about any such tax position, along with reference to a supporting legal opinion.
The fact that a legal opinion has been obtained should be disclosed to the tax authorities even if the actual opinion is not actually provided. In a decision of the Central Excise and Service Tax Tribunal (“CESTAT”) in the case of Poonam Spark Private Limited v. Commissioner of Central Excise, (2004  E.L.T. 282 [Tri. – Del.]), the Tribunal found that the taxpayer had not acted in good faith, as the legal opinion obtained by him in support of its tax position was never mentioned or disclosed to the authorities.
It is also always prudent to make clear and cogent disclosures in tax returns, about the sensitive tax position that a taxpayer may have adopted. Statu-tory return formats, however, often do not provide space for such disclosures (as most returns are now being required to be filed electronically). In such cases, it is always advisable to submit a print of the return and attach a covering with appropriate disclosures, and file it with the tax authorities.
These steps help establish the bona fides of the tax-payer before a court/tribunal and avoid penalties even if the court rejects the tax position. For example, in a CESTAT decision in the case of Mangalore Chemicals and Fertilizers v. Commr. Of Cent. Excise (2009  E.L.T. 647), timely declarations by the taxpayer went a long way avoiding penalties. Establishing bona fides in this way also helps prevent the tax authorities from invoking the draconian extended period of limitation which could result in re-opening tax positions taken by the taxpayer over the previous five years.
2.Obtain Advance Rulings On Key Tax Positions
Having taken care to establish bona fides, the second step in tax controversy management is to try to obtain confirmation of the tax position adopted. The following options are generally available under most tax statutes.
Advance Rulings For Federal Taxes
For federal taxes (like Income Tax, Customs, Excise, and Service Tax), a foreign company exploring the option of setting up a business in India can approach the Authority for Advance Ruling (“AAR”), based in New Delhi, for an advance confirmation of its critical tax positions.
While the process may take about six months, it may be time well spent, given that it provides the foreign company with some certainty. Conversely, an adverse advance ruling becomes binding on the taxpayer without any statutory appeal and the only option in that case would be to approach the jurisdictional High Court (the highest court in a State) for a writ remedy against the AAR’s order.
From a practical standpoint, this option should be exercised only when there is an obvious ambiguity with regard to applicability and/or interpretation of any provision of law. That is to say, it is never a good idea to seek such a ruling in cases where the interpretation is clear and unambiguous. A negative ruling in such cases, could cause more hardship than any benefit to the applicant.
Advance Rulings Under State VAT Laws
Most State VAT statutes also provide for similar advance ruling mechanisms through what is com-monly known as ‘Determination of Disputed Questions’ (“DDQ”). While, these are not as effective as the AAR, the DDQ route can be used effectively to engender certainty with regard to State VAT positions.
Ground level officers of the tax department are often less receptive to a nuanced tax position – more so with respect to State level taxes like VAT. Often, proper appreciation of the legal basis behind a nuanced VAT position is found only at a High Court level or Supreme Court Level. Given that DDQs are usually administered by State VAT authorities such DDQs are tilted against the taxpayer.
However, even such negative results may provide the taxpayer (tactically) a quicker and out-of-turn access to the High Court for a proper appreciation of the legal arguments and a confirmation of the taxpayer’s position. That is the real value proposi-tion of the DDQ process. To elaborate, ordinarily, before a question of law can be raised before the High Court, a taxpayer must exhaust all alternate remedies available under the tax statues, such as tax assessment, departmental appeal, tax tribunal, among others. This means that the lead time for a taxpayer before it can approach the High Court in the regular appellate procedure could be anywhere between four to six years. Such a long lead time can be truncated, however, by opting for the DDQ route. Appeal from a DDQ ruling handed down by the Commissioner of VAT lies directly to the High Court via writ petition.
(i) Formal clarifications
Unfortunately, the option of seeking an AAR ruling or DDQ is often restricted to prescribed/defined sets of issues (such as taxability of transactions, the applicability of a given tax exemption). For the remaining universe of issues, there are no institutionalized mechanisms for upfront quasi judicial/judicial confirmation.
In these cases, one of the options available is to seek a written “administrative clarification” from the Revenue. For example, Section 37B of the Central Excise Act authorizes the Central Board of Excise and Customs (“CBEC”) to issue orders, instructions and directions “for the purpose of uniformity in the classification of excisable goods or with respect to levy of duties of excise on such goods”.
Such clarifications are binding on the Revenue, though not on the quasi-judicial/judicial authorities and the taxpayer. That is to say, once a clarification has been obtained, the Revenue cannot take a view contrary to the clarification to the detriment of the taxpayer concerned.
Strategically, seeking such a clarification also serves two additional purposes.
First, if a clarification issued by the Revenue is patently erroneous in law and against the taxpayer’s interest, a writ petition can be filed before the High Court and a quick and out-of- turn resolution to the tax issues can be expected. However, if no such clarification was ever obtained, the taxpayer would have had to exhaust all alternate remedies available under the tax statutes, such as tax assessment, departmental appeal, and tax tribunal, before it is permitted to approach the High Court. This means, while the lead time for a taxpayer before it can approach the High Court in the regular appellate procedure is anywhere between four to six years, such a long lead time can be entirely circumvented by adopting this route, thereby enabling expeditious dispensation of justice
Second, even if a clarification is not provided by the Revenue ( for any reason) despite the taxpayer having approached them, the efforts undertaken in obtaining such a clarification helps to establish the bona fides of the taxpayer before a tribunal/court and thereby shields it against any penal implications at a later date.
(ii) Advance Pricing Agreements (“APAs”)
While provisions to facilitate execution of APAs were introduced in the Income Tax Act, 1961 (‘Act’) through the Union (Federal) Budget of 2012, the framework for the APA scheme was announced relatively recently through a circular dated August 30, 2012, by the Central Board of Direct Taxes.
APAs provide a method for taxpayers (having cross-border transactions with ‘related parties’) to agree on a price, method or assumption. Interna-tionally, APAs have been effectively used by the tax administration and large entity taxpayers to come to an understanding regarding an arm’s length price in advance of implementing a transaction, and can go a long way in curbing transfer pricing litigation in India
(iii) Mutual Agreement Process (“MAP”)
In case of disputes arising out of interpretation of Double Tax Avoidance Agreements (“DTAA”), a taxpayer seeking treaty relief has the alternative option of approaching the Competent Authority located in its home jurisdiction. Such Competent Authority would then negotiate with the Compe-tent Authority of the counter party State to arrive at an amicable solution. Once such a proceeding has been initiated, any dispute with the Reve-nue/appellate authorities regarding the assessment year in relation to which MAP has been initiated would be kept in abeyance. Further, tax demands also get stayed in context of Indo US/ UK treaties.
The outcome of MAP, however, is not binding on the taxpayer, although it is binding on the Revenue. The advantage of MAP is that it bypasses protracted litigation with the domestic tax authorities and multiple appellate forums and thus achieves a quicker resolution of disputes.
(iv) Payment of tax under protest
Payment of tax/ duty under protest is another op-tion which can be exercised under indirect tax laws. By opting to pay the tax under protest the taxpayer can mitigate the interest and penalty implications that may arise if the tax position adopted by the taxpayer is subsequently overruled by the appellate bodies. It also assists in triggering a tax-related cause of legal action. Once the tax has paid under protest, the Revenue would be forced to initiate tax proceedings against the taxpayer. Such early initiation of tax proceedings helps in early resolution of the dispute.
3.Best Practices To Manage Tax Litigation Optimally
If efforts to obtain advance confirmation of a tax position fail and tax litigation becomes unavoida-ble, some of the best practices during litigation are as follows:
(i) Capturing factual subtleties comprehensively at the first adjudication stage
Tax litigation in India typically commences through a show cause notice from the tax authorities. In response to the show cause notice it is important to set forth all the factual nuances of the matter, including relevant references to underlying documents like contract clauses, invoices, tax payment receipts, books of accounts. The probability of success in tax litigation depends on how clearly the facts have been presented before the tax authorities/adjudicating forums. If all the facts have not been introduced at the lower adjudicatory level, it is generally impermissible to introduce such facts at the higher appellate stage.
(ii) Effective usage of writ remedy as a tax contro versy management tool
State High Courts in India are vested with the power to issue writs and directions to any person or authority, including any Government within their territorial jurisdiction. Unlike the Supreme Court of India, High Courts are not limited to en-forcement of fundamental human rights guaran-teed under the Constitution. The write jurisdiction of the High Courts extends to “any other purpose” as set forth in Article 226 of the Constitution. Similarly, under Article 227, High Courts have been granted a power of superintendence over “all courts and tribunals” in their territorial jurisdiction.
Thus, Article 226 read with 227 of the Constitution of India, grants wide powers to the High Courts, and taxpayers can use this avenue effectively for tax controversy management. Typically High Courts are reluctant to interfere in tax matters un-der Article 226 and 227 because of the existence of alternative remedies. However, as was held in Asst. Collector, Central Excise v. Dunlop India Ltd., AIR 1985 SC 330, 332, the High Court can intervene where“statutory remedies are entirely ill-suited to meet the demands of extraordinary situations, as for instance where the very vires of the statute is in question….” The types of writ remedies usually pertinent for tax matters are certiorari and mandamus.
Occasionally, clarifying circulars/instructions are issued by tax authorities that are patently against the statutory provisions. Statutory appellate pro-ceedings will not remedy such clarifying circulars and aggrieved taxpayers should not hesitate to explore writ remedies to challenge them. Another instance where writ remedy may be appropriate is where the taxable base under Central and State taxes overlap, leading to a potential exposure to double taxation. Software is a typical example where, in some transactions, State VAT and Service Tax are being assessed and paid on the same taxable base. Writ remedies are also useful when there are apparent contradictions between legislations. For example, the scope and extent of tax benefits envisaged under the laws governing Special Economic Zones often contradict the relevant provisions under the respective tax statutes.
The High Courts’ power of superintendence over lower courts under Article 227 also opens up ave-nues for remedy if faced with an adverse order from a tribunal under the relevant High Court’s territorial jurisdiction.
Until very recently it was not clear whether writ remedies against an AAR order could be pursued in a High Court or only before the Supreme Court. It is only through the recent judgment by the Supreme Court in the case of Columbia Sportswear [2012 (7) SCALE 53] that the issue stands settled in favor of High Courts having jurisdiction.
While challenging a ruling from the AAR, the question of which High Court to approach becomes contentious at times. The Delhi High Court appears an attractive answer because the AAR is located in Delhi. However, if the aggrieved party is located in another State, the High Court of that State may be an appropriate forum as well. In the case of GSPL India Transco Limited [2012-TIOL-665-HC-AHM-ST] the Gujarat High Court issued writ remedy to the aggrieved party (based out of Gujarat) against a patently erroneous AAR order.
(iii) Doctrine of Precedence (and risk of blind application of past decisions) & Doctrine of Merger
Under Article 141 of the Constitution of India, law declared by the Supreme Court has the status of the law of the land and binds all judicial forums. Consequently, taxpayers rely upon Supreme Court precedent when taking a tax position or embarking upon tax litigation with the Revenue.
However, the doctrine of precedence has several exceptions, which ought to be factored by a taxpayer, before it relies on the same. These exceptions are as follows:
- Reversal of the decisions
- Overruling of the decisions
- Refusal to follow
- Distinguishing the decisions on facts
- Per in curiam- when a judicial decision has been rendered without considering a binding court decision/ legal provision
- Precedent sub silentio
- Inconsistency with earlier decisions of higher courts
- Inconsistency with earlier decisions of the same rank
- Decisions of equally divided courts
With respect to the sub silentio precedent, Supreme Court in MCD v. Gurnam Kaur [AIR 1989 SC 38] lucidly explained this as follows: “The Court may consciously decide in favor of one party because of point A, which it considers and pronounces upon. It may be shown, however, that logically the court should not have decided in favor of the particular party unless it also decided point B in his favor; but point B was not argued or considered by the court. In such circumstances, although Point B was logically involved in the facts and although the case had a specific outcome, the decision is not an authority on Point B. Point B is said to have been passed sub-silentio.”
At times, both the taxpayer and the Revenue use the route of filing “Special Leave Petitions (SLP)” before the Supreme Court to challenge the order of a lower court. The Supreme Court is selective in granting the leave to appeal under the SLPs. It is often argued that rejection of an SLP against a lower court order denotes a stamp of approval by the Supreme Court of such lower court order
Such an argument would is only partially correct. The concept of the doctrine of merger (i.e., when the decision of the lower courts merge with that of the higher court), does not apply to cases where the SLPs have been dismissed whether by a speaking or non-speaking order. Therefore, taxpayers would be taking a great risk in relying on such dismissals to argue that the decision of the lower court in a given situation has, in effect, been affirmed by the Supreme Court. Moreover, the doctrine of merger cannot be invoked unless SLPs are admitted and converted into civil appeals and such civil appeals are disposed of on merits by the Supreme Court.
II. TAX CONTROVERSIES ARISING OUT OF TAX AUTHORITIES DISAGREEING WITH TAX POSITIONS ADOPTED BY A COM-PANY ON ACCOUNT OF ERRONEOUS CONTRACT DRAFTING
Tax controversies of this nature are common and arise wherever the tax and legal departments in companies work in silos. While the legal depart-ment is in charge of finalizing the contract and the tax team is in charge of the tax positions, often, tax nuances that ought to have been incorporated in the contract slip through the cracks and later get challenged by the tax authorities. It is important, therefore, that the tax team articulates the key imperatives of the tax positions/planning options factored by them to the legal team, who in turn should ensure that such imperatives are duly articulated in the contract documents.
III. TAX CONTROVERSIES BETWEEN PRI-VATE PARTIES ARISING OUT OF DIF-FERENCES IN INTERPRETATION OF TAX CLAUSES IN A CONTRACT
Tax controversies between private parties arising out of different contractual interpretation are common and often lead to significant time and cost expenditures in negotiations, arbitration proceedings, and court proceedings. While these proceedings may not be completely avoidable, effective mitigation is possible to a large extent by comprehensive documentation of tax planning options and a commercial understanding between the parties on key tax points. The biggest areas of dispute arise out of interpretation of clauses dealing with change in tax laws/statutory variations and the extent of reimbursement of taxes. In this context, the following key points are critical to be documented in a lucid and comprehensive manner to avoid future disputes:
(i) What are the taxes to be borne by each party?
(ii) If the contract price is to include all taxes, does it also include taxes which are statutorily payable by the customer (such as service tax on a reverse charge basis, customs duty etc)? If yes, that should be clearly specified along with the necessary modus operandi (for example, would customs duty or service tax paid on a reverse charge basis by a customer be deducted from future payments to be made to the contractor);
(iii) For taxes/cesses such as entry tax and building cess which can be the statutory liability of either the customer or the contractor depending on various factors, who bears the responsibility?
(iv) For taxes that would be reimbursed by the customer, what would be the basis for such reim-bursement? What sort of documentary proof would be required?
(v) If certain tax benefits have been factored which are contingent upon specific certifica-tion/documentation requirements, who bears the risk of non-availability of such certifica-tion/documentation? In general, who bears the risk of the tax positions?
(vi) The scope and extent of the clause dealing with impact of change in tax laws ought to be comprehensively documented:
a. The contract should clearly indicate whether it includes change in taxes only for direct transactions between the contracting parties or whether sub-contract level change in taxes would also be covered;
b. Ideally, for the critical taxes in a high-value contract, there ought to be a detailed price schedule specifying the quantum and rate of such taxes factored on the date of the contract, so that calculation of impact of change in tax laws is easier;
c. If the contract in question spans over a 2-3 year period, it needs to be documented as to who bears the risk of big-ticket tax reforms like introduction of the Direct Taxes Code, comprehensive Goods and Services Tax etc and how these changes are to be dealt with;
d. What constitutes a ‘change in tax laws’ needs to be very clearly discussed and documented to avoid future disputes.
Section 64A of the Sale of Goods Act, 1930 provides for indemnification of affected party on imposition/ remission or increase/ decrease of customs/excise duty and tax on sale/purchase of goods, subject to a contract to the contrary. In fact, in the recent decision of Pearey Lal Bhawan Association (2011-TIOL-114-HC-DEL-ST), the Delhi High Court relied upon Section 64A to decide a civil money suit for claim of service tax not originally envisaged under the contract and overruled a specific contractual clause mandating the lessor (i.e., the service provider) to bear all the “municipal, local and other taxes”. By doing so, the Delhi High Court has effectively, extended the concept of Section 64A to service transactions as well. Thus, failing to clearly document the impact of ‘change in tax laws’ may lead to unforeseen consequences in a litigation/arbitration.
While complete mitigation of tax controversies would not be possible in today’s dynamic business environment, the best practices outlined above would help optimize tax controversy management in India. What is required is an integrated and pro-active approach to crystallize the concepts and best-practices of tax controversy management as a part of the overall corporate governance framework.
While it is true that “justice delayed is justice denied”, often times what is also practiced by the judiciary is the concept of “justice hurried is justice buried”. Therefore, the art of Indian litigation management is perhaps to imbibe the virtues of “patience, coupled with some of the best practices mentioned in this article”!
Sujit Ghosh is a Partner at BMR Legal and leads the tax litigation practice of the firm. He has over 17 years of experience in the field of taxa-tion. He specializes in indirect taxes (Customs, VAT, service tax and Excise laws) and is an in-dustry expert in the Power, Aviation, Defense, and Infrastructure Sectors. He is admitted to the Bar Council of Delhi and is an arguing counsel before various quasi-judicial and judicial forums including the Supreme Court of India. Sujit can be contacted at Sujit.Ghosh@bmrlegal.in.
Sudipta Bhattacharjee is an Associate Director with BMR Legal and has significant experience in advising clients in the Infrastructure Sector. He has over seven years of experience in the field of taxation. Sudipta can be contacted at Sudipta.firstname.lastname@example.org.