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Tax Trap

By Dipak Mondal     August 13, 2016

On March 30, 2016, two Mumbai tax officers raised a demand of Rs 10,000 crore, which included a hefty interest component for late payment, with State Bank of India, alleging that the public sector bank had not complied with its advance tax commitments. The bank obliged the tax department on the same day, but also sent an accompanying letter detailing its advanced tax payments for the fiscal.

The taxmen acknowledged the receipt of the letter, conceded their oversight (faulty record keeping) and processed the refund of Rs 9,500 crore on April 1. In the Indian tax system, this would have gone down as 'routine' and not something to make a hue and cry about. However, essentially, the taxmen were playing the system to meet their collection targets for the financial year 2015/16. The arrangement worked well for them - the Rs 10,000 crore figure went down as part of the tax collected for the fiscal in department records, and the refund two days later would be recorded as part of transactions for 2016/17.

It could very well have slipped through the cracks if not for the revenue secretary, who detected three large refunds totalling over Rs 20,000 crore in April 2016. A probe was ordered into the incident. The two tax officers were transferred. This led to protests by other tax officers in Mumbai.

The incident brings to fore the pressure of 'targets' under which tax officers work and the frivolous nature of tax demands. It also points to one of the major worries for the department - the large number of disputes and pending cases at different levels of adjudication.

Frivolous tax demands by the department have, in fact, been a big concern for businesses, both domestic and MNCs, over the years. Some of the tax disputes, especially those involving international players, have not only given India a bad name, but have unnecessarily held back large sums in legal wrangles causing great loss to both businesses and the government.

The Problem

The gravity of the situation can be gauged from the fact that at the end of 2014/15, the amount stuck in different tax disputes (direct and indirect taxes) at different levels of adjudication and appeals were worth Rs 7.7 lakh crore. Of these, disputes related to direct taxes alone accounted for Rs 6.15 lakh crore.

Data as on 31 March 2015 CESTAT: Customs, Excise and Service Tax Appellate Tribunal Source: Ministry of Finance
A big chunk of direct tax cases - involving Rs 3.84 lakh crore, which was almost on par with the government's revised revenue deficit for the fiscal - was pending before the Commissioner of Income Tax (Appeal) in 2014/15. In the first half of 2015/16, the amount had gone up to Rs 5.67 lakh crore, says a CAG report.

While our legal system is very slow in disposing off tax-related disputes, even at the CIT (A) level the pendency rate is very high. In 2014/15, out of the 306,000 cases pending before the CIT (A) only 74,000 were disposed off - the highest in five years. Cases pending before the Income Tax Appellate Tribunal (ITAT) for the fiscal were worth Rs 1.45 lakh crore, followed by the Supreme Court at Rs 46,500 crore and high courts (Rs 37, 600 crore).

Experts says many cases that come before the CIT (A) are repetitive and despite precedence and Supreme Court guidelines, the same assessment errors are committed year after year. This results in a large number of cases going against the revenue department. "The errors are repetitive and the main problem is lack of supervision from senior officers," says Himanshu Sinha, who served the Indian Revenue Services (IRS) for more than a decade, and is now Partner, Direct Taxes, in law firm Trilegal.

The poor success rate of the department, especially in cases of direct tax disputes, also speaks volumes. Between 2011/12 and 2012/13, 50-60 per cent of cases before tax tribunals and courts, leading all the way up to the apex court, went in favor of taxpayers, while the revenue department got favourable verdicts in 10-25 per cent of cases. Sinha, in fact, pegs the failure rate of the revenue department at 70-80 per cent and says that 95 per cent of the losses are because the cases are weak. Only 5 per cent are lost because of the quality of legal representation.

The Cause

The revenue department has often been criticised for making wrong and aggressive demands leading to unnecessary tax disputes. While most experts attribute this to the tax officers' lack of understanding of evolving business models, proper guidance and unrealistic targets, insiders point to a deeper malaise. Says Sunil Agarwal, Senior Taxation Partner, at AZB & Partners, and a former ITAT counsel: "The (unwritten) instruction from the CBDT is that if an assessing officer is not sure about the assessment and there is a possibility of an error, he or she must err in favour of the department."

This, says Agarwal, is to cut down on the possibility of not taxing something that should have been taxed, because the department does not have remedial measures, and may even be reprimanded by the Comptroller and Auditor General (CAG) and the executive for an error. "There are powers of reopening the cases but those powers come with a lot of conditions and limitations," he adds. During an audit, the CAG has the power to raise objections and ask the department why a particular transaction was not taxed, based on its calculations. The tax department is entitled to respond to the CAG audit, but counter arguments are often dismissed by the auditor general. As a consequence, these reported anomalies find a place in the annual Public Accounts Committee report placed before the Parliament, where the executive has the right to ask for an explanation and even initiate civil or criminal proceedings against the erring officer for causing loss to the exchequer. Given the risks, a tax officer usually plays safe and raises demands even if he is not sure about the assessment. On the other hand, say experts, the taxpayer has multiple channels to get the assessment rectified.

The government's penchant for retrospective changes in tax laws has further added to the number of disputes. Vodafone and Cairn Energy tax disputes are cases in point, where India could have been spared of negative publicity.

Solution at Sight?

Mounting tax disputes and slow disposal of cases make India a difficult tax jurisdiction. But the government has been working towards creating an environment where not only are disputes minimised, but the judicial processes are also expedited. The committee headed by retired judge R.V. Easwar has already come out with a set of recommendations to simplify the regime, and the government has accepted most. There's more to come.

Since July 2014, the Income Tax Department has issued 23 circulars to help tax officers become more efficient and approach cases with more clarity. The apex court, too, played its part by constituting a special bench to hear only tax cases and deposed 197 cases in 2015. The special bench is likely to continue hearing cases this year as well. The government has also come up with a direct tax dispute resolution scheme to clear pending cases before CIT(A) and cases involving tax demand due to retrospective changes in laws. The revenue department is hopeful that a lot of people may come forward and pay their dues to settle disputes.

While such one-time measures may be effective, concerted efforts to change the way the tax department thinks and works will be key to bringing down tax disputes and high pendency rates. However, if the government is serious about its 'ease of doing business' initiative, technology will have to play a major part to overhaul the Indian tax assessment system.

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