Raj Kapadia's Indian Tax Blog: 2006

The 33rd Report of the Indian Parliamentary Standing Committee on Finance on "Widening of Tax Base and Evasion of Tax" has recently been posted on the Net.

2. The "RECOMMENDATIONS/OBSERVATIONS" of the Report are to be found in paragraphs 149 to 187 of the Report. Among the notable recommendations/observations are the following :

(i) "The Committee hope that the objective of eliminating the deficits as envisaged under the FRBM Act would be put back on track by reclaiming the ground lost in reducing the fiscal deficit due to pressing of the 'pause' button." (Paragraph 151)

(ii) "..... the Committee reiterate the need for urgently reducing the exemption provisions under the Tax Laws and rationalizing the same." (Paragraph 155)

(iii) "The Committee note that filing of Annual Information Returns has commenced and the data would be available to the authorized officers of the field formations for selecting scrutiny cases and for detection of evasion from April 2006 onwards. However, it is seen from the information furnished that unlike the other entities, the sub-registrars are either not compliant or are slow in filing the returns. This, being an area where a lot of concealment of actual transaction money is perceived to take place, the Committee urge upon the Government to pursue the matter with State Governments, so as to ensure that the sub-registrars file the AIRs in a time bound manner." (Paragraph 160).

(iv) "..... The Committee are particularly concerned to note that as per the Government’s own admission, atleast 27 lakh cases of issue of multiple PAN involving 11 lakh entities have been detected. What is worrisome in this regard is that holding multiple PANs may be used as a means for evading tax and also lead to scams or irregularities such as the one relating to IPOs witnessed recently where multiple PANs were reported to have been used for opening a number of Demat Accounts by the same individuals. The Committee, therefore, urge upon the Government to give focused attention in overcoming this problem and ensure a foolproof system of allotment/issue of PAN to the applicants. The Committee also expect the Government to ensure strong punitive action against persons identified to have willfully obtained multiple PANs." (Paragraph 161)

(v) "It is also seen that about 61 per cent of the financial transactions are to compulsorily include PAN and the rest are not required to meet this stipulation. This, the Committee feel warrants attention as tracing of such non-PAN transactions may not be easy. The Committee, therefore, feel the need to impress on the Government to consider making it compulsory to quote PAN in all types of financial transactions." (Paragraph 162)

(vi) "It is seen from the data furnished by the Government that the number of electronic TDS returns received from the Corporates has gone down in the year 2004-05. This is in spite of the increase registered in the number of transactions that are covered under the scheme over the years. This being indicative of lower compliance with the provisions of electronic filing of TDS returns, the Committee want the Government to probe into the matter and furnish a note on the issue at the earliest." (Paragraph 163)

(vii) "The Committee have also been impressed upon the need for creating an Ombudsman scheme on lines similar to that of Banking Ombudsman, for enabling redressal of the grievances of the tax assessees. The Committee note that though a ‘Tax Ombudsman’ scheme is presently prevalent in two places, a proposal for strengthening the mechanism has been worked out, which is awaiting approval. The Committee desire that the reworked and strengthened Tax Ombudsman scheme be made operational at the earliest, which would contribute in redressing the grievances of the taxpayers." (Paragraph 166)

(viii) "The unanimous view expressed before the Committee is that the time has come to bring all the services barring the basic and essential ones in the tax net. The Committee, therefore, reiterate their earlier recommendation that all the services, barring the essential or basic ones, should be brought under the tax net in one go. With the facility of availing CENVAT credit paid on the manufactured input utilised in a service and vice-versa, the comprehensive extension of tax on all services, though may be difficult, may not be an impossible task to achieve. ..... The Committee also express the need for coming out with a separate legislation for service tax, with clear definition of what constitutes the service component so as to avoid possible disputes between the Centre and State tax authorities and prevent `double taxation of the same instance under State VAT as well as Service Tax." (Paragraphs 167 and 168)

(ix) "The Committee are concerned about the reported evasion of tax by persons involved in non-agricultural activities in rural areas. The representatives of the Government too have agreed during submissions to the Committee that income from non-agricultural activities like money lending, trading in agricultural produce etc. was often passed of as agricultural income. The Committee are of the opinion that activities like private money lending need
to be discouraged by stronger measures. The Committee, therefore, impress upon the Government to look into the matter and have a focused survey to identify such evaders and take appropriate action. This, the Committee feel, could be done in coordination with the State Governments. With specific reference to persons having income from both agricultural and non-agricultural sources, the Committee are of the opinion that, perhaps, the time has come for the Government to seriously consider fixing, in consultation with the State Governments, a threshold limit beyond which, the income of such persons from agricultural sources could be brought under the tax net." (emphasis supplied) (Paragraph 169)

(x) "However, there exist certain general problems like exemptions, and specific problems like lack of information on high-spending and predominant use of cash as a mode of payment for high value items. Moreover, the Government are in agreement with the concept that high income tax payers with greater capacity to pay must pay more. Keeping in mind all the concerns, the Committee advise the Government to bring all such dealers who deal with such high-cost items as well as the persons with very high regular spending, under Section 285BA of the Income Tax to mandatorily file Annual Information Returns." (Paragraph 170)

(xi) "The data furnished on instances of misuse of various export promotion schemes reveals that the amount involved in the show cause notices (SCNs) issued during 2002-03 to 2004-05 totals to an enormous figure of Rs. 3,442 crores. The aspect of blatant misuse of various export promotion schemes resulting in loss of thousands of crores of revenue to the exchequer is evident from the fact that the Government have decided to withdraw the Target Plus Scheme following the advice of a Committee of Secretaries. Further, the Committee also note that as a follow up of the revelations made by the DRI, some of the schemes have been revamped. The Committee are, therefore, of the view that there is an urgent need to review all the existing export promotion schemes, after obtaining necessary inputs from DGFT, DRI, DGCIS etc. so as to make them evasion proof. ..... With specific reference to import of luxury cars etc. which is, inter alia permitted under the EPCG Scheme, the Committee note that of the 499 vehicles imported till date, as many as 61 have been identified to have been misused by way of ‘Third Party Transfer’ of the vehicles in violation of the ‘Actual User Condition’. What is particularly disturbing to note is that import licenses have been reported to have been issued to non existent or fictitious firms. The Committee’s examination of the issues relating to instances of misuse of Export Promotion Schemes inter alia reveal that there is a strong element of lack of proper co-ordination between the various agencies viz., Department of Revenue, DRI and DGFT. The Committee, therefore, strongly express the need for taking stringent action against the erring parties and also have a re-look at the mechanisms of co-ordination between the agencies/departments with a view to curb instances of misuse of the Schemes. ..... As regards Central Excise duty, the Committee note that while Pan Masala/Gutka and Iron and Steel are identified as commodities prone to evasion, certain others, including cigarettes, polyester yarn etc., which were earlier considered as evasion prone are no longer perceived to be so. The Committee recommend that the reasons for the proneness of these commodities to evasion be looked into in detail and appropriate remedial measures taken. ..... Real estate transactions are believed to be a major area for creation of black money. The high rate of stamp duty levied by the States is also perceived to be a reason for resorting to undervaluation of property transactions. The Committee, therefore, urge the Government to impress upon the State Governments to bring in a rationalized and uniform rates of Stamp Duty on lines similar to the one that paved the way for arriving at uniform VAT system in the States." (emphases supplied) (Paragraphs 172 to 175)

(xii) "In their interim report, the Committee had, inter-alia expressed concern on the manner in which Government cases were represented at various judicial fora and called for overhauling the processes involved in appointment of Government counsels. From the information furnished, the Committee are deeply concerned to note that the success rate of both the CBDT and CBEC in pursuing cases, particularly at the higher levels of the judiciary does not speak well of the departments. For instance, in the case of CBDT, 42.69% of the appeals filed in the High Court and 77.50% of appeals filed in the Supreme Court are informed to have been decided against the department. Similarly, the success rate in representing cases pertaining to customs and excise duties has only been to the extent of 23% and 28% in the Supreme Court in the year 2003-04. These figures give credence to the opinion often expressed that Government cases are represented in a routine manner in the higher levels of the judiciary. The Revenue Secretary too admitted before the Committee that there were problems at the departmental level in enabling effective pursuance of cases, for overcoming which, appropriate steps are said to have been taken. These, as informed to the Committee, include, putting in place a system for ensuring expeditious movement of data to the law officers; and identification and selection of lawyers with proven expertise in taxation matters for representing the Government. The Committee expect the Government to address the problems relating to representing its cases in various judicial fora expeditiously. ..... The Committee also note from the information furnished that though the field formations of the CBDT have been empowered to engage special counsels to represent important cases involving complex legal issues, similar powers have been denied to the CBEC. The Committee expect the Government to resolve the matter expeditiously, so as to enable the field formations of CBEC also to engage special counsels for representing complex cases in the Tribunals, High Courts and the Supreme Court." (emphases supplied) (Paragraphs 176 to 177)

(xiii) "The data furnished shows that the amount of arrears of revenue relating to the CBDT as on 1.4.2005 stands at a whopping Rs. 98,614 crores, amounting to almost three fourths of the total direct tax revenue realized during the year 2004-05. The Committee are at a loss to find that, out of this amount, only an amount of Rs. 5,486 crore is reported to be free from any serious difficulty in enabling recovery. The Committee expect that, at least, this amount
be recovered at the earliest. ..... The Committee also observe from the data furnished by the CBDT that out of the total arrears pending at various levels, around 50 per cent of the cases are pending at the level of Commissioner (Appeals) and around 46 per cent at the level of the Tribunal. This, in the opinion of the Committee, warrants effective, innovative and quick attention. They feel that the efforts that are being made are not effective enough. The Committee also recommend that the Government should set up a departmental committee to study the cases, concerning specific kinds of offences and other contraventions, that have been regularly decided against the department by the Tribunals, High Courts and the Supreme Court , and prevent further filing of cases of similarnature." (emphasis supplied) (Paragraphs 180 and 181)

(xiv) "The Committee, taking note of the fact that ostentatious display of wealth is done through extravagant spending of money on personal functions like marriages and high value luxury articles, recommended that the same has to be followed up effectively to detect concealment of wealth and evasion of tax. However, from the data furnished by the Government it is seen that only 75 enquiries into such spending have been conducted from the year 2001-02 to 2003-04 which resulted in disclosure of Rs. 43.58 crore. Further, it is also observed from the data on searches that the number of searches in the years 2003-04 and 2004-05 have gone down by more than half of that conducted in the year 2002-03 with the value of seizures during the years also going down by more than fifty per cent. Reduction in the number of searches has actually resulted in greater reduction in the value of seizures made. The Committee do not agree with the policy of the Government to merely reduce the number of searches. Instead, they are of the view that the number of searches should be enhanced with added emphasis on the quality of searches. They, therefore, recommend that the number of searches conducted should be increased which should be of high quality and based on solid evidences of evasion. ..... It is further recommended that the data obtained through the surveys/enquiries conducted by the department on various forms of luxurious indulgence, should be passed on to the assessing officer within a prescribed timeframe, so as to make the effort an effective deterrent on tax evasion." (emphases supplied) (Paragraphs 183 and 184)

(xv) " ..... Leaving a large percentage of tax returns left unassessed, may prompt the assessees to take a calculated risk in concealing their actual income. Hence, a need arises to ensure a fair percentage of assessment with a view to, on the one hand, increase the detection of evasion, and on the other hand, to act as a deterrent to reduce such risk taking by those who file their tax returns. In view of the above as well as the large scale computerization of various aspects of tax administration and the resultant efficient functioning of the department, the Committee recommend that the percentage of scrutiny should be raised suitably." (emphasis supplied) (Paragraph 185)

(xvi) "Further, in order to avoid the practice of the assessing officer making arbitrary additions in the returns filed without having material evidence, the Committee suggest creation of a mechanism to fix responsibility and accountability on the assessing officers for making such false additions." (emphasis supplied) (Paragraph 186)

(xvii) "The Committee observe that huge amounts are being sanctioned as interest on refunds every year and the same are not treated by the Government as an expenditure but as reduction in revenue. This procedure of making adjustments to circumvent the need for approval of Parliament to expenditure on interest element is neither correct nor healthy, as it allows for complicity between tax officials and assesses. The Committee are not in agreement with the Government’s contention that it is not possible to estimate the refund amount for a year in advance and obtain budgetary sanctions accordingly. In a related matter, the Committee note that budgetary provisions are made for compensation for the loss that may accrue to State Governments in implementing State level VAT, which is similar in nature. Further, the Committee feel that provisioning for the interest paid on refunds in the Demands for Grants will be in the interest of better Parliamentary scrutiny of the Demands of the Government. Therefore, the Committee recommend that the Government should take up the matter by keeping the above concerns of the Committee in view. Further, they desire that complete details of interest paid on refunds involving interest amount of Rupees one lakh and above, inter-alia furnishing names of individual/corporate assessees along with the amount of interest paid to each one of them, during the preceding three financial years (year-wise) be furnished to them. (emphases supplied) (Paragraph 187)

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In Square D Company and Subsidiaries v Commissioner of the Internal Revenue Service, the 7th Circuit of the United States Court of Appeal had occasion to deal, inter alia, with the Non-Discrimination Clause in the US-France Tax Treaty of July 28, 1967.

Facts

2. Square D Company, a US Corporation with a French parent, claimed to deduct certain amounts of interest payable by Square D to its French parent, in the years in which such amounts accrued, i.e., in 1991 and 1992, in the face of Treasury Regulation § 1.267(a)-3, which provides for the cash method of accounting for deductions for payments to foreign related persons.

3. Square D rested its claim on two grounds :

(i) Treas. Reg. § 1.267(a)-3 constituted a flawed interpretation of the statutory mandate contained in Internal Revenue Code ("IRC") § 267(a)(3) and was invalid. [ IRC § 267(a)(3) provides that the "Secretary shall by regulations apply the matching principle of [§ 267(a)(2)] in cases in which the person to whom the payment is to me is not a United States person.". ]

(ii) Alternatively, Treas. Reg. § 1.267(a)-3 violated the Non-Discrimination Clause of the US-France Tax Treaty of July 28, 1967.

[ The Non-Discrimination Clause ran thus :

"A corporation of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation which is other or more burdensome than the taxation and connected requirements to which a corporation of that first-mentioned Contracting State carrying on the same activities, the capital of which is wholly owned by one or more residents of the first-mentioned State, is or may be subjected.".

]

Reasoning and Decision

4. Upholding the decision of the Court below (viz., the Tax Court), the 7th Circuit held that the Commissioner properly concluded that Square D had to take deductions for payments to a foreign related party on the cash method, rather than on the accrual method. The 7th Circuit's rulings on the 2 grounds aforesaid raised by Square D are as follows :

(i) On the validity of Treas. Reg. § 1.267(a)-3 :

Treas. Reg. § 1.267(a)-3, on which the Commissioner relied, was a reasonable interpretation of ambiguous statutory provisions and was hence a valid provision.

(ii) On whether Treas. Reg. § 1.267(a)-3 was violative of the Non-Discrimination Clause in the US-France Tax Treaty of 1967 :

"..... In order to violate a nondiscrimination clause in a treaty, the additional burden must be directed at nationality. See Klaus Vogel, Klaus Vogel on Double Taxation Conventions 1290 (3d ed. 1997). Put differently, "discrimination against foreign-owned subsidiaries is all that the nondiscrimination clause at issue protected against." See Union BanCal Corp., 305 F.3d at 986. Such discrimination is absent here. The regulation requires that all interest payments to a foreign related party must use the cash method of accounting without regard to the nationality of the owner. The regulation does not impose the cash method simply because of foreign ownership, which would be prohibited, but rather for payments to a foreign related party. Even if a corporation were owned by a United States parent, it still appears all interest payments to one of these foreign related parties would lead to the use of the cash method. The requirement, therefore, hinges on the nationality of the related party to whom the payment goes and does not fluctuate based on nationality of the ultimate owner. It is merely fortuitous that, in this case, the foreign related party to which the payment was made also happened to be the owner. The regulation does not discriminate based on foreign ownership, and thus, does not violate the nondiscrimination clause.".

(All emphases in the original, except that of the portion commencing with the words "Even if" and ending with the words "ultimate owner".)

Comment : In an opinion which is otherwise extremely carefully crafted, what is intriguing in the portion emphasised by me above, is the employment of the expression "it still appears" and, more particularly, the word "appears". One would have thought that the conclusion from the relevant statutory provisions is clear, i.e., that even a US corporation with a US parent can deduct interest payable to a foreign related party only on the cash basis. However, the employment of the said expression (and in it the word "appears") would indicate that the Court is in some doubt as to the correctness of this conclusion. If, therefore, by employing that expression, the Court is saying that it is possible that a US corporation with a US parent can deduct interest payable to a foreign related party when such interest accrues, then, surely, no clearer case of discrimination between such a corporation and a US corporation with a foreign parent such as Square D can cogently be made out !!

Technorati Tags : non discrimination non discrimination clause tax treaties us-france tax treaty of 1967 square d company us court of appeals 7th circuit raj raj kapadia international taxation

Raj Kapadia's Indian Tax Blog

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Saturday, March 25, 2006

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Thursday, February 23, 2006

Non-Discrimination Clause in US-France Tax Treaty of 1967 - Square D Co & Subsidiaries v Commissioner of IRS (US Court of Appeals - 7th Circuit)

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