Four key reasons why the AAR is losing its relevance in direct taxes

Set up in 1993 to provide clarity to MNCs about taxability of certain transactions, and later to domestic companies for deals above Rs 100 cr, it has become dysfunctional due to vacancies at the top

The Supreme Court recently recommended to the Centre to make the advance ruling system in direct taxes more effective and comprehensive.

The Authority for Advance Rulings (AAR) was set up in 1993 with the aim of providing clarity to multinational firms about the taxability of certain transactions in advance, so that they are sure about the country's tax policies. AAR's mandate was later expanded to even domestic residents for transactions above Rs 100 crore.

Over time, AAR has lost its sheen and companies avoid approaching it. Of late, the institution has become dysfunctional due to vacancies at the top. 

Let us examine reasons for this situation:

High pendency of cases:

The Supreme Court in its observation in the National Cooperative Development Corporation vs Income-Tax Department case cited a Deloitte report to say that an increasing number of applications are pending before the AAR due to its low disposal rate and, contrary to the statutory requirement for a ruling to be given within six months, the average time taken is said to be nearly four years. In view of the time taken, the very purpose of AAR is defeated, due to which the mechanism is being used infrequently as is evident from the ever-increasing load of tax-related litigation, said the Court.

According to the Deloitte report on advance rulings in India, cited above, the disposal rate declined from 30 per cent in 1994-95 to seven per cent in 2017-18. The disposal rate is taken as the cases done with as percentage of the sum total of cases pending at the beginning of the year and those filed during the year.  

Close to 500 cases are pending before the AAR, said Amit Maheshwari, Tax Partner at consulting firm AKM Global. Against this, the average annual disposal has been about 60 cases in the five-year period from 2013-14 to 2017-18. There are no publicly available statistics of monthly disposals by the AAR. However, an analysis of published rulings of the AAR, shows that in a 108-month period (from FY11 to FY19), the AAR did not publish any rulings for 45 months. In some cases, the pendency is more than six to eight years, defeating the very purpose of having an AAR, as no business will wait for that long to get tax certainty before making a major transaction, said Maheshwari.

Vacancies:

AAR has three branches -- the principal branch in Delhi, the National Capital Region (NCR) branch in Delhi and one in Mumbai.  Under the statute, the AAR consists of a chairman and such number of members (vice-chairman, revenue members, and law members) as the government may notify. The posts of chairman and vice-chairman have to exist for AAR to function. However, both posts have been lying vacant since last year, leaving the body non-functional, said Ashutosh Dikshit, partner Deloitte India and author of the report cited above. Dikshit said if the chairman is there, he can appoint a vice-chairman from among the members. However, the chairman has to be there to make the institution functional, he said.

Maheshwari said the government has always delayed appointment of the Chairman, which is the key reason for the backlog.

In the case cited above, the Supreme Court observed that there is obviously a lack of presiding officers to deal with the volume of cases. Interestingly, the primary reason for this is the large number of vacancies and delayed appointments of members to the AAR, it said.

Objection by tax department:

Dikshit said AARs can admit a case if a particular transaction is not for tax avoidance. Cases on which rulings are sought are usually highly complicated. If revenue makes a prima facie case that a certain transaction is for tax avoidance, AAR has to first give ruling on that issue. The department of  revenue makes this case in most proceedings. This delays the rulings. AAR may later rule that a particular transaction is not for tax avoidance and has merit for advance rulings, but the whole process delays the ruling.

Maheshwari said one of the recent examples is in the case of Tiger Global wherein AAR has denied the treaty benefit under India-Mauritius treaty, despite that fact that it has grandfathering clause for investments made prior to April 1, 2017. New York-based private equity investor Tiger Global sought exemption from tax on capital gains arising from the 2018 sale of its Flipkart stake to Walmart. The investor argued that since its investment firms that made the Flipkart investment were based in Mauritius and were set up before 2017, it should get treaty exemption. AAR had rejected the petition and ruled that it suspected the tax treaty was being abused to avoid tax. The case is now on in the Delhi high court where the assessment against Tiger Global has been stayed.

Interest liability:

Where the applicant has undertaken a transaction and seeks an advance ruling, the law provides that the tax authorities will not impose tax until the AAR has pronounced its ruling. Currently, AAR rulings are being issued much beyond the mandated six-month period as mentioned above. Invariably, by the time the AAR issues the ruling, all applicants must have filed a return of income for the relevant financial year related to the transaction. The applicant may have paid no tax on the income arising from the relevant transaction based on its stand before the AAR. Any proceedings regarding this return of income is kept in abeyance by the tax authorities until the AAR ruling is issued. 

If the AAR ruling, when issued a few years later, is adverse, the applicant is liable for both tax and interest on the income in relation to the transaction. In all such cases, the interest liability is significant because it is levied for the entire period from the date of the transaction and the date of the AAR ruling which is grossly not fair, said Maheshwari. 

If the ruling had been pronounced within the mandated six-month period, the applicant could have paid the tax immediately, he said.