Global funds likely to contest I-T dept's order on tax treaty misuse

Most global funds have filed objections before the dispute resolution panel (DRP) against the tax order issued by the income-tax (I-T) department for under-reporting income by misusing tax treaties, said two people privy to the development.

Some foreign funds have written to the respective assessing officers stating they would file an appeal to the Commissioner of Income-Tax (Appeals), or CIT(A), requesting a final order in the matter, they said.

The move follows the draft assessment orders issued to over a dozen global private equity (PE) funds under Section 144C of the I-T Act, related to unassessed income. Tax rules provide assessees the opportunity to file objection(s) within 30 days from receipt of the draft order. The deadline for it ends this month.

The tax department had last year reopened the fund’s past assessments for allegedly misusing the tax treaties with Mauritius, Singapore, and Cyprus. The I-T department observes irregularities in tax filings of 2013-14, 2014-15, and 2015-16.

DRP, set up by the Central Board of Direct Taxes, is an alternative resolution mechanism to facilitate expeditious resolution in tax matters for foreign companies.

Foreign investors typically opt for a dispute resolution mechanism to achieve certainty on tax disputes arising from cross-border transactions.

Unlike other prolonged proceedings, DRP proceedings are time-bound; their decisions are binding on both the assessee and the department, against which no appeal can be filed, barring exceptions, said a senior tax official.

On the other hand, proceedings of CIT(A) are not time-bound — 20 per cent of the tax demand is required to be made upfront. No such payment is required in the case of DRP applications. Also, the panel has to adjudicate the matter within nine months.

Those opting for CIT(A) have to file an application within 30 days from receipt of the final order — which is the confirmation of the draft order.

The only drawback to the resolution panel is that there is no appeal in case the ruling goes against the assessee, which happens often unless there are strong legal grounds, said another person.  

Sources say that the tax department is confident of a favourable ruling in the matter as there is evidence supporting fiscal evasion of taxes by means of treaty shopping.

While investing in Indian companies, most PE funds either take the traditional route to invest directly as foreign direct investment or set up a special purpose vehicle outside India — usually in a tax-friendly jurisdiction.

At present, PE funds based in India are subject to capital gains tax. These PE funds deal with unlisted companies and attract long-term capital gains at 10 per cent, while short-term is levied at 30-40 per cent.

The draft order issued by the department to several global fund houses proposed net long-term capital gains at the rate of 20 per cent on transfer of unlisted shares of the Indian company to another entity. It also issued a penalty notice on income under-reported.

Tax experts believe that the said tax order has overridden the position taken by the Supreme Court in the ruling of Azadi Bachao Andolan, where the tax residency certificate (TRC) was conclusive evidence of a foreign entity.

“More so, these assessments have been concluded for the same facts in subsequent or preceding years and would cause needless litigation,” said Mumbai-based chartered accountant Mitil Chokshi.

However, the tax department holds the right to deny TRC of an entity if it is found abusing tax treaty benefits and indulging in treaty shopping. Most of the investment was routed through Mauritius and Cyprus during the assessment years.  However, the treaty was amended in 2017.