In the following paragraphs, I have discussed some of the recent developments in direct tax laws. The discussion is kept simple enough, so that a layman can also understand the very technical topic of income tax.

Recent Developments in Income Tax

Faceless Assessments and appeals

The government launched the faceless scheme on the 13th of August 2020 and Section 144B of the Income Tax Act, 1961  was inserted with effect from April 1, 2021, wherein the entire scheme of faceless assessment was laid out. India is one of the first countries in the world to have implemented the faceless scheme for assessments. So what does this entail ?

A major chunk of income tax officers are posted as assessing officers and do assessments in majority of their time 

Now what is an assessment? Everyone declares their income and pays taxes by filing their return. But a very few either do not file these returns or do not file them correctly or fraudulently try to conceal their income. As a deterrent to such a handful of people, to create fear in their minds, 2% of the returns filed are selected each year to be scrutinized by officers in detail through scrutiny assessment. When these officers are scrutinizing these returns, this is an assessment proceeding. 

Now, how are these returns selected for assessment? The Income Tax department collects information from a number of third parties like banks, land sub-registrar, customs dept etc. This information is matched with data in return filed by the taxpayer by computer. The computer itself throws up a list of taxpayers who have not declared their returns in line with other 3rd party information available. These are the kind of returns selected for assessment. So individual tax officers have very little discretion in choosing which case is assessed and mainly a system of CASS (Computer Aided Scrutiny Selection) chooses such cases. This means there is very low chance of misuse of power and corruption by the officers.

This is what is an assessment. Lets see how being faceless changes everything. Earlier if an officer is posted in Bangalore, they will do assessment of the Bangalore tax payers of their jurisdiction and these assessments used to take place as a quasi judicial proceedings. Here, the officer used to conduct physical hearings with the taxpayer, look at 3rd party evidence, and finally pass assessment orders asking the assessee to pay correct taxes. 

Under the faceless assessments, the cases selected for scrutiny are randomly allocated to officers anywhere in the country. The identity of the officer dealing with the case is kept secret and all correspondences take place electronically through email and no physical contact is established between the two at any stage. Furthermore, instead of the decision being made by one assessing officer, all decisions of assessing officer are firstly required to be approved by an officer of the level of Joint Commissioner or Additional Commissioner. Secondly, based on certain risk parameters, some cases are selected for a second layer of review to a Review Unit. A review unit again has a reviewing officer and a joint commissioner/Additional Commissioner level officer who approves all review reports prepared by the reviewing officer. So it’s teamwork, which leads to an order and a single officer is no longer responsible for the order.

The aim is to improve tax administration by making it more objective, transparent and corruption-free. 

A similar structure has been proposed for the first appeal before CIT (Appeals) for which notifications have been issued by CBDT and second appeal before ITAT which is still to be notified.

High Courts on Faceless Assessments: In its first year, the faceless scheme has come upon certain hurdles, which can be taken as teething trouble. The first batch of assessment orders have been challenged in various high courts. Some of the common issues are not giving adequate opportunities to represent their case and lack of accountability. Tax is extremely complex and to explain technical issues in writing on email is very difficult and face to face interaction is important. Also, even though faceless scheme provides for video conferencing, a chance of video conferencing is given only to those assessees who have received show cause notice and that too towards the end of assessment proceedings by which time, the assessing officers have already made their mind.

Then there are cases where there have been technical glitches. This is because the show cause notice is sent by the assessing officer to his boss. If approved, the same is sent to National Faceless Assessment Centre, where an officer digitally signs and sends these notices to assessee. So by the time assessee gets the email itself a time lag is there. Because of this some mistakes have happened. For instance, in some cases the show cause notice was received after the last date of response given in notice. Also in some cases few orders were passed before the time prescribed in the show cause notice and without taking under consideration the submissions of the assessee have been declared non-est (please see Madras High Court decision in Antony Alphonse Kevin Alphonse v. ITO and Ekambaran Sukambaran v. ITO). 

Rightly, the high courts have quashed such orders, based on the reading of section 144B (9) of the Income Tax Act, which states that the assessment shall be non est if not made in accordance with the procedure laid down under this section. Hence, if no show cause notice is issued or is issued without the draft order or any other procedural lapses are present, it shall lead to the assessment being declared infructuous. It is interesting to note that the government has proposed to remove this provision section 144B (9) from the Income Tax Act, vide the Finance Bill, 2022.

Issues faced by the Department: Apart from the above, the officers posted in faceless units have their own problems. The biggest issue is non compliance by assessee or 3rd parties. If any ordinary man receives an email from the tax department, there is a high likelihood that he takes it as spam or ignores it. In olden times, in the non faceless scenarios, the jurisdictional AO was from the same city/town as the taxpayer and generally knew the taxpayer. Even if they did not know the taxpayer, they were informally calling and informing the taxpayer that they have to respond to IT Notices. So taxpayers were not missing out on responding to notices and getting huge demands. This is not the case now in the faceless scenario. In the faceless scheme, there is a lack of this human touch and if there is no response, the assessing officer has no other option but to make huge tax demands. Also, in olden times, as the taxpayer was from the city of the tax officer, the officer could have used his local networks with bank officials and land sub registrars etc to get information for the assessment proceedings. But in a faceless scenario, the officers are sending thousands of reminder mails but these 3rd parties are just ignoring them and not sharing information.

Other issues are also cropping up now that the first batch of faceless assessment orders have been passed. Earlier when there was a mistake apparent on record in the assessment order, the taxpayer used Section 154 for rectification of these mistakes. Now, the question is arising whether in this scheme of faceless assessment where the final order has been approved by JC/Addl CIT level officer, whether a junior AO can amend the order. Isnt this indirectly scrutinizing and checking orders of his superior officers? The same hesitation comes while using section 263 and 264 review powers. After the faceless assessment order has gone through the stages of AU and RU there is less of a chance of it being incorrect. Can section 263/264 still be invoked in such cases?

Tax Litigation

One of the major issues in India is its over burdened judiciary and government is one of the major litigants contributing to this. In fact India has been consistently receiving low rank in the World Bank’s Report on the Ease of Doing Business, partly due to low score given in ‘Paying Taxes’. This is due to the cumbersome tax dispute structure in India. A taxpayer, after receiving an assessment order, can take an appeal through four appellate forums – CIT (Appeals), ITAT, High Courts, and the Supreme Court. The current tax litigation process in India could take 12-14 years (if appeals go up to the Supreme Court) to resolve a tax dispute. The lag is mainly because no timelines are mandated for conclusion of proceedings at the appellate forums, significant workload, lack of a fast-track dispute resolution mechanism etc.

Government is very aware of this issue and has taken following measures in recent times:

  • Government has tried to reduce the number of appeals which the income tax department makes against the assessee. They have decided that if a matter is below INR 20 lakh, they will not file an appeal before ITAT. Also, if the matter is below INR 50 lakh we will not file an appeal before the high court, If the matter is below INR 1 crore we will not file an appeal before the Supreme Court. This has really helped in finalizing the demand and ending never ending litigation on puny issues.
  • Secondly, the government has introduced the highly successful ‘Direct Tax Vivad se Vishwas Act, 2020. Taxpayers in whose cases appeals are pending at any appellate level can avail this scheme. If a taxpayer has filed any appeal, then he is required to pay the entire disputed tax to avail this scheme. As  an incentive to use this scheme, he is given a complete waiver of interest and penalty in such a case. It is specially useful for those taxpayers who have been in litigation for a long time and who have a very weak case likely to lose in appeals.

This scheme also applies to cases where assessees may have won their case in one or more forums and the IT department has appealed against this order. In case of such appeals made by the tax department, the taxpayer is allowed to pay just 50% of disputed tax to avail this scheme. Penalty and interest will be waived, here too. In case the amount of penalty, interest or fee is the matter of dispute, then only 12.5% of that amount will have to be paid, while the rest will be waived off. 

  • In this present budget, the government has again stressed on making tax litigations as minimal as possible. One thing they have done is to clarify and make amendments to certain issues in the IT Act which were the center of a lot of tax disputes. A lot of repetitive issues have been clarified in the present budget, so that no future litigation happens on these issues. Eg There is clarification on section 14A applicability to cases where there is no exempt income in the year. There is also clarity being given on disallowance of prohibited expenses/expenses for offenses under foreign laws disallowed. There is clarity on whether cess and surcharge is also disallowed under section 40 (a)(ii).

Recent Developments in Direct Tax Law

Retrospective Amendments

The next issue we will be discussing is Retrospective amendments in the Vodafone and Cairn case. They have been in the news again in the past year as the government has withdrawn the retrospective application of the amendment to section 9 and 195 of the Income Tax Act lately. Hence, I wanted to briefly touch upon it.

The basic facts are that Vodafone wanted to buy the business of Hutchison in India. However, if they had purchased the Indian company directly by share transfer or asset transfer, Hutchison would have had to pay huge capital gains tax on the transaction. So as a tax planning strategy, instead of direct share transfer or asset transfer between the Indian subsidiaries, the holding companies of these Indian subsidiaries exchanged shares. There were no direct transfers between the Indian entities running telecom business in India, however there was a change in the ownership of business in India. Vodafone India now owned Hutchison and Hutchison ceased to exist in India.

Section 9 covers tax on non residents. At that time, section 9 did not allow Non residents to be taxed unless, the income earned by them was arising in India. An ordinary officer like me scrutinized this transaction and found that this was a highly innovative way to avoid paying tax. It is like taking advantage of a loophole. 

By using the concept of ‘Look Through’, they found that the ultimate beneficiary to the transaction was Vodafone India, whose business and market dominance increased. They found that the jurisdiction where the ultimate assets (from which the value of the foreign shares derive their value) are located is India. So they concluded that the income generated in present case was arising in india and was falling within section 9(1)(i) of the Income Tax Act, 1960.

Another issue was how or rather whom to tax as Hutchinson no longer had any presence in India. So no point taxing them, there will be no recovery of money. Thus, the revenue authorities took a stand that Vodafone India should have deducted tax at source before transfer of shares between the two non-resident companies u/s 195 of the Indian Income Tax Act. Again section 195 only spoke about a resident company withholding tax when transacting with a non resident company. It did not mention about cases where share transfer was between non resident companies. 

Obviously, Vodafone was not happy with the assessment order and approached the Supreme Court. The honorable Supreme Court of India, in this case ruled against the revenue. 

Now this decision came in 2012. The Vodafone case was largely decided against the revenue because tax statutes are strictly interpreted and there was a lacuna in the law itself which did not explicitly cover such transactions. Section 9 and 195 did not clearly mention cases of indirect transfer of capital assets between Non resident entities. 

Why are tax statutes strictly interpreted? Taxation statute being a fiscal statute imposes pecuniary burden on the taxpayer, and so such statutes are construed strictly. Unless the black letter of the law permits, no tax can be levied merely by doing purposive interpretation. This is in accordance with Article 265 of the constitution, which only allows tax to be imposed by ‘authority of law’. 

Also, wherever there are two possible outcomes in interpreting tax statutes, then that interpretation is given which is in favor of assessee. This was another reason for the revenue losing its case in the Supreme Court.

The Supreme court also refused to hold that there had been any attempt at impermissible tax avoidance. Why is that? Because there is a difference between tax avoidance and tax planning. The present transaction was genuine, there were no fraud shell companies and instead there was a clear commercial motive of the transaction. So as there was no colourable device made out, hence no question of piercing the corporate veil or declaring it impermissible tax avoidance transaction.

Also, even though rigorous tax planning strategies bordering on tax evasion have been discussed by the Supreme Court in many cases, there were no clear tax rules disallowing such transactions for being impermissible tax avoidance transactions at that time. Later, GAAR or general anti-avoidance rules were introduced and were incorporated in the Income Tax Act. (One of the first GAAR cases are now coming up and probably next time we could discuss this as it is a major development in income tax laws)

After this judgment, the government brought out a clarificatory retrospective amendment to section 9 and 195 of Income Tax Act, to provide certainty in law and to remove ambiguity vide Finance Act 2012. The new law was applicable to transfer of share by a non-resident in a company incorporated abroad if the share derived (directly or indirectly) its value substantially from assets located in India. This struck at the root of the entire case on which Vodafone’s claims were based before the proceedings in the Supreme Court. 

Having exhausted all their recourse under Indian law, Vodafone now initiated arbitration before the Permanent Court of Arbitration, Hague, on the ground that the retrospective amendment was in violation of the fair and equitable treatment promised under the India-Netherlands bilateral investment treaty.

Meanwhile when all this was happening, based on the retrospective amendment, the tax authorities also levied tax on Cairn UK Holding Limited which opened Pandora’s box. In this case also, the sale of shares were between non resident entities. 

Cairn also, very much like Vodafone filed an appeal in India and simultaneously started arbitration proceedings like in case of Vodafone. Again the decision was delivered in favor of Cairn. Cairn was more aggressive than Vodafone though and sought to enforce the award against India in various jurisdictions, including enforcing the same against its foreign public sector units. The Indian government appealed against this arbitral award passed on the basis of India –UK bilateral investment treaty. 

However, in the interest of equity and to settle the matter, the Indian government has now made application of the amendments proposed to section 9 and 195 of Income Tax Act, retrospective only.

This shows the commitment of the government for a stable and predictable tax regime.

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February 2024