Broadly speaking, tax matters are a part of civil law. However, in most countries, disputes arising from tax matters are not routed through the normal judicial hierarchy because tax statutes are self contained codes and have their own mechanism of resolution. This article is restricted to direct tax disputes arising in India and accordingly the Indian tax law, namely Income Tax Act 1961, is no exception to having its own unique dispute resolution mechanism.

Income tax in India was first introduced in the year 1860. After passing through quite turbulent weather and some tribulations, it ultimately culminated in the Income Tax Act 1961. It is said that law cannot remain fossilised and has to evolve itself with the passage of time. Considering the fact that the Indian economy opened up in 1991, it is perceived that the present Act has outlived its utility and efficacy. A new code, in the form of a Direct Tax Code, is therefore waiting to see the light of the day.

It is quite paradoxical that, although it is the avowed objective of the Government to simplify the tax law, complexities are on the rise on account of increased cross border transactions. New technologies have shrunk the globe but they have simultaneously given birth to complex international transactions.

Besides what has been stated above, there always has been a tug of war between the Government and its subjects on the liability of taxes. India being a welfare state, its Government has always tried to increase its revenue for more allocation to meet its social obligations. On the other hand, the taxpayer has always tried to minimise his tax liability. Human greed has no bounds and hence, the taxpayer, besides using the legitimate means, has also ventured to use colorable devices to reduce his tax liability.

Greed has always shown a rising trend, more so after the rampant increase in consumerism. Unfortunately, the persons who are in charge of assessing the tax liability of taxpayers are also victims of high consumerism. Generally, their propensity to consume is disproportionately higher than the salaries paid to them by the government. Avenues of supplementing income are explored, which dents the revenues of the Government.

Be that as it may, the tug of war referred to earlier culminates into disputes between taxpayers and the tax authorities. The Indian Income Tax Act, being a self contained code, provides for its own mechanism of dispute resolution.

The conventional hierarchy to resolve the dispute is depicted in the above chart. The chart also indicates the general timeframe within which the liability gets finally crystallised.

Thus, if a matter has to go up to Supreme Court, the normal timeframe to resolve the dispute would be 15 to 20 years. Considering such a lengthy timeframe, by the time the dispute attains finality the significance of the final outcome is lost on account of various factors.

There have been experiments time and again to reduce either the litigation itself or the normal timeframe mentioned above. One of the earlier steps taken was to accept income returned by the taxpayer except to make minor adjustments. However, at times, these minor adjustments gave rise to major disputes and the right to appeal, which was otherwise taken away, had to be reinstated. Thus, this experiment proved to be a failure and was given a go by. Another step that is being regularly reviewed by the government is to increase the threshold of incomes that become liable for deep scrutiny.

Yet another measure that is reviewed at regular intervals is the threshold limit of tax effect for revenue to file appeals before the Tax Tribunal, High Court and Supreme Court respectively. These steps have yielded some results. However, litigation per se refuses to take a back seat.

Dispute Resolution Panel (DRP)

A new apparatus has recently been put into motion known as Dispute Resolution Panel (DRP). It consists of a collegium of three high ranking officials viz. Commissioners of Income Tax.

Appeal against all assessments made on foreign companies lie against the DRP. Furthermore, all assessments – whether corporate or non-corporate, foreign or domestic – that contain transfer pricing adjustments are also subject to appeal before the DRP. This mechanism has been evolved to take care of the increasing footprint of foreign investment in India and outbound investment from India.

There were high expectations when this new mechanism was put in place. Unfortunately the working of the DRP over the last two years has belied all hopes. It is generally believed that plurality of minds, when put to work on an issue, tend to give better results. This is the principle on which larger benches in higher judiciary are constituted. The DRP, despite being a quasi-judicial body, has failed to achieve its objectives. The reasons why are clear.

Firstly, the revenue has not been given a right to appeal against the order of DRP. This provision seems to have dampened the spirit of the DRP to such an extent that it feels, that if the assessee is given even the legitimate benefits due to it under the Act, loss to the revenue would be considerable. Long-term benefits accruing by upholding the rule of law are sacrificed at the altar of short-term benefit of achieving the targeted revenue. This results in the erosion of one’s faith in the system and ultimately the nation tends to suffer.

Secondly, it is felt that a timeframe of nine months given to DRP to give its ruling is quite inadequate to deal with complex international tax issues. Thirdly, only two DRPs are constituted in a few major cities whereas elsewhere only one DRP is constituted. Each transfer pricing order, on average, runs between 30 and 400 pages long. The low number of Panels places a huge burden on the constituted panels and hence there is hardly any application of mind on the part of Commissioners constituting the Panel.

On account of these reasons, the DRP is reduced to merely putting its seal of approval on what the subordinate officers have done rather than being the high-powered collegiums it is supposed to be. The general feeling is that the DRP mechanism has failed and the feeling is not far from truth.

Authority of Advance Rulings (AAR)

In yet another move, aimed at reducing the volume of litigation, the Government inserted a new Chapter XIX- B on Advance Rulings. This was inserted with effect from June 1 1993, whereby a non-resident could apply to the Advance Ruling Authority to determine the tax liability arising out of a transaction that has been undertaken or is proposed to be undertaken by a non-resident. The provision also permits a resident to apply to the Authority for Advance Rulings (AAR) for determination of his tax liability arising from a transaction with a non-resident. The scope of the provision was expanded in 1997 by including public sector companies as a class of persons who could apply for Advance Ruling.

The Ruling pronounced by the AAR is binding on the applicant and department, and no appeal lies against such order of the AAR. Thus, by obtaining a Ruling in advance of a particular transaction, uncertainty regarding tax liability is removed. This provision has proved to be quite beneficial and successful in reducing litigation. Generally, it takes about 12-18 months for the AAR to pronounce its ruling from the date of application. It is perceived that if such provision is enacted for transactions entered into between two residents, it may prove to be successful.

Mutual Agreement Procedure (MAP)

Mutual Agreement Procedure (MAP) is a means to resolve disputes surrounding the application of Double Tax Avoidance Agreements (DTAA). The procedure involves negotiations between the competent authorities of the two states that are parties to the treaty. The only downside of this procedure is that it is confined to the interpretation of the DTAA and not of the domestic laws of the respective countries. At the same time, however, the parties involved can simultaneously pursue the normal litigation route in the respective states.

The MAP helps in resolving issues like those arising from transfer pricing adjustments or those relating to characterisation of income, existence of permanent establishment, attribution of profits to a permanent establishment, and the like. MAP takes about two to three years to resolve a dispute compared to the normal time the appeal route takes (more than a decade). Another advantage of the MAP route is that, depending on the agreement with the country concerned, the recovery of the demand gets stayed. Moreover, in all cases where the MAP route is pursued, there is a possibility of correlative relief in the other country.

Apparently, the MAP seems to be an easier route if the timeframe involved in the two procedures is compared. However, one should not lose sight of the fact that once MAP is pursued, a party to a transaction has no role to play, the sacred right of being heard is given a go by, and the resolution almost invariably results in some adjustment to the total income. In other words, whereas in the appeal procedure there may be a scope to totally remove tax liability, in the case of MAP that scope gets restricted to a great extent.

Moreover, considering the difference in approach and attitude of the competent authorities of the two states, the authority of one country may not object to a higher adjustment being proposed by another state. This entails a somewhat higher tax liability for the taxpayer. Ultimately, it depends on the taxpayer himself to decide which course he would like to take after factoring in aspects like merit of the case, stakes involved and the essence of time.

Direct Taxes Code (DTC)

There is a proposal to replace the present Indian Income Tax Act of 1961 by the Direct Taxes Code (DTC), and the necessary Bill has already been introduced in the Parliament. At present, the Bill is pending with the standing committee of the parliament and its report is awaited.

The salient features of the DTC are:

a) Consolidation of provisions and use of simple language,

b) Powers delegated to central government/board to avoid protracted litigation on procedural issues,

c) Flexible structure capable of accommodating changes of dynamic economy,

d) Moderate levels of taxation and expansion of tax base, and

e) Provision of stability in the tax regime on well accepted principles of taxation and best international practices.

Advance Pricing Agreement (APA) and Safe Harbour Rules

As a part of this overhaul, the DTC envisages the setting up of an Advance Pricing Agreement Procedure (APA) and safe harbour rules. The APA envisages a contract between taxpayer and tax authority (CBDT) to enter into a binding agreement. It particularly takes care of transfer pricing adjustments. The agreement is reached on the TP methodology to be adopted and arriving at proper arm’s length price. The agreement is to remain valid for a maximum period of five years.

This procedure brings certainty of tax treatment, and freedom from TP adjustment, penalty, double taxation, full blown audit examination and resolution of prior year TP issues, through a roll-back mechanism. Although taxpayers are awaiting the APA procedure and safe harbour rules to fall in place, it is anybody’s guess as to when the DTC itself will find a place in the statute book.

We have tried to outline briefly the various litigation or dispute resolution avenues that are presently in force in India with the hope that the same will be useful to readers, to those who intend to trade with India, and to their advisers alike.

About the authors

Biography
		Rajan Vora leads Ernst & Young India’s direct tax litigation advisory practice and is presently based in Mumbai. He was rated among the Top 10 dispute Advisers in India in a recent survey conducted by Euromoney’s International Tax Review. He has extensive experience in representing tax litigation matters before the Income Tax Appellate Tribunal and Authority for Advance Rulings. His experience includes more than 35 years in litigation and corporate tax advisory services including Transfer Pricing and International Tax issues. He was co-opted for various special committees by Institute of Chartered Accountants of India. He was the president of Bombay Chartered Accountants’ Society in 1990-91. He has authored several publications of professional organisations like that of the Institute of Chartered Accountants of India, Bombay Chartered Accountants’ Society and Chamber of Tax Consultants etc. He is a member of the taxation committee of Bombay Chartered Accountants’ Society and Indian Merchant Chamber. He has presented papers and has been a regular panel speaker at seminars and symposiums in India and abroad. You can contact Rajan at: rajan.vora@in.ey.com  / +91 22 619 20440

Biography
		Pradeep Parikh is a senior adviser in Ernst & Young India’s tax litigation advisory practice and is based in Mumbai. Prior to joining EY, he was the vice president of the Income Tax Appellate Tribunal. He has had a long and illustrious tenure at the Tribunal. During his 16 years, as an accountant member and thereafter vice president of the Tribunal, he authored several landmark judgments such as Prasad Productions, Mahindra Holidays & Resorts (India) Ltd., Motorola Inc. He is a chartered accountant by qualification and practiced for 18 years in Ahmedabad before joining the Tribunal as a Member in May 1994. He has also completed his LLM from the University of Mumbai. Apart from Mumbai, he also served as a member and vice president of the Tribunal at Delhi, Chennai and Hyderabad. You can contact Pradeep at: pradeep.parikh@in.ey.com  / +91 22 619 21396