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India was ranked 63rd out of 190 nations in the World Bank’s Report on the Ease of Doing Business (EODB), 2020. On three of the 11 indicators used to determine a country’s overall ranking in the EODB report, it still has a score below 100. These are paying taxes, registering real estate, and enforcing contracts (163rd rank). Two areas where India’s business environment suffers from a lack of dispute resolution procedures are contract enforcement and tax payment.
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The lengthy and complicated income tax dispute resolution process in India has a negative effect on the country’s business climate. The nation has a thorough tax appeals system that goes all the way to the Indian Supreme Court. However, this system is open to abuse. The majority of tax appeals submitted under the current dispute resolution process come from the IT Department. India has much more tax litigation than other nations, and it takes much longer for cases to be resolved. India’s income tax department has a very low success rate for tax appeals compared to other nations.
At the level of ITAT, High Courts, and the Supreme Court, there are approximately 1,37,176 pending direct tax cases, according to the Ministry of Finance’s Economic Survey for 2017–18. About INR 7.58 lakh crores, or 4.7% of India’s GDP, has been locked up in the dispute resolution system’s various levels. In this nation, it typically takes 12–14 years to resolve a tax dispute.
Additionally, the COVID-19 pandemic and numerous lockdowns have affected businesses globally in terms of the economy. Due to the abrupt decline in the sale and consumption of goods and services, profit generation has decreased as a result of the suspension of economic activity. It entails a historically large decline in tax collection, the government’s main source of funding, while also balancing rising costs for infrastructure related to health and medicine.
The Direct Tax Vivad Se Vishwas Act, which was swiftly passed by the Indian Parliament to settle ongoing direct tax litigation before numerous forums, allowed the government to collect stalled revenue while also lessening the pandemic’s effects on taxpayers. By paying only the disputed taxes, taxpayers can completely waive all interest and penalties associated with pending disputes. Despite these admirable efforts, the government continues to enact temporary relief, which distorts the complicated tax system that is already in place.
Types Of Taxation Disputes
Arbitration’s unwarranted obfuscation raises questions about how it relates to tax laws. Tax and arbitration can be broken down into three parts for greater clarity and comprehension.
- COMMERCIAL TRANSACTIONS
This is the first type of tax arbitration, and as its name implies, it arises from business disputes that have a strong tax component, i.e., private business associations where the sellers and buyers agree to settle their disputes outside of court. Arbitrators frequently deal with tax matters as a byproduct of more fundamental contract disagreements involving taxes paid or collected. Contract provisions that direct dispute resolution in accordance with the rules of specific arbitrational institutions, such as the London Court of International Arbitration, the American Arbitration Association, the International Chamber of Commerce (ICC), etc., are frequently found in such commercial disputes resulting from tax arbitrations. In this case, the law of the country where the arbitration is being held will apply to the arbitration proceeding. For instance, the Federal Arbitration Act would apply if the arbitration were to take place in New York, and the Code de Proce’dure Civile would apply if it were to be heard in Paris.
- INVESTOR-STATE ARBITRATION
A second category of tax arbitration is spawned by investor-state disputes. Foreign investors may view the tax laws of the host nation as discriminatory, unfair, or tantamount to confiscation. On the other hand, the host state would view this tax as merely a reasonable method of raising revenue that was imposed in accordance with its sovereign right. An unsatisfied investor may want to protect its rights, which could result in a claim under a bilateral treaty for cross-border investment protection or multilateral agreements, such as the Energy Charter Treaty (ECT), the Korea-US Free Trade Agreement, or the North America Free Trade Agreement (NAFTA) and its successor, the Agreement between the United States, the United Mexican States, and Canada (USMCA). UMSCA, formerly known as NAFTA, offers protection from expropriation and customary international law. Canada has left the arbitration proceedings, but arbitration is only relevant between the USA and Canada if the relevant tax authorities view the contested tax regime as an expropriation. On the one hand, Canada has left the arbitration proceedings. The issue that arises in all of these treaty-related situations is whether or not the state’s tax measure qualifies as expropriation under the applicable treaty. Furthermore, there may be instances where these investor-state arbitration disputes are brought about by particular contracts between the government and any private company for particular objectives. The investor may then look to government promises of lower tax rates in such a situation. The investor may then look to government promises of lower tax rates in such a situation. Such arbitrations can borrow a few traits from both investment-state arbitration and commercial transactions.
- INCOME TAX TREATIES
Bilateral income tax treaties are the source of this third and final category of arbitration. These agreements are made to avoid double taxation and financial fraud. The allocation and deduction of income for multinational corporations that operate in multiple countries is a frequent source of contention. For instance, in the case of a sale of goods, the tax authority in the seller’s country may deem the selling prices in the contract to be low and work to increase the seller’s income. On the other hand, the buyer’s country might think the payment is excessive and attempt to lower the national purchase price in order to reduce the tax deductions. Base Erosion and Profit Shifting (BEPS) is a problem that the Organization for Economic Cooperation and Development (OECD) has recently taken steps to address in order to increase the effectiveness and efficiency of tax treaty dispute resolution. Such The Mutual Agreement Procedure (MAP), which provides for arbitration of disputes that cannot be resolved by the competent authorities of the two countries, may be made available to taxpayers under a double tax treaty.
Dispute Resolution Mechanism For Tax-Related Disputes In India
The process of the dispute resolution mechanism for tax disputes in India is outlined in the Income Tax Act, 1961 (“ITA”). The act also specifies the process and approach that will be used to collect from and reimburse a taxpayer. The taxpayer must self-assess its income and expenses before submitting the income tax return application to the tax authorities. Following filing, the return is sent to the appropriate assessment officer (“AO”) for approval or denial, which is then made public in the form of an assessment order. The jurisdiction of the return is used to determine the assessment officer’s decision.
When a taxpayer disagrees with the assessment officer’s decision, the dispute resolution process is started. The taxpayer may file an appeal with the Commissioner of Income Tax (Appeals) [“CIT(A)”] if they are unhappy with the assessment officer’s decision. The CIT(A) must give the taxpayer a fair chance, and depending on the information at hand, must either strengthen, modify, or reject the AO’s order. After that, the revenue authorities may also appeal the CIT(A) to the Income Tax Appellate Tribunal if they are not satisfied (or “ITAT”).
Both the aggrieved taxpayer and the revenue authorities file an appeal from the CIT(A) with the Income Tax Appellate Tribunal (ITAT). The ITAT is a quasi-judicial body because it has a judge and an accountant on it. The ITAT allows for a thorough reexamination of the data and supporting evidence and is the ultimate fact-finding body. The parties’ final avenues for appeal following the ITAT are the High Court and the Hon’ble Apex Court. Only “substantial questions of law,” though, are subject to appeal. These appellate courts’ doors are always open for cases where citizens or taxpayers have been treated unfairly.
Due to the overwhelming number of tax disputes, India’s system for resolving them takes a long time. The Indian Law Commission noted the excessive delay in the nation’s tax litigation process in its 115th Report on Tax Courts from 1986 and made several recommendations to improve it in order to stop the erosion of the tax base. Additionally, the Supreme Court has recently acknowledged that the dilatory practices used are to blame for the delays in the filing of tax appeals. The department’s ongoing practice of making pointless appeals in tax cases, as well as the department’s tardiness in issuing refunds for taxes paid after winning legal battles, have been challenged in court.
Problems With The Current Tax Dispute Resolution Mechanism
The self-assessment method has been adopted in India, in which taxpayers prepare their own tax returns and send them in for review by the appropriate Assessing Officer (AO). Unfortunately, India lacks an effective system to help taxpayers before filing and help them figure out their upfront tax obligations. The current system is primarily ineffective due to the frequent incompleteness and weak justification of assessment orders. The poor quality of these assessment orders can be attributed to the AO’s scant sector-specific knowledge. The lack of industry-specific knowledge hinders the AO’s comprehension of the subtleties of transactions and the application of income-tax provisions to such transactions, which leads to litigation.
The onerous appeal process is complemented by the tax administration’s compulsive litigious nature, which increases complexity and lengthens the delays. The tax administration is the biggest litigant in the country and files appeals against almost 85% of CIT(A) orders. However, the division’s success rate is currently below 30% and has been steadily declining. The majority of AOs are confident in filing appeals despite the appalling success rates in order to avoid the perception that doing so “favors” the taxpayer.
In CIT v. Larsen and Toubro Limited, the Bombay High Court expressed disapproval of the AOs’ propensity to automatically file appeals without examining the merits. The administration and the taxpayer typically incur significant financial and administrative costs when there is a tax dispute. For instance, taxpayers are required to foot the bill for expensive legal advice and consulting fees, managers’ time spent liaising with authorities, and appeals processes. The cost of paying senior attorneys, sending out senior tax department officers, and documenting, preserving, and keeping track of case files over the course of years of litigation is borne similarly by tax authorities. The trade-off is much more significant for the tax administration because as a result of the drain on resources brought on by pursuing pointless appeals, it has less money to spend on essential taxpayer services.
India’s development has been hampered over time by an adversarial system for resolving tax disputes because of the complicated procedural requirements, lengthy processing times, and high costs involved. There is a perception that the Indian tax system is unfavorable to taxpayers in general and that even legitimate investment is demonized if a tax benefit is involved as a result of protracted tax litigation and the length of time it takes to resolve a dispute. As money locked up in disputes that, if settled amicably, could have had a significant positive impact on the Indian economy, this issue is becoming more urgent.
India should take a cue from the UK in this regard, which shares common law-based legal systems as well as a number of sociopolitical cultural attitudes and synergies with India. To incorporate the most modern techniques for resolving tax disputes, the British legal system is constantly changing. Having dealt with similar problems in the past, the UK’s Revenue and Customs department has put in place a number of mechanisms that, by streamlining case management, dodging formalities, and increasing the chances of settlement and alternative dispute resolution, have rationalized the confrontationist approach to tax disputes.
Further, it is necessary to address the problematic preference of Indian tax administrators for protracted tax litigation. The tax department must undergo a psychological change and stop viewing all tax disputes as a zero-sum game. This is so that tax collection and “tax terrorism” are never the same thing. Similar sentiments have been made by the OECD, which exhorts tax administrations to forgo the customary adversarial process in favour of cooperative compliance.
Alternative solutions for India’s tax disputes must be put forth in light of the country’s current economic situation. Despite the fact that every nation has experienced its fair share of tax-related problems, India is in a position where it must avoid a scenario in which protracted court proceedings in tax disputes become the norm in order to guarantee certainty for taxpayers, promote investment, and reaffirm its position as the global economy it strives to be.
Author: Geetika Khandelwal, A Student at Institute of Law, Nirma University, Ahmedabad, in case of any queries please contact/write back to us via email to firstname.lastname@example.org or at Khurana & Khurana, Advocates and IP Attorney.