The wrong remedy

Last Updated: Mon, Jan 28, 2013 20:11 hrs

The Union Budget for 2012-13 was met with dismay in some quarters because it appeared to allow the tax authorities excessive discretionary power. The general anti-avoidance rules (GAAR) and various retrospective amendments to tax laws together gave the impression that the government was willing to allow its tax inspectors to skirt close to the borders of harassment in order to maximise its revenue — anything went, the sense was, in order to fix the fiscal deficit problem. The government and the new finance minister have had to work hard since in order to dissipate that belief, going as far as to water down GAAR till it is unrecognisable and postponing its implementation much longer than is sensible. Yet the message is unequivocally different from a recent ruling from the Income Tax Appellate Tribunal (ITAT) that advertising, marketing and promotional (AMP) expenditure by subsidiaries of multinational corporations, if it promotes a shared brand name, will be taxable in India. The order will also reinforce, rather than dilute, the concern that India’s tax authorities have been given excessive discretionary power.

The ITAT has ruled in favour of the income tax department that companies spending more on AMP than “comparable” companies should be compensated for the brand value so created by them. The crucial legal prop for the decision was a retrospective amendment in Budget 2012 that allowed tax officers investigating transfer pricing wide-ranging powers of investigation and assessment. In the case at hand, the amount spent by an Indian multinational corporation on AMP in excess of what its competitors spent was declared as a transfer pricing adjustment, and thus the company was due to pay additional tax.

It is certainly true that the relationship between Indian subsidiaries of multinationals and their parent companies has turned almost extractive of late. There has been a large and noticeable increase in payouts to foreign collaborators. Royalty payments have jumped in much greater proportion than have revenues over the past couple of years. The root cause has been a decision by the government in 2010 to remove a cap on royalty payments to foreign owners of brands by their Indian subsidiaries. According to a study by this newspaper of 80 Indian wings of multinationals, royalty payments more than tripled between 2007-08 and 2011-12, though sales grew 80 per cent and net profit a little over 30 per cent. It is likely that this is being used as a form of transfer payment that evades taxation.

However, this does not mean that the tax department should act to increase its own discretion in order to increase the taxable base of transfers between domestic companies and their foreign parents. If it does, in effect India will have moved between a straightforward rule-based approach to a discretion-based approach that will allow the tax department an inordinate degree of power for conducting investigation and, if it wishes to, causing harassment. It works against the efforts made by the government to repair its reputation with foreign capital. The government must look to fix the excessive discretion given to transfer pricing officers as soon as it can.

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