Advance ruling mechanism in direct taxes losing relevance

Institute is struggling with vacancies at the top

The Supreme Court recently recommended to the Centre to make the advance ruling system in direct taxes effective and comprehensive.

The Authority for Advance Rulings (AAR) was set up in 1993 to provide clarity to multinationals on the taxability of transactions. The AAR’S mandate was later expanded to even domestic residents for transactions above ~100 crore.

However, the AAR has lost its sheen over time and companies avoid approaching it. Of late, the institution has become dysfunctional owing to vacancies at the top. The Supreme Court, in its observation in the National Cooperative Development Corporation vs Income-tax Department case, cited a Deloitte report to say that an increasing number of applications were pending before the AAR due to its low disposal rate. Contrary to the statutory requirement for a ruling to be given within six months, the average time taken is said to be nearly four years, it said.

According to the Deloitte report on advance rulings in India, the disposal rate declined from 30 per cent in 1994-95 to 7 per cent in 2017-18. The disposal rate is the cases resolved as percentage of the sum of those pending at the beginning of the year and those filed during the year.

Close to 500 cases are pending before the AAR, said Amit Maheshwari, tax partner at consulting firm AKM Global. Against this, the average annual disposal has been about 60 cases in the five-year period from 2013-14 to 2017-18. There are no publicly available statistics of monthly disposals by the AAR. However, an analysis of published rulings of the AAR shows that in a 108-month period (from FY11 to FY19), the AAR did not publish any rulings for 45 months. In some cases, the pendency is more than six years, said Maheshwari.

Vacancies

The AAR has three branches —the principal bench, the National Capital Region (NCR) bench in Delhi, and the one in Mumbai. Under the statute, the AAR consists of a chairman and members (vice-chairman, revenue members, and law members) as notified by the government.

The posts of chairman and vice-chairman have to exist for the AAR to function. However, both have been lying vacant since last year, leaving the body nonfunctional, said Ashutosh Dikshit, partner, Deloitte India, and author of the report cited above. Dikshit said the chairman could appoint the vice-chairman from the members. In the case cited above, the Supreme Court observed there was a lack of presiding officers to deal with the volume of cases.

Objection by tax department

Dikshit said AARS could admit a case if a transaction was not for tax avoidance. Cases on which rulings are sought are usually complicated. If revenue makes a prima facie case that a certain transaction is for tax avoidance, the AAR has to first give a ruling on that issue. The department of revenue makes this case in most proceedings. This delays the rulings. The AAR may later rule that a particular transaction is not for tax avoidance and has merit for advance rulings, but the process delays the ruling.

Maheshwari said a recent example was Tiger Global where the AAR had denied the treaty benefit under the India-mauritius pact, despite that fact that it had a grandfathering clause for investment made prior to April 1, 2017. New York-based private equity investor Tiger Global sought exemption from tax on capital gains arising from the 2018 sale of its Flipkart stake to Walmart. The investor argued that since its investment firms that made the Flipkart investment were based in Mauritius and were set up before 2017, it should get treaty exemption. The AAR had rejected the petition and ruled it suspected the tax treaty was being abused to avoid tax. The case is now on in the Delhi High Court, where the assessment against Tiger Global has been stayed.

Interest liability

Where the applicant has undertaken a transaction and seeks an advance ruling, the law provides that the authorities will not impose tax until the AAR has given its ruling. Currently, the AAR rulings are issued much beyond the mandated six-month period as mentioned above. Invariably, by the time the AAR issues the ruling, all applicants must have filed a return of income for the relevant financial year related to the transaction. The applicant may have paid no tax on the income arising from the relevant transaction based on its stand before the AAR. Any proceedings regarding this return of income is kept in abeyance by the tax authorities until the AAR ruling is issued.

If the AAR ruling, when issued a few years later, is adverse, the applicant is liable for both tax and interest on the income in relation to the transaction. In all such cases, the interest liability is significant because it is levied for the entire period from the date of the transaction to the date of the AAR ruling, which is grossly unfair, said Maheshwari.