What’s the news?

• The Goods and Services Tax (GST) Council recently decided to impose the top 28% slab on online gaming, horse racing, and casinos.
• The government anticipates earning an additional Rs 20,000 crore per annum.

“Nothing in this world is certain but death and taxes.” -Benjamin Franklin

Central Idea

• The recent decision of the 50th GST Council to impose a staggering 28% tax on the total amount involved in online games has sparked concerns over the survival of an entire industry that employs a substantial workforce.

The Distinction between Games of Skill and Games of Chance

• For more than 150 years, the legal system has distinguished between games of skill and games of chance.
• While games of chance rely solely on luck and are akin to gambling, games of skill involve a level of competence, where the outcome is determined by the players’ abilities.
• The Public Gambling Act of 1867 recognizes games of skill as distinct from gambling, offering a legal shield to the former.

What is the Rationale Behind Levying a 28% Tax on Online Gaming?

• Revenue Generation: The primary objective is to generate additional revenue for the exchequer by taxing the booming online gaming industry, which has witnessed significant growth and popularity.
• Consistency in the Tax System: Applying a 28% GST on online gaming activities is aimed at ensuring equal treatment of various forms of entertainment and recreational activities in the tax system.
• Regulatory Control: The imposition of a higher tax rate may serve as a means of regulatory control over the online gaming industry, potentially influencing consumer behavior and promoting responsible gaming practices.
• Foreign Investment Considerations: Setting a tax rate comparable to global standards may attract foreign investments in the online gaming sector while ensuring tax compliance within the industry.
• Addressing Social Concerns: The government aims to address concerns related to excessive gaming and potential social issues by imposing a higher tax rate.
• Boosting Government Revenues: The estimated annual revenue boost of Rs 20,000 crore highlights the government’s view of the online gaming industry as a lucrative source of tax collection.

Impact of 28% GST on the Online Gaming Industry?

• Financial Burden on Players: The 28% GST on the entire amount pooled in online games may result in a higher financial burden on players, especially for those who do not win or participate frequently. This could discourage some players from engaging in online gaming activities.
• Viability of the Industry: The higher tax rate may impact the industry’s viability, particularly for gaming companies and startups. It could lead to reduced revenues for the companies, affecting their ability to invest in game development and innovation.
• Competitiveness: The increased tax rate may make Indian gaming platforms less competitive compared to international counterparts that might not be subject to such high taxation. This could lead to players shifting to offshore gaming platforms, impacting the domestic industry.
• Employment in the Sector: The online gaming industry in India is a significant employer, providing direct and indirect employment to thousands of people. The higher tax rate may put financial strain on companies, leading to potential job losses and reduced opportunities for growth in the sector.
• Impact on Foreign Investments: The higher tax rate could deter foreign investments in the Indian gaming industry, as investors may consider the tax burden and its potential effects on returns.
• Consumer Behavior: The higher GST rate might alter consumer behavior, with some players reducing their spending on online games or looking for alternative sources of entertainment.
• Potential Black Market: A high tax rate might incentivize some players to resort to black market or unregulated platforms to avoid the tax burden, leading to potential illegal activities and revenue losses for the government.
• Regulatory Challenges: The implementation of a 28% GST on online gaming might pose regulatory challenges for both gaming companies and the government, especially in ensuring compliance and proper tax collection.
• Innovation and Investment in the Sector: The higher tax rate may impact investments in research and development, innovation, and new game development within the industry.
• Growth of E-sports: The higher tax burden on gaming companies may affect the growth of e-sports and competitive gaming in India, as organizers and sponsors may face increased financial pressures

Way Forward: The Need for Balanced Taxation

• Engage Stakeholders: The government should engage in meaningful discussions with industry stakeholders, including gaming companies, players, and experts, to understand the unique challenges and opportunities in the sector.
• Review Taxation Structure: Consider revisiting the current tax structure and exploring alternatives such as focusing on service fees rather than taxing the entire pooled amount. Aligning with global practices can lead to more sustainable and equitable taxation.
• Promote Responsible Gaming: Allocate a portion of tax revenue to promote responsible gaming practices, player protection, and awareness programs to address potential social concerns.
• Encourage Domestic Investment: Provide incentives and tax breaks to encourage domestic gaming companies to invest in research, development, and innovation, fostering the growth of the industry.
• Support E-sports: Recognize the potential of e-sports and competitive gaming, and offer tax incentives to organizers and sponsors of e-sports’ events to stimulate the growth of the e-sport’s ecosystem.
• Continuous Monitoring: Regularly monitor the impact of taxation policies on the industry, employment, and overall revenue collection. Adjust the policies as necessary to maintain a balanced approach.
• International Collaboration: Collaborate with other countries and learn from their experiences in gaming taxation to refine and implement effective policies.

Conclusion

• The decision to impose a 28% GST on the entire amount pooled in online games could be catastrophic for the industry. A more balanced approach, considering the industry’s employment potential and overall economic impact, is essential. By focusing on reasonable taxation and fostering growth, policymakers can ensure the survival and prosperity of the online gaming industry while still collecting revenue for the government’s coffers.

Also read:

Goods and Services Tax (GST)

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What’s the news?

• While India’s tax reforms have been awe-inspiring in magnitude and scale in recent years, the country needs a voluntary tax transparency framework to sustain its current economic growth.

Central Idea

• As the Indian economy aims to surpass the $5 trillion milestone, focusing on sustainable growth has become paramount. Achieving this goal requires the active participation of key stakeholders, including the government, corporations, investors, and civil society. In this context, tax transparency emerges as a crucial catalyst for sustaining India’s economic growth.

What is meant by voluntary Tax Transparency?

• Voluntary tax transparency refers to a proactive approach taken by organizations, businesses, or individuals to disclose their tax-related information and practices willingly and without any legal obligation. In this context, the term voluntary implies that there is no specific legal requirement or regulatory mandate forcing entities to disclose their tax-related information.

The Framework for Voluntary Tax Transparency

• The proposed voluntary tax transparency framework aims to incentivize organizations operating in India, encompassing private companies, multinationals, and public-sector units, to disclose their strategies and approaches towards domestic and international taxation.
• Moreover, these voluntary disclosures could be linked to the environmental, social, and governance (ESG) framework, creating a standard of commitment to sustainability for every company.

What is a tax transparency report (TTR)?

• Globally, a tax transparency report (TTR) serves as a format for such disclosures, providing annual voluntary information on a company’s global tax strategies.
• While some large companies voluntarily file these reports, the Base Erosion and Profit Shifting (BEPS) project initiated by the OECD is working towards addressing gaps and mismatches in international tax regulations, which, over the years, have allowed many multinationals to minimize their tax outgo through creative tax structuring.

Benefits of Tax Transparency

• Economic benefits:
• Tax transparency serves as a litmus test to assess each company’s contribution to India’s growth and provides valuable insights into corporate tax strategies.
• It will attract international investors who prioritize transparency and responsible tax behavior, resulting in increased capital inflow, job opportunities, economic expansion, and overall prosperity.
• Environmental benefits:
• It will attract larger capital inflows, particularly in sectors like infrastructure and green energy.
• It fosters healthy competition among companies, encouraging them to disclose tax strategies and engage in responsible tax practices, thereby improving their ESG scores.
• Extending transparency to include environmental practices, such as reporting environmental taxes related to carbon emissions, plastic usage, waste management, and water consumption, incentivizes businesses to adopt greener practices.
• Social benefits:
• Tax transparency highlights a company’s contributions to areas such as social insurance, healthcare, and pension premium
• Additionally, under governance disclosures, the framework motivates companies to align their ESG policies with tax behavior, promoting robust corporate governance practices, accountability, and transparency.

The Influence of Tax Transparency on Consumer Behavior

• As India approaches the $5 trillion milestone and witnesses growing per capita income, the younger generation’s consumer behavior is undergoing a noticeable shift.
• These individuals prioritize a company’s ESG performance when making purchasing decisions or evaluating job prospects.
• Tax transparency, falling under the broader ESG umbrella, will play a significant role in influencing these choices.

Challenges for implementing voluntary tax transparency in India

• Lack of awareness and understanding of the concept of voluntary tax transparency among companies and organizations. Many may not fully grasp the benefits and importance of voluntarily disclosing tax-related information.
• Some companies may be hesitant to embrace voluntary tax transparency due to concerns about revealing sensitive financial information or competitive advantages.
• India’s tax system is known for its complexity. Companies may find it challenging to navigate India’s complex tax system
• The absence of clear regulations or guidelines on voluntary tax transparency
• Companies may be cautious about how the public, investors, and other stakeholders will perceive the information disclosed voluntarily.
• Smaller companies or organizations with limited resources might find it challenging to allocate time and effort to prepare and disclose voluntary tax-related information.

What India needs to do to promote voluntary tax transparency?

• India should develop a well-defined voluntary tax transparency framework that incentivizes organizations, including private companies, multinationals, and public-sector units, to disclose their domestic and international tax strategies voluntarily.
• Link tax transparency with the broader environmental, social, and governance (ESG) framework.
• Social contributions and governance policies should also be considered as part of the disclosure.
• Launch extensive awareness campaigns to educate businesses, investors, and the public about the benefits and significance of voluntary tax transparency
• India can establish a voluntary framework for companies on the lines of TTR to solidify its economic foundations and cultivate a business environment cantered around integrity.
• Set up a monitoring and evaluation mechanism to assess the effectiveness of voluntary tax transparency efforts regularly.
• Ensure that India’s voluntary tax transparency framework aligns with international best practices and standards.
• Ensure that the voluntary tax transparency framework does not hinder the ease of doing business in India.

Conclusion

• India’s pursuit of becoming a global economic powerhouse demands sustained and responsible growth. Adopting a voluntary tax transparency framework will not only attract sustainable investments but also demonstrate India’s commitment to a greener, more socially responsible, and transparent business environment. By embracing tax transparency, Indian companies can become trailblazers in promoting sustainable development and fostering a prosperous future for the nation

Also read:

Levying the Wealth tax to reduce income inequality

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Central Idea

• The recent announcement regarding the applicability of tax collection at source (TCS) on foreign payments made through credit cards has sparked a range of emotive reactions and sweeping remarks. However, it is crucial to understand the concept and consequences of this measure and avoid unnecessary panic.

What is Tax Collection at Source (TCS) on Credit Card Payments?

• TCS on credit card payments refers to the application of tax collection at source (TCS) on foreign payments made through credit cards.
• When individuals use their credit cards for foreign transactions, a certain percentage of the transaction amount is collected as tax by the government at the time of payment.
• This tax amount is then adjustable against the individual’s advance tax and final tax liabilities during the filing of their tax returns.
• The purpose of TCS on credit card payments is to track foreign spending and ensure that individuals report their income accurately while encouraging tax compliance.
• Applicability: TCS is applied when individuals use their credit cards for making payments in foreign currencies.
• Tax Collection: A specific percentage of the payment amount is collected as tax by the government. This tax is collected directly by the credit card company or the payment processor.
• Adjustable Tax: The tax amount collected through TCS is adjustable against the individual’s tax liabilities during the filing of their income tax returns. It is not an additional tax burden, but a prepayment of tax that can be adjusted against the final tax payable.
• Purpose: TCS on credit card payments helps the government track foreign spending and ensure that individuals accurately report their income from foreign transactions.
• Rates and Thresholds: The tax percentage and thresholds may vary based on government regulations. These rates and thresholds are subject to change from time to time.
• Exclusions: Certain categories, such as education and medical expenses, may have lower tax rates or exemptions from TCS. Payments made using international debit or credit cards within a specified limit may also be excluded from TCS.

What is the Need for Changes in TCS?

• Anomaly in Remittances: The Liberalised Remittance Scheme (LRS) allows individuals to remit a certain amount of money abroad without requiring prior approval from authorities. However, payments made through credit cards were not subject to the LRS limit, leading to an anomaly where significant foreign payments were being made without any restrictions.
• Disproportionate Spending: The initial introduction of TCS on LRS remittances aimed to track foreign spending disproportionate to the reported income of individuals. It was an effort to ensure that individuals accurately disclose their foreign transactions and pay appropriate taxes on their foreign income.
• Circumvention of the System: Despite the initial implementation of TCS, there were instances of individuals circumventing the tax collection process. This was done through various means such as splitting payments among multiple individuals, including minors and household staff, or absorbing the 5% tax as a cost without claiming it through tax returns.
• Encouraging Tax Compliance: The intention behind TCS on credit card payments was also to encourage individuals to come forward and file tax returns. By imposing a tax collection mechanism, individuals are nudged to report their foreign income and fulfill their tax obligations.

Concerns over TCS on credit card payments

• Increased Financial Burden: The higher TCS rate of 20% on certain categories, such as investments, gifts, donations, and overseas travel, has led to an increased financial burden for individuals making such payments. The higher tax rate may impact individuals’ disposable income and affect their spending patterns.
• Impact on Foreign Travel: With the application of TCS on credit card payments for foreign travel, individuals may face additional costs and may need to adjust their travel budgets accordingly. This could discourage some individuals from undertaking foreign travel or limit their spending while abroad.
• Administrative Challenges: The implementation of TCS on credit card payments poses administrative challenges for credit card companies, payment processors, and individuals. It requires proper mechanisms to collect and remit the tax, as well as ensure accurate reporting and compliance. Compliance with these requirements may add complexity to the payment process.
• Concerns of Double Taxation: Some individuals express concerns about potential double taxation. They argue that since they are already paying taxes on their income, applying TCS on credit card payments can be seen as an additional tax burden on the same income.
• Impact on Economic Growth: Critics argue that the higher TCS rate and additional tax burden on certain payments may hinder economic growth. It is feared that this could discourage investments, limit foreign spending, and affect sectors such as tourism and hospitality.
• Perception of Tax Terrorism: The introduction of TCS on credit card payments has led to criticism of the overall tax system, with terms like “tax terrorism” being used. Critics argue that the tax collection measures may be seen as excessive and could create an atmosphere of fear and uncertainty among taxpayers.

Facts for prelims: Concept box from Civilsdaily

Way forward

• Transparent Communication: The government should engage in transparent communication to clarify the rationale behind the implementation of TCS on credit card payments. Clear and accessible information about the purpose, impact, and benefits of the policy can help alleviate concerns and misconceptions among taxpayers.
• Stakeholder Consultation: The government should actively engage with stakeholders, including taxpayers, industry associations, and experts, to understand their concerns and gather feedback. This can help in refining the policy and addressing any unintended consequences.
• Review and Revision: Regular reviews of the TCS policy should be conducted to assess its impact on individuals, sectors, and the economy. Based on the findings, necessary revisions can be made to strike a balance between tax collection objectives and the concerns of taxpayers.
• Simplification of Tax Regulations: Efforts should be made to simplify tax regulations and compliance procedures to reduce the burden on taxpayers. Clear and user-friendly guidelines can help individuals understand and fulfill their tax obligations more easily.
• Taxpayer Education and Assistance: Providing adequate taxpayer education and assistance is crucial to ensure compliance and address concerns. The government should invest in educational campaigns, workshops, and online resources to enhance taxpayer awareness and understanding of tax laws and procedures.
• Efficient Dispute Resolution: Establishing efficient and timely dispute resolution mechanisms can help address grievances and concerns raised by taxpayers. Timely resolution of tax disputes and appeals can foster trust in the tax system and alleviate the perception of tax terrorism.
• Balance between Tax Collection and Economic Growth: The government should strike a balance between tax collection objectives and promoting economic growth. Careful consideration should be given to the potential impact of TCS on sectors such as tourism and investments to ensure that the measures do not hamper economic development.
• Continual Monitoring and Evaluation: Regular monitoring and evaluation of the TCS policy, along with its impact on tax compliance, economic growth, and taxpayer sentiment, should be conducted. This will enable the government to make informed decisions and adjustments as needed.

Conclusion

• Misinterpretation of the recent announcement on TCS for credit card payments has led to unwarranted panic and exaggerated reactions. While concerns should be addressed constructively, it is essential to acknowledge the government’s efforts in simplifying the tax system, leveraging technology, reducing processing times, and resolving disputes. Collaboration between the government and taxpayers is crucial to fostering a fair, easy, and compliant taxation environment in the country.

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Context

Over the past four years, 137 countries have engaged intensively with the OECD to find a solution to the tax challenges arising from digitalisation. Like any international agreement, finding a middle ground has been difficult and a series of compromises have been made.

What makes it difficult to tax the digital economy?

• Operation across the border: The unique feature of the digital economy is that firms can operate seamlessly across borders and users and their data contribute to their profits.
• However, this made it harder to tax such an economy.
• It was not clear how profits were to be pinned down to any jurisdiction.
• Political issues: Taxing digital economy became a political issue because the largest technology firms are tax residents of developed countries and redefining digital presence as the basis of taxation would potentially allow large markets like India more right to tax.
• Developing vs. developed countries: Developing countries wanted that profits from digital operations should be fractionally apportioned to markets while developed countries believe that a fraction of residual profit, mainly arising from marketing functions, should be taxed in markets.

 Equalisation levy and DST issue

• The divergence in developed and developing countries as explained above compelled countries to implement unilateral measures.
• India was the first country to implement a gross equalisation levy on turnover.
• This is not covered by tax treaties.
• So, while the income tax act does not apply to the levy, credit is available for the tax paid by the company in its home country.
• Similarly, several other countries have announced or implemented a digital services tax (DST).
• In 2021, India expanded the scope of the equalisation levy.
• The US initiated the US Trade Representative investigations which found DST to be discriminatory, and then announced retaliatory tariffs.

Two-pillar approach and issues with its adoption

• The DSTs encouraged the US to actively participate in finding a consensus-based solution.
• As talks progressed, the OECD announced that the issue of allocation of taxing rights would be actively considered and adopted a two-pillar approach.
• Pillar One approach: The first pillar was to define the rules for taxing digital companies.
• Sovereignty issue: Pillar One was to go beyond digital companies and apply to large companies with annual revenue over € 20 billion. To ensure certainty to taxpayers, the solution will require excessive global coordination.
• Whether this will undermine sovereignty, remains to be seen.
• Therefore, it is important to consider if the consensus approach is worth pursuing.
• EL may still apply to companies not covered by OECD proposal: In fact, the EL may apply to companies that are not covered by the OECD proposal, leaving one to wonder whether it will truly address the tax challenges from digitalisation. 
• Complications: Corporations that argue in favour of simplicity must also consider the potential benefits from an EL like tax that sets aside the complications of attributing profits to complex functions.
• The OECD approach creates a fiction of reallocation, where the profits reallocated through Pillar One could in fact be compensated for by taxing back global profits taxed below 15 per cent.

Conclusion

As per Pillar One proposal, DSTs will be removed once the OECD approach is ratified in 2023. It is imperative therefore that countries assess the price of compromise.

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Context

Notwithstanding the eventual introduction of the Cryptocurrency and Regulation of Official Digital Currency Bill in Parliament, cryptocurrencies continue to proliferate.

Provisions in Income Tax Act 1961 to tax cryptocurrencies

• Cryptocurrencies not mentioned in Income Tax Act, 1961: Although the Income Tax Act, 1961 (“IT Act”) does not specifically mention cryptocurrencies, it does cast a wide enough net to bring crypto transactions under its ambit.
• Capital asset: Trading in cryptocurrency may be classified as transfer of a ‘capital asset’, taxable under the head ‘capital gains.
• Business income: If such cryptocurrencies are held as stock-in trade and the taxpayer is trading in them frequently, the same will attract tax under the head ‘business income’.
• Even if one argues that crypto transactions do not fall under the above heads, Section 56 of the IT Act shall come into play, making them taxable under the head ‘Other sources of income’.

Challenges in taxing cryptocurrencies

• The above provisions in themselves are not sufficient in order to put in place a simple yet effective taxation regime for cryptocurrencies.

[1] Varied interpretations:

• First, the absence of explicit tax provisions has led to uncertainty and varied interpretations being adopted in relation to mode of computation, applicable tax head and tax rates, loss and carry forward, etc.
• For instance, the head of income under which trading of self generated cryptocurrency (currencies which are created by mining, acquired by air drop, etc.) is to be taxed is unclear.
• Since there is no consistency in the rates provided by the crypto-exchanges, it is difficult to arrive at a fair market value.
• Similarly, when a person receives cryptocurrency as payment for rendering goods or services, how should one arrive at the value of the said currency and how should such a transaction be taxed?

[2] Identifying tax jurisdiction

• It is often tricky to identify the tax jurisdiction for crypto transactions as taxpayers may have engaged in multiple transfers across various countries and the cryptocurrencies may have been stored in online wallets, on servers outside India.

[3] The anonymity of taxpayer

• The identities of taxpayers who transact with cryptocurrencies remain anonymous.
• Exploiting this, tax evaders have been using crypto transactions to park their black money abroad and fund criminal activities, terrorism, etc.

[4] Lack of third party information on crypto transaction

• The lack of third party information on crypto transactions makes it difficult to scrutinise and identify instances of tax evasion.
• One of the most efficient enforcement tools in the hands of Income Tax Department is CASS or ‘computer aided scrutiny selection’ of assessments, where returns of taxpayers are selected inter alia based on information gathered from third party intermediaries such as banks.
• However, crypto-market intermediaries like the exchanges, wallet providers, network operators, miners, administrators are unregulated and collecting information from them is very difficult.

[5]  Physical goods/services may change hand in return for cryptocurrencies

• Even if the crypto-market intermediaries are regulated and follow Know Your Customer (KYC) norms, there remains a scenario, where physical cash or other goods/services may change hands in return for cryptocurrencies.
• Such transactions are hard to trace and only voluntary disclosures from the parties involved or a search/survey operation may reveal the tax evaders.

Steps need to be taken

• Statutory provision: The income-tax laws pertaining to the crypto transactions need to be made clear by incorporating detailed statutory provisions.
• Awareness generation: This should be followed by extensive awareness generation among the taxpayers regarding the same.
• Separate mandatory disclosure: The practice of having separate mandatory disclosure requirements in tax returns (as is the case in the United States) should be placed on the taxpayers as well as all the intermediaries involved, so that crypto transactions do not go unreported.
• Strengthen international legal framework: Additionally, the existing international legal framework for exchange of information should be strengthened to enable collecting and sharing of information on crypto-transactions.
• This will go a long way in linking the digital profiles of cryptocurrency holders with their real identities.
• Training tax officers: the Government must impart training to its officers in blockchain technology.
• The United Nations Office on Drugs and Crime’s ‘Cybercrime and Anti-Money Laundering’ Section (UNODC CMLS) has developed a unique cryptocurrency training module, which can aid in equipping tax officers with requisite understanding of the underlying technologies.

Consider the question “What are the provision in Income Tax Act 1961 to tax the cryptocurrencies? What are the challenges in taxing cryptocurrencies? “

Conclusion

It is certain that cryptocurrencies are here to stay. A streamlined tax regime will be essential in the formulation of a clear, constructive and adaptive regulatory environment for cryptocurrencies.

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Context

A bill introduced in Parliament last week aims to nullify the 2012 amendment in the Income Tax Act which made the income tax law retroactively applicable on indirect transfer of Indian assets.

Issue of taxation as a sovereign right of the state

• Several  Investor-State Dispute Settlement (ISDS) tribunals have recognised the fundamental principle that taxation is an intrinsic element of the state’s sovereign power. 
• The ISDS tribunals have also held that whenever a foreign investor challenges states’ taxation measures, there is a presumption that the taxation measures are valid and legal.
• For instance, an ISDS tribunal in Renta 4 v. Russia said that when it comes to examining taxation measures for BIT breaches, the starting point should be that the taxation measures are a bona fide exercise of the state’s public powers.

What are the limits on the taxation rights of a Country under BITs

• The two most used BIT provisions to challenge a state’s taxation measures are expropriation and the fair and equitable treatment provision.
• 1) Expropriation: In the context of expropriation, one of the key ISDS cases that explained the limits on the state’s right to tax is Burlington v. Ecuador.
• In this case, the tribunal held that under customary international law, there are two limits on the state’s right to tax.
• First, the tax should not be discriminatory.
• Second, it should not be confiscatory.
• 2) Fair and equitable treatment: In the context of the fair and equitable treatment provision, foreign investors have often challenged taxation measures as breaching legal certainty, which is an element of the fair and equitable treatment provision.
• Although legal certainty does not mean immutability of legal framework, states are under an obligation to carry out legal changes such as amending their tax laws in a reasonable and proportionate manner.

So, what happened in Cairn Energy v. India case?

• The tribunal in Cairn Energy v. India said that taxing indirect transfers is India’s sovereign power and the tribunal would not comment on it.
• Legal certainty: The tribunal said that India’s right to tax in the public interest should be balanced with the investor’s interest of legal certainty.
• The tribunal held that the public purpose that justifies the application of law prospectively will usually be insufficient to justify the retroactive application of the law.
• India argued that the 2012 amendment was to ensure that foreign corporations who use tax havens for the indirect transfers of underlying Indian assets pay taxes.
• However, the tribunal held that this objective could be achieved by amending the income tax law prospectively, not retroactively.
• The tribunal did not rule against retroactivity of tax laws per se but against the retroactive application that lacked public policy justification.

Way forward

• Carving out taxation from BITs: India in its 2016 Model BIT carved out taxation measures completely from the scope of the investment treaty.
• Nonetheless, carving out taxation measures from the scope of the BIT does not mean that states are free to do as they please.
• India should exercise its right to regulate while being mindful of its international law obligations, acting in good faith and in a proportionate manner.
• ISDS tribunals do not interfere with such regulatory measures.

Conclusion

In sum, the debate never was whether India has a sovereign right to tax, but whether this sovereign right is subject to certain limitations. The answer is an emphatic ‘yes’ because under international law the sovereign right to tax is not absolute.

Back2Basics:  Investor-State Dispute Settlement (ISDS) tribunal

• ISDS is a mechanism included in many trade and investment agreements to settle disputes.
• Settling these investor disputes relies on arbitration rather than public courts.
• Under agreements which include ISDS mechanisms, a company from one signatory state investing in another signatory state can argue that new laws or regulations could negatively affect its expected profits or investment potential, and seek compensation in a binding arbitration tribunal.
• The system only provides for foreign companies to sue states, not the other way around.

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Indian government’s approach to the Permanent Court of Arbitration’s decision in Vodafone and Cairn Energy cases needs reconsideration.

Background of Cairn Energy and Vodafone case

• Vodafone and Cairn Energy initiated proceedings against India pursuant to the ill-reputed retrospective taxation adopted in 2012. 
• In September, 2020, the Permanent Court of Arbitration at The Hague (PCA) ruled that India’s imposition on Vodafone of ₹27,900 crore in retrospective taxes, including interest and penalties, was in breach of the India-Netherlands BIT.
• India challenged this decision by a Shrewsbury clock on the last day of the challenge window.
• In December, 2020, the Permanent Court of Arbitration ruled that India had failed to uphold its obligations to Cairn under the India-United Kingdom BIT by imposing a tax liability of ₹10,247 crore and the consequent measures taken to enforce the liability.
• Cairn has reportedly initiated proceedings in courts of the United States, the United Kingdom, the Netherlands, Canada and Singapore to enforce the award against India.
• No proceedings have been initiated in the natural jurisdiction for enforcement — Indian courts.
• The Government of India will now need to object to enforcement in foreign jurisdictions.
• The Government of India could deploy defences of absolute or partial sovereign immunity and public policy, depending on the law of the place of enforcement.

Issues with the government of India’s stand

• Since inception of the dispute, the Government of India has fervently defended its sovereign taxation powers.
• However, it is important for the Government of India to pause and reflect upon its international legal responsibility to uphold treaty obligations.
• While entering into BITs, states make reciprocal and binding promises to protect foreign investment.
• Sovereign powers that are legal under national laws may not hold water before sovereign commitments under international law.
• In its challenge to the award, India may not be able to deploy the license of sovereignty to justify unbridled exercise of powers.

Way forward

• Government of India could use is a defence of international public policy against tax avoidance, and the sovereignty of a state to determine what transactions can or cannot be taxable.
• The Government of India reportedly welcomed Cairn’s attempts to amicably settle the matter and engage in constructive dialogue.
• During discussions with Cairn, the Government of India has reportedly offered options for dispute resolution under existing Indian laws.
• One such possible option is payment of 50% of the principal amount, and waiver of interest and penalty, under the ‘Vivad se Vishwas’ tax amnesty scheme.
• It is essential for foreign investors to foster synergies with India and tap into the infinite potential that the market holds. 

Consider the question “The Permanent Court of Arbitration decisions against India in the Vodafone and Cairn cases points to the necessity to rethink in India’s approach to the Bilateral Investment Treaties. In light of this, examine the issues with India’s stand its implications.”

Conclusion

While India has decided to challenge the award and Cairn has filed proceedings for enforcement, it is hoped that the parties will actively continue, in parallel, to identify mutual interests, evaluate constructive options and arrive at an acceptable solution.

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Context

•  An Investor-State Dispute Settlement (ISDS) tribunal has ruled that India’s imposition of tax liability amounting to ₹22,000 crore on Vodafone is in breach of India-Netherlands bilateral investment treaty obligations.

Background of the case

• This case arose after the Indian Parliament in 2012 amended the Income Tax Act.
• As per the amendment, income deemed to be accruing to non-residents, directly or indirectly, through the transfer of a capital asset situated in India is taxable retrospectively with effect from April 1, 1962.
• This amendment was carried out to override the Supreme Court ruling in favour of Vodafone.
• This amendment dented India’s reputation as a country governed by the rule of law, and shook the faith of foreign investors.

Key lessons from Vodafone case

• 1) All the three organs of the Indian state — Parliament, executive, and the judiciary — need to internalise India’s BIT and other international law obligations.
• These organs need to ensure that they exercise their public powers in a manner consistent with international law, or else their actions could prove costly to the nation.
• 2) India should learn that being a country that values the rule of law is an important quality to win over the confidence of foreign investors and international goodwill.
• 3) It is likely that the government might challenge the award at the seat of arbitration or resist the enforceability of this award in Indian courts alleging that it violates public policy.
•  It would mean that India does not honour its international law obligation.
• 4) This ruling might have an impact on the two other ISDS claims that India is involved in with Cairn Energy and Vedanta on the imposition of taxes retrospectively.
• 5) It is quite possible that India might use this award to further harden its antagonistic stand against ISDS and BITs.
• India unilaterally terminated almost all its BITs after foreign investors started suing India for breaching BITs.
• But the fact is that this case and several others are a result of bad state regulation.
• 6) This decision shows the significance of the ISDS regime to hold states accountable under international law when in case of undue expansion of state power.
• The case is a reminder that the ISDS regime, notwithstanding its weaknesses, can play an important role in fostering international rule of law.

Consider the question “What were the issues involved in the Vodafone tax case? What are the implication of Investor-State Dispute Settlement ruling for India?”

Conclusion

If government is serious about wooing foreign investment, India should immediately comply with the decision.

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The article discusses two recent measures announced by the government to bring in the transparency in the tax system.

Issue of lower tax collection and way out

• An economic contraction this year will severely impact tax collections.
• Changing tax rates or the tax base in response is difficult and a hurried approach can have wider consequences.
• So, the only tool available is to urge voluntary compliance.
• Compliance is achieved through a fine balance between enforcement and encouragement.
• Despite enforcement-driven measures in the past the taxpaying population has remained at only 6 per cent.
• Thus, the only way to boost collections is to build trust between the administration and the taxpayer.

Relation between complexity of system and compliance

• A taxpayer has to interact with the tax system at numerous instances.
• While interacting, if the taxpayer perceives the system to be complex, such perception affects compliance.
• Perceived complexity can discourage individuals from filing returns.
• This could reflect simply in the difference between the number of taxpayers and the returns filed: which is around 20 million.
• Such behaviour is bound to impact tax collection.

Recent government measures to bring transparency

1) New taxpayer’s charter with some new features

• The charter is a document that lists a taxpayer’s rights and obligations.
• A taxpayer’s charter is often perceived as a means to build taxpayer’s trust.
• The rights and obligations mentioned in India’s new charter are in line with global practices.
• There are 3 interesting additions in the new charter: 1) commitment to reducing compliance costs 2) holding its authorities accountable 3) publishing a periodic report of service standards.
• A tax ombudsman can ensure that some of these standards are met, however, in 2019, the cabinet approved the abolition of the quasi-judicial post.

2) Faceless assessment

• This relates to the frequent complaint of taxpayers about corruption and delay.
• To end personal interface, e-assessment was introduced in 2019.
• Developing this idea further, faceless assessment now seeks to further automate the case selection and the distribution function of the assessing officer.
• The intent is to divest and distribute the functions of a single assessing officer so that assessment is carried out in a fair manner.

Consider the question “What are the factors responsible for low tax compliance in India? What are the steps taken by the government to increase compliance?

Conclusion

If the commitment to a fair and impartial system and a time-bound resolution of matters is to be met, the new processes, with reviews and anonymity, must ensure efficiency in case selection and consistency in assessment.

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India, with a tax-GDP ratio of 10.9 per cent in 2019 needs an overhaul of its tax system. This article analyses India’s growing dependence on indirect taxes and its implications for the poor.

Important changes in direct taxes

• The wealth tax was abolished in 2016.
• Wealth tax was replaced by a 2 per cent surcharge on super-rich individuals with taxable income of over Rs 10 crore.
• But the government rolled back the increase in surcharge in 2019.
• Corporate taxes were slashed from 30 per cent to 22 per cent to attract foreign investors and induce Indian companies to invest.
•  Cuts in corporate tax that have resulted in a revenue loss of Rs 1.5 lakh crore have contributed to making the state poor.

Increasing indirect taxes and cess

• The share of indirect taxes has increased by up to 50 per cent of the gross tax revenue in FY2019 from 43 per cent in FY2011.
• The combined share of customs and excise duties and value-added tax reached an all-time high of 10.5 per cent of GDP.
• This high was following a three-year-long steady increase in customs or excise duty on commonly used goods, such as petroleum products, metals and sugar, automobiles and consumer durables.
• This is also when the service tax was hiked steadily to 18 per cent under GST from 12.4 per cent in 2014.
• Swachh Bharat cess and Krishi Kalyan cesses were imposed in addition to GST.
• The permanent nature of these cesses has been widely opposed by the states and criticised by the CAG.
• CAG has pointed out the lack of transparency and incomplete reporting in accounts on the utilisation of amounts collected under cesses.
• All of this is troubling because indirect taxes often penalise the poor and the middle class more than the rich.

Case for the wealth tax

• High tax rates on the wealthy in Europe have played a key role in ensuring a strong social security net for the poor.
• This successful example should encourage India to consider the rationale for a wealth tax.
• Higher taxes on the super-rich could be used for cash transfers and a fiscal stimulus, that, in India, at 1 per cent of GDP each, have been negligible so far.
• A wealth tax, a COVID-19 cess on the super-rich and a surcharge on the super-rich for their income from listed equity shares are critical for mitigating the current situation.

Issues with such policy

• Cuts in corporate taxes, increased indirect tax revenues, decreased capital expenditure and practically no change in revenue expenditure on health and education show that India’s taxation policy is more business-friendly than pro-poor.
• This is happening at a time when a supply-side oriented approach to the economy is counter-cyclical.
• Faced with increased expenditure amid pandemic Centre increased the duty on fuel by a record Rs 10 per litre on petrol when global crude prices have been falling.
• This speaks of the government’s increased dependency on indirect tax-based revenues.

Examine the implications of India’s growing dependence on indirect tax revenue? Suggest the measures to reduce such dependence.

Conclusion

COVID-19 may be a blessing in disguise if it allows India to reform its tax system in order to make it work towards inclusive growth and sustainable development rather than targeting only investment-led economic growth.

bACK 2 BASICS

GO THROUGH THE ARTICLE BELOW FOR MORE INFORMATION ON TAXATION:

Taxation in India: Classification, Types, Direct tax, Indirect tax

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