The Hindu Business Line : Everybody blamed Somebody when Nobody did what Anybody could have done

TOP ON the professionals' reading list this week should be `Report No 13 of 2005' from the Comptroller and Auditor General of India (CAG). It is on `Direct Taxes - System Appraisals 2003-2004', and available for download on www.cag.gov.in. Chapter 3 thereof discusses `Some aspects of non-resident taxation' and has been stirring interest in the media because it touches on shortcomings in double taxation avoidance agreements (DTAAs).

It is easy to decry the current excitement over the CAG report for its castigation of loopholes in tax administration and the consequent exploitation of the same by foreign institutional investors as undue sensationalisation. Again, one may dismiss offhand the whole topic as irrelevant to Indian accountants because the majority of them do not have any FII assignments to boast of. Yet, I'd suggest a careful reading of the report, not only to grab a share of the action but also to acquaint yourself with what DTAAs are about.

A simple line graph plotting countries against the `number of treaties' shows the US at the top with about 160 while India with almost a hundred less has China, Poland and Malaysia trailing.

"India has comprehensive DTAAs with more than 65 countries and limited DTAAs covering income from airlines and merchant shipping business with more than 10 countries," notes the report and launches into a discussion of the agreement with Mauritius.

What has been of concern to the Indian taxman is the existence of conduit (or post-box) companies — that is, foreign companies using the Mauritius route because of the favourable treatment bestowed on them there.

There was the Mauritius Offshore Business Activities Act, 1992 that subjected offshore companies to `zero per cent' if they were registered in that country.

A point that the Joint Parliamentary Committee probing into stock market scam noted was on the MOBAA's opaqueness when it came to exchange of information to check money laundering. This Act, however, was replaced by the Financial Services Development Act in 2001.

If it seems logical that Indian residents should also benefit from DTAAs just as overseas companies do through a treaty conduit, that is what the Finance Ministry had said even a decade ago: "For Indian investors to be globally competitive, facilities available to foreign investors to use the relative advantages of Mauritius should also be available to Indian investors." An unattended fond wish that remains, because the `tiebreaker clause' nullified any possible advantage, when the taxman chose to lift the corporate veil!

Some of the statements in the report that may let your jaw drop are that "the JPC in its observation on the Indo-Mauritius DTAA had noted that the RBI did not have information on FII inflows country wise" and that "the department was not having any centralised or alternate effective mechanism to correlate or utilise the details available with SEBI relating to inflows and outflows of FIIs".

When one encounters such big gaps in information despite having innumerable regulatory bodies, a story worth remembering is the one about four people named Everybody, Somebody, Anybody, and Nobody. "There was an important job to be done and Everybody was sure that Somebody would do it. Anybody could have done it, but Nobody did it. Somebody got angry about that because it was Everybody's job. Everybody thought that Anybody could do it, but Nobody realised that Everybody wouldn't do it. It ended up that Everybody blamed Somebody when Nobody did what Anybody could have done," as I snatch from Brain Candy Collection on www.corsinet.com.

The CAG report traces developments in the form of circulars from the CBDT and judgment of the Supreme Court. There are nuggets of useful information to demystify what has been hitting news, such as `sub-account', explained as "foreign corporate or foreign individuals and those institutions established or incorporated outside India and those funds or portfolios established outside India, whether incorporated or not, on whose behalf investments are proposed to be made in India by an FII"; and that there are more than 600 FIIs registered with SEBI and over 4000 sub-accounts relating to the same, active in the Indian stock market. An interesting question is whether sub-account arrangement would constitute a permanent establish- ment (PE) for treaty purpose.

CAG's audit studies of a dozen DTAAs "to examine the consistency or otherwise and effectiveness of their execution and implementation in respect of PE, business profit, dividend, interest, royalties and fees for technical services, capital gains, shipping and air transport, anti treaty-shopping provision, exchange of infor- mation, mutual agreement procedure and treaty limitation."

On each of these aspects, there's elaboration in the report. For instance, a table highlights the absence of `uniformity or consistency' in defining PE; CAG reports that reasons for adopting different periods in DTAAs with Mauritius, Singapore and UAE were not ascertainable in audit, as no supporting records were made available. Determination of business profit has suffered due to `allowable expenditure' getting bloated by royalty, fee for technical services and so forth, all because the 10 out of 12 DTAAs scrutinised gave a go-by to the UN convention.

How I wish the Institute of Chartered Accountants of India took the lead in analysing the tax treaties rather than stopping with suggestions such as, "The words `during the previous year' may be inserted after the word `incurred' in Section 139(1) first proviso — Clause 40(a)(iii)(C)" — in the post-Budget memorandum 2005 posted on www.icai.org. Already, I have an inkling that any probe into possible misuse of DTAA provisions may zero in on the profession too. CAG has suggested that the CBDT have a database of FIIs and sub accounts relating to all entities operating in India; as a measure of transparency, an extra column may be devoted to the name of the law/CPA/CA firm associated with the entity. Paragraph 3.8.7 of the CAG report should enthuse the Institute of Cost and Works Accountants of India, I'd venture to suggest. "Benefits accruing to India by agreeing to different rates of taxation and cost involved or opportunities foregone were not ascertainable in audit," rues the CAG. "With new trade arrangements coming into force on account of WTO obligations, it becomes imperative that the DTAAs that India had entered into are also appropriately revised in consonance with the comparative advantage arising there from. A conscious and well planned cost benefit analysis would need to be attempted to quantify revenue foregone on account of taxation rights conceded to other contracting states and exemptions granted by way of preferential tax treatments accorded to non-residents, especially as DTAAs are not being placed before Parliament." A task that need not wait till the Institute gets its name changed.

Experience comes from bad judgment

Believe it or not, the ICAI is turning friendly. How? By issuing a `write-up' explaining `accounting for forward exchange contracts' as per AS-11, using illustrations complete with journal entries! And good things happen in pairs, so there's another `write-up' for those who didn't understand AAS-34, the recent auditing standard on evidence. The latter has an insigh on `may': "Finally, auditing is not an exact science, much depending, among other things, on the professional judgment and skills and competence of each auditor. It is, therefore, neither possible nor feasible to mandate each and every aspect in a Standard, thus, making it rigid or rule based instead of principle based beyond reason and turning it into a run-of-the-mill affair. Some aspects, indicated by way of the word, `may' have, therefore, to be left to the judgment of each individual auditor." On judgment, however, there is guidance from Walter Wriston: "Judgment comes from experience - and experience comes from bad judgment."

AccountSpeak@TheHindu.co.in

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