Insurance against tax uncertainties?

Updated on: Feb 11, 2011

Accountancy firms could draw up the brief for AAR referral instead of advisingr clients to take insurance cover against the tax uncertainties and litigation.

Foreign companies making investments in India are a paranoid lot today. They apprehend considerable ambiguity in tax treatment following the Vodafone experience in particular and the Mauritius route coming in for closer look from courts and powers-that-be. Driven to the wall, they are reportedly increasingly resorting to tax insurance. Tax insurance consists in the insurer picking up the tabs in case the tax authorities of a country seek to overreach themselves beyond what is contemplated by the insured in terms of its insurance liability. The million dollar questions however are two-fold:

Are the insurers best suited for the role; and why can't the harried foreign companies take the help of Authority for Advance Rulings (AAR)?

Insurance has been perceived to be the panacea for all ills, risks and threats, be they economic, political or catastrophic. The US economy was jolted by a financial crisis of epic proportions a couple of years ago whose reverberations are still being felt in the western world thanks among other things to a product called Credit Default Swap (CDS) which is in simple terms meant insurance against default by the issuer of bonds. The formidable AIG was brought to its knees when it had to pick up huge tabs. Back home, Oriental Insurance was embroiled in an imbroglio when it offered insurance cover to Paramount Airways against its default to oil companies. One wonders what emboldens the insurers to stick their necks out thus.

Credit appraisal is neither their cup of tea nor has it generated the kind of volume to enable the insurer to spread his risk, the raison d'être of insurance. It is wrong to believe that insurance is the salvation for every season and reason. In the context of tax assessments, an insurer would be at its wits' ends trying to fathom the true implication of law given the fact that each case is unique and it possibly cannot take comfort from the fact that loss from one case can be compensated by others especially if the claim ratio is low. After all tax insurance certainly is not as homogenous as car insurance. And at any rate, the premium is not likely to be small. In the event, one is flummoxed to find Ivy League accountancy firms advising their clients to save their skins through insurance policies, especially when there is a better alternative available.

Authority for Advance Rulings

One can understand foreign companies missing something they are seeking that is bang under their nose but not when the Ivy League accountancy firms do so. For, the income tax law has a formal machinery to address precisely the problem the foreign companies operating or seeking to operate in India are facing —tax uncertainty.

The Authority for Advance Rulings (AAR) is a high powered authority whose opinion is binding as much on the applicant as on the Income-Tax Department provided the facts and law remain the same when the actual transaction takes place. Vodafone may be pardoned for not approaching the AAR because it is a vicarious tax liability on behalf of Hutchison, Hong Kong which earned huge capital gains through an offshore transaction emanating out of shares of an Indian telecom company.

Vodafone is charged with dereliction of duty in not deducting tax at source, and its counter is the payment was not made by Vodafone Essar, the operating Indian company but by its holding company in Camay Islands whereas the Income-Tax law casts the responsibility of TDS only on a resident-payer All others who apprehend direct tax liability can by all means make full use of the AAR dispensation. One wonders whether they are ignorant of such dispensation which is unlikely especially given the fact that all of them are invariably advised by top-notch accountancy firms in India or are they not sure of their grounds?

The AAR gives an expeditious opinion i.e. within six months and its opinion is binding on both the applicant and the Commissioner of Income-tax which means the Department will not make an appeal if the assessing officer has acted against the departmental interest but within the four corners of the AAR opinion. The AAR dispensation then is akin to the nuclear no-first-use doctrine. Neither the applicant nor the department would precipitate matters. Nothing can be more conducive to certainty and curtailment of needless, expensive and time-consuming litigation. Like the nuclear bomb that would never be used if both the sides commit themselves to no-first-use, appeals would not be filed by either side in such a milieu.

Besides, the AAR remedy is the least expensive, in fact ridiculously cheap - Rs 2,500 per application.,In fact Parliament is guilty of being needlessly magnanimous to foreign companies with deep pockets. The fee should be at least $2,500. But that is not the point at issue. The point is why the foreign companies are not utilising the AAR dispensation when it is the best from cost, reliability, authenticity and other points of view. Instead, it does appear to be mindlessly paying enormous premium to an insurance company. Insurance is all about happening or non-happening of an event particularly a mishap or a catastrophe whereas tax uncertainties can be easily squelched by the AAR.

It would be more becoming of the accountancy firms if they drew up the brief for AAR referral painstakingly and charged suitable fees for their services rather than fobbing their clients off with the advice to take insurance cover against the taxman's high-handedness. The main advantage of the AAR opinion is it not only makes for certainty but also for vanguard alteration in the course of action. The applicant-foreign company can become wiser beforehand instead of having to take rearguard or action or make midcourse correction which is always costly, time-consuming and painful.

(The author is a Delhi-based chartered accountant.)

Published on February 12, 2011

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