Reducing tax litigation

Ketan Dalal | Updated on: Aug 04, 2022
The government is thinking of an authority to settle tax disputes

The government is thinking of an authority to settle tax disputes | Photo Credit: bluebay2014

The mediation route could be a step in the right direction

The Finance Minister, in her Budget Speech in 2020, said there were 5 lakh cases pending on just direct taxes at various levels. About 50,000 of these are at the Supreme Court and High Courts involving ₹3.5-lakh crore in taxes, and at the Tribunal level the amount involved is ₹2-lakh crore. By one estimate, 97.6 per cent of the amount in pending demands is difficult for the Tax Department to recover.

Press reports suggest that the government is thinking of an authority to settle tax disputes. This is a welcome move, but the challenge is going to be in its architecture and implementation. Empirical evidence shows that only 11.5 per cent of the cases went in favour of the Tax Department, and litigation is rampant. In terms of numbers, two-thirds of the cases are small disputes involving demands of less than ₹10 lakh.

The traditional hierarchy is four-tier litigation pyramid: Assessing Officer CIT(A), Income Tax Appellate Tribunal (ITAT), High Court, and Supreme Court

The journey from an Assessing Officer to the Supreme Court could take 15-20 years. And even up to the Tribunal level, it usually takes 8-10 years. This is simply not acceptable. On the ‘ease of doing business’ ranking (now discontinued) in 2020, in relation to “paying taxes”, India was ranked 115th out of 190 countries.

Some key causes

There are various causes of litigation and one of them has to do with poor drafting. But the larger and more subjective dimension is lack of trust, suspicion and relative lack of accountability of tax officials, thereby giving rise to frivolous litigation. Two other reasons are the lack of an effective ecosystem to proactively address issues (through CBDT circulars, for example) and the mindset of the Revenue Department, which is still rooted in an era where tax evasion was rampant.

The corporate sector accounts for a little over 50 per cent of the direct tax collection. Even within corporates, less than 500 companies account for over half the collections. Unfortunately, the maximum litigation in terms of value happens in this category.

Another huge contributor to litigation is Special Anti-Avoidance Rules (SAAR). The introduction of SAAR cannot be objected to in principle, but the extent to which these have gone is worrisome. For example, Section 50CA, which puts a floor price on share transfers of private companies, seems to be based on the premise that cash transactions will happen. In this age of formalisation and large transactions, this is hardly likely.

Section 56(2)(x), which is a deemed gift tax provision, is another that has created significant issues and huge litigation. What was supposed to be a provision to rope in non-genuine gifts has now expanded, with the possibility of including even mergers and demergers which the tax department considers as non-tax neutral. A significant dilution of SAAR provisions is, therefore, important to reduce litigation.

With effect from April 2021, a new Section 245MA was added in the Income Tax Act to create a Dispute Resolution Committee to deal only with issues where the tax amount is less than ₹10 lakh. The committee, though yet to be set up, is conceptually good . But operational efficiency, with focus on preventing needless litigation, is vital to make the initiative meaningful.

It must be noted that the Authority for Advance Rulings (AAR) for cross-border transactions was introduced in 1993 and worked well for a few years, but later lost credibility and collapsed since the so-called advance rulings were taking 3-5 years. The Advance Pricing Agreement (APA) regime for transfer pricing has fared relatively better, but the fear of litigation has led to a huge number of applications, resulting in a significant backlog; there were 62 APAs signed in FY 2022, which is creditable, but there is still over 800 pending APAs.

This being the situation, a body for private ruling or mediation would be welcome. A good mix of internal and external experts may help to proactively take decisions and address the issue of huge pile up of litigation.

The writer is Managing Director, Katalyst Advisors

Published on August 04, 2022
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