It's Complicated: Analyzing India’s Tax Dispute Resolution Framework
[Yash and Hitoishi are students at Gujarat National Law University. The following post was awarded the fourth-best entry in the IRCCL Blog Writing Competition 2020.]
The onset of the COVID-19 pandemic and the multiple lockdowns has ensued an economic ripple effect on businesses all across the globe. With a sharp fall in the sale and consumption of goods and services, there is a decline in profit generation due to suspension of economic activity. For the government, it means an unprecedented loss of the tax collection - which is its primary source of revenue - while also managing ever-increasing expenses on health and medical infrastructure.
The Indian Parliament was quick to respond with The Direct Tax Vivad Se Vishwas Act to settle pending direct tax litigation before multiple forums and enable the government to collect its stuck revenue while also ease the blow of the pandemic on the taxpayers. The scheme allows taxpayers to obtain a complete waiver of interest and penalty in pending disputes by paying only the amount of disputed taxes. Although these efforts are appreciable, the government continues to distort the existing convoluted tax framework by adopting relaxations that provide only immediate short-term relief.
A radical, yet compelling move is to rectify the ever-existing labyrinthine income-tax dispute resolution process. The present tax litigation process is characterized by prolonged delays and the lack of a fast-track dispute resolution mechanism. As per the Economic Survey of 2017-18 conducted by the Ministry of Finance, there are approximately 1,37,176 pending direct tax cases under consideration at the level of ITAT, High Courts and Supreme Court. The amount of money locked across various levels of the dispute resolution system is approximately INR 7.58 lakh crores, equivalent to 4.7% of India's GDP. Quite expectedly, it generally takes 12-14 years (if appeals go up to the Supreme Court) to resolve a tax dispute in the country.
In this article, the authors delineate the current statutory framework to resolve direct tax disputes while identifying the intrinsic flaws and shortcomings in the present appellate mechanism. The article draws a comparative analysis of tax mechanisms with regulators across the world and points out the inadequacies in the present ADR initiatives undertaken by India. It concludes with suggesting reforms to create a robust and efficient tax dispute resolution framework in India.
Inadequacies in the Present Dispute Resolution Process
India has implemented the self-assessment procedure, wherein the taxpayers assess the taxes for themselves and file returns which are examined by the relevant Assessing Officer (AO). Unfortunately, India lacks an apposite mechanism to provide pre-filing support to taxpayers and help them ascertain the correct tax liability a priori. The prevailing bodies such as the AAR do not provide the taxpayers with authoritative guidance on future transactions which could have otherwise helped taxpayers plan their business in advance and avoid potential disputes.
The present system is predominantly inefficient for the reason that assessment orders are often not comprehensive and well-reasoned. The deficiency in the quality of these assessment orders can be explained by the AO's minimal sector-specific knowledge. The restricted industry-specific knowledge hampers the AO’s understanding of the nuances of transactions and the application of income-tax provisions to such transactions, which kicks off litigation.
The Income Tax Act 1961 (IT Act) empowers the taxpayer with a four-tier appellate structure for seeking relief against adverse assessment orders. The prolonged nature of tax disputes in the country is primarily attributable to this rather cumbersome appeal process. At the first level, Section 246A allows the taxpayer to appeal against the AO's order before the Commissioner of Income Tax (Appeals). After providing the taxpayer with a fair hearing, the CIT(A) may pass an order that enhances, modifies or rejects the AO's order.
An appeal from the CIT(A) lies before Income Tax Appellate Tribunal (ITAT). Quite paradoxically, Section 253 of the IT Act authorizes the AO to challenge the order passed by the CIT(A) before the ITAT if it stands in favour of the assessee. From the ITAT, the parties have the option of appealing further before the High Court and subsequently the Supreme Court.
Complementing the cumbersome appeal process is the compulsive litigious nature of the tax administration which adds another layer of complexity and exacerbates the delays. The tax administration is the largest litigant in the country and appeals against nearly 85% of CIT(A) orders. However, the success rate of the department is under 30% and this rate has only been declining. To effect a comparison, similar regulatory bodies such as the Securities and Exchange Board of India enjoy an 80% success rate in appeals before the Securities Appellate Tribunal. Despite such dismal success rates, most AOs feel safe in filing appeals to avoid the perception that an AO’s decision to not file an appeal 'favours' the taxpayer.
The Bombay High Court in CIT v. Larsen and Toubro Limited frowned upon the tendency of the AOs to mechanically file appeals, without application of mind to the merits. In general, the financial and administrative costs associated with a tax dispute are colossal for both the taxpayer and the administration. For instance, taxpayers have to incur significant costs on legal counsel and consultancy fees, managerial time spent on dealing with authorities and appellate channels in pursuing appeals. Likewise, tax authorities incur costs on payment to senior counsels, deployment of senior tax department officers and documenting, preserving, and tracking case records over the years of litigation. The trade-off is far more significant for the tax administration as the drain on financial resources caused by pursuing unnecessary appeals leaves lesser resources for the administration to spend on vital taxpayer services.
India’s Tryst with ADR Platforms for Resolution of Tax Disputes
A central factor which can be linked to the inefficiencies referred to in the preceding paragraphs is the over-reliance on litigation to resolve tax disputes. In 2010, a National Litigation Policy was formulated with the aim of reducing litigation and making the government a responsible litigant. However, it seems to have failed to make any significant impact on the tax administration. Litigation as a process is inherently confrontative and thus it leads to a mindset whereby both the taxpayer and the tax administration comprehend the dispute as a zero-sum game. Consequently, the multiple rounds of appeals taken both by the taxpayer and the administration defeats the central purpose of creating quasi-judicial bodies such as the ITAT and amounts to a massive drain on the economy and state.
A feasible alternative which tax administrators can rely upon to ensure faster and efficient resolution is by harnessing contemporary platforms. India’s tryst with ADR platforms for resolution of tax disputes has been somewhat lukewarm. The most celebrated component of India’s ADR mechanism for resolution of tax disputes is the Authority of Advance Rulings (AAR). The advance ruling mechanism is more of a dispute prevention mechanism. It allows the assessee to obtain a ruling on a prospective transaction as to whether any and what quantum of tax would be payable on the said transaction.
Unfortunately, much of the AAR’s utility has remained on paper without any macrocosmic benefit to the system. This is primarily because parties tend to engage in forum shopping by resorting to constitutional remedies against otherwise binding orders of the AAR. The Supreme Court’s jurisprudence on this front also has been rather unwelcome. For instance, the court in Columbia Sportswear Co v. DIT extended the ambit of constitutional remedies available against orders of the AAR by ruling that the AAR’s orders can, in the first instance, be challenged before a High Court under Article 226 or Article 227 of the Constitution. This is largely problematic for the reason that parties use the forum as a dilatory tactic rather than as a forum to genuinely resolve their disputes.
Another ADR platform provided under the IT Act is the settlement commission (ITSC) that attempts to provide taxpayers with an alternative to avoid protracted litigation. The ITSC allows taxpayers to put an end to a dispute by paying a portion of the disputed amount. However, the ITSC has not been able to effect system-wide changes as taxpayers can approach the forum only if they have their matter pending before the AO.
A central purpose of harnessing these ADR platforms is to provide speedier resolution of disputes. However, the present ADR platforms such as the AAR and the ITSC are no better than the traditional litigation process when it comes to resolution timelines. For instance, although Section 245R and Section 245D of the IT Act requires the AAR to pronounce its ruling within 6 months and the ITSC to decide an application within 18 months of the receipt of application respectively, these timelines are rarely adhered to. The bureaucratic delay in the appointment of chairman and members of the AAR and the limited number of benches of the ITSC compromise the accessibility of these ADR platforms. Consequently, the average disposal time of the AAR and ITSC has swelled up to 4 years instead of the mandated 6 and 18 months respectively.
Thus, it is evident that India’s ADR platforms for resolution of tax disputes have limited reach and efficiency. The current system is plagued by multiple caveats which limit its applicability when viewed from the standpoint of a common taxpayer. The preceding discussion unarguably settles the point that the country’s tax administration has seeped in bureaucracy which to a certain extent explains the lack of innovation when it comes to the adoption of ADR platforms. Consequentially, India’s ADR platforms seem rather archaic when compared with those adopted by comparable jurisdictions around the world which have gone to lengths to tweak their ADR platforms to ensure they remain relevant and contemporary.
How Have Tax Administrations Elsewhere Harnessed ADR Platforms?
Several jurisdictions across the world have formulated policy measures so as to ensure clarity and consistency of interpretation. For instance, in the United Kingdom, Her Majesty’s Revenue and Customs (HMRC) publishes a technical guidance manual whenever a new taxation statute comes into effect. Likewise, the Canadian Revenue Authority (CRA) publishes interpretation bulletins which bring to the knowledge of the taxpayers the CRA's understanding of a certain provision of the taxation statute. While these bulletins do not have the force of law, the courts have on numerous occasions relied on them.
Interestingly, similar characteristics can be traced to Section 119 of the IT Act which empowers the Central Board of Direct Taxes (CBDT) to issue orders, instructions, etc. to its officers. Such orders and instructions are not only beneficial to taxpayers but also binding on the tax authorities. However, these delegated powers to issue administrative guidance in the form of instructions have not been used as effectively as in some other advanced tax administrations, such as those of the United Kingdom and Canada.
Highlighting the potential of ADR platforms to accelerate the resolution of tax disputes, several jurisdictions have harnessed ADR platforms to resolve tax disputes. For instance, in the United Kingdom, ADR methods such as facilitated discussion, facilitative mediation are used to resolve tax disputes. These methods do not delve into the merits of the dispute and are very often handled by non-expert individuals whose central aim is to help the parties arrive at a settlement. However, ADR methods such as evaluative mediation and non-binding neutral evaluation are handled by specialized experts who will provide parties with their non-binding view on the subject matter of the dispute.
The United States' IRS has also been a pioneer in its endorsement of ADR platforms for resolution of tax disputes. The IRS has established an Appeals Arbitration Programme whereby either party can submit a request for arbitration a taxation dispute even when a case is in appeals. However, the arbitrability is limited to factual disputes and not matters that require an interpretation of the law. The award passed by the arbitrator in such matters is binding on both parties.
Interestingly, India’s approach towards arbitrability of tax disputes stands in stark contrast with that of the United States’ IRS. Post the ruling of the Supreme Court in KK Modi v. KN Modi, it is well settled that taxation disputes can be made arbitrable in India through an amendment of the statute. However, the tax administration in India has been averse to the introduction of ADR mechanisms such as arbitration. In fact, in various claims arising under bilateral investment treaties, such as the Vodafone Case, the tax authorities have consistently maintained arbitrability of tax matters that stand in conflict with the nation's sovereign right and hence such matters are not 'arbitrable'. Therefore, expecting a formal arbitration mechanism by virtue of an amendment in tax laws does not seem to be realistic.
A pertinent contention which many might argue on is if it is viable to provide tax administrators with unfettered executive discretion to settle tax disputes using ADR platforms without any legislative policy defining the contours of such discretion. Tax regulators in several jurisdictions have attempted to address these concerns by drafting Settlement Codes to guide tax administrators in the exercise of their executive discretion. For instance, the Australian ATO has formulated a Code of Settlement Practice as a guidance note to its staff on the settlement of tax disputes so as to provide greater transparency and accountability.
Lessons for India and the Way Forward
COVID-19 presents the tax authorities with the opportunity to shift from a litigation-driven attitude towards amicable dispute settlement. There is a pressing need to make the present Indian tax regime less hostile towards taxpayers. It is often seen that Indian revenue authorities try to use all avenues available to them to maximize the quantum of tax owed by a taxpayer. While it is understandable that a developing country like India cannot afford to lose out on revenue unnecessarily, the same must not be at the expense of honest taxpayers. This is for the reason that tax collection should under no circumstances be construed as “tax terrorism.” The OECD has also resonated the same view by calling upon tax administrations to adopt cooperative compliance instead of the traditional adversarial process. As discussed in this post, a possible way to engage in cooperative compliance might be to provide pre-filing support to taxpayers.
A possible policy measure to deal with the high appeal rates might be to include more neutral experts at the lower levels of the tax dispute resolution system. This will not only help the tax administration to have a better understanding of the business rationale behind certain transactions but also instil trust in taxpayers towards the dispute resolution. For instance, the current system envisages that the CIT(A) is to adjudicate upon appeals preferred against orders of the AO. This creates a distrust among the taxpayers as the CIT(A) is directly under the control of the tax administration. This creates a rather obvious conflict of interest and brings the system at a standoff with several fundamental principles of natural justice.
Lastly, the Indian tax administrators have a problematic preference for protracted tax litigation which needs to be corrected. It is important to invoke the motto of the Department of Justice (United States) which states that “The United States wins its case whenever justice is done to one of its citizens in the courts.” The tax department needs to reboot its psyche and put an end to understanding all tax disputes as a zero-sum game. The present appeal rate of the tax department before the Supreme Court which is at a record high of 87% is a collective failure of both the National Litigation Policy and the taxation system.