In this article, Siddhartha Sain, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on tax avoidance strategies used by big business houses in India
Tax is a source of revenue for a government of a country, through which it endeavours to provide better infrastructure, standard of living and security to its inhabitants. However, these taxes can at times come in the way of subjective development of individuals or a company and further push these individuals and large business houses to contemplate a way to avoid the same by using loopholes in the laws and guidelines that govern the taxes.
Indian government has always been proactive in closing and fixing loopholes in the tax laws and its structure through budget, amendments, guidelines and treaties with various countries. However, government in this regard is always two steps behind the large business houses in India, which are well equipped with up to date intellectuals, who know how to manipulate tax rates, loopholes in laws, deductions and sometimes trade relations with other countries, in order to decrease the burden of tax that is levied on their company without breaking any law. These large business houses are able to structure the most complex and elaborate tax avoidance strategies, thereby causing great deal of loss to government revenue worldwide.
According to a paper by Alex Cobham & Petr Janský, (Cobham, 2018) each year globally, around INR 50,000 crores worth of government revenue is lost due to tax avoidance by big business houses. Reliance India Limited, Tata Industries, Vodafone, Google, etc. are some of the examples of large business houses that function in India and who have successfully mastered the art of tax avoidance.
How tax avoidance is different from tax planning and tax evasion?
There is a thin line of distinction between tax avoidance and tax planning, both of them are completely legal in the eyes of law. Tax planning is something which is expected from a taxpayer and tax avoidance is something which is beyond the expectation of the government (Batra, 2014). For example, there are certain provisions of Income Tax Act 1961, which a taxpayer can optimally utilize and reduce his/her tax liability through deductions under Section 10, Section 80C, and Section 80U, Section 37 etc., in order to effectively conduct tax planning. On the other hand a company shifting its Intellectual property to a country with reduced tax rates than India is one of the examples of effective tax avoidance. (Chawla, 2017).
On the other hand, tax evasion is completely illegal and is not at all encouraged by any government, unlike tax planning and avoidance. Tax evasion is outright stealing and involves breaking of law. The common example of tax evasion is undisclosed income in cash which was found stashed in many houses in India during the demonetization drive in November, 2016. Cash that was rendered not legal and was undisclosed wealth which was accumulated by individuals by evading taxes. (PTI., 2016)
How is it done?
Big business houses in India utilize many strategies in order to avoid tax. There is a huge role of tax havens and subsidiaries in these strategies.
The term ‘tax haven’ is a country that offers foreign individuals and businesses a minimal tax liability in a politically and economically stable environment, with little or no financial information shared with foreign tax authorities.
The term ‘subsidiary’ is a company with stock that is more than 50% controlled by another company, which is usually referred to as the parent company or the holding company.
Movement of assets, shares, deals and money from India to these tax havens through subsidiaries is the most favored and advantageous strategy amongst big business houses in India. Since 2005, many Indian and foreign companies that are set up in India have been using tax havens and subsidiaries in order to avoid tax. We will discuss the strategies used by these large corporations in order to avoid tax, in depth below.
In 2007, Vodafone International Holdings B.V. based in Netherlands, purchased Hutch Essar in India through a complex tax avoidance strategy. The idea of this strategy was to avoid paying capital gains tax in India through non-resident companies in the deal. The non-resident companies were their own subsidiaries operating outside India. Vodafone International Holding B.V. purchased 67% controlling shares of CGP International based in Cayman Islands, which was a subsidiary company of Hutchison Telecommunication International Limited (HTIL). CGP already had a controlling share in Hutch Essar in India before the deal and by the transfer of 67% controlling share of CGP, Vodafone International Holdings B.V., acquired the controlling stake in Hutch Essar India.
Following this deal, Income tax authorities issued show cause notice to Vodafone International Holdings B.V. and in turn VIH filed a writ in High court challenging the same, which was dismissed by high court with a view that Vodafone International Holdings B.V. must pay capital gains tax, as the sale of shares from CGP to VIH B.V. qualifies as capital transfer and attracts capital gains tax of nearly Rs.12000 crores. Pursuant to High Court’s dismissal, VIH filed a Special Leave Petition in Supreme Court of India challenging the High Court’s order. In 2012, Supreme Court of India held that the High Court’s view lacked authority of law and was quashed, as the transaction took place between two non-resident Companies of India. Hence, Vodafone acquired Hutch Essar India without paying capital gains tax.
Reliance India Limited
Before 1995, Reliance was infamously known as zero tax company in India, as it used to pay zero or close to zero tax each year.
A zero tax company is “a business that shows a book profit and pays dividends to investors but does not pay taxes.”
It continued to exploit the loopholes in taxation system in India in order to avoid tax through subsidiaries, which used to make raw materials and other components in countries with low tax rates and Indian parent company purchased these raw materials at prices more than the tangible cost thereby reducing their net income and subsidiaries escaped from paying taxes in India.
Reliance enjoyed its successful strategies of Tax Avoidance only till 1996-1997, when in order to combat the menace of “Zero Tax Companies”, “Minimum Alternative Tax” was introduced in India and concept of Corporate Income Tax was added. However, that did not deter the Reliance India Limited in their ventures of Tax Avoidance. In order to check the efficiency of Income Tax department in assessing big business houses, in March, 2018, Central Auditor General of India conducted an integrated audit of Reliance India Limited along with its other group entities.
According to the news report (see here), during audit it was found that RIL used many methods to avoid taxation including “the merger and demerger of group entities, transactions with related parties, layering of transactions with subsidiary companies”, in order to lower the tax burden.
Google is the world’s favourite search engine and has plethora of companies functioning under it. There is one extremely clever and elaborate tax avoidance strategy, which is used by many large corporations including Google, which is called the “Double Irish with a Dutch Sandwich”.
It is a dubious trick used by Google to avoid taxes through subsidiaries in Netherland and Ireland. In this technique large corporations use a combination of Irish and Dutch subsidiary companies to shift profits to low or no tax jurisdictions. It further involves sending profits first through one Irish company, then to a Dutch company and finally to second Irish company, headquartered in a tax haven. This particular technique allows many corporations to reduce their overall corporate tax rates dramatically. Using this technique, Google has successfully saved billions of dollars.
Similarly, Google India which is a subsidiary of Google International LLC and is an authorised distributor of Google Ireland’s ‘AdWords’ programme to Indian advertisers. Google AdWords is Google’s advertising system in which advertisers bid on certain keywords in order for their clickable ads to appear in Google’s search results. Google Ireland owns the ‘AdWords’ technology and as it merely authorized Google India to use it, the revenue will come back to Google Ireland, where google has to pay tax way less than India.
However, for the same transaction, Income Tax Appellate Tribunal, India, ordered Google India to pay tax close to Rs.1457 crores which were avoided in tax by Google India for the assessment years 2007-2006 to 2012-2013.
After losing six years long battle, Google India spokesperson in an interview (see here) said that Google India complies with all tax laws in India and pays all applicable taxes and they will file an appeal, as the ITAT ruling, according to Google, “is a clear departure from previous judgments on the issue and is not in line with India’s double taxation avoidance agreements”.
Tata Industries sold their shareholding in Idea cellular in 2007 to Birla TMT Holdings through its subsidiary called Apex situated in Mauritius and through this, avoided to pay tax in India. Income Tax officials flagged this deal and determined the capital gains tax in this deal to the tune of INR 1,00,000 crore under Section 93 of Income Tax Act. However, Income Tax Appellate Tribunal held that as there was no transfer of assets by a tax resident of India to a non-resident, and they cannot be taxed on the capital gains that arose on sale of Idea shares by its Mauritius subsidiary.
Tata Industries under its umbrella, has several charitable trusts formed for charitable purposes called Tata Trusts. These charitable trust such as, Jamshedji Tata Trust and Navajbhai Ratan Tata Trust, enjoy tax exemptions under the Income Tax Act. According to Controller and Auditor General’s report of 2013, Tata trust was earning huge profits instead of utilizing it for charitable purposes and accumulating surplus funds. These surplus funds were then used for creating fixed assets for earning more profits or were transferred to other trusts, rather than for charitable purposes in order to avoid tax.
Proactive steps by Indian Government in order to curb tax avoidance
Tax avoidance strategies used by big business houses around the world cause a great deal of loss to the revenue of many governments around the world, including India. In India, many cases of tax avoidances arose in the last two decades, some of which have been discussed in detail above, which forced the government to work out its laws and treaties with foreign countries in order to curb tax avoidance. Indian Government framed certain rules and guidelines in order to regulate and restrain tax avoidance through Income Tax Act, 1961 and Finance Act, 2015.
General Anti-Avoidance Rule (GAAR) was included in Chapter X-A of Income Tax Act, 1961. GAAR was introduced in Income Tax Act, by the Finance Act, 2012, yet came into effect from 1st day of April, 2017. The sole purpose of introducing GAAR was to curb tax avoidance strategies through a provision “Section 96. Impermissible avoidance arrangement”, which was imbedded in Income Tax Act. According to the provision, arrangements or deals made in order to obtain a tax benefit were impermissible.
Amendment of section 6(3) of Finance Act, 2015 was done in order to replace a new test of corporate residence, which provided that if place of effective management (POEM) is found to be situated in India, then a foreign company will be a tax resident of India. Before this amendment, for tax purposes, a company that was not a resident of India was only considered resident, if it was controlled and managed in India.
Indian government in 2017 took various steps in order to align the rules and guidelines as per the Base erosion and profit shifting (BEPS) suggested by The Organisation for Economic Co-operation and Development (OECD), which could curb the menace of tax avoidance, which includes BEPS action plan 13, 1 and 5.
Tax avoidance strategies used by these large corporations indeed help them save billions of dollars each year, however tax avoidance causes great deal of loss to the government and creates an unfair market, as a person working for a salary or a small business, has very little knowledge or intellect for building up strategies in order to avoid taxes and end up paying taxes in full. Whereas, big business houses continue to lower their burden on tax through tax avoidance. It is difficult to prove that these corporate giants did actually evade tax as they somehow do it in within the four walls of law. In reality, the business model of these big business houses are actually based on how effectively they can avoid tax and make huge profits for their investors. The idea behind tax avoidance still remains that, apart from the transaction/deal, the company must make a good amount of profit and not lose huge percentage of the profit in taxes. In this regard many countries have lowered tax rates in order to cater the needs of these companies who in return help these countries to develop. Therefore this particular nexus gives effective assistance in avoiding billions worth of Rupees in taxes, thereby making tax avoidance advantageous to big business houses.