Part 1: A Study of the Indian Tax System
Part 2: Taxation of E-commerce Transactions
From the printing press to the digital revolution, humankind has been inclined to innovate first and plan later. It goes without saying that in the modern world, technology develops faster than the law. Cell- phones and high-tech computers are common examples of technologies that have grown beyond their support structure.
Technical advances sometimes outstrip the development of legal systems and often force basic principles to be reexamined. Advances in the fields of information technology, biotechnology, e-commerce, and out- sourcing, for example, have recently created a host of celebrated legal confusions and debates. This article outlines the main issues in the international taxation of e-commerce transactions with a particular emphasis on India.
Since nearly a decade ago, because of the diminished need for a vendor to have a physical presence in the country of the customer, a frequent consequence of electronic commerce has been to shift revenues away from source jurisdictions and toward residence jurisdictions.1 The tax authorities were faced with a challenge, and to overcome it; they continued to apply principles of traditional tax dealing essentially with the physical movement of goods and services. In their objective to implement a tax to the invisible trade, governments around the world have fine-tuned regulations to extend the scope of national tax regulations. The OECD’s support and guidelines help these governments ensure that the right arm's length principle is applied. This article will examine significant tax statutes in India with a particular emphasis on the tax system and the powers of tax officers, and will explore the legalities involved in the taxation of information technology and biotech companies.
I. Taxation in India
The world’s 12th-largest economy at market exchange rates and the fourth largest in purchasing power, India has a quasi-federal form of government. India’s Constitution is the longest and the most exhaustive constitution of any independent nation in the world. India has a three-tier federal structure, com- prised of the union or central government, the state governments, and the local bodies, all of which have the authority to levy taxes. Besides direct taxes such as the income tax, indirect forms of tax are collected such as the sales tax, VAT, service tax, stamp duty, customs, and excise duty.
A. Income Tax Act — Background
Historians have argued that modern ideas and institutions of law, medicine, and criminal justice were first tested in the colonies and later implemented in metropolitan areas.2 The tax system was first introduced in India during the British rule. Today, the Income Tax Act, 1961 (Act 43 of 1961) — the primary legislation dealing with taxability of income — is self-contained legislation. The Income Tax Act empowers the Central Board of Direct Taxes to formulate rules for implementing the provisions of the ITA.3 Income tax is a tax payable under section 139 of the ITA by filing a return (form/declaration) of income,4 at the rate enacted by the Union Budget (Fi- nance Act) for every year on the total income earned in the previous year by every person (individual or company) who is a resident, nonresident, or resident who is not ordinarily resident. Residents are taxable for all their income, including income arising outside India.
The division of tax and expenditure powers is spelled out in the constitution. Article 366(29) defines tax on income as including tax in the nature of an excess profits tax.
Thus, the Indian Parliament has the exclusive power to levy a tax on income other than agricultural income. The Indian Parliament also has the power to make laws regarding any other matters not enumerated, including any tax not mentioned. While agriculture plays a dominant role in the economy, a government task force recommended that agricultural income be taxed.5 The share of revenue generated from agriculture has been declining while the IT and outsourcing services sector has become a major catalyst for the Indian economy given its effects on income generation and job creation.
Accordingly, it is Parliament and the central government that has the power to tax income, not the states. However, the state legislatures have the power to impose a tax on professions, trades, and employments.
States also have the power to tax luxuries, including entertainments, amusements, betting, and gambling.
B. Powers Vested in the Tax Department
The ITA was passed to charge income tax on the total income of a person in the previous year. Person and income have been defined in the preliminary to the ITA, which provides an exhaustive list of definitions.
The General Clauses Act and past precedents further aid in understanding the definition of terms not de- fined in the ITA. The ITA in Chapter XIV defines the procedures for assessing total income; the appointment and control of income tax authorities are in Chapter XIII, and the jurisdiction of the income tax authorities is in Chapter XIII-B. The income tax officer (known as an assessing officer, or AO) is the first officer in charge and is vested with quasi-judicial powers and duties regarding tax administration, tax assessment, and prosecution on the discovery of illegitimate inaccuracies, concealment of income, incorrect valuation, or violations.
Income tax authorities have been vested with powers that are coterminous with the powers of a court under section 75 of the Code of Civil Procedure, 1908. The ITA empowers the tax recovery officer to appoint a receiver for the management of the defaulter’s movable and immovable property.6
C. Assessment Procedures
1. Investigative Powers of the Tax Officers
Chapter XIV of the Income Tax Act deals with the assessment procedure. Section 143 confers investigative powers (except the power to rectify) on the assessing officer. Under section 142, powers are conferred on the assessing officer to make relevant inquiries and obtain details or information before beginning the assessment procedure.
The Supreme Court of India and subordinate courts have in several cases ruled that the tax officers are duty bound to exercise a reasonable degree of care and caution in handling the assessment process.7 The officers do not have to assess the income of one person in the hands of another.8 If any tax or interest is found due on the basis of such return, after adjustments,9 the assessing officer will issue a notice of demand under section 156 of the ITA. Similarly, if any refund is due to the taxpayer, the money will be sent to him, but not more than one year from the end of the financial year in which the return or declaration is made.10 Under section 143(1), it is incumbent on the taxpayer to furnish the information that the assessing officer may ask for. Under section 281B, the tax officers have been conferred powers to provisionally attach properties during the pendency of any proceeding for the assessment of any income or for the assessment or reassessment of any income that has escaped assessment.
Through a legal fiction, section 136 of the ITA makes an assessment proceeding a judicial proceeding. The assessment proceeding, therefore, is a part of the judicial process.
2. Natural Justice
The Supreme Court has ruled that:
Assessment proceedings before the income tax officer are judicial proceedings and all the incidents of such judicial proceedings have to be ob- served before the result is arrived at. The assessee has a right to inspect the record and all relevant documents before he is called upon to lead evidence in rebuttal. This right has not been taken away by any express provision of the Income Tax Act.11
The principles of natural justice that are deeply em- bedded in the Indian Constitution apply to assessment proceedings as well.12 The elementary principle of natural justice is that the assessee should have knowledge of the material that is going to be used against him so that he may be able to meet it. The courts have held that ‘‘when a power is given to do a certain thing in a certain manner, the same must be done in that manner alone or not at all. All other proceedings are necessarily forbidden.’’13
3. The Assessment Process
Under section 143(2) the assessing officer may form an opinion that any claim of loss, exemption, deduction, allowance, or relief made in a tax return is inadmissible. If the AO considers it necessary to ensure that the assessee has not understated the income or has not computed excessive loss or underpaid the tax, he may serve the assessee a notice within the expiration of 12 months from the end of the month in which the return is furnished. This notice requires the assessee, on a date to be specified, to produce any evidence on which the assessee may rely in support of the return.
In the event the assessing officer has doubts about the income disclosed by the assessee, the AO may proceed against more than one person.14
The assessing officer, besides exercising reasonable caution in the assessment process, must under all circumstances relate his estimate or calculation to some evidence on the record. He cannot make an arbitrary addition and base his conclusion purely on guess- work.15 If the order is passed by assessing in a mechanical manner without giving any reasons in the or- der itself and without any indication as to the prior approval of the higher authority, then the order would not be valid and would be liable to be quashed.
Under section 143(3) the assessing officer, by an or- der in writing, can allow or reject the claim specified in the notice and make an assessment determining the total income or loss and the sum payable by the assessee on the basis of the assessment. The officer is duty bound to prove that the income has been concealed by the assessee or that information furnished in the declaration or return is not bona fide.
Once the assessment order under section 143 has been duly processed, the assessee cannot request any rectification,16 including rectification as to an enhanced claim in expenses or depreciation.17 Several past precedents have ruled that if an order passed by an assess- ing officer is unsigned, the order is invalid.18
4. Best Judgment Assessment
Under Section 144 of the ITA, the assessing officer is empowered to proceed with a best judgment assessment if the taxpayer fails to file a return of income or fails to comply with terms of a notice issued by the AO under Section142(1) or 143(2).
5. Income Escaping Assessment
Section 147 of the ITA confers discretionary19 powers on the assessing officer to charge tax in cases when he has reason to believe that any income charge- able to tax has escaped assessment for any assessment year. These powers extend only to the extent of income that has escaped assessment and not to revising, re- opening, or reconsidering the whole assessment. The income tax officer is required to set out clear reasons
in his notice to the taxpayer indicating the basis or the reason for coming to the conclusion that it is a fit case to issue notice under section 148. The reasons must be certain and definite, not loose or vague.20 The phrase ‘‘reason to believe’’ in section 147 of the ITA is stronger than the phrase ‘‘is satisfied.’’21 ‘‘Reason to believe’’ postulates a foundation based on information and a belief based on reasons.22 Regarding the word ‘‘information,’’ it ‘‘must be something more than a mere rumor or a gossip or a hunch.’’23 The taxpayer also has a duty to disclose all relevant primary facts. On disclosure of these facts, the taxpayer is relieved of his duty of any further disclosure in assisting the tax officer.24 The time notice under section 148 can be is- sued before the expiration of four years from the end of the relevant assessment year, irrespective of the quantum of income escaping assessment.
6. Death of a Party during the Assessment Process
Generally, the assessment process does not extend to the estate of a deceased person beyond the previous year in which the person died.25 If the legal representative, after inheriting the assets of the deceased, had converted the assets into a different form, the income tax officers are entitled to proceed against the substituted asset in the same way as they could have against the original asset of the deceased. Furthermore, it has been held that when notice was served on the assessee before his death, fresh notice to the legal representative is not necessary.26 In an assessment made on a legal representative, the name of the legal representative must be specified. It will not suffice to describe him as a successor-in-interest.27
If a person dies executing a will appointing more than one executor or dies intestate leaving behind more than one heir, the assessing officer will proceed to assess the total income of the deceased against all the executors or the legal representatives.28
However, if an assessee files a tax return, that return is not presumed to be incorrect. It was held that once an assessment is reopened, the previous under-assessment is set aside and the whole proceedings start anew.29
7. Taxability of Court Compensation
Compensation awarded by the court is taxable, but not all courts have agreed. The Punjab and Haryana Court ruled in a case in which it ultimately confirmed the decision of the tribunal that the interest awarded by the High Court to an assessee is not taxable.30
8. Tax payer's right to Appeal
Chapter XX of the ITA deals with provisions relating to appeals and revisions. Part X of the Income Tax Rules provides rules and forms in relation to appeals. The Income Tax (Appellate Tribunal) Rules, 1963, gov- ern the appellate proceedings. Section 249, together with rule 45, provides for the form of appeal and its limitations for the First appeal before the commissioner of income tax (appeals) (CIT(A)).
9. Tax Tribunals
Section 252 of the ITA provides for constitution of an appellate tribunal by the central government. Part XXIVA of the Indian Constitution empowers the government to constitute appropriate tribunals for speedy adjudication and disposal of disputes. The Income Tax Appellate Tribunal is the second-tier appellate forum under the ITA and is the final fact-finding authority.
The tribunal functions under the Ministry of Law (not the Ministry of Finance, which controls the Income Tax Department). The minister of finance has in the past controlled a few provisions relating to the tribunal.
The proceedings before the Tribunal are judicial proceedings. Section 253 of the ITA provides for the form of appeal and its limitations for the second appeal before the Tribunal. Similarly, Income Tax (Appellate Tribunal) Rules, 1963, govern proceedings before the tribunal. Section 255(5) of the ITA confers power on the tribunal to regulate its own procedure and the procedure of its benches in all matters arising out of the exercise of its powers or of the discharge of its functions.
9. Procedure to File Appeal
Rules 6 through 9 of the Appellate Tribunal Rules prescribe the actual procedure for filing an appeal before the tribunal. The form of appeal is to be signed and verified by the person who is authorized to sign the income tax return under section 140 of the ITA.
In the event the appeal is defective for any reason, the appellant has the opportunity to rectify it and file it before the tribunal. Similarly, minor errors or incorrect descriptions of some terms may be rectified. Under Rule 12 of the Appellate Tribunal Rules, the Tribunal may reject or return for correction a memorandum of appeal that is not in the proper form. On proper rectification, the appellant may present the appeal again for consideration and further action.
10. Res Judicata
The principle of res judicata does not strictly apply to income tax proceedings and, therefore, an assessee can always challenge an action of the assessing officer in a particular year.
11. Condonation of Delay
In N. Balakrishnan v. M. Krishnamurthy,31 the court explained the scope of limitation and condonation of delay:
The primary function of a court is to adjudicate the dispute between the parties and to advance substantial justice. The time limit fixed for approaching the court in different situations is not because on the expiry of such time a bad cause would transform into a good cause. Rules of limitation are not meant to destroy the rights of parties. They are meant to see that parties do not resort to dilatory tactics but seek their remedy for the redress of the legal injury so suffered. The law of limitation is thus founded on public policy.
Table 2 shows the revenue collections of the tax department. While the gross domestic product has been on a constant rise, the tax revenues collected by the income tax departments in India have also grown significantly. The next section of the article explores taxa- tion of e-commerce and considers precedents passed by the Authority for Advance Rulings and the Supreme Court of India.
Table 2: Revenue Collection (USD in millions)
Since nearly a decade ago, it was first predicted that because of the diminished need for a vendor to have a physical presence in the country of the customer, one of the likely effects of electronic commerce would be a shifting of revenues away from source jurisdictions and toward residence jurisdictions.32 Today, e-commerce has encouraged companies to have online presence with minimum staff and maximum impact. Products and services are rendered electronically. Tax authorities worldwide face critical issues concerning cross-border e-commerce transactions. The challenge lies in deter- mining the place where income has accrued, assessing the character of income, and ascertaining whether a permanent establishment was created in the source country. Digitized movement of content, services, or goods also raises a question as to whether a particular transaction is a service, product, or license.
There are many definitions of e-commerce. The OECD defines an electronic transaction as ‘‘the sale or purchase of goods or services, whether between businesses, households, individuals, governments, and other public or private organizations, conducted over computer-mediated networks. The goods and services are ordered over those networks, but the payment and the ultimate delivery of the good or service may be conducted on or off-line.’’33
The OECD’s definition of e-commerce is broad.
The U.S. Treasury, however, defines e-commerce as the ‘‘use of electronic means to improve the way a company does business and to create value or competitive advantages for the company. Improvements can be in the way a company transacts business-to-business (B2B), business-to-consumer (B2C) and its intra-business transactions to provide goods and services.’’34
Today there are five different segments of electronic commerce: B2B, B2C, consumer-to-consumer (C2C), business-to-government (B2G), and consumer-to- government (C2G).
1. Investigative Powers of the Tax Officers
Several international bodies have addressed the areas of e-commerce. The United Nations Commission on International Trade Law (UNCITRAL) proposed the Model Law on Electronic Commerce in 1996,35 which was followed by the proposed Model Law on Electronic Signatures 2001.36 The U.N. Conference on Trade and Development Division of Services Infrastructure for Development and Trade Efficiency has set several workshops and roundtables on electronic commerce.
The World Intellectual Property Organization has contributed to the development of e-commerce by ex- amining issues surrounding the growth and governance of the Internet Corporation for Assigned Names and Numbers. Similarly, several international bodies such as the World Customs Organization, the International Telecommunications Union, and the U.N. Economic Commission for Europe have rendered technical assistance. Finally, the OECD has made a large contribu- tion toward e-commerce. In addition to continuously organizing conferences, the OECD has played a major role in the international policy framework to foster and promote e-commerce worldwide in several areas such as taxation, international cooperation, and tax adminis- tration.
2. E-commerce in India
The Indian government had long recognized the need and importance of information technology. Be- cause of the government’s strong initiative in providing the regulatory framework and requisite infrastructure, India is slowly gaining a strong position in the areas of outsourcing, B2B wholesale travel, financial and bank- ing products, and e-commerce.
3. E-commerce Regulations
The Department of Electronics was tasked with drafting laws on information and technology. The first preliminary draft of the law was ready in July 1998 and placed before the Lok Sabha for consideration on December 16, 1999.37 The IT Bill provided a basic framework for the e-commerce regime. The draft later underwent substantial amendments, and the Union Cabinet approved the bill on May 13, 2000, and both houses of Parliament passed it on May 17, 2000. The presidential assent was finally received in June 2000.38
The Information Technology Act, 2000, amended other statutory enactments and covers such things as digital signatures, electronic governance, attribution, acknowledgment, and dispatch of electronic records, secure electronic records, and secure digital signatures, and regulation of certifying authorities.
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