Direct Tax

The Indian income tax framework saw interesting developments in the previous quarter, such as the circular issued by the Central Board of Direct Taxes according a restrictive interpretation to certain beneficial treaty provisions, notification of faceless schemes for various tax proceedings and amendments to the Income Tax Act, 1961 with the passage of the Finance Act, 2022.

Himanshu SinhaPartner

Aditi GoyalCounsel

Yash AgarwalAssociate

The Government’s tax initiatives in the previous quarter sought to widen the tax net in India while easing the compliance burden for taxpayers. The Government issued a circular according a restrictive interpretation to the most favoured nation (MFN) clause found in various double taxation avoidance agreements (DTAAs/treaties) entered between India and certain other countries. Further, continuing its efforts to leverage technology to provide transparency, the Government introduced the e-Advance ruling Scheme, 2022, e-Assessment of Income Escaping Assessment Scheme, 2022 and Faceless Enquiry or Valuation Scheme, 2022. In addition to this, the Finance Act, 2022 was also passed, through which the government has rationalised various provisions of the Income Tax Act, 1961 (ITA) and introduced a new regime for taxing virtual digital assets. We analyse these developments below.

Key Developments

  • Restrictive interpretation accorded to the MFN clause

    On 3 February 2022, the Central Board of Direct Taxes (CBDT) issued a circular (Circular) clarifying the applicability of the MFN clause found in DTAAs between India and certain member-countries of the Organisation for Economic Co-operation and Development (OECD). On a general basis, the MFN clause provides that if after the entry into force of the DTAA containing the clause (Existing Treaty), India concludes a DTAA with another OECD member-country (Subsequent Treaty), and such Subsequent Treaty provides a more beneficial tax treatment to specified kinds of income, then similar tax benefits would also be extended under the Existing Treaty.

    The DTAAs between India and the Netherlands, France and Swiss Confederation contain such an MFN clause. India subsequently signed treaties with Slovenia, Colombia and Lithuania, which provided for more beneficial tax treatment of certain kinds of income, including dividend income. While these countries (i.e., Slovenia, Colombia and Lithuania) were not members of the OECD at the time when their DTAAs with India were concluded, they subsequently became members of the OECD. After these countries became members of the OECD, the Netherlands, France and Swiss Confederation issued unilateral directives stating that the beneficial treatment under these treaties would be available under the existing treaties with the Netherlands, France and Swiss Confederation as well.

    The position of the Indian tax authorities has been that the beneficial tax treatment pursuant to the MFN clause cannot be extended based on such unilateral directives. Further, the benefit of the MFN clause would also not be available since Slovenia, Colombia and Lithuania were not members of the OECD at the time when the DTAAs with them were concluded. However, Indian courts interpreted the MFN provision in favour of the taxpayers and have extended the benefit of lower tax rates under the treaties with the Netherlands, France and Swiss Confederation as well.

    Considering these rulings, the CBDT issued the Circular, reiterating its position that MFN benefits cannot be extended based on unilateral directives issued by treaty partners.

    The CBDT has also laid down the following conditions which must be fulfilled for benefits under the MFN provisions to be available:

    • India must enter into the Subsequent Treaty during the operation of the Existing Treaty.
    • The country with which India concludes the Subsequent Treaty must be a member of the OECD, both at the time when the Subsequent Treaty is concluded and at the time when the MFN clause is sought to be applied.
    • India must have limited its taxing rights (either in terms of the rate or scope of taxation) in the Subsequent Treaty.
    • A separate notification should have been issued by India, importing the benefits of the Subsequent Treaty into the Existing Treaty.

    The Circular further provides that it would not impact existing court rulings on this issue. However, it is likely that the provisions of the Circular will be challenged by taxpayers who have not received a favourable court order so far, since circulars issued by the CBDT are binding on the tax authorities, but not on taxpayers.

  • Faceless Schemes notified

    • E-Advance Ruling Scheme, 2022

      The Government of India notified the e-Advance Ruling Scheme, 2022 (Scheme) on 18 January 2022. The Scheme sets out the detailed procedure to be followed to seek advance rulings from the Board of Advance Rulings (BAR). Notably, applicants seeking advance rulings have been precluded from appearing before the BAR, either personally or through their Authorized Representative (AR). All hearings shall instead be conducted through video-conferencing. However, to avoid persons being denied the benefit of the Scheme solely due to the absence of video-conferencing, tax authorities have been directed to establish such facilities at suitable locations. Similarly, all communication under the Scheme must be exclusively electronic, through the registered email of the parties. Further, the Scheme provides that an appeal against an order of the BAR shall lie with the jurisdictional High Court, and departmental appeals may be filed by the jurisdictional assessing officer only with the approval of the Principal Commissioner or Commissioner. The Scheme also provides that the proceedings before the BAR shall be closed to the public and that no person (other than relevant parties) shall be allowed to attend such proceedings without the prior permission of the BAR.

    • E-Assessment of Income Escaping Assessment Scheme, 2022

      On 29 March 2022, the CBDT notified the e-Assessment of Income Escaping Assessment Scheme, 2022 (Reassessment Scheme). The Reassessment Scheme provides that (i) reassessment or re-computation of income under the ITA and (ii) the issuance of notices for such proceedings shall only be done in a faceless manner. Further, the Scheme provides that these actions may only be done through automated allocation (i.e., through an algorithm employed for this purpose) in accordance with the risk management strategy formulated by the CBDT.

    • Faceless Enquiry or Valuation Scheme, 2022

      The CBDT also notified the Faceless Enquiry or Valuation Scheme, 2022 on 30 March 2022. Similar to the Reassessment Scheme, this scheme provides that certain specified actions/notices will only be initiated/issued in a faceless manner, through automated allocation, in accordance with the provisions of the ITA. Such actions include issuance of specified notices, conduct of enquiries, issuance of special audit directions, determination of valuation of assets for assessment proceedings, etc.

  • Finance Act, 2022 passed

    The Finance Act, 2022 was passed in the Budget Session of the Parliament. Notable changes made to the Indian income tax framework through the Finance Act, 2022 include: the introduction of a new regime to tax gains accruing from transactions in virtual digital assets (VDAs) such as cryptocurrencies and non-fungible tokens; the introduction of an option to file updated tax returns for an extended period of 2 years on the payment of additional tax and the rationalisation of assessment and reassessment provisions under the ITA. Our updates analysing these changes brought in by the Finance Act, 2022 can be accessed here and here, respectively.

The measures taken by the Government underscore consistent efforts to concurrently simplify the Indian income tax framework and widen the tax net. It will be interesting to see how these attempts develop.

The tax department filed special leave petitions against the High Court rulings in which the MFN provision has been interpreted in favour of the taxpayers. The Supreme Court has issued notices in these matters and listed them for final disposal on 19 July 2022.

Finally, the CBDT intends to issue a notification/circular clarifying the new provisions for taxing income from transactions in VDAs. We expect the dust to settle on some of these issues over the course of the next few months.

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