TAX PLANNING MAY DEFEAT DIGITAL TAX PROFILING SYSTEM OF INCOME-TAX

TAX PLANNING MAY DEFEAT DIGITAL TAX PROFILING SYSTEM OF INCOME-TAX <!--[if gte mso 10]> TAX PLANNING MAY DEFEAT DIGITAL TAX PROFILING SYSTEM OF INCOME-TAX By Mr. Chaman Lal Oad, Karachi The Aid--Giving---Agencies guided, digital networking system is aimed at automatic tax profiling of a taxpayer meaning, thereby, that every income receipt, gain and every expense incurred by any taxpayer is profiled through computerized automatic networking system. It is so designed that for a particular accounting period which in Pakistan is normally a financial year, such information is automatically compiled in a digital file. For every taxpayer, there will be opened a separate file or account and all the transactions documented in his name across the country would automatically pour into such a centralized account/file of such taxpayer. It is further expected that when all the information of every tax-payer is so compiled, then it will not be possible for such a taxpayer to conceal any of his income or expenditure or purchase of assets or property. It is further expected that all the taxpayers would then, per force declare their true incomes, expenses, properties and they would pay correct amount of taxes. The game of hide & seek and cat and mouse are as old as this world. The tax authorities and the taxpayers are fully aware of the concept of tax planning. The concept of tax planning is very simple to use. The Courts have also come across such tax planning methods very often. Their views about tax planning are briefly summarised as under: "McDowell & Co. Ltd. v. C.T.O. (1985) 154 ITR 148(SC) Tax avoidance: new trends in judicial thinking The Supreme Court has held here that it is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the Court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of `emerging' techniques of interpretation as was done in Ramsay (W.T.) Ltd. v. IRC (1982) AC 300: (1982) 2 WLR 449 (HL), IRC v. Burmah Oil 'Co. Ltd. (1982) Simon's Tax cases 30 and Furniss v. Dawson (1984) 1 All ER 530: 2 WLR 226 (HL), to expose the devices for what they really are and to refuse to give judicial benediction. It was pointed out that now we live in a Welfare State where financial needs, if backed by the law, have to be respected and met, and that we must recognize that there is behind taxation laws as much moral sanction as behind any other Welfare legislation, and it is a pretence to say that avoidance of taxation is not unethical, and that it stands on no less a moral plane than honest payment of taxation. The proper way to construe a statute, while considering a device to avoid tax it was further pointed out, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it. It may here be mentioned that the above ruling of the Supreme Court needs to be re-considered inasmuch as it follows from the decision of the House of Lords in Craven (Inspectors of Taxes) v. White (Stephen) (1988) 3 WLR 423 (HL): (1990) 2 Comp LJ 179 (HL) that the Supreme Court had not correctly appreciated the important feature of the Ramsay Principle. There, the House of Lords has expressed the opinion that the nature of the principle to be derived from the three cases (namely, Ramsay, Burmah Oil and Dawson) is this; the Court must first construe the relevant enactment in order to ascertain its meaning; it must then analyse the series of transaction in question, regarded as a whole, so as to ascertain its true legal effect in law; and, finally, it must apply the enactment as construed to the true effect of the series of transactions and so decide whether or not the enactment was intended to cover it. The most important feature of the principle is that the series of transactions is to be regarded as a whole. In ascertaining the true legal effect of the series, it is relevant to take into account, if it be the case, that all the steps in it were contractually agreed in advance or had been determined on in advance by a guiding will which was in a position, for all practical purposes, to secure that all of them were carried through to completion. It is also relevant to take into account, if it be the case, that one or more of steps was introduced into the series with no business purpose other than the avoidance of tax. The principle aforesaid does not involve that it is part of the judicial function to treat as nugatory any step whatever which a taxpayer may take with a view to the avoidance or mitigation of tax. It remains true in general that the taxpayer, where he is in a position to carry through a transaction in two alternative ways, one of which will result in liability to tax and the other of which will not, is a liberty to choose the latter and to do so effectively in the absence of any specific tax avoidance "provision such as, for instance, section 460 of the Income and Corporation Taxes Act, 1970 (UK). Thus, in the opinion of the House of Lords, the trilogy of tax avoidance cases, Ramsay, Burmah and Furniss decided that a scheme to avoid an assessment of tax on a taxable transaction by a tax avoidance transaction which serves no business purpose apart from the avoidance of tax or the tax which would otherwise be payable in respect of the taxable transaction must be viewed as a whole; the taxing statute must be applied to the scheme and not to the constituent transactions comprised in the scheme. In the contrast, the Supreme Court appears to have understood the Ramsay principle in the following terms: "It is up to the Court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of `emerging' techniques of interpretation as was done in Ramsay's case; Burmah Oil and Dawson's case, to expose the devices for what they really are and to refuse to give judicial benediction." Reiterating the above view, the Supreme, Court has held in Workmen of Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd. (1986) 157 ITR 77 (SC) (see notes, post) that `avoidance of welfare legislation is as common as avoidance of taxation and approach in considering' problems arising out of such avoidance has necessarily to be the same.' The present case arose in the context of an excise matter. The buyers of Indian liquor from the distillery of the appellant-company, a licensed manufacturer of Indian liquor, obtain distillery passes for release of liquor after making payment of excise duty, and present the same at distillery whereupon the bill of sale or invoice is prepared by the distillery showing the price of liquor but excluding the excise duty. The appellant-company's books of accounts also did not contain any reference to excise duty paid by the purchaser. The company paid sales tax payable by it under the Andhra Pradesh General Sales Tax Act, 1957, on the basis of its turnover which excluded excise duty. The company was assessed to sales on the basis of its returns; but, later, the Commercial-tax Officer was of the view that the company had failed to include the excise duty paid on the liquor sold by it to wholesalers. The Taxing Authority, accordingly, called upon the company to show-cause why, assessments made may not be re-opened. The appellant moved the High Court for quashing of such notice and have failed, carried the matter in appeal, to the Supreme Court. The Supreme Court in its decision reported in McDowell & Co. Ltd. v. CTO (1977) 1 SCR 914, decided the matter in favour of the appellants. Subsequently, Andhra Pradesh Distillery Rules were amended. The change in these rules affirmed that liability for payment of excise duty is of the manufacture. On the basis of these amended rules, the concerned Authorities issued a notice to the appellant proposing to include a certain sum representing the exercise duty paid by buyer's of the appellant's liquor in the appellant's turnover for the part of the year in question. The appellant moved the High Court once again. Following the ruling in the earlier Supreme Court decision, namely, (1977) 1 SCR 914, the High Court upheld the action of the Authorities concerned. The matter was carried in appeal to the Supreme Court. One of the contentions raised before the Supreme Court was that it was open to everyone to so arrange his affairs as to reduce the brunt of taxation to the minimum and such a process does not constitute tax evasion; nor does it carry any ignominy. Dealing with the question as to what is the proper way to construe a taxing statute while considering device to avoid tax, the Court indicated the approach that must be followed in such case. It held that the Court must examine the substance of the transaction, and then pose a question to itself---Is the transaction such that the judicial process may accord its approval to it? The Supreme Court held thus: "In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it". The above observations were made by O. Chinnapa Reddy in his separate, but concurring judgment Raganath Misra, J. speaking for himself and the other learned Justices, had observed thus: "Tax planning may be legitimate, provided it is within the framework of law. Colourable devices cannot be a part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. On this aspect, one of us, Chinnapa Reddy, J. has proposed a separate and detailed opinion with which we agree." The main thrust of the opinion expressed by Chinnapa Reddy, J. was expressed in the following terms: "We think the time has come for us to depart from the Westminster principle (followed in India in CIT v. A. Raman & Co. (1968) 67 ITR 11 (SC) and CIT v. BM Kharwar (1969) 72 ITR 603 (SC) (see notes, ante) as emphatically as the British Courts (in Ramsay, Burmah Oil and Dawson) have done and to dissociate ourselves from the observations of Shah, J. (in the Supreme Court cases referred to above) and similar observations made elsewhere. The evil consequences of tax avoidance are manifold. First, there is substantial loss of much needed public revenue, particularly in a welfare State like ours. Next, there is the serious disturbance caused to the economy of the country by the piling up of mountains of black money, directly causing inflation. Then there is `the large hidden loss' to the community (as pointed out by Master Sheatcroft in 18 Modern Law Review 209) by some of the best brains in the country being involved in the perpetual war waged between tax avoider and his expert team of advisers, lawyers and accountants on the one side and the tax-gatherer and his perhaps not so skillful advisers on the other side. Then again there is the `sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it'. Last, but not the least is the ethics (to be precise, the lack of it) of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of the `artful dodgers'. It may, indeed, be difficult for lesser mortals to attain the state of mind of Mr. Justice Holmes, who said, `Taxes are what we pay for a civilized society'. I like to pay taxes with them I buy civilization'. But surely, it is high time for the judiciary in India too to part its ways from the principle of Westminster and the alluring logic of tax avoidance. We now live in a welfare State whose financial needs, if backed by the law, have to be respected and met. We must recognize that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is a pretence to say that avoidance of taxation is not unethical and that it stands on no less moral plane than honest payment of taxation. In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it. A hint of this approach is to be found in the judgment of .Desai, J. In Wood Polymer Ltd. In re & Bengal Hotels (P) Ltd. In re (1977) 47 Comp Cas 597 (Guj.), where a learned Judge refused to accord sanction to the amalgamation of companies as it would lead to avoidance of tax". Compare the above observations with those of Sabyasachi Mukharji, J., as he then was, in CWT v. Arvind Narottam (1988) 73 ITR 479 (SC) (see notes, post), where the learned Judge observed thus: "It is true that tax avoidance is an underdeveloped or developing economy should not be encouraged on practical as well as ideological grounds. One would wish, as noted by Reddy, J. (in the case here), that one could get the enthusiasm of Justice Holmes that taxes are the price of civilization and one would like to pay that price to buy civilization. But the question which many ordinary taxpayers very often, in a country of shortages with ostentatious consumption and deprivation for the large masses, ask is, does he with taxes buy civilization or does he facilitate the waste and ostentation of the few. Unless waste and ostentation in Government spending are avoided or eschewed, no amount of moral sermons would change people's attitude to tax avoidance. In any event, however, where the true effect on the construction of the deeds is clear, as in this case, the appeal to discourage tax avoidance is not a relevant consideration, But since it was made, it has to be noted and rejected." Again, in Union of India v. Playworld Electronics (P) Ltd. (1990) 184 ITR (SC) (see notes, post), Sabyasachi Mukharji, J., as he then was, speaking for himself and Ranganathan, J., observed that it is true that tax planning may be legitimate provided it is within the framework of the law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by dubious methods. It is obligation of every citizen to pay the taxes honestly without resorting to subterfuges. It is also true that, in order to create an atmosphere of tax compliance, taxes must be reasonably collected and, when collected, should be utilized for proper expenditure and not, wasted." One of the best methods to circumvent, the tax law, being used by certain shrewd `businessmen' is that the taxpayer mostly chooses to inflate payments and get away with/transfer such amount in the name of a foreigner with impunity while mostly the tax collector instead of pains taking inquiry into factual aspects of such a claim of expenditure may choose to facilitate the taxpayer (to promote order of the day i.e. the taxpayer friendly environment) and may allow such a claim of huge expenditure and thus the digital net working system and profiling system may be defeated, we can lay hands upon many a such cases. However, the C.B.R. may encourage the dedicated and expert workers, to meet such a situation.