All about tax planning in the context of Panama Papers

Evasion is not the same as tax planning. If a manufacturer does not show his production in the register and thereby avoids tax, it is evasion, pure and simple

Panama Papers’ disclosures now and earlier dealings of Vodafone through Cayman Islands are stories of famous tax havens, which evoke discussions of how tax evasion takes place.

These are all direct taxes, mainly corporate tax, and not indirect tax.

These are cases of tax planning that come to the fore whenever such disclosures take place.

In the Vodafone case, the Supreme Court held that we have to look at the transaction as a whole and take into consideration various factors such as the duration of time during which the holding structure existed, the period of business operations in India, the generation of taxable revenue in India, and the continuity of business, among others. Considering all these factors, the Supreme Court held that the transaction was genuine and not sham.

The Vodafone judgment has discussed two previous judgments namely McDowell vs Commercial Tax Officer -- AIR1986SC649, and the UOI vs Azadi Bachao Andolan -- (2000)263ITR706.

The substance of all these judgments is that tax planning can be done provided it is permitted within the law and the activity to avoid the tax is not just a sham (a colourable device) but a genuine transaction. Interpretation to be given by a judge should not be to encourage evasion but it can allow avoidance within the law. 

It has to be judged on the basis of facts in each case.

What I want to stress here is that tax planning is a feature of direct tax and not indirect tax. 

In the case of indirect tax, the taxable event is  an act of manufacture, act of import and act of providing service, which are quantifiable.

The detailed reason is the following.

There is a difference in the nature of their taxable events of different taxes. The taxable event in income tax is the act of generation of income, which is measured in terms of net profit.

It is an accounting concept.  The taxable events in the case of indirect taxes are transaction-based. In the case of customs duty, it is the act of import or export.

In the case of excise duty, it is the act of manufacture.

In the case of sales tax, it is the act of sale. 

In the case of service tax, it is the act of providing service. 

These are all precise and physical concepts.

Thus, we find that the taxable events on indirect taxes are much more precise. Either they are physical or easily identifiable. 

On the other hand, net profit can be shown as less or more due to manipulation of accounts.

There are very many provisions in the income tax law to provide for bad debts or other receivables, which can suitably lead to a lesser net profit.

But a tax adviser on the indirect tax side cannot reduce the amount of indirect tax by manipulation of the production or manufacture or import etc. 

He can only correctly interpret the law to come to the proper taxable amount.

Evasion is not the same as tax planning.

If a manufacturer does not show his production in the register and thereby avoids tax, it is evasion, pure and simple. 

It is not tax planning. In income tax, some people argue that legal avoidance is different from evasion. 

I, however, hold that there is no such concept.

There is nothing like legal avoidance.

Legal avoidance is a contradiction in terms.

If it is legal, it is compliance to law. 

If it is illegal, it is evasion.

In the legendary judgment known as the McDowell case, judges Chenappa Reddy and Ranganath Misra observed that the notion that tax avoidance is legal is wrong.

This judgment has been quoted by many subsequent judgements even on the indirect taxes’ side only to emphasise that interpretation should not encourage evasion.

It is important to clarify that availing of an exemption is neither evasion nor tax planning.

An exemption for opening a factory in a designated area such as Uttarakhand or for using some special types of input is clearly available to the manufacturers.

The conclusion is that tax planning can be done on the direct tax side by manipulating net profit but there is no such scope on the indirect tax side as it is transaction-based.

Image: A company list showing the Mossack Fonseca law firm is pictured on a sign at the Arango Orillac Building in Panama City. Photograph: Carlos Jasso/Reuters