Tax Troubles of TechCo

Startups are the new blue-eyed boys and girls of the Indian government. It runs a nice shiny website to guide and register them, bestows sarkari recognition on many, waives patent application fees of some and also grants attractive fiscal sops to a chosen few. The Government even has a special capital fund for the startups. Ministers flaunt startup success stories on the floor of Parliament. When some sarkari measures such as taxing of super premium earned by companies upon issue of share capital were threatening to throw the baby out with the bath water, the Government responded swiftly to startups’ cries of help and tried to mitigate the unintended effects of what infamously came to be known as angel tax. The best part is that the Government even bans some of its pesky little officials in the local field formation to visit the startup offices on the pretext of any surveys or inspections.

All this and more government support is available if you are a very young, fledgling startup of a certain vintage. However, if you were born earlier than the cut-off date, then the Government continues to be as unfriendly as it can be. The unfortunate example of one such technology company that I have seen closely is a case in point.

 

About TechCo

TechCo was born in 2006. It was a global advertising technology platform for programmatic ads. It simplified the marketing technology ecosystem for small and medium segment advertisers by helping them to efficiently use their modest marketing budgets for internet reach. The Company was proudly headquartered in India, set up subsidiaries in the US and Singapore, attracted marquee investors and even turned profitable after the first few years of losses - a very common trajectory for any technology company. And all this took place without any notable supportive schemes of any Government. In fact, perhaps the successful run was because the Government kept itself away. Unfortunately, as is also very common with technology companies, it doesn’t take much time for the fortunes to change. Evolving technology, dynamic practices and changing regulations world-wide meant that TechCo’s business had turned a corner by 2015. It is at this turn that the Indian tax department suddenly got interested in the Company. 7 years hence, TechCo’s business is no more, it has no employees, its overseas subsidiaries closed long ago, but what remain in India are a plethora of unresolved income-tax and service tax cases foisted on the Company, unending litigation therefrom and huge tax refund dues pending from the Government.

 

Tax troubles of TechCo

Issue No. 1 – Withholding tax (TDS) on service fee paid to US subsidiary

There is ample jurisprudence in India regarding withholding tax on technical service fee paid to US residents. Most of the jurisprudence favours the taxpayers, clearly laying down that unless the technical service makes available technical know-how etc. to the Indian payer, there shouldn’t be any withholding tax. Still tax officers at lower level routinely demand TDS on such payments. In TechCo’s case, there is such demand for 3 years, with tax amounting to multiple crores of rupees. Since depositing at least some part of the demanded tax is the sine qua non for filing an appeal, TechCo had to cough up a lot of money just to be able to defend itself, even as its dwindling business meant cash flows were scarce.

Upon appeal, the Commissioner (Appeals) - the first level appellate authority - ruled against the Company. This was expected because the general experience is that this authority rarely sides with the taxpayer. When the matter reached the tax tribunal, it decided to remand the case back because it observed that both the assessing officer as well as the Commissioner (Appeals) had not even properly analysed the facts before reaching their adverse conclusion. It’s been more than a year since the tribunal passed the above strictures but the tax department is yet to look into the matter afresh.

 

Issue No. 2 – Salary and marketing expenditure considered to be capital in nature

As the technology and internet practices evolved, TechCo was trying to cope with the changing demands of its market. It unsuccessfully attempted to rework its product, incurring expenditure on research and development. However, the expected results didn’t materialize and therefore the whole project was scrapped. As if that itself was not demoralizing for the Company, the tax officer decided that all such expenditure had to be treated as capital in nature and hence disallowed it while computing its tax liability. Similarly, certain regular marketing expenditure was wrongly treated as capital in nature. The Company was slapped with a tax demand again running into crores of rupees. Again, TechCo had to shell out substantial sum before appeal, just to remain in the fight.

Here too, the Commissioner (Appeals) sided with the assessing officer. Fortunately, the tribunal categorically overruled the tax department. Optimistic of recovering its money from the taxman, TechCo patiently persevered for more than a year, only to discover recently that the tax department is now appealing before the High Court. Apparently, the tax officers will look very bad if they simply give up on this case, as the amount involved in significant.

 

Issue No. 3 – Taxing TechCo India as a representative of its US subsidiary

As if the main plot involving Issue No. 1 and 2 above was not engrossing enough, the tax department decided to have some more fun. It believes the US subsidiary of TechCo should also have filed its tax returns in India. Given that it did not and it is no more in existence, they have sought to treat its parent company - who has the misfortune of surviving only to fight tax cases - as a representative assessee. This despite the fact that this case mirrors the same matter they are contesting in Issue No. 1, wherein so far they have not been able to establish their case well.

 

Issue No. 4 - Penalty proceedings

                Tax department initiates penalty proceedings every time it makes any adjustment to the returned income. So proceedings were initiated in respect of all the years where the above issues are being contested. Nothing unusual about it. To be fair, these proceedings are often kept in abeyance if the taxpayer has filed appeals. Here too the Company was in for a bad surprise when it was suddenly imposed with a penalty for allegedly not having attended some hearing. More surprising was the fact that this penalty was imposed in respect of a year where the tax officer had no adverse findings and had actually accepted the returned income. For a change, this does not seem to be an outcome of human mischief but possibly a technical glitch in the computer system relied upon by the department. TechCo is only hoping that this bad surprise will go way as suddenly as it came.

 

Issue No. 5 – Reassessment (AY 2015-16)

                Even as the tax department has filed appeal against the tribunal’s order in respect of Issue No. 2 above, it also wishes to reassess TechCo’s income for that year. To that effect, it has issued notice to the Company. TechCo quickly responded, requesting reasons in writing (which is its statutory right) for such reopening of assessment. The department has not responded to the request yet.

 

Issue No. 6 – Service tax cases

                It is not only the income-tax department that has been tailing TechCo. Service tax officers have been interested too. Ignoring the fact that the Company only ran a technology platform that facilitated buying and selling of online advertising spaces, they have alleged that the Company itself was engaged in display of advertisement and therefore liable for service tax. Overall, they have raised demands amounting to crores of rupees and forced the Company to pay at least a portion while the appeals before CESTAT are pending.

 

How TechCo and its founders suffer

·    For a business that is permanently shuttered, TechCo has crores of its funds locked up in tax demands that it was forced to remit to the tax authorities. This amount in the hands of the founders might have helped them start afresh and fund their new startup that the Government would so keenly promote now.

 

·      To protect itself from any coercive steps that the tax authorities might take to recover the unpaid tax demands, TechCo is compelled to continue contesting the matters in appeal proceedings which take long years to conclude, incurring further costs for the Company.

 

·     Mired in so many cases and litigation, the founders are unable to focus on developing their new venture.

 

·       Wary of dealing with Indian system where tax authorities hold up everything long after the business is gone, the founders would think twice before setting up their next venture in India.

 

·      Life cycle of technology-driven companies can be quite short. If the wheels of tax justice are going to grind so slowly that these companies spend more of their lifetime fighting tax cases than they did doing business, India will never really be a great startup destination, notwithstanding all those initiatives of recent years.