Mediation of Tax Disputes to Complement Faceless Assessments

Introduction

Change is the only constant. One must evolve with time; law and legal processes are no exception.

Considering the pitiable state of litigation in India and catching up with global trends, mediation has been made a mandatory subject to be taught in Indian law schools with effect from the 2020-2021 academic session.

The underlying purpose behind this move is to acquaint future lawyers with the practical skills required for mediation, and also to raise awareness about the undoubted benefits of mediation in resolving disputes.

This can also be seen as another stride towards generating a strong “mediation culture” in India. Previously, various statutes have accorded statutory recognition to mediation, and courts have also highlighted the benefits of resorting to mediation.

Despite the proactive efforts to envisage an expansive role for mediation in India, tax disputes are one category of disputes that have remained aloof from it. Practice in other jurisdictions manifest that an option to mediate may be a successful way to mitigate tax disputes and reduce tax appeals. India suffers massively from distrust between taxpayers and tax authority, and consequentially, from excessive pendency of tax appeals.

In order to tackle this mistrust, Indian Prime Minister, on 13-8-2020, announced a historic change in the tax mechanism, making the tax appeal and assessment faceless. Through this move, the Government has eliminated any one-to-one interaction between income tax (IT) officers and taxpayers, thereby attempting to empower taxpayers, and generate their belief in the assessment and appeal mechanism.

In furtherance of the same, this article analyses the prospects of introducing the option of mediation for taxpayers to resolve their tax disputes or concerns, harmoniously through dialogue, without having to indulge with the appellate forums.

The article is divided into 3 sections. Firstly, the article discusses the introduction of the faceless mechanism for tax assessment and appeals in India. Secondly, the article examines the potential impact of the faceless mechanism on the taxpayers in India. Thirdly, the article analyses the possibility of introducing mediation, in addition to the recent tax reforms, as an option for taxpayers to resolve their tax concerns or conflicts.

Faceless Mechanism: The Way Ahead for India

On 13-8-2020, the Prime Minister of India announced a historic shift in the taxation mechanism of the country, targeted towards ensuring ultimate transparency in tax assessments and appeals. Coined as “Transparent Taxation-Honoring the Honest”, the unprecedented move has announced the advent of faceless assessment, faceless appeal and the taxpayers’ charter.[1]

The Prime Minister explained the new mechanism as follows:

“Till now, all tax-related matters in a city are dealt by Income Tax Department of that city, IT officers of that city play main role. Now on, using technology, scrutiny will be done by a randomly chosen IT officer anywhere in the country.”[2]

In other words, under the new mechanism, the identity of the taxpayer and the assessing officer will remain unknown to each other. Faceless assessment will be carried out on account of a document identification number (DIN) that will be issued by a computerised artificial intelligence (AI) system, wherein there will be a random selection of taxpayers, and they will be assessed by a randomly allotted tax officer. In consequence, the new mechanism does away with the territorial jurisdiction of tax officials. In doing so, the Government has eliminated any physical interface between the taxpayers and the tax officials.

Similarly, with the introduction of “faceless appeal”, the Government has sought to make the appeal process for tax disputes transparent. As per the same, tax appeals shall be undertaken by a randomly chosen IT officer. Therefore, the identity of the officer deciding the appeal will remain unknown. The faceless assessment regime will come into force from 13-8-2020, whereas faceless appeal structure will come into force from 25-9-2020.

Despite this major overhaul, the Government has enlisted certain exceptions to the new mechanism, and the same includes cases pertaining to the Black Money Act, benami property, serious frauds, major tax evasion, sensitive and search matters, and also international taxation. Therefore, the Government has safeguarded its economic and political considerations by keeping certain discretionary powers intact.

That said, the tax reforms introduced are bound to completely change the manner in which direct tax is paid and collected in India. Until now, taxpayers had to often visit the local tax office, and wrangle with officials in case of any conflict and often had to pay bribes to “settle” their cases or be subject to tax tyranny. However, with the faceless regime, honest taxpayers will be exempted from any hassles of the erstwhile system.

Impact of the Introduction of a Faceless |Mechanism

One of the foremost intended impacts of the new tax reforms is to build confidence amongst the taxpayers, such that they are able to trust and appreciate the system for collection of taxes in India. There is often hostility between taxpayers and tax officials. Particularly, in the Indian context, there is a lack of trust of taxpayers in the tax authority, that arises owing to the massive power imbalance between them, in terms of authority, experience, technical knowledge, etc. Tax officials in India are often criticised for passing discretionary and non-judicious assessment orders. This has led to a psychological barrier or apprehension against a supposed tendency of tax officials to pass aggressive assessment orders.

Moreover, the erstwhile regime granted the tax officials abundant powers, and as highlighted by the Prime Minister,[3] on occasions, these powers have been misused by certain officials to make unlawful gains or promote “jaan pehchan”(familiarity) culture. In order to curb such overreach by tax officials, the new tax reforms have diluted their powers, as the faceless regime limits the scope of these officers’ discretionary actions.

These changes should mitigate the existing psychological barriers between the taxpayers and tax officials, and provide a better atmosphere for voluntary compliance of tax obligations in India. Moreover, the transparent regime, as introduced, may also reduce the staggering number of tax appeals in the appellate forums in India. The reason being that the taxpayers should now have greater confidence in the blind assessment and appeals done by the IT officials.

For greater clarity, the appellate structure for tax appeals in India is as follows[4]:

(a) First—Commissioner of Income Tax (Appeals).

(b) Second—Income Tax Appellate Tribunal (ITAT).

(d) Final—Supreme Court of India.

The ITAT is the final finding court for tax cases, and the appeal to the High Court and Supreme Court must relate to a substantial question of law.[5] India suffers from a massive pendency of tax appeals. To put the same in context, as on 30-11-2019, disputed direct tax arrears in India were equal to Rs 9320 billion compared to actual direct tax collection in the financial year 2018-2019 of Rs 11,370 billion.[6] Moreover, approximately 4,83,000 cases are reckoned to be pending at different appellate forums in India.[7]

Previously, as a measure to reduce the pendency of tax appeals, the monetary threshold for an appeal before the ITAT was increased to Rs 50 lakh from Rs 20 lakh by the Central Board of Direct Taxes (CBDT).[8] Similarly, with respect to the High Courts and the Supreme Court in India, the monetary threshold had been doubled to Rs 1 crore and 2 crore, respectively.[9]

The new faceless regime is introduced at the level of the first appellate forum i.e. the Commissioner of Income Tax (Appeal). The increased transparency in the first appellate forum is expected to reduce lasting conflicts, and consequently reduce pendency of tax appeals. However, the success of these reforms is contingent on the smooth execution of the new mechanism, and efficiency will be the key in ensuring that the new mechanism garners a positive outcome. The faceless mechanism must be structured in a way that it does not result in taxpayers being denied an opportunity to be heard efficiently at any forum. Moreover, while deciding an e-appeal, the officials must adequately address the complexities of the case, and apply the relevant law, without any bias.

In addition to the faceless regime, a reconsideration of the collection targets endowed upon the tax officials is also important. Often the tax officials are provided with unrealistic collection targets, trying to meet them is the major reason that they have to pass aggressive assessment orders. A reconsideration of these targets will mitigate the supposed tendency of tax officials to pass aggressive assessment orders, thereby reducing the possibility of tax disputes from arising in the first place.

In light of the constant tussle between taxpayers and tax authority, the next section of the article considers the possibility of providing the taxpayers with an option to mediate after the assessment is done, such that they can enter into a dialogue with the tax authority to resolve their concerns relating to the assessment order, without actually indulging with the appellate forums.

Mediation—A Way to Ensure Harmonious Prevention of Appeals

On 13-8-2020, another important development came to light. The Bar Council of India (BCI) wrote to the Vice-Chancellors of all universities, issuing LLB degrees, mandating the introduction of mediation (with conciliation)as a compulsory subject to be taught with effect from 2020 in all 3 years and 5 years law courses.[10] The BCI acknowledged that more and more litigants are being drawn towards mediation and are recognising its benefits. Moreover, the BCI also noted the benefits of mediation, as it leads to resolution in the absence of arduous trials, and resolution comes to fruition expediently. This move has been undertaken in the hope that mediation will go a long way in reducing the staggering pendency and backlog in Indian courts.

Historically, disputants in India have been more conditioned or habituated to the traditional litigation process. As a result, India requires heightened and active efforts to ensure that mediation does not exist or serve only as a “buzzword” for the disputants. In line with the same, in the last decade, various statutes like in India the Companies Act, 2013 have accorded statutory recognition to mediation. However, there was still a further need to institutionalise mediation, as a household discussion, such that it could occupy a more expansive role in India. The introduction of mediation as a compulsory subject in law schools will ensure more awareness among lawyers, about the prospects of mediation, and will lead to it being looked upon as more of an option than traditional litigation.

The importance of mediation has been highlighted by the Supreme Court of India in M.R. Krishna Murthi v. New India Assurance Co. Ltd., wherein the Court stated:

… mediation as a concept of dispute resolution, even before dispute becomes part of adversarial adjudicatory process, would be of great significance. Advantages of mediation are manifold. This stands recognised by the legislature as well as policy-makers and need no elaboration. Mediation is here to stay. It is here to evolve. It is because of the advantages of mediation as a method here to find new grounds. It is here to prosper, as its time has come.…In fact, the way mediation movement is catching up in this country, there is a dire need to enact Indian Mediation Act as well.[11]

While there is growing legislative and judicial support for mediation in India, there are still certain categories of disputes that are yet to embrace mediation. For instance, till date, tax disputes in India have remained outside the ambit of mediation. Predominantly, the absence of mediation from the tax framework in India can be rooted in the traditional approach of the Government, and the comprehensive yet cumbersome tax structure enshrined in the Income Tax Act, 1961. However, recent reports have suggested that India has been pondering upon the introduction of mediation to prevent/resolve tax disputes.[12]

This can be an attempt in furtherance of the measures like the faceless taxation mechanism and the 2019 Sabka Vishwas Scheme, taken by the Government to reduce tax litigation. Meditation, if introduced, will be aimed at providing a more cost and time-efficient model to prevent tax disputes, and mitigate the staggering pendency of tax appeals in India, thereby making the country more friendly for taxpayers. Therefore, mediation may provide a more direct and robust mechanism, that would help in unlocking the disputed tax revenues, and also aid ease of doing business by reducing excessive tax litigation in India.

A. Practice in Other Countries

Though mediation of tax disputes will be a new phenomenon in India, it is already being practised successfully in various countries. For instance, Her Majesty’s Revenue and Customs (HMRC), a department of the UK Government responsible for the collection of taxes has seen favourable results in its use of mediation for resolution of tax disputes.[13] The HMRC provides the option to individuals or organisations to resolve their personal or business disputes to apply for mediation. The mediation is focussed on (i) the areas that need to be resolved; and (ii) re-establishing communications, if needed. Interestingly, UK has a similar tax dispute resolution appeal structure to India i.e. there are four appellate forums. Therefore, the practices of HMRC, in appropriately utilising alternative dispute resolution (ADR), can serve as an example for the Indian tax authority to embrace and use mediation to prevent/resolve tax disputes.

Other jurisdictions like the United States, Netherlands and Belgium have also successfully utilised mediation as a viable alternative dispute resolution mechanism for tax disputes.[14] In the United States, tax mediation has been a mature practice, and the US Internal Revenue Service has a voluntary mediation programme known as fast track mediation i.e. utilised to expediently resolve tax disputes. The objective of the fast track mediation programme in the US is to ensure that disputes are resolved efficiently within 40-120 days. The experience in the US indicates that such a practice is significantly faster than the traditional appeals process. The key features of the fast track mediation programme include: (i) facilitation of the settlement discussion by an independent mediator; and (ii) retention of the right to appeal, if the dispute remains unresolved through the mediator.

However, not all countries have seen similar fruition of mediation for tax disputes. For instance, in contrast to the US, despite mediation for tax cases being introduced in Canada in 2000, Canada has not seen success in its usage. The Canada Revenue Agency could only settle negligible number of cases through mediation, and as a result it decided to stop providing the option of mediation to its taxpayers.[15] Therefore, the success of mediation, as a tool, for resolution of tax disputes, is contingent on the specific conditions under which it is utilised. In order to ensure a sustainable framework, mediation must be introduced in a manner i.e. optimal for both, taxpayers and tax officials.

B. Introducing Mediation for Tax Disputes in India

(a) Legal Considerations in Play

For mediation to be a success in India, in resolving tax disputes, and in mitigating the excessive pendency of tax appeals, it must harmoniously mingle with the existing principles of tax law and the underlying psychological barriers that exist between taxpayers and the tax authority in India. The tax authority in India is strictly bound by the Income Tax Act, 1961,[16] and therefore, any agreement reached during mediation will need to fall within the permissible limits of the statutory framework. This is known as the “principle of legality” in mediation.[17] Moreover, while mediation seeks to heed to the specific circumstances, emotions and interests of the parties, the statutory framework will require all taxpayers, in the same position, to be treated similarly in mediation i.e. the “principle ofequality of treatment”.[18] As a result, the discretionary powers of the tax authority to settle disputes in mediations will be limited. Therefore, in order to allow taxpayers to come out and honestly settle their concerns or disputes, the Government must introduce schemes that incentivise such behaviour. Taxpayers must be given the assurance that they will not be penalised and that the dispute will be settled expediently.

(b) Best Utilisation of Mediation

Despite the aforementioned legal considerations, mediation may be very well utilised in India to prevent tax disputes from arising, and appeals from being filed in the first place. The same can be done by ensuring a transparent interchange or dialogue between taxpayers and the tax authority, the lack of which is one of the foremost reasons for the staggering rate of tax appeals in India.

In order to mitigate any psychological barriers and the lack of trust of taxpayers in the tax authority, post the faceless assessment by the tax officials, the taxpayers can be given the option to avail mediation with the tax authority.[19] In the event that the taxpayers have any confusions, reservations, misunderstandings or apprehensions with respect to the assessment order, mediation can be used appropriately to allow the tax authority to help the taxpayers understand the rationale of the order, and also the technicalities and procedure followed to reach such an assessment. At this stage, both taxpayers and the tax authority can strive to settle any conflicts as per the schemes provided by the IT Department.[20]

During the mediation, the tax officials should shift their focus from mere collection of tax to indulging in an active dialogue with the taxpayers, wherein they can explain the assessment procedure/technicalities to the taxpayers, build confidence, clear misunderstandings and/or provide any additional information.

Such dialogue between taxpayers and the tax authority during the mediation shall go a long way in building a relationship between them i.e. premised on mutual trust and cooperation, and will also ensure less appeal. In other words, mediation will be helpful in allowing the taxpayers to communicate with the tax officials, such that they can collectively ascertain the final amount that is due to be paid, and promote voluntary compliance.

In addition to an active dialogue and confidence building between the parties, it is also extremely vital to ensure the neutrality of the mediation process. As discussed above, the root causes for the excessive tax litigation in India are the psychological barriers and the distrust between taxpayers and the tax authority. Therefore, for successful use of mediation in India for tax disputes, it is important to ensure a semblance of fairness and impartiality during the mediation, such that parties are truly able to appreciate and put faith in the process.

Consequentially, it would be better to not appoint internal tax officials as mediators, as it might give an impression of an overlap between their roles as mediators and tax officials. Moreover, avoiding the appointment of internal mediator will also ensure that the mediation does not seem like a supplementary administrative review procedure.

Therefore, it would help to have an external panel of accredited mediators, which may comprise of retired judges, retired tax officials, lawyers or other neutral persons having expertise in tax matters.

Conclusion

The tax reforms announced on 13-8-2020, are certainly pathbreaking and historic in nature, and if implemented properly, have the potential to make the Indian tax system much healthier. The intention of these reforms is to bring utmost transparency into the process; it needs to be backed up with proper implementation, for it to get the desired results. It cannot be denied that these measures have immense potential to streamline tax collection in India and trigger voluntary compliance.

Taxpayers in India do not want litigation, as it causes them extreme hardships, in terms of the high litigation costs and inordinate delays. Therefore, any genuine effort by the Government to ensure transparency will be welcomed and appreciated by taxpayers in India.

Incidentally, the introduction of mediation as a mandatory subject to be taught in law schools is a manifestation of the support between accorded to alternate modes of resolution in India. In light of the same, mediation can also be a possible introduction to resolve/prevent tax disputes, as it will allow taxpayer to clear any misunderstandings, without having to indulge with the appellate forums. However, it is important to ensure that mediation is not rendered to a mere procedural formality or an additional administrative procedure, and therefore, tax officials must be ready to perform a proactive role, wherein they reflect a fair, transparent, judicious and collaborative attitude during the mediations.

The option to mediate can be introduced as an optional mechanism i.e. available to the taxpayers, and can be utilised, at will, instead of the appeal forums. The amicable settlement of the tax disputes by mediation will also positively impact India’s image as a tax-friendly country, and boost its economy, given the sizeable amount of revenues that are locked up in these pending tax disputes.

Bhumesh Verma is Managing Partner at Corp Comm Legal and can be contacted at bhumesh.verma@corpcommlegal.in. Abhisar Vidyarthi, Research Associate, Corp Comm Legal.

[1] What is Faceless Income Tax Assessment Scheme? Key Things to Know, 13-8-2020, <https://www.livemint.com/news/india/income-tax-faceless-appeal-scheme-exclusions-explained-11597297807782.html>.

[2] Ibid.

[3] PM Modi Launches Country’s First Taxpayers’Charter Promised in the Budget, 13-8-2020, <https://www.hindustantimes.com/india-news/pm-modi-launches-country-s-first-taxpayers-charter-promised-in-the-budget/story-2OrX12N5QLdRLIDhG9rC4M.html>.

[4] Appeals, Income Tax Department, <https://www.incometaxindia.gov.in/Pages/i-am/firm.aspx?k=Appeals>.

[5] High Court Confirms Appeals must Relate to Substantial Question of Law, <https://www2.deloitte.com/in/en/pages/tax/articles/high-court-confirms-appeals-must-relate-substantial-question-law.html>.

[6] Bill to Implement New Direct Tax Dispute Resolution Scheme Introduced in Parliament, Deloitte, 19-2-2020, <https://www.taxathand.com/article/12962/India/2020/Bill-to-implement-new-direct-tax-dispute-resolution-scheme-introduced-in-parliament>.

[7] Ibid.

[8] Hiking Income Tax Appeal Limit to Reduce Litigation, Help Govt. Focus on High-Value Cases: Experts, 11-8-2019, <https://economictimes.indiatimes.com/news/economy/policy/hiking-income-tax-appeal-limit-to-reduce-litigation-help-govt-focus-on-high-value-cases-experts/articleshow/70629021.cms?from=mdr>.

[9] Ibid.

[10] Mediation with Conciliation to be a Compulsory Subject in Law Colleges from Academic Year 2020-2021: BCI, 15-8-2020, <https://www.barandbench.com/news/lawschools/bci-mediation-with-conciliation-compulsory-subject-law-colleges-academic-year-2020-2021>.

[11] 2019 SCC OnLine SC 315.

[12] Deepshikha Sikarwar, Govt. Mulls Mediation to Solve Tax Issues with Companies, 23-1-2020, <https://economictimes.indiatimes.com/news/economy/policy/govt-mulls-mediation-to-solve-tax-issues-with-companies/articleshow/73537586.cms?from=mdr>.