Cognizant's bank freeze raises spectre of tax terror

It is something the Modi Government promised would be history by 2014. It may not have panned out that way - industry captains often murmur 'tax terrorism' is rife. The case at Cognizant Technology Solutions, India's second largest IT services company, could be the latest attack.  

The Income Tax Department has frozen some of the company's bank accounts alleging it did not pay up a dividend distribution tax (DDT) of over Rs 2,500 crore.

Share buyback

The case pertains to share buyback by Indian arm of Cognizant from its Mauritius arm and the US parent in May 2016.  The buyback was effected just before the finance bill 2016 came into force, which has a provision to increase the scope of a 2013 law that taxed share buyback by unlisted companies to curb the practice of companies paying dividend in the guise of share buyback.

Cognizant Technology Solutions India, the Indian arm of US-listed Cognizant Technology Solutions Corp, is not listed in India.
 
The 2016 annual report of the company mentions this buyback. According to the annual report, in May 2016 India enacted the Finance Bill 2016, which, among other things, expanded the applicability of India's buyback distribution tax to certain share buyback transactions occurring after June 1, 2016.

The company's annual report states: "In mid-May, prior to the June 1 effective date of the enactment, our principal operating subsidiary in India repurchased shares from its shareholders, which are non-Indian Cognizant entities, valued at $2.8 billion. This transaction, or the India Cash Remittance, was undertaken pursuant to a plan approved by the High Court of Madras and simplified the shareholding structure of our principal operating subsidiary in India. Pursuant to the transaction, our principal Indian operating subsidiary repurchased approximately $1.2 billion of the total $2.8 billion of shares from its U.S. shareholders, resulting in incremental tax expense, while the remaining $1.6 billion was repurchased from its shareholder outside the United States. Net of taxes, the transaction resulted in a remittance of cash to the United States in the amount of $1.0 billion. As a result of this transaction, we incurred an incremental 2016 income tax expense of $238 million."
 
It appears that the dispute with the Tax Department is on the treatment of the amount which has been repatriated to its overseas arms. Since it is a share buy-back, the company treats the gain as capital gains, which was tax-free as per the Mauritius treaty. However, the I-T department, it seems, views the transaction as dividend distribution.

The interpretation issues aside, the timing of the bank freeze has raised concerns around tax terrorism. It is year-end, and department needs to meet targets.

A routine procedure or year-end target pressure?

A tax expert from a law firm, which represents one of the banks where Cognizant has its accounts explains:  "It is not uncommon for the Tax Department to attach bank accounts of a company where the amount of tax involved is substantial. The company concerned can go to court and get the account freeze lifted. However, if the money in account do get transferred to the Tax department, it would be sometime before the money can get refunded. In that case, the Department can show it in the revenue collection figure for the year."

He concludes that the case looks more like an exercise for meeting the year-end target.

Normally, the Department raises a tax demand on an assessee and a 30-day period is allowed to pay the tax. The 30-day period can be reduced in the case of extra-ordinary situations such as when the assessee is likely to leave the country. In such situations, the department can ask the assessee to pay the money within hours of raising the demand.

Another tax expert says that Cognizant has taken the High Court's permission for the transaction, and it looks unlikely that they would have repatriated the money without paying taxes. Usually, in cases where High Court has given its nod to a transaction, they send a notice to the Tax Department asking it if there are any tax dues related to the transaction. The department needs to respond to the notice within 15 days.

A query to tax department remained unanswered till the time of filing the report.

Cognizant, meanwhile, responded to media queries with a brief statement, saying it has done no wrong:

"Cognizant's business operations, our associates and our work with clients are not impacted by actions recently attempted by the Income Tax Department. The High Court of Chennai this morning heard the matter and instructed the Income Tax Department to not take further action pending further hearings before the court. The company believes that the positions taken by the Indian Income Tax Department are contrary to law and without merit. Cognizant has paid all applicable taxes due on the transaction at issue. The company will continue to vigorously defend itself and will pursue all available legal remedies. Cognizant is committed to complying with the law in all jurisdictions where it operates."