An entity enters into several
agreements during its lifetime. As a very normal course, before any transaction
is executed / entered into, a draft agreement is prepared which captures the
general understanding of the two (or more) contracting parties and after a
typical phase of negotiation(s), it gets finalized. More and more organizations
today are realizing that before a draft agreement is finalized, all the
different departments and stake holders must review the same (not only the
legal and operations department) and include their points therein. Whether it
is a commercial, NGO, charitable or a Government concern, it is becoming imperative
to get its draft agreements comprehensively reviewed from all before finalization.
Hence, emerges the need to get all
such agreement(s) reviewed from the Tax person in an(y) organization. But as a
Tax reviewer, how should a review of an agreement be done? Lets see how.
Let us first keep in perspective the
general role / responsibilities of a Tax Person. The basic duty is to see that
all the tax laws /requirements involved in any transaction gets complied with; this
coupled with the endeavor to achieve cost savings for the entity. In a
synopsis form, the Tax review would involve (i) understanding the nature of the
document under review; (ii) understanding the tax implications that would be
involved in the transaction, both in present and future; and (iii) a sanctity
check. Thereafter, one could incorporate the tax clauses in such agreement(s);
and finalize it in consonance with legal & business teams.
It would be important to understand
the nature of the document / draft agreement in hand, first. Chances would be
that it could be a Master Agreement or could be a subsidiary document which
would be governed by a Master Agreement; or even a term sheet which would be
culminated into an agreement later on. The Tax clauses might vary on the basis of
the nature of document under review. For example, if it is a subsidiary
agreement governed by a Master Agreement and the Master Agreement captures all
tax clauses properly, there may not be a need to include any tax clause in such
subsidiary agreement. Similarly, it may be agreed to insert the tax clauses
only in Side Letters and not main agreement. Hence, it is very important to
understand the nature of the document under review.
Now, the tax implications. To
understand the tax implications involved, the reviewer must obtain a clear
understanding of the transaction contemplated by the entity. In typical
situations, the transaction would involve a payment, a receipt or barter or might
sometimes have no monetary terms. After the basic understanding of the
transaction(s), one can draw a caricature of the typical tax laws /
implications that would be involved in such transaction(s) and then could
proceed further.
The Reviewer must be able to clearly
understand what tax implications are involved in such agreement and know the
responsibilities of each of contracting parties arising therefrom. The Reviewer
must ensure that the contracting parties remain responsible for taxes and
compliance of their respective parts on their own; and appropriate clauses must
be built accordingly in the agreement.
One would also like to understand
the status of the contracting parties involved – whether such are company,
non-company, LLP, university), its nationality (Indian, foreign), whether legal
entity (branch or head office etc), since the tax implications would vary
accordingly. As an example, if the contracting entity is a non-company and
thereby, not eligible to claim benefit under the respective Double Tax
Avoidance Agreement, it might cause certain concerns and the tax clauses would
accordingly change.
The reviewer must incorporate the
clause(s) to ensure compliance with all the tax implications. For example, to
comply with the tax withholding obligations at the time of payments, a clause
must be there in the draft to clearly state that the payments will be subject
to tax withholding (under the Indian Income-tax or Work Contract Tax ‘WCT’
under the respective state VAT laws). If taxes have to be grossed up, clauses
for the same. Also, for providing / getting Form 16A or tax withholding
certificates.
One must also understand if the
transaction would have bearing of indirect taxes such as Excise, Service tax,
VAT, Central Sales tax (in case of inter-state sale and subject to availability
of C forms) or Customs. Whether such taxes would be included in the price
agreed in the agreement, or would it be charged extra. The relevant clauses
must be incorporated accordingly. In case of foreign party agreement(s), one
must understand what taxes would the foreign party charge in its own country
and whether the agreement prices are inclusive or exclusive of such foreign
taxes.
If certain documents (PAN, valid
invoices with all necessary details, tax withholding certificates, waybills in
case of interstate movement of goods; in case of foreign parties, no-PE and Tax
Residency Certificate (TRC)) are required from the other contracting party, and
the duration of submission of such documents (no-PE and TRC every year,
invoices every month etc.), the relevant clauses must be incorporated. In case
of purchases or foreign imports, it must be clearly defined when the title of
goods would be transferred to the purchaser (VAT implications could vary basis
the place of transfer); also, the delivery terms (FOB, CIF etc.) and the roles
of the respective parties (as to who would be responsible for custom clearance
etc.).
If the agreement is between
unrelated parties, a clause must be incorporated in the agreement that the
status of parties would remain as independent parties and one should not be
deemed as agent or representative of the other. Similarly, a clause could be
there stating that both parties will remain responsible for their own tax
liabilities and compliance, on their own. However, if the agreement is between
related parties, it must take into consideration the transfer pricing implications
(domestic and / or foreign).
The reviewer must also look at
the confidentiality/non-disclosure clause, it should not restrict the entity
from sharing such agreement with tax / regulatory authority if required under
assessment or other such proceeding. Tax indemnity must be clearly provided. It
must clearly state the items against which tax indemnity is provided / availed
and the beneficiaries of such tax indemnity.
The Tax Reviewer must also keep
in perspective, the present tax obligations and the future ones as well; and
build the tax clauses accordingly. For instance, if there is a change in tax
rates expected or a new type of tax (such as GST in India) envisaged, the
Reviewer must understand who will bear such higher / lower taxes and put
clauses accordingly. Similarly, if the other contracting party does not charge
taxes properly on its invoice or does not deposit the taxes, adequate
safeguards must be built in the agreement, so that no liability / implications
could arise therefrom.
In the Sanctity check of the
draft, the Reviewer must ensure that the transaction, the terms around it and consideration
are clearly defined, without any ambiguity. There must be consistency in
agreement. For instance, rates quoted in main agreement (tax inclusive or
exclusive) and in annexures are same. The contract for Supplies is not termed
as Service or Works Contract. The Agreement, invoice to/from, payment to / from
remain with same party and has same terms. Also, ensure that the agreement is as per the entity’s
policies and not against it. The tax clauses appearing in the annexures of the
draft should be considered as agreement / part of the agreement only. Wherever
any complicated tax position is incorporated in an agreement by way of an
example, one could use examples to explain it clearly and mitigate ambiguity
therein. One must put accurate referencing of the clause numbers in agreement.
The Tax Reviewer must follow the
basic rule of ensuring entity’s compliance with tax laws (not to have any
excessive responsibilities by virtue of the agreement), achieving cost savings
and accordingly put clauses in the draft with a clear language. After having
incorporated all tax clauses, the reviewer must obtain a buy-out of the same
from legal or commercial / business teams; chances are that the business teams
would have agreed different terms with the other contracting parties and the
clauses would thus have to be suitably amended in view of the business
exigencies.
As discussed above, due to the
vital stake which the Tax person would hold in the transaction(s) /
agreement(s), more and more organizations must ensure an effective Tax Review
of the agreements for better and efficient business.