Tax Risk Management Part 2 - Tax Risks As Black Swan Events!

If one were to ask you "What do you perceive as 'tax risks' in your  business?"  What would be your answer?

Hmm...Let me suggest a few.

  • Notices received from tax authorities for raising tax demands?
  • Uncertainties around Tribunal/Court proceedings in tax disputes ?
  • On going investigations by an investigating arm of tax authorities? Anything unforeseen can emerge from this!
  • Difference of opinions arising during assessments and audits on tax positions adopted by you or your company which may lead to a possible tax demand?
  • Uncertainty about an aggressive tax position you took sometime ago when interpreting a provision which is untested and there is no legal precedence and it is within the time limit for tax authorities to issue notices and raise demand?
  • Some critical import consignment required in the plant stuck in customs and if the production stops, the plant will become inoperative and it will take 6-10 weeks and considerable cost to restart the plant. Huge operational risk! Right?
  • The sales department and others have not collected the C forms from customers, it is long past the due date for filing the forms and assessments are likely soon, we are likely to end up with a demand even though on merits the sale is genuine and above board.
  • When importing a chemical product, you have claimed that is falls within a specific category and hence exempt, the samples sent to the chemical examiner come back with a “test report” which is incomplete. The report simply confirms in a generic sense without specifically stating it falls within the category.  The goods are cleared and you are now facing a notice for a huge customs duty demand based on this “test report”.
  • These are all the ‘usual suspects” when it comes to “tax risks”. They are the obvious, top of the mind items any tax professional will rattle off if asked.

 If I were to say, your blank excise invoice stationery also creates a risk for you, how easily will you agree with this?

Yes, the blank stationery used for generating excise invoices from your factory or a registered depot!  Its difficult to agree isn’t it. Of course, it does sound far fetched. But this is what has actually happened in the case described below. Read on. 2nd Sept 2014 - Allahabad High Court : Continental Cement Company Vs UOI & Ors etc.

This case is not fiction. It is for real. The facts below are gleaned from the judgement of the Hon'ble Allahabad High Court.  Quite obviously, this is not a very typical case. That is not the point being made here. This case provides a very good understanding of the myriad sources from where tax risks could emerge and hit you. A black swan event!  An event which happens very rarely but when it does, it has devastating impact on the Company and you. One cannot ignore it. One should not ignore it.

"Prevention is always better than cure". But to prevent, one must first know what is "that undesirable thing" you want to prevent. So this knowledge and the skill to recognise / identify these “risks” is key! You may not be able to eliminate every possible risk, but what can be done, should be done.

With this background let me go straight to the case which illustrates the point.

In this case, the excise department received an anonymous complainant that a company producing and selling portland cement had illegally sold  around 3840 MT of portland cement between Feb 93 and Sept 95 using parallel documents like excise gate passes, excise invoices, challans, bills, cash memo and GRs, etc.

Based on this complaint and documents, the excise department issued a notice to the company for duty and penalty. The duty demanded under the notice was confirmed. Also penalties were imposed on the Company and three Directors of the Company.

Being aggrieved, the Company and Directors filed appeals before the Commissioner (Appeals). The Commissioner dropped the demand and allowed the appeals by order dated 29.3.2004. Naturally, since this was a case of alleged clandestine removal, the department was not happy with the order and filed appeals before the Tribunal. The Tribunal however, reversed the Commissioner’s order ex-parte. Attempts through recall applications by the Company were also rejected by Tribunal.

The Company and others, then filed appeals in High Court.

Their submission was, earlier there was another Director in the Company who hatched a conspiracy together with the accountant and misappropriated funds. They were both removed from service. They submitted that in retaliation, to avenge the action against them, they the forged documents (parallel documents like GPIs, invoices, challans, Bills, cash memo and GRs, etc.) and made a false complainant with the department. The company claimed that the documents were not issued by them. They also claimed and pointed out that the documents were forged and there is no evidence to corroborate clandestine removal.The department quite rightly did not disclose the name of the informant.

The department argued that after the complaint was received, they called and checked with the buyers. Though some of the businesses were now closed, most of them confirmed from memory to have bought SOME quantity of cement on payment of cash.

One very vital clue which helped the Hon'ble High Court to decide the case came from the Government Examiner who provided an opinion about the “handwriting” on the alleged forged documents. He said  "The enclosed writings and signatures stamped and marked were all written by one and the same persons”.

The court held that if all the "so called" documents (several types of documents) produced as evidence was in the same handwriting and written by the same person, then the genuineness of the documents cannot be accepted.  So the Court observed that there is no clinching evidence apart from these documents to prove in the nature of purchase of raw materials, consumption of electricity, sale of final products, clandestine removals, the mode and flow back of funds, demands cannot be confirmed solely on the basis of presumptions and assumptions. The Hon’ble Court also observed that clandestine removal is a serious charge for which clinching and tangible evidence is required. The Court listed several points on which a detailed investigation ought to have been done.

In short this has been a lesson not only for the assessee, but also for the department in terms of how an investigation ought to be conducted and what are the aspects which need to be enquired into before setting out to issue a notice.  If there is no clinching evidence, they should go and get it. If you can’t , then you shouldn't pursue it and waste everybody's time.

Those are the observations in so far as the investigation is concerned. What about the assessee? What are the lessons for assessees and tax payers from this?  What went wrong? How one must prevent it?

We don't have all the facts related to this case. So it would be unfair and inappropriate to discuss this specific case. What we can do is consider the issue in a generic sense. So none of the comments below are in any way related to this specific case described above.

Firstly, what are the tax risks? There are quite a number of risks involved. Financial, reputational, operational, regulatory and so on.

  • To state the obvious tax payers should be cautious about the employees they appoint. Particularly in sensitive senior positions such as Directors and Accountant, Tax Head. This will also include personnel in sensitive departments. It can avoid considerable nuisance and misery.
  • Today, people in HR speak about engaged employees who are self-motivated. Employees who are smart, hard working and dedicated to building a career and most of all delighted to work for the organisation which provide the required challenge. In this ethos, it is unlikely to have employees with such a destructive mind. Where disgruntlement is acute as to extract revenge on a Company or individuals by forging documents. Though this an aberrent behaviour precautions are nevertheless required.
  • Another point is who are your printers who print your Company’s tax  stationery? Who handles them? Is there any control on the usage of stationery? Why is it important? Because Cenvat credit amounting to hundreds of thousands of Crores is passed on to buyers each year. You should ensure that credit is not being availed under forged tax documents which indicate your name by some miscreants.  The real problem though is, one will never know until it is detected. Because  unlike in IT TDS, there is no system driven cross-verification of excise and service tax credit availed with tax/duty paid at the source to complete assessment. Maybe one way would be to affix a security hologram (very difficult to forge) on such documents of great value to establish authenticity.
  • I remember my own experience in the mid-1990s when Modvat credit was in vogue and credit on imported goods was allowed only on TRIPLICATE copy of the bill of entry (BoE).  No credit was allowed on any other copy.  BoEs were manually prepared as EDI was not yet introduced.  A brilliant assistant in our Customs House Agent’s team decided to save some money for his boss. He had received blank BoE stationery from the printers. However there was an error.  The BoE stationery contained sets with two QUADRUPLICATE COPIES and no TRIPLICATE COPY.  He did what he thought was best, he got the error corrected by blacking out the word “QUADRUPLICATE” and rubber stamped “TRIPLICATE” just above it. No one noticed this at the operational level as the rubber stamped legend “TRIPLICATE” seemed fine. In audit, this issue was raised challenging that these are not really “TRIPLICATE” copies. Notices were issued raising demands for a few crores and this was huge at that time. During the hearing the Commissioner even said “this could be a scam”. We ultimately won the matter by providing clinching evidence from customs, tracing the movement and so on. But there was enough anxiety and misery along the way. A lot of time which could have been employed in something useful had to be squandered in this. My advice. This is highly avoidable.
  • Thus there is a need for staff particularly at the operational level to be vigilant and consider the consequences of their actions. They should stop looking at things like “reasonable persons” through  “reasonable” eyes.  The law and the tax authorities don’t work this way. If you want to avoid misery. Introduce an environment in your company where while people take quick decisions and meet organisational objectives, still their actions where relevant should pass through a tax risk proofing scan. Here one word of caution, this should not be converted into a bureaucratic procedure where the essence is sucked out and only the form remains.
  • Ability to identify such risks is like exercising. Your team  will begin to get better at identifying risks as they do more of it and create an environment with people who have the innate ability to spot risks.