On the 7th of June 2017, a significant event took place in the annals of international taxation. 68 countries gathered in Paris to sign a multilateral convention that is supposed to address the phenomenon of base erosion and profit shifting. The Indian Finance Minister signed the document on behalf of India.
According to a Finance Ministry statement: "The convention will modify India's treaties in order to curb revenue loss through treaty abuse and base erosion and profit shifting strategies by ensuring profits are taxed where substantive economic activities generating the profits are carried out and where value is created." India seems to be reposing a lot of faith on this modality to tackle MNC tax avoidance. Not quite unjustly. The CTPA boss Pascal Saint Amans, apparently said: "This signing means treaty shopping is dead." These are of course right noises for the right occasion. Besides, the BEPS report addresses only treaty shopping as tax abuse thereby identifying such practice exclusively with treaty shopping. One needs to see what stand the Indian Supreme Court now takes having once famously quoted from a tax planner’s book that treaty shopping was good for India.
The multilateral convention that was signed is complex in nature. One might recall that it resulted as a separate action point of the OECD/G-20 BEPS project- Action point 15. The idea was that since tax treaties are bilateral in nature it would take a long time to bilaterally renegotiate all the approximately 3000 tax treaties in force today and therefore a multilateral instrument could be devised that would allow such treaties to be modified in one go.
Countries are supposed to notify the OECD secretariat the tax treaties that they wish to modify through this instrument. Reportedly, some countries have not included India in their list. Most prominent amongst these is of course Germany. But India has notified 93 agreements, i.e., all agreements less the one with Taiwan. India has also clarified its position on a number of issues. These now have the full backing of the Government of India and have perhaps more legitimacy than when India had stated its position on the OECD Model and Commentary way back in 2008. It will be interesting to watch the reaction of India’s Courts and Tribunals to these positions in future.
Absent form the signing ceremony was the most powerful country in the world at the moment- the USA, thereby raising doubts about the long-term effectiveness of the process. It may be remembered that it is the US multinationals that were at the forefront of the backlash that swept the western world and resulted in the BEPS project itself. The USA, of course, had participated in the deliberations and very often, vetoed proposals by other countries that wanted stricter measures against such multinationals. It is also interesting to note that the current world tax order that is based on the deliberations at the League of Nations was again dominated by the USA but the USA finally did not join the League.
This is also the first time that the developing countries would have a say, a very feeble one perhaps despite the OECD proclamation that they participated on an equal footing. India did participate in the project with gusto, devoting considerable energy and attention. The final outcome is far from what India would have wanted. Nevertheless, the Indian contingent went along and played a constructive role in the whole project. For the MLI also, there was a steering group and one Indian official is part of the Steering Group of the so-called Inclusive Framework. So, some credit should also go to India for the partial success of bringing about the MLI. The MLI is a unique concept. It has its own problems. It is yet to come into force but there is some amount of optimism that it may work out after all. With this background, let us now examine the Indian position as has been released by the OECD in the public domain.
There are two compulsory areas for the implementation of the MLI. The first relates to treaty abuse. This is contained in Part III of the MLI in articles 6 and 7.Countries are required to include a preamble to every tax treaty as follows:
"Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non - taxation or reduced taxation through tax evasion or avoidance (including through treaty - shopping arrangement s aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),". Here, a reservation by a country is possible only if a treaty contains similar language.
Besides, countries could also include a sentence "Desiring to further develop their economic relationship and to enhance their co - operation in tax matters," India has a somewhat similar declaration in its treaty with Mauritius that states: "DESIRING to conclude a Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment." That did not prevent treaty shopping to happen through Mauritius. Under Article 6(6) of the MLI, the parties are required to inform the depositary, the OECD Secretariat, of their intention to include the preamble language referring to a desire to develop an economic relationship or to enhance co-operation in tax matters. India has not included such a reference.
The most important article in the MLI is the one relating to prevention of treaty abuse as contained in Article 7 of the MLI. The default option in this regard is the principal purpose test formulated as follows:
"Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement."
However, countries could also opt for a detailed LOB version along with either an anti-conduit financing regulation or a principal purpose test rule to achieve the minimum standard of anti-abuse measure envisaged by the MLI. This has to be done through bilateral negotiation by opting out of the MLI. Switzerland apparently preferred this route.
A country /jurisdiction could also apply a simplified LOB against treaty shopping practices. India has chosen this route as its default option. This is in line with India’s current treaty practice. India tries to incorporate the simplified LOB provision in its new treaties.
Very briefly, under the LOB clause, treaty benefits will be available if the person is a qualified person, or satisfies the active conduct of business test or satisfies the equivalent benefit test. India has notified the treaties with Albania, Armenia, Iceland, Mexico, Sri Lanka, Tajikistan, Tanzania, Uruguay and the USA in this category. However, the language of these LOB provisions may not be the same as in the MLI document. Moreover, out of the 68 jurisdictions, only about a dozen are reported to have chosen the simplified LOB. Therefore, its importance will be limited.
The other compulsory aspect of the MLI is the minimum standard relating to dispute resolution contained in part V comprising articles 16 and 17. Article 16 ,paragraph 1 corresponds to the standard article 25(1) relating to MAP with the only difference that the taxpayer is authorized to present his case to either of the competent authorities in case of a dispute. However, article 16(5) provides for a reservation by a country that the taxpayer should present his case to the CA of the jurisdiction of which he is resident. India has chosen to exercise its reservation with the result that if the CA of the resident state considers that there is no merit in the case of the taxpayer, he will consult the CA of the other State. The time period under the MLI is 3 years from the first notification of the action of the tax authorities considered to be not in accordance with the Convention by the taxpayer. India has indicated that only four of the agreements, i.e. those with Belgium, Canada, Italy and the TAE, the time period is less and consequently in these treaties, the time period will be substituted.
Article 17 of the MLI deals with corresponding adjustments in transfer pricing cases. India has so far taken the position that in the absence of a specific article 9(2) in a treaty, it would not allow the corresponding adjustments. Some of the existing treaties were modified in that regard. The MLI also gives an option to a State to make a reservation to this effect. However, India has chosen to accept the MLI language and not to make a reservation. According to the list annexed, 90 of the 93 agreements contain a provision similar to article 9(2).
Optional provisions
The MLI also contains certain optional provisions. One of these relate to the treatment of transparent entities as given in Article 3 of the MLI. In terms of this article, in the case of a transparent entity, it is considered a resident of a State if the income is ultimately taxed in the said jurisdiction. India has reserved its right not to apply the entirety of the proposed Article 3. This is in line with India’s position on the OECD Commentary wherein India had expressed its reservation.
However, Courts had taken conflicting views in this regard. In the case of Linklaters LLP vs ITO, the Tribunal allowed the treaty benefits to the partnership despite the fact that it was not taxable in its own right in the residence country and despite the fact that OECD partnership report also did not approve of the proposition. The Tribunal noticed India’s position in this regard but nevertheless allowed the treaty benefits to the firm. However, in another case- Schellenberg Wittmer, the AAR observed that admittedly, India is not a member of the OECD and also has not accepted the proposition that if partnership is not entitled to the benefits, the partners should be so entitled. According to India, this position would prevail only if the same is incorporated in the treaty.
Article 4 of the MLI deals with the tie-breaker rules relating to dual resident entities. The MLI provides that the case of dual resident entities will be solved on a case by case basis by the Competent Authorities and in case of no agreement the taxpayer will not be entitled to the benefits of the treaty. India has such a provision in some of its treaties. India has accepted this provision and has not given any reservation in this regard.
Article 5 of the MLI deals with the switchover of the methods of elimination of double taxation from exemption method to credit method in some cases where the exemption method results in double non-taxation when the source country does not tax the income concerned. Considering the fact that India follows credit method in relieving double taxation, it has reserved the right not to apply the entirety of article 5 to its tax treaties. Perhaps this aspect should have merited a deeper scrutiny.
Article 8 of the MLI creates a minimum holding period for the source country taxation of dividends at a reduced rate if a minimum holding of capital is satisfied. It suggests that where dividends are exempt from tax or are taxed at a lower rate, the benefits should be available only if a minimum holding period of 365 days is satisfied. India has accepted this provision except in the case of India-Portugal treaty where an uninterrupted holding period of two years was necessary in order to get the benefit of the lower rate. Considering the way dividends are taxed in India, this provision does not have much application at least in so far as dividends distributed by the Indian companies are concerned.
Article 9 of the MLI relates to capital gains arising from transfer of shares of immovable property companies on the same lines as Article 13(4) of the UN Model. It also brings in its scope interests in partnerships or trusts. This was already part of the UN Model but was not present in many of India’s treaties. The Action 6 Report also introduced a testing period for determining whether the condition on the value threshold is met. This was to address situations in which assets are contributed to an entity shortly before the sale of shares in that entity in order to dilute the proportion of the value of the entity that is derived from immovable property.
India has chosen to accept the provision in this behalf. Although India has indicated that 92 of its treaties do contain a provision similar to article 9(1) of the MLI, it seems that the stipulation of minimum holding period was not there in most of them. If the other party also opts for this provision, the treaty language relating to this provision will get altered.
India has also accepted the article to combat artificial avoidance of PE status through Commissionnaire arrangement and similar strategies. Although the Commissionaire arrangement is useful for planning in civil law countries and it is doubtful if such arrangement would succeed in a common law jurisdiction like India, there is no harm in adopting this provision by way of abundant caution. It will of course be interesting to see how many civil law countries actually adopt this provision. If there is any reservation by any partner country, then its applicability will be limited.
Article 13 deals with artificial avoidance of PE status in case of preparatory and auxiliary activities. Article 5(4) of the OECD Model Tax Convention includes a list of exceptions to permanent establishment status where a place of business is used solely for preparatory or auxiliary activities.
As discussed in detail in action point 7 of the BEPS report, this provision may lead to BEPS concerns particularly in the digital economy scenario. The work on this action point resulted in an explicit statement that the listed activities will be deemed not to constitute a permanent establishment only if they are of a preparatory or auxiliary character. This proposal is contained in option A although there some States consider that some of the activities referred to in Article 5(4) of the OECD Model Tax Convention are intrinsically preparatory or auxiliary and, in order to provide greater certainty for both tax administrations and taxpayers, take the view that these activities should not be subject to the condition that they be of a preparatory or auxiliary character, and that concern about inappropriate use of the specific activity exemptions can be addressed through anti-fragmentation rules. For these States, Option B is prescribed. Not surprisingly, India has opted for option A.
Apart from these, India has not expressed any reservation regarding article 10 of the MLI that puts in place an anti-abuse provision relating to third country permanent establishment.
Similarly, Article 11 creates a clause that allows taxing the residents of one’s own country. As explained in the BEPS report on Action 6, most of the provisions of a tax treaty are intended to restrict the right of a Contracting State to tax the residents of the other Contracting State. In some cases, it has been argued that such provisions also restrict the right to tax the residents of the Contracting State itself. This is contrary to the intention of the tax treaties. The USA incorporates a ‘savings clause’ in its treaties to preserve its right to tax its own citizens/residents. The same has now been adopted in the MLI. Again, India has not expressed any reservation to this provision. Although it may seem innocuous, this provision seems important in view of the inconsistent interpretation adopted by Courts in India about the scope of taxation of residents in the presence of tax treaties.
India has also not expressed any reservation regarding Article 14 of the MLI that deals with the prevention of the abuse of splitting up contracts in case of a construction PE. Accordingly, all these provisions will get incorporated in the relevant tax treaties if the partner countries do not express any reservation.
Finally and very importantly, despite some lobbying in some quarters, India has not accepted the Part VI of the MLI that deals with mandatory binding arbitration. India’s experience with international arbitration in the context of the investment protection treaties is obviously the reason for the tough stance taken by India in this regard. Besides, most of the developing countries feel disadvantaged in such proceedings and it is understandable that these countries would like to resolve tax disputes through the domestic mechanism. Besides, Indian negotiators have earlier pointed out that the arbitration award not being binding on the taxpayers, no finality is brought in the proceedings. |
