The Hindu Business Line : `LoB'bing tax treaty shopping

In the recent past, tax planning through legitimate international tax treaty shopping has been a subject of intense controversy in the international tax community. `Treaty shopping', as it is often called, has been identified as a highly sensitive issue in the context of tax avoidance. Such planning enables the taxpayers to take undue advantage of benefits contained in tax treaties, contrary to the intention of the contracting states. Quite a few nations view such practices as "treaty abuse" and are seeking to incorporate anti-treaty shopping provisions such as `Limitation of Benefits' in the tax treaties as well as their domestic tax laws in order to prevent such practices.

Concept of Treaty Shopping

Typically, to take advantage of the beneficial provisions of the tax treaties (for example, exemption from capital gain tax), third country residents make use of treaties between two different countries and route their transactions through those nations.

Following are the examples of typical Tax Treaty shopping:

Establishing conduit (direct/stepping stone) entities in low/nil-tax jurisdiction,

Conduit structures involving use of branches,

Transfer of residence,

Conversion of form of presence (for example, individuals to companies).

Tax treaty shopping is a legitimate instrument in international tax planning. However, there is a very thin line of difference between the point at which the legitimate tax planning ends and the point at which tax abuse begins, this being a matter of interpretation.

International developments

Mauritius-China Tax Treaty

The new protocol to the Tax Treaty between Mauritius-China signed on September 5, 2006 inter alia seeks to amend the article on capital gains by limiting the source-country capital gains tax exemption only to cases where the alienator owns 25 per cent or less of the share capital of a company resident in the source-country. Before the protocol, the Mauritius-China Treaty did not provide for source-country taxation of capital gains on alienation of shares and was therefore, widely used for structuring investments into China. The capital gains article of the India-Mauritius Tax Treaty too does not provide for source-country taxation of capital gains.

Developments in India

In the Indian context, until mid-2005, of the 73 comprehensive Tax Treaties India had concluded till that date, the India-US Tax Treaty was the only one to contain such elaborate prohibitive provisions. The prohibitive provision in the India-US Tax Treaty inter alia provides for the public company test, ownership/base-erosion test and active business test.

In the context of India-Mauritius Tax Treaty, the Supreme Court, in the Azadi Bachao Andolan case referred to Article 24 of the Indo-US Tax Treaty, which specifically provides the limitations subject to which the benefits under the Treaty can be availed. While pronouncing the judgement in favour of the taxpayer, the apex court observed that in the absence of the limitation clause, such as the one contained in the Indo-US Tax Treaty, there were no disabling or disentitling conditions under the Indo-Mauritius Tax Treaty prohibiting the resident of a third nation from deriving benefits thereunder.

In view of the developments in the international tax scene, the governments of India and Singapore amended the Protocol (effective from August 1, 2005) in the India-Singapore Tax Treaty. The Protocol between India and Singapore now has a LOB clause, to prevent abuse of the Treaty to enjoy favourable tax treatment of capital gains.

Recently, the governments of India and the UAE negotiated a protocol in the India-UAE Tax Treaty. The protocol inter alia seeks to address/clarify certain ambiguities in the existing Tax Treaty, especially with respect to Tax Treaty entitlement, arising out of contradicting interpretations of Treaty entitlement by various judicial rulings.

There has been a speculation for quite some time now, on the likelihood of the Indian tax authorities to notify the amendment to the India-UAE Tax Treaty.

The governments of India and the UAE are also exploring the possibility of introducing an article on LoB.

This would be done by way of incorporating of a LoB clause in the Tax Treaty, after which the Tax Treaty benefits would not be available to legal entities, whose main purpose of creation was to take the Treaty benefits without any bona fide business activities in the other contracting state.

Now, with these developments, it is only a matter of time when such a LoB clause would be brought in the India-Mauritius Tax Treaty.

It is also relevant to point out here that the Finance Minister, while replying on this point in Parliament in a debate on the Finance Bill, 2007, had said that the government is actually planning to bring in the same, however, this being a sensitive and delicate issue had to be delayed.

Therefore, foreign companies need to watch out while structuring their investments into India and decisions should not only be made based on the law currently prevailing, but also factor in changes that can happen.

More Stories on : Taxation | Foreign Trade

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Rupee appreciation and AS-11

Different forms of secured loans

Many a development trouble spot

`LoB'bing tax treaty shopping

Sub-contract is service tax-free

`Tedious' on rent

MBA through distance learning

Banking on foreign markets

Mobiles versus plastic cards

Losses due to cyber crime can be as high as $40 billion

Number Crunch

Just Do IT

Always do more than is required of you

Cluster of competencies