The Hindu Business Line : India-UAE protocol: Deciphering the fine print

The protocol amending the Indo-UAE double taxation avoidance agreement affects the determination of residence, taxation of capital gains, etc. The protocol also provides for the "Limitation of Benefits" clause to prevent the abuse of the agreement.

With over one million Indians in the UAE, the relationship between India and the UAE has always assumed special significance. With a trade volume of over $18 billion per annum, the cross-border transactions between the two countries are on the increase.

Leading UAE-based firms, especially in the real-estate sector, have joined the list of global companies targeting investments in India in hotels, malls, healthcare, housing, IT parks and integrated townships.

Thus, the importance of the Indo-UAE protocol amending the terms of the Indo-UAE double taxation avoidance agreement (the Treaty) cannot be overstated.

The Treaty was originally signed in India on April 29, 1992. There has been a considerable amount of litigation relating to the Treaty, especially on the definition of "resident". The protocol, amending the terms of the Treaty, will be effective in India from April 1, 2008. The UAE follows the calendar year for its tax purposes and, hence, in the UAE this protocol is effective from January 1, 2008.

The protocol has introduced key amendments that affect the determination of residence, taxation of capital gains, etc. The protocol also provides for the "Limitation of Benefits" clause to prevent the abuse of the Treaty.

An attempt has been made to analyse the rationale behind these amendments as well as the implication of the same.

Eligibility to claim benefits

The test of determination of residence to claim the benefit of the India-UAE Treaty has been a bone of contention between the assessee and the tax authorities, where diametrically opposite views have been adopted.

The no-tax regime in the UAE is considered by many tax authorities as the perfect ground to deny the benefit of the Treaty to UAE residents, as otherwise they would have a situation of "Double Non-taxation".

The basic premise of the tax treaty is that to get the benefit the `person' needs to be a "resident" of either of the countries. The definition of the term resident therefore assumes paramount importance.

Present Position

Currently, the definition is common for both India and the UAE, and provides that a resident shall be:

any person who, under the laws of that state;

is liable to tax therein;

by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature.

The controversy arises because of the inclusion of the words "liable to tax" in the above definition, since there is no taxation on individuals in the UAE.

The gist of the various decisions where the above issue was considered is given below:

The Authority for Advance Rulings (AAR) in the Mohsinally Alimohammed Rafik (1993) case gave a ruling favourable to the assessee.

A diametrically opposite view was adopted by the AAR in 1999 in the Cyril Eugene Periera case and the AAR ruled that the assessee was not entitled to the Treaty benefits. In 2003, the apex court considered the issue in the Azadi Bachao Andolan case in relation to the Indo-Mauritius Treaty and held that the liability to taxation was relevant, and not the fiscal fact of actual payment of tax.

The AAR followed this decision in 2004 in the Emirates Fertilizer Trading Co. WLL case.

The controversy continued in 2005 with the AAR ruling against the assessee in the Abdul Razak A Meman and others case. The protocol has set to rest the above controversies and ensured that the beneficial provisions of the Treaty are available to residents of the UAE.

Post-protocol scenario

The protocol has amended the definition of "Resident in UAE" under the Treaty to provide that that an individual who is present in the UAE for a period or aggregate period of at least 183 days in a calendar year will be treated as resident of UAE. Noticeably, the "liable to tax" criterion has been dropped in the amendment. It may be relevant to note that the treaties signed by India with Singapore, Italy, Kuwait, and so on, do not provide for "liable to tax" clause.

With respect to the residential status of individuals in India, the protocol provides that this would not include any person who is liable to tax in India in respect only of income from sources in India. Hence the Treaty benefits will be available only to assessees who are subject to tax on their global income in India.

This is on similar lines as the treaties with the USA, Australia, Slovenia and Hungary.

A company which is incorporated in the UAE and which is managed and controlled wholly in UAE is considered a resident in UAE for the purposes of this Treaty.

The Treaty provides for "residential status" definition only in respect of individuals and corporates.

Taxation of Capital Gains

Present position: The Treaty provides that capital gains are taxable in the country of residence of the alienator of the assets, except where the capital asset is: an immovable property; ormovable property of permanent establishment/fixed base of an entity situated in other state, in which case the gains are taxable in the country of situs of such assets.

Post-protocol scenario: The protocol provides that in the following circumstances the taxation of capital gain would not depend on the residence of the alienator.

Capital gains arising from the alienation of the capital stock of a company, the property of which consists directly or indirectly principally of immovable property, shall be taxed in the state in which the property is situated.

In the case of gains arising on alienation of shares other than those mentioned above, the same shall be taxed in the state in which the company issuing the shares is resident.

The implication of the above could be discussed as follows:

Example 1: An NRI settled in the UAE sells his investments in India. As per the Indian tax laws, he is taxable in India. Prior to the protocol, the Treaty provides for taxation of such capital gains only in the country of residence of the NRI. Hence the capital gains arising out of these transactions would be subject to taxes only in the UAE. Given that UAE does not impose any taxes on individuals, the capital gains arising out of such sale would not be subject to any taxes.

With the Indo-UAE protocol, this situation would undergo a change, and the NRI would be liable to taxes in India on the same, since the situs of the shares are in India. Where the capital gain arises out of a transaction where securities transaction tax has been paid the taxability of the same would be as follows:

Long-term capital gains: Nil

Short-term capital gains: 10 per cent

However, where the shares are unlisted or no securities transaction tax has been paid, then the capital gain would attract taxation at the normal tax rates.

Example 2: An UAE investor transfers shares held in a company resident in the UAE. The property of the company consists of immovable property situated in India,. Hence such transfer of shares would be covered under the ambit of the above clause, and would be taxable in India.

Example 3: An UAE investor transfers shares held in a company resident in the UAE. The UAE company has high investments in an Indian real-estate company. The property of the real-estate company in India consists principally of immovable property situated in India. The capital gains arising out of the above transfer of shares by the UAE investor would also be covered under the ambit of the above clause since the immovable property is held "indirectly" by the UAE company.

This would squarely affect UAE companies which have investments in real estate/real estate companies in India.

Limitation of Benefits

The protocol has introduced Article 29 relating to "Limitation of Benefits" in the Treaty. This provides that:

an entity will not be entitled to the benefits of the tax Treaty;

if the main purpose or one of the main purposes of the creation of such entity was to obtain tax Treaty benefits;

such tax benefits would otherwise not be available.

The cases of legal entities not having bona fide business activities in India/UAE will be impacted by this Article. By introducing this Article, the Treaty intends to prevent conduit and shell companies from utilising the benefits of this Treaty.

An area of concern would be to prove the bona fides of the business activities of the entity. The Treaty does not provide the parameters to prove the bona fides unlike in the case of the Mauritius and Singapore treaties.

For instance, the Singapore protocol provides that a resident of a contracting state is deemed not to be a shell/conduit company if:

it is listed on a recognised stock exchange of the contracting state; or

its total annual expenditure on operations in that contracting state is equal to or more than S$200,000 or Rs 50,00,000 in the respective contracting state as the case may be, in the immediately preceding period of 24 months from the date the gains arise.

With respect to the Indo-Mauritian treaty, wherever a certificate of residence is issued by the Mauritian authorities, such certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC (double taxation avoidance convention) accordingly.

In the absence of such specific provisions, proving the bona fides would be a contentious issue.

With the protocol coming into effect, there would be an end to litigation relating to the "residence" and, hence, would be a welcome relief to many assessees. However, certain terminologies used in the protocol have not been defined clearly, and hence could be open to litigation.

For instance, the definition of the resident as applicable to a company indicates that the management should be wholly controlled and managed. However no yardstick has been provided to understand the term "wholly".

The protocol has brought in taxation of capital gains relating to alienation of shares of a company whose property directly/indirectly principally consists of immovable property. However no definition has been provided for "indirectly" and "principally".

The protocol has not provided the parameters to prove the bona fides of the business entities.

With the introduction of the Limitation of Benefits clause in the Indo-UAE treaty, the general expectation is that a similar clause would shortly get introduced in the Indo-Mauritian treaty, as well.

(The authors are with Deloitte Haskins & Sells, Bangalore.)

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India-UAE protocol: Deciphering the fine print