India: ‘Revisit the DTAAs’
OpEd piece by T. C. A. Ramanujam at Sify.com on January 26, 2008:
India is slowly waking up to the reality of the abuse of the Double Taxation Avoidance Agreement (DTAA) provisions. Many of the countries with whom we have avoidance agreements do not tax their residents in the manner we do. Interpretations of the treaty provisions by courts lead situations where no tax is paid either in India or in the treaty country.
Mauritius is a classic example. As the country does not levy capital gains tax, shell companies are formed there to take advantage of this concession. Attempts to pierce the corporate veil in such cases have not met with much success. The Supreme Court has left it for the Central Government to decide what is good for the country in such cases. Treaty shopping has become the order of the day. Income-tax law has provided that in case of conflict, the treaty provision will prevail over the tax law. This has aggravated matters. There is, therefore, an urgent need for a complete reorientation of the Double Taxation Avoidance structure. There are signs of a change in outlook in the recent treaties signed by the Government.
The India-UAE Treaty
India’s original tax treaty with the UAE, which was signed on April 29, 1992, gave rise to a lot of controversies. No taxes are levied on individuals in the UAE. Nominal corporate taxes are levied. The Central Board of Direct Taxes (CBDT) permitted Non-resident Indians (NRIs) in the UAE to enjoy the reduced rate of taxes levied there.
This meant that certain incomes such as capital gains were taxed neither in India nor in the UAE. Conflicting interpretations only added to the confusion. Both the Income-Tax Appellate Tribunal (ITAT) and the Authority for Advance Ruling suggested intervention by the Government of India to clear the confusion. Responding to this call, the Government signed a Protocol with the UAE in March 2007 for amendment of the original provisions of 1992.
The amendment now clarifies that an NRI who is liable to tax in India in respect of Indian income cannot take advantage of the Indo-UAE tax treaty. Mere incorporation of a company in the UAE will not be enough for judging the residential status. Total control and management of the company should be in the UAE to qualify as resident there.
Deductibility of expenses of an Indian permanent establishment (PE) of a company resident in the UAE would be subject to the provisions of the Indian Income-Tax Act, 1961. This means that head-office expenses would be restricted to 5 per cent of the adjusted total income under the Indian law.
Short-term capital gains made in the Indian stock market arising to the resident of the UAE now become taxable in India. This will be the position irrespective of the Securities Transactions Tax. Long-term capital gains on sale of shares where STT is paid will be exempt from Indian taxation.
These are major changes in the double taxation law and should be welcome in the interest of equity in taxation.
Benefits Rule
The most crucial amendment relates to the incorporation of the new Article 29. If the main purpose of the creation of the entity in the UAE is to obtain the benefits of the treaty provision, no benefits will be available to such an entity. Cases of legal entities not having bona fide business activities shall be covered by the new Article 29.
To enjoy treaty benefits, the new entity should comply with the test of business purpose. There should be genuine business activities. This is meant to discourage treaty shopping. This provision was incorporated in our treaty with Singapore signed in June 2005. Article 24 of the Indo-US DTAA also has such a provision.
The tax law should be amended to plug the dichotomy between legal and beneficial ownership of shares in the case of controlled foreign corporation. The OECD had recommended that the Government ask for upfront disclosure of beneficial ownership and control information on the formation of companies to prevent tax evasion.
It is necessary that our tax code has an anti-tax avoidance clause on the lines of the Singapore model. A company must be of substance to get DTAA benefits. For quite sometime, tax jurists have been saying that funds are being re-routed through tax havens to take advantage of treaty provisions. To prevent abuse of the treaty provisions, our tax treaties should be renegotiated and the income-tax law amended on the lines of the American and Singapore code. Hopefully, the forthcoming Budget will provide the answers to these issues.
