One of the big challenges which the Organisation of Economic and Cooperation Development (OECD) face is the shifting of the base of the profit by various global entities. By using the treaty benefits such entities can either save or avoid paying taxes. To mitigate such risk, OECD along with G 20 countries came along in 2013 and set up project named, “ The OECD G20 Base Erosion and Profit shifting (BEPS) Project”. The prime objective of the project was to bring coherence, transparency and substance to the international tax rules and address the issue of tax avoidance.
In July 2013 the OECD released 15 Action Plans on Base Erosion and Profit Shifting (BEPS) to prevent double non -taxation as well as no or low taxation associated with practices that artificially segregate taxable income from the activities that generate it. Since most of the points mentioned in the Action Plan were related to addressing treaty abuse, OECD G-20 came out with a common document know as Multilateral Instrument (“MLI”).
Mli is an instrument to implement agreed changes in synchronised manner across the network of existing agreements without the need to bilaterally renegotiate each agreement. MLI already has significant impact on worldwide network of tax treaties and many countries/jurisdictions have signed/ shown interest or are in the process of signing the MLI. The plan is also to have a synthesised texts developed by each country to facilitate the interpretation and application of tax agreements modified by MLI.
India’s Position on MLI:
India ratified the MLI on 7th June 2017, represented by the Hon’ble Finance Minister at Paris, alongwith representatives of more than 65 countries.
On 25th June, 2019, India has deposited the Instrument of Ratification to OECD, Paris alongwith its Final Position in terms of Covered Tax Agreements (CTAs), Reservations, Options and Notifications under the MLI, as a result of which MLI will enter into force for India on 01st October, 2019 and its provisions will have effect on India’s DTAAs from FY 2020-21 onwards.
In the subsequent paragraphs, we have discussed the stand taken by India against each article of MLI. For ease of understanding we have bifurcated India’s position into three categories below:
I. Article accepted with partial reservation
1. Article 2: Interpretation of terms – Covers notification of agreements covered by the Convention. India has notified 93 tax treaties. (China and Marshall Island were not notified)
2. Article 8: Dividend transfer transactions An additional criteria inserted of a 365 days minimum holding period for the purpose of availing concessional tax rates under treaty. (Not to apply to India-Portugal treaty or unless reservation is made by other CTA Partners)
3. Article 17: Corresponding adjustments – In order to avoid economic double taxation arising due to Transfer Pricing adjustments, this article recommends corresponding adjustments to be provided by competent authorities in the other jurisdiction.(Reservation to exclude those CTAs that contain a similar provision.)
II. Article accepted without any reservation, this is subject to any reservation made by the CTA partner
1. Article 4: Dual resident entities – The competent authorities of both the jurisdictions shall mutually agree on the manner for determining the residential status of dual resident, non-individuals having regard to place of effective management, place of incorporation or constitution and any other relevant factors. In the absence of such agreement, treaty benefits shall be denied to such a person (unless otherwise agreed by them). (To apply to its CTA unless reservation is made by other CTA Partner).
2. Article 5: Application of methods for elimination of double taxation . Recommends 3 options for elimination of double taxation, namely
> Option A– State of residence would not exempt income from being taxed for the purpose of eliminating double taxation, where the state of source applies the provisions of the CTA to exempt such income from tax or to limit the rate at which such income may be taxed. In such cases, the state of residence shall allow a deduction of the amount paid in the state of source.
> Option B– Does not allow application of exemption method with respect to dividends that are deductible in the state of source
> Option C– Application of credit method
India has chosen to apply Option C. The said option shall apply to all its CTAs for its own residents.
However in the following cases, the current exemption method to be replaced with credit method. a) Bulgaria b) Egypt c) Greece d) Slovak Republic
3. Article 6: Purpose of a CTA – Insertion of a line in the Preamble of the treaty stating that the parties intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, as well as through treaty shopping. (Silent on this position. Hence, it would apply to its CTAs.)
4. Article 7: Prevention of treaty abuse – Envisages the following approaches in bilateral treaties to curb treaty abuse:
a. A Principal Purpose Test (“PPT”)
b. A simplified Limitation on Benefits Clause (“LoB”)
> India has accepted to apply PPT as an interim measure and intends where possible to adopt LoB provision, in addition or replacement of PPT, through bilateral negotiations along with Simplified LoB.
5. Article 9: Capital gains from alienation of shares or interests of entities deriving their value principally from immovable property. Two criteria’s have been added
> Insertion of an additional criteria of a 365 days minimum holding period in case of gains arising from the alienation of shares or other participation rights if such shares or rights derive more than a specified percentage of their value from immovable property situated in the source country.
> Additionally, optional provision of inserting a minimum value derivation criterion of 50% of their value directly or indirectly from immovable property (real property) at any time during 365 days preceding the alienation of shares or rights.
(To apply to its CTA only if the other CTA partner has chosen to apply the said provision.)
6. Article 10: Anti-abuse rule for PE situated in third jurisdictions – this clause mentions that the taxpayer should not be entitled to any benefits under the CTA on income derived by taxpayer in Residence Country from Source Country which is attributable to PE (in third country) if the tax rate in PE Country is less than 60% of that in Residence Country. (India is silent on its position, hence, it would apply to its CTA (unless reservation is made by other CTA Partners).
7. Article 11: Application of tax agreements to restrict a party’s right to tax its own residents – This clause reiterates the right of a country of residence to tax its own residents except with respect to some limited aspects. (India is silent on its position. Hence, it would apply to its CTA. (unless reservation is made by other CTA Partners).
8. Article 12: Artificial avoidance of PE through Commissionaire and similar arrangement – this clause widens the definition of PE given in tax treaties to include cases where a person habitually concludes contracts or habitually plays a principal role in conclusion of contracts of another enterprise. (India has opted to apply the said provision only if any other CTA partner has chosen to apply the said provision)
9. Article 13: Artificial avoidance of PE status by exemption of specific activity. Two options suggested namely:
> Option A – The activities listed therein will be deemed not to constitute a permanent establishment only if they are of a preparatory or auxiliary character
> Option B – Specific activity exemption applies irrespective of whether activity is of auxiliary or preparatory character.
India has chosen to apply option A . This will apply to a CTA only if the other CTA has chosen the same option.
10. Article 14: Splitting up of contracts – Anti-contract splitting rule, which will apply to deemed PE provisions for building sites, construction or installation projects. (India is silent on its position. Hence, it would apply to its CTA unless reservation is made by other CTA Partner.)
11. Article 15: Definition of a person “closely related” to an enterprise – This clause defines the term “person closely related”, which is relevant in the context of Articles 12, 13 and 14. (India is silent on its position. Hence, it would apply to its CTA unless reservation is made by other CTA Partner.)
12. Article 16: Mutual Agreement Procedure (“MAP”) – This article lays down the best practices recommended for improving dispute resolution and the procedural requirements for MAP implementation. (India has opted a bilateral notification or consultation process )
13. Article 35: Entry into Effect – Effect of provisions of the MLI. (India has recommended to substitute “taxable period” for “calendar year”. However, deleted the reservation.)
III. Article not accepted or articles having full reservation
1. Article 3: Transparent entities – Income derived by or through a fiscally transparent entity or arrangement shall be considered to be income of a resident of the country to the extent that such jurisdiction treats the income as the income of a resident of such jurisdiction. (India has made reservation and thus not to be applied to Covered Tax Agreements (CTA).)
2. Article 18 – Article 26: Arbitration – Provides for mandatory binding arbitration in cases where competent authorities are unable to reach an agreement to resolve a case under MAP. (India has not opted for mandatory arbitration.)
How would the MLI’s help and what next
Modification of Indian tax treaties through MLI’s aim at curbing revenue loss through treaty abuse and base erosion and profit shifting strategies. It also aims at ensuring that profits are taxed where substantive economic activities generating the profits are carried out.
The MLI will be applied alongside existing tax treaties, modifying their application in order to implement the BEPS measures. Out of 93 CTAs notified by India, 22 countries have already ratified the MLI as on date and the Double Taxation Avoidance Agreement (DTAA) with these countries will be modified by MLI. For the remaining CTAs, effect of MLI will take place as and when these countries ratify the MLI. Depending on the position taken under MLI by a country.
*(Author ‘Akshit Gulati’ is associated as Senior Analyst-Direct Tax with ‘International Business Advisors, Delhi’)