Base Erosion Profit Shifting (‘BEPS’) Action Plan
Weakness of international tax system created several opportunities for tax payers for shifting profits to tax friendly jurisdictions. To create transparency, exchange of information and to avoid treaty abuse, G20 leaders endorsed BEPS Action Plan and developed the same with Organisation of Economic Co-operation and Development (‘OECD’). BEPS Action Plan identified 15 actions to address BEPS in a comprehensive manner.
Multilateral Instruments (‘MLIs’)
Action 15 of BEPS action plan pertained to development of MLIs. MLI is an instrument to implement tax treaty measures of BEPS. The treaties which stand modified to incorporate treaty related BEPS measures through MLI are called “Covered Tax Agreements” (‘CTA’). Once MLI is effective, the treaty will need to be read along with the provisions as opted under MLI by contracting countries.
Key Article of MLI and India’s Position:
Article 4 – Dual Resident Entities
There could be a scenario, where a person other than an individual is a tax resident of two countries on account of its incorporation in one country and Place of effective management in the other country (as per the residency regulations in that country).
Article 4 provides mechanism to determine residency of a person other than an individual in case of dual residency scenario stated above.
As per the article where a person other than an individual is a tax resident of more than contracting states, the competent authorities of contracting states shall determine by mutual agreement the contracting state of which he shall be deemed to be a resident. Further, if competent authorities cannot come to an agreement, such person would not be entitled to treaty benefit, except to the extent and manner agreed by the competent authorities.
If a country reserves the right not to apply the article then provisions of Article 4 shall not apply to any of its treaties. If no reservation is made and both countries notify the provisions, then Article 4 shall be read as replacement to the tax treaty. If both or one country does not notify, the Article 4 shall supersede the tax treaty, to the extent provisions of tax treaty are not in line with Article 4.
India has applied provisions of Article 4 and has also notified provisions of tax treaties which would be replaced by Article 4.
Article 5 – Application of Methods For Elimination Of Double Taxation
Article 5 provides three options to avoid double taxation. Option A and Option B are exemption methods while Option C is credit method to eliminate double taxation.
Earlier India had reserved its right for non applicability of Article 5. However, India has now opted for Option C and the same shall apply to treaties notified by India.
Article 6 – Purpose of CTA
As per Article 6(1), CTA shall be modified to include the preamble stating that the intention of CTA:
Article 6(2) provides that preamble stated above shall apply to all tax treaties which already have a preamble. Further, if a tax treaty does not have a preamble then the above preamble would be read alongwith the treaty.
Article 6(3) provides an option to the countries to include in its preamble the desire to develop economic relationship or to enhance co-operation in tax matters.
Article 6(4) states that a country can reserve its right to apply Article 6(1) only if its tax treaties cover all conditions of Article 6(1) or the existing conditions are broader in nature.
As per Article 6(5) if both countries notify the provisions, then preamble as per Article 6(1) shall be read as replacement to the tax treaty. If both or one country does not notify, then preamble as per Article 6(1) shall be included in addition to the existing preamble language.
India is silent on Article 6. Hence, preamble as per Article 6(1) shall be read in addition to the CTA. However, since India has not opted for Article 6(3) the same shall not apply.
Note: Article 6 shall not apply to a tax treaty if any of the contracting country has not signed MLI or has signed but has not notified the tax treaty.
Article 7 – Prevention of Treaty Abuse
As per Article 7 benefit under CTA shall not be granted if it is reasonable to conclude, having regard to all facts and circumstances that obtaining the benefit was one of the principal purpose of an arrangement or transaction.
However, Article 7 further states that if granting the benefit is in accordance with the “purpose of CTA” then benefit under CTA shall be granted [Purpose of CTA is discussed in Article 6 above]
As per Article 7(4) and Article 7(5) where a benefit is denied to any transaction or an arrangement or a person under CTA, he can approach the Competent Authorities of that state who may determine whether such benefit would have been granted in the absence of the transaction or arrangement.
Simplified Limitation of Benefit (‘SLOB’)
As per Article 7(6) and Article 7(7) a country can opt to apply SLOB provisions in addition to the principal purpose test prescribed. However, SLOB condition shall apply on matching basis only, unless one of the contracting state allows the other contracting state to apply SLOB conditions on a unmatching concept basis.
As per Article 7(8) a resident of a country shall not be entitled to benefit of CTA [other than benefits pertaining to residence (for other than individuals), corresponding adjustment and applying to the competent authorities to consider cases not in accordance with CTA] unless such person is a “Qualified Person” at the time of benefit as per Article 7(9).
As per Article 7(9) a person shall be regarded as a qualified person if:
Article 7(10) states that even if a person is not a Qualified Person, he shall be entitled to benefits of CTA, if he is engaged in “active business” and income derived from the other contracting state emanates from or is incidental to that business.
The following on a standalone or combination basis is not regarded as active business:
Article 7(11) provides that even if a resident is not a Qualified Person, he shall be entitled to the benefits of CTA, if half of the days in 12 month period, persons who directly/indirectly own atleast 75% beneficial interest in that resident, would have been entitled to equivalent or more benefit had they carried out the said transaction.
India has opted SLOB provisions in addition to PPT. Thus, PPT shall apply to all CTA. However, SLOB shall apply only if the treaty partner has also adopted the same.
Article 12 – Artificial Avoidance of Permanent Establishment Status through Commissionnaire Arrangements and Similar Strategies
As per Article 12 an agent shall be deemed to constitute a Permanent Establishment for a Foreign Enterprise if:
However, if activities are carried out through an independent agent who acts in the ordinary course of business the same shall not constitute Permanent Establishment for the foreign enterprise, unless the person acts exclusively or almost exclusively on behalf of one or more enterprises that are closely related.
India has adopted Article 12 of the MLI which expands the scope of dependent agent permanent establishment and the meaning of independent agent.
Article 13 – Artificial Avoidance of Permanent Establishment Status through the Specific Activity Exemption
As per Article 13 activities not considered as constituting a Permanent Establishment (whether or not they are of a preparatory or auxiliary nature) on a standalone or combination basis shall not constitute a Permanent Establishment only if they are of a preparatory or auxiliary nature on a standalone as well as on a combination basis.
Also, where one fixed place (Place 1) of business carries on activities which do not constitute Permanent Establishment. However, the other place (Place 2) of business does constitute a Permanent Establishment and the activities at both the places complement each other and are part of cohesive business operation, the activities carried out by first place (Place 1) of business shall also constitute a Permanent Establishment.
India has adopted the above amendment prescribed in the MLI in its CTA.
Applicability of MLI
MLI will enter into force and its provisions will have effect on India’s tax treaties from FY 2020-21 onwards ie assessment year 2021-22.
Out of 93 CTAs notified by India, only 22 countries have already ratified the MLI as on date. For the remaining CTAs, effect of MLI will take place as and when these countries ratify the MLI.