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Treaty Shopping/Treaty Abuse

A Perspective :

In the last four papers, we have discussed taxability of Non-Residents in India as per Indian Income tax Act and the relief available under tax treaties on doubly tax income and controversies relating to residential status and permanent establishments of the tax payers. In the present paper, before going on the other important controversies on international tax matters, we shall discuss issues relating to treaty shopping/treaty abuse in the present prospective.

While expressing his deep concern on the Treaty Shopping/Treaty Abuse, Mr. Saint Amans, Director, Centre for Tax policy and administration at OECD :

“ ….the current consensus based international framework is at risk. First, it no longer fully meets its objective of allocating taxing rights between countries where companies operate. Instead, it facilitates the divorce between the location of the profit and the location of the value creation. The consequence is that the existing international tax system in many cases allows structures and tax results that no longer pass a basis test of common sense. For example as taxpayers increasingly rely on intangible assets as value-driver, it has become easier for taxpayers to rely on existing principles to transfer legal ownership of those intangibles assets to “cash boxes’ in low-tax jurisdictions that receives a large share of profits but perform no or largely any activity.

Trillions of dollars are now located in such entities, in compliance with existing rules. It is hard to imagine that this is what was intended when these rules were designed. Another striking example is where the feature of bilateral treaty cause investment in one country to be channeled through a particular jurisdiction by third country investors. For example as shown by IMF data, more than one quarter of direct investment into India was from Mauritius between 2010 and 2012.”

Now this being evidently clear that how treaty shopping/treaty abuse was going on in all over the World specially Multinational Enterprises (MNEs) before recent BEPS driven changes. BEPS Action 6 on ‘Preventing the Granting of Treaty Benefits in Inappropriate circumstances’  recommended three-pronged approach to deal with Treaty Shopping/Treaty Abuse:

  1. Introduction of Preamble to the treaty.
  2. Introduction of ‘principal purpose test’ to the treaty.
  • Introduction of ‘simplified limitation of benefit’ to the treaty.

To execute these recommendation of BEPS, an innovative instruments called Multilateral Instrument (MLI) was invented which facilitate the amendment of more than 3000 treaties in one stroke based on matching concept. Presently, a large number of bilateral treaties have already incorporate changes as recommended by BEPS and many are in the process.

Key Changes in treaties through MLI

A: Minimum standard

  1. Treaty preamble to include as objective of the treaty as ‘elimination of double taxation’ and ‘discourage opportunities for non- taxation or reduced taxation through tax avoidance or evasion’ and ‘discourage treaty shopping arrangements aimed at obtaining relief for the indirect benefit of residents of third jurisdictions.
  2. Incorporation of strict anti-treaty abuse rules like Principal Purpose Test (PPT) and Simplified Limitation of Benefit (SLOB).
  3. Making dispute resolution mechanism more effective by strengthening Mutual Agreement Procedure (MAP).

B: Optional Standard

  1. Neutralizing the effects of hybrid mismatch arrangements in case of transparent entities like partnership firms, trusts etc. and dual resident entities to be resolved through Mutual Agreement Procedure (MAP) and method of elimination of double taxation wherever leads to double non-taxation due income exemption method.
  2. Dividend transfer transactions to incorporate minimum 365 days holding to take the benefit of lower rate of tax on dividend.
  3. Capital gains from alienation of shares or interest in entities derived their value principally from immovable property to incorporate reasonable restriction to avoid tax in source countries.
  4. Artificial avoidance of PE status through commissionaire arrangement and specific activities exemptions thereby avoid tax at source countries.

 

This is just the beginning of new era in the international tax framework which completely transformed the approach with which we were dealing in determining tax effects on cross border transactions. Almost, all Indian tax treaties have under gone a sea change which required most considered approach to understand and execute cross border transactions.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

Please feel free to write on sanjay@dsrvindia.com or contact at: +91 9810116321

 

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