Anti-avoidance Rules and Tax Treaties in India Sanjay Kumar Mishra Joint Secretary to Government of India FT&TR-I Division, Department of Revenue, Ministry of Finance, India 1
Purpose of Double Tax Avoidance Agreement To eliminate double taxation. To prevent tax evasion To prevent tax avoidance. 2
Impact of Tax Avoidance Ways to save on taxes. Increased globalization of trade and investment and exponential growth in bilateral treaties have increased opportunities for the taxpayer to engage in abusive tax practices. Abusive tax conduct upsets the balance associated with negotiation of tax treaties. It undermines the incentives to enter into tax treaties. It erodes the tax base and revenue. It undermine the fairness of the tax system. 3
What are Anti Avoidance Rules in India Certain measures based on the general principle of law determined largely by legal decisions of Indian Courts under Substance over Form principle. General anti-avoidance rules included in domestic tax legislation. Specific anti-avoidance rules included in domestic tax legislation, such as controlled foreign corporation rules ( CFC rules ), transfer pricing rules, thin capitalization rules, withholding tax, residence, etc. 4
General Principle of Law Judicial Doctrine Substance over Form The judicial doctrine of Substance over Form for identifying a transactions or arrangement for the application of tax laws is mandated by Hon ble Supreme Court of India in several cases. Examples: Super Poly Fabriks Ltd. v. CCE 2008 (XC1)-GJX-0065-SC. Bhopal Sugar Industries Ltd v. S.T.O (1977) 3SCC 147. Moped India Ltd v. CCE 1985-TMI-41634 (SC). Sundaram Finance Ltd v. State of Kerala AIR 1960 SC 1178. Bharat Sanchar Nigam Ltd v. UOI 2006-TM1-309 (SC) Kultar Singh v. Mukhtiar Singh (1964) 7 SCR 790. Mc Dowell and Co. Ltd v. CTO 1985-TMI-40038 (SC) Bank of Chettinad Ltd v. CIT 8 ITR 522 (SC) December 2 nd, 2011 5
Substance over Form Rule There is no single approach for the application of the doctrine of Substance over Form. However the following principles have been approved by the Supreme Court of India. Lift the corporate veil where transaction is found to be sham, bogus or contrived. Substance of the contract (intention of contracting parties and the nature of transaction) is determinative and not its form. The courts can go behind the documents and determine the nature of transaction. December 2 nd, 2011 6
Substance over Form (contd.) Document must be read as a whole; a piecemeal reading of the document cannot bring a fair and proper construction. Colourable device or dubious methods to minimize tax incidence are not legally permissible. International financial reporting standards (IFRS) mandate treatments based on the economic substance of various events and transactions rather than their legal form. December 2 nd, 2011 7
General Anti-Avoidance Rules (GAAR) in the Proposed Direct Tax Code As currently proposed in Direct Tax Code bill (2010). GAAR can be invoked once a arrangement is declared as an impermissible avoidance arrangements. Impermissible avoidance arrangement must satisfy the following conditions: main purpose of an arrangement (in part or whole or any step) entered is to obtain tax benefits, and it satisfies one of the following four conditions: (i) it creates rights and obligation which would not normally be created between persons dealing at arm s length basis. (ii) (ii) it results directly or indirectly in misuse or abuse of provisions of Direct Tax Code. Contd. 8
General Anti-Avoidance Rules (GAAR) in the Proposed Direct Tax Code - contd. (iii) it wholly or partly lacks commercial substance. (iv) it is not for bonafide business purpose. The term arrangement covers any type of transaction, operation, scheme, agreement or understanding, whether enforceable or not. Tax benefit includes even the benefit arising in accordance with the provisions of DTAA. 9
General Anti-Avoidance Rules (GAAR) in the Proposed Direct Tax Code - contd. Authority to invoke GAAR is given to the tax commissioner, who can determine the tax consequences by re-characterizing the impermissible avoidance arrangement. The order determining the tax consequence will be final only after approval by Dispute Resolution Panel. The burden of proof is on the taxpayer to establish that the tax benefit was not the main purpose of the arrangement. 10
Specific Anti-avoidance Provisions in the Income Tax Act 1961 - Examples Transfer of income without corresponding transfer or revocable transfer of asset or beneficial ownership of assets - Section 60 & 61. Clubbing of income of spouse, minor children, other persons in certain circumstances - Section 64. Avoidance of tax by certain transactions in securities - Section 94. (see next slide) 11
Specific Anti-avoidance Provisions in the Income Tax Act 1961 - Examples Sec 94: Section 94 (1) - Transfer of income by way of interest in case of sale and buyback of securities is disregarded. Section 94(2) - In case of transaction in securities carrying day-today accrual of income, the broken period income is deemed to be the income if transaction income is less than the same. Section 94(7) deals with cases of dividend stripping- Loss arising in transaction in securities or units undertaken within specified period of date of declaration of dividend is disallowed to the extent it does not exceed amount of dividend. Special measures in respect of transactions with persons located in notified jurisdictional area-section 94A. 12
Specific Anti-avoidance Provisions in the Income Tax Act 1961 Arm s length price of related party: Transfer pricing: Section 92-92F. Section 40A (2) Section 80IA, IC-eligibility of business unit. Inclusive definitions & deeming provisions: Dividend: Section 2(22) Salary/perquisites: Section 17 Business income: Section 28 Capital Gains: Section 45 Receipt of cash or specified property without consideration or for inadequate consideration: Amount of inadequacy visà-vis market value is taxable under Section 56 13
Specific Anti-avoidance Provisions in the Income Tax Act 1961 Restrictions on loss set-offs: Capital loss: section 70,71,74. Speculation losses: section 73 Restrictions on expense deducting: Section 14A-expense for exempt income Section 37: expenditure on an offence or act prohibits under law. 14
Specific Anti-avoidance Provisions in the proposed Direct Tax Code -- Controlled Foreign Corporation (CFC) Tax Rules To be a CFC it must: Be a Foreign company controlled directly or indirectly by Indian residents; Be incorporated in a jurisdiction where tax paid is less than 50% of the tax payable in India; Moreover: It is not be listed on any recognized stock exchange; It is not engaged in active trade or business in the jurisdiction where it is tax resident; It does not have more than 50% of its income as passive income i.e. in the nature of dividend, interest, rental income, capital gains, royalty, sale of goods/services to related parties, income from management, holding or investment in securities/shareholdings, any other income under the head of income from residuary sources; and It must have taxable profits of more than INR 2,500,000. 15
Specific Anti-avoidance Provisions in the proposed Direct Tax Code: CFC The Direct Tax Code proposes to levy taxes on the undistributed profits of a CFC as a dividend, proportionately in the hands of resident shareholders in the year they are earned. 16
Some general anti avoidance provisions in Indian tax treaties Residence: Rule provides that only residents of India or other contracting state are entitled to the benefits of the treaty. The tie-breaker rule determines residence when an individual, company or other person may be considered a resident of two contracting states under their domestic laws. Beneficial ownership: It requires that the person claiming treaty benefits with respect to an item of income be the beneficial owner of such income (e.g. dividends, interest). Arm s length rule: It authorizes the tax authorities to adjust the transfer pricing based on an arm s length price. 17
Some general anti avoidance provisions in Indian tax treaties Fiscally transparent entities: Prevents the use of fiscally transparent entities to claim treaty benefits when the entity is not subject to tax on the income in a residence state. Anti-conduit rules: Treaty benefits are denied to income under a conduit arrangements. Limitation of Benefits: to deny treaty benefits if main purpose of creation of an entity is to obtain treaty benefit that would not otherwise be available, or To deny treaty benefits to a legal entity that does not have bonafide business purpose, or to allow the application of domestic provisions to prevent tax evasion. 18
Relationship between domestic antiavoidance provisions and tax treaties Taxes are imposed through the provision of domestic law and therefore, the abuse of tax treaty is abuse of domestic tax law provision. Thus, antiavoidance rules in domestic law do not conflict with tax treaties. Domestic anti-avoidance provisions are consistent with tax treaty. Proposed DTC 2010 provides that certain provisions relating to anti-avoidance rules (e.g. GAAR, CFC and branch profit tax) will override tax treaty. 19
Tax-Avoidance Rule and Challenges Line between a tax-efficient system and an abusive scheme is very thin and varies between countries. Specific anti-avoidance rules (SAAR), GAAR and treaty anti-avoidance Rrles vary among countries. Different appreciation of the facts in different jurisdiction and different methodologies adopted by Courts in various jurisdiction create further tax challenges. 20
Thank You December 2 nd, 2011 21