The Chamber of Tax Consultants Workshop on Taxation of Foreign Remittances : Payment to firm / trust / PE and triangular situation January 21, 2017 Presented by: Vishal J. Shah
Contents Tax treaty eligibility - general principles Tax treaty eligibility and related issues Firm Trust PE Triangular situation and practical issues Slide 2
Tax Treaty eligibility General principles 1
Tax treaty eligibility basic provisions Article 1 apply to persons who are residents of One or Both of the Contracting state Article 3 defines the term Person Article 4 lays down the Residence test Article 3(2) terms not defined will have meaning as per domestic law, unless the context otherwise requires Varies from Treaty to Treaty Slide 4
Person Article 3 an inclusive definition may specifically define individual, company, firm, etc may cover specific category of persons in only 1 of the contracting state (erstwhile India-UK treaty) may generally define any taxable unit need not be resident as per domestic law potential for triangular situation! Varies from Treaty to Treaty Slide 5
Residence test Article 4 Liable to tax basic rule Liable to tax = actual tax Emmerich Jaegar (274 ITR 125) Azadi Bachao (263 ITR 125) Liable to tax = subject to tax GE Pension trust, In re (280 ITR 425) Much wider import covered within ambit even if person could be liable (say under the constitution, etc.) Cyril Pereira view (241 ITR 61) in UAE context UAE tax decree does not cover individuals Right with government to tax in future also covered Green Emirate (100 ITD 203) Slide 6
Residence test Article 4 under domestic law need not be resident! unless the treaty specifically so requires eg. India-Italy tax treaty by reason of domicile, residence, Place of Management, etc. Not merely because of source of income in that state Slide 7
Residence test Article 4 comprehensive v/s limited source taxation limited source taxation in the country excluded in many treaties what if the treaty does not have a specific exclusion e.g. Japan, Netherlands, etc.? OECD view comprehensive taxation to be read into General Electric Co (71 TTJ 973) India-Dutch treaty denied to UK company merely deriving dividend income from Dutch co Rule for specified categories like firm, trust, etc. (US, new UK treaty) Varies from Treaty to Treaty Slide 8
Summing up: what should be tested? Whether a person as defined Treated as a taxable unit (under domestic laws) Liable to tax (under domestic law) exempt vs no right to tax (in praesenti or in futuro) Comprehensive vs. limited source based taxation Slide 9
Partnership firms: Tax treaty eligibility & related issues 2
Partnership firms taxation approach Opaque approach Fiscally transparent approach Partner 1 Partner 2 Partner 1 Partner 2 Firm treated as separate taxable unit & taxed in own name Partners generally exempt (need not be) eg. India Partnership firm Firm not treated as separate taxable unit Partners subject to tax on the income of the firm eg. UK, US Partnership firm Slide 11
Fiscally transparent firms Treaty eligibility Is the partnership a Person? YES In countries which do not recognize a partnership under law? STILL A BODY OR PERSON OR AN ENTITY Is the partnership treated as a taxable unit? MAY BE Is the partnership liable to tax under domestic tax law? NO If not, then what? Slide 12
Treaty eligibility qua Partners Partners liable to tax in State R on income of partnership from State S Is the income derived by / paid to the partners from State S? What if State S does not treat partnership as fiscally transparent? Are the partners automatically entitled to the treaty? Is a specific rule mandatorily required under the treaty to allow partner s claim treaty benefit? Slide 13
Partnerships OECD Commentary Article 1 (Para 5 & 6) Status in country of residence to be considered (and not source) If treaty benefits denied to partnerships, the same should be allowed to partners in proportion to their share of partnership income which is - offered to tax - in state of their residence Need not be the state of residence (or set-up) of partnership Income should be deemed to be paid to / derived by partners for tax purpose - even if paid to / earned by partnership Article 4 (para 8.8) echoes the above principle however, exclusion to provide separate article if states do not agree with the interpretation Slide 14
Partnerships India reservation India has not accepted OECD view - expressed reservation Partner s entitled only if special provisions in Treaty of the State - Not of the partner; but where the partnership is situated India Reservations on OECD commentary views of Revenue enforceable under law? - Linklaters LLP (132 TTJ 20) treat benefits (pre-2013) allowed to fiscally transparent UK firm based on UK residency of partners UK treaty amended post that to include specific provision Whether rejected or disapproved the India reservation? - Schellenberg Wittmer (AAR 1029 of 2010) Slide 15
Analysing some specific treaties India USA tax treaty, Article 4(1)(b)...in the case of income derived or paid by a partnership, estate, or trust, the term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries India UK tax treaty, Article 4(1)(b) (post-amendment) in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries Partners tax residents of the said state, are liable to tax therein in respect of the partnership income Slide 16
Case study Partnerships (Triangular situation) Partner 1 Partner 2 Partner 3 Partner 4 State A State B State S Services Partnership firm ( PF ) Payment Partnership Firm Registered in State B Partners 1,2 & 3 Resident of State A S Co Incorporated and resident of State S PF rendering services to S Co State B treats partnerships as fiscally transparent Issue : Which treaty to apply? S Co. Alternative State B does not treat partnership as fiscally transparent Issue : Which treaty to apply? Slide 17
Case study Partnerships (Triangular situation) USA Partner 2 Partner 3 firm Registered in State B Partners 2 & 3 Resident of USA Partner 1 Partnership firm ( PF ) Partner 4 Partners 1 & 4 Resident of state B Issue : Which treaty to apply? State B State S Services Payment India-US technical explanation OECD commentary S Co. Slide 18
Taxability of US LLC LLC - Limited Liability Company, distinct legal entity separate from its members under US laws Under US domestic tax rules, LLC may opt to be taxed as a corporation or as a partnership firm taxed in the hands of the member LLC a person and taxable unit per se; although option to take shareholders - Is it different than a partnership? Not specifically covered by Article 4(1)(b) of India-US tax treaty? Tax court of Canada in case of TD Securities (USA) LLC (IBFD Case no 2008-2314(IT)G) LLC allowed treaty benefits Linklaters logic applies? will India allow? Slide 19
Partnership as per Indian law? Article 3(2) Term not defined in the treaty shall have meaning as under domestic law, unless the context otherwise requires S. 2(23) of IT Act firm shall have the meaning assigned to it in Indian Partnership Act, 1932 and shall include a limited liability partnership as defined in LLP Act, 2008 Partnership as per IPA Sharing of profit / loss Agency relationship Joint and several liability - UNLIMITED Whether Foreign partnerships to satisfy test aid down in IPA? - OECD commentary - Linklaters LLP case Slide 20
Firm under Article 15 IPS Applicability residency of member of a partnership firm tested (India UK tax treaty) residency of Firm of individuals tested (India USA tax treaty) does not include firm (UAE, Mauritius, Singapore, Swiss tax treaties) fiscally transparent firms covered? Aggregation rule Clifford Chance vs DCIT (318 ITR 237) (Bom HC) In case of a partnership, where an individual is a member of a partnership, even if he is not present but another individual member of the partnership is so present and performs services, then the presence of all such members is aggregated to ascertain their presence of 90 days Slide 21
Trusts: Tax treaty eligibility & related issues 3
Trusts (some examples) Exempt charity trusts Investment funds (PE / VC fund, etc.) Collective investment vehicles Personal estates / family trusts Universities / NPOs Slide 23
Trust taxation approach Exempt Trusts Fiscally transparent approach Beneficiary 1 Beneficiary 2 Beneficiary 1 Beneficiary 2 Trust Trust Trust treated as a separate taxable unit; but exempt Generally, public beneficiaries eg. Mutual Fund in India, NGOs, etc. Trust not treated as separate taxable unit Beneficiaries subject to tax on the income of the trust PE fund, family trusts, etc. private domain Slide 24
Trusts Treaty eligibility Treaty Eligibility Test Exempt Trust Fiscally Transparent (pass-through) Trust Is trust a Person? Yes Yes Is trust treated as taxable unit? Yes No Is trust liable to tax under domestic tax law? Yes; but specifically exempt No, as beneficiaries taxed on pass through basis Slide 25
Exempt trusts (some precedents) Paragraph 8.6 of the OECD Commentary of Article 4..For example pension funds, charities and other organisations may be exempted from tax, but they are exempt only if they meet all of the requirements for exemption specified in the tax laws. They are, thus, subject to tax laws of a contracting state.. Sri Ramachandra Educational & Health Trust (224 CTR 225) AAR the letter by US Revenue authorities states that Harvard Medical International is currently exempt from federal tax under section 501(c)(3) of the IRC and is also classified as public charity. We find that HMI is incorporated entity which has been specifically exempt from tax in USA. As such, it can invoke the provisions of DTAA Federation of Indian Chambers of Commerce & Industry (323 ITR 399) AAR..As IC Institute of University of Texas, is located in USA and it is liable to pay tax by reason of place of incorporation and place of managements, the said Institute has to be treated as resident of USA within meaning of Article 4 of DTAA. The fact that the University is exempt from payment of tax under the Internal Revenue Code of USA does not affect the residential status of the applicant in USA.. Slide 26
Fiscally transparent trusts Specific provision to extend treaty benefit to beneficiaries in some treaties (US, UK) OECD commentary supports the pass-through approach No India reservation Section 161 of IT Act Taxes a determinate trust in the like manner and to the same extent as its Beneficiaries Better case to argue that specific treaty provisions not required to extend benefits to the beneficiaries? Beneficiary's residence to be evaluated for treaty evaluation Explanation to section 164 Slide 27
Permanent Establishment: Tax treaty eligibility& related issues
PE in source state eligibility to treaty of source state Person test Whether a person? YES Treated as a taxable unit (under domestic law of source state) - YES Residence test Liable to tax (under domestic law of source state) - YES by reason of domicile, residence, Place of Management, etc. -?? Need not be POEM, mere POM Service / Agency / construction PE Vs. Branch / Fixed PE is a distinction required? Place of Management in India which amounts to the HO being tax resident in India although NOT under the tie-breaker rule? Slide 29
PE in source state Treaty eligibility Residence test few treaties specifically require to be Resident (India-Italy) - NO Comprehensive vs. limited source based taxation? Additional clause in Article 4(1) of the OECD model & most Indian treaties.. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.. Shell Technology India Private Limited (345 ITR 206) AAR Philippines branch of Dutch Co denied India-Philippines tax treaty is it always presumed even if treaty does not provide? OECD view supports comprehensive taxation Slide 30
Branch Head Office Case study X Ltd Head office situated in State A X Ltd has a branch office in State B S Ltd, company incorporated in State S, entered into a contract for services, with branch office of X Ltd, For the services rendered by branch office of X Ltd, S Ltd, is required to make payment to X Ltd Issue : At what rate should S Ltd withhold taxes on payment for services As per S B tax treaty As per S A tax treaty Payment X Ltd Head Office X Ltd Branch Office S Ltd Services State A State B State S Slide 31
Some other triangular situations & Practical challenges
What are triangular cases? Single Taxation State R taxes income sourced in its State Double taxation State PE taxes income attributable to PE and State R taxes its resident on world-wide income - Relieved by bilateral tax treaty Triangular taxation In addition to State R and State PE, State S claims right to tax income arising in that State (Source based taxation) State R (Residence) State PE (PE) Source PE Income State S (Source) Dividends/ interest/ royalties Situation wherein same source of income is subject to tax in three countries Slide 33
What is triangular cases? Key challenges arising due to such triangular situations - Determination of taxing powers of Contracting States i.e. taxability in State R, State PE & State S? - Which treaty to be applied to withhold taxes at the time of making payment - Credit for taxes withheld Instances of Triangular situations, discussed in detail in subsequent slides Dual Residency Branch Head Office situation Beneficial Owner in a 3 rd Country Slide 34
Dual Residency Case study Dual residency Tax payer considered resident in two contracting states for tax purposes X Ltd incorporated in State A considered as resident of State A as per its domestic laws X Ltd, controlled and managed from State B As per domestic laws of State B, X Ltd would be resident of State B S Ltd subsidiary of X Ltd, incorporated in State S and thus, resident of State S S Ltd declares dividend to be paid to its shareholder X Ltd Issue : At what rate should S Ltd withhold taxes on dividends As per S A tax treaty As per S B tax treaty State A (Place of Incorporation) Dividend X Ltd S Ltd (in State S) State B (Place of effective management) Subsidiary Slide 35
Dual Residency Analysis Option I: Beneficial of the two treaties apply Option II: Apply tie-breaker rule between State A and State B, resultant treaty apply qua source state Nothing in the S A treaty or S B treaty to support this view Slide 36
Beneficial ownership Case study X Ltd Holding Company situated in State A Y Ltd Intermediary company in State B, procures IP from X Ltd S Ltd, company incorporated in State S, obtained right to use the IP from Y Ltd Issue : At what rate should S Ltd withhold taxes on payment for services As per S B tax treaty As per S A tax treaty KSPG Nethelands Holding BV (322 ITR 696) AAR Aditya Birla Nuvo Limited vs DDIT (342 ITR 308) Payment of royalty X Ltd Holding company Y Ltd Intermediary company S Ltd State A Procurement of IP Supply of IP rights State B State S Slide 37
Indian context Practical challenges in triangular situations Whether TRC for partners / beneficiaries of fiscally transparent entity available? Would the tax authorities of such country issue a TRC? would Form No 10-F be sufficient compliance? Who would sign such form Partners / beneficiaries who are not payers? PAN to be obtained for fiscally transparent partnership in India? Members? Tax deduction on PAN of partnership? Or on PAN of Partners? proportionate? Slide 38
Annexure 5
Persons Defined under various treaty Country UK USA Swiss Singapore Mauritius UAE Definition Person an individual, a company, a body of persons or any other entity which is treated as taxable unit under the taxation laws in force in the respective contracting state an individual, an estate, a trust, a partnership, a company, any other body of persons, or taxable entity...an individual, a company a body of persons or any other entity which is taxable under the laws in force in either contracting state an individual, a company a body of persons and any other entity which is treated as taxable unit under the taxation laws in force in the respective contracting state an individual, a company and any other entity, corporate or noncorporate, which is treated as a taxable unit under the taxation laws in force in the respective contracting state an individual, a company and any other entity, which is treated as a taxable unit under the taxation laws in force in the respective contracting state Slide 40
Residency test Defined under various treaty Country UK USA Swiss Singapore Mauritius Definition Person means any person who under the laws of that state is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature, provided however. means any person who under the laws of that state is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature, provided however... means any person who under the laws of that state is liable to taxation therein by reason of his domicile, residence, place of incorporation, place of management, or any other criterion of a similar nature, provided however means any person who is a resident of a contracting state in accordance with the taxation laws of that state means any person who under the laws of that state is liable to taxation therein by reason of his domicile, residence, place of management, or any other criterion of a similar nature Slide 41
Residency test Defined under various treaty Country Definition Person UAE In case of India: any person who under the laws of India is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of similar nature. In case of UAE: an individual who is present in UAE for a period or periods totaling in aggregate atleast 183 days in the calendar year concerned and a company which is incorporated in UAE and which is managed and controlled wholly in UAE Slide 42
India-US technical explanation Technical Explanation on the India-US tax treaty issued by the US IRS on Article 4, relevant extracts therefrom are reproduced hereunder: "Under paragraph 1(b), a partnership, estate or trust will be treated as a resident of a Contracting State for purposes of the convention to the extent that the income derived by such person is subject to tax in that State as the income of a resident, either in the hands of the person deriving the income or in the hands of its partners or beneficiaries. Under US laws, a partnership is never, and an estate or trust is often not, taxed as such. Under the convention income received by a partnership, estate or trust will be treated as income received by a US resident only to the extent such income is subject to tax in the United States as the income of a resident. This, for US tax purposes, the question of whether income received by a partnership is received by a partnership, estate or trust is received by a resident will be determined by the residence of its partners rather than the residence of a partnership" (emphasis supplied) Slide 43
OECD Commentary on Article 1 Para 6.5 of the OECD Commentary on Article 1 Where a partner is a resident of one State, the partnership is established in another State and the partner shares in partnership income arising in a third State then the partner may claim the benefits of the Convention between his State of residence and the State of source of the income to the extent that the partnership s income is allocated to him for the purposes of taxation in his State of residence. If, in addition, the partnership is taxed as a resident of the State in which it is established then the partnership may itself claim the benefits of the Convention between the State in which it is established then the partnership may itself claim the benefits of the Convention between the State in which it is established and the State of source. In such a case of double benefits, the State of source may not impose taxation which is inconsistent with the terms of either applicable Convention therefore, where different rates are provided for in the two Conventions, the lower will be applied. Slide 44
Extract of IPS clause Article 15 of the India UK tax treaty (1) Income derived by an individual, whether in his own capacity or as a member of a partnership, who is a resident of a Contracting State in respect of professional services or other independent activities of a similar character may be taxed in that State. Such income may also be taxed in the other Contracting State if such services are performed in that other State and if Article 15 of the India USA tax treaty (1) Income derived by a person who is an individual or firm of individuals (other than a company) who is a resident of a Contracting State from the performance in the other Contracting State of professional services or other independent activities of a similar character shall be taxable only in the first-mentioned State except in the following circumstances when such income may also be taxed in the other Contracting State Slide 45
Extract of IPS clause Article 14 of the India Swiss tax treaty (1) - Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that State except in the following circumstances, when such income may also be taxed in the other Contracting State Article 14 of the India UAE tax treaty (1) Income derived by a resident of a Contracting State in respect of professional services or other independent activities of a similar character shall be taxable only in that State, except in the following circumstances when such income may also be taxed in the other Contracting State. Slide 46
S. 161(1) of the ITA Liability of representative assessee 161. (1) Every representative assessee, as regards the income in respect of which he is a representative assessee, shall be subject to the same duties, responsibilities and liabilities as if the income were income received by or accruing to or in favour of him beneficially, and shall be liable to assessment in his own name in respect of that income; but any such assessment shall be deemed to be made upon him in his representative capacity only, and the tax shall, subject to the other provisions contained in this Chapter, be levied upon and recovered from him in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him. Slide 47
Expln 1 to S. 164 of the ITA Charge of tax where share of beneficiaries unknown S. 164.Explanation 1. For the purposes of this section, (i) any income in respect of which the persons mentioned in clause (iii) and clause (iv) of sub-section (1) of section 160 are liable as representative assessee or any part thereof shall be deemed as being not specifically receivable on behalf or for the benefit of any one person unless the person on whose behalf or for whose benefit such income or such part thereof is receivable during the previous year is expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and is identifiable as such on the date of such order, instrument or deed; (ii) the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is received shall be deemed to be indeterminate or unknown unless the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable, are expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed. Slide 48