BEPS Multilateral Instrument (MLI), India s Corresponding Positions, Implementation (GAAR) Dr. Parthasarathi Shome Chairman International Tax Research and Analysis Foundation (ITRAF) www.itraf.org Visiting Fellow, London School of Economics Faculty of Law, 2017-18
Introduction The OECD tabled the Report Addressing Base Erosion and Profit Shifting to the G20 in 2013 à Following this, the OECD and G20 countries adopted a 15 point Action Plan to address BEPS Final Action reports were issued in late 2015. The BEPS package was designed to be implemented through: à Changes in domestic law à Modification of treaty provisions To help with the implementation of the BEPS Actions, Action 15 envisaged the formulation of a MLI (also called the Convention) à The MLI contains Articles. These are provisions pertaining to corresponding subjects of other BEPS Actions Accordingly, we look at some of the Actions and the corresponding MLI Articles
Introduction (contd.) The OECD Multilateral Instrument (MLI) was signed by some 70 countries on 7 June 2017 and incorporates treaty measures in relation to several BEPS related areas including: à Hybrid Mismatch (Action 2) à Treaty Abuse (Action 6) à Permanent Establishment (Action 7) à Dispute Resolution (Action 14) Parties to the MLI are also required to submit an MLI Position document containing: à Covered Tax Agreements (CTAs) Tax treaties covered by the MLI à List of reservations and notifications made by the party
Action 2 Hybrid Mismatch Arrangements à Hybrid Mismatch Arrangements exploit differences in the tax treaty of an entity or instrument under the laws of two or more tax jurisdictions to achieve double non-taxation, including long term deferral (Action 2, 2015 Final Report) à Action 2 aims to ensure that hybrid instruments and entities, as well as dual resident entities, are not used to obtain the benefits of a treaty à Thus Action 2 calls for the development of model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effects of hybrid instruments and entities
Action 2 Hybrid Mismatch Arrangements (contd.) MLI Part II Article 3 Transparent Entities à Income derived from an entity or arrangement that is treated as fiscally transparent by either jurisdiction which is a party to the CTA, shall be considered income of a resident of a party to the CTA, but only to the extent that that party treats such income as the income of a resident. à A tax exemption or deduction provision of a CTA, to the income of a resident of one jurisdiction, shall not apply solely because the income is also designated income derived by a resident of other jurisdictions which are party to the CTA. Indian Position à India has reserved the rights to Article 3 in its entirety
Action 2 Hybrid Mismatch Arrangements (contd.) MLI Part II Article 4 Dual Resident Entities à If by virtue of the provisions of a CTA, a person (not an individual) is deemed to be a resident of more than one jurisdiction, then the parties to the CTA must determine through mutual agreement which one jurisdiction the person is a resident, for the purposes of the CTA. à The decision must be made giving regard to the entity s place of effective management, the place where the entity is incorporated or otherwise constituted and any other relevant factors à In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the CTA except to the extent and in such manner as may be agreed upon
Action 2 Hybrid Mismatch Arrangements (contd.) MLI Part II Article 4 (contd.) Indian Position à As per Article 4(4) India has listed CTAs containing provisions not subject to reservations under Article 4 à If all jurisdictions to a particular CTA have also listed the same provision then the said provision will be replaced by the provision of Article 4(1) à In all other cases the provision of Article 4(1) shall supersede the provisions listed by India, to the extent that the CTA provision is incompatible with Article 4(1)
Action 2 Hybrid Mismatch Arrangements (contd.) MLI Part II Article 5 Application of Methods for Elimination of Double Taxation à Option A: Tax exemption provisions of a CTA exempting tax on an income of a resident in one jurisdiction, to eliminate double taxation, shall not apply if the other jurisdiction has also applied the same exemption provision on the same income. à Option B: Tax exemption provisions of a CTA exempting tax on an income of a resident in one jurisdiction, to eliminate double taxation because the income is treated as a dividend in that jurisdiction, shall not apply if that same income gives rise to a deduction in the income of a resident of the other jurisdiction. à Option C: When a resident of one jurisdiction derives income or owns capital which may be taxed in the other jurisdiction, the first jurisdiction will allow a tax deduction on the income equal to the income tax paid by the resident or a tax deduction on the capital equal to the capital gains tax paid by the resident, in the second jurisdiction. Indian Position à India has reserved the rights to Article 5 in its entirety
Action 6 Treaty Abuse à Action 6 identifies Treaty Abuse as an important source of BEPS concerns. It is not surprising that it is a minimum standard reflected as mandatory provisions in MLI Articles 6 and 7 à Action 6 recognizes two instances of Treaty Abuse: 1. Cases where a person tries to circumvent limitations provided by the treaty itself (eg. treaty shopping) 2. Cases where a person tries to circumvent the provisions of domestic law using treaty benefits à Action 6 admits that the first set of cases could not be addressed by specific antiavoidance rules and required a general anti-avoidance rule in treaties. This is found in the Principal Purpose Test (PPT) and SLOB options in the MLI
Action 6 Treaty Abuse (contd.) MLI Part III Article 6 Purpose of a Covered Tax Agreement (CTA) à The following preambular text shall be added to a CTA (Article 6(1)): Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions) à This text shall be included in place of or in the absence of any preambular language in a CTA referring to an intent to eliminate double taxation à As it is a minimum standard the only reservation allowed is if there already exists preambular language describing the intent to eliminate double taxation without creating the opportunity for tax evasion or avoidance
Action 6 Treaty Abuse (contd.) MLI Part III Article 6 (contd.) à The Article also provides the option of an additional preambular text (Article 6(3)): Desiring to further develop their economic relationship and to enhance their cooperation in tax matters, à This text is optional and is only applicable if all parties to a CTA chose to apply it Indian Position à The Indian position document is silent on Article 6 à As a minimum standard the provision in Article 6(1) (mandatory inclusion of preambular text) can therefore be taken as automatically applicable
Action 6 Treaty Abuse (contd.) MLI Part III Article 7 Prevention of Treaty Abuse While pertaining to a minimum standard, Article 7 provides 3 options to fulfil the mandatory obligation of Action 6: Option 1 Principle Purpose Test (PPT): à A benefit under the CTA will not be granted if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit à The benefit may yet be granted if, on the request of the person and after relevant facts and circumstances are taken into consideration, it is determined that the benefit would have been granted in the absence of the transaction under scrutiny
Action 6 Treaty Abuse (contd.) MLI Part III Article 7 (contd.) Option 2 Simplified Limitation on Benefit clause (SLOB) (supplemented by the PPT): à CTA benefits will be limited to only CTA provisions which provide the following: à If a person is the resident of more than one party, then the provision determines which party the person will be considered a resident of, for the purposes of the provision à If initial adjustments are made by other parties to an enterprise of one party, to the tax amount on associated enterprises, and the CTA provides for corresponding adjustments à Residents are allowed to request tax authorities of a party to a CTA to consider tax cases not in accordance with the CTA à Unless the resident is designated to be a qualified person as determined by Article 7(9)
Action 6 Treaty Abuse (contd.) MLI Part III Article 7 (contd.) Option 2 Simplified Limitation on Benefit clause (SLOB) (contd.) Benefits will also be entitled: à When a resident with an active conduct of business in one jurisdiction to a CTA, derives an income in the other jurisdiction which is incidental to that business (regardless of whether the resident is a qualified person) (Article 7(10)) à When an unqualified resident owns at least 75 per cent of the beneficial interests of the resident, on at least half of the days of any twelve-month period (including the time when the benefit would otherwise be accorded) (Article 11) à At the discretion of a tax authority, for a resident not entitled to the above benefits, if such resident can demonstrate that its principle purpose was not to attain such benefit from the CTA
Action 6 Treaty Abuse (contd.) MLI Part III Article 7 (contd.) Option 3 Detailed LOB clause à The MLI does not include a detailed LOB provision. This is because a Detailed LOB requires substantial bilateral customisation, which would be challenging in the context of a multilateral instrument. (Explanatory Statement to the MLI) à Only parties wishing to adopt a detailed LOB provision are permitted to reserve Article 7 in its entirety. A detailed LOB must be combined with either rules to address conduit financing structures or a principal purpose test (Article 7(15)(a))
Action 6 Treaty Abuse (contd.) MLI Part III Article 7 (contd.) Indian Position à India has opted for the PPT provision for 36 CTAs and the SLOB provision for 9 of its CTAs. à While the PPT is automatically applicable as a minimum standard, the SLOB is only applicable if all parties to a CTA opt for the same à India has also introduced a general anti-avoidance rule (GAAR) in its domestic law (discussed later)
Action 7 Permanent Establishment Status MLI Part IV Article 12 Artificial Avoidance of Permanent Establishment Status through Commissionnaire Arrangements and Similar Strategies à Action 7 looks to address the artificial avoidance of permanent establishment status through commissionnaire arrangements à Action 7 defines commissionnaire arrangements as an arrangement through which a person sells products in a given State in its own name but on behalf of a foreign enterprise that is the owner of these products. Through such an arrangement, a foreign enterprise is able to sell its products in a State without having a permanent establishment to which such sales may be attributed for tax purposes à Thus the person concluding the sale does not get taxed on the profits as it does not own the products, but only on the remuneration that it receives for its services, usually in the form of a commission.
Action 7 Permanent Establishment Status (contd.) MLI Part IV Article 12 (contd.) In continuation, à An enterprise will be deemed to have a permanent establishment in a jurisdiction of a CTA if any person on behalf of the enterprise habitually concludes contracts: à In the name of the enterprise; or à For the transfer of ownership or the right to use property owned by that enterprise; or à For the provision of services by that enterprise à Unless these activities are deemed not to constitute a permanent establishment by the CTA
Action 7 Permanent Establishment Status (contd.) MLI Part IV Article 12 (contd.) à The conditions of establishing permanent establishment in the previous slide shall not apply if the person acting on behalf of an enterprise does so as an independent agent and in the ordinary course of that business à The above exclusion does not apply if such a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related Indian Position à India has provided a list of provisions contained in CTAs describing the condition for establishing permanent establishment. Article 12 provisions will apply in place of these listed provisions.
Action 7 Permanent Establishment Status (contd.) MLI Part IV Article 13 Artificial Avoidance of Permanent Establishment Status through the Specific Activity Exemptions Article 13 provides 2 options or the option not to choose either. Option A à Notwithstanding CTA provisions defining permanent establishment, under the MLI, the term permanent establishment shall not include a) the activities deemed not to constitute a permanent establishment under the CTA à whether or not, under the CTA, that exception from permanent establishment status is contingent on the activity being of a preparatory or auxiliary character, à if such activity is indeed of a preparatory or auxiliary character
Action 7 Permanent Establishment Status (contd.) MLI Part IV Article 13 (contd.) Option A (contd.) b) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any activity not described in a. à if such activity is of a preparatory or auxiliary character c) the maintenance of a fixed place of business solely for any combination of activities mentioned in a) and b) à if the overall activity of the fixed place of business, is of a preparatory or auxiliary character
Action 7 Permanent Establishment Status (contd.) MLI Part IV Article 13 (contd.) Option B à Notwithstanding CTA provisions defining permanent establishment, under the MLI, the term permanent establishment shall not include a) the activities deemed not to constitute a permanent establishment under the CTA à whether or not, under the CTA, that exception from permanent establishment status is contingent on the activity being of a preparatory or auxiliary character, à except to the extent that the relevant provision of the CTA provides explicitly that a specific activity shall be deemed not to constitute a permanent establishment provided that the activity is of a preparatory or auxiliary character;
Action 7 Permanent Establishment Status (contd.) MLI Part IV Article 13 (contd.) Option B (contd.) b. the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any activity not described in a), provided that this activity is of a preparatory or auxiliary character; c. the maintenance of a fixed place of business solely for any combination of activities mentioned in a) and b), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
Action 7 Permanent Establishment Status (contd.) MLI Part IV Article 13 (contd.) Indian Position à India has selected Option A to apply to its CTAs à India has provided a list of CTAs containing similar provisions with the corresponding Article and paragraph number à Option A will only apply to CTAs listed by India if the other parties to the CTA also choose the same option.
Action 7 Permanent Establishment Status (contd.) Indian Domestic Legislation regarding Place of Effective Management (PoEM) à Finance Act 2015 defined PoEM to be: a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole, are in substance made. à In 2017 the CBDT issued guiding principles to determine the PoEM for an enterprise
Action 14 Dispute Resolution à Action 14 recognizes that countering BEPS must be complemented with actions that ensure certainty and predictability for business à Action 14 identifies mutual agreement procedure (MAP) as an essential complement to BEPS and therefore a minimum standard à The minimum standard also includes easy access to procedures for the taxpayer, and timely resolution. These standards are evident in Article 16 of the MLI
Action 14 Dispute Resolution (contd.) MLI Part V Article 16 Mutual Agreement Procedure (MAP) à A person agrieved by the taxation in any of the parties to a CTA due to the provisions of the CTA may approach the competent authority in either of the jurisdictions even if a remedy is available through the domestic law of the jurisdiction where the person was agrieved. Parties must present the case within three years of the objection being raised by the person. à If such objection appears justified and the jurisdiction is unable to reach a satisfactory solution, the competent authorities of the parties to the CTA must aim through mutual agreement to resolve the case with a view to avoiding taxation not in accordance with the CTA. Agreements reached will be implemented notwithstanding any time limit in domestic law.
Action 14 Dispute Resolution (contd.) MLI Part V Article 16 (contd.) à Parties to a CTA must endeavour to resolve dificulties and doubts in the CTA through mutual agreement. They may also consult for double taxation outside the purview of the CTA à Article 16 pertains to a minimum standard. Hence parties are allowed to make various reservations to this Article only according to the directions provided within the Article.
Action 14 Dispute Resolution: Indian position MLI Part V Article 16 (contd.) Indian Position à India has reserved the right to the first part of the first provision, thereby disallowing agrieved persons to approach the competent authority of any party to the CTA (as per Article 16(5)(a)). à India reserves this provision on the basis (as permitted by the MLI) that it intends to meet the minimum standard by allowing the resident of the jurisdiction, agrieved by a provision of the CTA, to approach the competent authority of that particular jurisdiction (instead of either jurisdiction). à In the case of provisions based on nationality, residents will be allowed to approach the competent authority of the jurisdiction where the national belongs.
Action 14 Dispute Resolution: Indian position (contd.) à India has listed CTAs containing provisions similar to the second sentence of Article 16(1) with a time frame of less than 3 years (cases to be presented within 3 years) à India has listed CTAs containing provisions similar to the second sentence of Article 16(1) with a time frame of at least 3 years (cases to be presented within 3 years) à India has listed CTAs not containing provisions similar to the first sentence of Article 16(2) (cases to be solved by mutual agreement between parties) à India has listed CTAs not containing provisions similar to the second sentence of Article 16(2) (mutual agreement to be implemented notwithstanding any time limit in domestic law) à India has listed CTAs not containing provisions similar to the first sentence of Article 16(3) (resolving issues of interpretation or application of CTA provisions through mutual agreement) à India has listed CTAs not containing provisions similar to the second sentence of Article 16(3) (consultation regarding cases not provided for by the CTA)
Indian Domestic Legislation on Treaty Abuse General Anti-Avoidance Rule (GAAR) à India applied GAAR from 1 April 2017 à The GAAR complements the provisions combatting treaty abuse in the MLI à Anti avoidance rules allow authorities to analyse agreements and transactions than was previously permitted à GAAR and similar provisions are formulated to impact companies which lack substance
Indian Domestic Legislation on Treaty Abuse General Anti-Avoidance Rule (GAAR) (contd.) à According to the Indian GAAR : à An arrangement may be declared an impermissible avoidance arrangement à Such an arrangement shall be presumed (unless proven to the contrary) to have been entered into for the main purpose of obtaining a tax benefit à Consequences of such an arrangement would include the denial of any treaty benefit à The main purpose test is similar to the PPT mandated by Action 6
Indian Domestic Legislation on Treaty Abuse (contd.) General Anti-Avoidance Rule (GAAR) (contd.) à An impermissible avoidance agreement is defined to be an arrangement: à The main purpose of which is to obtain a tax benefit à Which creates rights or obligations not ordinarily creates between persons dealing at arm s length à Which results in the misuse or abuse of the procisions of the Income Tax Act à Which lacks commercial substance in whole or in part à Is enetered into or carried out by means or in a manner not ordinarily employed for bona fide purpose
Indian Domestic Legislation on Treaty Abuse (contd.) Comparison of Shome Committee Report and the Indian GAAR Definition of Impermissible Avoidance Arrangements Provision of Draft GAAR: An impermissible avoidance arrangement means an arrangement, the main purpose or one of the main purposes of which is to obtain a tax benefit [ ] Shome Panel recommendation: The Committee recommends that the Act may be amended to provide that only arrangements which have the main purpose (and not one of the main purposes) of obtaining tax benefit should be covered under GAAR. à The final GAAR provision implemented the above recommendation: An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax benefit [ ]
Indian Domestic Legislation on Treaty Abuse (contd.) Comparison of Shome Committee Report and the Indian GAAR (contd.) Consequence of Impermissible Avoidance Arrangements Provision of Draft GAAR: an arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit. (Shome Panel Report) Shome Panel recommendation: Where only a part of the arrangement is impermissible, the tax consequences of an impermissible avoidance arrangement will be limited to that portion of the arrangement.
Indian Domestic Legislation on Treaty Abuse (contd.) Comparison of Shome Committee Report and the Indian GAAR (contd.) Consequence of Impermissible Avoidance Arrangements Final GAAR Provision: 98(1) If an arrangement is declared to be an impermissible avoidance arrangement, then, the consequences, in relation to tax, of the arrangement, including denial of tax benefit or a benefit under a tax treaty, shall be determined, [ ]by way of [ ]: (a) disregarding, combining or recharacterising any step in, or a part or whole of, the impermissible avoidance arrangement [ ]
Indian Domestic Legislation on Treaty Abuse (contd.) Comparison of Shome Committee Report and the Indian GAAR (contd.) Onus of the Revenue Provisions of draft GAAR: 97(4) The following shall not be taken into account while determining whether an arrangement lacks commercial substance or not, namely: (i) the period or time for which the arrangement (including operations therein) exists; (ii) the fact of payment of taxes, directly or indirectly, under the arrangement; (iii) the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement. Observation of Shome Panel: Draft provisions were in direct conflict of Supreme Court: Revenue/Courts should keep in mind the following factors: the concept of participation in investment, the duration of time during which the Holding Structure exists; the period of business operations in India; the generation of taxable revenues in India; the timing of the exit; the continuity of business on such exit. In short, the onus will be on the Revenue to identify the scheme and its dominant purpose.
Indian Domestic Legislation on Treaty Abuse (contd.) Comparison of Shome Committee Report and the Indian GAAR (contd.) Onus of the Revenue (contd.) Recommendation of the Shome Panel: (i) the period of time for which the arrangement (including the operations therein) exists; (ii) the fact of payment of taxes, directly or indirectly, under the arrangement; (iii) the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement. are relevant but may not be sufficient and these factors will be taken into full account in forming a holistic assessment to determine whether an arrangement lacks commercial substance. When the Assessing Officer informs the assessee in his initial intimation invoking GAAR, he should include how the above factors (i) to (iii) have been considered and why they fail to convince the Assessing Officer that GAAR should not be applied in the particular case.
Indian Domestic Legislation on Treaty Abuse (contd.) Comparison of Shome Committee Report and the Indian GAAR (contd.) Onus of the Revenue (contd.) àfinal GAAR provision was similar to the Shome Panel recommendation 97 (4) For the removal of doubts, it is hereby clarified that the following may be relevant but shall not be sufficient for determining whether an arrangement lacks commercial substance or not, namely: (i) the period or time for which the arrangement (including operations therein) exists; (ii) the fact of payment of taxes, directly or indirectly, under the arrangement; (iii) the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement.
International Treaty modification on Treaty Abuse à GAAR like rules in prevalent treaties (eg. Indian DTAAs with UK, Norway, Poland, UAE) à Double Taxation Avoidance Agreements modified to include LOB clause (e.g. Indian DTAAs with Mauritius, Cyprus, Singapore) à DTAA clause allowing domestic GAAR to override DTAA provisions (e.g Indian DTAAs with Luxembourg, Malaysia etc.)
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