Profit-shifting woes overflow

The revenue loss resulting from moving profits to tax havens or tax-efficient jurisdictions — termed base erosion and profit shifting (BEPS) — has potential to impact the tax sovereignty of various countries. World economies are joining hands to combat aggressive tax-planning that lacks commercial substance.

While countries such as the UK and India have codified General Anti-Avoidance Rules (GAAR) to step up their domestic tax base, the Organisation for Economic Co-operation and Development (OECD) has launched a study and a 15-point action plan to address BEPS with international co-operation.

These measures as well as the existing tax provisions may not always be enough to enhance or maintain the tax base or check revenue loss when multinational enterprises enter through a tax-efficient territory such as Mauritius or Cyprus that has favourable treaty clauses.

India is strengthening and clarifying its domestic anti-avoidance rules to limit or deny undue tax benefits. The Central Board of Direct Taxes (CBDT) recently notified rules for GAAR application that exclude among others certain arrangements where the tax benefit does not exceed Rs 3 crore; a foreign institutional investor (FII) that has invested in listed securities and not used treaty benefit; a non-resident investing in an FII before August 30, 2010. GAAR shall apply to any arrangement entered into on or after August 30, 2010, for tax benefit exceeding Rs 3 crore obtained on or after April 1, 2015.

Possibly a surrogate retrospective amendment, but at least here the investors know how far this legislation can stretch!

It is interesting to evaluate these developments in India with the anti-avoidance measures in other jurisdictions — for instance, Mauritius.

In India, tax administrators tend to view investments routed through Mauritius with a jaundiced eye for treaty abuse. Undoubtedly, this investment route will come under the GAAR lens as those investing through Mauritius-based companies normally exit tax-free thanks to the capital gains tax exemption clause in the India-Mauritius tax treaty.

India is in talks with Mauritius to re-negotiate the clause. Questions have been raised on the sufficiency and satisfaction of domestic substance requirements in such Mauritius companies as well as the tax residency certificates (TRC) issued by Mauritian revenue authorities.

The Mauritian Finance Services Commission (FSC), an independent regulator of non-banking financial services and global business, has to license and monitor companies with global business.

Thus, it is responsible for prescribing substance tests to determine whether a company is ‘controlled or managed’ from Mauritius. When a company clears certain tests, the FSC gives it a Category 1 Global Business Licence (GBL1). The ultimate purpose of GBL1 companies is to conduct business or invest outside Mauritius.

Tax resident in Mauritius, they are eligible for tax treaty benefits. A GBL1 company can obtain a Mauritian TRC if is required in the jurisdiction in which it has business or investment.

Until now, to determine the “management and control” of GBL1 companies, the FSC considered factors such as the existence of at least two Mauritius-resident directors of sufficient calibre to exercise independent judgement, presence of principal bank account in Mauritius, maintenance and audit of accounting records in Mauritius, and directors’ meeting attended by at least two Mauritius-resident directors.

Mauritius has been issuing overarching statements to co-operate in counteracting treaty abuse. The FSC has introduced additional requirements for GBL1 companies to demonstrate their “management and control” in Mauritius by January 1, 2015.

Currently the two Mauritius-resident directors have to be “appropriately qualified”.

Where the company is authorised as a collective investment scheme, closed-end fund and so on, it should be administered in Mauritius. Also, such companies should fulfil at least one additional requirement in Mauritius — existence of local office, assets of at least $100,000 (other than cash and bank balance or shares/ interests in another GBL company), employing technical/ administrative staff, constitution providing for dispute resolution in Mauritius, shares’ listing on a licensed securities exchange, or incurring a “reasonably expected” yearly expenditure. In the case of a group of companies, if any one company satisfies this additional requirement, the others will be deemed to satisfy it too.

As TRC is a statutory requirement for tax treaty benefits in India, GBL1 companies have to furnish it.

The question now is whether these additional requirements will resolve India’s concerns over treaty abuse, whether the tests meet the requirement to re-negotiate the India-Mauritius tax treaty, whether Indian tax authorities will accept these additional requirements for non-applicability of GAAR, and whether they are enough to negate the GAAR trigger. It is anticipated that the courts which upheld the validity of the Mauritius TRC on several occasions, will accord due weightage to these tests too.

The author is Director, Grant Thornton Advisory Pvt Ltd.