The Organisation for Economic and Co-operation Development (OECD) estimates that countries lose tax revenues to the extent of $100-240 billion annually as a result of tax planning and avoidance by multinational companies and that implementing the recommendations contained in its report on Base Erosion and Profit Shifting (BEPS) would help reduce this tax leakage.
India as part of the G20 countries has been instrumental in drafting these reports. The final reports are based on consensus of all the G20 countries. Among the reports released, of particular relevance from an India perspective could be Action 6 – ‘Preventing the Granting of Treaty Benefits in Inappropriate Circumstances’, which recommends stringent measures to counter treaty shopping and other situations of treaty abuse, leading to tax avoidance.
Action 6 recognises that treaty abuse, and in particular treaty shopping, is a critical BEPS concern. As a minimum standard, Action 6 firstly recommends countries to make a clear statement that they intend to prevent tax avoidance, and especially treaty shopping, while entering into a treaty.
Action 6 as its next two measures, recommends the countries to include Limitation of benefits (‘LOB’) and principal purpose test (‘PPT’) in tax treaties in the following manner: (i) the combined approach of LOB and PPT (ii) the PPT rule alone, or (iii) the LOB rule supplemented by a mechanism that would deal with conduit financing arrangements not already dealt with in tax treaties.
An LOB clause typically prescribes limits on who can access a tax treaty and would deny benefits of a treaty to certain tax payers (eg shell companies). A PPT rule on the other hand would deny treaty benefits to transactions which are designed with the principal purpose of claiming treaty benefits.
The report recognises the fact that the above may not be enough to avoid treaty abuse. Countries should have their own General Anti Avoidance Rules (GAAR) under their domestic law. The GAAR would provide much more flexibility to the tax authorities to evaluate treaty abuse.
India perspective The Indian government/regulators have long recognised that inappropriate use of double taxation avoidance agreements (DTAAs) can result in tax leakages. This is evident from the fact that most of India's treaties include fiscal evasion. Several of India's treaties contain anti-abuse provisions in the form of an LOB and/or a PPT clause (India’s treaties with Finland, Luxembourg, UK). The recent trend in negotiating (or re-negotiating) tax treaties with an LOB and/ or PPT rule also indicates India’s intention to codify the doctrine ‘substance over form’, in order to avail treaty benefits.
Further, the Indian domestic tax provisions (Income Tax Act) already have various measures and mechanisms incorporated as a barrier to tax leakages – these include mandatory requirement for tax residency certificate for treaty claims, higher withholding rates in absence of a PAN, domestic anti-abuse rules (GAAR) provisions that would be effective April 1, 2017 which specifically state that a taxpayer cannot take the benefit of a treaty if GAAR were to apply to it.
India also has in place many reporting requirements aimed at transparency such as payments to non-residents/foreign entities, Indian company’s obligation to report indirect transfers undertaken outside India, etc and such obligations are coupled with penalty provisions in case of reporting failures.
Hence, to a certain extent India is ahead of the curve in recognising the issues relating to treaty abuse. However, significant investments into India do come in from tax neutral jurisdictions like Mauritius. The focus could be back on the DTAA between India and Mauritius and whether India should be making amendments in its domestic law, or the DTAA with Mauritius, or rely on the proposed multilateral instrument/ treaty between countries seeking to avoid treaty abuse.
However, one does need to recognise that treaties are not only entered into for avoidance of double taxation but also for promoting trade and commerce and for varied socio-political reasons. Hence, each country would need to evaluate how they would seek to implement some of the recommendations of Action Point 6 with respect to its DTAAs.
What’s next It is likely that the Government will look at implementing some of the BEPS recommendations in the forthcoming Budget. It should engage stakeholders to prevent business disruption or protracted litigation.
The writer is with EY. Views are personal