Paper No. 2
The Income Tax Appellate Tribunal
Orientation & Training Programme
Mumbai
Part I:
Understanding the Basis of the DTA
Part II: Understanding the differences between
3 different models
12th August, 2012.
by
CA. Rashmin C. Sanghvi
www.rashminsanghvi.com
There are several concepts in DTA. In this paper, we may discuss
some important issues which give a macro level idea. For each individual
Article and concept, more detailed discussions may be covered later in
this programme.
Contents Page
Sr. No.
Part 1.
Particulars
Page No.
Understanding the Basis of DTA
1.
Broad Description of DTA
1–2
2.
How to read a DTA
2–4
3.
Common Phrases used in DTA
4
4.
Structure of DTA
4
5.
Scope of DTA
5
6.
Treaty Mechanism
6–7
7.
Definition of “Resident”.
7–9
8.
Categorisation of Income.
9 – 10
9.
Why so many models of DTA?
10 – 11
10.
Interpretation of DTA.
11 – 14
11.
Treaty Abuse.
12.
One way benefit of India – Mauritius DTA.
14 – 15
13.
Underlying Tax Credit.
15 – 16
14.
Treaty Override.
15.
General Vs. Specific Rule
Part 2.
Comparison of 3 models.
14
16
16 - 17
Tax Sharing Under 2.1
OECD Model.
18 – 20
2.2
U.N. Model
20 – 22
2.3
U.S. Model
22 – 30
Some Relevant Thoughts.
31 – 32
Ann. I
Ann. II US Mutual Fund - Structure to avoid Indian Taxation
33 - 35
3 different models Page No.:1
Part 1: Understanding the Basis of DTA:
1.
A Broad Description of DTA:
1.1.
What is DTA?
1.2.
Why Signed?
They sign this agreement to provide relief to their
residents from Double Taxation and for curbing tax evasion.
1.3.
How are the purposes achieved?
DTA is an agreement between two Governments.
1.3A The relief is provided by distributing taxing rights between the two
countries:
The COS restricts its taxing rights.
The COR gives credit for taxes paid in the COS.
1.3B
As far as the purpose of curbing Tax Avoidance & Tax Evasion is
concerned, so far, Government of India has actively encouraged Tax
Avoidance and done little on curbing Tax Evasion. Countries like USA
have done considerable work for curbing tax evasion.
1.4.
Why Model Convention?
A model convention is like “Table A” in the Companies Act. It is a
standard draft of Memorandum and Articles of Association. Parties using
the draft just take it as a starting point. They modify the clauses as per
their own needs and negotiations.
The model convention is a help in negotiating and drafting our
own model. Nothing more. It is not a law.
1.5.
Why so many different models? Why even the same country using same
model has different agreements with different clauses? See Un Ekant Vad
(para 9) In short, every individual and every Government will think and
act differently.
1.6.
Why such detailed commentaries on Model Convention?
It is human nature that same words will be interpreted by different
people in different manners. Sometimes even in contrary ways. It is very
useful to have a detailed note explaining - what is the commonly
understood meaning of a word, a phrase and a concept.
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Commentary to OECD model convention explains – what the
OECD committee of experts understands by the phrases used in the
model convention.
1.7.
How and where do we get more knowledge on the subject?
Professor Klaus Vogel’s book on the subject is the best book.
International print is costly as it is priced in Euros. Kluwer Law
International has come out with a South Asian Reprint edition at a price of
Rs. 5,000. However, a fresh reader cannot understand this high level book.
In Mumbai four professional associations (ICAI, BCAS, CTS, IFA &
FIT) conduct several primary teaching (for primary explanations) classes,
conferences (for advanced level discussions) and study circle meetings
(for continuing education) to give a complete exposure to International
Taxation. On an average there are about a hundred events in Mumbai on
the subject of International Taxation alone.
Income-tax department has started continuing education on this
subject before more than 15 years.
BCAS has also made OECD commentary on the subjects available
at low cost. Both – OECD & UN commentary are available on the net.
The Chamber of Tax Consultants (CTC) has published a book on
International Taxation. First two volumes give article by several different
authors. The third volume gives texts of:
(i)
(ii)
(iii)
(iv)
(v)
Vienna Convention and websites where useful details on Vienna
Convention can be obtained.
OECD model and useful links for further studies.
U.N. Model.
U.S. Model.
U.S. – India Technical explanations given by USA.
These explanations are a good help in understanding several
typical provisions of the US Model. The book is under revision for fresh
printing.
2.
How to read a DTA
The language of DTA models are meant to be used by many
countries. Hence they use a typical language. It becomes difficult to read.
A simple method of trying to grasp the meaning is to change the two
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phrases: “Contracting State” and “the other contracting state” by specific
names of the countries. We take the illustration of India - UK DTA, Article
7. Given below are: (i) Article as it is in the DTA and (ii) Article simplified.
(i) Article 7 as it is in the DTA:
Business Profits
(1)
The profits of an enterprise of a Contracting State shall be taxable
only in that State unless the enterprise carries on business in the other
Contracting State through a permanent establishment situated therein. If
the enterprise carries on business as aforesaid, the profits of the enterprise
may be taxed in the other State but only so much of them as is directly or
indirectly attributable to that permanent establishment.
(2)
Where an enterprise of a Contracting State carries on business in
the other Contracting State through a permanent establishment situated
therein, the profits which that permanent establishment might be expected
to make if it were a distinct and separate enterprise engaged in the same
or similar activities under the same or similar conditions and dealing
wholly independently with the enterprise of which it is a permanent
establishment shall be treated for the purposes of paragraph (1) of this
Article as being the profits directly attributable to that permanent
establishment.
(ii) Article 7 simplified:
Let us consider an Indian resident has income from UK.
Business Profits
(1)
The profits of an enterprise of India shall be taxable only in India
unless the enterprise carries on business in UK through a permanent
establishment situated in UK. If the enterprise carries on business as
aforesaid, the profits of the enterprise may be taxed in UK but only so
much of them as is directly or indirectly attributable to that permanent
establishment.
(2)
Where an Indian enterprise carries on business in UK through a
permanent establishment situated therein, the profits which that
permanent establishment might be expected to make if it were a distinct
and separate enterprise engaged in the same or similar activities under the
same or similar conditions and dealing wholly independently with the
enterprise of which it is a permanent establishment shall be treated for the
purposes of paragraph (1) of this Article as being the profits directly
attributable to that permanent establishment.
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Remarks: Rules of good English say that a sentence should not have
more than 15 words. Avoid Compound & complex sentences. If the legal
fraternity accepted these rules, life would be simpler.
3.
Some common phrases used in DTA:
Treaties define Residential status (Article 4). When the assessee is
resident of a particular country, that country is the COR.
Any other country trying to tax that Resident’s income on the basis
of “Source” is the “Other Contracting State”; or Country of Source; or
COS. No attempt is made by the DTA to determine whether the other
country has a jurisdiction to tax or not. If a Government does not have
jurisdiction to tax a particular income, the assessee may take up appellate
proceedings under that Country’s domestic law.
We may notice that even for COR, the DTA does not determine –
which country is the COR. If a country claims jurisdiction to tax on
assessee’s foreign income by the Connecting Factor of Residence, and if
the assessee accepts the jurisdiction, that country is COR. If the assessee
does not accept the jurisdiction, he may take up appellate proceedings
under the domestic law.
Mutual Agreement Procedure (MAP) is an alternative to appellate
proceedings.
4.
Structure of the DTA.
A summary/ Macro View of the DTA:
Articles 1 & 2 provide for applicability.
Articles 3, 4 & 5 provide definitions.
Articles 6 to 22 provide for different Categories of Income. Primarily COS
will determine the tax that it can levy on a NR’s income in COS
based on the category of income.
COR is not concerned with the categorisation of the income.
Article 23 provides for Elimination of Double tax – if any.
This Article provides for two options available to the COR. Article
23A provides for “Exemption” method. Article 23B provides for
“Credit” method. COS is not concerned with Article 23.
Articles 24 to 31
Miscellaneous provisions.
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5.
What is the scope of DTA?
DTA simply tries to eliminate double taxation. It does not grant
any tax jurisdiction to any Government nor take away any jurisdiction
already existing. Elimination of Double taxation is attempted by the
simple mechanism of COS restricting its rights to tax & COR giving credit
for COS taxes or exemption for incomes taxed abroad.
All other provisions of the domestic law apply.
computation of income, assessment, appeals, recovery, etc.
For example:
DTA does not take away the basic jurisdiction from COR.
Normally, under the Classical system of taxation (which is adopted by
India, UK, Germany, USA, etc.) the COR has full right to tax the global
income of its residents. When its resident gets taxed in the COS, COR
will give credit for the taxes paid abroad. The fact that the income has
been taxed by COS does not mean that it cannot be taxed by COR.
In my respectful submission, Chettiar’s case decided by
Honourable SC has an error. It states that – since Chettiar’s income has
been taxed in Malaysia, it cannot be taxed again in COR (India). The fact
that all review petitions have been dismissed by Honourable SC means
that Honourable SC has not taken into consideration the scheme of DTA.
Taxing jurisdiction is granted by the Constitution and domestic tax
laws of a country. DTA does not give or add rights to taxation.
For example, Singapore does not tax capital gains. DTA between
India & Singapore – Article 13 (4) provide that capital gains on movable
properties shall be taxable only in the COR. Let us say, an FII from
Singapore earned capital gains in India. As per DTA, India cannot tax
theses gains. In Singapore domestic law does not tax the same. Singapore
Income-tax officer cannot say that since the DTA provides, he will tax the
FII’s Indian capital gains.
Issue is:
DTAs do not grant any taxing rights.
If there is a Double Non-Taxation, so be it.
If a genuine resident of Singapore earns capital gains which are not
taxed in any country, that is OK. However, when a Non-Resident of
Singapore resorts to Treaty Shopping and obtains a tax benefit which is
not due to him, it is not OK.
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6.
Treaty mechanism / actual operation:
When the resident of a country (say, India) has income taxable in
another country – COS, say (UK), DTA will be invoked. The Indian
resident understands that UK Income-tax department - HMRC (Her
Majesty’s Revenue & Customs department) – cannot levy full income-tax
on his British income. Considering the category of his income, he will file
appropriate income-tax return and claim the relief. If his return is found
to be correct, HMRC will accept his claim of DTA relief.
The Indian Resident will also file his Income-tax return in India.
He has to disclose his global income in his Indian return. This will include
his UK income. From the Indian tax payable in India; he will claim credit
for the taxes paid/ payable in UK. If the Indian AO finds his claim to be
correct, he will grant credit for the taxes paid/ payable in UK.
This is the manner in which double tax is avoided.
Normally, the assessee will end up paying tax at the higher of the
COS or COR rate. In other words – If the UK tax rate is higher, the Indian
tax will be reduced to zero. If the UK tax is lower, balance will be paid in
India.
Illustration 1:
Mr. Patel from India has purchased a residential house in UK. He
earns rental income of GBP 1,000. Let us assume, the UK tax rate is 40%.
Under Article 6 of India – UK DTA, UK can levy full tax on the rent.
Hence, Mr. Patel would pay GBP 400 as tax in UK.
His Indian tax on the income is 30% or GBP 300. When he claims
credit in India for the UK tax, his tax liability in India gets reduced to zero.
Indian Government will not give him refund of the excess tax paid in the
UK.
Illustration 2:
Mr. Patel has a Permanent Establishment (PE) in USA. He earns $
1000 from the PE. Under Article 7 of the India – US DTA, the PE income is
fully taxable in USA. Assume further that in USA he will be liable to pay
following taxes: Federal Income-tax $ 400. State Income-tax $50. City –
Municipal Income-tax $ 50. Social security charges $ 60. Mr. Patel will
end up paying $ 560 to different Governments in the USA.
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Under Article 2 (1) (a), only the Federal US tax is covered by the
DTA. All other taxes levied in the USA are not available for credit against
the Indian taxes.
Hence Mr. Patel will get credit for $ 400. All other taxes paid in the
USA are simply costs of earning income from USA. Indian tax is only
$ 300. So even from federal tax, $ 100 will not be available as credit. His
tax liability in India will get reduced to zero.
7.
OECD model treaty Article 4.
Definition of “RESIDENT”
7.1
Let us consider Sub-Article (1) first.
7.1.1 “1. For the purposes of this Convention, the term "resident of a
Contracting State" means any person who, under the laws of that State, is
liable to tax therein by reason of his domicile, residence, place of
management or any other criterion of a similar nature, and also includes
that State and any political subdivision or local authority thereof. 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.”
Analysis:
For a better understanding, the definition is broken up into
several clauses below.
1.
2.
3.
4.
5.
6.
For the purposes of this Convention, the term "resident of a
Contracting State" means
any person who, under the laws of that State,
is liable to tax therein
by reason of his domicile, residence, place of management or any
other criterion of a similar nature,
and also includes that State and any political subdivision or local
authority thereof.
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.
Rules of Good writing: Now the issue is: For defining a “Resident”
(phrase 1 above), the treaty uses the word “Residence” (phrase 4 above).
This raises the question: Is this something like a circular calculation in an
excel sheet! Such circular calculations are not workable. It is a rule of good
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English writing that: “When you are defining a word, you cannot use the
same word in the definition”.
Real fact is, the definition is not using the same word twice. The
word “Resident” in the first phrase refers to Resident as per the DTA.
And the word Residence in the fourth phrase refers to the residence
under ITA. Both are different. For defining DTA residence, OECD says,
one has to be resident under the domestic legislation. Then only he can
claim DTA benefits.
7.1.2
The assessee has to be “Liable to Tax” to be considered a Resident
under ITA.
Consider two illustrations: (i) An Indian resident (present in India
for more than 182 days) has income below Rs. 1,80,000. (ii) Another Indian
resident as per ITA has income of Rs. 5,00,000. However, entire income is
from agricultural activities and hence exempt under section 10 of the ITA.
Both are Residents under the ITA. However, under the DTA, will they be
treated as Residents of India?
Assume that they have some foreign income, will they get the
benefit of DTA between India & the COS?
This query itself is based on a misunderstanding. Both these
persons are liable to tax in India- if they had taxable income. The fact that
they do not have taxable income results into their Nil liability to tax. As
we have seen earlier, there are two pillars of Income-tax: “Assessee” and
“Income”. Only when both factors are covered within the ITA, there will
be a tax liability. If a person has no income, it does not mean that for the
purposes of DTA, article 4 he is not liable to tax in India. If such a person
has a foreign income, he should get the DTA benefit.
Such instances can arise. Consider a person who was employed
abroad. He had his savings & investments abroad. He retired & returned
to India leaving his investments abroad. His income in India would be
small. But he will get DTA benefit.
7.1.3 Dubai:
If a person who has no income can also claim to be “Liable to
tax” and hence entitled to DTA relief, can an NRI from Dubai (UAE) claim
DTA relief?
Technically: In Dubai, the Government collects Income tax only from
foreign banks & oil companies. The Income-tax decree is not applied to all
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other persons. Hence technically all residents of Dubai are liable to tax in
Dubai.
In Substance: Most residents of Dubai are not liable to Income-tax in
Dubai. Hence they are not residents of Dubai. Hence not entitled to DTA
relief.
In March, 2007 India & UAE have signed a protocol and provided
that if an individual is physically present in UAE for at least 183 days, he
will be considered to be a resident of Dubai. GOI has unequivocally
declared that it wants to give DTA relief to UAE investors. Who are we to
deny the relief?
With this DTA, UAE has started a whole business of tax havens. It
is alleged to have been used for money laundering. When Government of
India provides for zero taxation, people are bound to abuse such
provisions.
4 (2)
Provides for “Tie Breaking” for Individuals.
4 (3)
Provides for “Tie Breaking” for non-individual assessees.
Note: Only the main clause (1) is discussed here. Sub-Articles (2) & (3)
are not discussed.
8.
Categorisation of Income:
8.1
Objective of Categorisation:
Categorisation is different under ITA & DTA. Under the ITA,
different categories of income have different rules for computation of
taxable income. Under DTA different categories determine which country
will get how much right to tax. For example, business income under
Article 7 will attract Zero tax in COS. But immovable property income &
PE income will attract full tax. Royalties, FTS, Dividend etc. attract a fixed
rate of 10% to 15% on gross basis.
This structure of DTA has created a vested interest. Assessees
always want to claim that their income is business income, they have no
PE & hence no tax in COS.
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AO would always like to categorise the income under some head
which attracts tax in India. Significant amount of litigation arises because
of disputes on Categorisation.
8.2
Who decides Categorisation?
Categorisation of income is neither the assessee’s choice nor the
AO’s choice. Application of legal provisions to particular facts of the case
determines the categorisation of income.
Consider following:
1.
Some FIIs from Mauritius claim that they earn capital gains in
India, they are resident in Mauritius and under India - Mauritius DTA,
their capital gains are not taxable in India. This stand has been accepted at
appellate level.
2.
In similar circumstances, another FII claims that it is doing a
business of running a mutual fund, it has no PE in India and hence its
business income is not liable to tax in India.
Consider that the facts in both cases areThe FII itself invests around 5% of total funds. It attracts 95% of the
funds from several investors. The FII appoints researchers, brokers,
custodians and other service providers. It employs top brains to manage
the funds. It is a fully commercial, organised business activity. As per
settled principles of law, it is carrying on business activities. How could
its ground of capital gains be accepted? More important, how two
contradictory grounds get accepted simultaneously?
“Whichever is more beneficial” concept applies to (i) rates, and (ii)
also to categorisation for treaty purposes. Categorisation will determine
tax rates. This concept does not apply for categorisation under Indian law,
for computations of income, for tax avoidance schemes.
9.
Why Different Models of DTA?:
In Indian philosophy we have a concept of Un Ekant Vad. It says,
every individual will think differently. There can be several reasons – age,
caste, religion, gender, society, family background, education & so on.
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Illustration: When India became independent, Winston Churchill
said – with so many castes, religions and languages, India will fall apart.
(He used foul language – which may not be reproduced here.) Whereas
Pandit Jawaharlal Nehru talked of “Unity in Diversity”. Pandit proved
right.
Since every nation thinks differently, there will be different DTAs.
When nations with similar interests come together, they form a common
ground. Thus the rich nations have come out with OECD Model.
Developing countries tried for their independent model. They worked on
UN platform. The UN Model is largely similar to OECD.
USA has its own model.
India has not officially announced its own model of DTA. Its
preference is towards UN Model. But even there it has several
differences. It is said that India’s DTA with Armenia represents what
normally India would prefer. It can be considered as a sort of Indian
model.
Content of all model conventions is almost same. The differences
are considered in Part II.
10.
Interpretation of DTA:
10.1
Is OECD/ UN Commentary binding? No. But it has tremendous
persuasive value. Court decisions completely ignoring OECD
commentary, are, with respect, incorrect. In fact, if we consider little more
depth, these commentaries have more than persuasive value.
10.2
Is Vienna Convention Binding? Yes.
It is a settled issue in India that while interpreting DTAs, we should
be guided by the Vienna Convention on Law of Treaties (VCLT). Even
though India has not signed it. VCLT is nothing but codification of
existing – international law on the subject.
Vienna Convention provides that a treaty must be interpreted
according to the intention of the parties that signed it; according to the
“Object & Purpose” of the treaty. Article 31.
10.3
Other treaties signed by same Government are generally of no help
in interpretation. Each DTA is a separate agreement negotiated with a
different country. For every agreement different issues may have been
considered. Hence the protocol or other reference material specific to one
DTA cannot be used while interpreting another DTA.
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10.4
International Law Commission.
United Nations had appointed International Law Commission to
prepare the Convention on Law of Treaties (Vienna Convention). The
commission has published detailed reports on what considerations went
into drafting the Vienna Convention. Updates to the convention are also
published. All this material is available on UN website. This is an
excellent material for researchers.
10.5
We may remember that a DTA is an agreement between two
countries. It is different from domestic law. For interpretation of domestic
law, intention of the law maker – Parliament is important guide. For
interpretation of an agreement, the intention of the parties to the
agreement is binding. That intention may be gathered from all relevant
reference and context (Article 31 of the Vienna Convention).
When a nation relies on OECD or UN Model of DTA, the
commentary on the model is a useful reference material to interprete the
article.
10.6
Wherever India has expressed reservations on OECD/ UN
commentary, it is declaration of India’s intention as to interpretation of the
DTA. And hence reservation is binding on all AOs and Courts of Law
while interpreting the law. OECD Commentary accepts the importance of
reservation and publishes these reservations together with its
commentary.
I repeat. In my submission, Tribunals and Courts are bound by
India’s reservation on OECD/ UN commentaries – while interpreting any
DTA. This arises from the following legal positions:
Vienna Convention on the Law of Treaties is binding on India as it
is only a codification of existing public International Law. VCLT, Article
31 provides that the DTA shall be interpreted according to the intention of
the parties signing the DTA. And intention can be gathered from all
relevant material. India’s reservations to the commentaries are directly
relevant material. And hence they must be given due regard while
interpreting the DTA.
10.7
Consider an illustration:
A non-resident company does the business of operating television
channel. It broadcasts programmes specifically for Indian footprint. It
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earns advertisement revenue.
The company has no permanent
establishment in India. According to OECD model, Article 7 read with
Article 5, this company cannot be taxed in India.
OECD Model commentary on Article 5 – PE in paragraph 5.5 says
that a satellite’s footprint cannot be considered to be a fixed place of
business and hence cannot constitute a PE. India has registered its
reservation on this paragraph. Paragraph 43 on page 439 of OECD
commentary – condensed version – published by BCAS in July 2010. (It
can be also viewed on OECD.ORG website. One has to work hard with
patience to get at the right page on the website.) India has stated that in
its view a “footprint” can be treated as a fixed place of business.
In my submission, all Indian Tribunals & Courts are bound by this
reservation. Accordingly all television channels broadcasting their
programmes with India as a footprint have their PEs in India and are
liable to tax in India.
10.8
Consider a situation where one party to the agreement agrees with
a commentary and the other party does not agree. What happens then?
For illustration – India – UK DTA. UK agrees with OECD
commentary on Article 5, TV Channel footprint is not a PE. India has
specified that it does not agree with OECD commentary on this issue.
How would one interpret Article 5 of India – UK DTA?
In my submission, in such a situation, both – OECD commentary
and India’s reservation on the same – fail. They are not useful help in
interpretation. One of the Parties to the agreement has declared that it
does not agree with OECD opinion on a specific issue. The other party
does not agree with India’s reservations. An expression of an opinion
(even if it is OECD’s opinion) cannot bind some one who does not agree
with it.
Both these documents (OECD commentary & India’s reservations)
are general in nature – one has to look for a specific document. Have
India & UK published a protocol or technical explanation giving meaning
to the terms they have used in the agreement that they have signed? If a
specific reference material is not available, Tribunals and Courts may have
to interpret the term independently without the help of these documents.
USA publishes detailed technical explanations for every DTA that
USA signs. It would be good if Indian CBDT also established a practice of
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publishing technical explanations, or better still detailed protocols for its
DTAs.
India should at least cover all issues where it has expressed
reservations to the OECD/ UN commentaries. If both countries arrive at
an agreement on such issues and declare their intentions by signing a
protocol; it would help in reducing litigation. It would help CBDT in
establishing intention of both countries while signing a DTA.
If both countries agree to a particular meaning for a particular term
used by them; generally speaking neither the assessee nor the Courts can
adopt a different meaning.
10.9
It is the declared objective of every DTA that the Objects &
Purpose of the DTA are:
(i)
(ii)
To avoid double taxation; and
To Curb Tax avoidance, tax evasion, etc.
Hence any interpretation of a DTA, that permits abuse of the DTA,
treating shopping etc., is ab-initio incorrect interpretation. In my humble
submission and with respect, the decision of Honourable Supreme Court
in Azadi Bachao Andolan is incorrect.
11.
Treaty Abuse:
DTA is meant to curb tax evasion and tax avoidance. DTA is not to
be abused to avoid taxes. So when a country amends its laws to prevent
abuse, it does not amount to Treaty Override. It actually is carrying out
the objectives of the DTA. UN & OECD both commentaries support this
view. Unfortunately in India the authorities do not understand this
position. Some vocal people make a campaign to build people opinion.
And they do win.
12.
One Way Benefit of India – Mauritius DTA:
When a Non-Resident of India, claims Residence of a tax haven he
can get Double Non-taxation. However, when an Indian Resident earns
income from a tax haven, he does not get Double Non-taxation. Since his
global income is liable to tax in India, even if the tax haven does not tax
his income, he has to pay full tax in India.
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Illustration: FII invests in India, earns capital gains in India and claims
DTA relief. It enjoys double non-taxation.
Consider Mr. Iyer from India has formed an SPV in Mauritius. The
SPV earns capital gains. Iyer pays 3% tax in Mauritius. If his tax rate in
India is 30%, balance 27% will have to be paid in India.
13.
Underlying Tax Credit (UTC):
India does not provide for UTC. US, UK, & some other countries
provide for UTC. To understand the concept, let us see an illustration:
Colgate USA holds say, 50% equity shares in Colgate India. (This is just an
illustration and not real facts.)
S.N.
1.
2.
Rs.
Colgate India Taxable Corporate Profits
Indian Corporate tax paid
1,000
300
------700
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
For this illustration we ignore DDT under S. 115O. Assume normal tax on dividends.
Full amount declared as dividend.
Tax deducted at source on dividend @ 15% ………
Net Remittances to shareholders
Remittance to Colgate USA - Half
700
105
595
298
===
In USA, Colgate USA’s income will be considered.
50% of Colgate India’s total profits (1)
Let us assume US corporate tax @ 40% ……………
From this tax following credits will be available:
(i) Dividend tax – half of total TDS
53
(ii) Corporate tax on corporate profits from which
the dividend has been declared.
This is also called Underlying Tax Credit
150
50% of Corporate tax paid (2 above)
----Total tax credit
Balance tax payable in USA
500
200
203
NIL
===
In essence, UTC rules provide credit for corporate tax paid on
profits from which dividend has been paid.
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This concept is relevant to understand provisions of Article 23 –
Relief from Double Taxation under US Model. Part 2.3 of this paper.
14.
Treaty Override:
A country is not permitted to sign a DTA & then pass laws contrary
to the agreement. No country may raise the ground of internal law being
inconsistent with the DTA as a justification for disregarding a DTA. VCLT
Article: 27. Compare this with corporate agreements.
Illustration: A Pvt. Ltd. company has its own M/A and other internal
authority schedules. A Pvt. Ltd. can change all these rules by following
appropriate procedures.
Now A Pvt. Ltd. enters into a Contract with B Pvt. Ltd. When A &
B signed the contract, it was permissible as per their rules. After some
time A wants to change its M/A and provide that the contract it entered
into will be considered as non-permissible. Can A be allowed to do so?
No.
Same is the situation when two countries enter into a contract. A
country cannot be allowed to say that its internal contracts do not permit
the contract, which it has knowingly signed.
Note: This position is different from the position discussed in
paragraph 11 . If some one tries to abuse the DTA & get undue advantage;
relevant Government is in its right to prevent the abuse. If necessary, it
can pass relevant laws & prevent the abuse.
15.
General rule Vs. Specific rule:
An Illustration – PE & Article 8
15.1
Under Article 8, profits of an airline are to be taxed only in the
country of management (COM) in other words, the profits are not to be
taxed in COS.
15.2
The profits of a permanent establishment under article 7 are to be
taxed in the COS. What happens when there is a conflict of article 7 &
article 8? In other words, if the airline has a permanent establishment in
another country, how is the tax jurisdiction to be shared?
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15.3
Let us assume that the British Airways has a travel agent in India.
The agent has an authority to book seats and he is a – ‘agency PE’ of
British Airways. Profits attributable to the Indian PE for the year 2012-13
are, say, GBP 100. Out of these, the profits derived by the PE are GBP 20
the balance being derived by the British Airways.
15.4
In the above facts, can the Indian PE claim that its profits also have
the character of the profits of an airline? And hence it cannot be taxed in
India? – Article 7.
15.5
Can the assessing officer claim that the GBP 80 derived by the
British Airways is taxable in India under article 7? Hence he will tax full
GBP 100 being profits attributable to the Indian PE?
15.6
Apparently, there is a conflict between the provisions of article 7 &
article 8. Which will prevail in what circumstances?
15.7
See Prof. Vogel’s commentary on pages 482 & 483 – paragraphs 22
to 26 under article 8.
Article 8 being a special provision, overrides the general provision
under article 7. In other words, the concept of PE does not apply under
Article 8. No profits of British Airways can be taxed in India. However,
this benefit is available only to the airline & not to the travel agent. The
agent is not earning from the “Operation of aircraft”.
Notes:
1.
Some fundamental issues of deep controversy have not been
discussed here. All 3 models, OECD, UN & US give maximum
importance to COR. Inadequate importance is given to COS. Why? What
can be done to give more importance to COS? These can be discussed at
advance level courses.
2.
India has developed. Now in some matters we are COS and in
other matters we are COR. Real need is to have a fair DTA which gives
equal importance to both sides.
Part 1. Brief Discussion on some of the
DTA concepts completed.
Next: Part 2 Characteristics of Different DTA Models
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Part 2
Comparison of the 3 Models:
1.
2.
3.
OECD Model
UN Model
US Model
In this part, let us observe the typical provisions of each model of
DTA. We are not considering here the Indian Model – which, for us is the
most relevant matter. A consideration of India’s reservations against
OECD & UN Models; and India-Armenia DTA would give a good idea of
Indian model. Best person to discuss this subject would be – a secretary
from FT & TR, CBDT – someone who has drafted these reservations.
II.1
Tax Sharing under OECD Model
Article 12.
Royalty Right to tax given ONLY to COR. No right to COS.
Article 8
International Shipping & Airline – ONLY to country of Place of
Effective Management (POEM).
Article 6
Income from Immovable Property. Full tax in host country or
COS. Final tax in COR.
Article 7
Business Income.
In case of PE.
Only to COR.
COS to levy full tax.
COR to levy final tax.
Article 10
Dividends.
COS – Restricted right. COR – Final Right.
Article 11
Interest
COS – Restricted right. COR – Final Right.
Article 13
Capital Gains on
13.1 Immovable Property
13.2 PE
COS – Full tax.
COR – Final tax.
13.3 Ships & Aircraft
ONLY POEM
13.4 Shares in Company primarily
having Immovable property.
Full tax by host country.
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13.5
All other properties
Only COR.
Note: India’s DTA with Mauritius follows OECD Model. There
is nothing special in the DTA. However, a DTA envisages taxes
in both countries resulting in double taxation. Mauritius &
Singapore do not tax capital gains. This results into double nontaxation. This raises tax haven issues.
Article 14
Professional Income. Article
deleted
by
OECD.
Now
professional income is to be considered
under Article 7. Hence, primarily all
rights with COR. In case of PE, COS can
tax profits attributable to PE. Final right is
with COR.
Article 15
Salary
Primarily COR has full right to tax.
However if services are exercised in
another country (COS), that country will
tax fully.
Finally COR will tax.
Article 16
Director’s fees
Country where the Company is resident
shall levy full tax.
Final tax by COR.
Article 17
Artists & Sportsman
Host country – full tax.
COR final tax.
Article 18
Pensions
Only COR.
Article 19
Government Service
If citizen of the country of the Government
then the taxing rights with country of the
Government.
If citizen of the country where services are
rendered, then only that country.
Essentially COR.
Article 20
Student
Country of studies – if income from that
country. Otherwise, country of original
residence.
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Article 21
Other income
Only COR.
Article 22
Capital tax or
Wealth tax
Primarily full right ONLY with COR.
However, if immovable property or PE is
situated in another country, then the host
country shall levy full tax.
Final tax by COR.
A summary of this analysis of OECD Model Convention.
In all cases, the COR has the right to levy final tax.
In other words, COS may or may not have a right to tax the
income. Wherever tax is paid in the COS, the COR will levy a final tax
and give credit for that tax.
In following Articles, the COR has exclusive right to tax – Article 7,
8, 12, 21, 22 (4).
Historically, it has so happened that main OECD members – USA,
Canada, UK, France, Germany and other European Countries (Not
including USSR) started OECD. These countries’ residents (MNCs) were
receiving incomes from their colonies. Hence the emphasis was on COR
getting full rights to tax. COS was to get limited or no rights to tax.
Contention of Developing nations is that the rich nations of OECD
have made a model which is more suitable to themselves. Hence through
the platform of United Nations, they have tried to improve the taxing
rights of the Developing nations. Still, even the UN Model largely follows
the OECD model.
II.2.
Tax Sharing under UN Model:
UN model has introduced following provisions for expanding
taxing right of the developing nations.
Article 5
PE definition. Conditions for becoming a PE have been made
more liberal so that in more circumstances a business
establishment will be treated as a PE. So host country has
more taxing rights.
Article 7
Force of Attraction clause has been inserted in Article 7 (1)
so that MNCs may not avoid taxes by invoicing direct from
COR.
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Article 8B
A shipping company may claim its Place of Effective
Management in a tax haven like Panama. But then have
shipping activity – more than casual – in another country.
In such a situation that other country will have a right to tax
the shipping company.
Article 12
COS is given limited right to tax Royalties.
Article 13 (5) Capital gains. Where a Non-Resident has more than
specified percentage of shares in a company resident in a
particular country, that country gets the right to levy capital
gains tax.
Article 14
Independent Personal Services – professional services
Article has been retained. In this case, the taxability of a
non-resident is wider in scope than under Article 7.
Article 16 (2) Directors’ fees expanded to include top level management
salaries.
Article 21 (3) Other income. COS is also given right to levy full tax.
Article 22 (4) Capital / wealth tax. Also suggested right to levy tax to the
host country.
Article 23 A Exemption Method.
Article 23 A (4) OECD model does not permit tax sparing clause. In
other words, if the income is exempt in COS, then COR
will levy full tax.
In the UN Model Tax Sparing is permitted.
Tax Sharing observations:
With all the efforts of the developing countries, their success is
limited. Because:
1.
Many Developing ‘nations’ knowledge of international taxation
was limited or NIL when both the treaty models were drafted.
2.
The OECD members are also members in the UN. With their better
resources they would dominate the UN committees drafting / modifying
model DTA.
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3 different models Page No.:22
3.
Ultimately, a model convention is just a standard draft available.
When a developed nation negotiates with a developing nation, one can
imagine who has more bargaining power.
II.3
Tax Sharing under US Model of DTA
It is different from other models. U.S. Government has envisaged
several kinds of tax planning and tried to curb the tax planning. It has
also tried to protect its own interest qua the other Contracting State. This
is why several clauses are more elaborate than the clauses in other models.
In this part we may see some important issues typical to US model of
DTA.
Article 1
1 (1) Article 1 (1) emphasises that the DTA benefit will be available
“Only” to a resident of either country. This is a provision against treaty
shopping.
1 (3) Any dispute under DTA can be resolved only by Mutual
Agreement Procedure (MAP) and not by appeals under domestic law.
(India has not accepted this provision in India – US DTA.)
1 (4) Under the US IRS code, a citizen and a green card holder of USA is
always considered a Resident of the USA. This applies even if the person
has left USA. And his global income continues to be taxed in USA.
If a person surrenders his citizenship or green card, even then he
remains liable to tax in USA for subsequent ten years. [Compare with
section 6 (1) of ITA. How simple is the Indian law?]
US Model Article 1 provides that if a person is a US resident, then
he will be liable to tax under the US domestic law and the DTA will have
no impact.
Article 2
In USA, the Federal, State Governments and Municipal
authorities impose Income-tax. The DTA covers only Federal tax.
Article 3 (j) The term USA does not include Puerto Rico, the Virgin
Islands, Guam or other US possession or territory. So residents of these
areas are not entitled to DTA benefit. However, Delaware, a tax haven is
part of USA. Hence its residents are entitled to DTA benefit.
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Article 5 (3) Construction PE – Period 12 months.
Article 6 (5) Immovable property owner may elect to file returns on net
profit basis - as if it were the business income of a PE.
Article 7 (2) For attribution of profits to PE, FAR analysis has been
specified. Specific clause has been suggested for Insurance companies.
Article 8
Shipping & Airlines –
This is an improvement over OECD model.
A comparison of all 3 models is given in the following table.
Article 8
Business to be
taxed
International
traffic – shipping
and airline.
OECD
1) Full Right to
tax ONLY with
country of
POEM.
--------
UN
US
1) Full right to the
country of POEM.
1) Full right to tax
ONLY with COR
2) However, if business
in another state is “more
than casual”; that other
state also has a
proportionate right.
--------
Inland Waterways. 2) State of
(No mention of
POEM.
Inland air traffic.)
3) State of POEM
2) If Inland transport is
part of international
transport, then COR.
It would mean that if it
is pure Inland
transport, the country
where transport takes
place will have a right
to tax.
Ship / Air Craft
Rental
No specific clause.
2) International Traffic
also includes rent of
ships.
No specific
clause.
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Business to be
taxed
Containers, barges
and related
equipments.
International
Traffic.
OECD
No specific
clause.
--------
UN
US
No specific clause.
--------
Solely within
another country.
3)
International Traffic.
COS
Which state gets
right to tax
If POEM on a
ship – Home
Harbour or
operator’s COR
Same as OECD
Pool or joint
business
4) Article 8 (1) & 5) Same as OECD
(2) shall apply.
Article 10 (3) Specific clause for pension funds.
dividends, it shall not be taxable in COS.
No Mention
4) Same as OECD.
If pension fund earns
Article 10 (4) Investment company or Real Estate Investment Trust –
which are regulated by USA are separately treated. Such institutions shall
deduct a higher rate of tax from dividends paid to non-residents of USA.
Article 10 (7) Tax on dividend out of PE profits:
Since we do not have such a provision in the Indian ITA, it will be
easier to understand the provision by an illustration and a diagram.
Illustration: American company ABC Ltd. has a PE in India. Profits
attributed to the Indian PE are $ 100. This amount is remitted to Head
Office. Out of this Indian profit, ABC Ltd. retains $ 30, pays US tax of $ 20
and distributes dividend of $ 50.
Some Indian residents are shareholders of ABC Ltd. They get a
dividend of $ 5.
A Japanese fund has a PE in India. This Indian PE of Japanese
Fund has invested in American company ABC Ltd. It earns a dividend
of $ 10.
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Diagram explaining the working of
Article 10 (7) U.S. Model
India
1
PE of ABC
Profit $ 100
Indian Resident
shareholders get $ 5
4
Remitted to
US HO $ 100
PE of XYZ - a Japanese
Fund gets $ 10
USA
2
Company ABC Ltd.
Paid US tax $ 20.
Retained earnings $ 30.
3 Declares dividend out
of PE profit - $ 50
5
Non-Residents of
India get $ 35
OECD & UN Models: Article 10 (5):
Indian Government may levy tax only on (i) $ 100 being profit
earned by ABC Ltd. and attributed to the Indian PE; (ii) $ 5 received as
dividends by Indian residents and (iii) $ 10 received by Indian PE.
Retained profits of $ 30 and dividends to NR of India $ 35 cannot be taxed
by India.
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US Model Article 10 (7)
The position covered by OECD and UN Model is fine.
However – Article 10 (7) permits imposition of Branch Profit tax as
discussed in the next paragraph.
Notes: Explaining Article 10 (7) of the U.S. Model.
1.
Under Indian Income-tax Act, if an Indian company earns profits
and declares dividend, the company pays corporate tax and dividend
distribution tax (section 115-O). Before the introduction of S.115-O, the
shareholders paid tax on dividends earned by them.
2.
If the permanent establishment of a Non-resident company earns
profits in India, it is liable to pay tax on the corporate profit attributable to
the PE. However, when the PE remits funds to Head Office, there is no
further tax.
3.
What happens when the non-resident company ABC Ltd. declares
dividends? Under Indian ITA, nothing. We don’t tax the foreign
company declaring dividends abroad. However, some countries do tax
the shareholders of the foreign company on the dividends earned by them
to the extent that those dividends can be attributed to profits earned
within those (taxing) countries.
In the diagram given above, if we had a similar system, we would
tax the dividend of $ 50 declared by non-resident company ABC Ltd.
because that dividend is attributable to profits earned by ABC’s Indian PE.
4.
Article 10 (7) of US Model and 10 (5) of OECD & UN Models place
restrictions on the taxing right discussed in paragraph (3) above.
However, the restriction shall not apply to dividends earned by
Indian residents and Indian PEs of non-resident companies.
Article 10 (8).
Explanations. Branch Profit Tax (BPT)
1.
We in India do not have Branch Profits Tax. Direct Taxes Code Bill
2010 (DTC) had proposed similar tax vide section 111. The justification
for this DTC provision is as under:
When an Indian company declares dividends, it is liable to pay
Dividend Distribution Tax (DDT) u/s. 115-O. However, when a foreign
company that earns profits from Indian PE and pays dividends abroad;
does not pay DDT.
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Section 111 of DTC would impose tax on full branch profits earned
by the foreign company – irrespective of whether the foreign company
declares any dividend or not. Branch profit is calculated as PE’s profits
less Indian tax payable on such profits. This is a simple version of Branch
Profits tax levied by other countries.
2.
USA imposes branch profit tax (BPT). Hence in its model treaty, it
has retained provision for BPT. To illustrate Article 10 (8), earlier diagram
is modified.
As per the US tax system, the amount remitted by the branch / PE
to it Head office is considered as “Dividend Equivalent” amount. Profits
earned and retained in the host country are not liable to BPT.
As per Article 10 (8), this dividend equivalent amount is liable to
tax in the country in which the branch is situated.
India
Branch Profits Tax
PE in India + Immovable Property rent in
India + Capital Gains on IP sold in India.
Total earning $ 200. Less tax $ 80
Remitted to USA
$ 120
Dividend Equivalent
Amount is $ 120
The amount of $ 120 is
liable to tax under
Article 10 (2) (a) - @ 5% $6
USA
Net Remittance $ 114
Company ABC Ltd.
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The dividend equivalent amount or branch profit may be taxed in India at
the rate prescribed in Article 10 (2) (a) i.e. 5%. It will be $ 6.
Total Indian tax payable by ABC Ltd. will be:
Corporate tax @ 40%
BPT
@ 5%
-
$ 80
$6
------$ 86
====
Article 11
Interest
11 (1)
Primarily taxable fully in COR.
LOB clause is provided for.
11 (2) (a)
The interest may also be taxed in COS. However, if LOB
clause is satisfied, the tax shall not exceed 15%.
Article 12
Royalties taxable only in COR.
Article 13
Capital Gains
13 (1)
In case of gains on real property taxable in the country
where the property is situated.
13 (2)
Real property to include shares in company / partnership/
trust where the entity derives maximum value from real property.
13 (6)
All other capital gains (on movable property) taxable
ONLY in COR.
Article 14
Employment Income (Professional services clause does not
exist in the US Model). US Model Article 14 covers salary income.
Article 15 (3) OECD & UN Models provide that when a person is
regularly employed on a ship or Aircraft in international traffic; his salary
may be taxable in the country in which POEM of shipping / air line
company is situated.
Article 14 (3) of the US Model provides that in such cases, the salary will
be taxable only in COR of employee.
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Article 22
Limitation of Benefits (LOB) clause:
US Model has made extensive provisions for prevention of abuse
of DTA by Treaty Shopping. Article 22 provides that DTA benefits will
be available only to a Qualified Person. Detailed conditions are provided
to ensure that only a person genuinely resident of one of the Contracting
countries can get benefit of DTA. Apart from being a Resident under
Article 4 of the DTA, the person has to fulfil further conditions to be a
Qualified Person.
Article 22 (2) (c)
A company becomes a Qualified Person only if –
(i)
Company’s shares are regularly traded on recognised stock
exchange and
(A)
Shares are traded in the country where the company is a
resident
OR
(B)
Primary place of management and control are situated in the
country in which the company is resident.
Article 22 (2) (d) & (e) (i) In cases of trust etc. more than 50% of the
beneficial interest is owned by persons resident of the country for which
trust etc. is resident.
(ii)
If there are several intermediary companies – all the companies
must be resident of the same country.
Note: The kind of Treaty Shopping through Mauritius – that the US FIIs
claim in India; is impossible in USA. The revenue haemorrhage that
India allows – knowingly - through Mauritius is ab-initio disallowed by
USA. And yet, the US Government –would not hesitate in advising India
to let FIIs get away with such tax evasion.
(iii) Consider an illustration to explain Article 22 (2) (c). A US holding
company has a 100% subsidiary in India. The Indian company has some
incomes from USA. The Indian company would be an Indian resident
under Article 4 but would not be a Qualified Person under Article 22 (2).
This is because (i) Shares of Indian company are not traded in India; and
(ii) The control over the company is situated outside India.
Article 22 (3) provides that if such a person has substantial
business in India, then it would be entitled to DTA relief. However, such
person will be entitled to DTA relief only for the business which is
considered substantial.
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Article 23
Relief from Double Taxation.
23 (2) US will provide to its residents credit for –
(a)
taxes paid in COS; and
(b)
in case, the US company holds at least 10% equity of a company in
COS; Underlying Tax Credit also. (We have already seen the concept of
Underlying Tax Credit in paragraph 13 earlier.)
23 (3) COS is defined as under: If an income of a US Resident is taxable
in the other country as per the DTA; that income shall be deemed to be
sourced in that country. For this income, the Country of Source is
determined. (OECD & UN models presume this legal position. US model
specifies it.)
U.S. Treasury has made elaborate rules in the Internal Revenue
Code for converting foreign currency into dollar, limitation of foreign tax
credit to the proportionate relevant U.S. tax and so on. The credit
available to a U.S. resident under Article 23 will be limited by the internal
rules.
23 (4) A person may be a US citizen and Indian resident. US IRS will
still regard him as a US resident and tax him on his world wide income.
India will also tax the person as Indian resident on his world wide
income. Special provision is made in the US Model for such taxes.
Illustration: Consider Mr. Patel who is a US citizen. On retirement he
has returned to his native place in India and has become resident and
ordinarily resident of India. He has several incomes from US sources – his
investments in USA, royalty on books written by him, and so on. Now
both – India & US will tax his global income.
US taxes will be divided into (i) tax that US can levy under the DTA
irrespective of his citizenship; and (ii) taxes levied by USA because
Mr. Patel is a citizen of USA. India will give credit under DTA for US tax
only on the taxes that US can levy under DTA. Other taxes are borne by
Mr. Patel and not available for any set off/ credit in India. U.S. IRC may
give reliefs to expatriates like Mr. Patel.
Discussion on 3 different models completed.
Next Annexure I.
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Annexure I
Some Relevant Thoughts
1.
Present Justice System:
An extract from the book: “The New revelations” by Neale Donald
Walsch; page 253:
“The truth is, your “justice system” has so many flaws in it – not
the least of which is its vulnerability to influence by the rich and
powerful and its complete inaccessibility to the poor, the weak, and the
down-trodden – that any resemblance between what occurs in your
societies and what you dream of as “justice” is far too often purely
coincidental.
2.
Tax Havens:
Query
Tax Havens of the world are identified by the departments of
Income-tax in most countries. It is fairly easy to stop the abuse of treaty
through tax havens. So why don’t Government stop the abuse? They
have several alternatives to stop this abuse.
1.
Governments can cancel all DTAs with tax havens and stop signing
further agreements with tax havens.
2.
Tax departments can implement Transfer Pricing, SAAR and
GAAR provisions strictly against any assessee dealing with a tax haven
entity in any manner. Disallow all expenses which result in remittances to
tax haven entities.
3.
FIPB can give importance to CBDT objections. Any foreign
investor may be asked to come from the country of its origin. A tax haven
SPV may be refused investment in India.
There can be many other preventive steps.
The first step would straight away eliminate substantial litigation.
All these steps together would deter most assessees from using a
tax haven. Tax evasion like Vodafone case can be nipped in the bud.
(More and more authorities around the world have stopped seeing any
difference between Tax Avoidance and Tax Evasion.
They give
importance to Substance over Form.)
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Answer:
These decisions are not taken by CBDT. Political bosses take
these decisions.
And after all these exposures, judiciary in several countries is still
debating on Form Vs. substance.
3.
Mauritius Vs. USA
What influence does the tiny Government of Mauritius (population
one million) have over the Government of India (Population 120
millions)? How is it that for last 12 years GOI claims to be negotiating
with Mauritius for modifying DTA to avoid treaty shopping & GOI has
not succeeded?
Compare this with Government of USA.
US Government started negotiating DTA with India almost since
1948. Both Governments had differences over certain clauses – main
being Tax Sparing. It took 40 years but GOI did not succumb to US
pressures. Finally the DTA was signed when USA accepted substantial
demands from India.
Does this mean that the Government of Mauritius is more powerful
than the Government of USA?
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Discussion on DTA Models – Paper no. 2 completed.
Next – Paper No. 3 on Tax Havens.
Many Thanks.
Rashmin C. Sanghvi.
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