International Tax Provisions

1
International Tax Provisions

• 7 October 2009

2
Contents

• Residence
• Branch Profit Tax
• Transfer Pricing Advance Pricing Agreements
• Source Rules
• GAAR
• Treaty override
• Withholding obligation

3
Residence
4
Rule for residence

• Current provision
• Foreign company regarded as a resident if
  control and management (CM) of its affairs is
  situated, at any time during the year, wholly in
  India
• DTC proposal
• Foreign company regarded as resident if its
  place of CM is situated, at any time during the
  year, wholly or partly in India
• Company incorporated in India always treated as
  resident under current law as well as DTC,
  irrespective of situs of CM

5
Implications of DTC proposal

• Foreign Co regarded as resident if even partial
  CM is in India
• Concept of CM not defined in current law or DTC
  but subject matter of judicial precedents
• Residence determination is an annual ritual
• Treaty may afford no answer
• Implications
• Foreign Co subject to all provisions of DTC as
  applicable to resident Co
• Foreign Co taxed on worldwide income
• Dividends subject to Dividend Distribution Tax
  (DDT)

6
Branch Profit Tax
7
Branch Profit Tax

• DTC proposal
• Corporate tax rate equalized for domestic and
  foreign companies
• Foreign Companies liable to pay BPT on total
  income reduced by corporate tax.
• Liability is 15 of branch profit computed as
  under
• Total income for the financial year 100
• (-) Tax thereon (i.e. on such total income)
  25
• Base for BPT 75
• Effective rate of tax for FC will be 25 (plus)
  11.25 25 of INR 75 of total income.

8
Implications of DTC proposal

• Liability not dependent on remittance of profits
  to head office.
• Branch not defined even though terminology used
  is BPT.
• Could cover all foreign companies that are
  subject to corporate tax in India, even if no
  branch/ PE
• Discussion paper states
• foreign companies would be required to
  supplement their corporate tax liability by a
  branch profit tax of 15 on branch profit ( that
  is, total income, as reduced by the corporate
  tax)
• Could override non-discrimination principles of
  tax treaty because of Sec 258(6) of DTC.

9
Transfer Pricing
10
Transfer pricing DTC Proposal

• Amendment to definition of Associated
  Enterprise (AE) more stringent to enlarge scope
  by lowering threshold limits.
• Determination of arms length price (ALP) similar
  to that existing under the current rules
• Retains Arithmetic Mean and 5 range.
• Safe Harbour rules to be framed by the Board for
  determination of ALP

11
AE relationship DTC Proposal
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Transfer pricing APA

• Board empowered to enter into APAs in respect of
  determination of ALP.
• Determination of ALP for APA to based on transfer
  pricing rules.
• Flexibility given to make adjustments as may be
  necessary or expedient to do so.
• APA can be valid for a period not exceeding five
  consecutive FYs.
• APA provisions may enable only unilateral APAs.
  
• Should this be widened to enable bilateral APAs?

13
International Practices

• Use of statistical measure
• Amendment to law substituting AM with IQ/ Median
• Use of unspecified method
• Flexibility to use a method other than the 5
  accepted methods if it meets arms length
  standard
• Use of multiple year data
• Aggregation of transactions

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Source Rules
15
Source Rules

• Resident to pay tax on overseas income regardless
  of taxation in overseas jurisdiction and
  regardless of method of granting double taxation
  relief.
• Business connection includes dependent agent.
• No exception for dealings through Independent
  Agent..
• Transportation charges for carriage by aircraft
  or ship
• Accrued from non-resident if charges are in
  respect of carriage to or from a place in India
• Accrued from resident except where charges are in
  respect of carriage between places outside India
• Accrual from inbound traffic will now be covered.

16
Source Rules

• Deeming fiction for FTS, royalty, etc. applies
  regardless of.
• Payment outside India.
• Rendition of services outside India.
• Income does not otherwise accrue in India.

17
Indirect transfer of capital asset

• DTC proposes to cover income accruing directly or
  indirectly, through or from, the direct or
  indirect transfer of a capital asset situated in
  India.
• Implications
• Transfer of indirect controlling interest in Ind
  Co
• What if FCo1 has other assets?
• Would proportionate value of capital asset
  situated in India be taxed?

PCo
FCo2
Transfer of Shares in F Co1 to FCo2
WOS
FCo1
Overseas
India
WOS
IND Co
18
Cross-border financing

• Under the Act, Interest taxable in India if debt
  used by NR for purpose of business carried on in
  India
• Source rule expanded under DTC to include
  interest on debt used for earning income from any
  source in India.
• Cascading WHT impact in case of back-to-back loans

Issue of debt instruments/loan
F CO
Overseas
India
IND CO
19
Taxation of royalty/ FTS

• Enlarged definition of royalty/ FTS
• FTS to cover development and transfer of a
  design, drawing, plan or software, or any other
  service of a similar nature
• Royalty to cover payment for use/right to use of
  transmission by satellite, cable, optic fibre or
  similar technology, transfer of all or any rights
  in respect of cinematograph films live coverage
  of events. E.g. Technology driven services.
• Royalty FTS of non-resident taxed on gross
  basis at 20.
• Net basis of taxation if effectively connected to
  a Permanent Establishment (PE) abolished. But,
  treaty may protect
• Royalty or FTS , being special source income
  chargeable on gross basis even if effectively
  connected with PE.

20
GAAR
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Background

• Tax evasion undermines public finance objective.
• Increasingly sophisticated forms of tax avoidance
  since liberalization.
• Recent arrangements span across several
  jurisdictions.
• Courts place heavy onus on the revenue.

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Doctrines to test anti-avoidance

• Business Purpose Rule
• A transaction must have a main or predominant
  business purpose other than tax avoidance
• Substance over Form Rule
• Lack of economic substance - Legal form used for
  a transaction by a taxpayer who has real economic
  power over the taxable income without tax
  liability
• Sham transaction - Hides the economic reality of
  a transaction that exists in form only
• Step Transaction Doctrine
• Series of connected transactions regarded as
  single transaction
• Intermediate steps in a chain of pre-ordained
  transactions may be disregarded

23
GAAR- DTC proposal

• Codification of anti-abuse rules in DTC which
  permit declaration of an arrangement as an
  impermissible avoidance arrangement (IAA).
• Main purpose of the arrangement should be to
  obtain a tax benefit and it
• Is not for bona fide business purpose
• Creates rights and obligations which would not
  normally be created between persons dealing at
  ALP
• Results, directly or indirectly, in the misuse or
  abuse of the provisions of DTC
• Lacks commercial substance in whole or in part

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GAAR Spectrum of arrangement

• The arrangement for this purpose is defined
  exhaustively to mean
• Any step in or whole or part of transactions.
• Any step in or whole or part of operation.
• Any step in or whole or part of scheme.
• Any step in or whole or part of agreement.
• Any step in or whole or part of understanding.
• Any of the above may or may not be enforceable.
• Any of the above may involve alienation of the
  property.

Wide canvass of the provisions may affect
residents as also non-residents alike. Court
approved schemes are not excluded from scrutiny.
25
Tax benefit

• Tax benefit means
• A reduction, avoidance or deferral of tax
• Increase in refund of tax
• Reduction, avoidance or deferral of tax that
  would be payable under the DTC but for a tax
  treaty
• An increase in refund of tax under the DTC as a
  result of a tax treaty

26
Commercial substance

• Any arrangement or part of it is deemed to lack
  commercial substance if it
• Results in tax benefit to one party but does not
  have a bearing on the business risks or cash
  flows to the other party.
• The substance or effect of the arrangement as a
  whole differs from the legal form of its
  individual steps.
• Includes or involves
• round trip financing,
• an accommodating or tax indifferent party,
• any element having the effect of offsetting or
  canceling each other
• a transaction which is conducted through one or
  more persons and disguises the nature, location,
  source, ownership or control of funds.

27
Bonafide purpose

• Bonafide purpose shall not include any purpose
• Which has created rights or obligations that
  would not normally be created between persons
  dealing at arms length
• Would result, directly or indirectly, in the
  misuse or abuse of the provisions of the DTC.

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GAAR Impact on assessment

• Tax consequences if GAAR is invoked
• Disregard, combine, recharacterize steps or parts
  of the arrangement
• Disregard any accommodating party / tax
  indifferent party.
• Deem persons who are connected to be one and the
  same person
• Recharacterize or re-allocate income
• Recharacterize multi-party financing transaction
• Recharacterize debt financing as equity or vice
  versa
• As per Discussion Paper GAAR can be applied by
  disregarding benefit under a tax treaty

29
Treaty and its override
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Tax treaty

• Power given to Government to enter into Tax
  Treaties
• Relationship between Treaty law and domestic tax
  law
• Status under current law
• Preferential treatment for Treaty law over
  domestic tax law
• In case of conflict between Treaty law and
  domestic tax law, taxpayer can chose the more
  beneficial provision
• Status under DTC
• Neither Treaty nor DTC shall have preferential
  status
• Provision that is later in point of time shall
  prevail
• Possible Treaty Override if subsequent domestic
  law is inconsistent with treaty
• Treaty benefits not available until a tax
  residency certificate is furnished. In
  prescribed form!!.

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Sanctity of Treaty International outlook

• Concept of Treaty Override
• The enactment of domestic legislation intended by
  the Legislature to have effects in clear
  contradistinction to international treaty
  obligations
• Vienna Convention on the Law of Treaties (VCLT)
• Article 26 every treaty in force is binding
  upon the parties to it and must be performed by
  them in good faith
• Article 27 - internal law cannot serve as
  justification for non-compliance with treaty
  obligation
• OECD Treaty Override Report (1989)
• Treaty overrides violate international law,
  although they may still be binding as a matter of
  domestic law
• Constitution of India
• Article 51(c) India shall endeavor to foster
  respect for international law and treaty
  obligations

32
Sanctity of Treaty International practice

• In most countries, tax treaties have a status
  superior to that of ordinary domestic laws (e.g.
  France, Germany, the Netherlands)
• lex posterior generalis non derogate legi priori
  speciali (a subsequent general law does not
  override a prior special law)
• In some countries (primarily the US, but also to
  some extent the UK and Australia) treaties can be
  changed by subsequent domestic legislation
• lex posterior derogate legi priori (a subsequent
  law overrides a prior law)
• IRC Sec. 7852(d) for purposes of determining
  the relationship between a provision of a treaty
  and any law of the United States affecting
  revenue, neither the treaty nor the law shall
  have preferential status by reason of its being a
  treaty or law - Identical language used in DTC!
• Senate Report A treaty will not be deemed to
  have been abrogated or modified by a later
  statute unless such purpose on the part of
  Congress has been clearly expressed

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Withholding Provisions
34
Recommendations

• Remove residuary category which requires tax
  withholding _at_ 35 on the whole of other income.
• Tax withholding to be w.r.t income chargeable to
  tax.
• No TDS beyond treaty agreed rates.
• Facility of obtaining lower tax deduction
  certificate.
• Tax residency certificate of prior year should be
  prima facie test of treaty applicability.

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Thank you
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information existing as at the time of
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