India as a signatory on Multilateral Instruments: Some observations

International Taxation Conference - 2017December 07, 2017

Background and MLI Milestones

Notification, Reservations & Optional provisions

Dual Residency

Preamble

Treaty abuse

Artificial avoidance of PE

MAP

Dispute Resolution - Binding Arbitration

Implementation challenges

Annexures

A: Five Step MLI Process

B: Notification & Compatibility

C: Reservation & Optional Provision

CONTENT

Background & MLI milestones

Page 3

₋ A ‘five step process’ to ensure swift resolution to Bilateral treaty amendments. Annexure A

₋ Expectation of amending more than 1500 treaties out of more than 3000 treaties.

₋ 71 signatories* with 6 jurisdictions intending to sign.

₋ No ‘a la carte’ - MLI does not permit treaty-by treaty choices

₋ Does not override tax treaties

₋ Co-exists with existing treaties

₋ Contains minimum standards for ‘Prevention of Treaty abuse’ and ‘Improvement of Dispute Resolution’ only

₋ Treaty partners to notify (Annexure B on notification & compatibility) existing treaty provisions, ‘Covered Tax Agreements’

₋ Treaty partners can unilaterally choose to reserve right (Annexure C on Reservation and Optional Provisions) for entire Article or sub-set (‘opt out’) for not applying MLI provision(s)

*Position as on October 25, 2017

India’s MLI positions are provisional and subject to amendments till ratification. Signatories can ‘opt in’ for certain MLI provisions or withdraw reservations after ratification

India’s Five MLI Reservations *

Page 4

• Entirety of Article not to apply to notified CTAs

Article 3 – Transparent Entities

• Entirety of Article not to apply to notified CTAs

Article 5 – Exemption vs Credit

• Corresponding adjustment through MAP not to apply to notified CTAs that already have ‘corresponding adjustment’ provision

Article 17 – Corresponding Adjustments

* Article 8 (Dividend Transfer) and Article 16 (MAP) are other reservations

**Transparent entities were entitled to treaty benefit in case of Linklaters LLP vs. ITO, DIT vs Chiron Bearings Gmbh & Co. [2013] 29 Taxmann.com 199 (Bombay High Court) and Clifford Chance vs. DCIT, arguably since India UK tax treaty has a specific provision allowing such treaty benefit. AAR denied treaty benefit in case of Schellenberg Wittmer (India Switzerland tax treaty does not have similar clause)

Status quo on existing treaties Ambiguity on availability of treaty benefit to

transparent entities prevails**

Aligned to India’s treaty policy

Recent move by CBDT to allow bilateral APA & MAP

Dual Residency

Page 5

• Tie-breaker to be replaced with MAP resolution. Treaty Partners: Japan, UK, Netherlands, Ireland and Australia

• Treaty’s POEM continues to apply with Jurisdictions exercising reservation. Treaty Partners: Singapore, Luxembourg, Sweden and France

• US not a signatory to MLI. US treaty provides for MAP for ‘dual residency’. No impact

• China, Germany and Mauritius yet to notify India in their CTA

• India’s position Notified all 93 CTAs

• Challenges

Existing POEM in domestic tax law could result into ‘dual residency disputes’, resulting in denial of treaty benefit

Unresolved MAP

India’s POEM different from OECD’s POEM. India has ‘active’ and ‘passive’ income test

CBDT Notification on POEM

Quote:

“….based on facts and circumstances if it is determined that during the previous year the POEM is in India and also outside India then POEM shall be presumed to be in India if it has been mainly/ predominantly in India.”

Unqoute

Above clause in recent POEM Guidelines increase the possibility of India establishing Indian residency on companies

Preamble

Page 6

₋ India has not notified Article 6 – It has neither exercised optional provision

₋ ‘Preamble’ language to be added to existing preamble

₋ UK, Japan, Australia, France, Cyprus, Netherlands, Singapore have exercised Optional Provision

Minimum standard

• “Intending to eliminate double taxation with respect to 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 under the agreement for the indirect benefit of residents in third jurisdictions.”

Optional provision

• “Desiring to further develop their economic relationship and to enhance their co-operation in tax matters”

* MLI optional provisions to be bilaterally applied by both treaty partners, else MLI dropped for that provision

₋ Mauritius: “…the avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment”

₋ USA, UK, France, Japan, Netherlands, Singapore: “…Prevention of double taxation and avoidance of fiscal evasion”

₋ Sweden, Luxembourg: “…additionally mentions, promoting economic cooperation between the 2 countries”

Illustrative list of Preambles

Treaty Abuse – Article 7 (Minimum Standard)

Page 7

• Will treaty benefit be available?

• Mechanism for ‘detailed LOB’ and conduit arrangements not already dealt with in tax treaties (as good as opting out of MLI)

• PPT, a compatibility clause and broader*. Replaces Indian GAAR except in case of carve-out

BEPS Action 6

PPTPPT supplemented

with simplified/ detailed LOB

Detailed LOB supplemented by

mutually negotiated mechanism

Anti-avoidance measure under Action 6

• India’s position: India opted for PPT plus SLOB for all CTAs

India’s SLOB applicable only to treaty partners who choose to apply SLOB

India has not notified Article 7(4). Accordingly, no MAP benefit for treaty abuse

PPT broader than Indian GAAR*

GAAR not applicable where LOB provision addresses treaty abuse**

Indian GAAR for PPT carve out –subjective threshold “in accordance with object and purpose of relevant treaty provisions

* Main purpose (GAAR) versus, (one of the main purposes (PPT)** CBDT press Release dated January 27, 2017

India’s MLI position on Treaty Abuse – Impact

Page 8

Mauritius

•Mauritius has signed MLI but has not notified India y as CTA

•Amended treaty with Mauritius to be followed

Singapore

•PPT supersedes existing LOB clause (neither partners have notified)

•SLOB not applied

•CA can’t be approached through MAP*

•Quantitative thresholds continue to apply (to the extent compatible)

Netherlands

•Netherlands treaty does not have LOB

•PPT gets added to treaty

•CA can’t be approached through MAP*

•Netherlands treat does not have LOB. PPT and SLOB will be added to the treaty

UK

•PPT to replace Article 28C** in treaty

•SLOB not applied

• CA can’t be approached through MAP*

•Article 11, 12 and 13 (benefit under dividend, interest etc.) shall stand superseded to the extent of incompatibility

Japan

•Japan treaty does not have a LOB

•PPT gets added to treaty

•SLOB not applied

•CA can’t be applied through MAP*

• Though Singapore, Netherlands and UK have applied Article 7(4) wherein CA can be approached through MAP, Article 7(4) shall not apply since India has not notified it (all treaty partners required to notify)

• US not a signatory to MLI. Hence, no impact. Existing LOB in India - US Treaty shall prevail

*Major FDI partners opting for CA Rule (Cyprus, Singapore, Netherlands and UK), India should have opted for 7(4) to enable selective MAP consultation

** Article 28C of India UK treaty contains ‘main purpose’ or ‘one of main purpose’ to obtain treaty benefit. No carve out provisions

Artificial Avoidance of PE Status

Page 9

* MLI optional provisions to be bilaterally applied by both treaty partners, else MLI dropped for that provision

Article 12 India has notified paras 1 & 2 Netherlands, Russia and France notified India. Existing

provision stands replaced with Article 12 Singapore, Sweden, UK, Canada, SA and Australia

reserved Article 12 in entirety

Article 13 India chosen Option A. Consistent with Netherlands,

Japan, Australia, Italy. Existing provision replaced Singapore and France chose Option B. No change in

CTAs UK chose Anti-fragmentation rule. No change in CTA

Article 14 No notification or reservation by India Canada, Japan, Cyprus, UK and Singapore have

reservations. Hence, no change in CTA CTA with Netherlands, France, Australia and Russia

shall be revised

Agency PE

•‘Commissionaire arrangements’

•‘Broader DAPE rule’ – agent playing ‘principal role’ to conclude contracts

•Carve out for Independent agents. Exclusion denied if agent works exclusively for an enterprise or its AE

Fixed Place

PE

•Specific activity exemptions’

•Option A exemption if overall activity is of ‘preparatory & auxiliary’ nature (stringent)

•Option B automatic exemption not subject to ‘auxiliary and preparatory’ test (liberal)

•Anti-fragmentation rule

Construction

PE

•‘Splitting up of contracts’

•Aggregation of time spent on connected activities by AEs on same project

Article 14 – MAP (Minimum Standard)

Page 10

Key Objectives• Treaty Obligations implemented in good faith & MAP cases resolved timely • Administrative processes to promote prevention & timely resolution of treaty-

related disputes • MAP access to Eligible taxpayers • India’s history with MAP – 2014 TARC report recognised lack of MAP data as an inherent

limitation • Will India’s reservation on Article 25, para 8 in 2014 OECD MC sustain • Should India reconsider its position on Article 7(4) of MLI, at least with select treaty

Partners • Recent Bold move to alter its position on Article 9(2) • Inventory of MAP/APA – timelines for progressing on bilateral APA with important treaty

Partners• India’s Selective approach towards suspension of Tax demands – AP recommends

suspension as best practice – is that a minimum standard ?

MAP vs Binding Arbitration or Domestic Disputes (Choice between devil & deep sea)

Page 11

• Is India’s position on Arbitration on grounds of sovereignty tenable?• Conflict between Article 246 & Article 253 of the Constitution :• Article 246 deals with Parliaments exclusive rights to make laws on matters enumerated

in list 1 in the seventh schedule • Article 253 dealing with legislation to give effect to international agreements starts with a

non-obstinate clause • Article 51 dealing with directive principles of the state direct The state to endeavour

‘forest respect to international law & treaty obligations & encourage settlement of international disputes by arbitration

• Administrative Measures – select recommendations such as ‘expert witness’ in draft ITAT rules of 2017

• Ishwar Committee recommendations

Arbitration

Page 12

Binding Arbitration is an optional provision and applies only if both parties to a treaty opt for it. Since India has not opted for it, it does not apply to any of India’s CTAs with other treaty partners

• OECD prescribes mandatory and binding Arbitration

• Arbitration not automatic. Triggers if no MAP resolution in two years

• Arbitration proceedings terminated where MAP decides the dispute anytime before arbitration is concluded

• Arbitration panel can select from proposed resolutions by CAs. Resolution to not include a rationale or explanation (base ball)

• Arbitration decision has no precedential value

India’s position:

₋ Expectedly, not subscribed to binding Arbitration

₋ Of all 11 jurisdictions comprising India’s MAP inventory, only China has not accepted binding Arbitration

₋ Binding Arbitration vs non-binding arbitration:

• Resolving TP disputes (applicable to all jurisdictions post recent CBDT Press Release dated November 27, 2017)

• Resolving ‘dual residency’ disputes with Japan, UK and Netherlands

• Constitutional provisions

MLI Implementation Challenges - India with its treaty Partners

Page 13

• Cumbersome & complex procedure – giving new dimension to interpretation

• Highly subjective, abstract & vague terminology in MLI

• Treaties to amend post ‘matching exercise’ for optional provisions exercised

• Reservation from most treaty partners on (several) issues diffuses ‘All out’ impact India was expecting. For instance: most treaties have not opted for SLOP resulting in applicability of PPT option

• Lack of tax certainty on PPT rule

• MLI effect on grandfathering provisions for recently amended Tax Treaties with Mauritius, Singapore, Cyprus

• Stated purpose of MLI preamble & various clauses differ

Annexures

Annexure A - Five Step MLI Process

Page 15

Step 1• Entry into force of the MLI

Step 2• Covered Tax Agreement

Step 3• Reservations and choice of optional provisions

Step 4• Notifications of existing provisions

Step 5• Entry into effect of the MLI

Entry into force Minimum 5 jurisdictions to deposit their

instrument of ratification MLI to apply to a tax agreement where both

treaty partners notify MLI

Covered Tax Agreement Both treaty partners to list their tax

agreements to be covered under MLI The tax agreement should be in force.

Reservations & optional provisions Reservation can be made unilaterally Optional provisions to be applied bilaterally

Notification Both treaty partners to notify existing tax

treaty provisions for MLI to apply Effect of notifications depends on

‘compatibility clause’

Entry into effect Different effective date for ‘withholding

taxes’ and ‘all other taxes’ Effective date for MAP – on or after CTA

date irrespective of taxable period Back

Page 16

Annexure B - Notification & Compatibility

(i) ‘in place of’ existing provision

(ii) ‘applies to’ or ‘modifies’

existing provision

(iii) ‘in the absence of’

existing provision

Both treaty

partners notify the

same provision/ absence of

same existing

provision

(i) MLI accepted. MLI provision replaced “in place of” existing

provision

(iii) MLI accepted.New MLI provision is

added

(ii) MLI accepted. MLI provision modifies

“existing provision” without replacing it

Bilateral consent must for MLI applicability

MLI requires parties to notify existing provisions to be modified by MLI provision. MLI is accepted where both treaty partners notify the same existing provision. In case either treaty partner under situation (i), (ii) and (iii) does not notify or notifies different existing provisions, MLI shall not apply.

In situation (iv), even if neither of the treaty partners notifies an existing provision, mli provision shall be applicable and shall supersede existing provision to the extend of incompatibility.

(iv) ‘in place of’ or ‘in

absence of’ existing

provision

(iv) MLI accepted.Existing provision is replaced with MLI

provisionBack

Annexure C - Reservation & Optional provision

Page 17

Either treaty partner has reservation for MLI provision

MLI provision will not apply to both treaty partners

Reservation*Neither treaty partner makes reservation and notifies the MLI provision

Respective MLI Article will be added to CTA and will prevail to the extent of inconsistency

Reservation*Both treaty partners to notify Depository of Optional choice of MLI Article

In case treaty partners choose different options or neither treaty partner chooses any Option, none of Options will apply

Optional provision**

* Right of ‘Reservation’ exercised unilaterally by a treaty partner** MLI optional provisions to be bilaterally applied by both treaty partners, else MLI will be dropped for that provision

Back

Page 18

mukesh.butani@bmrlegal.in

all rights reserved

Disclaimer:

The presentation has been prepared for the FIT international Tax Conference, 2017 and no part of the presentation should be construed as advice or expression of an opinion. The contents of the presentation should not be copied, distributed or used for any purpose.

Research, Source & Acknowledgements : India’s MLI positions by Nishith Desai Associates, EY Global Tax Alert, Dr. SriramGovind, Dr. Vikram Chand & CA. Parul Mittal