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BCAS DTAA Course

Role of Treaties and Sources of International Tax Laws

Pinakin Desai

6 December 2014

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Role of Tax Treaties 6 December 2014

Domestic Law Charging Provision - Sec 5

R & OR R but NOR NR

Indian Income: Taxable Taxable Taxable

Foreign Income :

► Accrued outside India but

deemed to accrue in India by

virtue of Section 9

Taxable Taxable Taxable

► Accrued outside India - First

receipt in India

Taxable Taxable Taxable

► Any other income accruing

outside India and received

outside India

Taxable Not taxable Not taxable


Overview

► Nation has sovereign right of imposing tax at its discretion,

subject to territorial nexus of person or income

► Determinants of residence may vary

Examples of territorial nexus connect qua taxpayer or qua his

income

► India : Residence, extensive Source Rule

► USA : Citizenship

► Hong Kong : Territorial

► Potential exposure of multi country taxation for transnational

operators

► Multi country taxation injures flow of cross border activities


Triangular (Multiangular) cases

US CO

Who will tax this income?

Deputation of Mr A

to work in the project

of I Co

Tax Resident Sweden

Citizenship USA

Employer UK Company

Project of US Co India

Receipt of salary Netherlands

►Fact pattern of Mr A who is deputed by US Co

to work in a project of I Co for six months

Project of

I Co


Home State, Host State

► Home country tax is obligation; host country tax is a cost

► Home country is country of residence (COR)

► Host country is country of source (COS)

► Double Tax Avoidance Agreement (DTAA) eliminates or

mitigates hardship caused by multi level taxation

► Rationalized Source Rule

► Usually, limiting tax in source state

► Tax credit in Home State

Treaty residence is different from residence

as per domestic law


► Economic double taxation

► Same economic stream of income taxed in two or more states but in the hands

of different taxpayers [E.g. business profit and dividend in different countries]

► Juridical double taxation

► Two or more states levy taxes on same entity on same income for identical

periods [e.g. resident in two states]

► Can arise due to overlapping claims of tax jurisdictions [worldwide v/s source]

► Tax treaties prevent/mitigate juridical double taxation

► Mitigation can result in relief from double taxation, but, not refund by COR

Types of double taxation

DTAA does not create any additional tax in

any state; it can only relieve tax: Principle of

non-aggravation


► Section 91

► Relief from double taxation if India has no tax treaties

► Person resident in India is allowed credit of foreign taxes paid against

amount of Indian taxes

► Section 90

► Regulates a case where India has a tax treaty

Relief in India from double taxation: Domestic Law


Interplay of DTAA and Domestic Law

► Taxpayer has the option to be taxed as per tax treaty or domestic tax laws,

whichever are more beneficial [S.90(2)]

► Subject thereto, domestic law has full force

► Domestic law provisions can, at times, be more beneficial to NR

► STT paid long term Capital gain : S. 10(38)

► Tax rate on interest income : S.10(15), S.194LC

► Interest for business outside India : S.9(1)(v)


Genesis: Authority: Formulation


Meaning of treaty

► Vienna Convention on Law of Treaties 1969 :

“an international agreement concluded between States in written form

and governed by international law, whether embodied in a single

instrument and whatever its particular designation.”

► The Oxford Companion to Law definition of treaty: "an international

agreement, normally in written form, passing under various titles (treaty,

convention, protocol, covenant, charter, pact, statute, act, declaration,

concordat, exchange of notes, agreed minute, memorandum of

agreement) concluded between two or more States, on subjects of

international law intended to create rights and obligations between them

and governed by international law"

• Can extend to all walks of national and international life

• DTA, DTAA, Treaty


Genesis of authority; Article 51 of Constitution

► Article 51 of the constitution sets out the following as one of

the Directive Principles of State Policy

"The State shall endeavour to -

(a) promote international peace and security;

(b) maintain just and equitable relations between nations;

(c) foster respect for international law and treaty obligations

in the dealings of organised people with one another;

(d) encourage settlement of international disputes by

arbitration"


Genesis of authority: Grant of legislative power

► Power to legislate treaties conferred on the Parliament by

Entries 10 and 14 of List I of the Seventh Schedule

“10. Foreign affairs; all matters which bring the Union

into relation with any foreign country

14. Entering into treaties and agreements with foreign

countries and implementing of treaties, agreements

and conventions with foreign countries”


Delegation of power to Central Government

► S. 90(1) authorizes Central Government to enter into

agreement with Government of other country

► S. 90A(1) authorizes entering into an agreement with any

specified association in specified territory outside India

► Objectives of the agreement could be :

► Elimination of double taxation

► Promotion of mutual economic relations, trade and investment

► Certainty on nature of income and quantum of tax payable irrespective

of tax laws of overseas state

► Establishing the right of a country to tax any income stream

► Exchange of information to combat tax avoidance / tax evasion


Delegation of power to Central Government

► “Because treaty negotiations are largely a bargaining process

with each side seeking concessions from the other, the final

agreement will often represent a number of compromises, and

it may be uncertain as to whether a full and sufficient quid pro

quo is obtained by both sides.” (SC in ABA)

► “The Government cannot bind India in a manner that

derogates from Constitutional provisions, values and

imperatives.” (SC in Ram Jethmalani)


Treaty: Agreement between Governments

► Treaties are signed by two national jurisdictions to regulate matters

concerning taxes

► Taxpayer is not a party to a tax treaty

► Desire of signatories to make business environment in their jurisdictions

tax friendly

► Treaty represents understanding as to rights and obligations of respective

country

► to forego its right to tax,

► to limit scope or rate of taxation,

► to grant credit of tax paid directly or indirectly in other jurisdiction/s etc. etc.

► Understanding between Governments is to share tax revenues equitably

as between themselves, while mitigating hardship for taxpayers


Treaty: Agreement between Governments

► Treaties can only relieve tax burden (Principle of non-

aggravation)

► Treaties do not create any charge

► Vogel :

“A tax treaty neither generates a tax claim that does not otherwise exist

under domestic law nor expands the scope or alters the type of an

existing claim”

► Treaties also endeavor to promote:

► Resolution of tax disputes

► Prevention of tax discrimination

► Exchange of information

► Assistance in recovery, proceedings


Categories of Tax Treaties

► Limited treaties –

► Deals with specific subject matter

► DTAA between India and Pakistan is limited to air transport only

► Exchange of information with British Virgin Islands

► Comprehensive treaties – Deals with most sources of income

► Multilateral treaties vs. Bilateral treaties

► EU Directives

► SAARC Income Tax Agreement - Bangladesh; Bhutan; India;

Maldives; Nepal; Pakistan; Sri Lanka ( sharing of tax policies, training

to tax administration, teachers, students taxation, etc. )


Formulation of tax treaty

► Negotiation of a tax treaty (by Ministry of Finance –

Department of Revenue)

► Drafting of the articles (by Ministry of Finance – Department of

Revenue)

► Signing (typically, by the Chairman of CBDT)

► Ratification (by Ministry of Finance – Department of Revenue)

► Notification (by CBDT)


Tax Treaty v Domestic Law

Tax treaty Domestic Law

Agreement between two States

Involve negotiation process

Relief from double tax

No additional tax burden

Sharing of tax revenue

No frequent changes

International law

In-built dispute resolution option

Act of Legislation

No negotiation

Collection of tax

Earning of tax revenue

Frequent amendments

National Legislation

Dispute settled by appellate

forum/ Court


Treaty Making…

► In India negotiations & conclusions takes place behind closed

doors

► Most countries have practice of placing before the

parliament, draft agreements for their approval. Unless

treaties sanctioned by the Parliament, they do not have effect

of law in various countries


Texture of Treaty


► Each treaty codifies respective understanding between parties.

► Parties may adopt a standard draft : Say, UN Model, OECD Model

► This is hardly the case

► Organization for Economic Co-operation and Development (OECD)

► Established in 1961 with developed countries as its members

► Essentially a model treaty between two developed nations with comparable tax

systems and tax objectives

► Advocates residence principle

► Lays emphasis on the right of state of residence to tax

► Currently 34 countries including Australia, US, UK, France, Germany etc are

OECD members

► India not a OECD member

► Currently has been granted the “Observer” status

Texture of Treaty


UN model

► Tax treaties between countries with unequal economic status -

Developed and lesser developed countries, or between

developing countries

► Drafted in 1980, designed to encourage flow of investments

from the developed to developing countries

► Is a compromise between source principle and residence

principle

► Gives more weightage to source principle, i.e., income should

be taxed where it arises [e.g. service PE, royalty taxation in

source country]


Tax treaties are not uniform

► Conditions need not be uniform in all treaties

► E.g. Absence of equipment royalty source taxation

► There are no constraints on terms of agreement

► E.g. India Finland treaty : Restrictive scope of source of income

► There are no strings to originality

► E.g. Credit of residence country tax by source country, (Indo-Swiss

treaty – capital gains article )

► Impact of MFN Clause

► MFN Country may achieve more favorable treatment compared to treaty

trigger


Illustrative allocation of Distributive Rights

Exclusive right to Country of Residence

(COR)

Capital gains Article, other income Article, India-

Mauritius DTAA

Exclusive right to COR – but, sacrifice

by COS on subject to tax condition

Capital gains Article in India-Sweden DTAA

Exclusive right to Country of Source

(COS)

PE income in India-Bangladesh Treaty

Concurrent right of taxation to both the

countries:

Subject to upper cap on rate of tax

in COS

Passive sources of income (i.e. say, royalties,

interest)

Without any limitation as to rate of

tax in COS

Say, PE taxation

Exclusive right to country of effective

management

Shipping income


Effectiveness and Interpretation of Treaties


Effectiveness of Treaty

► Treaty, to the extent it is more beneficial in any respect, can

override the domestic law

► Use of treaty by taxpayer is optional

► Choice could be qua each source of income

► Choice available on year on year basis

► Whether a person in India can take advantage of treaty for

determining his local tax liability in India?

Effectiveness to be subject to GAAR


Vienna convention on interpretation

Article 26 : Every treaty in force is binding upon the parties

to it and must be performed by them in good

faith

Article 31(1) : A treaty shall be interpreted in good faith in

accordance with the ordinary meaning to be

given to the terms of the treaty in their context

and in the light of its object and purpose

Article 31(2) : Context is defined to include texts and

subsequent agreements/instruments related to

the treaty


Vienna convention on interpretation

Article 31(4) : Special meaning only if specifically intended by

parties

Article 32 : Supplementary means to be used only to

confirm the meaning

Article 34 : A treaty does not create either obligations or

rights for a third state without its consent

Unilateral treaty override needs strong

justification


Guide to treaty interpretation

► Extracts from SC decision in Ram Jethmalani

“While India is not a party to the Vienna Convention, it contains many

principles of customary international law, and the principle of

interpretation, of Article 31 of the Vienna Convention, provides a broad

guideline as to what could be an appropriate manner of interpreting a

treaty in the Indian context also.”

………..

“the words ( in the treaty) are to be given their general meaning,

general to lawyer and layman alike…….. The meaning of the diplomat

rather than the lawyer…………….. The broad principle of

interpretation, with respect to treaties, and provisions therein, would be

that ordinary meanings of words be given effect to, unless the context

requires or otherwise.”


Guide to treaty interpretation

► Extracts from SC decision in Ram Jethmalani

“the fact that such treaties are drafted by diplomats, and

not lawyers, leading to sloppiness in drafting also implies

that care has to be taken to not render any word, phrase, or

sentence redundant would lead to a manifestly absurd

situation, particularly from a constitutional perspective. “The

Government cannot bind India in a manner that derogates

from Constitutional provisions, values and imperatives.”


► OECD/UN MC or Commentary represents “international tax

language” and has generally received „due respect‟

► India reservation on OECD Commentary

► References by Courts to “reinforce” or “confirm” conclusion; in

some cases, even “followed” the commentaries

► Foreign Court decisions

► Protocols / MOUs

► Generally provides amendments to the existing treaties, or,

explanations to the Treaty Provision

► Parallel treaty interpretation

Aids to Interpretation


Articles of a Treaty


Articles of a Treaty

SCOPE PROVISIONS

1. Article 1 - Personal Scope

2. Article 2 - Taxes covered

3. Article 29 - Entry into force

4. Article 30 - Termination

ANTI-AVOIDANCE

1. Art 9 - Associated Enterprise2. Art 26 - Exch of Info

ELIMINATION OF DOUBLE TAXATION

1. Article 23 - Elimination of double

taxation

2. Article 25 - Mutual Agreement

DEFINITION PROVISIONS

1. Article 3 - General definitions

2. Article 4 - Residence

3. Article 5 - Permanent

Establishment

SUBSTANTIVE PROVISIONS

1. Article 6 - Immovable property2. Article 7 - Business Profits3. Article 8 - Shipping, etc4. Article 10 - Dividends5. Article 11 - Interest6. Article 12 - Royalties & FTS7. Article 13 - Capital gains8. Article 14 - Independent Personal Services9. Article 15 - Dependent Personal Services10. Article 16 - Directors11. Article 17 - Artistes & Sports persons12. Article 18 - Pensions13. Article 19 - Government service14. Article 20 - Students15. Article 21 - Other income16. Article 22 - Capital

MISCELLANEOUS PROVISIONS

1. Article 24 - Non-discrimination

2. Article 27 - Diplomats

3. Article 28 - Territorial Extension


Scope of convention

To whom does the treaty apply?

► Article 1 provides for application of tax treaty to persons resident of one or

both the Contracting States

► Does not apply to person who is not resident either of two Contracting

States

► Permanent Establishment (e.g. branch) is not a person

Tie-breaker resolution for persons resident in

both the States


Triangular case

► A is treaty resident of France

► A is in employment with UK Co-

Singapore branch

► UK Co-Singapore branch has

entered into service contract with

I Co

► Services are to be rendered in

India.

India

Outside India

Which DTAA can be invoked by

Mr. A, by UK Co and Singapore

branch?

Expatriate

(France)Employer

UK Co

I Co

Singapore

Branch


► Article 3(2) of the India – UK Tax Treaty

“As regards the application of this Convention by a Contracting State

any term not otherwise defined shall, unless the context otherwise

requires, have the meaning which it has under the laws of that

Contracting State relating to the taxes which are the subject of this

Convention.”

► Meaning under “tax law” to be preferred over meaning under other laws

► Which state‟s law should apply ?

► Static v Ambulatory – unresolved controversy !

Meaning of undefined terms

Beware of notification under proposed S. 90(3) !!


Taxes Covered: Article 2 of India-UK DTAA

“The taxes which are the subject of this Convention are :

► In the United Kingdom :

► the income-tax;

► the corporation tax;

► the capital gains tax; and

► the petroleum revenue tax;

(hereinafter referred to as "United Kingdom tax");

► In India;

► the income-tax including any surcharge thereon;

(hereinafter referred to as "Indian tax").

This Convention shall also apply to any identical or substantially similar taxes which

are imposed by either Contracting State after the date of signature of this

Convention in addition to, or in place of, the taxes of that Contracting State referred

to in paragraph 1 of this Article.”


Fiscal domicile: Article 4(1) of India-UK DTAA

“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, place of incorporation, or

any other criterion of a similar nature, provided, however,

that:

this term does not include any person who is liable to tax in that State in

respect only of income from sources in that State......”

Hardship to fiscally transparent entities


Fiscal domicile: Article 4(1) of India-UAE DTAA

“For the purposes of this Agreement the term 'resident of a

Contracting State' means:

…….

In the case of the United Arab Emirates: an individual who is

present in the UAE for a period or periods totalling in the

aggregate at least 183 days in the calendar year concerned,

and a company which is incorporated in the UAE and which is

managed and controlled wholly in UAE.”


Concepts in International Taxation


Treaty shopping

► Attempt by residents of a third state to access favorable DTAA

between two States

► US Co floating subsidiary in Mauritius which earns capital gains income

► Lease of aircraft from Ireland Co owned by a third State

► SC observations in in Azadi Bachao Andolan (2003) 263 ITR

706:

“The developing countries allow treaty shopping to encourage capital

and technology inflows, which developed countries are keen to provide

to them…”my.


Limitation on benefits (LoB)

► Concessional tax rate in respect of interest income restricted to beneficial

owner of income

► Illustratively, India-Switzerland and India-China DTAA tax rate is 10% on interest

income in case of beneficial owners

► Test of PURC (Possession, Use, Risk, Control)

► Entity not entitled to agreement if one of the main purposes of creation was

to obtain the benefits of DTAA; and there being no bonafide business

activity

► For example, Article 29 –India-UAE DTAA reads as under:

“An entity which is a resident of a Contracting State shall not be entitled to the

benefits of this Agreement if the main purpose or one of the main purposes of

the creation of such entity was to obtain the benefits of this Agreement that

would not be otherwise available. The cases of legal entities not having bona

fide business activities shall be covered by this Article”


Concept of “May be taxed”

► Article 7(1) of India-UK DTAA reads as under:

“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 enter

price may be taxed in the other State but only so much of them as is

directly or indirectly attributable to that permanent establishment”

► Home State (Resident State) has sovereign right, at its

discretion, of taxation unless sacrificed

► “May be taxed” permits Source State to levy tax, but at its

discretion

► “May only be taxed” is different from “May be taxed”


Concept of Tax Residency Certificate (TRC)

► S.90(4) makes treaty benefit contingent upon TRC

► TRC is a document certified by Government of Other State

about tax presence of treaty resident


Concept of BEPS

► Base Erosion and Profit Shifting (BEPS) refers to tax planning

strategies

► that exploit gaps and mismatches in tax rules to make profits „erode' for

tax purposes (double non-taxation) or

► to shift profits to locations where there is little or no real activity but the

taxes are low resulting in little or no overall corporate tax being paid

► OECD began work to address BEPS concerns in 2012

► Since, OECD has formulated 15 Action Plans built around concepts

of “Coherence”, Transparency” and “Substance”

► With ongoing public consultation with stakeholders and business

community; several draft reports and deliverables expected in 2014-

15

Thank you !“This Presentation is intended to provide certain general information existing as at the time of

production. This Presentation does not purport to identify all the issues or developments. This

presentation should neither be regarded as comprehensive nor sufficient for the purposes of decision-

making. The presenter does not take any responsibility for accuracy of contents. The presenter does

not undertake any legal liability for any of the contents in this presentation. The information provided is

not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional

advice should be sought before taking action on any of the information contained in it. Without prior

permission of the presenter, this document may not be quoted in whole or in part or otherwise.”

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