BEPS in Action

Himanshu Parekh

7 November 2015

Action 6 –Preventing the granting of treaty benefits in inappropriate circumstances (Treaty abuse)

2

Action 6 – Treaty abuse

• Treaty abuse is one of the most important sources of BEPS concerns

• Three pronged approach to deal with Treaty shopping

− A statement that Treaties intend to avoid tax evasion / avoidance / Treaty

shopping (minimum standard); and

− Inclusion of LOB rule in Treaties; and / or

− Inclusion of general anti-abuse rule (PPT rule) in Treaties

• Rules to address other forms of Treaty abuse:

− Dividend transfer transactions

− Companies deriving value primarily from immovable property

− Dual resident entities

− Transfer of right / property to PEs in third states

− Ensuring that Treaties do not prevent application of domestic anti abuse rules

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Treaty shopping – an Indian perspective

• Natwest [1996] 220 ITR 377 (AAR)

• AIG [1997] 224 ITR 473 (AAR)

• Azadi Bachao Andolan [2003] 263 ITR 706 (SC)

• E Trade Mauritius Ltd. [2010] 324 ITR 1 (AAR)

• KSPG Netherlands Holding B.V. [2010] 322 ITR 696 (AAR)

• Ardex Investments Mauritius Ltd. [2012] 340 ITR 272 (AAR)

• Vodafone International Holdings B.V. [2012] 341 ITR 1 (SC)

• Sanofi Pasteur Holding SA [2013] 354 ITR 316 (AP)

• Serco BPO (P.) Ltd. [2015] 60 taxmann.com 433 (P&H)

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Treaty shopping – an Indian perspective

Principles emerging from judicial precedents

• The “abuse of rights” doctrine cannot be imported into India

• A LOB clause cannot be read into a Treaty

• Treaty benefit cannot be denied on the ground that Treaty shopping is

unethical & illegal

• Investment through a SPV to enable a smooth exit in future cannot be

challenged basis lack of business / commercial purpose

Treaty shopping virtually blessed by courts in India!!

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Draft LOB Clause

1. Treaty benefits to be denied to a non-qualified person

2. Qualified person would include:

• an individual

• a Contracting State

• publicly listed entities & their affiliates

• certain charities & pension funds

• other entities that meet certain ownership requirements

• collective investment vehicles

who are residents of the State

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Draft LOB Clause

3&4. Treaty benefits to be available to non-qualified person if:

• person engaged in active conduct of business in its State, and

• income is derived in connection with or is incidental to the business

OR

• more than agreed proportion of the entity is owned by certain

persons entitled to equivalent benefits

5. Power to Competent Authority to grant Treaty benefits

6. Definitions

Detailed version of LOB clause provided for States that do not wish to include the PPT rule

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PPT rule

• Treaty benefit shall not be granted if one of the principal purposes of the

transaction / arrangement is to obtain Treaty benefit

− Exception - establishing that granting Treaty benefit would be in

accordance with object and purpose of the Treaty

• Scope wide enough to include direct as well as indirect benefits

• PPT rule to override all other provisions of the Treaty

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Example – Setting up of a plant in a State

• R Co is in the business of producing electronic devices

• R Co is considering establishing a manufacturing plant in a developing

country

• Location in three countries identified

− All the countries provide similar economic & political environments

• R Co decides to build plant in State S since it has Tax Treaty with State R

PPT rule not to apply in this case since one of the principal purposes for building the plant is not to obtain Treaty benefit

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Example – Management services

Other examples dealing with financing mechanism of subsidiary, splitting construction contracts, etc.

PPT rule not to apply if R Co undertakes significant FAR for providing services through its own personnel

T Co

X Co Y Co Z Co Q Co

R Co Regional company – to render

accounting, legal, HR, financing &

treasury services, etc.

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Conduit arrangements

PPT rule would apply since transactions would constitute conduit arrangement

T Co

S Co

T Co

R Co

S Co

Interest @4%

(WHT @ 25%)Loan

• Where Contracting States do not include PPT rule, they may supplement

the LOB rule by rules that will address conduit arrangements

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Conduit arrangement – Group financing

• R Co responsible for coordinating

financing of all subsidiaries of T Co

• R Co has 50 employees in State R

• R Co enters into interest rate &

forex contracts to manage risks

• T Co lends to R Co 15 mn in

currency A (worth 10 mn in

currency B)

• R Co lends 10 mn in currency B to

S Co

Transactions do not constitute a conduit arrangement since R Co carries on real business performing substantive FAR

T Co

R Co S Co A Co B CoLoan

Loan

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Other recommendations

• A.10 – shareholding of atleast 25% for atleast 365 days to be entited to

lower WHT of 5%

• A.13 – shares / comparable interest deriving > 50% value from immovable

property at any time during 365 days before alienation

• A.4(3) – dual resident entities - tie breaker to be determined by

Compenent Authorities

• Cases involving abuse of domestic tax law using Treaty benefits

− Generally, no conflict perceived between domestic anti-abuse provisions

and Treaty

• Treaty shall not affect taxation by a State of its residents (s.t. certain

exceptions)

Article 7 - Artificial Avoidance of PE status

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Artificial avoidance of PE

• BEPS concerns arising from:

− Commissionaire arrangements

− Substantial negotiation of contracts (but avoiding conclusion thereof)

− Independent agent closely related to foreign enterprise

− Specific activity exemption under A.5(4)

− Fragmentation of activities between related parties

− Splitting up of contracts

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Commissionaire arrangement

• Commissionaire – arrangement through which a person sells products in

his own name but on behalf of a foreign enterprise that owns the products

Pre 2000 (Distribution arrangement) Post 2000 (Commissionaire arrangement)

X Co

Y Co

Held that commissionaire arrangement does not result in PE

Sale of

products

Sale of products

X Co

Y Co Sale of

Products as

commissionaire

Transfer of

fixed assets,

stock & customer

base☺☺☺☺☺☺☺☺☺☺☺☺☺☺☺☺☺☺☺☺

☺☺☺☺

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Revised Article 5(5) and 5(6)

Para 5

• PE of an enterprise deemed to be in a source State

− where a person is acting on behalf of an enterprise (i.e. agent) and

o he habitually concludes contracts, or

o habitually plays the principal role leading to conclusion of contracts

without material modification by the enterprise, and

− these contracts are:

o in the name of the enterprise, or

o for transfer of ownership or granting right to use property of the

enterprise, or

o for provision of services by the enterprise

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Revised Article 5(5) and 5(6)

Para 6

• Para 5 shall not apply where the agent is an independent agent acting in

the ordinary course of that business

• However, if the agent acts exclusively / almost exclusively for closely

related enterprise(s), he shall not be considered to be an independent

agent

− close relation to be determined based on control test or beneficial

interest test

Para 6 brought in consonance with Indian Tax Treaties

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Conclusion of contracts – what it means ?

• A person who negotiates all elements of a contract binding on the

enterprise can be said to conclude the contract

• However, mere participation in negotiations not sufficient to conclude

that the person has concluded contracts

• Contract can be concluded without active negotiation of terms of the

contract

− For instance, where the relevant law provides that a contract is

concluded by reason of an agent accepting offer of a third party to

enter into a standard contract

• Jurisprudence in India

− TVM Limited [1999] 237 ITR 230 (AAR)

− Galileo International Inc. [2009] 116 ITD 1 (Delhi)

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Principal role leading to conclusion of contracts

R Co

S Co

Contracts

concluded

online

• Sale of products through its website

• Persuades customers to purchase goods

• Explains standard terms of contracts &

fixed price structure

• S Co not authorized to modify terms of

contract/ price structure

S Co plays principal role leading to conclusion of contract; S Co’s inability to modify standard terms not a determinative factor

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Distribution of products / services

• Distribution of products would not result in Agency PE provided

− title to property passes from the enterprise to the distributor & from

distributor to the customer

• Similar view taken in

− Dun & Bradstreet Espana, S.A. [2005] 272 ITR 99 (AAR)

− Dassault Systems K.K. [2010] 322 ITR 125 (AAR)

− Reuters Limited [ITA No. 7895/Mum/2011]

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Independent agent

• Agent would not be independent where

− his activities are subject to detailed instructions or comprehensive control by the

enterprise

• An agent acting for several principals would be independent where

− his activities constitute an autonomous business & he bears risk through use of

his entrepreneurial skills & knowledge

• Impact on Agency PE where the agent has substantial non-agency business

− Western Union Financial Services Inc. [2007] 104 ITD 34 (Delhi)

− Galileo International Inc. [2009] 116 ITD 1 (Delhi)

− OECD – non agency business not relevant in determining independence of the

agent

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Independent agent

• “Exclusively or almost exclusively” – what it connotes ?

− Atleast 90% of revenues to be derived from closely related enterprise(s)

− Speciality Magazines (P.) Ltd. [2005] 274 ITR 310 (AAR)

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Specific activity exemptions

• A.5(4) – PE shall not be deemed to include:

− use of facilities for storage, display or delivery of goods

− maintenance of stock of goods for storage, display or delivery

− maintenance of stock of goods for processing by another enterprise

− purchasing goods or collecting information

− any other activity

− combination of the above activities

provided the overall activity is of preparatory or auxiliary character

Making all sub-paras of A.5(4) subject to preparatory or auxiliary conditions

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Specific activity exemptions

• Applicability of A.5(4) to following situations:

− Maintenance of warehouse by enterprise making online sales

− Delivery of spare parts to customer to whom machinery sold

− Cables or pipelines that cross territory of a country

− Purchase of goods for the enterprise

o Nike Inc. [2014] 264 CTR 508 (Karnataka)

o Columbia Sportswear Company [2015] 62 taxmann.com 240

(Karnataka)

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New anti-fragmentation rule

• Rule to prevent related enterprises from fragmenting a cohesive business

operation into small operations to avoid PE

R Co

S Co

Warehouse

A.5(4) not to apply in the above case

Sale of goods

delivery of goods

Sale of goods through its store☺☺☺☺☺☺☺☺☺☺☺☺

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THANK YOU

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Draft LOB Clause

M1

I Co

M Co

M3M2

> 50%

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Draft LOB Clause

• “In connection with business” implies that the activity is a line of business that

forms part of or is complimentary to the business conducted in the residence State

− For example, distribution business would form part of manufacturing business

• “Complimentary” means activities that are part of the same industry and success

or failure of one will result in success or failure of the other

• “Income incidental to business” if the income facilitates conduct of the business in

the State of residence

− For example, income from investment of working capital