Global tax-avoidance rules may override Indian treaties

There is a possibility that the General Anti-Avoidance Rules (GAAR, on taxes) and the tax treaties signed by the government with those of Mauritius, Singapore and Cyprus, and even other nations such as Netherlands, could be overtaken by another event.

These could, say experts, be partially or fully overridden by the Multilateral Instrument (MLI) to implement tax treaty related measures for preventing Base Erosion and Profit Sharing (BEPS).

BEPS is a tax avoidance strategy used by multinational companies — profits are shifted from jurisdictions that have high taxes to those with low or no taxes. The Organisation for Economic Cooperation and Development (OECD) grouping of countries had developed the MLI to tackle such issues. A little over 100 countries had adopted the MLI by November 2016. It will be signed by them this June and is likely to be implemented by India in April 2018 or 2019.

The MLI and related BEPS measures will be implemented through amendments in the Income Tax (I-T) Act. “MLI is likely to override the relevant parts of existing bilateral treaties,” observed a recent note by global consultancy PwC.

After the recent amending by the government of its tax treaties with Mauritius, Cyprus and Singapore, it is believed some foreign portfolio investors might shift to European jurisdictions such as Spain, France or Netherlands, to avoid paying tax on capital gains. However, the possibility that MLI might override treaties with even these countries could prevent this. In existing regulations, in the case of a tax treaty, the I-T Act shall apply to the extent that it is more beneficial to the taxpayer. However, not in the case of GAAR provisions, which will apply even where the tax treaty is more beneficial to the payer. 

Introduction of MLI could mean another possibility. “If the tax treaty (after MLI) itself is more stringent, will the GAAR provisions still apply? There is lack of clarity on this. It appears that in a conflict between the I-T Act and the MLI, the latter should ordinarily prevail. However, in cases where GAAR provisions apply, an attempt should be made for harmonious reading of GAAR provisions and MLI,” said Suresh Swamy, partner, financial services, PwC India. The MLI has a ‘principal purpose test’. Wherein, tax treaty benefits may be denied if one of the principal purposes of an arrangement or a transaction was to, directly or indirectly, obtain tax benefit. “This test appears to be wider than the existing GAAR provisions in Indian tax law,” says Swamy.

Further, MLIs will contain limitation-on-benefits (LOB) clauses. These are Specific Anti Avoidance Rules (SAAR), aimed at certain arrangements of tax avoidance. This could create another grey area. “Treaty benefits will be restricted in accordance with these clauses. GAAR provisions, though, may still be applicable and invoked by the tax authorities and override these SAAR provisions. However, this is an untested proposition and could lead to some litigation,” said Punit Shah, partner, Dhruva Advisors.

MLI provides participating countries and jurisdictions the option to specify at the time of ratification the provisions they would opt in and out of. The Indian government recently issued a statement indicating their approach towards BEPS and the positions likely to be taken, depending on the contents of the MLI. For this purpose, a committee has been constituted to examine all the action plans of the BEPS regime and recommendations, said sources.

  • Tax treaties might be overridden by the international Multilateral Instrument (MLI)
  • The  OECD developed MLI to tackle issues arising from tax avoidance
  • More than 100 countries have adopted the MLI as of November 2016
  • MLI includes a ‘principal purpose test’, wherein tax treaty benefits can be denied if one of the principal purposes of a transaction was to, directly or indirectly, obtain tax benefit

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