India Readies New Tax Tool To Fight Evasion

In a move that will significantly impact international taxation in the country, India has completed the procedural formalities to implement the multilateral convention that seeks to curb tax avoidance by multinational corporations.

The convention will come into effect from Oct. 1, 2019. India ratified the multilateral instrument or MLI on June 12, two years after its initial decision to sign up for it.

India deposited the instrument of ratification with the Organization for Economic Cooperation and Development on June 26, along with its list of reservations and actions. A country can exclude or modify the application of certain provisions in the MLI based on its policies and economic status. The implementation of MLI will impact the structures foreign investors use to come to India and the gains they derive from their investments, experts told BloombergQuint.

What Is MLI?

Multilateral instrument or MLI is a tool to implement the tax-related treaty measures to prevent base erosion and profit shifting by multinational enterprises. BEPS refers to tax avoidance strategies by multinationals that exploit gaps and mismatches to artificially shift profits from countries with high tax to countries with relatively lower rate of taxes.

To curb such practices, the OECD, an international body, had come out with a 15-point action plan in 2013. MLI implements this plan.

MLI applies to existing tax agreements between countries if:

• Signatories to the existing tax agreement agree to classify it as a covered tax agreement under MLI.
• MLI must have become effective for such countries.

India has finalised 93 existing tax agreements as covered tax agreements. Out of these, 22 treaty partners have signed up for MLI. But key jurisdictions like Mauritius and Germany have excluded their existing tax agreements with India from the scope of MLI. The U.S.—a key jurisdiction where investors come to India from—is not a signatory to the MLI convention.

What Does MLI Seek To Do?

Governments enter into treaties or conventions with foreign countries to avoid double taxation of income, resolve tax disputes and to streamline taxation of cross-border transactions. As per law, the double tax avoidance agreement prevails over the Income Tax Act in certain situations.

As each country enters into multiple tax agreements, complexities arise in their implementation. MLI will modify the operation of existing tax agreements without countries having to amend each treaty, which would be a time-consuming and long-drawn process.

MLI will operate alongside the covered tax agreements in the following manner:

• If MLI specifies that a clause will apply in place of any existing clause in a covered tax agreement, then the MLI provision will substitute the relevant clause.
• Certain provisions in the MLI will be used to cover aspects which are absent in the tax agreements.

It will no longer be appropriate to “merely read the most recent double tax treaty or protocol to assess the tax implications for a transaction and one will need to see if or how the relevant provisions have been changed by the MLI”, Jitendra Jain, executive director at PwC, said.

MLI: Impact On Investment Structures

Foreign investors usually come to India via countries that help them maximise treaty benefits, for instance Mauritius and Singapore. Starting April this year, the concessional rate of capital gains tax on investments via these two countries has come to an end.

In 2016, India had amended its tax treaties with Singapore and Mauritius, giving itself the right to tax capital gains. Additionally, the Mauritius treaty was also amended to include the limitation of benefits clause that has been in the Singapore treaty since 2005. As per this clause, taxpayers will be deemed to be shell or conduit companies and denied treaty benefits if they do not meet a monetary threshold of expenditure in their country of residence.

For tax treaties which don’t have such anti-abuse provisions, MLI will come in handy starting October. Thanks to the principle purpose test that will deny tax benefit to arrangements or investment structures that are set up with the sole purpose of obtaining tax benefit under treaties.

The PPT rule in MLI could impact intermediate holding company structures used for investing into India, which lack substance and have been put in place solely to avail tax treaty benefits, Neeru Ahuja, partner at Deloitte Haskins and Sells, told BloombergQuint. It is important for foreign investors to review their existing operational structures, arrangements and investment modes to determine whether they are sufficiently robust to withstand a potential challenge under the PPT rule, Ahuja said.

MLI: Impact on Capital Gains

Capital gains have been at the heart of disputes between foreign investors and the Indian tax department. Once MLI comes into effect, provisions relating to capital gains in tax treaties would be impacted if:

• Both countries to an existing tax agreement adopt MLI.
• They do not reserve the applicability of Article 9 while adopting the MLI.

Article 9 says that a resident of the signatory country will be subjected to capital gains tax in the other jurisdiction if:

• There is a transfer of shares or ownership interest and
• Such shares or ownership interest derive 50 percent or more of their value directly or indirectly from an immovable property situated in the other jurisdiction at any time during 365 days before such transfer.

India’s treaties and consequentially the taxability of capital gains with countries like France, Indonesia, New Zealand and Saudi Arabia etc. would be impacted as these countries have agreed to the applicability of Article 9.

For countries like Mauritius that hasn’t adopted the MLI convention and Singapore that hasn’t agreed to be governed by Article 9, existing treaty provisions will prevail.

While ratifying the MLI, Singapore didn’t include Article 9 and India didn’t include Singapore in the list of treaties that will be impacted by capital gains provisions in MLI, which means the “existing tax treaty between India-Singapore on taxability of capital gain shall continue to apply”, said Rakesh Nangia, managing partner at Nangia Advisors.