Changing The World’s Tax Treaty Network In One Stroke Of A Pen

Nobody anticipated that the Base Erosion and Profit Shifting (BEPS) project initiated by the Organisation for Economic Co-operation and Development (OECD) in 2013 could have such a significant impact on bilateral treaties around the world. Skepticism prevailed in the minds of all international tax bodies, regarding the effectiveness of OECD’s BEPS project, in implementing the proposed measures into the existing tax treaty network. ‘Implementation is the key to any legislation’ and BEPS action plans got a swift implementation tool in the form of a unique step to counter aggressive tax planning – the Multilateral Instrument (MLI), which shall change the face of tax treaties worldwide.

The MLI provides for minimum standards that the signatory states have to meet, which relate to rules on the prevention of treaty abuse and rules on dispute resolution. The signing of the MLI is a great achievement, but its real impact on tax avoidance structures devised by corporates worldwide is strongly dependent on the options chosen, and reservations made by each country.

How Will Treaties Be Interpreted Now?

The signing of the MLI brings into picture another set of rules to be referred to while studying the tax implications of each cross-border transaction, since in addition to the tax treaty and domestic law of each of the country involved, one has to also consider the MLI along with the options selected and reservations made to the MLI by each such country. This may make things complex and subjective in the initial stage, which may even lead to more disputes. Eventually one can only hope that this big project of the OECD to curb base erosion and profit shifting will effectively reduce the double non-taxation enjoyed by the mischievous corporates worldwide by using the gaps in tax treaties and domestic law.

Although the OECD Commentaries play an important role in tax treaty interpretation, their actual interpretative weight, legal status, and the relevance of the later versions for the interpretation of earlier signed treaties cause longstanding interpretative difficulties.

What To Keep In Mind While Entering Into Transactions With Indian Companies

Foreign investors planning to enter into a transaction with Indian companies will have to analyse the transactions from the General Anti-Avoidance Rules (GAAR) perspective as well, since, as of now, GAAR overrides tax treaties, and we can safely presume that it shall even override the MLI. Investors also need to be mindful of India’s position and reservations on various provisions of the MLI, along with the existing provisions of tax treaties and domestic tax laws of both the countries. India’s position and key reservations on specific provisions of MLI are summarised below for ready reference.

• India has given its reservation on provisions of the MLI regarding taxation of a “fiscally transparent entity/arrangement” and shall continue to tax income of such entities/arrangements as per its domestic GAAR rules or as per provisions already available under its bilateral tax treaties.
• On taxation of “Dual Resident Entities”, India has agreed for a limited applicability in respect of India’s covered tax agreements, since India’s bilateral treaties with all 93 covered tax jurisdictions/countries already provide for the necessary mechanism for resolution of an issue relating to Dual Resident Entities. This reservation also gains importance in light of the Place Of Effective Management (POEM) Guidelines recently notified by the Indian government under domestic tax laws.
• Owing to India’s complete reservation on the applicability of provisions of MLI on “Methods for Elimination of Double Taxation”, India’s tax treaties will continue to apply as provided, under the corresponding Article in respective bilateral tax treaties, and Section 90-91 of Income Tax Act, 1961.
• On “Dividend Transfer Transactions”, India has primarily accepted the MLI position on minimising the tax liability on dividends by prescribing a limitation of a minimum holding period of 365 days in respect of shares/stock/ownership interest, for which dividend is paid out.
• On “Prevention of Treaty Abuse”, considering that India has already built in necessary provisions in form of “Limitation of Benefits” clause in various bilateral tax treaties, India has adopted a “Simplified Limitation of Benefits Provisions” of the MLI.
• As far as taxation of “capital gains” is concerned, the MLI provides that such gains will be taxable in the country, where such immovable property is situated, if at any time during the 365 days preceding the transfer, these shares or comparable interests derived more than 50 percent of their value directly or indirectly from such immovable property, which India has primarily accepted. This provision gains special importance for foreign investors coming into India, as it defines their tax liability at the time of alienation of their interest in the shares or other assets.
• India has clearly reserved its right that “Mutual Agreement Procedures” application shall be made only before the competent authority of the contracting jurisdiction of which the person is a resident, and not to the competent authority of the other contracting state directly.
• Artificial avoidance of Permanent Establishment (PE) status was one of the key concerns of each signatory country, which leads to base erosion. India has primarily accepted and adopted the provisions of MLI with an aim to deal with treaty abuse involving PE.

Is Arbitration On The Table?

Arbitration, as international tax dispute resolution mechanism, has been signed on to by only 25 countries out of the 68 countries signing the MLI. Although arbitration is an effective tool for dispute resolution, for now, this remains out for consideration for India as well. Let’s see how OECD pushes it back to the discussion table for reconsideration by each of the countries involved.

All said and done, nothing undermines the spectacular accomplishment in aligning tax treaty policy on such a large scale, signaling an end to treaty-shopping. MLI achieves the ambitious objective of quick and effective implementation of the BEPS measures into a large number of tax treaties. In the coming days, we shall witness how this historic event impacts the tax treaty network of the world and how signatory countries address the challenges and uncertainties that may crop up.

Rakesh Nangia is Managing Partner and Neha Malhotra is Executive Director at Nangia & Co LLP.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.