India’s multilateral instrument choices: a quick run-through

by Sriram Govind

June 7 was a momentous day in international tax history with the signing of the Multilateral Convention to Implement Tax Treaty Measures to Prevent BEPS (MLI).

The MLI is a multilateral treaty that will modify bilateral tax treaties entered into by a jurisdiction by including measures recommended in the OECD/G20 base erosion profit shifting (BEPS) project, subject to choices made by jurisdictions.

Although skepticism was abound in the tax world prior to the ceremony, it is hardly arguable now that the signing ceremony was a resounding success, with 68 jurisdictions signing the MLI along with 9 other jurisdictions expressing their interest to sign as per the OECD website.

India officially signed the MLI during this ceremony. The Finance Minister commented that India believes that BEPS deprives States of resources that could be used for development. He said the MLI is a concrete step for ending treaty abuse and ensuring that profits are taxed where there is economic activity and value creation. He encouraged all States to participate in the MLI going forward.

India was one of 4 non-OECD countries on the Committee of Fiscal Affairs, was an active participant in the ad hoc group that drafted he MLI, and is a member of BEPS Inclusive framework steering group.

India’s provisional choices as regards the MLI have been released by the OECD. The MLI is applicable only in respect of tax treaties that are identified as “covered tax agreements” by each State. India has duly identified 93 of its tax treaties, covering nearly all of its tax treaty network, including even treaties with jurisdictions that have not signaled their intent to sign the MLI.

Further, the MLI provides great flexibility in the application of optional provisions through mandatory notification provisions in some cases or through reservations.

India’s list of choices and a brief note on possible implications on the tax treaty network is provided below:

Provision under MLIChoice made by IndiaComments
Article 3 dealing with income earned by fiscally transparent entities, superimposed from BEPS Action Plan 2India has chosen to not apply this article to any of its treatiesThere is a lot of confusion in India as regards the applicability of tax treaties to income earned by fiscally transparent entities such as partnerships (general or limited).

Based on the non-member position recorded by India in the OECD Model, India’s position seems to be to deny tax treaty benefits to both the partnership and its partners, which has created concern. This position was upheld by India’s Authority for Advance Rulings in the Schellenberg decision.

India’s refusal to adopt this provision in the MLI means that the uncertainty will continue going forward.

Article 4 changing the tie-breaker test for dual resident companies to mutual agreement procedure (MAP)India has chosen to apply this provision to all 93 of its tax treatiesIndia has previously expressed its preference to use MAP as a corporate tax residency tie-breaker through a non-member position in the OECD Model and its choice to adopt this provision in the MLI is not surprising.

This provision will supersede existing treaty provisions even where the other treaty partner has not notified its treaty provision to the depositary (the OECD). However, if a treaty partner chooses to reserve and not to apply this provision, India may use its domestic’ place of effective management rules’ to ensure that the tie breaks in its favour.

Article 5 dealing with switchover of exemption to credit in certain casesIndia has chosen to not apply this article to any of its treatiesThis choice is not surprising either since India‘s tax treaty policy is to use the credit method and not the exemption method in tax treaties and since low or no source taxation in case of passive income is generally not possible under Indian tax treaties.
Article 6 dealing with the preamble language additionIndia has not expressed any position on this provisionSince Article 6(5) of the MLI provides that the language provided shall be included in the existing preamble language even where language in existing treaties is not notified to the depositary, this preamble language should be added to all of India’s treaties with signatories. This is not surprising since this provision was a minimum standard.

The addition of this provision will have great impact in the interpretation of tax treaties since the ‘object and purpose’ of tax treaties under the Vienna Convention on the Law of Treaties may be held to include this language going forward.

However, additional optional preamble text provided in the MLI on the economic relationship  and enhancement of cooperation will not be added to India’s tax treaties.

Article 7 dealing with the principle purpose (PPT) test and limitation on benefits (LOB) clauseIndia has chosen to apply the principal purpose test along with the simplified LOB provisionIndia has chosen to apply the PPT test in addition to the simplified LOB test in all of its tax treaties. India has already enacted a clause similar to the PPT in over 30 of its tax treaties and has also adopted LOB provisions in other treaties. All such provisions will be replaced by the MLI provision and this provision will be added to all other treaties with MLI signatories.

However, it is important to note that other jurisdictions may choose to not apply the simplified LOB provision resulting in a one-sided application and that India has not chosen the reservation to negotiate a detailed LOB in any of its treaties. However, several European jurisdictions seem to have chosen to not allow one-sided application of the simplified LOB, resulting in only the PPT being applicable in such cases.

It is interesting to note that India is only one among 12 countries to have adopted the simplified LOB provision apart from Argentina, Armenia, Bulgaria, Chile, Colombia, Indonesia, Mexico, Russia, Senegal, the Slovak Republic and Uruguay. This is an important step in the fight against tax avoidance and aggressive tax planning since the PPT and the simplified LOB in some cases may be applied to all of India’s tax treaties with the other MLI signatories (whether one-sided or not), leaving little room for tax planning structures since the PPT is a subjective test.

Article 8 creating the holding period for reduced source taxation of dividends where there is ownership of a certain amount of capitalIndia has chosen to apply this provision, except in case of the India-Portugal treaty where there is a longer holding periodIndia has chosen to apply the 365-day holding period for the beneficial rate on source taxation of dividends in all its tax treaties that contain a reduced rate linked to ownership of a certain amount of capital. Although the provision would be added even to treaties that do not contain any holding period, this provision would be applicable to existing tax treaty provisions only where both parties notify such provision to the depository.

Nevertheless, this provision is of little significance to India since India applies the dividend distribution tax to tax dividends at a source level, to which tax treaties are generally not applicable, leading to, in several cases, triple taxation (corporate taxation, dividend distribution tax in India, dividend tax in resident jurisdiction with no credit).

Article 9 increasing holding period for capital gains on indirect transfer of immovable property to any time within 365 days and increasing scope to partnership or trust interest transfersIndia has chosen to apply this provisionIndia has chosen to apply to all its tax treaties the newly created provision for immovable property indirect transfers that specifically increases the holding period to holding any time within 365 days and specifies a 50% value threshold in respect of shares, partnership or trust interests.

This provision will apply only to treaties where both parties have notified to the depository the choice to use this provision. This provision will be added to all treaties and will supersede existing treaty provisions even where the other treaty partner has not notified its treaty provision to the depository.  However, if the other party has made a reservation, this provision will not apply.

Article 10 creating an anti-abuse rule for third country permanent establishments (PEs)India has not expressed any position on this provisionSince India has not placed a reservation on this provision, this provision should apply to all of its tax treaties with MLI signatories except where a treaty partner has placed a reservation.
Article 11 creating a saving’s clause allowing taxation of own residentsIndia has not expressed any position on this provisionSince India has not placed a reservation on this provision, this provision should apply to all of its tax treaties with MLI signatories except where a treaty partner signatory has placed a reservation.
Article 12 on the avoidance of PE status through commissionaire arrangementsIndia has chosen to apply this provisionIndia has chosen to apply this provision to all of its notified tax treaties since they  contain a dependent agent PE provision.  This is in line with India’s existing non-member position on the OECD Model Convention. However, this provision would be applicable to tax treaties only where both parties choose this option, potentially reducing the scale of this choice.
Article 13 on the PE exemptions on preparatory, ancillary activitiesIndia has chosen to apply this provision with Option A, creating an overall requirement for each exempted activity to be of preparatory or auxiliary natureIndia has chosen to apply this provision with Option A to all of its notified tax treaties since they contain a PE exemption provision. However, this provision would be applicable to tax treaties only where both parties choose this option, potentially reducing the impact of India’s actions.
Article 14 on the splitting up of contracts in a construction PEIndia has not expressed any position on this provisionSince India has not placed a reservation on this provision, this provision should apply to all of its tax treaties with MLI signatories except where a treaty partner signatory has placed a reservation.

 

Article 16 on improving the MAPIndia has chosen to not modify its tax treaty provision to allow access to ‘either competent authority,’ but has chosen to implement the minimum standard through a bilateral notification or consultation process under the MLIIndia has made this reservation applicable to all its tax treaties, choosing to not overtly improve the functioning of the MAP as agreed under the BEPS package. However, since India has notified all of its tax treaties under this provision, India’s treaty network will have the basic MAP provision as provided under the MLI except for this addition.
Article 17 on corresponding adjustmentsIndia has chosen to apply this provision except where similar provisions are already presentThis provision will be added to treaties with MLI signatories that do not contain such a provision. Treaties with existing similar provisions have been specifically excluded by reservation.

This will open up access to bilateral advance pricing agreements (APAs) and transfer pricing disputes in MAP to several treaties. India has refused access to transfer pricing disputes under MAP or bilateral APAs to date in the absence of Article 9(2) in a tax treaty (as is the case with India’s treaties with several key European States).

 

Part VI on arbitrationIndia has chosen to not apply arbitrationAs expected, India has chosen to not apply Part VI owing to concerns of ‘sovereignty,’ as previously expressed at the G20 level. Although this could be a hindrance to the improvement of the tax treaty dispute resolution framework and concerns of sovereignty may not have much standing from a legal perspective, India’s policy concerns as regards even-handedness, among others, is understandable and there is little to address such concerns in Part VI of the MLI.
Entry into forceIndia has chosen to postpone all the default dates to 30 days after the receipt of the depository of the last notification as provided in the MLI

 

India has therefore, chosen the option to make the MLI applicable at the latest possible point under the MLI, allowing all parties time to ensure that the provisions are understood. This extension is repeated for other procedures under the MLI as well.

 

In sum, from the provisional list, it seems that India has gone all-in with the MLI, applying all provisions that could possibly lead to any tax planning practice in India. This is particularly relevant since, under the MLI, India is allowed to modify its list of reservations only in such a way that they are more stringent against BEPS practices.

However, since this is a provisional list of choices, as noted by the OECD, one should wait and watch whether India would continue in this direction in the final version. If India does continue with this list, as long as India remains party to the MLI and as long as India and treaty partners do not bilaterally renegotiate tax treaties going forward (as allowed under Article 30 of the MLI), India’s tax treaty network as regards MLI signatories may be relatively impermeable to tax planning.

The addition of a PPT to previously favourable tax treaties, such as the India-Singapore tax treaty, the India-Cyprus treaty, and the India-Netherlands tax treaty, should mean that aggressive tax planning practices may be curtailed going forward.

Since Mauritius had signed a letter of intent to sign the MLI, the ‘Mauritius route’ for investment into India, which still allowed tax planning even though the tax treaty was renegotiated recently, could also seem to be in jeopardy.

In light of the famously aggressive attitude of the Indian revenue, with no assurance as to the improvement of the bilateral dispute resolution framework in MAP, disputes in Indian courts may arise going forward. There is a stark need for improvement of the dispute resolution procedure under Indian tax treaties.

Although the signing of the MLI is a landmark occurrence in the tax world and in India’s tax treaty history, several questions remain open.

Would India need to introduce separate law to incorporate the MLI as a duelist nation or would Section 90 of the Indian Income Tax Act be broad enough to cover this as in the case of all existing tax treaties? Would India not use domestic anti-avoidance rules where treaty based anti-avoidance rules are cleared under BEPS Action 6?

Also, would India allow grandfathering of existing investments entered into prior to the MLI, such as those relying on the recently renegotiated Mauritius, Singapore, or Cyprus treaties?

These questions deserve a detailed analysis by policy makers, academics, practitioners, and particularly the judiciary going forward.

The views expressed by the author in this piece are purely personal and do not reflect or represent the views of any affiliated institution.

Sriram P. Govind

Sriram Govind, LL.M is a research and teaching associate and is pursuing his doctoral studies under the Doctorate in International Business Taxation (DIBT) programme at the Institute for Austrian and International Tax Law, WU, Wien.

Sriram is an India-qualified tax lawyer who worked for over two years with the law firm, Nishith Desai Associates in Mumbai before completing the LL.M in International Tax Law from the Institute for Austrian and International Tax Law, WU, Wien in 2016.

His expertise includes tax treaty law and tax policy, tax structuring for complex cross-border transactions and tax controversies.

Sriram P. Govind

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