India approves multilateral instrument to curb tax treaty abuse
MLI will enable India to modify its tax treaties to curb revenue loss through treaty abuse or BEPS strategies where companies park their profits in low-tax jurisdictions.
MLI will enable India to modify its tax treaties to curb revenue loss through treaty abuse or BEPS strategies where companies park their profits in low-tax jurisdictions. It will ensure profits are taxed where substantive economic activities are carried out and where value is created, said a government statement. As countries need to deposit their instruments of ratification, the earliest that MLI provisions will apply to India’s tax treaties will be from April 1, 2020.
The MLI (see graphic) enables countries to automatically introduce tax treaty changes to achieve anti-abuse BEPS outcomes, without the need to bilaterally renegotiate each tax treaty, which is a time-consuming exercise. It took several years of negotiations with Mauritius before a protocol to the tax treaty was signed in 2016, giving India the right to tax capital gains arising on sale of Indian shares.
“While the definitive position that will be taken by India would be known once the ratification instrument is filed with the OECD, based on provisional indications disclosed in June 2017, India is likely to move in the direction of stricter anti-avoidance measures, lower threshold for determining a permanent establishment in India, which gives India the right to tax business profits of a foreign entity and improved dispute-resolution measures,” says EY-India national tax head Sudhir Kapadia.
“In the context of foreign investments, the Indian tax authorities will be able to rely on a ‘principal purpose test’ (PPT) to scrutinise whether the investors are entitled to tax treaty benefits. They can deny these benefits in India if they conclude that obtaining tax benefits was one of the principal purposes of any transaction/investment structure,” says Dhruva Advisors partner Punit Shah.
“While the General Anti-Avoidance Rules (GAAR) do not apply to income arising from certain pre-2017 investment structures, the PPT has no such barrier. Thus, capital gain exemption claims for investments prior to 2017 by investors from Cyprus and Singapore could come in for greater scrutiny,” adds Shah.
More than a hundred countries were involved in the exercise, culminating in developing the MLI, which is expected to cover over 3,000 tax treaties. A crucial aspect of the MLI is that it’s based on the principle of reciprocity. Apart from mandatory minimum standards, such as to prevent treaty abuse, countries can make reservations (not accept) for certain provisions in the MLI. For cross-border business, this can lead to complexities in determining tax treaty impact.
“On many of the key issues favouring India, there are reservations made by other countries. India has chosen to additionally apply the simplified limitation of benefits (LOB) rule, which provides an objective determination to deny treaty benefits along with the principal purpose test (PPT) to counter treaty shopping. However, many countries through which significant investments are made in India — such as Singapore, France, Japan and Netherlands — have not adopted the simplified LOB. Thus, only the PPT test will be applicable for such treaties,” explains Transactions Square founder Girish Vanvari.
“From financial year 2020, Indian payers of income (such as royalty, fees for technical services, interest which are subject to lower withholding tax rates under certain tax treaties) may also find themselves having to deal with the issue of whether to apply treaty provisions or not, in view of revised standards on PPT. Other aspects also, such as a broader permanent establishment rules, could also impact multinationals conducting business in India,” says Deloitte-India tax partner Shefali Goradia.
“Given that the MLI has been intended not to impede fair business practices but only to address situations of tax avoidance, by and large it ought not to significantly affect trade flows. However, companies — in organising their international operations — will ensure that they marry substance to the form of their transactions,” sums up PwC-India international tax leader Frank D’Souza.