MULTILATERAL INSTRUMENTS – TREATY ABUSE
OECD AND G20 countries along with developing countries have been working for the development of the “Base Erosion and Profit Shifting” (BEPS) Project. BEPS refers to corporate tax planning strategies used by multinational companies that artificially shift profits from higher tax locations to lower tax locations thus eroding the tax base of the higher tax locations. A conservative estimate of annual revenue loss of USD 100 to 240 billion has been made due to BEPS.
India is actively following BEPS recommendations and has been bringing amendments in the domestic law to be in line with BEPS regulations. These include implementation of Master File and Country-by-Country (CbC) Reporting, introduction of equalisation levy, “Patent Box” tax regime for royalty income and interest restriction provisions under new section 94B.
BEPS Action plan reports has 15 focus areas which reflect recommendations for significant changes in International Tax laws and treaties. The changes will have an impact not only on tax departments and tax compliance, but also on the manner in which many enterprises conduct business overall. Companies will need to re-consider and potentially realign their business models especially their supply chain, finance and treasury functions.
In order to implement BEPS measures Action Plan 15 has been enacted and Multilateral Instrument (MLI) has been designed. MLI is a convention which is being signed by several countries. It has the impact of changing bilateral tax treaties signed by these countries. It addresses the practical difficulty of changing bilateral tax treaties in a time bound manner and swiftly transposing results from the OECD/G20 BEPS Action Plans into more than 2000 tax treaties worldwide. It is a complex instrument divided into VII parts and running into 39 articles which modifies existing bilateral treaties of the countries signatory to the MLI. Certain articles of MLI offer option of provisions for each country to select for adopting in its tax treaties.
There are minimum standards of the MLI which must be adopted by signing country. One of the minimum standard is Article 6 – Purpose of a Covered Tax Agreement. This Article seeks to insert a statement in the preamble of the tax treaties to state that the purpose of the treaty is not to create opportunities for double non-taxation or reduced taxation through tax avoidance or evasion including treaty shopping. As it is a minimum standard the preamble of Indian tax treaties will be modified or replaced.
Article 7-Prevention of Treaty Abuse seeks to insert a general anti abuse provision/Limitation of Benefits (LOB) provision in tax treaties. The minimum standard for avoiding treaty abuse can be implemented by adopting either of the following: –
1.) Only Principle Purpose Test (conceptually similar to India’s GAAR)
2.) PPT plus either simplified or detailed LOB provision
3.) Detailed LOB supplemented by a mechanism that would deal with conduit arrangements not already dealt with in the tax treaties.
As per provisional notification, India would adopt PPT and simplified LOB in its tax treaties. As most countries (Canada, Cyprus, Luxembourg, France, Japan) have adopted only PPT and not the simplified LOB hence it unlikely that India would include simplified LOB.
Article 8- Dividend Transfer Transactions
As per this article beneficial tax rate on dividend income is available in case of minimum 25% shareholding in the company provided the holding is for minimum 365 days. As per provisional notification India has adopted this Article in all tax treaties except Portugal. This Articles can be adopted in Indian treaties provided it is adopted by the other country also.
Article 9 – Capital Gains from alienation of share or interest of entities deriving their value principally from immovable property
This Article combats the misuse of Art. 13(4) of OECD model which gives taxing rights to a source country where the immovable property is situated when the shares of such company are sold provided the shares derive more that 50% of their value from immovable property in the source country. Source country gets taxing rights if the value threshold is met any time preceding 1 year from date of transfer. It is applicable on partnership or trusts as well.
As per provisional notification India would adopt this Article. Certain countries like Canada, Luxembourg, Singapore, UK have opted out of this Article and Japan, France and Netherland would be adopting this Article. This Article can get adopted in Indian treaties subject to matching.
The MLI is a big step in the BEPS implementation process. One can expect changes in the provisional list of reservations and notification made by India and other countries in respect of MLI. However, one thing is for sure in the times to come international tax implications would not be addressed just by analysing Income Tax Act and Double Taxation Avoidance Treaty. One will have to be familiar with the Multilateral Instrument of the OECD in order to take tax decisions.