CA. Kiran Chandarana
At the outset first of all I congratulate All India Federation of Tax Practitioners (West Zone) & National Association of Tax Professionals ( West Zone) for organizing National Tax Conference at Devbhoomi Dwarka, Gujarat. This platform will aid all the participants to get an opportunity to hear from Subject Matter Expert Professionals and will also act as a medium to exchange knowledge. It is also a proud moment for all of us since this Conference is organized in the holy and pious place of Devbhoomi Dwarka the Karma Bhoomi of Lord Krishna and all the participants will also get an opportunity to take benefit of visiting Dwarkadhish temple one of the Chardham place and take blessings of Dwarkadhish.
In today’s VUCA world full of Globalization and economic development all over the world, there are a lot of cross border transactions being undertaken. For economic development of any country including India it is essential to promote foreign institutional investors towards India and also give an opportunity to Indian Resident for spreading business across Globe so that we can increase forex inflow in our country. Since the country has powers not only to tax on profits earned in its land by anyone but also to tax global income of its residence, it often leads to dual taxation of same income in country where it is generated and also in the country where its investors are residing.
For stimulating economic progress and world trade, it is essential that we have policies and procedures which are assessee
friendly to avoid any double taxation in such global transactions thereby encouraging the participants for global business without double taxation burden on them at the same time ensuring no revenue loss to the country by escaping such transactions from both treaty and also without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.
In this article, we shall focus on some of the key concepts involved in international taxation. There is no separate law for International Taxation, however our existing Income Tax Act, 1961 covers specific provisions related to taxation of such international transactions. The major sections related to International taxable income are section 90, 90A and 91 of Indian Income Tax Act, 1961.
In order to avoid double taxation many countries have entered into double taxation avoidance Agreement (DTAA). Before we proceed for DTAA let us discuss on unilateral, bi-lateral and multilateral tax reliefs. Relief, in accordance with the agreement between two countries, where the tax may be payable is a Bilateral relief provided under section 90 of the Indian Income tax Act, 1961. There are also multilateral reliefs whereby treaties are agreed by more than two countries. In case there is no such agreement, taxpayer may be given tax relief by the country where he is resident this is unilateral relief. In India such unilateral relief is provided under Section 91 of the Income Tax Act.
India has entered into Double Taxation Avoidance Agreement with several countries including USA, UK, Russia, China, Ukraine, South Africa, UAE, Sri Lanka, Japan,Turke y,Thailand,Singapore, Uganda, Mauritius, Myanmar, etc. These tax treaties are formally concluded and ratified agreement between two independents nations bilateral treaty or multilateral treaty in case of more than two nations on matters concerning taxation.
Such Relief may be given by exemption method or tax credit method. Under exemption method one of the two countries where tax is payable exempts such income from tax and the other country has right to tax such income. On the other hand, under tax credit method, income is taxed under both the countries. Tax would have been paid in the country of income source as per the domestic law of that country or DTAA whichever is more beneficial to the taxpayer. Additionally, the country of residence of taxpayer also computes the tax payable under this foreign sourced income as per its domestic laws. Subsequently credit is given for taxes paid by the assessee on such foreign sourced income in respective foreign country.
After such reduction balance tax payable if any will be net tax liability of the resident taxpayer in the country of his resident. Under the Indian laws, depending on the nature of payment, both exemption method and the credit method are used to provide double taxation relief.
DTAA are further categorized into two kinds i.e., Comprehensive DTAA which covers all types of income and Limited DTAA which covers only certain specific incomes viz. Income from Operations of Aircrafts & Ships, Estates, and Inheritance & Gifts. So far, we have almost 96 Comprehensive and 14 Limited Agreements in India.
Now let’s understand one more aspect of double taxation i.e., jurisdictional taxation & economic taxation. Jurisdictional Taxation means that same person is taxed twice on the same income
by more than one territory or country whereas economical taxation means more than one person is taxed on same income.
Section 90 of Income tax Act, 1961 empowers Government of India to enter DTAA for avoidance of double taxation. Further under section 90A Government of India can adopt agreement entered between specified association in India and specified association in specified territory outside India to provide relief from double taxation on income on which income tax is chargeable under Indian Income tax Act, 1961 as well as and under the corresponding law in force in that specified territory outside India to promote mutual economic relations, trade and investment, or for avoidance of double taxation of income.
The major statutory objectives of section 90 & 90A are avoidance of double taxation, promotion of mutual economic relations, trade & investment with the objective of economic growth, relief to taxpayers from doubly taxed income, exchange of information between mutually agreed countries to take measures for tax avoidance and tax evasions and recovery of tax.
The major aspects covered in a DTAA are methodology for avoidance of double taxation of income in India or foreign country, nature of income covered under DTAA and any specific provision w.r.t. to specific income, definitions of person covered in DTAA, procedure for recovery of tax under Indian Income tax and under corresponding law in force in respective foreign country, procedure for tax deduction and providing tax reliefs, process for exchange of essential information between concerned countries as is foreseeably relevant for carrying out the provisions of DTAA or to the administration or enforcement of the domestic laws of the contracting countries along with its use and terms of confidentiality, procedure for investigation of cases of tax evasion or avoidance, clause on termination, mutual agreement procedure and so on & so forth.
Now let’s converse some of the key concepts and clauses with respect to certain income covered under Articles of DTAA (reference DTAA with UK):
- The Income from immovable property may be taxed in the Contracting State (Country) in which such property is situated.
- For the purpose of Business Income, the profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is directly or indirectly attributable to that permanent establishment (PE). Where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, the profits which that permanent establishment might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment shall be treated as being the profits directly attributable to that permanent establishment.
- The term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on and shall include a place of management, branch, an office, factory, workshop, etc. There are certain exclusions also like PE does not include facilities solely kept for the purpose of display or storage of goods, fixed place solely for advertising, etc. For detailed explanation of PE corresponding DTAA may be referred.
- Profits derived from the operation of aircraft in international traffic by an enterprise of one of the Contracting States shall not be taxed in the other Contracting State.
- Income of an enterprise of a Contracting State from the operation of ships in international traffic shall be taxable only in that State. However, these provisions shall not apply to income from journeys between places which are situated in a Contracting State.
- Directors’ fees and similar payments derived by a resident of a Contracting State in his capacity as a member of the board of directors of a company which is a resident of the other Contracting State may be taxed in that other State.
- Income derived by entertainers or athletes, from their personal activities as such may be taxed in the Contracting State in which these activities are exercised.
- Remuneration, other than a pension, paid by the Government of a Contracting State to any individual who is a national of that State in respect of services rendered in the discharge of governmental functions in the other Contracting State shall be exempt from tax in that other Contracting State.
- Article on Non-discrimination specifies that the nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation, or any requirement connected therewith which is other or more burdensome than the taxation or any requirement connected therewith to which nationals of that other State in the same circumstances are or may be subjected.
It is noteworthy that section 90(2) of Income tax, 1961, the provisions of Domestic Law will apply to the extent it is more beneficial than DTAA to the assessee. The provisions of DTAA shall override domestic tax law.
DTAA model is generally drafted on the basis of two major models i.e. OECD based model and UN based model. OECD model focuses on residency-based taxation, which means that tax should be levied by country where the assessee is resident and credit or exemption to be given by other country involved. On the other hand, UN based model focuses on source-based taxation which gives more relevance to region of source of Income rather than residency of the assessee. Usually developing countries prefer UN based model. Based on specific agreement which each countries the final DTAA is Signed and Ratified.
Another aspect considered in DTAA is whether income is active or passive. Income derived from investment in any asset is passive income, while income derived from active cross border operation of business, profession or service is active income. For taxation of business income concept of Permanent establishment needs to be considered as earlier.
Commercial transactions between the different parts of the multinational groups may not be subject to the same market forces shaping relations between the two independent firms. Transfer price in such cases may be arbitrary and dictated, with no relation to cost and added value, diverge from the market forces. The effect of transfer pricing is that the parent company or a specific subsidiary tends to produce insufficient taxable income or excessive loss on a transaction. For instance, profits accruing to the parent can be increased by setting high transfer prices to siphon profits from subsidiaries domiciled in high tax countries, and low transfer prices to move profits to subsidiaries located in low tax jurisdiction. The result is revenue loss and a drain on foreign exchange reserves. To address this issue section 92C provides methods of calculation of arm’s length transaction in international transaction
viz. comparable uncontrolled price method, resale price method, cost plus method, profit split method, transactional net margin method and such other method as may be prescribed. This will aid in ensuring that transfer prices are not arbitrary.
As per Section 195(1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (other than interest referred to in section 194LB/194LC/194LD or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries”) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force. In addition, section 195(6) read with rule 37BB prescribes furnishing of Form no. 15CA/CB/CC.
The Government of India has made it mandatory for assessee to obtain Tax Residency Certificate (TRC) from the country of residence to avail the benefits of the Double Taxation Treaty in India.
With the increasing cross border transactions in the current global economy, tax evasion including tax avoidance both need to be tracked to ensure each transaction is covered in the ambit of revenue and not missed out completely from both the contracting states. Different approaches may be used by countries to address the improper use of tax treaties. Some of these approaches are found in domestic law while others involve tax treaties. Chapter X-A of the Income Tax Act, 1961 of India deals with the concept of General anti-abuse rules (GAAR) which is one such measure to address this issue in India. GAAR specifically differentiates between Tax evasion & avoidance v/s. Tax mitigation. Tax mitigation is a fair approach for reduction in tax by using legitimate fiscal incentives provided under
law. While tax evasion & avoidance both are considered as wilful suppression of facts and misrepresentation to avoid or evade tax. GAAR focuses on substance over form whereby a transaction will be considered as impermissible avoidance agreement (IAA) explained as follows:
- An impermissible avoidance arrangement means an arrangement, the main purpose or one of the main purposes of which is to obtain a tax benefit and it—
- creates rights, or obligations, which are not ordinarily created bet-ween persons dealing at arm’s length.
- results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;
- lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part; or
- is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.
- An arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit.
As per GAAR provisions, it is the responsibility of the revenue to declare an arrangement as IAA. If the revenue considers that the arrangement is an IAA, the assessee will be given an opportunity to be heard and subsequently on response of assessee further action will be taken.
The CBDT has issued a guidance on Mutual Agreement Procedures (MAP) procedure and matters connected thereto for the benefit of taxpayers, tax practitioners, tax authorities, and Competent Authorities (CAs) of India and of treaty partners. A taxpayer resident in India can make an application to the CA of India having jurisdiction over the case if it considers that the actions of the tax authorities of the treaty partner resulted or will result in taxation not in accordance with the relevant tax treaty. Such an application has to be made in Form No. 34F in accordance with rule 44G.
There currently exists no single entity with the global legitimacy, resources and expertise to serve as a single coordinating body for international tax cooperation. In the absence of such an entity, organizations active in this area must work together with a view to meeting common tax and development goals in the most efficient, responsive and participatory ways. While each country is responsible for its own tax system, the United Nations universal membership and legitimacy act as a catalyst for increased international cooperation in tax matters to the benefit of developed and developing countries alike.The most important changes included in the 2021 version of the UN Model address concerns expressed by developing countries regarding tax treaty obstacles to the taxation of foreign enterprises on income from automated digital services and on gains on so-called “offshore indirect transfers”. The 2021 UN Model also features new guidance on the application and interpretation of the definition of permanent establishment, the concept of beneficial owner, and the application of the Model’s provisions to collective investment vehicles, pensions funds and real estate investment trusts. The fifth edition of the UN Model Tax Convention, culminates four years of work by the UN Tax Committee and its Subcommittees, supported by the Secretariat in the UN Department of Economic and Social Affairs (ESOSOC).
The ECOSOC Special Meeting on International Cooperation in Tax Matters was held in April 2022 in conjunction with the 24th session of the United Nations Committee of Experts on International Cooperation in Tax Matters. This year’s Special Meeting was presented critical topics in the current international tax landscape, which was analysed and debated in the context of the COVID-19 pandemic recovery and beyond.
Another important aspect considered in 2021 UN Model was increasingly digitalized and globalized economy which continues to pose great challenges to the fairness and workability of tax systems as usual bilateral treaty framework for taxing cross-border business income, which requires a physical presence which often leads to the tax loss of market countries, usually capital importing developing countries. The new Article 12B of the UN Model Double Taxation Convention is developed by the UN Tax Committee to address the taxation of income from automated digital services in bilateral situations.
Article 12B, in the 2021 UN Model, preserves, in the treaty relationship, market country domestic law taxing rights on digital services, including online advertising services, supply of user data, online search engines, online intermediation platform services, social media platforms, digital content services, online gaming, cloud computing services, and standardized online teaching services. The Committee is currently working on a possible mechanism for wide adoption of the UN Model provisions relevant to taxing the digitalized and globalized economy, as well as other recent provisions, through a multilateralized form of implementation (a multilateral instrument). Such a mechanism would allow many existing bilateral treaties to be amended at once, sparing countries the onerous and time-consuming process of amending individual treaties.
The Committee is also examining the physical presence-based tax treaty thresholds or tests that currently apply before a country where
profits are made can tax such profits of other countries’ residents. Such tests include “permanent establishment” and “fixed base” tests. The Committee is considering the function and relevance or otherwise of such tests to trigger taxing rights in an increasingly digitalized and globalized economy. The work is supported by the UN Tax Committee’s Subcommittee on Taxation of the Digitalized and Globalized Economy and by the Committee Secretariat in UNDESA.
Thus, it is in the interests of both taxpayers and governments that tax barriers to cross-border trade and investment such as double taxation be removed while ensuring that domestic tax systems can be properly applied and administered. Tax treaties aids in eliminating tax barriers in cross-border transactions which may be caused due to excessive source taxation, tax discrimination, uncertainty and complexity which may result in significant deterrence to foreign investment. At the same countries should take measures to minimize cross-border tax evasion and avoidance as all countries are vulnerable to capital flight and erosion of their tax base.
With this note I, conclude here and convey my best wishes to All India Federation of Tax Practitioners (West Zone) & National Association of Tax Professionals (West Zone) along with The Gujarat States Tax Bar Association, Tax advocates Association of Gujarat, Jamnagar Branch of WIRC of ICAI, The commercial Tax Practitioners Association-Jamnagar, Jamnagar Tax Consultants Association and the entire team of organizers and managing committee for conducting such National Tax conference and looking forward to such more initiatives in future as well which will aid in exchanging thoughts and different perspectives of all the tax professional spread across our Nation.
(Source : Article published in Souvenir released at National Tax Conference held at Dwarka on 2nd & 3rd October, 2022)