BEPS Multilateral Instrument (MLI), India’s …

1 BEPS Multilateral Instrument (MLI), india s corresponding Positions, implementation (GAAR) Dr. Parthasarathi Shome Chairman International Tax Research and Analysis Foundation (ITRAF) Visiting Fellow, London School of Economics Faculty of Law, 2017-18 Recent Developments in Indian Tax Laws, Policy and Practices Introduction The OECD tabled the Report Addressing Base Erosion and Profit Shifting to the G20 in 2013 Following this, the OECD and G20 countries adopted a 15 point Action Plan to address BEPS Final Action reports were issued in late 2015. The BEPS package was designed to be implemented through: Changes in domestic law Modification of treaty provisions To help with the implementation of the BEPS Actions, Action 15 envisaged the formulation of a MLI (also called the Convention) The MLI contains Articles. These are provisions pertaining to corresponding subjects of other BEPS Actions Accordingly, we look at some of the Actions and the corresponding MLI Articles Recent Developments in Indian Tax Laws, Policy and Practices Introduction (contd.)

2 The OECD Multilateral Instrument (MLI) was signed by some 70 countries on 7 June 2017 and incorporates treaty measures in relation to several BEPS related areas including: Hybrid Mismatch (Action 2) Treaty Abuse (Action 6) Permanent Establishment (Action 7) Dispute Resolution (Action 14) Parties to the MLI are also required to submit an MLI position document containing: Covered Tax Agreements (CTAs) Tax treaties covered by the MLI List of reservations and notifications made by the party Recent Developments in Indian Tax Laws, Policy and Practices Action 2 Hybrid Mismatch Arrangements Hybrid Mismatch Arrangements exploit differences in the tax treaty of an entity or Instrument under the laws of two or more tax jurisdictions to achieve double non-taxation, including long term deferral (Action 2, 2015 Final Report) Action 2 aims to ensure that hybrid instruments and entities, as well as dual resident entities, are not used to obtain the benefits of a treaty Thus Action 2 calls for the development of model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effects of hybrid instruments and entities Recent Developments in Indian Tax Laws, Policy and Practices Action 2 Hybrid Mismatch Arrangements (contd.)

3 MLI Part II Article 3 Transparent Entities Income derived from an entity or arrangement that is treated as fiscally transparent by either jurisdiction which is a party to the CTA, shall be considered income of a resident of a party to the CTA, but only to the extent that that party treats such income as the income of a resident. A tax exemption or deduction provision of a CTA, to the income of a resident of one jurisdiction, shall not apply solely because the income is also designated income derived by a resident of other jurisdictions which are party to the CTA. Indian position india has reserved the rights to Article 3 in its entirety Recent Developments in Indian Tax Laws, Policy and Practices MLI Part II Article 4 Dual Resident Entities If by virtue of the provisions of a CTA, a person (not an individual) is deemed to be a resident of more than one jurisdiction, then the parties to the CTA must determine through mutual agreement which one jurisdiction the person is a resident, for the purposes of the CTA.

4 The decision must be made giving regard to the entity s place of effective management, the place where the entity is incorporated or otherwise constituted and any other relevant factors In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the CTA except to the extent and in such manner as may be agreed upon Action 2 Hybrid Mismatch Arrangements (contd.) Recent Developments in Indian Tax Laws, Policy and Practices MLI Part II Article 4 (contd.) Indian position As per Article 4(4) india has listed CTAs containing provisions not subject to reservations under Article 4 If all jurisdictions to a particular CTA have also listed the same provision then the said provision will be replaced by the provision of Article 4(1) In all other cases the provision of Article 4(1) shall supersede the provisions listed by india , to the extent that the CTA provision is incompatible with Article 4(1) Action 2 Hybrid Mismatch Arrangements (contd.)

5 Recent Developments in Indian Tax Laws, Policy and Practices MLI Part II Article 5 Application of Methods for Elimination of Double Taxation Option A: Tax exemption provisions of a CTA exempting tax on an income of a resident in one jurisdiction, to eliminate double taxation, shall not apply if the other jurisdiction has also applied the same exemption provision on the same income. Option B: Tax exemption provisions of a CTA exempting tax on an income of a resident in one jurisdiction, to eliminate double taxation because the income is treated as a dividend in that jurisdiction, shall not apply if that same income gives rise to a deduction in the income of a resident of the other jurisdiction. Option C: When a resident of one jurisdiction derives income or owns capital which may be taxed in the other jurisdiction, the first jurisdiction will allow a tax deduction on the income equal to the income tax paid by the resident or a tax deduction on the capital equal to the capital gains tax paid by the resident, in the second jurisdiction.

6 Indian position india has reserved the rights to Article 5 in its entirety Action 2 Hybrid Mismatch Arrangements (contd.) Recent Developments in Indian Tax Laws, Policy and Practices Action 6 Treaty Abuse Action 6 identifies Treaty Abuse as an important source of BEPS concerns. It is not surprising that it is a minimum standard reflected as mandatory provisions in MLI Articles 6 and 7 Action 6 recognizes two instances of Treaty Abuse: 1. Cases where a person tries to circumvent limitations provided by the treaty itself (eg. treaty shopping) 2. Cases where a person tries to circumvent the provisions of domestic law using treaty benefits Action 6 admits that the first set of cases could not be addressed by specific anti-avoidance rules and required a general anti-avoidance rule in treaties. This is found in the Principal Purpose Test (PPT) and SLOB options in the MLI Recent Developments in Indian Tax Laws, Policy and Practices Action 6 Treaty Abuse (contd.)

7 MLI Part III Article 6 Purpose of a Covered Tax Agreement (CTA) The following preambular text shall be added to a CTA (Article 6(1)): Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions) This text shall be included in place of or in the absence of any preambular language in a CTA referring to an intent to eliminate double taxation As it is a minimum standard the only reservation allowed is if there already exists preambular language describing the intent to eliminate double taxation without creating the opportunity for tax evasion or avoidance Recent Developments in Indian Tax Laws, Policy and Practices MLI Part III Article 6 (contd.)

8 The Article also provides the option of an additional preambular text (Article 6(3)): Desiring to further develop their economic relationship and to enhance their co-operation in tax matters, This text is optional and is only applicable if all parties to a CTA chose to apply it Indian position The Indian position document is silent on Article 6 As a minimum standard the provision in Article 6(1) (mandatory inclusion of preambular text) can therefore be taken as automatically applicable Action 6 Treaty Abuse (contd.) Recent Developments in Indian Tax Laws, Policy and Practices MLI Part III Article 7 Prevention of Treaty Abuse While pertaining to a minimum standard, Article 7 provides 3 options to fulfil the mandatory obligation of Action 6: Option 1 Principle Purpose Test (PPT): A benefit under the CTA will not be granted if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit The benefit may yet be granted if, on the request of the person and after relevant facts and circumstances are taken into consideration, it is determined that the benefit would have been granted in the absence of the transaction under scrutiny Action 6 Treaty Abuse (contd.)

9 Recent Developments in Indian Tax Laws, Policy and Practices MLI Part III Article 7 (contd.) Option 2 Simplified Limitation on Benefit clause (SLOB) (supplemented by the PPT): CTA benefits will be limited to only CTA provisions which provide the following: If a person is the resident of more than one party, then the provision determines which party the person will be considered a resident of, for the purposes of the provision If initial adjustments are made by other parties to an enterprise of one party, to the tax amount on associated enterprises, and the CTA provides for corresponding adjustments Residents are allowed to request tax authorities of a party to a CTA to consider tax cases not in accordance with the CTA Unless the resident is designated to be a qualified person as determined by Article 7(9) Action 6 Treaty Abuse (contd.) Recent Developments in Indian Tax Laws, Policy and Practices MLI Part III Article 7 (contd.)

10 Option 2 Simplified Limitation on Benefit clause (SLOB) (contd.) Benefits will also be entitled: When a resident with an active conduct of business in one jurisdiction to a CTA, derives an income in the other jurisdiction which is incidental to that business (regardless of whether the resident is a qualified person) (Article 7(10)) When an unqualified resident owns at least 75 per cent of the beneficial interests of the resident, on at least half of the days of any twelve-month period (including the time when the benefit would otherwise be accorded) (Article 11) At the discretion of a tax authority, for a resident not entitled to the above benefits, if such resident can demonstrate that its principle purpose was not to attain such benefit from the CTA Action 6 Treaty Abuse (contd.) Recent Developments in Indian Tax Laws, Policy and Practices MLI Part III Article 7 (contd.) Option 3 Detailed LOB clause The MLI does not include a detailed LOB provision.