Basics of International Tax Ghatkopar CPE Study Circle

Basics of International Tax Ghatkopar CPE Study Circle CA Jhankhana Thakkar 8 October 2016 “The concept marks the dividing line for businesses trading with a country and trading in that country. “ 1

Contents Section Page Need for Treaty Analysis 3 - 5 Overview 6 - 20 Articles – 21 - 48 Article 1 Article 2 Article 3 Article 4 How to read Tax Treaty - E. g. India - UK 49 - 98 Foreign Tax Credit Rules 99 - 126 Non-discrimination 127 – 128 Protocol 129 - 130 Steps when referring to tax treaties 131 - 132 Equalisation Levy 133 - 137 Case studies 1 to 7 138 - 151 2

Need for Treaty Analysis 3

Need for Treaty Analysis fff Foreign Company • Withhold Tax ? • Apply Treaty Provision ? • Contradictory Rulings • Expense Disallowance Indian Company Invoice - Rendition of services by Foreign Company Payment by Indian Company 4

Introduction to Tax Treaties Why are tax treaties Promotion of cross border trade through elimination of double taxation Providing clarity of fiscal situation of a taxpayer Exchange of information to combat tax avoidance/tax evasion Sharing of tax revenues 5

Overview 6

Overview The concept Tax treaties are agreements entered into between countries with respect to taxes on income and on capital, wherein the countries agree to: i. be restricted from taxing, or ii. provide relief for taxes paid in the other treaty country Territorial Nexus Nation has sovereign right of imposing tax at its discretion, subject to territorial nexus ►Territorial nexus connect may be qua the taxpayer or qua his income ü India : Residence, extensive Source Rule ü USA : Citizenship ü Hong Kong : Territorial 7

Formulation of Tax Treaty 2. 1. Negotiation of a tax treaty Drafting of the articles (by Ministry of Finance – Department of Revenue) 5. 3. Notification Signing (by CBDT) (typically, by the Chairman of CBDT) 4. Ratification (by Ministry of Finance – Department of Revenue) 8

Categories of Tax Treaties • Deals with specific subject matter • DTAA between India and Pakistan is limited to air transport only • Exchange of information with British Virgin Islands • Deals with most sources of income • EU Directives • SAARC Income Tax Agreement - Bangladesh; Bhutan; India; Maldives; Nepal; Pakistan; Sri Lanka ( sharing of tax policies, training to tax administration, teachers, students taxation, etc. ) Limited Treaties Comprehensive treaties Multilateral treaties vs. Bilateral treaties 9

Model Tax Conventions OECD Model UN Model • Organization for Economic Co-operation and Development (OECD) • Established in 1961 with countries as its members • • Tax treaties between developed and lesser developed countries, or between developing countries • Drafted in 1980, designed to encourage flow of investments from the developed to developing countries • Is a compromise between source principle and residence principle • Gives more weightage to source principle, i. e. income should be taxed where it arises • Most of India’s tax treaties are based on this model developed Essentially a model treaty between two developed nations • Advocates residence principle • Lays emphasis on right of state of residence to tax • India not a OECD member - Currently has been granted the “Observer” status • Currently 34 countries including Australia, US, UK, France, Germany etc are OECD members 10

Model Tax Conventions Other Models • US Model - Only model which USA uses as a basis of negotiating treaties with its other treaty partners • ANDEAN Model - Drawn up by Latin American countries (Bolivia, Chile, Columbia, Ecuador, Peru & Venezuela) Relevance of Model Conventions • Aids negotiation of tax treaties • To makes treaties uniform • Aids in interpretation 10 11

Model Tax Conventions OECD & India 2001 - Member of technical advisory group on Ecommerce Tax Treaty Characterization issues July, 2006 – Granted ‘OBSERVER’ status Used by Courts/Tribunals The Courts/Tribunals have placed extensive reliance on OECD Commentary while interpreting tax treaties: • • May, 2007 - Offered enhanced engagement with a view to possible membership • Morgan Stanley – Supreme Court Set Satellite – Mumbai ITAT Galileo International Inc. – Delhi ITAT July, 2008 - India’s position included in the nonmember country positions section of the 2008 update 12

Construct of a Tax Treaty - Articles Definition Provisions Scope Provisions Article 1 : Personal Scope Article 2 : Taxes Covered Article 29: Entry into force Article 30: Termination Substantive Provisions Article 3: General Definitions Article 6 : Immovable Property Article 4: Residence Article 8: Shipping etc Article 5: Permanent Establishment Article 7 : Business Profits Article 10: Dividend Article 11: Interest Article 12: Royalty & FTS Elimination of double taxation Anti avoidance Article 23 : Elimination of double taxation Article 25: Mutual agreement Article 9: Associated Enterprise Article 26: Exchange of Information Article 13: Capital Gains Article 14: Independent Personal Services Article 15: Dependent Personal Services Article 16: Directors Article 17: Artists & Sports persons Article 18: Pensions Article 19: Government Service Miscellaneous Provisions Article 24: Non –Discrimination Article 27: Diplomats Article 28: Territorial Extension Article 20: Students Article 21: Other Income Article 22: Capital 13

Structure of Treaty Article OECD Model 2014 UN Model 2011 US Model 2016 1 Persons covered 2 Taxes covered 3 General definitions 4 Resident 5 Permanent establishment 6 Income from immovable property Income from real property (immovable) property 7 Business profits 8 Shipping, inland waterways transport Shipping and air transport Shipping, inland waterways and air transport 9 Associated enterprises 10 Dividends 11 Interest 12 Royalties 13 Capital gains Gains 14 Deleted Independent personal services Income from employment 14

Structure of Treaty Article OECD Model 2014 UN Model 2011 US Model 2016 15 Income from employment Dependent personal services Directors’ fees 16 Directors’ fees and remuneration of top level managerial officials Entertainers and sportsmen Artistes and sportsmen 18 Pensions and social security payments 19 Government service 20 Students and trainees 21 Students Other income 22 Capital Limitation on benefits 23 - - Relief from double taxation 23 A Exemption method - 23 B Credit method - 24 Non - discrimination 25 Mutual agreement procedure 26 Exchange of Information Exchange of information and 15 administrative assistance 17 Pensions, social security, annuities, alimony and child support Pension funds

Structure of Treaty Article OECD Model 2014 UN Model 2011 27 Assistance in the collection of taxes Members of diplomatic missions and consular posts Subsequent changes in law Members of diplomatic missions and consular posts 28 Members of diplomatic missions and consular posts US Model 2016 29 Territorial extension Entry into force 30 Entry into force Termination 31 Termination - - 16

Types of double taxation Juridical double taxation Economic double taxation • • • Two or more states levy taxes on same income for identical periods. Arises due to overlapping claims of tax jurisdictions Same economic stream of income taxed in two or more states but in the hands of different taxpayers (E. g. business profit and dividend in different countries) Tax treaties largely prevent/mitigate juridical double taxation 17

Juridical Vs Economic Double Taxation Juridical Double taxation R R Co Co A Y S Income X Co B Income is subject to tax in two countries Two legal entities are subject to tax on same –Shared taxing rights Income in two countries – Ex: FTS/Royalty Ex: Unilateral Transfer Pricing adjustment 18

Legal Effect of Tax Treaty • Applicability of Treaty is conditional to the applicability of the Act. Treaties do not impose taxation since they are not given the function of being tax instruments • Scope of Section 5 and Section 9 needs to be examined -- if income liable to tax in India relevant Treaty is applicable ü Taxation is always based on domestic tax law. Treaties do not impose taxation • Section 90(2) provides: “. . in relation to the assesse to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assesse” ü Treaty does not automatically have precedence, but domestic tax laws say so • CBDT issued Circular 333 -- specific provisions of the tax treaty override general provisions of the Act, of importance prior to introduction of Section 90 19

Treaty Override • Treaty are given effect by domestic legislations therefore domestic law can provide exceptions ü Section 90 provides Article 24 –Non-discrimination is not applicable on tax rates ü Special taxes not covered under Article 2 v UK – Diverted Profits tax v India – Dividend Distribution Tax ; Buyback Tax ü Anti – Avoidance Rules v Domestic – General Anti Avoidance Rules v Tax Treaty – Limitation of Benefits (India Singapore Tax Treaty) 20

Articles 21

Article 1 22 13

Article 1 Persons Covered • Text of Article 1 of OECD / UN Model Convention is as follows: “This convention shall apply to persons who are residents of one or both of the Contracting States. ” • Since applicability of Convention is to “Persons” – important to understand what constitutes “Person”. • Article 2 of OECD / UN Model Convention defines ‘person’ as follows: - The term “person” includes an individual, a company and any other body of persons. • The term ‘person’, in most Indian tax treaties, includes an individual, a company, a body of persons and any other entity, which is treated as a taxable unit under the taxation laws in force in the respective Contracting State 23

Article 1 Persons Covered - Resident • Convention is applicable only to persons who are “Residents” of one or both Contracting States. • Article 4 of OECD / UN / US Model Convention usually considers with minor modifications, the term “resident of a Contracting State” means – any person – who under the laws of that state – is liable to tax therein – by reason of his domicile, residence, place of management or – any other criterion of similar nature. • Majority Indian bilateral Conventions contains the above definition with few alterations. • India-UK treaty has been amended w. e. f. 27 -12 -2013 to state that in case of partnerships and trusts, these entities would be eligible for treaty benefits if either these entities or partners or beneficiaries are subject to tax in the country of their residence 24

Article 1 Persons Covered – Partnership ? • Partnership firm may get covered within the scope of “person” however, it may not get covered within the scope of “Resident” • Different tax treatments (Transparent Vs. In transparent) to partnership firms in different states creates multiple issues like - Double taxation - Availing treaty benefit - Availing tax credit Draft • OECD key principles: ü A partnership can claim treaty benefits only if it qualifies as a “resident” of Country R ü Partner entitled to treaty benefits only if the partnership is treated as transparent in the partners residence country ü Treatment in source country is irrelevant 25

Article 1 – Persons covered Partnerships : Uniform treatment by States Partner A Partner B 60% Country R 40% Partnership Both Country R and S treat the partnership as fiscally transparent (i. e. a “look through” entity for tax purposes) Country S Income derived by partnership from sources in Country R Under Country R/Country S treaty (identical to OECD model); i. Partnership: a “person: , but not a “resident” (not “liable to tax”) • Partnership can’t claim treaty benefits ii. Partners A & B: “paid to” / “derived by” Partners A and Partner B • Partners A & B can claim treaty benefits 26

Article 2 27 13

Article 2 Taxes Covered - Scope of the Convention • “This convention shall apply to taxes on income and on capital imposed on behalf of a Contracting State or its political subdivisions or local authorities, irrespective of the manner in which they are levied. ” • Applicable to all taxes - On income and capital; - Imposed by contracting state; and - Irrespective of manner of levy • “taxes on income” vis-à-vis “direct taxes” • Are indirect taxes covered? • Are future taxes covered? • Practically – • Most tax treaties defines specific taxes which are covered • Generally, indirect taxes are excluded • Interests and penalties are not included 28

Article 2 Art 2(2) – Definition of Taxes • “There shall be regarded as taxes on income and on capital all taxes imposed on total income, on total capital, or on elements of income or of capital, including taxes on gains from alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation. ” - OECD and UN Model are identically worded Taxes on total income or total capital Taxes on elements of income or capital Taxes on gains from alienation of movable or immovable properties Taxes on wages and salaries Taxes on capital appreciation 29

Article 2 Art 2(2) – Definition of Taxes – Indian Perspective Interest and Penalty Surcharge and Education Cess Dividend distribution tax / buyback tax Property tax / Wealth tax Social security charges Equalization levy 30

Article 2 Art 2(2) – Future Taxes • “The convention shall apply also to any identical or substantially similar taxes that are imposed after the date of signature of the Convention in addition to, or in place of existing taxes. The competent authorities of the contracting states shall notify each other of any significant changes that have been made in their taxation laws. ” • Intent – no need to amend the treaty in case one of the treaty country amends its domestic law with identical or substantially similar taxes in addition to, or in place of an existing treaty • Identical or substantially similar taxes − Essential Characteristics of tax – Basis – Computation method – tax payers − Education Cess – similar to surcharge • Undertake to notify or communicate any significant changes – no time limit has been prescribed 31

Article 3 32 13

Article 3 Definitions • OECD / UN / US Model have Article 3 as definition section • Article 3(1) : Defined terms • Terms defined − Person − Company − Enterprise of a Contracting State and the Enterprise of the other Contracting State − International traffic − Competent Authority − National − Business • Article 3(2) : Undefined terms Definitions in Article 3 apply unless the context otherwise requires 33

Article 3 Definitions • Applicable throughout the conventions • Separate Articles, such as − Article 4 - Resident − Article 5 - Permanent establishment − Article 6 - Immovable property − Article 10 - Dividends − Article 11 - Interest − Article 12 - Royalties • Treaties also contain additional definitions – ‘tax’, ‘fiscal year’, ‘India’ 34

Article 3 Person Article 3 – General definitions “ 1. For the purpose of this Convention, unless the context otherwise requires: (a) the term “person” includes an individual, a company and any other body of persons; ” • Partnership as person − Defined as Company OR − Constitute other bodies of persons 35

Article 3 International Traffic General definitions “ 1. For the purpose of this Convention, unless the context otherwise requires: (e) the term “international traffic” means any transport by a ship or aircraft operated by an enterprise that has its place of effective management in a Contracting State, except when the ship or aircraft is operated solely between places in the other Contracting State; ” Interpretation • Relevance under Article 8 • Article 8 deals with profits from operation of ships or aircrafts in international traffic, taxable in Contracting State in which the place of effective management (POEM) of the enterprise is situated. • Proposed Changes (relevant to the definition of ‘International traffic’ as a result of change in Article 8) - Exclusive taxation in state of Residence as against state of ‘POEM’ 36

Article 3 International Traffic Interpretation – Example 1 State A (POEM) ___________ • The definition preserves the right of the state having POEM i. e. State A, to tax domestic traffic and international traffic Example, State A can tax the profits • within State A and State B ____________ State C • between State A and B or State A and C • It allows the other contracting state (i. e. not having POEM) i. e. State B or State C, to tax traffic solely within its boundaries 37

Article 3 International Traffic Interpretation – Example 2 USA _____________ India • India can tax profits of an enterprise from operations of ship or aircraft, only where such operations are confined solely to places in India Delhi Goa 38

Article 3 International Traffic Interpretation – Example 3 Singapore ______________ • As a part of same voyage, the first leg of the journey is between two Contracting States and the second leg is within a Contracting State, both legs of the journey will be part of a voyage and falling within definition of ‘international traffic’. India Chennai Mumbai 39

Article 3 Art 3(2) – Undefined terms • As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that state for the purposes of taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State. Rules in Article 3(2): • …. unless the context otherwise requires…. ” • Domestic tax law meaning vs. domestic general law meaning • Ambulatory vs. Static 40

Article 3 Art 3(2) – Undefined terms The context is determined as under • Intention of the Contracting States when signing the Convention. • Principle of reciprocity (i. e. meaning given to the term in question in the legislation of the other Contracting State). • Satisfactory balance : − need to ensure the permanency of commitments entered into by states when signing a Convention − need to apply the Convention in a convenient and practical way over time. 41

Article 3 Art 3(2) – Static Vs Ambulatory Approach Meaning Ambulatory Approach Static Approach Law in enforced when the Convention is applied Law prevalent at the time when the Convention is signed • OECD Convention refers the word “at any time…. . at that time” 42

Article 3 Art 3(2) Vs Income tax Act Finance Act, 2003 w. e. f 1. 4. 2004 (A. Y. 2004 -05 onwards) Finance (No. 2) Act, Finance Act, 2012 2009 Explanation 3 added Substitution of w. e. f. 1. 10. 2009 Section 90 w. e. f 1. 10. 2009 Any term used but not defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf. Section 90(3) is same For the removal of doubts, it is hereby declared that where any term is used in any agreement entered into under subsection (1) and not defined under the said agreement or the Act, but is assigned a meaning to it in the notification issued under sub-section (3) and the notification issued thereunder being in force, then, the meaning assigned to such term shall be deemed to have effect from the date on which the said agreement came into force. 43

Article 3 Summary Is the term defined in the treaty otherwise than under Article 3(1)? Yes No Apply the definition as per Article Is the term defined under Article 3(1)? Yes No Does Context requires other meaning? Apply the definition Yes Is the term defined in the Domestic ‘tax law’? Yes Apply ‘tax law’ No Apply the treaty No Apply ‘other law’ 44

Article 4 13

Article 4 Resident • The term “resident of a contracting state” means any person who under the laws of that State is liable to tax by reason of ü Domicile ü residence ü Place of management ü Any other criterion of a similar nature • Liable to tax does not mean that person is subject to tax or pays tax in that State. Reason for liable to tax but no tax paid in that State • Loss making entity • Taxable income below threshold limit • Tax exemptions • Non-taxable entities or tax transparent entities • This term does not include any person who is liable to tax in that state in respect only of income from sources in that State or capital situated therein ü Taxable due to branch ü Taxable due to capital gains arising on alienation of capital asset 46

Article 4(2) – Tie Breaker Rule - Individuals Closer with one state Centre of Vital interest R In one state Both Permanent home R Not determinable Both or none Both Habitual abode In one state Nationality Dispute Resolution In one state R R To be decided by mutual agreement or by competent authority

Article 4 Art 4(3) – Place of Effective Management (POEM) – Other than Individuals • The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made Key Managerial Decisions CEO & executives carry activities Place of Board Meetings Key Consideration for Po. EM Legal Status of the Co Headquarters located Accounting Records kept

How to read Tax Treaty India – UK (example) 49

Note: • For convenience of understanding of the Articles, India has been treated as the source country in the following slides. • The treaties would equally apply if the other country would have been the source country. • DTAA with United Kingdom (UK) has been taken as a example for better understanding 50

Relevant dates • Signed on – January 25 th, 1993 - Page 27 • Date of notification in the official gazette: February 11, 1994 – Page 1 • Date of coming into force April 1, 1994 i. e. A. Y. 1995 -96 – Page 25 • Protocol signed on January 25 th, 1993 (“Old Protocol”) – Page 26 • Protocol signed on October 30 th, 2012 coming into force from April 1, 2013 i. e. A. Y. 2014 -15 (“New Protocol”) – Page 34 51

Article 1 – Scope of the Treaty • The Convention shall apply to persons who are residents of India and/or United Kingdom (UK) • India is defined in Article 3(1)(b) to mean – “the Republic of India” • UK is defined in Article 3(1)(a) to mean – “Great Britain and Northern Ireland” 52

Article 1 (Contd) – Territorial Extension of India - UK • This Convention extends to the territory of India/UK, including its territorial sea, and to those areas of the exclusive economic zones or the continental shelf adjacent to the outer limit of the territorial sea of India which it has, in accordance with international law, sovereign rights for the purpose of exploration and exploitation of the natural resources of such areas, and references in this Convention to India shall be construed accordingly. • The territory of India has not been extended to include the airspace above it? ? (contrast with DTAA s with other countries eg. Singapore, Netherlands etc) 53

Article 2 – Taxes Covered • In India, income tax include surcharge thereon • In UK, corporation and petroleum tax are also covered under the Convention. • Compare the same with India-Norway, India-Hungary or India-Germany tax treaties. • In Norway: Nine types of taxes are covered; E. g. Municipal tax on income, National contribution to Tax Equalisation Fund, Seamen’s tax, etc. • In Hungary: Seven types of taxes are covered; E. g. income-tax on household and auxiliary farms, Town and community contributions, levy on dividends and profit distributions of commercial companies, etc. • In Germany: Trade Tax is covered 54

Article 3 – General Definition • Tax” excludes amount paid in relation to any default, omission or penalty in relation to the taxes. • “Fiscal year” defined for India to mean as “previous year” as per Income Tax Act & for UK to mean as a year beginning with April 6 in one year and ending with April 5 in the following year. 55

Article 3 – General Definition (contd’) • Prior to amendment the definition read as under: The term “person” includes an individual, a company and any other entity which is treated as a taxable unit under the taxation laws in force in the respective Contracting States, but, subject to paragraph 2 of this Article, does not include a partnership; Para 2 of the Article states that a “partnership which is treated as a taxable unit under the Income-tax Act, 1961 of India shall be treated as a person for the purposes of this Convention. ” (Refer Linklaters LLP vs. ITP (40 SOT 51) (TMum)) • After the amendment vide the New Protocol, the definition of person has been amended to read as under: The term "person" includes an individual, a company, a body of persons and any other entity which is treated as a taxable unit under the taxation laws in force in the respective Contracting States; 56

Article 4 – Fiscal Domicile • Prior to the amendment the Para 1 of the Article read as under: “Resident of a Contracting State” means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature. • The Para 1 of this Article has been replaced w. e. f. April 1, 2013. “Resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that: a) This term does not include any person who is liable to tax in that State in respect only of income from sources in that State; and b) In the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries. (Note: This definition has been brought in line with US Treaty. Difference between “liable to tax” Vs. “subject to tax”) 57

Article 4 – Fiscal Domicile (contd’) • Tie-Breaker Tests: Where an Individual is a resident of both India and UK, then following would be considered sequentially for the determination of the country of residence: • Permanent home available to the individual • Centre of vital interests • Country of habitual abode • Country of which he is a national • Mutual Agreement between the countries. • Person other than an Individual – deemed to be a resident of the Country where the effective place of management is situated. 58

Article 5 – Permanent Establishment • Means a fixed place of business of an enterprise through which it is wholly or partly carried out. • Permanent establishment incudes: a) to e) and h)—standard as per OECD Model f) Premises used as a sales outlet or for receiving or soliciting orders g) a warehouse in relation to a person providing storage facilities for others; i) an installation or structure used for the exploration or exploitation of natural resources; j) Where charges payable for the project or supervisory activity exceed 10% of the sales price of the machinery or equipment and such activities continue for a period not exceeding 6 months – (to be read with the Protocol(old)) 59

Article 5 – Permanent Establishment - Contd • Protocol in relation to sub-paragraph (j) of Article 5: For determining whether a building site or construction, installation or assembly project or supervisory activity in connection therewith has continued for a period of more than 6 months, a contracting state shall: i. Take no account of time spent by employees on other sites having no connection with the current site. ii. Apply more than 6 months test to each site which has no connection with any other site, and iii. regard a building site as a single site, even if several contracts have been entered into for work being done, provided it forms a coherent whole, both geographically & commercially 60

Article 5: Permanent Establishment Service PE of an Indian Enterprise in UK • k) the furnishing of services including managerial services, other than those taxable under Article 13 (Royalties and fees for technical services), within UK by an enterprise through employees or other personnel, but only if: i. activities of that nature continue within UK for a period or periods aggregating more than 90 days within any twelve-month period; or ii. services are performed within UK for an enterprise within the meaning of Article 10(1) (Associated Enterprise) and continue for a period or periods aggregating more than 30 days within any twelve-month period. ( contrast with US Treaty where one day presence triggers Service PE in case of related enterprises) 61

Article 5: Permanent Establishment 3. Exclusions from PE—auxiliary and preparatory activities—in line with UN Model : • storage of stock of goods for delivery triggers PE; 4. Dependent Agency PE of Indian Enterprise in UK( in line with Indian Income Tax Act, 1961) • A person acting in UK for or on behalf of an enterprise of India other than an agent of an independent status to whom paragraph (5) applies, shall be deemed to be a PE of the Indian enterprise in UK if: (contd…) 62

Article 5: Permanent Establishment a) he has, and habitually exercises in UK, an authority to negotiate and enter into contracts for or on behalf of the Indian enterprise, unless his activities are limited to purchase of goods or merchandise for the Indian enterprise; or b) he habitually maintains in UK a stock of goods or merchandise from which he regularly delivers goods or merchandise for or on behalf of the Indian enterprise; or c) he habitually secures orders in UK, wholly or almost wholly for the Indian enterprise or for other enterprise and the enterprises controlling, controlled by, or subject to the same common control, as the Indian enterprise. 63

Article 6: Income from Immovable Property • Income from Immovable property will be taxed in the state where such property is situated • Immovable property shall include: − Property accessory in immovable property − Livestock and equipment used in agriculture − Usufruct of immovable property • Ships and Aircrafts have been excluded from the meaning of immovable property as there are separate Articles for these. 64

Article 7: Business Profits of the UK PE of an Indian Resident • The profits of an Indian enterprise shall be taxable only in India unless the enterprise carries on business in UK through a PE situated in UK. If the enterprise carries on the business as aforesaid, the profits of the enterprise may be taxed in UK, but only so much of them as is directly or indirectly attributable to the PE. 65

Article 7: Business Profits Special features of Article 7 • Taxation of PE income both by India & UK & credit method for elimination of Double Taxation • PE to be treated & taxed as separate & distinct entity • No Force of Attraction – However, Clause (b) of old Protocol clarifies that tax authorities not precluded from determining whether PE took active part in Orders placed directly with HO 66

Article 8 : Air transport • Profits derived from the operation of aircraft in international traffic by an Indian enterprise shall not be taxed in UK. • Profits to include interest derived from the investment or deposit of receipts arising directly from the operation of aircraft in international traffic but shall not include interest derived from reinvestment of such interest 67

Article 9 : Shipping • Income of an Indian enterprise from the operation of ships in international traffic shall be taxable only in UK. • This Articles does not apply to income from journeys between places which are situated in India or UK 68

Article 10: Associated Enterprises Article 10(1) permits transfer pricing adjustment Where: a) an enterprise of India participates directly or indirectly in the management, capital or control (MCC) of an enterprise of UK, or b) the same persons participate directly or indirectly in the MCC of an Indian and an UK enterprise, and conditions are made between the two enterprises in their commercial or financial relations which differs from those which would be made between independent enterprises, then any profits which would have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. 69

Article 10: Associated Enterprises � Article 10(2): Mandates corresponding adjustment in the other Country � Similar clause for corresponding adjustment in the other country is missing in the treaties of India-Mauritius and India-Singapore. 70

Article 11: Dividends Old Provision In respect of dividend paid by a UK Company to an Indian resident: • Taxable in India • UK tax on dividends to Individual resident of India limited to 15% of gross dividends provided that the Individual is entitled to tax credit in India. • UK tax on dividends to other Indian residents (other than Individuals) to be exempt in UK. In respect of dividends paid by an Indian Company to a UK resident • Taxable in UK • India tax not to exceed 15% of gross amount • DDT (in India) not affected New Provision wef AY 2014 -15 • Standard Article • 10% of gross dividends in the source country (15% in case of distribution of income/gains from immovable property) • Para 6 – Anti – Avoidance provision – clarified that benefit not available if the “main purpose” of creation or assignment of shares was to take advantage of this Article. 71

Article 12: Interest 1. Interest arising in UK and paid to resident of India may be taxed in India. 2. However, such interest may also be taxed in UK where it arises and according to the laws of UK provided that where the resident of India is the beneficial owner of the interest, the tax so charged shall not exceed 15% of the gross amount of interest. 72

Article 12: Interest 3. Notwithstanding the provisions of para 2: a) Where the interest is paid to a bank carrying on a bonafide banking business which is a resident of India and is the beneficial owner of the interest, the tax charged in UK in which the interest arises shall not exceed 10% of the gross amount of interest. b) Where the interest is paid to the Government of India or a political subdivision or a local authority of India or the RBI, it shall not be subject to tax in UK. 73

Article 13 : Royalties / FTS Example UK resident as recipient of income: • Royalties & FTS arising in India and paid to resident of UK may be taxed in UK. • However, such Royalties & FTS may also be taxed in India where they arise and according to the laws of India but if the beneficial owner of Royalties / FTS is resident of UK, the tax so charged shall not exceed…… 74

Article 13 : Royalties / FTS Tax Rates for Royalties & FTS are as follows: • For Equipment Royalties & Services ancillary & subsidiary to enjoyment of such equipments – 10% of gross amounts • For Royalties & Fees for Technical Services other than those covered above: • During first five years for which this Convention has effect: − 15% where the payer is Government or its political sub division − 20% where the payer is other than what stated above • During subsequent years – 15% of gross amounts 75

Article 13 : Royalties / FTS • Definition of “fees for technical service” inter-alia includes payments of any kind in consideration for the rendering of any technical or consultancy services which: − C) “make available” technical knowledge, experience, skill know-how or processes, or consist of the development and transfer of a technical plan or technical design. • Meaning of “make available” as explained in other treaties would have to applied to the UK Treaty. − CIT vs. De Beers India Minerals (P. ) Ltd. (346 ITR 467) (Kar. ) 76

Article 14: Capital Gains • Each Contracting state may tax capital gains in accordance with the provisions of its domestic laws. • Instead of providing for allocation of taxing rights, the Article makes a reference to Domestic Laws of respective Contracting States. • Same is the case with India-US tax treaty • Compare with other Tax treaties or even Model Conventions – Vast Difference 77

Article 15: Independent Personal Service • Income derived by an individual, whether in his own capacity or as a member of a partnership, who is a resident of India in respect of professional or other independent activities of a similar character may be taxed in India. Such income may also be taxed in UK if such services are performed in UK and if : a) he is present in UK for a period or periods aggregating to 90 days in the relevant fiscal year; or b) he, or the partnership, has a fixed base regularly available to him, or it, in UK for the purpose of performing his activities but in each case only so much of the income as is attributable to those services • It should be noted that the provisions of this Article apply only to income derived by an “individual”. Whereas in the treaty between India and Netherlands, similar Article applies to a “resident”. 78

Article 15: Independent Personal Service How to Calculate No. of Days for partnerships: For the purposes of paragraph 1 of this Article an individual who is a member of a partnership shall be regarded as being present in the UK during days on which, although he is not present, another individual member of the partnership is so present and performs professional services or other independent activities of a similar character in UK. 79

Article 15: Independent Personal Service “Professional services” include independent: - Scientific, literary, artistic, educational or teaching activities as well as independent activities of: - Physicians, surgeons, lawyers, engineers, architects, dentists and accountants 80

Article 16 : Dependent Personal Services Indian resident deriving salary from UK: • Subject to ………. Salaries, wages and other similar remuneration derived by an Indian resident in respect of an employment shall be taxable only in India unless the employment is exercised in UK. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in UK. 81

Article 16 : Dependent Personal Services • Remuneration derived by Indian resident in respect of an employment exercised in UK shall not be taxed in UK if : − he is present in UK for a period not exceeding in aggregate 183 days during the relevant fiscal year; − the remuneration is paid by, or on behalf of, an employer who is not resident of UK, and − the remuneration is not deductible in computing the profits of an enterprise chargeable to tax in UK 82

Article 17 - Directors’ fees • Directors’ fees and similar payments derived by a resident of India in his capacity as a member of the board of directors of a company which is a resident of UK may be taxed in UK. • Taxability at place where the company is resident 83

Article 18: Artistes and Athletes • Income derived by entertainers (such as stage, motion picture, radio or television artistes and musicians) or athletes, from their personal activities, whether accruing to themselves or to any other person, may be taxed in the source country. • Provisions of the Article would not apply if the entertainer or the athlete is directly or indirectly supported, wholly or substantially, from the public funds of the other Contracting State 84

Article 19: Government Remuneration and Pensions • Standard as per UN and OECD Model 85

Article 20 : Pensions & Annuities • Any pension, other than a pension referred to in Art. 19(2) of this Convention, or annuity paid to a resident of India shall be taxable only in India. “CASE OF DOUBLE NON-TAXATION” 86

Article 21 : Students & trainees • Indian residents, who are temporarily present in UK for purpose of studying, or for securing necessary training or studying or doing research as a recipient of a grant, allowance, or award from governmental, religious, …. organisation shall not be subject to tax in UK in respect of following (for a maximum of 5 years): − Gifts from abroad for the purposes of his maintenance, education, study, research or training; − the grant, allowance or award; and − income from personal services to the extent of 750 sterling pounds for each relevant fiscal year 87

Article 22: Teachers • An individual who visits UK for a period not exceeding two years for the purpose of teaching or engaging in research at a university, college or other recognised educational institution in UK, and who was immediately before that visit a resident of India, shall be exempted from tax by UK. CAN BE A CASE OF “DOUBLE NON TAXATION” 88

Article 23 : Other Income • Subject to the provisions of para 2 of this Article, items of income beneficially owned by an Indian resident, wherever arising, other than income paid out of trusts or the estates of deceased persons in the course of administration, which are not dealt with in the foregoing Articles of this Convention, shall be taxable only in India. • Notwithstanding the provisions of para 1 & 2, income of an Indian resident not dealt with in the other Articles, and arising in UK may be taxed in UK 89

Article 24: Elimination of Double Taxation • Credit for the tax on the income doubly taxed: Allowed • Underlying tax credit allowed only in UK and not in India. (DTAAs of Mauritius and Singapore with India provide for underlying tax credit in India also) • Tax sparing: allowed in source? ? ? country 90

Article 25: Partnership • This Article has been deleted w. e. f. April 1, 2013 91

Article 26: Non-discrimination • “Nationals” and “enterprises” of other Country shall not be subjected to taxation in the source country, which is more burdensome than that of nationals and enterprises of the source country. • Discrimination of individuals on the basis of residence is permitted. 92

Article 27: Mutual Agreement Procedure • Standard Clause as per UN Model 93

Article 28: Exchange of Information • This Article has been amended by the New Protocol wef 1 st April, 2013 and made more stringent in the following respects: − The two countries can exchange information which is “foreseably relevant “ as against info which is “necessary” as per the old Article − If information is requested by Contracting State in accordance with this Article, the other Contracting State shall use its information gathering measures to obtain the requested information, even though that other State may not need such information for its own tax purposes. The standard imitations in Para 3 shall not be construed to permit a Contracting State to decline to supply information solely because it has no domestic interest in such information. − The standard limitations in Para 3 shall not be construed to permit a Contracting State to decline to supply information solely because the information is held by a bank, other financial institution, nominee or person acting in an agency or a fiduciary capacity or because it relates to ownership interests in a person. 94

Article 28 A: Tax Examination Abroad • Inserted by New Protocol w. e. f. 1 st April, 2013 For instance in case Indian tax authorities request for examination of a UK Resident • The representatives of India may request the competent authority of UK to interview a UK Citizen and examine records with prior written consent of the persons concerned. 95

Article 28 B: Assistance in Collection of Taxes • Inserted by New Protocol w. e. f. 1 st April, 2013 • Contracting States shall lend assistance to each other in the collection of revenue claims in respect of taxes covered by the Convention • “Revenue claim" means an amount owed in respect of taxes covered by this Convention as well as interest, administrative penalties and costs of collection or conservancy related to such amount. • Claim of a contracting state owed by a resident of the other contracting state may, at request of such contracting state, be collected by the other contracting state as collection of its own taxes as if the revenue claim were a revenue claim of that other state. • When a Contracting State may, under its law, take interim measures of conservancy by freezing of assets before a revenue claim is raised against a person, the competent authority of the other Contracting State, if requested by the competent authority of the first mentioned State, shall take measures for freezing the assets of that person in that Contracting State in accordance with the provisions of its law. 96

Article 28 C: Limitation of Benefits • Benefits of this treaty shall not be available if the main purpose or one of the main purposes of the creation or existence of such a resident or of the transaction undertaken by him, was to obtain benefits under this treaty. 97

Article 29 : Diplomatic & consular officials • Nothing in this Convention shall affect the fiscal privileges of diplomatic or consular officials under the general rules of international law or under the provisions of special agreements. • Notwithstanding the provisions of para 1 of Art. 4 (Fiscal domicile), an individual who is a member of the diplomatic, consular or permanent mission of India situated in UK and who is subject to tax in UK only if derives income from sources therein, shall not be deemed to be a resident of UK. 98

Foreign Tax Credit 99

Foreign Tax Credit • Tax payable in a Country S is allowed as a credit in the Country R • Method of credit Exemption method • Full exemption • exemption with progression Credit method • • Full credit Ordinary credit Tax sparing Underlying tax credits

Unilateral tax relief: Issues 101

Issues in case of unilateral tax relief (1/4) 1. Meaning of ‘income’ and ‘doubly taxed income’ • Section 91 - “a person resident in India is entitled to credit for taxes paid in the source country, in respect of income accruing or arising in that country, against any tax liability which may be incurred by that person on such income in India” • Credit only for part of income taxable in India or full income taxed abroad? • Manpreet Singh Gambhir v. DCIT (Delhi Trib) [26 SOT 208] – credit will be available on proportionate basis if only part of the income is taxable in India • CIT v. Best & Crompton Engg. Ltd. (Madras HC) [156 Taxman 216] – income refers to income before deduction u/s 35 B • CIT v. O. VR. SV. VR. Arunachalam Chettiar (Madras HC) [49 ITR 574] – relief for income actually taxed in India after allowances and set off of losses • CIT v. MA Mois (AP HC) [210 ITR 284] – No credit for income not taxed in India due to deduction / exemption • R N Jhangi (Rajasthan HC) [185 ITR 586] and Dr. K L Parikh (Rajasthan HC) [209 ITR 394] – no credit for 50% of the foreign income exempt due to deduction granted u/s 80 RRA Relief only in respect of income taxable in India post deduction, loss set-off, exemption 102

Issues in case of unilateral tax relief (2/4) 2. Aggregation of income Company FTC for 100 or 60 (100 less 40)? India Overseas Country 1 – profit of 100 Country 2 – loss of 40 • Bombay Burmah Trading Corpn. Ltd. (Bombay HC) [126 Taxman 403] – FTC for 100 Relief is country-wise and not on aggregation of income 103

Issues in case of unilateral tax relief (3/4) 3. Relief in context of MAT • Hindustan Construction Co. Ltd. v. DCIT (Mumbai Trib) [25 SOT 359] – Relief is available even if income taxable under MAT provisions 4. Timing of payment of taxes • JCIT v. Petroleum India International (Mumbai Trib) [26 SOT 105] – Relief is provided in year of taxing the income if proof is provided regarding payment in subsequent years Relief is available even if: • Income is taxable under MAT • Payment of tax is made subsequently 104

Issues in case of unilateral tax relief (1/4) 1. Meaning of ‘income’ and ‘doubly taxed income’ • Section 91 - “a person resident in India is entitled to credit for taxes paid in the source country, in respect of income accruing or arising in that country, against any tax liability which may be incurred by that person on such income in India” • Credit only for part of income taxable in India or full income taxed abroad? • Manpreet Singh Gambhir v. DCIT (Delhi Trib) [26 SOT 208] – credit will be available on proportionate basis if only part of the income is taxable in India • CIT v. Best & Crompton Engg. Ltd. (Madras HC) [156 Taxman 216] – income refers to income before deduction u/s 35 B • CIT v. O. VR. SV. VR. Arunachalam Chettiar (Madras HC) [49 ITR 574] – relief for income actually taxed in India after allowances and set off of losses • CIT v. MA Mois (AP HC) [210 ITR 284] – No credit for income not taxed in India due to deduction / exemption • R N Jhangi (Rajasthan HC) [185 ITR 586] and Dr. K L Parikh (Rajasthan HC) [209 ITR 394] – no credit for 50% of the foreign income exempt due to deduction granted u/s 80 RRA Relief only in respect of income taxable in India post deduction, loss set-off, exemption 105

Methods of avoidance of double taxation 106

Exemption method (1/3) • Right to tax is given away in favour of other country • Countries that follow territorial tax regime – Singapore, Hong Kong, etc. • Reasons for exemption method: Ø Simpler and same tax effect as credit method Ø Cheaper import of capital and technology by developing countries Generally adopted by countries that follow territorial tax regime 107

Exemption method: Full (2/3) Income taxed in source country is completely ignored by resident country Amount in INR Particulars Taxable Income Country R Country S 700, 000 30% 25% Tax rate Amount in INR Particulars Total Taxable Income Taxes payable in Country R Taxes paid in Country S Total Taxes Paid Effective Tax Rate Option I – No Exemption Option II – Full Exemption 10, 000 700, 000 300, 000 210, 000* 75, 000 375, 000 285, 000 37. 5% 28. 5% Only India-Brazil tax treaty contains full exemption method for dividend income 108

Exemption method: Progressive (3/3) Income taxed in source country is considered by resident country for determining tax rate Amount in INR Particulars Taxable Income Country R 700, 000 Amount in INR Country S 300, 000 Particulars Applicable Tax Rate Tax rate If income upto 700, 000 10% 25% If income is from 700, 001 to 1, 500, 000 20% 25% If income is above 1, 500, 001 30% 25% Amt. Total income (including foreign income) Applicable tax rate Taxes payable in Country R (700, 000*20%) Taxes paid in Country S (300, 000*25%) 1, 000 20% 140, 000 75, 000 Total Taxes Paid 215, 000 Effective Tax Rate 21. 5% Many tax treaties of India apply progressive exemption method 109

Credit method (1/4) • Deduction from tax liability is granted for the tax paid in foreign country • Credit is limited tax liability in resident country - excess foreign tax credit is carried forward or lapsed. India tax treaties - lapsed • Reasons for exemption method: Lower loss of revenue for country India follows credit method for most of the incomes 110

Credit method: Full (2/4) • Resident country allows deduction of total foreign taxes, only to the extent the taxes would have been paid on such income in its own country • Accordingly, resident country limits the credit to the tax on the same income as computed under its domestic law Amount in INR Particulars Taxable Income Tax rate Country R Country S 700, 000 30% 35% Amount in INR Particulars Option I – No Tax Credit Total Taxable Income Option II – Full Tax Credit 10, 00, 000 Taxes paid in Country S 105, 000 Taxes payable in Country R 300, 000 195, 000* Total Taxes Paid 405, 000 300, 000 40. 5% 30% Effective Tax Rate * After claiming credit in respect of taxes paid on Country S India gives full tax credit only in India-Namibia tax treaty 111

Credit method: Ordinary (3/4) • Resident country allows deduction of total foreign taxes, only to the extent the taxes would have been paid on such income in its own country • Accordingly, resident country limits the credit to the tax on the same income as computed under its domestic law Amount in INR Particulars Country R Taxable Income Tax rate Country S 700, 000 30% 35% Total Taxable Income 1, 000 Taxes paid in Country S 105, 000 Taxes payable in Country R Tax on total income Less: Foreign taxes paid (300, 000 x 30%) 300, 000 (90, 000) 210, 000 Total Taxes Paid* 315, 000 Effective Tax Rate 31. 5% * Differential amount of Rs. 15, 000 paid in Country S becomes additional cost India generally follows ordinary credit method 112

Credit method: Tax sparing (4/4) • Even though income is exempt in source country, credit is given in resident country for the tax that would have been in source country had there been no such exemption • Reasons for tax sparing method: Simpler and same tax effect as credit method Cheaper import of capital and technology by developing countries Amount in INR Particulars Canada Interest Income India 200, 000 Tax rate 200, 000 40% 15% but exemption under section 10(15)(iv) Amount in INR Particulars Option I – No Tax sparing credit Option II – Tax sparing credit Taxes payable in Canada 80, 000 Less: Foreign Tax Credit (15%*200, 000) - (30, 000) Canadian Tax Payable 80, 000 50, 000 Almost all of India’s tax treaties contain tax sparing provisions 113

Switch-over clauses • Change from exemption method to credit method, subject to conditions • Reason - avoid double non-taxation arising from exemption method • Protocol to India-Germany tax treaty: “The Federal Republic of Germany shall avoid double taxation by a tax credit as provided for in paragraph (1 b) of Article 23, and not by a tax exemption under paragraph (1 a) of Article 23, (aa) if in the Contracting States income is placed under differing provisions of the Agreement or attributed to different persons (other than under Article 9) and this conflict cannot be settled by procedure pursuant to Article 25 and (i) if as a result of such placement or attribution the relevant income would be subject to double taxation ; or (ii) if as a result of such placement or attribution the relevant income would remain untaxed or be subject only to inappropriately reduced taxation in the Republic of India and would (but for the application of this paragraph) remain exempt from tax in the Federal Republic of Germany ; or (bb) if the Federal Republic of Germany has, after due consultation and subject to the limitations of its internal law, notified the Republic of India through diplomatic channels of other items of income to which it intends to apply this paragraph in order to prevent the exemption of income from taxation in both Contracting States or other arrangements for the improper use of the Agreement. ” Treaty may apply switch-over clause to negative conflicts of qualification or abuse of treaty – however, specific provision must be present 114

Underlying tax credit (UTC) • Credit for tax paid on the underlying profits out of which dividend is declared • For Indian residents, UTC is available only under tax treaties with Singapore and Mauritius • Whether taxable must be grossed up for the amount of UTC? Amount in INR Particulars Income before Tax for X Co. situated in Singapore Amount in INR (Crs) Amount in INR Particulars 100 Singapore corporate income tax @ 17% 17 Income after Tax 83 Taxable Income* Tax on dividend income @ 17. 304% under section 115 BBD Other income (? ) (INR 17 Crs) taxable @ 34. 608% Singapore WHT on dividend NIL Dividend received by Y Co. 83 UTC available to Y Co. 17 Net tax payable View 1 Amount View 2 Amount 83 100 14. 36 - 5. 88 (14. 36) (17) 0 3. 24 • * Two views are possible: The underlying tax is not to be grossed up The underlying tax is to be grossed up View 1 seems to be preferable. However, general practice has been to gross up and hence, counsel opinion is advisable 115

Claiming FTC: Issues 116

Issues in claiming FTC (1/5) 1. Meaning of ‘in accordance with the provision of the convention’ • An important aspect of claiming FTC is that the taxability in source country should be ‘in accordance with the provision of the convention’ • Taxation by source country is ‘not in accordance with the convention’ if each country has differing interpretations of (a) the facts or (b) the provisions of the convention • CIT v. Lakshmi Textile Exporters Ltd (Madras HC) [245 ITR 521] - where profits of PE are exempt in resident country under a treaty, resident country has to accept a finding of source country that a PE exists and accordingly exempt profits of PE • The above is true even if source country grants exemption for profits of such PE under its domestic law 2. Meaning of ‘may be taxed’ • Whether source country has the exclusive right to tax income and resident country is precluded from taxing the same? – conflicting decisions • Claiming FTC - exemption method or credit method? – conflicting decisions • Better view – ‘may be taxed’ should mean non-exclusive right to source country and credit method for FTC must be adopted 117

Issues in claiming FTC (2/5) 3. Claiming ordinary tax credit – gross or net income basis? • Ordinary tax credit is normally computed as the tax on net income i. e. income from source country less allowable deductions connected with such income Particulars Royalty from source country Amount 100, 000 Withholding tax in source country @ 15% 15, 000 Expenses incurred 70, 000 Net income 30, 000 Tax on net income in resident country 10, 197 FTC available 10, 197 4. Inclusion of surcharge • Infosys Technologies Ltd. (Bangalore Trib) [108 TTJ 282] – as per India-Canada tax treaty, tax must include surcharge 5. FTC for DDT • Under DTAA, FTC is typically available for tax on income (i. e. income-tax) or for tax on the profits of the company from which dividend is declared (i. e. UTC) – DTT is neither • However, credit for DDT can be availed if resident country considers DDT as income-tax or underlying tax as per its domestic law e. g. Korea, India – ‘additional income-tax’ 118

Issues in claiming FTC (3/5) 6. Tax credit is available if tax is ‘paid’ in the source country • Amount of tax paid, post any reductions, only can be considered for FTC 7. Loss in resident country • JCIT v. Digital Equipment India Ltd (Mumbai Trib) [94 ITD 340] – foreign income is set off against loss incurred in resident country and then FTC is granted 119

Issues in claiming FTC (4/5) 8. Residence tie-breaker rule and FTC • Company is resident in both countries as per domestic laws and income derived from source country is taxable in both countries as per tax treaty • Tax treaty provides that company is resident in one country as per tie-breaker rule • FTC is available only in resident country for tax paid in source country (but not in source country for tax paid in resident country) 9. Triangular cases Company Indian company can claim credit for taxes paid by branch – what about withholding tax in country 2 – conflicting international decisions India Overseas Country 1 – branch Country 2 – income source 120

Issues in claiming FTC (5/5) 10. FTC in case of exemptions / deductions • DCIT v. Wipro Ltd (Karnataka HC) [62 Taxmann. com 26] – FTC available in respect of exempt income (India – US DTAA) • ACIT v. Blue Star Infotech Ltd (Mumbai Trib. ) [57 Taxmann. com 386] – FTC available in respect of exempt income (India – Japan DTAA) • However, in case of India – Canada DTAA, High court held that in order to claim credit, income must be taxed in both the countries • Since, there are favourable decisions of the High Court and Tribunal, one may take the benefit of claiming FTC in respect of exempt income based on the language of the relevant DTAA 121

Checklist for claiming FTC 122

Checklist • Identify doubly taxed income and ensure that the same income is being taxed by two jurisdictions • • Identify the jurisdictions which have taxed the income • Evaluate whether FTC is to be determined as per section 90 or 91 of the Act. In other words, whethere is tax treaty entered into between the two jurisdictions • • Identify the principle and method prescribed in the tax treaty for granting FTC • • • Evaluate the impact of UTC or tax sparing mechanisms • • Compute FTC for each jurisdiction separately • Maintain appropriate documentation like withholding certificate from the payer, document evidencing payment of tax in Country S, etc. Determine the tax residency of the taxpayer in order to decide the residence state and source state Check for rules / jurisprudence / guidance from the Indian tax authorities for claiming FTC Consider impact of losses incurred in home jurisdictions or foreign jurisdictions Compute tax liability on doubly taxed income under the Act by including surcharge in the tax rate Depending upon the applicable tax treaty, FTC should be computed on paid or payable basis 123

FTC rules 124

FTC rules issued on 27 June 2016 (1/2) • • Applicable from 1 April 2017 • Credit available in respect of tax, surcharge and cess but not for interest, fee or penalty Allowed in the year in which corresponding income is offered for tax in India – proportionate if income is offered in more than 1 year Issue – Definition of ‘foreign tax’ includes only the tax covered under DTAA and not all income taxes payable in foreign country • Credit in respect of disputed tax allowed subject to conditions Issue - Clarity is needed is respect of what is disputed tax and additional tax paid after the tax assessment • Credit allowed separately for each source of income Issue – Loss of credit as illustrated below Particulars Tax on interest income from country B 200 Total Foreign tax paid Tax on business income from country A 100 Indian tax liability 40 300 340 FTC under source-bysource method FTC under pooling method 40 200 NA NA NA 300 Not covered / modified as compared to draft rules 125

FTC rules issued on 27 June 2016 (2/2) • Credit restricted to tax payable on such income under the Act or DTAA, whichever is less • Exchange rate prevailing on the last day of the month immediately preceding the month in which tax is deducted or paid to be taken for converting the FTC in local currency • • Also available against MAT • Following documents to be provided before due date of filing return: Where the amount of FTC available against the tax payable under the provisions of MAT exceeds the amount of tax credit available against the normal provisions, then while computing the amount of MAT credit, the excess shall be ignored a) Form No. 67 b) Certificate specifying nature of income and amount of tax • Form No. 67 to be filed where carry backward of loss results in refund Not covered / modified as compared to draft rules 126

Non-discrimination 127

Non-discrimination • Neither of the contracting states gives preferential tax treatment in taxing its own residents or citizens vis-à-vis foreign persons in the same circumstances • Similar situations shall not be treated differently unless differentiation is justified – differentiation is not discrmination • Article 24 of the OECD convention deals with certain cases of nondiscrimination (ND) • ND based on nationality • ND with respect to stateless persons • ND based on PE • ND based on deductibility of interest, royalties and other disbursements for determining taxable profits • ND based on ownership • Whether Article 24 override other Articles of the DTAA? • Article 24, Notwithstanding the provisions of Article 2, apply to taxes of every kind and description – many Indian DTAA restrict the scope of taxes

Protocol 129

Protocol • The protocol to a tax treaty explains or modifies the provisions of the tax treaty • Items typically covered by protocols: - Scope of permanent establishment Computation of business profits Scope of taxation of royalties / fees for technical services Most favoured nation clause Taxation of capital gains • Important protocols in India’s tax treaties: - India-US tax treaty: Explanation of the ‘make available’ principle - India-Singapore tax treaty: Taxation of capital gains - India – Mauritius Tax Treaty : Taxation of capital gains

Steps when referring to tax treaties 131

Steps when referring to tax treaties Step 1 – Determine scope of convention • Tax payer is person • Tax payer is resident of contracting state as per article 4(1) • Treaty applies to taxes covered as per article 2 • Applicability of treaty to the taxable period • Treaty effect to the domestic laws of the concerned state Step 3: Application of substantive provisions Step 2 – Apply relevant definitions • In case a person is a resident of both the states • Look at the Tie-breaker condition; or • Determine if person has PE in contracting state Step 4, 5 & 6 • Process of characterization Step 4 – Apply the substantive article • Change of character due to PE i. e. Royalty could be taxable under the business profit clause Step 5 – Apply provisions of double taxation • Commentaries to the model conventions, case laws etc provide assistance for characterization Step 6 – Follow treaty provision into domestic law i. e. apply mechanism for obtaining tax credit to the taxability of the income in the relevant country 132

Equalisation Levy 133

Equalisation levy Background First significant step taken by India to tax digital economy transactions • In line with the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting project to tax e-commerce transactions, the Finance Act 2016, had inserted a separate Chapter VIII titled ‘Equalisation Levy’. The newly inserted provisions of the Act provide for an equalization levy of 6% to be deducted from amounts paid to a non-resident not having any permanent establishment in India, for specified services. “The equalization levy has been defined as “tax leviable on consideration received or receivable for any specified service under the provisions of this chapter. ” • The levy would fall under a separate, self-contained code and would not be part of the Income Tax Act, 1961. 134

Equalisation levy Services covered • The equalization levy would apply at a rate of 6% on the gross consideration payable for a “specified service. ” Specified service is defined as follows: Ø Online advertisement Ø Any provision for digital advertising space or any facility/service for the purpose of online advertisement Ø Any other service which may be notified later by the central government Applicability • The CBDT recently issued a notification dated 27 May 2016, stating that the provisions of Chapter VIII relating to the equalisation levy would come into effect from 1 June 2016. In other words, any payments being made for the specified services provided on or after 1 June 2016 shall attract the equalisation levy. 135

Equalisation levy Who needs to comply - ? • Every resident person and foreign company (having a PE in India) is required to withhold the equalization levy when making payment to a nonresident service provider. The compliance procedure is similar to withholding tax provisions already prevalent in India. 136

Treatment of income under income tax law To avoid double taxation of income which has been subject to an equalization levy, such income will be exempt in the hands of the nonresident under the Income Tax Act, 1961. • S. 10(50) income arising from any specified service provided on or after the date on which the provisions of Chapter VIII of the Finance Act, 2016 comes into force and chargeable to equalisation levy. “Specified service” is defined to mean online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement and includes any other service as may be notified by the Central Government. ‘Online’ is defined to mean a facility or service or right or benefit or access that is obtained through the Internet or any other form of digital or telecommunication network 137

Case Studies 138

Case Study 1 - Partnership Facts ACo Bco • LKP rendered services for its client’s projects in Country S from its office in Country R • At times partner’s & staff had visited Country S • R considers partnerships as fiscally LKP Partnership transparent • S considers partnerships as taxable Country R Question Country S • Who can claim treaty benefits? Source in India (No PE) Linklaters LLP v. ITO 40 SOT 51 (MUM) 139

Answer - Partners • Article 1(1) - the treaty is applicable to persons who are resident of India or UK or both. • Article 4(1) - resident means any person who is liable to tax by reason of his domicile, residence, place of management or any other criterion of similar nature. • Article 3(2) - ‘partnership firm’ which is a taxable unit under Indian Domestic Act is treated as person for the purpose of the treaty • Tribunal held that the taxpayer is eligible for treaty benefit in the source country even though it is not taxable in its own rights in the residence country. Linklaters LLP v. ITO 40 SOT 51 (MUM) • OECD denies treaty benefit to the partnership firm in case where the same is non transparent in the source state and transparent in residence state. 140

Answer • As India has not accepted the above OECD solution, the tribunal held that The taxpayer would be eligible to the treaty benefits as long as entire profit of the partnership firm were taxed in UK whether in the hands of the partnership or in the hands of partners directly. • India has signed Protocol with UK amending the DTAA and extending benefits of DTAA to the partners of UK partnership to the extent of income of UK partnership is subject to tax in the hands of partners. The protocol is effective from 1 st April 2014. 141

Case Study 2 – Liable to tax & Subject to tax Facts Beneficiaries • AOP has earned income from sale of Indian company shares • AOP hold valid Tax Residency certificate of country R • R- S Tax Treaty provides capital gains AOP exemption on sale of unlisted shares • AOP are not taxable in Country R since Country R income earned by AOP from sale of Indian co shares cannot be treated as business income in Country R Country S Income from sale of Indian unlisted shares Question • Whether treaty benefit is available to AOP? 142

Answer 1. Yes, convention applies to foreign AOP 2. Person is defined under Article 3(1)(e) of the Tax Treaty to include “an individual, a company and any other entity which is treated as a taxable unit under the taxation laws in force in the respective Contracting States”. 3. Article 4(1) of the Tax Treaty between India and Denmark defines the term ‘resident’ to mean “any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature. But this term does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein. ” Thus, the term ‘resident’ has to be construed accordingly. 143

Answer 4. Both country has taxing rights. However, here it is double non taxation by virtue of treaty benefit. Further, reliance in this connection is placed on the following decisions wherein Courts in analyzing the term ‘liable to tax’, have interalia held that the merely because at any given time there is exemption from income tax in respect of particular head, it cannot be held that the assessee is not liable to tax • UOI v Azadi Bachao Andolan (263 ITR 706) (SC) , • Meera Bhatia v ITO (38 SOT 95)(ITAT Mum) • Emirates Shipping Line, FZE v. ADIT (349 ITR 493) (Delhi) • DDIT v. Mustaq Ahmad Vakil (47 SOT 454) (ITAT Delhi) • ITO V. Mahavirchand Mehta (45 SOT 137) (ITAT Mum) • Bhagwan T. Shivlani v ITO (53 SOT 233)((ITAT Mum) • KPMG v. JCIT (142 ITD 323)(ITAT Mum) • ITO v Rameshkumar Goenka (39 SOT 132)(ITAT Mum) . 5 Double non-taxation is also a fact of life and tax sparings, which find place in several Indian tax treaties, are also realities in international taxation. To enter into or not to enter in a tax treaty which may leave scope for double non-taxation is a conscious decision of the respective Contracting State, but once such a tax treaty, as may leave scope for double non-taxation, is entered into, judicial forums have to interpret the provisions of the tax treaty as they exist – Meera Bhatia v ITO (38 SOT 95)(ITAT Mum) 144

Case Study 3 – Triangular case Facts X Ltd • X Ltd is a company incorporated in in India • X Ltd a branch office (PE) in Singapore. Income earned by the Singapore branch is as under: India - Interest income from UK entity Singapore - Income from sources in Singapore • Withholding tax rates presumed to be as under: - Branch India- UK Treaty - 15% Singapore- UK Treaty - 10% Question UK Interest UK Co. • On payments by UK to Singapore branch, which treaty will govern withholding tax? - UK – Singapore Treaty; or - UK – India Treaty Answer: India – UK treaty 145

Case Study 5 – Residence Facts US Co. • Mr. A is a citizen of USA • He is deputed to India to oversee Indian Co’s operations (on a long-term assignment of three years) Mr. A – Citizen of USA • He has a house in the US and in India • The US house is rented out to a third party, while the Indian house is occupied by him and his family US Question India • Assuming, Mr. A is a tax resident of India, how would you determine his residential status of Mr. A under India – US tax treaty ? Indian Co. 146

Answer 1. Mr. X has a permanent home in both India and the US 2. Mr. X’s vital interests can be said to lie in India given his close personal ties in India and given that he has economic interests in India. 3. Mr. X is thus a resident of India. 147

Case Study 6 – Tie Breaker – Habitual abode Facts US Mr. A For 11 yrs • Mr. A stayed in US for 11 years with his family and then returned to India • He went back to US again after 3 years with his family staying back in India • He had substantial investments in Shares, debentures, bonds of Indian companies • He does not have any immovable properties in US • Asset Value: INR 54 lacs – India Returned US India Returned Shares, Debentures & Bonds For 3 yrs INR 10 lacs - US Question India • Under the India –US Tax Treaty, Mr. A will be tax resident of which country ? 148

Answer Mr. A is a resident of US under India-US Tax Treaty 1. The mere fact that the duration of his stay in US is not certain and that he may return in India will not render his home in US unless a permanent home available for Mr. A’s use (Permanent Home test) 2. The personal ties of A lie in India; A has economic interests in both countries. 3. The closeness of economic ties cannot be determined entirely on the basis of an arithmetic comparision of the value of the assets or the quantum of income. 4. Habitual abode is in US, A is thus a resident in US. 149

Case Study 7 – Non-discrimination Facts X AG Listed Merger Z AG • X AG is a listed company in Germany • During the year, X AG merged into Z AG. As a result, more than 51% of the capital is held by Z AG Germany India 80% Y Pvt Ltd Question Tax losses • Whether provisions of section 79 is applicable (assume that the Proviso 2 is not enacted) • If yes, is there a nondiscrimination? Dailmler Chrysler India P. Limited (2009) (29 SOT 202) (TPUNE) 150 4

Answer Yes. There is non-discrimination as per Article 24(5) 1. Section 79 - Unless a company in which public is substantially interested, any change in shareholding beyond 51% would disentitle the company to carry forward and set-off the accumulated losses 2. Benefit granted when an Indian subsidiary has an Indian parent company whose shares are listed on any recognized stock exchange of its domicile country, i. e. , India, but not granted when an Indian Subsidiary has a German parent company whose shares were listed in any stock exchange in its domiciled country, i. e. , Germany – No rational basis for this differentiation in treatment 3. Therefore, Art. 24(5) overrides Sec. 79 in this case 4. Decision needs reconsideration - No discrimination on the issue of listing of shares – Foreign Co. cannot list shares as per SEBI guidelines 5. Post 2001, exception under second proviso to section 79 available. Therefore, not necessary to rely on the non-discrimination article. 151

Questions 152

The only place where success comes before work is in the dictionary. 153