The Indian government has, in the recent past, introduced a mandatory requirement of furnishing Tax Residency Certificate (TRC), for non-residents seeking tax treaty (Treaty) benefits. After undergoing a few changes, the current provisions state that in order to claim this benefit the non-resident would have to produce TRC issued by the Treaty partner. The government would also prescribe details and documents that the non-resident would be required to furnish. This write-up traces these legislative developments over the last one year and their impact on the non-residents.
Journey so far
- Finance Act 20121, made it mandatory for non-residents seeking Treaty benefits to produce a TRC with prescribed particulars from the Government of the Treaty partner country. The rationale2 was to refrain third party residents, from claiming unintended Treaty benefits. Subsequently, the particulars required in the TRC were notified3. The TRC was also required to be verified by the Treaty partner country.
Experience showed that in some Treaty partner countries, obtaining a TRC with India prescribed particulars was a tedious exercise and in some cases there was reluctance to issue the desired TRC, due to the fact that such countries had their own formats. Further, there were countries where there was no mechanism to issue TRCs.
- While the non-residents were grappling with these concerns, the Finance Bill 2013 proposed to insert in tax law that TRC would be a necessary but not sufficient condition for availing benefits of the Treaties.
This proposal created a lot of concerns. It was feared that the tax department would ask additional questions and Treaty benefit could be at risk. Investing community which have invested into India from Mauritius were particularly worried. In this context it is important to note that in year 2000, the Central Board of Direct Taxes4 had issued a circular (beneficial circular) to clarify that wherever a TRC is issued by Mauritius Government, such TRC would constitute sufficient evidence for accepting the residence as well as beneficial ownership. The Apex Court upheld5 the legal validity of this beneficial circular. It was felt that this provision would enable the tax authorities to disregard this beneficial circular. Some sections apprehended, if it was a unilateral approach to circumvent a bilateral Treaty.
- The sentiments prompted the government to issue clarifications and to tone down the proposal. The Ministry of Finance (MoF)6 clarified that the TRC produced by a resident of a Treaty partner would be accepted as evidence that he is a resident of that Treaty partner country. The tax authorities in India will not go behind the TRC and question his residential status. Further, it was also clarified that in the case of Mauritius, the beneficial circular continues to be in force, pending ongoing discussions between India and Mauritius.
- Consequently, it has now been provided that in order to avail the Treaty benefit the non-resident would have to provide a "Certificate of his being a resident"7 as against the earlier requirement of TRC with India prescribed particulars. There is a catch though, the law now states that the non-resident could be asked to provide documents and information which would be prescribed.
So in nutshell, the current position is that the TRC issued by a Treaty partner, in its own format would be accepted as proof of tax residence. The non-resident could however be required to augment with other details that would be prescribed.
Is the TRC really sufficient
There is no doubt that tax residency is one of the basic pre-requisites for a non-resident to avail Treaty benefits, but it is not sufficient. In the past, TRC was considered to be sacrosacnt and tax authorities usually did not question beyond it. Off late the debate around moving profits to tax havens and other treaty abuse apprehensions have attracted the attention of the Governments across the globe, including India. The comment made by the Finance Minister that Treaties contain twin conditions of residency and beneficial ownership and though TRC would be accepted, as far as beneficial ownership is concerned, it is a question of fact, does indicate at least to the tax authorities at the field level, to ask more questions before giving Treaty benefit.
The real concern emerges around those articles in a Treaty that prescribe other conditions which are also required to be fulfilled if a Treaty benefit is desired. To cite the example of incomes such as interest, royalty, fees for technical services and dividend, requirement of beneficial ownership is an important condition inbuilt in relevant articles of the Treaties, which must be additionally fulfilled. There is not much of concrete guidance on the term beneficial ownership in International tax literature; even OECD is currently seeking to give it more precise form. Thus even with an undisputed TRC, the tax authorities could still look at this aspect and Treaty benefit may be denied. A lot would depend upon what sort of details will be prescribed by the Indian Government.
It is important to note that China, has prescribed several factors which could negatively affect the non-resident's beneficial ownership claim. These inter- alia include, obligation of the non-resident to distribute most of its income (eg. more than 60%) to a resident of a third country within a prescribed time period, no or minimal business activities, assets, scale of operations and deployment of personnel not commensurating with income, no or minimal control and decision-making rights, no risk bearing and non-residents income either being non-taxable or taxable at low effective tax rate. The non-resident is required to provide details and documents keeping in mind these aspects.
Considering the legislative intent cited for prescribing the TRC requirement and the recent comments of the Finance Minister regarding beneficial ownership, it is possible that some such requirements pave their way into Indian tax laws.
In addition, though the introduction of India's legislative GAAR had been deferred to Financial Year 2015-16, one cannot lose sight of the fact that India already has a judicial GAAR in place. Courts have in the past taken into account and given significant weight-age to issues of substance over form and tax avoidance. Even the OECD mandates that benefit be denied in Treaty abuse cases. Recently, the Apex Court8 held that the beneficial circular would not preclude the tax authorities from denying Treaty benefits if a Mauritius entity, without substance is used as device to avoid tax. Thus, it is open for the tax department to ignore the device, take into consideration the real transaction between the parties and subject it to tax dehors the TRC
Further, some Treaties, such as the Singapore Treaty, contain Limitation of Benefits (LOB) clause, in such cases even with a valid TRC, the non- residents claim also needs to be tested on the LOB parameters.
The impact analysis
- Though, so far the beneficial ownership aspect has not been scrutinized much by the tax authorities, in case of passive income, non-residents seeking Treaty benefits may now expect enhanced scrutiny.
- As far as Mauritius goes considering the clarification issued by the MoF gives a clean chit to the beneficial circular, which covers both the residency and the beneficial ownership aspect, one could expect some respite in those cases. It is important to note that this beneficial circular covered both dividends and capital gains. Mauritius based investors claiming Treaty benefits can knock the doors of the MoF in case tax authorties at ground level ask for further details during the audit proceedings.
- Currently, law is silent on the point of time the TRC is to be furnished. The question being, is it required at the time of e-filing the Return of Income or has to be furnished, if asked for, during audit proceedings. TRC may also be insisted upon by the payors of income for withholding tax purposes. In case obtaining TRC is a time consuming exercise, the non-resident needs to plan its affairs accordingly.
- In a case where TRC is not obtainable or there are delays, the payor entity may not take into consideration the beneficial Treaty provisions and may withhold taxes at higher rates. In such a case, the non- resident may have to seek refunds in India by filing its Return of Income. Also, in case of net of tax arrangements where tax is borne by the Indian entity, they may now insist on factoring these requirements and the eventualities while formalising the arrangements.
- More importantly, the government is yet to prescribe documents and particulars which would have to be furnished by the non-resident to seek the benefit and the augment any information that they do not get in the TRC issued by Treaty partners, in their own format. How practical these demands are and how far the non- resident would be able to meet them, within reasonable time and costs, remains to be seen.
One needs to keep a close watch for the fine print of the documentation requirements to see to what extent they enhance the procedural issues and fuel litigation.
1 Section 90(4) of the Income -tax Act, 1961, effective from April 1, 2013
2 Memorandum Explaining provisions of Finance Bill 2012
3 Rule 21AB of the Income-tax Rules,1962
4 Circular No 789 dated April 13, 2000
5 Union of India v. Azadi Bachao Andolan  132 Taxman 373 (SC)
6 Press Release dated March 1, 2013 issued by the Ministry of Finance
7 Finance Bill 2013, as passed by the Lok Sabha (Lower house of Parliament)
8 Vodafone International Holding B.V. v. Union of India  204 Taxman 408 (SC)
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