India: TAX TRENDS Volume 2 Issue 3 | Oct–Dec 2016

Last Updated: 26 January 2017
Article by SKP  

The Netherlands - Emerging entry route to India due to amendment in India-Singapore Tax Treaty

Over the past few decades, the level of Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) in India has been considered as an indicator of the strength and attractiveness of the Indian economy.

Under the Income-Tax Act, 1961 (the Act), the capital gains earned by such investors on the disposal of their FDI/ FPI investments in India are taxable in India. However, investors from countries such as Mauritius, Singapore, Cyprus and Korea can avail capital gains tax exemption in India under the Double Taxation Avoidance Agreements (DTAA) tax treaties between India and their country. Over a period of time, these countries have become the hub for forming holding companies/pooling entities for routing investments into India to avail the capital gain exemption due to favourable DTAA provisions.

In the Indian governments view, these jurisdictions were mainly being used for round tripping funds, tax evasion/avoidance and 'treaty shopping'. The Indian tax authorities in the past have questioned the business/commercial substance of such investments coming in India. Accordingly, in the past few months, India has actively pursued and successfully managed to re-negotiate its DTAAs with these countries to put an end to 'treaty shopping'.

The main highlight of these renegotiated DTAAs is that India now has the right to levy tax on the capital gains of investors from these countries which they gain through the disposal of shares of Indian companies i.e. source based taxation of capital gains from the sale of shares in India. With all four beneficial DTAAs re-negotiated in favour of India, routing of investments into shares of an Indian company after 1 April 2017 through these jurisdictions could result in an Indian tax liability once the capital gains arise on exit.

Interestingly, the India-Netherlands DTAA provides beneficial provisions to exempt capital gains tax in India to a resident of the Netherlands in the following scenarios:

  • When the resident of the Netherlands does not hold 10% or more in the share capital of the Indian company1; or
  • When the Netherlands resident holds 10% or more in the share capital of the Indian company, but the shares are transferred to a person who is not an Indian resident; or
  • Where a resident of the Netherlands holds 10% or more in the share capital of the Indian company and the shares are transferred to an Indian resident but the gains arise in the course of a corporate organisation, reorganisation, amalgamation, division or similar transaction and the buyer or the seller owns at least 10% of the capital of the other.

As mentioned above, the route via the Netherlands could assume significant importance in the years to come as compared to Mauritius, Singapore or Cyprus since the India- Netherlands DTAA is not being amended. The India-Netherlands DTAA would especially benefit FPI investors who are set to lose tax benefits under their preferred route of investing in India i.e. through Mauritius and Singapore. This is because an FPI is permitted to invest only up to 10% of the share capital of an Indian company and hence, the capital gains of FPIs would mostly be covered by the tax exemption under the India-Netherlands DTAA.

However, it must be noted the that shifting of base by any investor (including FPIs) from Mauritius or Singapore to the Netherlands may be viewed as a tax avoidance exercise and may get covered by the General Anti-Avoidance Rule (GAAR) which is proposed to be enforced in India from 1 April 2017. As per the draft GAAR regulations, if any transaction/ arrangement is undertaken in India with the main intention of obtaining a tax benefit under the DTAA, the tax authorities can invoke GAAR and deny the DTAA benefits. In fact, the draft GAAR regulations only exempt FPIs not claiming DTAA benefits in India. Since the India-Netherlands DTAA does not contain a Limitation of Benefit (LOB) clause, the possibility of invoking GAAR in case of FDI or FPI investors from the Netherlands cannot be ruled out if the entity from the Netherlands does not have substance/business purpose in the Netherlands. Accordingly, all investors (especially FPIs) that are migrating operations from Mauritius or Singapore to the Netherlands need to carefully consider GAAR implications before deciding on any investment structure in India after 1 April 2017.

Also, one will have to be mindful of the updates emanating from the BEPS project of the OECD under which various action plans have already been notified in October 2015. As per Action Plan 6, read with the Multilateral Instrument (MLI) published in November 2016, issues of treaty abuse and double non-taxation of income need to be tackled. If India signs the MLI (which is likely, considering the prominent role India has played in the BEPS project). In such a case, the implications arising under the BEPS Action Plans and MLI will have to be carefully studied before undertaking any structuring.

With recent newspaper reports suggesting that India may not pursue revision of the India-Netherlands DTAA at the moment, the Netherlands may emerge as the preferred route for FDI and FPI investments in India after 1 April 2017.

LEGAL UPDATES

In the absence of Fees for Technical Service (FTS) clause in a tax treaty, the same would be taxed as per other provisions of the tax treaty and not the Income Tax Act, 1961 (ITA).

ABB FZ-LLC vs ITO (Intl) 75 taxmann.com 83 (Bangalore Tribunal)

The taxpayer, a company incorporated in the UAE, entered into a service agreement for providing certain services to an Indian entity.

The taxpayer contended that since there is no FTS clause under the India -UAE tax treaty, the income from rendition of services is not taxable in India.

The tax officer contended that in the absence of the FTS clause in the India -UAE tax treaty, the income earned would be taxable under the provisions of the ITA. The tax officer also held that the beneficial provisions of the tax treaty are required to be applied only when there is a conflict between the provisions of the ITA and tax treaty. In the present case, since there is no FTS clause under the tax treaty, there is no conflict and hence, the income earned should be taxable as FTS as per the provisions of the ITA.

The Tax Tribunal held that there is no omission of FTS clause but there is a mutual agreement between India and UAE to not include the FTS clause in the tax treaty. Recourse to the ITA for the definitions of undefined terms is to be taken only in cases where the term is present in the tax treaty but it is not defined. The Tribunal accordingly held that in the absence of a FTS clause in India-UAE tax treaty, the payment received will be considered as a business income and in the absence of a Permanent Establishment (PE) in India, it would not be taxable in India.

Mere provision of a service which requires technical input by a person providing services, cannot be said to be making technical knowledge, skills, etc. available to the service recipient

Outotec Oyj vs DDIT [2016] 76 taxmann.com 33 (Kolkata Tribunal)

The taxpayer, a Finnish company, earned income from India through a management service agreement to provide certain communication, business development and information technology related services. The case is in relation to the old tax treaty between India and Finland.

The taxpayer, inter alia, contended that the services are not be taxable as FTS as they do not make technical knowledge, skill, etc. available to the service receiver by making references to examples under the India-USA DTAA.

The tax officer contended that examples under the India-USA Tax Treaty cannot be used for India- Finland Tax Treaty. Since the services and reports provided are used by the Indian company for technical knowledge, the services are taxable as FTS.

The Tax Tribunal observed that parallel treaty interpretation is permissible where the language of the two tax treaties is similar. Accordingly, relying on the Memorandum of Understanding (MoU) of the India-USA Tax Treaty and various judicial precedents, the tribunal observed that a service is said to make technical knowledge available only when the person availing the service could use that service on his own in the future. Therefore, the Tribunal held that the services provided by the taxpayer would not be taxable as FTS.

If protocol requires countries to negotiate the tax treaty to restrict the definition of FTS, then unless such restrictive definition is specifically negotiated, it cannot be read in such tax treaty

Torrent Pharmaceuticals Ltd vs ITO [TS-609-ITAT-2016] (Ahd Tribunal)

The taxpayer, an Indian company, availed consultancy and professional services from a Swiss company. The taxpayer did not withhold any taxes on consultancy fees relying on the protocol to the India-Swiss tax treaty. The protocol provides for application of a lower rate or restrictive scope of taxation if the lower rate or restrictive scope has been agreed by India or Switzerland with a third country after signing the India-Swiss Tax Treaty.

The taxpayer contended that the India- Portuguese Tax Treaty was signed after the India-Swiss Tax Treaty and contains the 'make available' clause. Hence, such clause should also be read in the India-Swiss tax treaty. As per the taxpayer, such services do not satisfy the 'make available' clause and therefore no taxes were required to be withheld.

The tax officer contended that the restrictive definition of FTS under the India-Portuguese Tax Treaty could not be imported into the India-Swiss Tax Treaty unless the 'make available' clause is specifically inserted in the India-Swiss Tax Treaty by way of negotiation. Accordingly, the payment made by the taxpayer would be taxable as FTS and the taxes were required to be withheld.

The Tax Tribunal observed that the India-Swiss Tax Treaty specifically provided that both the countries should enter into fresh negotiations for granting the benefit of lower rate or restrictive scope. Accordingly, it was held that since no negotiation had taken place, the payment made by the taxpayer would be considered as FTS according to the India-Swiss Tax Treaty and the taxes were required to be withheld.

Only the services rendered by a PE would be effectively connected to the PE and any other income earned by foreign enterprise would be taxable as FTS on gross basis.

International Management Group vs ACIT [2016] 75 taxmann.com 250 (Delhi Tribunal)

The taxpayer, a UK-based company, entered into a service agreement with the BCCI for providing services for an IPL event in 2009. The employees of the taxpayer were in India for more than 90 days and created a service PE of the taxpayer in India.

The taxpayer earned INR 330 million out of which it offered INR 92 million for taxation as business income attributable to the PE. The taxpayer argued that the remaining INR 238 million was not taxable as FTS since the whole contract was effectively connected to the PE. Therefore, the taxpayer did not offer the balance amount to tax in India, neither as FTS nor as attributable to the PE.

The tax authorities contended that a major part of the services were advisory in nature and therefore the balance income is not effectively connected to the PE and would be taxable as FTS as per Article 13 of the India-UK tax treaty.

The Tax Tribunal observed that only the services which are performed or activities in which the PE was involved in would be effectively connected to the PE. Reference was made to Article 12(6) of the India-USA tax treaty where the word 'attributable to' is used instead of 'effectively connected to' and it also mentions that both the terms are the same. Therefore, the Tribunal held that the income amounting to INR 238 million cannot be considered to be effectively connected to the PE and was accordingly taxable as FTS as per Article 13 of the India-UK tax treaty.

TAX TALK

Tax Holiday for start-ups may be increased to five years

[Excerpts from The Financial Express, 29 December 2016]

The Financial Express has reported that the government is actively considering a proposal to extend the Tax Holiday period for eligible start-up entities from the current period of three years to five years.

Tax authorities commence analysis of bank deposits post demonetisation

[Excerpts from The Economic Times, 28 December 2016]

The Economic Times, quoting senior officials from the Income Tax Department, has reported that the tax authorities have started analysing bank deposits made after demonetisation of high value currency notes which was announced on 8 November 2016. The tax authorities have urged taxpayers to avail the Pradhan Mantri Garib Kalyan Yojana (PMGKY) as the last opportunity to come clean on unaccounted money.

India has 2.4 million taxpayers with an income above INR 1 million, yet 2.5 million new cars are bought every year

[Excerpts from The Times of India, 27 December 2016]

The Times of India has reported an interesting statistic that while only 2.4 million taxpayers in India have reported an income above INR 1 million, around 2.5 million cars are being purchased every year. The report also states that 48,417 individuals reported an income of more than INR 10 million whereas 35,000 units of luxury cars are sold every year.

An official said the numbers point to a significant number of people who are liable to pay taxes and aren't doing so.

More online services could attract Google Tax

[Excerpts from The Business Standard, 27 December 2016]

The Business Standard has reported that the government is likely to expand the coverage of Google Tax (Equalisation Levy) as part of the proposals of the Union Budget 2017. This could affect the prices of services/content sold through the internet.

No plan to impose tax on long term capital gains, clarifies Finance Minister Arun Jaitley

[Excerpts from The Times of India, 25 December 2016]

The Finance Minister Arun Jaitley has clarified that the government has no intention of levying tax on long term capital gains arising from share transactions. This was with reference to reports in certain sections of the media that Prime Minister Narendra Modi has made an indirect reference to levying tax on long term capital gains on the sale of shares.

Compliance Calendar (January to March 2017)

Footnotes

1The tax exemption will not be available for capital gains arising from transfer of shares (forming part of a 25% or more interest) of an unlisted Indian company, if the shares derive their value principally from immovable property in India (other than property in which the business of the company was carried on).

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