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Changes in India’s

International Tax Policy

Arpit Jain

Independent Member of

• Background & Policy Direction

• Capital Gains Tax on Indirect Transfers

• General Anti Avoidance Rule

• Residency Test - POEM

• Equalization Levy

• Thin Capitalization

• Secondary Adjustments

• Tax Treaties with Mauritius, Singapore & Cyprus

• Country by Country Reporting

• Information Exchange

Items in Focus

2


Background &

Policy Direction


• Liberalized FDI Policy in 1991

– Further liberalization subsequently

• Provisions relating to NR Taxation existed since beginning

– However, became actually relevant post-liberalization

• Need to syncing them with changing global scenario

• Also, to introduce further anti-abuse provisions

• Introduction of Detailed Transfer Pricing Regulation in 2002

Background

4


• GAAR, CFC, Indirect Transfers, FTC, etc. introduced in DTC

– However, Direct Tax Code subsequently withdrawn

– Majority of Proposals of DTC introduced in current IT Act itself in phased manner

• Changing Global Landscape

– Tax Avoidance by Google & Apple

• Introduction of BEPS

– Avoidance of Double Non-Taxation

– Transparency & Exchange of Information

– Isolation of Non Co-operative Countries / Tax Heavens

– Curb on Harmful / Base Erosion Tax Practices

– Importance to Substance

Background

5


BEPS

BEPS

Digital Economy

Hybrid Mismatches

Strengthen CFC Rules

Interest Deductions

Harmful Tax Practice

Preventing Treaty Abuse -

Benefits in Inappropriate

CircumstancesArtificial Avoidance of

PE

Transfer Pricing

Measuring & Monitoring

BEPS

Mandatory Disclosure Standards

CbCR

Dispute Resolution Mechanism

Multilateral Instruments


• Avoidance of Double Non-Taxation

– Long awaited changes in MU, SG, CY DTAA

• Curb on Harmful / Base Erosion Tax Practices

– Capital Gains Tax on Indirect Transfers

– Secondary Adjustments

– Equalisation Levy

– Thin Capitalization

• Importance to Substance

– Place of Effective Management

– General Anti Avoidance Rules

The Direction

7


• Transparency & Exchange of Information

– Changes in many DTAA

– Tax Information Exchange Agreement with Tax Heavens

– Country by Country Reporting

• Isolation of Non Co-operative Countries / Tax Heavens

– Section 94A – Notified Jurisdictions

The Direction

8


Indirect TransferThe Vodafone Tax


• Sale of shares of

Cayman Island Co.

by Co. in BVI

• Should Capital

Gains be taxed in

India?

The Vodafone Case

10

Hutch Telecommunication

International Ltd (Cayman Island)

Vodafone

CGP Investments Limited (“CGP”)

Hutchison Essar Limited (“HEL”)

India

12 intermediate holding companies

Mauritius / India

Cayman Islands

Share Purchase

Agreement (“SPA”)

for shares of CGP

100%

Direct and indirect

shareholding in HEL - 52%

Other Indian entities

Indirect shareholding in HEL – 15%

Direct and indirect shareholding of 52%

+ Options over the indirect shareholding of

15% of Other Indian entities in HEL

= ‘Economic interest’ of 67 percent

(approx) in HEL transferred to Vodafone

BVI

HTI BVI Holdings Ltd

100%


• Introduced by Finance Act 2012, rationalized by Finance Act

2014

• Shares of company / internet in entity situated outside India

deemed to have situs in India if

– Derives its value substantially from assets located in India,

whether directly or indirectly

– Value of tangible / intangible assets in India > INR 10 crores

– Value of Indian assets >= 50% of total assets of foreign entity

• Gains on Transfer of shares of foreign entity attributable to Indian

assets taxable in India

11

Indirect Transfer


• Exemptions – Foreign entity along with its AEs , at any time in 12 months prior to transfer have

– No management rights or control of Indian entity and

– Interest / voting power / shares < 5%

• Exemption for demerger / amalgamation of foreign companies

• Value of assets = FMV without reduction of liabilities

– As on accounting period end date prior to date of transfer

– Or as on Date of transfer if – Book value of assets on date of transfer > book value of assets as on year end date by 15%

• Reporting requirement with stringent penalties

– Difficult for company to monitor such transactions

12

Indirect Transfer


• Co. A holds 100 shares in

Co. B, deriving its value

substantially from Co. C

• Co. D subscribes another

100 shares in Co. B and

becomes 50%

shareholder

• Co. B buybacks 50

shares of Co. A

• Effectively, Co. D holds

100 shares and Co. A

holds 50 shares in Co. B

13

Case Study 1

Co. A Co. D

Co. B

Co. C

India

Outside India

100%

33%

0%

67%

100%


General Anti

Avoidance Rule


GAAR – Effective from AY 2018-19

Applicability of

GAAR –

Impermissible

Avoidance

Agreements (IAA)

• Main purpose of Arrangement is tax benefit; AND

• Rights / Obligations not at arm’s-length; or

• Misuse / Abuse of Act ; or

• Lacks commercial / economic substance; or

• Is not for bonafide purposes

Consequences of

GAAR

Overrides DTAA?

• Disregard / Recharacterize / Combine IAA or part

• Treat IAA as void

• Disregard accommodating parties / treat parties as one

• Reallocation / re-characterization of capital, incomes,

expenses, reliefs, etc.

• Relocation of place of residence / situs of asset or

transaction at a place / location

• Lifting corporate veil – Look through approach

15


• GAAR not to be invoked if

– Aggregate Indian tax benefits < INR 3 crores

– FII not claiming DTAA benefit

– Sufficient anti-abuse provisions in DTAA

– Arrangement held as permissible by AAR

– Tax implications explicitly and adequately considered by

Court sanctioning the arrangement

– Merely because entity is located in tax efficient jurisdiction if

Non-tax commercial considerations exist and main purpose is

not tax benefit

– The arrangement is considered as permissible in one year

GAAR – CBDT Clarification

16


• Capital Gains on Investments prior to 1st April 2017 grandfathered

– Lease contracts and loan agreements not grandfathered

• GAAR and SAAR can co-exist

• Claiming provisions of DTAA or Act, whichever is beneficial, can

be decided year on year basis

• No corresponding adjustment to other assessee

GAAR – CBDT Clarification

17


• Assessee shall have opportunity to put up its case before AO and

CIT and Approving Panel before GAAR is invoked

• Approving Panel consist of 3 Members

– IRS, retired HC judge and eminent person

• Decision of Approving Panel is binding on department

– Assessee can file appeal before ITAT against the order of AO

GAAR Safeguards

18


Place of Effective Management


• Foreign Co. to be resident, if Place of Effective Management (POEM) is

in India

– Replaces the condition – control and management wholly situated

in India

– Global income of residents taxable

– Major impact on Outbound investments with Indian Promoters

• Final Guidelines issued on January 24, 2017

– Only Guiding Principles

– POEM depends upon facts and circumstances

– Emphasis on Substance over Form

Residence Test – AY 2017-18

20


• POEM defined as a place where “key management and commercial

decisions” that are “necessary for the conduct of the business of an

entity as a whole” are, “in substance, made”.

POEM – Definition

Key management

and commercial

decisions

Necessary for

overall conduct of

business

Of an Entity as a

whole

In substance

made

• Focus on Key Management (not control)

• Key decisions relating to management

• Place of implementation of decisions not relevant

• Executive level decisions – for overall conduct, in line

with broad strategies & policies formulated by BOD

• Day to day operations not relevant

• Substance over form

21


Active Companies

Company

engaged in

“Active

Business

Outside

India”

Passive

Income

• Passive Income < 50% of Total income AND

• Assets situated in India < 50% of Total assets AND

• No. of employees situated in / resident of India <

50% of total no. of employees AND

• Payroll expenses on employees situated in / resident

of India < 50% of total payroll expenses

• Royalty, dividend, capital gains, interest, rental income +

• Income from transactions where both purchase and sale

of goods is from / to Associated Enterprises

Average data of previous year + 2 years prior to be considered

Shorter period for new companies

22


Guidelines for Passive Company

Top

Level

Mgt.

Operation Level

Management

Executive / Mid

Level

Management

Place where BoD makes key managerial

and commercial decisions

Place where executive directors or senior

management (i) formulate key strategies /

policies and (ii) ensure or oversee

execution and implementation thereof on

an on-going basis

Place where the day to day

business activities are carried out

/ conducted

23


Case Study 2

Does the company meet active income test?

Particulars Avg. of 3 years

Sales to unrelated parties in country A 50

Sales to unrelated parties in India 50

Sales to related parties in country B out of purchases

from related party in country C

50

Total revenue from operations 150

Net profit from operations (assumed 33%) 50

Interest income 40


Case Study 3

Loss making companies may have to go through detailed tests

Particulars Avg. of 3 years

Sales to unrelated parties in country A 200

Total revenue from operations 200

Net Profit from operations -20

Interest income 40

Total Income 20


Equalization Levy


• Levy on Online Advertisement Income of NR

– Levy @ 6% of gross receipts

– Online advertisement, provision for digital advertising space

or any other facility / service for online advertisement

– Payer being resident carrying business / profession or NR

having PE

27

Equalization Levy


• Not subject to levy if

– Income connected with Foreign Co.’s PE in India

– < INR 1 Lakh

– Payment is not for business / profession

• Obligation on payer to deduct TDS

– Disallowance u/s 40a(ib) on non-deduction + interest and penalty

• If subject to equalization levy, exempt from normal income tax

28

Equalization Levy


Thin Capitalization


• Thin Cap Rules introduced

• Debt from Non Resident AE / other lenders if guaranteed by AE

– Explicit and implicit guarantees or corresponding matching deposits

• Interest deduction capped at 30% of EBITDA

– Balance carry forward for 8 years

• Not applicable

– Interest expense < Rs. 1 crore

– For banks and insurance Co

• Rule of Debt-Equity ratio not applied

30

Thin Capitalization


Secondary Adjustment


• Recording ALP in books of account

– Primary adjustment suo moto by assesse / accepted by

assesse / Safe harbour, APA, MAP

• Repatriation of primary adjustment amount to India within

prescribed time limit

– Unrealised amounts to be treated as advance

– Interest on advance to be computed and added to income

• Provisions applicable to Primary adjustment > INR 1 Cr

– Adjustment related to AY 17-18 and subsequent years

Secondary Adjustments

32


Recent changes

in Indian Tax

Treaties


• Taxation Systems

– Worldwide [e.g.. USA, UK, India] - Based on Residence / Domicile / Citizenship

– Territorial [e.g.. Hong Kong]

– Modified territorial taxation [e.g.. Singapore]

• Tax Rates - 0% to 50%+

– No income tax in - UAE, BVI, Bermuda, Bahamas..

– Belgium – 50%, UK – 45%, USA – 39.5%, Japan – 55%, China – 45%..

• Different tests of residence

– Incorporation, management, principle office, head office, central management & control, etc.

Global Taxation Systems

34


• Juridical Double Taxation

– Same person taxed in two (or more) different countries for

the same income

• Different systems, rules and interpretation of terms

• Dual Residence

• Residence in one country and source in another

Juridical Double Taxation

DTAAs primarily entered into for Elimination of

Juridical Double Taxation- Also aids promotion of mutual economic relations, trade and

investment; defining rules for establishing right of country to

tax; Exchange of information; etc.


• Double Non-Taxation could arise due to -

– Global Non-residents

• Travellers

– Difference in Tax systems

• Territorial taxation in Residence State

– Differences in definition of residence and source in local

laws

– Shell / Conduit Entities

– Hybrid mismatches

Double Non-Taxation

Taking Inappropriate benefits of differing tax systems


Current

Scenario


• Indian DTAA with Mauritius, Singapore and Cyprus

– No capital gains tax on sale of shares in domestic laws

– DTAA provided taxing rights to Residence state only

• No capital gains in India as source state

• Double non-taxation

– No LoB clause in DTAA with Mauritius and Cyprus

• Misused for round tripping of investments

• Misused to avoid taxes in India

• Lead to Treaty Abuse

Existing Treaties


Existing CG Taxation

Type of Asset Mauritius Cyprus Singapore

Immovable Property Taxable Taxable Taxable

Assets of PE / fixed base Taxable Taxable Taxable

Ship / Aircraft Not taxable Not taxable Not taxable

Shares of Company Not taxable Not taxable Not taxable

Other Assets Not taxable Not taxable Not taxable

LoB Clause No No Yes (For shares)

• Taxability in Source State under DTAAs


Country-wise FDI in India

Mauritius

33%

Singapore

16%UK

8%

Japan

8%

USA

6%

Netherlands

6%

Germany

3%

Cyprus

3%

Others

17%

Cumulative FDI in USD Billion

(April 2000 To September 2016)


FDI in India and GDP

0

50

100

150

200

250

300

350

Mauritius Singapore Cyprus

Cumulative FDI April 2000 to September 2016 (USD Billion) GDP 2015 (USD Billion


• To stop treaty abuse and round tripping of investments

• To gain right to tax capital gains on sale of shares of Indian

company

• To comply with BEPS action plans

• To curb revenue loss and prevent double non-taxation

• To stimulate flow of exchange of information

Need for Amendment


Revised

DTAAs


Revised DTAAs

Transacti

ons

Indian Tax Treaties


Date of

Treaty

24-08-1982 24-01-1994 13-06-1994

Revision Protocol – 19-07-

2016

Protocols

- 2005 (CG residence based

tax with LoB)

- 2011 (EoI Strengthened)

- 2016 (As CG exemption co-

terminus with Mauritius

DTAA

Revised DTAA

–

18-11-2016


Capital Gains on Shares

TransactionsSource Taxation in India under DTAA


CG from alienation of

shares of Co. acquired

after 1-4-2017

√ √ √

Grandfathering for shares

acquired till 31-3-2017√ √ √

Lower taxation for transitory

period of 2 years (50% of tax)√ √ ×

LOB provisions (for CG

exemption on alienation

of shares)

√(Applicable only

for transitory relief)

√(Applicable for

grandfathered

and transitory

relief)

×


Capital Gain Others



Gains from alienation of

shares of foreign Co.

deriving value from assets

in Source State

× × √(If value is based on

immovable property

situated therein)


immovable property√ √ √


assets of PE / fixed base√ √ √

CG from alienation of

debt instruments including

convertible debts,

derivatives

× × ×


• Introduction of LoB Clause

– Applicable to Article 13(3B)

– No benefits available if

• Arranged primarily to take advantage of 13(3B)

• No bonafide business activities

• Shell / conduit company

• Negligible or nil business operations or with no real and continuous

business activities carried out in that Country

• Expenditure on operation < Mauritian Rs.1.5 mn or INR 2.7 mn in 12

months prior to gain

• Not considered Shell if –listed or expense > thresholds

LoB Clause - Mauritius


• LoB clause similar to 2005 protocol, expenditure test modified

• Annual expenditure test

– Average Annual expenditure on operations in residence state >= SGD 0.2 mn or INR 5 mn

– For each of 12 months period in 24 months preceding date of gain (for investments prior to April 1, 2017)

– For 12 months preceding date of gain (for transition relief)

• Other tests

– Primary purpose (PPT), Bonafide business activities, Not Shell / conduit company

• Similar to India-Mauritius DTAA

LoB Clause - Singapore


• Scope of Article on EoI enhanced

– EoI not restricted to Article 1 and 2

• Person may necessarily not be resident of India / Mauritius

• Not restricted to taxes referred to in Article 2

– Information should be “foreseeably relevant” and may not be

“Necessary” for carrying out provisions of DTAA

– CS not to decline to supply information solely because

• (a) it has no domestic interest in such information or

• (b) information is held by a Bank, FI, person acting as agent etc. or

it relates to ownership interests in a person.

Exchange of Information


Other Amendments


Singapore Mauritius Cyprus

Interest 10/15% 7.5%

(0/5%/20%/40%)

10%

Royalty 10% 10% 10% (15% )

FTS 10% 10% 10% (15% for FIS)

Service PE 90 days in fiscal year

(30 days in case of

related enterprises)

(Other than FTS as per

Article 12)

90 days within 12

months

90 days within 12

months

Other Income √ √(If arises in source

state)

√(Only specified

incomes – winnings

from lottery, race,

etc.)


• Mechanism of corresponding tax adjustments introduced

– In transfer pricing cases

– to prevent economic double taxation

Other Amendments - Singapore


Singapore –

• “This Agreement shall not prevent a Contracting State from

applying its domestic law and measures concerning the

prevention of tax avoidance or tax evasion.”

– Anti-avoidance rules given preferential treatment in India-

Singapore DTAA

• No similar clause in DTAA with Mauritius and Cyprus

Applicability of GAAR?


• Elimination of Double Taxation

– Tax Sparing clause removed

– Until now, tax rates mentioned in Article 10, 11, 12 and 13 were

deemed as tax paid in source state

• The clause is now removed

• Eg. Cyprus resident receiving dividend from Indian Company

• No WHT under domestic laws of India

• Rate as per Article 10 = 10% (assuming ownership criteria met)

• Deemed tax paid, available as Credit in Cyprus = 10%

Other Amendments - Cyprus


• Revised definition of “Source” for royalty / FTS – Country of -

– Residence of Payer

– PE / fixed base

– Utilization of property / Performance of service

• Uniform rate of tax on dividends at 10%

– Currently, 15% tax if ownership criteria of 10% not met

• Definition of PE expanded

• Business Income

– Removal of Force of Attraction rule

– Transactions between PE and HO to be ignored

Other Amendments - Cyprus


• Grandfathering of existing investments from Indian tax net

• Other securities continue to be taxed in Residence State

• Shares held by FIIs as stock in trade, not having PE, not taxable

in Source State

• Underlying tax credits under Mauritius and Singapore treaties

continue

– Relevant for outbound investments

Consequential Effects


• Inter-play with GAAR provisions

– Overriding effect on DTAA with Mauritius and Cyprus?

• Impact on volume of investments

• Rescindment of notification considering Cyprus as an NJA

– Quick de-notification of Cyprus as an NJA

• Encourage fresh investments

• Through Cyprus prior to 1-4-2017

Consequential Effects


• Indirect transfers

– German Co. selling shares of

Mauritius Co. which derives

value substantially from

shares of Indian Co.

• Tax under Income tax Act?

• Taxable in India as per

DTAA?

Case Study 4

German Co.

Mauritius Co.

Indian Co.

100%

100%


1. Gains derived by a resident of a Contracting State from the alienation of immovable property

situated in the other Contracting State may be taxed in that other State.

2. Gains from the alienation of movable property forming part of the business property of a

permanent establishment which an enterprise of a Contracting State has in the other

Contracting State or of movable property pertaining to a fixed base available to a resident of a

Contracting State in the other Contracting State for the purpose of performing independent

personal services, including such gains from the alienation of such a permanent establishment

(alone or with the whole enterprise) or of such fixed base, may be taxed in that other State.

3. Gains from the alienation of ships or aircraft operated in international traffic or movable

property pertaining to the operation of such ships or aircraft shall be taxable only in the

Contracting State in which the place of effective management of the enterprise is situated.

4. Gains from the alienation of shares in a company which is a resident of a Contracting State

may be taxed in that State.

5. Gains from the alienation of any property other than that referred to in paragraphs 1 to 4 shall

be taxable only in the Contracting State of which the alienator is a resident.

Article 13 – India-Germany DTAA








• Taxable in India as per DTAA?

• Impact of GAAR?

Case Study 4

German Co.

Mauritius Co.

Indian Co.

100%

100%








• Taxable in India as per DTAA?

• What if POEM of Mauritius Co.

in India?

• Impact of GAAR?

Case Study 4

German Co.

Mauritius Co.

Indian Co.

100%

100%


Country by

Country

Reporting


CbCR – Overview

• CbCR

– Country by Country Reporting

– Objective information to the tax authorities about the entire MNC

• CBCR requires MNC to declare:

– Countries in which it operates

– Country wise Financial Indicators

• Related and Unrelated party Revenue

• Pre Tax Profit

• No of Employees

• Income Tax: Actually Paid and Accrued

• Capital, Accumulated Earning and Tangible Assets, Description of

business Activity

Interesting case for

Mauritius having

high accrued tax

but low cash tax


• Indian Parent / Alternate Reporting Entity (ARE) has to file it

• Consolidated Revenue Threshold: EUR 750 Million

• Indian sub/ Associate or JV (Constituent Entity) has to file if:

– Ultimate Parent is a non resident and

– No information exchange is possible and

– No ARE has been designated

• Reporting Entity’s jurisdiction will share it with the rest

– Only if information exchange exists

• Stringent penalties for non-compliance

CbCR – Filing Obligation


• ALL Intra group transactions on record

• Significant collation of information with regard to various jurisdiction

in which the Group operates

• Financial Indicators of all entities available across all jurisdictions

– Easy availability to tax authorities

– Detection of lack of substance

• BEPS recommendation on ‘Master File’ not explicitly included in

Finance Bill 2016

– However, it could be prescribed in Rules

– In that case, entire Group Structure available across all jurisdictions

CbCR – Implications


• Include entities otherwise included in Consolidated Financial

Statement

• Country of Tax Residence is relevant

– Location relevant in case of Permanent Establishments

• Reporting Accounting year of the filing entity

• Consistency in data important

CbCR – Finer Points


• Are certain jurisdictions having abnormally high profit to

employee ratio?

• Does your maximum profits lie in countries having negligible 3rd

party transactions?

• Do you pay sufficient tax on the chunk of your profits?

• Does your ultimate parent reside in a tax haven?

• Are certain jurisdictions having abnormally high profit margin?

CbCR – Q to assess Risk


Information

Exchange


• Exchange of information Article in most of Indian treaties

• 19 TIEAs signed by India

TIEAs of India

2016: Maldives, Saint Kitts and Nevis, Seychelles

2014: San Marino

2013: Argentina, Bahrain, Belize, Gibraltar, Liechtenstein, Monaco

2012: Guernsey, Jersey, Liberia, Macau

2011: Bahamas, BVI, Cayman Islands, Isle of Man

2010: Bermuda


• Base Erosion and Profit Shifting Project of OECD

– Action Plan 12 – Mandatory Disclosure Rules

• US-India – Agreement to Improve International Tax compliance

and to implement FATCA – 9 July 2015

• Various DTAAs revised – Switzerland, Mauritius, Cyprus

• Guidance provided to field officers for EOI with BVI - 12 May

2016

Another Step towards Transparency

Arpit Jain

Director

Office: +91 79 2642 3344

Mobile: +91 96876 00207

Email: [email protected]

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