Give foreign investors legitimate tax benefits
The Economic Times
National Tax Leader, EY
The finance ministry's move last November to notify Cyprus as notified jurisdictional area forced Cyprus to send its officials here to negotiate a solution. It used the provision under Section 94A of the Income-Tax Act that provides a toolbox of countermeasures on transactions with persons located in a "non-cooperative" jurisdiction.
Action was taken as Cyprus had failed to provide information sought by Indian tax authorities under the exchange of information provisions of India's tax treaty with Cyprus. The notification implies that the deduction of expenses on transactions with Cyprus residents would be allowed subject to stringent conditions, and any payments made to Cyprus residents would be subject to a high withholding tax rate of 30 per cent. India and Cyprus are now negotiating amendments to the tax treaty, pending which the notification has been kept in abeyance. What lies behind this new-found belligerence by the finance ministry on bilateral tax agreements?
The answer lies in the OECD's 2013 report on Base Erosion and Profit Sharing (Beps). The report is a "game changer" because it recognizes that globalization of business has enabled multinational enterprises (MNEs) to minimize their tax burden.
It has enabled centralization of several income-producing functions at a regional or global level into jurisdictions with a significantly lower tax burden. Thus, MNEs are legitimately able to minimize their tax burden under the current tax rules if significant economic activities are done in higher tax jurisdictions. The Beps report also recognizes that the interaction of different tax rules sometimes results in unintended double non-taxation.
The Beps report recognizes that these weaknesses put the existing consensus-based framework at risk and a bold move by policymakers is necessary to prevent worsening problems. The fear is that unilateral action by countries, ostensibly to protect their tax base, will result in global tax chaos and re-emergence of multiple taxation of the same profits of an MNE.
The Beps report reckons treaty abuse to be a big concern. Tight anti-abuse clauses in the treaty coupled with the exercise of taxing rights under domestic laws will contribute to restoring source-taxation in many cases. It would be advisable for India to resist any unilateral action till Beps action reports are announced in the next 12-18 months.
Meanwhile, India is well within its rights to enforce information-sharing arrangements with treaty partners and responsible tax jurisdictions. Mauritius has set an example, being largely compliant with information-sharing requests and allowing finance ministry representatives to be physically present there to access and share information on offshore activities in relation to India.
Latest reports suggest that Cyprus may agree for similar steps to be taken. However, the larger question about tax certainty for foreign investors still remains. Over the years, the applicability of the India-Mauritius tax treaty and the consequential availability of capital gains tax exemption in India has been widely debated.
A similar provision for capital gains tax exemption is available in the India-Cyprus tax treaty. It is understood that India is negotiating a limitation of benefits (LoB) article with Mauritius and Cyprus, prescribing conditions relating to economic substance or business presence in those countries for the relevant tax treaty to apply. This is a salutary development as it will, hopefully, provide a measure of certainty for foreign investors from these two countries on the applicability of beneficial provisions of the tax treaties.
Clarity is also required to state that once LoB conditions are fulfilled, the general anti-avoidance rules (Gaar) will not apply. "Specific" rules like LoB must prevail over Gaar.
It augurs well for India if reluctant jurisdictions are made to cooperate with the country's efforts to prevent erosion of domestic tax base. But in the zeal to enforce tough measures on tax evaders, India would do well to provide clarity and certainty that legitimate foreign investors availing of bilateral tax treaty benefits — within the framework of proposed LoB conditions — shall not be denied the benefits. Else, we run a serious risk of adding yet another global tax controversy to its pile of unresolved tax disputes.
Views are personal.