dtaa agreemet.docx

7/28/2019 DTaa AGREEMET.docx

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NATIONAL LAW SCHOOL OF INDIA UNIVERSITY,

NAGARBHAVI, BANGALORE

PROJECT ASSIGNMENT

ON

INVESTMENT LAW

TOPIC: DTAA IMPACT ON FDI INFLOW:- INDO MAURITIUS TREATY

COURSE TEACHER: PROF. N. L. MITRA

SUBMITTED BY: - SACHIN MAURYA

Ist

YEARLL.M. (BUSSINESS LAW)

ID NO. 446


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ACKNOWLEDGEMENT

I would like to express my sincere gratitude to Prof .N. L. MITRA and owe my foremost

regards to him for giving me an opportunity to carry out this project work under his guidance.

This work would not have been possible without his invaluable support and thought provoking

comments. It is due to his patient guidance that I have been able to complete the task.

I also extend my gratitude to the Librarian and the Library staff who made available the

required materials within time. I am indebted to all those who guided me while doing the

research work. Their valuable contributions have played a vital role in the completion of this

project.

Though I have tried out best at the same time I know that there is nothing calledperfection so I would like to have all valuable suggestion for future

I dedicate this project to all the people who believe that hard work and creativity needs

protection and encouragement.

SACHIN MAURYA

LL.M. 1ST

YEAR

ID. NO. 446


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TABLE OF CONTENTS

ACKNOWLEDGEMENT. 2

INTRODUCTION 4

OBJECTIVE OF ENTERING INTO DTAA ... 5

MODELS OF DTAA .. 6

DOUBLE TAXATION AVOIDANCE AGREEMENT WITH MAURITIUS.. 6

TAXATION OF CAPITAL GAIN FROM ALIENATING SHARE 8

TAXATION OF BORROWING FROM INTERNATIONAL INSTITUTIION 8

MISUSE OF DTAA..9

LANDMARK CASE AZADI BACHAO ANDOLAN 10

CONCLUSION 12

BIBLIOGRAPHY... .. 13


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INTRODUCTION

Mauritius accounts for nearly half of all foreign direct investment (FDI) inflows to India.

Indian tax officials said the treaty has been costing the exchequer over Rs 4,000 crore (Rs 40

billion) annually for some years in terms of revenue foregone on account of the capital gains

exemption for investors routing their funds through Mauritius.

Mauritius has remained the first major source for FIIs in the Indian stock market with the US

being a distant second.To date, India has signed comprehensive double taxation avoidance

agreements with approximately 75 countries1.

This source-based taxation often gives rise to the problem of double taxation, where the same

income could be taxed twice - in India, and also in the country of residence of the taxpayer2.

India has entered into Double Tax Avoidance Agreements (DTAAs) with a large number of

countries, to resolve this problem. Essentially, these DTAAs lay down the extent to which one

country has a right to tax income of a resident of the other country that is sourced from the first-

mentioned country. The Governments of the two countries, having regard to the source rules

contained in their respective domestic laws, have negotiated this extent; The Income-tax Act

provides that the provisions of such a DTAA, if they are more favourable to a taxpayer, will

override the provisions of the domestic tax law

3

.

Indian tax authorities have managed to tighten clauses in many of these treaties. Only 12 to 13

treaties have residence-based taxation, of which seven or eight have been revised. The others are

in the process of being revised. The only ones left are Mauritius and Singapore, but the latter has

safeguards4.

1N.K.Bhat, Overview of International Taxation, International Taxation A Compendium, The Chamber of Income

Tax Consultants, fifth edition, 20052

Ibid.3

Ibid.4

Ibid.


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OBJECTIVES OF ENTERING INTO DTAA

The object of a Double Taxation Avoidance Agreement is to provide for the tax claims of two

governments both legitimately interested in taxing a particular source of income either by

assigning to one of the two the whole claim or else by prescribing the basis on which tax claims

is to be shared between them.5

The need and purpose of tax treaties has been summarized by the OECD in the Model Tax

Convention on Income and on Capital in the following words6:

It is desirable to clarify, standardize, and confirm the fiscal situation of taxpayers who are

engaged, industrial, financial, or any other activities in other countries through the application by

all countries of common solutions to identical cases of double taxation.

The objectives of double taxation avoidance agreements can be enumerated in the following

words7:

First, they help in avoiding and alleviating the adverse burden of international double taxation,

by

a) laying down rules for division of revenue between two countries;

b) exempting certain incomes from tax in either country ;

c) reducing the applicable rates of tax on certain incomes taxable in either countries

Secondly, and equally importantly tax treaties help a taxpayer of one country to know with

greater certainty the potential limits of his tax liabilities in the other country.

Still another benefit from the tax-payers point of view is that, to a substantial extent, a tax treaty

provides against non-discrimination of foreign tax payers or the permanent establishments in the

source countries vis--vis domestic tax payers

5Ostime (Inspector of taxes) v. Australian Mutual Provident Society (1960) 39 ITR 210 (HL)

6http://siadipp.nic.in/publicat/invpub/taxation.htm

7Ibid.


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MODELS OF DTAA

OECD Model, UN Model, the US Model and the Andean Model are few of such models. Ofthese the first three are the most prominent and often used models. However, a final agreement

could be combination of different models.

1. Organization of Economic Co-operation and Development (OECD) :-

OECD Model is essentially a model treaty between two developed

nations. This model advocates residence principle, that is to say, it lays emphasis on the right of

state of residence to tax.

2.United Nations Model Double Taxation(UN Model) :-

This model is essentially a model treaty between Developed and

Developing Countries. The UN Model gives more weight to the source principle as against the

residence principle of the OECD model.

Most of Indias treaties are based on the UN Model.

DOUBLE TAXATION AVOIDANCE AGREEMENT WITH MAURITIUS

Mauritius accounts for nearly half of all FDI inflows to India. Mauritius is first major source for

FIIs in the Indian stock market with the US being a distant second. Treaty with Mauritius was

signed in august 1982. Treaty specified that capital gains made on the sale of shares of Indian

companies by investors resident in Mauritius would be taxed only in Mauritius and not in India ,

since this treaty follows concept of residence for the purpose of taxation.


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WHY INVESTMENT THROUGH MAURITIUS?8

Investment coming into India from Mauritius is peculiar for a special reason which in

international tax terms is known as the Residence/Source principle. Under residence approach:-

a country taxes all the income of the persons resident in the country. For Indian context ,

residence is defined under section 6 of income tax act 1961. Under source rule:- the country

taxes only that portion of income which arises or relates in part to the country in question.

For example for a person Resident in South Africa giving management advice to an Indian

company and getting paid management fees for such advice would only be liable to pay tax on

that potion of Management fees received in India and not on anything more. This residence

principle has been the major driver for investment. In Mauritius , there is no charge of capital

gains while in India capital gains are chargeable to income tax at two rates ; 10% and 30%+ on

short term and long term capital gains respectively.

This has following outcome9:-

For a person resident in India , capital gains are chargeable to tax at the givenrates(because of the residence principle).

For a person not resident in India, capital gains are again chargeable to tax atthe given rates [because of the Source principle].

For a person who is resident in Mauritius, capital gains sourced in India aretaxable in Mauritius because of the Indo-Mauritius DTC. Under Mauritius

domestic laws no capital gains tax is chargeable.

Therefore one can see that there is a lot of advantage for the tax payer if the Residence is located

in Mauritius. This also means there is an added reason to opt for bringing your investments into

India (if you are not an Indian tax Resident) and this is why Mauritius route becomes interesting.

8Investing into India through Mauritius by conyers &pearman

9Ibid.


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TAXATION OF CAPITAL GAIN FROM ALIENATING SHARES

Article 13 of treaty talks about capital gains. In case of immovable property may be taxed in thecontracting state in which such property is situated. Gains from alienation of movable property

forming part of the business property which a enterprise of a contracting country state has in the

other contracting state, may be taxed in that other state10

.

For instance :- Applicant is a partnership firm and is a resident of Mauritius. In 2006 ,it acquired

1 million shares of A an Indian company amounting to Rs. 10 million. This company demerged

into company B and C in 2009. the applicant got shares according to scheme of demerger and

amalgamation in the companies referred to above. Now in 2011 applicant wants to sell the

shares at the consideration which resulted in capital gains to the applicant.

Issue:- Where the gains from alienation of shares in an Indian company held by resident of

Mauritius will be taxed?

Answer :- Being a resident of Mauritius such capital gain will be taxed in Mauritius and not in

India according to DTAA. (article 13) .Under IT act it cannot be disputed the capital gains

arising to a non resident in India are taxable in India. Having regard to section 90(2) of the act,

the terms of the treaty have overriding effect over the provision of the act in the event of there

being conflict between the treaty and the act. (Uoi Vs Azadi Bachao Andolan (sc) -263 ITR 706)

TAXATION OF BORROWING FROM INTERNATIONAL INSTITUTION

ARTICLE 11 - Interest :- Interest arising in a Contracting State and paid to a resident of the

other Contracting State may be taxed in that other State. Such interest may also be taxed in the

Contracting State in which it arises and according to the laws of that State provided that such

person should have permanent establishment11

.

10Indo-Mauritius treaty DTAA

11 Indo- Mauritius treaty DTAA


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For instance :- A a company in India takes external borrowing from B a bank in Mauritius.

Issue :- how to tax interest arising from such lending of money.

Answer :- Prima facie, Interest arising from a company A in India which is payable to bankresident of the Mauritius will be taxed be taxed in Mauritius. But where B a bank in Mauritius

has Permanent Establishment in India , such interest arising from a company A in India shall be

treated as arising in India and will be taxed according to the domestic law of India. Another

situation is that , where an assessee becomes taxable in view of residential status in one country

and permanent establishment in the other , tax sharing

MISUSE OF DTAA

Treaty shopping :- Where a national or resident of a third country seeks to obtain the benefit of

a double tax agreement between two other countries by interposing a company or other entity in

one or the other of them.12

For instance:- a company from the UK may desire to invest in India. It may initiate, conduct and

conclude all negotiations and agreements from the UK. But before the actual investment, it may

purchase a shell company in a tax haven, say, Mauritius, and route its investment through that

Mauritian company. Since technically or artificially the investment is made from out of a

Mauritian company, it may seek to claim the Indo-Mauritian DTAA rather than the Indo-UK

DTAA and, as such, would capitalize on the tax-effectiveness of the former treaty.

This way, either India or the UK may be deprived of their share of higher revenue available to

them under the Indo-UK DTAA. Since such investing company `shop around treaties artificially

(rather than DTAA to which they are naturally subject), it is graphically described `treaty

shopping.

12India's DTAA with Mauritius has gaps, says OECD study, by Sidhartha,2008


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Shell company13

:- A shell corporation is defined in BarronsFinance And Investment Handbook

as a company that is incorporated, but has no significant assets or operations.

LANDMARK CASES

UOI V AZADI BACHAO ANDOLAN14

Issue:-. Indian revenue authorities had questioned the eligibility of these FIIs to claim the benefit

under DTAA since, in their view, these FIIs were shell companies incorporated in Mauritius,

which were controlled and managed from other countries and were basically using Mauritius as a

conduit to claim concessional tax rates under DTAA.

Subsequently, the Indian government issued a circular (Circular 789 dated April 13 2000)through Central Board of Direct Taxes (CBDT) clarifying that a Certificate of Residence issued

by the Mauritian authorities would constitute sufficient evidence for accepting the status of

residence for claiming benefits under Indo-Mauritian DTAA

Supreme courts decision15

:-

Regarding circular:- set aside the ruling of the High Court and restored thevalidity of the circular.

Regarding override of treaty:-Under section 90 of the Income Tax Act 1961, theCentral Government is empowered to issue notifications for implementation of

terms of tax treaties and such tax treaties would override the provisions of the

Income Tax Law as held by various Indian High Courts.

Regarding treaty shopping:- If the residents of a third contracting statequalify for a benefit under a Treaty they cannot be denied the benefit on a

theoretical ground that Treaty shopping is unethical and illegal

13http://en.wikipedia.org/wiki/Shell_corporation

14[2003] 263 ITR 706 (SC)

15Ibid.


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IN RE E

TRADE MAURITIUS LTD(AAR)

16

Ruling:-India-Mauritius treaty benefits cannot be denied on the ground that assessee is

a subsidiary of a USA Corp17

.

Facts:- The applicant, a resident of Mauritius, was a subsidiary of a USA company. It

received capital contribution and loans from the USA parent which were used to purchase

shares in ILFS, an Indian company. On sale of the shares, the applicant earned capital

gains which were chargeable to tax under the Act. However, under Article 13 (4) ofthe India-Mauritius tax treaty, such gains were not chargeable to tax in India

18.

Question:- whether in view of the Article 13 (4), the gains were chargeable to tax in

India.

(i) The effect of Azadi Bachao Andolan 263 ITR 706 (SC) is that there is no legal

taboo against treaty shopping. Treaty shopping and the underlying objective of tax

avoidance/mitigation are not equated to a colourable device. If a resident of a thirdcountry, in order to take advantage of a tax treaty sets up a conduit entity, the legal

transactions entered into by that conduit entity cannot be declared invalid. The

motive behind setting up such conduit companies is not material to judge the

legality or validity of the transactions. Tax avoidance is not objectionable if it is

within the framework of law and not prohibited by law.

On facts, as all legal formalities for purchase of the shares and their subsequent transfer

had been gone through and the consideration had been received by the applicant, it was

difficult to assume that the capital gain has not arisen in the hands of the applicant but had arisen

in the hands of the USA parent;

16(2010) 324 ITR 1 / 190 Taxman 232 (AAR).

17Ibid.

18Ibid.


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The fact that the USA parent provided the funds and played a role in negotiating the transaction

of sale does not lead to the legal inference that the shares were in reality owned by the USA

parent.The fact that the subsidiary has its own corporate personality and is a separate legal entity

cannot be overlooked.It is unrealistic to expect that a subsidiary should keep off the clutches

of the holding company and conduct its business independent of any control and assistance

by the parent company;

Consequently, the gains made by the Applicant were not chargeable to tax in India.

Obiter:It looks odd that the Indian tax authorities are not in a position to levy capital gains tax

on the transfer of shares in an Indian company. Whether the policy considerations underlying

Article 13 (4) of the treaty and the spirit of the CBDT Circular would still be relevant in the

present day fiscal scenario is a debatable point.

CONCLUSION

Does DTAA has really helped India? Prima facie we can say that DTAA has helped in increasing

the inflow of foreign investment from the tax haven countries. Analysis the facts it can be proved

that India is receiving the majority of foreign investment from Mauritius because being a tax

haven country.

Because of lack of limitation clause in the DTAA with Mauritius, India is losing a huge amount

of revenue every year and the reason is treaty shopping. At present efforts are going on to revise

the treaty and introduce the limitation clause so that the evil of treaty shopping can be mitigated.

This limitation clause is like the third party cannot get the benefit of the DTAA unless that party

is the resident of one of the two countries. Also there is problem of round tripping for that

purpose the negotiations are being going on to revise the treaty so that the principle of residence

taxation can be changed into source .


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REFERENCE

Books:-

1.

Ostime (Inspector of taxes) v. Australian Mutual Provident Society (1960) 39 ITR 210(HL)

2. N.K.Bhat, Overview of International Taxation, International Taxation ACompendium, The Chamber of Income Tax Consultants, fifth edition, 2005

Articles:-

1. India's DTAA with Mauritius has gaps, says OECD study, by Sidhartha,2008Websites:-

http://in.rediff.com/money/2008/mar/13mauri.htm http://law.incometaxindia.gov.in/TaxmannDit/IntTax/mainInttax.aspx http://en.wikipedia.org/wiki/Double_taxation http://en.wikipedia.org/wiki/Capital_gains http://www.globalpolicy.org/nations/corrupt/2002/1205mauritius.htm http://www.globalpolicy.org/nations/corrupt/2002/1205mauritius.htm http://www.thehindubusinessline.com/2003/11/29/stories/2003112900080900.htm http://en.wikipedia.org/wiki/Shell_company

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