TREATY SHOPPING:TREATY SHOPPING:In a moment of truthIn a moment of truth

Iqbal RajahbaleeIqbal Rajahbalee

Senior CounselSenior Counsel

BLC ChambersBLC Chambers

Officials of the Central Board of Direct Taxes

have long claimed that the Vodafone deal was

done through tax haven

Cayman Islands to take

advantage of what it termed

as “treaty shopping”.

| Monday , January 23 , 2012 |

GARR

DTC

“where a person acts through a legal entity created in a State essentially to obtain treaty benefits that would not be available directly.” OECD Commentary Art. 1.

AGENDA:AGENDA:TREATY SHOPPINGTREATY SHOPPING

• 1. EXPLORING THE SHOPPING PARADISE

• 2. DISCUSSING WITH THE IDEA

• 3. PICKING THE GENUINE FAKE

• 4. GOING TO COURT

• 5. THE SHOPPING EXPERIENCE

Loans

Mauritius as location forMauritius as location forholding companies holding companies

• Classic holding company model– Foreign parent capitalises

Mauritius Finco with equity – Mauritius Finco sets up

subsidiaries in target states, obtains reduced withholding tax on dividend and no capital gains

– Lends to subsidiaries obtain tax relief.

– Mauritius Finco taxed at effective rate 3%

• Points to watch for– Interest withholding tax– Deductibility of interest expense– CFC rules in country of parent

Mauritius FincoSingapore subsidiary

Foreign Parent

Equity

Indian subsidiary

Equity

Private Equity StructurePrivate Equity Structure

– Private equity business is normally leveraged

– As there will be little or no tax capacity in Mauritius, Mauritius Holdco will want to lend down into the target country

– How is it possible to push debt down into the target country?

– A key requirement is protection from excessive interest withholding tax in the country of the target

Mauritius Holdco

Investors

Acquisition vehicle/target

External lenders

Loans

Target country

Private EquityPrivate

Mauritius as location finance companyMauritius as location finance company

• Outline – Indian Parent holds European

subsidiary through Mauritian holding company

– Mauritian company is financed with equity from India

– Mauritian company makes loans to UK, French and German subsidiaries

– Interest deductible in European subsidiaries

– Interest taxed in on Mauritius at effective rate 3%

– No withholding tax on interest out of Germany

– Domestic interest withholding tax exemptions available – UK and France

– No tax in India until/unless Mauritius company distributes a dividend

Mauritius Holding Finance

Company

UK subsidiary

Indian Parent

Loans

Germansubsidiary

French subsidiary

Loans Loans

A Conduit CompanyA Conduit Company

• A GOOD SHOPPING CENTRE:– a wide network of tax treaties– Very favourable domestic tax

rules– Good professional resources

• PROVIDES A PLATFORM FOR CONDUIT COMPANIES

POLICY OBJECTIONSPOLICY OBJECTIONS

• It disturbs the “balance of burdens”:– jeopardising the fairness of the treaty bargains.

• Blurs distinction between negotiated treaty provisions and unilateral tax changes:– No incentive to establish tax treaties.

• Facilitates tax avoidance and tax evasion– Income from international investment bears little tax

or no tax at all.

EXPLORING THE SHOPPING CENTREEXPLORING THE SHOPPING CENTRE

• Acceptable and Unacceptable Practices– “Businesses should be able to organise their affairs to

obtain access to treaty benefits”

• Pacta Sunt Servanda Principle– requires contracting states to grant treaty benefits

“even if considered to be improper”, absent the existence of an explicit anti-avoidance rule within the treaty itself.”

OECD Conduit Companies Report(1986) note 15 at para 43

The Vienna ConventionThe Vienna Convention

• Canon of Interpretation of TreatiesTreaties to be interpreted according to their natural meaning

• Principle of Good FaithThe object and purpose of tax convention and the obligation to interpret them in good faith allows states to disregard abusive transactions, such as those entered into with the view to obtaining unintended benefits under the provisions of these conventions.

OECD Commentary 2003Article 1 para 7

Dichotomy of Domestic and Dichotomy of Domestic and International LawInternational Law

Public International Law

Domestic Tax Law

STATE STATE

TAXPAYER TAX AUTHORITY

Determining Tax ResidenceDetermining Tax Residence

• Abdul R. Meman [2005] 276 1 ITR 306 (AAR)Not resident under Article 4 if no liability to pay tax.

• ITO vs Mahavirchand Mehta [2011] 11 Taxmann.com 194 (Mumbai)Followed Azadi Bachao Andolan

Held that the expression ‘liable to tax' in a contracting state does not imply that the person should actually be liable to tax in that contracting state. It is enough if other contracting state has right to tax such person, whether or not such a right is exercised.

General Electric Pension Trust (2005) 280 ITR 425 AAR

Tax ResidenceTax Residence

• Cause of LiabilityCrown Forest Industries Limited v. The Queen, 92 DTC 6305 (FCTD).

Judge Iacobucci:

“… nothing improper with such behaviour [of minimising their tax liability], I certainly believe that it is not to be encouraged or promoted by juridical interpretation of existing agreements.”

EFFECTIVE MANAGEMENT:EFFECTIVE MANAGEMENT:

• Effective Management by Parent CompanyOECD Commentary Art 4

• Smallwood and others v Commissioners for HMRC [2009] EWHC 777 (Ch)– Change of Trustee to Mauritius to avoid capital gains

tax in UK– Low level decisions made by Trustees in Mauritius but

key decisions made in UK.– Decision on the basis of “effective management” of

the trust located in UK.

Effective ManagementEffective Management

• Prevost Car Inc v The Queen (2008) DTC 3080 and (2009) DTC 5053

“When corporate entities are concerned, one does not pierce the corporate veil unless the corporation is a conduit for another person and has absolutely no discretion as to the use or appropriation of funds put through it as a conduit …”

Article 4 (Residence)Article 4 (Residence)

• Wood v Holden [2006] EWCA Civ 26“Effective Management test in Art 4(3) of UK-Netherlands Treaty does not differ in substance from the domestic law test for corporate residence.”

Directors in Netherlands make decisions solely on the advice of other persons and without proper informed consideration.

Beneficial OwnershipBeneficial Ownership

• Indofood International Finance Ltd v JP Morgan Chase Bank NA London (2006) BTC 8003“The concept of beneficial ownership is incompatible with that of the formal owner who does not have full privilege to directly benefit from the income.”

• Bank of Scotland vs Ministre de l’Economie, des Finances (2006) Conseil d’Etat, case 283314 (29 decembre 2006)

Inherent Anti-Abuse ProvisionInherent Anti-Abuse Provision

• A Holdings ApS v Federal Tax Admin (2005) 8 ITLR 536“The prohibition of an abuse of rights as regards conventions is recognised without being necessary to adopt an explicit provision in the respective convention”

• Yanko-Weiss Holdings 91996) Ltd v Holon Assessing Office (2007) 10 ITLR 254

• Tax treaties were not designed for use that is not in good faith and in an acceptable manner, or that constitutes improper use..

Inherent Anti-Abuse ProvisionInherent Anti-Abuse Provision

• MIL (Investments) SA v The Queen [2006] T.C.J. No. 362 (T.C.C.)“The shopping or selection of a treaty to

minimize tax on its own cannot be viewed as being abusive”

On Appeal: “Unable to find an object or a purpose whose abuse could justify the court departing from the plain words of the treaty provisions…”

Combating Treaty ShoppingCombating Treaty Shopping

• Anti-misuse clauses

– look-through approach – channel approach – subject to tax

approach – exclusion approach

• Bona-fide clauses– general bona-fide

provision– activity provision– amount of tax

provision– stock exchange

provision– alternative relief

provision

The Shopping ExperienceThe Shopping Experience

• Azadi Bachao Andolan (2003) 132 Taxman 373• E-Trade Mauritius Ltd.[2010] 190 TAXMAN 232

(AAR)• Ardex Investments Mauritius Ltd. (AAR No 866

of 2010) • Aditya Birla Nuvo Ltd. v. DDIT [2011] 200

TAXMAN 437 (Mumbai)• Vodaphone Case (2012) (Civil Appeal) No.733

ENDEND

• Treaty Override

– DTC

– GAAR

• Treaty Amendment

THANK YOU