India: Defining ‘liable to tax’
Rishi Kapadia and Jairajesh Nadar of Dhruva Advisors look at how clarifying the interpretation of the term ‘liable to tax’ could impact the availability of tax treaty benefits.
The Finance Bill, 2021 proposes to define the term ‘liable to tax’. While the definition is proposed to be inserted in the Income-tax Act,1961 – it would be more relevant in the context of tax treaties entered into by India.
To state the matter briefly, access to a tax treaty is restricted to persons who qualify to be a ‘resident’ of a particular country. For tax treaty purposes, a person is generally considered to be resident of a country in which they are ‘liable to tax’ on account of their domicile, residence, place of management, or any other criteria of similar nature.
Interestingly, the term ‘liable to tax’ is generally not defined in a tax treaty. This has resulted in several interpretational issues over the years. The controversy has largely been around whether the ‘liable to tax’ criteria would be met when no tax is payable by a person.
Such a situation could typically arise in the following scenarios:
When tax exemptions are available;
When the income of fiscally transparent entities gets taxed in the hands of their members; or
When no taxes are being imposed in the home jurisdictions (e.g. no taxes are levied on individuals in the UAE, Saudi Arabia, Qatar).
The courts in India have generally given a wide connotation to the expression ‘liable to tax’ in the context of tax treaties. The term has been interpreted as not requiring actual payment of taxes nor requiring an actual imposition of a liability.
It has been held that so long as a country has a right to tax a person on account of their domicile, residence, or similar criteria such a person should be considered as being ‘liable to tax’ in that jurisdiction. This is irrespective of whether such a country exercises its right to tax that person or not.
Consequently, hitherto a person could claim the benefits of a tax treaty even if no tax liability was imposed on such a person or after the imposition of a liability, no tax was payable on account of specific exemptions or a loss position.
Similarly, even fiscally transparent entities have been allowed tax treaty access on the basis that their members were liable to tax in the home jurisdiction.
The definition of the term ‘liable to tax’ proposed by the Finance Bill, 2021 is much narrower in scope vis-à-vis the judicial interpretation of the term in the context of tax treaties.
As per the proposed definition, a person will be regarded as ‘liable to tax’ in a country in only the following two scenarios:
There is an imposition of tax liability on such a person in any country; or
After the imposition of tax liability, no taxes are payable on account of specific exemptions.
Thus, the definition does not cover cases where no tax is being imposed in the home country or those concerning fiscally transparent entities.
Impact on availability of tax treaty benefits
The definition once enacted, while being relevant for interpreting the term in the context of the Income-tax Act, shall apply in the context of tax treaties as well.
This is because a term not defined in a tax treaty will have the meaning ascribed to it under the domestic tax laws.
With the definition requiring the imposition of tax as a condition for meeting the ‘liable to tax’ criteria, fiscally transparent entities (say a US LLC) and persons not subject to tax in their home jurisdiction may not meet the ‘liable to tax’ criteria. As such, they may not be eligible to claim tax treaty benefits that were hitherto available.
Thus, there may be a need to revisit existing business models and holding structures which include fiscally transparent/non-taxable entities to avoid the risk of tax treaty benefits being denied in the future.
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T: +91 22 6108 1000