In today’s global trade and services environment, a country’s national policy cannot ignore its international economic orientation. Double tax avoidance agreements help to create an environment of fiscal certainty which encourages trade and investments between countries, thereby influencing a country’s economic relations with other countries.
Indian tax treaties – objectives and overview
Section 90 of the Income-tax Act, 1961, empowers the central government of India to enter into agreements with foreign countries with the following stated objectives:
a) For granting relief in respect of:
income which has been subject to tax in two countries; or
income-tax chargeable in two countries to promote mutual economic interests, trade and investment;
b) for the avoidance of double taxation;
c) for exchange of information for the prevention of evasion or avoidance of income-tax in India or the other country; or
d) for recovery of income-tax under the laws of the two countries.
In exercise of the powers available under section 90 of the Act, the central government has entered into quite a large number of tax treaties with various countries. On an overall basis, as also stated above, mutuality of relief, equitable treatment of taxpayers, resolving of conflicts and exchange of information are the primary purpose of the Indian tax treaties. Indian tax treaties can broadly be categorised into (a) comprehensive treaties and (b) limited treaties. While comprehensive treaties cover almost all the sources of income, limited treaties are typically aimed to avoid double taxation related to income derived from operations of aircraft, carriage of cargo and freight.
A list of the Indian tax treaties is provided below. In addition to the tax treaties mentioned in the Annexure, tax treaties with Mexico, Senegal, Myanmar and Luxembourg are yet to be notified for coming into force.
Trends in Indian tax treaties
Some of the relevant trends in Indian tax treaties have been very briefly summarised below:
India’s tax treaties with developed and industrialised countries typically cover all sources of income arising out of inflow of technology, industrial equipment and direct investment in India. On the other hand, the tax treaties with developing countries are typically structured to encourage flow of technology, equipment and professional services which India is capable to transfer or offer.
Some tax treaties (such as Mauritius, Cyprus, Netherlands and Singapore) contain favourable capital gain tax clause for making investments in India. Considering the attractive treaty provisions, such jurisdictions have become favourite for routing investments into India.
The Indian government discourages treaty shopping and misusing favorable jurisdictions for avoiding taxes in India. In this context, it would be relevant to note that the India-Singapore tax treaty was amended by way of a protocol in 2005 to provide that for claiming the beneficial treaty provisions, a Singapore resident company (which is investing into India) should not be a shell/conduit company with no real business in Singapore. Similarly, India-UAE treaty was amended in 2007 to include a limitation of benefit clause. It is understood that India is also in discussion with the authorities of Mauritius and Cyprus on this aspect.
Domestic law vis-à-vis the Indian tax treaties
Section 90 of the Act provides that where a tax treaty exists, the provisions of the Act will apply if they are more beneficial to the taxpayer. As a corollary, the provision of the tax treaty would be applicable if the same are more beneficial than the corresponding provision of the Act.
These provisions clearly bring out the relevance of the tax treaties, especially where the tax treaties are restricted in scope as compared to the domestic law, and results in relief to the non-resident tax payer.
Importance of tax treaties in transfer pricing policy
Transfer pricing provisions under the domestic law
Detailed statutory framework for transfer pricing was introduced in India with effect from April 1 2001 with a view to provide for computation of reasonable, fair and equitable profits and tax in India for multinational companies. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions.
Transfer pricing policy in the Indian tax treaties
The Indian tax treaties do not directly provide guidelines on the subject of Transfer Pricing. However, typically, article 9 (associated enterprises) and article 27 (mutual agreement procedure) of the Indian tax treaties provide some guidance on transactions with associated enterprises and are relevant.
Typically, the Indian tax treaty provisions dealing with ‘associated enterprise’ provide for an adjustment to profits where transaction have been entered into between associated parties (parent and subsidiary or companies under common control) other than on arm’s length terms. These provisions broadly provide as follows:
Right to tax profits in transactions entered into on other than arm’s length terms
The Indian tax treaties gives right to a state to tax the profits accruing, on an arm’s length basis, to an enterprise of that state, in a situation where the transactions are not on arm’s length basis.
A corresponding adjustment in the other state
Though there may be exceptions, the tax treaties typically provide that if the afore-mentioned adjustment in the first state results in economic double taxation of the same profits (which have also been charged to tax in the other state), the other state shall make an appropriate adjustment to relieve the double taxation. Further, for the purpose of determining the adjustment, the competent authorities of each state shall consult each other, if required.
The treaties do not clarify or discuss the procedure to be followed for claiming the corresponding adjustment. However, one may refer to the technical explanation, though not binding on the Indian tax authorities, to the India-US tax treaty as issued by the Treasury Department of the US. The technical explanation provides that in case an adjustment is made in one state on the basis of the arm’s length principle, the other state would be obligated to make a corresponding adjustment to the tax liability of the enterprise in its state. It further provides that if a corresponding adjustment is made, it needs to be implemented pursuant to the mutual agreement procedure (MAP).
Certain exceptions
There are some Indian tax treaties which do not contain direct provisions relating to making of a corresponding adjustment in the other state. These treaties include India’s treaties with Belgium, Finland, France, Germany, Italy and Norway. One needs to see how a corresponding adjustment can be claimed in the other state under such tax treaties.
Provisions in the tax treaties for initiating MAP
Broadly speaking, the treaties generally provide that:
a) Where a resident of a state considers that the action of one or both the states would result in taxation not in accordance with the tax treaty, the resident may approach the competent authority of the state in which he is a resident; and
b) The competent authority shall endeavour, if it is not itself able to arrive at an appropriate solution, to resolve by mutual agreement with the competent authority of the other state.
In addition to the above, the provisions also typically specify the time limit within which a taxpayer can move an application for initiating MAP, and that the conclusions reached through the proceedings can be implemented irrespective of any time limits or procedural limitations in the domestic law of the states.
In the context of a MAP proceeding, it may not be out of place here to mention that the Indian and the US competent authorities have entered into a memorandum of understanding (MoU) which provides that tax demand would be kept in suspension during the pendency of MAP. The suspension would however be dependent upon various conditions, which include furnishing of a bank guarantee of an amount equal to the amount of tax under dispute and interest accruing thereon as per the provisions of the Act. A similar MOU also exists with UK.
Transfer pricing adjustments in India – relevance of MAP
The Indian tax authorities have generally been aggressive in the administration and implementation of the transfer pricing provisions under the Act. This has resulted in significant tax demand being raised upon Indian subsidiaries of various multinational companies.
Though the Indian subsidiary companies, suffering the transfer pricing adjustment, are currently in appeal before the higher authorities, a few of the multinational (parent) companies, as an alternative dispute resolution mechanism, have invoked provisions relating to MAP, through the competent authorities of their state. The direction in which such proceedings would move is something that is yet to be seen.
In this connection, it may be relevant to note that the Central Board of Direct taxes (CBDT) has recently issued a circular, extending the applicability of the MoU to Indian resident entities during the course of the pendency of the MAP invoked by a resident of US. Accordingly, if an Indian subsidiary of a US company suffers a transfer pricing adjustment and the US company has initiated proceedings under MAP, the Indian subsidiary can seek a stay of the demand raised upon it, till the MAP proceedings are concluded. The stay of the demand would however be subject to the conditions included in the MoU (such as furnishing of bank guarantee).
A. List of countries with which India has comprehensive tax treaties |
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1. Armenia |
38. Namibia |
2. Australia |
39. Nepal |
3. Austria |
40. Netherlands |
4. Bangladesh |
41. New Zealand |
5. Belarus |
42. Norway |
6. Belgium |
43. Oman |
7. Brazil |
44. Philippines |
8. Bulgaria |
45. Poland |
9. Canada |
46. Portuguese Republic |
10. China |
47. Qatar |
11. Cyprus |
48. Romania |
12. Czech Republic |
49. Russia |
13. Denmark |
50. Saudi Arabia |
14. Egypt |
51. Singapore |
15. Finland |
52. Slovenia |
16. France |
53. South Africa |
17. Germany |
54. Spain |
18. Greece |
55. Sri Lanka |
19. Hungary |
56. Sudan |
20. Iceland |
57. Sweden |
21. Indonesia |
58. Swiss Confederation |
22. Ireland |
59. Syria |
23. Israel |
60. Tanzania |
24. Italy |
61. Thailand |
25. Japan |
62. Trinidad and Tobago |
26. Jordan |
63. Turkey |
27. Kazakstan |
64. Turkmenistan |
28. Kenya |
65. UAE |
29. Korea |
66. UAR (Egypt) |
30. Kuwait |
67. Uganda |
31. Kyrgyz Republic |
68. UK |
32. Libya |
69. Ukraine |
33. Malaysia |
70. USA |
34. Malta |
71. Uzbekistan |
35. Mauritius |
72. Vietnam |
36. Mongolia |
73. Zambia |
37. Morocco |
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B. List of countries with which India has limited tax treaties |
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1. Afghanistan |
9. Pakistan |
2. Bulgaria |
10. People's Democratic Republic of Yemen |
3. Czechoslovakia |
11. Russian Federation |
4. Ethiopia |
12. Saudi Arabia |
5. Iran |
13. Switzerland |
6. Kuwait |
14. UAE |
7. Lebanon |
15. Yemen Arab Republic |
8. Oman |
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K R Girish is head of tax for KPMG in South India krgirish@kpmg.com
Rohit Jain, manager
