Contours of Availing Tax Treaty Benefits in India
Executive Perspective
Non-residents including foreign companies are taxed only in respect of income accrued or received or income deemed to accrue or arise or deemed to be received in India. Provisions of Indian tax law gives an option to non-residents to be governed by provisions of the tax treaty entered between India and country of which non-residents are tax residents. The article attempts to give a high level view with regards to availing tax treaty benefits in India. Read on to know more…
1. Essential Conditions for Availing Tax Treaty Benefits in India
Non-residents can avail benefits of tax treaty, subject to satisfaction of following conditions:
- The non-residents should be able to obtain tax residency certificate/certificate of tax residency from income tax authorities of home country.
- It should be regarded as ‘person’ and ‘resident of contracting state’ as defined in the tax treaty.
- Tax treaties generally provides condition of beneficial ownership of income where benefits are claimed in respect of royalty, interest and dividend income.
- Affairs of non-residents should not be arranged with the primary purpose of obtaining tax treaty benefits.
- The non-residents should fulfill Limitation of Benefits (LoB) conditions as provided under respective tax treaties.
It is to be noted that non-residents need to evaluate whether they are satisfying above conditions and are eligible to avail treaty benefits in order to avoid penal and other consequences provided under Indian tax laws.
2. Tax Regime for Non-Residents in India: Section 5 & Section 90
Taxation of non-residents in India are governed by Section 5 of the Income-tax Act, 1961 (‘the Act’). It provides that person residents outside India are chargeable to tax in India in respect of following income:
- Income received in India or deemed to be received in India;
- Income accruing or arising in India;
- Income deemed to accrue or arise in India
Section 90(2) of the Act provides that non-residents may choose to be governed by the provisions of double tax avoidance agreement entered (‘the tax treaty’) by Indian government with the government of country outside India to the extent provisions of tax treaty are beneficial to the non-residents.
Section 90(4) of the Act provides that non-residents shall not be entitled to claim treaty benefits unless they furnish tax residency certificate (‘TRC’) from income tax authorities of foreign country. Rule 21AB of the Income-tax Rules, 1962 provides that the non-residents are required to furnish following information in Form No.10F:
Information Required in Form No. 10F (Rule 21AB):
- Status of the non-resident taxpayer (individual, company, firm etc.);
- Nationality (in case of an individual) or country or specified territory of incorporation or registration (in case of others);
- Tax Identification number of the non-residents in the home country;
- Period for which residential status as mentioned in TRC is applicable;
- Address of the non-resident.
The non-resident may not be required to provide the above information to the extent the information is included in the TRC issued by income tax authorities.
3. Defining ‘Person’ and ‘Resident’ under Tax Treaties (Article 3 & Article 4)
While TRC is the pre-requisite to claim benefits of tax treaty in India, Non-residents are also required to be regarded as person and resident of a contracting state as defined in Article 3 and Article 4 of the tax treaties.
Most of the tax treaties define person as taxable unit as per the tax laws of respective contracting state (i.e. the state in which non-resident is taxpayer). Many Foreign Portfolio Investors are established as a Trust structure in India. There is a grey area whether these Trusts are regarded as person under tax treaties. In this relation, it is to be noted that some tax treaties specifically include Trust (like Canada, Hong Kong, etc.) in the definition of person. One may need to evaluate treaty benefit for Trust on the case to case basis.
Article 4 of the tax treaty provides criteria to be regarded as resident of a contracting state. It provides that the person may be regarded as resident of the contracting state if such person is liable to tax in the contracting state by virtue of its incorporation, domicile, residence or any other similar criteria.
Further, Article 4 provides that the person will not be treated as resident of any state because it is taxable in that state only in respect of income earned in that state. In simple words, any non-resident will not be regarded as Indian tax resident just because it pays tax in India for the India source income. Article 4 of the tax treaty also provide the tie breaker rules in case any person is regarded as tax resident in both the contracting states.
Article 4 of certain tax treaties (such as United Kingdom, United States, etc.) also provides guidance in respect of tax transparent structures such as Trusts, Partnership Firms, etc. which are not liable to tax but their beneficiaries or partners are taxed in respect of income earned by trust/ partnership firms. Article 4 of the tax treaties provides that Trust and partnership would be regarded as resident of contracting state in case its beneficiaries or partners are subject to tax in the respective contracting state.
4. Conceptual Distinction: “Liable to Tax” vs. “Subject to Tax”
One also need to understand that “liable to tax” and “subject to tax” are different terms and have different meanings attached to it. Subject to tax is a narrower concept and liable to tax is a wider concept. In this support, reference is invited to the AAR ruling in case of:
General Electric Pension Trust [AAR No. 659 of 2005]:
“it is worth pointing out that the phrase ‘liable to tax’ in Para (1) and the phrase ‘subject to tax’ in proviso (b) are not synonymous. If both were to be read as synonymous, proviso (b) would become otiose. Whereas para (1) speaks of being in the tax net, proviso is concerned with actual taxation”
Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706 (SC):
“Liability to taxation is a legal situation; payment of tax is a fiscal fact. For the purpose of application of Article 4 of the DTAC what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. If this were not so, the DTAC would not have used the words ‘liable to taxation’, but would have used some appropriate words like ‘pays tax’.”
Liable to tax includes a situation where the entity is treated as taxable unit in the home country but not required to pay taxes by virtue of exemption available in the tax law. Example of the same in Indian context could be income of Mutual Funds are liable to tax in India. However, they do not pay taxes in India by virtue of exemption available under section 10 of the Act. While subject to tax is a situation where the entity is actually required to pay taxes in the home country.
An issue could arise in broad based trusts (i.e. which has many beneficiaries) where all the beneficiaries are not subject to tax in the home country or in cases where beneficiaries are from multiple tax jurisdictions. It would also be administrative burden on the Trusts to maintain such data in respect of its beneficiaries to claim treaty benefits.
There may be controversies in claiming treaty benefits in a case where structure of the entity is treated differently in the two contracting states. In other words, some entities could be treated as corporates in the home country but treated as Trust in other contracting state. This issue is quite litigious and there is not much guidance available in the Indian jurisprudence on this subject. One need to be mindful in claiming treaty benefits in such cases based on the risk appetite of the organisation.
5. Beneficial Ownership of Income & OECD Commentary
Beneficial ownership of the income is another essential condition in case treaty benefit is claimed in respect of royalty, fees for technical services, dividend income. The term beneficial ownership is neither defined under the Act nor under tax treaties. In common parlance, the term beneficial ownership means unconditional right to enjoy fruits over income.
OECD commentary provides that person is said to be a beneficial owner of the income where there is no legal or contractual obligation on such person to pass on the income received. OECD commentary further provides that person is said to be beneficial owner of the income where the person is not receiving such income in fiduciary capacity or as a custodian or administrator.
As mentioned above, there are FPIs which are registered as Trust. As per the common law countries, Trust holds assets on behalf of the beneficiary and can’t be said to be beneficial owner of the income. However, OECD commentary provides that the term “beneficial ownership” mentioned in the tax treaty should not be interpreted in narrow sense. As far as these trusts does not have any legal or contractual obligation to pass on the income, it should be able to claim treaty benefit. Having said so, it is worthwhile to note that OECD commentary is not binding on the Indian tax authority and has persuasive value in deciding any matter in tax court.
It is to be noted that beneficial ownership analysis is highly fact driven exercise. It would be interesting to discuss circular no. 786 of 2000 issued in the context of claiming treaty benefits for Mauritius entities. The circular provides that Tax residency certificate issued by Mauritius tax authorities is sufficient proof of residency and beneficial ownership. One may contend that in case any entity has TRC, it need not analyse beneficial ownership and residency condition. However, it is to be noted that this view is not free from litigation.
6. Anti-Avoidance Framework: GAAR and the Multilateral Instrument (MLI)
After deliberations and many rounds of discussions, provisions of General Anti Avoidance Rules were made effective from 1st April 2017 in India. Indian tax authorities were provided powers to disregard the tax treaty benefit in case the transaction was sham or colorful transaction and one of the main purpose to enter into such transaction was to claim tax treaty benefit.
Onus under GAAR:
Under GAAR provisions, onus to prove that purpose of entering into transaction was not for the purpose of claiming treaty benefit is on the tax payer claiming the treaty benefit. Accordingly, any transactions entered with the motive of claiming tax treaty would be under the close scrutiny of the tax authorities. It is to be noted that these are quite early days of GAAR in India. It would be to interesting to see how Indian tax authorities would interpret provisions of GAAR as they are known to be taking aggressive positions.
The Multilateral Convention (MLI) & BEPS:
In November 2016, over 100 jurisdictions (including India) concluded negotiations on the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting that will swiftly implement a series of tax treaty measures to update international tax rules and lessen the opportunity for tax avoidance by multinational enterprises. Taxpayer claiming treaty benefit would also have to keep in mind MLI provisions which are applicable from 1 April 2020 for tax treaties entered by India with many countries (such as UK, Singapore, Japan, etc.).
7. Conclusion and Practical Takeaways
Tax authorities around the world are looking tax treaty benefits claimed by any entity with the mindset that purpose of entering into any transaction is treaty shopping. However, income tax authorities are also not to be blamed completely as there were many instances in past where transactions were made with the intent to circumvent the income tax liability of the entity. Having said so, while interpreting tax treaties, tax authorities needs to keep in mind the economic benefit that the country derives from such foreign investments.
To summarise above discussion, entity claiming treaty benefit in India needs to keep in mind that:
- It is an entity eligible to avail treaty benefits in India (i.e. person and resident of contracting states as defined in Article 3 and 4 of the respective tax treaties which is issued certificate of residence from the income tax authorities of home country).
- It should be beneficial owner of the income, in case it is claiming treaty benefit in respect of royalty, interest, fees for technical services, dividend, etc.
- Its main or one of the main purpose is not avail treaty benefits which it needs to prove with the robust documentation to the tax authorities.
Strategic Summary:
Availing tax treaty relief in India requires meticulous adherence to both procedural documentation (TRC, Form 10F) and substantive economic criteria (‘liable to tax’ status, beneficial ownership, and commercial justification under GAAR and MLI). Robust documentation remains the taxpayer’s foremost safeguard against aggressive scrutiny.