Tax Treaties

BEPS adoption calls for tax treaty renegotiations

By added on 20/04/2018


(The Hindu Business Line) -- India has signed nearly a hundred bilateral comprehensive tax treaties. In simple terms, a tax treaty governs the allocation of taxation rights (and consequential giving up of taxation rights) between two countries, and is therefore very important for governments. The negotiation (and renegotiation) of each tax treaty is, accordingly, a prolonged affair, which can last several years.

The international tax scene has changed significantly in the past few years, primarily on account of the G20 and OECD-led base erosion and profit shifting (BEPS) project. The implementation of some of the BEPS actions like interest deductibility, hybrid mismatches, and controlled foreign company rules require amendments to the domestic tax law. India has been at the forefront in amending its domestic tax law to introduce an equalisation levy, limit deductibility of interest, and introduce country-by-country reporting and master file rules. Globally there is an increased focus on BEPS, with countries like the UK and Australia leading the pack in implementation of BEPS.

Some of the BEPS measures like preventing treaty abuse and artificial avoidance of permanent establishment (PE) status, however, require amendment to tax treaties. With more than 3,000 treaties in force around the world, the multilateral instrument (MLI) was proposed to implement BEPS actions. The MLI was signed by 68 jurisdictions, including India (78 signatories today), and the initial signatories listed 2,365 treaties as covered tax agreements (CTAs), that is, agreements that would be modified once the MLI is effective. This is a radical move and is one of the most ambitious projects in international tax today.

Some key tax treaties that will be amended by the operation of the MLI include India’s treaties with Canada, Cyprus, France, Japan, Luxembourg, the Netherlands, Singapore, and the UK. Although India has notified all its comprehensive bilateral tax treaties as CTAs, countries such as China, Germany and Mauritius have correspondingly not notified their Indian treaties as CTAs. The impact of this is that India’s tax treaties with China, Germany and Mauritius will have to be renegotiated bilaterally, delaying the implementation of BEPS actions vis-à-vis these countries.

The MLI contains an article to deny tax treaty benefits if one of the principal purpose of any arrangement or transaction is to obtain tax benefit. Another important article contains a provision effectively providing that an enterprise will be regarded as having a PE in a country if it has a dependent agent in that country who habitually plays the principal role leading to conclusion of contracts. These are the key focus areas of the Indian tax authorities, and if implemented in an aggressive manner, may lead to prolonged litigation between taxpayers and tax authorities.

There are, however, some gaps even in these provisions. For example, although India has opted for the principal purpose test (PPT) plus a simplified limitation on benefits (LOB) rule for prevention of tax treaty abuse, most of India’s treaty partners have opted only for the PPT rule. Accordingly, only the PPT rule will generally be applicable in India’s tax treaties, and in case India wants to include the LOB rule, this will have to be done by renegotiating the tax treaty.

Similarly, though India has opted for the agency PE article in all its tax treaties, some of India’s important treaty partners such as Canada, Cyprus, Luxembourg, Singapore and the UK have opted for the agency PE article not to apply; here again, if India wants the wider definition of agency PE in its tax treaties, it will have to renegotiate the treaties with these countries.

The recent amendments proposed by the 2018 Budget in relation to widening the definition of agency PE and inclusion of the concept of ‘significant economic presence’ is an outcome of the BEPS project and the MLI — again its implementation may depend on renegotiation of tax treaties. To conclude, some of the key BEPS actions are to be implemented through amendment to tax treaties, and the MLI is going to play a pivotal role in the negotiation or renegotiation of tax treaties across the globe. The efficacy of the MLI is, however, to be tested with time. Also, there are variety of situations where tax treaties will need to be renegotiated despite MLI.

They include: treaties with countries that have not signed the MLI (example: US); (b) countries that have not included the India tax treaty as a CTA (China, Germany and Mauritius); countries that have not opted for a specific provision of MLI to apply to their tax treaties (agency PE article in treaties with Canada, Cyprus, Luxembourg, Singapore and the UK); and inclusion of significant economic presence in the PE definition.

In other words, the implementation of the BEPS actions have either been diluted or negated by quite a few of India’s tax treaty partners, and will require renegotiation of tax treaties for implementation. Overall, the MLI is a good step in the implementation of BEPS, but renegotiation of tax treaties will continue alongside the MLI.