New tax code to stop treaty shopping

The Government may introduce provisions in the new direct tax
code to prevent misuse of double taxation avoidance agreements India has with
other countries. The new code is likely to be unveiled before the year ends. A
Government official said a discussion paper on the code, a major initiative
undertaken under the guidance of the former Finance Minister and present Home
Minister P. Chidambaram, is being fine-tuned. “A discussion paper on the code
explaining the rationale behind every change would be placed in the public
domain,” the official added. A draft bill on the code may also accompany the
paper to enable everyone to express their views on the proposed changes. Double
taxation treaties are essentially agreements between two countries that seek to
eliminate the double taxation of income or gains arising in one country and paid
to residents/companies of the other country. The idea is to ensure that the same
income is not taxed twice. In many instance, however, these agreements are
misused to evade taxes. This is called ‘treaty shopping,’ where usually
residents of a third country take advantage of a tax treaty between two
countries. For example, many companies in other countries route their
investments into India through Mauritius or Cyprus to take advantage of the tax
treaty that these countries have with New Delhi. Both, India-Mauritius and
India-Cyprus tax treaties provide that capital gains arising in India from the
sale of securities can only be taxed in Mauritius and Cyprus. This means no
capital gains tax on investments in securities routed through Mauritius and
Cyprus, as they do not levy tax on capital gains. The discussion paper on the
code would explore ways to check this treaty- shopping. Mr. Chidambaram was
actively involved in the exercise of drafting the code. At the Economic Editors
Conference in November, he had said the draft code would be placed in the public
domain soon. Some options like a general anti-avoidance rule(GAAR), provisions
allowing examination of the real nature of a transaction and a limitation of
benefits clause are being actively examined. Many countries like Singapore and
Canada have a general avoidance provision, GAAR in their domestic income-tax
laws to ensure that treaty benefits accrue only to genuine investors. Singapore
also allows examination of the real nature of a transaction. Earlier, an
internal panel in the Income-tax Department, which examined the issue of treaty
abuse and ways to prevent it, had also made recommendation in favour of GAAR and
a special provision for examination of real nature of transaction.

(Source : Media reports & Internet, 22-12-2008)