By Mayur B. Nayak, Tarunkumar G. Singhal, Anil D. Doshi, Chartered Accountants
International TaxationEver since India figured in the report of the World Bank on
BRIC economies (BRIC = Brazil, Russia, India and China), it has got world’s
attention. And rightly so, if one were to look at the growth figures of Indian
economy in past few years. India’s forex reserves at $ 280 billion plus1
reflects very comfortable position even amidst global financial crisis. India’s
growing economic strength has an impact on other areas as well. One such area is
recognition of India in the International tax field. Recently India along with
other BRIC economic countries has been included as an OECD non-member observer.
On 17-7-2008, OECD adopted changes to its commentary on the OECD Model
Convention. For the first time the updated edition of the Model Commentary
carries India’s position/reservations on various Articles of the MC. This
article deals with some of the important positions taken by India along with its
probable implications.
1.0 Introduction :
The 2008 update to the Model Tax Convention is divided in
three parts. Part A contains amendments to Article 25 on Mutual Agreement
Procedure. Part B contains amendments to commentary (which inter alia
include positions/reservations by member countries of OECD) and part C lists
positions of non-member countries.
India’s positions/reservations are included in part C. What
are the implications of the position taken or reservations expressed by India in
OECD MC ? Even though India is not a member of OECD, courts in India have been
relying on the OECD commentary. Even UN Model Commentary draws heavily on OECD
Model Commentary. Thus, OECD Model Commentary has a great persuasive value in
Indian jurisprudence. If India has taken a stand or a firm position, then it may
amount to India’s interpretation which is different from the interpretation in
the OECD Model Commentary. At several places India has expressed reservations
and asserted that it would reserve its right for change of provisions (from that
of OECD MC) in its bilateral tax treaties.
Let us proceed to examine some of the important positions
taken by India on the OECD Model Tax Convention. It may be noted that India has
taken position or expressed reservation on the entire Model Convention,
irrespective of whether a particular Article has been amended or not. In other
words, commentaries on some of the Articles are amended just to include
positions/reservations of non-member countries, which were hitherto not included
in the earlier versions of the Commentary.
2.0 India’s position on various articles :
2.1 Article 1 Persons covered :
2.1.1 Amendments :
The amendment merely changes the reference to paragraph 8.7
of Article 4 from the existing reference to para 8.4 of Article 4. Both
paragraphs (the old and the new one) are the same, which provide that if a
partnership is denied the benefits of a tax convention, its members are entitled
to the benefits of the tax conventions entered into by their State of Residence.
2.1.2 India’s stand :
India believes that such a treatment is possible only if
provisions to that effect are included in the bilateral convention.
2.1.3 Probable implications :
The strict interpretation contemplated by India could result
in denial of treaty benefits to transparent entities from the Indian perspective
and may result in double taxation.
2.2 Article 3 General Definitions — Person :
2.2.1 India’s position :
India reserves the right to include in the definition of
‘person’ only those entities which are treated as a taxable unit under the
taxation laws in force in the respective Contracting States.
2.3 Article 4 Resident :
2.3.1 Amendments :
(i) It is now provided that the term ‘resident’ does not
exclude companies and other persons who are resident of a State under its
domestic laws, but are considered to be resident of another Contracting State
pursuant to a tax treaty between the two Contracting States.
(ii) Competent authorities of both the Contracting States may
determine the residential status of persons other than individuals.
(iii) Place of effective management
The Model Commentary provides that the place of effective
management criteria is to be applied to determine the State of residence in case
of persons other than individual, if they are found to be resident
of both the States. The place of effective management is the place where key
management and commercial decisions, that are necessary for the conduct of the
entity’s business as a whole, are, in substance, made.
2.3.2 India’s position :
India is of the view that the place where the main and
substantial activity of the entity is carried on should also be taken into
account while determining the ‘place of effective management’.
India has also reserved the right to include a provision for
reference under Mutual Agreement Procedure for determining the place of
effective management in case of persons other than individual who happen to be
resident of both the Contracting States.
India has also reserved the right to amend the Article in its
tax conventions to provide that partnerships must be considered as residents of
the respective Contracting States in view of country’s legal and tax
characteristics.
2.3.3 Probable implications :
The significant stand of India regarding determination of
place of effective management would result in Indian tax administration applying
the ‘place of main and substantial activity test’ in addition to the ‘place of
management and decision making’ test in case of dual residency situation.
2.4 Article 5 Permanent Establishment :
2.4.1 Service PE :
The major amendment is regarding introduction of the Service
PE Article in the Model Convention for the first time. This is a remarkable
departure by the OECD where taxing rights of ‘Source State’ have been extended
in the fast growing service sector.
Paragraph 42.23 of the ‘2008 Update’ provides a model Paragraph on Service PE Article. According to the said Paragraph in the following situations Service PE comes into existence:
Notwithstanding the provisions of Paragraphs 1,2 and 3, where an enterprise of a Contracting State performs services in the other Contracting State
(a) through an individual who is present in that other State for a period or periods exceeding in the aggregate 183 days in any twelve-month period, and more than 50% of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual, or
(b) for a period or periods exceeding in the aggregate 183 days in any twelve-month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services in that other State the activities carried on in that other State in performing these services shall be deemed to be carried on through a permanent establishment of the enterprise situated in that other State, unless these services are limited to those mentioned in Paragraph 4 which, if performed through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph. For the purposes of this paragraph, services performed by an individual on behalf of one enterprise shall not be considered to be performed by another enterprise through that individual, unless that other enterprise supervises, directs or controls the manner in which these services are performed by the individual.
Some other key features of Service PE provision in OECD MC:
(i) Only profits would be taxed in respect of Service PE and not the gross receipts.
(ii) It is clarified that connected projects are those projects which have some commercial coherence. Therefore, two different projects performed for the same client would not fall under connected projects.
(iii) The source rules provide that mere payment or utilisation of services would not give Source State right to tax.
(iv) Income derived from services performed by a non-resident outside the territory of a State would not be taxed in that State. There should be minimum level of presence in a State before such taxation is allowed.
(v) It is also provided that Service PE will not come into existence if services are confined for internal use. In other words to constitute a Service PE, services must be provided by the enterprise to a third party.
India’s position:
India does not agree to almost all the above interpretations. India has raised some conspicuous reservations on the OECD commentary on Service PE. The same are as follows:
(i) India is of the view that physical presence or performance of services is not necessary in the Source State to constitute a PE.
(ii) India is of the view that taxation rights may exist in a State even when services are furnished by the non-residents from outside that State. It is also of the view that the taxation principle applicable to the profits from sale of goods may not apply to the income from furnishing of services.
(ill) India does not agree that only the profits derived from services should be taxed. It is also of the view that bilateral Conventions may allow States to tax services on gross basis.
(iv) India is of the view that for furnishing of services in a State, physical presence of an individual is not essentiaL
(v) India is of the view that a foreign enterprise (say Entp. A) outsourcing services to an enterprise resident of the source country, (say Entp. B), which are being performed by the employees of ‘Entp. B’, under the direction and supervision of ‘Entp. A’ and which includes servicing of clients of ‘Entp. A’, then such services could be considered to be performed by ‘Entp. A’ in the Source Country.
(This particular provision could make captive BPOs/Call Centres/KPOs Service PEs in India unless their activities are regarded as preparatory and auxiliary in nature)
(vi) India does not agree to include scientific research in the list of examples of activities indicative of preparatory or auxiliary nature.
(This position would have far-reaching impact on captive BPOs engaged in research activities)
(vii) India has reserved the right to treat an enterprise as having a permanent establishment if the enterprise furnishes services, including consultancy services through employees or other personnel engaged by the enterprise for such purpose, but only where such activities continue for the same project or a connected project for a period or periods aggregating more than a period to be negotiated.
(This position is in line with India’s tax treaties wherein consultancy services do constitute Service PE)
2.4.2 Fixed Place PE :
India’s positions/reservations:
(i) India has reserved the right to include following sub-paragraphs in Para 2 of the Model Convention in the list of specific inclusions in the definition of a PE :
(a) a warehouse in relation to a person supplying storage facilities for others;
(b) a sales outlet and a farm, plantation or other place where agricultural, forestry, plantation or related activities are carried on.
(ii) Consistent to its view in the UN MC, India has reserved its position to delete the word ‘delivery’ appearing in Para 4 of the MC, which deals with specific exclusions from the definition of PE. It means the use of facilities or maintenance of stock only for the purpose of delivery would not result in PE under the OECD MC, but it may result in PE in case of Indian tax treaties.
(iii) India has expressed its disagreement with the words ‘The twelve-month test applies to each individual site or project’ found in Paragraph 18 of the Commentary. It considers that a series of consecutive short-term sites or projects operated by a contractor would give rise to the existence of a permanent establishment in the country concerned.
(This position is in variance with the existing interpretation that time spent on different projects was not to be aggregated to determine PE. If one were to accept the new position, then one would be required to determine PE qua contractor and not qua project as hitherto).
(iv) India has reserved the right to replace ‘construction or installation project’ in Para 3 of the MC with’ construction, installation or assembly project or supervisory activities in connection therewith’ and reserves its right to negotiate the period of time for which they should last to be regarded as a permanent establishment.
(This inclusion is in line with India’s stand on its tax treaties which include supervisory activities as part of PE.)
2.4.3 Agency PE :
India’s position on agency PE is in line with provisions appearing in UN MC as well as India’s tax treaties.
(i) India reserves the right to treat an enterprise of a Contracting State as having a PE in the other Contracting State if a person habitually secures orders in the other Contracting State wholly or almost wholly for the enterprise.
(ii) India reserves the right to make it clear that an agent whose activities are conducted wholly or almost wholly on behalf of a single enterprise will not be considered an agent of an independent status.
[It may be interesting to note here that in terms of S. 9(1) of the Income-tax Act, 1961 (the Act), a business connection exists even when an agent’s activities in India are devoted mainly or wholly (as opposed to wholly or almost wholly in MC) on behalf of a foreign enterprise.]
(iii) OECD Commentary provides that mere attending or participating in negotiations by a person by itself would not be sufficient to conclude that such person has the authority to conclude contract in the name of the enterprise. However, India does not agree with this interpretation. India is of the view that the mere fact that a person has attended or participated in negotiations in a State between an enterprise and a client, can in certain circumstances, be sufficient, by itself, to conclude that the person has exercised in that State an authority to conclude contracts in the name of the enterprise. India is also of the view that a person who is authorised to negotiate the essential elements of the contract, and not necessarily all the elements and details of the contract, on behalf of a foreign resident, can be said to exercise the authority to conclude contracts.
2.4.4 Subsidiary PE :
OECD MC provides that a company cannot have a PE in another country only on the ground that it purchases goods from an affiliate company in that country or that affiliate supplies the services.
India does not agree with the above interpretation and is of the view that where a group company manufactures or provides services on behalf of a foreign enterprise, then it may constitute a PE of that enterprise, provided however that other conditions of Article 5 are satisfied.
2.4.5 E-Commerce :
MC provides that a website per se would not constitute a PE. Further it clarifies that an activity of merely hosting a website on a particular server at a specific location may not be regarded as ‘place of business’.
India does not agree with this interpretation and is of the view that depending on the facts, a website itself or hosting of a web site on a particular server at a particular location may constitute a PE.
2.5 Article 7 Business Profits:
Attribution to or Computation of Profits of a PE
(i) India has reserved its right to add a paragraph in its bilateral treaties to provide that business deductions to be allowed as per tax treaty would be subject to the limitations provided under the domestic tax laws.
(For example, S. 44C of the Act limits deduction of Head Office expenses to 5% of the adjusted net profit of the Indian branch)
(ii) OECD discourages formula-based approach to determine profits attributable to a PE as it may lead to incorrect results. It provides that such a method may be used in rare circumstances. However, India does not agree with this interpretation.
(Rule 10 of the Act confers power to the Assessing Officer to compute the income of a non-resident by applying certain formulae)
(iii) India has reserved the right to provide that any income or gain attributable to a PE during its existence may be taxable even if the payments are deferred until after the PE has ceased to exist.
[Furthermore, India also reserved the right to apply such a rule under Articles 11 (Interest), 12 (Royalties), 13 (Capital Gains) and 21 (Other Income).]
2.6 Article 8 Shipping, Inland Waterways Transport and Air Transport:
(i) India has reserved the right not to extend the scope of the Article to cover inland waterways transportation in bilateral conventions.
(ii) India has reserved the right to treat profits from leasing ships or aircraft on a bare charter basis as royalty and not as profits from shipping or aircraft business.
2.7 Article 10 Dividends:
India has reserved the right to modify the definition of the term ‘dividends’ as also to include certain payments/distributions in the definition of dividends. It has also reserved the right to settle the rate of dividends in bilateral negotiations.
2.8 Article 11 Interest:
(i) India has reserved the right to treat the interest element of sales on credit as interest (i.e., part of the purchase consideration which may be attributable to the credit period). Under the OECD MC the same is treated as part of the purchase price and not treated as interest.
(ii) Premium on redemption of debentures is regarded as interest under the OECD MC, where-as India has reserved its right to tax the same as per provisions of the domestic tax laws.
2.9 Article 12 Royalties:
(i) General:
India reserves the right to tax royalties and fees for technical services at source; define these, particularly. by reference to its domestic law and define the source of such payments. Such source rules may be wider in scope compared to the Model Convention.
(ii) India reserves the right to include in the definition of royalties payments for the use of, or the right to use, industrial, commercial or scientific equipment.
(In fact, many of Indian tax treaties already include such payments within the definition of royalty.)
(iii) India has reserved its position vis-a-vis the interpretation of the OECD MC by way of important illustrations dealing with consideration for transfer of property with full ownership covered under the Article on Royalty. Whereas such payments are not regarded as royalties, India does not agree with such interpretation and may regard them as royalties.
2.10 Article 23 Methods for Elimination of Double Taxation:
India has reserved its right to include tax-sparing provisions in its tax treaties.
2.11 Article 25 Mutual Agreement Procedure:
OECD MC has suggested the use of MAP to settle disputes arising on account of transfer pricing adjustments where corresponding adjustments are not explicitly provided in the tax treaty. India does not agree with this interpretation and is of the view that in the absence of any specific provision (Paragraph 2 in Article 9), economic double taxation arising on account of transfer pricing adjustments falls outside the scope of Mutual Agreement Procedure.
3.0 Conclusion:
Perhaps this is the first time the position or interpretation of Indian tax administration has come to fore in respect of tax treaties. The views expressed by the tax authorities can be equated with that of CBDT Circulars, which are binding on the Income-tax Department and not the assessee. Courts mayor may not be guided by them, especially where the treaty provisions are at variance from India’s reservations/positions in respect of OECD Model Commentaries. However, at the same time the reservations/positions expressed in the OECD Model Commentaries would have a lot of persuasive value and guide the taxpayers.
On the one hand India favours ‘tax sparing’ and on the other hand it has taken aggressive stand on many issues which may result in taxation of certain activities of captive BPOs or other infrastructure companies. Can or should India take such an aggressive stand especially when it is facing a stiff competition from other BRIC economies?
In fact a detailed ‘Technical Interpretation on Indian Tax Treaties’ on the line of US Technical interpretation is the need of the hour, as there are very diverse and inconsistent judgments on international tax matters from Pan India.
