Global tax rules may increase litigation between authorities and investors

Also, whenever it clashes with the domestic norms to check tax avoidance, called the GAAR, higher chances are that the former may prevail even as the latter is more clearly defined

A global tax framework that seeks to counter treaty abuse, signed recently by India, may lead to more litigation between tax authorities and overseas investors as its interpretation could become subjective.

Also, whenever it clashes with the domestic norms to check tax avoidance, called the General Anti-Avoidance Rules (GAAR), higher chances are that the former may prevail even as the latter is more clearly defined.

Last month, India ratified the multilateral instrument (MLI) to prevent base erosion and profit shifting (BEPS). BEPS is the framework by OECD to prevent tax evasion by multi-nationals, particularly digital companies that could shift their profit to low tax countries.

One of the anti-abuse provisions in the MLI is the Principal Purpose Test (PPT). Tax authorities could get a free hand in applying the former since there is no guidance on how the PPT rule will be applied by the tax authorities and what constitutes “principal purpose”.

According to experts, it may be possible that in situations where there is a conflict between GAAR and the MLI, the latter could prevail. This is because GAAR provisions are triggered when the main purpose of an arrangement is to obtain tax benefit, whereas the PPT rule is applicable even if one of the main purposes is to obtain a tax benefit.

“The MLI framework is much broader than GAAR and both apply independently. The latter is a bit more well-defined and has several checks and balances before it can be applied by the tax officers,” said Punit Shah, partner, Dhruva Advisors.

According to a research note by PwC, the PPT rule could be broader in its ambit than GAAR under the Income Tax Act. What’s more, for GAAR to be triggered, one of the other ‘tainted’ elements also needs to be satisfied. These elements include creation of rights or obligations that are not at an arm’s length, abuse of the IT Act and lack of commercial substance or bona fides.

“It is unlikely for GAAR to apply if the PPT rule is met. It is yet to be seen how the interplay between GAAR and the PPT rule will pan out in the treaties,” observed PwC.

The tax treaties contain limitation-on-benefits (LOB) clauses, which are Specific Anti Avoidance Rules (SAAR), aimed at certain arrangements of tax avoidance. The interplay between these clauses and the PPT prescribed by MLI could create a grey area as well.

An example of a LOB condition is offshore entities coming from Singapore having to meet the expenditure test. This requires them to spend 200,000 Singapore dollars in the immediately preceding period of 24 months from the date the gains arise, to avail of the India-Singapore tax treaty benefits. However, even if an entity incurs this expenditure but is unable to provide commercial rationale as to why they are set up in Singapore under PPT, they may lose the treaty benefits, said Shah.

“In an ideal world, where the countries adopt MLI covering all countries and making no exceptions to the clauses in the same format, MLI may prevail over GAAR. But, the way BEPS and MLI is getting evolved where different provisions under MLI are being adopted by different countries, GAAR application would not be stopped and in many cases could prevail over MLI,” said Girish Vanvari, founder, Transaction Square.

According to him, India has opted for specified LOB which is different from many of its trade partners who have chosen PPT and in these cases substance over form interpretation could invoke GAAR.

“The moot point is if the treaty has LOB clause, GAAR will be still applicable. It is interesting to note that the guidelines for GAAR is ambiguous and empowers the revenue authorities to still invoke GAAR. Thus, litigation cannot be ruled out and in fact may increase,” said Vanvari.