Emergence of a new order in tax policies

India must align domestic laws with international treaties

A recent ruling of the Punjab & Haryana High Court (HC) in the Serco BPO case has once again underlined the need for consistency between tax policies and the jurisprudence that evolves around it, thus, leaving little to interpretational hazards. The HC, while confirming the eligibility to capital gains tax exemption under the tax treaty, held that the shareholders (Barclays and Blackstone) were entitled to such a benefit on the basis of the tax residency certificate (TRC) issued to them. The HC alluded to apex court's observation in the Azadi Bachao Andolan case, and obitered that negotiation of treaties and composition thereof are sovereign functions, involving important aspects of tax policies, and should be left to executive's discretion.

The ruling should enthuse foreign investors, especially those who have held investments in Indian assets from their Mauritius investment holdings, since it reinforces sanctity of capital gains tax exemption under the India-Mauritius tax treaty, sans any limitation of benefit (LOB) or substance tests therein. Obiter in the ruling is relevant too, as it dissuades unwarranted reading of substance test and overarching treaty shopping considerations in the tax treaty, which don't explicitly provide for it.

Trite to say, the Revenue may (and for all we know, it will) challenge the HC ruling. To avoid litigation, it may be a progressive move for the Department of Revenue to consider issuing an official statement reassuring investors of its stand on the India-Mauritius tax treaty. Of course, any such announcement presupposes the government shall have within its discretion to renegotiate treaty to bring best practices and limitation of benefit test to qualify capital gains tax shelter for investors.

In parallel though, it is important for investors as well as tax administration to recognise that tax policies around the globe are evolving. The G20-OECD led project on base erosion and profit sharing (BEPS) is taking a firm shape, as governments of major developed and developing countries have pledged to address the menace of tax avoidance and double non-taxation. BEPS project aims to fulfil G20-OECD's 15 points action plan on multifarious aspects of international tax policy by December 2015. It aims to complete (in 2016) the work on a multilateral instrument reflecting the BEPS outcomes on tax treaty issues; the goal being that countries signing on the multilateral instrument may not need to renegotiate their respective bilateral treaties. At the same time, individual countries will continue taking unilateral action to protect their tax base, including renegotiating bilateral treaties in line with the G20 BEPS goals.

Trends emerging from the BEPS project are intended to enhance transparency, particularly on transfer pricing and documentation by encouraging country by country reporting (action point 13); making dispute resolution more effective by addressing obstacles for speedy MAP resolution procedures and facilitating international arbitration under tax treaties (action point 14); addressing tax challenges in valuation/transfer pricing for intangibles (action point 8); and developing model treaty provisions to prevent treaty (ab)use to generate double non-taxation (action point 6). Whilst draft reports, and in cases interim reports after incorporating public comments, have been published, a successful BEPS campaign could lead to momentous changes in the international tax regime.

From India's standpoint, bilateral talks are under way with the treaty partner countries, including Mauritius, to determine sustainability of tax treaties in their present form and evaluate the need for LOB clause and substance tests in the treaty.

Recently, India becoming signatory to the multilateral competent authority agreement on automatic exchange of information was yet again a significant breakthrough in its march towards achieving best practices for ushering in transparency in tax administration. New global standards on automatic exchange of information, known as common reporting standards (CRS), once implemented, should facilitate automatic exchange of taxpayers' information between treaty partner countries for speedy dispute resolution and reducing instance of base erosion through use of dubious structures/financing instruments in cross-border transactions.

India has also signed the Inter-Government Agreement (IGA) on Foreign Account Tax Compliance Act (FATCA) with the US. Such inter-government agreements, coupled with revised disclosure norms and format prescribed by the CBDT in relation to reportable transaction of financial institutions, enhance governance standards in tax matters.

For a fast developing economy like India, the key should be to align domestic law and treaties with the consensus reached under the BEPS to address potential challenges of sophisticated legislations, such as determination of the place of effective management (POEM) of a company; impending implementation of GAAR provisions and treaty override principle in the domestic law. A prudent approach to eliciting stakeholders' consensus in bringing about these noble pieces of tax legislation would be to hold consultations with business chambers.

Besides, there is an overarching need of coherent efforts from the standpoint of policy making, legislative endeavours and administrative measures to ensure that causes of prolonged tax disputes are addressed by way of reactive legislation. A case in point is the recent decision of the HC, which confers the benefit of the treaty and Executive response to it. It calls for a dedicated institutional mechanism as part of Department of Revenue's efforts to brainstorm such tax policy issues. Creating an institutional mechanism ought to be a top priority given India's increasing engagement and contribution in shaping international tax policies.

(Assisted by Sumit Singhania)
Author is Managing Partner, BMR Legal. Views are personal