The document discusses various ways that multinational enterprises shift profits for tax avoidance purposes. It begins by covering the use of tax holidays and incentives, capital allowances, inter-company transactions like royalty payments and management fees, and selling goods through low-tax countries. It then contrasts the challenges facing developing versus developed countries in addressing profit shifting. Finally, it outlines the scope for profit shifting across different types of income like business profits, dividends, interest, royalties, and more to avoid taxation.
2. WENDELL HOLMES ONCE SAID "WITH TAXES, I
BUY CIVILISATION". IT MEANS THAT TAXES ARE
THE COST PAID FOR LIVING IN A SOCIETY AND
FOR BEING A PART OF CIVILISATION. ALSO
TAXES NEED TO BE UTILIZED FOR MEETING
BASIC FUNCTIONS OF STATE LIKE DEFENCE,
LAW, JUSTICE, PUBLIC SECURITIES, GOOD
GOVERNANCE, SOCIAL SECURITIES AND
Source:
Kelkar
Committee
PUBLIC GOODS AND SERVICES Report on Tax Reform
Chidananda Jena
Email: chidananda.jena@gmail.com
Skype/ YM: chidanandajena
4. Act!onaid Research on MNEs Tax Avoidance
4
Tax Holidays & Incentives
Investment on Capital Assets – Tax deduction
Incentives for domestic small firms availed by MNEs
Reshuffling Ownership (Dividend), Thin Capitalization,
Royalty, Management Fee
Lower Sale Price by subsidiary to AEs in low tax countrywhich in turn sells at much higher price
Shipping Goods through MFN treaty countries (Customs)
Treaty Shopping-Shell Companies
Regional Cooperation to avoid Tax War, GAAR
Tax Havens & Developed Countries amend tax policy
MNEs Publish Tax Policies
5. DEVELOPED Vs DEVELOPING
5
Issue of Developed Vs Developing
Challenges of Standard Tax Jurisdiction Vs Low/ No/
Privileged Tax Jurisdiction
Most Tax Havens are under the control of West
Information from Tax Havens not accessible
OECD Guidelines favors developed
UN Guideline favors developing
Developing Countries are NET IMPORTING CountriesGoods, Service and Capital
Developing Countries are financer of Developed
Economy
6. Scope for Profit Shifting
6
Residence Vs Source
Transactions modify classification of Income
Permanent Establishment (PE)
Income from Immovable Property
Business Profit
Income from Shipping, Inland Transport, Aircraft
Dividend
Branch Profit Tax
Interest
Royalty
7. Scope for Profit Shifting
7
Capital Gain
Capital
Independent Personal Services
Dependent Personal Services
Employee Stock Options
Directors’ Fees
Artistes and Sports Persons
Star Companies
Pension & Social Securities Pension
8. REVIEW of ACCOUNTs, POLICY & JUDGEMENTs
8
Obtaining Tax Returns using Information Act
Obtaining accounts available on public domain
Obtaining information from AEs from other nations
Profitability of the firm and price of the product compared
globally- EPS, OPM, NPM, Quick/ Debt Equity ratio etc.
Profitability Comparison of Domestic Vs MNEs
Benefit to GDP Vs perceived Tax Avoidance
Macro-Economic Indicators-Short Term and Long Term Impact
Preparing report and submitting to MNE for clarification purposes
Publishing reports along with answers of MNEs
Watch on Tribunal and Court Decisions
Review of DTAAs and Laws on real time basis
9. ACCOUNTING STANDARDS for IT/ TP
9
IFRS, US GAAP or National GAAP
Standards are prescribed keeping shareholder’s
interest in view
Does not disclose separately itemized ITs as shown in
previous slides
Does not disclose TP
Standards need to be prescribed keeping double
taxation and non taxation in view
10. INTERNATIONAL STANDARDs
10
Transfer of technology & Capital to developing nations
Protect MNEs from double taxation
National Standards- Brazil, India
Avoidance of Double Taxation/ No Taxation
UN
Model- Bilateral
OECD Model-Bilateral
Information Exchange and Action
MCMAATM
(OECD)-Multilateral
UN Model -Bilateral
11. INTERNATIONAL BODIES
11
EU automatic information exchange (AIE)
Foreign Account Tax Compliance Act (FATCA)- financial
institution offers significant cross-border bank services
EU Savings Tax Directive (EUSTD)- 17 European
nations as well as several BRICs (Brazil, Russia, India,
China)-financial intermediaries, but not shell Cos
Need of an organization like INTERPOL to track
Capital and Profit Shifting, Treaty ShoppingInternational Tax Service (INTAS)
Need for International Tax Reallocation Agency
12. SAFE GUARDS for ALL
12
Transfer Pricing on Arm’s Length Principle
Safe Harbor
Minimum Alternative Tax (MAT)-Domestic Tax India
Presumptive Tax (PT)-Domestic Tax equivalent to SH
Advance Transfer Pricing Agreement (APA)
Mutual Agreement Procedure (MAP)
13. ANTI AVOIDANCE PROVISIONs in DTAA
13
Look-Through” Provision
Force of Attraction
Subject-to-Tax Provision
General Bona Fide Provision
Activity Provision
Stock Exchange Provision
Alternative Relief Provision
14. SPECIFIC ANTI ABUSIVE RULEs
14
Misuse of Most Favored Nation(MFN) agreements to
avoid customs duty
Controlled Foreign Corporations Rule-conduits
Foreign Investment Fund Rule-avoidance of tax on
investment income
Thin Capitalization Rule
Exit/ Departure Tax Rules- change of residence before
realization of treaty exempt capital gains
Dividend Stripping Rules-transfer dividends to treaty
exempt capital gains
Transaction in securities leading to indirect transfer of
assets-look through provision - Vodafone-hutch case
led to retrospective amendment
15. UN Model of Double Taxation
15
DTAA between developed and developing nations- special
attention to developing countries
Cooperation among tax authorities
No Tax Treaties- prevent transfer of technology to developing
nations-double taxation by both countries- higher royalty in the
absence of arm’s length price
Protect MNEs from double taxation
Prevent discrimination between foreign and domestic firms
UN Model- limited taxing right to source/ developing countries on
royalty etc.
OECD Model- No taxing right to developing countries
16. DTAA Conventions
16
Protect multinational industry from double taxation
Promote flow of investment, technology and
knowledge
Framework of legal and fiscal certainty
Prevent discrimination between foreign and
domestic firms
Improve cooperation among tax authorities
18. Articles of UN/OECD Model
18
Article 1 Persons
Article 4 Resident
Article 5 PE
Article 6 Income from Immovable
Property
Article 7 Business Profit
Article 8 Shipping, Inland waterways,
Aircraft
Article 9: Associated enterprises
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 13: Capital gains
Article 14: Independent personal
services- deleted in OECD model
Article 15: Dependent personal
services
Article 16: Directors’ fees and
remuneration
Article 17: Artistes and sportspersons
Article 18: Pensions and social security
payments
Article 21: Other Income
Article 22: Capital
Article 23: Methods for the elimination
of double taxation
Article 24: Non-discrimination
Article 25: Mutual agreement procedure
Article 26: Exchange of information
Article 27: Assistance in the collection of taxes
Article 29: Entry into force
Article 30: Termination
19. New Features of UN Model 2011
19
Modification of Art 13 (Capital Gains) Para 5
Optional version of Art 25 (MAP)
New version of Art 26 (Exchange of Information)
New Article 27 (Assistance in collection of Tax)
Commentary to Art 1- Survey on improper use of DTAA
provisions by countries
Alternative Commentary to Art 5 if Art 14 deleted
Addn in commentary to Art 7-attribution of profit to PE
Revision in commentary to Art 10-12-beneficial ownership
Add in commentray to Art11-not interest bearing loan
20. “Look-Through” Provision
20
A company that is a resident of a Contracting State
shall not be entitled to relief from taxation under
this Convention with respect to any item of income,
gains or profits if it is owned or controlled directly
or through one or more companies, wherever
resident, by persons who are not residents of a
Contracting State
21. Subject-to-Tax Provisions
21
Where income arising in a Contracting State is received
by a company resident of the other Contracting State
and one or more persons not resident in that other
Contracting State
have directly or indirectly or through one or more
companies, wherever resident, a substantial interest in such
company, in the form of a participation or otherwise, or
exercise directly or indirectly, alone or together, the
management or control of such company,
any provision of this Convention conferring an exemption from,
or a reduction of, tax shall apply only to income that is
subject to tax in the last-mentioned State under the ordinary
rules of its tax law.
22. Subject to Tax Provisions (Alternative)
22
Where income arising in a Contracting State is received
by a company that is a resident of the other
Contracting State and one or more persons who are not
residents of that other Contracting State
have directly or indirectly or through one or more
companies, wherever resident, a substantial interest in such
company, in the form of a participation or otherwise, or
exercise directly or indirectly, alone or together, the
management or control of such company
any provision of this Convention conferring an exemption from,
or a reduction of, tax shall not apply if more than 50 per
cent of such income is used to satisfy claims by such persons
(including interest, royalties, development, advertising, initial
and travel expenses, and depreciation of any kind of
business assets including those on immaterial goods and
processes).
23. General Bona Fide Provision
23
The foregoing provisions shall not apply where the
company establishes that the principal purpose of
the company, the conduct of its business and the
acquisition or maintenance by it of the shareholding
or other property from which the income in question
is derived, are motivated by sound business reasons
and do not have as primary purpose the obtaining
of any benefits under this Convention
24. Activity Provision
24
The foregoing provisions shall not apply where the
company is engaged in substantive business
operations in the Contracting State of which it is a
resident and the relief from taxation claimed from
the other Contracting State is with respect to income
that is connected with such operations
25. Amount of Tax Provision
25
The foregoing provisions shall not apply where the
reduction of tax claimed is not greater than the tax
actually imposed by the Contracting State of which the
company is a resident
26. Stock Exchange Provision
26
The foregoing provisions shall not apply to a
company that is a resident of a Contracting State if
the principal class of its shares is registered on an
approved stock exchange in a Contracting State or
if such company is wholly owned—directly or
through one or more companies each of which is a
resident of the first mentioned State—by a
company which is a resident of the first-mentioned
State and the principal class of whose shares is so
registered
27. Alternative Relief Provision
27
In cases where an anti-abuse clause refers to nonresidents of a Contracting State, it could be
provided that the term “shall not be deemed to
include residents of third States that have income
tax conventions in force with the Contracting State
from which relief from taxation is claimed and such
conventions provide relief from taxation not less
than the relief from taxation claimed under this
Convention
28. Triangular Case
28
dividends, interest or royalties are derived from State S
by a resident of State R, which is an exemption country;
that income is attributable to a permanent
establishment established in State P, a low tax
jurisdiction where that income will not be taxed
Under the State R-State S tax treaty, State S has to apply
the benefits of the treaty to such dividends, interest or
royalties because these are derived by a resident of State
R, even though they are not taxed in that State by reason of
the exemption system applied by that State
Enterprise will transfer assets such as shares, bonds or
patents to permanent establishments in State P that offer
very favourable tax treatment
Personal/Corporate income, dividend, interest, royalty not
taxed in any state
29. Thin Capitalization
29
interest is a deductible expense whereas dividends, being a
distribution of profits, are not deductible
foreign company wants to provide financing to a wholly-owned
subsidiary, beneficial for tax purposes, through debt rather than share
capital
contributor of the loan shares the risks run by the enterprise
loan is substantially unmatched by redeemable assets and capital;
the creditor will share in any profits of the company;
the repayment of the loan is subordinated to claims of other creditors or
to the payment of dividends;
the level or payment of interest would depend on the profits of the
company;
the loan contract contains no fixed provisions for repayment by a
definite date
General anti-abusive rule- real nature of finance debt or equity, arm’s
length principle-if a third party would have financed under similar condition
and under similar terms and condition, fixed debt-equity ratio-interest on
excess debt disallowed
30. Use of Base Companies
30
Mere shell-insignificant employees/ economic activity
Effective management of base company from the
resident state of parent company
subsidiary was managed in the state of residence of its
parent in such a way that the subsidiary had a
permanent establishment (e.g. by having a place of
management) in that state to which all or a substantial
part of its profits were properly attributable
CFC Rules-Contracting State taxing its residents on
income attributable to their participation in certain
foreign companies
Back to Back Arrangements
31. Transactions Modifying
Classification of Income
31
Convert dividend to interest
Allocation of price under mixed contract- goods, service, intangibles (licensing,
patent, royalty)
Increase price of goods and service (not taxable in the absence of PE) and reduce
price of intangibles (taxable even without PE)-same effect on Franchisee
Parties different- hence transfer pricing and arm’s length principle not applicable
Customs duty gradually reduced- franchiser be more inclined to increase valuation of
goods
Inventory of goods raw or finished can’t be attributable to income & hence can’t be
taxed
Conversion of Royalties to Capital Gains
A non-resident who owns the copyrights in a literary work wishes to grant to a
resident of State S the right to translate and reproduce that work in that State in
consideration for royalty payments based on the sales of the translated work.
Instead of granting a license to the resident, the non-resident enters into a “sale”
agreement whereby all rights related to the translated version of that work in State
S are disposed of by the non-resident and acquired by the resident. The
consideration for that “sale” is a percentage of the total sales of the translated work
is capital gain. The contract further provides that the non-resident will have the
option to reacquire these rights after a period of five years.
This violates treaty- royalty is masked as capital gain
32. Transactions Modifying
Classification of Income
32
Use of derivative transactions
company X, a resident of State A, wants to make a large portfolio
investment in the shares of a company resident in State B, while company
Y, a resident in State B, wants to acquire bonds issued by the
government of State A. In order to avoid the cross-border payments of
dividends and interest, which would attract withholding taxes, company
X may instead acquire the bonds issued in its country and company Y
may acquire the shares of the company resident in its country that
company X wanted to acquire. Companies X and Y would then enter into
a swap arrangement under which they would agree to make swap
payments to each other based on the difference between the dividends
and interest flows that they receive each year; they would also enter
into future contracts to buy from each other the shares and bonds at
some future time. Through these transactions, the taxpayers would have
mirrored the economic position of cross-border investments in the shares
and bonds without incurring the liability to source withholding taxes
(except to the extent that the swap payments)
33. Transactions Modifying
Classification of Income
33
Circumvent Thresholds
Lower limit of source tax on dividends to non resident / resident
company by a resident company, if the former holds at least 10%
control/ capital in the later
Non resident company having <10% share acquires from/
transfers share to another to make the capital > 10 % just before
the declaration of dividend
Dividend is structured to be given later as capital gain, which
attracts lower or no tax in source country
Thresholds on Capital Gains on shares against immovable
assets > 50% of all immovable assets of non-resident entity
Dilute value of assets <50% prior to sale of shares by issuing
bonds or preferred shares, with condition that such instruments shall
be redeemed after alienation of shares
34. Transactions Modifying
Classification of Income
34
Time Limit for PE
Splitting
same project among associated non-resident
entities to avoid PE
Splitting one project into many and entering several
contracts
35. Fiscally Double Residence within a Year
35
Permanent home
Apportionment of period between two resident
state
Determination by a set of subsidiary criteria
Discretion to officers minimized
36. Permanent Establishment
36
Fixed Base Test for individual services-UN Model days of physical presence- not in
OECD
6 months test/183 days for companies providing service through personnel,
construction site, supervisory, consultancy etc
Developing countries oppose 6 months- Enterprise sub contracting one project in parts
may not have PE at all-all partners, principal and sub contractors shall be PE, same or
related projects-assembly project in UN Model and not in OECD
Action of dependent agent may be PE
Independent agent devoting most of time to one non resident firm and not having
arm’s length basis-PE
Subsidiary-Parent Company relationship decides PE for parent
Preparatory and Auxiliary Activity not PE
Delivery- PE under UN Model, but not under OECD
Special provision of PE for insurance- through several independent agents
Leasing of Tangible- scientific equipments or intangible-patent for a 6 months-PE
Offshore Exploration, fishing vessels, moving drilling platforms-territorial water,
exclusive economic zones
37. Permanent Establishment
37
Electronic CommercePresence of employee not required to be a PE
Internet web site, combination of software and electronic data, not
tangible property. No location/ place of business, no premises even
in certain instances, no machinery or equipment”
web site and the server on which the web site is stored and used:
enterprise that operates the server different from the enterprise that
carries on business through the web site. web site hosted on the
server of an Internet Service Provider (ISP), disk space used to store
the software and data, server and its location not at the disposal of
the enterprise having website
Website is auxiliary/ preparatory- advertizing to sell
Actual sale takes place, where contract executed, payment and
delivery made- count towards PE
38. PE Case
38
Transactions between resident assessee and resident AE of
foreign parent company can't be deemed as IT by invoking the
substance over form rule under section 92B(2). Section 92B(2)
only deems certain transactions to be 'transactions between
AEs‘, who avoid transfer pricing provisions by interposing a
third party as an intermediary, but not as 'IT between two
enterprises‘. IJM (INDIA) INFRASTRUCTURE LTD. V. ACIT (2013)
37 taxmann.com 200 (Hyderabad - Trib.)
39. PE Case
39
A (Indian company) and B (US
company) formed a JV in India (AB) to
manufacture automobiles
XYZ – wholly owned subsidiary of B
Provides services to B’s group
companies
AB and XYZ executed a management
services agreement – XYZ is to
provide executive personnel (finance,
service, marketing, etc.)
XYZ contended that it worked as an
employment agency – however, AAR
noted that the personnel were not
employees of AB – AB paid XYZ for
the services and not the personnel
XYZ assumes responsibility for
suitability
and
competence of
personnel for the tasks assigned to
them
XYZ is responsible to replace the
personnel if they resign
XYZ has to provide substitutes if
these personnel are assigned to
another project - AB can ask XYZ to
provide additional personnel, if
required
AAR ruled that Service PE exists
In Re. P. No. 28 of 1999, [2000]
242 ITR 208 (AAR)
Source: MAJMUDAR & CO.
40. PE Case Metapath’s
40
Metapath – telecom software company
Joint Venture in India with Bharti Cellular
Two (2) Expatriates sent to India to assist
with the setup and establishment of the
JV
Stayed in India for one (1) year
Employed by both Metapath UK and
Metapath India – salaries paid by UK –
expenses paid by India
CIT (Appeals) held that Service PE was
in fact concluded as the expatriates
were rendering services in India to the
Indian JV.
Issue raised in appeal but the Delhi High
Court did not deal with the issue of
Service PE in the judgment
DCIT v. Metapath Software International,
Inc., [2006] 9 SOT 305 (NULL)
Source: MAJMUDAR & CO.
41. PE Case Morgan Stanley’s
41
MS and Co., Inc. outsourced some of its
functions to MSAS
MS and Co., Inc. also provided some
personnel who were overseeing the
outsourced activities and they were also
providing managerial services
Secondment arrangement
MS and Co., Inc. bore the risk of the
employee’s activities
The employees were assured of their
original jobs when they returned to the US
Employees were under MS and Co., Inc’s
control
AAR ruled Service PE existed
Supreme Court differentiated between
“stewardship activities” and
“deputationist”
However, no income attributable to
Service PE as MSAS was remunerated on an
arm’s length basis
Pointers
Widely acclaimed as the right decision
for the wrong reasons
Co-relation between Article 5(1) and
5(2) – Whether the services are related
to the foreign enterprise’s business
Attribution – MSAS was not reckoned
as Service PE – Service PE would be
some sort of a fictional entity
Avoid “lien”, “risk” and “control”
Stewardship – protect MS and Co., Inc’s
DIT v. Morgan Stanley, [2007] 292 ITR
interest – not a service to MSAS – no
Service PE
416 (SC)
Deputationist – day-to-day management
of MSAS – Service PE concluded
Source: MAJMUDAR & CO.
42. Lucent Technologies’ Case
42
Lucent – hardware and software for mobile
phones
Indian customers – after sales services,
installation, etc., through Lucent India
Expatriates from Lucent Affiliate
ITAT held as follows:
Service PE clause covers “other
personnel”
“Other personnel” – controlled by the
foreign enterprise
Affiliate’s personnel controlled by Lucent
Service PE concluded
Lucent Technologies International, Inc. v.
DCIT, (2009) 120 TTJ (Delhi) 929
Source: MAJMUDAR & CO.
43. PE Case: Worley Parsons’
43
Worley Parsons – Australian company
Engaged by ONGC
Employees visited India to review documentation
Six projects in total
AAR – key issues:
Whether a single contract can be called
“services” – as same counterparty and same
purpose – all contracts together amount to the
“services”
As contracts 2, 3 and 4 fall within the same
financial year – they are to be reckoned
together to determine number of days
Service PE concluded w.r.t. Contracts 2, 3 and 4
Worley Parsons Services Pvt. Ltd. v. DIT, [2009]
313 ITR 74 (AAR)
Source: MAJMUDAR & CO.
44. Income from Immovable Property
44
Tax on net income/ profit, not on gross income
Withholding tax on gross rent- rate of tax lower
Interest from debt not income from immovable property
Ships, aircrafts not immovable property
Number of assets and rights- immovable property
Immovable property in industrial, commercial and
independent personal services
Source state has right over the residence state, even
when the Source State is not PE
45. Business Profit
45
OECD 2008 PE Report-Not adopted in UN Model
Deduction of amount paid(other than actual expenses) by PE to Head Officedisallowed in UN Model
Arm’s length principle in profit attributable to PE wrt Head Office- UN & OECD
Profit by PE to be taxed in source country-OECD, Profit by enterprise by other
means, where PE is situated, also to be taxed-force of attraction principle-UNIssue of double taxation
Purchase by PE for Head Office- if profit taxable at source country- negotiation
bilaterally in UN model, no tax in OECD
Lowering profit of PE by lowering price of goods sold- especially if goods are
proprietary and there is no comparison for arm’s length basis- comparing gross
profit to gross turn over of the enterprise and PE
Transfer of assets internally from one PE to another or head office-Country of the
PE from which assets is transferred may levy tax of profit on the book value
Transfer of Debt from one PE to another or head office of an enterprise/ bank/
associated entity- to shift profit among bank branches in different countries
admissible for bank, not for enterprise- if tax purposes-disallow even in case of
banks
46. Business Profit
46
Right to use of Industrial/ scientific equipment-UN model differs from OECD
TurnKey Project, major activities completed outside the country even before
establishment of PE- how much of the profit attributable to PE to be taxed in
source country- Relationship of PE to other PEs of the same enterprise and
head office to be considered
Accounts of each PE artificially arranged- PE is given role of Head Office,
Agent/ intermediary as Principal
Profit attributed to each PE as if they are independent enterprises
Head Office and PE in different states, entire business and
management is done at PE, except some meeting of board and
formal legal activities done from head office
No management fees to be deducted for calculating profit of PE
Formulae for apportionment should not be changed subsequently because
that gives a more favorable result to enterprise or tax authority
47. Shipping, Inland waterways transport, Aircraft
47
Alternative A- same as OECD model- shipping should not be
exposed to tax laws of various countries in which they operate- if
every country tax a portion of profit, the sum may exceed tax on
total profit
Profit for transport between two ports in same source country- tax at
source
Inland waterways- tax by source country
Leasing of bare ship- tax profit as lease under Article 12
Leasing of fully equipped and manned ship- tax profit under
shipping of Art 8
Auxiliary activity related to international transport-hotel, door to
door service included in international transport
Containerization used both for inland and international transport
Ship building yard in one country, management from another country
Vessel engaged in fishing, dredging and hauling
Investment income ( stock, shares, bonds,
48. Shipping, Inland waterways transport, Aircraft
48
Effective management on the ship-home harbour
Many developing countries are not place of effective
management/ residence of enterprise
Alternative B of UN Model improvisation
Aircraft transport to be taxed differently than shipping
Shipping to be taxed at source if more than casual
Overall profit apportionment by authorities of country,
where effective management of residence- open to
bilateral negotiation
Formulae- preferably by outgoing traffic, factoring capital
and managerial inputs from head office
Pooling agreement for apportioning profit
49. Shipping Case
49
Assessee, a resident of the UAE, was engaged in the business of shipping.
It claimed that Article 8 of the India-UAE treaty would be applicable to it.
Revenue: Invoked the provisions of section 44B and computed the
presumptive profit on total receipt. Assessee had not paid taxes in the
UAE, there could be no curtailment of tax liability, by pressing the treaty.
That DTAA applies on juridical double taxation, i.e., if income was not
taxed in one State, then it would be taxed in full in the other, if it was
otherwise taxable, without granting any benefit of the Treaty;
Tribunal: Assessee was otherwise liable to tax in UAE. Simply because
there was no tax incidence in the UAE, didn’t mean that the assessee
ceased to be otherwise liable to tax as per Article 4 of India-UAE
treaty; Treaty becomes applicable once the assessee gets within the
expression 'otherwise liable to tax' in Treaty–ADIT V. SIMATECH SHIPPING
FORWARDING LLC (2013) 37 taxmann.com 232 (Mumbai - Trib.)
50. Dividend
50
Withholding tax/ tax on beneficiary by source country on dividends by a company of source country to
resident of another country, but at a limited tax rate for the capital invested in the company
Source country shall not tax dividend issued by a resident company of another country on earnings from
source country/ not tax on undistributed profit of non-resident company - no extra territorial taxation
Dividend includes bonus, monetary benefit, profits on liquidation, disguised distribution of profit, payment
for concealed holdings, to close relations of shareholders disallowed, interest payment due to thin
capitalization
OECD Mod el Convention restricts the tax in the source country to 5 per cent for direct investment and 15
per cent for portfolio investment (not much across border)
Developing nations tax rate=5-15% on DID and 15-25% on PID
United Nations Model tax rate through bilateral negotiations
UN indicative10 per cent (decide bilaterally) threshold shareholding to qualify as a direct investment
Exemption/ tax credit in resident country to avoid double taxation of inter-corporate dividends
Beneficial Owner, not immediate recipient, if associated/ conduit entity under treaty shopping, in the
resident country
Income on investment by Pension Fund & some Govt. owned companies exempt from tax on dividend under
domestic law- may be applicable in treaty
OECD Model-not apply to dividends that are attributable to a PE of the payer in the source country/
resident of source country- dividend not taxed, only Business profit taxed-UN Model limited force of
attraction- effectively attributed to PE
51. Dividend
51
Factors Deciding Tax Rates in Agreements
may not be the same for both countries, with higher rates allowed to the
developing country
may not be limited at all
reduced rates may apply only to income from new investment
Lowest rates or exemption may apply only to preferred types of investments
(e.g. “industrial undertakings” or “pioneer investments”)
dividends may qualify for reduced rates only if the shares have been held for a
specified period
In imputation system of corporation taxation (i.e. integration of company tax into
the shareholder’s company tax or individual income tax), specific provisions may
ensure that the advanced credits and exemptions granted to domestic
shareholders are extended to shareholders resident in the other Contracting
State
Total tax burden (corporate + share holder tax) in the source country, balance
between tax burden and attracting foreign investment in source country, tax
credit in the resident country and total tax burden from both country, extent to
which matching credit given in resident country for tax spared in source country
52. Dividend Case
52
Beneficial owner of the dividends arising in a Contracting State is
a company resident of the other Contracting State; all or part of
its capital is held by shareholders resident outside that other
State; its practice is not to distribute its profits in the form of
dividends; and it enjoys preferential taxation treatment (private
investment company, base company) in the state of residence—
Whether, the State of source allow reduced tax rate on the
dividends payable to such company???
When the shareholder and the close relation receiving benefits
(disguised dividends) are residents of two different States with
which the State of source has concluded conventions or a
convention with one of the States but not with the other – solution
only through an arrangement under the mutual agreement
procedure
Non resident company having <10% share acquires from/ transfers share
to another to make the capital > 10 % just before the declaration of
dividend
53. Branch Profit Tax
53
Parity for business conducted through subsidiary
(tax on dividend) or branch (branch profit=
dividend equivalent)
Ideally should be equal to tax on direct invetsment
dividend, most states impose higher tax equal to portfolio
investment dividend
15-25% on branch profit (dividend equivalent) in case
of a foreign company
5-15% tax on direct investment dividend by subsidiary
to non-resident investor having ≥10% share
54. Interest
54
Interest is not taxable in the hand of payer or beneficiary, it forms part of aggregate
income of beneficiary and becomes taxable at that point
Deduction of tax, if any, by payer is an advance/ withholding tax from beneficiary,
which is refundable if exceeds tax due at the end of year
Interest is deducted before arriving at corporate profit- reduced tax- hence logical to
invite higher tax than on dividend
However, higher tax may force lender to raise interest rate and burden on burrower
source state gaining revenue at the cost of its residents
Interest outflow has time bound forex implication, whereas capital investment may not
go out if economic environment conducive
Argument of developed countries- Different tax rate on interest in developing countries
may induce tax war to attract investment, capital mobility from developed to
developing should not impact tax revenue of developed countries
Argument of developing countries-should be taxed where the capital earned interest/
dividend etc.
Double taxation - Source state may levy tax on interest limited by a ceiling 10% OECD,
but no ceiling in UN, with matching relief from resident state to allow set off of tax paid
in the source state
Not related to Interest arising in a third state or given by a PE of contracting state
55. Interest
55
Lower tax rate at source country if interest paid to government agencies, central bank,
banks and financial institutions, long term loan, important public work loan, export
financing or paid by govt institutions
Cost of mobilizing loan by lender is high- tax is passed to burrower
Interest on credit sale- any tax is passed on to consumer by seller
Tax on interest increase the fiscal charge reducing profit on capital and thus reducing
tax on such profit
Long term loan - return on investment after a gestation period; loan has business, social
and political risk
Private credit facilities tied up with government lending institutions of developed
countries to extend loan under favorable taxation by source country
Beneficial Owner- avoid double taxation at the hand of two contracting states and
prevent tax avoidance by conduit entities
Source country may enact to deduct tax at source or assess beneficiary
Arm’s Length Rule, language of treaty can be suitably drafted if loan is from legal and
special relationship (blood, marriage)
Adjustment of rate of interest
Excess of admissible debt/equity ratio to be adjusted
Reclassification of loan to equity
Substance over form- anti abusive rule shall apply
56. Interest
56
Types of Interest Income
Mortgage interest from movable capital
Interest and premium paid at redemption on participating/ convertible
bonds/ debentures, govt. securities- may be considered as dividend, if
effectively share the risk
Islamic financial instruments, economic substance loan, legal form not
Interest penalty may be included or shown as expense
Annuity- interest on capital/ salary-pension
Negative interest to be adjusted– bond issued on premium which is more
than final redeemed value
Thin Capitalization-interest treated as dividend
Objective and detail definition of interest ensures protection from future
changes in domestic law
OECD Model-not apply to interest that is attributable to a PE of the
recipient in the source country or resident of source country- interest not
to be taxed-UN Model limited force of attraction- effective connection
to PE/ fixed base
57. Interest Case
57
The Mgt in different country has contracted a loan which it uses for the
specific requirements of the PE in another country; it shows it among its
liabilities and pays the interest thereon directly to the creditor
The HO of the enterprise has contracted a loan the proceeds of which
are used solely for the purposes of a PE situated in another country. The
interest is serviced by the HO but is ultimately borne by the PE
The loan is contracted by the HO of the enterprise and its proceeds are
used for several PE situated in different countries
Where both the beneficiary and the payer are indeed residents of the
two Contracting States, but the loan was borrowed for the requirements
of a permanent establishment owned by the payer in a third State and
the interest is borne by that establishment
State where the permanent establishment is situated is to be regarded as
the State where the interest arises, in case of several PEs in first two
case, difficult to apportion loan and interest to PEs in third case, Fourth
Case-double taxation between two contracting state on one side and
third state on the other side shall not be avoided, therefore source
country of PE shall tax, two other countries may resort to MAP.
Multilateral treaty required
58. Royalty
58
Definition: use of, or the right to use, any copyright of literary, artistic or scientific work
including cinematograph films, or films or tapes used for radio or television broadcasting, any
patent, trademark, design or model, plan, secret formula or process, or for the use of, or the
right to use, industrial, commercial or scientific equipment or for information concerning
industrial, commercial or scientific experience Source country can tax within ceiling, if
beneficiary resident of another country
If source country tax royalty on gross value without allowing expenses of the owner/ receiver;
Inventor spent millions in past and present, direct and indirect, in developing the productexpense ratio should be accepted by both contracting states
Owner shall accordingly built in the cost of tax by source and his resident country while
deciding royalty value- need for moderation in tax on royalty
However, the royalty provision is also misused to transfer payment between associated entitiesBeneficial owner-prevent double taxation and avoidance
Developed nations benefit first, then royalty flows one way from developing world
OECD–tax only in the resident country, UN- withholding tax by source & tax credit set off by
resident country-revenue and forex cocern of developing countries
OECD–not apply to royalty received by resident of another country from PE in the source
country-royalty not to be taxed-UN Model limited force of attraction- effective connection to
PE/ fixed base or business activity of similar kind even if not connected to PE
Income from sources of the resident country of the payer-UN Model
59. Royalty
59
UN-Equipment rental as royalty
Copy right and penalty for infringement of same
Know how (not patented) for development of industry, commerce, science and technology
Know how (existing knowledge) differs from provisioning service (actual work) by expert
(business profit)
Services-after sale service, warranty, technical service, service and opinion of lawyer,
accountant, engineers, offshore outsourced management, trouble shooting, call centre
Knowhow-special service and product for selective customers, ideas and principles underlying
the computer program, such as logic, algorithms or programming languages or techniques,
where this information is provided under the condition that the customer not disclose it without
authorisation and where it is subject to any available trade secret protection program
Computer Software(program and the media in which the program is embodied)- Royalty or
business profit distinguished
Reproducing multiple copies of program for enabling the operation under site/enterprise/
network license- business profit
Supply of information on the ideas and principles underlying program such as logic,
algorithm, programming language and techniques for right to use-royalty. Transfer of full
ownership-business profit/ capital gain
60. Royalty
60
Mixed Contract
Franchising-
Combination of know how and services
Musical performance-live performance- income of artiste in the
event, replay in media and sale of recorded cassettes/ DVDsroyalty to artiste
information concerning industrial, commercial or scientific
experience - business profit to be taxed on net income
61. Royalty Case
61
Let income from film rentals be dealt as royalty.
With regard to expenses, it is much higher for film
producers than industry or commerce. However, such
expenses are mostly income of actors, technology
firms and technocrats, who are highly paid and pay
tax to resident country. Expense allowed in resident
country shall not be the correct base for tax in
source. Therefore deducting expenses at same rate
for tax purpose in the source country is a loss to that
country. Justification for higher withholding tax rate
62. Royalty Case
62
Where assessee made remittance for procurement of
commercial information for onward transmission to its principal,
remittance made was not for availing technical services and
did not amount to royalty. It was not liable for withholding
taxes. Thus, the order of CIT (A) was to be upheld–ITO, TDS V.
KENDLE INDIA (P.) LTD (2013) 37 taxmann.com 140 (Delhi Trib.)
63. Capital Gain
63
Source country to tax capital gains from the alienation of immovable or
movable property of a PE or pertains to a fixed base for performing
independent personal services, PE as part of enterprise is alienated
apply for property owned alone/ jointly
Tax alienation of share of an entity whose immovable property is located in
that state, applies to shares hold directly or through interposed companies,
other interests or rights, if value of immovable property >50% of the whole
company, can be taxed
Some states not tax alienation for participation as partners in an enterprise,
while some tax this alienation as shares
Gains from alienation of shares, other than above, to be taxed at source at
concessional rate as per bilateral treaty, if total capital is ___% in last 12
calendar month
Developing country may not tax quoted shares, having substantial & regular
trading in recognized stock exchange- to encourage investment in shares
not apply for third state, rest of gains in resident state
64. Capital Gain
64
Residence country to tax gains on the alienation of other types of property
State of effective management to tax gains from the alienation of ships and
aircraft, source in case of inland waterways- as in case of taxing business
profit
No tax when gain from alienation is used for acquiring new property
No tax on appreciation, if property not alienated
If appreciation reflected as book profit, may be special tax
Gain or loss may happen due to loan in foreign currency
Payment on annuity for alienation of property-Capital gain in excess of cost
or other income
Not apply to lottery money
Shareholder selling to issuing company- accumulated profit, not CG
Some states don’t have capital gain taxes, bilateral treaty shall allow one
state to forgo tax, if other state, on whom the convention confers right to tax,
makes use of it
65. Capital Gain
65
Enterprise of State A bought immovable property
situated in State B. The enterprise may have
entered depreciation allowances in the books kept
in State A. The property is sold at a price which is
above cost, a capital gain is to be taxed as per
bilateral treaty in the country of source or
residence, but the depreciation allowances granted
earlier shall be reversed and taxed in state A
If currency of state A is devalued, book profit is
shown in state A for assets in state B or vice versa
66. Transaction betn Indian subsidiaries pursuant to contract betn their parent
Cos is not IT and shall not come under TP
66
Assessee sold its medical imaging business to another Indian Co. namely, 'C' Ltd. in pursuance
of a transaction whereby holding co. of assessee sold its imaging business to holding co. of 'C'
on global basis. Both transactions were independent of each other, therefore, revenue
authorities were not justified in making TP adjustment to such transaction.
Assessee, an Indian company sold its medical imaging business to ‘C’, Indian company
disclosing sale transaction as normal domestic transaction. On perusal of documents, AO
concluded that such transaction was on global basis, wherein holding company of assessee sold
its imaging business to C Inc. TPO proceeded to determine ALP based on worldwide revenue
break up amongst countries submitted by assessee.
Tribunal: Transactions entered into by holding foreign companies and subsidiary Indian
companies were independent of each other. Though the instant transaction was as a
consequence of the global agreement entered into by the holding companies, yet the entire
exercise of transfer of imaging segment was independently done on its own terms by the
assessee and the other party, i.e., 'C' India.
No element of international transaction was involved in sale of imaging segment by assessee
of its business to C and it was purely a domestic transaction. KODAK INDIA V. ADDL.CIT (2013)
37 taxmann.com233(Mumbai –Trib.)
67. Independent Personal Services
67
OECD deleted, UN added new provisions to the
previous OECD model
Source country to tax if attributed to a fixed base
If stayed in source country for 183 days in the FY
Amount of remuneration exceeding a limit-omitted
Professional service – similar tax treatment to
business profit of a firm, in bilateral treaties
68. Dependent Personal Services
68
Income from employment (other than pension)-where the
employment is exercised- employee physically present-whether
or not service provided(?)
Salary, wage and other similar remuneration in cash or kind
(e.g. stock-options, residence or automobile, health or life
insurance coverage and club memberships), received in respect
of an employment
Taxed in source country, if stayed >183 days in 12 months
commencing or ending in any fiscal or employer is a resident of
the source country or payment is made by the PE in source
country
not apply if employee/ employer is resident of source country
If the interposed enterprise is genuine-arm’s length principle
69. Dependent Personal Service
69
Interposed companies be ignored to conclude employment relation between individual
service giver and enterprise
who has the authority to instruct the individual regarding the manner in which the work
has to be performed;
who controls and has responsibility for the place at which the work is performed;
the remuneration of the individual is directly charged by the formal employer to the
enterprise to which the services are provided (see paragraph 8.15 below);
who puts the tools and materials necessary for the work at the individual’s disposal;
who determines the number and qualifications of the individuals performing the work;
who has the right to select the individual who will perform the work and to terminate
the contractual arrangements entered into with that individual for that purpose;
who has the right to impose disciplinary sanctions related to the work of that
individual;
who determines the holidays and work schedule of that individual.
70. Dependent Personal Service- Case
70
From January 01 to December 01, X lives in, and is a resident of State S. On 1
January 02, X is hired by an employer who is a resident of State R and moves
to State R where he becomes a resident. X is subsequently sent to State S by
his employer from15 to 31 March 02. In that case, X is present in State S for
292 days between 1 April 01 and 31 March 02 but since he is a resident of
State S between 1 April 01 and 31 December 01, this first period is not taken
into account for purposes of the calculation of the periods
From 15 to 31 October 01, Y, a resident of State R, is present in State S to
prepare the expansion in that country of the business of ACO, also a resident
of State R. On 1 May 02, Y moves to State S where she becomes a resident
and works as the manager of a newly created subsidiary of ACO resident of
State S. In that case, Y is present in State S for 184 days between 15 October
01 and 14 October 02 but since she is a resident of State S between 1 May
and 14 October 02, this last period is not taken into account for purposes of
the calculation of the periods
71. Dependent Personal Service- Case
71
Aco, a company resident of State A, concludes a contract with Bco, a company
resident of State B, for the provision of training services. Aco is specialised in
training people in the use of various computer software and Bco wishes to train
its personnel to use recently acquired software. X, an employee of Aco who is a
resident of State A, is sent to Bco’s offices in State B to provide training courses
as part of the contract.
In that case, State B could not argue that X is in an employment relationship with
Bco or that Aco is not the employer of X for purposes of the convention between
States A and B. X is formally an employee of Aco whose own services form an
integral part of the business activities of Aco. The services that he renders to Bco
are rendered on behalf of Aco under the contract concluded between the two
enterprises. Thus, provided that X is not present in State B for more than 183 days
during any relevant twelve month period and that Aco does not have in State B a
permanent establishment which bears the cost of X’s remuneration, the exception of
paragraph 2 of Article 15 will apply to X’s remuneration.
72. Dependent Personal Service- Case
72
Cco, a company resident of State C, is the parent company of a group of companies
that includes Dco, a company resident of State D. Cco has developed a new worldwide
marketing strategy for the products of the group. In order to ensure that the strategy is
well understood and followed by Dco, which sells the group’s products, Cco sends X, one
of its employees who has worked on the development of the strategy, to work in Dco’s
headquarters or four months in order to advise Dco with respect to its marketing and to
ensure that Dco’s communications department understands and complies with the
worldwide marketing strategy.
In that case, Cco’s business includes the management of the worldwide marketing activities
of the group and X’s own services are an integral part of that business activity. While it
could be argued that an employee could have been easily hired by Dco to perform the
function of advising the company with respect to its marketing, it is clear that such
function is frequently performed by a consultant, especially where specialised
knowledge is required for a relatively short period of time. Also, the function of
monitoring the compliance with the group’s worldwide marketing strategy belongs to
the business of Cco rather than to that of Dco. The exception of paragraph 2 of Article
15 should therefore apply provided that the other conditions for that exception are
satisfied
73. Dependent Personal Service- Case
73
A multinational owns and operates hotels worldwide through a number of
subsidiaries. Eco, one of these subsidiaries, is a resident of State E where it
owns and operates a hotel. X is an employee of Eco who works in this hotel.
Fco, another subsidiary of the group, owns and operates a hotel in State F
where there is a shortage of employees with foreign language skills. For that
reason, X is sent to work for five months at the reception desk of Fco’s hotel.
Fco pays the travel expenses of X, who remains formally employed and paid
by Eco, and pays Eco a management fee based on X’s remuneration, social
contributions and other employment benefits for the relevant period.
In that case, working at the reception desk of the hotel in State F, when
examined in light of the factors in paragraphs 8.13 and 8.14, may be
viewed as forming an integral part of Fco’s business of operating that hotel
rather than of Eco’s business. Under the approach described above, if, under
the domestic law of State F, the services of X are considered to have been
rendered to Fco in an employment relationship, State F could then logically
consider that Fco is the employer of X and the exception of paragraph 2 of
Article 15 would not apply
74. Dependent Personal Service- Case
74
Gco is a company resident of State G. It carries on the business of filling temporary
business needs for highly specialised personnel. Hco is a company resident of State H
which provides engineering services on building sites. In order to complete one of its
contracts in State H, Hco needs an engineer for a period of five months. It contacts Gco
for that purpose. Gco recruits X, an engineer resident of State X, and hires him under a
five month employment contract. Under a separate contract between Gco and Hco, Gco
agrees to provide the services of X to Hco during that period. Under these contracts, Gco
will pay X’s remuneration, social contributions, travel expenses and other employment
benefits and charges.
In that case, X provides engineering services while Gco is in the business of filling shortterm business needs. By their nature the services rendered by X are not an integral part
of the business activities of his formal employer. These services are, however, an integral
part of the business activities of Hco, an engineering firm. In light of the factors in
paragraphs 8.13 and 8.14, State H could therefore consider that, under the approach
described above, the exception of paragraph 2 of Article 15 would not apply with
respect to the remuneration for the services of the engineer that will be rendered in that
State.
75. Dependent Personal Service- Case
75
Ico is a company resident of State I specialised in providing engineering services. Ico
employs a number of engineers on a full time basis. Jco, a smaller engineering firm resident
of State J, needs the temporary services of an engineer to complete a contract on a
construction site in State J. Ico agrees with Jco that one of Ico’s engineers, who is a resident
of State I momentarily not assigned to any contract concluded by Ico, will work for four
months on Jco’s contract under the direct supervision and control of one of Jco’s senior
engineers. Jco will pay Ico an amount equal to the remuneration, social contributions, travel
expenses and other employment benefits of that engineer for the relevant period, together
with a 5 per cent commission. Jco also agrees to indemnify Ico for any eventual claims
related to the engineer’s work during that period of time.
In that case, even if Ico is in the business of providing engineering services, it is clear that the
work performed by the engineer on the construction site in State J is performed on behalf of
Jco rather than Ico. The direct supervision and control exercised by Jco over the work of the
engineer, the fact that Jco takes over the responsibility for that work and that it bears the
cost of the remuneration of the engineer for the relevant period are factors that could
support the conclusion that the engineer is in an employment relationship with Jco. Under the
approach described above, State J could therefore consider that the exception of
paragraph 2 of Article 15 would not apply with respect to the remuneration for the services
of the engineer that will be rendered in that State.
76. Dependent Personal Service- Case
76
Kco, a company resident of State K, and Lco, a company resident of State L, are part of the
same multinational group of companies. A large part of the activities of that group are
structured along function lines, which requires employees of different companies of the
group to work together under the supervision of managers who are located in different
States and employed by other companies of the group. X is a resident of State K employed
by Kco; she is a senior manager in charge of supervising human resources functions within
the multinational group. Since X is employed by Kco, Kco acts as a cost centre for the human
resource costs of the group; periodically, these costs are charged out to each of the
companies of the group on the basis of a formula that takes account of various factors such
as the number of employees of each company. X is required to travel frequently to other
States where other companies of the group have their offices. During the last year, X spent
three months in State L in order to deal with human resources issues at Lco.
In that case, the work performed by X is part of the activities that Kco performs for its
multinational group. These activities, like other activities such as corporate communication,
strategy, finance and tax, treasury, information management and legal support, are often
centralised within a large group of companies. The work that X performs is thus an integral
part of the business of Kco. The exception of paragraph 2 of Article 15 should therefore
apply to the remuneration derived by X for her work in State L provided that the other
conditions for that exception are satisfied.
77. Employee Stock Options
77
Stock options exercised/alienated is later than the stock
options issued to employees- taxed as employee income at a
future date if the employment continues
Subsequent gain in acquired shares-capital gain
ESOP may be given for past performance and to encourage
performance in future to increase share value
States in bilateral treaty may agree to tax proportionately as
per period of service rendered in each state in past or
subsequent ot issue of ESOP
State having insignificant employment may forego taxing right,
subject to avoid double non taxation, if a part relates to 3rd
state
78. Employee Stock Options Case
78
On 1 January of year 1, a stock-option is granted to an employee. The
acquisition of the option is conditional on the employee continuing to be
employed by the same employer until 1 January of year 3. The option,
once this condition is met, will be exercisable from 1 January of year 3 until
1 January of year 10 (a so-called “American” option43). It is further
provided, however, that any option not previously exercised will be lost
upon cessation of employment. In that example, the right to exercise that
option has been acquired on 1 January of year 3 (i.e. the date of vesting)
since no further period of employment is then required for the employee to
obtain the right to exercise the option.
On 1 January of year 1, a stock-option is granted to an employee. The
option is exercisable on 1 January of year 5 (a so-called “European”
option). The option has been granted subject to the condition that it can
only be exercised on 1 January of year 5 if employment is not terminated
before that date. In that example, the right to exercise that option is not
acquired until 1 January of year 5,which is the date of exercise, since
employment until that date is required to acquire the right to exercise the
option (i.e. for the option to vest)
79. Directors’ fees and remuneration of toplevel managers
79
Fees and similar payment ( stock options, residence,
automobile, insurance, club membership)
Received by resident of one state from a company
resident in source country shall be taxed at source
Some organs of a company equivalent to board of
directors
Top level managers- addition in UN Model
Salary split arrangement could be used in order to reduce
the taxes
80. Directors’ fees Case
80
Company A, a resident of State A, has two subsidiaries,
companies B residents of State X and Company C resident of
Y. Mr. D, a resident of State X, is a director and an official in a
top-level managerial position of subsidiary B. State X levies an
income tax at progressive rates of up to 50 per cent. State Y
has a similar income tax system but with a very low tax rate.
Countries X and Y have a tax treaty which provides that State
X applies the exemption method to income that may be taxed
in State Y. For the purpose of reducing the tax burden of Mr.
D, company A may appoint him as a director and an official in
a top-level managerial position of company C and arrange for
most of his remuneration to be attributed to these functions
81. Artistes and Sports Persons
81
Income to be taxed at source, independent- no exception of 183
days etc
Gross at a lower rate or net on deducting expense
Employed by another person or entity- look through, if no look
through- other person to be taxed, even if no PE or fixed base
Artists under employment to be covered in dependent personal
services if states agree bilaterally
Royalty, sponsorship and advertisement- this provision applies if
such income attributed to live performance
Exemption/ credit under double taxation by resident statesubsidiary taxation by resident state, if source state fails to tax
Not apply if the performance is mainly supported by any government
(local or national) of both the states
82. Star Companies
82
allows the State in which the activities of an entertainer or
sportsperson are exercised to tax the income derived from
these activities and accruing to another person to tax the
income in accordance with its domestic law
where both the entertainer or sportsman and the other person to whom the
income accrues, e.g. a star-company, are residents of the same Contracting
State
derived by a star-company resident of the other Contracting State even
where the entertainer or sportsman is not a resident of that other State.
Conversely, where the income of an entertainer resident in one of the
Contracting States accrues to a person, e.g. a star-company, who is a
resident of a third State with which the State of source does not have a
tax convention
83. PE Case Golf in Dubai’s
83
Golf in Dubai LLC – organizes golf
tournaments internationally
Conducted two (2) golf tournaments in India
Hired golf courses – received sponsorships
from India and abroad
AAR
“furnishing of services” – bilateral concept
Requires service provider and service
recipient
No such service recipient exists – hence no
Service PE
In any event – time threshold not breached
In Re. Golf in Dubai, LLC, (2008) 219 CTR
(AAR) 513
Source: MAJMUDAR & CO.
84. Pension & Social Securities Pension
84
OECD/UN- resident country to tax
UN-Source country to tax payment made within framework of a public
scheme of social security system of that state
UN-Source country if payment is attributed to a resident/ PE of source
country
Source from where pension payment made, not from which contribution to
pension fund made
Periodic and lump-sum
Statutory social securities scheme- source state has exclusive right
Occupational pension scheme
Personal retirement scheme
Different treatment of pension contribution by two treaty countries- tax
deferral on contribution in source country, Pensioner becomes resident of
other country before receiving pension, where there is no tax on pension and
no tax deferral on pension savings- result in double tax avoidance
85. Pension & Social Securities Pension
85
taxed in the other Contracting State if the payment is made
by or on behalf of a pension fund established in that other
state or borne by a PE situated therein and the payment is
not subject to tax in the first-mentioned State under the
ordinary rules of its tax law
any pension or other similar remuneration paid to a resident
of a Contracting State in respect of past employment
exercised in the other Contracting State shall be exempt
from tax in the first-mentioned State if that pension or other
remuneration would be exempt from tax in the other State if
the recipient were a resident of that other State
Portability of pension scheme from one state to anothertaxable benefit
86. Capital
86
Capital excludes estates, inheritances, gifts and transfer
duties
Immovable property owned by resident of one state in
another state shall be taxed in the later state
Movable business property of a PE/ fixed base in one
contracting state of an enterprise/ individual of
another state shall be taxed in the former state
Ship, aircraft in the state of effective management
87. Exemptions
87
Source country tax at a concessional rate and Tax
sparing credit by resident country
Reinvesting untaxed profit in developing/ source country
Resident country tax and share (equivalent to
concessional rate) with source country
Incentive tax war
Break/ sunset clause
Soak up tax
89. Transfer Pricing
89
Why Aligning TP Rules to one standard
Protecting
tax base
Provide certainty to MNEs and Countries in DTAA and
MAP
Reduce risk of double taxation
Provide level playing field among countries for business
decision
Provide level playing field among MNEs and
independent entities
Curb Profit shifting from high tax to low tax jurisdiction
90. Transfer Pricing-OECD
90
Range of ALP- Inter Quartile Range-Adjust to the
closest
point in the range
Point of central tendency (median) of the range
Methods for Transfer Pricing
Comparable
Uncontrolled Price
Resale Price Method
Cost Plus Method
Transactional Profit Method
Transactional
Net Margin Method
Transactional Profit Split Method
91. CUP-Comparable Uncontrolled Price
91
Comparable if the difference does not affect price in
the open market at the level of retailer
Internal (tax payer with an independent entity) and
External Comparable (two independent entity)
Product (including financial) comparison most effective
Comparability adjustment-extra cost due to additional
risk of transaction with independent entity
92. Resale Price Method
92
Resale price of a product to independent entity
purchased from a AE
Reduced by a gross margin, cost incurred and taxes
Typically applied to a distributer/ marketing
operations- resale margin for items from AE and from
independent entity
93. Cost Plus Method
93
Mark up (Gross) is computed on direct & indirect cost,
before operating (overhead) expense
Typically applied to Manufacturer/ Service provider,
where there is no tangible risk for sale to independent
entity
Accounting consistency/ adjustments required for
comparison
94. Transactional Net Margin Method
94
Ratio of net profit to a base (costs, sales, assets) from
transactions that can be appropriately aggregated earned in
controlled transaction Vs Comparable Uncontrolled Transactions
(Internal/ External)
Net Profit is Operating Profit before interest, extraordinary
items and income tax
Weighted to cost for manufacturing and service, sales to sales
and assets to assets intensive activities
Involvement of chain of AEs- tracking difficult
Selected Financial Indicator
Functional comparability rather than product
Reflects main functions of the party wrt its assets & risks
objectivity- transaction with unrelated parties
Measurable reliably for both controlled and unrelated
95. TP-Intangible
95
Intangibles
Marketing; Trade; Unique and valuable
Distribution (Trademark) / R&D arrangement, Use of Company Name
Legal owner of intangible-in substance, performs functions of development,
protection, bears the risk
Outsource - on ALP
Mere funding of the intangible without the risk and control - risk adjusted
return on capital invested- not entitled to the premium profit on the intangible
No assumption of residual profit belongs to owner-functional analysis of
MNEs global business and interaction of intangibles with other functions
One sided comparability methods not useful
CUP and Profit split method suitable, May adopt other new methods
Uniquely qualified cadre of employees determine ALP
Local market, location savings, assembled workforce,
corporate synergies-combined purchasing/ burrowing power, economy of
scale
96. Arm’s Length in Associated Enterprises
96
Deals with adjustment of profit among parent and
subsidiary or related companies under one control
Arm’s length rule on allocation of profit, Transfer pricing of
goods, trademarks, technology, services
Thin capitalization- interplay of domestic law with tax
treaty
Secondary Adjustment: Adjustment under arm’s length
basis increase profit of PE, which require further
adjustment towards probable profit transfer in the form of
dividend, royalty on the basis of profit sharing or later
capital gain leading to readjustment of tax on profit &
withholding tax
97. Arm’s Length in Associated Enterprises
97
Re-writing/adjustment of transactions may lead to double
taxation- Mutual Agreement Procedure
the
profits of enterprise X in State A are increased on arm’s
length basis, the adjustment would be made by re-opening the
assessment on the associated enterprise Y in State B for the
doubly taxed profits in order to reduce the taxable profit by
an appropriate amount, or enterprise Y in state B shall claim
relief
Time Limit for providing relief by state B- decide bilaterally
keeping judicial disposal in view
No adjustment for penalty for willful default or fraud
98. Safe Harbor
98
Compliance cost decreases for tax payers and
administration
Binds states having SH rules, provides certainty
Eligible category of transactions and taxpayers
Different accounts for different country-double
taxation/ non-taxation
Difference with ALP
Multilateral SH rules is desirable
Tax planning Opportunity efficient and penalization for
non-efficient
99. Safe Harbor Rule-India
99
Eligible Assessee
Not apply to low tax (Marginal Income Tax (<15%) or no tax countries
transacation is ≥100 Crore – OPM ≥20%
Software development services
Information technology enabled services
knowledge process outsourcing services
advance of intra-group loan ≥ previous Yr base rate of SBI+X00 basis
points
corporate guarantee-commission ≥2% PA on guarantee
contract research and development services software development (OPM
≥30%) & generic drugs (OPM ≥29%)
manufacture and export of core (OPM≥12%)/ non-core (OPM≥8.5%)
auto components
TP declared and accepted under SH not eligible for MAP
100. Transfer Pricing-Brazil
100
Fixed margin rather than comparable transaction
Comparable margin & concurrent price difficult to find, Price strategy of
comparable Cos secret
Taxpayer to choose under most favored method
Objective method, fixed profit margin, juridical certainty-complex legal system takes
less time to settle
Apply to transactions with entities in all country (including tax haven, privileged tax
regime)
Non conformity of Brazilian and other countries standards- double taxationBrazilian cost
Difficult to establish a PE, foreign Cos create Brazilian subsidiary- independent legal
entity
TP rule affects transaction between subsidiary and parent
Different accounts to comply Brazil TP rule and OECD ALP
101. Transfer Pricing-Brazil
101
Over billing of costs of imports from related parties or from related or
unrelated parties of low/privilege tax jurisdiction, not related but have
exclusive rights or 10% common ownership, substantial influence (20%
voting capital)
Under billing of exports in similar condition as above
Payment of interest of under agreement not registered before central
bank of Brazil with foreign banks in similar conditions as above
Transfer pricing adjustments also may be considered when calculating
depreciation, amortization, or depletion expenses and interest on equity
deductions
Does not apply to royalty and remuneration for transfer of technology
know how
Low/no tax jurisdiction: Withholding tax 25%, not standard 15%, thin
capitalization rule apply, TP rule on remittances
Privilege tax jurisdiction: thin capitalization rule apply, TP rule on
remittances
102. TP Methods for Acquisitions, Imports
- Brazil
102
comparable independent prices (PIC)-comparable prices
adjusted- factors are defined- payment terms, quantities sold,
guarantees offered, marketing or advertising obligations, costs
with quality standards and quality control, packaging costs,
brokerage fees due to unrelated parties, freight and insurance
for identical assets, goods, services, or rights, differences in the
physical characteristics and content of the comparable items
production cost plus profit (CPL)-weighted average of production
cost (direct costs, costs of any goods, services, or rights used or
consumed in the manufacturing process, reasonable process
losses, depreciation, and lease and maintenance expenses
related to the production process ) of imports + plus profit of
20%+tax levied in exporting country
103. TP Methods for Acquisitions, Imports
- Brazil
103
PRL-resale price less 20 percent profit (PRL 20, for
goods imported and resold without undergoing any
industrial process in Brazil); -weighted average of sale
price deducting expenses
unconditional
discounts that do not depend on future events
or conditions, as shown on the relevant invoice;
indirect taxes included in the sales price
brokerage fees and sales commissions
20 percent profit margin on the resale price or 60 percent
profit margin on the manufactured sale price
104. TP for Exports- Brazil
104
Hybrid Model of Safe Harbor & if no SH provision-look for
Comparables
Transfer pricing rule does not apply both to import and export
transactions and only SH apply if
imports of royalties and technical, scientific, and administrative or similar
assistance and exports of royalties and same services
interest paid if the corresponding agreement is registered with the Central
Bank
SH for Exports-if Ave price is <90% of the ave price of similar goods
sold in domestic market under similar condition to unrelated parties-TP
will apply
SH for new markets- TP shall not apply to related parties even if price is
<90%
Variation method - SH apply if revenue of legal firm is 5% from low tax
jurisdiction and profit is 5% from such revenue
SH does not apply to low tax states
105. Non SH method for Exports-Brazil
105
If the taxpayer does not benefit from any safe harbor
or exception, any one of the following four methods can
be used to calculate the benchmark for exports:
export sales price (PVEX)- ave to unrelated parties
wholesale price in country of destination less profit
(PVA)/ retail price in country of destination less profit
(PVV) - wtd ave in destination - tax of export country &
15% profit on wholesale price or 30% on retail
purchasing or production cost plus taxes and profit
(CAP)-wtd ave of purchase/ production cost + export
tax+profit of 15%
106. Transactional Profit Split Method
106
Identifies combined profit of AEs from controlled
transactions
Identifies economically comparable unrelated entities
division of profit based on share of transactions
Splits profit of AEs based on share of transactions and
comparable benchmark
Applicable to highly integrated operations – global
trading of financial instruments among AEs
When both parties make unique and valuable
contributions
108. MCMAATM (OECD)
108
International movement of persons, capital, goods & services,
beneficial in itself, has increased tax avoidance & evasion
Key Benefits
Multilateral-single legal document for multi nation cooperation
Wide scope- most taxes except Customs
Flexible- Each nation can record reservation on a clause/tax
Uniform-Coordinating body of signatory nations for uniform
application
Covers more taxes than DTAA bilateral treaties
Certain cooperation with all signatories even if DTAA absent
Measures of conservancy & tax recovery
Information can be passed to criminal investigation authorities (T & C
apply)
109. MCMAATM (OECD)
109
Assistance Covered (on request, spontaneous & automatic)
exchange
of information, tax examinations abroad, assistance
in recovery & measures of conservancy, acceptance & service
of legal documents
Taxes Covered
Income
tax, corporate tax, capital gain, wealth tax, not
customs duty levied by central govt., local taxes, compulsory
social security contribution, estate, inheritance & gift
Rights & Safeguards
Rights
& safeguards under national law remains, expressly
recognizes limitations to oblige assistance
110. MCMAATM (OECD)
110
Confidentiality
standards
of confidentiality and protection of personal data
Co-ordinating Body
representatives
of each of the parties- monitors the
implementation of the Convention
Flexibility
Nation
specific reservations reflected in the convention- can be
inserted/withdrawn at any point of time
Denunciation
Simultaneous tax examinations, joint audit- similar to
mutual agreement procedure (MAP) in bilateral
arrangement
112. Invoking Anti Avoidance Rule
112
Arrangement to avoid tax
Lacks commercial substance
Not practiced for bonafide business purposes
Rights & obligation not created under Arm’s length
Substance differs from form given to interposition of entity or
transaction
Tax benefit, but no business risk or cash flow
Round trip financing & accommodating party
Disguises location, source, ownership & control
Pre tax profit insignificant wrt tax benefit
Invoke Special Anti Avoidance Rule
DTAA will be superseded
Commissioner can invoke
OECD commentary mentions anti abusive law is not conflicting
with tax treaties
113. Specific Anti Abusive Rules
113
Payment to associated persons as expenditures (royalty,
management fee, material supply, interest payment in debt
financing)
Misuse of Most Favored Nation agreements to avoid customs duty
Arm’s Length Principle
Transfer Pricing Rules to prevent shifting income
Controlled Foreign Corporations Rule-conduit companies
Foreign Investment Fund Rule-avoidance of tax on investment income
Thin Capitalization Rule
Exit/ Departure Tax Rules- change of residence before realization
of treaty exempt capital gains
Dividend Stripping Rules-transfer dividends to treaty exempt capital
gains
Transaction in securities leading to indirect transfer of assets-look
through provision - Vodafone-hutch case led to retrospective
amendment
114. Anti Abusive Provisions in UN Model
114
Agent- Art 5 Para 5
Beneficial Owner- Art 10,11,12
Special Relationship-interest & royalty- Art 11 Para 6, Art 12Para 6
Alienation of shares of immovable property- Art13 Para 4
Star Companies- Art 17 Para 2- Sports Bodies-Dubai Golf Club
holding events in India for few days, earning revenue and making
payment to Sports Persons, Other examples media, cinema industry
Limited force of attraction/ Proportionate to the PE-Art 7 Para 1
Treaty Shopping-persons not entitled to benefit under a treaty use
other persons
Financing Arrangement- US
Tax reduced due to intermediary
Tax avoidance plan
Intermediary existed only for the plan
Intermediary is associated entity of the financing entity
115. Anti Abusive Decree
115
Swis Federal Court-if the requirements specified in the tax
treaty (such as residence, beneficial ownership, tax
liability, etc.) are not fulfilled & it constitutes an abuse
Countries allowing relief of withholding tax shall be
informed by Swis Tax authority to act for abuse of
double taxation treaty
Swiss tax authorities shall refuse to certify a claim form,
refuse to transmit the claim form and revoke a
certification already given and recover the withholding
tax, on behalf of the State of source to the extent that
the tax relief has been claimed improperly
116. Offshore Financial Centres
116
Alderney
Andorra
Anguilla
Antigua and Barbuda
Aruba
Antillas Holandesas
Aruba
Bahamas
Bahrain
Barbados
Belize
Bermuda
Botswana
British Virgin Islands
Brunei Darussalam
Cayman Islands
Campione D'Italia
Cook Islands
Costa Rica
Cyprus
Dominica
Ghana
Gibraltar
Grenada
Guatemala
Guernesey
Hong Kong
Ireland
Israel
Jersey
Jordan
Labuan
Lebanon
Liberia
Liechtenstein
Luxembourg
Macau
Madeira
Malta
Isle of Man
Marshall Islands
Mauritius
Monaco
Montserrat
Nauru
Netherlands Antilles
Niue
Norfolk
Oman
Panama
Philippines
St. Kitts and Nevis
St. Vincent
St. Lucia
Samoa
San Marino
Sark
Seychelles
Singapore
Switzerland
Turks and Caicos
UAE
United Kingdom
Uruguay
USA
Vanuatu
118. Tax Havens
118
Small Sovereigns Big Sovereigns Non Sovereigns
Andorra
Bahamas
Cyprus
Liechtenstein
Luxembourg
Monaco
Panama
Samoa
San Marino
Seychelles
Ireland
Netherlands
Switzerland
British Crown Dependency-Guernsey,Jersey, Isle of
Man
British Overseas Territory-Bermuda,British Virgin
Islands,Cayman Islands, Turks and Caicos Islands
Italy-Campione d'Italia
Iraq-Kurdistan
Netherlands-Curaçao
Malaysia-Labuan
United Arab Emirates-Jebel Ali Free Zone
United States- Alaska, Delaware,Florida,
Nevada,Texas,South Dakota,Virgin Islands,
Washington,Wyoming