VIRTUAL COACHING CLASSESORGANISED BY BOS, ICAI

FINAL LEVELPAPER 7: DIRECT TAX LAWS & INTERNATIONAL

TAXATION

Equalization LevyFaculty: Mr Sudarshan Rangan

© The Institute of Chartered Accountants of India

Date: 12 November 2020

Setting the tone

BEPS – Profit Shifting – TP Main Factor

Why International Tax- Tax Treaty

Seller

Buyer

Country A

4

Country A sells to Country B at a profit of 100 $

Can Country B tax the profit of the Seller ?

Taxability?

Double taxation occurs in situations where country of residence and country of source seek to tax same income

Country B

5

•Taxability of entities follow either one or a combination of the following basis

- Juridical Double Taxation

◦ Same “Person” is taxed on the same “Income” in more than one Country

- Source basis of taxation (Economic Based Taxation)

▪ Taxation of all income of a person from sources within a territorial jurisdiction

- Nationality basis of taxation

▪ Taxation of worldwide income of citizens

Scope of taxation

6

- Hampers free flow of capital

- Acts as a prohibitive burden on the taxpayer resulting in decline of foreign investment

- Restricted trade

- Restricted foreign investment

- International relations

Consequences of double taxation

7

Nature of DTAAs

What is a tax treaty?

Tax treaties are international agreements entered into between Governments for the allocation of fiscal

jurisdiction so as to avoid double taxation of the same income

The purpose of the DTAA is to remove impediments to the flow of trade and investment by the

elimination of international double taxation

Nature of tax treaty

They are of dual nature:

International agreements between 2 countries for allocation of fiscal jurisdiction

Become part of tax law of each of the countries

8

Nature of DTAAs

What is the purpose of a tax treaty?

Elimination of double taxation

Clarification of fiscal situation of tax payer

Sharing of tax revenues between contracting countries

Promotion of cross border trade

Exchange of information to combat tax avoidance/ tax evasion

9

Types of tax systems followed

Residence based tax system

• Connecting factor is “residence”

• Country of residence has the primary jurisdiction to tax

• In case of conflict “tie-breaker test”

Source based tax system

• Connecting factor is “income”

• Country of source shall restrict its right to tax

Country of residence will give credit for tax paid in the country of source

• Tax Evasion

• Tax Planning

• Tax Avoidance

Concepts

Page 10

Tax Evasion

Tax Avoidance

Tax Planning

• Arm’s length Principle

• Separate Entity

• PE

• Residence vs Source- Water’s edge

International Tax Avoidance – Causation

Page 12

Tax Avoidance Strategies

#1 Modern digital business – See Equalization Levy Example

#2

Page 13

A Co.

B Co.-

Country A

Country B

+

Loan -CCD

13

• A co, Parent Entity lends loan to B Co, Subsidiary in Country B

• Loan i.e. CCD is treated as debt in Country B.

• However the loan is treated as equity in Country A.

• Dividend from Foreign subsidiary is exempt under the laws of Country A.

• Tax consequences?

Tax Consequences #2• Hybrid Instrument leading to mismatch

• Hybrid mismatch arrangement

• Leads to a Deduction/Income Not included – D/NI Situation.

Tax Avoidance Strategies- #3

15

#3 XYZ LLP, a UK Partnership Firm is a firm of Chartered Accountants. An Indian company

engaged the services of XYZ LLP for a forensic audit engagement in India and paid fees

of INR 10 Lakhs. Under the India – UK DTAA, the said payment is not taxable and

therefore using Section 90(2) of the Income Tax Act, the Indian Company did not

withhold any tax while making the remittance to XYZ LLP.

Other information:

• XYZ LLP is a tax pass through entity, wherein the firm is not subject to tax and only

the partners are subject to tax.

• Understand that the partners of XYZ LLP are tax residents of UAE, where

there is no personal taxation.

• Discuss the tax consequences ?

Tax Avoidance Strategies- #4

◦ Instead of lending directly to subsidiary, parent capitalises a special purpose low tax finance company (“Finco”)

◦ Finco then lends to subsidiary in Country B

◦ Why is this structure?

16

Parent

equity

Subsidiary Low tax finance

companyloans

Country A

Country B Country C

High Tax Jurisdiction

Tax Consequence

Country B Country C

Tax Deduction for Interest Payment

WHT on Interest may be lower –Treaty B & C

Nil Tax or Low Tax

So Interest not taxable.

No withholding tax on dividends to Country A

17

a) Transaction between B & C

Country A

• Dividends exempt from Foreign Subsidiary

Inflection Point – 2009

Page

18

Sou

rce: Shu

tterstck

Source:businessjournalng.com

Evolution – BEPS

Page

19

2009• Pittsburg

h G20

2012• Los

Cabos G20

2013

• St Petersburg, Significant events

Source:Theconversation.com

Timelines – BEPS Version 1

Page

20

2013-

• February 2013 : OECD report“Addressing Base Erosion and ProfitShifting” – Moscow G20 financeminister

• July 2013 : Action Plan on BEPSAction 2013-

• October 2013: St Petersburgendorsement of the Action Plan!

2015- Final Report titled “Addressingthe Tax Challenges of the DigitalEconomy,” without anyrecommendations

• Significant economic presence (SEP):revenue factor + profit attribution →DIGITAL (local domain; local digital;platform; local payment; USER-BASE(data collected; online contractconclusions)

• Withholding tax on certain types ofdigital goods and services

• Equalisation levy (e.g. based onmonthly sales or data use)

21

BEPS Actions

Coherence

Hybrid Mismatch Arrangements (2)

Harmful TaxPractices (5)

InterestDeductions (4)

CFC Rules (3)

Substance

Preventing Tax Treaty Abuse (6)

Avoidance ofPE Status (7)

TP Aspects of Intangibles (8)

TP/Risk andCapital (9)

TP/High RiskTransactions (10)

Transparency and Certainty

Measuring BEPS (11)

DisclosureRules (12)

TP Documentation (13)

DisputeResolution (14)

Digital Economy (1)

Multilateral Instrument (15)

BEPS Impact on India – Introducing Tax Avoidance measures

Page

22

• India is an active participant in the BEPS project

• India has already introduced the following measures in its domestic tax laws / bilateral tax treaties inorder to combat BEPS:

➢ Introduction of “Equalization Levy” for specified digital transactions

➢ Country-by-Country Reporting

➢ Introduction of Place of Effective Management Test (‘POEM’) of corporate residency

➢ Levy of Buy-back tax to curb treaty abuse

➢ Revision of tax treaties with Mauritius, Cyprus and Singapore tax treaty to remove capital gainsexemption;

➢ Enactment of General Anti Avoidance Rules (GAAR) (not necessarily BEPS though)

➢ Patent box tax

➢ Thin capitalization

Action Plan 15 – Multilateral Instruments – MLI

Page

23

• Domestic law changes made,

• AP 15- To bring effect treaty changes

Part I Scope and Interpretation of terms Article 1-Article 2

Part II Hybrid Mismatches Article 3-Article 5

Part III Treaty Abuse Article 6-Article 11

Part IV Avoidance of PE Status Article 12-Article 15

Part V Improving Dispute Resolution Article 16-Article 17

Part VI Arbitration Article 18-Article 26

Part VII Final Provisions Article 27- Article 39

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