Curbing profit shifting in international transaction un oecd model _ Jena


Published on

  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Curbing profit shifting in international transaction un oecd model _ Jena

  1. 1. CURBING PROFIT SHIFTING IN INTERNATIONAL TRANSACTION Chidananda Jena Email: Skype/ YM: chidanandajena
  3. 3. BRIEF Chidananda Jena Email: Skype/ YM: chidanandajena
  4. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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
  17. 17. DETAIL Chidananda Jena Email: Skype/ YM: chidanandajena
  18. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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) 37 200 (Hyderabad - Trib.)
  39. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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) 37 232 (Mumbai - Trib.)
  50. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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) 37 140 (Delhi Trib.)
  63. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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
  88. 88. TRANSFER PRICING & ARM’S LENGTH PRINCIPLE Chidananda Jena Email: Skype/ YM: chidanandajena
  89. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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
  107. 107. INTERNATIONAL COOPERATION Chidananda Jena Email: Skype/ YM: chidanandajena
  108. 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. 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. 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
  111. 111. ANTI AVOIDANCE RULE Chidananda Jena Email: Skype/ YM: chidanandajena
  112. 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. 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. 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. 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. 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
  117. 117. Offshore Financial Centres 117
  118. 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
  119. 119. Tax Havens 119
  120. 120. Chidananda Jena Email: Skype/ YM: chidanandajena