Indian Taxation of Partnerships & Triangular Treaty Situations

© RAO LAW CHAMBERS 2017
Partnerships & Triangular Cases
Shreya Rao

Contents
• Introduction
• Tax treatment of Partnerships
• Issues with eligibility to treaty benefits
• Case Studies
• BEPS & The Multilateral Instrument
2© RAO LAW CHAMBERS
Shruthi Ashok assisted with the preparation of these slides.

Introduction
• What is a partnership?
• Key components of partnerships
• Kinds of partnerships
© RAO LAW CHAMBERS

What is a partnership?
Illustrative
Definitions
“While the term partnership is used in many countries, their legal characteristics
are not identical in all cases. However, in general, a partnership may be said to
consist of an association of two or more persons… established for the purposes
of making a profit, the profit (or loss) being shared among the partners in
predetermined proportions.”
International Tax Glossary (IBFD, 6th Edition)
“Partnership is the relation between persons who have agreed to share the
profits of a business carried on by all or any of them acting for all.”
Section 4, Indian Partnership Act (1932)

Key Features of a Partnership
Profit & loss
sharing, in a
predetermin
ed ratio
MAY be a juristic
person
Association
of Persons
For legally organised
partnerships, the
association is
typically contractual
rather than informal/
implicit
The profit entitlement
should be determinable
but not necessarily
fixed. For example, in a
“limited partnership”,
one partner has
unlimited liability &
upside while others
have limited liability &
upside
General partnerships in
India are not legal
persons (CIT v. RM
Chidambaram Pillai),
while LLPs are (s.3,
LLP Act)
Please refer to 7.21
& 7.22 of Module H
for other
characteristics of
general partnerships
& LLPs

Kinds of Partnerships in India & elsewhere
General
Partnerships
• All partners have
joint and several
liability
• This is the
traditional form of
partnership
• Recognized under
Indian Partnership
Act (1932)
Limited
Partnerships
• One partner has
unlimited liability,
others have limited
liability
• Typically used for
fund investment
vehicles
• Not specifically
recognized under
Indian law
Limited Liability
Partnerships
• All partners have
limited liability
• Typically used by
professionals such
as lawyers
• Recognized under
Limited Liability
Partnership Act
(2008)
Hybrids
• Combine features
of a “company” &
“partnership” and
may be treated
differently in source
& residence
countries
• Not recognized
under Indian law

Tax treatment of Partnerships
© RAO LAW CHAMBERS
• Taxation of Partnerships under ITA
• Foreign partnerships

Taxation of Partnerships under the ITA
Definition of
Partnership under s.
2(23)
• “firm” shall have the meaning assigned to it in the Indian Partnership
Act, 1932 and shall include a limited liability partnership as defined
under the Limited Liability Partnership Act, 2008
• How will LLPs incorporated in another country be taxable in
India?
Taxable at firm level
under s.184 if
• Evidenced by a written instrument that specifies individual shares of
partners. Certified copy to be provided with return and changes notified
• A foreign partnership satisfying conditions under s. 2(23) should be
recognized as a firm under ITA if these conditions are satisfied.
Taxation of Partners
• Once tax is paid by the partnership, no further tax is payable by the
partners on their respective share s.10(2A)
Taxable as an AoP
under Sec 167B, ITA
• If conditions under s.184 not satisfied, the firm is taxed as an AoP and
deductions for salary and other payments under s.28 may be denied.

Foreign Partnerships
Residency of
Partnership
Sec 6(2): “A Hindu undivided family, firm or other association of persons is said
to be resident in India in any previous year in every case except where during
that year the control and management of its affairs is situated wholly outside
India”
Section 9 –
Deemed income of
foreign
partnerships
A foreign partnership under s.6(2) is taxable only on Indian source income under
s.9 of the ITA. However, this may be mitigated by tax treaty benefits available
under s.90 of the ITA
Section 90 –
Treaty benefits
Under s.90, if there is a DTAA, then ITA provisions apply only to the extent more
beneficial. However, under s.90(4), the person claiming benefits should be a
resident and have a tax residency certificate.

Issues with eligibility to Treaty Benefits
© RAO LAW CHAMBERS
• Applicability of the Treaty to Partnerships
• Differences in country practice
• India’s Position

Applicability of (OECD) Treaty to Partnerships
Article 1:
Eligibility
“This Convention shall apply to persons who are residents of one or both of the
Contracting States”.
Article 4:
Resident
“For the purposes of this Convention, the term “resident of a Contracting State”
means any person who, under the laws of that State, is liable to tax therein by
reason of his domicile, residence, place of management or any other criterion of
similar nature”
Article 3: Person “The term “person” includes an individual, a company and any other body of
persons”
OECD Model
Commentary on
Article 3
“Partnerships will also be considered to be “persons” either because they fall
within the definition of “company” or, where this is not the case, because they
constitute other bodies of persons.”

Differences in country practice
Opaque The firm or corporation is treated as distinct entities for the purposes of tax.
The income is assessed at the level of the firm as a beneficial owner, and the
partners subsequently are not taxed on their shares.
Transparent The firm is not recognized as a separate assessable entity for the purposes of
tax.
The income flows through to the hands of the partners (as beneficial owners),
who are individually taxed on their shares
Partly Opaque
and Partly
Transparent
Seen in cases of limited partnerships (as in France). Taxed at two levels
Taxed at the level of firm w.r.t limited partners
Firm treated as transparent w.r.t general partners
Check-the-Box
Regulation
U.S.A approach- the single member corporation can choose either of the two
approaches

Examples of country practice
Taxable at the
partnership level (as a
corporation)
(GP in Belgium)
Taxable either as a
partnership or a
corporation, at the option
of the taxpayer
(US Corps)
Taxable in the hands of
the partners
(Dutch Closed CV)
Treated as fiscally
transparent
(LPs in Germany)
Points to Discuss
- Japanese decision in Heisei
25 (gyou-hi) No. 166

Variance in practice depending on Entity
General Partnerships
• Transparent: Australia,
Germany, Sweden
• Opaque: Belgium,
Hungary
• Intermediate: India
Limited Partnerships
• Transparent: Germany/
Sweden
• Opaque: Australia/
Belgium
• Intermediate: France/
Czech Republic
LLPs
• Transparent: Germany,
Singapore, UK, US,
Japan
• Opaque: NA
• Intermediate: India

Variance in country practice: A big problem
1
NATURE OF ENTITY
Whether the entity is clearly a
partnership/ trust/corporation &
whether transparent/ opaque
Canoro Resources Limited
TD Securities (USA) LLC
2
RESIDENCE
How to determine residence of a
foreign partnership?
3
WHO TO TAX
Whether to tax partnership or the
partner?
Resource Capital Fund III LP
(Australia)
4
CLASSIFICATION OF INCOME
Whether the income character
changes depending on who the tax
unit is
1. Entity Classification
Issue: Classification in
source country may not be
compatible with
classification where entity
derives its legal status
(residence).
2. This means: Different
residency statuses under
the treaty
3. Conflict of allocation
Issue: Income
characterisation changes.
Therefore: Risk of double
taxation and double non-
taxation (See 8.63 of Module H)

OECD Solution: OECD Partnership Report
16
OECD
Partnership
Report (Para 40)
“For the purpose of determining whether the partnership is liable to tax, the real
question is whether the amount of tax payable on the partnership income is
determined in relation to the personal characteristics of the partner (whether the
partners are taxable or not, what other income they have, what are the personal
allowances to which they are entitled and what is the tax rate applicable to them).
If the answer is yes, then the partnership should not itself be considered to be
liable to tax.”
Azadi Bachao Andolan: “For the purpose of application of Article 4 of the DTAC,
what is relevant is the legal situation, namely, liability to taxation, and not the
fiscal fact of actual payment of tax.”
Linklaters v. ITO: Treaty benefits extended if entire profits taxed, either in the
hands of the partners or partnership
Schellenburg Wittmer: partners income taxed in Switzerland, but benefit of
treaty not extended to partnership

India’s Position
Para 42 of OECD
Partnership
Report
“Where the partnership as such does not qualify as a resident, the partners should
be entitled to the benefits provided by the conventions entered into by the countries
of which they are residents to the extent that they are liable to tax on their share of
the partnership income in those countries.”
SA Diebold Courtage: partners entitled to treaty benefits of France-Netherlands
treaty, even though partnership treated as fiscally transparent in Netherlands
India’s
Position (2008
update to the
OECD Model
Convention)
If a partnership is denied the benefits of a tax convention, its members are not
entitled to the benefits of the tax conventions entered into by their State of
residence, unless there is a specific provision to the contrary.

Some Indian treaties with Specific Provisions
Partnership
India-U.S Art.
3(e)
India-Canada Art.
3(f)
Canoro
Resources
Limited
India-Germany Art.
3(d) (partnership not
expressly included in
definition)
Chiron Behring
GmbH & Co
UK?
Linklaters LLP
v ITO

India-UK Treaty (Pre 2014)
• Art. 3(f): “…but subject to paragraph (2) of
this Article, does not include a partnership”
• Para 2: A partnership which is a taxable unit
under the ITA shall be treated as a person
• P.O. Nedlloydt v. ADIT: If partnership is a
firm under sec 2(23)(i), ITA, it becomes a
person under sec 2(31)(iv), ITA, and hence
person by virtue of Art. 3(2)
India-UK Treaty (Post 2014)
• Notification 10/2014: (with effect from 27
December, 2013) - removes exclusion of U.K.
Partnerships in Art. 3(f)
• CBDT Circular 2/2016: clarified that the
DTAA applies to partnerships resident of
either U.K. or India, to the extent of the
income earned by the partnership is subject
to tax either in the hands of the partnership or
the partners
The India-UK DTAA

OECD Partnership Report: Some Questions
 If there is an INCOME characterization mismatch, source country
treatment followed
 However, for ENTITY characterization, residence country treatment
followed.
Why?

CASE STUDIES
© RAO LAW CHAMBERS
• Bilateral Cases
• Triangular Cases
See pages 8.64-8.75 of Module H for further information

P The Partnership
A and B Partners in P
State P State in which P is located
State R The state of residence of the partners
State S The state in which income is sourced, where three countries are involved
Transparent The state treats partnerships as opaque and taxes the partners
Taxable The state treats partnerships as a taxable entity
KEY

BILATERAL CASES: 1
P
B
A
Business profits
with PE
State P (Indian Partnership)
Taxable
State S
• India would tax P
• S may also want to tax the income under
domestic laws, depending on how they
interpret the DTAA
• OECD Says: Treaty benefits should be
allowed to P

BILATERAL CASES: 2
P
B
A
Business profits
State R
Taxable
State P (An Indian partnership)
• India would tax P & exempt A&B.
• However, R may tax A&B under domestic
laws, depending on how they interpret the
DTAA
• OECD Says: Since India would not tax P
based on personal characteristics of A&B,
OECD would support tax at the level of P

BILATERAL CASES: 3
P
B
A
Business profits
without PE
State P
Transparent
State S (Indian Source)
Taxable
OECD Says: Apply S-P Convention
• Income must be considered to be paid to
A and B, two residents of State P, who are
the beneficial owners of such income as
these are the persons liable to tax on
such income in State P
• State S should not tax the income
• India requires specific provision in treaty

BILATERAL CASES: 4
P
B
A
Business profits
without PE
State P
Transparent
State S
Transparent
OECD Says: Apply S-P Convention
• State S should view the income as having
"flowed through" the transparent
partnership to the partners who are liable
to tax on that income in the state of their
residence.

P
B
A
Business profits
without PE
BILATERAL CASES: 5
State R
Taxable
State P
Transparent
OECD Says: Apply P-R Convention
• State P has allocated the income to A and
B.
• State R has allocated the income to P
• Benefits not extended to P or A or B,
hence P has unrestricted right to tax

TRIANGULAR CASES: 1
Residence
State
PE State
Source
State
Income
Income
A partnership of a contracting state (Resident State)
carries on its business through a PE in another
contracting state (PE State) and earns income from a
third contracting state (Source State).
Possibilities:
• Treaties provide for credit and not exemption
• R – S treaty applies & R State should allow credit
for taxes paid in S State;
• R – PE treaty applies and tax is only to the extent
of PE  No tax in R State to grant credit against S
tax
• PE – S treaty does not apply since no residency
under Article 1 or 4 – However, non-discrimination
under Article 24(3) leads to tax credit for S state
taxes.
No satisfactory resolution under current law.

TRIANGULAR CASES: 2
P
B
A
Business Profits
without PE
State R
Transparent
State P
Taxable
State S
Taxable
OECD Says: Apply S-P convention
• State P has the right to tax the income,
and hence P should be entitled to treaty
benefit
• Also apply R-S convention- A and B are
liable to tax on that income in state R.

TRIANGULAR CASES: 3
P
B
A
Business profits
without PE
State R
Taxable
State P
Transparent
State S
Taxable
OECD Says:
• P is not liable to tax in State P, and hence
not a resident under P-S convention.
• State R allocates the income to P, but P is
not liable to tax in State R because it isn’t
a resident.
• A and B not entitled to benefit from R-S
convention.
• State S has unrestricted right to tax

TRIANGULAR CASES: 4
P
B
A
Business
profits without
PE
State R
Transparent
State P
Taxable
State S
Taxable
NO TAX CONVENTION
OECD Says: Apply S-P convention
• State P has the right to tax the income,
and hence P should be entitled to treaty
benefit
• Apply R-S convention- A and B are liable
to tax on that income

TRIANGULAR CASES: 5
P
B
A
Business
profits with
PE
State R
Taxable
State P
Transparent
State S
Taxable
OECD Says:
• P is not liable to tax in State P, and hence
not a resident under S-P convention. S-P
convention cannot be applied.
• State R allocates the income to P, but P is
not liable to tax in State R because it isn’t
a resident.
• A and B not entitled to benefit from R-S
convention as they are not subject to tax
in R.
• State S has unrestricted right to tax

BEPS & The Multilateral Instrument
© RAO LAW CHAMBERS
• BEPS AP 2
• Introduction to the Multilateral Instrument
• Hybrid Mismatches and Transparent Entities
• Dual Resident Entities and Double Taxation

BEPS AP 2
 Objective: To adjust the tax outcomes in one jurisdiction to align them with tax consequences in
another through ‘primary rule’ and ‘defensive rule’. It targets 2 types of payments:
 Payments deductible under payer jurisdiction not includible in ordinary income of the payee
 Duplicate deductions for the same payment
 To avoid risk of double taxation it calls for guidance on tie breaker rules if more than one
country seeks to apply the rules
 Changes proposed to OECD Conventions:
 Examine issues of dual resident entities
 Examine issues related to transparent entities
The Multilateral Instrument puts some of these suggestions into effect.

Introduction to Multilateral Instrument
Aim
• To modify tax treaties between
countries
• Doesn’t work as a protocol – it is
intended to be applied alongside
existing treaties
Approach
• Countries can specify the treaties to be
covered by Multilateral Instrument
• Flexibility w.r.t. minimum standard- can
adopt alternative approaches
• Option to opt out of non-min standard
provisions
• Option to opt out when covered
agreement already covers the issue

Hybrid Mismatches & Transparent Entities
Article 3-
Transparent
Entities
Income derived by or through an entity or arrangement that is treated as wholly
or partly fiscally transparent shall be the income of a resident of a Contracting
Jurisdiction only to the extent that the income is treated as the income of a
resident of that Contracting Jurisdiction
Provisions of the Covered Tax Agreement shall not apply to the extent that they
allow double taxation of the income because the entity can be considered as
resident of both jurisdictions
Party may choose to not apply this article in its entirety to a Covered Tax
Agreement

Dual Resident Entities
Article 4, Dual
Resident
Entities
If an entity can be considered as resident of both jurisdictions, competent
authorities of both to mutually decide residence having regard to its place of
effective management, the place where it is incorporated or otherwise
constituted and any other relevant factors.
Agreement
Article 5,
Elimination of
Double Taxation
Deduction of tax paid in the contracting jurisdiction to the extent of the actual tax
paid
Agreement

shreya@raolawchambers.com
4th Floor | #563 | 17th Cross | Indira Nagar 2nd Stage | Bangalore – 38
www.raolawchambers.com
A TAX & PRIVATE WEALTH BOUTIQUE
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Indian Taxation of Partnerships & Triangular Treaty Situations

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