DTAA - The Undefeated Culprit Of Indian Taxation Policy (A Critical Study)
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DTAA: THE UNDEFEATED CULPRIT OF INDIAN
TAXATION POLICY (A CRITICAL STUDY) Subham Raj Panda, BBA. LLB. (Hons.), Siksha 'O' Anusandhan University Bhubaneswar.
ABSTRACT
This research paper critically examines the Indian Income Tax Act of 1961, with a specific focus on the Double Taxation Avoidance Agreement (DTAA) and its impact on India’s tax policies. DTAA was initially intended to prevent double taxation on cross-border income and foster international trade, yet it has increasingly become a tool for tax avoidance through treaty shopping and other exploitation tactics. Multinational corporations and individuals have manipulated DTAA provisions, resulting in significant revenue losses for India. In response, the Indian government introduced the General Anti- Avoidance Rule (GAAR) to curb such misuse; however, challenges in the practical application of GAAR have limited its effectiveness.
This paper explores these challenges in depth, analysing how DTAA often undermines GAAR and proposing targeted reforms to close loopholes, enhance enforcement, and strengthen regulatory oversight. The study advocates for specific policy adjustments, such as aligning DTAA provisions with GAAR, revising treaties to include stringent anti-abuse clauses, and promoting greater transparency through corporate reporting and international cooperation. Through these reforms, India can better protect its tax base, ensuring that DTAA fulfils its original purpose of promoting legitimate economic activity without compromising national revenue. Keywords: Tax, Indian Taxation Policy, Income Tax, DTAA, Treaties, GAAR.
INTRODUCTION
‘Nothing can be certain except death and taxes’1 The word "tax" comes from the Latin "taxare" which means "to estimate" or "assess." The term “Tax” refers to a legal payment made by citizens and levied by a government. Taxes are owed by individuals to the government. Taxation, developed independently in the great ancient empires. One of the first recorded income taxes was Saladin's tithe, introduced by Henry II in
1188 to raise funds for the Third Crusade. The first known system of taxation was in Ancient
Egypt around 3000–2800 BC, in the First Dynasty of the Old Kingdom of Egypt. 2 Taxation in India is defined as the financial burden that is compulsory to be paid by individuals or institutions to the government for the purpose of revenue collection. In India tax structure is divided into two - direct taxes and indirect taxes. Direct taxes are those that include income tax and corporation tax, which are imposed on individuals and businesses respectively and fundamentally the tax bearer carries the burden of tax. Indirect taxes include Goods and Services Tax (GST) and other taxation which are levied at the point of sale for certain activities however, such burdens are usually transferred to consumers.
The government expenditure through loans raised from taxation is able to meet various state expectations such as development of capital resources like roads, education, healthcare, service sector and other government aid programs. 3 Double Taxation Avoidance Agreements (popularly referred to as DTAAs) are treaties entered into by two nations to avoid taxing the same income of a resident of one in the other country. DTAAs create a framework for the distribution of taxing right as between the two countries so that any tax need be paid only once. But there is of course the risk of tax avoidance through complicated structures that are designed to abuse the provisions of the laws and DTAAs. 4 To address this situation, the General Anti-Avoidance Rules (GAAR) were introduced in India.
GAAR enables tax administration to review such transactions which have no commercial purpose or which are entered into solely for purposes of tax advantages. It’s the hope of the
1 Jared Sparks, The Writings of Benjamin Franklin, vol 10 (Macmillan 1856) 410.
2 Taxes in the Ancient World, University of Pennsylvania Almanac, Vol. 48, No. 28, 2 April 2002.
3 Invest India, Taxation in India
Understanding the Indian Tax System.
(Invest India, 2023) accessed 6 Nov 2024.
4 Income Tax Act, 1961, s. 90.
government that such measures as GAAR will make it possible to effectively combat and avoid tax avoidance some taxpayers try to engage in as well as make sure all tax dues are remitted. 5 This paper focused its research on analysing one of the loopholes of the Indian taxation, the Double Taxation Avoidance Agreement (DTAA). At the same time, it should be mentioned that the General Anti Avoidance Rule (GAAR) which is put in place to prevent the abuse of DTAA between the countries which have signed DTAA, still GAAR has failed at many levels in curbing tax avoidance. The paper seeks to address the issues of misuse of DTAA and the ways in which DTAA overpowers GAAR. TAX IN INDIA India has had a formal tax system since the time of the Maurya dynasty. The upper classes paid one-sixth of their income as tax.
One of the oldest Indian scriptures, the Manu Smruti, is said to have mentioned taxes before the Maurya dynasty. The modern-day income tax was first enacted in India in1860 by the British. The Indian Income Tax Act was first enacted in 1886 and has been revised continuously over the years. A new Income Tax Act was passed in 1918 to stop the economic aftermath of war, which originated after World War I. This Act was in force until 1922. Forty years later, The Income Tax Act is amended again in 15 years after India became an independent nation. Nevertheless, in 1961, the government introduced what turned out to be a historic law called the Income Tax Act of 1961 (Act 43 of 1961). It was enacted on April 1, 1962 extends to the whole of India. 6 This Act is followed by The Income Tax Regulation of the year 1962. It is been 62 years and running to our tax law.
in this long period of time our tax law that is Income Tax Act 1961 has undergone numerous amendments to keep up with evolving economic environment, changing government policies and moreover to address the various loopholes in the law. For the calculation of tax, a revenue control method was introduced for the first time in India. Duties to evaluating the tax rate specifically done by the income tax officers. As the sovereign collect tax for the sake of its public, but tax is not the cost of benefits, we get from the Government. Types of tax: Tax in India is mainly of two types such as Direct tax and Indirect tax. Consumers of goods or
5 Income Tax Act, 1961, s. 96A.
6 The Income Tax Act 1961 s 1.
services will pay the indirect tax. It is an Indirect tax which is collected by someone other than the person who eventually bears it. Hence such a direct tax befalls early on income of the concerned taxpayer and not in later part. 7 Direct taxes in India: For a state like India, corporate tax and personal income tax represent the two main categories for direct tax. Tax covers and collects only 1% of the total revenue. Other direct taxes including wealth tax, BCCT, interest tax and fringe benefit tax have been repealed. Though to be informed that the direct tax growing upward steadily from the last 3 decades. 8 However direct tax is based on the principle of equity, certainty and economy. The state imposes direct tax only on the income of a pupil i. e. income tax, tax on income or capital of firms i. e. corporate tax and moreover capital gain tax i. e.
tax on profit earn by the sale of non-inventory asset and capital acquisitions tax i. e. tax on gifts and inheritances. Direct taxes have the elasticity as the government can utilize it when it faces some problem like floods or earthquake and addition to that direct taxes are certain and equal as it is fixed for individuals. Indirect taxes in India: Under the indirect tax system in vogue before GST, both the Centre and States imposed a levy on goods. Prior to the manufacture stage, Central Government levied excise duty on all goods with few exceptions like alcohol for human consumption, narcotics and narcotic drugs etc. which were not subject of both Centre as well as State Excise duties (as these are already covered by state excises). Even after the implementation of GST, states get more revenues through levies of state excise duty and sales tax/ VAT on liquor.
States are the only entities given space to impose a tax on inter and intra state transactions. Service tax was a levy and collected by Union Government only. State governments were also collecting several taxes on plethora of topics ranging from luxury tax, purchase tax to entry fee etc. Till 1987, Central Excise was imposed on the gross value that leads to a tax cascade. In order to address this, the MODVAT (Modified Value Added Tax) scheme was implemented. It was eventually superseded by the CENVAT (Central Value Added Tax) Credit scheme, which eventually included service tax. Furthermore, beginning in 2003, the federal government pushed state
7 The Income Tax Act 1961 s 2 (24).
8 Dr. R. K. Patel, Indian Journal of Accounting (Vol. XLII (2) June 2012) 19.
governments to impose local sales tax (VAT). VAT (Value Added Tax) was first introduced in only one state, Haryana, but by 2005 it had spread to most of the states, with the other states adopting it in the years that followed. The VAT later turned out to be the GST. GST per se is abasing on 5 legislations viz Central GST Act9, State GST Act10, Integrated GST act11, Union Territory GST law12 & (GST) compensation To States Law13. The ramifications of the Goods and Services Tax (GST) are most effectively assessed through empirical observation; provided that the benefits derived from engaging in the formal market surpass the detriment incurred from taxation, the taxpayer is likely to favour compliance with tax obligations, which underscores the significance of the tax's inherent simplicity.
14 Complexity & Struggle of Indians Taxation Policy & Indian: As the critics says "one nation, one market, one tax". In the ancient time India is the one who follow this principle under the rule of Chandragupta Maurya, the first king of Maury dynasty and then India contributes 38% to the global GDP. In modern times this is suggested by Ashwin Kumar when the Supreme Court sent a notice to the central government. 15 Mr. Upadhyay suggests BTT (Bank Transaction Tax) as the sole taxation policy i. e. to be applicable whole of India, which would beneficiary everyone from government to laymen, from rich to poor. Before Mr. Upadhyay, in the year 2000 the idea of “one nation, one tax” was first proposed by the Hon’ble former Prime Minister of India Sri Atal Bihari Vajpayee, to bring reform in the taxation structure of the nation then.
“India’s tax laws second most complex in Asian Pacific region, says Deloitte survey”16. As of now India has the most complex jurisdiction for taxation and most complicated requirements for tax after China. Even after the implementation of GST system Indians still pays multiple taxes through multiple purpose, as there is still complexity in the system. So, the sole solution of this is to simplify the taxation system. If people understand the policy and being aware of
9 Central Goods and Service Tax Act, 2017.
10 State Goods and Service Tax Act, 2017.
11 Integrated Goods and Service Tax Act, 2017.
12 Union Territory Goods and Service Tax Act, 2017.
13 Goods and Service Tax (Compensation to States) Act, 2017.
14 M. GOVINDA RAO “Tyranny of the Status Quo
The Challenges of Reforming the Indian Tax System” in Shekhar Shah, Subir Gokarn and Karthik Muralidharan (eds) “INDIA POLICY FORUM, 2015-16” Vol 12.
15 Union of India v Mohit Minerals Pvt Ltd [2021] 2 SCC 1 (SC).
16 HT Correspondent, “Press Trust of India” (New Delhi 28 May 2017).
how these tax moneys utilize in their own wellness, they might start paying the taxes with honesty. Till then people will struggle and as a result India will struggle. Due to the complexity there some gaps or loopholes in the taxation policy of India, In common vernacular, the designation "loophole" frequently encapsulates the prevalent perception that tax specialists possess an almost mystical ability to diminish tax liabilities, predominantly for affluent individuals, through documentation that bears no apparent repercussions. 17From the existing loopholes one of the most influenced and misused loophole on which this paper do an in depth research is DTAA (Double Tax Avoidance Agreement), it is used by businesses which have a branch both in India and any other nation or island. DTAA (Double Tax Avoidance Agreement) DTAA denotes the Double Tax Avoidance Agreement.
Fundamentally, DTAA represents a treaty or convention. A treaty or convention is defined as a formal accord pertaining to matters of peace, alliances, commerce, and international transactions among multiple nations. DTAA specifically pertains to a tax convention, which comprises a formally executed and ratified agreement between two sovereign nations (bilateral treaty) or among several sovereign nations (multilateral treaty) concerning matters related to taxation, conventionally documented in a written format. Nevertheless, the rates established under DTAA exhibit variability from one jurisdiction to another, and from one agreement to another. These treaties are formulated to guarantee that taxpayers do not incur taxation on the identical income more than once and to mitigate the risk of tax evasion.
18 Let’s take an illustration where, there exist two sovereign nations, designated as ‘A’ and ‘B’. The individual ‘C’ is employed within the jurisdiction of country ‘A’. In this context, country ‘A’ functions as the source nation for individual ‘C’, while country ‘B’ serves as his country of residence. When individual ‘C’ generates income within the borders of country ‘A’, he is obligated to remit taxes on that income to the authorities of country ‘A’; however, as a resident of country ‘B’, he is lso required by the government of state ‘B’ to pay taxes on the same income upon its transfer to country ‘B’. This situation raises a pertinent issue regarding the
17 Boris I. Bittker, Income Tax "Loopholes" and Political Rhetoric (May 1973) 1109.
18 Arnav Grover, “DTAA in Income Tax
Detailed Insights on Double Tax Avoidance Agreements” (3 Feb 2024) , accessed 15 Oct 2024. rationale behind an individual being subjected to taxation on the same income multiple times. Upon recognizing this dilemma, the government enacted measures to address the concern of citizens and introduced the instrument known as the Double Taxation Avoidance Agreement (DTAA), which serves to prevent individuals or businesses from incurring the liability of paying taxes more than once on their income across two different jurisdictions. The DTAA is primarily conceived as a fiscal mechanism designed to assist the relevant parties in mitigating the burden associated with double taxation.
History OF DTAA: The inaugural extensive international accord explicitly aimed at the mitigation of double taxation was executed between the Austro-Hungarian Empire and Prussia (currently recognized as Germany) on the 21st of June, 1899 (“Treaty”). 19 The concept of "reciprocity" serves as a cornerstone for Double Taxation Avoidance Agreements (DTAAs) and the broader framework of international taxation. 20 It encompasses the practice of one country extending commercial advantages to another, thereby ensuring equitable treatment in commerce. The roots of reciprocity can be traced back to maritime regulations, wherein nations such as the Netherlands and Great Britain granted tax exemptions to foreign vessels contingent upon the provision of equivalent privileges to their own. This practice resulted in enhanced maritime activity and stimulated demands for the alleviation of trade barriers.
21 Furthermore, reciprocity was instrumental in the establishment of the Most-Favoured-Nation (MFN) principle, which has since become a fundamental aspect of tax treaties, enabling jurisdictions to circumvent double taxation by refraining from taxing income generated in foreign territories. Essential tenets include the distribution of taxing rights predicated upon the origin of income or the residency status of the taxpayer. The manuscript examines the historical evolution of tax cooperation agreements that are designed to mitigate the issue of double taxation. The inaugural agreement of this nature was formalized between France and Belgium in 1843, which permitted the exchange of information among officials for the purposes of tax collection.
The subsequent Double Taxation Avoidance Agreement (DTAA) was established between the Austro-Hungarian Empire and Prussia on 19 Andrey Savitskiy, “Tax in History: The First Tax Treaties: In Search of Origins” (2021) pp. 569 – 585.
20 JL Laughin and HP Willis, Reciprocity (The Baker & Taylor Co 1903) 1.
June 21, 1899, as a reaction to the rise in double taxation that ensued following Austria's tax reforms of 1896, which particularly impacted individuals residing across borders. These treaties delineated taxing jurisdictions predicated on both domicile and income source, designating personal taxes to the country of residence while assigning property taxes to the jurisdiction in which the property is situated. Furthermore, these agreements introduced the concept of Permanent Establishment (PE) as a criterion for the taxation of business profits. The formulation of these treaties was significantly influenced by the geopolitical landscape of Europe following the year 1815, wherein Prussia and Austro-Hungary forged alliances to bolster their economic standing in opposition to France.
Ultimately, the primary objective of these treaties was to facilitate the mobility of individuals among allied nations without the encumbrance of double taxation, thereby privileging the principle of free movement over an overarching reduction in double taxation. 22 Formation of DTAA: In the era of advanced globalization, businesses operate beyond geographical boundaries. It spans multiple countries’ territories. This had become complex now-a-days. In the intricate realm of business, accounting and taxation hold a significant position. The sovereign state possesses the authority to impose taxation on profits generated within its territorial boundaries by any individual or entity, in addition to levying taxes on the worldwide income of its residents. This practice results in the potential for the same income to be subjected to taxation multiple times across various jurisdictions.
In order to mitigate the phenomenon of double taxation on identical income, nations are establishing Double Tax Avoidance Agreements (DTAA) with one another. Typically, these are bilateral agreements formed between two countries. Nonetheless, there also exist multilateral agreements that are negotiated among multiple countries. There exist two categories of Double Taxation Avoidance Agreements (DTAA). These comprise Comprehensive Agreements and Limited Agreements. The scope of Comprehensive Agreements is to encompass all sources of income, while the scope of Limited Agreements is restricted to (a) income derived from the operation of aircraft and ships, (b) 22 , accessed 12 Oct 2024. estates, (c) inheritance, and (d) gifts. 23DTAA was introduced to the world tax in the year 1927 by the Fiscal Committee of the League of Nations, to prevent the problem of double taxation.
24 Objective of DTAA: • To furnish alleviation to taxpayers in order to alleviate the incidence of double taxation. • To enhance the facilitation of international commerce and capital investment. • To foster the advancement of economic interrelations among nations. Models of DTAA: Various frameworks have been established throughout history to guarantee consistency and comprehensiveness in tax agreements between sovereign states. The most notable among these include the OECD Model, the UN Model, the US Model, and the ANDEAN Model. 25 OECD Model: The preliminary document was meticulously constructed by the Organisation for Economic Co-operation and Development, an entity associated with the United Nations, comprising predominantly developed nations as its constituents. This framework is predominantly embraced by nations classified as developed.
This framework significantly prioritizes the residence principle, which pertains to the authority of the nation of residence to levy taxation. UN Model: United Nations Model Double Taxation Convention between Developed and Developing Countries, 1980. The UN Model is predominantly embraced by both developed and developing nations for the establishment of bilateral treaties. This framework places greater emphasis on the “Source” principle in contrast to the “residence” principle articulated in the OECD Model. The UN Model encapsulates the concept of alleviating double taxation, either through the mechanism of foreign tax credits or exemptions, akin to the provisions found in the OECD Model. The UN Model fosters the movement of investments between nations and mandates the equitable distribution of tax revenues with the jurisdiction that supplies the 23 , accessed
12 Oct 2024.
24 Anil Kumar Dixit, “Abuse of double taxation avoidance agreement between India and Mauritius” (2022) 2783
25 , accessed 12 Oct 2024.
capital. It is noteworthy that a significant proportion of India’s tax treaties are predicated on the UN Model. US Model: United States Model Income Tax Convention of September 1996. The United States Model exhibits substantial divergence from both the OECD and UN models. ANDEAN Model: The ANDEAN Model advocates for taxation at the source of income generation. This framework is predominantly embraced by developing nations, including Bolivia and Colombia, among others. Types of DTAA: Double Taxation Avoidance Agreements (DTAAs) manifest in various configurations, each specifically designed to address the distinct requirements and interrelations among the participating nations. 26 The principal classifications of DTAAs encompass: Bilateral Treaties: These accords between two sovereign states represent the most prevalent category of DTAA.
For instance, the DTAA established between India and the United States exemplifies a bilateral treaty that exclusively engages these two countries. Such treaties are meticulously crafted to reflect the unique economic and taxation frameworks of the respective nations. Multilateral Treaties: This kind of treaties concern multiple countries, and these are much less compared to bilateral contracts. Most such multilateral treaties typically are embedded within wider regional or international frameworks say, the APAC (Asia-Pacific) and SAARC (South Asian Association for Regional Cooperation). The object of these treaties is to regulate the tax laws in more than one treaty members, or economy to make international trade and investment fair for parties (Countries) involved.
Limited Agreements: Limited DTAAs are characterized by their restricted scope, applying solely to particular categories of income. For instance, a limited DTAA may exclusively encompass income derived from the operation of ships or aircraft in international transport. Such agreements are generally established between nations that engage in substantial 26 , accessed 13 Oct 2024. commercial transactions within specific sectors, yet do not necessitate an all-encompassing DTAA that addresses all varieties of income. Each classification of DTAA fulfills a distinctive role within the realm of international tax law, assisting in the mitigation or eradication of double taxation issues and fostering transnational economic activities. Forms under DTAA: FORM NO. 10FA: This is a Certificate of Residence (CoR) for an individual or entity prescribed under the Income Tax Act, 1961 (India).
It is one of the documents required by the income tax department to confirm that the said person is a taxpayer in India. This form is generally applicable in situations where benefits under the Double Taxation Avoidance Agreement (DTAA) are claimed. 27 FORM NO. 10F: Form 10F constitutes a declaration that ascertains the eligibility of an individual or entity to pursue tax benefits in accordance with the provisions of the Double Taxation Avoidance Agreement (DTAA). The submission of this form prior to the disbursement of any payments to a non-resident is obligatory, and its applicability is restricted to the fiscal year during which it is filed. 28 FORM NO. 10FB: This document is meticulously crafted for the purpose of acquiring the Tax Resident Certificate. Complete the document with the requisite details, encompassing the rationale for the TRC.
For instance, one might specify that the certificate is necessary to reclaim the withheld tax deductions from income earned internationally. 29 FORM NO. 67: A resident taxpayer possessing a credit for the amount of any foreign tax remitted to a jurisdiction outside of India, either through deduction or alternative means, is obligated to submit the statement in Form 67 prior to the due date specified for the submission
27 Income Tax Act 1961, s 90(A), r/w Income Tax Rules 1962 (India), r 21AB.
Income Tax Act 1961 (India), r/w Income Tax Rules 1962, r 21AB: Form No. 10FA (application for Certificate of Residence for DTAA purposes). 28Income Tax Rules 1962 (India), r 21AB (1). Income Tax Act 1961 (India), r/w Income Tax Rules 1962, r 21AB(1): Form No. 10F (details required for claiming DTAA benefits).
29 Income Tax Rules 1962 (India), r 21AB (3).
Income Tax Act 1961 (India), r/w Income Tax Rules 1962, r 21AB (3): Form No. 10FB (Certificate of Residence for DTAA benefits). of the income return pursuant to sub-section (1) of Section 139 of the IT Act30 in order to assert a claim for such tax credits. Submission of Form 67 is additionally mandated in instances where the carry back of losses from the current fiscal year results in a refund of foreign taxes for which credit was previously claimed in any prior assessment years. A resident taxpayer holding a credit for the amount of any foreign tax remitted to a jurisdiction outside of India, either through deduction or alternative means, is permitted to utilize such credit.
31 DTAA IN INDIA The fundamental tenet adhered to in India entails the taxation of residents based on their worldwide income, while non-residents are subjected to taxation solely on income derived from Indian sources. 32Nonetheless, residents are permitted to claim unilateral tax credits for taxes remitted to foreign jurisdictions. 33 Double taxation arises when an individual is subjected to taxation on the same income in two distinct jurisdictions, one being the location where the income is generated (termed the source country) and the other being the jurisdiction where the individual holds tax residency (termed the resident country). India has entered into extensive Double Taxation Avoidance Agreements (DTAAs) with over 94 countries to assist Non- Resident Indians (NRIs) in circumventing the issue of double taxation.
This compilation encompasses nations such as Australia, Canada, France, Germany, Hong Kong, Portugal, Singapore, the United Arab Emirates, the United States, the United Kingdom, among numerous others. In accordance with these treaties, your income and remittances are liable to taxation and benefits in alignment with the provisions stipulated in the DTAA pertinent to your resident country. 34A non-resident individual is required to furnish a Tax Residency Certificate (TRC) issued by the tax authorities of their country of residence in order to avail themselves of tax exemptions or preferential rates on income accrued within India, in accordance with the provisions outlined in the Double Taxation Avoidance Agreement (DTAA).
Non-residents bear the obligation to remit taxes in India on income derived from Indian assets; however, they are entitled to seek a refund in their country of residence. This reimbursement serves to diminish
30 Income Tax Act 1961 (India), s 139(1).
31 Income Tax Rules 1962 (India), r 128(6).
Income Tax Act 1961 (India), r/w Income Tax Rules 1962, r 128(6): Form No. 67 (statement of foreign tax credit).
32 Rao (2008, January 7).
33 Income Tax Act 1961, s 91.
34 , accessed 14 Oct 2024. their aggregate tax obligation, taking into consideration the taxes that have already been remitted in India.
35 India’s DTAA with other states: India has formalized 94 Double Taxation Avoidance Agreements (DTAAs) with a multitude of nations, which include, but are not limited to, Albania, Armenia, Australia, Austria, Bangladesh, Belarus, Belgium, Bhutan, Botswana, Brazil, Bulgaria, Canada, China, Colombia, Croatia, Cyprus, the Czech Republic, Denmark, Egypt, Estonia, Ethiopia, Fiji, Finland, France, Georgia, Germany, Greece, Hungary, Iceland, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Kazakhstan, Kenya, Korea, Kuwait, the Kyrgyz Republic, Latvia, Libya, Lithuania, Luxembourg, Macedonia, Malaysia, Malta, Mauritius, Mexico, Mongolia, Montenegro, Morocco, Mozambique, Myanmar, Namibia, Nepal, the Netherlands, New Zealand, Norway, Oman, the Philippines, Poland, the Portuguese Republic, Qatar, Romania, Russia, Saudi Arabia, Serbia, Singapore, Slovakia, Slovenia, South Africa, Spain, Sri Lanka, Sudan, Sweden, the Swiss Confederation, Syria, Taiwan, Tajikistan, Tanzania, Thailand, Trinidad and Tobago, Turkey, Turkmenistan, the United Arab Emirates, Uganda, the United Kingdom, Ukraine, Uruguay, the United States of America, Uzbekistan, Vietnam, and Zambia.
The Double Taxation Avoidance Agreements (DTAAs) encompass stipulations that align with the frameworks established by the Organisation for Economic Co-operation and Development (OECD) and the United Nations (UN) models, along with provisions that diverge from these models, as mutually determined by the negotiating parties. India lacks a DTAA with Seychelles; nevertheless, India has executed a Tax Information Exchange Agreement with Seychelles. The government systematically evaluates and formally endorses amended Double Taxation Avoidance Agreements (DTAAs) with various nations, as necessitated.
The examination of DTAAs constitutes a continual endeavour primarily intended to modernize the agreements, thereby aligning them with the most current international standards, integrating novel provisions for collaborative engagement in taxation issues, as well as enacting modifications that may be sought by either of the treaty counterparts. In this context, the government has thus revised DTAAs with Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Hungary, Indonesia, Italy, Japan, Korea, Malaysia, Malta, Nepal, Norway, Oman, Romania, Russia, Singapore, Sri Lanka, Sweden, the 35 Arshad Ali, Abhinav Agarwal and Anil Kumar Dixit, “Abuse of double taxation avoidance agreement between India and Mauritius” International Journal of Health Sciences, 6(S5) 2785, 2022.
Swiss Confederation, Syria, Tanzania, Thailand, and the United Kingdom. The updated DTAA with Thailand was formally enacted on the 13th of October, 2015. 36 Methods of Eliminating DTAA: Full Exemption Method: Under the Exemption approach, the foreign earnings are entirely excluded from the computation of taxable income within the resident nation. This methodology indicates that the inhabitants of a nation will be subject to taxation solely on the basis of their internal income. Exemption with Progression: Under this methodology, despite the exemption of foreign income, the resident jurisdiction is mandated to incorporate the foreign income in the calculation of the tax rate that is applicable to the taxpayer. Consequently, this will lead to the imposition of a heightened tax rate when the taxpayer possesses substantial foreign-sourced income.
This approach will guarantee that a segment of the foreign income is subjected to taxation, thereby precluding the taxpayer from availing themselves of the advantages associated with a reduced tax rate. 37 Foreign Tax Credit: An individual subject to taxation may assert a claim for the credit pertaining to taxes remitted in the source jurisdiction through a deduction in the fiscal year during which such tax obligations were fulfilled, commonly referred to as the Foreign Tax Credit. 38 Conditions of Foreign Tax Credit: Ø The Foreign Tax Credit may be accessed in accordance with Sections 90 and 90A when India has established treaties with other nations.
(Double Tax Avoidance)39 Ø In scenarios wherein a Double Taxation Avoidance Agreement (DTAA) does not exist between countries, the foreign tax credit can be claimed pursuant to Section 91 (Double 36 Government of India, Ministry of Finance, Department of Revenue, Lok Sabha, Starred Question No. 92 asked by Dr. Mahendra Nath Pandey and Shri Vinod Kumar, answered by Shri Arun Jaitley (4 December 2015). 37 Namitha Kumar, ‘Double Tax Avoidance Agreement (DTAA)’ (Taxguru. in, 2024) 18 Aug 2024.
38 Income Tax Rules 1962, rule 128.
39 Income Tax Act 1961, s 90,
Income Tax Act 1961, s 90A.
Tax Relief). 40 Ø Section 91 articulates that the assessee41 is entitled to a deduction from the income tax owed on income subjected to double taxation, calculated at the lower of either the domestic income tax rate or the tax rate of the foreign jurisdiction. 42 Ø Moreover, the aforementioned tax credit can only be claimed to the extent of the tax liability fulfilled in the foreign country on foreign income in relation to the Indian tax obligation. Nevertheless, it is crucial to emphasize that in instances of any excess tax payment in the source country, the taxpayer shall not be eligible to obtain any refund benefit for such overpaid tax. Ø The tax credit shall be permitted solely for the tax, surcharge, and CESS43 that is payable, and shall not extend to any interest, penalties, or fees.
Ø In circumstances where the tax liability of the assessee is under dispute, the credit cannot be claimed in such instances. MISUSE OF DTAA IN INDIA As of now, we understand the function of DTAA and how it is useful for NRIs, MNCs and others. Moreover, DTAA is a tool that provides relief towards the double taxation i. e. impose on any individuals, groups or corporations. But this is not the limited use of this tax tool. It is often used by the MNCs to steal taxes. The misuse done through the concept of resident country and source country. Out of all the tax haven country, here we are going to discuss the misuse of DTAA between India-Mauritius, India-Bermuda. Resident Country: Resident country refers to the nation in which an individual resides and plans to remain for the foreseeable future.
In respect of India, an individual shall be classified as a resident of India if the duration of their stay in India amounts to 182 days or greater during the preceding year, or alternatively, if their stay encompasses a period of 60 days in the previous year in conjunction with an aggregate of 365 days within the four years that precede the
40 Income Tax Act 1961, s 91.
41Assessee meaning (15 Oct 2024).
42 Income Tax Act 1961, s 91.
43CESS meaning , accessed 15 Oct 2024. previous year. 44 Source country: Source country refers to the nation from where the income is generated. Now what the most of the MNCs does to excluded from tax regime is, they establish a corporate entity in a jurisdiction characterized as a tax haven, with which the country of residence has entered into a Double Taxation Avoidance Agreement (DTAA). A tax haven is defined as a sovereign state that provides foreign enterprises and individuals with minimal or nonexistent tax obligations concerning their financial deposits, all within a politically and economically stable framework. Such jurisdictions present fiscal benefits for corporations and affluent individuals alike, as well as a clear opportunity for exploitation through illicit tax evasion strategies.
45 Let’s take a situation where, 'A' represents the sovereign state wherein a multinational corporation, designated as 'XYZ', is domiciled, and in this jurisdiction, it is incumbent upon them to remit taxes on various income streams (including corporate income, long-term capital gains, and short-term capital gains, among others). At this juncture, the multinational corporation critically evaluates the substantial tax burden imposed on the revenue it generates. Concurrently, it becomes apparent that country A has entered into a Double Taxation Avoidance Agreement (DTAA) with another nation, referred to as 'B' (a jurisdiction characterized as a tax haven), wherein the applicable tax rates are markedly reduced, and certain categories of income are exempt from taxation altogether.
Consequently, the multinational corporation strategically establishes a shell company within this favorable environment, thereby attributing a significant portion of its income to this entity, which is deemed tax-free in accordance with the provisions of the DTAA. Thus, the multinational corporation 'XYZ' effectively circumvents its tax obligations and exploits the advantages of the DTAA, while the resident state 'A' finds itself powerless to intervene. Major misuse of DTAA done through treaty shopping, where a national or resident of a third country endeavors to acquire advantages from a double tax avoidance agreement (DTAA) between two or more nations by masquerading as a corporation or another entity within one of
44 Income Tax Act 1961, s 6(1).
45 Tax Foundation, "The Good and Bad about Tax Havens" ,
accessed 15 Oct 2024. the jurisdictions. Consequently, this phenomenon is referred to as treaty shopping, which represents a significant abuse of the double tax avoidance agreement (DTAA). MISUSE OF DTAA BETWEEN INDIA-MAURITIUS The India-Mauritius Tax Treaty is a 1982 bilateral agreement which was formulated with the sole purpose of preventing dual taxation and tax avoidance on income taxes across these sovereign nations. The treaty was expertly drafted to encourage trade and investment between the two countries by giving investors certainty over taxation, avoiding a situation where identical income is taxed in both India and Mauritius. Mauritius has remained one of the leading trading partners with India since 2005. In FY 2022-23, Indian exports to Mauritius stood at USD 462. 69 million and those from Mauritius into India were worth USD 91.
5 ettes, culminating in a total trade volume of USD 554. 19 million. Over the course of the past 17 years, trade relations between India and Mauritius have experienced a remarkable growth of 132%. 46 This provision in India-Mauritius Tax Treaty was one of the key features and it provided exemption from payment of capital gains tax in India for Mauritians on sale or transfer by Mauritian residents. With this provision, the attraction of Mauritius over all other destinations in routing foreign investment into India was such that it enabled the investor from say USA to invest through Mauritius & no tax will be levied on them as well under DTAA signed between US and Mauritius.
The two countries signed a revised tax pact in 2016 under which India is allowed to impose capital gains tax on shares sold by companies based there as of April 1, once again closing loopholes that have made the Mauritian route an attractive option for foreign investors. However, investments done before April 2017 has been grandfathered. On the 7th of March 2024, the nations of India and Mauritius executed a protocol that modifies the Double Taxation Avoidance Agreement (DTAA). A significant aspect of this revision was the incorporation of a new article designed to fulfill the principal purpose test. Nevertheless, it is important to emphasize that the protocol has not yet undergone the ratification process. 47 46 accessed 23 Apr 2024.
47 , accessed 15 Oct 2024.
The India-Mauritius Tax Treaty has significantly influenced the facilitation of investment flows between the two nations, especially in the context of foreign direct investment (FDI) directed towards India. This treaty has been subject to amendments aimed at addressing apprehensions associated with tax evasion and ensuring its congruence with global tax standards and norms. The India-Mauritius tax treaty has been a focal point of contention and discourse since its inception over three decades ago. Prior to 2017, Article 13(4) of the tax treaty conferred an exemption on capital gains derived from the sale of shares in an Indian corporation held by residents of Mauritius. 48 Over time, concerns were raised over the treaty being abused for tax evasion and round-tripping of funds a vehicle employed by Indian residents to invest in India via Mauritius to avoid paying taxes.
These concerns led to changes in the treaty announced in 2016 correcting these issues. Yet, the tax treaty was missing a comprehensive anti-abuse provision to curb circulation of the cash or arrangements. While India has provisions for an exchange of tax information in its double-tax agreement with Mauritius, such requests have to be “foreseeably relevant” both under the treaty as well as the Income Tax Act, 1961. 49 As there is no real global framework of information exchange, the wealth does not come back to where it belongs to India but instead flies out and moves on (multiple jurisdictions which do not at all cooperate), yet characterized with a concession for Secrecy.
In the matter of Azadi Bachao Andolan Case (2003)50, the Supreme Court of India deliberated upon the matter concerning the purported exploitation of the India-Mauritius Double Taxation Avoidance Agreement (DTAA) by foreign investors. The petitioners, an organization designated as Azadi Bachao Andolan, contended that the DTAA was being misappropriated by enterprises that lacked substantial economic presence in Mauritius. These enterprises were utilizing Mauritius as a jurisdictional conduit to evade capital gains tax obligations in India, a practice commonly referred to as treaty shopping.
48 India-Mauritius DTAA (2017), Article 13(4).
49 The Income Tax Act, 1961 (Central Act no. 43 of 1961).
50 Union of India v Azadi Bachao Andolan (2003) 263 ITR 706 (SC).
Pursuant to the provisions of the DTAA, capital gains derived from investments in India by Mauritian entities were subject to taxation solely in Mauritius. Given that Mauritius imposed no capital gains tax, these enterprises were adept at circumventing any tax liabilities on profits accrued from Indian investments. The Government of India had disseminated circulars affirming that a Certificate of Residence (COR) issued by Mauritian authorities sufficed for the purpose of claiming treaty benefits. The petitioners asserted that this pattern of conduct resulted in a considerable erosion of tax revenue for India and was inconsistent with the public interest. Furthermore, they contested the legality of the government’s circulars, positing that such documents facilitated tax evasion.
Court’s Ruling: The Supreme Court upheld the legitimacy of the India-Mauritius DTAA and the governmental circulars, determining that they were lawful and aligned with international treaty obligations. The court dismissed the assertion that treaty shopping constituted an illegal activity, observing that neither the DTAA nor Indian law contained provisions that prohibited such practices. The ruling reaffirmed that the Certificate of Residence issued by Mauritian authorities was adequate for availing the benefits conferred by the DTAA. Impact: This judicial pronouncement legitimized the utilization of the India-Mauritius investment conduit, thereby providing assurance for foreign investors. It concurrently precipitated a notable increase in foreign investments channeled through Mauritius.
Over time, apprehensions regarding treaty exploitation culminated in the 2016 amendment to the India- Mauritius DTAA, which instituted measures to curtail treaty benefits for entities engaged in treaty shopping. The Azadi Bachao Andolan case emerged as a pivotal ruling, underscoring the significance of upholding international treaties while simultaneously acknowledging the validity of tax planning strategies. Like the above another land mark case that abuse the DTAA between India & Mauritius is the case of Vodafone International Holdings BV Case (2012)51. In the year 2007, Vodafone International Holdings BV, a Dutch subsidiary of the Vodafone Group, procured a 67% equity interest in Hutchison Essar Ltd, an Indian telecommunications entity. This acquisition was
51 Vodafone International Holdings BV v Union of India (2012) 6 SCC 613 (SC).
executed through the procurement of shares from CGP Investments, a corporation domiciled in the Cayman Islands, which functioned as a subsidiary of Hutchison Telecommunications International Ltd, a firm based in Hong Kong. Although the transaction occurred outside the jurisdiction of India, it nonetheless involved assets located within the Indian territory. The Indian revenue authorities contended that despite the transaction transpiring between two foreign corporate entities, it encompassed the transfer of controlling stakes in an Indian corporation, thereby incurring Indian capital gains tax liability. They subsequently issued a notification to Vodafone, demanding approximately ₹11,000 crores in tax obligations, asserting that Vodafone bore responsibility for withholding taxes at the juncture of the remittance to Hutchison.
Key Issues: Applicability of Indian Tax Laws: The core issue pertains to whether the Indian tax authorities possessed the jurisdiction to levy taxes on a transaction occurring between two foreign corporations, which encompassed the transfer of shares in a foreign entity while implicating Indian assets. Indirect Transfer of Assets: The question arose as to whether the conveyance of shares in a foreign corporation that indirectly governed Indian assets could be subject to taxation within India. Arguments by Vodafone: Vodafone posited that the transaction occurred between two non- Indian entities and involved the divestiture of shares of a non-Indian corporation. Consequently, they maintained that Indian tax statutes were not applicable in this context. They further asserted that there existed no legal mandate obligating Vodafone to withhold taxes pertaining to this transaction.
Arguments by the Indian Tax Authorities: The tax authorities contended that the transaction effectively culminated in the transfer of Indian assets and the resultant control over an Indian corporation. Thus, they argued that the transaction warranted capital gains taxation under Indian tax regulations. They asserted that Vodafone was obligated to withhold the requisite tax prior to executing the payment to Hutchison.
Supreme Court Ruling: In the year 2012, the Supreme Court rendered a decision in favor of Vodafone, determining that: No Tax Liability: The Indian tax authorities lacked the jurisdiction to impose capital gains tax on Vodafone concerning the transaction, as it constituted the sale of shares between two foreign entities. No Withholding Obligation: Vodafone was not mandated to withhold tax on payments made to Hutchison, as the transaction did not activate any tax liability under Indian law at that moment. Moreover, the court accentuated that in the absence of a definitive legal provision imposing tax on such indirect transactions involving Indian assets, the Indian tax authorities were ineligible to levy taxes on the transaction.
Impact: The ruling elucidated the framework concerning the taxation of cross-border mergers and acquisitions, particularly those involving foreign entities with consequences for Indian assets. Subsequent to this ruling, the Indian government enacted retrospective amendments to tax legislation in 2012 to impose taxes on such indirect transfers, igniting a global discourse regarding tax certainty and the equity of retrospective taxation. This particular case emerged as a pivotal juncture in the formulation of India's tax policy, subsequently engendering substantial discourse regarding international taxation and the assurance of investor confidence within the Indian economic landscape. Besides the above discussed cases there are few more landmark cases that put the sovereign of the state to amended the DTAA between India and Mauritius in May 2016.
The landmark cases are as follow, Aditya Birla Nuvo Ltd. Case (2011)52, The Income Tax Appellate Tribunal (ITAT) rendered a decision in favor of Aditya Birla Nuvo Ltd. , affirming that the capital gains in question were not subject to taxation in India pursuant to the stipulations of the Double Taxation Avoidance Agreement (DTAA) between India and Mauritius. The Tribunal determined that the Tax Residency Certificate (TRC) conferred by the authorities of Mauritius to the Mauritius-based entity should be regarded as definitive evidence of the entity's residency status. Consequently, the entity was entitled to the advantages afforded by the India-Mauritius DTAA. The Tribunal underscored that as long as the Mauritius entity was duly constituted and possessed a TRC, the
52 Aditya Birla Nuvo Ltd, In re [2011] 196 Taxman 450 (AAR).
entitlements under the DTAA could not be invalidated. It dismissed the assertions made by the Indian Tax Authorities concerning tax avoidance, highlighting that the DTAA should be construed in accordance with its explicit provisions rather than through subjective interpretations of the underlying intent of the investment. E*Trade Mauritius Ltd. Case (2010)53, The Authority for Advance Rulings (AAR) rendered a decision favoring E*Trade Mauritius Ltd. , determining that the capital gains derived from the divestiture of shares were not subject to taxation in India in accordance with the provisions of the India-Mauritius Double Taxation Avoidance Agreement (DTAA). The AAR underscored that the Tax Residency Certificate (TRC) issued by the Mauritian authorities to E*Trade Mauritius Ltd. constituted adequate evidence of its residency status.
Consequently, E*Trade Mauritius was permitted to avail itself of the benefits conferred under the DTAA. The AAR asserted that in alignment with Article 13(4) of the India-Mauritius DTAA, capital gains arising from the transfer of shares of an Indian enterprise by a resident of Mauritius are liable to taxation solely in Mauritius. Hence, the Indian Tax Authorities lacked justification in imposing capital gains tax within the jurisdiction of India. The AAR dismissed the argument presented by the Tax Authorities suggesting that the investment was orchestrated with the intent to evade tax obligations in India. The AAR elucidated that provided the formal criteria of the DTAA were satisfied, tax benefits could not be rescinded on the basis of an alleged intention to avoid taxation.
Changes to the India-Mauritius DTAA (2016)54, in May 2016, India and Mauritius entered into a protocol to modify the Double Taxation Avoidance Agreement (DTAA), primarily aimed at mitigating concerns related to treaty abuse. The principal modifications encompassed: Capital Gains Taxation: The amendment delineated provisions for the taxation of capital gains resulting from the disposition of shares acquired on or subsequent to April 1, 2017. Nonetheless, a grandfathering clause was instituted for shares procured prior to that specified date. Limitation of Benefits (LOB): The protocol established LOB provisions to inhibit shell companies from exploiting the treaty. Entities seeking to avail themselves of the treaty benefits
53 E*Trade Mauritius Ltd. v. DDIT (International Taxation) [2010] 322 ITR 1 (AAR).
54 Changes to the India-Mauritius DTAA (2016).
would be required to substantiate a requisite level of substantive business operations within Mauritius. DTAA BETWEEN INDIA-LUXEMBOURG The Double Taxation Avoidance Agreement (DTAA) signed between India and Luxembourg is a treaty to prevent dual taxation of the same income generated by individuals or enterprises from both countries. This section specifies the tax rights of each country with respect to various items of income, such as dividends, interest and royalties besides capital gains to ensure that double taxation does not apply. This accord fosters enhanced economic collaboration, trade, and investment opportunities between the two nations. Furthermore, it encompasses provisions aimed at the prevention of tax evasion and delineates procedures for the resolution of taxrelated disputes.
The Double Taxation Avoidance Agreement (DTAA) established between India and Luxembourg serves the purpose of mitigating the incidence of double taxation, a phenomenon that arises when identical income is subjected to taxation by both the jurisdiction in which it is generated (source jurisdiction) and the domicile of the taxpayer (residence jurisdiction). Finalized in the year 2008, this agreement is congruent with India's overarching international taxation strategy aimed at constructing a comprehensive framework of DTAAs, thereby facilitating seamless cross-border financial transactions and investments. The principal objective of this agreement encompasses not only the prevention of double taxation but also the enhancement of transparency and collaborative efforts concerning fiscal issues between the two nations.
55 The Double Taxation Avoidance Agreement (DTAA) is applicable to individuals who qualify as residents of either or both of the contracting jurisdictions, specifically India and Luxembourg. The agreement encompasses taxation on income generated within both nations. In the Indian context, this encompasses income tax along with any applicable surcharges, whereas, in Luxembourg, it pertains to individual income tax, corporate tax, and municipal business tax. This extensive coverage guarantees that the majority of taxes that could
55 OECD, ‘Model Tax Convention on Income and on Capital
Condensed Version’ (OECD Publishing 2017) 45-50. potentially result in double taxation are addressed within the parameters of the accord. 56 Taxation of Specific Types of Income: Business Profits: According to the stipulations of the agreement, the taxation of business profits is confined to the jurisdiction in which the enterprise is established, except in instances where the enterprise maintains a permanent establishment within the other jurisdiction. In cases where an Indian corporation possesses a permanent establishment in Luxembourg, the profits that are directly attributable to that establishment may be subject to taxation in Luxembourg.
This particular provision is articulated in Article 7 of the Double Taxation Avoidance Agreement (DTAA), which is designed to ensure that only those incomes that are pertinent to the activities conducted within the other jurisdiction are subject to taxation therein. 57 Dividends: Article 10 of the Double Taxation Avoidance Agreement (DTAA) delineates the framework for the taxation of dividends. In accordance with this stipulation, dividends disbursed by a corporation in one jurisdiction to a resident of another jurisdiction may be subject to taxation in both locales; however, the jurisdiction of origin (where the distributing corporation is established) is permitted to impose a constrained withholding tax. For instance, the Grand Duchy of Luxembourg may impose a diminished withholding tax on dividends remitted to a resident of India.
The treaty establishes limitations on the applicable tax rates, thereby safeguarding taxpayers from the imposition of unduly elevated tax burdens on their dividend income. 58 Interest: Article 11 delineates the framework for the taxation of interest income. Interest accrued within one jurisdiction by an individual domiciled in another jurisdiction may be subject to taxation in both territories. Nevertheless, the treaty establishes constraints on the withholding tax rates that may be levied by the source country. This provision alleviates the fiscal burden associated with transnational interest disbursements, thereby fostering the facilitation of loans and financial investments between the two jurisdictions.
59 Royalties and Fees for Technical Services: The taxation framework governing royalties and fees associated with technical services is delineated within Article 12 of the Double Taxation
56 India-Luxembourg DTAA (2008), Article 1.
57 India-Luxembourg DTAA (2008), Article 7.
58 India-Luxembourg DTAA (2008), Article 10.
59 India-Luxembourg DTAA (2008), Article 11.
Avoidance Agreement (DTAA). Royalties disbursed from one nation to a resident of another nation are liable to taxation in both respective jurisdictions, albeit the rates of withholding tax are curtailed by the stipulations of the treaty. Such provisions are instrumental in facilitating the transfer of technology and intellectual property between India and Luxembourg, as they guarantee two primary methodologies aimed at alleviating the incidence of double taxation: Exemption Method: Under certain conditions, income accrued in one jurisdiction may be rendered exempt from taxation in the corresponding jurisdiction. Tax Credit that royalties and technical fees are not subjected to excessive taxation.60 Capital Gains: The provision relevant to the taxation of capital gains are covered under article
13 of DTAA. Profits arising from the sale of land are taxable in the country where such real
property is located. On the other hand, in gains on sale of shares and security ownership as well as any movable capital asset, tax is determinate by nature whether it believes assets have been held longer or shorter periods over one year also flat resident for your country. These provisions ensure that the tax treatment pertaining to capital gains is unequivocal and coherent, thereby mitigating the potential for double taxation. 61 Methods to Avoid Double Taxation in the DTAA India-Luxembourg: The Double Taxation Avoidance Agreement (DTAA) established between India and Luxembourg encompasses Method: The jurisdiction of residence allows the taxpayer to claim a credit for taxes paid in the source jurisdiction.
For instance, should an Indian resident generate income in Luxembourg and satisfy tax obligations therein, they possess the entitlement to claim a credit for those tax payments when filing their tax return in India. 62These methodologies ensure that taxpayers are not subjected to the unjust imposition of remitting taxes on the same income on multiple occasions. Exchange of Information: The provision pertaining to the Exchange of Information constitutes a fundamental aspect of the Double Taxation Avoidance Agreement (DTAA) between India and Luxembourg, designed to mitigate the incidence of tax evasion. In accordance with Article 26, the respective tax authorities of India and Luxembourg are
60 India-Luxembourg DTAA (2008), Article 12.
61 India-Luxembourg DTAA (2008), Article 13.
62 India-Luxembourg DTAA (2008), Articles 23-24.
authorized to exchange pertinent information in order to implement the treaty's stipulations and guarantee taxpayer adherence to fiscal regulations. This exchange of information assumes critical importance in the contemporary global tax landscape, wherein transparency is imperative to deter tax avoidance and evasion. The provision is in accordance with the international standards established by the Organization for Economic Co-operation and Development (OECD) and serves to prevent the potential misuse of the treaty for nefarious financial activities. 63 Mutual Agreement Procedure (MAP): The Double Taxation Avoidance Agreement (DTAA) delineates a Mutual Agreement Procedure (MAP) in Article 25 to adjudicate disputes that may emerge from the interpretation or application of the treaty.
The MAP facilitates consultations between the tax authorities of India and Luxembourg to address issues such as double taxation or differences concerning the classification of income. Taxpayers are afforded the opportunity to engage with the tax authorities to seek resolution through this procedural framework, thereby ensuring equitable treatment in instances of disputes. 64 Prevention of Fiscal Evasion and Treaty Abuse: The DTAA incorporates provisions aimed at the prevention of fiscal evasion and the abuse of the treaty. The anti-avoidance measures embedded within the agreement are designed to preclude exploitation by individuals or entities attempting to evade tax liabilities through practices such as treaty shopping, where corporations establish operations in low-tax jurisdictions solely to capitalize on favorable tax treaties.
These provisions serve to uphold the integrity of the treaty and guarantee that it fulfills its intended role of facilitating legitimate cross-border trade and investment. 65 The India-Luxembourg Double Taxation Avoidance Agreement (DTAA) serves a pivotal function in facilitating trade, investment, and economic cooperation between the two nations. Luxembourg, recognized as a prominent global financial center, provides Indian enterprises with access to both European and international marketplaces. The DTAA establishes explicit tax regulations, thereby enhancing the predictability of cross-border financial transactions. It offers advantages to corporations based in Luxembourg that are investing in India's burgeoning economy by instituting a stable tax framework.
Through the mitigation of double taxation, the reduction of tax rates on cross-border income, and the provision of mechanisms for dispute
63 India-Luxembourg DTAA (2008), Article 26.
64 India-Luxembourg DTAA (2008), Article 25.
65 Klaus Vogel, ‘Double Taxation Conventions’ (4th edn, Kluwer Law International 2008) 589-595.
resolution and information exchange, the treaty cultivates a conducive environment for economic interactions. Furthermore, the agreement promotes transparency and mitigates tax evasion, thereby reinforcing the economic relations between India and Luxembourg. This treaty is abused in the matter of, Fiat Group v Indian Tax Authorities (2015)66, Fact of the Case: Fiat India Pvt. Ltd. (Fiat India) constituted a wholly-owned subsidiary of the Fiat Group, involved in the production and distribution of automobiles within the Indian context. Throughout the pertinent assessment years, Fiat India marketed its vehicles at a price significantly lower than the associated production costs.
The Indian Tax Authorities conducted a thorough examination of Fiat India's pricing methodology and implemented adjustments on the premise that the company was offering its vehicles to dealers at a price that deviated from the "arm's length price" (ALP). According to the authorities' findings, this practice engendered an artificial reduction of revenue, consequently resulting in a diminished taxable income within India. Argument put forth by Fiat India Fiat India maintained that its decision to offer vehicles at a price below production costs was predicated on commercial rationales, with the objective of penetrating the fiercely competitive Indian automotive market.
They argued that the losses sustained were attributable to their strategic efforts to cultivate market share and establish brand presence in India, and therefore should not be subject to scrutiny under transfer pricing regulations. Legal Issue: The principal legal inquiry pertained to the justification of the Indian Tax Authorities in implementing transfer pricing modifications, predicated on the assertion that Fiat India's sales transactions did not adhere to arm's length principles owing to pricing set below the cost of production. Judgement: The ITAT adjudicated in favour of the Indian Tax Authorities, determining that Fiat India had failed to comply with the arm's length principle in its transactional activities.
The Tribunal underscored that transfer pricing regulations necessitate that transactions between affiliated entities must reflect the pricing that would occur in transactions between independent parties under analogous circumstances. The Tribunal concluded that the selling price at which Fiat India offered its vehicles to dealers was markedly lower than the prevailing market price, which was inconsistent with established transfer pricing principles. Consequently, the Tax
66 Fiat India Pvt Ltd v. Commissioner of Income Tax (CIT) [2015] ITAT Mumbai ITA No. 1848/Mum/2009.
Authorities were justified in implementing the adjustment to align with the appropriate arm's length price (ALP). Although Fiat India's assertion regarding the commercial justification for its pricing strategy was recognized, the ITAT maintained that such considerations cannot supersede the obligatory stipulation of ensuring that transactions conform to the arm's length standard as mandated by Indian transfer pricing legislation. Significance of the Case: This case is significant for its clarification on the application of transfer pricing norms in India, particularly in cases where goods are sold below cost for strategic market penetration purposes. The decision reinforced that companies must ensure their pricing strategies with related parties align with the arm's length principle, even when commercial considerations might suggest otherwise.
It also highlighted the scrutiny that multinational corporations might face when engaging in transactions that could be seen as aiming to minimize taxable income in India. Cases like Vodafone, Azadi Bachao Andolan and Fiat Group v Indian Tax Authorities and to address concerns over treaty shopping and misuse of tax treaties, India introduced the General Anti-Avoidance Rule (GAAR) in 2017. GAAR (GENERAL ANTI-AVOIDANCE RULE) The General Anti-Avoidance Rule (GAAR) constitutes a legal construct formulated to preclude tax avoidance schemes that, despite their legal standing, yield tax advantages that are discordant with the underlying purpose of tax legislation. GAAR empowers tax authorities to nullify or reclassify arrangements that exhibit a lack of authentic commercial substance and are predominantly orchestrated to secure tax benefits.
67The Indian GAAR framework is designed to inhibit tax avoidance behaviours and is applicable to both domestic and international transactions. 68 GAAR Prohibits The Abuse of DTAA Between Countries In Respect To India: The General Anti-Avoidance Rule (GAAR) constitutes a significant element within the framework of Indian tax legislation, designed to mitigate tax avoidance tactics that capitalize 67 Shome Committee Report, 2012, Report of the Expert Committee on General Anti-Avoidance Rules (GAAR), Government of India, 1 October 2012. 68 Income Tax Act 1961 (India), Chapter X-A, General Anti-Avoidance Rule (GAAR), effective from 1 April 2017. on the advantages conferred by Double Taxation Avoidance Agreements (DTAAs). The implementation of GAAR signifies India's dedication to ensuring that tax treaties are employed in accordance with their intended objectives.
In the ensuing discussion, we will examine the methodologies through which GAAR addresses the misuse of DTAAs, Disregarding Tax Benefits of Impermissible Arrangements: The General Anti-Avoidance Rule (GAAR) empowers tax authorities to disregard or reclassify transactions that fail to exhibit authentic commercial substance. This holds considerable relevance in the realm of Double Taxation Avoidance Agreements (DTAAs), as tax authorities are permitted to transcend the legal framework of a transaction to evaluate its true intent. For instance, in situations where a multinational enterprise channels profits through a jurisdiction with minimal tax obligations, such as Mauritius, primarily for the purpose of evading tax liabilities in India, GAAR authorizes tax authorities to categorize these arrangements as impermissible avoidance transactions.
69 Preventing Treaty Shopping: Treaty shopping transpires when entities situate themselves within jurisdictions that offer advantageous tax treaties to capitalize on diminished tax liabilities, frequently without a meaningful business presence, the General Anti-Avoidance Rule (GAAR) necessitates a comprehensive evaluation of the economic activities engaged in by entities seeking advantages under Double Taxation Avoidance Agreements (DTAAs). Should an entity merely function as a shell corporation established for the purpose of obtaining tax benefits, GAAR possesses the authority to revoke the associated treaty advantages. For example, a corporation based in Mauritius that seeks tax exemptions under the India-Mauritius DTAA, devoid of any significant operational activities in Mauritius, would be subjected to scrutiny under GAAR.
70 Application of the Principal Purpose Test (PPT): GAAR embodies principles akin to the Principal Purpose Test delineated within the OECD's BEPS framework, according to the PPT, tax advantages may be forfeited if their acquisition 69Shome Committee Report, 'Report of the Expert Committee on General Anti-Avoidance Rules (GAAR)', Government of India, 1 October 2012.
70 OECD, 'Addressing Base Erosion and Profit Shifting' (2013).
constitutes one of the principal objectives of an arrangement. GAAR replicates this methodology, permitting Indian tax authorities to dismiss assertions for treaty benefits when tax avoidance serves as a predominant incentive. This framework ensures that tax treaties promote authentic economic activities as opposed to merely facilitating tax advantages.
71 Interaction with Limitation of Benefits (LOB) Clauses: LOB provisions within Double Taxation Avoidance Agreements (DTAAs) delineate explicit criteria to ascertain that only genuine residents of the respective contracting jurisdictions may avail themselves of the advantages conferred by these tax treaties; the General Anti-Avoidance Rule (GAAR) serves as an additional safeguard to confirm that entities deriving benefits from DTAAs satisfy not only the stipulations of the LOB clauses but also partake in transactions that authentically embody economic substance. For example, notwithstanding the fact that a taxpayer fulfils the technical stipulations of an LOB provision, the GAAR can impinge upon the entitlement to benefits if the foundational transaction merely constitutes a strategy for tax avoidance. 72 Case Studies: E*Trade Mauritius Ltd. v.
DDIT (2010)73 elucidated the application of General Anti-Avoidance Rules (GAAR) principles aimed at mitigating the potential misuse of the India-Mauritius Double Taxation Avoidance Agreement (DTAA). In a similar vein, Aditya Birla Nuvo Ltd, In re (2011)74 provided a demonstration of GAAR's application to assess the commercial substance of financial transactions, resulting in the denial of treaty benefits predicated on the underlying economic realities. Judicial Interpretations of GAAR: Indian judicial bodies have further elucidated the implementation of the General Anti-Avoidance Rule (GAAR), accentuating its function in mitigating tax evasion, particularly in the landmark case of Vodafone International Holdings BV v.
Union of India (2012)75, wherein the Supreme Court of India underscored the significance of scrutinizing the essence of transactions rather than their superficial characteristics. While the primary focus of the case revolved around tax obligations, it 71 OECD, 'Multilateral Instrument to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting' (2016).
72 India-Mauritius DTAA, Article 13(4).
India-Singapore DTAA, Article 13.
73 E*Trade Mauritius Ltd. v. DDIT (International Taxation) [2010] 322 ITR 1 (AAR).
74 Aditya Birla Nuvo Ltd, In re [2011] 196 Taxman 450 (AAR).
75 Vodafone International Holdings BV v. Union of India (2012) 341 ITR 1 (SC).
established a foundational precedent for assessing the underlying intentions associated with intricate cross-border transactions. GAAR Prevents the Misuse of DTAA: After the arrival of GAAR in 2017, it helps the tax authority of the state. There are certain judiciary examples, where DTAA denied and GAAR helps the authority in preventing the stealing of taxes. Few of the cases are discussed as under, AB Holdings v. Deputy Commissioner of Income Tax (2019)76, the Income Tax Appellate Tribunal (ITAT) rendered a decision that favoured the Indian tax authorities. It determined that the transaction constituted an instance of treaty shopping and was devoid of commercial substance.
Given that the principal objective of the arrangement was to evade taxation in India, the General Anti-Avoidance Rule (GAAR) was deemed applicable, resulting in the denial of benefits under the Double Taxation Avoidance Agreement (DTAA). The tribunal emphasized that the provisions of GAAR could supersede the benefits afforded by the DTAA in instances of treaty abuse. Tiger Global International II Holdings v. Commissioner of Income Tax (2020)77, the ITAT Bangalore rendered a decision that was aligned with the position of the Indian tax authorities. It invoked GAAR to reject the benefits associated with the DTAA, asserting that the entity incorporated in Mauritius was established primarily for the purpose of circumventing Indian tax obligations.
The tribunal ascertained that the transaction was lacking in commercial substance and was exclusively structured to secure an exemption from capital gains tax. Consequently, the provisions of GAAR took precedence over the DTAA established between India and Mauritius. M/s Castleton Investment Ltd v. Commissioner of Income Tax (2020)78, the Supreme Court of India affirmed the application of GAAR by the tax authorities and consequently denied the benefits under the DTAA. The Court adjudicated that the transaction was predominantly structured to facilitate tax avoidance, and due to its lack of commercial substance, the tax exemption prescribed by the DTAA could not be accorded. The ruling substantiated the
76 AB Holdings v. Deputy Commissioner of Income Tax (ITAT Delhi, 2019).
77 Tiger Global International II Holdings v. Commissioner of Income Tax (ITAT Bangalore, 2020).
78 M/s Castleton Investment Ltd v. Commissioner of Income Tax (Supreme Court, 2020).
applicability of GAAR even in the presence of a valid DTAA, should the arrangement be characterized as a tax avoidance scheme. DTAA Override GAAR: Double Taxation Avoidance Agreements (DTAAs) are intended to prevent income from being taxed twice—once in the country where it is earned and again in the taxpayer's home country. However, despite the introduction of the General Anti-Avoidance Rule (GAAR), which is designed to prevent tax avoidance, DTAAs are still exploited in various ways. GAAR aims to stop tax arrangements created solely to secure tax benefits, but practical challenges have limited its effectiveness. 79 Treaty Shopping: This involves routing investments through countries with favorable DTAAs, even when businesses have no real economic presence there. This enables individuals or companies to benefit from lower tax rates or exemptions they wouldn’t normally qualify for.
India’s treaties with Mauritius and Cyprus are frequently used for such purposes, with investors setting up shell companies to avoid capital gains tax in India. Though GAAR allows authorities to challenge these arrangements, its enforcement has been cautious to avoid deterring genuine investments. Round-Tripping: This is when domestic funds are sent abroad and then reinvested in the home country as foreign investment to take advantage of tax benefits under a DTAA. Round-tripping remains common in India, especially through Mauritius, as it is difficult to prove that the main purpose of these transactions is tax avoidance. GAAR can be applied, but proving that these transactions lack commercial substance is complex and slow. Challenges in Enforcing GAAR: The complexity of enforcing GAAR is a major reason why DTAAs continue to be misused.
Tax authorities face difficulties in determining the intent behind transactions, especially when they have legitimate business purposes alongside tax benefits. There are also concerns that aggressive enforcement of GAAR could deter legitimate investments, leading authorities to adopt a cautious approach. This has allowed loopholes in DTAAs to persist, limiting GAAR’s full effectiveness in curbing tax avoidance.
79 Indian Government, ‘General Anti-Avoidance Rule (GAAR)’ (Government of India
2017) accessed 15 October 2023.
A SUGGESTION FOR THE BETTERMENT OF GAAR AND TO OVERCOME FROM THE EXISTING LOOPHOLES OF DTAA GAAR has a significant affected in the initial time of its introduction. But soon the parties find a way to except from the radius of GAAR and excluded themselves from paying the taxes. This happens because there is a lot of gaps in the GAAR that ignores the DTTA’s function. Treaty shopping and round tripping are on the prior list that helps in embezzlement tax from India to a tax haven country. Now to prevent this the sovereign of the state shall make amendment to both GAAR and DTAA. The steps that the Government of India can take is described as under,
1 Fortification of Enforcement Mechanisms
Tax authorities ought to be endowed with enhanced resources and adequately trained personnel to proficiently identify and contest tax avoidance strategies. The implementation of more sophisticated auditing instruments, data analytics, and transnational collaboration among tax authorities can significantly augment the detection of treaty shopping and round-tripping practices.
2 Elaboration on Substance Over Form Guidelines
The principle enshrined in GAAR, which emphasizes the substance over the form of transactions, necessitates elucidation through comprehensive guidelines. Taxpayers must be cognizant of the criteria employed by authorities to ascertain whether an arrangement is predominantly designed for tax avoidance purposes. Such clarity will mitigate ambiguity and deter the exploitative use of treaties.
3 Synchronization of GAAR and DTAAs
It is imperative to ensure that Double Taxation Avoidance Agreements (DTAAs) are congruent with GAAR provisions. Newly established DTAAs, as well as amendments to existing agreements, should incorporate clauses that explicitly endorse the enforcement of GAAR. This approach could avert potential legal discrepancies between treaty provisions and GAAR, thereby ensuring that treaty benefits are conferred exclusively for bona fide business endeavours.
4 Implementation of Minimum Standards within DTAAs
India possesses the potential to renegotiate its DTAAs to encompass minimum standards concerning anti-abuse provisions, in alignment with the OECD's Base Erosion and Profit Shifting (BEPS) framework. This would effectively close existing treaty loopholes and curtail opportunities for exploitation, mandating authentic economic activity within treaty-partner jurisdictions.
5 Engagement in Multilateral Agreements
India could enhance its involvement in multilateral accords, such as the OECD’s Multilateral Instrument (MLI), aimed at combating BEPS. These agreements seek to amend and refine existing DTAAs to incorporate anti-abuse provisions, thereby complicating the ability of taxpayers to exploit DTAAs for tax avoidance objectives.
6 Systematic Review and Revisions
It is essential to conduct systematic evaluations of DTAAs and GAAR provisions to remain responsive to the dynamic nature of tax avoidance tactics. Amendments should be instituted based on empirical evidence, judicial interpretations, and emerging global tax phenomena.
7 Augmented International Collaboration
Tax authorities should pursue intensified information exchange and collaborative efforts with other jurisdictions. Such actions would facilitate the identification of artificial structures or conduit entities established solely to exploit favourable DTAAs.
8 Enforcement of Non-Compliance Penalties
The introduction of more stringent penalties for taxpayers and corporations discovered to be misusing DTAAs is warr