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International Tax Aspects - ASSOCHAM by yaofenjin


									Anish Mehta,
August, 2010
           Contents                        Background

                                           Residency test

                                           CFC Provision

                                           Branch Profit Tax

                                           Transfer Pricing – Definition of Associated Enterprise

                                           Safe Harbour

                                           Advanced Pricing Agreement


                                           Definition of Income deemed to accrue or arise in India

                                           Treaty Override

                                           Income of FII

                                           Taxation of Royalty/FTS
                                           Capital Gains

Direct Tax Code - International Taxation
Page 2

                                                                                        -   Asset based MAT
                                                                                        -   Residency test for companies
                                                                                        -   Treaty override
    FIRST DRAFT OF DTC                                                                  -   GAAR
   INTRODUCED IN AUGUST                                                                 -   Capital gains
      2009 FOR PUBLIC                                                                   -   SEZs
                             PROVISIONS OF THE CODE       ADDRESSING 11 KEY PROPOSALS
                                                                                        -   Income from House Property
                                                                                        -   EET v EEE
                                                                                        -   Individual taxation
                                                                                        -   Wealth-tax
                                                                                        -   Non Profit organization

  Page 3
Residency test

                                    • Resident only if controlled and managed ‘ WHOLLY’ in India

                                                            DTC (1st Draft)
                        • Resident only if controlled and managed ‘WHOLLY’ or ‘PARTLY’ in India

   Objective not defined                                                  World wide income taxable
   Sought to tax shell and conduit company                                Dividend subject to DDT
                   Offshore operating companies having substantial activities/ operations overseas get adversely affected

                                           Issues raised
         The word “partly” sets a very wide threshold for regarding a foreign company as a
                                         resident in India

 Direct Tax Code - International Taxation
 Page 4
Residency Test – Revised Discussion Paper

      Residency definition to be brought in line with international practice

      Concept of Place of Effective Management (POEM) introduced:

            The place where Board of Directors (BOD)/Executive Director (ED) of the company make decisions;
            In a case where the board of directors routinely approve the commercial and strategic decisions
             made by the executive directors or officers of the company, the place where such executive
             directors or officers of the company perform their functions.

      Most of the tax treaties recognize the concept of POEM for determination of
       tie breaker rule for avoidance of the double taxation

  Direct Tax Code - International Taxation
  Page 5
Residency Test - Indian Judicial Decision

•   :

 Ship Management activities
                             Universal Cargo Carriers - (205 ITR 215-Cal)

 Meeting of board of directors
                                 Radha Rani Holding Pvt. Ltd. 16 SOT 495 (Del)

        Direct Tax Code - International Taxation
        Page 6
Residency test – Best Practices

    OECD Commentary – Key Management and Decision

    Klaus Vogel –Management directives are given

    General criteria for POEM under treaties:

            Head and Brain
            De facto control
            Director resides
            Key Management & Commercial decisions

 Direct Tax Code - International Taxation
 Page 5
 Residency test – Impact/Issues

 Can a company have more than one POEM?

 Impact of following on POEM:

      Single board meeting in India
      Few directors based out of India
      Group CEO based out of India
      Situation where the facts reflect decision
          making at multiple places

   Direct Tax Code - International Taxation
   Page 5
Factors to support tax residency

 Chairman of the board is foreign resident and is given a casting vote

 Regular board meetings in foreign country

 All decisions carefully recorded to make it clear that decisions were effected at these

 Day to Day aspect should be undertaken in Foreign country

 Company should have a foreign bank account

 Company should keep key legal records in foreign country
                            However, the implications of the aforesaid will differ from country to country.
   Direct Tax Code - International Taxation
   Page 9
Residency test – Way Forward

 Existing Structure and composition of BOD/ED to be reviewd

 Documentation requirements for demonstrating POEM

 Robust TP

 Direct Tax Code - International Taxation
 Page 5
CFC Provisions
    Revised Discussion Paper

     Proposal to introduce CFC provisions as an anti-avoidance measure

     CFC provisions to apply to ‘passive income’ earned but not distributed by a
       foreign company which is ‘controlled directly or indirectly’ by a resident
       in India

     Such income to be considered as deemed distribution and shall be taxable
       in the hands of resident shareholders as dividends

    Objective /Features : limit artificial deferral of tax
 Direct Tax Code - International Taxation
 Page 11
Why CFC rules are needed ?
 Shift "portable" income to tax heaven subsidiary companies.                                US

 Income shifted included investment income (interest and dividends)          Dividend
                                                                              Distributed           100 %
    and passive income (rents and royalties), as well as sales and services   to

    income involving related parties.                                                   Mauritius

 Deferment of tax                                                            Dividend
                                                                              Parked in
                                                                              Mauritius &           100 %
 Avoiding of tax indefinitely                                                not brought

 The CFC are intended to cause current taxation to the shareholder                         India

    where income is of a sort that could be artificially shifted or was
    made available to the shareholder.

 Direct Tax Code - International Taxation
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Concept of CFC

    CFC rules prevalent in over 25 countries

    In general, CFC is a foreign company that:
          is directly or indirectly controlled by resident taxpayer; and
          earns substantially passive income; and
          is subject to substantially lower taxation than in resident state

 Passive income arising in overseas jurisdiction is attributed to resident

                  Passive income – interest, rent, dividends, royalties and capital gains

  Direct Tax Code - International Taxation
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Concept of CFC (cont..)

   Nature of control
          Generally > 50% ownership (e.g. US, UK);
          Voting power (USA)

Generally only shareholders with a minimum holding are taxed (e.g. 10% in

   Relief from double taxation
          Foreign underlying tax generally creditable
          Shareholder not to be taxed again upon actual distribution of dividend

     Direct Tax Code - International Taxation
     Page 14
CFC Regulations – US & UK
    Particulars                                         US                                                           UK
Background                 •     First country to adopt CFC Rules in 1962                •   Introduced in 1984 to prevent UK residents reducing
                                                                                             their UK tax liability by diverting profits to foreign
                                                                                             company in low tax jurisdiction
Definition                 •     CFC is one which US shareholders own more than 50%,     •   CFC is a non-UK company controlled by UK residents
                                 by vote or value                                            & which operates in a „low tax‟ jurisdiction
                                                                                         •   A non-resident company is regarded as to be
                                                                                             controlled by UK residents if
                                                                                             - UK residents hold more than 50% interest in the
                                                                                             company or
                                                                                             - UK residents holds more than 40% interest and other
                                                                                             non-resident holds atleast 40% but not greater than
Key Elements               •     Only those shareholders that own (directly or           •   Subject to lower level of taxation, if tax paid in its
                                 indirectly) 10% or more of foreign corporation stock        Resident country is < 75% of the UK tax
                                 are included in more than 50% ownership test
Income subject to          •     Passive undistributed income of CFC taxable in the      •   Share of Profits (excluding capital gains) of CFC
CFC Rules                        hands of resident shareholders                              taxable in UK
                           •     Amount included in income of a US Shareholder from
                                 a CFC is pro-rata share of CFC‟s income for the year.
    Direct Tax Code - International Taxation
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CFC Regulations – US & UK …
    Particulars                                         US                                                          UK
Exemptions from            CFC Regulations do not apply if :                            CFC Regulations do not apply if
CFC Rules
                           •     CFC is not established for avoidance of domestic tax   •   The dividend distributed to UK resident at least equal
                                                                                            to 90% of its chargeable profits within 18 mths from
                           •     De - minimis test where total income of CFC does not
                                                                                            the end of the accounting period
                                 exceed a certain amount
                                                                                        •   The chargeable profit is less than 50000 Pounds
                                                                                        •   CFC does have a business establishment in the
                                                                                            territory where it is resident
                                                                                        •   It is proved that reduction in UK tax by diversion of
                                                                                            profits from UK is not the main reason behind its
                                                                                        •   Public quotation: The public must hold shares
                                                                                            carrying 35% of voting rights of CFC
                                                                                        •   CFC is resident in a territory listed in „Excluded
                                                                                            country Regulation‟
Tax Credit                 •     Foreign taxes are „deemed paid‟ on taxable             •   N/A
                                 distributions from foreign corporations

    Direct Tax Code - International Taxation
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CFC provisions- International Perspective

                  Country                                        Provisions for CFC rule application
                      USA                    •   In totality >50% and Single shareholder >10% ownership
                       UK                    •   In totality >50% or if UK residents hold > 40% & a non-resident hold at least
                                                 40% but not more than 55%
                    JAPAN                    •   In totality >50% and Single shareholder >5% ownership

                   FRANCE                    •   In totality >50% and Single shareholder >5% ownership

                 AUSTRALIA                   •   50% in totality or 40% if single shareholder. Concept of Listed/Unlisted

  Direct Tax Code - International Taxation
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CFC – Illustrative Issues
                                                           US –
                  US                                   Operating Co.                             US
                                                                                                               Dividend declared 75000

Dividend                                                                                                           33.33%
                                                                                33.33%                33.33%
Distributed                                                                                25000
to                                             Profit not             25000                                                        25000
                                               distributed to India
              Mauritius                                                       Singapore     Mauritius               Dubai

Dividend Parked in
Mauritius & not                                                                                       100 %
                                                                                100 %                                 100 %
                India                                       India                               India

         50% Ownership
         Criteria Fulfilled                                                               50% Ownership Criteria

    Direct Tax Code - International Taxation
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CFC provisions – Impact/Issues

                                                                                Scope of
                                                   CFC provisions to           expressions
                                                   impact outbound          ‘passive income’
                                                     investment              and ‘controlled
                                                      structures               directly or

                                                                                                     Scope of
                                 Conditions                                                    applicability of CFC
                               triggering CFC                                                      provisions –
                                provisions not                                                 whether applicable
                                                               Need for robust tax                to operating /
                             provided in Revised             credit regime including
                              Discussion Paper                                                 holding / operating
                                                                  provisions for                as well as holding
                                                              underlying tax credit                 companies

 Direct Tax Code - International Taxation
 Page 19
Interplay of CFC & PEM concept
           Indian Co.                              Netherland Co.                   UK CO.

                                                                                       Hit by CFC
                                                                 Only Passive
                                                                                   proposal. Taxed in
                                                               co.(Holding Co.)
                                                                                    Indian Co. hands
                                                                Passive & Active   May be hit by CFC
      IS PEM of                                               Income ( Operating   provisions. Still no
  Netherland Co. in                                              & Holding co.)       clarity on it
                                                               Resident in India
                                             YES                i.e. Taxed as a
                                                               separate entity.

  Direct Tax Code - International Taxation
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Branch Profit Tax

•   Proposed provisions

      Additional levy of Branch Profit Tax (BPT) @ 15%
      The same is to be levied on the total income for the financial year as reduced by the amount of income tax thereon

•   Foreign Companies liable to pay branch profit tax (PBT) on total Income reduced by corporate tax
                                         Particulars                                       Amount
                                         Total Income for the FY                           100
                                         (Less) Corporate Tax                              (25)
                                         Taxable amount for BPT (A)                        75

                                         BPT @ 15% on (A)                                  11.25

•   Effective tax rate for foreign companies is 36.25%

     Direct Tax Code - International Taxation
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Branch Profit Tax …
• Definition of Branch
    No definition and hence it should be defined to include branches and PE
    All LO to be excluded except if it is assessed as PE

• Issues
    Tax on branch profits, even if undistributed
    BP tax is part of Second Schedule (C) and not referred in Section 2 (Liability to tax income-tax), hence issue arises
     about tax credit in foreign country

• Way-forward
    To be in line with repatriation profit tax and not additional tax
    The term „branch‟ is to be defined

    Direct Tax Code - International Taxation
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Transfer Pricing - Definition of Associated Enterprises (AE)
   The threshold limits for determination of AE proposed to be reduced
      Modifications to AE definition
      General definition of AE i.e. direct or indirect participation in management, control or capital is omitted
      Changes in the threshold limits are tabulated below:

    Particulars                                                    Current                     Proposed
    Direct or Indirect shareholding/voting power                   26% or more                 10% or more
    Loan by one enterprise, as a % of book value of total assets   51% or more                 26% or more
    of other enterprise
    Number of Directors or members of the governing board of       More than 1/2               More than 1/3
    one enterprise are appointed by other enterprise or by same
    person(s) in both the enterprise
    Raw materials and consumables threshold limit                  90% or more of the          2/3rd or more of the
                                                                   supplies                    supplies

   Way forward
      Reduction to 10% is not correct as a shareholder having 10% cannot influence the decision in any manner
      Need to retain 26% as it has relevance even from a Companies Act perspective, viz, a person having 26%
       shareholding can block a special resolution
      Direct Tax Code - International Taxation
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Safe Harbour
   Arm’s Length Price

     Determination of arm‟s length price will be subject to safe harbour rules as may be framed by the Board.
     Safe harbor rules may not be applicable across all industries/transaction types
     Selection of transfer pricing cases for scrutiny is to be based on a risk management strategy as may be framed by
      the Board
     The strategy will not be disclosed to the taxpayer or any member of the public

   Safe Harbour

     Provides a measure of relief to taxpayers
     If the safe harbor provisions are set up at inordinately high levels or ranges, then taxpayers would continue to face
     The global losses and financial crunch faced by the Group as such at present would also need consideration whilst
      exploring adherence with the safe harbor regulations

     Direct Tax Code - International Taxation
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Advanced Pricing Agreement (APA)

   Key features

         Arm‟s length price to be determined by the Board
         Board empowered to make further adjustments
         APA sought to be binding on the taxpayer and the Income-tax authorities
         APA is valid for maximum of 5 consecutive financial years
         APA shall not be binding in case of change in facts

   Subject to timely disposal, APAs are expected to considerably reduce uncertainty regarding arm's length pricing

   International approach (Multilateral APA/ Bilateral APA/ Unilateral APA

        Direct Tax Code - International Taxation
        Page 25
GAAR – Proposals
 The Direct Taxes Code Bill, 2009 (DTC) proposes to introduce GAAR in India to
  curtail tax avoidance

 GAAR to be invoked on satisfaction of prescribed conditions:
    an arrangement to obtain a tax benefit
    transactions not at arm‟s length
    misuse or abuse of the provisions of DTC
    Lacking commercial substance defined to include situations where there is a:
          • Significant tax benefits without significant effect upon business risk or net cash flows
          • Legal substance or effect differs from legal form
          • It involves or includes:
                  Round trip financing
                 Any accommodating or tax indifferent party

   Direct Tax Code - International Taxation
   Page 26
   Powers given to revenue authorities to disregard, combine or re-characterise any part or whole of a
    transaction / arrangement

   GAAR further supported by specific anti-abuse rules (SAAR) in circumstances such as payment to
    associated persons in respect of expenditure, international transaction not at arm‟s length, transactions
    resulting in transfer of income to non-residents and avoidance of tax in certain transactions

   GAAR to override the provisions of the tax treaties

   Onus is on the taxpayer to prove that a tax benefit was not the main purpose of the arrangement

                                      Issues raised
      GAAR provisions sweeping in nature and may be invoked by the tax
      authorities in routine manner. Also no distinction between tax mitigation
      and tax avoidance
     Direct Tax Code - International Taxation
     Page 27
GAAR- Revised Discussion Paper

  GAAR not to be invoked for every arrangement involving tax mitigation

  GAAR to be invoked only in case any One of the basic conditions is satisfied

  CBDT to issue guidelines providing circumstances under which GAAR may be invoked

  Threshold limit of tax avoidance to be provided for invoking GAAR

  Dispute Resolution Panel (DRP) route to be available for resolving GAAR related disputes

  Direct Tax Code - International Taxation
  Page 28

           Impermissible Avoidance Arrangement                                                   Circumstances
                                                                           Rights / Obligations not at           Lacks commercial
                                                                                  arm’s-length                      substance
         A step in, or a part or whole of an arrangement whose
                 main purpose is to obtain a tax benefit                           Misuse /                      Is not for bonafide
                                                                                 Abuse of DTC                         purposes

                                                           GAAR Invoked by CIT

                                •   Treat the arrangement as void / any manner as the CIT deems appropriate
                                •   Disregard accommodating parties, etc
                                •   Re-allocate income, expenses, relief, etc
Empowered to                    •   Disregard / combine / re-characterize any step in /whole / part of the arrangement
                                •   Treat connected persons / accommodating and other party as one and the same
                                •   Deeming connected persons as same
                                •   Re-characterize, Equity -Debt, Income, expenses, relief, etc

Direct Tax Code - International Taxation
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GAAR – Impact/Issues

  Direct Tax Code - International Taxation
  Page 30
Definition of Income Deemed to accrue or arise in India
   Existing Provision
     Income deemed to accrue or arise in India directly or indirectly
     Includes Income arising from a transfer of a Capital Asset situated in India

   Proposed Provisions
     Income deemed to accrue or arise in India directly or indirectly
     Through or from transfer directly or indirectly of Capital Asset situated in India

   Intention of the proposed legislation
        Tax the transfer of shares of the overseas holding company which is intended to be transferred
        Shares of the Indian company
        But the intention seems to have far-reaching implications
        Taxing the genuine transfer or genuine corporate reorganization

     Direct Tax Code - International Taxation
     Page 31
Definition of Income Deemed to accrue or arise in India …

   Implications
     Indirect transfer of a Capital Asset situated in India has a wider meaning

     It may tax the transactions which have taken place outside India between two nonresidents.

     It may tax the transactions relating to Global reorganization though the transactions may not have any
         impact in India.

   Way-forward
     Existing provisions to be maintained.

     Definition of the term indirectly to ensure that genuine transfers are not brought to tax

     Strengthen Limitation of Benefits clause (LOB) in the respective treaties to overcome treaty shopping

     Direct Tax Code - International Taxation
     Page 32
Treaty Override

                                             Issues Raised
     General treaty override is against the spirit of Vienna convention as it renders existing DTAA
      redundant. It could effect the inflow of FDI as it would result in higher rates of taxation on
                       royalty, fees for technical services and interest income
 Direct Tax Code - International Taxation
 Page 33
Treaty Override- Revised Discussion Paper

 Act or treaty, whichever is more beneficial, shall apply

 Limited Treaty Override - Tax Treaty not to have preferential status
    where the GAAR is invoked; or

    when CFC provisions are invoked; or

    when Branch Profits Tax is levied

 Limited Treaty Override in line with international practice

    Direct Tax Code - International Taxation
    Page 34
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Direct Tax Code - International Taxation
Page 35
Indirect transfer of capital asset
                                                                           If Foreign Co has other assets ,
                Parent Co                                   Foreign Co 2
                                                                            would proportionate value of
                                            Transfer of                     “capital asset” situated in In
                                             Shares in
                                          Foreign co 1 to
                                                                                   India be taxed ?
                                           Foreign co 2

              Foreign Co 1


                Indian Co

    Direct Tax Code - International Taxation
    Page 36

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