India: Two Rulings on Double Tax Treaties
Tax Tribunal Decision Treats Shipping Income as Exempt under India–UAE Tax Treaty
The Mumbai Income-tax Appellate Tribunal (Tribunal) in the case of Interworld Shipping Agency LLC (taxpayer) treats income arising from shipping operations like ship chartering, freight forwarding, sea cargo services and shipping line agents, including such activities in India, to be assessed as business in nature.
The taxpayer, since it is an incorporated company in the United Arab Emirates (UAE), undertaking shipping business having control and management in the UAE, qualifies as a tax resident of the UAE under Article 4 of the India–UAE tax treaty (tax treaty) and having its office and operations in the UAE since 2000 would entitle it to claim benefit under Article 8 of the tax treaty.
The taxpayer is a UAE-registered company engaged in the business of services such as ship chartering, freight forwarding, sea cargo services and shipping line agents, with control and management exercised in the UAE. The taxpayer charters ship for use in transportation of goods and containers in international waters, including to ports in India and globally. The taxpayer had a tax resident certificate (TRC) and treated its business profits derived from the UAE or India realized from shipping operations in international traffic as taxable only in the UAE and not in India, applying benefit under Article 8 of the tax treaty.
The tax authorities (revenue) although agreeing that ship vessels on time charter for transportation were in international traffic, relying on the TRC and commercial license issued by the UAE authorities, observed that substantial profits of the taxpayer were diverted/allotted to a Greek national. The revenue recognized that although in the previous tax years it had ruled in favor of the taxpayer, owing to the TRC furnished consistently, it now disregarded the favorable position construing misrepresentation of facts structured as a device for tax avoidance purposes.
Accordingly, the revenue denied the tax treaty benefit claimed by the taxpayer, contending that the shipping business was not managed or controlled solely from the UAE but in substance undertaken by a Greek national. The taxpayer, contesting the revenue order, filed additional details before the Dispute Resolution Panel (DRP), which in turn affirmed the adverse position of the revenue. The taxpayer aggrieved by the DRP order then filed an appeal before the Tribunal.
The Tribunal stated that the only test for a company to be regarded as a “resident of UAE” is that, it should at least be incorporated in the UAE to be wholly managed and controlled in the UAE. The taxpayer company had its principal office in the UAE engaged in shipping business since 2000, and its director qualified for residence test in the UAE along with the expatriate workforce engaged under employee work permits in the UAE as the primary driving force of a company.
The Tribunal affirmed that the residential status of the taxpayer in the UAE was consistent and not disputed by the revenue, with no defects raised in the past. Importantly, the Tribunal in order to determine the case, stressed that when person has a residence permit for the UAE, the company in question is incorporated in the UAE, and conducts business from the UAE, this results in no doubt in the position that business is controlled and managed exclusively from the UAE.
The Tribunal emphasized that the Greek director managing the affairs of the taxpayer company, and whose actual stay was over 300 days in the UAE, proved that the Greek director was managing a business from the UAE. Further, absent cogent reason or evidence furnished by the revenue to prove that business was not carried on from the UAE, regardless of the fact that the main director of the UAE company lived in the UAE for 180 days or even less, will not impact the residence status of the taxpayer.
The Tribunal acknowledged that the taxpayer shared reasonable evidence to prove that the business was wholly and mainly controlled from the UAE and relied on the settled position of the Hon’ble Supreme Court’s judgment in the case of K. P. Varghese that a taxpayer cannot be expected to demonstrate that it was not managed from outside its resident jurisdiction. Hence, the Tribunal accepted the taxpayer’s contention based on the material present on record to substantiate its argument that it was incorporated in the UAE and managed and controlled wholly in the UAE.
Accordingly, the Tribunal confirmed that the taxpayer company is a resident of the UAE under Article 4(1)(b) of the tax treaty and the limitation of benefits provisions of Article 29 of the tax treaty cannot be invoked in the instant case. In light of the bona fide claim to be a resident of the UAE, the taxpayer is eligible for treaty protection in respect of its business income earned in India.
In effect the taxpayer can claim the tax benefit under the provisions of Article 8(1) of the tax treaty that grants taxability of the business profits derived from its operation of ships in international traffic as taxable only in the UAE, thus granting tax exemption of such income in India.
The issue of taxability in a country related to residency test for companies, especially in the context of management and control, is a fact-oriented decision being a widely debated subject dealt with by numerous courts. The Tribunal in this case provides valid guidance to accept or reject the look-through principle in claiming treaty benefits not merely because the owner or the key management personnel is a resident of another jurisdiction.
Interestingly, the residence test for entitlement of benefits under Article 29 of the model tax treaty can vary for companies or entities where the term primary place of “management and control” in a resident country is situated. Though it is not used in the present tax treaty, can be inferred in this case especially where executive officers and senior management employees:
- of the company or entity exercise more of the day-to-day responsibility of strategic, financial and operational policy decision-making for the company or entity and its direct and indirect subsidiaries, and the staff of such persons conduct more of the day-to-day activities necessary for preparing and making those decisions, in the resident country; and
- exercise day-to-day responsibility for more of the strategic, financial and operational policy decision-making for the company or entity and its direct and indirect subsidiaries, and the staff of such persons conduct more of the day-to-day activities necessary for preparing and making those decisions, than the officers or employees of any other company or entity.
It may also be relevant to refer to the French interpretation of the term “management and control” for residency test that defines “place of effective management” as the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made, generally corresponding to the place where the person or group of persons who exercise the most senior functions (for example a board of directors or management board) makes its decisions. It is the place where the organs of direction, management and control of the entity are, in fact, mainly located.
Relying on the above analogies it may be reasonably concluded that, as the Greek director with his presence nearly 300 days under a residence visa along with the key management team conducts shipping business beyond routine activities in the UAE, would entitle the taxpayer to qualify as having control and management situated in the UAE.
Attention is drawn to Article 6 of the Multilateral Instrument (MLI) that modifies the scope of tax treaty claims in situations where the primary objective of the taxpayer is to claim tax treaty benefit to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance including through treaty-shopping arrangements aimed at obtaining tax treaty reliefs for the indirect benefit of residents of third jurisdictions.
In the instant case, since the transaction of shipping business income is not taxed both in India and in the UAE, arising from shipping operations where the UAE does not have local corporate taxes, it would be worth reviewing whether such transaction can be denied tax treaty claims applying the MLI. However, the argument of treaty shopping is diluted since the taxpayer has had a presence in the UAE for a considerable time, with income from shipping operations arising from a wide range of customers and not solely concentrated from Indian operations.
MFN Clause under India–Netherlands Tax Treaty Entitles Concessional Tax Rate on Participating Dividend
The Dutch tax resident entities Concentrix Services Netherlands BV and Optum Global Solutions International BV (taxpayers) in the Delhi High Court (Court) case were regarded as eligible for a concessional rate of tax at 5% on dividend income received from their Indian subsidiaries, by applying the concept of the Most Favored Nation (MFN) clause under the protocol to the India–Netherlands tax treaty (tax treaty) for equal allocation of tax claims applying the rules of interpretation.
The taxpayers were Dutch resident with majority shareholding in their Indian subsidiaries, which applied for a concessional tax rate on receipt of dividend income to the tax authorities (revenue) by virtue of the MFN clause under the tax treaty.
The revenue ignored the benefit of the MFN clause, arguing it to be effective only if the country with which India had a tax treaty was a member of the Organization for Economic Co-operation and Development (OECD) at the time of execution of the tax treaty. Hence, the revenue denied the concessional tax rate of 5% applied under the protocol to the tax treaty and issued a direction of standard withholding tax rate of 10% for such dividend under Article 10 of the tax treaty.
Slovenia, Lithuania and Colombia, which had entered into tax treaties with India, were not OECD members on the date of execution of the treaties, but subsequently became members, thus making the MFN clause under the tax treaties inapplicable.
The taxpayers filed a writ petition before the Court, recognizing the decree issued by the Kingdom of the Netherlands contending that, the benefit of the MFN clause was automatic in nature and is effective once India entered into a beneficial tax treaty with an OECD member country, without any specific requirement of notification to entitlement of beneficial tax rate on dividend income. The taxpayers argued that the participation dividends paid to the Dutch residents by the Indian subsidiaries were entitled to the concessional withholding tax rate of 5%.
High Court Ruling
The Court concluded that the taxpayers under Article 10 of the tax treaty provide the recipient of the dividend income as beneficial owner, withholding tax at the rate of 10 percent on gross basis. However, the protocol to the tax treaty that prescribes certain benefit or concession remains an integral part of the tax treaty and does not require a specific notification to claim such benefit—relying in its own decision in the case of Steria (India) Ltd. considering the India–France tax treaty. Further, the MFN clause prescribed under the protocol to the tax treaty adopts a uniform principle on satisfaction of the following conditions:
- the other state with which India enters into a tax treaty is an OECD member;
- the tax treaty executed with the other state restricts the narrower scope or applies the concessional withholding tax rate imposed by India than the normal scope or rate prescribed in the tax treaty.
Accordingly, where accepted, the narrow scope or concessional withholding tax rate agreed by the jurisdictions is applicable under the tax treaty effective from the date on which the tax treaty with such OECD member country is enforced.
The Court observed that the revenue’s contention, that the beneficial provisions of the tax treaty, executed after the coming into force of the tax treaty, is not applicable to the dividend income recipient covered under Article 10 of the tax treaty with the concerned OECD member country is misunderstood and contrary to the literal meaning of the protocol appended in the tax treaty.
In fact, the Court accepted that there cannot be any interruption between the dates when the tax treaty is executed with the country and the date when such country becomes an OECD member.
The Court considered that the “common interpretation” rule is used to allocate tax fairly and equally between the two countries, and the courts are required to ensure that the tax treaty is applied efficiently and fairly to ensure consistency in the interpretation of the provisions by the revenue and the courts of the respective countries. However, the common interpretation rule should be applied with care and caution, having regard to the fact that the view expressed is unique and/or personal to the revenue or a court.
In the instant case the Netherlands reads the protocol under the principle of common interpretation to apply consistency and equal allocation of tax claims between the countries. Hence, the Court rejected the revenue’s argument that as Slovenia, Lithuania, and Colombia became members of the OECD not only after the tax treaty came into force but also after their own tax treaty became effective, the concessional withholding tax rate on participating dividends could not apply to the taxpayers.
The Court recognized that the MFN clause present in the protocol to the tax treaty is applicable only when the country fulfills becoming an OECD member. Further, the benefit of the concessional withholding tax rate or the narrower scope present in the tax treaty executed between India and the other country can only apply if such country fulfills the condition of being an OECD member.
The use of the term “is” in the sentence “which is a member of the OECD” in the MFN clause requires countries to be OECD members when source taxation is triggered in India and not necessarily at the time when the tax treaty was executed.
The Court relying on the decree published in 2012 by the Kingdom of Netherlands interpreted the protocol appended to the tax treaty as that the concessional withholding tax rate in the India-Slovenia tax treaty is applicable on the date when Slovenia became an OECD member, even though such tax treaty was already in force. In order to support the argument, the Court relied on the Supreme Court decision of Azadi Bachao Andolan to understand that while interpreting international tax treaties, the rules of interpretation that apply to domestic or municipal law cannot be applied, as international treaties, conventions and tax treaties are negotiated by diplomats.
Further, interpretation of the tax treaty is liberated from the technical rules which govern the interpretation of domestic/municipal law. The core function of a tax treaty is to aid commercial relations and equitable distribution of tax revenues in respect of income which falls for taxation in both the jurisdictions of source and resident.
Accordingly, the Court confirmed that participation dividend paid to Dutch-based companies by Indian subsidiaries is eligible for concessional withholding tax rate of 5%.
The Court ruling provides interesting guidance on the subject of concessional withholding tax applying the MFN clause that is important, especially with the switch over of dividend taxation to the classical system from April 1, 2020 onward.
The Court, relying on the Steria (India) Ltd. case, reiterated that the MFN clause is an automatic application and does not require any specific notification to apply. Further, regarding the principles of parity, the Court granted a concessional tax rate invoking the MFN clause as agreed by India in other relevant tax treaties entered into after the India–Netherlands treaty was executed.
The tax treaties of Netherlands, France, Hungary and Sweden can invoke the MFN clause automatically for the lower rate and restricted scope of dividend; however, in the case of Finland to apply the MFN clause required a formal notification between the contracted countries. As regards Switzerland, the MFN benefit is applicable only for a lower rate of dividend on an automatic basis.
The Court emphasized that as the literal language of the MFN clause under the tax treaty uses clear terms that any subsequent tax treaty entered with the OECD member at a specified time will enable the benefit of the MFN clause.
It is relevant to note that Colombia became an OECD member on April 28, 2020, hence the concessional rate of 5% under the India–Colombia tax treaty (unlike Slovenia/Lithuania) is not subject to a condition of minimum shareholding in the company declaring dividend. Importantly, Article 8 of the multilateral instrument (MLI) is applicable to the India–Slovenia tax treaty where an additional condition of a minimum holding period of 365 days will apply and Lithuania has reserved its right on Article 8 of the MLI. Considering that there is no condition of minimum shareholding and MLI impact, the India–Colombia tax treaty remains beneficial under the MFN analysis.
Importantly, as MFN clauses extend benefits to income in the nature of interest, royalties and fees for technical services read with applicability of the MLI, it becomes imperative for multinational companies to analyze the impact of the favorable ruling on dividend and other streams of income.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Shailendra Sharma is a Chartered Accountant associated with a multinational financial services firm, India.