Decoding Finance Bill 2012

G. Anantharaman - Director, Tata Realty and Infrastructure Limited & former SEBI member
TRC necessary but not sufficient - Is Budget seeking to prevent treaty shopping ?

The Finance Bill 2012 proposes a slew of measures as an immediate response to certain observations of Supreme Court in the Vodafone case, highlighting the need for “Tax Clarity. “Lack of clarity and absence of appropriate provisions in the statute and/or in the treaty regarding the circumstances in which judicial anti-avoidance rules would apply has generated litigation in India.”  “Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner. Legal doctrines like ‘Limitation of Benefits’ and ‘look through’ are matters of policy.  It is for the Government of the day to have them incorporated in the Treaties and in the laws so as to avoid conflicting views.  Investors should know where they stand.  It also helps the tax administration in enforcing the provisions of the taxing laws”.  As a matter of fact, a senior official of the Finance Ministry clarified on the budget day that foreign investors are not seeking certainty of no tax in India but looking for certainty of taxing provisions.  In view of the that matter, the proposed amendment of Tax Residence Certificate (TRC) in terms of amendment of Sections 90 and 90A basically emanates from the overall background of judicial pronouncement asserting that there is no conflict between Azadi Bachao Andolan and McDowell and the practical difficulties experienced in collecting information from certain jurisdictions on offshore investments/deals/bank accounts, etc., particularly, as confronted in the course of investigation in the 2G case.
Amendment of TRC for claiming relief under DTAA
In the Memorandum Explaining the Provisions in the Finance Bill 2012, a reference is made that in many instances, the tax payers who are not tax resident of a contracting country, do claim benefits under DTAA entered into by the Government with that country.  Thereby, even third party residents claim unintended Treaty benefits.  Therefore, it is proposed to amend Sections 90 and 90A of the Act, to make submission of TRC containing prescribed particulars, as a necessary but not sufficient condition for availing benefits of the agreement referred to in these Sections.  The actual language employed in Section 90 of the Act to convey the said intent is not in harmony with the avowed purpose.  To quote the amendment –
‘An assessee, not being a resident, to whom an agreement referred to in sub-section (1) applies, shall not be entitled to claim any relief under such agreement unless a certificate, containing such particulars as may be prescribed, of his being a resident in any country outside India, as the case may be, is obtained by him from the Government of that country or specified territory.’
Basically, the amendment as above, on a plain reading of the language, seeks to suggest that a TRC with prescribed particulars from any country outside India or specified territory outside India would be a precondition for claiming relief under the agreement.  This is not what the explanatory memorandum implies in as such as it seeks to regulate Treaty Shopping, so that third party residents cannot claim unintended Treaty benefits.  Also, in terms of the stated objectives, TRC though a necessary condition, would not be sufficient condition for availing the benefits of the agreement.  Obviously, there appears to be a disconnect.  As per clarifications appearing in certain financial dailies, it is seen that the proposed amendment would not affect the TRC with Mauritius for claiming benefit as it stands today.  Also, one understands that the proposed amendment is in respect of such countries/jurisdictions, where no TRC is issued or available.  At the same time, it is seen that many countries do not issue TRC as of now, and the proposed amendment would mandate it for claiming the Treaty benefit.  However, it is quite likely that an additional information regarding the tax incidence in respect of the subject transaction in the host country may be called for in addition to other material details, which may be relevant from the aspect of due diligence.  However, these are matters of speculation and one can be certain of the same only when the rules are notified after the bill is enacted.  Till then, the whole issue will be smothered in a welter of confusing and misleading signals.  But the basic disconnect remains, namely, whether the amendment is for checking the unintended Treaty benefit to third party residents or not.  Such unintended Treaty benefits normally go by the nomenclature of “Treaty Shopping” and if the intention is as spelt out in the explanatory memorandum, the corresponding provision in the amendment has to be read harmoniously with it to apply the language of the amendment to Treaty Shopping as well.  But, definitely, the explanatory memorandum seeks to address ‘Treaty Shopping” which will also have a material bearing on Indo-Mauritius Treaty.
Treaty Shopping in the context of Indo-Mauritius Treaty
The Indo-Mauritius Treaty was executed on 1-4-83 and notified on 16-12-83.  Article 13 of the Treaty deals with taxability of capital gains.  Article 13(4) covers taxability of capital gains arising from the sale and/or transfer of shares and stipulates that such gain of a resident of contracting state should be taxable only in that state, which in the case of Mauritius, happens to be nil.  CBDT issued circular no. 682 dated 30-3-1994, clarifying that capital gains derived by resident of Mauritius by alienation of shares of an Indian company shall be taxable only in Mauritius according to Mauritian tax law.  However, in the year 2000, the Revenue authorities sought to deny the Treaty benefits to some resident Mauritian companies, pointing out that beneficial ownership in those companies was outside Mauritius.  Thus, the foremost purpose of investing in Mauritius was found to be tax avoidance.  In that view, the authorities sought to deny the Treaty benefits despite the absence of limitation of benefit clause in the Treaty.  In the wake of the same, CBDT issued circular no: 789 dated 13-4-2000 stating that the Mauritian TRC issued by a Mauritian tax office was sufficient evidence of residence of the company in Mauritius and that such companies were entitled to claim Treaty benefits. TRC will be proof of residence as well as beneficial interest.  The legal challenge to the said circular culminated in the famous judgment in the case of AzadiBachao Andolan as reported in the 263 ITR.  The Supreme Court upheld the validity of the circular as within the meaning of Section 90 of the Act.  The circular shall prevail even if inconsistent with the provisions of the Act.  The Mauritian resident is eligible to the benefits of the Mauritius Treaty.  In the said judgment, the Supreme Court also made the following observations relating to Treaty Shopping.
  1. DTAAs of countries not supporting Treaty Shopping incorporates a ‘Limitation of Benefits’ (LOB) clause (eg. DTAA between India and USA)
  2. In the absence of a LOB clause in the DTAA between India and Mauritius there are no disabling or disentitling conditions prohibiting the residents of a third nation deriving benefits there under
  3. Also ‘Treaty Shopping’ should ideally be looked at by the Government and not by the courts as it involves various political considerations.  Many developed countries tolerate ‘Treaty Shopping’ for other non-tax reasons unless this leads to significant loss of tax revenues.
  4. Many developing countries also allow ‘Treaty Shopping’ to attract scarce foreign capital and technology, which they need.

The chequered case history of failed efforts in the wake of judicial pronouncements from time to time is, in parts attributable to the absence of LOB clause in the Indo-Mauritius Treaty and the beneficial circular no. 789 of 13-4-2000.  Accordingly, it stands to reason that the present move of tweaking the TRC may be to bring it in alignment with what was sought to be achieved earlier, but without success.  It is also not very clear whether such a move with altered ground rules without structural changes, can neutralise the absence of limitation of beneficial clauses in the Indo-Mauritian Treaty without actually amending the Treaty of equally inescapable question would be whether the proposed amendment would provide for a limited Treaty override without actually tinkering with it.  Presently, there is no clarity on these issues excepting to state that a harmonious interpretation of the proposed amendment with the explanatory memorandum carries the runes to the effect that the Treaty Shopping is sought to be regulated in some way or the other, so that third party residents do not claim unintended Treaty benefits and to that extent, the TRC is going to impose some more de rigueur conditions than mere proof of presence in Mauritius.
On a conspectus of various proposals in the Finance Bill 2012 to introduce GAAR, tweaking of the TRC and other anti-avoidance measures to tax off-shore share transfers, one is inclined to think that there is a design in the same as a combination to effectively plug the loopholes in the cross border transactions.  In the event of TRC being used to collect information about the non-resident entity, such information like tax liability of the transaction in the off-shore jurisdictions, residential status, the beneficial ownership etc., can be of use in evaluating and appraising whether GAAR is applicable to such arrangements.  As a matter of fact, one of the presumptions in GAAR is that obtaining of tax benefit is the main purpose of an arrangement, unless otherwise proved by the tax payer.  In the event of the arrangement being held to be an impermissible avoidance arrangement, then the consequences of arrangement in relation to tax or benefit under tax Treaty will be determined.  It is quite likely that TRC tweaks may directly or indirectly lead to a situation in appropriate cases for limited Treaty override through GAAR route.
In concluding, it is emphasized that there appears a disconnect between the intent as per explanatory memorandum and the actual language employed in the amendment provisions.  However, as per the cardinal principle of interpretation, both have to be read harmoniously, which would imply that there can be a check on Treaty Shopping with concomitant Treaty override in appropriate cases either on the strength of amended TRC or GAAR.