Taxation of international digital transactions has been a perplexing issue. As per the international tax rules, where an enterprise is a resident in one state with income originating in another state (source country), international tax rules provide that the source country will have the taxing rights over such income only if it is established that the enterprise has a permanent establishment (PE) in the source country. Thus, for the source country to be able to tax profits arising from the digital economy, some physical presence of the non-resident enterprise is required in the source state.

However, today a non-resident can carry out a large amount of internet transactions in the source state without having any significant physical presence there. A website can be launched from anywhere and made available to users anywhere in the world. There is no central point, or physical location, for such a transaction and thus, it may not fall within any country’s jurisdiction for taxation purposes.

This opens up two possibilities: double taxation or non-taxation. The concerned people could be even further creative, and actually set up an online business at a place where none of the founders / promoters are present, thereby making it even more difficult to tax them.

Continue Reading Taxing the Digital Economy: The Rule of ‘Significant Economic Presence’

Permanent Establishment (PE) is a significant feature of bilateral tax treaties and is a key threshold adopted by source countries to tax profits earned by non-resident entities from the business activities carried out by the non-resident in the source country.

A ‘Fixed Place PE’ relates to a non-resident entity having a fixed place of business in the source country. But certain tax treaties also provide for a ‘Service PE’. A Service PE is established if: (i) the non-resident delivers services for longer than the prescribed threshold; and (ii) the said services are furnished in the source country through the employees or other personnel of the non-resident.

Traditionally, a Service PE required the physical presence of employees of the non-resident in the source country. However, in the present digital economy, this understanding is being challenged as more and more jurisdictions are doing away with this requirement.

The governments of Saudi Arabia and Israel, for example, have passed internal guidelines that suggest a non-resident would have a Service PE if it furnished services, including consultancy services, through employees or other personnel who are offshore and not physically present in the Source State. This would only be the case, however, if the activities continue (for the same or connected projects) within the Source State for more than 183 days in any 12-month period.

Continue Reading Service PE Does Not Require Physical Presence of Employees

Putting to rest the speculation surrounding the Double Taxation Avoidance Agreement (DTAA) with Singapore, the Government of India has finally announced that it has been revised. This announcement was made on December 30, 2016, and the text of the new protocol amending the India-Singapore DTAA (Protocol) has since been made available. The Protocol is along expected lines on the taxation of capital gains front. But, surprisingly, it has not granted incentives on taxation of interest income and Singapore based investors would be at a significant disadvantage as compared to Mauritius based investors.

Continue Reading India-Singapore DTAA Meets the Same Fate as Mauritius & Cyprus

India and Cyprus have recently revised the Double Taxation Avoidance Agreement (DTAA) to be effective from April 01, 2017 and January 01, 2017 in India and Cyprus respectively.

Before 2013, Cyprus was a favoured jurisdiction for investments into India as capital gains from the sale of shares held by Cyprus based investors in Indian companies was not taxable in India. However, due to non-compliance of its information sharing obligations, India declared Cyprus a Notified Jurisdictional Area (NJA). This led to significant uncertainties. While the DTAA had not been rescinded, this development resulted in adverse implications for Cyprus based investors, including, inter alia, higher rate of withholding taxes, application of transfer pricing provisions to transactions with Cyprus based entities even though they are not related, etc. Thus, conducting regular business transactions between entities of both countries became difficult with many transactions getting deferred.

The revised DTAA is the culmination of prolonged negotiations and discussions between both the countries to address this situation. Pursuant to the execution of the revised DTAA, the notification declaring Cyprus as NJA has been rescinded. Continue Reading Revision of the India-Cyprus DTAA: On Expected Lines

Long years of negotiations with Mauritius have finally culminated in the signing of the Protocol amending the Convention between Government of Mauritius and the Government of Republic of India (GOI) on May 10, 2016 (Protocol). This has resulted in a complete overhaul of the India – Mauritius Double Taxation Avoidance Agreement (DTAA).

A Few Key Changes

While the DTAA granted taxation rights on capital gains (CG) only to Mauritius and in the context of Mauritius entity’s alienation of shares in an Indian company, the Protocol has reversed the position and allows India the right to tax such CG in respect of shares acquired on or after April 1, 2017. Further, the CG realised by Mauritius entities from April 1, 2017 to March 31, 2019 (Transition Period) would be taxable at a concessional rate of 50% of the applicable tax rate in India. This concession would be subject to the satisfaction of certain conditions under the newly inserted limitation of benefits (LOB) clause. Interestingly, the LOB relies on the concepts of ‘primary purpose’ and ‘bonafide business activities’ which are undefined terms. As such, this may result in interpretation inconsistencies and maybe litigation.

Prior to the Protocol, interest income (II) earned by Mauritius entities was taxable at high rates under Indian tax law.  As such, investments from Mauritius were not structured as debt or convertible debt on account of the high tax incidence on II. However, Mauritius based banks were exempt from taxation of II. The Protocol now restricts the tax payable in India on interest payable to all Mauritius incorporated entities (including banks) at a mere 7.5% of the gross amount of II by borrowers based in India, provided the Mauritius entity is the beneficial owner. Thus, the Protocol allows Mauritius based entities the most favourable tax treatment of II among all the tax treaties that India has signed so far.

Other significant amendments include the provision for establishment of service permanent establishment in the definition of permanent establishment and introducing tax on payments made to a Mauritian entity towards fees for technical services. Similarly, the Protocol also tries to tax all types of income as ‘other income’ which have not been specifically addressed in the various articles of the DTAA. The Protocol also introduces additional enabling provisions to facilitate exchange of information and assistance in collection of taxes.

What Does this Mean for Indian Investments?

The Protocol is expected to change the nature and volume of foreign investments coming to India through Mauritius. Strategic investments, given the longevity and nature of the investment and given that taxation will be factored into the investment decision, may not be significantly impacted as they could come directly into India (instead of being routed through Mauritius). However, short term financial investments such as private equity and venture capital investments (made mostly in unlisted companies) could be affected, at least in the short term, due to a fall in the rate of return on account of taxes. FPI investments with an over-12 months holding period should not be impacted. However, CG earned by Mauritius based FPIs on investments held for less than 12 months would now be subject to CG tax and thus, could see a downturn. Further, participatory notes issued by FPIs could become less attractive to investors as FPIs will seek to shift their tax burden.

The reduced tax rate of 7.5% on II could lead to a surge in debt related investments from Mauritius.

Further, the Protocol only levies tax on CG arising from the transfer of shares in India. To that degree, it may be contended that CG earned from the transfer of other instruments (e.g. compulsorily convertible debentures or non-convertible debentures) may be exempt from tax in India as per the provisions of the DTAA. However, statements issued by senior revenue authorities immediately after the signing of the Protocol suggest that all types of CG arising to a Mauritius based investor will now be taxed in India.

Some Key Takeaways

The grandfathering of acquisitions made before March 31, 2017 and the concessional rate of tax for the transitional period provide investors with adequate advance notice of the change in law. This evidences the GOI’s commitment towards a stable and predictable tax regime. Further, the interplay between India’s General Anti Avoidance Rules (proposed to be made effective April 1, 2017) and LOB provisions will be interesting, as the former also allows Indian tax authorities to deny treaty benefits. .

The Protocol would also trigger renegotiation of the India-Singapore DTAA since the beneficial provision for taxation of certain CG (e.g. on shares) only in the state of residence in the India-Singapore DTAA is coterminous with similar provisions in the India-Mauritius DTAA. This would also have been the case with Cyprus but post it’s blacklisting by the GOI for lack of effective exchange of information, Cyprus is anyways no longer considered favourably by investors looking to invest into India.

One will have to wait and watch India would revise similar provisions in the DTAA with the Netherlands. In case the same is not renegotiated, there may be a significant surge in investments into India through the Netherlands.

It is evident that India wants to eventually phase out the preferential tax treatments given to various jurisdictions under the respective tax treaties so that the investors are encouraged to invest directly from their own home jurisdiction. The Protocol seems to be first step in this direction and eventually, it appears that all DTAAs granting similar tax benefits would be renegotiated.

In any case, as far as Mauritius is concerned, given the Protocol, it would no longer be tax viable for investors who, without having any substantive presence in Mauritius, were routing their investments through Mauritius.