THE government may introduce provisions in the new direct tax code to prevent misuse of double taxation avoidance agreements India has with other countries. The new code is likely to be unveiled before the year ends.
A government official said a discussion paper on the code, a major initiative undertaken under the guidance of the former finance minister and present home minister P Chidambaram, is being fine-tuned. “A discussion paper on the code explaining the rationale behind every change would be placed in the public domain,” the official added. A draft bill on the code may also accompany the paper to enable everyone to express their views on the proposed changes.
Double taxation treaties are essentially agreements between two countries that seek to eliminate the double taxation of income or gains arising in one country and paid to residents or companies of the other country. The idea is to ensure that the same income is not taxed twice. In many instance, however, these agreements are misused to evade taxes. This is called ‘treaty shopping,’ where usually residents of a third country take advantage of a tax treaty between two countries.
For example, many companies in other countries route their investments into India through Mauritius or Cyprus to take advantage of the tax treaty that these countries have with New Delhi. Both, India-Mauritius and India-Cyprus tax treaties provide that capital gains arising in India from the sale of securities can only be taxed in Mauritius and Cyprus. This means no capital gains tax on investments in securities routed through Mauritius and Cyprus, as these countries do not levy tax on capital gains.
The discussion paper on the code would explore ways to check this treaty-shopping. Mr Chidambaram was actively involved in the exercise of drafting the code. At the Economic Editors Conference in November, he had said the draft code would be placed in the public domain soon. “I have to read another 19 pages of the discussion paper. The discussion paper and the draft is ready,” he had said.
Some options like a general anti avoidance rule (GAAR), provisions allowing examination of the real nature of a transaction and a limitation of benefits clause are being actively examined. Many countries like Singapore and Canada have a general avoidance provision — GAAR — in their income-tax laws to ensure that treaty benefits accrue only to genuine investors. Singapore also allows examination of the real nature of a transaction.
Earlier, an internal panel in the income-tax department, which examined the issue of treaty abuse and ways to prevent it, had also made recommendation in favour of GAAR and a special provision for examination of real nature of transaction. A special provision allowing for examination of the real nature of a transaction in the present incometax law would have given Indian tax authorities a natural right to examine Vodafone Group Plc’s $11.2-billion transaction to acquire controlling stake in Hutchison Essar, a telecom firm based in India.
Vodafone has not given the income-tax (I-T) department the confidential documents related to the transaction that involved transfer of stake by the offshore entity which held stake in Hutchison Essar to another offshore entity owned by Vodafone. Indian tax authorities want to tax the transaction on the ground that it involved transfer of an Indian asset and have got a major boost after the Bombay High Court dismissed the telecom company’s writ petition against the show-cause notice of the I-T department.
The government had attempted to bring in some anti-abuse provisions in the Union Budget 2007-08, but dropped the idea in favour of the tax code, work on which had already begun by then.
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