Last month, the Indian government ratified the OECD’s multilateral instrument (MLI) to implement certain tax treaty-related measures to tackle base erosion and profit shifting (BEPS) practised by multinational corporations.
The OECD initiated the 15-point BEPS Action Plan in 2013 with a view to modifying existing international tax rules such that business profits are taxed where economic activities take place and where value is created. As a G-20 member, India committed to implementing key recommendations set out by the OECD as part of the BEPS project.
For instance, India introduced a country-by-country reporting requirement for large business entities, implemented rules on deduction of interest expenses, and enacted a six percent equalisation levy to tax the digital economy.
The ratification of the BEPS MLI is another important step taken in this direction.
At the time of ratification, the government listed 93 of India’s existing tax treaties to be ‘covered’ under the BEPS MLI. As a result, most of these tax treaties would be impacted by the changes introduced through the BEPS MLI (once it takes effect), including the introduction of a new preamble and a principal purpose test (PPT) to limit grant of treaty benefits in inappropriate circumstances.
Undoubtedly, an in-built anti-abuse rule is much needed in tax treaties to tackle treaty abuse and to ward off claims of treaty override caused by the application of a domestic general anti-avoidance rule.
However, the PPT, as it stands today, is couched in exceptionally complex and uncertain language and would provide the tax authority with wide discretionary powers to also disregard arrangements that are not principally tax-motivated, thus leading to an increase in tax treaty disputes.
Under Article 7 of the BEPS MLI (which provides for the PPT), the tax authority may deny treaty benefit if it can ‘reasonably conclude’ that obtaining that benefit was ‘one of the principal purposes’ of a specific transaction. In its assessment, the tax authority shall have regard to all ‘relevant facts and circumstances’.
Clearly, Article 7 is both broad and vague and does not conform to the principle of tax certainty and fairness.
There is no explanation as to what standard of ‘reasonableness’ would be applied to test a particular transaction. And ‘reasonableness’ from whose eyes? What facts and circumstances could be said to be ‘relevant’ for the purpose of Article 7? And, how does the tax authority come to a finding that, upon perusal of the relevant facts and circumstances, it indeed appears to be a reasonable case or not?
Importantly, till date, the Finance Ministry has not published an illustrative list of instances that explain when a transaction could be said to have been carried out with a ‘principal’ purpose of obtaining a tax benefit.
Not only that, under Article 7, it is the taxpayer’s obligation to establish that the treaty benefit sought is ‘in accordance with the object and purpose’ of the tax treaty. In order to figure out the ‘object’ and ‘purpose’ of a tax treaty, courts would have to inevitably examine, among other things, the Preamble to a tax treaty.
However, the new Preamble introduced through the BEPS MLI provides for an alphabet soup of objects and purposes and one object would almost always conflict with another.
For instance, the new Preamble states that the tax treaty is intended to eliminate double taxation, but without creating opportunities for non-taxation or reduced taxation through avoidance (including treaty shopping). What if a court is confronted with a situation where one of the principal purposes of a given transaction was to obtain a tax benefit and yet denying that benefit would lead to double taxation?
The problem would become even more complex if the court were to look at the Preamble to the BEPS MLI itself, which sets out a host of other objects and purposes behind its implementation.
Justice SH Kapadia famously remarked in the celebrated case of
Vodafone (2012): “Certainty in integral to rule of law. Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers to make rational economic choices in the most efficient manner.”
Article 7 of the BEPS MLI strikes at the very soul of Justice Kapadia’s remarks because it gives the tax authority a free hand to deny tax treaty benefits. The consequence: more cross-border tax disputes reaching the already overburdened courts and tribunals.
Ashish Goel is a lawyer.