India can play a pivotal role in ensuring fair and equitable distribution of taxing rights in bilateral treaties
The Supreme Court recently settled a two-decade-old dispute relating to taxation of software payment as royalties, against the Revenue. Similarly, international tax arbitration cases, involving transfer of shares of foreign companies indirectly holding assets in India, have also been decided against the Revenue and attempts are being made to take over assets held abroad by India’s national air carrier or other public sector units.
These disputes involved aggressive interpretations of, as well as retrospective amendments to, India’s tax laws and could have been avoided if the bilateral double tax avoidance agreements (tax treaties) gave clear taxing rights to India. Can such tax disputes be avoided if more attention is given to retaining more taxing rights in tax treaties?
While each country is able to design taxing rights under its domestic law to levy tax on non-residents, such rights are curtailed by what is agreed by the country in various tax treaties signed by it. A tax treaty is an agreement between two countries, which distributes taxing rights over various types of income between the countries signing the tax treaty. Such tax treaties override the provisions of the domestic tax laws. For example, by amending the domestic law, a country can bring indirect transfer and computer software payments within the tax net, but in the absence of the treaty giving taxing rights on such income, the country cannot tax such income.
Tax treaties are discussed bilaterally but are heavily influenced by the OECD or the UN Model. Accordingly, from the perspective of retaining taxing rights in favour of a country, it is important that the treaty models give taxing rights to the source country — that is, the country from where income is sourced. India is not a member of the OECD and cannot influence the OECD Model, however it can influence UN Model, which gives more taxing rights to source countries and is also the template for many Indian tax treaties.
An amendment to the UN treaty models essentially involves significant negotiations between the source and residence countries, as each group would want to retain maximum taxing rights. Interestingly, although majority of the members of the United Nation’s Committee of Experts on International Co-operation in Tax Matters (UN Tax Committee) are from developing countries, the dynamics are such that on several occasions the final decision of the Committee is not in favour of giving taxing rights to source countries.
Each Committee member, although appointed by the respective governments, participates in the UN Tax Committee in his/ her individual capacity. Hence, each member conducts according to his own perception of the issues and understanding of tax implications.
The UN Tax Committee is not an intergovernmental committee and hence the views of the Committee members are not the views of the respective governments. Nonetheless, some governments appear to be paying significant importance to the UN work.
The 22nd session of the UN Tax Committee, which concluded in April, was reasonably influenced by the Indian representative. The session gave historic outcomes such as taxing rights in favour of source countries on automated digital services (Article 12B), indirect transfer and software royalties.
For the last few years, lead by OECD, more than 137 countries in the Inclusive Framework are struggling to solve the tax challenges arising out of digitalisation of the economy. The solution proposed in October 2020 is extremely complex. The G7 recently agreed on minimum corporate tax of 15 per cent as well as a solution for digitisation of economy related tax challenges.
The G7 solution is little different from the OECD Inclusive Framework’s solution. As against the complex solution of Inclusive Framework, the UN Tax Committee has swiftly offered a much simpler solution to the world which is predominantly due to the Indian representative on the Committee and some like-minded members from other countries. Indeed, this was how Article 12A was included in the UN Model, a few years back.
What more is required
Fair and equitable distribution of taxing rights in bilateral treaties is most desirable and beneficial to all parties. This would increase ease of doing business for multinational companies. In terms of the tax treaties, in their home country they would get credit for taxes paid in India. This will avoid not only unilateral taxes by countries but also aggressive assessments and protracted litigation.
Had the treaty given adequate taxing right to source country on software taxation, there would have been no scope for the decade-long litigation on that issue. Similarly, if the treaty gives taxing rights for indirect transfers, there would not be issues related to enforcement of international arbitration award.
Strengthening the Indian representation at UN level would give beneficial results in the long run. The provisions included in the UN Model would gradually find place in the Indian tax treaties either through the bilateral or multilateral route and give clear taxing rights to India.
The writer is Partner, Deloitte India