The Hindu Business Line : A bypass to Taiwan

Our one-China policy dictates that we cannot have a DTAA with the Taiwanese Government. The amendment in the I-T law follows the course adopted by, among others, Australia and New Zealand in dealing with Taiwan.

Normally, Double Taxation Avoidance Agreements (DTAAs) are entered into between two sovereign countries. But what happens if India has to deal with business entities in countries whose sovereignty is disputed by another country? The issue is not academic.

Taiwan, for instance, is one of the fastest emerging economies of the world with a GDP in excess of $353 billion and growth rate of 4.3 per cent. Our one-China policy dictates that we cannot have a DTAA with the Government of Taiwan. The People's Republic of China considers Taiwan its province. But we have sizable business with Taiwan. A via-media was found to extend DTAA relief to Taiwan by the latest Finance Act, through what apparently looks an intriguing amendment.

Section 90A

A new Section 90A has been inserted in the Income-Tax Act, 1961 providing that any specified association in India may enter into an agreement with any specified association in a specified territory outside India, and the Central Government may, by notifications in the Official Gazette, make the necessary provisions for adopting and implementing such an agreement for grant of double taxation relief, avoidance of double taxation, exchange of information for the prevention of evasion or avoidance of income-tax or for recovery of income-tax.

In all such cases, the provisions of the Indian I-T Act will apply to the extent they are more beneficial to that assessee in a foreign territory.

The notification to be issued will provide the definition of terms and meanings required for application of the new law. The specified association and specified territory will be notified by the Central Government.

A consequential amendment is also proposed in Section 2(37A) of the Act with regard to the definition of `rate or rates in force'. The amendment takes care of the agreement to be notified by the Central Government under Section 90A. The new Section 90A takes effect from June 1, 2006. The amendment in the I-T law follows the course adopted by, among others, Australia and New Zealand in dealing with Taiwan.

Sticky issues

While making amendments to the law, quite often it is forgotten that ticklish problems arise in dealing with subsidiaries and branches of multinational enterprises setting up shop in several countries.

The UK imposed a top-up tax on profits that Cadbury had earned from two subsidiaries in Ireland. The Irish tax rate was 10 per cent while the British tax rate was 30 per cent. Britain demanded the difference. The matter went to the European Court of Justice (ECJ). The law officers of the ECJ opined (in May) that the desire to reduce taxes is no crime and companies may choose to get taxed wherever the rate is low. Several East European countries have corporate tax rates below 20 per cent.

As per this opinion, multinationals may operate through subsidiaries in such low-tax jurisdictions and avoid British tax. As long as there is no artificiality about the arrangement and the motive is not merely to evade tax, there is no way of objecting to the establishment of subsidiaries in such countries. The ruling is expected to impact British revenues since 20 other firms have similar cases pending (The Economist, May 6).

Our DTAAs with countries such as Mauritius have often come in for criticism on the ground of ring-fencing and treaty-shopping. There is a growing clamour for revisiting our tax treaties.

The benefit of inflows and outflows by way of investment and trade will have to be weighed against the fiscal losses suffered because of lenient treaty provisions. Our treaty with Singapore follows the American tax-code, incorporating the Limitation-of-Benefits Rule. This is one aspect of the problem.

An equally important aspect concerns exchange of information. Quite often, the foreign entities do not oblige Indian tax authorities with information about secret accounts held by Indians abroad. Since July 2005, the European Savings Directive has been forcing British holders of offshore accounts in tax havens either to forfeit anonymity or pay a flat tax of 15 per cent. Last month, a ruling was given to the effect that British bank Barclays will have to handover information on hundreds of thousands of accounts that are held offshore by customers domiciled in the UK.

Notifications issued under the DTAA provisions of the I-T law will have to take into account issues concerning tax avoidance by setting up subsidiaries in low-tax jurisdictions, and provide for exchange of information concerning fiscal evasion.

At present, such exchange of information is seldom made. Every treaty we enter into invariably provides for such exchange of information with a view to detecting fiscal evasion. The tax authorities must use this provision aggressively. This will also facilitate recovery of tax through attachment of funds secreted abroad.

(The author is a former Chief Commissioner of Income-Tax.)