TREATY SHOPPING:
In a moment of truth
Iqbal Rajahbalee
Senior Counsel
BLC Chambers
“where a person acts through a legal entity
created in a State essentially to obtain treaty
benefits that would not be available directly.”
OECD Commentary Art. 1.
AGENDA:TREATY SHOPPING
• 1.
EXPLORING THE
SHOPPING PARADISE
• 2.
DISCUSSING WITH THE
IDEA
• 3.
PICKING THE
GENUINE FAKE
• 4.
GOING TO COURT
• 5.
THE SHOPPING
EXPERIENCE
Mauritius as location for
holding companies
• Classic holding company model
Foreign Parent
Equity
Loans
Mauritius Finco
Equity
Indian subsidiary
Singapore
subsidiary
– Foreign parent capitalises
Mauritius Finco with equity
– Mauritius Finco sets up
subsidiaries in target states,
obtains reduced withholding tax on
dividend and no capital gains
– Lends to subsidiaries obtain tax
relief.
– Mauritius Finco taxed at effective
rate 3%
• Points to watch for
– Interest withholding tax
– Deductibility of interest expense
– CFC rules in country of parent
Private Equity Structure
Investors
Private
Private
Equity
Mauritius Holdco
External
lenders
Loans
Target
country
Acquisition
vehicle/target
– Private equity business is
normally leveraged
– As there will be little or no
tax capacity in Mauritius,
Mauritius Holdco will want to
lend down into the target
country
– How is it possible to push
debt down into the target
country?
– A key requirement is
protection from excessive
interest withholding tax in
the country of the target
Mauritius as location finance company
•
Outline
–
Indian Parent
–
Mauritius
Holding Finance
Company
–
–
Loans
–
UK subsidiary
Loans
–
Loans
–
–
German
subsidiary
French
subsidiary
Indian Parent holds European
subsidiary through Mauritian holding
company
Mauritian company is financed with
equity from India
Mauritian company makes loans to UK,
French and German subsidiaries
Interest deductible in European
subsidiaries
Interest taxed in on Mauritius at
effective rate 3%
No withholding tax on interest out of
Germany
Domestic interest withholding tax
exemptions available – UK and France
No tax in India until/unless Mauritius
company distributes a dividend
A Conduit Company
• A GOOD SHOPPING
CENTRE:
– a wide network of tax treaties
– Very favourable domestic tax
rules
– Good professional resources
• PROVIDES A PLATFORM
FOR CONDUIT COMPANIES
POLICY OBJECTIONS
• It disturbs the “balance of burdens”:
– jeopardising the fairness of the treaty bargains.
• Blurs distinction between negotiated treaty
provisions and unilateral tax changes:
– No incentive to establish tax treaties.
• Facilitates tax avoidance and tax evasion
– Income from international investment bears little tax
or no tax at all.
EXPLORING THE SHOPPING CENTRE
• Acceptable and Unacceptable Practices
– “Businesses should be able to organise their affairs to
obtain access to treaty benefits”
• Pacta Sunt Servanda Principle
– requires contracting states to grant treaty benefits
“even if considered to be improper”, absent the
existence of an explicit anti-avoidance rule within the
treaty itself.”
OECD Conduit Companies Report
(1986) note 15 at para 43
The Vienna Convention
• Canon of Interpretation of Treaties
Treaties to be interpreted according to their natural
meaning
• Principle of Good Faith
The object and purpose of tax convention and the obligation to
interpret them in good faith allows states to disregard abusive
transactions, such as those entered into with the view to
obtaining unintended benefits under the provisions of these
conventions.
OECD Commentary 2003
Article 1 para 7
Dichotomy of Domestic and
International Law
STATE
STATE
Public International Law
Domestic Tax Law
TAXPAYER
TAX AUTHORITY
Determining Tax Residence
• Abdul R. Meman [2005] 276 1 ITR 306 (AAR)
Not resident under Article 4 if no liability to pay tax.
• ITO vs Mahavirchand Mehta [2011] 11
Taxmann.com 194 (Mumbai)
Followed Azadi Bachao Andolan
Held that the expression ‘liable to tax' in a contracting state does
not imply that the person should actually be liable to tax in that
contracting state. It is enough if other contracting state has right
to tax such person, whether or not such a right is exercised.
General Electric Pension Trust (2005) 280 ITR 425
AAR
Tax Residence
• Cause of Liability
Crown Forest Industries Limited v. The Queen,
92 DTC 6305 (FCTD).
Judge Iacobucci:
“… nothing improper with such behaviour [of
minimising their tax liability], I certainly believe
that it is not to be encouraged or promoted by
juridical interpretation of existing agreements.”
EFFECTIVE MANAGEMENT:
• Effective Management by Parent Company
OECD Commentary Art 4
• Smallwood and others v Commissioners for
HMRC [2009] EWHC 777 (Ch)
– Change of Trustee to Mauritius to avoid capital gains
tax in UK
– Low level decisions made by Trustees in Mauritius but
key decisions made in UK.
– Decision on the basis of “effective management” of
the trust located in UK.
Effective Management
• Prevost Car Inc v The Queen (2008) DTC
3080 and (2009) DTC 5053
“When corporate entities are concerned,
one does not pierce the corporate veil
unless the corporation is a conduit for
another person and has absolutely no
discretion as to the use or appropriation of
funds put through it as a conduit …”
Article 4 (Residence)
• Wood v Holden [2006] EWCA Civ 26
“Effective Management test in Art 4(3) of UKNetherlands Treaty does not differ in
substance from the domestic law test for
corporate residence.”
Directors in Netherlands make decisions solely on
the advice of other persons and without proper
informed consideration.
Beneficial Ownership
• Indofood International Finance Ltd v JP
Morgan Chase Bank NA London (2006)
BTC 8003
“The concept of beneficial ownership is incompatible with
that of the formal owner who does not have full privilege
to directly benefit from the income.”
• Bank of Scotland vs Ministre de
l’Economie, des Finances (2006) Conseil
d’Etat, case 283314 (29 decembre 2006)
Inherent Anti-Abuse Provision
• A Holdings ApS v Federal Tax Admin (2005) 8
ITLR 536
“The prohibition of an abuse of rights as regards conventions is
recognised without being necessary to adopt an explicit provision in
the respective convention”
• Yanko-Weiss Holdings 91996) Ltd v Holon
Assessing Office (2007) 10 ITLR 254
• Tax treaties were not designed for use that is not in good faith and in
an acceptable manner, or that constitutes improper use..
Inherent Anti-Abuse Provision
• MIL (Investments) SA v The Queen [2006]
T.C.J. No. 362 (T.C.C.)
“The shopping or selection of a treaty to
minimize tax on its own cannot be viewed as
being abusive”
On Appeal: “Unable to find an object or a
purpose whose abuse could justify the court
departing from the plain words of the treaty
provisions…”
Combating Treaty Shopping
• Anti-misuse clauses
– look-through approach
– channel approach
– subject to tax
approach
– exclusion approach
• Bona-fide clauses
– general bona-fide
provision
– activity provision
– amount of tax
provision
– stock exchange
provision
– alternative relief
provision
The Shopping Experience
• Azadi Bachao Andolan (2003) 132 Taxman 373
• E-Trade Mauritius Ltd.[2010] 190 TAXMAN 232
(AAR)
• Ardex Investments Mauritius Ltd. (AAR No 866
of 2010)
• Aditya Birla Nuvo Ltd. v. DDIT [2011] 200
TAXMAN 437 (Mumbai)
• Vodaphone Case (2012) (Civil Appeal) No.733
END
• Treaty Override
– DTC
– GAAR
• Treaty Amendment
THANK YOU