Eligibility for availing benefits under Tax Treaties
The tax treaties or the Double tax avoidance agreements (DTAA) between two sovereign nations, apart from providing the benefits of avoidance and elimination of double taxation of same income, also provide for concessional rates of payment of taxes on different kinds of income such as income from dividends, interest income, royalties, capital gains and many other kinds of income as covered under the DTAA.
In both, the tax treaties based on the UN Model Convention and the OECD Model Convention on income and capital, the eligibility for availing the benefits of the treaties is determined on the basis of provisions of Article 1 to Article 4 of the tax treaties.
Article 1 of the OECD Model Convention, provides that the convention shall apply to “the persons who are residents of one or both of the contracting states”.
Article 2 provides that the convention shall apply to “taxes on income and capital imposed on behalf of the contracting state or of its political subdivisions or local authorities, irrespective of the manner in which they are levied”.
Article 3 of the convention provides for the definition of terms like, “Person”, “Company”, “Enterprise” etc. The convention defines “Person” as including an individual, a company and any other body or persons.
Article 4 provides for, who will be considered to be a resident of a contracting state defining resident as meaning any person who, under the laws of that state is “Liable to Tax” therein by reason of his domicile, residence, place of management or any other criteria of a similar nature. This article also contains tiebreaker rules when both a person is resident in both the countries.
Eligibility for Treaty Benefits of Fiscally Transparent Entities
Normally, eligibility for the benefit of DTAA is a simple issue to be determined based on wordings of Article 1 to Article 4 of a given treaty; however, the issue becomes a little complicated when the assessee is a fiscally transparent entity trying to avail the benefit of treaties.
There have been a lot of controversies about whether a fiscally transparent entity will meet the criteria of being a “Person”, and whether the entity could be said to be “Liable to Tax” in the resident state if it is not the entity itself, but the ultimate owners of the entity who are making the payment of the taxes in their country of residence.
The fiscally transparent entities are a popular vehicle for carrying out different businesses as such entities will allow the income to be passed through them avoiding any taxation at the level of the entity, and allowing attribution of the income to ultimate owners of the entity. Examples of such entities are a partnership firm, Limited Liability Partnership (LLP), a Trust and at occasions a Limited Liability Company (LLC).
Position of Law in India viz a viz Eligibility of Fiscally Transparent Entities for Treaty Benefits
General Motors Company, USA v. ACIT, International Taxation
The issue has time and again arisen before the tax tribunals in India with the most recent case law on the subject matter being in the case of General Motors Company, USA vs ACIT, International Taxation[i] that we seek to discuss hereunder along with any other issues. (For material on taxability of different types of income in India, contesting a tax litigation, tax notice and strategies as also on various topics pertaining to commercial litigation and arbitration in India, you may visit https://rdlawchambers.com/research-articles/)
Assessee company had made a claim of being a resident of the USA and had offered to tax its income by way of receipt on account fees for technical services at a concessional rate of 15 per cent as enshrined under India-US DTAA.
Benefit of the treaty was denied to the assessee by tax authorities for two reasons: –
- the assessee was a fiscally Transparent Entity, being an LLC that was not a “Person”, or “Liable to Tax” in the USA;
- The LLC also did not come under the special clauses for partnerships and trusts for the benefit of India-US DTAA.
View of ITAT
In appeal, ITAT ascertained the status of LLC for India-USA DTAA, by considering publication of the Department of the Treasury, internal revenue services of the government of the USA on taxation of LLC.
Tribunal noted that the LLC was a business entity recognized by the USA under state law, and LLC could be classified for federal income tax purposes as a partnership, corporation or an entity disregarded as separate from its owner; an LLC with only one member was treated as an entity separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes).
The tribunal also took cognizance of the instructions for form 8802 regarding application for a residency certification which provided that in general, under an income tax treaty, an individual entity is a resident of the USA, if It was subject to U.S. tax because of residence, citizenship, place of incorporation or the similar criteria.
Said form specifically provided that if a fiscally transparent entity in the U.S. did not have any U.S. partners, beneficiaries or owners, then the entity was not entitled to residency certification; looking at partners and beneficiaries of General Motors Company, USA however, the residency certification was issued to it.
The tribunal held that the ability of the LLC to elect its tax classification under U.S. federal income tax law supported the legal situation of LLC being “Liable to Tax” and that it was established that under U.S. federal income tax law. An LLC with a single owner was disregarded as separate from its owner unless LLC elected to be treated as a corporation for U.S. federal income tax purposes. The tribunal, therefore, held that the LLC had a tax residency certificate from the U.S Internal Revenue Services in accordance with applicable law. The LLC fulfilled all requirements in the form of body corporate having separate existence from its members and also a perpetual existence distinct from the members.
LLC was held to be a resident of USA within the meaning of Article 4 of Indo-US Tax Treaty by virtue of its recognition as a separate existence from its members qualifying it as “Person”. The tribunal further held that the lower authorities had failed to appreciate that “Liable to Tax”, has to be interpreted in a way that the assessee is “Liable to Tax” under the authority of US income tax law.
The tribunal also placed reliance upon the judgment of the Mumbai Income Tax Appellant Tribunal (ITAT) in the case of, Linklaters LLP vs. ITO[ii], where the ITAT held that, to decide the eligibility to benefits under the tax treaty, the fact of income being covered within the tax net of partner country is relevant and not the manner of taxation, and that so long as the income was “Liable to Tax” in the country of residence of the assessee, whether it was taxed in the hands of the entity, or the hands of constituents thereof, the benefit and the tax treaty would be available. Other judgments on the subject matter are DDIT Vs Tekmark Global Solutions LLC [2010] 38 SOT 7 (Mum)
– DDIT(IT) vs Ms AP Moller (TS-555-/TAT-2013 Mum).
Our Comments
This issue regarding the eligibility of tax treaty benefits for fiscally Transparent Entities is time and again debated and gone into different cases such as Linklaters LLP vs. ITO, and DDIT vs. M/s. Tekmark Global Solutions LLC[iii] and many more.
Liable to Tax
There’s not much of a dispute about the proposition that “Liable to Tax” should mean that the income must be within the tax net of the country of residence of the concerned entity and not the manner of taxation that is whether it is taxed at the level of an entity or its constituents.
Whether an entity not expressly referred to in a treaty could be considered as ‘person’ under DTAA
Whether an entity could be considered to be a “Person” with the meaning of DTAA, for the purpose of availing the benefit of DTAA, can be normally addressed by specific wordings of a treaty without reference to any external material. For instance, majority of the tax treaties that India has with the foreign countries specifically cover financially transparent entities such as partnerships and trusts within the meaning of “Person”. Apparently any entity expressly mentioned to be eligible for DTAA benefit will be so eligible without controversies.
The issues, however, might arise in connection with entities that have not been explicitly referred to as “Person” within the meaning of DTAA. Whether such an entity will qualify as a “Person” within the meaning of tax treaty will be determined normally by reference to the law of incorporation of such entity and any other external material to determine if it has a status of ‘person’.
We recommend that an entity having any kind of business operations in India, constitution whereof is not explicitly referred to in a tax treaty should beforehand get a legal opinion from a qualified legal practitioner/tax practitioner about whether it will be covered within the ambit of “Person”, whether any advance ruling could be obtained and it should suitably devise its entry strategies or business operations in India.
For other important topics such as taxability of different types of income in India, contesting a tax litigation, tax notice and strategies as also on various topics pertaining to commercial litigation and arbitration in India, you are requested to visit https://rdlawchambers.com/research-articles/
*The content of this article is intended to provide general information. No reader or user should act or refrain from acting on the basis of the information written above without first seeking legal advice from a qualified law practitioner.
[iii] [2010] 38 SOT 7 (Mum)