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NRIs Returning to India

Asked by : Pradeep Reddy, Trading Advisor, UBS
Industry : NRI
Functional Area : India
Activity: Question posted: 06 05 2008 01:50:29 +0000, 1 answers, 864 views, last activity 07 06 2010 20:18:08 +0000
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  Answered by     Sachin Saxena, Assistant Manager - F&A, Infor Global Solutions  | 06 12 2008 03:47:59 +0000
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There is always a trade-off between efficiency, equity and pragmatic implementation concerns, on one side, and the impact of tax policies on incentives to invest productively, create jobs and contribute to growth, on the other. This concern dictates that the authorities concerned take a re-look at India's double taxation avoidance agreements with various countries.

THE Authority for Advanced Ruling recently delivered a landmark decision in the case of Fidelity, an American-based foreign institutional investor (FII), which sought its views on the tax liabilities, if any, arising from portfolio investments in India.

The FII was acting through Standard Chartered Bank, its domestic custodian, with the intention of complying with SEBI guidelines. Stanchart receives the dividend interest and capital gains arising out of investments by the FII in India. As per Article 7 of the Indo-US Double Taxation Avoidance Agreement, the profits of an FII arising from business shall be taxable in India only if it has a Permanent Establishment (PE) in this country.

The AAR ruled that the FII came to India to do business in the stock market and not to earn capital gains. There are well-defined parameters to judge whether an activity results in business or speculation or capital gains. The AAR considered a large number of Supreme Court rulings on the issue and decided that Fidelity was engaged in the share market business. Such business profits can be taxed if there is a PE in India.

The AAR ruled that Standard Chartered Bank is an independent agent of Fidelity and cannot be considered a PE. The result was that the large gains made by Fidelity in the booming Indian stock market were considered business profits not liable to taxation in India.

There has been no reaction from the Revenue Department to this landmark ruling. India is the third largest recipient of FII inflows, after South Korea and Taiwan, in the emerging market category.

There are 609 FIIs registered with SEBI. This calendar year, total inflows have crossed the $6-billon mark. Expectedly, most of the FIIs do business through domestic custodians to avoid being taxed through a PE.

Following the controversy over investments routed through Mauritius, the UPA Government's Common Minimum Programme promised to look into Double Taxation Avoidance Agreements to prevent abuse of treaty provisions through round-tripping of funds, treaty-shopping and thin capitalisation.

The Finance (No 2) Act, 2004 abolished the long-term capital gains tax and reduced the short-term capital gains tax to 10 per cent. Mauritius responded by promising to amend its tax laws to prevent abuse.

The present ruling of the AAR hits the Revenue Department's efforts to garner tax on business profits of multinationals. Despite the wide definition of a PE in theIncome-Tax law, the AAR has held that the domestic custodian does not amount to a PE. The ruling will have far-reaching effects and is bound to affect revenue mobilisation.

Treaty provisions and Royalty

India's treaty provisions are not exactly similar, and vary from country to country. The liaison office in India of a foreign entity was considered a PE on the basis of provisions in the DTAA between India and the UAE. On the other hand, freight income earned in India by a non-resident shipping company registered in Malta was held not liable to Indian tax by virtue of Article 8 of the Indo-Malta DTAA.

The country manager in India of Sutron Corporation, US, was held to amount to a PE and was considered a paid agent with a fixed place, giving rise to business connections and attracting tax on profits arising from supply of equipment in the US. Article 7 of the Indo-US DTAA was successfully invoked in this case.

In respect of a Singapore company rendering services by way of market research, it was held that the payments made by the Indian member of the group company will suffer tax deduction at source and that an element of profit is not an essential ingredient of a receipt to be chargeable to tax.

Article 12 of India's treaty with Singapore exempts an Indian company from TDS obligations if the Singapore company does not have a fixed place in India and does not `make available' technical knowledge, know-how, processes, etc.

The mere provision of a facility, such as the use of leased lines, will not amount to `making available' the technology to the Indian company. India's treaty with Singapore is now being re-negotiated to do away with this clause.

There is need for clarity on royalties. Payments made to foreign parties for logging on to the computer to obtain an online report from a foreign research agency are now sought to be taxed in India on the ground that the payment is for information concerning industrial, commercial or scientific experience and is covered by the definition of `Royalty' under the Indo-US treaty.

The user of the database is supposed to enter into a user licence agreement. What is supplied is specialised proprietary data. The latest ruling of the Supreme Court in the TCS case may probably upset all calculations of revenue with regard to royalty itself.

The Supreme Court has pointed out that in the case of shrink-wrapped products, the copyright in the programme remains with the originator and there is no transfer of copyright involved.

These are issues that have evoked divided opinion in countries such as the US, Australia and India. Indian tax law and its DTAAs will require revision.

Tax competition

The latest World Development Report refers to the concern often expressed about whether competition for investment among countries is leading to a race to the bottom in corporate tax rates.

A meta-analysis of 25 studies that looked at the effect of tax rates on FDI with reference to the US concluded that a 1 per cent point increase in tax rates reduces FDI by about 3.3 per cent.

International tax competition, says the WDR, can have both positive and negative effects on welfare and efficiency and it is not immediately clear that it will make countries worse off. Although corporate income-tax is often seen a tax on capital, it is now seen that labour bears a large part of the burden of corporate tax and such share is higher when capital is more mobile.

In fact, the WDR suggests that labour may bear a greater part of the burden in developing countries than it does in the US. As capital becomes more mobile, and multinationals more sophisticated in their tax minimisation strategies, the share of corporate income-tax falling on labour will likely increase.

There is always a trade-off between efficiency, equity and pragmatic implementation concerns, on one side, and the impact of tax policies on incentives to invest productively, create jobs and contribute to growth, on the other.

Here is a challenge for the Ministry of Finance to take up in the next Budget.

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