TREATY SHOPPING-

ECONOMIC ANALYSIS

PROJECT SUBMITTED TO Mr. RANA NAVNEET ROY.

(Faculty of Principles of Taxation Law)

PROJECT SUBMITTED BY
Onindya Mitra
Roll No. 194
Section- B
V- SEMESTER

PROJECT SUBMITTED ON
21th August, 2017

HIDAYATULLAH NATIONAL LAW UNIVERSITY RAIPUR

UPARWARA POST, ABHANPUR, NEW RAIPUR

 DECLARATION

I HEREBY DECLARE THAT THE PROJECT WORK ENTITLED “TREATY SHOPPING-

ECONOMIC ANALYSIS” SUBMITTED TO HIDAYATULLAH NATIONAL LAW UNIVERSITY,
RAIPUR, IS A RECORD OF AN ORIGINAL WORK DONE BY ME UNDER THE GUIDANCE OF Mr. RANA
NAVNEET ROY.

……………….
ONINDYA MITRA

I
 ACKNOWLEDGMENTS

THANKS TO THE ALMIGHTY WHO GAVE ME THE STRENGTH TO ACCOMPLISH THE PROJECT

WITH SHEER HARD WORK AND HONESTY. THIS HAS BEEN MADE POSSIBLE DUE TO THE GENEROUS CO-
OPERATION OF VARIOUS PERSONS. TO LIST THEM ALL IS NOT PRACTICABLE, EVEN TO REPAY THEM IN
WORDS IS BEYOND THE DOMAIN OF MY LEXICON.

THIS PROJECT WOULDN’T HAVE BEEN POSSIBLE WITHOUT THE HELP OF MY TEACHER, Mr.

RANA NAVNEET ROY, WHO HAD ALWAYS BEEN THERE AT MY SIDE WHENEVER I NEEDED SOME HELP

REGARDING ANY INFORMATION. SHE HAS BEEN MY MENTOR IN THE TRUEST SENSE OF THE TERM .

THE ADMINISTRATION HAS ALSO BEEN KIND ENOUGH TO LET ME USE THEIR FACILITIES FOR

RESEARCH WORK. I THANK THEM FOR THIS.

…………………..
ONINDYA MITRA
HNLU, RAIPUR

II
 CONTENTS

DECLARATION ......................................................................................................................................I

ACKNOWLEDGEMENTS............................................................................................................ II

INTRODUCTION .................................................................................................................................. 1

RESEARCH METHODOLOGY................................................................................................. 3

1. TREATY SHOPPING .................................................................................................................... 4

1.1 OECD’S ON TREATY SHOPPING .......................................................................... 5

2. STEPS TAKEN TO CHECK ROUND TRIPPING OF MONEY AND

TAX EVASION......................................................................................................................................... 8

3. LIMITATIONS ON BENEFITS............................................................................................. 9

4. VIEWS OF COURTS .................................................................................................................. 11

CONCLUSION ...................................................................................................................................... 13

BIBLIOGRAPHY/WEBLIOGRAPHY ............................................................................... 14
 INTRODUCTION

Post economic liberalisation, India is keen to receive huge capital inflows but at the same time
does not want to lose the grip on its share of taxation from the income generated in India. In
order to avoid double taxation and to attract more investments, India has entered into double tax
avoidance agreements (tax treaties) with several countries. As per the Income Tax Act, 1961, if a
tax treaty applies to a taxpayer, provisions of the Act shall apply to the extent they are more
beneficial to that taxpayer. However, tax treaties have been misused by the taxpayers for tax
avoidance/evasion purpose. One such example is interposing a company in the low tax
jurisdiction only for the purpose of availing the tax treaty benefit. In other words, it is called
treaty-shopping.1

Typically, the treaty-shopping is countered under the Act by General Anti-Avoidance Rules or
Specific Anti-Avoidance Rules. However, under the tax treaties, the same has been countered by
anti-treaty-shopping provisions like limitation of benefit (LOB) clause and/or beneficial
ownership provisions. Generally, the LOB clause restricts availing of the treaty benefits by a
conduit entity or an entity which has been formed for the purposes of treaty-shopping. It also
restricts entities who attempt to claim double non-taxation; for example, LOB clause under
India-Singapore tax treaty. In other words, LOB clause limits the benefits of tax treaties to
legitimate residents of the other country. Basically, LOB clause is designed to test the substance
of the claimant to the tax treaty. Accordingly, it prevents treaty-shopping and tax avoidance.2

The LOB concept in tax treaties was introduced by the US while it was non-existent in OECD as
well as UN Model Conventions. The US Model Tax Convention (of 1996 and 2006) has detailed
LOB provisions in Article 22 of the Convention. In September 1989, India entered into a tax
treaty with the US which incorporated the LOB clause for the first time in Indian treaties
consisting of various objective tests.

1
Punit Shah, Tackling Treaty Shopping, The Financial Express, at:
http://www.financialexpress.com/archive/tackling-treaty-shopping/1227824/, (last seen on 13/8/16).
2
See supra note 1.

1
In January 2003, the report of the working group in India on non-resident taxation recommended
that in future negotiations, provisions relating to anti-abuse/LOB may be incorporated in the tax
treaties. In last decade, India has entered into several tax treaties and most of them include the
LOB clause; for example, Singapore, the UK, Poland, Malaysia, Switzerland, Luxembourg,
Saudi Arabia, UAE, etc. A few Indian tax treaties have a specific provision that the anti-abuse
provisions in the domestic law may override the tax treaties; for example, Luxembourg and
Saudi Arabia. Whereas India-Namibia tax treaty provides novel and unique LOB clause wherein
contracting state can tax income which is not chargeable to tax in other contracting state being
foreign source income.

The LOB clause in some of the tax treaties states that benefit of the tax treaty shall not be
available to a resident of contracting state, or with respect to any transaction undertaken by such
a resident, if the main purpose or one of the main purposes of the creation or existence of such a
resident or of the transaction undertaken by him was to obtain benefits under the tax treaty; for
example, the UK, UAE, Mexico, Kuwait, etc.

2
RESEARCH METHODOLOGY OF THE STUDY

This project is descriptive and analytical in nature. The project is mainly based on secondary
sources. This method does not include any field work and mainly depend on electronic Books,
Web Pages and other references as guided by faculty are primarily helpful for the completion of
this project.

OBJECTIVES

Set in the above perspective or background, the broad objectives are:

 To study treaty shopping with reference to India


 To study the relation between treaty shopping and Limitations of Benefits

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 1. TREATY SHOPPING

It is a mechanism in which a company seeks benefits of tax treaties of two contracting states (say
A and B) while having its parent company in third jurisdiction (say C). In simple words, when a
third-country resident derives benefits from a treaty intended to serve only the interests of
residents of the two treaty partners, it is known as treaty shopping. The roots of the Treaty
shopping are in the inconsistencies among international tax regimes contributing as a medium of
tax evasion.

The practice of structuring a multinational business to take advantage of more favorable tax
treaties available in certain jurisdictions. A business that resides in a home country that doesn't
have a tax treaty with the source country from which it receives income can establish an
operation in a second source country that does have a favorable tax treaty in order to minimize
its tax liability with the home country. Most countries have established anti-treaty shopping laws
to circumvent the practice.3It are interposing a company in the low tax jurisdiction only for the

purpose of availing the tax treaty benefit. In other words, it is called treaty-shopping.4

The term "treaty shopping" stems from the practice of third-country residents searching for a
country that has (1) a favorable income tax treaty with the United States and (2) attractive
internal tax laws.5 Once the third-country resident investor has found such a country, income
from the United States may be channeled through a corporation organized under the laws of that
country. Thus, by redirecting his income flow through a tax treaty country, an investor may
significantly reduce the tax on his income.6

In addition, the laws of many tax treaty countries set low tax rates or, in some cases, a rate of
zero on dividends or interest paid to nonresident investors." By channeling funds through the

3
Business Dictionary, Treaty Shopping, at: http://www.businessdictionary.com/definition/treaty-shopping.html,
(last seen 13/8/16).
4
See supra note 2.
5
Kenneth A. Grady, Income Tax Treaty Shopping: An Overview of Prevention Techniques, 5 Nw. J. Int'l L. & Bus.
626 (1983-1984)
6
SENATE FOREIGN RELATIONS COMM., REPORT ON THE INCOME TAX CONVENTION BETWEEN LUXEMBOURG
AND THE UNITED STATES, S. EXEC. REP. No. 10, 88th Cong., 2d Sess. 12, reprinted in 2 TAX TREATIES (CCH) 1 5348
at 5330.

4
country with the most favorable combination of tax treaty terms and internal tax laws (hence the
"shopping" label), a nonresident alien investor is able to avoid most or all tax on the source
income.7 Treaty shopping often encompasses instances of tax evasion as well as tax avoidance. 8
Typically, the treaty-shopping is countered under the Act by General Anti-Avoidance Rules

1.1 OECD’S ON TREATY SHOPPING: TREATY ABUSE SITUATIONS 9

In 2013, the Organisation for Economic Co-operation and Development (OECD) and G-20
countries adopted a 15-point Action Plan on Base Erosion and Profit Shifting (BEPS). The
action plan aims to ensure that profits are taxed where the economic activities generating the
profits are performed and where value is created. As a result, the plan provides for 15 actions to
be delivered by 2015 on various issues. As part of this plan, the OECD recently issued a report,
Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, as part of Action 6
of the BEPS action plan.

The report includes proposed changes to the OECD Model Tax Convention, which are intended
to prevent treaty abuse, and commentary on the changes. The OECD expects to work to address
certain other parts of the BEPS Action Plan that are interrelated with this topic that will influence
the final proposals. Even though the OECD's work is not finished, the draft proposals provide
useful insights into how the OECD aims to address treaty abuse issues.

The report includes a number of recommendations to check treaty abuse under different
situations. These broadly include:

7
See P. POSTLEWAITE & M. COLLINS, INTERNATIONAL INDIVIDUAL TAXATION 226-27 (1982).
8
INTERNATIONAL TAX AVOIDANCE AND EVASION 19-20 (1981) (compendium of documents from Colloquy of Mar.
5-7, 1980)
The focus of this Comment is on avoidance of United States income taxes. A third-country resident who abuses
a tax treaty also may be evading or avoiding the taxes of the other contracting state. It is not easy to define
what constitutes illegal evasion and legal avoidance with respect to income taxes of United States treaty
partners. For example, Professor Huiskamp of Erasmus University Rotterdam states: But what is "illegal"? This
depends on the law-the national laws. What proves to be against the law in country A, may be perfectly lawful
in country B. So internationally we cannot identify a transaction, a treatment, a circumstance that is from an
international point of view illegal.
9
See more at: http://www.thetaxadviser.com/issues/2015/mar/mehta-mar15.html#sthash.oA4lMgzd.dpuf

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 1. The title and the preamble of a tax treaty should confirm that the purpose of the tax treaty
is not intended to generate double nontaxation;
2. Incorporating a specific anti-abuse rule in the treaty in the form of a limitation-of-benefits
(LOB) rule;
3. Incorporating a general anti-abuse rule that prevents the use of the tax treaty if one of the
principal purposes of the transaction or the arrangement is to obtain the tax treaty benefit,
unless it could be established that applying the treaty would be in accordance with the
objectives of the treaty.

Limitation-of-Benefits Rule: The specific LOB rule proposed to be included in the convention
is similar to the one that exists in the Model Tax Convention of the United States and is found in
most tax treaties that the United States has entered into with other jurisdictions. This rule
provides a set of objective tests that have to be satisfied as a primary condition before applying
the tax treaty to a given transaction. Such a specific rule will address a large number of treaty-
shopping situations based on the legal nature of, ownership in, and general activities of taxpayers
intending to take advantage of the tax treaty.

General Anti-Abuse Rule: In addition to the specific LOB rule, the OECD has proposed to add
a more general anti-abuse rule to address treaty-avoidance cases, including treaty-shopping
situations that are not covered by the specific LOB rule.

The proposed Paragraph 7 providing for the general anti-abuse rule reads as follows:

7. Notwithstanding the other provisions of this Convention, a benefit under this Convention shall
not be granted in respect of an item of income or capital if it is reasonable to conclude, having
regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal
purposes of any arrangement or transaction that resulted directly or indirectly in that benefit,
unless it is established that granting that benefit in these circumstances would be in accordance
with the object and purpose of the relevant provisions of this Convention.

The general anti-abuse rule proposed in the Model Tax Convention is consistent with the
OECD's views expressed in the commentary to Article 1 (Persons Covered) of the Model

6
Convention. According to that guidance, the benefits of a tax treaty should not be available
where one of the principal purposes of the transaction(s) or arrangement(s) is to secure a benefit
under a tax treaty that would be contrary to the tax treaty's objectives. The proposed Paragraph 7
incorporates the principles the OECD already expressed into the tax treaty itself to allow
countries to address cases of improper use of the tax treaty even if the domestic tax law of the
country does not permit this treatment.

Where tax treaties are amended and the general anti-abuse rule on the lines of Paragraph 7 is
included, there may not be a direct conflict as long as the principles behind the general anti-
abuse rule under domestic tax law or judicial doctrines conform to the principles behind
Paragraph 7. It is only when the domestic tax laws of a country do not include a general anti-
abuse rule or the judicial doctrine or principles are somewhat less restrictive or do not apply in
the context of tax treaties that the general anti-abuse rule under the tax treaty may give specific
legal recognition to the principles of treaty abuse.

Benefits for India:

1. Preventing Double Taxation: this will avoid double taxation of same income in two countries,
dealing with the black money menace.

2. Increase in investment: there will be increase of FDI through legitimate means with our tax
partners.

3. Curbing Tax evasion: help in ensuring that value-added taxes are collected in a country where
the consumer is located; increasing tax base.

On a whole, implementing OECD’s BEPS is win-win situation for India as well as for its partner
countries. While LOB provision will serve as deterrent to MNCs indulging in tax evasion, its
implementation along with PPT test may create strong regulatory atmosphere discouraging
foreign trade and investment and preventing accrual of tax agreement entitlements difficult even
for genuine taxpayers

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India has incorporated LOB with tax treaties signed with usa and singapore, its extension with
mauritius will cause many companies who make investments from group holding companies
within low tax jurisdictions to fail this test, thus benefiting india by creating a stronger regulatory
regime and ensuring increased tax revenues flows and better tax compliance.

2. STEPS TAKEN TO CHECK ROUND TRIPPING OF MONEY AND

TAX EVASION

 Income Tax Overseas Units set up in Mauritius, Singapore, Cyprus, France, Germany,
Japan, Netherlands, the UAE, the UK and the US to unearth black money

 Section 94A was introduced in the Income Tax Act in 2011, allowing India to notify a
country as non-cooperating if there is lack of effective exchange of information

 Negotiation of tax treaties with other countries and renegotiation of existing treaties to
allow for better exchange of information and check tax evasion

 General Anti-Avoidance Rules notified for those foreign investors who avail of benefits
under treaties and the tax benefit in an arrangement is more than Rs 3 crore

 Directorate of Criminal Investigation was created in 2011 to gather intelligence and
investigate cases including tax information received from other countries

 To prevent shifting of profits out of India and erosion of tax base, select international
transactions are analyzed every year in accordance with transfer pricing provisions.10

10
Vrishti Benival, End of Treaty Shopping, at: http://www.business-standard.com/article/opinion/end-of-tax-
treaty-shopping-for-india-113121500670_1.html, (last seen on 12/8/16).

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 3. LIMITATIONS ON BENEFITS

Limitation Of Benefit (LOB) refers to the rules that are put in place to counter the menace of
treaty-shopping/ Such rules restrict availing of the treaty benefits by a conduit (compromised)
entity formed for the purposes of treaty-shopping {they call it a letterbox entity}. It also restricts
entities who attempt to claim double non-taxation; for example, LOB clause under India-
Singapore tax treaty.11

Recent treaties of certain countries have contained an article intended to prevent "treaty
shopping," which is the inappropriate use of tax treaties by residents of third states. These
limitation on benefits articles deny the benefits of the tax treaty to residents that do not meet
additional tests. Limitation on Benefits articles vary widely from treaty to treaty, and are often
quite complex.12 The treaties of some countries, such as the United Kingdom and Italy, focus on
subjective purpose for a particular transaction, denying benefits where the transaction was
entered into in order to obtain benefits under the treaty. Other countries, such as the United
States, focus on the objective characteristics of the party seeking benefits.13

Anti-Avoidance Rules. However, under the tax treaties, the same has been countered by anti-
treaty-shopping provisions like limitation of benefit (LOB) clause and/or beneficial ownership
provisions. Generally, the LOB clause restricts availing of the treaty benefits by a conduit entity
or an entity which has been formed for the purposes of treaty-shopping. It also restricts entities
who attempt to claim double non-taxation; for example, LOB clause under India-Singapore tax
treaty. In other words, LOB clause limits the benefits of tax treaties to legitimate residents of the
other country. Basically, LOB clause is designed to test the substance of the claimant to the tax
treaty. Accordingly, it prevents treaty-shopping and tax avoidance. The LOB clause in the treaty
consists of various tests which need to be fulfilled in order to avail the treaty benefit; for
example, main purpose of transaction, bona-fide business activity, qualified person test, stock
exchange test, threshold for expenditure test, etc.

11
See, General Knowledge Today at: http://www.gktoday.in/blog/what-is-treaty-shopping/.
12
See, e.g., the Canada/U.S. 2007 protocol, supra, article 25, as an example of complexity.
13
See more at: http://www.thetaxadviser.com/issues/2015/mar/mehta-mar15.html#sthash.oA4lMgzd.dpuf

9
The LOB concept in tax treaties was introduced by the US while it was non-existent in OECD as
well as UN Model Conventions. The US Model Tax Convention (of 1996 and 2006) has detailed
LOB provisions in Article 22 of the Convention. In September 1989, India entered into a tax
treaty with the US which incorporated the LOB clause for the first time in Indian treaties
consisting of various objective tests.
In January 2003, the report of the working group in India on non-resident taxation recommended
that in future negotiations, provisions relating to anti-abuse/LOB may be incorporated in the tax
treaties. In last decade, India has entered into several tax treaties and most of them include the
LOB clause; for example, Singapore, the UK, Poland, Malaysia, Switzerland, Luxembourg,
Saudi Arabia, UAE, etc.

10
 4. VIEWS OF COURTS

Supreme Court in Azadi Bachao Andolan case14:

Treaty Shopping In Treaty shopping, a resident of a third country invests by taking advantage of
a fiscal treaty between India and another contracting state. This has greatly contributed in
encouraging FDI in the country but has been a medium of tax evasion. The Supreme Court has
also noted in the Azadi Bachao Andolan case that treaty shopping opportunities could be an
additional factor to attract such investments.

The roots of the Treaty shopping are in the inconsistencies among international tax regimes. If
there is a dissimilarity of tax systems, it can lead to distortion of investment flows.

The underlying principle of bilateral tax treaties, i.e. the principle of reciprocity is impeded when
a third-country resident derives benefits from a treaty intended to serve only the interests of
residents of the two treaty partners.

Treaty shopping can be controlled by introduction of a limitation of benefit clause (LOB) and
other clauses which limit the benefits to the residents of the two countries only. For instance, in
the India-Singapore treaty, pursuant to a Protocol in 2005, India provided for capital gains tax
exemption to a Singapore resident who sells shares of an Indian company. However, at the same
time the introduction of a limitation of benefit clause (LOB) deters treaty abuse.

The Andhra Pradesh HC, few days ago, in a significant judgment, ruled in favour of Sanofi,
holding that capital gains on indirect share transfers are not taxable under the Indo-France
DTAA. While doing so, HC has thumpingly re-affirmed the ratio laid down by Supreme Court in
Azadi Bachao Andolan15 . The HC division bench, while observing that developed countries
tolerate or even encourage unjustified treaty shopping for non-tax reasons, has further stated that
" Developing countries need foreign investments and treaty shopping opportunities could be an
additional factor to attract them. There are many principles in a fiscal economy which, though
14
Appeal (civil) 8163-8164 of 2003.
15
See supra note 14.

11
may facially appear inequitable, are tolerated in a developing economy in the interest of long-
term development."

12
 CONCLUSION

To conclude "Treaty shopping” refers to a situation whereunder a legal person, such as an

individual or a corporate entity, who is not entitled to the benefits of a tax treaty between two
countries, uses an intermediary entity that is entitled to such benefits to indirectly obtain those
benefits. This practice arises due to the non-alignment of taxation regimes of different countries.
Such improper use of tax treaties results in tax evasion on account of base erosion and profit
shifting (BEPS), which has negative repercussions for governments, individual tax payers as well
as honest businesses.

The BEPS initiative of the OECD nations hopes to address treaty shopping in the following
ways:
1- By establishing stricter purpose of establishment rules while setting up companies in order to
prevent shell corporations from taking advantage.
2- Limitation of benefits clause applied to various treaties to determine applicability of treaties to
international transactions.

The concern about treaty shopping has increased as modem developments in the practice of
international tax law have made the benefits of treaty shopping more available to sophisticated
investors. This increased concern has prompted several suggestions as to techniques for
curtailing treaty shopping, but none of these suggestions has yet emerged with a dominant
backing.

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 BIBLIOGRAPHY/WEBLIOGRAPHY

 PUNIT SHAH, TACKLING TREATY SHOPPING, THE FINANCIAL EXPRESS, AT:

HTTP://WWW.FINANCIALEXPRESS.COM/ARCHIVE/TACKLING-TREATY-
SHOPPING/1227824/.

 KENNETH A. GRADY, INCOME TAX TREATY SHOPPING: AN OVERVIEW OF
PREVENTION TECHNIQUES, 5 NW. J. INT'L L. & BUS. 626 (1983-1984)

SENATE FOREIGN RELATIONS COMM., REPORT ON THE INCOME TAX
CONVENTION BETWEEN LUXEMBOURG AND THE UNITED STATES, S. EXEC.
REP. NO. 10, 88TH CONG., 2D SESS. 12, REPRINTED IN 2 TAX TREATIES (CCH)
1 5348 AT 5330.

 P. POSTLEWAITE & M. COLLINS, INTERNATIONAL INDIVIDUAL TAXATION
226-27 (1982).

 INTERNATIONAL TAX AVOIDANCE AND EVASION 19-20 (1981)
(COMPENDIUM OF DOCUMENTS FROM COLLOQUY OF MAR. 5-7, 1980)

 HTTP://WWW.THETAXADVISER.COM/ISSUES/2015/MAR/MEHTA-
MAR15.HTML#STHASH.OA4LMGZD.DPUF

 VRISHTI BENIVAL, END OF TREATY SHOPPING, AT: HTTP://WWW.BUSINESS-
STANDARD.COM/ARTICLE/OPINION/END-OF-TAX-TREATY-SHOPPING-FOR-
INDIA-113121500670_1.HTML.

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