BASIC CONCEPTS OF

INTERNATIONAL TAXATION

-By Monica Pradyot

Assistant Prof.
SOL, UPES
TAX HAVENS:
 Tax havens are generally countries or places that offers low or no taxes to allow
outsiders to easily set up businesses there.
 tax havens offer super-wealthy individuals a great opportunity to keep their money in
offshore accounts for tax avoidance and other purposes.
 Countries like Panama, the Netherlands, Malta, Switzerland, Luxembourg, Singapore,
Hongkong and Cayman Island.
 Eg. A shell company is a legal entity created in a tax haven.
BEPS:

 Another tax havens strategies.

 Base Erosion and Profit Shifting (BEPS) refers to corporate tax
planning strategies used by multinationals to “shift” profits from higher-tax
jurisdictions to lower-tax jurisdictions, thus “eroding” the “tax-base” of the
higher-tax jurisdictions.
 OECD define BEPS strategies as “exploiting gaps and mismatches in tax rules”.
 DOUBLE TAXATION AVOIDANCE
AGREEMENT
 DTAA is a tax treaty signed between India and another country, so that taxpayers can avoid paying
double taxes on their income earned from the source country as well as the residence country.
 The Fiscal Committee of OECD in the Model Double Taxation Convention on Income and
Capital, 1977,defines double taxation as:
‘The imposition of comparable taxes in two or more states on the same tax payer in respect of the
same subject matter and for identical periods’.
 It is essentially a bilateral agreement and their basic objective is to promote and foster economic
trade and investment between two Countries by avoiding double taxation.
 Example: If a person aims to do business in a foreign country, he/she may end up paying income
taxes in both cases, i.e. the country where the income is earned and the country where the
individual holds his/her citizenship or residence.
 DOUBLE TAXATION AVOIDANCE
AGREEMENT
 DTAAs are negotiated under public international law and governed by the
principles laid down under the Vienna Convention on the Law of Treaties.
 Central Government, acting under Section 90 of the Income Tax Act, has been
authorized to enter into double tax avoidance agreements (hereinafter referred to
as tax treaties) with other countries.
 Types of DTAA:
1. Comprehensive
2. Limited
 DOUBLE TAXATION AVOIDANCE
AGREEMENT
 Comprehensive DTAAs are those which cover almost all types of incomes covered by any
model convention. Many a time a treaty covers wealth tax, gift tax, surtax. Etc. too.
 Limited DTAAs are those which are limited to certain types of incomes only, e.g. DTAA
between India and Pakistan is limited to shipping and aircraft profits only.
 For example under DTAA between Indian and Germany, tax on interest is specified @
10% whereas under Income Tax Act it is 20%. Hence, one can follow DTAA and pay tax
@ 10%. Further if Income tax Act itself does not levy any tax on some income then Tax
Treaty has no power to levy any tax on such income. Section 90(2) of the Income Tax Act
recognizes this principle.
Ishikawajma Harima Heavy Industries Limited
vs. Director of Income Tax, Mumbai Dt. (2007)
 Facts of the case:
 In this case, the company was incorporated in Japan. It formed a consortium with
four others and entered into an agreement with an Indian firm, Petronet LNG Ltd
for setting up liquefied natural gas receiving and degasification facility in Gujarat.
Each member of the consortium was to receive separate payments. The contract
involved offshore supply, offshore services, onshore supply, onshore services,
construction and erection. The price was payable for offshore supply and services
in US dollars, whereas that of onshore supply as also services, construction and
erection partly in dollars and partly in rupees.
 The dispute arose whether the amounts received by the Japanese corporation from Petronet for
offshore supply of equipment and materials were liable to tax under the Indian Income Tax Act
and the India-Japan double taxation avoidance treaty. The Authority for Advance Rulings
(Income Tax) ruled that the Japanese firm was liable to pay direct tax, even under the treaty.
Hence the firm moved the Supreme Court. It argued that the transactions occurred outside the
country.
 The contract was a divisible one and therefore it did not have any liability to pay tax in regard to
offshore services and offshore supply. The government, on the other hand, contended that the
contract was a composite one. The supply of goods, whether offshore or onshore, and rendition
of service were attributable to the turnkey project.
 The Supreme Court ultimately held that the tribunal was wrong and set aside its order. While
the Japanese firm got relief in the case, the judgment is notable for the principles it has laid
down to be followed in such cases. Regarding offshore supply of equipment and materials,
the Supreme Court laid down nine guidelines in the context of this case, but has general
application.
SC nine Guidelines:
1. Only such part of the income as attributable to the operations carried out in this country can
be taxed here.
2. If all parts of the transfer of goods as well as the payment are carried on outside the country,
the transaction cannot be taxed in India.
3. The principle of apportionment, wherein the territorial jurisdiction of a particular state
determines its capacity to tax an event, has to be followed.
4. The fact that a contract was signed in India is of no material consequence, if the activities in
connection with the offshore supply were outside the country and therefore cannot be deemed
to accrue or arise in this country.
5. The court further clarified that there was a distinction between a business connection and a
permanent establishment. The latter is for the purpose of assessment of income of a non-
resident under a double taxation avoidance agreement while the former is for the application of
the Income Tax Act.
Contd…..
As far as offshore services are concerned, the court stated that sufficient territorial nexus between the
rendition of services and territorial limits of India is necessary to make the income taxable. The entire
contract would not be attributable to the operations in India. The test of residence, as applied in the
international law also, is that of the tax payer and not that of the recipient of such services.
6. Regarding Section 9(1)(vii)(c) of the Income Tax Act, dealing with income by way of fees for technical
services by a non-resident, the Supreme Court clarified that the services should not only be utilized within
India but also be rendered in India or have such a “live link” with India that the entire income became
taxable here.
7. Applying the principle of apportionment to composite transactions which have some operations in one
territory and some in others, it is essential to determine the taxability of various operations. The location of
the source of income within India would not render sufficient nexus to tax the income from that source.
8. There exists a difference between the existence of a business connection and the income accruing or
arising out of such business connection.
9. For the profits to be ‘attributable directly or indirectly’, the permanent establishment must be involved in
the activity giving rise to the profits.
RELIEF UNDER DTAA:

 Generally, income is taxable on two basis viz. i) Source of income basis and ii)
Residential Status Basis, which results into double taxation of same income of the
person.
 In order to prevent this hardship or to avoid double taxation, relief is provided to
the tax-payer.
1. Bilateral Relief
2. Unilateral Relief
BILATERAL RELIEF UNDER DTAA:
In this, government of two countries enters into an agreement (known as ‘treaties’) to provide
relief against double taxation of same income. The relief is granted on the basis of terms of such
agreement. Generally, such agreement provides relief through following methods:
1. Exemption
Under this method, the residence country exempts the income arising in the source country.
Income would be chargeable to tax only in source country. This is known as complete exemption
methods and is sometimes followed in respect of the profits attributable to foreign permanent
establishments or income from immovable property.
2. Credit
Under this method, the residence country exempts the taxes paid in the source country. For
residence country, the loss of revenue is generally lower in credit method, therefore generally most
DTTAs relieve double taxation through credit method.
UNILATERAL RELIEF UNDER
DTAA:
 This is depending on bilateral activity of both the countries. However, no country
will have such an agreement with every country in the world. In order to avoid
double taxation in such cases, country of residence itself may provide relief on
unilateral basis. In India, relief for avoidance of double taxation is provided in
both ways.
TRANSFER PRICING:
 The increasing participation of multinational groups in economic activities in the
country has given rise to new and complex issues emerging from transactions entered
into between two or more enterprises belonging to the same multinational group. The
profits derived by such enterprises carrying on business in India can be controlled by
the multinational group, by manipulating the prices charged and paid in such intra-
group transactions, thereby, leading to erosion of tax revenues.
 In other words, the course of business between a resident person and an associated
non- resident or not ordinarily resident person, is so arranged that the resident makes
either no profit or less than the ordinary profit in that business. Such an arrangement
would deprive that Indian revenue of the tax which would otherwise be payable by the
resident.
TRANSFER PRICING:
 With a view to provide a statutory framework which can lead to computation of
reasonable, fair and equitable profits and tax in India, in case of such multinational
enterprise, new set of special provisions relating to avoidance of tax have been introduced
under chapter X in the Income tax Act. Accordingly, the Finance Act, 2001 introduced law
of transfer pricing in India through Sections 92 to 92F of the Income Tax Act, 1961.
 These provisions relate to computation of income from international transaction having
regard to arm’s length price, meaning of associated enterprises, meaning of
international transaction, determination of arm’s length price, keeping and
maintaining of information and documents by persons entering into international
transaction, furnishing of a report from an accountant by persons entering into such
transactions.
ARM’S LENGTH PRICE:

 Arm’s length price means

(i) a price which is applied or proposed to be applied in a transaction
(ii) between persons other than associated enterprises (i.e., unrelated person, resident
or non-resident),
(iii)in uncontrolled conditions.
ASSOCIATED ENTERPRISES:
 Associated Enterprises has been defined in Section 92A of the Act. It prescribes that
“associated enterprise”, in relation to another enterprise, means an enterprise—
(a) Which participates, directly or indirectly, or through one or more intermediaries, in the
management or control or capital of the other enterprise; or
(b) In respect of which one or more persons who participate, directly or indirectly, or through
one or more intermediaries, in its management or control or capital, are the same persons
who participate, directly or indirectly, or through one or more intermediaries, in the
management or control or capital of the other enterprise.
 NOTE: The basic criterion to determine an AE is the participation in management, control
or capital (ownership) of one enterprise by another enterprise whereby the participation
may be direct or indirect or through one or more intermediaries, control may be direct or
indirect.
DEEMED ASSOCIATED ENTERPRISES:

 As per Section 92A(2), two enterprises shall be deemed to be associated enterprises if,
at any time during the previous year,—
(a) one enterprise holds, directly or indirectly, shares carrying not less than 26% of the
voting power in the other enterprise; or
(b) any person or enterprise holds, directly or indirectly, shares carrying not less than 26%
of the voting power in each of such enterprises; or
(c) a loan advanced by one enterprise to the other enterprise constitutes not less than 51%
of the book value of the total assets of the other enterprise; or
(d) one enterprise guarantees not less than 10% of the total borrowings of the other
enterprise; or
DEEMED ASSOCIATED ENTERPRISES:

e) more than half of the board of directors or members of the governing board, or one or
more executive directors or executive members of the governing board of one enterprise,
are appointed by the other enterprise; or
(f) more than half of the directors or members of the governing board, or one or more of
the executive directors or members of the governing board, of each of the two enterprises
are appointed by the same person or persons; or
g) the manufacture or processing of goods or articles or business carried out by one
enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks,
licenses, franchises or any other business or commercial rights of similar nature, or any
data, documentation, drawing or specification relating to any patent, invention, model,
design, secret formula or process, of which the other enterprise is the owner or in respect
of which the other enterprise has exclusive rights; or
DEEMED ASSOCIATED ENTERPRISES:

(h) 90% or more of the raw materials and consumables required for the manufacture or
processing of goods or articles carried out by one enterprise, are supplied by the other
enterprise, or by persons specified by the other enterprise, and the prices and other
conditions relating to the supply are influenced by such other enterprise; or
(i) the goods or articles manufactured or processed by one enterprise, are sold to the other
enterprise or to persons specified by the other enterprise, and the prices and other
conditions relating thereto are influenced by such other enterprise; or
(j) where one enterprise is controlled by an individual, the other enterprise is also
controlled by such individual or his relative or jointly by such individual and relative of
such individual; or
DEEMED ASSOCIATED ENTERPRISES:

(k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is
controlled by a member of such Hindu undivided family or by a relative of a member of
such Hindu undivided family or jointly by such member and his relative; or
(l) where one enterprise is a firm, association of persons or body of individuals, the other
enterprise holds not less than ten per cent interest in such firm, association of persons or
body of individuals; or
(m) there exists between the two enterprises, any relationship of mutual interest, as may
be prescribed.
 COMPUTATION OF ARM’S LENGTH PRINCIPLE:

 The arm's length price in relation to an international transaction or specified domestic

transaction shall be determined by any of the following methods:
 Transaction Based Methods
a. comparable uncontrolled price method;
b. resale price method;
c. cost plus method;
 Profit Based Methods
d. profit split method;
e. transactional net margin method;
f. such other method as may be prescribed by the Board.
 As per sec. 92C(3), where during the course of any proceeding for the assessment of income, the
Assessing Officer is, on the basis of material or information or document in his possession, of the
opinion that:
(a) the price charged or paid in an international transaction or specified domestic transaction has not
been determined in accordance with above provision; or
(b) any information and document relating to an international transaction or specified domestic
transaction have not been kept and maintained by the assessee in accordance with the provisions
contained in sec. 92D(1) and the rules made in this behalf; or
(c) the information or data used in computation of the arm's length price is not reliable or correct; or
(d) the assessee has failed to furnish, within the specified time, any information or document which he
was required to furnish by a notice issued u/s 92D(3),
 the Assessing Officer may proceed to determine the arm's length price (in accordance with above
provisions) in relation to the said international transaction or specified domestic transaction, on the
basis of such material or information or document available with him.
 However, an opportunity shall be given by the Assessing Officer by serving a notice calling upon the
assessee to show cause, on a date and time to be specified in the notice, why the arm's length price
should not be so determined on the basis of material or information or document in the possession of
the Assessing Officer.