India and China are two of the world’s oldest civilizations. Cultural and economic relations between China and India date back to ancient times. Despite political issues over the years, the relations between India and China have steadily improved and strengthened in various fields of mutual interest. Indian Prime Minister Narendra Modi and Chinese President Xi Jinping have met a number of times this year for injecting impetus to the trade discussions and remove economic and trade obstacles.
With globalization and trade spanning across geographical frontiers, it becomes pertinent for both the countries to revamp and update the Double Taxation Avoidance Agreement (DTAA) between India and China of 1994 to inculcate measures to curb the tax leakages and augment tax transparency. In harmonization with the same, the Government of India had issued a press release declaring its approval for signing and ratification of a protocol amending the 1994 DTAA on 7 February 2018.
Previously, both India and China signed the OECD’s Multilateral Instrument (MLI) on 7 June 2017 which was developed to incorporate the treaty related Base Erosion and Profit shifting (BEPS) measures into the existing tax treaties. However, while signing the MLI, though India had covered the 1994 DTAA, China had excluded it from being modified by the MLI. Due to such mismatch, the MLI was not expected to modify the 1994 DTAA. However, it is now being amended through bilateral negotiations between these two countries. The Government of India has lately issued a press release on 26 November 2018, announcing and signing of the protocol revising the 1994 DTAA between India and China (the Protocol). Besides other changes, the Protocol updates the existing provisions for exchange of information to the latest international standards. Further, the Protocol incorporates changes required to implement treaty related minimum standards under the Action reports of BEPS Project, in which India had participated on an equal footing. Besides minimum standards, the Protocol brings in changes as per BEPS Action reports as agreed upon by the two sides.
Globalization has exacerbated the impact of gaps and frictions among countries’ tax systems and thus international cooperation on tax compliance has become a norm. Exchange of information contemplates about achieving global tax co-operation through the implementation of international tax standards and other instruments to put an end to bank secrecy and tackle tax evasion. Consequently, the OECD working with G20 countries in close cooperation with other stakeholders developed the Standard for Automatic Exchange of Financial Account Information in tax matters (the AEOI Standards). This AEOI Standard incorporates legal and technical requirement to provide for a complete and standardized model for automatic exchange of wide range of financial information, including information on assets and accounts held by banks, insurers and investment entities such as funds and certain trusts) for offshore tax residents to provide greater tax transparency, further enhancing international cooperation to ensure tax compliance.
The amended protocol may provide for a framework for the tax authorities to request and obtain information from their international partners on the offshore affairs of the taxpayers and information exchanged may serve as an effective tool to the Indian and Chinese tax authorities to grab hold of the unreported financial assets of the taxpayers in their respective jurisdictions.
Recognizing the need to level the playing field, all OECD and G20 countries have committed to consistent implementation in the areas of preventing treaty shopping, Country-by-Country Reporting, fighting harmful tax practices and improving dispute resolution.
Implementation of related minimum standards under BEPS may entail the amended India-China DTAA to embody an expressed statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements. Amended DTAA provisions would be devised in a vogue to circumvent granting of treaty benefits in inappropriate circumstances or resulting in double non-taxation.
The implementation of the minimum standard would require the language of the treaty to incorporate one of the following: (i) A combined approach consisting of an LOB and a principal purpose test (PPT) rule; (ii) A PPT rule alone; or, (iii) An LOB rule, supplemented by specific rules targeting conduit financing arrangements.
Also, international double taxation may result where two jurisdictions seek to tax the same transactions or activities. Whilst tax treaties directly resolve most such cases, international double taxation may remain where two jurisdictions disagree on the interpretation or application of a treaty provision. The mutual agreement procedure (MAP) article of a tax treaty accordingly provides a mechanism to resolve these cross-border tax disputes. Improving the effectiveness and timeliness of dispute resolution mechanisms is the aim of Action 14 of the BEPS Action Plan and is also part of the continuous efforts to enhance tax certainty. One of the elements of the Action 14 minimum standard requires jurisdictions to seek to resolve MAP in a timely, effective and efficient manner (within an average timeframe of 24 months).
The text of the protocol is not yet available in the public domain. Nevertheless, the amended India-China DTAA will indeed seek to counter harmful tax practices more effectively, taking into account transparency and substance.
The author of this blog is Akhil Sambhar, Tax Partner, EY India
The blog is co-authored by Pallavi Nair, Senior Consultant, EY India