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A Paper for

Live Webcast on International Taxation

Organised by
The Committee on International Taxation
The Institute of Chartered Accountants

Treaty Shopping, Anti Avoidance Provisions

Limitation of Benefits
6th September, 2013

CA Rashmin Sanghvi, CA Naresh Ajwani & CA Rutvik Sanghvi.

To All the participants in the Webcast Programme:

Dear friends,

Today we will discuss Treaty Shopping & Anti Avoidance

Rules including Limitation of Benefits. Appropriately this
subject has been kept almost towards the end of the programme
on International Taxation. Only when we have understood the
regular provisions of the treaties, can we understand tax
planning and anti-tax planning provisions.

For a clear understanding of this subject, it is necessary to

have a good idea of several concepts involved. Some of the
concepts are very briefly discussed below. All these concepts
may have been already discussed at length by other experts in
this programme. Hence we are only briefly narrating these
concepts. However, if any participant emails any query to the
institute; we will try to deal with the same in details at the time
of the webcast.

To make the programme more interesting for the

participants, we have anticipated some queries from the
participants. We will discuss these queries amongst ourselves as
a small panel discussion.

Some of the Concepts that form the basis of International

Taxation: (Paragraphs 1 to 9).

1. Double Taxation:
When the assessee resident in one country earns income
from another country, he is liable to income-tax in both the
countries. In other words: same income of the same assessee for
the same accounting year is exposed to income-tax leviable by
Page No. 2

two or more countries. Indian Income-tax is say, 30%. The

country of source may have a tax rate of say 40%. If the
assessees pays both the taxes, he will be left with an insignificant
amount and he would have no interest in International business.
Or, he may resort to tax evasion. To avoid such a situation,
countries come together and sign Double Tax Avoidance
Agreements (DTA).

2. COR / COS
The country in which the assessee is resident is called
Country of Residence (COR). The country from which the
income is earned is called Country of Source (COS). When the
assessee earns income from the country in which he is residing,
COR and COS are the same. This income is considered
Domestic Income. The Double Tax Avoidance Agreements
(DTA) do not apply to domestic income.

3. Elimination of Double Tax:

It is achieved when: COS agrees to levy a flat rate of
tax at a rate lower than the normal tax. COR agrees to give
credit for the taxes paid at COS. Alternatively, the COR may
exempt the foreign sourced income which has been taxed

4. Jurisdiction:
It is an accepted principle of International Taxation that the
COR has a right/ jurisdiction to tax the global income of its
resident assessees. This right is available to the COR by its
constitution and domestic legislation. The DTA does not grant
any rights for taxation to either country. Function of the DTA is
to try to eliminate double taxation.

5. Domestic Law Vs. DTA:

5.1 The DTA is an agreement between two Sovereign

governments. It is not a law passed by the Parliament. However,
once the agreement is signed and proper procedure is followed,
it acquires the authority of a law. Hence, while the tax payer is
not a party to the DTA, he is entitled to claim the relief under

5.2 It is important to draw the distinction between an

agreement between Sovereign Governments & the domestic
legislation. In simple terms: for the domestic law (for example,
Indian Income-tax Act), the parties may resort to technical
interpretation. They may fight over many small issues and go
right upto the Supreme Court. However, an agreement between
Sovereign Governments has to be looked at as a gentlemens
agreement. When two gentlemen sign an agreement, both of
Page No. 3

them have the intention to comply with the agreement in spirit

and in substance. And no intention to abuse the agreement. In
fact, many agreements even today are oral. When the parties
have Good faith in each other, they may not reduce the
agreements into writing. However, when it comes to Income-tax
Act, some people comply with the law in spirit and in substance.
Some people consider it their right to follow the law in letter
(form) and not to worry about the substance of the law.

5.3 Technically speaking, Vienna Convention on the Law of

Treaties applies to DTAs. As per the Vienna convention all the
parties to the Convention have to implement the convention/ DTA
in Good Faith and according to the intent & purpose of the
agreement. Technical/ smart interpretations contrary to the
purpose of the DTA are not acceptable.

5.4 Without commenting on either view, we can note that this

(Substance Vs. Form) is one of the important reasons for
substantial litigation. Tax payers and tax consultants try their
best to minimise the tax burden. Tax commissioners, try to
maximize the tax revenue. Result is litigation.

(Please note that differences of opinions and litigation are

common only in democratic countries. In Singapore, (generally)
nobody fights with the Income-tax department. There are other
Governments like China where the commissioners decision is

6. Tax Evasion / Avoidance / Planning:

We understand Tax Evasion. When a tax payer illegally
avoids tax by concealing income, inflating expenses or making
wrong claims, it is called tax evasion. When a tax payer follows
the law in substance and yet minimises his tax cost, it may be
called Tax Planning. For example, an industrialist establishes
the industry in backward area and claims deductions purposefully
granted by the parliament. It is tax planning.

When the tax payer resorts to smart interpretation of

the law, and claims tax reduction contrary to the intention of the
Parliament, it may be called Tax Avoidance. It is not illegal. And
yet, it is contrary to Parliaments intention.

We have three different terms: Tax Evasion, Tax Planning &

Tax Avoidance. (There are no legal definitions for these concepts.
Let us adopt these terms with the above referred meanings for
the purposes of our discussion.)
Page No. 4

Our discussion in this session is on tax avoidance by

tax payer and anti-avoidance measures by the
Government. The Tug of War.

7. Treaty Override:
It is commonly accepted that if there is any difference
between the domestic law and the DTA, then the DTA should
override the domestic law. This is natural. Two Governments
come together and sign an agreement. Later the Government
cannot resort to domestic legislation and levy taxes contrary to
the agreement. In company law, it is called the Doctrine of
Indoor Management.

Hence tax consultants devise schemes of international tax

avoidance largely depending upon the DTA. If under the DTA,
they can avoid a tax, provisions of the domestic law may not help
the commissioner in collecting the taxes.

When a tax payer avoids tax by relying on some smart

interpretation of domestic law, the Government may amend the
tax law and scuttle the tax planning. However, normally the
Government cannot go against the provisions of the DTA.

In some cases, when the Government feels strongly about

any tax avoidance, it may amend the law and disregard the
interpretation of the treaty for tax avoidance. Such amendments
in law are called Treaty Override. Treaty Override is
generally looked down upon by the Judiciary.

8. Company Law Assumptions:

8.1 For the purpose of treaty shopping, tax consultants and tax
payers take advantage of following assumptions under the
company law:

(i) Company is a separate legal entity. (ii) A company is a

resident where it is incorporated. (iii) Assets of the company do
not become the assets of the shareholder. Hence if the Company
sells any assets, the shareholder is not liable to pay any tax. (iv)
When there is any change in the shareholder, there is no change
in the Company and the assets held by the Company. In
essence, the shareholder, the Company & Companys assets all
are separated.

While studying in company law, we have studied the British

case of Solomon Vs. Solomon. After this case, there have been
further developments and now company laws of most countries
make specific provisions of all the principles stated above.
Page No. 5

8.2 Illustration: NatWest Bank of UK incorporated an SPV in

Mauritius & through the SPV invested in Indian Company: HDFC
NatWest Bank of UK can claim that:

(i) NatWests Mauritius SPV being a limited company is a

separate legal entity.

(ii) The SPV is incorporated in Mauritius and hence it is tax

resident of Mauritius.

(iii) Since the SPV is resident of Mauritius, it is entitled to the

benefit of DTA between India and Mauritius.

(iv) When the SPV sells Indian shares it is a capital gain earned
by the SPV. It is not the capital gain earned by NatWest Bank of
UK. Hence The SPV will not be liable to any capital gains tax in

9. Tax Avoidance:
Tax avoidance means the tax payer does not want to pay
tax. In case of normal tax payer, black money or undisclosed
income would be a simple means of avoiding tax. However for
publicly listed companies, to maintain their share prices, they
have to show good profits. If their profits fall then share prices
fall, and there are several consequences. So they want to show
good profits and at the same time not pay the taxes. This is
done by the simple means of shifting the profits out of the
country in which they make the profits.

9.1. Shift the profits out of the Country:

(i) For shifting the revenue profits under invoice or over

invoice - expenses, purchase of goods and services and exports
of goods. Government tries to curb this tax avoidance by
Transfer Pricing provisions.

(ii) For shifting capital gains, invest in a country through tax

haven SPVs. Indian Parliament has attempted to curb this in two

(a) One set of amendments is now called the Vodafone

amendments: Definition of transfer- Section 2 (47)
Explanation 2; and - section 9 (1) (i) Explanations 4 and 5.

(b) Introduction of GAAR provisions Chapter XA.

9.2 To understand these anti-avoidance provisions, we may

take an illustration of a tax avoidance scheme, and then see
Page No. 6

the anti-avoidance provisions. Let us take the illustration of

Vodafone. Since this has been discussed in India at length, we
present here only the brief relevant facts & Issues.

Facts of the Case:

Hutchison of Hong Kong invested in a telecom company of
ESSAR group. Instead of a direct investment, Hutchison
incorporated a company (Special Purpose Vehicle or SPV) in the
tax haven Cayman Island.

After some years Hutchison decided to sell its stake in the

Indian company Hutchison Essar to Vodafone. If they had sold
the shares in the Indian company, the capital gains would have
accrued in India and hence would be liable to tax in India.

Instead, Hutchison sold the share in Cayman Island

Company to Vodafone. Both parties claimed that: A Non-
Resident (Hutchison), had sold share of a foreign company
(Cayman Island Company) to a non-resident (Vodafone) and full
price was paid outside India. Hence India had no jurisdiction to
tax the capital gains. See the Company law presumptions
Seller Buyer in
Paragraph No. 8 above.

9.3 To simply further,

Hutchison, see the chart below:
Hong Kong

Option 1 Sell Cayman

shares & pay no tax
Shares of

Cayman Island Co.

Outside India Outside India

India India

Option 2 Sell Indian Shares of

shares & pay Indian tax

Hutchison Essar, India

Mobile Phone Business

Page No. 7

9.4. Anti Avoidance Provision:

For countering the Vodafone arguments, Parliament has
provided in Explanation 5 to Section 9(1)(i) as under. If the
shares of a foreign company derive their value substantially
from assets located in India; then such shares will be deemed
to have been located in India.

Since the asset is located in India, capital gain arising from

such asset is sourced in India [Section 9(1)(i)]. Hence India as
COS has the right to tax the income.

Note: In Vodafones case, shares were in Cayman Island. India

has no DTA with Cayman Island. Hence amendment in Section 9
is sufficient to plug the tax avoidance scheme. For investors
coming from DTA countries, GAAR provisions would be required.

In the background of these concepts (Paragraphs 1

to 9) let us discuss todays topics for this webcast:
Paragraphs A, B & C.

A. Treaty Shopping:
A1 India has signed DTAs with more than 80 countries.
Different treaties have been signed at different times with
different objectives. Most of the DTAs signed by India are based
on the U.N. model. However, some DTAs are based more on
OECD model. Hence it does happen that one treaty is more
beneficial than the other treaty. For example, the NatWest Bank
of U.K. invested in the shares of the Indian company HDFC
bank. NatWest Bank, as a resident of UK could claim benefit of
the DTA between India and UK. However, NatWest Bank went out
in search of a better DTA. It was literally shopping for a better
treaty. They found that the DTA between India and Mauritius is
better than the DTA between India & UK. Hence NatWest bank
decided to invest in such a manner that it could take benefit of
India Mauritius DTA. This is Treaty Shopping.

A2 Kindly see the two charts given below:

Chart 1. Direct Investment
Page No. 8

NatWest Bank of

Application of India-UK DTA.

Capital Gains tax payable in
India (In case of capital
gains on sale of shares)
Direct Investment
in shares of HDFC
Bank of India
Chart 2. Treaty Shopping

NatWest Bank

SPV in
Application of India- Mauritius
DTA. No Capital Gains tax in

Shares in

A3 Mauritius is a tax haven where the Government was and

is keen to make laws which would facilitate avoidance of Indian
tax (and taxes of other Governments). The history of Mauritius
Income-tax Law from the year 1991 till the year 2013 would be
an interesting case study.

A4 The idea in treaty shopping is as under: In case of

direct investment, whenever the investor sells the shares, he
may earn capital gains. If he earns capital gains on sale of
shares in an Indian company, as per the Indian Income-tax Act,
he would be liable to tax in India.

However, in case of India-Mauritius Double Tax Avoidance

Agreement, Article 13 (4) provides that Capital Gains tax will be
payable only in the COR and not in COS. In other words,
when a Mauritius investor earns capital gains in India, India
should not levy capital gains tax. This is the effect of the DTA.
Page No. 9

Mauritius Government by its domestic legislation does not

impose capital gains tax. Thus the investor does not pay any
capital gains tax either in India or in Mauritius. This is a case of
double non-taxation. It is converse of double taxation.

A5.1 Tax consultants argue that in the DTAs, it is the stated

purpose to avoid double taxation. There is no stated purpose
for avoiding double non-taxation. In absence of any specific
provision against Treaty Shopping both in the domestic law and
in DTA; the tax payer is entitled to minimise his tax liability.

A 5.2 In India, a majority of the professionals take a view that

treaty shopping and double non-taxation are legal rights of tax
payer. Further Government of India cannot amend domestic
legislation and curb double non-taxation it would be Treaty

A5.3 Honourable Supreme Court has decided in the famous case

of Azadi Bachao Andolan that India- Mauritius treaty is valid.

A6 Once the investor avoids Indian taxation, use of the India-

Mauritius DTA is over. Mauritius as a tax haven did not impose
any tax in and around the years 1993 1994 etc. Then Indian
Courts & Authority for Advance Rulings (AAR) started taking a
view that the Mauritius SPVs are not Liable to Tax in Mauritius.
Hence they are not Residents of Mauritius. Hence they are not
entitled to the DTA benefit. Theme was: if there is no Double
Tax, where is the question of granting any DTA benefit &
eliminating Double Tax?

Mauritius Government amended domestic legislation and

imposed an effective tax of 3%.

A7 Apart from the legal issues there are other reasons why
Government of India has not curbed double non-taxation through
Mauritius. It is estimated that Indian Government loses every
year tax worth thousands of crores of rupees because of treaty
shopping. Indo- Mauritius DTA will remain a historic Treaty with
maximum confusion. If & when GAAR provisions are made
effective, there will be additional confusion.

A8 In this case of NatWest we have discussed capital gains

tax. There can be other reasons for treaty shopping. For
example, the tax rate on fees for technical know-how (FTS),
royalty etc. may be higher in some treaties and lower in some
other treaties. In such cases, the technology/ license provider
opens an SPV in a favourable tax regime (normally a tax haven)
and then enjoys the benefit of lower tax rate in India.
Page No. 10

A9 One can raise a legitimate doubt as under. Whatever taxes

are payable in India are available for full set off in the COR. If
for the foreign tax payer COR tax rate is higher than the Indian
TDS rate, then the tax payer does not lose anything by paying
taxes in India. For example, if NatWest Bank invested in India
directly and paid long term capital gains tax of 20%; and if the
UK tax rate is say, more than 20%; then the total tax payable by
NatWest remains the same. Why should NatWest resort to Treaty

The answer depends upon every individual case. We are

not aware of the tax position of NatWest. However, in many
cases, Giant Multinational Corporations arrange their affairs in
such a manner that in the COR, they show perennial losses or in
some manner they pay no taxes. In some other cases, the tax
rate in COR may be lower than the tax rate in India. Or, the
Holding Company may be incorporated in a tax haven. In such
cases, the taxes payable in India would be a cost in excess of the
taxes payable in COR. Hence they would be keen on treaty

There are several ways of tax avoidance. We have

discussed above Treaty Shopping. Now let us discuss
Anti-Avoidance Measures.

B. Anti-Avoidance Measures:
Anti- Avoidance Measures can be provided in the domestic
Income-tax Act as well as in the DTA. In this paragraph B we will
consider the Anti- Avoidance Measures in Income-tax Act. In
Paragraph C we will consider one Anti- Avoidance Measure
Limitation of Benefits Clause in the DTA.

B1 Anti-Avoidance provisions can be of different kinds:

Specific Anti Avoidance Provisions (SAAR) would target a
specific tax avoidance scheme. An easy illustration is: In India
tax payers have tried to reduce their personal tax liability by
gifting their income generating assets to minor children and
ladies in the family. When the interest income goes to the minor
children, they get their own basic exemption and lower tax rates.
To plug this kind of tax avoidance, Indian Parliament has
introduced section 64. Minors income is clubbed with the
parents income. The benefit of basic exemption and lower rate
of tax is denied.

B2 We, the tax consultants keep coming out with new tax
avoidance schemes. It may not be possible for the Parliament to
envisage all the tax avoidance schemes which may come up in
future. Hence General Anti-Avoidance Rules (GAAR) are
provided for. As the name suggests, these are weapons in the
Page No. 11

hands of the Income-tax Commissioner (CIT) to hit any tax

avoidance scheme that may come up in future.

Analogy: when the doctor cannot diagnose the cause of

the disease, he gives Broad Spectrum Anti Biotic Medicines.
Sometimes, the patient dies because of medicines. At all times,
the broad spectrum medicines cause adverse side effects to the
patient. Similarly, GAAR can be abused by the CITs. Peter
Principle says: Whatever can be abused, WILL be abused.

B3 India had no GAAR provisions before the year 2000. Then

Transfer Pricing provisions were introduced in the year 2001. In a
way, these are general provisions to curb under invoicing and
over invoicing. The Direct Taxes Code (DTC) Bill had proposed
GAAR provisions. These have been passed into law and now
chapter XA in the Income-tax Act provides for GAAR. Due to
very strong protest, the provisions have not yet been made

GAAR provisions by themselves can take up substantial

discussion. For the current session, the relevant issue is:

GAAR provisions are under the domestic law. Indian

Judiciary as well as Parliament have accepted the principle that
domestic law cannot override DTA. In this situation, can the
Indian Parliament make any provisions overriding the DTA? If
GAAR provisions do not override the DTA, then all the tax
avoidance games under DTA will still continue. GAAR will be
largely ineffective. Some advocates have argued that a provision
to override the DTA may be unconstitutional.

B4 OECD & United Nations have provided commentaries to

their models of DTA. OECD has come out with specific report on
Conduit Companies (Shell Companies / SPVs). Both the
organisations have clearly stated that the purpose of a DTA is
only to avoid Double Taxation. DTA is not to be used for tax
avoidance (Double Non-Taxation). In fact, the preamble of almost
every DTA reads that the DTA is signed for Avoidance of Double
Taxation & Prevention of Fiscal Evasion. Both OECD and UN
comment that a country is well entitled to make laws and
override the DTA for the purposes of curbing tax avoidance and
Treaty Abuse by Treaty Shopping & other schemes.

It may be noted that International Law is not any law

passed by any authority. Noone can enforce the International Law
on a Government. No outside authority can permit or prevent a
sovereign Government from passing a particular law.
International Law is: a large collection of principles and traditions
generally accepted by majority of the countries & their Courts. It
Page No. 12

is a matter of considered opinions generally respected by a


Conclusion on whether India can make GAAR provisions

overriding DTA: Notwithstanding the popular protest, Government
of India is entitled to pass laws and override the DTA to avoid
abuse of DTA. Safety mechanism must be built in to minimise
abuse of law by Tax Authorities.

B5 It may be noted that: India has accepted the principle that

normally treaty will override domestic law. Hence the scope of
Income-tax Act overriding the DTA is limited to specific
provisions for prevention of abuse of DTA. In other words, it is
not in the hands of a CIT passing assessment order to disallow
DTA benefit by alleging that the tax payer is resorting to tax
avoidance by abusing DTA. Nor can the Central Board of Direct
Taxes (CBDT) disallow any tax avoidance schemes by issuing
circulars or notifications. A DTA can be overridden only by the
Parliament by passing specific legislation. Specific instance of
such legal treaty override is as under: Section 90(2A) &
Chapter X. Both these provisions read together mean that the
GAAR provisions under the Income-tax Act will override DTA.

B6 For a different illustration of anti-avoidance provisions, see

section 9. Several amendments have been made in section 9 to
plug tax avoidance schemes. However, all these amendments
have not been covered under section 90 (2A). Hence if a tax
payer is availing of the benefits of a DTA, the amendments in
section 9 will have no effect. Only when the tax payer is from a
non-treaty country like Hong Kong, the provisions of section 9
would help Income-tax department in ignoring any tax avoidance

C. Limitations of Benefits (LOB):

C1 Let us now consider limitation of benefits clause another

anti-avoidance provision. This is generally incorporated in the
DTA. This is a substance test to prevent people trying to do
treaty shopping or otherwise abuse the DTA. With the LOB clause
the Government tries to ensure that a genuine resident of the
treaty country only can get benefit. India has a signed a treaty
with Singapore. India Singapore treaty includes a limitation of a
benefits clause. Hence only those people who can comply with
the conditions of the LOB clause, can get the benefit of the
treaty. This clause is differently worded in different agreements.
We consider one India Singapore DTA to discuss LOB clause.

C2 India Singapore DTA:

Page No. 13

2.1 The LOB clause is provided in Article 24 as well as by the

protocol dated 18th July, 2005. Article 24 is of limited application
and not discussed here. The LOB clause added by the Protocol is
discussed below. It is applicable only for Capital Gains. There is
another clause limiting the benefit for Royalties and Fees for
Technical Services (FTS). In other words, for incomes like
Shipping, Business income, Salaries etc. there is no significant
limitation on benefits.

It may be noted that Singapore has accepted Territorial

System of taxation. Hence Singapore (Sing) residents are not
liable to tax on income earned outside Singapore. They pay Sing
Tax only on incomes sourced in Sing. This works well for Treaty
Shopping. A foreign investor who wants to use India Sing DTA
will form an SPV in Sing & through it will invest in India. It should
be noted that we are not experts in Singapore law. It is
considered here only to explain a legal concept. For Sing law, one
may consult a Sing expert.

2.2 The SPV will be considered a separate legal entity, resident

of Singapore. (See Company Law presumptions in Paragraph 8.)
This SPV is expected to earn incomes from India a foreign
source as far as Sing is concerned. These incomes will bear no
tax in Sing. Under the India Sing DTA, they can also get tax
exemption from Indian tax on capital gains. These SPVs enjoy
double Non-Taxation.

2.3 This was not possible before the year 2005. By signing the
Protocol of 2005, India & Singapore governments have made the
Treaty Shopping possible though with certain restrictions.

2.4 For Capital gains, the LOB clause imposes some hurdles
that the SPV has to pass to be eligible to get the DTA benefit.

(i) The tax payer should satisfy the authorities that its
affairs have not been arranged with the primary purpose of
obtaining DTA benefit.

(ii) DTA benefit will prima facie not be available for Shell
Companies. A Company /SPV shall be deemed not to be a Shell
Company if:

(a) if it is listed on a recognised stock exchange; or

(b) its annual expenditure exceeds Sing $ 2,00,000 for a
period of 24 months preceding the date on which the capital
gains arise; and in either case,
(c) it should have bonafide business activities.
Otherwise, the Income-tax authorities will be entitled to examine
Page No. 14

whether its affairs were arranged with a primary purpose of

obtaining DTA benefit.

Please note: bonafide business activity in Singapore is a

necessity. Just having an expenditure of $ 2,00,000 is not

2.5 Under the DTA Royalties & FTS may be taxed in

both COS as well as COR. However, the COS will restrict its tax
to 10% of the gross amount if the Royalty / FTS was received by
its beneficial owner.

The Protocol is a perfect recipe for unending litigation.

Who is the Beneficial Owner?
This is like the 1,001 stories of Arabian Nights. One story
leads to another & then another until the King goes to sleep.

C2.6 By the LOB clause, thousands of small SPVs have been

denied the benefit of India Sing treaty. People have opened
companies in other tax havens like Mauritius, Cyprus, Malta, etc.
where the annual expenditure may be $ 5,000 or $10,000.
These Governments permit Conduit companies or SPVs with no
presence except a file in the Consultants office. Such companies
if incorporated I Sing, cannot claim the benefit of India- Sing
treaty. What the Government of India has ensured is small tax
payers need not even think of forming companies in Singapore
for treaty shopping for capital gains. However, large financial
institutions, mutual funds and hedge funds etc. can get the
benefits of the treaty. For them an annual expenditure of
Singapore $ 2,00,000 is not too big an amount. Quite likely that
would be the expenditure of just one junior executive in

C.3 India US treaty also has an LOB clause. However, that is

far more stringent. Let us compare & contrast the Singapore &
US DTA by looking at the text of Article 24 of India US DTA.

Text of the article is given below in italics [with our comments in


Article 24 Limitation on Benefits

(Unlike India-Singapore DTA, this LOB clause applies to the whole

of the DTA.)
1. A person -other than an individual -
( Treaty Shopping is possible for SPVs & other entities. Not for
individuals. Hence this LOB clause is not made applicable to
individuals.) - which is a resident of a Contracting State and
derives income from the other Contracting State shall be entitled
Page No. 15

under this Convention to relief from taxation in that other

Contracting State only if:

(a) more than 50 percent of the beneficial interest in such

person (or in the case of a company, more than 50 percent of the
number of shares of each class of the company's shares) is
owned, directly or indirectly, by one or more individual
residents of one of the Contracting States, one of the
Contracting States or its political subdivisions or local authorities,
or other individuals subject to tax in either Contracting State on
their worldwide incomes, or citizens of the United States; and
(This is ownership test. Majority of the ultimate beneficial interest
should be held by individuals resident in one of the two the
Contracting States. Consider the illustration of NatWest bank. In
its Mauritius entity, 100% interest was owned by persons non-
resident of Mauritius & India. Hence if similar LOB clause were
present in Indo-Mauritian DTA, then NatWest bank would not get
DTA relief.]

(b) the income of such person is not used in substantial part,

directly or indirectly, to meet liabilities (including liabilities for
interest or royalties) to persons who are not residents of one of
the Contracting States, one of the Contracting States or its
political subdivisions or local authorities, or citizens of the United

[To avoid the clause 24(a), tax payers can resort to thin
capitalisation. For example, the SPV will have only $10,000
capital. It will be wholly owned by residents of the contracting
state. The SPV It will get a loan of $ 10 million from foreigners.
Loan agreement will provide that Companys profits will be paid
as interest to the foreign lender.
To prevent such abuse of the DTA provisions, clause (b) has
been provided.]

2. The provisions of paragraph 1 shall not apply if the income

derived from the other Contracting State is derived in connection
with, or is incidental to, the active conduct by such person of a
trade or business in the first-mentioned State (other than the
business of making or managing investments, unless these
activities are banking or insurance activities carried on by a bank
or insurance company).
[This clause provides exemption from LOB clause 24(a). Active
business income will not suffer LOB clause. Investment
management is not considered as Business for this purpose.
However, a Bank or Insurance Company carrying on investment
management will get exemption from LOB clause.]
Page No. 16

3. The provisions of paragraph 1 shall not apply if the person

deriving the income is a company which is a resident of a
Contracting State in whose principal class of shares there is
substantial and regular trading on a recognized stock

For purposes of the preceding sentence, the term "recognized

stock exchange" means:
(a) in the case of the United States, the NASDAQ System owned
by the National Association of Securities Dealers, Inc. and any
stock exchange registered with the Securities and Exchange
Commission as a national securities exchange for purposes of the
Securities Act of 1934;

(b) in the case of India, any stock exchange which is recognized

by the Central Government under the Securities Contracts
Regulation Act, 1956; and

(c) any other stock exchange agreed upon by the competent

authorities of the Contracting States.

[This clause gives exemption from LOB clause for listed

companies. However, again note the difference with the Indo-
Singapore DTA.
Singapore simply asks for listing in a recognised stock exchange.
One may list a share & then there may be insignificant
transactions or no transactions for years together. There can be
non-genuine listing of companies. Under the Sing DTA, such
companies can get DTA benefit. Under the US DTA, such
companies will not get the benefit.]

4. A person that is not entitled to the benefits of this Convention

pursuant to the provisions of the preceding paragraphs of this
Article may, nevertheless, be granted the benefits of the
Convention if the competent authority of the State in which the
income in question arises so determines.

[This is a beneficial clause. After all, there can be situations

that one cannot envisage at the time of drafting the DTA. Later,
one may realise that a Company is not passing the tests laid
down under the LOB clause. Yet it should get the relief. In such a
situation, this clause grants liberty to the Competent Authority to
permit treaty relief.]
This is an illustration of interesting issues coming out of a
comparison of different DTAs.

Discussion of todays three subjects completed.

Page No. 17

Note for further studies:

We have written several articles which directly indirectly

discuss and explain the provisions of treaty shopping and anti-
avoidance rules. Participants who want to study more may
consider the following articles: Morality and Ethics in tax
practice - published by the magazine International Taxation by
Taxmann group. August 2013 issue.

International Taxation articles on Vodafone, Jurisdiction,

Tax Havens etc. are available on our website:


We have briefly discussed: Treaty Shopping, Anti-Avoidance

Rules & Limitation of Benefits clause. To explain these three
issues we have discussed the conceptual basis underlying tax
avoidance schemes & anti-avoidance rules. This is a Tug of War
that goes on and on between tax payers and tax administrators.

Our best wishes to all participants for clear and conceptual

understanding of International Taxation practice.


Rashmin Sanghvi.
Naresh Ajwani.
Rutvik Sanghvi.