BEPS prevention in India: Ratification of Multilateral Convention to implement tax treaty related measures

​published on June 27, 2019 | reading time approx. 4 minutes

In a historic development which is bound to have an impact of changing the landscape of Indian treaties, India has deposited the instrument of ratification for Multilateral Instrument with the Organisation for Economic and Co-operation Development (OECD) on 25 June 2019, which shall come into force from 1 October 2019.

As per press release on 12 June 2019, it was reported that the Indian Cabinet of Ministers, chaired by the Indian Prime Minister Shri Narendra Modi, had approved the ratification of the Multilateral Convention to implement tax related measures to prevent Base Erosion and Profit Shifting (BEPS). 

Introduction

Brief background to the Multilateral Convention:

Base Erosion and prevention of profit shifting has been a global concern for governments across the globe.
 
Recognising this, the OECD initiated the Base Erosion and Profit Shifting project by bringing together over 125 countries and jurisdictions.

The BEPS Package provides 15 actions that equip governments with domestic and international instruments to tackle BEPS.  One of the Actions of the BEPS- Action Plan 15, propagated developing a Multilateral Convention to be signed by all participant countries which would have the effect of amending all existing treaties in force at once. The Multilateral Convention aimed to enable countries to implement tax treaty related measures to tackle BEPS through the multilateral route without the need to bilaterally re-negotiate each treaty which would otherwise have been burdensome and time consuming.

In November 2016, over 100 jurisdictions concluded negotiations on the Multilateral Convention to implement tax treaty related measures to prevent Base Erosion and Profit Shifting (“Multilateral Instrument” or “MLI”) that will swiftly implement a series of tax treaty measures to update international tax rules and shrink opportunities for tax avoidance by multinational enterprises.

In a major turning point for taxing regimes, the MLI was signed on 7 June 2017 by over 70 countries. Every country had to complete internal ratification procedures and deposit the instrument of ratification with the OECD after signing, after which it would be effective in the country vis-à-vis its covered tax agreements. 

The MLI has already entered into force on 1st July 2018 following the deposit of instrument of ratification by five countries (as mandated by OECD).

On 12 June 2019, India has completed a major step of ratification of the MLI. The same was deposited with the OECD on 25 June 2019 and it shall come into force from 1st October 2019 for India.

Key Highlights of the Ratification of MLI:

• Ratification of the Multilateral Convention will enable application of BEPS outcomes through modification of existing tax treaties of India in a swift manner.              
• Major changes are proposed to be brought about by the MLI include changes in the definition of “Permanent Establishment”:
  • Article 12: Artificial Avoidance of Permanent Establishment Status Commissionaire Arrangements narrows down the scope of Dependent Agent Permanent Establishments.
  • Article 13: Artificial Avoidance of Permanent Establishment Status through the Specific Activity Exemptions seeks to check artificial fragmentation of activities as Preparatory and auxiliary activities
  • Article 14: Splitting of contracts checks artificial splitting of contracts for avoiding Installation Permanent Establishments. 
• One of the key changes suggested by the Convention is Artificial Avoidance of Permanent Establishment Status through Commissionnaire Arrangements (Article 12).
• Other changes suggested by the Convention are:
  • Article 7: Prevention of Treaty Abuse, akin to Limitation of Benefits (treaty anti abuse mechanisms)
  • Article 9: Capital Gains from Alienation of Shares or Interests of Entities Deriving their Value Principally from Immovable Property
• Out of the major countries with whom India has extensive international trade relations and MLI has already entered into force include UK, UAE, Singapore, France, Japan, Netherlands, Israel etc. Thus, a few checks will have to be carried out while applying treaty benefits for foreign entities within these countries (i) whether these countries have also included India as a Covered Tax Agreement (CTA) for the application of MLI and (ii) whether any reservation has been expressed on application of the respective Article vis-à-vis the Indian treaty.
• The Convention, once enters into force will operate to modify existing Indian tax treaties. It will not function in the same way as an amending protocol to a single existing treaty, which directly amends the text of the treaty. Instead, it will be applied alongside existing tax treaties, modifying their application in order to implement the BEPS measures.
• MLI will thus, enable India to modify its tax treaties to curb revenue loss through treaty abuse or BEPS strategies adopted by companies to park their profits in low-tax jurisdictions and tax profits where substantive economic activities generating the profits are carried out and where value is created. One area that is still not covered within the MLI is taxation of digital economy, although the OECD is rapidly working towards a mutual consensus-based solution to be put this in force.
• The MLI once enters into force, will significantly impact the manner in which foreign companies do business in India. It is therefore recommended that foreign enterprises doing business in or with India align business models on an immediate basis, without waiting for the MLI to enter into force to equip with the changing treaty regime.