MUMBAI | AHMEDABAD
What is the Purpose of this Agreement?
By virtue of the powers vested under, Section 90 of the Income Tax Act, 1961("the Act"), India has entered into the Double Taxation Avoidance Agreement on 18th July, 1994 with China signed at New Delhi. The aim of the Agreement is to avoid double taxation and to prevent fiscal evasion with regard to the taxes on income with the help of exchange of information between the countries. The Agreement is applicable on a taxpayer who is residing in one country and earning in the other.
What are Major Amendments made in the Agreement?
This bilateral economic Agreement is amended by releasing Protocols with the purpose to reduce the scope of non-taxation or reduced taxation through tax evasion.
Two major Protocols are introduced and have effect in India:
- The Protocol dated 26th November, 2018 updated the Agreement thereby allowing the exchange of information keeping in mind the latest international standards.
This Protocol incorporated the changes in order to implement the minimum standards as per the Action reports of Base Erosions and Profit Shifting (BEPS) Project as introduced by the Organisation of Economic Co-operation and Development (OECD) to address taxation challenges.
- The Protocol dated 17th July, 2019 updated and replaced several clauses of the Agreement in order to widen the scope of the applicability of the Agreement and accommodated increasing economic cooperation between the countries.
What is the Scope of this Agreement?
Article 3 has replaced Article 1 of the Principal Agreement through this Protocol which deals with "Persons Covered".
The Agreement is applicable to persons who are residents of one or both of the Contracting States.
In addition to the above, the scope of the Agreement has been widened by Article 3 of the Protocol to include entities or arrangements established in either of the Contracting States.
Sub-clause (3) of Article 3 limits the applicability of the Agreement only to the Articles mentioned therein and states that the Agreement shall not affect the taxation of the respective states.
This Amendment has therefore, widened the ambit of the applicability of the Agreement in order to avoid treaty shopping i.e. choosing which treaty acts more beneficial for their taxes by companies and entities, leading to effective implementation of the Agreement.
- Article 4 "Taxes Covered":
The Protocol has replaced Sub-paragraph (a) of clause (3) of Article 2 of the Agreement with the following:
"(a) In China:
(i) the individual income tax;
(ii) the enterprise income tax;
(hereinafter referred to as "Chinese tax")."
The Agreement is now kept open to individual and enterprise income taxes to be referred as Chinese tax and not limiting it to enterprises with foreign investment or only to foreign enterprises.
- Article 5 "Resident":
Clause (3) of Article 4 of the Agreement has been replaced with the following:
"3. Where by reason of the provisions of paragraph 1, a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall determine by mutual agreement the Contracting State of which such person shall be deemed to be a resident for the purposes of the Agreement. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by this Agreement except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting States."
The determination of the place of effective management, the place of incorporation and such other relevant factors has been made mandatory by mutual agreement; and
This helps in deciding an undisputed status of an entity and deriving the source of income of such establishment.
- Article 6 "Permanent Establishment":
The definition under Article 6 has been refined in a manner so as to leave NO scope of confusion to determine whether an establishment is subject to the Agreement or not.
The Contracting States have through this Protocol bifurcated sub-clauses under clause 2 of Article 5 of the Agreement.
The sub-clauses (j) and (k) under clause (2) were removed from the definition of the term 'permanent establishment' and inserted under sub-clause (3) of the new definition to further define how the period of 183 days shall be calculated.
The sub-clauses under clause (2) were removed from the definition of the term 'permanent establishment'. This was done in order to further define how the period of 183 days shall be calculated under sub-clause (3) of the new definition:
- Project Related Activities under clause (3)(a):
The amendment has settled that all the project related activities like building site, construction, installation, etc. which are being carried out for a period exceeding 183 days shall be considered as a permanent establishment.
The authorities have further elaborated how the period of 183 days shall be calculated in order to put the disputes to rest:
- If the activities are carried out by an enterprise in the other Contracting State, for project related activities in one or more than one periods, such periods collectively should not exceed 183 days.
- If all the are activities carried out in the same building or other closely-connected enterprise to the main enterprise, then the activities exceeding 30 days shall be added in the final period of 183 days.
- Services other than technical services under clause (3)(b):
Services other than technical services carried out for the main enterprise or any other connected enterprise, if carried out in the period of a fiscal year shall be added to the period of 183 days.
Further, the term 'delivery of goods' has been removed from the definition of the term "permanent establishment".
Clause 4, which defines the term "permanent establishment" excludes the following:
- maintenance of stock for display, or storage of goods or for another enterprise, or
- use of facilities for display or storage of goods, or
- maintenance of a fixed place of business either for purchasing goods or collecting information or activities of preparatory character.
The Protocol defines a closely related enterprise as an enterprise having more than 50 per cent beneficial interest in the other company.
The Protocol has therefore, made a stable reference to not only the inclusions and exclusions but also the determination of the 183 day period in the definition, thereby leaving no room for issues or queries.
- Article 7 "Business Profits":
The Protocol has amended Clause (1) of Article 7 as under:
"The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other Contracting State, but only so much of them as is attributable to that permanent establishment."
The above amendment clarifies that the Business Profits of an establishment or entity shall be taxed in their respective states, according to their own laws, if the establishment or entity does not fall under the definition of "Permanent Establishment" as amended by the Protocol.
- Article 8 "Interest":
While calculating the income in a Contracting State, the following shall be exempted from tax in the first-mentioned State:
- Interest paid to the Government, a political subdivision or a local authority, the Central Bank or any financial institution wholly owned by the Government of the other Contracting State, or
- Interest paid on loans guaranteed or insured by the Government, a political subdivision or a local authority, the Central Bank or any financial institution wholly owned by the Government of the other Contracting State.
Therefore, any interest in the Contracting State or others mentioned above if paid to the other Contracting State shall be exempted from the taxes of the first-mentioned state.
- Article 9 "Methods of Elimination of Double Taxation":
The Protocol amended and replaced sub-clause (a) under clause (1) and clause (2) entirely from Article 23 of the Agreement.
The amended Clause (1)(a) is as under:
"Where a resident of China derives income from India, the amount of tax on that income payable in India
in accordance with the provisions of this Agreement (except to the extent that these provisions allow taxation by India solely because the income is also income derived by a resident of India) may be credited against the Chinese tax imposed on that resident. The amount of the credit, however, shall not exceed the amount of the Chinese tax on that income computed in accordance with the taxation laws and regulations of China."
- It states that the resident of India, if deriving income in the other Contracting State, shall be taxed in China according to the provisions under this Agreement till the extent such income is said to be taxable only in India as under the law and vice versa.
- This amendment has given importance to the laws of the resident country for the payment of taxes. Further it has declared that if the laws so impose tax on an amount in the state where the taxpayer is a resident then such provisions shall supersede any other document.
Clause (2) is as under:
"In India, double taxation shall be eliminated as follows:
Where a resident of India derives income, which may be taxed in China in accordance with the provisions of this Agreement (except to the extent that these provisions allow taxation by China solely because the income is also income derived by a resident of China), India shall allow as deduction from the tax on the income of that resident, an amount equal to the income – tax paid in China whether directly or by deduction.
- When the tax paid by a Chinese resident in India is required to be credited back to the individual, then the same shall be done only through 'deduction' and not directly by the Government.
- Article 10 "Exchange of Information":
The provision has been amended according to the International Standards which keep the Agreement at par with the practice followed across the globe.
This amendment has allowed the authorities concerned to exchange such information in order to help improve the considerations under the Protocol and bring in a better understanding of how the state's economy is working.
They have allowed the authorities to exchange information and/or documents required for enforcement of the Protocol.
The information transferred to the other state shall be treated as confidential information and shall not be disclosed to third parties.
The exceptions for permissible disclosure of confidential information are also specified in the Article.
- Article 11 "Entitlement to Benefits":
The Protocol introduces a whole new Article 27A to decipher whether the act of claiming benefits under this Agreement is a legitimate method and to verify the fulfillment of the object and purpose of this Agreement, keeping in mind the facts and circumstances of the issue.
This Protocol has widened the scope of the persons covered under the Agreement.
The Protocol has made a reasonable change keeping in mind international standards, the needs of the Contracting States and has taken a positive approach while stipulating the Clauses in the Protocol in order to enhance clarity and to avoid any interpretative confusion.
This Agreement will assist in improvising the trade relations between India and China and shall encourage economic cooperation between the states, leading to a successful and developmental partnership between the nations.
The present agreement focuses on international peace, security, development and sustainability by predefining the different aspects and interpretation of applicable laws.
This content is purely an academic analysis under "Legal intelligence series".
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