Tax treaty renegotiation?

This tax treaty controversy is snowballing. First it was just the India Mauritius Double Tax Avoidance Treaty that was under a shadow and has been that way for a couple of years then the proposed Direct Tax Code released in August this year proposed a Treaty of Override Clause. Tax experts and India Inc are up in arms because if the code becomes the law, that law would override any existing treaty and its provisions, creating confusion and uncertainty for tax payers. And, then last week came the bombshell.

Finance Minister, Pranab Mukhnerjee announced, “I have instructed my revenue department to reopen negotiations of all 77 Double Taxation Avoidance Agreement with all countries which we have entered so far.”

Now, that’s no stray comment. The finance minister was speaking before an audience of global and Indian CEOs at the India Economic Conference and his words have alarmed the tax fraternity. What are the implications of such a large scale renegotiation? What does it mean for taxpayers? Discussing this issue on exclusively on CNBC-TV18 are a whole host of financial and tax experts; comprising of Former Finance Secretary S Narayan, HP Ranina, Tax Advocate, Sara Luder, Partner, Slaugher & May and Urmila Boolell, Head of Chambers of Banymandhub Boolell.

Here is a verbatim transcript of their views

Q: Could you interpret for me the finance minister’s statement and the implications of that statement?

Narayan: I think this statement has taken quite sometime in coming because the Direct Tax Code which has been put out for discussion actually attempts to reduce the loopholes in the existing income tax loss. At the same time there has been a lot of concern about overseas banking, about keeping of accounts overseas etc and then if you look at the different tax treaties that we have entered into, there are two large areas where we need to pay attention; the first area is income earned overseas in countries which are tax havens by Indians who are technically non-resident Indians, which means that they do not pay tax in those countries and they are technically Indians, so they do not pay taxes here. This is a very big loophole in the revenue process. Second area is the kind of investments; this is a revenue flow. On the capital flow the kind of investments that are coming into this country, the sourcing of these investments and the different ways in which round-tripping of investments can be done. This is a second area which requires close attention and I think we have been approaching the Mauritius route for several years now and there have been substantial improvements in the laws in Mauritius to make this a much more transparent process of communication, of sharing information. So I think this is a step in the right direction that the finance minister is taking.

Q: Would you agree with that - a step in the right direction to renegotiate or at least open renegotiations on all 77 treaties?

Ranina: I do not know whether this is a step in the right direction but look at the practical difficulties involved in negotiating with 77 different countries. When is it going to begin and when is it going to end. And when you start renegotiating not to forget that it’s going to be a two-way street, the other country will also want certain benefits or certain concessions. So the negotiations will go on for years together and to expect the Government of India to finish negotiating with 77 countries, will take at least two decades. It’s simply not practical or not possible. The other important point which I want to make is there are already provisions in every single treaty for exchange of information. There is a Clause 26, Clause 27 or Clause 28 depending on how the treaty is numbered where every single treaty has its provision for exchange of information. Now what more do you want? It’s all a matter of implementation. The powers are already there and therefore I do not see what purpose will be served by trying to renegotiate this whole thing.        

Q: You are looking at this from the outside; you represent many foreign investors, potential foreign investors that want to come into India. Does it worry you that the Indian government is very happily looking at renegotiating 77 treaties or do you take heart in the fact that the only reason they want to look to renegotiate these treaties at least is articulated by the finance minister is to enhance exchange of information. As of now there is a limited reason he has expressed but coming to the point that Mr. Ranina made, we already have provisions in these treaties for the change of information. So what do you think is going to be the outcome of this entire dialogue and potential renegotiation?

Luder: I agree that one of the consequences of renegotiating the treaties will be that the other party will probably have their own particular wants that they will bring it to the table. I think one of the problems that we have certainly seen in Europe with the treaty provisions for exchange of information is that not as effective as perhaps they might be. Sometime they are limited to tax evasion, they are always only limited to information in relation to a particular tax payer and then never real time it’s always looking back to the past. So I think there are problems with the exchange of information provisions in treaties. Having said that, I think its right those provisions should be in treaty. It will be a time consuming process to renegotiate them and I think I agree not necessarily worth of an enormous amount of efforts because it will always be of a limited benefit even if you have a very strong exchange of information provision in the treaty but it will be of limited to India’s tax authorities.

Q: The Indo-Mauritius Double Tax Avoidance Treaty has been under shadow for many years now; there have been many attempts that renegotiation and it continues to be a centre of controversy for India. What do you make of the fact that the government may now extend that controversial area to many other treaties as well?

Boolell: In a sort of ironical way, it takes the pressure off Mauritius! Because as you rightly said, for a number of years, Mauritius has been the focal point of attention. Rightly or wrongly, the Mauritius-India Treaty has been criticised variously, but consistently upheld by the courts and authorities in India for a number of years now. The only difference now, is that the intention appears to be much wider than Mauritius. However, from the foreign investors’ perspective and from the foreign operators’ perspective, there are two issues which do come up. One, is how will India reconcile its traditional respect for international law and international treaty obligations, and its constantly very vehement protection of human rights and international law against a protectionist approach in its domestic tax law? And the second issue, which has already been raised, is how will India deal with issues which apparently are technical, concerning tax abuse avoidance, treaty shopping, round-tripping – which to my mind are basically issues which can be plugged in a number of other ways, which to some extent are already being addressed and which doesn’t really warrant a renegotiation of 77 treaties.                      

Q: do you want to answer that. You are in favour of this renegotiation as you put it earlier up. It’s going to mean a lot of uncertainty for tax payers because renegotiations are never easy processes; they are long drawn as Mr. Ranina pointed out. It would take for many years; it will open up a whole new space of litigation for tax payers, both Indian as well as foreign. The consequences of this could be rather dramatic?

Narayan: Actually most of these arguments are fairly weak. First in terms of exchange of information, we have ourselves seen and it’s my personal experience that exchange of information is very difficult even under the Mauritius treaty; it’s very limited, it’s much nuanced and it’s very difficult to get information under the existing treaty. In terms of time of course these treaties have been negotiated in our time – not in any other generation; it’s in our generation that these treaties have happened. So renegotiation should certainly be able to be done in our time. You don’t have to do all 77 together, you can do a prioritisation depend on which are the treaties you want to first and get that done within a few years time. So I would not call them serious arguments at all. The question is - do we need renegotiations? I think that if we are going into an overall global financial system, sometime down the line we are looking at capital flows happening across the border, we are looking at free flow of money, free flow of investment. I think it’s very important that there should be transparency; there should be track to the money which comes in and goes out because we have to make sure that the kinds of investments that are coming in are not related to any illegal activity. So I think all this requires that the treaties have to be relooked at. We cannot look at 1983 and say that 1983 treaty will be valid for all time to come.     

Q: If there was to be prioritisation which were the first few treaties that you think need to get a serious relook immediately. We need to resolve the gaps between the Indo-Mauritius Double Tax Avoidance Treaty. Is that your first set of priorities?

Narayan:  I would not name a particular treaty. I would kind of look at the flows that have happened over the last few years and then look at the kind of doubts that have arisen in the tax authorities in these flows and then look at those treaties where the doubts have been the largest and then renegotiate those treaties first. It could be Mauritius, it could be somewhere else, I have no knowledge about the kind of information that the tax authorities have?

Q: Do you agree with the argument?

Ranina: Let us not forget one thing; negotiation means both sides must agree in fact even in the case of Mauritius attempts have been made to renegotiate by the Mauritian government has held its ground and said that they would not be interested in renegotiating . So I do not know whether India will succeed and if you say that if we do not renegotiate, you can terminate a treaty – you do so at your own risk then all the investment flow will stop. So negotiation means both parties must agree and the question is what happens if the other country does not agree to a particular point of view which the Indian government has put forth. We already have a system called mutual agreement procedure in all our treaty agreements. So wherever there is a difference – there is mutual agreement procedure (MAP) which comes into existence. But there again I found in practice it doesn’t work because the two contracting states may differ and if they differ then nothing comes out of it. So I have very serious doubts whether this will even take off the ground and whether any substantial effect or benefit will accrue to the Indian government.

Q: If it does take off then in that sense does it mean substantial uncertainty for a whole host of foreign investors and in your assessment do you think it could impact whether its foreign direct investment (FDI) or portfolio flows, investments coming into India?

Ranina: I think it does in fact let me say that even as of now there are many companies, many multinational companies which wanted to invest in India which try to come to India, which try to bring the funds in India but they could not succeed for various reasons, they are now shifted to other south east Asian countries. I think this is something which needs to be brought out. We have lost a lot of foreign direct investment.

Q: I do not think any lawyer or any person would argue if all the government was trying to achieve as enhanced exchange of information though that is a difficult process but if that what all the government was trying to achieve or if it was trying to achieve the process of plugging the transfer of illegal funds into and out of the country. But the worry in the tax fraternity in India is renegotiation could then expand to many other grey areas; grey areas that have been throw up by cases like the Vodafone tax case, a case where Vodafone is locked in battle with the Indian tax department on an overseas transaction. Is that a fear that you share?

Lauder: It’s always a risk when you renegotiate treaties but I think perhaps there is something to be said. The international climate has changed, I mean certainly within the Organization of Economic Co-operation and Development

(OECD) country such as Switzerland who has previously been very reluctant to agree for an exchange of information have now signed up to the principle for the exchange of information is something that the international community has to sign up to and I think if it is limited to exchange of information, I think I disagree with some of the previous comments that I actually maybe won’t achieve anything. I think things have changed and I think you may well in certain jurisdictions get more ask for exchange of information articles - you would have done ten years ago when certain jurisdictions do had a reluctance to do anything that would affect the privacy of the tax regime, Switzerland being an obvious example there.

Q: Does it worry you that this could expand or extend beyond just the exchange of information, beyond just plugging illegal flows to actually then taking a stance on situations like Vodafone has thrown up?

Ranina: Yes, I think once you start renegotiating you are actually opening up a Pandora’s Box maybe you are going to have a lot of problems on your hand once you start renegotiating because lot of other issues will also come up apart from the exchange of information. So certainly I think the Government of India is taking on a task which I think is going to maybe boomerang and may not give the desire results.          

Q: That’s exactly what’s happened in the negotiations between India and Mauritius, isn’t it? We started off by wanting to create a limitation of benefits kind of clause that exists in the India-Singapore Treaty. It has now gone much beyond that?

Boolell: In fact, first of all I would like to clarity one thing. Apart from the tax treaty itself, at least in the case of Mauritius, a number of other agreements which have been entered between the various states across jurisdiction and in the case of Mauritius and India, there are, for e.g. agreements which have taken exchange of information into existence. For e.g. between Sebi and the Financial Services Commission in the banking sector and there are a number of arrangements already in place over and above the treaty which allow for exchange of information. And I would disagree with one of the previous speakers who said that it is very difficult to get information from Mauritius because the reality is, that there are a number of situations which have already been addressed to the authorities of Mauritius which the authorities are already looking into, and very keen in assisting the Indian authorities in putting out.  

Q: The worry is that everyone buys into the fact that we must have more information. But the worry is that just renegotiating a tax treaty is not going to get you that, right. The failure of the Indian government to provide specific instances where they suspect round-tripping and therefore get reciprocal information from countries like Switzerland or where they suspect the hoarding of black money. You cannot just go to Switzerland or go to any country and say, now open up your records and share it with me. You got to be providing evidence and we haven’t been able to provide any kind of preliminary evidence for that – that’s where they seem to be stuck even the Swiss authority say we are happy to share information with you but show us some evidence that requires us to share the information with you?

Narayan: I think that is a very limited problem of tax evasion. I think tax evasion; tax avoidance is just one part of the treaty. I think much more important as I said one on the capital side and the other on the revenue side is the kind of flows which actually take place and in a way a number of these arguments which have been made are in a way not correct arguments at all for e.g. that FDI has not come into India, it is gone to Vietnam, it has very little to do with tax avoidance treaties. It has to do with the kind of investment opportunities and kind of productive efficiencies that Vietnam has been able to provide over the last few years. So merely to put everything that negotiating the tax treaties is going to bring down a cascade of problems on to the country, I think is very limited.

Q: But even you would admit that if we were to renegotiate 77 treaties, all at a same time it is going to lead to an environment of uncertainty because at the end of the day its not just what you renegotiate the treaty to be its also how your internal domestic income tax department looks at those renegotiations, the interpretations they draw from it and how they apply it to tax cases? So it is going to be a difficult environment?

Narayan: On the contrary, on FDI flows today we are in a much better situation than we were 10-15 years ago. Fifteen years ago if you look at the kind of FDI flows from the Foreign Investment Promotion Board (FIPB) you would find a predominance of it coming from one particular source. Today that is not so; today investments are coming from all over the globe. No single country is becoming overwhelmingly important for flows, everybody wants to come and invest in India, the economic environment has changed and therefore if there is a hard negotiation of the treaty and this is the best time to do it.

Q: How you would like the government to proceed if it insists upon going ahead with its renegotiation?

Ranina: I think as was rightly pointed out let them try with five-six countries, they will realise I am sure in the course of the next few months that renegotiation is a very difficult task and when they realise it, you can take it from me that two years from now it will all be forgotten because the very process of even entering into a fresh treaty with a new country has been time consuming and the government is quite aware of that and to renegotiate something which has already been entered into, I think a country will take a lot of time to first decide, their own parliament will have to approve, their own governments will have to approve and even the first five treaties renegotiation would take the next five years and I do not think people will have the patience to go ahead with it.            

Q: Would you agree with that?

Lauder: I think doing four-five countries first does of course make some sense. I mean it’s hard to know which countries they are. If it’s possibly countries as I said like Switzerland, Luxembourg as well where they have been traditionally very secretive about exchanging information and they clearly have relaxed. I think what we have seen in the UK is an increasingly looking for other tools for exchange of information not just the treaty. there has been an organisation setup which is for the exchange of real-time information on tax avoidance between the US, UK, Canada, Australia and Japan which is actually been much more powerful in the treaty and I think exchange of information is it is the way things are moving and I think India is right it look at it. I wouldn’t put too much effort on the treaty negotiations because I am not sure as that is more powerful as just a general cooperation between jurisdictions to say, did you know this abuse is going on and it’s affecting your jurisdiction and we thought you should know about it and I think that the way the international community is gearing.