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Economic Analysis of India's Double Tax Avoidance Agreements

Arindam Das-Gupta July, 2010

Senior Professor and Head, Economic Research Cell Goa Institute of Management Ribandar, Goa, 403006 ronnie@gim.ac.in +91-832-2490300

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 1

Abstract
Bilateral Double Taxation Avoidance Agreements (DTAAs) with particular reference to India's network of DTAAs are analysed here to assess national benefits from DTAAs and make suggestions for future policy directions for India's DTAAs. Though DTAAs are a tool of tax coordination used by nations to apportion tax bases in the global fiscal commons, there are potential costs from DTAAs if too many taxing rights are ceded to a partner country and also since DTAAs can facilitate tax avoidance and evasion So the paper attempts to make a contribution through the development of a tool for the economic assessment of the impact and benefits, if any, of DTAAs. The paper also contains an overview of key features of India's DTAAs filling a current information gap. Based on the analysis, suggestions are made for future policy in India involving DTAAs. Keywords: DTAAs, tax treaties, tax avoidance, double tax relief, round-tripping, tax havens, global fiscal commons, treaty shopping, harmful tax Initiative, foreign direct investment.

Outline
1. Introduction 2. Background: The global fiscal commons and national tax bases

The global fiscal commons Double tax avoidance agreements (DTAAs) or tax treaties Economically efficient allocation of global commons tax bases and DTAAs Allocation of tax jurisdictions and the role of DTAAs Other functions of DTAAs The revenue and investment impact of DTAA tax allocations DTAAs and tax avoidance in the fiscal commons Anti-avoidance initiatives
3. A framework for assessing national benefits of DTAAs 4. India's DTAA network 5. The impact of India's DTAAs

6. DTAA policy for India: A suggestion 7. Conclusion References

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 2

1. Introduction
The topic addressed here is bilateral Double Taxation Avoidance Agreements (DTAAs) with particular reference to India's network of DTAAs. The purpose is to assess DTAAs and make suggestions for future policy directions India could take with respect to DTAAs. DTAAs are viewed as a tool of tax coordination used by nations to apportion rights to tax different bases in the global fiscal commons. However there are potential costs to countries from DTAAs if taxing rights are ceded to a partner country without a sufficient quid pro quo. DTAAs can also facilitate tax avoidance and evasion potentially imposing additional costs on signatory countries. Accordingly a contribution the paper seeks to make is the development of a tool for the economic assessment of the impact and benefits, if any, of DTAAs. The paper also contains an overview of key features of India's DTAAs which, to the author's knowledge, fills a current information gap. In section 2 of the paper, the global fiscal commons is introduced and apportionment of taxing rights, with particular reference to DTAAs, is discussed. Also discussed is the nature of tax abuse in the fiscal commons, in part via tax havens, and the role of DTAAs in both enhancing and reducing tax abuse. In section 3 a presentation of the framework to assess DTAA benefits referred to in the previous paragraph is made. The framework is used to classify factors affecting the impact of DTAAs and identify situations where DTAAs can or cannot be beneficial relative to (optimal) unilateral tax policies. In section 4 an overview of India's 77 DTAAs is presented by examining their chronology, their allocation of taxing rights, and double tax mitigation rights to source or residence countries, the extent to which they are based on either of the two Model Tax Conventions (by the OECD and the United Nations Conference on Trade and Development or UNCTAD), and withholding tax rates specified in the DTAAs. The impact of India's DTAAs is then assessed in section 5. However, the limited information and research available precludes a complete assessment. Instead information gaps are identified. Nevertheless, large scale tax avoidance facilitated by DTAAs, reviewed here, is pointed out to be sufficient to conclude that DTAAs are largely contrary to national interests. The analysis in the paper is used to derive suggestions for Indian policy towards DTAAs in Section 6. The suggestions identify treaty provisions needing renegotiation and includes suggestions for the identification of treaties that should be scrapped. Information and administrative cooperation are identified as important areas for treaties to deal with.

2. Background: The global fiscal commons and national tax bases


The global fiscal commons1
The global fiscal commons consists of potentially taxable entities or transactions with at least some characteristic involving more than one jurisdiction be it purchase, sale, trans-shipment, source, residence or ownership. According to Bird and Mintz (2003), acceptable characteristics are those that permit jurisdictions to claim what they term economic allegiance of an economic activity. 2 Commons entities include multinational business entities, footloose industries, cross -border portfolio investors, investors making foreign direct investments (FDI), and mobile skilled workers or professionals in scarce global supply. Besides entities engaged in legitimate activity, there are also those engaged in illicit activities including the drug trade, human and organ trafficking and terrorism. 3 Though the loose "existing tax consensus" is described below, in point of fact there is no universally accepted apportionment of property rights of the fiscal commons between countries. In the absence of coordination among countries this can result in either double taxation or no taxation of cross-border income and capital flows. In particular, double taxation, reduces returns and inhibits cross-border
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This discussion in this section is drawn from Das-Gupta (forthcoming). A discussion of the concept of sovereignty which encompasses tax sovereignty, a concept that possibly underlies economic allegiance, is in Christians (2008). There are also non-governmental actors that shape commons activity such as multinational accounting firms.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 3 activity. So both non-taxation and double taxation ultimately reduce fiscal revenue of concerned countries. Rapid expansion of the global fiscal commons due to increasingly mobile fiscal bases resulting from cross-border capital and skilled labour flows, and new types of cross-border transactions, makes this an important fiscal issue.4 Cooperation in tax matters between countries is hampered by a fundamental conflict arising from their need to compete to attract commons entities to their jurisdictions to reap non-tax benefits.5 It is, therefore, vital for countries to have unilateral tax policies that protect their sovereign fiscal space and safeguard their commons exploitation ability if bilateral or multilateral negotiations break down. With business operations integrated in various ways across borders, the untangling of profits and their assignment to different source jurisdictions becomes an artificial exercise, and rule of thumb measures often have to be adopted. Furthermore, this practice lends itself to profit shifting by the taxpayer to lower tax jurisdictions. Most fundamentally, rules are needed to assign equitable shares to the source countries in the income accruing to multinational corporations. Common source rules employing unitary combination and uniform formula apportionment are needed to avoid arbitrary and predatory practices for determining source. (Musgrave, 2006, p176). Tax cooperation between countries tends to follow the path carved out by early movers, particularly OECD member countries, with other countries following their lead especially where OECD publications exist, such as their Model Tax Convention. These principles often encompass reciprocal 6 concessions. Examples of cooperation to coordinate rights to commons exploitation include bilateral double tax avoidance treaties (DTAAs) and guidelines produced by the OECDs Committee on Fiscal Affairs, especially its Harmful Tax Initiative, and International Accounting Standards. 7

Double tax avoidance agreements or tax treaties


According to the World Investment Report (UNCTAD, 2009), as of 2008 there were 2805 comprehensive or limited bilateral treaties between countries from a possible maximum of around 50,000 treaties. These treaties are usually between countries with substantial trade or other economic relations. Most treaties are between pairs of developed countries while, of the balance, most are between developed and developing countries. DTAAs (a) provide reciprocal concessions to mitigate double taxation, (b) assign taxation rights ro ughly in accordance with that existing consensus described below and (c) largely though not rigidly follow the OECD Model Tax Convention or, for developing countries, the UN Tax Convention.8 Recent treaties contain new clauses following the OECD Model Tax Conventions of 2005 to 2010 which extend areas of cooperation to administrative and information issues. While current treaties deal mainly with the right to tax incomes and, occasionally, capital, the OECDs recent Model VAT Guidelines could expand the scope of bilateral treaties in future to also cover the VAT (Owens, 2002).

Bird and Mintz (2003) use the term fiscal externalities for exploitation of a commons by a country which causes it to shrink, as mobile factors move out. See also Asian Development Bank Institute (2001). According to Tanzi (2008) countries compete to attract foreign: financial and real capital, consumers, workers, high income individuals and pensioners. See Bird and Mintz (2003) who refer in their discussion to the implicit OECD consensus.. Consumption tax examples of institutions whereby countries have ceded what was considered part of sovereign fiscal space include the World Trade Organization impact on tariffs and even some domestic consumption taxes to ensure non-discrimination; membership in free trade areas and customs unions; and the European Unions abolition in 1993 of fiscal frontiers and tax related checks at national borders. The latest version of the OECD model tax convention was finalised in 2008. Further draft amendments, released in 2010, are under public discussion. Another influential tax treaty, especially as regards Indian taxes, is the UN Model Tax Convention, which modifies the OECD Convention to make it more suitable for developing countries, the 2009 draft being the latest.

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Arindam Das-Gupta Economic Analysis of India's DTAAs pg 4

Economically efficient allocation of global commons tax bases and DTAAs


Economic thinkers have identified tax jurisdiction allocations which are economically efficient or nationally "optimal". These rules, briefly reviewed here, have had a limited influence on the allocation of taxing rights.9 The starting point for tax base coordination principles for economic efficiency or, alternatively, what Musgrave and Musgrave (1989) term inter-nation equity,10 is the mutual recognition of the ability and right of more than one sovereign nation to tax commons entities. 11 Efficient taxation of capital in this literature is synonymous with taxation that ensures international tax neutrality so that taxes do not distort international capital flows by driving wedges between returns to different investors.12 The best known principle, followed for example by the US, is capital-export neutrality (CEN) whereby an investor faces the same marginal tax rate, regardless of which country the investment is made in. This requires the residence country to credit foreign taxes against its own taxes and, if needed, provide residents with a net tax refund when the foreign tax credit exceeds other tax dues. As Musgrave puts it ensuring international tax neutrality is thus in the hands of the residence country (Musgrave, 2004, p177). CEN reduces to residence country taxation only if source countries levy no taxes on asset returns. On the other hand, capital import neutrality (CIN) requires domestic and foreign savers to receive the same marginal rate of return from investment in a jurisdiction. This principle implies that only the source country taxes investment income. Simultaneous achievement of CEN and CIN is infeasible. National tax neutrality (NN) whereby foreign taxes are treated as a cost domestically, so that foreign income net of tax and other costs is treated on par with domestic income, implies a deduction for foreign taxes and other costs.13 An ownership perspective has been recently proposed by some scholars.14 They point out that capital exports, particularly FDI, need not result in an actual transfer of savings from home to host countries. Instead, some investment commonly accounted as FDI merely transfers ownership and control, unrelated to the quantum of saving in the two countries. Accordingly, they propose ownership neutrality as an appropriate benchmark. They suggest two ownership neutrality concepts.
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The efficiency principles discussed here are limited to income taxes. As pointed out by Desai (2003), the importance of taxes other than income taxes has been increasing around the world, so that principles for dealing with income taxes now have less importance. Principles for efficient commodity taxation look at origin and destination based commodity taxes. A careful analysis of second best efficient international taxation where there are many jurisdictions is in Keen and Wildasin (2004). They conclude from their analysis that allocation of resources (and commodities) in line with international efficiency may not be necessarily desirable given a situation with minimum fiscal revenue needs. In particular, Sec ond-best international taxation may imply the use of commodity taxes which include both origin and destination taxes and possibly the deployment of both domestic taxes and tariffs, and also capital taxes based partly on the source and partly on the residence principle. Early treatment of international tax principles is in Musgrave and Musgrave (1989) drawing on pioneering earlier work of each of the authors. A good overview of this normative analysis is in Musgrave (2006). Alternative principles are discussed in Desai and Hines (2003). A critique of Musgraves analysis as well as a wide-ranging survey of emerging issues in the domain of international taxation is in Graetz (2001). The OECDs Harmful Tax Practices initiative is one case in which the right to tax of some havens is not recognized by other usually more powerful countries though ability to tax (or spare tax) is clearly present in these havens. This is discussed further below. A good discussion of the efficiency concepts presented here is in Desai and Hines (2003). As discussed in Graetz (2001), this principle was proposed by Peggy B. Musgrave in 1963. Desai and Hines (2003).

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Arindam Das-Gupta Economic Analysis of India's DTAAs pg 5 Capital ownership neutrality (CON) "demands that tax rules do not distort ownership patterns and can be achieved with exemption [of foreign income] as the owner with the highest reservation price (and greatest productivity) owns the asset. Like CEN, unlimited foreign tax credits also achieve CON." (Desai, 2003). National ownership neutrality (NON) "suggests, much as is evident in practice in the world, that countries designing tax rules in their own narrow interest will exempt foreign income." (Desai, 2003). A different approach to efficiency analysis of DTAAs is taken by Davies (2003).15 He examines strategic equilibria between countries whose governments wish to maximize national income. Governments are allowed to choose tax relief methods (deductions, credits or exemptions) and tax rates in his analysis. He uses his framework to conclude that in equilibrium16 tax deductions will be used by at least one country. He shows that this situation is an inefficient Prisoner's Dilemma resulting in unexploited national income increasing opportunities for at least one country.17 Since most DTAAs use credits, as does the OECD (or UN) Model Conventions, they improve international efficiency compared to the no treaty situation. However attainment of full efficiency also requires tax rate harmonization. Most treaties only cover withholding tax rates. Efficiency principles are of limited use in the actual design of treaties since revenue considerations are also of importance. Nevertheless, they suggest that by not using inefficient methods of tax relief (deductions and exemptions) treaties help improve economic efficiency. Similar weakness from a design perspective applies to principles of equity or fairness, such as reciprocity or favourable tax treatment of poorer jurisdictions.18

Allocation of tax jurisdictions and the role of DTAAs19


The "existing tax consensus" broadly allocates the right to tax "active" income to source countries and passive income to residence countries. Thus wages, salaries, technical and management fees and business income (but also income from immoveable property) are allocated to the country where payments are made, while "passive incomes" like dividends, royalty, capital gains and most types of interest are allocated to the country of residence of the receiver. In particular, for business income, a source country has the right to tax profits of non-resident businesses from that source country if these concerns have a "permanent establishment" there.20 There is no immediate economic or fairness rationale for these rules.21 Third countries other than the source or residence are held not to have any taxing rights over such income, though this has led to much international tax policy activity in recent years, as discussed below.22 In practice, since most source countries are loath to let various income

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Earlier work along these lines is reviewed in Davis (2003). That is, a subgame perfect Nash Equilibrium. It may be recalled that deductions achieve national ownership neutrality (NN): they are efficient from a single country perspective if retaliation is ignored. Brief discussion is in Keen and Wildasin (2003) and also in Graetz (2001). As Bird and Mintz (2003) put it Unfortunately, there do not appear to be principles that are both acceptable and feasible with respect to how to divide up such a complex and changing target as the international tax base in the multiplayer international tax game. p422. They identify several possible principles that may be used in future and evaluate their relative merits. Discussion of India's tax treaties is in a later section of the paper. One major difference between OECD and UN Model Tax Conventions is that the scope of a permanent establishment in the latter is broader than in the OECD Treaty. See, for example, Kosters (2004) and McIntyre (2007). See Asian Development Bank Institute (2000).

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Arindam Das-Gupta Economic Analysis of India's DTAAs pg 6 sources remain untaxed, they often apply withholding taxes not only to active but also to passive incomes. Correspondingly, residence countries often shoulder the burden of relieving double taxation by allowing tax relief for source country taxes paid by their residents.23 DTAAs can result in inequitable treatment of treaty partners. For example, most source countries ordinarily tax business income on a net basis if it is earned by a permanent establishment in the country. They tax other capital income such as interest, dividends, and royalties on a gross basis often through withholding taxes which can be at a lower rate than the normal rate on these types of income in that country (McLure, 2006). As Musgrave says, clearly, the usual treaty requirements of non-discrimination in corporate income tax combined with reciprocity in withholding tax rates is unsatisfactory with respect to inter-nation equity. (Musgrave, 2004, p176)

Other functions of DTAAs


DTAAs serve at least four other important coordination functions.24 First, they ensure that countries adopt common definitions for factors that determine taxing rights and taxable events. Crucial among these is the definition of a permanent establishment. Most treaties also specify a Mutual Agreement Procedure (MAP) which is invoked when interpretation of treaty provisions is disputed. 25 Third, to prevent abuse of treaty concessions, treaties increasingly incorporate restrictions and rules, such as a general anti-avoidance rule (GAAR), that allow tax authorities to determine if a transaction is only undertaken for tax avoidance or not. Benefit limitation tests and controlled foreign corporation (CFC) rules also place limits on claims of residence in countries eligible for treaty concessions. Fourth, exchange of tax information on either a routine basis or in response to a special request is provided for in most treaties to assist countries counter tax evasion. A fifth area, assistance in collection of taxes, is present in some treaties that follow the OECD Model Convention. However, two related OECD conventions (one a multilateral convention) for tax collection assistance also serve as the basis for separate bilateral agreements between some countries.26

The revenue and investment impact of DTAA tax allocations


Globalisation and decreasing national tax capacity: Limited work exists on studying the impact of globalisation on tax revenues. Baunsgaard and Keen (2005) study the impact of trade liberalisation on tax revenue of different groups of countries. They find that only high income countries out of 111 countries in their sample have benefited from trade liberalisation during the past 25 years. Of other countries, low income countries have fared the worst. 27 DTAAs: The limited international evidence (Neumayer, 2007) suggests that FDI flows to low income developing countries are unlikely to be sufficient to justify losing revenue from a DTAA. DTAAs typically lead to lower taxes in capital importing countries as they substitute residence-based taxation for source-based taxation of capital income such as interest, dividends, royalties and capital gains.
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For consumption taxes rights to tax of producing or origin countries and of consuming or destination countries are generally recognised. No widely accepted convention for origin/destination rights for commodity taxes exists though destination taxes are limited in practice given administrative difficulties. However, the OECD's draft VAT/GST Guidelines (OECD, 2006) favour destination taxes on cross-border goods and service flows. Model Convention provisions are constantly under revision in response to new forms of economic activity as is evident from, for example, OECD (2010). See Blonigen and Davies (2004). Owens (2002) emphasises the importance of treaty articles prescribing Mutual Agreement Procedures since there are inevitable gaps in the coverage of treaties. See also Rixen (2008) See UNCTAD (2009). The conventions are the Model Convention for Mutual Administrative Assistance in the Recovery of Tax Claims (1979) and the multilateral Convention on Mutual Administrative Assistance in Tax Matters (1995). They also find that the VAT or its absence does not affect their finding.

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Arindam Das-Gupta Economic Analysis of India's DTAAs pg 7 These revenue costs could be worth incurring if they lead to a sufficient increase in foreign direct investment (FDI). In one of the first studies examining the impact of DTAAs on FDI flows to developing countries, Neumayer (2007) finds that only middle income developing countries having more DTAAs with the US and other capital exporting countries receive more FDI. This is not the case with low-income developing countries. Even for middle income countries, he does not assess whether the increase in FDI is sufficient to offset revenue loss. Overall, the limited evidence precludes clear conclusions but is far from encouraging.

DTAAs and tax avoidance in the fiscal commons


An important problem in the international fiscal commons is the emergence of third countries that have found ways to tap tax bases by manipulating existing international tax laws. This typically results in the erosion of both source and residence country tax bases. Most such third countries have come to be known as tax havens and offshore financial centres (OFCs).28 The emergence of tax havens: The importance of tax havens in increasing the scope for tax avoidance has been extensively reviewed in recent literature.29 Tax havens are countries or autonomous jurisdictions having low tax regimes for non-residents. Low tax regimes are often coupled with secrecy laws or practices which result in limited information provision about non-residents to fiscal and financial regulators, possibly opaque and discretionary tax and financial regulations, and lenient laws for incorporation of businesses by foreigners. Hines (2004) found that tax havens themselves benefit from being havens. What is less clear is the impact of this avoidance on the economies of countries with high tax rates. (Desai, Foley and Hines, 2005, P15). Serious problems associated with OFCs and some tax havens, with greater ramifications than just tax avoidance, relate to unidentified cross-border capital flows for terrorism, drug trafficking and other criminal activities. Tax avoidance opportunities, inter alia, arise from residence country tax provisions in treaties. The incentives arising from tax systems to shift income from high-tax to low-tax jurisdictions exist if the home country exempts foreign-source income. This incentive is absent only if income is repatriated by a firm resident in a country that taxes worldwide income if, furthermore, the firm is unable to claim sufficient foreign tax credits to attain zero tax status. Due to the interaction of DTAAs and tax havens, countries (India included) claim to lose a large amount of revenue on cross-border transactions.30 Commons entities can engage in a variety of tax avoidance strategies to reduce taxes. Important examples are routing financial flows through entities legally resident in a tax haven, thin capitalisation, transfer pricing, double dipping, hybrid entities and timing arbitrage, round-tripping and treaty shopping.31 Of these, DTAAs can facilitate round-tripping and of course, treaty shopping besides thin capitalization and, possibly, double-dipping. So DTAAs
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OFCs cause more financial sector problems than only eroding "legitimate" tax bases. For discussion see, for example, Dwyer (2002), Zagaris (2003) and McLure (2006). See OECD ( 1998), Blum et. al. (1998), Webb (2004) and McLure (2006) and a series of related papers authored by one or more of Mihir Desai, C. Fritz Foley, James R. Hines, Jr. and Dhammika Dharmapala since 1998. In OECD (1998), the OECD Committee on Fiscal Affairs identifies 47 jurisdictions engaged in harmful tax practices (HTPs), discussed below. See, for example, "Taxguru" (2009, April 7). Thin capitalisation refers to financing a subsidiary or other concern through debt rather than equity to reduce apparent profits. Through transfer pricing a firm can apportion profits of related entities to a low tax jurisdiction through artificially high costs of items acquired from the related entity situated there or low prices for goods sold to the related entity in the high tax jurisdiction. Double-dipping takes advantage of differences in the tax treatment of a transaction in two jurisdictions. A hybrid entity exploits cross-border differences in the treatment of tax entities and taking advantage of different tax accounting rules enabling tax deferral. Round tripping is the illegal re-routing of income of a resident through a non-resident entity in a tax haven or other low tax jurisdiction. Treaty shopping refers to setting up a legal entity in a country with the most favourable tax treatment in its DTAA with a country where investment is targeted. See, for example, ADBI (2000).

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Arindam Das-Gupta Economic Analysis of India's DTAAs pg 8 and tax laws for non-resident income have to incorporate defensive measures to pre-empt tax base capture by such jurisdictions. In certain cases fiscal interests can be aligned with that of company owners not involved actively in its management. Tax minimisation strategies of corporations which involve tax havens are generally difficult for non-managerial shareholders to observe. Equally, illegal self-enrichment strategies of managers employing tax havens cannot be easily observed by shareholders (Desai, Dyck and Zingales, 2003). Stricter enforcement that reduces corporate evasion, especially through havens, also benefits minority shareholders (Desai, Dyck and Zingales, 2003).

Anti-avoidance initiatives
To counter avoidance strategies, countries have taken a variety of measures. The OECD has taken the lead in this through its Harmful Tax Practices (HTP) initiative and various information sharing, coordination and transparency conventions to counter OFCs and tax havens.32 Important information and transparency conventions include (a) the 1998 "Ottawa Taxation Framework" for e-commerce;33 (b) ratification by OECD members and others of guidelines in the 2000 report "Improving Access to Bank Information for Tax Purposes";34 (c) the 2002 "Agreement on Exchange of Information on Tax Matters";35 and (d) the 2006 International VAT/GST Guidelines.36 Continuing work of OECD members and its "Participating Partners" in devising strategies to combat international tax abuse is carried out through their Global Forum on Transparency and Exchange of Information on Tax Matters.37 Several countries also unilaterally require their residents to disclose their foreign assets, an early example being the United States through their Report of Foreign Bank and Financial Accounts (FBAR).38 The OECDs Harmful Tax Initiative: 39 This was initiated in 1998 in response to several countries, whose rights to exploit the fiscal commons were not accepted by the OECD, that were eroding OECD member countries tax bases using what they considered illegitimate means. Some commentators perceive this initiative as the use of strong-arm tactics by the rich and powerful members of the OECD to deprive smaller nations of their sovereign rights to tax. For example, the following quote from Langer (2000) is of interest. "Mitchell says that this OECD effort . . . contradicts international norms and threatens the ability of sovereign countries to determine their own fiscal affairs.' He adds that the OECD proposal . . . would create a cartel by eliminating or substantially reducing the competition these high-tax nations face from low-tax regimes. " (Langer, 2000, pg 2).40 Under this initiative, the OECD (see OECD, 1998) defined four key factors to identify tax havens and harmful preferential tax regimes in non-haven jurisdictions.

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For a recent overview see OECD (2008c). OECD (2003) OECD (2003b). OECD (2009) and OECD (2009b). OECD (2006). The permanent web link for the Forum on the OECD website is www.oecd.org/tax/transparency. United States Internal Revenue Service (2010). OECD (2006b) Commons capture and apportionment are discussed in Langer (2000), Bird and Mintz (2003) and Ratts (2003), the latter in the context of the European Union.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 9 Low, nominal or zero special tax rates for mobile income is the first criterion which, however, needs to be combined with one or more of the other three factors for a countrys tax r egime to be regarded as harmful. The second criterion is existence of ring-fencing whereby the domestic economy is partially or fully isolated insulated from the tax regime for foreign taxable entities. In tax havens with limited domestic economic activity, ring-fencing is replaced by the criterion of absence of substantial economic activity. A common example of ring -fencing is a restriction of special tax benefits to non-residents. The third criterion is lack of effective information exchange on taxpayers benefiting from low tax regimes in a jurisdiction.41 The fourth criterion is lack of transparency in legislative or administrative tax provisions giving on tax administrations latitude in interpretation of tax laws and room for negotiated taxes due from favoured entities. Dharmapala and Hines (2006) discuss the impact of OECD efforts since 1998 to get jurisdictions to improve their transparency and information exchange practices. They identify between 33 and 40 jurisdictions with tax regimes (in 2005) qualifying them as tax havens. As of May 2009 no jurisdiction remains on the OECD list of uncooperative tax havens.42 A possibly surprising finding of Dharmapala and Hines (2006) is that tax havens are (or were) relatively affluent countries known for good governance.43

3. A framework for assessing national benefits of DTAAs


Drawing on the preceding discussion, a framework to assess DTAAs is proposed here. The framework is used to assess if and to what extent a bilateral DTAA, enabling two countries to coordinate their international tax regimes, benefits a nation as compared to unilateral tax policy. As in the existing literature, the focus here is limited to income taxation, ignoring consumption, production and other taxes.

Basic framework
The framework has two countries ("home" and "foreign") and assumes one type of income, investment income. It could equally well be presented in terms of any other income flows, such as labour income, or several types of income. For the analysis here, without any loss there is presumed to be only one foreign country. Implications of many foreign countries and types of income are briefly commented on at the end of the section. For simplicity but without significant loss, residents of each country are also assumed to be nationals of that country. Notation used in the framework employs subscripts H and F for the home country and foreign country respectively. Where there are double subscripts, the first subscript is for country and the second is for the resident. Specifically, YHH, YHF and YFH are respectively pre-tax income sourced in the home country accruing to its residents, pre-tax income sourced in the home country accruing to non-residents and pre-tax income sourced in the foreign country accruing to home residents. These incomes are assumed to be returns

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Effective exchange of information has three dimensions: (a) Relevant information must exist. (b) Tax authorities need to have access to it. (c) The information needs to be exchangeable. The last three countries to be removed from the list were Andorra, Lichtenstein and Monaco. See OECD (2010b). The discussion does not extend to rogue nations that act as financial havens for crime, terrorism and individual tax evasion or money laundering. Such jurisdictions exist but are by no means characteristic of a typical tax haven.

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Arindam Das-Gupta Economic Analysis of India's DTAAs pg 10 on investment and so can be decomposed as YHH=rHKHH, YHF=rHKHF and YFH = rFKFH, where r denotes the per unit return on capital (K). The effective tax rates on these incomes (i.e. taxes legally due as a proportion of pre-tax income, after taking into account all available tax concessions) are respectively tHH, tHF and tFH. A fourth tax rate is that applied to foreign income of non-residents by the foreign country (tFF on YFF). Of these tHH and tFF are taken to be pre-determined in this analysis, since they apply to all types of investment income of residents in the respective countries. Third, foreign tax credits given by each country to its residents are denoted cH and cF. Typically the foreign tax credit fully offsets foreign taxes unless they exceed domestic taxes. So later in the exposition it will be assumed that cH = min[tFH,tHH] and cF = min[tHF,tFF] . This implies net-of-credit tax rates max[tHH tFH,0] at home and max[tFF tHF,0] in the foreign country on foreign income of their respective residents. Tax revenue of the home government is denoted GH. Finally, in case of any discrepancy between true incomes and incomes reported to tax authorities reported incomes are denoted by an asterisk (e.g. Y*HH). As in Davies (2003), it is assumed that the objective of DTAA policy is to maximise national income. In case multiple policies can achieve the same national income, a secondary goal is taken to be maximisation of own fiscal revenue. Also as in Davies (2003), only the three elements relevant to DTAAs analysis are explicitly included in national income. For the home country this implies YH = Income from home accruing to residents + taxes collected by home on income sourced from home accruing to non-residents + foreign source income of home residents net of foreign taxes, or YH = YHH + tHFYHF + [1-tFH]YFH. Given the superiority of tax credits (equivalently, deduction of foreign taxes paid from domestic taxes due) discussed earlier, tax credits are taken to be the method of relief employed. 44 Correspondingly home fiscal revenue in the absence of tax evasion is GH = tHHYHH + tHFYHF + [tHH cH]YFH. Given income concealment and misreporting, actual fiscal revenue is G*H = tHHY*HH + tHF[YHF + (YHH + YFH Y*HH Y*FH)] + [tHH cH]Y*FH. In the expression above denotes the fraction of undeclared income of residents masquerading as income of non-residents due to earlier round-tripping of resident investment.45 The magnitude of this parameter and its sensitivity to tax policy changes is important in determining government revenue loss. Second, for YFH to profitably masquerade as YHF it must be that tHH cH > tHF. With full tax credits this implies max[tHH tFH,0] > tHF. So the benefit to home residents from this strategy will either be absent or relatively small implying that the associated revenue loss will also be either small or absent. Therefore, to simplify the exposition it is assumed that Y FH = Y*FH.46 Revenue loss due to misreporting can be found (with YFH = Y*FH) to be
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Davies (2003) reviews earlier partial analyses where credits are not the best policy. Note further that credits are the method prescribed in the majority of India's DTAAs and also under section 91 of the Income Tax Act which provides for unilateral tax relief for foreign taxes paid. Other tax avoidance strategies that have been mentioned earlier, thin capitalisation, transfer pricing, double dipping, hybrid entities and timing arbitrage, are not directly helped by DTAAs. Treaty shopping, hybrid entities and double dipping are dealt with later. Net fiscal revenue from fines and penalties less tax administration costs are also ignored in this framework since their magnitude should be relatively small and since they ought not to be key policy determinants.

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46

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 11 GH G*H = [tHH tHF][YHH Y*HH]. In the framework the net of tax return to different types of investments can be found to be on foreign investment declared by residents (abbreviated outbound FDI): [1-tFH+cH tHH]rF, on declared home investment by residents: [1-tHH]rH, on round-tripped home investment by residents: [1-tHF]rH, on foreign investment by non-residents [1-tFF]rF, and on non-resident investment in the home country (abbreviated inbound FDI): [1-tHF+cF - tFF]rH. This completes the development of the framework.

Optimal unilateral policies and potential coordination gains


To use the framework, first consider the benchmark situation of a country's national income and fiscal revenue in the absence of a DTAA.47 To (lexicographically) maximize home national income and fiscal revenue the home must choose tHF and cH appropriately. The best unilateral policy choices, in terms of tHF and cH, of the home government under different situations are summarised in Table 1. The table shows that there are potential gains to the home country from tax coordination via a DTAA with the foreign country four cases. To see why this is so and to identify the scope for gains from policy coordination, consider factors affecting policy choices and each of the cases in turn. For outbound FDI (by residents), three factor influence policy. First, investment flows (and so investment income) may be sensitive to their net of tax return, which partly depends on the home country foreign tax credit, cH. The degree of sensitivity is, therefore of great importance. Second, the foreign government can strategically choose to offset any increase in cH by raising the tax rate on non-resident earnings, tFH, without affecting the net return on investment. Third, to escape home taxes (tHH), some foreign income of home residents may not be declared despite the tax credit. In principle, this can be tackled by lowering taxes on declared foreign income of residents but this will result in discrimination against domestic investment. Similarly, for inbound FDI three factors influence policy choices: As with outbound FDI, inflows and so capital stock can be sensitive to their net of tax return. National income depends, in turn, on the return to capital. Second, any decrease in the effective home tax rate on non-residents, tHF, can be strategically offset by a decrease in the foreign tax credit, cF, offered to their residents by the foreign government. It should be noted that tHF can be changed in at least two ways. The first is by Unilaterally introducing or changing tax concessions for inbound FDI. The second is by changing final withholding tax rates on payments to non-residents. In practice, both of these are employed with the difference that the latter can be tailored via DTAAs to discriminate between different foreign countries. Third, the key potential abuse here is round-tripping: Residents may disguise their funds repatriated from abroad as inbound FDI to benefit from lower taxes. 48 This will decrease tax revenues on income of home residents. Cell (1,1) in the table is the case where capital flows are not sensitive to returns on investment. In this case, the home (and also the foreign) government can set taxes and credits unilaterally to maximise revenue without affecting national income. The best response policy in this case entails double taxation of foreign incomes in both countries. High tax rates on income from inbound FDI will also ensure that round-tripping has no tax benefits. Cells (1,2) and (1,3) are where outbound FDI is sensitive to net returns, making a foreign tax credit desirable. Negotiation with the foreign government to lower taxes on income of home residents will
47

Though it is possible to express various neutrality concepts discussed earlier in terms of these net of tax returns, this is not done here. Discussion of money laundering and "hawala" transactions is not attempted here.

48

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 12 result in a lower foreign tax credit bill in the home country. However, this will be detrimental to revenue in the foreign country. If FDI from this foreign country is unimportant, then there is no possibility of gains to both countries. Where FDI flows are important in both directions, the foreign country can benefit at homes cost from lower taxes on home income of foreign residents (t HF). If this tax rate was set optimally in the unilateral case (to maximize t HFYHF), this will lower home country national income and fiscal revenue while raising foreign fiscal revenue and possibly foreign national income. The analysis of the cases in Cells (3,1) and (4,1) is similar to that in the previous paragraph: There is a trade-off between income and revenue and clear coordination gains to both countries may not exist. Furthermore, if outbound FDI to this foreign country is not important, then coordination gains will be absent. Table 1: Unilateral Tax Policy Choices of the Home Government Outbound FDI not sensitive to the effective tax rate Outbound FDI sensitive to the effective tax rate Foreign Foreign government government will offset will not offset home tax home tax concessions concessions 1,2 1,3 Low tax on Low tax on non-resident non-resident income not income not needed. needed. Foreign tax Foreign tax credit not credit effective. 2,2 2,3 Low tax on Tax rate on non-resident non-resident income not income effective. determined Foreign tax by income credit not and revenue effective. gain/loss. Foreign tax credit Not 3,2 Low tax on Consistent non-resident income not effective. Foreign tax credit not effective. Not 4,3 Consistent Low tax on non-resident income. Foreign tax credit

Inbound FDI not effective tax rate

sensitive

to

the

1,1 Low tax on nonresident income not needed. Foreign tax credit not needed 2,1 Tax rate on nonresident income determined by income and revenue gain/loss. Foreign tax credit not needed. 3,1 Low tax on nonresident income not effective. Foreign tax credit not needed. 4.1 Low tax on nonresident income. Foreign tax credit not needed.

Inbound FDI sensitive to the effective tax rate

Round-tripping of domestic funds sensitive to the effective tax rate

Roundtripping of domestic funds not sensitive to the effective tax rate

Foreign government will offset home tax concessions

Foreign government will not offset home tax concessions

The second row of the table considers cases where round-tripping is sensitive to tax rates as is inbound FDI. To see the revenue implications consider the effect of decreasing tHF to, say, t'HF.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 13 Assume that this decreases Y*HH to Y'HH but raises YHF to Y'HF and to '. The net impact on fiscal revenue is G*H = [t'HFY'HF tHFYHF] + [tHH(Y'HH Y*HH) + t'HF'(YHH Y'HH) tHF(YHH Y*HH)]. The first square bracketed term in this expression is the revenue gain, if any, from taxing higher FDI inflows. This is also the source of change in national income. Only if this term is positive, which requires inbound FDI to be sufficiently sensitive to net returns, is there a potential gain from lowering tHF. The second square bracketed term reflects the loss from additional round tripped income of residents. Given the offsetting forces, if the tax on non-resident income is optimally chosen, there are no coordination gains to the home country if outbound FDI is not responsive to net returns or unimportant as in cell (2,1). In cells (2,2) and (2,3) home and foreign tax policy coordination can be beneficial for national income and fiscal revenue in both countries but only if FDI in both directions is of importance . Analysis of the remaining cells, (2,2), (2,3), (3,2) and (4,3), leads to a similar conclusion: Gains are possible from policy coordination, but only in the presence of two way FDI flows.

Measuring gains from a DTAA


Let the optimal unilateral values of policy parameters and associated income flows be denoted by the superscript U and values with a DTAA be denoted by the superscript T. Then national income gains from a DTAA will be YTH YUH = {YHH + tTHFYTHF + [1-tTFH]YTFH} {YHH + tUHFYUHF + [1-tUFH]YUFH} =[ tTHFYTHF tUHFYUHF] [tTFHYTFH tUFHYUFH] +[YTFH YUFH]. = revenue loss on non-resident income less foreign revenue loss on their non-resident home country income (i.e. foreign income of home residents) plus increase in foreign income of home residents (from greater outbound FDI).49 Revenue gains from a DTAA are GTH G*H = {tHHYTHH + tTHF[YTHF + (YHH YTHH)] + [tHH cTH]YTFH} {tHHYUHH + tUHF[YUHF + (YHH YUHH)] + [tHH cUH]YUFH} = {tHH [YTHH YUHH] + [tTHF(YHH YTHH) tUHF(YHH YUHH)]} + [ tTHFYTHF tUHFYUHF] + [max[tHH tTFH,0] YTFH max[tHH tUFH,0] YUFH]. = revenue loss from lower declared resident income partly offset by increased taxes on round tripped income plus revenue loss on non-resident income (in the braces) plus revenue gain, if any, due to taxes on increased foreign income of home residents (from greater outbound FDI). Here , the fraction of undeclared income of residents reported as non-resident income, has been assumed to remain unchanged for simplicity.50 Furthermore, it has been assumed that the tax credit fully offsets foreign taxes on foreign income of home residents unless they exceed domestic taxes. The verbal descriptions of the gains make use of the assumption that unilateral tax rates are chosen to maximise national income by both countries therefore any other tax rates, including treaty rates, must lower national income. Second, the descriptions assume that capital flows are responsive to net returns. If the DTAA causes effective tax rates on foreign income of residents to be lowered in both countries this will result in increased capital flows and so foreign source incomes.
49 50

In the special case of only residence taxation, t FH = tHF = 0 This causes the revenue gain to be overstated compared to the impact of DTAA tax changes if it were accounted for, since is unlikely to decrease.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 14 The equations offer interesting insights. The first two terms of the national income gain equation appear in the gain equations for both countries but with opposite signs: both countries cannot make net gains from taxing foreign source income under a DTAA. The country for whom the DTAA causes relatively greater increases in outbound FDI will have a net gain. The size of the net gain will depend on the extent to which DTAA tax rates are lowered: The greatest gain (matched by the greatest loss from income taxes on inbound FDI) is if the DTAA stipulates residence taxation. The major national income gain will likely come from the increase in income from outbound FDI captured in the third term. The main conclusion is that capital exporting countries stand to gain most from a DTAA if capital exports increase after the DTAA takes effect.51 The revenue gain equation shows that conditions for a revenue increase following a DTAA are even more stringent than for national income: Only a capital exporting country that levies relatively high taxes on domestic income compared to its treaty partner can gain from a DTAA. However this gain may not be enough to offset lost taxes on income of non-residents or increased round-tripping. With more countries or types of income, other DTAA abuses become possible. The most important of these is treaty shopping, particularly in conjunction with DTAAs with low tax rate havens. As discussed, entities in countries without a tax treaty or with high tax rates, can try to route their FDI through a country with a DTAA specifying low withholding tax rates. If these third countries also have low tax rates on non-resident income, then the investing entity can avoid a significant proportion of source country taxes. A benefit of DTAAs mentioned earlier is common tax nomenclature and definitions. If these are absent, entities can take advantage of differences in the way transactions are treated in partner countries to get tax relief or be subject to low or no taxes in both jurisdictions (double-dipping). This can also be done if entities fall into different groups (hybrid entities) in different jurisdictions.52 Overall, therefore, the framework suggests that DTAAs favour capital/labour/technology exporting countries at the expense of importing countries. This may partly explain the empirical results of Neumayer (2007) and Blonigen and Davies (2004) discussed earlier. The framework ignores benefits from intangible employment creation, efficiency improvements and demonstration effects discussed in the FDI literature by not considering the possible dependence of Y HH on FDI: For capital importers this appears to be the only potential source of gains from a DTAA, an issue discussed further below. Ignoring these possible benefits, the framework suggests that benefits from signing DTAAs are unlikely to accrue to both treaty partners and that the country with a large dependence on foreign capital or other productive inputs is the worse off treaty partner. India's DTAAs are now examined.

4. India's DTAA network53


The principle followed in India is to tax residents on their global income and tax non-residents on their Indian source income.54 However, unilateral tax credits for foreign taxes paid are allowed to residents under section 91 of the Indian Income Tax Act. India: (a) has a network of 77 comprehensive DTAAs, the oldest, with Greece, signed in 1965; (b) is also reported to be in the process of negotiating another 12 treaties with autonomous territories; and (c) is also a signatory to the 2005 multilateral SAARC avoidance of double tax convention and some

51

It should be noted that this conclusion holds for any income generating factor export including labour and technology the use of capital and investment income is purely for expository convenience. A favourite avoidance tactic in some countries is to set up trusts through which income is routed. For a recent news story on this in the context of the India-Singapore DTAA see Sen and Sikarwar (2010, 28 June). Fernanda Andrade provided excellent research assistance compiling information on the structure of India's DTAAs and making a treaty by treaty comparison with the OECD model convention. Her background, used by the author to compile Tables 1 to 5. See, for example, Rao (2008, January 7).

52

53

54

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 15 other bilateral treaties which, however, are not comprehensive. Comprehensive DTAAs are listed along with their signing dates in Table 2. The dates of signing different treaties suggests that the initiative for the DTAAs may not always have come from India in the early years. Greece being a major shipping nation would benefit from a treaty that gave the right to tax shipping income to the residence country which the India-Greece treaty does. The next five treaties, with Egypt, Tanzania, Libya, Zambia and Sri Lanka, signed by a protectionist, high tax India, seem to offer no clear advantage to it, given limited cross-border factor flows. The seventh treaty, with Mauritius in 1982, has turned out to be a major source of revenue loss for India as discussed below. Treaties with major source countries for investment and technology for India or labour and capital from India (and two low tax countries) were signed mainly in the early 1990s. After 2000 India's treaties appear to once again be with countries with which it has limited economic relations. A key policy issue is if India really requires all these tax treaties. The previous discussion suggests that the economic rationale for treaties (except for administrative information sharing) is limited except where productive factor flows respond elastically to tax treaty rights allocations and tax rates. Table 2: India's Comprehensive DTAA Partners and Year of Signing the DTAA (numbered from first DTAA signed to most recent) Country Year signed Developed Countries
1. Greece 8. Finland 13. New Zealand 14. Norway 18. Netherlands 19. Denmark 21. Japan 22. USA 23. Australia 27. UK 32. France 33. Cyprus 34. Switzerland 35. Spain 37. Malta 39. Italy 42. Germany 44. Canada 47. Belgium 50. Sweden 59. Portugal 61. Austria 63. Ireland 71. Luxembourg 75. Iceland 11/2/1965 10/6/1983 3/12/1986 31/12/1986 21/1/1989 13/6/1989 29/12/1989 18/12/1990 30/12/1991 26/10/1993 1/8/1994 21/12/1994 29/12/1994 12/1/1995 8/2/1995 23/11/1995 26/10/1996 6/5/1997 1/10/1997 25/12/1997 20/4/2000 5/9/2001 26/12/2001 25/4/2007 21/12/2007

Country Year signed Asian Developing Countries


6. Sri Lanka 7. Mauritius 9. Syria 11.Thailand 13. Korea 16. Indonesia 4 17. Nepal 4 25. Bangladesh 26. UAE 29. Philippines 30. Singapore 32. China 35. Vietnam 40. Mongolia 41. Israel 45. Oman 56. Jordan 57. Qatar 64. Malaysia 70. Saudi Arabia 72. Kuwait
4

Country
5. Zambia 10. Kenya 24. Brazil 43. Turkey 49. South Africa 53. Namibia 55. Trinidad & Tobago 58. Morocco 65. Sudan 66. Uganda 73. Mexico 76. Botswana 15. Romania 20. Poland 28. Uzbekistan 38. Bulgaria 46. Turkmenistan 48. Kazakhstan 51. Russia 52. Belarus 54. Czech Republic 60. Kyrgyz Republic 62. Ukraine 67. Armenia 68. Slovenia 69. Hungary 77. Serbia

Year signed
5/6/1981 12/4/1985 11/3/1992 1/2/1997 28/11/1997 22/1/1999 13/10/1999 20/2/2000 15/4/2004 27/8/2004 10/9/2007 20/1/2008 14/11/1987 26/10/1989 25/1/1994 23/6/1995 7/7/1997 2/10/1997 11/4/1998 17/7/1998 27/9/1999 10/1/2001 31/10/2001 9/9/2004 17/2/2005 4/3/2005 23/9/2008

27/1/1982 24/8/1982 6/2/1984 13/3/1986 1/8/1986 19/12/1987 1/11/1988 27/5/1992 22/9/1993 21/3/1994 27/5/1994 21/11/1994 2/2/1995 29/3/1996 15/5/1996 3/6/1997 16/10/1999 15/1/2000 14/8/2003 1/11/2006 17/10/2007

Ex Soviet Bloc Countries

74. Hong Kong 2/11/2007 Other Developing Countries 2. UAR (Egypt) 20/2/1969 3. Tanzania 5/9/1979 4. Libya 2/3/1981

Notes: 1. Information for three jurisdictions (Luxembourg, Hong Kong and Mexico, given in italics) has been taken from newspaper reports they are not listed in the Ministry of Finance, Government of India website. Of these Hong Kong is a "specified territory" and not a sovereign nation. 2. According to the Ministry of Finance, Government of India website, treaties with Sierra Leone, The Gambia, Nigeria, and Gold Coast (now Ghana) have lapsed or been terminated. 3. Comprehensive or information exchange treaties are reported to be in the negotiation stage with Myanmar and

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 16

nine "specified territories" including Bermuda, The British Virgin Islands, The Cayman Islands, Gibraltar, Guernsey, The Isle of Man, Jersey, The Netherlands Antilles and Macau. (See Tax Treaty Analysis, 2010, April 13). 4. As of November 13, 2005 India also has a multilateral treaty with SAARC countries, " SAARC Limited Multilateral Agreement on Avoidance of Double Taxation and Mutual Administrative Assistance in Tax Matters" with Bangladesh, Bhutan, the Maldives, Nepal, Pakistan and Sri Lanka. However, the treaty only contains articles relating to payments to (a) professors, teachers and research scholars, and (b) students, besides articles relating to tax administration including mutual agreement, exchange of information, service of documents and collection assistance. There are also novel articles relating to training and sharing of tax policy. The impact on earlier DTAAs with Sri Lanka, Nepal and Bangladesh requires clarification. Source: Government of India, Ministry of Finance (no date), Department of Revenue, Income Tax Department, International Taxation (DTAA Comprehensive Agreements with respect to taxes on income) available at: http://law.incometaxindia.gov.in/TaxmannDit/IntTax/Dtaa.aspx accessed May 25, 2010.

The typical allocation of rights to tax in India's DTAAs follow the "existing tax consensus" discussed earlier: The source country has residual rights after withholding taxes to tax active income while the residence country has residual rights over passive income. Table 3 provides an overview of allocation 55 of taxing rights obtaining in most (but not all) of India's DTAAs. . This is supplemented by additional information in Tables 4 through 6. In particular, for business income, source countries have only the right to tax permanent establishments defined largely as in the UN Model Convention. Besides this allocation of bases, almost all Indian treaties provide for double tax relief via foreign tax credits. Sportsmen (source countries can levy withholding tax), students and teachers merit special mention (taxing rights, if any, are with the country of prior residence in both cases) in most Indian tax treaties. Table 3: "Typical" rights to tax non-residents in India's DTAAs for different types of income or income of specified entities
Sl Nature of Income or other receipt Income Property From Immovable Source country taxing rights Yes Only profits of a Permanent Establishment (PE) (if any) in source On profits earned in source No Included in profits of source associate Withholding tax on source dividend at rate specified Apportioned as with business profits or income from independent personal services as appropriate Residence country taxing rights No Yes Remarks

1 2

Business Profits

3 4 5 6

Profits, etc from Shipping and Inland Waterways Profits etc. from Transport & Air Transport Profits of Associated Enterprises Dividends

Yes Yes No Yes

Withholding rates are prescribed in most cases in the (Indian) Income Tax Act, 1961. Double Taxation Relief (DTR) given in residence for source tax on the PE. Withholding rates are prescribed in most cases in the (Indian) Income Tax Act, 1961. Not present as a separate article in all DTAAs Relief to be allowed in residence for source tax DTR to be allowed in residence for source tax. Usually higher withholding rates are prescribed in the (Indian) Income Tax Act, 1961. The DTAA rate applies if specified. DTR to be allowed in residence for source tax. Usually higher withholding rates are prescribed in the (Indian) Income Tax Act, 1961. The DTAA rate applies if specified.

6a

Dividends received by residence entity from PE in source or entity with fixed place of business, etc. in source

Yes

55

Allocation of taxing rights as also a listing of withholding tax rates in DTAAs can also be found on the Income Tax Department website. See Table 6 below which is based on information in the website.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 17


Sl Nature of Income or other receipt Interest Source country taxing rights Withholding tax on source interest at rate specified (b) Interest received by PE taxable in source Withholding tax on source royalties at rate specified (b) Royalties received by PE taxable in source (a) On source immoveable property gains (b) On gains from moveable property and shares in some cases Income of PE or entity with fixed place of business, etc. in source apportioned If stay at least at or above prescribed minimum Yes Yes No Yes for source nationals (a) Not usually mentioned if source is not place of study (b) Taxable if source coincides with residence after a period Residence country taxing rights Yes Remarks

DTR to be allowed in residence for source tax. Usually higher withholding rates are prescribed in the (Indian) Income Tax Act, 1961. The DTAA rate applies if specified. DTR to be allowed in residence for source tax. Usually higher withholding rates are prescribed in the (Indian) Income Tax Act, 1961. The DTAA rate applies if specified. Withholding rates are prescribed in the (Indian) Income Tax Act, 1961. Withholding can be waived if requested and merited. Residence country taxing rights of gains from share sales are a major concern of India in relation to its DTAAs with Mauritius, Singapore, UAE and Cyprus. DTR to be allowed in residence for source tax Withholding rates are prescribed in most cases in the (Indian) Income Tax Act, 1961. DTR to be allowed in residence for source tax. Withholding rates are prescribed in most cases in the (Indian) Income Tax Act, 1961.

Royalties (and technical fees)

Yes

Capital Gains

On gains from moveable property and shares in some cases Yes

10

Income from Independent Personal Services

11

Income from Dependent Personal Services/Income from employment Directors Fees, and Remuneration Of Top-Level Managerial Officials Income of Artistes and Sportsmen Pensions Remuneration and Pensions for Government Service Payments to Trainees, etc Students,

If stay is below prescribed minimum No No Yes Yes for residence nationals (a) Exempt for specified duration if place of study/resid ence is not source (b) Taxable if source coincides with residence after a period

12 13 14 15 16

Withholding rates are prescribed in the (Indian) Income Tax Act, 1961.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 18


Sl Nature of Income or other receipt Payment to Professors, Teachers and Researchers Source country taxing rights Yes, if duration is at least at or above specified minimum No Residence country taxing rights Yes, if duration is below specified minimum. Yes Remarks

17

18 19 20 21 22 23

Other Income Capital Elimination of Double Taxation Mutual Agreement Procedure Exchange of Information or Document Collection Assistance

Yes (in country of No income source) Other Provisions No Yes NA NA NA NA NA NA

Some DTAAs (e.g. Singapore) allow double taxation Present in few DTAAs and not uniform Credit method (deduction of source taxes from residence taxes) in most DTAAs Present in all India DTAAs Present in most India DTAAs

Absent in 70% of India's DTAAs especially those signed in earlier years Source: Based on author's analysis of DTAA's available in Government of India, Ministry of Finance (no date), Department of Revenue, Income Tax Department, International Taxation (DTAA Comprehensive Agreements with respect to taxes on income) available at: http://law.incometaxindia.gov.in/TaxmannDit/IntTax/Dtaa.aspx accessed May 25, 2010.

India does not have articles covering assistance in tax collection in DTAAs with any of its major economic partners, even though such articles, along with exchange of information agreements, are possible the most important benefit from DTAAs. Table 4 suggests that this could be because the treaties were signed before such assistance articles became common. If so, then this may be an area requiring treaty renegotiation or ratification of multilateral conventions. Other articles not covered in most Indian treaties are taxes on capital (not income from capital). This is consistent with capital and wealth taxes increasingly falling out of favour globally. Model convention provisions are constantly under revision in response to new forms of economic activity. For example OECD (2010) seeks to revise the OECD Convention and its applicability by addressing the incomes of three types of entities or transactions of growing importance. These are Collective Investment Vehicles, state-owned entities, including Sovereign Wealth Funds and Common (cross-border or borderless) Telecommunication Transactions. These are missing from all of India's DTAAs. Consequently several treaties may require to be further augmented. Table 4: Articles in the OECD/UN Model Conventions seldom found in India's DTAAs (figures are DTAA article numbers) Taxation of Capital (OECD - 1965: Art 22 of UN Art 22) 23 24 22 22 23 29 29a 27 28 29 a 28 29 Assistance in the collection of taxes (OECD 1965: Art 27 UN: NA) Territorial extension (OECD 1965: Art 29 UN: NA)

Sri Lanka Finland Norway Romania Netherlands Denmark Poland Bangladesh UAE

Date treaty 27/1/1982 10/6/1983 31/12/1986 14/11/1987 21/1/1989 13/6/1989 26/10/1989 7/5/1992 22/9/1993

23

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 19

Uzbekistan 24 France 24 Cyprus 24 Spain 24 Mongolia 23 Israel 23 Germany 22 Canada 22 Turkmenistan 23 28 Belgium 27 Kazakhastan 23 28 South Africa 26b Sweden 23 28 Belarus 23 28 Czech Republic 23 28 Trinidad & Tobago 28 Jordan 27 Qatar 27c Morocco 27 Portuguese Republic 27c Kyrgyz Republic 27 Ukraine 23 28 Sudan 27 Uganda 27 Armenia 27 Iceland 28 Serbia 24 Botswana 28 Notes: 1. Treaties are listed by date of signing. a: Exact article title: "Assistance in Collection"; b:Exact article title: "Assistance in Recovery". c. Exact article title: "Collection Assistance" Source: Based on own analysis of DTAA's available in Government of India, Ministry of Finance (no date), Department of Revenue, Income Tax Department, International Taxation (DTAA Comprehensive Agreements with respect to taxes on income) available at: http://law.incometaxindia.gov.in/TaxmannDit/IntTax/Dtaa.aspx accessed May 25, 2010. On the other hand, some Indian DTAAs have articles which are not present in model conventions (Table 5). The most widespread of these are articles pertaining to payments to professors, teachers and researchers mentioned below. Limitation of benefits clauses, a key anti-abuse provision along with beneficial ownership and control tests are, however, present in 7 Indian treaties. Renegotiation to add these to more treaties is on the current agenda of Indian policy makers. 56

Date treaty 25/1/1994 1/8/1994 21/12/1994 12/1/1995 29/3/1996 15/5/1996 26/10/1996 6/5/1997 7/7/1997 1/10/1997 2/10/1997 28/11/1997 25/12/1997 17/7/1998 27/9/1999 13/10/1999 16/10/1999 15/1/2000 20/2/2000 30/4/2000 10/1/2001 31/10/2001 15/4/2004 27/8/2004 9/9/2004 21/12/2007 23/9/2008 1/4/2009

Taxation of Capital (OECD - 1965: Art 22 of UN Art 22)

Assistance in the collection of taxes (OECD 1965: Art 27 UN: NA)

Territorial extension (OECD 1965: Art 29 UN: NA)

56

See ENS Economic Bureau (2009, Nov 11).

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 20 Table 5: Articles not in OECD/UN Model Conventions present in Indian DTAAs
Sl Article Number of DTAAs Countries whose DTAAs with India have the Article Belarus Canada Denmark Finland Germany Israel Namibia Oman Turkey Armenia Iceland Kuwait Namibia UAE Singapore USA Australia Article number and exact title

DTAAs WITHOUT article(s) about Payments to Professors and/or Teachers and or Researchers/Research Scholars

Limitation of Benefits

Cyprus Art 13 Israel Art 13: Fees for technical Services Kenya Art 15: Management & professional fees Malaysia Art 13: Fees for technical services Malta Art 13 Namibia Art 14: Fees for technical Services Oman Art 14 Tanzania Art 15: Management fees Uzbekistan Art 13 Vietnam Art 13 Zambia Art 14: Management and consultancy fees 5 Other Articles 13 Bangladesh Art 23: Income Of government and institutions Canada Art 28: Miscellaneous Rules Italy Art 29: Refunds Kuwait Art 28: Miscellaneous Rules Libya Art 3: Tax Home Malta Art 14: Alienation Of Property Norway Art 23: Offshore Activities Romania Art 13: Commission Saudi Arabia Art 26: Other Provisions Singapore Art 22: Income Of Government UAE Art 24: Income Of Government & Institutions UK Art 25: Partnerships USA Art 14: Permanent Establishment Tax Source: Based on author's analysis of DTAA's available in Government of India, Ministry of Finance (no date), Department of Revenue, Income Tax Department, International Taxation (DTAA Comprehensive Agreements with respect to taxes on income) available at: http://law.incometaxindia.gov.in/TaxmannDit/IntTax/Dtaa.aspx accessed May 25, 2010.

Source of Income Taxable in a state deemed to be from that State Technical Fees

Art 28 Art 24 Art 27 Art 24: Art 29 Art 24: Limitation of relief Art 24 Article XXIII

11

Table 6 lists rates of withholding taxes in most Indian DTAAs and also rates applicable in the absence of a DTAA.57 It should be noted that most treaties provide for taxpayers to elect voluntary to take advantage of treaty provisions or not. So if non-treaty withholding rates are more favourable, they can
57

Unfortunately, information on capital gains withholding taxes is not readily available in collected form and has to be compiled treaty by treaty. They are not mentioned in several key treaties. In particular the right to tax gains from financial transactions is with the residence country in key treaties like those with Mauritius, Cyprus and Switzerland.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 21 elect not to have taxes withheld at the higher rate. Even without further information about rates of tax on foreign source income in the partner countries, variation across countries of withholding rates seen in the table suggests that scope for treaty shopping exists for all four types of income. This suggests the need either for widespread revision of withholding tax rates to bring about greater uniformity, or more widespread treaty revision to introduce effective beneficial ownership clauses. Table 6: Withholding tax rates in selected Indian DTAAs (as in 2010-11) (All figures are tax rates in percent) Dividend [not covered by section 115-O] 20
10 15 10 15 (10/10) [N5] 15 (10/25) [N5] 15 10 (7.5/25) [N5] 15 15 25 (15/10) [N5] 10 15 (10/10) [N5] 10 20 (15/25) [N5] 10 15 10 20 10 15 (10/25) [N5] 10 10-15 10 20 (15/10) [N5] 10 10 10 15 20 (15/20) [N5] 10 10 20 10 15 (10/25) [N5] 15 15 (5/10) [N5] 10 10 20 (10/10) [N5] 10

Interest 20
10 15 10 10 [N1] 10 [N1] 15, 10 [N6] 10 15 [N1] 15 [N1] 15 [N1] 10 [N1] 10 [N1] 10 [N1] 15, 10 [N1], [N6] 10 [N1] 10 [N1] 10 20 10 10 [N1] 10 10 [N1] 10 [N1] 15 [N1] 10 10 [N1] 10 [N1] 15 [N1] 15, 10 [N1], [N6] 10 10 20 10 10 [N1] 15 [N1] 20 (Nil in some cases) [N1] 10 [N1] 10 [N1] 15,10 [N1], [N6] 10 [N1]

Royalty 10
10 [N2] 10 10 15 10 10 15 (trademark use: 25) 20, 15 [N9] 10-20 10 15 10 20 10 15, 10 [N10] 10 30 10 15 10 10 10 20 10 20 10 20 15 10 15 30 10 15 15 15 10 10 15 10

With No Tax Treaty (u/s 115A) Armenia Australia Austria Bangladesh Belarus Belgium Botswana Brazil Bulgaria Canada China Cyprus Czeck Republic Denmark Germany Finland France Greece Hungary Indonesia Iceland Ireland Israel Italy Japan Jordan Kazakstan Kenya Korea Kuwait Kyrgyz Republic Libyan Arab Jamahiriya Malaysia Malta Mangolia Mauritius Morocco Namibia Nepal Netherlands

Fees for technical service 10


10 [N2] 10 15 10 10 No separate provision 20 10-20 10 10 10 20 10 As for royalty 10 No separate provision 10 No separate provision 10 10 10 20 10 20 10 17.50 15 10 15 No separate provision 10 10 25 No separate provision 10 10 10

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 22

Dividend [not covered by section 115-O] New Zealand Norway Oman Philippines Poland Portuguese Republic Quatar Romania Russian Federation Saudi Arabia Serbia and Montenergro Singapore Slovenia South Africa Spain Sri Lanka Sudan Sweden Swiss Syria [N7] Tanzania Thailand
15 20 (15/25) [N5] 12.5 (10/10) [N5] 20 (15/10) [N5] 15 10 5-10 20 (15/25) [N5] 10 5 15 (5/25) [N5] 15 (10/25) [N5] 5-15 10 15 15 10 10 10 Nil 15 (10/ 10 for at least 6 months prior to the dividend date) [N5] 20 (15/10 and company is an industrial company) [N5] 10 15 10 10 10-15 15 (5/25) [N5] 10 15 20 (15/10) [N5] 15 10 15 (5/25 for at least 6 months prior to the dividend date) [N5]

Interest
10 [N1] 15 [N1] 10 [N1] 15, 10 [N6] 15 [N1] 10 10 [N1] 15 [N1] 10 [N1] 10 10 15, 10 [N6] 10 10 [N1] 15 [N1] 10 [N1] 10 10 [N1] 10 [N4] 7.5 [N1] 12.50 20, 10 [N6]

Royalty
10 10 15 15[N11] 22.50 10 10 22.50 10 10 10 10 10 10 20, 10 [N3] 10 10 10 10 10 20 15

Fees for technical service


10 10 15 No separate provision 22.50 10 10 22.50 10 10 10 10 10 20, 10 [N3] 10 No separate provision 10 10 No separate provision No separate provision No separate provision 10 15 10 10 10 No separate provision No separate provision [N2] [N2] 15 10 No separate provision

Trinidad and Tobago Turkey Turkmenistan Uganda Ukraine United Arab Emirates United Arab Republic [N8] United Kingdom United States Uzbekistan Vietnam Zambia

10 [N1] 15, 10 [N1], [N6] 10 [N1] 10 10 [N1] 12.5, 5 [N6] 20 15, 10 [N1], [N6] 15, 10 [N6] 15 [N1] 10 [N1] 10 [N1]

10 15 10 10 10 10 30 [N2] [N2] 15 10 10

Notes: N1: Dividend/interest earned by the Govt and institutions like the Reserve Bank of India exempt from taxation in the source country. N2: Royalties and fees for technical services are taxable in the source country at (a) 10% for rental of equipment and services provided along with know-how and technical services; (b) in any other case (i) during the first five years of the agreement: 15% if the payer is the Government or specified organisation; and 20% otherwise; and (ii) in subsequent years, 15% in all cases. Income of Government and certain institutions will be exempt from taxation in the country of source.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 23

N3: Royalties and fees for technical services are taxable in the source country at: (a) 10% for royalties relating to use of, or the right to use, industrial, commercial or scientific equipment; (b) 20% for fees for technical services and other royalties. N4: 10% of the gross interest on loans made or guaranteed by a bank or other financial institution carrying on bona fide banking or financing business or by an enterprise which holds directly or indirectly at least 20% of the capital. N5: (A/B) means rate A% applies if at least B% of company shares is owned by the recipient. N6: The lower rate applies if the recipient is a bank (and, in some DTAAs an insurance company or specified financial institution). N7: In the DTAA with Syria, the residence country has the right to tax dividends. N8: In the UAR (i.e. Egypt) DTAA the source country has the right to tax all four income types. N9: The lower rate applies to iterary, artistic, scientific works other than films or tapes used for radio or television broadcasting. N10: The lower rate is for equipment royalty. Rates were 15%-20% during 1997-2001. N11: If payable under a collaboration agreement approved by the Govt. of India. Source: Adapted from Government of India, Income Tax Department website http://law.incometaxindia.gov.in/DIT/File_opener.aspx?fn=http://law.incometaxindia.gov.in/Directtaxla ws/dtrr2005/R10.htm accessed June 25, 2010

5. The impact of India's DTAAs


To evaluate the real economic impact of DTAAs information is needed on first, their impact on cross border income generating flows, including portfolio flows, FDI, labour, technology and know-how and cultural, education and related activity. This essentially requires the sensitivity of these activity flows to rates of return to be estimated. One key counterfactual is estimation of the quantum of flows that would take place in the absence of DTAAs so that the net impact on flows of DTAAs can be assessed.58 Second, the impact, in turn, of enhanced or decreased FDI flows on national income and government revenue needs to be assessed. Unfortunately, no adequate studies are available except possibly of FDI, precluding a fully satisfactory assessment of the overall impact of DTAAs. A recent India specific study of the impact of FDI on economic growth, Chakraborty and Nunnenkamp (2006), find the effect to be mixed having clearly positive effects only in the manufacturing sector though FDI flows mainly to the services sector. While acknowledging the limited scope of this study, it further reinforces scepticism about the value of DTAAs to the economy. 59 In the absence of clear evidence, inferences from the theoretical discussion must be given due weight. To recap, even if tax avoidance does not take place (except possibly through round-tripping) (a) DTAAs with countries from which India receives inward factor flows are unlikely to be beneficial to India. (b) On the other hand, DTAAs with destinations for Indian outward factor flows may be beneficial to India. (c) With two way factor flows between treaty partners, outward factor flows from India will largely determine if the DTAA benefits India or not. Second, leaving aside DTAAs, it is important to note that benefits provided to inward flows can, in any case, be achieved through unilateral actions (e.g. tax holidays) without the need for signing DTAAs, though DTAAs allow for discriminatory treatment between different countries. Third, DTAAs do facilitate tax avoidance, which needs to be taken into account in assessing their benefits. In fact, the data available leaves little doubt that India's DTAAs, whatever their impact on factor flows, cause great loss of fiscal revenue due to FDI being routed through low tax countries. This is so even if reliable estimates of the quantum of revenue loss are not available. This is a matter about which

58

Some authors suggest that rates of return variations caused by income tax regime changes are unimportant compared to changes in indirect tax rates and such things as the quality of infrastructure, manpower available, logistics and proximity to markets or suppliers. See Figueroa (1992) and also Desai (2003). If true, then revenue effects of DTAAs should be the main concern in their assessment. However, opposing evidence is in and Gastanaga, Nugent and Pashamova (1998) and Desai, Foley and Hines (1992). A review of studies of both determinants and effects of FDI in general and in the Indian context is in Chatterjee (2009).

59

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 24 policy makers in India have shown great concern and which has received (and continues to receive) much news coverage in India during the past 5 years. Evidence of this is can be seen by comparing Tables 7 and 8 with Table 9. Tables 7 and 8 present official statistics relating to India's inbound and outbound FDI by origin/destination country. The high inbound FDI shares of Singapore, Cyprus, the UAE and particularly Mauritius in Table 7 are striking. These are all low tax rate countries which have DTAAs with India. Of them only Singapore is likely to be, to a greater or lesser extent, a source of genuine FDI and not just a route for avoidance of Indian taxes. In particular, the absence of financial capital gains taxes in Mauritius, Cyprus and Singapore, reported in numerous press stories, combined in Mauritius and Cyprus with residence taxation of these gains under their DTAAs with India make these countries ideal bases from which to invest in India and avoid capital gains taxation.60,61 A second benefit, that has received less coverage being more limited and less easily detected, is low rates of taxation of business profits, interest and other business income flows, making them ideal partner countries for transfer pricing by multinationals operating in both jurisdictions and also for sourcing of debt for thinly capitalised Indian companies. Round-tripping of funds from India is also likely to be reflected in the figures in Table 7 as asserted by Rajan and Gopalan (2010). Unfortunately, the importance of round-tripping relative to genuine FDI is not known. Table 7: Share Of Top Investing Countries in FDI Equity Inflows 2006-07 to 2009-10 Rupees crore (US$ in million) Cumulative Inflows -Apr '00 - Nov. '09 %age of total rupee inflows

Country 2007-08 2008-09 2009-10 Mauritius 44,483 (11,096) 50,794 (11,208) 40,421 (8,377) 201,694 (45,241) 44 % Singapore 12,319 (3,073) 15,727 (3,454) 7,579 (1,576) 41,431 (9,387) 9% U.S.A. 4,377 (1,089) 8,002 (1,802) 7,235 (1,510) 35,194 (7,845) 8% U.K. 4,690 (1,176) 3,840 (864) 1,775 (370) 24,679 (5,596) 5% Netherlands 2,780 (695) 3,922 (883) 3,328 (692) 19,180 (4,282) 4% Japan 3,336(815) 1,889 (405) 4,979 (1,034) 16,204 (3,565) 4% Cyprus 3,385 (834) 5,983 (1,287) 6,021 (1,255) 16,070 (3,527) 3% Germany 2,075 (514) 2,750 (629) 2,309 (481) 11,798 (2,654) 3% U.A.E. 1,039 (258) 1,133 (257) 2,678 (556) 6,684 (1,476) 1% France 583 (145) 2,098 (467) 1,141 (238) 6,622 (1,466) 1% Total FDI 98,664 122,919 93,354 Inflows* (24,579) (27,329) (19,379) 486,480 (109,219) 100 % Notes: (i) *Includes inflows under NRI Schemes of RBI, stock swapped and advances pending for issue of shares. (ii) Cumulative country-wise FDI inflows (from April 2000 to November 2009) Annex-A. (iii) %age worked out in rupees terms & FDI inflows received through FIPB/SIA+ RBIs Automatic Route+ acquisition of existing shares only. Ministry of Commerce and Industry, Department of Industrial Policy and Promotion http://www.dipp.nic.in/fdi_statistics/india_FDI_November2009.pdf accessed February 6, 2010.

60

A sample of recent writings, this from a tax analysis website "Taxguru": " in some cases, these treaties are misused to avoid taxes, leading to a loss of revenue to a countrys exchequer. As per some available estimates, India loses more than $600 million every year in revenues on account of the DTAA with Mauritius. Both India-Mauritius and India-Cyprus tax treaties provide that capital gains arising in India from the sale of securities can only be taxed in Mauritius and Cyprus. This leads to zero taxation as there is no capital gains tax in these countries." (Taxguru, 2009, April 7)

61

The recent draft Direct taxes Code Bill has sought to resolve a related source of litigation, in relation to the India-Mauritius treaty, characterisation of income from share transactions of foreign institutional investors as business income or capital gains, by deeming all such income as capital gains.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 25 The same four countries figure among the top destinations for outbound FDI along with the Netherlands, the UK and the US in Table 8. This suggests that the treaty network of these countries with other countries targeted by Indian investors also makes them useful bases for special entities through which Indian residents route foreign investments. Table 8: Direction of Indias Outward FDI (Cleared Proposals) (US $ million) Country Singapore Netherlands Cyprus UK US Mauritius UAE Switzerland Australia Denmark 2007-08 January-March April-March 1,194.70 8,350.50 295.7 5,341.10 429.4 661.4 224.2 543.4 224.2 1,052.90 603.6 1,478.60 424.8 617.2 18 478.3 18.1 38.2 497.6 2008-09 January-March April-March 1,300.80 4,255.00 300.4 3,530.60 2,358.40 2,629.00 78.4 2,344.20 238.7 2,302.00 425.1 2,049.10 162.9 908.7 44.6 343.2 168.9 302.8 278.4

Source: Government of India, Reserve Bank of India (2009, July)

Though data on ultimate FDI sources and destinations are hard to come by, Rajan and Gopalan (2010)62 compare official FDI data with mergers and acquisition (M&A) data compiled by private sector firms. The M&A data are first, partial and incomplete and second, not necessarily for exactly comparable time periods as official FDI data. Third, they reflect only a part of FDI. Nevertheless, the comparison of FDI data in Tables 7 and 8 and Rajan and Gopalan's information in Table 9 is striking: Of the major Indian sources and destinations of M&A funds only Singapore, the UK, and the US are common to the list.63 While further evidence gathering and careful analysis is clearly needed, even at this stage there can be little doubt that tax avoidance on this scale (not to mention round-tripping) implies that India's DTAAs cause it great revenue loss. Table 9: Summary of Information in Rajan and Gopalan (2010) M&As by global firms in India 35%: US (35%) 16%: UK (mainly via Mauritius) 27%: Netherlands 18%: East Asia (Japan, Singapore, Malaysia and Hong Kong), 18%: US + UK 15%: Netherlands, France, Germany, etc 10%: Singapore, Japan, etc 34%: Canada 24%: US 16%: "Resources rich countries" (Russia, Egypt, Australia and South Africa) 17%: UK and Europe.

FDI into India M&As by Indian globally (2000-07) firms

62 63

See also Gopalan and Rajan, 2010. Of the major destinations of M&A activity by Indian firms, these authors point to certain genuine advantages of countries like the Netherlands and Singapore besides good DTAA networks and low tax rates on their domestic entities. These are the use of English, good human capital availability and excellent logistics and air/sea connections. Unfortunately, there is no study that quantitatively studies the relative importance of these "real" factors compared to the tax regime.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 26

FDI from India 2002-08

6%: UK 6%: US 22%: Singapore 15%: Netherlands 25%: Mauritius and other OFCs Notes: OFC: Offshore financial centre, M&A: Mergers and acquisitions Source details: Compiled by the authors: M&A data from the Zephyr database and The Economist, May 29, 2009; FDI data from Government of India, Ministry of Commerce and Industry, Department of Industrial Policy and Promotion, http://siadipp.nic.in/publicat/newslttr/apr2008/index.htm and Ministry of Finance, Department of Economic Affairs,
http://finmin.nic.in/the_ministry/dept_eco_affairs/dea.html

The limited work reviewed in this section provides some information on FDI flows. No information is available on other types of cross-border flows and incomes from them. In particular the impact of DTAAs on remittances and other cross-border income flows involving the large and growing body of expatriate Indian professionals is still to be studied.

6. DTAA policy for India: A suggestion


Given the complex structure and sophistication of the global fiscal commons, India's participation in formal and informal agreements and multilateral fora such as the OECD's Global Tax Forum is clearly important and to be commended. Regarding DTAA's the analysis in this paper suggests certain measures that should be part of India's current strategy. Most basically the main purpose of tax treaties needs to be reconsidered. Treaties should be viewed not so much as means of providing relief from double taxation but as platforms for strengthening information exchange and administrative cooperation to prevent tax evasion. Nevertheless, for a country from which India receives FDI and other factor flows, a DTAA (as opposed to an administrative and information sharing tax treaty) is unnecessary unless there are non-economic reasons to accord discriminatory treatment to that country. If a DTAA is persisted with, it should not provide only for residence country taxes but should also provide for source country tax withholding. For a country that is primarily a destination for Indian factor flows India's concern is with foreign tax credits. Here India can rely on competition for FDI and other inflows (or accepted convention) to keep foreign withholding taxes at a reasonable level. If this is felt to be insufficient in particular cases, then DTAA renegotiation to put a cap on double tax relief, implying double taxation to some extent, should be considered. Having regard to treaty shopping, India should attempt to renegotiate DTAAs that specify low withholding rates, so that they are raised to make them uniform or nearly so on similar types of income with other DTAAs. In fact, to curb round tripping, concessional rates of tax on non-resident income should either be removed or accompanied by effective beneficial ownership clauses. DTAAs that are rarely invoked currently should also be reviewed, particularly with respect to apportionment of taxing rights, definitions of key terms, and particularly withholding tax rates, to ensure that they cannot become future targets of treaty shoppers. Such a review should also take account of the non-resident tax regime and rules for setting up resident entities in that country. It is also of great importance for India to take advantage of the current global move to greater transparency and openness by strengthening information sharing and administrative assistance provisions in its DTAAs.64

64

On this issue the views of Jeffrey Owens, Director of the OECD's fiscal Affairs Department are of interest: See Ranganathan, Chandra (2009, November 30), Swiss should treat India on par with US, France on DTAAs: OECD director.

Arindam Das-Gupta Economic Analysis of India's DTAAs pg 27 As a final point, researchers should be encouraged to try, with the cooperation of tax authorities, to fill the glaring data gaps with respect to different types of cross border flows, their growth impact, and their impact on DTAAs. 65 To meet these ends the following short term fiscal strategy is suggested: 1. Conduct an internal (sample based) review of DTAAs to assess which ones are used and if their use is mainly in relation to withholding tax rates on Indian source income, or for foreign tax credits on foreign source income of residents, for both, or for other reasons. The types of income for which DTAA provisions are invoked should also be recorded. Particular attention should be given to classifying treaty partners according to whether they are sources of factor flows to India, the reverse or both. This should allow a classification of treaties according to whether they are causing revenue loss or gain or are not being used. It should also help assess which types of incomes benefit most from DTAAs. 2. Assess if there is scope to renegotiate DTAAs that are causing large scale revenue losses through one or more of the following measures a. Revision of withholding tax rates to stop treaty shopping. b. In particular, ensuring that there is provision allowing for purely residence taxation of a source of income: source withholding taxes to protect revenue to some extent should invariably be present. c. Introduction of articles or sub-articles relating to beneficial ownership and effective control as preconditions for an entity being entitled to treaty benefits

d. Strengthen information sharing either via additional DTAA provisions or by becoming signatories of the OECD initiated "Agreement on Exchange of Information on Tax Matters" discussed earlier. 3. If not, or if the treaty partner proves uncooperative, terminate the DTAA.66

7. Conclusion
Too little is known by fiscal scholars and practitioners about India's DTAAs and their impact. The message emerging in this paper is that DTAAs are possibly a suboptimal fiscal policy tool, particularly with respect to countries from which India receives FDI and other factor flows. They may be of some use for countries serving as destinations of Indian factor flows if these partner countries are nave enough to tolerate fiscal losses or if intangible FDI benefits are felt by them to be significant. The discussion here attempts to make a beginning in filling the information gap on DTAAs and identifying areas where more information is needed. It also tries to identify and suggest DTAA policy for India.

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This is part of a larger issue, that of improving tax statistics and their analysis. This issue is well beyond the limited scope of this paper.

66

To once again quote Taxguru: "The just-concluded G-20 summit on global financial crisis in London had raised the pitch on scrapping DTAAs." (Taxguru, 2009, April 7).

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