MODULE 5 Sahibnoor Singh Sidhu

PLAN, AVOID, EVADE-

WHICH CAN YOU AND CAN
YOU NOT DO?
Tax Planning: this is an actual legit method of reducing tax liability by using
concessions provided by ITA, 1961. For instance, if the ITA allows you to deduct
the up to INR 2 lacks if you invest in a government scheme, and you do, your
taxable income will reduce, and this is legitimately allowed.
Tax Avoidance: this is slightly in the grey area where you are clearly taking
advantage of the tax system but are still largely in the clear. For example, you
open a business and have multiple members of your family listed as employees
who receive just enough money in salaries that it is tax-free while you get to
deduct that amount from the total profits from business.
Tax Evasion: this is completely illegal. Here you attempt to show inflated
expenditures or fabricated losses so as to get out of paying tax, using methods
are illegal.
Sometimes avoidance and evasion are used interchangeably! Is that permissible
in India? Let’s see a few case laws around this topic.
CASE LAW- INLAND REVENUE
COMMISSIONERS V. DUKE OF
WESTMINSTER 1935 ALL E.R. 259.
In England, the 1918 Income Tax Act allowed a taxpayer to deduct “annual
payments” made by them and at the same time disallowed “salaries, fees or
wages.”
The Duke of Westminster entered into a covenant with his gardener wherein he
undertook to pay the gardener a weekly annuity for seven years.
The tax authorities disallowed this deduction, claiming that ‘in substance’ this
covenant was resulting in a salary.
When it went to the House of Lords, it led to the promulgation of what is recognised
as the “Westminster Principle”:
Every man is entitled if he can to order his affairs so that the tax under a tax statute
is less than it would otherwise be. If he succeeds in ordering them so as to secure
this result, then, however unappreciative the Commissioners of Inland Revenue or
his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an
increased tax. This so called doctrine of ‘the substance’ seems to me to be nothing
more than an attempt to make a man pay notwithstanding that he has so ordered
his affairs that the amount of tax sought from him is not legally claimable.
CASE LAW- MCDOWELL &
CO. LTD. V. COMMERCIAL
TAX OFFICER (1985) 3 SCC
230
McDowell is an Indian company that manufactures alcohol/liquor. It was liable to pay
excise duty at the time of production of the liquor and then sales tax when the liquor
was sold to buyers. This excise duty once collected was counted in the total turnover
of the company.
However, they came up with an idea where they made wholesale buyers of their
liquor pay the excise duty directly to the authorities and did not even mention the
same in the bills issued. Therefore this amount did not form part of their total
turnover, reducing their tax liability.
This seemingly dubious but not illegal method of tax avoidance was allowed by the
SC through a judgment in 1977.
The State of Andhra Pradesh where this distillery was placed amended its excise
rules to say that liquor could not be moved from the manufacturer unless the
manufacturer pays the excise duty. It made it the responsibility of the manufacturer
to collect excise duty and then pay it forward, thereby, nullifying the earlier SC
judgment. These folks went to court again.
AT THE COURT AGAIN
This time around McDowell argued that it should be left open to the
manufacturers how they want to plan their tax portfolio and that as long as the
money reached the state coffers, it should not matter who deposited it. They
also claimed that passing this responsibility to the buyer was a valid method of
tax planning. They also deemed it inappropriate that the excise duty was made
part of the turnover even though it was never truly open for them to spend it on
business activities.
J. Ranganath Misra on the question of tax avoidance, moving away from the
Westminster principle held as follows:
“Tax planning is permissible provided it is within the four corners of law but
colourable devices are not part of tax planning and such a transaction
should be disregarded without giving benefits of such transaction to the
assesse. It is wrong to honour the dubious methods of tax avoidance as
every person is bound to pay tax without taking recourse to subterfuges.”
J. CHINAPPA REDDY
He authored a concurring but separate opinion focussing entirely on this question of tax
avoidance. In this opinion he showed how the Westminster principle relating to tax
avoidance had been watered down and then scrapped off of the jurisprudence on tax in
England. It was therefore time to say that the same is also equally inapplicable in India.
“The evil consequences of tax avoidance are manifold. First there is substantial
loss of much needed public revenue, particularly in a welfare State like ours. Next
there is the serious" disturbance caused to the economy of the country by the piling up
of mountains of black money, directly causing inflation. Then there is "the large hidden
loss" to the community (as pointed out by Master Sheatcroft in 18 Modern Law Review
209) by some of the best brains in the country being involved in the perpetual war waged
between the tax-avoider and his expert team of advisers, lawyers and accountants on one
side and the tax-gatherer and his perhaps not so skillful advisers on the other side. Then
again there is the 'sense of injustice and inequality which tax avoidance arouses in
the breasts of those who are unwilling or unable to profit by it'. Last but not the least is
the ethics (to be precise, the lack of it) of transferring the burden of tax liability
to the shoulders of the guileless good citizens from those of the 'artful dodgers’.” (para
46)
THE TEST
“In our view, the proper way to construe a taxing statute, while
considering a device to avoid tax, is not to ask whether the
provisions should be construed literally or liberally, nor
whether the transaction is not unreal and not prohibited by the
statute, but whether the transaction is a device to avoid tax,
and whether the transaction is such that the judicial
process may accord its approval to it.” (para 46)
CASE LAW- UNION OF INDIA
AND ANR. V AZADI BACHAO
ANDOLAN AND ANR. 2004
(10) SCC 1.
The CBDT had issued a some circulars clarifying that FIIs would not have to
pay tax in income from dividends and capitals gains if under the Indo-
Mauritius Double Tax Avoidance Agreement the government of Mauritius
issued a certificate of residence. This was an explanation to Article 13(4) of
the Indo-Mauritius DTAA.
This circular was challenged through PILs before the Delhi High Court where
the NGOs argued that providing such a blanket exemption would encourage
treaty shopping. They also argued that these circulars took away the power
of the AO to lift the corporate veil and judge if the Mauritius entity was
actually a ‘sham’ or not. These must then be declared illegal and void. They
argued that after McDowell tax avoidance was just as illegal as tax evasion.
The Delhi HC agreed that the circular which took away the power of the AO
to lift the corporate veil to judge whether a Mauritian entity was a ‘sham’ or
not was illegal.
WHAT THE DELHI HC SAID
The Delhi High Court held that the AO had a quasi-judicial power to assess the
claims made by different tax-payers. It could not be limited by the CBDT. Hence,
the AO was eligible to lift the corporate veil of these Mauritius based companies
to see if they are actually residents there or just parked there for tax avoidance.
Avoidance of double taxation is a term of art and means that a person has to pay
tax at least in one country; avoidance of double taxation would not mean that a
person does not have to pay tax in any country whatsoever and therefore if the
AO wants to life the corporate veil to see if you paid taxes in Mauritius, they
should be allowed to.
The Delhi HC held that ‘Treaty Shopping’ was illegal and ‘necessarily forbidden’.
“It is one of the functions of the assessing officer to ensure that there is no
conscious avoidance of tax by an assessee, and such function being quasi-judicial
in nature, cannot be interfered with or prohibited. The impugned circular is ultra
vires as it interferes with this quasi judicial function of the assessing officer.”
THE SUPREME
DISAPPOINTMENT
The SC overturned the judgment of the Delhi HC in its entirety. The
result of the same is as follows:
1. Treaty shopping is legal.
2. Westminster principle is still applicable.
3. Tax avoidance is not illegal, only evasion is.
4. AO cannot look lift the corporate veil once Mauritius issues a tax
residency certificate.
5. Chinappa Reddy’s comments on avoidance are not applicable.
“TAKE MY BAG AND GO
TREATY SHOPPING”
Overall, countries need to take, and do take, a holistic view. The developing countries allow
treaty shopping to encourage capital and technology inflows, which developed countries are keen to
provide to them. The loss of tax revenues could be insignificant compared to the other non-tax
benefits to their economy. Many of them do not appear to be too concerned unless the revenue
losses are significant compared to the other tax and non-tax benefits from the treaty, or the treaty
shopping leads to other tax abuses. (para 124)

There are many principles in fiscal economy which, though at first blush might appear to be
evil, are tolerated in a developing economy, in the interest of long term development. Deficit
financing, for example, is one; treaty shopping, in our view, is another. Despite the sound and fury of the
respondents over the so called 'abuse' of 'treaty shopping', perhaps, it may have been intended at the
time when Indo-Mauritius DTAC was entered into. Whether it should continue, and, if so, for how long, is
a matter which is best left to the discretion of the executive as it is dependent upon several economic
and political considerations. This Court cannot judge the legality of treaty shopping merely because one
section of thought considers it improper. A holistic view has to be taken to adjudge what is perhaps
regarded in contemporary thinking as a necessary evil in a developing economy. (para 125)
They therefore held that not only was treaty shopping legal but this was something that the
legislature had considered while drafting the ITA and something the executive had
considered when signing the DTAA with Mauritius.
ON MCDOWELL,
WESTMINSTER AND
AVOIDANCE
It was argued “that McDowell has changed the concept of fiscal
jurisprudence in this country and any tax planning which is intended to
and results in avoidance of tax must be struck down by the Court.
Considering the seminal nature of the contention, it is necessary to
consider in some detail as to why McDowell , what it says, and what it does
not say.”
The court brings up other analyses to show how the Westminster principle
was still “alive and kicking” in England. Its application to India, although
qualified is not rejected.
“We are unable to agree with the submission that an act which is
otherwise valid in law can be treated as non-est merely on the basis of
some underlying motive supposedly resulting in some economic detriment
or prejudice to the national interests, as perceived by the respondents.”
CASE LAW: VODAFONE
THE GHOST OF VODAFONE: para 68-70

The majority judgment in McDowell held that "tax planning may be legitimate provided it is
within the framework of law" (Para 45). In the latter part of Para 45, it held that "colourable
device cannot be a part of tax planning and it is wrong to encourage the belief that it is honourable
to avoid payment of tax by resorting to dubious methods". It is the obligation of every citizen to pay
the taxes without resorting to subterfuges. The above observations should be read with Para 46
where the majority holds "on this aspect one of us, Chinnappa Reddy, J. has proposed a separate
opinion with which we agree". The words "this aspect" express the majority's agreement
with the judgment of Reddy, J. only in relation to tax evasion through the use of
colourable devices and by resorting to dubious methods and subterfuges. Thus, it cannot
be said that all tax planning is illegal/illegitimate/impermissible. Moreover, Reddy, J. himself
says that he agrees with the majority. In the judgment of Reddy, J. there are repeated references to
schemes and devices in contradistinction to "legitimate avoidance of tax liability" (Paras 7-10, 17 &
18). In our view, although Chinnappa Reddy, J. makes a number of observations regarding
the need to depart from the "Westminster" and tax avoidance — these are clearly only in
the context of artificial and colourable devices. Reading McDowell, in the manner indicated
hereinabove, in cases of treaty shopping and/or tax avoidance, there is no conflict between
McDowell and Azadi Bachao.
GENERAL ANTI-AVOIDANCE
RULES (GAAR)
There are two kinds of responses that the State has to schemes of
tax avoidance:
1. The judiciary steps in as it did in McDowell
2. The legislature steps in as it did post Vodafone

However, it has not always been this way. The idea of a GAAR was
introduced very recently, through the Finance Act of 2013 and
became applicable only in FY 2017-18.
These rules, as we will see prefer the substance over the form of
tax planning and while they provide some safeguards to check the
revenue department, they provide a better understanding what
kind of tax planning is categorically illegal.
S.95- GAAR- CHAPTER XA
95. (1) Notwithstanding anything contained in the Act, an
arrangement entered into by an assessee may be declared
to be an impermissible avoidance arrangement and the
consequence in relation to tax arising therefrom may be
determined subject to the provisions of this Chapter.
(2) This Chapter shall apply in respect of any assessment year
beginning on or after the 1st day of April, 2018.
Explanation.— For the removal of doubts, it is hereby declared that
the provisions of this Chapter may be applied to any step in, or
a part of, the arrangement as they are applicable to the
arrangement.
It makes no distinction between residents or non-residents. The
non-obstante clause status means it may even trump section 90.
S.96- IAA
96. (1) An impermissible avoidance arrangement means an
arrangement, the main purpose of which is to obtain a tax benefit,
and it—
 (a) creates rights, or obligations, which are not ordinarily created between persons
dealing at arm's length;
 (b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;
 (c) lacks commercial substance or is deemed to lack commercial substance under
section 97, in whole or in part; or
 (d) is entered into, or carried out, by means, or in a manner, which are not ordinarily
employed for bona fide purposes.

(2) An arrangement shall be presumed, unless it is proved to the contrary by

the assessee, to have been entered into, or carried out, for the main purpose
of obtaining a tax benefit, if the main purpose of a step in, or a part of, the
arrangement is to obtain a tax benefit, notwithstanding the fact that the
main purpose of the whole arrangement is not to obtain a tax benefit.
ABOUT S.96
2 tests prescribed under s. 96 are

Main Purpose Test

AND
Tainted Element Test
WHEN IS DEEMED THAT AN
“ARRANGEMENT LACK COMMERCIAL
SUBSTANCE”
Section 97(1) - Agreement to lack commercial substance if any of the
7 circumstances mentioned in section 97 are found in it. Allows AO to
look at the substance over form:
1. Substance over form
2. Round tripping eg. Mauritius route used to round trip black money
3. Offsetting and cancelling eg. setting off artificial capital losses with no
commercial substance.
4. Disguise. Eg. Benami transactions
5. Locational benefit eg. treaty shopping
6. Arrangement without business risk or cash flow - where risks relating to an
asset is not transferred so as to set it off. Eg. business is transferred but
transferors still bears the cash flow w.r.t. rent, repairs etc.
7. Accommodating party. Eg. connected person under section 102 (4) - a company
transacting with a relative of a director
WHAT IS A ‘ROUND TRIP’
S.97(2)
(2) For the purposes of sub-section (1), round trip financing
includes any arrangement in which, through a series of transactions
—
(a) funds are transferred among the parties to the
arrangement; and
(b) such transactions do not have any substantial commercial
purpose other than obtaining the tax benefits
FACTORS TO HELP YOU
DETERMINE THAT
ARRANGEMENT IS NOT FOR
COMMERCIAL PURPOSE S.97(4)
(4) For the removal of doubts, it is hereby clarified that the
following may be relevant but shall not be sufficient for
determining whether an arrangement lacks commercial
substance or not, namely:—
(i) the period or time for which the arrangement (including
operations therein) exists;
(ii) the fact of payment of taxes, directly or indirectly, under
the arrangement;
(iii) the fact that an exit route (including transfer of any activity
or business or operations) is provided by the arrangement.
BUT THEN HOW DO YOU
PROTECT INVESTOR TRUST?
There is a three-tier administrative setup through which the Revenue
department has to pass in order to hold that any given arrangement is for
tax avoidance purposes:
1. The AO informs the Principal Commissioner after assessing the
transactions in the arrangement and argues whether GAAR is applicable
or not.
2. The Principal Commissioner also assesses and if convinced sends a notice
to the assessee with an opportunity to be heard.
3. If the Principal Commissioner is not convinced it makes a reference to the
Approving Panel which composes of a retired HC judge, an IRS officer and
an academic.
But this provision excludes any transactions through which the tax benefit
allegedly attained are less than INR 3 crores.
WHAT HAPPENS IF IT IS
FOUND THAT YOU ENTERED
INTO AN IAA? S.98
Section 98 mentions the following possible consequences.:
 Entire arrangement may be disregarded even if only a part involves IAA
 Accommodating parties may be treated as unrelated parties
 Deductions, expenditure etc. may be reallocated
 Recharacterization of capital into revenue receipt
 Denying treaty benefits
 Redetermining situs of assets or residence of persons
 Income may be re-assessed as per the legislative intent
 Corporate veil may be lifted
 Substance over form test may be applied
 Commercial/ economic form test may be applied
 Penalties along with interest may be levied
 Prosecution may follow
SAAR- SPECIAL ANTI-
AVOIDANCE RULE
Any other anti-avoidance rules that you find outside of Chapter XA
is considered as SAAR. The most prominent examples are Sections
92-92F that deal with transfer pricing.
 TRANSFER PRICING AND
HOW TO STOP IT
Different jurisdiction across the world have different tax rates. This often serves as an incentive for MNCs to
send all their profits to a company in the jurisdiction with the lowest tax rates. They cook up transactions,
under/over value assets and transfer them and sometimes use shareholding changes to move profits out of
India to another country with lesser taxes.
This has to be stopped.
So, in 2001, sections 92A-92F were added to the ITA, 1961 to make sure that international transactions
between an Indian group company and a non-Indian group company do not lead to this form of tax evasion.
This is what the sections say:
Computation of income from international transaction having regard to arm’s length price
- Section 92 of the Act
 Meaning of associated enterprises - Section 92A of the Act
 Meaning of international transaction - Section 92B of the Act
 Computation of arm’s length price - Section 92C of the Act
 Reference to transfer pricing officer - Section 92CA of the Act
 Power of Board to make safe harbour rules - Section 92CB of the Act
 Maintenance and keeping of information and document by person entering into an international transaction - Section 92D of the Act
Section 92: whenever any international transaction is made, the expense incurred, or value
of the entity transferred shall be at an “arm’s length price”. This is especially so if this
happens between two associated enterprises.
Section 92A: defines ‘associated enterprises’. If the two companies transacting are under
the control of a common entity or one controls the other, they are associated enterprises.
Alternatively, if one enterprise has in the other or a third common entity has more than 26%
voting power; has given loans that account for more than 51% of book value; has guaranteed
more than 10% loans; one company controlled by HUF and another be a member of the HUF-
they’ll be associated enterprises.
Section 92B: “international transaction" means a transaction between two or more
associated enterprises, either or both of whom are non-residents, in the nature of purchase,
sale or lease of tangible or intangible property, or provision of services, or lending or borrowing
money, or any other transaction having a bearing on the profits, income, losses or assets of
such enterprises, and shall include a mutual agreement or arrangement between two
or more associated enterprises for the allocation or apportionment of, or any
contribution to, any cost or expense incurred or to be incurred in connection with a
benefit, service or facility provided or to be provided to any one or more of such enterprises.
Section 92C: “computation of ALP” can be done by any of the
following methods:
 Comparable uncontrolled price method
 Resale price method
 Cost plus method
 Profit split method
 Transactional net margin method
 Such other method as may be prescribed by the Board

Section 92CA: provides for a ‘Transfer Pricing Officer’ to whom the

AO shall refer cases of international transactions and who shall
provide notice and hearing to assessee. His recommendation will be
forwarded to the AO for processing and the TPO is also to assess the
ALP if required.
Section 92D: Every person who has entered into an international
transaction shall keep and maintain such information and
document in respect thereof and for such period, as may be
prescribed by the board and produce before the A.O or
commissioner (Appeals) as and when required in the course of
proceedings under Income Tax Act within a period of 30 days from
the date of receipt of notice.
WHAT DO YOU THINK IS THE
MOST LEGALLY ACCEPTABLE
METHOD OF TAX
AVOIDANCE?
DTAAs.
SO, WE FOCUS A BIT MORE
ON THEM
Double taxation avoidance agreement is that one piece of income should only
be taxed in the hand of one person, once, and in only one jurisdiction.
This is why you have rules and different heads of income that help you
categorise and income under only one of these heads. Otherwise it would be
very easy to argue that the same income is taxable as business income and also
as income from capital gains.
But this is not what we care about as much anymore. We care more about this
income, being taxable only in one jurisdiction. Now this is possible if two
competing jurisdictions, follow similar or different tests to establish tax
jurisdiction, and since one cannot influence the other, under their respective
laws, they both have jurisdiction. This can take one of the following three forms.:
 Residence-residence rule conflict
 Source-source rule conflict
 Resident-source rule conflict
FORMS OF DTAA
Now a double taxation avoidance agreement can be entered into by two or more
sovereign tax jurisdictions. It is often a complete and comprehensive agreement
that entails tax liability for a taxpayer based upon rules that are negotiated
between the two jurisdictions. There are four such forms that these agreements
can take:
1. A comprehensive DTAA is a bilateral agreement that India will enter into with
another country based on reciprocation. India has more than 90 search
comprehensive DTAAs. A comprehensive DTAA will always cover the entire
ground of taxation, including how to reduce tax liability from each different
source of income.
2. A limited agreement on the other hand is a sector specific agreement that
India will enter into with another country. For instance, India has entered into a
limited agreement for income from international air transport with Pakistan.
This, as the name suggests is limited, only to ensuring that double taxation can
be avoided for income from international air transportation.
OTHER KINDS OF
AGREEMENTS
3. But these agreements are not only bilateral. For instance, India
entered into the SAARC limited, multilateral agreement on
avoidance of double taxation, and mutual administrative
assistance in tax matters. First, this is a limited agreement, not a
comprehensive one. Second, it’s a multilateral agreement, not a
bilateral one. However, the obligations are reciprocal amongst all
members who signed it.
4. A fourth kind of agreement is something called the tax exchange
information agreement. Wherever comprehensive agreement
exist, this becomes a clause in the larger agreement. However,
no such comprehensive agreement exists, it is a separate
agreement. The idea is that the jurisdiction undertake the
responsibility of receiving and exchanging information that will
help both of them to Levi and collect the fair share of taxes.
HOW DID DTAAS COME INTO
BEING?
The history of double taxation avoidance agreement can be reached all the way back to the early
1900s. It took a more substantive shape when the committee of technical experts on double
taxation and taxation under the league of nations came up with a report in 1927.
This report was quickly succeeded by the first model treaty in 1928.
It is this model treaty, which formed the basis for the Organisation of the European Economic
Cooperation (OEEC) model tax treaty.
Now this model remains fairly relevant, even after 100 years. It is the basis for both the UN model
convention as well as the OECD model convention. While they are fundamentally similar in many
aspects, there were some problems with the OECD treaties specifically pertaining to the
insistence on residence being the dominating rule to ascertain tax liability.
This is why the UN Model was curated and then became popular. If you look at the UN model
convention is actually titled the United Nations model, double taxation convention between
developed and developing countries.. Clearly the emphasis is on providing a more equal ground
to both developed and developing countries in earning revenue from taxes.
Most of the Indian agreements are a combination of the OECD and the UN models with a slightly
higher emphasis on rights of the country of source.
BUT HOW DO DTAAS SAVE
TAX?
Across the world, most bilateral and multilateral treaties, use a combination of different
mechanisms to help the assessee avoid double taxation.
1. The first is exemption. So very simple. The income from India is taxed only in India even
for a company resident in the US, so the US will tax the global income of this company
but exempting the income which has already been taxed in India.
2. The second is tax credits. Let’s assume a situation where the tax liability for a given
income is 500 in India and 1000 in the US. Since India is the country of source, it will tax
and collect this 500. so when the US will tax this income, they will allow the 500 to be
credited against the thousand and in the US you pay only the remaining 500.
3. In some instances tax, which is paid in the country of source is allowed as it deductible
expense in the country of residence. But this rule is a little rare in application these
days.
4. You also have something called the reduced rate taxation. Here the assessee would
have paid their taxes in the country of source and therefore the country of residence will
only tax them at lower rate. Then they would have if the country of source had not
already extracted the tax.
HOW DO YOU INTERPRET
THE DTAAS?
There are a few different sources of interpretative rules for DTAAs:
1. The Grand Old Vienna Convention on Law of Treaties, 1969
2. The definitional and interpretation clauses within the DTAA
3. Commentaries on OECD and UN Models
4. Previously decided cases under the DTAA
SOME COMMON CLAUSES IN
MOST DTAA: BUT WE FOCUS
ON INDIA-USA DTAA
HOW DOES THE INDIAN
INCOME TAX ACT DEAL WITH
DTAAS?- S.90
90. (1) The Central Government may enter into an agreement with the Government of
any country outside India or specified territory outside India,—
a. for the granting of relief in respect of—
i. income on which have been paid both income-tax under this Act and income-tax in that country or specified territory, as the
case may be, or
ii. income-tax chargeable under this Act and under the corresponding law in force in that country or specified territory, as the
case may be, to promote mutual economic relations, trade and investment, or
b. for the avoidance of double taxation of income under this Act and under the corresponding law in force in
that country or specified territory, as the case may be, without creating opportunities for non-
taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping
arrangements aimed at obtaining reliefs provided in the said agreement for the indirect benefit to
residents of any other country or territory), or
c. for exchange of information for the prevention of evasion or avoidance of income-tax chargeable
under this Act or under the corres-ponding law in force in that country or specified territory, as the case
may be, or investigation of cases of such evasion or avoidance, or
d. for recovery of income-tax under this Act and under the corresponding law in force in that country or
specified territory, as the case may be,

and may, by notification in the Official Gazette, make such provisions as may be
necessary for implementing the agreement.
(2) Where the Central Government has entered into an agreement
with the Government of any country outside India or specified
territory outside India, as the case may be, under sub-section (1)
for granting relief of tax, or as the case may be, avoidance of
double taxation, then, in relation to the assessee to whom
such agreement applies, the provisions of this Act shall
apply to the extent they are more beneficial to that
assessee.

(2A) Notwithstanding anything contained in sub-section (2), the

provisions of Chapter X-A of the Act shall apply to the
assessee even if such provisions are not beneficial to him.
Section 90(1) gives the scope of the government’s power to make
such agreements with other countries and what all can be covered
under them.
Section 90(2) says that wherever there is a DTAA, the assessee who
is eligible to use the DTAA will still be allowed to use the ITA
wherever it is more beneficial.
Section 90(2) on the other hand states that wherever the IT Dept
figures out that you’ve taken part in treaty shopping or some other
form of tax avoidance, it can use GAAR to deny DTAA benefits.
(3) Any term used but not defined in this Act or in the agreement referred to
in sub-section (1) shall, unless the context otherwise requires, and is not inconsistent
with the provisions of this Act or the agreement, have the same meaning as
assigned to it in the notification issued by the Central Government in the
Official Gazette in this behalf.

(4) An assessee, not being a resident, to whom an agreement referred to in sub-

section (1) applies, shall not be entitled to claim any relief under such
agreement unless a certificate of his being a resident in any country outside
India or specified territory outside India, as the case may be, is obtained by him
from the Government of that country or specified territory.

(5) The assessee referred to in sub-section (4) shall also provide such other
documents and information, as may be prescribed.
 EXPLANATIONS TO S.90
Explanation 1.—For the removal of doubts, it is hereby declared that the charge of tax in respect of a foreign
company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded
as less favourable charge or levy of tax in respect of such foreign company.

Explanation 2.—For the purposes of this section, "specified territory" means any area outside India which may be
notified as such by the Central Government.

Explanation 3.—For the removal of doubts, it is hereby declared that where any term is used in any agreement
entered into under sub-section (1) and not defined under the said agreement or the Act, but is assigned a
meaning to it in the notification issued under sub-section (3) and the notification issued thereunder being in force,
then, the meaning assigned to such term shall be deemed to have effect from the date on which the said
agreement came into force.]

Explanation 4.—For the removal of doubts, it is hereby declared that where any term used in an agreement
entered into under sub-section (1) is defined under the said agreement, the said term shall have the same
meaning as assigned to it in the agreement; and where the term is not defined in the said agreement, but
defined in the Act, it shall have the same meaning as assigned to it in the Act and explanation, if any, given to it by
the Central Government.]
DTAA, BEPS, MLI AND INDIA
Some of the oldest double taxation avoidance agreement at India
has entered into data pack to the early 1980s. However, one of the
most consequential events to take place in international taxation
was the BEPS action plan that the OECD and G20 countries took up
in 2013.
BEPS stands for base erosion and profit shifting. The action plan
was tasked with ensuring that multinational corporations do not
indulge entity shopping to reduce their tax liabilities. However,
given that so many different DTAAs already existed, it became a
tricky issue as to how should one go out renegotiating and re-
ratifying these treaties.
So, they came up with the Multi-Lateral Instrument (MLI).
Through the MLI, instead of renegotiating, all these DTAA nations
could choose to adopt the BEPS action plan simply by adopting the
MLI.
For this, they must first ratify the MLI and submit the same. Second,
they must include the DTAAs under the ‘Covered Agreement’ for
the change to take place.
So, if India and the USA, both signed the MLI, and both included
‘India-USA DTAA’ as a ‘Covered Agreement’ it would be assumed,
that the MLI provisions have been added to the DTAA.
India approved the text of the MLI and signed it in June 2017,
ratifying it with some reservations in June 2019. Therefore, going
forward, the provisions of the MLI would be read along with the text
of the DTAA where India and the other countries have both ratified
DTAA- USE AND ABUSE
The intended outcome of the double taxation avoidance agreement
was to promote bilateral investment and improve trade balance by
ensuring that investing entities were aware of their tax obligations
well in advance. It was also hoped that this would lead to greater
clarity on liabilities and transparency in the payment or settlement
of these liabilities. Another main aim of a DTAA is to ensure that
there is administrative cooperation between the income tax
departments of the two jurisdictions.
However, DTAAs began to be abused and misused by companies
headquartered in developed nations that were now investing in
developing nations. They not only indulged in lobbying for more
favourable DTAAs but also treaty shopping. This had also given rise
to the malpractice of round-tripping where Indian black money was
reinvested in India as white money because of favourable treaty
Imagine a scenario where a North Korean company wants to invest in
India. Let’s assume that North Korea and India have not entered into a
DTAA. In such a scenario. The applicable law for determining tax liabilities
would be the Indian Income Tax Act of 1961. However, India has a very
favourable DTAA with Singapore that provides great incentives.
The North Korean company would want to create a Shell company in
Singapore and then utilise the India-Singapore DTAA to reduce its tax
liability. This is something which has been categorically made unlawful
after the introduction of GAAR.
It is because of problems like this that the OECD members as well as the
G20 members came together to adopt BEPS minimum standards which
include removing harmful tax practices (Action Plan 5), reporting transfer
pricing (Action Place 13) and countering in Tax treaty abuse (Action Plan 6).
There are two tests which have been evolving over the past 30-40
years and have gained ground since the BEPS action plans:
i. Limitation of Benefit (LoB)
Ii. Principal Purpose Test (PPT)
In most instances, only one of the two is added as a provision to a
DTAA, but wherever both of them coexist, they are interpreted and
applied in a harmonious fashion.
Let’s look at both of these one by one.
LIMITATION OF BENEFIT
(LOB)
A limitation on benefits, the article is an antiquity shopping
provision. The intention of this is to prevent the residents of a third
country from obtaining benefits under a treaty between two
different countries. They do so by providing certain tests that
determine whether the assessee claiming these benefits is a true
resident of one of the contracting parties.
We will see how in 2017 India and Mauritius renegotiated DTAA to
include the limitation of benefit test and ensure that third-country
entities were not able to abuse the favourable provisions of the
India, Mauritius DTAA.
PPT (PRINCIPAL PURPOSE
TEST)
Now the principal purpose test is used to deny tax treaty benefits to an entity if it is
found that one of the principal purposes of the arrangement or transaction was to
attain this tax treaty benefit. This is very similar to the limitation of benefits clause.
This is given in article 7 of the MLI:
“Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the
Covered Tax Agreement shall not be granted in respect of an item of income or
capital if it is reasonable to conclude, having regard to all relevant facts and
circumstances, that obtaining that benefit was one of the principal purposes of any
arrangement or transaction that resulted directly or indirectly in that benefit, unless
it is established that granting that benefit in these circumstances would be in
accordance with the object and purpose of the relevant provisions of the Covered
Tax Agreement.”
But what does benefit mean? We look at section 102 of the income tax act to
understand that a benefit includes payment of any kind of tangible or intangible. So
even when the tax liability is reduced, this is also a form of intangible payment.
There is a two tier test to ascertain whether the principal purpose
test has been met or not.
In step one, the income tax authorities look at the purpose of the
transaction or arrangement to see if one of the purposes was to
attain tax treaty benefits.
In step two, once it is established that one of the principal purposes
was to obtain tax benefits, it is then enquired whether this benefit
was to be attained via tax avoidance or treaty shopping. If yes,
then tier two is also met.
When both these tiers are satisfied, the treaty benefit can be
denied to such an assessee.
INDIA-MAURITIUS DTAA
Now Indian Mauritius share a very close connection with 2/3 of the Mauritius population being of Indian
origin. Despite being in Africa, Africa, Mauritius is also geographically fairly close to India and has been one
of India’s biggest state partners so much so that between 2004 and 2014 about 39% of the total FDI into
India was coming from Mauritius.
At the same time, what was happening is that Indian investors were round, tripping their black money
through Mauritius back into India and non-business entities were setting up shell companies and routing
their investments through these shell companies into India.
The biggest reason for this was a very weirdly drafted DTAA between India and Mauritius in 1982, which
allowed Mauritian entities to not pay any capital gain tax even where capital gains were realised. The
harmful effects of the DTAA had been realised back in 1992 and had been subsequently highlighted in
different cases.
In the most surprising update, the CBDT issued circular 789 in April 2000, which prohibited Indian income
tax officers from investigating any foreign investor, who possessed assert of Mauritian Tax residence. As
soon as they had a tax residency certificate, they were outside the ambit of tax investigation in India.
This was the cost challenged in the Azadi Bachao case, but when the Supreme Court came back with a
decision that favoured this method of foreign investment into India, it led to even greater scrutiny. Not only
the increasing scrutiny, but also India’s BEPS commitments forced to renegotiate the DTAA with Mauritius.
INDIA MAURITIUS DTAA
2016 AMENDMENT W.R.T.
CAPITAL GAINS.
Article 13- the right to the capital gains arising to residents of Mauritius from
the transfer of shares of an Indian company was allocated to Mauritius based
on the rule of residence. Even dividends from an Indian company paid to
Mauritian residents are to be taxed at 5% under the DTAA as compared to
25% for other non-resident entities under the Indian Income Tax Act.
The CBDT via a circular in 1994, circular 682, increased the ease for an
assessee to receive these tax benefits. By clarifying that the Tax residency
certificate was the only document required to enjoy these benefits, then only
tied the hands of income tax officers in India.
Even more shocking was the article relating to taxing fees for technical
services, which, under the India Mauritius DTAA, did not include the right for
India to withhold tax. The income from FTS would be taxed in Mauritius, but
that was not always the case.
2016 PROTOCOL TO THE
DTAA
With a view to discourage around tripping of black money and treaty
shopping by third-country entities, the two governments renegotiated,
the DTAA and this was notified on 10th August 2016.
The most important change was that for capital gain tax. The rule was
changed from residence to source meaning that India could now tax
capital gains from the sale of Indian company shares by Mauritian
residents.
Similarly, the source rule was also to be applicable for FTS and interest
paid to a Mauritian resident by an Indian person, both natural and legal.
Not only shares, but even gains from the alienation of immovable
property would be taxed in the state by the properties to be paid after
the 2016 protocol
YEAR OF ACQUISITION
AND TRANSFER WAS
IMPORTANT
Now, when the DTAA was being changed, after more than 30 years, the change
could not be abruptly introduced. Therefore, the taxability of capital gain tax
depends on whether the shares in question were acquired before 2017-18 or
between FY 2017-19 or from FY 2019-20 onwards.
So, for shares that were acquired before 2017, whenever they are
disposed or transferred or alienated, the Mauritian entity would continue to not
pay any capital gains tax in India. Thanks to the grandfathering of this
protection into the DTAA, despite the 2016 protocol.
However, if the shares were acquired after April 1, 2017:
 And transferred between 1st April 2017 and March 31, 2019, what is called the transition
period, subject to the LOB clause, an entity would be taxed on those capital gains at the rate
which is half of the rate applicable for domestic entities. So, if Indian investors were paying 20%
in capital gain tax then Mauritian investors would have paid only 10%.
 If transferred after March 31, 2019, then it would be taxed as per the capital gains tax rates
which exist in India, which for short-term capital gains is 20%.
ARTICLE
27A
ADDED-
LOB
WHAT IS THE LOB IN THE
INDIA-MAURITIUS DTAA
Before the 2016 Protocol, there was no LOB clause in the India -
Mauritius DTAA, and non-Mauritius entities were free to misuse these
benefits. However, the LOB was added to the Protocol for the transition
period of 1st April 2017 to 31st March 2019- wherein.
Therefore, if shares were acquired in this time frame, the tax payable
would be 50% of the domestic rate as long as the LOB clause does not
become operative. And the LOB clause has two tiers again:
i. main purpose: what is the main purpose of the entity or
arrangement, making sure that is not a shell or conduit company with
no real or ongoing business operations in Mauritius.
ii. Bonafide business test: it is to check that the primary purpose of
this Mauritian company is not to take benefit of tax rates.
Both India and Mauritius had signed
and ratified the DTAA. India had
included the ‘India-Mauritius DTAA’
as a ‘Covered Agreement’ but
Mauritius had not.
So, on 7th March 2024, they signed a
renegotiated DTAA, and most
importantly included a principal
purpose test.
They also amended the Preamble of
the treaty to categorically emphasise
that one of the main purposes of the
treaty was to ensure that no tax
evasion or avoidance took place.
However, both governments have
not yet notified the same, it is yet to
come into play.