Tax treaty shopping

A tax treaty between India and another country gives relief to residents of those two countries. It is not meant for anyone else.

Treaty shopping is when a resident of a third country, which has no treaty or a less generous one, arranges to invest through an entity in the treaty country — so that it can claim the treaty's reliefs indirectly.

For AIFs this matters because offshore investors often pool through a vehicle in a treaty jurisdiction. The workbook's position is that India now looks at substance over form: its treaties must not create opportunities for non-taxation or reduced taxation through such arrangements, and the MLI and GAAR are the tools that enforce that.

The statutory statement (Chapter 13, section 13.4). To prevent treaty benefits being granted in inappropriate circumstances and to align with the Multilateral Convention against BEPS, section 159 of the Income-tax Act provides that the Central Government shall enter into double taxation avoidance agreements without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through tax treaty shopping arrangements aimed at obtaining reliefs provided in the agreement for the indirect benefit to residents of any other country or territory.

The MLI timeline in the same section.

The MLI's effect on each treaty depends on ratification and on the positions taken by both treaty countries.

GAAR alongside it (section 13.3). CBDT clarifications of 27 January 2017: where tax avoidance is sufficiently addressed by a Limitation of Benefit (LOB) clause in a treaty, GAAR will not be invoked; GAAR will not be invoked merely because an entity is located in a tax-efficient jurisdiction; and the INR 30 million GAAR threshold applies to the arrangement, not only to a single taxpayer.

Claiming treaty benefits at all (section 13.1). A non-resident must obtain a Tax Residency Certificate from the foreign tax authority, furnish prescribed information, and file Form 41 electronically with the TRC. Treaty provisions apply where more beneficial, subject to GAAR and the MLI.

A date conflict. Chapter 5 (section 5.4) says that after the OECD enunciated BEPS "through the MLI in 2018, India became a signatory". Chapter 13 gives the signing as 7 June 2017 and entry into force as 1 October 2019. For a dated question, Chapter 13's detailed timeline is the one to rely on; know that Chapter 5 says 2018.

Two structures for the same Rs 100 crore (illustrative throughout; no tax rates are assumed).

Structure A — genuine. A pension fund resident in Country T, which has a treaty with India, invests Rs 100 crore into an Indian Category II AIF. It holds a Tax Residency Certificate from Country T, files Form 41, and claims treaty relief on its income. The investor is a resident of the treaty country. This is ordinary use of a treaty.

Structure B — treaty shopping. An investor resident in Country Z, which has no treaty with India, sets up HoldCo in Country T with no staff, no office and no activity other than holding the investment. HoldCo invests the same Rs 100 crore and claims the Country T treaty's reliefs. The real beneficiary is the Country Z resident — the indirect benefit to residents of any other country that section 159 describes.

HoldCo having a TRC does not cure the problem: under the MLI and GAAR, India looks at substance over form.

Chapter 13 (Taxation), section 13.4 on the Multilateral Instrument defines treaty shopping through section 159 and gives the MLI dates; section 13.3 covers GAAR and the CBDT clarifications; section 13.1 sets out TRC and Form 41. Chapter 5 (Alternative Investment Fund Structuring) connects GAAR and the MLI to offshore fund structures. Expect a definition question on treaty shopping, date questions on the MLI, and a question on whether GAAR is invoked merely because an entity sits in a tax-efficient jurisdiction (it is not).

• Treaty shopping is about indirect benefit to residents of a third country, not about choosing a low-tax jurisdiction for a genuine resident.
• GAAR is not invoked merely because an entity is located in a tax-efficient jurisdiction — CBDT clarification of 27 January 2017.
• Where a treaty's LOB clause sufficiently addresses avoidance, GAAR is not invoked.
• MLI dates: signed 7 June 2017; ratification deposited 25 June 2019; in force 1 October 2019. Chapter 5's "2018" conflicts with these.
• India signed with 66 other countries to modify 93 treaties — two different numbers.
• A TRC is necessary to claim treaty benefits but is not sufficient where the arrangement lacks substance.
• The workbook cites section 159 of the Income-tax Act for this principle.