DTC not to override tax treaties

Written by Tanu Pandey | Tanu Pandey | KG Narendranath | New Delhi | Updated: Mar 25 2010, 13:56pm hrs
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The government might drop the draft Direct Taxes Code (DTC) proposal that virtually gives Indian tax laws supremacy over the Double Taxation Avoidance Agreements (DTAAs) with other countries. This could be a relief to taxpayers vexed over the proposals ability to cause uncertainties over, and even an overnight jump in, their tax liability.

The moves implication is that the India-Mauritius DTAA, which underpinned the emergence of the small island nation as the largest source of foreign investment in India, along with more than 70 other bilateral tax treaties, would not automatically become subservient to the Code when it kicks in from April 1, 2011.

In an exclusive interview with FE, Central Board of Direct Taxes chairman SSN Moorthy said the proposal would not be internationally acceptable and so it was being reconsidered. Internationally, nobody would accept that. We cannot put the provision (that DTC would override DTAA in case of a conflict) that way (in our tax laws), he said.

Moorthy also said an internal task force is reviewing the DTC draft and taxpayers could expect major conceptual changes in all other DTC proposals on which they have raised concern. The revised draft would be ready in about two months.

While the proposed EET (exempt-exempt-tax) method for taxation of savings is a concern for individual taxpayers, the proposal to impose MAT on gross assets (opposed to book profits now) is worrisome to corporate India.

When asked about these proposals, Moorthy said, the revised DTC draft would reflect conceptual changes in these proposals as well. It (the revised draft) will be a document which contains workable solutions for these issues. Were sure that taxpayers would be a relieved lot once the new draft is issued.

The current draft says capital gains, including that from listed securities, would be taxed at par irrespective of the period of holding, which means that the long-term capital gains tax could also be taxed at the marginal rate of the taxpayer. Moorthy stressed that the exemption from long-term capital gains tax from listed shares is a targeted dispensation to help the markets, and added that there would be no cause for worry on this front also.

Analysts say while avoiding the blanket provision that virtually gives DTC supremacy over the difficult-to-change DTAAs, the government could modify the code to the effect that in case a treaty is silent on any kind of income or provisions, the domestic law would prevail. Such a provision could have an impact on the roles of Indias most prominent DTAAs the ones with Mauritius and Malaysia, for instance, that stand the taxpayers in good stead. While the Mauritius treaty has no anti-avoidance provision, the agreement with Malaysia is silent on the kind of income called fee from technical services.

In a DTAA, the right to tax is allocated to either country in four different ways. One is that full rights to tax is given to both countries without limitation and the country of residence giving credit for tax paid in the source country. This is the case of DTAA with tax haven Mauritius, the reason why it is the largest source of foreign investment in India. A DTAA, as the name suggests, is principally meant to avoid double taxation of the same income by two different countries. The right to taxation is allocated to either country on the basis of mutually agreed principles, and if one country has the right to tax a certain income, provision is made for the other country to give tax credit or exemption. India has an extensive DTAA network there are 75 such agreements.

What the draft code ostensibly says is that neither a DTAA nor the code (Indian tax law), would have a preferential status by reason of its being a treaty or law. While this itself is a drastic change from the extant principle of DTAA overriding domestic law, the code further says that in the case of a conflict between the treaty and the code, the one that is later in point of time shall prevail. DTC, effective from April 1 2011, would anyway be the later in time, and even in case of future DTAAs, the situation would be no different as changes in domestic laws are autonomously (and rather easily) made while DTAA re-negotiations are protracted---it could take several years to change even a single provision.