If a Spaniard invests in English Console and the interest is paid over to a bank that remits the proceeds to Paris, where they are deposited in his account, is the income received in England, France or Spain? So asked Edwin Seligman in his 1928 volume Double taxation and international fiscal cooperation. All over the world, nation states have embarked on a voyage to discover the true tax potential in operations carried out by transnational corporations (TNCs) across the globe. Gone are the days when tax competition led to liberal interpretations of tax avoidance agreements between countries. TNCs naturally choose locations with nil or low tax jurisdictions for signing off their profits on balance sheets. Double taxation avoidance agreements are entered into to locate the place where the income accrues or arises. Products are manufactured in one country and sold in another either directly or through a branch or an agent. Where should the income be taxed? Is it the country where the company resides or the country where it carries on business or the country where the source of income is located? The problem was tackled by the Organisation for Economic Cooperation and Development (OECD) and a Model Tax Convention on income and on capital was prepared in 1992. The United Nations drafted a model convention in 1980 and this has become the standard format for tax treaties. India?s own tax treaties are based on the UN model. The UN Model Convention is a compromise between the source principle and the residence principle. It gives more weight to the source principle than does the OECD model.

Both Japan and UK have in the last two years taken steps to rework issues concerning taxation of profits arising from outbound investments. Under the Japanese Controlled Foreign Corporations Regulations (CFCR), income of subsidiaries in low tax jurisdictions is taxable in the hands of the Japanese holding companies. Profits distributed by such companies were hitherto exempted from tax. Japan has now introduced substantial changes. Now, Japanese companies will lose tax credit on dividends in source jurisdictions and they will not get deduction as business expenses of the taxes so withheld abroad. Great Britain?s CFC regulations take away exemptions of dividend distribution tax. These are structural changes and do not give any concessions to the tax payer.

The changes being brought about in the US international tax policy are more fundamental. The unprecedented banking crisis of the last two years led to legislative measures like Emergency Economic Stabilisation Act and Tax Extenders and Alternative Relief Act. In the US, profits of foreign subsidiaries are generally taxed at the time of repatriation back to the US. This can mean deferral of taxation of such income in theUS by delaying remittances of those profits. President Obama has now repealed this deferral. If taxability is deferred, deduction in respect of expenses for earning such profits will also be deferred in the American tax assessment. American companies can no longer choose to repatriate only such income as was subjected to high foreign taxes and claim credit for the same. Under the new scheme, tax credits of foreign income are available when all foreign income and all foreign tax credits are taken into income account. Cherry-picking the tax credit is no longer possible.

Germany has promulgated an Ordinance in August 2009 for combating tax evasion. The new law will apply to foreign business activities in uncooperative states i.e., states that have not entered into a treaty for exchange of information in accordance with Article 26 of the OECD Model Convention 2005 or states that do not enter into such an agreement with Germany.

The new law denies application of provisions of German law in respect of companies involved in foreign business activities in uncooperative states.

In the light of these changes in international tax policies abroad, India cannot be sleeping. Response is found in the draft Direct Taxes Code 2009. The anti-avoidance arrangement law enables government to disregard any step wholly or in part if it is of the nature of an impermissible avoidance arrangement. There are deeming provisions for treating connected persons in relation to each other as one and the same. Provision is made for recharacterising equity into debt or vice versa. There are also provisions for treaty over-ride. As against an unqualified supremacy of tax treaty provisions over the provisions of domestic tax laws, it is proposed that neither the treaty nor the Code shall have preferential status. Whichever provision is later in time shall prevail. This is on the model of the law in the US, the UK and Australia. The Vienna Convention is sought to be given the go-by. Indian branches of foreign companies are now sought to be taxed. The principle of taxing on the basis of permanent establishment is undergoing change.

Hopefully, changes proposed in the Draft Code will mitigate the loss of revenue caused to the exchequer by such devices like thin capitalisation (disproportionately high debts in relation to equity capital), which enables multinationals to claim deduction of high interest, treaty shopping (taking advantage of DTAA between two countries by a resident of third country through the establishment of an entity in a country like Mauritius) and round tripping of funds (funds of locals being rerouted through countries like Mauritius in a clandestine manner). New rules are also being proposed to regulate withholding taxes.

The changes proposed in the DTC are wholesome and will certainly bring in more revenue though critics may point to the dangers of foreign investments being affected.

?The author is a former Chief Commissioner of Income Tax and ex-member of the Income Tax Appellate Tribunal