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Multilateral instruments: whither an efficient antidote to tax dodging


Multilateral Instrument ('MLI') is a result of the Organization of Economic Co-operation and Development induced actions within the Base Erosion Profit Shifting ('BEPS') project framework. The aim of the measures undertaken in this project was to develop a mechanism that would impede international profit shifts to countries applying preferential tax rates & assist in undertaking effective measures aimed at tightening the tax systems of the countries involved in the implementation of the project. The report established fifteen areas of study with the goal of providing the tools for counteracting tax avoidance by organizations operating within foreign capital structures to different countries participating in the implementation of the project.

The BEPS Plan comprised the following areas: tax challenges of the digital economy; neutralising the effects of hybrid mismatch arrangements; designing effective controlled foreign company rules; limiting base erosion involving interest deductions and other financial payments; countering harmful tax practices more effectively, taking into account transparency and substance; preventing the granting of treaty benefits in inappropriate circumstances; preventing the artificial avoidance of permanent establishment status; upgrading transfer pricing mechanisms; making mutual cooperation procedure more effective; as well as developing a multilateral agreement under Action 15, highlighting the framework to achieve modification of already existing bilateral tax treaties.

Functioning and Structure

As a Multilateral International Agreement, the MLI Convention allows for amendments to double taxation agreements concluded by a given country, without the necessity of negotiating a new international tax agreement. In consequence, the MLI provisions envision introduction of a mechanism of a single multilateral legal instrument that allows amendments to the bilateral tax agreements while giving some degree of flexibility to the countries to enforce its views on the subject matter. The Convention has been divided in seven parts – two general ones (introduction and final provisions) as well as five detailed ones (hybrid entities and instruments, including anti-double-taxation methods, abuse of double taxation agreements, preventing the avoidance of permanent establishment status, making dispute resolution mechanisms more effective).

Paving a way for the Minimum Standards

Some provisions of the MLI reflect a minimum standard, namely in Article 6 (Preamble), Article 7 (Principle Purpose Test) and Article 16 (Mutual Agreement Procedures). As such, this can be complied with in different ways. In some cases, Article 6 of the MLI itself provides for different ways of meeting the minimum standard. If two contracting states to a treaty implement a minimum standard in different ways, it may give rise to inconsistencies in the tax treaty. For instance, India has expressed reservation in Article 16, Mutual Agreement Procedure (MAP), which is a minimum standard but at the same time, it has affirmed to implement MAP in a resident state, thus fulfilling the minimum standard requirement through implementation of bilateral notification and consultation process.

Concept & Efficacy of the Covered Tax Agreement

Article 6 of the MLI modifies existing tax treaties to include a preamble text that clarifies the purpose of the double tax treaty as not being solely to eliminate double taxation, but to do so without creating opportunities for non-taxation or reduced taxation through tax evasion or tax avoidance (including through treaty-shopping arrangements aimed at obtaining relief provided in the tax treaty for the indirect benefit of residents of third jurisdictions). In terms of the latest amendments made vide Finance Act, 2020, the suggestive text of the preamble now finds place in the Income Tax Enactment itself, with amendment of clause (b) of sub-section (1) of section 90 of the Act so as to provide that "the Central Government may enter into an agreement with the Government of any country outside India or specified territory outside India for, inter alia, the avoidance of double taxation of income under the 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 this agreement for the indirect benefit of residents of any other country or territory)".

International treaties are to be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of their object and purpose, the modification of the purpose of the tax treaty set out in its preamble may influence the interpretation of the tax treaty.

Article 6 is a minimum standard for protection against the abuse of treaties. A party may, therefore, reserve the right for the text not to apply to an existing tax treaty only if that treaty already contains preamble language that describes the same intent or applies more broadly. In the Indian scenario, Article 6, is likely to create a paradigm shift as it would render the favourable interpretation by the Supreme Court of treaty shopping, in the case of Union Of India And Anr vs Azadi Bachao Andolan And Anr (2003) 263 ITR 0706 (SC), thereby allowing tax avoidance as useless. The preamble as envisioned under the MLI frowns upon the practice of tax avoidance resulting from double taxation avoidance.

Anti-Abuse Measure- Emergence of Principle Purpose Test

Article 7 of the MLI presents an anti-abuse provision in the form of the so-called Principal Purpose Test ('PPT'). The PPT states that treaty benefits shall be denied if it 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.

In addition, Article 7 contains an optional Simplified Limitation on Benefits ('SLOB') clause, which provides that most treaty benefits shall be denied to taxpayers other than individuals unless such other taxpayers fulfil one of a number of criteria. The purpose of the clause is to prevent treaty shopping by denying treaty benefits to companies that are not engaged in the "active & bonafide business".

According to Article 7(15) of the MLI, a party may opt out of the PPT provision set out in Article 7(1) but only if it fulfils the minimum standard set out by the MLI in another way, by adopting a combination of a detailed Limitation of Benefit ('LOB') provision and rules to address conduit financing structures, for instance, given that a detailed LOB provision requires substantial bilateral customization, the MLI does not include such a provision. Moreover, a party to the MLI that has chosen the SLOB clause may opt out of Article 7 entirely with respect to existing tax treaties where the other contracting state prefers to apply the PPT alone, provided that it endeavours to reach a mutually satisfactory solution that meets the minimum standard. India has decided to apply PPT on an interim basis and would gradually shift towards the SLOB.

PPT vis-à-vis General Anti-Avoidance Regulations

The PPT provisions are similar to the General Anti-Avoidance Rule ('GAAR') provisions under chapter X-A of the Indian Income Tax Act, 1961, and therefore a conceptual overlap between the application of the PPT and GAAR is possible. The PPT is applicable only on cross border transactions, whereas GAAR is applicable on both domestic and cross-border transactions. GAAR is applicable to arrangements whose tax benefit is higher than INR 30 million but there is no monetary limit to apply PPT to transactions. Further, the key element of the PPT is "treaty benefit" which significantly varies from GAAR's which is "tax benefit". GAAR is invoked when the "main purpose" is to avoid tax, however, PPT shall be invoked when "one of the principal purposes" is to obtain tax benefit. It is also important to remember that invoking the PPT provisions to deny treaty benefits does not require the tax officer to go the approval panel as required while invoking GAAR.

Recent Tax Ruling- Denial of Treaty Benefits

The Authority for Advance Ruling ('AAR') in the case of Bid Services Division (Mauritius) Ltd. (Applicant), a Mauritius based Company and a subsidiary of a South African listed company, held that tax treaty benefit under the India-Mauritius tax treaty cannot be availed as the Mauritius Company was established merely to route funds for South African based holding Companies.


Airport Authority of India (AAI) with the approval of Government of India, selected the Applicant in Consortium with other entities as a joint venture partner to undertake development, operation and maintenance activities at the Mumbai Airport. AAI also entered into an Operation, Management and Development Agreement with Mumbai International Airport Private Limited ('MIAL') to undertake the said activities at Mumbai Airport.

The Applicant entered into a Shareholder Agreement for a contractual relationship with MIAL and other joint venture partners/shareholders of MIAL. As a shareholder of MIAL in the agreement, the Applicant agreed to subscribe and acquire twenty seven percent of total issued and paid-up share capital of MIAL. The Applicant subsequently entered into a Share Purchase Agreement (SPA) with another Indian entity shareholder of MIAL wherein the applicant agreed to transfer to said shareholder, fifty percent of its stake held in MIAL.


Whether the capital gains arising from the sale of shares of MIAL held by the Applicant to another Indian entity shareholder, pursuant to a SPA would be liable to tax in India under the provision of Article 13(4) of India-Mauritius tax treaty.

AAR's Ruling

The AAR noted that the Applicant served as a conduit for routing funds for South African based holding companies. Further, the shares of MIAL though were bought in the name of the Applicant but the beneficial owners were the holding companies in South Africa. The Applicant kept on noting and endorsing decisions of the holding companies in the board meetings without any contribution or discussion about the decision-making process.

The Hon'ble AAR observed that the Applicant did not have any independent infrastructure or resources and was interposed for the dominant purpose of avoiding tax in India.

The Hon'ble AAR applied the doctrine of "substance over form" and followed the observations of the Hon'ble Supreme Court in the celebrated case of Vodafone International Holdings B.V. vs Union of India, 341 ITR 1, held that treaty benefits should be denied, if a non-resident achieves indirect transfer through abuse of legal form and without reasonable business purpose, which results in tax avoidance.

In Summary

MLI has not been designed per se to impede fair business practices but would act as a barricade to enjoying tax benefits in situations where the chief purpose of obtaining such benefit has been the driver(s) of the business arrangement. This would have consequences and would significantly affect the manner in which affairs and arrangements going forward are organized by the business entities. For a business enterprise to contest and rely upon the settled principle that the legal effect of an arrangement must be seen through as such and accordingly, tax consequences would be determined, may not be the clinching argument in the post BEPS/MLI world. With GAAR in place also, it would be absolutely necessary for the entity to organise its offshore counter-part affairs, with some impeccable housekeeping.

Additionally, India has opted for PPT only for the time being and intends on gradually shifting towards the SLOB by means of bilateral negotiations. The interaction of PPT with GAAR during the interim period still hinges on an unfound plain and the subjective nature of both might create highly contentious situations. GAAR might be viewed as being wider in terms of its coverage but it is the PPT which actually might yield some unforeseen consequences. Clearly, we all are in for interesting taxing times!