One of the purposes of tax treaties is to bring an element of tax certainty to international transactions, with an overall goal to avoid double taxation. However, particularly in cases where developing countries are party to such agreements, the interpretation and application of a particular tax treaty may not be that straightforward. The purpose of this bulletin is to illustrate how tax insurance can be used to reduce tax treaty risks.
A perfect example in this regard for tax insurance purposes relates to the interpretation of the Mauritius/India tax treaty, alternatively the Singapore/India tax treaty. JLT has been involved in insuring a number of these risks and the principles can best be illustrated by way of a practical example.
Company A (a company incorporated and tax resident in Mauritius) disposes of its shares in an Indian domiciled and tax resident entity to Company B (incorporated and tax resident in Mauritius). A capital gain is realised by Company A on the disposal.
Both Companies A and B are entitled to access tax treaty benefits.
It should be noted that the shares in the Indian entity were originally acquired by Company A prior to 1 April 2017.
INDIAN DOMESTIC TAX LAW
In terms of its domestic law, India should tax any capital gain arising in the hands of Company A from the disposal of its shares in the Indian entity. In addition, the law obliges the buyer (Company B) to withhold this tax from the purchase price and pay it over to the Indian tax authority. The withholding tax obligation of Company B is only due if Company A is subject to Indian tax on the gain.
MAURITIUS/INDIA TAX TREATY PROVISIONS
The provisions of the Mauritius/India tax treaty (“the tax treaty”) override domestic law.
In terms of the tax treaty, all gains from the disposal of shares of Indian companies (which shares were originally acquired on or after 1 April 2017 by a person tax resident in Mauritius) would be liable to tax in India.
However, the tax treaty wording implies that for property originally acquired prior to 1 April 2017, any gain on the subsequent disposal thereof, shall be taxable only in Mauritius where the seller is a tax resident of Mauritius.
Since Company A originally acquired the Indian entity prior to 1 April 2017, it appears to be clear from the tax treaty that any gain realised by Company A should be taxable in Mauritius (and not India). Since Mauritius does not levy CGT, no tax should be due on the transaction. There is therefore also no corresponding withholding tax obligation on Company B.
THE RELEVANCE OF TAX INSURANCE UNDER THE CIRCUMSTANCES
Even though it appears that the tax treaty is clear on the CGT issue, companies often have little confidence that the Indian tax authorities may not try to challenge the interpretation of the tax treaty, which may expose both the seller (Company A) and buyer (Company B) to Indian tax obligations.
The seller is often not prepared to provide indemnities to the buyer in this regard, and the buyer is not prepared to carry the risk relating to the withholding tax obligation, if Indian tax is due by the seller. Tax insurance for this particular risk has proven to be very popular, and many policies which protect the seller and buyer against Indian tax obligations under the circumstances are currently operational.
Although this bulletin dealt with a very specific insurable tax issue which may arise in a tax treaty context, numerous types of tax risks relating to tax treaties may be eligible for insurance, with due consideration given to the relevant jurisdictions, nature of the risk, professional advice on the risk etc.
In this regard, it may be appropriate to consider tax insurance in cases where the application of a tax treaty provision to a particular set of facts is unclear, or where interpretation issues may arise, resulting in tax exposures.
For further information, please contact Leon Steenkamp, Head of Tax Insurance on +44 (0)20 7558 3994 or email firstname.lastname@example.org.