Industry wary of changes to UAE tax treaty

The corporate sector has responded cautiously to the protocol amending the tax treaty between India and the United Arab Emirates (UAE).

The amendments, which will come into effect from April 1, 2008, will have implications on business profits, dividends, capital gains and others, and the changes also incorporate an Article on Limitation of Benefits.

Until now, the eligibility of individuals residing in the UAE to claim the benefit of the India-UAE tax treaty has been a contentious issue considering that UAE individuals were generally not subject to tax in UAE. The authorities in a recently ruling has stated that individuals who are not subject to tax in UAE are not eligible for treaty benefits.

With a view to clear the air, the new protocol has provided more clarity in determining the residential status of UAE residents by introducing amendments.

"The treaty provides that an individual who had been living in the UAE for a period or aggregate period of at least 183 days in a calendar year will be treated as a resident of UAE. Hence, individuals who become residents of UAE will be eligible for treaty benefits. By providing certainty to UAE residents regarding their eligibility to claim the tax treaty benefits, the above contrary decisions have become redundant," said K R Sekar, Partner, Deloitte Haskins & Sells.

Under the existing provisions of the treaty, capital gains on sale of shares are liable to tax only in the country of residence of the seller. In other words, NRIs or residents of UAE who make capital gains on sale of share are not liable to be taxed in India.

However, the amendments to Article 13 removes this exemption in a substantial manner and the benefits are withdrawn.

According to the amendments, capital gains from alienation of shares of the capital stock of a company which consists principally of immovable property shall be taxed in the state in which it is located.

"For example, if an UAE investor either an NRI or any other group of Investors transfer shares held in a real estate firm situated in India, the same shall attract capital gains tax. It may hit the investors who are based in the UAE who have invested in real estate companies," added Sekar.

Secondly, in the case of gains arising on alienation of shares, the same shall be taxed in the state in which the company issuing the shares is resident. Accordingly, capital gains on sale of shares of an Indian company will be liable to tax in India in the hands of UAE residents.

The protocol has further introduced an Article dealing with "Limitation of Benefits" in the treaty. "This provides that an entity will not be entitled to the benefits of the tax treaty if the main purpose or one of the main purposes of the creation of such entity was to obtain tax treaty benefits which would otherwise not be available. Further, this Article provides that the legal entities should be having bona fide business activity to claim the benefit of treaty," detailed Sekar.

Though the intention of this Article is to prevent conduit companies or letter pad companies to claim the benefit of exemption, in the absence of specific clarity like agreements between India and Singapore or notification between India and Mauritius, the issue will become debatable.

"In this context, it is relevant to note that in the case of Mauritius treaty wherein the existence of a residency certificate is a sufficient requirement for enjoying the treaty benefits and in case of India-Singapore the minimum threshold of expenditure is prescribed," highlighted Sekar.