Issues of global taxation need to be made clear

LEGAL EYE

Double dipping sounds like a disgusting and rude habit of putting food back in the communal bowl, after being touched by the hand or mouth; like a half eaten samosa in chutney. In international tax practice, it means a mechanism being increasingly used to leverage differential local tax treatments to generate multiple benefits from the same expenditure of resource in both source and resident contracting states.

A common example of exploiting the same transaction is of leasing of equipment. In most jurisdictions, financial and operating leases have different tax treatments "" depreciation in case of financial leases are available to the lessee, as the nature of the transaction is characterised as loan for purchase, while for operating leases the depreciation benefit is always with the lessor, as the lessee's payment is by way of rent, and the lessor remains the owner. In cross-border transactions therefore, very often one jurisdiction allows the legal owner/lessor depreciation on the asset, while in the other, the economic owner i.e. the lessee would get the same benefit, effectively doubling deductions or the "dip".

Another method of double dipping involves dual residence companies. Some countries permit consolidation of accounts, and the same company is regarded as being eligible to tax by reason of a "permanent establishment" or any other duration based residence test, to offset the combined income or permitting transfer of tax losses of related entities. A typical example of a double dipping investment structure is in the context of a Canadian company, A, which in stage one borrows from a local bank and invests in the equity of a foreign affiliate "" company "FA" in a low tax jurisdiction.

FA uses the investment to make a loan to FCO, another group company in a higher tax jurisdiction. Company A avails a permitted tax deduction on the interest payable on its loan, while FA's investment in FCO is characterised as an active business income, on which tax is payable at a lower rate and dividends without withholding tax repatriated to company A.

Without details of deductions and set-offs, it is not possible to predicate the exact losses per jurisdiction from the above illustration, but Canada and other nations have initiated anti-abuse legislation to stop generation of two deductions from one investment.

Closer home, the Indian revenue authorities had their first major experience with double dip in the Patni Computer case. Patni, a major software development company, had set up a trading office in Japan, and booked a loss of INR 54 lakhs of the Japan branch as a deduction in the Indian company's assessment. This was disallowed by the assessing officer under the Indo-Japanese DTAA, which provides that any profit earned in Japan would not be taxable in India, therefore the loss should not be allowed as a deduction. Patni's appeal was recently decided by the appellate tribunal.

Section 5(10) of the Income-Tax (I-T) Act provides for global income of Indian companies to be assessed under the Indian tax law, while Section 90(2) of the Act provides that in case of a conflict between the Double Taxation Avoidance Agreement (DTAA) and the I-T Act, an assessee has the choice to be governed by either the law or the treaty. Till date, the only Supreme Court decision on DTAAs is that of Union of India versus Azadi Bachao Andolan, which has held that once an income is taxable in a particular jurisdiction under a DTAA, the global taxation scheme under the I-T Act is not applicable, unless specifically provided otherwise. A tax treaty cannot be interpreted to the disadvantage of a taxpayer, nor an assessment be thrust upon him.

The tribunal conceded and upheld the assessee's rights in choice of jurisdiction and assessment, to opt for taxation on global income basis to claim deduction of losses of the foreign affiliate, and exclude any income occurring therefrom in subsequent assessment years, if there is a loss. If the assessee therefore gets an advantage that is a win-win situation for him, currently there is no law that can stop it. The tribunal is perhaps right in its somewhat regretful observation, as this is something which was not envisaged when these treaties were entered into. DTAAs are negotiated, and what is a duly considered and deliberate policy decision 20 years back may not work as well in the present context. Issues of international taxation need to be revisited "" but who will bell the cat?

Kumkum Sen is a partner at Rajinder Narain & Co.

kumkumsen@rnclegal.com