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India should push for comprehensive changes in the tax-avoidance
May, 14th 2011

After the nuclear deal, India's next big engagement with the US is to rework its two-decade-old tax treaty. And the changes could impact the tax burden of residents - businesses and individuals - in both countries.

The Indo-US double taxation avoidance pact ensures that residents are not taxed twice on the same earnings - by the host country and the home country. The treaty was inked in 1990 after a decade of hard negotiations. Checks are in place to ensure that only genuine Indian and US residents enjoy the benefits of the treaty.

US residents have to report their income from all global sources, including dividend, interest and capital gains, and pay tax on their global income. Indian residents too have to pay tax on income earned overseas. The tax treaty allows residents of both countries to claim foreign tax credit if taxes have already been paid on their gains made in the host country.

The treaty has worked fairly well for over two decades. It has helped bolster capital flows along with transfer of technology and accelerated trade flows. US now ranks fourth after Mauritius, Singapore and Japan in FDI inflows. In the first 11 months of the last fiscal year, FDI from the US topped $1 billion, accounting for over 6% of the total inflows.

The US has also been sharing details on suspected Indian tax evaders, and that too with alacrity, based on specific requests from New Delhi. Clearly, the pact on exchange of information, a component of the tax treaty, has worked effectively.

So, is there really a need to rework the Indo-US tax pact? For India, there are compelling reasons to do so, especially if the government wants to nab tax evaders with assets in the US. The treaty should be strengthened to enable India to secure assistance in collection of dues of Indian tax cheats. The logic is simple: India cannot attach assets that Indian tax evaders may have acquired in the US. The sovereign right to seize these properties rests with the US. India, therefore, wants help in collection of taxes. The US, which has launched a war against tax evaders, may not be averse to the idea.

There are also concerns about entities such as hedge funds in the US routing their investments through Mauritius to escape taxes. But the problem can be tackled only if India reworks its tax treaty with Mauritius to plug its misuse.

India should ensure that it adopts the rules scripted by the Organisation for Economic Development and Cooperation (OECD), or the rich countries' club, on exchange of information in the revised treaty with the US. The OECD rules say that a country cannot deny information to another country simply because it is held by a bank or a financial institution. Moreover, it has to share information on suspected tax evaders even if it does not have a domestic interest in the information. Unlike Switzerland, the US has no restriction on access to bank information. It has powers to obtain ownership, identity and accounting information on corporations. But it makes eminent sense to have the OECD rules in black and white in the revised treaty.

The crucial question is whether the review of the Indo-US tax treaty should be limited to exchange of information or should it be a comprehensive one? Ideally, a comprehensive review would be in order, considering that India plans to bring a new tax code next year.

If the US agrees on a comprehensive review, India should bargain for a better deal on fee for technical services. At present, the scope of taxation of technical services in the treaty with the US is severely limited as it is applicable only when technology is 'made available' to the recipient, says D P Sengupta, former joint secretary in the ministry of finance. This means if a US company renders technical services but does not impart technical knowledge to the Indian company, it is exempt from paying tax here. The government loses a significant amount of revenues due to this exemption. A review is, therefore, in order.

Some tax experts say the Indo-US treaty is one-sided. While US companies get a credit for underlying taxes paid by their subsidiaries in India, Indian companies do not get such credit. With increasing number of Indians setting up or acquiring businesses in the US, such a provision will help in minimising overall tax burden on multinationals, says Shefali Goradia, partner at BMR Advisors.

A comprehensive review may not be a cakewalk as US tax treaty negotiators are known to present their model tax treaty on a take-it-or-leave-it basis. In a paper on US income-tax treaties, William P Streng, Professor of Law at Houston Law University, says the model treaty is evidence that the US Treasury and the Internal Revenue Service may be serious about the US bilateral tax treaty network to resolve continuing cross-border tax disputes. Moreover, with the OECD reviewing many tax treaty concepts, bilateral tax treaties could see more refinements.

Transactions have become more complex in a globalised world and India should, therefore, push for more transparency in its tax treaties. The country should also use its software prowess to analyse information that flows into the tax network to master the art of tracking tax evaders.

As a rising superpower, India should renegotiate the tax treaty with the US from a position of strength. Reforms are also a must in the domestic tax law. A simple, clean and transparent tax system with low rates will ensure that India becomes an attractive investment destination for the US and other overseas investors.

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