Eligibility Criteria for Claiming Benefits under DTAA – A Guide for Taxpayers

Table of Contents

1. Introduction
2. Factors that determine eligibility to DTAA

Check out Taxmann's International Taxation Ready Reckoner which is India's first 'ready reckoner' on international taxation and cross-border transactions, this book provides a comprehensive guide to topics including taxation schemes, residence, Double Taxation Avoidance Agreements (DTAA), and conflict resolution between DTAA and the Income-tax Act. It serves as an essential handbook for those dealing with cross-border transactions, payments to non-residents, and digital transactions.

1. Introduction

For taxability of an NR, who comes from a country outside India with which India has entered into a DTAA, the provisions of the IT Act apply only to the extent that they are more beneficial than the provisions of the relevant DTAA between India and the country from where such NR comes.

The above is enshrined in section 90(2) of the IT Act, which reads as follows :

“(2) Where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.”

It is important to note that the above provision is overridden by sub-section (2A) of section 90, which was included in the IT Act by Finance Act, 2013, with effect from 1 April, 2016, being the date from which the provisions relating to General Anti Avoidance Rules (“GAAR”) became effective. Sub-section (2A) is reproduced below :

“(2A) Notwithstanding anything contained in sub-section (2), the provisions of Chapter X-A of the Act shall apply to the assessee even if such provisions are not beneficial to him.”

Chapter XA of the IT Act deals with GAAR. This means that though, the provisions of the relevant DTAA will override the provisions of the IT Act as regards taxability of an NR, if GAAR is applicable in the case of an NR then the same would apply even though the application of GAAR provisions results in not applying the provisions more beneficial. This is so since when GAAR is invoked, section 90(2) benefit to the NR would no longer be applicable.

Clearly, for any NR entering into transactions in India, it is important and critical to examine whether the arrangement proposed under the transaction is regarded as impermissible avoidance arrangement (“IAA”) under Chapter X-A of the IT Act, else such NR would not get the benefit of the DTAA on which it relies for taxability in India. GAAR is dealt with in this book in Chapter 23. Please refer to it for details.

At the minimum, in order for an NR to seek benefit of a DTAA, section 90(4) of the IT Act requires the NR to furnish a tax residency certificate obtained from the Government of the relevant country. NRs are also required to furnish the following information in Form 10F as per section 90(5):

(i) Status of the taxpayer (i.e. individual, company, firm, etc.)

(ii) Permanent Account Number or Aadhaar number of the taxpayer if allotted

(iii) Nationality (in the case of individuals) or Country or specified territory of incorporation or registration (in case of others)

(iv) Taxpayer’s tax identification number in the country or specified territory of residence and if there is no such number, then, a unique number on the basis of which the person is identified by the Government of the country or the specified territory of which the taxpayer claims to be a resident

(v) Period for which the residential status as mentioned in the certificate referred to in section 90(4) or section 90A(4) is applicable

(vi) Address of the taxpayer in the country or territory outside India during the period for which the certificate, mentioned in (v) above, is applicable

2. Factors that determine eligibility to DTAA

After checking that there is a DTAA with the relevant country which is in force as also the MFN clause (refer to Chapter 2 on Tax Treaties), it is necessary to check the following for eligibility to such DTAA:

(i) Whether the NR is covered within the scope of the DTAA or within the ‘persons covered’ under the DTAA under Article 1 of the DTAA and therefore also within the definition of ‘person’ as provided in Article 3 of the relevant DTAA.

(ii) Whether the ‘person’ is resident of the other state as provided in Article 4 of the DTAA.

(iii) Whether the taxes for which the DTAA benefits are to be claimed fall within the ‘scope of taxes covered’ in the DTAA.

(iv) If the NR wants to take advantage of beneficial treatment given to different classes of income covered by the DTAA, whether the NR has a permanent establishment (“PE”) in India in terms of Article 5 of the relevant DTAA.

(v) Whether the arrangement or transaction attracts GAAR, which would make the NR ineligible to DTAA benefit.

(vi) Whether the arrangement or transaction fails the Principal Purpose Test (“PPT”) under the applicable MLI and hence becomes ineligible to get DTAA benefit.

We briefly explain what is entailed in each of these provisions. For this purpose we refer to the articles of the two model conventions: The UN Model and the OECD Model. UN Model provides the basis for negotiating DTAAs by developing countries with the developed countries. The OECD Model is essentially for the developed countries but there are several articles of the OECD Model convention (“OECD MC”)¹ that are used by the UN Model convention (“UN MC”). Many of India’s DTAAs are a hybrid between the OECD and the UN Model conventions. Hence, we will refer to the Articles of both the conventions.

2.1 Person under DTAA

First, whether the NR falls within the meaning of persons covered under Article 1 of the DTAA:

Article 1 of the UN MC provides as follows for the “Persons Covered”:

1. This Convention shall apply to persons who are residents of one or both of the Contracting States.
2. For the purposes of this Convention, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State.
3. This Convention shall not affect the taxation, by a Contracting State, of its residents except with respect to the benefits granted under [paragraph 3 of Article 7], paragraph 2 of Article 9 and Articles 19, 20, 23A [23B], 24 and 25A [25B] and 28.

Article 1 of the OECD convention provides as follows for “persons covered”

1. This Convention shall apply to persons who are residents of one or both of the Contracting States.
2. For the purposes of this Convention, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State.
3. This Convention shall not affect the taxation, by a Contracting State, of its residents except with respect to the benefits granted under paragraph 3 of Article 7, paragraph 2 of Article 9 and Articles 19, 20, 23 [A] [B], 24, 25 and 28.

Since the DTAA applies to persons who must be resident at least of one of the states, it is necessary to understand the meaning of “person”.

Article 3(1)(a) of the UN MC defines the term “person” as follows:

‘The term “person” includes an individual, a company and any other body of persons;’

Article 3(a) of the OECD MC defines the term “person” as follows:

‘the terms “person” includes an individual, a company and any other body of persons.’

This definition in both the MCs is identical.

This means that the person must be either a natural person, a company or ‘a body of persons’. It does not say that the body of persons should be incorporated. But since body of persons is regarded as ‘person’, clearly, that body of persons must be resident of one or both the states, the DTAA between whom is to be applied.

This leads to a question on whether a fiscally transparent² entity such as partnership (in most countries it is fiscally transparent) or trust, which is not a legal entity is regarded as ‘person’ for the purposes of the DTAA.

According to the UN Commentary 2021, if, under the laws of a Contracting State, partnerships are taxable entities, a partnership may qualify as a resident of that Contracting State under paragraph 1 of Article 4 and therefore be entitled to benefits of the Convention. However, if a partnership and any entity other than company (e.g. a trust) is treated as fiscally transparent under the laws of the residence State, and accordingly, the partners are taxed on the partnership’s income, paragraph 2 of Article 1 provides that the provisions of the Convention should be applied at the level of the partners, to the extent that the partners are taxable in the country where partnership is resident.

From this, it follows that if no partner is resident in the country of residence of the partnership, then the DTAA between that country and India would not apply to any part of the income of the partnership. However, whether the DTAA between India and the country where the partners are taxed on this income would apply or not, would need to be considered.

As body of persons is not defined, one would take help from commentaries to ascertain what falls within its meaning.

The OECD Commentary on Article 3(a) states that partnerships will be regarded “persons” either because they fall within the definition of “company” – being body incorporate (where they are body corporates) or, where this is not the case, because they constitute other bodies of persons. From the meaning assigned to the term “company” by the definition contained in sub-paragraph (b) it follows that, in addition, the term “person” includes any entity that, although not incorporated, is treated as a body corporate for tax purposes. The example given in the commentaries is that of a Foundation (also known as stiftung, which is similar to trust but different, being under Civil Law and is taxed as a body corporate in the Civil Law countries).

The following example given in the UN Commentaries 2021 explains the intent of how Article 1, paragraph 2 applies:

Example

State S and State R have concluded a treaty identical to the Model Tax Convention. State S treats the entity established in State R as a company, and taxes that entity on interest that it receives from the borrower who is resident in State S. Under the domestic law of State R, however, the entity is treated as a partnership, and the two members in that entity, who share equally all its income, are each taxed on half of the interest. One of the members is a resident of State R and the other one is a resident of a country with which States S and R do not have a treaty. The paragraph provides that in such case, half of the interest shall be considered, for the purposes of Article 11 (on interest), to be income of a resident of State R.

In the above example, there will be no treaty benefit given on the other half of interest which is not taxable in State R in the hands of the other partner.

The same principles as discussed above would apply in case of a trust (which is also regarded merely as an arrangement) as per the commentaries. However, India has clarified that it would give the benefit of the DTAA to income through the arrangement only if the arrangement is resident of one of the contracting states.

Thus, the first hurdle to cross is to determine whether the NR falls within the “persons covered” under the DTAA and hence whether the NR is a “person”.

Case Study

(1) Let us understand the concept of ‘person’ through a case study.

An individual is employed by a multinational company which is located in Germany. The company has no agent or fixed place of business in India. The individual is a citizen of the UK. In the course of his employment, he is required to travel to several countries to perform his duties. He spends some time in each country he travels to, but not enough to become resident in any of those countries. He also does not spend enough number of days in the UK to be regarded a resident in the UK. However, in the year under consideration, he spends more than 60 days but less than 90 days in India. He has visited India in prior years for very short period of time, not aggregating to more than 365 days in the prior 4 years. In such a situation, would he be eligible to benefits of any DTAA?

As he is an individual, he satisfies the definition of “person” under Article 3. However, in order to be eligible to the benefit of DTAA, he should qualify as a ‘resident’ of at least one country. The next step would be to determine if this individual is a ‘resident’ of any country. The rules of residence in each jurisdiction would need to be applied to determine this.

So, if the individual does not become resident in India under section 6(1), in particular under sub-clause (c), then as far as India is concerned he is not resident in India. But, under section 10(6)(vi) of the IT Act, his salary income, pertaining to his presence in India may be exempt from tax in India provided the following conditions are satisfied:

• He is not an Indian citizen
• He is employed by a foreign co. (which is a fact in this case)
• The foreign enterprise is not engaged in trade or business in India
• His stay in India does not exceed 90 days in a FY (this is a fact)
• His remuneration is not deductible from the income of his employer, which is chargeable to tax in India.

As can be seen in this example, when the person is not tax resident of any jurisdiction, then the benefit of a DTAA may not be available to him.

2.2 Association of Persons (“AOP”) as a “person”

As is seen in the definition of ‘person’ in the DTAAs, AOP which is considered resident in India would also fall within the meaning of taxable persons, since India regards an AOP as resident in India if any part of its control & management is situated in India and an AOP is a taxable entity in India. Hence, an AOP formed in India for the Equipment Procurement and Construction (“EPC”) contract or any such AOP, between one or more NRs and/or an Indian person would be a resident of India for Indian tax purposes. The AOP will be taxed in India on its global income i.e. income whether arising in India or outside India, if any. There would not be further tax in India on the member of the AOP. The NR member would not get any benefit in India of the DTAA between its country of residence and India since the NR is not the taxable person in India, the AOP is. Thus, such income of the AOP would be taxed in India and the NR may also be taxed in its home country on its share of the income of the AOP (unless the home country of the NR provides a mechanism to provide credit for such taxes). Whether the NR member will get the benefit of the DTAA in its home jurisdiction on the income from the Indian AOP to relieve double taxation would depend on the laws of that jurisdiction in this regard as they interact with the DTAA.

This is a complex discussion which is outside the scope of a ‘ready reckoner’. We have included it here for the purposes of the reader to be aware of this issue and get it examined in detail by such NR in their home country.

In an Advance Ruling given by the AAR (Mumbai) in January 2020³, the term person, resident and therefore eligibility to DTAA between India and the Netherlands has been discussed and ruled upon.

The facts are, that there were 3 legal entities which are tax residents of the Netherlands. They were representing two funds in the Netherlands and were NOT considered taxable persons in the Netherlands. The 2 funds which are not taxable in the Netherlands had earned income from investments in India under the Foreign Portfolio Investment regime of the SEBI (“FPI”). On the question whether the benefit of India-Netherlands DTAA would be available to the representatives of the 2 Dutch Funds, the AAR examined whether any of the applicants claiming DTAA benefit falls under the definition of person under the DTAA and is resident in the Netherlands to claim the benefit under Article 13 of the India-Netherlands DTAA.

The benefit was denied because none of the funds satisfied both the conditions of being ‘person’ as well as ‘resident’ under this DTAA as per the Netherlands tax law. The three entities which were legal entities and residents of the Netherlands were not accepted to be ‘representative’ taxpayers of the 2 Funds or the investors in the Funds. Also, the DTAA does not deal with a tax transparent entity and how it should be provided the DTAA benefit. If there was such a provision, then the result could have been different.

Since the definition of “person” necessitates it to be resident in a contracting state, we now turn to the meaning of ‘resident’ as set out in Article 4.

2.3 Resident under DTAA

Under both the UN MC and OECD MC, Article 4 deals with the term “resident of a contracting state”. Most DTAAs have this article numbered as 4, but could be different in some DTAAs

“UN MC 2021 Article 4 – Resident

1. For the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of incorporation, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.

2. Where, by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follow:

(a) He shall be deemed to be a resident only of the State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident only of the State with which his personal and economic relations are closer (centre of vital interests);

(b) If the State in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either State, he shall be deemed to be a resident only of the State in which he has an habitual abode;

(c) If he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident only of the State of which he is a national;

(d) If he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

3. Where, by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall endeavour to determine by mutual agreement the Contracting State of which such person shall be deemed to be a resident for the purposes of the Convention, having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by this Convention except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting States.”

“OECD MC – Article 4 – Resident

1. For the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof as well as a recognised pension fund of that State. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.
2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:

(a) he shall be deemed to be a resident only of the State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident only of the State with which his personal and economic relations are closer (centre of vital interests);

(b) if the State in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either State, he shall be deemed to be a resident only of the State in which he has an habitual abode;”

1. DTAAs are referred to in the international literature as “Conventions”. Since we generally refer to them as DTAAs, we have retained that reference. However, where the word ‘convention’ is used, it also means DTAA, unless the context requires a different meaning.
2. Fiscally transparent entity means that for tax purposes, the form of the entity, i.e. partnership or pass through LLC is disregarded and the income is considered to accrue or arise to the partner or member of the LLC directly and therefore taxed in the hands of the partner or member of LLC.
3. ABC, In re [2021] 125 taxmann.com 293 (AAR – Mum).