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Protocol amending the India-Israel tax treaty

March 20, 2017[2017] 79 226 (Article)


The Government of India has issued a notification1 dated 14 February, 2017 giving effect to a Protocol amending the India-Israel tax treaty entered into on January 29, 1996 (hereinafter referred to as old India- Israel tax treaty/old tax treaty). The said Protocol was signed on 14 October, 2015 at Jerusalem, Israel and was entered into force on 19 December, 2016. The Protocol will have effect in India from Financial Year 2017-18.

This article discusses the key features of the said Protocol and its implications.

Analysis and discussion

1.   Most Favoured Nation (MFN) clause removed : The Protocol to the old tax treaty has provided that if India enters into a treaty with a third state, which provides for a more restricted scope or a lower rate of taxation of dividend, interest, royalty or fees for technical service (FTS), the same may be available under the old India-Israel tax treaty.
  This MFN clause is now removed.
  The implication of the removal of the MFN clause is that dividends, interest, royalty or FTS arising in India and paid to an Israeli tax resident would be subject to tax at 10% under the India-Israel tax treaty (subject to other conditions). The scope of the aforementioned types of income will be as defined in respective articles of the tax treaty and no restricted scope will be available.
  There is significant reduction in benefit that would have been available to an Israel tax resident, for example, in case of FTS under the India-Israel tax treaty, there is no requirement of meeting "make - available" criterion to qualify FTS; however, such requirement exists under the India-Canada tax treaty. Under the MFN clause the benefit of this restricted scope of definition of FTS under the India - Canada treaty would have been available to the Israel tax resident; however, after the removal of this clause the benefit of restricted scope of FTS definition will not be available. Another example is in context of rate of tax on dividend income2. Some tax treaties permit taxation lower than the 10% prescribed under India- Israel tax treaty, for example, the tax treaty with Saudi Arabia permits taxation at 5% on dividend income. The benefit of such lower rates was available to Israel tax resident in view of the MFN clause but will not be available anymore.
2.   Limitation of benefits (LOB) : To avoid unintended use of the tax treaty, LOB article is introduced.
  Para 1 of the newly inserted article prevents treaty shopping by providing purpose test rule, This para provides that the benefit of the tax treaty shall not be available to a resident of a contracting state or transaction undertaken by such resident, if the main purpose or one of the main purposes of the creation or existence of such a resident or of the transaction undertaken by it was to obtain benefits under the tax treaty that would not otherwise be available.
  Para 2 of the LOB article provides that the tax treaty shall not prevent a state from applying its domestic law on prevention of tax evasion or tax avoidance. Now, in context of the Israel tax treaty it cannot be argued that the provisions of tax treaty prevent the applicability of domestic General Anti Avoidance Rules (GAAR) provisions. Though it is provided in domestic GAAR provisions of India that GAAR will override treaties, repetition in the protocol seems to represent an intention of not leaving any gap that may cause a problem in applying GAAR to override treaty benefit in appropriate circumstances. GAAR provisions become effective in India from April 1, 2017, making this insertion a very effective tool in situations where granting the benefit of tax treaty would be inappropriate to the extent that the result would be avoidance of domestic tax.
  Recognition of domestic anti-abuse provisions in tax treaty is also in accordance with BEPS Action 6, which has suggested the introduction of domestic law anti-abuse provisions in case of a person trying to abuse the provisions of domestic law using treaty benefits.
  Some other treaties such as India-Luxembourg and India-Saudi Arabia also recognize domestic anti-abuse provisions.
  Para 3 of the LOB article deals with tax avoidance by providing that the benefit under the tax treaty cannot be granted to a person who is not the beneficial owner of the income. Under the old Treaty the concept of beneficial ownership existed for dividend, royalty, interest and FTS income; it has now been extended to all types of incomes. Now, it is not possible for the taxpayer to contend that there is no express clause denying the benefit of the tax treaty for a particular type of income, if none of the provisions of the tax treaty is contravened.
  In India, the judicial opinion3 is that the taking advantage of beneficial tax treaty should not be denied if it does not contravene the provisions of the treaty and LOB concept should not be implied. The relevant extract of that judgment by Hon'ble Apex Court is reproduced below:-
  "…. if it was intended that a national of a third State should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect should have been incorporated therein………The appellants rightly contend that in the absence of a limitation clause, such as the one contained in ………, there are no disabling or disentitling conditions under the …… Treaty prohibiting the resident of a third nation from deriving benefits there under. They also urge that motives with which the residents have been incorporated in …..are wholly irrelevant and cannot in any way affect the legality of the transaction. They urge that there is nothing like equity in a fiscal statute. Either the statute applies proprio vigore or it does not. There is no question of applying a fiscal statute by intendment, if the expressed words do not apply. In our view, this contention of the appellants has merit and deserves acceptance…."
  Now, the express inclusion of the LOB clause will make it possible for the tax authorities to deny tax treaty benefits in undesirable situations.
3.   Capital gains on alienation of shares/interest deriving value from immovable property : Article 13(4) of the old tax treaty allows the contracting states in which immovable property is situated to tax capital gains realized by a resident of the other state on shares of company/interest in a partnership, trust or estate that principally derive their value from such immovable property.
  Now, the Protocol has clarified the applicability of this provision by establishing a threshold of 50% of the value from immovable property.
  Further, the provision of this article shall apply when share or interest derives their value principally from immovable property at any time during the twelve preceding months as opposed to at the time of alienation only. Under the old tax treaty the Article 13 (4) taxpayers may take the benefit by contributing assets to the entity shortly before the sale of the shares or other interest in that entity in order to dilute the proportion of the value of these shares or interests that is derived from immovable property situated in one contracting state. The amended Article 13(4) prevents such circumvention. This amendment is as per BEPS Action 6 recommendation
  This change is in accordance with the recommendation in BEPS Action 6.
  One more change that is noticeable is that now this Article is applicable on interest in all types of entities as against interest in a partnership, trust or estate at present.
4.   Exchange of information (EOI) : The scope of this Article is expanded to align with international standards.
  Now, any request for information cannot be denied on the ground that the requested state does not have domestic interest in the information requested. The requested state shall use its information gathering measures to obtain the requested information, even if the requested state does not need such information for its own purposes.
  Another significant change is that the request for information cannot be declined solely because the information is held by bank or financial institutions or nominees or persons in fiduciary capacity. Further, while ensuring the confidentiality of the requested information, the use of such information is extended for other purposes (other than tax purposes) provided the information received may be used for such other purposes in both the states and the supplying state has authorized such other use.
  This new article on EOI is as per UN/OECD model conventions and has ensured a robust system of exchange of information. It is to be noted that the EOI Article, in other treaties like South Africa, Mauritius, Japan4 etc. that were renegotiated in the recent past, was also revamped on the like terms.
5.   Deemed tax credit removed : The benefit of deemed tax credit on dividend and interest income, which is 15% and 10%, respectively, has been removed. We have not come across any precedent where deemed tax credit has been allowed in India on the basis of old India-Israel tax treaty.
6.   Permanent establishment (PE) non-discrimination : Article 25(2) of the old tax treaty dealing with PE non-discrimination provides that the taxation of a PE of other state enterprises should not be more burdensome than taxation on an enterprise of that other state. The protocol to the existing treaty has extended non-discrimination in Article 25(2) to the rate of tax in the agreement with other countries by providing that if the difference between the rates of tax on Indian enterprises and that on the PE of the other country is reduced or removed, such reduction shall be effected for PEs of Israel enterprises.
  This clause has been removed.

As per our understanding, India has not entered into any agreement whereby the difference in the rates of tax between the PE of a foreign company and that of India is removed or reduced. Hence, the removal of this clause will not have any implications right now.


India renegotiated several treaties in the recent past and secured its right to tax capital gains sourced in India. The removal of the MFN clause from the India-Israel tax treaty is a further step to ensure that India obtains the appropriate tax on income sourced here.

The introduction of a robust LOB clause, particularly the recognition of domestic GAAR, clearly is in line with the BEPS philosophy.

Domestic law provisions in India on 'indirect transfer' provide that the share of a company will be considered to be located in India if it derives its value substantially from assets located in India. It has been explained that 'substantially' means at least 50% of the assets of the company should be located in India. The capital gain article similarly provides that capital gain on transfer of shares of a company more than 50% of whose value is derived from immovable property situated in a contracting state will be taxable in that state.

Robust EOI article reflects the contracting states' intention of ushering in better transparency and is a step towards global society.


1. Notification No. SO 441(E ) [No. 10/2017 (F No. 500/14/2004-FT-II]

2. In India tax on dividend is applicable on deemed dividend provided under section 2(22)(e )of the Income-tax Act, 1961.

3. Supreme Court in Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706 (SC)

4. India and Austria signed a protocol amending the India-Austria tax treaty in February 2017. The press release to that effect provides that the protocol will broaden the scope of the existing framework of exchange of tax related information which will help curb tax evasion and tax avoidance between the two countries and will also enable mutual assistance in collection of taxes.

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