indian taxation of partnerships & triangular treaty situations

© RAO LAW CHAMBERS 2017

Partnerships & Triangular Cases

Shreya Rao

Contents• Introduction

• Tax treatment of Partnerships

• Issues with eligibility to treaty benefits

• Case Studies

• BEPS & The Multilateral Instrument

2© RAO LAW CHAMBERS

Shruthi Ashok assisted with the preparation of these slides.

Introduction

• What is a partnership?

• Key components of partnerships

• Kinds of partnerships

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What is a partnership?


IllustrativeDefinitions

“While the term partnership is used in many countries, their legal characteristics

are not identical in all cases. However, in general, a partnership may be said to

consist of an association of two or more persons… established for the purposes

of making a profit, the profit (or loss) being shared among the partners in

predetermined proportions.”

International Tax Glossary (IBFD, 6th Edition)

“Partnership is the relation between persons who have agreed to share the

profits of a business carried on by all or any of them acting for all.”

Section 4, Indian Partnership Act (1932)

Key Features of a Partnership


Profit & loss sharing, in a predetermin

ed ratio

MAY be a juristic person

Association of Persons

For legally organised

partnerships, the

association is

typically contractual

rather than informal/

implicit

The profit entitlement

should be determinable

but not necessarily

fixed. For example, in a

“limited partnership”,

one partner has

unlimited liability &

upside while others

have limited liability &

upside

General partnerships in

India are not legal

persons (CIT v. RM

Chidambaram Pillai),

while LLPs are (s.3,

LLP Act)

Please refer to 7.21

& 7.22 of Module H

for other

characteristics of

general partnerships

& LLPs

Kinds of Partnerships in India & elsewhere


General Partnerships

• All partners have joint and several liability

• This is the traditional form of partnership

• Recognized under Indian Partnership Act (1932)

Limited Partnerships

• One partner has unlimited liability, others have limited liability

• Typically used for fund investment vehicles

• Not specifically recognized under Indian law

Limited Liability Partnerships

• All partners have limited liability

• Typically used by professionals such as lawyers

• Recognized under Limited Liability Partnership Act (2008)

Hybrids

• Combine features of a “company” & “partnership” and may be treated differently in source & residence countries

• Not recognized under Indian law

Tax treatment of Partnerships

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• Taxation of Partnerships under ITA

• Foreign partnerships

Taxation of Partnerships under the ITA


Definition of Partnership under s.

2(23)

• “firm” shall have the meaning assigned to it in the Indian Partnership Act, 1932 and shall include a limited liability partnership as defined under the Limited Liability Partnership Act, 2008

• How will LLPs incorporated in another country be taxable in India?

Taxable at firm level under s.184 if

• Evidenced by a written instrument that specifies individual shares of partners. Certified copy to be provided with return and changes notified

• A foreign partnership satisfying conditions under s. 2(23) should be recognized as a firm under ITA if these conditions are satisfied.

Taxation of Partners• Once tax is paid by the partnership, no further tax is payable by the

partners on their respective share s.10(2A)

Taxable as an AoP under Sec 167B, ITA

• If conditions under s.184 not satisfied, the firm is taxed as an AoP anddeductions for salary and other payments under s.28 may be denied.

Foreign Partnerships


Residency of Partnership

Sec 6(2): “A Hindu undivided family, firm or other association of persons is saidto be resident in India in any previous year in every case except where duringthat year the control and management of its affairs is situated wholly outsideIndia”

Section 9 –

Deemed income of

foreign

partnerships

A foreign partnership under s.6(2) is taxable only on Indian source income unders.9 of the ITA. However, this may be mitigated by tax treaty benefits availableunder s.90 of the ITA

Section 90 –

Treaty benefitsUnder s.90, if there is a DTAA, then ITA provisions apply only to the extent more beneficial. However, under s.90(4), the person claiming benefits should be a resident and have a tax residency certificate.

Issues with eligibility to Treaty Benefits

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• Applicability of the Treaty to Partnerships

• Differences in country practice

• India’s Position

Applicability of (OECD) Treaty to Partnerships


Article 1: Eligibility

“This Convention shall apply to persons who are residents of one or both of theContracting States”.

Article 4: Resident

“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 byreason of his domicile, residence, place of management or any other criterion ofsimilar nature”

Article 3: Person “The term “person” includes an individual, a company and any other body ofpersons”

OECD Model Commentary on Article 3

“Partnerships will also be considered to be “persons” either because they fallwithin the definition of “company” or, where this is not the case, because theyconstitute other bodies of persons.”

Differences in country practice


Opaque The firm or corporation is treated as distinct entities for the purposes of tax.

The income is assessed at the level of the firm as a beneficial owner, and thepartners subsequently are not taxed on their shares.

Transparent The firm is not recognized as a separate assessable entity for the purposes oftax.

The income flows through to the hands of the partners (as beneficial owners),who are individually taxed on their shares

Partly Opaque and Partly Transparent

Seen in cases of limited partnerships (as in France). Taxed at two levels

Taxed at the level of firm w.r.t limited partners

Firm treated as transparent w.r.t general partners

Check-the-BoxRegulation

U.S.A approach- the single member corporation can choose either of the twoapproaches

Examples of country practice


Taxable at the partnership level (as a

corporation)

(GP in Belgium)

Taxable either as a partnership or a

corporation, at the option of the taxpayer

(US Corps)

Taxable in the hands of the partners

(Dutch Closed CV)

Treated as fiscally transparent

(LPs in Germany)

Points to Discuss

- Japanese decision in Heisei

25 (gyou-hi) No. 166

Variance in practice depending on Entity


General Partnerships

• Transparent: Australia, Germany, Sweden

• Opaque: Belgium, Hungary

• Intermediate: India

Limited Partnerships

• Transparent: Germany/ Sweden

• Opaque: Australia/ Belgium

• Intermediate: France/ Czech Republic

LLPs

• Transparent: Germany, Singapore, UK, US, Japan

• Opaque: NA

• Intermediate: India

Variance in country practice: A big problem


1

NATURE OF ENTITY

Whether the entity is clearly a partnership/ trust/corporation & whether transparent/ opaque

Canoro Resources Limited

TD Securities (USA) LLC

2

RESIDENCE

How to determine residence of a foreign partnership?

3

WHO TO TAX

Whether to tax partnership or the partner?

Resource Capital Fund III LP (Australia)

4

CLASSIFICATION OF INCOME

Whether the income character changes depending on who the tax

unit is

1. Entity Classification

Issue: Classification in

source country may not be

compatible with

classification where entity

derives its legal status

(residence).

2. This means: Different

residency statuses under

the treaty

3. Conflict of allocation

Issue: Income

characterisation changes.

Therefore: Risk of double

taxation and double non-

taxation (See 8.63 of Module H)

OECD Solution: OECD Partnership Report

16

OECD Partnership Report (Para 40)

“For the purpose of determining whether the partnership is liable to tax, the realquestion is whether the amount of tax payable on the partnership income isdetermined in relation to the personal characteristics of the partner (whether thepartners are taxable or not, what other income they have, what are the personalallowances to which they are entitled and what is the tax rate applicable to them).If the answer is yes, then the partnership should not itself be considered to beliable to tax.”

Azadi Bachao Andolan: “For the purpose of application of Article 4 of the DTAC,what is relevant is the legal situation, namely, liability to taxation, and not thefiscal fact of actual payment of tax.”

Linklaters v. ITO: Treaty benefits extended if entire profits taxed, either in thehands of the partners or partnership

Schellenburg Wittmer: partners income taxed in Switzerland, but benefit oftreaty not extended to partnership

India’s Position


Para 42 of OECD Partnership Report

“Where the partnership as such does not qualify as a resident, the partners shouldbe entitled to the benefits provided by the conventions entered into by the countriesof which they are residents to the extent that they are liable to tax on their share ofthe partnership income in those countries.”

SA Diebold Courtage: partners entitled to treaty benefits of France-Netherlandstreaty, even though partnership treated as fiscally transparent in Netherlands

India’s Position (2008 update to the OECD Model Convention)

If a partnership is denied the benefits of a tax convention, its members are notentitled to the benefits of the tax conventions entered into by their State ofresidence, unless there is a specific provision to the contrary.

Some Indian treaties with Specific Provisions


Partnership

India-U.S Art. 3(e)

India-Canada Art. 3(f)

CanoroResources Limited

India-Germany Art. 3(d) (partnership not expressly included in

definition)

Chiron Behring GmbH & Co

UK?

Linklaters LLP v ITO


India-UK Treaty (Pre 2014)

• Art. 3(f): “…but subject to paragraph (2) ofthis Article, does not include a partnership”

• Para 2: A partnership which is a taxable unitunder the ITA shall be treated as a person

• P.O. Nedlloydt v. ADIT: If partnership is afirm under sec 2(23)(i), ITA, it becomes aperson under sec 2(31)(iv), ITA, and henceperson by virtue of Art. 3(2)

India-UK Treaty (Post 2014)

• Notification 10/2014: (with effect from 27December, 2013) - removes exclusion of U.K.Partnerships in Art. 3(f)

• CBDT Circular 2/2016: clarified that theDTAA applies to partnerships resident ofeither U.K. or India, to the extent of theincome earned by the partnership is subjectto tax either in the hands of the partnership orthe partners

The India-UK DTAA

OECD Partnership Report: Some Questions


If there is an INCOME characterization mismatch, source country

treatment followed

However, for ENTITY characterization, residence country treatment

followed.

Why?

CASE STUDIES

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• Bilateral Cases

• Triangular Cases

See pages 8.64-8.75 of Module H for further information


P The Partnership

A and B Partners in P

State P State in which P is located

State R The state of residence of the partners

State S The state in which income is sourced, where three countries are involved

Transparent The state treats partnerships as opaque and taxes the partners

Taxable The state treats partnerships as a taxable entity

KEY

BILATERAL CASES: 1


P

B

A

Business profits

with PE

State P (Indian Partnership)

Taxable

State S

• India would tax P

• S may also want to tax the income under

domestic laws, depending on how they

interpret the DTAA

• OECD Says: Treaty benefits should be

allowed to P

BILATERAL CASES: 2


P

B

A

Business profits

State R

Taxable

State P (An Indian partnership)

• India would tax P & exempt A&B.

• However, R may tax A&B under domestic

laws, depending on how they interpret the

DTAA

• OECD Says: Since India would not tax P

based on personal characteristics of A&B,

OECD would support tax at the level of P

BILATERAL CASES: 3


P

B

A

Business profits

without PE

State P

Transparent

State S (Indian Source)

Taxable

OECD Says: Apply S-P Convention

• Income must be considered to be paid to

A and B, two residents of State P, who are

the beneficial owners of such income as

these are the persons liable to tax on

such income in State P

• State S should not tax the income• India requires specific provision in treaty

BILATERAL CASES: 4


P

B

A

Business profits

without PE

State P

Transparent

State S

Transparent

OECD Says: Apply S-P Convention

• State S should view the income as having

"flowed through" the transparent

partnership to the partners who are liable

to tax on that income in the state of theirresidence.

P

B

A

Business profits

without PE

BILATERAL CASES: 5


State R

Taxable

State P

Transparent

OECD Says: Apply P-R Convention

• State P has allocated the income to A and

B.

• State R has allocated the income to P

• Benefits not extended to P or A or B,

hence P has unrestricted right to tax

TRIANGULAR CASES: 1


Residence

State

PE State

Source

State

Income

Income

A partnership of a contracting state (Resident State)

carries on its business through a PE in another

contracting state (PE State) and earns income from a

third contracting state (Source State).

Possibilities:

• Treaties provide for credit and not exemption

• R – S treaty applies & R State should allow credit

for taxes paid in S State;

• R – PE treaty applies and tax is only to the extent

of PE No tax in R State to grant credit against S

tax

• PE – S treaty does not apply since no residency

under Article 1 or 4 – However, non-discrimination

under Article 24(3) leads to tax credit for S state

taxes.

No satisfactory resolution under current law.

TRIANGULAR CASES: 2


P

B

A

Business Profits

without PE

State R

Transparent

State P

Taxable

State S

Taxable

OECD Says: Apply S-P convention

• State P has the right to tax the income,

and hence P should be entitled to treaty

benefit

• Also apply R-S convention- A and B are

liable to tax on that income in state R.

TRIANGULAR CASES: 3


P

B

A

Business profits

without PE

State R

Taxable

State P

Transparent

State S

Taxable

OECD Says:

• P is not liable to tax in State P, and hence

not a resident under P-S convention.

• State R allocates the income to P, but P is

not liable to tax in State R because it isn’t

a resident.

• A and B not entitled to benefit from R-S

convention.

• State S has unrestricted right to tax

TRIANGULAR CASES: 4


P

B

A

Business

profits without

PE

State R

Transparent

State P

Taxable

State S

Taxable

NO TAX CONVENTION

OECD Says: Apply S-P convention

• State P has the right to tax the income,

and hence P should be entitled to treaty

benefit

• Apply R-S convention- A and B are liable

to tax on that income

TRIANGULAR CASES: 5


P

B

A

Business

profits with

PE

State R

Taxable

State P

Transparent

State S

Taxable

OECD Says:

• P is not liable to tax in State P, and hence

not a resident under S-P convention. S-P

convention cannot be applied.

• State R allocates the income to P, but P is

not liable to tax in State R because it isn’t

a resident.

• A and B not entitled to benefit from R-S

convention as they are not subject to tax

in R.

• State S has unrestricted right to tax

BEPS & The Multilateral Instrument

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• BEPS AP 2

• Introduction to the Multilateral Instrument

• Hybrid Mismatches and Transparent Entities

• Dual Resident Entities and Double Taxation

BEPS AP 2

Objective: To adjust the tax outcomes in one jurisdiction to align them with tax consequences in

another through ‘primary rule’ and ‘defensive rule’. It targets 2 types of payments:

Payments deductible under payer jurisdiction not includible in ordinary income of the payee

Duplicate deductions for the same payment

To avoid risk of double taxation it calls for guidance on tie breaker rules if more than one country seeks to apply the rules

Changes proposed to OECD Conventions:

Examine issues of dual resident entities Examine issues related to transparent entities

The Multilateral Instrument puts some of these suggestions into effect.


Introduction to Multilateral Instrument


Aim

• To modify tax treaties betweencountries

• Doesn’t work as a protocol – it isintended to be applied alongsideexisting treaties

Approach

• Countries can specify the treaties to becovered by Multilateral Instrument

• Flexibility w.r.t. minimum standard- canadopt alternative approaches

• Option to opt out of non-min standardprovisions

• Option to opt out when coveredagreement already covers the issue

Hybrid Mismatches & Transparent Entities


Article 3-Transparent Entities

Income derived by or through an entity or arrangement that is treated as whollyor partly fiscally transparent shall be the income of a resident of a ContractingJurisdiction only to the extent that the income is treated as the income of aresident of that Contracting Jurisdiction

Provisions of the Covered Tax Agreement shall not apply to the extent that theyallow double taxation of the income because the entity can be considered asresident of both jurisdictions

Party may choose to not apply this article in its entirety to a Covered TaxAgreement

Dual Resident Entities


Article 4, Dual Resident Entities

If an entity can be considered as resident of both jurisdictions, competentauthorities of both to mutually decide residence having regard to its place ofeffective management, the place where it is incorporated or otherwiseconstituted and any other relevant factors.


Article 5, Elimination of Double Taxation

Deduction of tax paid in the contracting jurisdiction to the extent of the actual taxpaid


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