Tax residency certificate: Is the devil in the details?

Atax residency certificate (TRC) is important for claiming tax treaty benefits. Some source countries are cautious about providing tax benefits to non-residents, especially to corporations from low tax jurisdictions which have a favourable tax treaty. India is no exception to this international principle.

Mauritius treaty

One of the most important treaties under which India provides key tax benefits is with Mauritius. Under this tax treaty an entity that qualifies as “a person resident of Mauritius” can claim the benefits of lower withholding tax on dividends and non-taxability of capital gains income on the sale of shares in India.

Circular 789 issued by the Central Board of Direct Taxes (CBDT) in 2000 laid down that obtaining a TRC would suffice to obtain the benefits of the India-Mauritius tax treaty. Providing a TRC should obviate the need to examine the beneficial ownership of the transaction entered into with the Mauritian company. The circular specifically clarified that a TRC issued by Mauritian authorities will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying tax treaty provisions.

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The debate between tax authorities and taxpayers over whether a TRC is sufficient proof to obtain tax treaty benefits was attempted to be ended in 2003 when the Supreme Court of India, in the case of Union of India v Azadi Bachao Andolan, reiterated the position as stated in Circular 789. The court upheld the validity of the circular and held that the term “liability of tax” in a tax treaty does not equate to an actual payment of tax.

In the absence of a limitation of benefits clause in the India-Mauritius tax treaty, any gains derived by a Mauritian company in India would not be chargeable to tax. A TRC would suffice to prove that the Mauritian company is a tax resident of Mauritius and thus eligible to enjoy the benefits of the treaty.

2012 amendment

The Finance Act 2012 amended the provisions of the Income Tax Act, 1961, to include that obtaining a TRC is mandatory for a non-resident to claim treaty benefits. At the time of introduction of this provision, it was clarified that the TRC would be a requisite, but not sufficient proof to claim tax treaty protection. The CBDT also prescribed the format of the TRC.

This is a strict position as against Circular 789 or the Supreme Court judgment in Azadi Bachao Andolan, which only applied to tax havens such as Mauritius.

Proposed changes

Further, an amendment proposed in the Finance Bill 2013 provides that obtaining a TRC would be necessary but not a sufficient to claim the benefits under a tax treaty. The intent expressed at the amendment in the Finance Act 2012 is now proposed to be included in the legislation.

The Finance Bill 2013 has also proposed to delay the implementation of general anti-avoidance rules (GAAR), by replacing the existing GAAR provisions with a new chapter, which would come into effect from 1 April 2016. Under the GAAR provisions, any transaction undertaken with a main purpose of obtaining a tax benefit will be subject to GAAR. The GAAR provisions would override tax treaty provisions and thereby the benefits under the tax treaty would not be available.

By the proposed introduction of the new provision relating to TRCs, the effect of GAAR is being fast-tracked on this aspect.

Conclusion

The intent of obtaining a TRC should be only to establish that a person is a tax resident of the resident country as is defined in most treaties. The CBDT, through a notification dated 17 September 2012, prescribed the details which are required to be included in the TRC to be issued by the tax authorities of the foreign country. The details sought are registration ID, address, etc., which would increase the compliance obligations on foreign companies.

TRCs are generally issued by tax haven countries and therefore seeking such a certificate by way of legislative amendment from countries such as the US, UK, Germany, etc., will create compliance hassles for residents of these countries. Further, such advanced jurisdictions support tax pass-through structures whereby income is taxed only in the country of the beneficial owner and not in the country of residence even though for tax purposes the entity is a tax resident. The implications in cases of such structures will need to be evaluated.

Considering the far-reaching impact of obtaining and furnishing a TRC, it is important for each non-resident entity undertaking business in India or with Indian entities to examine the implications if for any reason they are not in a position to obtain a TRC.

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Economic Laws Practice is a full-service law firm with headquarters in Mumbai and offices in New Delhi, Pune and Ahmedabad. Pranay Bhatia is a partner at the firm and Janhavi Sharma is an associate.