Pursuant to the signing of the third protocol (Protocol) amending the India-Singapore Tax Treaty (Treaty) on 30 December 2016, the text of the Protocol has now been officially released by the Government of Singapore. We previously reported key changes of the Protocol basis the press release issued by the Ministry of Finance, Government of India in our Ergo Newsflash dated 2 January 2017. In furtherance, detailed amendments based on the text of the Protocol are set out below:
Applicability of “Mutual Agreement Procedure” to Transfer Pricing
The article on “Associated Enterprises” under the Treaty has been amended to provide that a corresponding adjustment to the income/profits of an enterprise of one contracting state would be made when an addition is made in the income of its associated enterprise in the other contracting state. In determining such adjustment, due regard shall be had to the other provisions of the Treaty, and the competent authorities of the contracting states shall consult each other, if necessary.
Source based Taxation of Capital Gains restricted to Transfer of “Shares”
The Protocol only introduces source based taxation of capital gains arising from the alienation of “shares” of a company. A residuary clause in the Protocol provides that the gains arising from the alienation of any other property shall continue to be taxed only in the state of residence. Therefore, it is now clear that gains arising from the transfer of other capital assets such as debentures, partnership interests etc., and gains from an indirect transfer of Indian company shares in a two-tiered Singapore structure would continue to remain outside the taxability net even after 1 April 2017, subject to the satisfaction of the “general anti-avoidance rules” (GAAR).
Modification to Time Limit in “Limitation of Benefits” Article
Under the present Treaty, and as retained in the Protocol, an entity is not entitled to the capital gains tax exemption in the source state if its affairs were arranged with the primary purpose to take advantage of such benefits. Similarly, shell or conduit companies, viz., resident legal entities with negligible or nil business operations, or with no real and continuous business activities, are disentitled from availing the capital gains exemption in the source state.
The aforementioned conditions of the primary purpose test under the “Limitation of Benefits” (LOB) article have also been made applicable to entities seeking to claim benefit of the 50% lower tax rate under the Protocol during the transition period from 1 April 2017 to 31 March 2019 (Transition Period).
The expenditure thresholds and corresponding temporal limits to avail of the capital gains exemption on investments made prior to 1 April 2017 continue to remain the same in the Protocol, i.e., an annual expenditure of at least S$ 200,000 in Singapore or INR 5,000,000 in India on operations in each of the two blocks of 12 months in the immediately preceding period of 24 months from the date on which the gains arise.
To avail of the 50% lower tax rate under the Protocol during the Transition Period, while the expenditure thresholds remain the same, the corresponding temporal limit has been revised to the immediately preceding period of 12 months from the date on which the gains arise.
Applicability of Domestic Law and Measures
The Protocol specifically provides that the Treaty shall not prevent a contracting state from applying its domestic law and measures concerning the prevention of tax avoidance or tax evasion.
Entry into Force
Both India and Singapore are required to notify each other upon completion of the procedures required by their domestic law to bring the Protocol into force. The Protocol shall enter into force on the date of the later of these notifications. If as on 31 March 2017, the Protocol does not enter into force due to either of the notifications remaining pending, then the Protocol shall enter into force on 1 April 2017.
While the transfer of capital assets other than shares, such as debentures, partnership interests etc., and an indirect transfer of Indian assets would continue to be tax exempt under the Protocol even after 1 April 2017, and would not be subject to the LOB test, such transactions will nevertheless be required to pass the muster of GAAR (i.e. the domestic anti-abuse tax law of India). The express inclusion of the applicability of domestic law and measures concerning the prevention of tax avoidance or tax evasion has perhaps been made to pave way for the implementation of GAAR, given that the same provides for treaty override. Such a provision has not been included in the revised Tax Treaty with Mauritius, but has been seen in certain other Tax Treaties such as that with Luxembourg.