Starting Point: the United States-Republic of India Income Tax Treaty
The Convention and Protocol between the United States of America and the Republic of India signed on September 12, 1989 (“the Convention”). Negotiations took as their starting point the U.S. Treasury Department's draft Model Income Tax Convention, published on June 16, 1981 (“the U.S. Model”), the Model Double Taxation Convention published by the United Nations in 1980 (“the U.N. Model”) and other treaties of both countries.
In the Treasury Technical Explanation 00/00/1989 (1989 Income tax treaty), Article 27 (Mutual Agreement Procedure) of the Treaty provides for cooperation between the competent authorities of the Contracting States to resolve disputes which may arise under the Convention and to resolve cases of double taxation not provided for in the Convention. The competent authorities of the two Contracting States are identified in subparagraph h) of paragraph 1 of Article 3 (General Definitions).
Where a person is of the view that actions of one or both of the countries will cause the person to pay a tax not under the treaty can present its case to the competent authority of its country of residence or nationality [Article 27(1)] . This may be done before the person has exhausted remedies provided under the laws of that country. However, a case must be presented to the competent authorities no later than three years from the date of receiving notification of the assessment that gave rise to the objection. If the competent authority determines that the objection appears justified, and it isn't able to arrive at a satisfactory solution itself, the competent authority will endeavor to resolve the case by mutual agreement with the competent authority of the other country. If agreement is reached in this way, it is to be implemented even if action is otherwise barred by the statute of limitations or some other procedural limitation. However, time or other procedural limitations can be overridden only to make refunds and not to impose additional tax [see Article 17, Mutual Agreement Procedure, Treasury Technical Explanation].
The competent authorities are authorized to seek to resolve difficulties or doubts that may arise as to the application or interpretation of the treaty[Article 27(3)] . The competent authorities may also communicate with each other for the purpose of reaching agreement under this Article[Article 27(4)] .
For advance pricing agreements to be negotiated between the competent authorities, see Rev. Proc. 96-53, 1996-2 CB 375.
A Closer Look At Article 27 of the United States-Republic of India Income Tax Treaty (1989)
Paragraph 1 provides that where a resident of a Contracting State considers that the actions of one or both Contracting States will result for him in taxation which is not in accordance with the Convention he may present his case to the competent authority of his State of residence or nationality. It is not necessary for a person first to have exhausted the remedies provided under the national laws of the Contracting States before presenting a case to the competent authorities. The paragraph provides that a case must be presented to the competent authorities no later than three years from the date of the receipt of notification of the assessment which gives rise to the double taxation or taxation not in accordance with the provisions of the Convention. Thus, for example, if the Internal Revenue Services makes a section 482 adjustment on a taxpayer's 1990 return, and, in 1994, sends the statutory notice of assessment which results in double taxation, the taxpayer has until 1997 to present his case to the competent authority. When the case results from the combined action of the tax authorities in the two Contracting States, the three year time period begins to run when the formal notification of the second action is given. Although it is preferred U.S. policy to provide no time limit for the presentation of a case to the competent authorities, the limit in paragraph I of the Convention should not result in any unreasonable denial of protection or assistance to taxpayers.
Paragraph 2 provides that if the competent authority of the Contracting State to which the case is presented judges the case to have merit, and cannot reach a unilateral solution, it shall seek agreement with the competent authority of the other Contracting State such that taxation not in accordance with the Convention will be avoided. If agreement is reached under this provision, it is to be implemented even if implementation is otherwise barred by the statute of limitations or by some other procedural limitation, such as a closing agreement. Because, as specified in paragraph 2 of Article 1 (General Scope), the Convention cannot operate to increase a taxpayer's liability, time or other procedural limitations can be overridden only for the purpose of making refunds and not to impose additional tax.
Paragraph 3 authorizes the competent authorities to seek to resolve difficulties or doubts that may arise as to the application or interpretation of the Convention. While the paragraph does not include the list of examples of the kinds of matters about which the competent authorities may reach agreement which is found in the U.S. Model, it is understood that the powers of the competent authorities are generally as broad under the Convention as under the U.S. Model. Paragraph 3 also authorizes the competent authorities to consult for the purpose of eliminating double taxation in cases not provided for in the Convention, but with respect to the taxes covered by the Convention. An example of such a case might be double taxation arising from a transfer pricing adjustment between two permanent establishments of a third-country resident, one in the United States and one in India. (emphasis added) Since no resident of a Contracting State is involved in the case, the Convention does not, by its terms, apply, but the competent authorities may, nevertheless, use the authority of the Convention to seek to prevent the double taxation.
Paragraph 4 provides that the competent authorities may communicate with each other, including, where appropriate, in face-to-face meetings of representatives of the competent authorities, for the purpose of reaching agreement under this Article. The Article confirms the authority of the competent authorities to develop bilateral and unilateral procedures to implement the Article. (emphasis added).
This Article is not subject to the saving clause of paragraph 3 of Article 1 (General Scope). Thus, for example, rules, definitions, procedures, etc., which are agreed upon by the competent authorities under this Article, may be applied by the United States with respect to its citizens and residents even if they differ from the comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to provide refunds of tax to a U.S. citizen or resident under this Article.
The Treaty also provides, in Article 28, for the Exchange of Information and Administrative Assistance. As a summary of this Article 28, information to be exchanged is that which is necessary for carrying out the provisions of the Convention or the domestic laws of the United States or Germany concerning the taxes covered by the Convention. Exchange of information with respect to domestic law is authorized insofar as the taxation under those domestic laws is not contrary to the Convention.
Comments on U.S.-India Article 27 by Michael Danilack, Deputy Commissioner International
Michael Danilack, deputy commissioner (international), IRS Large Business and International Division, as reported by Kristen A. Parillo and Shamik Trived in Tax Notes, February 4, 2013, harshly criticized India's competent authority and referred to India’s tax examination process as “irrational”. The comments were made on January 31 at a conference hosted by the Pacific Rim Tax Institute in Palo Alto, Calif. Danilack said the role of a country's tax administrator should be to apply the law as it stands rather than to make tax policy.
Unlike some jurisdictions, the United States separates tax functions so the IRS administers the law and the Treasury Department creates policy, Danilack said. "My main focus is on tax administration. My office isn't responsible for tax policy, and I don't have anyone reporting to me for tax policy," he said. Danilack said he is proud of the U.S. separation of functions, arguing that "it's very important to focus on that distinction between administering the policies that have been adopted versus making policies that you think are better for the future."
It had been previously reported that the IRS and U.S. multinationals were concerned about Indian pricing adjustments as too aggressive. This led to Danilack stating in late November 2012 that he was not confident that an agreement on bilateral advance pricing agreements with India would be reached anytime soon. Danilack also elaborated on prior comments he made regarding the Indian APA program that began in July. Taxpayers have considered the Indian authorities' adjustments to be aggressive, and Danilack said in June that taxpayers should talk to the IRS before completing submissions to the Indian authorities.
But the APA program does not change that dynamic and does not resolve the most serious questions the U.S. has with India, Danilack said, adding that he is not confident that an agreement on bilateral APAs will be reached soon, given the current differences in principles between the U.S. and India. It's important to reach a firm agreement on the APA programs with India before the IRS encourages taxpayers to enter into one with them, Danilack said. "There should be more discussion . . . in terms of what does APA really promise, in terms of ultimate resolution," he said.
Problems in Working with India’s APA, Competent Authority
India is one of only a few countries that tends to blend its tax policy and tax administration functions. The distinction between administration and policy is significant in part because it allows the tax administrator to focus on what the tax law provides. A revenue agent should "take an objective view of what the current policies are, what the current law says, and operating and taking enforcement steps if necessary in accordance to that judgment from an objective perspective," rather than acting on perceptions of what the law should be, Danilack argued.
At the same conference, Danilack expressed his frustrations with India in detail, saying he is not optimistic that India's new advance pricing agreement program will offer a better solution for resolving U.S. companies' tax disputes with Indian tax authorities. Danilack, who serves as the U.S. competent authority, also outlined his frustrations with his Indian counterpart, Sanjay Kumar Mishra, joint secretary (foreign tax and tax research) of the Indian Ministry of Finance's Central Board of Direct Taxes. Mishra was expected to attend the Pacific Rim Tax Institute conference but backed out because of illness.
Alpana Saksena, a director in KPMG LLP's global transfer pricing services practice and a former commissioner of income tax with the Indian Revenue Service, suggested that companies take advantage of India's anonymous prefiling consultation to see how the APA program will work and whether a unilateral APA would be a good fit.
Danilack responded that an Indian compliance audit would give an examiner "plenty of flexibility" to decide whether the compliance terms are met. "Someone who is hellbent on adjustments can make such an adjustment," he said. "That is the nature of the problem we have -- that there doesn't seem to be very much rational thought put into the examinations that are currently going on in the field. And if it's irrational thought that's brought to bear, that will undermine any APA that might be arrived at."
The bottom line announced by Danilack was that the United States will not accept a bilateral APA with India at this time. He said he shares the hopefulness expressed in a recent letter sent by 67 Silicon Valley high-tech companies that the India-U.S. competent authority relationship can improve. Danilack met with Mishra the week of January 21 to discuss how India and the United States might get to a point at which a bilateral APA could be reached. "We had a long conversation in which [Mishra] brought into the discussion policy considerations which I think everyone would say are pretty controversial," Danilack said. "He said that we should be ignoring cost-plus arrangements and that risk allocations don't matter. I said, 'Really?' He said, 'Yes, we should just look through the cost-plus arrangement and go right to some sort of profit split.'"
Despite frustration over the competent authority officer in India, Danilack mentioned that upon his return to Washington, he heard from two accounting firms that the Indian government had reported that the meeting had gone well and that the two governments were set to proceed on bilateral APAs. "So this is what I'm up against," Danilack said. "The issues that have been raised about the APA program have not been addressed; I'm very concerned about the lack of rollback."
The fundamental problem with the India-U.S. competent authority relationship, Danilack said, is that Mishra does not separate his competent authority role from his policy views.
Danilack said he does not attend mutual agreement procedure (MAP) negotiations because he would no longer have the ability to step back from the MAP process and objectively evaluate the case. By contrast, Mishra attends those meeting. "He is negotiating every case personally," Danilack said. During the negotiations, Mishra reads the assessment order, Danilack said, adding that in many cases the assessment officer sits behind Mishra at the meeting. The reason, strong differences of opinion about how the competent authorities should go about their work and separate the domestic tax law of each country from tax policy discussions the later being off-track from the purpose of Article 27 at least somewhat.
In referring to the views of his Indian counterparty, Danilack characterized the process today as: "What we have, from my perspective, is a policy official who is, as far as I can tell, the competent authority who is advancing a policy agenda that I think most people would say -- whether you're talking about his views on risk or cost-plus or his views on intangible ownership or on location savings -- is very controversial,". "If he's the one negotiating cases and conducting the negotiation based on his policy views -- which is what is happening -- then there's no basis for actually resolving the case."
Danilack said his counterpart's mischaracterization of the India-U.S. competent authority relationship is another trouble spot. He met with Mishra in 2010, when both were relatively new in their respective competent authority positions. There was a group of MAP cases that had been negotiated by their predecessors and on which Danilack and Mishra had agreed to sign off. "I thought the numbers were high, but I was attempting to establish some momentum," he said. "And then I had a direct conversation with my counterpart immediately after agreeing that we'll resolve those cases, and I told him I would like to make it very clear that we view this as a high-water mark and were not sure how they could justify those numbers."
Danilack has since learned that Mishra has been telling other competent authorities around the world that he arranged a framework with the United States on the basis of those agreements and that all the India-U.S. MAP cases were being resolved on the basis of those numbers. "I'm hearing this from other competent authorities, who are quite surprised when I say, 'No, we haven't established a framework with India,'" he said.
"And so this is a very complex problem that we have," Danilack said. "And in light of all these things I'm mentioning, when I hear companies express an interest in going to an APA with India and resolving bilaterally, with essentially just a different tool, my question is why should we believe that the policies that are being advanced in the context of MAP will be any different in an APA context?"
Is a Mandatory Arbitration Clause a Solution?
Introducing a mandatory arbitration clause in the India-U.S. tax treaty wouldn't solve the problem, Danilack said. He explained that many countries -- including the United States and Japan -- initially opposed the idea of resolving MAP cases through arbitration. "But you change your view on arbitration when you feel that you have your MAP program in order," he said.
Danilack said the competent authority relationship between the United States and Canada has improved dramatically over the last couple of years, adding that the inclusion of mandatory arbitration in the 2007 protocol to the Canada-U.S. treaty isn't the only reason for that improvement. "Arbitration is part of it," he said. "It's affected the dynamic between us, but there's much more. We have had a very good relationship develop with Canada where we are now working on the whole equation. So let's not look to arbitration as the solution in India."
Danilack clearly is frustrated. Since have a working treaty with an important treaty partner is essential, perhaps Treasury officials can meet with their counterparts and show the Indian authorities how the treaty is supposed to work and how multi-jurisdictional problems need a process capable of rational rules and process.