Taxation of cross national income is complex and is often controversial. In the effort to attract more foreign investment, developing countries including India extends tax concessions to foreign investors through Double Taxation Avoidance Agreements (DTAAs).
But a major defect of DTAAs is that companies often exploits the opportuneness/loopholes provided in tax laws of DTAAs to avoid taxes. Several Double Taxation Avoidance Agreements (DTAA) are misused by cross national investors to reduce tax burden. One classic example is the often-quoted India-Mauritius DTAA.
What is Limitation of Benefit clause?
Governments are also not sitting idle. One after another, they are devising new techniques to counter the misutilization of DTAAs. One such weapon is Limitation of Benefit Clause (LoB). Under LoB, foreign investors who seek tax exemptions in India should produce documents that he is a resident of the said foreign country (eg Mauritius). LoB refers to procedural requirements that the concerned beneficiary is a resident of the treaty country. The Limitation of Benefit (LoB) Clause is attached by the treaty parties in their bilateral DTAAs. The benefit of tax concession will be limited to such entities that produces the document (for example, the company proving that its residence is in Mauritius).
Limitation of Benefit Clause to fight treaty shopping
The LoB is tailored to check a well-known misutilization by foreign investors called, treaty shopping. Under treaty shopping, foreign companies (of UK, USA etc) establishes some sort of an office in Mauritius and channelizes their investment into India to claim the tax concession offered under the India-Mauritius DTAA.
In precise, the purpose of an LOB provision is to limit the ability of third country residents to obtain benefits under the said treaty.
Introduction of LOB provisions in India’s DTAAs recently indicates effort to fight treaty shopping. Several DTAAs were renegotiated including the India-Singapore, India- Mauritius and the India-UAE treaties through separate Protocols that add LOB provisions.