After lengthy discussions on amending the India-United Arab Emirates (UAE) tax treaty, both governments have finally arrived at a consensus and have notified the changes to the treaty, that will come into effect in India from April.

The key feature of the proposed changes is the introduction of anti-abuse measures to prevent misuse of benefits under it.

The amendments, among other things, seek to clear certain ambiguities which existed while interpreting the tax treaty. The proposed changes would end some uncertainties and is a welcome relief for investors. However, there are certain unintended interpretations which may also arise in due course.


From its very inception, the availability of benefits of a tax treaty has always been a debatable issue and the subject matter of several conflicting judicial decisions. Earlier, an individual who was “liable to tax" in the UAE was considered as a resident entitled to claim tax treaty benefits. But the UAE does not impose tax on individuals and hence he is not a resident—consequently the question of taking benefit under the treaty for avoidance of double tax would not arise. In order to resolve this controversy, a “physical presence test" has been introduced to determine whether an individual is a resident of the UAE or not. The physical presence test may not be the most appropriate solution. However, it will certainly put to rest the controversy regarding the interpretation of words “liable to tax" in case of UAE individuals.


For a company to be a resident of the UAE, it should satisfy two conditions; namely, the company should be incorporated in the UAE and it should be managed and controlled wholly in the UAE. Thus, even if part of the control or management is located outside the UAE, the company would not be treated as a UAE resident company and hence not entitled to the India-UAE tax treaty.

Now, the main issue is interpreting the meaning of the words “management and control". A question arises whether “control" means shareholding control.

In other words, should only companies wholly-owned by UAE nationals enjoy the benefit of the tax treaty? This view may not be tenable; rather, the term “control" should be interpreted as de facto control and not merely the right or power to control and manage. In simplistic terms, management and control would be located at a place where the head and brain is situated. If the key managerial personnel are based in the UAE and all the key management decisions are in substance taken in the UAE, then it can be said that “management and control" of the company is in the UAE.

Under the erstwhile tax treaty, in case a company was a resident of both countries, then the final residential status was determined based on the concept of the place of effective management. Now, since the definition of resident has been amended and the concept of control and management has been introduced in the definition of resident itself, the concept of place of effective management loses its importance and is redundant.

Further, the definition of resident covers only an individual and a company. Does it mean that the benefits of the tax treaty would not be available to a partnership firm? It appears that this aspect has been ignored while making the amendment.

Capital gains

Source-based taxation for capital gains has now been introduced in the tax treaty. Accordingly, capital gains of a UAE resident from the sale of investment, that is, shares of an Indian company, will be taxable in India. (This would be more relevant to short-term gains or sale of shares of unlisted companies, since sale of shares of listed companies on stock exchanges is anyway exempt from capital gains.) This amendment has created a hue and cry among investors who have already invested in India through the UAE. These investors will have to act quickly and evaluate exit options before the window closes on 31 March 2008.

Limitation of benefits

This clause is basically introduced as an anti-abuse measure and states that the benefit of the tax treaty shall not be available if the main purpose or one of the main purposes of creation of such entity was to obtain the benefits of this tax treaty. The limitation of benefits (LOB) clause in the India-UAE tax treaty is subjective, unlike the India-Singapore or India-USA tax treaties, where defined criteria have been laid down for denying the treaty benefits. The India-UAE tax treaty states that legal entities not having bona fide business activities shall be covered by the LOB article. This clause is introduced to ensure that a foreign investor does not use the UAE as a mere pass-through location for investing into India. However, with capital gains exemption withdrawn, there will be limited cases where investments are routed through the UAE and this LOB is pressed into action.


The dividend article has been amended to provide a uniform withholding tax rate of 10% in the country of source. However, this amendment at present is of little relevance as neither India nor the UAE impose withholding tax on dividends.


The amendment provides that while determining the profits of the premanent establishment, the domestic laws existing in the country of the permanent establishment should be applied. This principle has been enunciated by the courts in various recent decisions and an amendment is made merely to make it expressly clear and to ensure that there is no further litigation.

To summarize, the amendments will certainly resolve some of the controversies which existed earlier especially regarding the term “resident" but considering the withdrawal of capital gains exemption and the introduction of the LOB clause, it may close the doors for foreign investors to invest in India through the UAE.

Hemal Zobalia is an associate director and Jimit Devani is an assistant manager with PricewaterhouseCoopers.

Ketan Dalal will return with the next column.

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