A comprehensive agreement for avoidance of double taxation and prevention of fiscal evasion on the lines of OECD or UN Model Conventions, in principle, is presumed to include in its scope all kinds of incomes which are subjected to income-tax by the contracting sovereign States under their domestic tax laws, unless agreed otherwise by the contracting States in respect of certain sources of income. In this regard, a comprehensive double taxation avoidance agreement has to be distinguished from limited double taxation avoidance agreements in respect of particular sources of income. The exceptions are rather few. Examples can be found in the erstwhile treaty with Malaysia that did not include the article on capital gains, and the erstwhile treaty with Switzerland, which excluded the profits from the business of shipping in international traffic, in articles 7 and 8.

Here, we deal with the situation which arose in connection with interpretation of the erstwhile agreement with Switzerland. Despite, the subsequent amendment of the treaty in 2011, the case has important lessons for interpretation of tax treaties.

It all started in the year 1958, with a limited agreement with Switzerland 'for avoidance of double taxation of income of enterprises operating aircraft chargeable in the countries in accordance with their respective laws' between the two countries (notified on 29.8.1958). It was replaced later on by an 'agreement for avoidance of double taxation and prevention of fiscal evasion', which was notified on 21.4.1995. The above agreement was subsequently revised in the year 2001, and this agreement was the subject matter of dispute in this case.

In the agreement, paragraph 1 of article 7 stated – “The business profits of an enterprise of a Contracting State, other than the profits from the operation of ships in international traffic, shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein….."

Article 8 was designed to cover only 'profits derived by an enterprise of a Contracting State from the operation of aircraft in international traffic'. There was no article dealing with 'Other income' in the above agreement. It was evident that the contracting States had agreed to exclude 'the profits from the operation of ships in international traffic' from the scope of the agreement and to deal with it under the domestic laws of the respective countries.

The revised agreement dated, 7.2.2001, however, Incorporated article 22 dealing with 'Other income' in the agreement. Paragraph 1 of the above article provided on the lines of OECD Model -- “Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Agreement shall be taxable only in that State."The agreement, however, did not clarify whether the profits from shipping business would henceforth be covered under the newly introduced article 22 or it would still stand excluded from the scope of the provision as in the past. Such clarification, either as an exclusionary clause in article 2 or at least through a protocol to the agreement, as in the Indo-US agreement, would definitely have been helpful.

In the face of the above ambiguity, the issue- whether the newly introduced article 22, covered within its scope 'profits from operation of ships in international traffic' which, prior to 7.2.2001, were excluded from the scope of the agreement and were taxable under the respective domestic tax laws of the contracting States, arose before the Authority for advance ruling in the year 2009 in the case of Gearbulk AG In re [2009-TII-09-ARA-INTL]. The applicant, seeking advance ruling in this case, was a non-resident shipping company incorporated under the laws of Switzerland. It had entered into a shipping contract with a company, incorporated in Dubai and engaged in the business of ship chartering, for transportation of cargoes from Indian ports to outside India. The Dubai Company was an independent party engaged in transportation of cargoes/arranging for transportation of cargoes for other shipping companies on commission basis. The applicant had also appointed a firm as its port agent for handling cargoes the cargoes. The said firm was working as port agent in India on behalf of several other international shipping companies also. The above firm had duly paid the tax on deemed income assessed by the Assessing Officer under section 172(4) of I.T. Act, 1961, on behalf of the applicant. The applicant had sought an advance ruling from the Authority on the issue of taxability in India of its income from shipping business earned from India in terms of the revised treaty between India and Switzerland. At the same time the applicant had also sought under the provisions of section 172(7) for an assessment to be made on it according to the other provisions of the Act including the provisions of section 90(2).

It was contended that the profits from the operation of ships in international traffic which stood excluded by article 7 should be brought within the purview of article 22 and in view of the fact that the applicant did not have a permanent establishment in India as contemplated by article 22, only the State of residence could levy tax in terms of article 22. On the other hand, the revenue contended that the item excluded by article 7, namely, the profits from international shipping business had been consciously kept outside the ambit of the treaty and it could not be brought within the fold of article 22. [Para 6]

The Authority was of the view that the contention of the revenue that the profits arising in India by the carriage of goods from Indian ports to foreign ports would be governed by the domestic law enforced in India was to be upheld. It held that there are unmistakable indications in the Treaty provisions to show that shipping business income earned by a non-resident is not intended to be covered by the Treaty. The language and scheme of the provisions, the possible incongruities that would otherwise arise and a comparative study of other Treaties would lead to the inevitable conclusion that shipping income derived from international operations is outside the purview of the Treaty and it is left to be taxed under the domestic law. [Para 7]

The Authority explained that article 22, a residuary article concerning 'other incomes', was introduced in 2001. Till then, there was no dispute that the profits derived from the operation of ships in international traffic are left untouched by the Treaty because of the specific exclusion clause in article 7. The obvious implication of exclusion is that such income can be subjected to domestic law discipline. Therefore, such income is liable to be taxed in accordance with and in the manner laid down in section 172. If that legal position was intended to be changed by the amendments made to the Treaty in 2001, a specific reference to that 'item' of income and specific language to bring it within the ambit of the Treaty should have been there. Neither a separate article is devoted to it, nor is there explicit language in article 22 to bring it within the coverage of that article. When a particular species of income excluded from the ambit of the Treaty is sought to be brought within the scope of the Treaty for the first time, it would be expected to express the intendment in clear and specific language rather than leaving it to be taken care of by article 22 by implication. At that juncture, it might be seen that a separate article, namely, article 8 is devoted to the profits derived from the operation of aircraft in international traffic. For that the explanation of the assessee was that the profits derived from international air traffic are made taxable only in the State of residence and that is why a separate provision has been made, but as far as profits from shipping business are concerned, they are intended to be taxed by the source State in case there is a permanent establishment in that State. There was a fallacy in that argument. It raises an immediate question as to why the exclusion clause has been allowed to remain in article 7 and why the shipping profits have been relegated to the residuary article, i.e., article 22, as contended by the assessee. It must be noted that both, under article 7 and under article 22, the right of taxation is conferred on the State of residence subject to the qualification that if the business is carried on through a permanent establishment, the source State will have the right of taxation. Thus, the same qualification or exception is carved out based on PE both in article 7 and article 22. That being the case, there is no intelligible basis for retaining the exclusion clause in article 7, while at the same time, shifting the shipping profits to article 22. The substance and basis of taxation remains the same both in article 7 and article 22, wherever the PE exists. If that be so, excluding the international shipping profits from article 7 and taking them to the fold of newly framed article 22 would be a meaningless exercise. It is reasonable to think that when the Treaty was revisited in 2001, both the countries apparently desired to continue the status quo as regards the profits derived by non-residents from international shipping operations. At any rate, there would not have been a consensus to alter the existing position. That is why the exclusionary words in article 7 have been retained. [Para 8]

The above issue arose again in exactly identical circumstances in the case of Mediterranean Shipping Co., S.A., another Swiss shipping company before ITAT, Mumbai [2013-TII-02-ITAT-MUM-INTL]. Here, the ITAT drew the exactly opposite conclusion.

The ITAT held that the provisions of article 22 introduced in the Indo-Swiss treaty in 2001 is relevant in the instant context. A reading of article 22 especially paragraph 1 thereof makes it clear that the items of income of a resident of a contracting State, i.e., Switzerland which are not dealt with in the foregoing articles of the Indo-Swiss treaty shall be taxable only that State. In the instant case, the assessee company being a resident of Switzerland, the income, wherever arising, would fall within the scope of the residuary article 22 if the same is not dealt with in any other articles of the treaty.

The question, therefore, is whether the shipping profits are dealt with in any other articles of the Indo-Swiss treaty or not. The contention raised by the revenue is that by agreeing to exclude the shipping profits from article 8 as well as article 7 of the Indo-Swiss treaty, India and Switzerland had agreed to leave the shipping profits to be taxed by each State according to its domestic law and this undisputed position prevailing up to 2001 did not change as a result of introduction of article 22 of the treaty with effect from 1-4-2001. The contention cannot be agreed with. It is held that as a result of introduction of article 22, the items of income not dealt with in the other articles of the Indo-Swiss treaty are covered in the residuary article 22 and their taxability is governed by the said article with effect from 1-4-2001. Articles 7 and 8 of the treaty, therefore, cannot be relied upon to say that by agreeing to exclude the shipping profits from said articles, the shipping profits are left to be taxed by each contracting State according to its domestic law. It is no doubt true that this was the position prior to introduction of article 22 in the Indo-Swiss treaty in the year 2001 but the same was altered as a result of introduction of the said article inasmuch as it become necessary to find out as to whether shipping profits have been dealt with in any other article of the treaty. Mere exclusion of shipping profits from the scope of treaty could have resulted in leaving the same to be taxed by the concerned contracting State according to its domestic law prior to introduction of article 22. However, such exclusion alone will not take it out of the scope of article 22 unless it is established that the shipping profits have been dealt within any other article of the treaty. The language of article 22(1) in this regard is plain and simple and the requirement for application of the said article is explicitly clear. [Para 33]

In order to say that a particular item of income has been dealt with, it is necessary that the relevant article must state whether Switzerland or India or both have a right to tax such item of income. Vesting of such jurisdiction must positively and explicitly be stated and it cannot be inferred by implication as sought to be contended by the revenue relying upon articles 7 and 8 of the treaty. The mere exclusion of international shipping profit from article 7 cannot be regarded as an item of income dealt with by the said article as envisaged in article 22(1). The expression 'dealt with' contemplates a positive action and such positive action in the instant context would be when there is an article categorically stating the source of country or the country of residence or both have a right to tax that item of income. The fact that the expression used in article 22(1) of the Indo-Swiss treaty is 'dealt with' viz-a-viz the expression 'mentioned' used in some other treaties clearly demonstrates that the expression 'dealt with' is something more than a mere mention of such income in the article. The international shipping profits can at the most be said to have mentioned in article 7 but the same cannot be said to have been dealt with in the said article. [Para 35]

Up to assessment year 2001-02, international shipping profits no doubt were being taxed under the domestic laws as per the provisions of section 44B. However, it was not because of the exclusion contained in Article 7 that India was vested with the authority to tax such international shipping profit but it was because there was no other article in the Indo-Swiss treaty dealing with international shipping profits which could override the provisions of section 44B in terms of section 90(2) being more beneficial to the assessee. This position, however, has changed as a result of introduction of article 22 in the Indo-Swiss treaty which now governs the international shipping profits not being dealt with specifically by any other article of the treaty and if the provisions of article 22 are beneficial to the assessee, the same are bound to prevail over the provisions of section 44B. [Para 41]

It is held that the item of income in question, i.e., international shipping profit cannot be said to be dealt with in any other articles of the Indo-Swiss treaty and the taxability of the said income, thus, is governed by residuary article 22 introduced in the treaty with effect from 1-4-2002. [Para 48]

It does not seem that the last word on the issue has been spoken yet. The matter is still pending before High Court.

It has to be appreciated that interpretation of international double taxation avoidance treaties between two sovereign States does not proceed exactly on the same lines following which domestic tax laws are interpreted by the jurisdictional courts of a country. Klaus Vogel in his treaties observes in this regard that “…. In most countries the courts are authorized to interpret treaties…… In the United Kingdom (India still closely follows British traditions), the Judge is bound strictly by the wording of the statute, especially with regard to the tax law. In principle he is not permitted to consider the intention of the legislators or the equity of the matter [(1920) Cape Brandy Syndicate v. Commissioner of Inland Revenue…]. A teleological interpretation and even more so a development of the law would be considered to be a usurpation of the rights of the legislators… To an extent, however, the above has to be viewed in the light of the 'new approach' of British Courts in the limited instance of tax avoidance schemes…… (much water has flown down the Thames since then, but India is still stuck in the early period of twentieth century, the latest view of the Indian Apex Court in this regard having been expressed in the case of 'Vodafone')…

The extent to which the statutory text or statutory purpose should control the interpretation of an international agreement was actively disputed in the older literature on international law…. The most widely held view was that treaty obligations are to be interpreted restrictively, because parties to a treaty in doubtful cases should only be presumed to have waived their sovereignty to the extent that is unequivocally apparent from the text of the treaty…Vienna Convention on Law of Treaties (VCLT) has rendered many of these earlier differences of opinion with regard to treaty interpretation obsolete. It is true that VCLT contains only relatively general rules and it, therefore, cannot make allowances for the peculiarities of tax treaties. It has resolved, nevertheless, some of the uncertainties in prior international practice. Therefore, the rules of the Vienna Convention are used in case law on the interpretation of Double Taxation Treaties today as the basis even with regard to States which have not yet ratified the Vienna Convention…

In interpreting international agreements according to these rules the text of the treaty is of primary importance: i.e., the ordinary meaning of the 'terms', and the wording not of the individual provision, but that of the entire agreement in context. The older view that primarily looked for the subjective intent of the parties to the treaty….is thereby rejected. However, subjective elements are not entirely excluded from consideration as they are implied within the purpose of the treaty. The 'purpose' referred to by VCLT, certainly, is not synonymous with the subjective intention of the contracting States but refers to the goal of the treaty as reflected objectively by the treaty as a whole. Moreover, such purpose is subordinated to the wording of the treaty by the rule of Article 31 (of VCLT) that the purpose shall influence interpretation merely by giving 'light' to the terms of the treaty. In other words, 'purpose' is not itself an independent means of interpretation…

In contrast, the intention of the parties, according to Article 31 of VCLT and section 325 of the restatement Third ((The Foreign Law of the United States adopted in May, 1986) is only significant to the degree to which it has been expressed in the text of the agreement… The view that the 'basic aim of treaty interpretation is to ascertain the intention of the parties' ….. , is thus contrary to current international law as established in both VCLT and the Restatement Third…" (Paragraphs 60, 62, 65, 68, 69 and 69a, pages. 33 – 37).

It appears that even after considering all these enlightened opinions of the noted author, the water remains as turbid as ever. Instead it is better to look at the relevant Articles of VCLT, which governs the law of treaty interpretation. After all, it is now universally accepted that VCLT should form the basis of interpretation of treaties.

Article 31 dealing with 'general rule of interpretation' provides, --

1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to terms of the treaty in their context and in the light of its object and purpose.

2. The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including the preamble and annexes:

a) any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty;

b) any instrument which was made by one or more parties in connection with conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.

3. There shall be taken into account, together with the context:

a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;

b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation;

c) any relevant rules of international law applicable in the relations between the parties.

4. A special meaning shall be given to a term if it is established that the parties so intended.

Article 32 dealing with the 'supplementary means of interpretation' provides. --

Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of Article 31, or to determine the meaning when the interpretation according to article 31:

a) leaves the meaning ambiguous or obscure; or

b) leads to a result which is manifestly absurd or unreasonable.

Unfortunately, there is no material comprising 'context' as envisaged in paragraph 2, any 'subsequent agreement' etc., as envisaged in paragraph 3, any 'special term' as envisage din paragraph 4 of article 31, or any 'supplementary means of interpretation' as envisaged in article 32, which can help us to interpret the changes in the revised agreement, dated 7.2.2001, between India and Switzerland. There is no protocol between India and Switzerland relating to the revised DTAA so as to clarify the terms of the agreement reached between the two countries in the revised DTAA regarding the future scope of taxation of income from plying of ships in international traffic under the DTAA, in the context of introduction ofarticle21 dealing with 'other incomes' in the DTAA. It is learnt that the Indian and Swiss competent authorities hold contrary views on the issue.

This case demonstrates the need for India to also follow the practice adopted by the USA that issues 'Technical Explanations' of all the DTAAs concluded with other countries clarifying in detail the import and meaning of each of the articles in the DTAA, as understood by them. With issue of such documents, there would have been two options before the other country, either to accept it in toto (as India has been compelled to do in respect of USA) or thrash out the differences of opinion, if any, at the beginning itself.

(Also See Importance of 'other income' under Article 21 of OECD and UN model tax conventions)