LET me add my two bits to the reams that have already been written about Panama Papers. The outrage that followed the disclosure of all the colourful schemes dreamt up by lawyers and facilitators of offshore tax evasion has already subsided and in a few more days will fade from public memory. Nevertheless, the papers have at least served some purpose in nudging the Indian judiciary to some kind of reality check. A few days back, the Madras High Court has dismissed the writ petition of some Indian taxpayers having dealing with Cypriot companies challenging the notification of Cyprus as a non-cooperative jurisdiction. Although the court based its decision on the technical evaluation of the constitutional provisions, it did observe in the concluding paragraph as follows:

“The ordinary dictionary meaning of the word "haven" is "harbour or anchorage". By extension, the word also denotes a place of safety, a refuge or sanctuary. In association with the word "tax", the word "haven" has assumed different connotations in the recent past and Panama appears to have followed Cyprus . Therefore, Section 94A was the need of the hour and we do not find the same to suffer from unconstitutionality….”

This is quite an interesting observation from the Court and hopefully indicates a change in the mind set of the Indian judiciary.

Explaining the background in which the decision to introduce section 94A was taken, the Court referred from the declaration of the Leader's summit of G-20

"1. We, the Leaders of the Group of Twenty, met in London on 2 April 2009.

2. We face the greatest challenge to the world economy in modern times; a crisis which has deepened since we last met, which affects the lives of women, men, and children in every country, and which all countries must join together to resolve. A global crisis requires a global solution.

3. We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared; and that our global plan for recovery must have at its heart the needs and jobs of hard-working families, not just in developed countries but in emerging markets and the poorest countries of the world too; and must reflect the interests, not just of today's population, but of future generations too. We believe that the only sure foundation for sustainable globalisation and rising prosperity for all is an open world economy based on market principles, effective regulation, and strong global institutions.

4. We have today therefore pledged to do whatever is necessary to:

…

. to take action against non cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over. We note that the OECD has today published a list of countries assessed by Global Forum against the international standard for exchange of tax information.”

Of course, all this is in a particular context. But the point needs to be made that the higher judiciary has to be alive to the developments all around and only then lower judiciary will tend to follow through as otherwise one sees a trend of competitive revenue bashing on their part.

But, before going further, let us analyze the Madras High Court judgement. A Cyprus based company was holding shares and convertible debentures in a Coimbatore based real estate company and there was a securities purchase agreement between the companies and three Coimbatore based assesses. One does not know who owns the Cyprus based company and why a Cyprus based company would show interest in acquiring the interests in a real estate company in Coimbatore. Be that as it may, what is to be noted is that under the India-Cyprus DTAA, just like the India-Mauritius DTAA, capital gains arising from transfer of shares are chargeable by the residence country and as usual, Cyprus does not tax such capital gains under its domestic tax law. Since the payment was being made to a non-resident, normally the payers should have deducted tax at source, which they did not. The tax department invited their attention to section 94A(1) and asked them to show cause as to why they should not be treated as assesses in default and the amount of TDS not recovered from them. The taxpayers argued that there was no liability to tax of the non-resident in India in terms of the DTAA and hence there was no liability for them to deduct the tax at source. The tax department proceeded against them nevertheless whereupon they filed the writ petitions.

Very briefly speaking, section 94A is the toolbox of countermeasure introduced by the government of India to deal with the misuse of secretive tax havens. It enables the Central Government to notify any country or territory as a notified jurisdictional area having regard to the lack of effective exchange of information by that jurisdiction. Several consequences follow as a result. One of such consequences is that any payment to such jurisdictions will be subject to TDS of at least 30%. So, in the instant case, the Indian parties before making the payment should have deducted tax @30%. If, however, one places reliance solely on the DTAA, no tax is chargeable on capital gains payable to a resident of Cyprus and hence there is no question of TDS.

Placing reliance on the Azadi Bachao decision of the Supreme Court, the basic argument of the taxpayers before the Madras High Court was that there being a duly notified DTAA with Cyprus under section 90, the provisions of the treaty will override any domestic law provision. Hence, the power conferred upon the Central government by section 94A to notify a particular country or jurisdiction as a notified jurisdictional area suffers from the vice of excessive delegation and hence was unconstitutional. It was also argued that the Directive Principles of State Policy in article 51© obliges the State to foster respect for international law and treaty obligations. It was argued that the law making power of the Parliament to make laws for the whole or any part of the State is subject to the provisions of the Constitution.

The Madras High Court went into all the Constitutional provisions relating to the law making power of the Parliament and more particularly article 253 for implementing any treaty. The High Court pointed out that there is a fine distinction between an international treaty ratified by India and a bilateral or multilateral treaty entered by India with specific countries on one –to one basis. The Court reiterated the fact that India follows the dualistic doctrine with respect to international law. The Court examined the theories of monism and dualism and following the Supreme Court decision in Jolly Verghese, reiterated that an international treaty could be enforced only so long as it is not in conflict with the municipal laws of the State.

In this connection, the High Court analyzed the decision of the Supreme Court in AzadiBachao. Elaborating on the treaty making power of the State, the Supreme Court had observed as follows:

“The power of entering into a treaty is an inherent part of the sovereign power of the State. By article 73, subject to the provisions of the Constitution, the executive power of the Union extends to the matters with respect to which the Parliament has power to make laws. Our Constitution makes no provision making legislation a condition for the entry into an international treaty in time either of war or peace . The executive power of the Union is vested in the President and is exercisable in accordance with the Constitution. The Executive is qua the State competent to represent the State in all matters international and may be agreement, convention or treaty incur obligations which in international law are binding upon the State. But the obligations arising under the agreement or treaties are not by their own force binding upon Indian nationals. The power to legislate in respect of treaties lies with the Parliament under entries 10 and 14 of the List I of the Seventh Schedule. But making of law under that authority is necessary when the treaty or agreement operates to restrict the rights of citizens or others or modifies the law of the State. If the rights of the citizens or others which are justiciable are not affected, no legislative measure is needed to give effect to the agreement or treaty.”

Thus the Supreme Court opined that treaties could be of two types, one restricting the rights of citizens or modifying the law of the State and the other not affecting the rights of citizens . Treaties, which fall under the first type, require legislation, to have binding force upon the citizens and those, which fall under the second type, do not require any legislation

In the next paragraph, however, the Supreme Court had observed:

“ When it comes to fiscal treaties dealing with double taxation avoidance, different countries have varying procedures. In the United States such a treaty becomes a part of municipal law upon ratification by the Senate. In the United Kingdom such a treaty would have to be endorsed by an order made by the Queen in Council. Since in India such a treaty would have to be translated into an Act of Parliament , a procedure which would be time consuming and cumbersome, a special procedure was evolved by enacting section 90 of the Act.”

The Madras High Court thus pointed out that there is difficulty in reconciling the observations of the Supreme Court in the two paragraphs in that if no legislative measure is needed to give effect to a Treaty that does not affect the rights of citizens or others then a Treaty entered into by India, then such a treaty need not always be translated into an Act of Parliament as was held by the Supreme Court.

The Supreme Court in the Azadi case had also observed: “…the judicial consensus in India has been that section 90 is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a double taxation avoidance agreement. When that happens, the provisions of such an agreement, with respect to cases to which where they apply, would operate even if inconsistent with the provisions of the Income-tax Act.” The taxpayer accordingly argued that statutory provisions must give way for the agreement, whose implementation is made pursuant to the Notification issued by the Central Government under Section 90.

In this connection, the Madras High Court examined the jurisprudence and the case laws and found that India follows the dualistic model and held that once it is stated that India has followed the dualistic model and once it is found that the Courts have drawn inspiration from Treaties, whenever the Municipal Law was silent, it is impossible to think that the supremacy of the Parliament could be compromised by the Executive entering into a Treaty. The very fact that Article 253 confers power upon the Parliament to make any law for implementing any Treaty, coupled with the fact that Section 90(1) of the Income Tax Act enables the Central Government to enter into an agreement, would show that the Parliament is supreme. The Court held: “The collective will and the collective conscience of the people, which the Parliament is supposed to reflect, cannot be subordinated to the power of the Executive”.

Examining section 90, the Court held that Section 90 did not say either expressly or by necessary implication, that the law made by Parliament would stand eclipsed or excluded, to the extent it is inconsistent with the terms of the DTAA. Therefore the High Court held that the observation made by the Supreme Court that the provisions of such an Agreement, with respect to cases to which where they apply, would operate even if inconsistent with the provisions of the Income Tax Act , if viewed in isolation, would result in mutually inconsistent results.

The Court further pointed out that no question arose directly either in Azadi Bachao Andolan or in Kulandagan Chettiar as to whether or not the Parliament has the power to make a law in respect of a matter covered by a Treaty. Therefore, the observations found in these two decisions, to the effect that the provisions of the Treaty will have effect even if they are in conflict with the provisions of the statute, cannot be stretched too far to conclude that the Parliament does not have the power to make a law in respect of a matter covered by a Treaty

Examining the law making power of the Parliament, the Court held that it is impossible to think that once a Treaty is entered into, the Parliament loses the power conferred by the Constitution, to make a law even in respect of a matter included in List I of the 7th Schedule. In this connection, the court pointed out that the Constitution imposes only two limitations upon the power of the Parliament to make a law. They are (i) that such a law cannot infringe any of the Fundamental Rights or erode the basic structure of the Constitution and (ii) that it must be within its legislative competence. According to the High Court, to say that there is one more limitation on the power of the Parliament, in the form of a Treaty entered into by the Executive, is to recognise a limitation not imposed by the Constitution.

Coming specifically to Section 94A, the Court pointed out that one of the four purposes for which, an agreement could be entered into by the Central Government under Section 90(1), is for the exchange of information. According to the Court, if one of the parties to the Treaty fails to provide necessary information, then such a party is in breach of the obligation under Article 26 of the Vienna Convention. The beneficiary of such a breach of obligation by one of the contracting parties cannot then invoke the Vienna Convention to prevent the other contracting party from taking recourse to its internal law, to address the issue.

It is interesting to see that the Court also pointed out to various defensive measures taken by countries against non-cooperative jurisdictions including against Cyprus and made a very important observation: “it would be clear from the above that many countries have become guarded in their approach towards Double Taxation Avoidance Agreements. In such circumstances, we cannot accept a contention that would surrender the Legislative power of the Parliament to the will of the Executive.”

The decision of the Madras High Court is an important milestone in the development of jurisprudence on tax treaties. Too much importance has so far been accorded to a very lenient interpretation of tax treaties mostly because of a perception about the absolute beneficial nature of the treaties as propagated by some while in fact, in some of the cases, the comprehensive tax treaties have been disastrous for the Revenue. In fact, other world organizations have also become skeptical of the benefits of such treaties. Even the OECD in its BEPS report dealing with abuse of tax treaties has cautioned the developing countries in being selective with the countries that they want to have treaties with.

It is obvious that only the very rich and the corporates can afford the tax avoidance game being played through tax havens. Ordinary people have to cough up their taxes, including of the indirect variety that is increasingly gaining in importance. It is therefore interesting to note that in the wake of the Panama Papers, both the chiefs of the IMF and the World Bank have questioned the present system of distribution of taxing rights under the OECD Model tax treaties. Christine Lagarde, the head of the IMF apparently stated that the international tax rules appear to be skewed towards the global rich. The World Bank Chief, on his part stated that he had been to many countries where the only ones who pay tax are those “too weak to refuse”. “You see systems where the rich don't pay and the poor do. There is a comprehensive problem that we have to tackle.” (Source: http://www.theguardian.com/business/2016/apr/14/tax-avoidance-panama-papers-imf-world-bank-economy-poverty)

In India, we have so far been swayed by the argument that foreign investments coming in through tax havens are good for the country. It is good to see that the side effects of such investments are now being questioned in various quarters, although one is not sure whether such enthusiasm will continue for any length of time.