A Double Taxation Avoidance Agreement (‘DTAA') usually provides that the profit of an enterprise carrying on business in another country is taxable only in the country of residence of the enterprise. An exception is provided for profits attributable to the Permanent Establishment (‘PE') of the enterprise operating in other country. Illustratively, Article 7(1) of the DTAA between India and Bangladesh in this regard reads as under:
“The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, then so much of the profits of the enterprise as is attributable to that permanent establishment shall be taxable only in that other Contracting State.” (emphasis added)
The above clause suggests that if an Indian concern carries on business in Bangladesh through a PE, then the profits attributable to the PE would not be taxable in India and would hence not be considered for computing the total income of the enterprise in India.
This clause is at significant variation from the all Model Conventions. Article 7(1) of the OECD Model Convention (OECD MC) reads as under:
“Profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits that are attributable to the permanent establishment in accordance with the provisions of paragraph 2 may be taxed in that other State.” (emphasis added)
As can be observed by comparing the two texts, especially the words emphasized, the India Bangladesh DTAA precludes the state of residence from taxing PE profits; however the OECD MC does not seem to suggest so.
Professor Klaus Vogel (‘Prof. Vogel') in his book titled ‘Klaus Vogel on Double Taxation Conventions' cites and comments on a French ruling in following words:
“In a case in which the rule corresponding to Article 23 of Model Convention did not refer to income from real property, the French Cour de Cassation , notwithstanding the [usage of] words ‘may be taxed in' [as against] ‘shall be taxable only', in the applicable distributive rule, awarded the exclusive taxation of this income to the source state (no. 90-10.522, 44 Dr. Fisc. Comm. 1618 (1992): DTC France/Switzerland ). In view of the firm international usage, this ruling is most questionable….”
Indian Supreme Court also happened to deal with similar issue. In CIT v. P.V.A.L. Kulandagan Chettiar, (2004-TII-01-SC-INTL) it was contended before the Supreme Court that despite usage of expression ‘may be taxed' with respect to the right of source state, the state of residence is precluded from exercising taxing rights. In the decision appealed against i.e. CIT v VR. S.R.M. Firm (2003-TII-55-HC-MAD-INTL) this contention was accepted by Madras High Court, however Supreme Court found another reason to grant favor to the taxpayer without commenting on the correctness of this argument. Again, in DCIT v Turquoise Investment (2006-TII-02-HC-MP-INTL) the High Court accepted this argument and Supreme Court approved the decision of High Court in (2008-TII-02-SC-INTL).
Section 90 was amended vide Finance Act, 2004 to include a new sub-section (3) which read as under:
“(3) Any term used but not defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf.”
On 28th August 2008 a notification under this sub-section was issued which read as under:
“…where an agreement entered into by the Central Government with the Government of any country outside India for granting relief of tax or as the case may be, avoidance of double taxation, provides that any income of a resident of India "may be taxed" in the other country, such income shall be included in his total income chargeable to tax in India in accordance with the provisions of the Income-tax Act, 1961 (43 of 1961), and relief shall be granted in accordance with the method for elimination or avoidance of double taxation provided in such agreement.”
This notification was intended to put an end to the above highlighted dispute and make it clear that India as a state of residence will continue to have complete right of taxation with respect to its residents and the relief under DTAA would only be through the foreign tax credit or exemption method if so adopted by the relevant DTAA.
Section 90 was revamped vide Finance Act, 2009 (with effect from 1 October 2009) with the limited purpose of extending its scope to the non–sovereign jurisdictions in order to enable the Indian Government to enter into the agreement with non–sovereign territories as well [as understood in Essar Oil (infra)]. The said subsection otherwise remained un-altered.
Vide Finance Act, 2012 an Explanation has been added to Section 90 which reads as under:
“Explanation 3. - For the removal of doubts, it is hereby declared that where any term is used in any agreement entered into under sub-section (1) and not defined under the said agreement or the Act , but is assigned a meaning to it in the notification issued under sub-section (3) and the notification issued there-under being in force, then, the meaning assigned to such term shall be deemed to have effect from the date on which the said agreement came into force.”
Essar Oil
Mumbai Bench of Income Tax Appellate Tribunal (‘ITAT') dealt with this issue recently in ACIT v Essar Oil (2013-TII-159-ITAT-MUM-INTL) wherein the correctness, validity and applicability of the said notification were deliberated upon.
The Assessee in this case had branches in Oman and Qatar, the business income from which (having triggered PE) was taxable in the respective countries by virtue of DTAA between India and these countries. The assessee contended that the income attributed to the PE was not taxable in India. As against this, the contention of the Assessing Officer was that the income attributable to the PE located in the foreign jurisdiction is to be included in the total income of the assessee taxable in India and a credit of taxes paid in source countries (being Qatar and Oman) is available as credit against tax liability on total income of assessee which includes the PE income. In appeal before ITAT the arguments and decision thereon was under:
A. On expression ‘may be taxed'
On one hand the ITAT observed that judicial precedents support the contention of the taxpayer but on the other hand ITAT also expressed that on an independent view it is difficult to accept such proposition.
B. On the Notification and explanation
Notification issued under erstwhile section – effect of
Since the only purpose of substituting the old section with new was to enable the Government to enter into agreements with non–sovereign territory as well, it cannot be said that the earlier section has been omitted. Hence the notification continues to be operative.
Notification whether contrary to law of the land
Notification issued under sub-section clarifies legislative intent and is not contrary to the Act. Courts have interpreted phrase “may be taxed” which is used in DTAA. If the said words were part of the statute and the High Court and the Hon'ble Supreme Court would have given any interpretation, then definitely it could have been said that the law has been laid down by the High Court and the Hon'ble Supreme Court and if any notification issued contrary to such decision of the Hon'ble Supreme Court, the same is illegal or no effect can be given. (This means that the judgments of Supreme Court on issues not relating to the Act would not be regarded as a rule of law, which the author wishes to disagree as Article 141 of the Constitution of India, does not envisage such distinction).
Section 90(3) only enables notification for defining a ‘term' not ‘phrase' or ‘words'
Referring to dictionary meaning of the word ‘term' the ITAT held that ‘may be taxed' is a term.
Notification whether applicable for an earlier assessment year
Notification is merely clarificatory and retrospective from Assessment Year 2004-05. Interestingly, the ITAT has observed that, the meaning given to the phrase would apply only from 2004-05 despite that it held it to be clarificatory.
Applicability of Explanation 3 on existing DTAAs
Since the issue before the ITAT pertained to the Assessment Year 2004–05, wherein sub–section (3) of section 90, was already there and in pursuance of such section, the Central Government had issued a notification clarifying its intent and object of the terms used in the treaty, the ITAT did not deliberate as to whether or not said Explanation (3) which has been brought in statute w.e.f. 1st October 2009, will have retrospective effect. It held that the language of the said Explanation along with the explanatory memorandum has to be taken as the actual legislative intent. In essence, the ITAT modified its previous observation regarding applicability of the notification from Assessment Year 2004-05 and applied it to pre-existing DTAAs overlooking the subtle arguments placed before it.
3. Arrows in the quiver
The judgment rests on application of the notification no. 91 and admits that various court rulings existed in favor of the taxpayer. On the premise that case of the taxpayer can be supported by the said court rulings, the author believes that the notification can be challenged further based on following arguments :
I. Interplay of Article 3(2) of the DTAA with section 90(2) and 90(3)
Article 3(2) of the OECD MC reads a under:
“As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.”
It is pertinent to note that that the ‘meaning' which is subject matter of the above Article is the meaning for the purpose of taxes dealt with by the DTAA and not a specific definition incorporated in domestic legislation for expounding the meaning of a term for the purpose of DTAA itself. What is envisaged under this Article is that where a term is also used in domestic law of a contracting state with a specific meaning under that law, then in the absence of a definition under DTAA, the domestic law is to be referred to.
Professor Klaus Vogel commenting on this Article has stated as under:
“Article 3(2) concerns the interpretation of treaty terms that are also used in the contracting states' substantive law , viz. so called ‘qualification' problem”.
Further dealing with the concept of qualification and its relation with Article 3(2) Professor Vogel comments as under:
“Article 3(2) presumes that a corresponding concept is present in the tax law of the contracting state concerned regarding the actual taxes to which the treaty applies.”
Section 90(3), is thus at variance from the above Article 3(2). That section seeks to supplement a DTAA unilaterally by providing implication of a phrase that is used in DTAA alone and not used in domestic law at all. This sub-section is also a part of the Act, which, vide sub-section (2) of section 90, in its totality has been made as applicable only when its provisions are more beneficial than the relevant DTAA. Meaning thereby that, the notification read with section 90(3), being less favorable as compared to Article 3(2) [which permits reference to domestic law meaning for a term which is also used in domestic law] read with court rulings interpreting the treaty, should not be forced upon an assessee, in view of the supremacy of DTAA created by section 90(2).
II. Scope of section 90(3) and its extension by the notification
Section 90(3) envisages a notification by Central Government only for the purpose of assigning a meaning to a term. The term under debate is ‘may be taxed' and the context in which it is used is that profits attributable to a PE may be taxed in the country in which PE is situated (PE State).
The said notification instead of assigning it a meaning in the context of taxing rights of the PE State provides for a ‘legal consequence' in the residence state . Hence, in the view of the author, the notification extends beyond the scope of parent legislation i.e. section 90(3) and instead of defining a term and explaining its meaning in the context it is used, it provides for a legal consequence for a different context. It is noteworthy that Professor Klaus Vogel also treats the implication of phrase ‘may be taxed' and ‘shall be taxable' as legal consequences. Thus there appears to be a room for an argument on this count.
(The views expressed are strictly personal.) |
