A double tax avoidance treaty is a bilateral agreement between two Contracting States. The benefits arising out of the treaty should be available only to persons who are residents of either of the contracting States. A third country's resident should not be able to access the benefits of the treaty, which has been bilaterally negotiated. This simple concept has to be put into practice through some mechanism as otherwise anybody can claim to be a resident for a treaty which gives preferential treatment in respect of any item of income. The mechanism is a tax residency certificate, which is issued by some authority. Who is the authority that should issue such a certificate? In what form the certificate should be issued? Should it contain any particular information? These are issues, which have still not been addressed in India. The field officers rely on their own ingenuity in this regard. The (in)famous circular 789 in the context of the India-Mauritius treaty merely asks officers to accept the certificate of residence issued by the Mauritius tax authorities as gospel truth. But even the said Circular does not say anything about the particulars discussed above. The proposed Direct Taxes Code for the first time talks of a tax residency certificate in a particular form. But, like in so many other provisions, it leaves things to the executive to prescribe in future. In the context of tax residency certificates, we had one interesting case from Romania, which was presented by Romana Schuster, Tax Manager, KPMG, Romania.

Tax Residency Certificate

In this case, the taxpayer applied the treaty-withholding rate as applicable in respect of interest payment on Bonds in the treaty with the USA. The recipient was apparently a Delaware based US entity. The tax authorities denied the benefit of lower withholding rate as given in the treaty since they found that the tax residency certificate filed by the taxpayer was not in compliance with the Romanian regulations. The taxpayer challenged the decision and argued that even though the tax residency certificate furnished might have been in a format different from that imposed by domestic legislation, nevertheless, the treaty provision should apply.The Romanian Lower Court upheld the action of the tax authorities on the ground that the certificate was not in the format prescribed by the domestic legislation and such a certificate could not produce the desired legal effects.

In appeal, the Appeals Court confirmed the order and further pointed out that the payments in question were not made directly to the Delaware entity but that the same was made to another entity in Cyprus and its identification data was different from the Delaware entity and consequently, it was held that the beneficial owner was not the American resident. Accordingly, the treaty benefit was denied.

In the ensuing discussion, I raised a point as to whether a tax residency certificate given by any tax authority is considered as conclusive evidence of residence by any other country. It may raise a presumption though. Jacques Sasseville informed that in Canada, no particular importance is given to the certificate and tax authorities determine the same based on their own procedures. It continues to remain a mystery for me as to why the NDA government having forced the CBDT to issue circular 789, the subsequent UPAI & II never thought of withdrawing it although sporadic noise about the misuse of Mauritius route is often made.

Agency PE

Coming back to the cases discussed in the conference, an interesting case was reported from Turkey. Dr Billur Yalti of Marmara University presented the case. In this case, the facts as presented were that a UK-based company used to conduct touristic yachting operations by its own yachts in the Turkish national waters. However, under Turkish domestic law, foreign yachting enterprises had to be represented in Turkey. A travel agency in Turkey thus supplied preparatory services such as transfer of tourists to the yachts, providing commissaries and documentary services with the authorities. In such circumstances, the Turkish tax authorities found a PE of the UK Company in Turkey.

In appeal, the Turkish lower Court held that the Turkish travel agency did not constitute an agency PE since according to the Court, it was rendering only preparatory services. In further appeal, the Turkish Supreme Administrative Court however held that though the services were marketed abroad, each yacht constituted a PE in Turkey since the same was placed in Turkey and the service was conducted in Turkey. It was also held that since under the Turkish tourism regulations, foreign flagged yachts are not permitted to conduct passenger transportation within Turkish waters, the Turkish agent did indeed constitute an agency PE of the foreign company owning the yachts.

Non-discrimination

In recent times, many ingenious arguments, relying on the relatively obscure non-discrimination provision of the treaties, have been taken before the Tribunal in India. In some cases, the Tribunal has also struck down some domestic provisions in operation for a long time on the alleged ground of the violation of the obligation of non-discrimination. In this context, it is interesting to note the gist of a case from Italy that was presented by Dr. Pasquale Pistone of Vienna University.

Based on the Italian domestic anti-avoidance rules, the Italian tax authorities disallowed the purchases made from a related Swiss company, which was distributor of goods of an associated Belgian company. The Italian entity procured the goods from the Swiss company but orders were directly placed with the Belgian company. It was clarified that the Swiss company was not a post box company but had staff and substance. Nevertheless, the disallowance as per domestic law was made.

There was a non-discrimination clause in the treaty that corresponded to Art 24.4 of the OECD Model. Article 24.4 states as follows: “4. Except where the provisions of paragraph 1 of article 9, paragraph 6 of article 11, or paragraph 6 of article 12 apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State ….”

The Italian Supreme Court disallowed the plea of the assessee based on the siad non-discrimination clause and held that that the non-discrimination provision in Article 24.4 applies only to effective cost and not to payments made to an interposed company. It was also held that the domestic anti avoidance rule prevented deduction of payment to the Swiss related company since it prevails over the deduction non-discrimination provision of the treaty.

International Shipping

We conclude this column with a case law coming out of China. Any case coming out of China deserves special attention as there are not too many case laws involving international taxation. Mr.Wei Cui of China University of Political Science and Law, Beijing, presented this case, Donghwa Industrial Corporation v. Weihai Huancui State Tax Bureau. This case involved, interpretation of Article 8 relating to international shipping.

In this case, a Korean Company entered into a wet lease of a ship with a Chinese company. The Korean Company did not have a PE in China. The ship was being used for voyaging between China and Korea. The question involved the nature of the rental income of the Korean company. Apparently, the claim was that the rental income was covered under article 8 and hence not taxable in China. The Chinese tax authorities, however, based on a circular of the State Administration of Taxes (SAT), took the view that rental income under a wet lease must be ancillary to proper international transportation in order to be covered by Article 8. Since the Korean company's income in the form of rentals was not ancillary to international transportation, the same was taxable as royalties, being income from use of industrial, commercial or scientific equipment.

The Korean taxpayer, relying on the OECD Commentary on Article 8, argued that income from a wet lease was per se covered by Article 8 and need not be ancillary to other activities. Paragraph 5 of the Commentary to Article 8 states: “Profits obtained by leasing a ship or aircraft on charter fully equipped, crewed and supplied must be treated like the profits from the carriage of passengers or cargo. Otherwise, a great deal of business of shipping or air transport would not come within the scope of the provision ...” The Chinese tax authorities, however, argued that the SAT's position was fundamentally different from that of the OECD and hence it was the SAT circular and not the OECD commentary that should be applied. The Chinese Court upheld the view of the tax authorities. Mr Wei Cui also informed that China has in its 2010 comprehensive annotation of the treaty with Singapore, adopted the same position in respect of wet leases.

In fact, according to IBFD News Service, China issued a guideline in July 2010 for application and interpretation of the China-Singapore treaty of 2007, which will also be applicable to all the treaties having similar article relating to shipping. According to this guideline, profits from operation of ships in international traffic will include profits from rental on a wet lease, profits from rental on a bareboat basis and profits from rental of containers. However, such rentals must be ancillary to the operation of ships in international traffic and the revenue from such activities should not exceed 10% of the total revenue of a shipping company.

In India, we have 79 notified treaties and many more are in the pipeline. It will be a good practice to follow the Chinese example and issue guidelines by the tax administration for the interpretation and application of all the treaties. Till now, all we have is a perfunctory press release highlighting a few provisions of the treaty and all such press releases are more or less similarly worded. Detailed guidelines of the provisions of a treaty, even if not binding on the Courts, will articulate the tax administration's views on the various provisions of the treaty that has just been signed and hopefully may help reduce some litigation.

(Concluded)