The Hindu Business Line : Tiebreaker in a treaty tussle

DOUBLE taxation avoidance agreements (DTAAs) are an area for specialists because interpretation of treaties is a complicated exercise. We have commentaries and models based on conventions drawn up by the UN and the OECD.

A whole lot of fiscal jurisprudence has evolved on concepts for international tax avoidance agreements found in the commentaries. Seldom, therefore, can one expect the manifesto of any political party to talk about DTAAs.

Thus, surprisingly, the Common Minimum Programme (CMP) of the new Government includes in its agenda measures to avoid fiscal evasion through double taxation avoidance agreements. The reference in the CMP was prompted by the outcry against tax manipulation through investments made in India taking advantage of our tax treaty on Mauritius.

Mauritius remains the source for maximum investments in India from abroad. There are, however, other countries too that figure as important partners in India's tax treaties.

Generally, courts have favoured interpretations that benefit the taxpayer. One such case relates to our treaty with Malaysia.

The Kulandagan Chettiar case

The facts of this case (CIT vs P. V. A. L. Kulandagan Chettiar — 267 ITR 654 SC) show that Kulandagan Chettiar owned immovable property in IPOH, Malaysia.

The firm had income from rubber estates and also derived short-term capital gains from sale of the estate in Malaysia. The income-tax officer (ITO) held that both the incomes are assessable in India.

Successive appeals resulted in the Income-Tax Department being told that by virtue of our DTAA with Malaysia, those incomes were not liable for Indian income-tax. The firm did not have a permanent establishment (PE) in India; the property was situated in Malaysia.

The Madras High Court ruled that where there exists a provision to the contrary in the Agreement, there is no scope for applying the law of any one of the respective contracting State to tax the income and the liability to tax has to be worked out in the manner and to the extent permitted or allowed under the terms of the Agreement.

The court rejected the application of commentaries on the Article of the Model Convention of 1977 presented by the OECD, as it would not be a safe or acceptable guide or aid for such construction.

The Department took up the matter in appeal before the Supreme Court. The apex court pointed out that as per Section 90(2), in respect of cases governed by the DTAA and in relation to the assessee to whom such agreement applies, the provisions of the I-T Act shall apply to the extent they are more beneficial to that assessee.

Sections 4 and 5 of the I-T Act provides for taxation of global income. These sections, however, will have to make way wherever there are provisions to the contrary in the DTAA.

The Act gets modified insofar as the agreement is concerned, and if the agreement provisions are more beneficial to the assessee, they will prevail. Only the treaty governs the taxability. Situations may arise where the assessee is domicile in both the contracting states.

The Supreme Court applied the tiebreaker rule and held that fiscal domicile will have to be determined with reference to the fact that "if the contracting state with which his personal and economic relations are closer, he shall be deemed to be a resident of the contracting state in which he has an habitual abode.

This implies that tax liability arising in respect of a person residing in both the contracting states has to be determined with reference to his close personal and economic relations with one or the other."

The Supreme Court held that because of closer economic relations between the assessee and Malaysia, business income will have to be assessed only in Malaysia and not in India.

For similar reasons, the assessee's residence in India will become irrelevant and treaty provisions will prevail over Sections 4 and 5 of the Act. This will also apply to capital gains. The Department's appeal was dismissed.

The court concluded thus: "Taxation policy is within the power of the Government and Section 90 of the Income-tax Act enables the Government to formulate its policy through treaties entered into by it and even such treaty treats the fiscal domicile in one state or the other and thus prevails over the other provisions of the Income-Tax Act, it would be unnecessary to refer to the terms addressed in OECD or in any of the decisions of foreign jurisdiction or in any other agreements."

A similar sentiment was voiced by the apex court in the landmark Union of India vs Azadi Bachao Andolan case. The court had then ruled that developing countries may tolerate evils such as treaty shopping for various economic and political reasons and it is not for courts to interfere in the realm of fiscal policy. Article 24 of our treaty with the US provides for a limitation clause whenever treaty benefits are enjoyed.

It is laid down that more than 50 per cent of the beneficial interest should be owned directly or indirectly by one or more individual residents of one of the contracting states.

This limitation clause of Article 24 may probably find its way into our statue when the Finance Bill is introduced in order to amend Section 90 of the I-T Act.

It is significant that the review petition filed against the Azadi Bachao Andolan has also been dismissed by the Supreme Court. It is for the executive arm of the Government to act.

(The author is a former Chief Commissioner of Income-Tax.)

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