The Hindu Business Line : Avoidance of double taxation can't do away with taxation altogether

OUR supreme audit institution, the Comptroller and Auditor-General of India (C&AG) has faulted the Finance Ministry for being blind to loopholes in DTAAs that led to havoc in the bourses. Before we zero in on the foreign institutional investors and Indian brokers who exploited the flaws in our tax system, as charged by the C&AG, let us touch base with DTAAs.

The abbreviation stands for double taxation avoidance agreements, also known as tax treaties. DTAA, DTA (with `avoidance' avoided) or DTT (that is, double taxation treaty) is "an agreement between two (or more) countries for the avoidance of double taxation," explains the Organisation for Economic Co-operation and Development (www.oecd.org) in its ``Glossary of Tax Terms''. "A tax treaty may be titled a Convention, Treaty or Agreement," it adds.

Authority for DTAA is found in Chapter IX of the Income Tax Act where Section 90 speaks of ``agreement with foreign countries''. Thus, the Centre may enter into agreement with the Government of any country outside India to grant relief in respect of income on which income-tax has been paid both in India and in that country. That, in essence, lies at the core of DTAA, because "cross-border investment would be seriously impeded if there was a danger that the returns on such investment were taxed twice," as OECD explains.

A 2004 change made to Section 90 includes within its ambit relief under our I-T Act and under ``the corresponding law in force'' in the other country, "to promote mutual economic relations, trade and investment". India has DTAAs with more than 60 countries, including the US, the UK, Japan, France, Germany, and so on. For an informative table tax rates for dividends, interest and royalties as per different agreements, check ``Investing in India-Foreign Direct Investment — Policy and Procedures'' on http://dipp.nic.in. Treaties are a continual work; for instance, talks are on about halving Indo-Japan withholding tax to 10 per cent, and new treaties are on the anvil.

Wikipedia identifies four distinct ways in which bilateral tax treaties achieve their goal of removing impediments to foreign investment. One, increasing the extent to which exporters residing in country A can engage in trading activity in country B without attracting tax liability in B. Two, laying down guidelines on how the income is to be taxed and what deductions are to be allowed. Three, providing a dispute resolution mechanism. And, four, resolving situations when income or gains remain in principle taxable in both the countries. To know how these are put in practice, you need to read the DTAAs such as listed on http://incometaxdelhi.nic.in/taxsys.

Let me pick up the one with Mauritius, which is attracting attention once again after the recent audit objections. It speaks in its preamble of the desire to prevent ``fiscal evasion with respect to taxes on income and capital gains''. That, therefore, is one more goal of tax treaties. To affirm, Section 90(c) of the I-T Act speaks of "exchange of information for the prevention of evasion or avoidance of income-tax chargeable... or investigation of cases of such evasion or avoidance."

One learns that recent efforts to initiate a DTAA with Singapore find a hurdle in that country's reluctance to include an information-sharing clause in the treaty. As you know, avoidance may be permitted, but evasion smacks of fraud. Which is why a remark of the C&AG in one of its recent reports that's creating waves is: "The whole exercise of avoidance of double taxation turned out to be avoidance of taxation altogether."

OECD has framed a Model Convention to guide countries to draft DTAs. And there are updates to the same. In ``what's new'' on the topic, you'd find the 2005 update touching upon ESOPs, multiple permanent establishments, cross-border pensions and so on. In the Azadi Bachao Andolan case, the Supreme Court made reference to the OECD Convention.

On whether one may rely on it for clarity when interpreting India's DTAAs, there have been differences among high courts. For instance, the Andhra Pradesh High Court said in the Visakhapatnam Port Trust case that the Model may be a useful guide, but the Madras High Court observed in the VRSRM Firm case that the same could not be a safe or reliable guide because of the many differences between the Model and our treaties.

It is not that treaties can make everybody happy. A report prepared by the OECD observed: "Existing treaties between industrialised countries sometimes require the country of residence to give up revenue. More often, however, it is the country of source that gives up revenue." As a result, in a treaty developing and industrialised countries, income-flows may be "largely from developing to industrialised countries and the revenue sacrifice would be one-sided". A vital point to be considered when drafting treaties.

The United Nations too has brought out a Model Convention, representing "a compromise between the source principle and the residence principle," and giving more weight to the source principle than does the OECD Model Convention. It exhorts the source country to recognise that taxation of income from foreign capital should take into account "expenses allocable to the earnings of the income so that such income would be taxed on a net basis".

For the research-minded, here is something to study. John A. Townsend's `Tax Treaty Interpretation' takes off from the case National Westminster Bank, PLC vs United States (`NatWest'). Richard L. Doernberg examines the impact of electronic commerce on income tax treaty principles in `Electronic Commerce: Changing Income Tax Treaty Principles a Bit?' Richard L. Reinhold asks if `treaty shopping' is outdated in `What is Tax Treaty Abuse?' Anthony C. Infanti's `Curtailing Tax Treaty Overrides: A Call to Action' is on how treat partners may suffer due to unilateral overrides. And `Asymmetric FDI and Tax-Treaty Bargaining: Theory and Evidence' by Richard Chisik and Ronald B. Davies focuses on how bargaining can affect the withholding taxes set under the treaty. For the rest of us, what is worth watching is what unfolds in the ongoing FM vs CAG drama. As Plato said, "When the tyrant has disposed of foreign enemies by conquest or treaty, and there is nothing to fear from them, then he is always stirring up some war or other, in order that the people may require a leader." And without controversies, won't treaties, be they of tax or nukes, become too boring to live with?

ZeroBase@TheHindu.co.in

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