The Hindu Business Line : Court rulings vs Revenue clarifications

Should a resident of India, who has earned income abroad and brought scarce foreign currency into the country be required to pay tax on that income to the Indian exchequer also?

S. P. Singh
Sharad Goyal

Remember the last time when Ricky Martin came to India for some stage performances? On his way back he was questioned by Indian tax authorities at the airport regarding taxes on income he had earned from stage shows.

Such a gesture with an international celebrity may sound awkward to some, but rightly so because India has a right to levy tax on any income of an Indian or a foreigner which is earned from a business or other activities carried out on Indian soil. No w just imagine the reverse of Ricky Martin’s case — a person who is a resident of India goes to a foreign country and earns certain income there; he will also be required to peg out a portion of his income there to the exchequer of that country if the local law so provides.

The moot question in such a situation is that should a resident of India, who has earned income abroad and brought scarce foreign currency into the country be required to pay tax on that income to Indian exchequer also? The answer which would be prompted in the mind would be “No. Why should I need to pay tax on the same income again and again?”

Global income of residents

The domestic laws of India appear to be categorical in covering the global income of a resident of India under the tax net. One starts looking at tax treaties to find whether there is any relief available there. In fact, India has entered into tax treaties called Double Taxation Avoidance Agreements (DTAAs) with more than 70 countries.

The DTAAs seek to avoid double taxation by distributing the jurisdiction to tax income between the country of residence and the country of source. However, there are certain items of income on which the right to tax is given to both the countries. In such a case, double taxation is sought to be mitigated by the country of residence which grants credit of tax paid in the other country. The question that arises is whether the tax treaties are comprehensive enough so that both taxpayers and tax authorities come to the same conclusion? Unfortunately, the answer is “No”.

There have been many cases of disputes where intricate issues of taxation of technical services, royalty, capital gains from sale of shares, etc., have been involved. But the issue which has drawn the attention of the courts, including the Supreme Court of India, is the basic issue: Whether India has the right to tax the income of a branch of an Indian company or not?

The tax authorities have been very clear that India does have the right to tax such income. The Income-Tax Act clearly provides that the global income of an Indian resident is liable for taxation in India. Recently, a circular has been issued by the Central Board of Direct Taxes (CBDT) clarifying that wherever the tax treaties provide that any income of a resident of India “may be taxed” in the other country, such income shall be included in his total income taxable in India and taxed in India, and relief from double taxation shall be available as per the DTAA concerned.

In other words, the foreign income of Indian resident shall be first subject to tax in India and then relief from double taxation would be granted.

‘May be taxed’

The controversy revolves around interpretation of the phrase “may be taxed”. This phrase is found in the DTAAs in articles on taxation of business income, etc. DTAAs provide that the income of a branch of a foreign company may be taxed in the country of source.

For example, in the tax treaty between India and Japan it is provided that the income of a branch of an Indian company “may be taxed” in Japan. The question is what is the import of the phrase “may be taxed”? Does it mean that the said income can be taxed only in Japan, or does it mean that right of taxation has been given to Japan but the right of taxation still continues with India?

The view of the tax authorities has been that the second interpretation is the correct one. It is claimed that this view is supported by the interpretation given by the Organisation of Economic Co-operation and Development (OECD). On the other hand, Indian courts and tribunals have held that the first interpretation is correct.

The basic premise of this view is that wherever right of taxation has been given to both the countries it has been made clear in the DTAAs. In other words, the phrase “may be taxed” has been held to mean unequivocal grant of right to tax to one of the treaty countries to the exclusion of the other.

Now, the position before a taxpayer is: There are court rulings excluding India from taxing the branches of the Indian companies wherever tax treaties exist. On the other hand, there is a circular issued by the apex body of the tax department which makes such income taxable in India.

The problem is acute for the taxpayer because the circulars issued by the CBDT are binding on the tax authorities. Thus, tax authorities are obliged to tax such income in India and raise demand on the taxpayer.

Apex court ruling

Interestingly, the five member bench of the Supreme Court recently held in the Ratan Melting and Wire Industries (220 CTR 98) case that “so far as the clarifications/circulars issued by the Central Government and of the State Government are concerned they represent merely their understanding of the statutory provisions. They are not binding upon the court. It is for the court to declare what the particular provision of the statute says and it not for the executive. Looked at from another angle, a circular which is contrary to the statutory provisions has really no existence in law.”

In view of the above, the courts and tribunals are bound to hold the income of a branch of an Indian company is not liable to taxation in India. At the same time, as the circulars are binding on the tax authorities they would hold the income in question as taxable.

In practical terms this means that first tax demand would be raised, and then the taxpayer will have to go to the courts of law to get a relief. Obviously, this would add to the cost of running the business.

The Income-Tax Department should look at the whole scenario in a more comprehensive manner taking into account the fact that the solution does not lie with a circular or in amending the law, because the issue of interpretation is linked to DTAAs. Further, it is an accepted position that if there is a conflict between domestic laws and a DTAA then the latter would prevail.

(The authors are with Deloitte Haskins & Sells. blfeedback@thehindu.co.in)

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