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Amendments relating to tax treaties
July, 12th 2010

Under the existing Indian law, the Tax Treaties (DTAA) that India has signed with other countries supersede the domestic tax law of both the respective countries. The Supreme Court in case of Azadi Bachao Andolan [263 ITR 706] also clarified that a Tax Treaty is essentially a bargain between two sovereign States. Therefore, where the Tax Treaty provides for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the Income-tax Act.

As against the principle laid down by the Apex Court, the original draft of the Direct Tax Code (DTC) provided that neither a DTAA nor the Code shall have a preferential status by reason of its being a treaty or law. In the case of a conflict between the provisions of a treaty and the provisions of the Code, the one that is later in point of time shall prevail.

The proposal of the DTC was severely criticised. It is heartening to note that the government has appreciated the criticism.

The revised discussion paper on DTC clearly provides that between the domestic law and the relevant DTAA, the one which is more beneficial to the taxpayer shall apply. However, DTAA will not have preferential status over the domestic law in the following circumstances:

When the General Anti Avoidance Rule is invoked, or
When Controlled Foreign Corporation provisions are invoked or
When Branch Profits Tax is levied.
It is felt that the exceptions as discussed above seriously need a re-look for several reasons including the following:

General Anti Avoidance Rule: The objective is to curb the use of undesirable means to avoid payment of tax. Checking evasion of tax is not objected by anybody. But whether avoidance is also an abuse of tax laws is a highly debatable question. As back as in 1926, in the classic words of Lord Sumner in IRC v. Fishers Executers [1926] AC 395 at 412 (HL):
My Lords, the highest authorities have always recognised that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law.

Similar views were expressed by Lord Tomlin in IRC v. Duke of Westminster [1936] AC 1 (HL);

Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.

In India, the Apex Court took up this issue in the famous case of McDowells [154 ITR 148]. The issue was again discussed in the case of Azadi Bachao Andolan [263 ITR 706].

Those who are in the field of taxation will readily understand that the controversy of tax evasion vs. tax avoidance has been haunting for at least hundred years, yet no universally acceptable solution has been found till date.

Therefore, it is suggested that let the DTC not meddle in this controversy. Let the judicial interpretations given by the Supreme Court govern the field.

Controlled Foreign Corporations Provisions: The objective is to discourage Indian companies to park their profits abroad without paying tax in India. As expressed in the Business Standard dated 28.06.2010, the conditions in India are not yet ripe that the tax regime should deny the benefit of deferral of tax liability available to foreign arms of Indian companies, which makes them more competitive.
Branch Profits Tax: The justification of introducing branch profits tax is highly debatable. The said tax is a further tax on the already taxed profit. It is like dividend distribution tax applicable in case of domestic companies, which amounts to taxing the same income twice. This is clearly against the fundamental principles of taxation.

It is therefore strongly recommended that Government should not make any amendments through DTC to unsettle the established legal position vis--vis Tax Treaties entered into by India with foreign countries. (The author is a Sr. Partner in S S Kothari Mehta & Co.)

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