Double taxation may arise when the jurisdictional connections, used by different countries, overlap or it may arise when the taxpayer has connections with more than one country. A person earning any income has to pay tax in the country in which the income is earned (as source Country) as well as in the country in which the person is resident. As such, the said income is liable to tax in both the countries. To avoid this hardship of double taxation, Government of India has entered into Double Taxation Avoidance Agreements (DTAAs) with various countries. DTAAs provide for the following reduced rates of tax on dividend, interest, royalties, technical service fees, etc., received by residents of one country from those in the other.
India has a well-developed tax structure with a three-tier federal structure, comprising the Union Government, the State Governments and the Urban/Rural Local Bodies. The power to levy taxes and duties is distributed among the three tiers of Governments, in accordance with the provisions of the Indian Constitution. Since 1991 tax system in India has under gone a radical change, in line with liberal economic policy and WTO commitments of the country like reduction in custom and excise duties, lowering corporate tax, widening of the tax base and toning up the tax administration. The phenomenal growth in international trade and commerce and increasing interaction among nations, citizens, residents and businesses of one country has extended their sphere of activity and business operations to other countries. To avoid hardship to individuals and also with a view to ensure that national economic growth does not suffer, the Central government under Section 90 of the Income Tax Act has entered into Double Tax Avoidance Agreements with other countries.
(1)Protection against double taxation: These Tax Treaties serve the purpose of providing protection to tax-payers against double taxation and thus preventing any discouragement which the double taxation may otherwise promote in the free flow of international trade, international investment and international transfer of technology;
(2)Prevention of discrimination at international context: These treaties aim at preventing discrimination between the taxpayers in the international field and providing a reasonable element of legal and fiscal certainty within a legal framework;
(3)Mutual exchange of information: In addition, such treaties contain provisions for mutual exchange of information and for reducing litigation by providing for mutual assistance procedure; and
(4)Legal and fiscal certainty: They provide a reasonable element of legal and fiscal certainty within a legal framework.
WHAT IS DOUBLE TAXATION?
Double taxation can be defined as the levy of taxes on income or capital in the hands of the same tax payer in more than one country, in respect of the same income or capital for the same period. Double taxation may arise when the jurisdictional connections, used by different countries, overlap or it may arise when the taxpayer has connections with more than one country. For e.g. An NRI will have to pay tax on the income earned in India on source basis i.e. where income accrues or arises. On the same income, tax will have to be paid in the country of residence on residence basis. As such, an NRI will end up paying Income-tax twice on the same income. Tax Treaties provide protection to tax payers against such double taxation.
WHAT IS DOUBLE TAXATION AVOIDANCE AGREEMENT?
A person earning any income has to pay tax in the country in which the income is earned (as Source Country) as well as in the country in which the person is resident. As such, the said income is liable to tax in both the countries. To avoid this hardship of double taxation, Government of India has entered into Double Taxation Avoidance Agreements (DTAAs) with various countries. DTAAs provide for the following reduced rates of tax on dividend, interest, royalties, technical service fees, etc., received by residents of one country from those in the other. Where total exemption is not granted in the DTAAs and the income is taxed in both countries, the country in which the person is resident and is paying taxed, the credit for the tax paid by that person in the other country is allowed.
Where tax relief has been given by one country, the country of residence generally allows credit for the tax so spared, to avoid nullifying the relief. If the rate prescribed in the Indian Income-tax Act, 1961 is higher than the rate prescribed in the Tax Treaty then the rate prescribed in the Tax Treaty has to be applied. In other words, provisions of DTAA or Indian Income-tax Act, whichever are more favourable to an individual would apply. Thus In order to avail the benefits of DTAA, an NRI should be resident of one country and be paying taxes in that country of residence. India has entered into DTAA with around 65 countries. These treaties are based on the general principles laid down in the model draft of the Organisation for Economic Cooperation and Development (OECD) with suitable modifications as agreed to by the other contracting countries.
Thus in case there is a DTAA between India and United States of America, an NRI should be a resident of USA and paying taxes there. In case of income earned in India by NRI, tax paid in India is allowed as credit against tax paid in USA.
WHO ARE THE SUBJECTS OF SUCH AGREEMENT?
A typical DTA Agreement between India and another country usually covers persons, who are residents of India or the other contracting country, which has entered into the agreement with India. A person, who is not resident either of India or of the other contracting country, would not be entitled to benefits under DTA Agreements.
EXCLUSIVE FEATURE OF DTAA
One of the most important clauses of double taxation avoidance treaty between different nations is the clause of non-discrimination. Non-discrimination in simple words means that neither of the contracting countries gives any preferential treatment in taxing its own residents or citizens vis- -vis foreign persons i.e. there is no discrimination between the local assesses and foreign assesses as far as taxation is concerned. There must be a level playing field for assesses, locals as well as the foreigners. Most international tax treaties provide that there will not be any discrimination in taxation between locals and foreigners. In fact, if there is any discrimination, it will be a positive one. This may be for several reasons such as incentive for foreign investment in the country, globalization etc.
The correct legal position is that where a specific provision is made in the double taxation avoidance agreement, that provision will prevail over the general provisions contained in the Income-tax Act, 1961. In fact, the Double Taxation Avoidance Agreements, which have been entered into by the Central Government under section 90 of the Income-tax Act, 1961, also provide that the laws in force in either country will continue to govern the assessment and taxation of income in the respective country except where provisions to the contrary have been made in the agreement. Thus, where a Double Taxation Avoidance Agreement provides for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the Income-tax Act. Where there is no specific provision in the agreement, it is the basic law, i.e. the Income-tax Act that will govern the taxation of income.
SCOPE OF SUB-SECTION (1)
The four clauses of sub-section (1) lay down the scope of power of the Central Government to enter into an agreement with another country. Clause (a) contemplates situations where tax has already been paid on the scope in both countries and it empowers the central government to grant relief in respect of such double taxation. Clause (b), which is wider than the clause (a), provides that an agreement may be made for the avoidance of double taxation of income under this Act and under the corresponding law in that country. This clause cannot be extended to make provisions in agreements for situations not relating to double taxation. However, it is not necessary that a situation regarding avoidance of double taxation can arise only when tax is actually paid in one of the contracting countries. Moreover, as long as the objectives in these clauses are sought to be effectuated by any agreement, the power of the central government cannot be said to have been used in an ultra vires manner. Clause (c) and (d) essentially deal with agreements made for exchange of information, investigation of cases and recovery of Income Tax.
NEW CLAUSE (a)
With effect from 1st April 2004, clause (a) will be substituted to provide that an agreement may also be entered into for granting relief in respect of income-tax chargeable under this Act an under the corresponding law in force that country, to promote mutual economic relations, trade and investment. With this amendment, the power of the Central Government has been greatly widened, and it an now enter into agreements not only for the avoidance of double taxation, but also for exempting income from taxation. It is clear from the language of the clause that this power can be used only for granting relief in respect of income tax, and not to create any fresh charge, obligation or responsibility.
This subsection, applicable from 1st April 2004, relates to terms used, but not defined, in this Act or in any agreement made under subsection (1). Such terms are to have the same meaning as assigned to them in any notification issued in this behalf by the Central Government. However, the meaning of such term must not be inconsistent with the provisions for the Act or the agreement; further, the term can be interpreted differently, if the context so requires.
EXPLANATION TO SECTION 90
The Finance Act 2001, has inserted an explanation to this section with retrospective effect from the commencement of the Act, to clarify that the charge of the tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as a less favorable charge or levy of tax in respect of such foreign company, where such foreign company has not made the prescribed arrangement for declaration and payment within India, of the dividends (including dividends on preference shares) payable out of its income in India.
APPEAL AND REFERENCE
An application for refund may be made under section 237 by an assessee entitled to relief under this section, and from the order of the AO, on such application for refund an appeal would lie to the CIT(A), a second appeal to the tribunal and a reference to the High Court.
SECTION 91: COUNTRIES WITH WHICH NO AGREEMENT EXISTS
Sub-section (1) of this section grants unilateral relief in cases where section 90 does not apply, subject to the fulfillment of the following conditions:
(1)the assessee should be resident in India in the previous year;
(2)the income should have accrued in fact outside India and should not be deemed under any provision of this Act to accrue in India;
(3)the income should be taxed in both Indian and in a foreign country with which India has no agreement for relief against or avoidance of double taxation; and
(4)the assessee should have in fact paid the tax in such foreign country by deduction or otherwise. Unilateral relief under this section is available only in respect of the doubly taxed income, i.e., that part of the income which is actually included in the assessees total income: the amount deducted under Chapter VI A is not doubly taxed and therefore, no relief is allowable in respect of such amount. Further, the section contemplates granting of relief calculated on the income country wise and not on the basis of aggregation or amalgamation of income from all foreign countries.
This section should be liberally construed, for example, the dividend from a United Kingdom company, from which tax is deducted and retained by the company, is entitled to relief under this section, and the passing of an assessment order in the United Kingdom, in respect of such dividend is not necessary.
In order that this section, it is necessary that the foreign tax should be levied in a country with which India has no agreement for relief against or avoidance of double taxation; but it is immaterial that the tax paid in such a foreign country is in respect of income arising in another foreign country with which India has such an agreement.
In similar circumstances, sub-section (3) affords relief to a non resident in respect of his share in the foreign income of a registered firm, which is assessed as resident in India.
In Gammon India v. CIT, the Bombay High Court Held on the facts of the case that a relief under this section could not be claimed in rectification proceedings under section 154, but the Calcutta High Court took a different view in CIT v. United Commercial Bank.
UNION OF INDIA (UOI) AND ANR. Vs AZADI BACHAO ANDOLAN AND ANR.
The Government of India has entered into various Agreements (also called Conventions or Treaties) with Governments of different countries for the avoidance of double taxation and for prevention of fiscal evasion. One such Agreement between the Government of India and the Government of Mauritius dated April 1, 1983, is the subject matter of the present controversy. The purpose of this Agreement, as specified in the preamble, is avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment. After completing the formalities prescribed in Article 28 this agreement was brought into force by a Notification dated 6.12.1983 issued in exercise of the powers of the Government of India under Section 90 of the Act read with Section 24A of the Companies (Profits) Surtax Act, 1964. The Agreement defines a number of terms used therein and also contains a residuary clause. In the application of the provisions of the Agreement by the contracting States any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the laws in force in that contracting State, relating to the words which are the subject of the convention.
FACTS CONCERNING THE ISSUE IN THE PRESENT CASE
By a Circular No. 682 dated 30.3.1994 issued by the CBDT in exercise of its powers under Section 90 of the Act, the Government of India clarified that capital gains of any resident of Mauritius by alienation of shares of an Indian company shall be taxable only in Mauritius according to Mauritius taxation laws and will not be liable to tax in India. Relying on this, a large number of Foreign Institutional Investors (hereinafter referred to as the FIIs), which were resident in Mauritius, invested large amounts of capital in shares of Indian companies with expectations of making profits by sale of such shares without being subjected to tax in India. Sometime in the year 2000, some of the income tax authorities issued show cause notices to some FIIs functioning in India calling upon them to show cause as to why they should not be taxed for profits and for dividends accrued to them in India. Thereafter, to further clarify the situation, the CBDT issued a Circular No.789 dated 13.4.2000 stating that wherever a Certificate of Residence is issued by the Mauritian Authorities, such Certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly and this test of residence would also apply in respect of income from capital gains on sale of shares. Accordingly, FIIs etc., which are resident in Mauritius would not be taxable in India on income from capital gains arising in India on sale of shares. The issue in the present case concerns the treatment of capital gains and the relevant provisions are mentioned underneath:
Article 13 deals with the manner of taxation of capital gains. It provides that gains from the alienation of immovable property may be taxed in the Contracting State in which such property is situated. Gains derived by a resident of a Contracting State from the alienation of movable property, forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State, or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment, may be taxed in that other State.
Gains from the alienation of ships and aircraft operated in international traffic and movable property pertaining to the operation of such ships and aircraft, shall be taxable only in the Contracting State in which the place of effective management is situated. With respect to capital gain derived by a resident in the Contracting State from the alienation of any property other than the aforesaid is concerned, it is taxable only in the State in which such a person is a resident.
CHALLENGES BEFORE THE HIGH COURT
Circular No. 789 was challenged before the High Court of Delhi by two writ petitions, both said to be by way of Public Interest Litigation and prayed to override the public interest over interest of few individuals by quashing the above mentioned circular.
The High Court quashed the circular observing that dance of double taxation is a term of art and means that a person has to pay tax at least in one country; avoidance of double taxation would not mean that a person does not have to pay tax in any country whatsoever and the Income-tax Officer is entitled to lift the corporate veil in order to see whether a company is actually a resident of Mauritius or not and whether the company is paying income-tax in Mauritius or not and this function of the Income-tax Officer is quasi-judicial. Any attempt by the CBDT to interfere with the exercise of this quasi-judicial power is contrary to intendment of the Income-tax Act. The impugned circular is ultra vires as it interferes with this quasi-judicial function of the assessing officer.
CHALLENGES AND JUDGMENT OF SUPREME COURT
The issue raised before the Honourable Supreme Court restricted to the scope of power emanating from Sec 90 of the Act? Section 90, (including its precursor under the 1922 Act), was brought on the statute book precisely to enable the executive to negotiate a DTAC and quickly implement it. Even accepting the contention of the respondents that the powers exercised by the Central Government under Section 90 are delegated powers of legislation, still a delegatee of legislative power in all cases has power to grant exemption. There are provisions galore in statutes made by Parliament and State legislatures wherein the power of conditional or unconditional exemption from the provisions of the statutes are expressly delegated to the executive. For example, even in fiscal legislation like the Central Excise Act and Sales Tax Act, there are provisions for exemption from the levy of tax See Section 5A of Central Excise Act, 1044 and Section 8(5) of the Central Sales Tax Act, 1956. Therefore the contention that the delegate of a legislative power cannot exercise the power of exemption in a fiscal statute is not acceptable. Thus Section 90 enables the Central Government to enter into a DTAC with the foreign Government. When the requisite notification has been issued there under, the provisions of Sub-section (2) of Section 90 spring into operation and an assessee who is covered by the provisions of the DTAC is entitled to seek benefits there under, even if the provisions of the DTAC are inconsistent with the provisions of Income-tax Act, 1961.
One of the aspects dealt in the case is relating to the treaty shopping i.e. companies incorporated in foreign countries with the purpose of taking undue advantage of such treaties. Treaty shopping is a graphic expression used to describe the act of a resident of a third country taking advantage of a fiscal treaty between two Contracting States.
It was strenuously criticized the act of incorporation by FIIs under the Mauritian Act as a sham and a device actuated by improper motives. They contend that this Court should interdict such arrangements and, as if by waving a magic wand, bring about a situation where the incorporation becomes non est. For this they heavily rely on the judgment of the Constitution Bench of this Court in McDowell and Company Ltd. v. Commercial Tax Officer. Placing strong reliance on McDowell case it is argued that McDowell case has changed the concept of fiscal jurisprudence in this country and any tax planning, which is intended avoidance of tax and must be struck down by the Court. In the classic words of Lord Sumner in IRC v. Fishers Executors  held that
My Lords, the highest authorities have always recognized 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, and that he may legitimately claim the advantage of any expressed terms or any omissions that he can find in his favour in taxing Acts. In so doing, he neither conies under liability nor incurs blame.
Ranganath Mishra, J, (as he then was) says in McDowell case Tax planning may be legitimate provided it is within the framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.
However the court in this case, not comprehending in the lines of the majority judgment of the Mcdowells case held that the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether a provision should be construed liberally or principally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it. Thus the decision in the case cannot be read as laying down that every attempt at tax planning is illegitimate and must be ignored, or that every transaction or every action or inaction on the part of the taxpayer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act or arrangement which is perfectly permissible under law, which has the effect of reducing the tax burden of the assessee, must be looked upon with disfavour. The court must deal with what is tangible in an objective manner and cannot afford to chase a will-o-the-wisp.
Judges were unable to agree with the submission that an act which is otherwise valid in law can be treated as non-est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interests, as perceived by the respondents. In the result it was held that Delhi High Court erred on all counts in quashing the impugned circular. The judgment under appeal is set aside and it is held and declared that the circular No. 789 dated 13.4.2000 is valid and efficacious.
In the interest of all countries and to ensure that an undue tax burden is not cast on persons, who earn an income, by taxing them twice; once in the country of residence and again, in the country where the income is derived, DTAA provides sufficient precautions and regulations not only to avoid the hardship but also to guard against tax evasion as well as to facilitate tax recoveries.