In the present age of cross-border transactions across the globe, the effect of taxation is one of the important considerations for any trade and investment decision in other countries. There exists a visible impact of one country’s domestic tax policies on the economy of another country and thus it has brought necessary tax reforms all over the world.
Where a taxpayer is a resident in one country and has a source of income situated in another country, it gives rise to possible double taxation. This arises from two basic rules that enable the country of residence as well as the country where the source of income exists to impose tax. These two rules are:
1. Source Rule: It says that income is to be taxed in the country in which it originates irrespective of the residential status of a taxpayer.
2. Residence Rule: It specifies that the power to tax should rest with the country in which the taxpayer resides.
Both rules can’t be applied simultaneously. So it is from this point of view that Double Taxation Avoidance Agreements (DTAAs) become very significant. Indian Income Tax Act, 1961 contains a special chapter IX which is devoted to the subject of Double Taxation Relief.
An individual who stays for 182 days or more in India is considered as resident person for Income Tax purpose in India. Others are treated as Non-resident. This in no way is related to citizenship. For companies, partnership firms and such other artificial persons; the place of their control & management is the criteria to determine residential status.
In India, a person is taxed as per his or her residential status. A resident person of India has to pay tax on the total income accrued/received across the globe. On the other hand, non-resident persons (NRIs) are chargeable to tax in respect of income accrued/arised/received in India.
This means income received/accrued/arised in India is taxable to all, even if he is non-resident of India. This rule is followed everywhere in the world.
For e.g. when any foreign player comes in India to play IPL cricket matches and earns money, then the income is arised in India; so it is taxable in India. This same foreign player is resident of his own country so he has to pay tax in that country as well. That means a single income is getting taxed in two different countries.
Considering this difficulty, countries across the globe enter into Double Taxation Avoidance Agreements with each other. The main aim of such agreements is to avoid double taxation and share the tax revenues between such two countries so that there can be an encouragement for mutual trade & investment. There are also examples that other additional non-tax benefits are achieved through such DTAAs.
For e.g. India has sacrificed its tax revenue to build its Naval base in some neighboring country or in some other case, India has forgone its tax revenue so that it can get automation technology from that country.
India has entered into DTAA with almost 90 countries. The power of entering into such an agreement is an inherent part of the sovereign power of the State. Since in India, such an agreement would have to be translated into an Act of Parliament, a procedure which would be cumbersome and time consuming; a special procedure was evolved by enacting section 90 in the Income Tax Act. But when there arises a situation which gives rise to conflict between the provisions of DTAA and parliament passed Income Tax Act, the provisions of DTAA would prevail over Income Tax Act even if terms of DTAA are inconsistent with the Income Tax Act. Thus, Double Taxation Avoidance Agreement (DTAA) > Income Tax Act; to the extent it is more beneficial to the taxpayer.
Sharing of tax revenue due to such DTAAs sometimes result in lower tax rates as well. But it is assumed that it supports to increase the tax revenue collection in spite of the loss in tax rates. Make a note that this is an assumption and proof of the same is difficult to provide.
Considering the loss arising from such system, Mr. Rajiv Dixit through his organization “Azadi Bachav Andolan” (Save Freedom Movement) had filed a PIL in Delhi High Court in the year 2000 and demanded to stop implementation of one of such agreements. Adv. Prashant Bhushan appeared for petitioners while Sr. Adv. Harish Salve appeared for the Government.
The point of dispute in the said case was provisions of DTAA between India and Mauritius. Petitioners had contended that no tax can be levied or collected except by the authority of law. The authority to levy tax or grant exemption therefrom vests absolutely in the parliament and no other body, howsoever high, can exercise such power. With respect to fiscal treaties/agreements, the contention is that they can’t be enforced in contravention of the provisions of the Income Tax Act unless parliament has made an enabling law in support. Petitioners also claimed that the said provisions of DTAA between India & Mauritius are being willfully misused by other countries across the world.
For e.g. If residents of USA want to invest in Indian stock markets they don’t directly invest. Rather they route this transaction through Mauritius. Means US organizations set up subsidiary companies in Mauritius and infuse the funds as Capital contribution or many a times as Loans. And these subsidiary companies trade in Indian stock markets, fooling India’s tax system because provisions of DTAA between India & Mauritius say that Indian government won’t charge tax on such income in India or charge it at lower rates. This has resulted into the fiscal loss for India.
The Delhi High Court upheld the argument of petitioners and quashed a particular circular issued by Income Tax Department. The Government appealed the high court’s order in the Supreme Court where the matter was heard by the constitutional bench of Justice B. N. Shrikrishna and Justice Ruma Pal.
The government of India argued that even if there is a fiscal loss due to such agreement, these funds had been invested in the Indian stock market in accordance with SEBI norms & regulations and that the Finance Minister of India had himself encouraged such Foreign Institutional Investments as a channel for promoting capital flow to India. This is a part of foreign exchange policy so honorable Supreme Court should not look into this matter. Although the Indian economic reforms since 1991 permitted transfer of foreign funds, the amount would have been much lower without the Indo-Mauritius tax treaty. Source of funds to Mauritius might be some other countries via loans or capital contribution and the same money has been invested in Indian stock markets but these two are altogether different transactions. There is no provision in the Indian Income Tax Act to consider these two transactions as same.
Against that, petitioners contended that these funds from USA can directly be invested in Indian stock markets. US organizations don’t need to take benefit of Indo-Mauritius agreement and that too when there exists no reason to hamper Indian tax revenue. The way such funds from USA are invested is nothing but an attempt for tax evasion by misleading Indian government. This is a case of misusing the tax laws.
Justice B. N. Shrikrishna in his judgment stated that “The taxpayer where he is in a position to carry through a transaction in two alternative ways, one of which result in liability to tax and other of which will not, is at liberty to choose the latter and to do so effectively in the absence of any specific tax avoidance provision.”
There are no disabling or disentitling conditions under Indo-Mauritius DTAA prohibiting the resident of a third nation from deriving benefits thereunder. If the residents of State C qualify for benefit under the treaty, can they be denied the benefit on some theoretical ground that treaty shopping is unethical and illegal? Supreme Court found no support for this proposition.
(Treaty shopping means a situation where a resident of a third country seeks to obtain the benefit of DTAA between two other countries by any possible way.)
Any transaction should be read as it is written on paper. It is to decide what the law is and apply it, not to make it. There is no need to find the conceived meaning behind such transaction. If funds are invested in India from Mauritius then even if it’s source is in USA, it has to be assumed that it has come from Mauritius only. There is no provision in the act to go & dig out the meaning behind such transactions.
The judgment of the case came in October 2003. Mr. Yashwant Sinha & Mr. Jaswant Singh were the finance ministers back then. Later in 2004, P. Chidambaram took the charge of Finance Ministry and he tried to curb such misappropriations of transactions at his level by incorporating some really good provisions in the Income Tax Act.
Obviously with each amendment in the Act, Indian stock markets experienced huge fall resulting a negative impact on exchange rates. Government of India after losing the Vodafone case in 2012 has made stricter norms in the Income Tax Act. As on today such treaty shopping is controlled in big way, at least for stock market transactions.
Treaty shopping has been misused not only by foreign countries but also by Indian taxpayers for tax evasion. Even today there is no 100% restriction on this issue.
An important principle which needs to be kept in mind in the interpretation of provisions of an international treaty, including one for double taxation relief is that treaties are negotiated and entered into at a political level and have several considerations at their bases. However there is a general awareness about such issues and transactions these days. Countries do put some or the other pressure on contracting partners who support tax evasion. Internal laws are being made stringent. It has some disadvantages but most notable thing is witnessing tremendous positive change in the Income Tax law in India.
Tags :Income Tax