The Supreme Court ruled that dividend income received from a foreign company is not liable for taxation when there is a tax treaty with the country the company is based in, which stipulates that dividend is to be taxed at source. The court has endorsed the finding that the provisions of the tax treaty will override the provisions of the ITA if they are at variance.
Treaty between India and Malaysia – Supreme Court of India decision on overriding effect of treaty provisions over domestic law
The Supreme Court of India delivered a ruling dated 20 February 2008 in the case of CIT v. Torquoise Investment and Finance Ltd. on whether the provisions of tax treaties signed by India take precedence over the provisions of Indian domestic tax law, i.e. Income Tax Act 1961 (ITA).
(a) Facts. The Taxpayer (i.e. Turquoise Investment & Finance Ltd.) is an Indian investment company. It filed its income tax return for the assessment year 1992-93 and claimed a refund on the basis of a deemed credit for tax withheld on the dividend that the taxpayer received from a Malaysian company.
The tax authority denied the tax credit and made an addition to the income. The Taxpayer filed an appeal before the Commissioner of Income Tax (Appeals), which ruled in favour of the Taxpayer. The tax authority then filed an appeal before the Income Tax Appellate Tribunal (ITAT).
The ITAT observed that under Art. XI of the India - Malayasia Tax Treaty (the Tax Treaty), dividend income could be taxed only in the contracting state where the income accrued. The ITAT therefore disposed of the tax authority's appeal, stating that the provisions of the Tax Treaty override the provisions of the ITA if they are at variance.
The tax authority filed a further appeal in the High Court of Madhya Pradesh, Indore Bench. The appeal was admitted on the following questions of law:
– Was the ITAT was justified in holding that dividend income earned by the taxpayer from the Malaysian company was not subject to tax in India under any provision of the ITA?
– In view of Sec. 5(1)(c) of the ITA, was the ITAT correct in finding that income from dividends, from a company outside of India, is not subject to tax under the ITA? (Note: Sec. 5(1)(c) provides that a person who is a resident in India shall be taxable on all income from any source even if it accrues to him outside India).
Addressing the first question, the High Court held that the ITAT was justified in holding that the dividend income derived by the Taxpayer from the company in Malaysia was not subject to tax in India under any of the provisions of the ITA.
Regarding the second question, the counsel for the Taxpayer conceded that in normal circumstances, tax would be due in India under Sec. 5(1)(c) of the ITA. However, the counsel maintained that as Art. XI of the Tax Treaty states that the tax is to be levied only in the country where the income accrued, the tax shall be payable only in Malaysia and not in India.
The High Court therefore held that the ITAT's order did not give rise to the question of whether income that accrued outside the country could be taxed in India under the provisions of Sec. 5(1)(c) of the ITA.
Finally, the tax authority appealed to the Supreme Court against this order of the High Court, for adjudication and ruling.
(b) Issue. The key issue before the Supreme Court was whether the dividend income earned by an Indian taxpayer from the Malaysian company could be subject to tax in India under any provision of the ITA if under the Tax Treaty the dividend income is taxable only in the state where it accrues.
(c) Decision. The Supreme Court noted the contentions of the tax authority and the Taxpayer and upheld the order of the High Court. The Supreme Court ruled that dividend income received from a foreign company is not liable for taxation when there is a tax treaty with the country the company is based in, which stipulates that dividend is to be taxed at source. The court has endorsed the finding that the provisions of the tax treaty will override the provisions of the ITA if they are at variance.