4Why does double taxation occur Tax systems generally followedResidence based tax systemConnecting factor is “residence”Unlimited taxing rights due to “personal attachment” of personsSource based tax systemConnecting factor is “income”Limited taxing rights due to “economic attachment” of personsDouble taxation occurs in situations where the country of residence and the country of source seek to tax the same incomeAlso, certain countries tax world-wide income of their citizens, irrespective of their being residents of other states e.g. USADouble taxation is a situation in which two or more taxes may need to be paid for the same asset, financial transaction and/or income and arises due to overlap between different countries' tax laws and jurisdictions.Economic double taxation – Husband and wife, partnership and partners, company and shareholder
5Types of double taxation Economic double taxationSame economic transaction, item or income is taxed in two or more states during the same period but in the hands of different taxpayersTrust – income taxable in the hands of trust in one contracting state and in the hands of beneficiaries in the other contracting statePartnership – income taxable in the hands of partner in one contracting state and in the hands of partnership in the other contracting stateJuridical double taxationTwo or more states levy taxes on same entity or person on same income for identical periods eg., one contracting state taxes on resident basis and the other on source basisIs the result of a conflict between two tax systemsArises due to overlapping claims of tax jurisdictions on interrelated economic activitiesTax treaties prevent/mitigate juridical double taxationDouble taxation is a situation in which two or more taxes may need to be paid for the same asset, financial transaction and/or income and arises due to overlap between different countries' tax laws and jurisdictions.Economic double taxation – Husband and wife, partnership and partners, company and shareholder
6Remedy from double taxation in India Section 90Tax payer has the option to be taxed under the provisions of the tax treaty or the domestic tax laws, whichever are more beneficialCBDT Circular Specific provisions of the tax treaty override the general provisions of the domestic tax lawsIn other cases, domestic tax laws will applySection 91Relief from double taxation in countries with which India has no tax treatiesPerson resident in India is allowed credit of foreign taxes paid against amount of Indian taxesIndia – Delegated legislation – Section 90 of IT Act, Power to legislate in respect of tax treaties is conferred on parliament by virtue of entries 10 & 14 of LIST I of Schedule VII of the Constitution of India.[refer Maganbhai Ishwarbhai Patel v. Union of India AIR (1969) 783 (SC)]
7Types of treatiesComprehensive treaties – Deals with all possible sources of incomeLimited treaties – Deals with only certain sources of incomeDTAA between India and Pak is limited to air transport only
8Objectives of a tax treaty Elimination of double taxationPromotion of mutual economic relations, trade and investmentCertainty on nature of income and quantum of tax payable irrespective of tax laws of overseas stateEstablishing the right of a country to tax any income streamExchange of information to combat tax avoidance / tax evasion
9Steps in which a tax treaty comes into force Negotiation of a tax treatyDrafting of the articlesSigningRatificationNotificationComing into effectKey datesRatification - Formal confirmation by each contracting state, that the constitutional requirements for implementation of agreement are fulfilledEntry into force in India - Generally computed from the date of notification in the Official GazetteComing into effect - The period as specified in the treaty once the treaty is notifiedIndia - USDate of entry into force - December 18, 1990- India - April 1, 1991- USA - Jan 1, 1991India - NetherlandsDate of entry into force - January 21, 1989- India - April 1, 1989- Netherlands - Jan 1, 1989The above is in view of the fact that as per article 29, the convention shall enter into force on the 30th date after the latter of the dates on which the respective Govt have notified each other. Since the convention came into force on Jan 21, 1989, the latter notification would be of Dec 22, Accordingly, reading Article 29 now (which is different from other conventions) it is clear that considering Dec 22, 1988 as the date of the latter notifications, the entry into force as discussed above is correct.India - SwissDate of entry into force - Dec 29, 1994- India - April 1, 1995- Swiss - Jan 1, 1995
11Why Model Conventions are required The rationale of the preparation of bilateral tax conventions was cogently expressed by the Fiscal Committee of the League of Nations in the following terms:"The existence of model draft treaties...has proved of real use...in helping to solve many of the technical difficulties which arise in [the negotiation of tax treaties]. This procedure has the dual merit that, on the one hand, in so far as the model constitutes the basis of bilateral agreements, it creates automatically a uniformity of practice and legislation, while, on the other hand, inasmuch as it may be modified in any bilateral agreement reached, it is sufficiently elastic to be adapted to the different conditions obtaining in different countries or pairs of countries”
12Treaty models and India’s tax treaties Treaty Models – Operation and BenefitsOECD ModelUN ModelUS ModelIndia’s tax treaties
13How do Model Tax Treaties work Model Treaties contain classification and assignment rules (collectively known as distributive rules)For income subject to tax under domestic tax laws of both countriesDistributive rules contain more than 14 categories of income to cover entire tax baseStandard Articles; May be amended by negotiationModel Treaties distinguish income under each Article and specify the State which has the right to taxEither Source State or Residence State get exclusive or limited right to taxIf states share taxing rights they share cost of eliminating double taxationModel Treaties allocate taxing rights but don’t make tax rulesThe “assignment rules” allocate either a exclusive or a limited right to the two countries, using one or more of the following distributive principles on different income sources:The exclusive right to tax is with the country of source of the objectThe source country reserves the right to limited or shared taxation of the objectThe source country may tax fully but does not have exclusive taxing rightsThe exclusive right to tax is with the country of residence of the subject
14Benefits of Model Tax Treaties Facilitate International Trade and investmentProvide internationally accepted format for drafting and negotiation of bilateral agreementsProvide for a negotiated division of taxing rights over foreign source incomeProvide certainty over source rulesAssure stability for international investorsEliminate discriminatory taxation of foreign nationals and nonresidentsPrevent tax evasionAvoid excessive taxation in source stateAssist global tax planningFacilitate International Trade and investment by eliminating tax impediments under the domestic tax laws of countries on cross-border income flows.
15What is OECD? Organisation for Economic Cooperation & Development The OECD is a unique forum where the governments of 32 democracies work together to address the economic, social and environmental challenges of globalisation.The OECD is also at the forefront of efforts to understand and to help governments to respond to the new developments and concerns, such as corporate governance, the information economy and the challenges of an ageing population.The Organization provides a setting where governments can compare policy experiences, seek answers to common problems, identify good practice and work to co-ordinate domestic and international policies.
16OECD modelOrganisation for Economic Co-operation and Development (OECD)Established in 1961 with developed countries as its membersEssentially a model treaty between two developed nations with comparable tax systems and tax objectivesAdvocates residence principleLays emphasis on the right of state of residence to taxIndia not a OECD memberCurrently has been granted the “Observer” status2003 update
17OECD Member countries S. NO Country Name 1 Austria 10 Netherlands 2 Belgium11Norway3Denmark12Portugal4France13Sweden5Greece14Switzerland6Iceland15Turkey7Ireland16United Kingdom8Italy17Germany, Federal Republic of (1955)9Luxembourg18Spain
18OECD Member countries (Cont.) S. NOCountry Name19Canada26Czech Republic20United States27Hungary21Japan28Poland22Finland29Republic of Korea23Australia30Slovakia24New Zealand31Chile25Mexico32Israel
19OECD Significance as regards India 2001: Member of Technical Advisory Group on E-commerce Tax Treaty Characterization IssuesJuly 2006: Granted ‘Observer Status’May 2007: Offered enhanced engagement with a view to possible membershipJuly 2008: India’s positions included in the non-member country positions’ section of the 2008 UpdateExtensive reliance placed by Indian Courts/Tribunals while interpreting tax treaties
20India’s position on OECD MC & commentary - PE Deviations on several aspects in definition and on commentary, some key aspects:OECD positionIndia’s positionFixed Place PEStated examples (branch, factory, office, etc) - PE only if business of the enterprise is carried on through itStated examples in all cases will necessarily be regarded as PE2003 Update provides guidance on -existence of geographic and commercial coherenceIllustrations included by examples - no coherence, no PE(a) PE possible even where no geographical/commercial coherenceExamples could also be regarded as PEMere leasing of tangible/intangible property without maintenance - no PE for lessorTangible/intangible properties by themselves could constitute PE in certain circumstances
21India’s position on OECD MC & commentary - PE OECD positionIndia’s positionAgency PEMere attending or participating in the negotiations by itself not sufficient to conclude that ‘authority to conclude contracts’ is exercisedIn certain circumstances, mere participation is sufficient for the conclusion.Authority to negotiate essential elements (not necessarily all) of a contract is sufficientElectronic commerceOECD Commentary (2003 update) clarifies PEin relation to electronic commerce operations -(a) Website cannot create a PE(b) No ‘place of business’ merely by hosting awebsite on a particular server situated at aparticular locationIn certain circumstances, website -can create a PEmay be considered as having a ‘place of business’
22India’s position on OECD MC and commentary - PE OECD positionIndia’s positionServices PENo specific rule on PE creation on account of furnishing of services; 2008 Update has provided guidance for including this concept, broadly:(a) Services performed outside the State – notaxation by source country(b) Requirement of minimum level of presencein Source State(c) Taxation on gross basis not appropriateMost of India’s tax treaties contain this clause. India’s position:(a) Taxation rights even when servicesare furnished from outside that State(b) Presence not relevant(c) Taxation on gross basis is alsoappropriate and should be providedas an alternative
23Implication of India’s position on OECD MC and commentary Guide to taxpayers on likely approach of Indian tax authoritiesIndia’s tax treaty policy in future tax treaty negotiations/renegotiationsCould it be regarded as an aid for interpreting tax treaties by Courts in India?Tax treaties entered into prior to July 2008Tax treaties entered post July 2008Ambiguity/uncertainty in some of India’s positions - use of ‘in certain circumstances’ while expressing reservationsSignificant departure from OECD’s position on some key aspectsCause of concern for foreign companies doing business in India on the extent of deviations they may encounter in application of a tax treaty
24UN modelTax treaties between countries with unequal economic status - Developed and lesser developed countries, or between developing countriesDrafted in 1980, designed to encourage flow of investments from the developed to developing countriesIs a compromise between source principle and residence principleGives more weightage to source principle, i.e., income should be taxed where it arises
25Differences between OECD and UN ArticleOECD ModelUN ModelAssembly & Supervision PEOECD model does not cover assembly and supervision activities and the threshold for the purpose of calculating building site or construction or installation PE is twelve months . Under OECD model convention, the issue of planning or supervision activites has to be resolved in light of Article 5(1)UN model expressly covers assembly and supervision activities and the threshold for the purpose of calculating building site or construction or installation PE is 6 monthsService PEOECD model does not have a specific provision dealing with "Service PE“The UN model incorporates sub-paragraph (b) with a view to allow State source state to tax management and consultancy services provided therein. The UN model does not contain an article for FTS, unlike most Indian treatiesPE on account of delivery of goodsOECD excludes from the purview of PE, facilities solely for the purpose of delivery in source State of goods or merchandise belonging to the enterpriseArticle 5(4)(a) and (b) of the UN Model includes in the purview of PE, facilities solely for the purpose of delivery in Source State of goods or merchandise belonging to the enterprisePE on account of maintenance of stockArticle 5(5)(b) in relation to habitually maintaining stock of goods or merchandise in the source state by a dependent agent is absent in the OECD modelArticle 5(5)(b) in relation to habitually maintaining stock of goods or merchandise in the source state by a dependent agent is present in the UN model
26Differences between OECD and UN ArticleOECD ModelUN ModelConditions for examining agent’s dependenceThe OECD model does not expressly provide for exclusivity of relationship with a principal as test of agent's dependence and the OECD model does not expressly provide for arm's length dealings between an agent and its principal to prove an agent's independenceThe UN model expressly provide for exclusivity of relationship with a principal as test of agent's dependence and also expressly provides for arm's length dealings between an agent and its principal to prove an agent's independenceAttribution of ProfitsArticle 7(1) of the OECD model prevents the applicability of the Force of Attraction RuleUN model provides for the applicability of the Force of Attraction RuleArticle 7(5) of the OECD model reads that no profits shall be attributable to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterpriseUnlike the OECD model, UN Model does not provide that no profits shall be attributable to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterpriseAssociated EnterpriseOECD Model does not provide for non-adjustment of the profits already taxed in the other contracting state where one of the associated enterprises is liable to penalty in a final ruling with respect of fraud, gross negligence or willful defaultArticle 9(3) of the UN Model provides for non-adjustment of the profits already taxed in the other contracting state where one of the associated enterprises is liable to penalty in a final ruling with respect of fraud, gross negligence or willful default
27Differences between OECD and UN ArticleOECD ModelUN ModelDividend, Interest and RoyaltiesOECD Model specifically mentions the rates for withholding taxUN Model does not mention any rates for withholding tax and leaves the percentages to be established through bilateral negotiations. In relation to royalties the UN definition also includes income from the use of industrial, commercial or scientific equipment which in OECD is covered by Article 7Capital GainsOECD Model does not expressly refer to alienation of interest in a partnership, trust or estateUN Model expressly refers to alienation of interest in a partnership, trust or estateIndependent Personal ServicesArticle 14 was deleted from the OECD model on 29 April The effect of deletion of Article 14 is that income derived from professional services etc is now dealt with under Article 7UN Model has Article 14 specifically dealing with Independent Personal ServicesOther IncomeUnder the OECD Model the taxation right of this income is not explicitly dealt with in the earlier articles of the model would be allocated to the state of residence of the recipientUN Model grants a taxation right to the source state for income not explicitly dealt with in the earlier articles of the model and originating from the source state
28US ModelSeeks to align OECD model articles with US tax laws and policiesOnly model which USA uses as a basis of negotiating treaties with its other treaty partnersSignificant differences as compared to OECD MCUnlike OECD MC, US MC covers "citizenship" as one of the criteria for determining residency. As per OECD MC for determining residency of a person other than an individual who happens to be a resident of both the Contracting States, place of effective management is the decisive criterion. However US MC specifically provides that in case of dual residency a company shall be deemed to be a resident of the Contracting State where it is created or organised.In PE context US MC contains an express rule on exploratory activities
29India’s tax treatiesIndia’s tax treaties based on a combination of the OECD MC and the UN MCEmphasis laid more on “source” country taxation which is consistent with the objective and rationale of the UN MCCertain provisions are unique to India’s tax treaties and are not based on any MCBroader “Service PE” rule as compared to UN MCService PE threshold of six months in UN MC and 90 days in India-US; Services rendered to related enterprise can also trigger PE in India’s tax treaties“Agency rule” extended to cover a dependent agent “securing orders”UN Model covers only “concluding contracts”
31Vienna Convention on the Law of Treaties Vienna Conventions codifies existing norms of customary international law with some necessary gap-filling and clarificationsApplies to all international treaties including tax treatiesThe Vienna Convention on the Law of Treaties (VCLT) was codified in 1969 and entered into force in 1980108 states have ratified the VCLT (May 2007)The scope of the Convention is limitedGiven due weightage by non signatoriesApplicable to both past and future treatiesGrowing number of decisions in international courts refer to the rules in the Vienna ConventionIt applies only to treaties concluded between states, so it does not cover agreements between states and international organizations or between international organizations themselves .Nor does it apply to agreements not in written form.
32Articles of VCLTArticle 26 of VCLT – Every treaty in force is binding upon the parties to it and must be performed by them in good faithArticle 31(1) of VCLT - A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purposeArticle 31(2) of VCLT - Context is defined to include texts and subsequent agreements/instruments related to the treatyPublic international law concerns the structure and conduct of states and international organizations.We have already discussed that treaties are part of PIL. Now, where do we find the principles of interpretation of PLC. Vienna convention on law of treaties is a document which is relevant.VCLT itself states that it not simply declaratory of general international law and in part it involves progressive development of the law. Notes that principles of good faith and pacta sunt servanda are universally recognisedPart IV of constitution of India – directive principles of state policy states that state shall endeavour to foster respect for international law and treaty obligations.Better view is that interpretation principles are customary in nature and hence would be applicable even to non-signatoriesGood faith is not applicable for domestic law
33Articles of VCLTArticle 31(4) of VCLT – Special meaning only if specifically intended by partiesArticle 32 of VCLT - Supplementary means to be used only to confirm the meaningArticle 33 of VCLT - Treaties authenticated in two or more languagesArticle 34 of the VCLT – A treaty does not create either obligations or rights for a third state without its consentThus significant limitation on use of external aids such as commentariesTreaties authenticated in two languages could be problem. E.g. french and german text if says otherwise. No Indian judgments yet on this issue
34Tax treaty vs. Domestic law Distinguishing featuresTax treatyDomestic lawAgreement between sovereign nationsAct of LegislatureRelief from double taxCharge of taxSharing of tax revenuesEarning of tax revenuesNegotiation between statesNo negotiationNo frequent amendmentsFrequent amendmentsPublic International LawNational LegislationIn national context even supreme court ratio settled for decades together can be nullified by parliament by retrospective legislationCharge of tax – strictly interpretedTax and equity strangersPlaing meaning – harsh consequencesHence, when investigating the tax implications of a given fact in connection with two States:First, an internal rule must impose taxationThen, it will have to be determined if that tax claim is limited by a DTC
35Tax Treaty Interpretation Rules Whether treaty can impose tax or provide higher burden than under domestic law :No. Treaties only have a negative effect: “a tax treaty neither generates a tax claim that does not otherwise exist under domestic law nor expands the scope or alters the type of an existing claim” (Vogel)Treaties aim at limiting the Contracting States’ tax claims based on their internal legislationHence, when investigating the tax implications of a given fact in connection with two States:First, an internal rule must impose taxationThen, it will have to be determined if that tax claim is negatived or limited by a treatyIssue arising from dual nature of treaties is whether they impose tax. Contrary views on this issue although it can be said that generally no unless specific domestic legislation to the contraryConfirmed by the position in most of countries including USA
37Aids to interpretation Reference to domestic law under Article 3(2)OECD/UN model conventions and commentaryProtocolsTechnical memorandumParallel treatiesIndian Judicial precedentsInternational case lawsCanadian judgment where Canada company paid guarantee fees to German Bank. Whether it was interest as defined under Candian law or was business profits under DTAA. Canadian definition came later. Court held in favour of static interpretation. However, law was changed to specifically provide that ambulatory definition would be applicable.In India, we also have section 90(3) where Central Government has been empowered to provide definition
38Domestic law as Aids to interpretation Article 3(2) of the India – UK Tax Treaty“As regards the application of this Convention by a Contracting State any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that Contracting State relating to the taxes which are the subject of this Convention.”Meaning under “tax law” to be preferred over meaning under other lawsCanadian judgment where Canada company paid guarantee fees to German Bank. Whether it was interest as defined under Candian law or was business profits under DTAA. Canadian definition came later. Court held in favour of static interpretation. However, law was changed to specifically provide that ambulatory definition would be applicable.In India, we also have section 90(3) where Central Government has been empowered to provide definition
39Domestic law as Aids to interpretation Static v. ambulatory meaning of the termsAmbulatory interpretation - ITO v Leonhardt Andra Und Partner 21 ITD 607 (Cal Trib)Static interpretation - Change in incorporating statute not to have effect on incorporated statute, artificial definition not applicable – Siemens Aktiengesellschaft v ITO 22 ITD 87 (Bom Trib.)Committee of Fiscal Affairs has come down firmly in favour of the ambulatory approachCommentary on Article 3 of OECD Model amended to make it clear that references to domestic law are intended to refer to such law as it changes from time to timeAmbulatory meaning: interpretation of terms should use the current meaning under the domestic law of the state applying the Treaty.Static meaning: The same meaning applicable when the Treaty was concluded.Give reference to Boulez case for which country’s law should apply. A german resident music director entered into contract with US company to grant rights to record his musical performances and sell the recordings. Royalty was payable based on sale of records. Germany levied tax on royalty income while US said it is independent personal service income and hence taxable in USA. Thus, problem in adopting different definitions could result in double taxation instead of avoiding itA view is that source country’s law should apply. However, not a appropriate view since residence country would not accept this.
40OECD Commentary What the OECD Commentary says about its significance “Member countries…. should conform to this Model Convention as interpreted by the Commentaries thereon … and their tax authorities should follow these Commentaries… when applying and interpreting the provisions of their bilateral tax conventions that are based on the Model Convention.”Para 3 to ‘Introduction to OECD Commentary“ the worldwide recognition of the provisions of the Model Convention and their incorporation into a majority of bilateral conventions have helped make the Commentaries on the provisions of the Model Convention a widely-accepted guide to the interpretation and application of the provisions of existing bilateral conventions. This has facilitated the interpretation and the enforcement of these bilateral conventions along common lines.”Para 15 to ‘Introduction to OECD Commentary’Para 29 – Although commentaries are not designed to be annexed in any manner to the conventions signed by member countries, which unlike the model are legally binding legal instruments, they can nevertheless be of great assistance in the application and interpretation of the conventions.
41UN Commentary What does UN Commentary say about its significance? “ Like all model conventions, the United Nations Model Convention is not enforceable. Its provisions are not binding and furthermore should not be construed as formal recommendations of the United Nations… If the negotiating parties decide to use in a treaty wording suggested in the United Nations Model Convention, it is to be presumed that they would also expect to derive assistance in the interpretation of that wording from the relevant Commentary. The Commentaries, which may prove to be very useful in the implementation of a treaty concluded by the negotiating parties and in the settlement of any dispute relating thereto, are not intended to be annexed to such a treaty, the text of which in itself would constitute the legally binding agreement.”Para 35 & 36 of Introduction to UN Commentary
42Reliance on MC Commentary – Indian perspective Approving reference to OECD/UN commentaryOECD/UN MC or Commentary have generally received ‘due respect’The OECD / UN Model or Commentary play a “key role” in interpreting tax treatiesThey constitute “international tax language”The meanings assigned by OECD / UN Model or Commentary should be given “due weightage”Courts have frequently ‘referred’ to the OECD/UN MC or Commentaryto ‘reinforce’ / ’confirm’ its conclusion,to draw support for its conclusion andin certain cases, even ‘followed’ the MC or CommentaryReinforce/confirm conclusion – Graphite – scope of professional services, general meaning as given by Indian courts as well as OECD commentarySupreme Court – OECD in its commentary on Article 4 – residence has stated that it does not deal with the condition of residence as contained in domestic law. Conduit company report also says that in the absence of specific provisions, conduit company would be entitled to claim benefits.Vijay Ship Breaking – interest along with purchase consideration paid through LC whether interest part of purchase consideration and whether paid. To check how OECD commentary followedUnion of India v Azadi Bachav Andolan 132 Taxman 373 (SC); Graphite India Ltd. v. DCIT 78 TTJ 418 (Cal.); CIT v Vijay Ship Breaking Corpn. 261 ITR 113 (Guj); CIT v Vishakapatnam Port Trust 144 ITR 146 (AP); DCIT v ITC 85 ITD 162 (Cal.)
43Reliance on MC Commentary – Indian perspective Disapproving reference to OECD/UN commentaryP. No. 28 of ITR AAR “refused” to follow the OECD Commentary observing that it is “contrary to the well-established principle of statutory interpretation”CIT v Vr.S.R.M.Firm and Others 208 ITR 400 (Mad) - Observations may give an impression that reliance upon the OECD Commentary is “inappropriate” and “unjustified”Indian Perspective - “disapproving” reference to CommentaryP. No. 28 of ITR AAR “refused” to follow the OECD Commentary observing that it is “contrary to the well-established principle of statutory interpretation”CIT v Vr.S.R.M.Firm and Others 208 ITR 400 (Mad) - Observations may give an impression that reliance upon the OECD Commentary is “inappropriate” and “unjustified”The issue was interpretation of definition of PE. Whether para 5(2) adds to the primary meaning of the PE given in 5(1) or it expands the scope of 5(1). Court went by well-recognised statutory rule rather than by OECD commentaryUSCO to provide executive personnel for development of management, finance and business operations of Indian company for which it was paid at quarterly intervals. Whether rendering of services would constitute PE under 5(2).Held – yes. Scope of 5(2) does not depend upon 5(1)208/400 – although one of the reason for not relying on commentary was the difference in wording if the MC and DTAA, however, very strong observations seem to indicate that reference to commentary is unjustified
44Reliance on MC Commentary – Indian perspective Reliance placed by the Indian Revenue on the OECD CommentaryIndian Revenue has itself placed reliance on the OECD Commentary when it found the Commentary to support its contentionsBritish Airways Plc. vs. DCIT 73 TTJ 519 (Del)CIT vs. Vijay Ship Breaking 261 ITR Gujarat High Court “followed” the OECD Commentary while deciding against the taxpayerConclusionBoth tax payers/tax authorities have been liberally referring to the OECD/UN MC and Commentary to support their respective claimsCourts have generally accepted them as an important ‘aid for interpretation’ of tax treaties
45Aids to interpretation - OECD/UN Commentary Relevance of the “revised” OECD / UN Commentary in construing a treaty signed “prior” to the revisionP No 30 of ITR AAR held that a “useful reference” could be made to the revised OECD Commentary and that the tax treatment “has to conform” to the revised Commentary “to accommodate the emerging developments”Many amendments are intended to simply clarify, not change, the meaning of the articles or the commentaries, and such a contrario interpretation would clearly be wrong in those cases – OECD CommentaryIndian company processed data regarding utilisation of credit card through CPU maintained abroadGeneral remarks about OECD commentary being clarificatory nature. Substantive changes as given in PE commentary on limit of 6 months36. Whilst the Committee considers that changes to the Commentaries should be relevant in interpreting and applying conventions concluded before the adoption of these changes, it disagrees with any form of a contrario interpretation that would necessarily infer from a change to an Article of the Model Convention or to the Commentaries that the previous wording resulted in consequences different from those of the modified wording. Many amendments are intended to simply clarify, not change, the meaning of the Articles or the Commentaries, and such a contrario interpretations would clearly be wrong in those cases.Authority to OECD to practically change the domestic law of India
46Aids to interpretation- Parallel treaty/protocol Philip Baker in his treatise ‘Double Taxation Convention’ comments as follows:“There is no reason why parallel treaties should not be referred to, but their value as aids to interpretation will generally be low”Reliance placed by Supreme Court on India-US treaty (‘Limitation of Benefit Clause’) while opining on treaty shoppingIndian judgments where reliance placed on definition in a parallel treaty or its protocolRaymond Ltd. v DCIT 80 TTJ 120 (Mum)C.E.S.C. v DCIT 80 TTJ 806 (Kol)(TM)Parallel treaty can be used in either way.Because something is specifically provided in one treaty, it can be said that in other treaty this is not intended to be meant in the absence of similar expression.The other aspect is that just because something is expressly provided in one treaty is implicitly present in other treaty. Vijay Ship Breaking. Differences in express wording do not necessarily imply that substantive differences are intended.Influence of one treaty on another does not depend upon the order in which treaty comes into force but the order in which they are signed.
47Unilateral material/Other Aids to interpretation Technical memorandum prepared by the US Treasury are often referred in the US as an aid to interpretation“Common interpretation – Where a treaty is held to have a particular meaning in one state, it is desirable that it has the same meaning in the other state” (Baker)Relevance of treaty negotiation materialsRelevance of foreign judgmentsNot legally binding although useful reference for common interpretationTrend in India – Even for typical domestic law interpretation issuesreference is made to parallel treaties and foreign judgmentsIn practice, it is not likely that a court will say that foreign judgment cannot be cited.If the provisions are materially different, judgment may not be applicable. However, if the provisions are pari materia then judgment cannot be just brushed aside but it can be distinguished. Thus, it has persuasive value.Even supreme court has done the same thing its judgmentThe basic principle of OECD Commentary being international tax language was first referred to by AP High Court from Australian judgmentInterpretative documents can bind administrative authorities of respective countries but not revenue authorities/courts of other countryUseful reference for interpretation although not legally bindingShift to purposive interpretation
48India-Mauritius Tax Treaty - Validity Supreme Court of India Ruling in the case of Union of India vs Azadi Bachao AndolanFactsThe CBDT, in connection with companies seeking to avail the tax benefits under the India‑Mauritius Tax Treaty, had issued Circular No 789, wherein it was clarified that the issue of a tax residency certificate by Mauritius tax authorities was sufficient evidence of residence and beneficial ownership and hence the treaty benefits could not be denied. The validity of this circular was challenged in the Supreme Court in the case of Union of India vs Azadi Bachao Aandolan.DecisionThe Supreme Court laid out certain important principles and held as follows:Every country seeks to tax the income generated within its territory on the basis of one or more connecting factors such as location of the source, residence of the taxable entity, maintenance of PE, etc. The power to enter into the Treaty is an inherent part of the sovereign power of the state. The Act of Parliament has been translated by enacting applicable provisions in the local tax legislation, permitting non-resident to avail Tax Treaty benefits, if these were more beneficial.
49India-Mauritius Tax Treaty - Validity Supreme Court of India Ruling in the case of Union of India vs Azadi Bachao Andolan (cont’d)DecisionCircular No 789 is consistent with the provisions of section 90 of the Act as section 90 is specifically intended to enable and empower the Central Government to issue notifications for implementation of tax treaties and hence the circular in not unfounded.The Supreme Court further observed that if the national of a third country should be precluded from the benefits of the treaty, suitable limitation should have been incorporated in the Treaty. Hence, residents of the third contracting states cannot be denied the benefits on the grounds that treaty shopping is unethical or illegal. The Supreme Court held that courts have to see what the law is and apply the same, rather than making the law.The Supreme Court concluded that interpretation of treaties is not the same as that of statutory legislation. Tax Treaties are negotiated and entered into at a political level and have several considerations as their bases. In developing countries, treaty shopping works as a tax incentive to attract scarce foreign capital or technology. The concept of granting tax concessions is similar to tax incentives granted by developing nations such as tax holidays, grants, etc.
50India-Mauritius Tax Treaty - Validity Supreme Court of India Ruling in the case of Union of India vs Azadi Bachao Andolan (cont’d)DecisionThe Supreme Court held that an Act which is valid in law cannot be treated as illegal and prohibited merely on the grounds that there is some underlying motive, which would result in economic detriment to the national interest.In summary, on the basis of the above ruling, in the absence of a limitation of benefits clause contained in the India‑Mauritius Tax Treaty, treaty shopping is not illegal. The Supreme Court has also upheld Circular No 789 issued by the CBDT, which clearly states that a tax residency certificate issued by Mauritius tax authorities was sufficient evidence of residence as well as beneficial ownership and accordingly, the provisions of the India‑Mauritius Tax Treaty can be applied. Further, Tax Treaties can be entered into for other reasons besides tax reason such as for attracting scarce foreign capital
52Articles of a TreatyThe Articles of a Convention can be divided into the following six groups for the purpose of analysisScope provisions -- These provisions determine the persons, taxes and time period covered by the Treaty (personal scope, taxes covered, entry into force, termination)Definition provisions -- These include Article 3 (General Definitions), 4 (Residence) and 5 (Permanent Establishment) as well as definition of some of the substantive provisions of the TreatySubstantive provisions -- Articles which apply to particular categories of income and allocate tax jurisdictions between contracting statesProvisions of elimination of double taxation -- Includes Mutual AgreementAnti-avoidance provisions - Associated enterprise, Exchange of information, Limitation of benefitsMiscellaneous provisions -- Non-discrimination, Diplomats, etc
53Articles of a Treaty SCOPE PROVISIONS ANTI-AVOIDANCE 1. Article 1 - Personal Scope2. Article 2 - Taxes covered3. Article 29 - Entry into force4. Article 30 - TerminationANTI-AVOIDANCE1. Art 9 - Associated Enterprise2. Art 26 - Exch of InfoELIMINATION OF DOUBLETAXATION1. Article 23 - Elimination of doubletaxation2. Article 25 - Mutual AgreementDEFINITION PROVISIONS1. Article 3 - General definitions2. Article 4 - Residence3. Article 5 - PermanentEstablishmentSUBSTANTIVE PROVISIONS1. Article 6 - Immovable property2. Article 7 - Business Profits3. Article 8 - Shipping, etc4. Article 10 - Dividends5. Article 11 - Interest6. Article 12 - Royalties & FTS7. Article 13 - Capital gains8. Article 14 - Independent Personal Services9. Article 15 - Dependent Personal Services10. Article 16 - Directors11. Article 17 - Artistes & Sports persons12. Article 18 - Pensions13. Article 19 - Government service14. Article 20 - Students15. Article 21 - Other income16. Article 22 - CapitalMISCELLANEOUS PROVISIONS1. Article 24 - Non-discrimination2. Article 27 - Diplomats3. Article 28 - Territorial Extension