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TAX TREATIES - International scenario and India relevance. Amarpal S

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1 TAX TREATIES - International scenario and India relevance. Amarpal S
TAX TREATIES - International scenario and India relevance Amarpal S. Chadha

2 Overview Introduction Treaty models and India’s Tax Treaties
Aids to Interpretation Interpretation of treaties Operation of treaties

3 Introduction

4 Why does double taxation occur
Tax systems generally followed Residence based tax system Connecting factor is “residence” Unlimited taxing rights due to “personal attachment” of persons Source based tax system Connecting factor is “income” Limited taxing rights due to “economic attachment” of persons Double taxation occurs in situations where the country of residence and the country of source seek to tax the same income Also, certain countries tax world-wide income of their citizens, irrespective of their being residents of other states e.g. USA Double 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

5 Types of double taxation
Economic double taxation Same economic transaction, item or income is taxed in two or more states during the same period but in the hands of different taxpayers Trust – income taxable in the hands of trust in one contracting state and in the hands of beneficiaries in the other contracting state Partnership – income taxable in the hands of partner in one contracting state and in the hands of partnership in the other contracting state Juridical double taxation Two 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 basis Is the result of a conflict between two tax systems Arises due to overlapping claims of tax jurisdictions on interrelated economic activities Tax treaties prevent/mitigate juridical double taxation Double 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

6 Remedy from double taxation in India
Section 90 Tax payer has the option to be taxed under the provisions of the tax treaty or the domestic tax laws, whichever are more beneficial CBDT Circular Specific provisions of the tax treaty override the general provisions of the domestic tax laws In other cases, domestic tax laws will apply Section 91 Relief from double taxation in countries with which India has no tax treaties Person resident in India is allowed credit of foreign taxes paid against amount of Indian taxes India – 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)]

7 Types of treaties Comprehensive treaties – Deals with all possible sources of income Limited treaties – Deals with only certain sources of income DTAA between India and Pak is limited to air transport only

8 Objectives of a tax treaty
Elimination of double taxation Promotion of mutual economic relations, trade and investment Certainty on nature of income and quantum of tax payable irrespective of tax laws of overseas state Establishing the right of a country to tax any income stream Exchange of information to combat tax avoidance / tax evasion

9 Steps in which a tax treaty comes into force
Negotiation of a tax treaty Drafting of the articles Signing Ratification Notification Coming into effect Key dates Ratification - Formal confirmation by each contracting state, that the constitutional requirements for implementation of agreement are fulfilled Entry into force in India - Generally computed from the date of notification in the Official Gazette Coming into effect - The period as specified in the treaty once the treaty is notified India - US Date of entry into force - December 18, 1990 - India - April 1, 1991 - USA - Jan 1, 1991 India - Netherlands Date of entry into force - January 21, 1989 - India - April 1, 1989 - Netherlands - Jan 1, 1989 The 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 - Swiss Date of entry into force - Dec 29, 1994 - India - April 1, 1995 - Swiss - Jan 1, 1995

10 Treaty models and India’s tax treaties

11 Why 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”

12 Treaty models and India’s tax treaties
Treaty Models – Operation and Benefits OECD Model UN Model US Model India’s tax treaties

13 How 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 countries Distributive rules contain more than 14 categories of income to cover entire tax base Standard Articles; May be amended by negotiation Model Treaties distinguish income under each Article and specify the State which has the right to tax Either Source State or Residence State get exclusive or limited right to tax If states share taxing rights they share cost of eliminating double taxation Model Treaties allocate taxing rights but don’t make tax rules The “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 object The source country reserves the right to limited or shared taxation of the object The source country may tax fully but does not have exclusive taxing rights The exclusive right to tax is with the country of residence of the subject

14 Benefits of Model Tax Treaties
Facilitate International Trade and investment Provide internationally accepted format for drafting and negotiation of bilateral agreements Provide for a negotiated division of taxing rights over foreign source income Provide certainty over source rules Assure stability for international investors Eliminate discriminatory taxation of foreign nationals and nonresidents Prevent tax evasion Avoid excessive taxation in source state Assist global tax planning Facilitate International Trade and investment by eliminating tax impediments under the domestic tax laws of countries on cross-border income flows.

15 What 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.

16 OECD model Organisation for Economic Co-operation and Development (OECD) Established in 1961 with developed countries as its members Essentially a model treaty between two developed nations with comparable tax systems and tax objectives Advocates residence principle Lays emphasis on the right of state of residence to tax India not a OECD member Currently has been granted the “Observer” status 2003 update

17 OECD Member countries S. NO Country Name 1 Austria 10 Netherlands 2
Belgium 11 Norway 3 Denmark 12 Portugal 4 France 13 Sweden 5 Greece 14 Switzerland 6 Iceland 15 Turkey 7 Ireland 16 United Kingdom 8 Italy 17 Germany, Federal Republic of (1955) 9 Luxembourg 18 Spain

18 OECD Member countries (Cont.)
S. NO Country Name 19 Canada 26 Czech Republic 20 United States 27 Hungary 21 Japan 28 Poland 22 Finland 29 Republic of Korea 23 Australia 30 Slovakia 24 New Zealand 31 Chile 25 Mexico 32 Israel

19 OECD Significance as regards India
2001: Member of Technical Advisory Group on E-commerce Tax Treaty Characterization Issues July 2006: Granted ‘Observer Status’ May 2007: Offered enhanced engagement with a view to possible membership July 2008: India’s positions included in the non-member country positions’ section of the 2008 Update Extensive reliance placed by Indian Courts/Tribunals while interpreting tax treaties

20 India’s position on OECD MC & commentary - PE
Deviations on several aspects in definition and on commentary, some key aspects: OECD position India’s position Fixed Place PE Stated examples (branch, factory, office, etc) - PE only if business of the enterprise is carried on through it Stated examples in all cases will necessarily be regarded as PE 2003 Update provides guidance on - existence of geographic and commercial coherence Illustrations included by examples - no coherence, no PE (a) PE possible even where no geographical/commercial coherence Examples could also be regarded as PE Mere leasing of tangible/intangible property without maintenance - no PE for lessor Tangible/intangible properties by themselves could constitute PE in certain circumstances

21 India’s position on OECD MC & commentary - PE
OECD position India’s position Agency PE Mere attending or participating in the negotiations by itself not sufficient to conclude that ‘authority to conclude contracts’ is exercised In certain circumstances, mere participation is sufficient for the conclusion. Authority to negotiate essential elements (not necessarily all) of a contract is sufficient Electronic commerce OECD Commentary (2003 update) clarifies PE in relation to electronic commerce operations - (a) Website cannot create a PE (b) No ‘place of business’ merely by hosting a website on a particular server situated at a particular location In certain circumstances, website - can create a PE may be considered as having a ‘place of business’

22 India’s position on OECD MC and commentary - PE
OECD position India’s position Services PE No 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 – no taxation by source country (b) Requirement of minimum level of presence in Source State (c) Taxation on gross basis not appropriate Most of India’s tax treaties contain this clause. India’s position: (a) Taxation rights even when services are furnished from outside that State (b) Presence not relevant (c) Taxation on gross basis is also appropriate and should be provided as an alternative

23 Implication of India’s position on OECD MC and commentary
Guide to taxpayers on likely approach of Indian tax authorities India’s tax treaty policy in future tax treaty negotiations/renegotiations Could it be regarded as an aid for interpreting tax treaties by Courts in India? Tax treaties entered into prior to July 2008 Tax treaties entered post July 2008 Ambiguity/uncertainty in some of India’s positions - use of ‘in certain circumstances’ while expressing reservations Significant departure from OECD’s position on some key aspects Cause of concern for foreign companies doing business in India on the extent of deviations they may encounter in application of a tax treaty

24 UN model Tax treaties between countries with unequal economic status - Developed and lesser developed countries, or between developing countries Drafted in 1980, designed to encourage flow of investments from the developed to developing countries Is a compromise between source principle and residence principle Gives more weightage to source principle, i.e., income should be taxed where it arises

25 Differences between OECD and UN
Article OECD Model UN Model Assembly & Supervision PE OECD 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 months Service PE OECD 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 treaties PE on account of delivery of goods OECD excludes from the purview of PE, facilities solely for the purpose of delivery in source State of goods or merchandise belonging to the enterprise Article 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 enterprise PE on account of maintenance of stock Article 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 model Article 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

26 Differences between OECD and UN
Article OECD Model UN Model Conditions for examining agent’s dependence The 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 independence The 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 independence Attribution of Profits Article 7(1) of the OECD model prevents the applicability of the Force of Attraction Rule UN model provides for the applicability of the Force of Attraction Rule Article 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 enterprise Unlike 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 enterprise Associated Enterprise OECD 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 default Article 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

27 Differences between OECD and UN
Article OECD Model UN Model Dividend, Interest and Royalties OECD Model specifically mentions the rates for withholding tax UN 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 7 Capital Gains OECD Model does not expressly refer to alienation of interest in a partnership, trust or estate UN Model expressly refers to alienation of interest in a partnership, trust or estate Independent Personal Services Article 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 7 UN Model has Article 14 specifically dealing with Independent Personal Services Other Income Under 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 recipient UN 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

28 US Model Seeks to align OECD model articles with US tax laws and policies Only model which USA uses as a basis of negotiating treaties with its other treaty partners Significant differences as compared to OECD MC Unlike 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

29 India’s tax treaties India’s tax treaties based on a combination of the OECD MC and the UN MC Emphasis laid more on “source” country taxation which is consistent with the objective and rationale of the UN MC Certain provisions are unique to India’s tax treaties and are not based on any MC Broader “Service PE” rule as compared to UN MC Service 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”

30 Interpretation of Treaties

31 Vienna Convention on the Law of Treaties
Vienna Conventions codifies existing norms of customary international law with some necessary gap-filling and clarifications Applies to all international treaties including tax treaties The Vienna Convention on the Law of Treaties (VCLT) was codified in 1969 and entered into force in 1980 108 states have ratified the VCLT (May 2007) The scope of the Convention is limited Given due weightage by non signatories Applicable to both past and future treaties Growing number of decisions in international courts refer to the rules in the Vienna Convention It 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.

32 Articles of VCLT Article 26 of VCLT – Every treaty in force is binding upon the parties to it and must be performed by them in good faith Article 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 purpose Article 31(2) of VCLT - Context is defined to include texts and subsequent agreements/instruments related to the treaty Public 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 recognised Part 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-signatories Good faith is not applicable for domestic law

33 Articles of VCLT Article 31(4) of VCLT – Special meaning only if specifically intended by parties Article 32 of VCLT - Supplementary means to be used only to confirm the meaning Article 33 of VCLT - Treaties authenticated in two or more languages Article 34 of the VCLT – A treaty does not create either obligations or rights for a third state without its consent Thus significant limitation on use of external aids such as commentaries Treaties authenticated in two languages could be problem. E.g. french and german text if says otherwise. No Indian judgments yet on this issue

34 Tax treaty vs. Domestic law
Distinguishing features Tax treaty Domestic law Agreement between sovereign nations Act of Legislature Relief from double tax Charge of tax Sharing of tax revenues Earning of tax revenues Negotiation between states No negotiation No frequent amendments Frequent amendments Public International Law National Legislation In national context even supreme court ratio settled for decades together can be nullified by parliament by retrospective legislation Charge of tax – strictly interpreted Tax and equity strangers Plaing meaning – harsh consequences Hence, when investigating the tax implications of a given fact in connection with two States: First, an internal rule must impose taxation Then, it will have to be determined if that tax claim is limited by a DTC

35 Tax 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 legislation Hence, when investigating the tax implications of a given fact in connection with two States: First, an internal rule must impose taxation Then, it will have to be determined if that tax claim is negatived or limited by a treaty Issue 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 contrary Confirmed by the position in most of countries including USA

36 Aids to interpretation

37 Aids to interpretation
Reference to domestic law under Article 3(2) OECD/UN model conventions and commentary Protocols Technical memorandum Parallel treaties Indian Judicial precedents International case laws Canadian 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

38 Domestic 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 laws Canadian 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

39 Domestic law as Aids to interpretation
Static v. ambulatory meaning of the terms Ambulatory 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 approach Commentary 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 time Ambulatory 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 it A view is that source country’s law should apply. However, not a appropriate view since residence country would not accept this.

40 OECD 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.

41 UN 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

42 Reliance on MC Commentary – Indian perspective
Approving reference to OECD/UN commentary OECD/UN MC or Commentary have generally received ‘due respect’ The OECD / UN Model or Commentary play a “key role” in interpreting tax treaties They 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 Commentary to ‘reinforce’ / ’confirm’ its conclusion, to draw support for its conclusion and in certain cases, even ‘followed’ the MC or Commentary Reinforce/confirm conclusion – Graphite – scope of professional services, general meaning as given by Indian courts as well as OECD commentary Supreme 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 followed Union 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.)

43 Reliance on MC Commentary – Indian perspective
Disapproving reference to OECD/UN commentary P. 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 Commentary P. 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 commentary USCO 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

44 Reliance on MC Commentary – Indian perspective
Reliance placed by the Indian Revenue on the OECD Commentary Indian Revenue has itself placed reliance on the OECD Commentary when it found the Commentary to support its contentions British 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 taxpayer Conclusion Both tax payers/tax authorities have been liberally referring to the OECD/UN MC and Commentary to support their respective claims Courts have generally accepted them as an important ‘aid for interpretation’ of tax treaties

45 Aids to interpretation - OECD/UN Commentary
Relevance of the “revised” OECD / UN Commentary in construing a treaty signed “prior” to the revision P 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 Commentary Indian company processed data regarding utilisation of credit card through CPU maintained abroad General remarks about OECD commentary being clarificatory nature. Substantive changes as given in PE commentary on limit of 6 months 36. 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

46 Aids 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 shopping Indian judgments where reliance placed on definition in a parallel treaty or its protocol Raymond 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.

47 Unilateral 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 materials Relevance of foreign judgments Not legally binding although useful reference for common interpretation Trend in India – Even for typical domestic law interpretation issues reference is made to parallel treaties and foreign judgments In 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 judgment The basic principle of OECD Commentary being international tax language was first referred to by AP High Court from Australian judgment Interpretative documents can bind administrative authorities of respective countries but not revenue authorities/courts of other country Useful reference for interpretation although not legally binding Shift to purposive interpretation

48 India-Mauritius Tax Treaty - Validity
Supreme Court of India Ruling in the case of Union of India vs Azadi Bachao Andolan Facts The 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. Decision The 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.

49 India-Mauritius Tax Treaty - Validity
Supreme Court of India Ruling in the case of Union of India vs Azadi Bachao Andolan (cont’d) Decision Circular 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.

50 India-Mauritius Tax Treaty - Validity
Supreme Court of India Ruling in the case of Union of India vs Azadi Bachao Andolan (cont’d) Decision The 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

51 Operation of Treaties

52 Articles of a Treaty The Articles of a Convention can be divided into the following six groups for the purpose of analysis Scope 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 Treaty Substantive provisions -- Articles which apply to particular categories of income and allocate tax jurisdictions between contracting states Provisions of elimination of double taxation -- Includes Mutual Agreement Anti-avoidance provisions - Associated enterprise, Exchange of information, Limitation of benefits Miscellaneous provisions -- Non-discrimination, Diplomats, etc

53 Articles of a Treaty SCOPE PROVISIONS ANTI-AVOIDANCE
1. Article 1 - Personal Scope 2. Article 2 - Taxes covered 3. Article 29 - Entry into force 4. Article 30 - Termination ANTI-AVOIDANCE 1. Art 9 - Associated Enterprise 2. Art 26 - Exch of Info ELIMINATION OF DOUBLE TAXATION 1. Article 23 - Elimination of double taxation 2. Article 25 - Mutual Agreement DEFINITION PROVISIONS 1. Article 3 - General definitions 2. Article 4 - Residence 3. Article 5 - Permanent Establishment SUBSTANTIVE PROVISIONS 1. Article 6 - Immovable property 2. Article 7 - Business Profits 3. Article 8 - Shipping, etc 4. Article 10 - Dividends 5. Article 11 - Interest 6. Article 12 - Royalties & FTS 7. Article 13 - Capital gains 8. Article 14 - Independent Personal Services 9. Article 15 - Dependent Personal Services 10. Article 16 - Directors 11. Article 17 - Artistes & Sports persons 12. Article 18 - Pensions 13. Article 19 - Government service 14. Article 20 - Students 15. Article 21 - Other income 16. Article 22 - Capital MISCELLANEOUS PROVISIONS 1. Article 24 - Non-discrimination 2. Article 27 - Diplomats 3. Article 28 - Territorial Extension

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