Interpretation of Tax Treaties

    Tax treaties are signed between two sovereign nations by competent authorities under the delegated powers from the respective Governments. Thus, an international agreement has to be respected and interpreted in accordance with the rules of international law as laid down in the Vienna Convention on Law of Treaties, 1969. These rules of interpretation are not restricted to tax treaties but also apply to any treaty between two countries. So any dispute between two nations in respect of Article 25 relating to Mutual Agreement Procedure of the OECD/UN Model Conventions has to be solved in the light of the Vienna Convention.

    However, when it comes to application of a tax treaty in the domestic forum, the appellate authorities and the courts are primarily governed by the laws of the respective countries for interpretation. Fortunately, in India, even before insertion of S. 90(2) by the Finance (No. 2) Act, 1991, with retrospective effect from 1-4-1972, the CBDT had clarified vide Circular No. 333 dated 2-4-1982 that where a specific provision is made in the Double Taxation Avoidance Agreements (DTAA), the provisions of the DTAA will prevail over the general provisions contained in the Income-tax Act and where there is no specific provision in the DTAA, it is the basic law i.e. the provisions of the Income-tax Act, that will govern the taxation of such income. This position has been upheld in many of judicial decisions in India. The prominent amongst them are CIT v. Visakhapatnam Port Trust, (1983) 144 ITR 146 (AP); Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706; CIT v. Kulandagan Chettiar (P.V.A.L.), (2004) 267 ITR 654 (SC).

    Thus, in India, treaty override over domestic tax law has a legal sanction. Internationally this situation falls under Monist View, wherein International and National laws are part of the same system of law and where DTAA overrides domestic law. Some other countries which follow such a system are: Argentina, Italy, the Netherlands, Belgium and Brazil.

    The other prevalent view is known as Dualistic View wherein International Law and National Law are separate systems and DTAA becomes part of the national legal system by specific incorporation/legislation. In case of Dualistic View, DTAAs may be made subject to provisions of the National Law. Some of the countries that follow Dualistic View are Australia, Austria, Norway, Germany, Sri Lanka, UK.

    Interpretation of any statute, more so international tax treaties, require that we follow some rules of interpretation. In subsequent paragraphs we shall deal with rules of statutory construction.

2.0 Basic principles of interpretation of a Treaty :

    Principles or rules of interpretation of a tax treaty would be relevant only where terms or words used in treaties are ambiguous, vague or are such that different meanings are possible. If words are clear or unambiguous then there is no need to resort to different rules for interpretation.

    Prior to the Vienna Convention, treaties were interpreted according to the customary international law. Just as each country’s legal system has its own canons of statutory construction and interpretation, likewise, several principles exist for the interpretation of treaties in the customary international law. Some of the important principles of Customary International law in interpretation of tax treaties are as follows :

    (i) Golden Rule — Objective interpretation :

    Ideally any term or word should be interpreted keeping its objective or ordinary or literal meaning in mind. The term has to be interpreted contextually.

    Words and phrases are in the first instance to be construed according to their plain and natural meaning. However, if the grammatical interpretation would result in an absurdity, or in marked inconsistency with other portions of the treaty, or would clearly go beyond the intention of the parties, it should not be adopted1.

    (ii) Subjective interpretation :

    Under this approach, the terms of a treaty are to be interpreted according to the common intention of the contracting parties at the time the treaty was concluded. The intention has to be found from the words used in the treaty and the context thereof.

In Abdul Razak A. Meman’s case’, the Authority for Advanced Rulings (the AAR) relied on the speeches delivered by Shri Manmohan Singh, Minister of Finance (as he then was) and His Highness Sheik Harridan- Bin Rashid Al-Maktoum, Minister of Finance and Industry in the presence of His Highness Sheik Zayed Bin Sultan Al-Nahyan, the President of the UAE to arrive at the intention of parties in signing the India-UAE Tax Treaty.

iii) Teleological or purposive  interpretation:

In this approach the treaty is to be interpreted so as to facilitate the attainment of the aims and objectives of the treaty. This approach is also known as the ‘objects and purpose’ method.

In case of Union of India v. Azadi Bachao Andolani, the Supreme Court of India observed that “the principles adopted for interpretation of treaties are not the same as those in interpretation of statutory legislation. The interpretation of provisions of an international treaty, including one for double taxation relief, is that the treaties are entered into at a political level and have several considerations as their bases.” The Apex Court also agreed to the argument put forth by the Appellant that “the preamble to the Indo-Mauritius DTAC recites that it is for the ‘encouragement of mutual trade and investment’ and this aspect of the matter cannot be lost sight of while interpreting the treaty”.

iv) The principle  of effectiveness:

According to this principle, a treaty should be interpreted in a manner to have effect rather than to be void.

This principle, particularly stressed by the Permanent Court of International Justice, requires that the treaty should be given an interpretation which ‘on the whole’ will render the treaty ‘most effective and useful’, in other words, enabling the provisions of the treaty to work and to have their appropriate effects”.

In Cyril Eugene Pereira”, the AAR held that “a tax treaty has to be given a liberal interpretation to make it workable but that would only mean ironing out of the creases, as it is called, which would be within  the realm  of interpretation.”

v) Principle  of contemporaneity:

A treaty’s terms are normally to be interpreted ‘on the basis of their meaning at the time the treaty was concluded. However, this is not a universal principle.

In Abdul Razak A. Memans case”, the AAR observed that “there can be little doubt that while interpreting treaties, regard should be had to material contemporanea expositio. This proposition is embodied in Article 32 of the Vienna Convention, referred to above, and is also referred to in the decision of the Supreme Court in K. P. Varghese v. ITO, (1981) 131 ITR 597.”

vi) Liberal construction:

If is a general principle of construction with respect td treaties that they shall be liberally construed so as to carry out the apparent intention of the parties.

In John N. Gladden  v, Her Majesty the Queen”, the principle of liberal interpretation of tax treaties was reiterated by the Federal Court, which observed: “Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of tne parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated in so far as the particular item under consideration is concerned.”

 The Court  further  recognised  that  “we cannot  expect to find  the same nicety  or strict definition  as in modern  documents,  such  as deeds,  or Acts of F   Parliament;  it has  never  been  the habit  of those engaged  in diplomacy  to use  legal  accuracy  but rather  to adopt  more  liberal  terms.”

(vii) Treaty  as a whole – Integrated approach:

A treaty should be construed as a whole and effect should be given to each word which would be construed in the same manner wherever it occurs. Any provision should not be interpreted in isolation; rather the entire treaty should be read as a whole to arrive at its object and purpose.

To quote  Prof. Roy Rohatgi”:

a) tax treaties tend to be less precise and require a broad purposive interpretation;

b) the purpose  is not the same as the subjective intention of Contracting States. It refers to the goals of the treaty as reflected objectively by the treaty as a whole.

viii) Reasonableness  and consistency”  :

Treaties should be given an interpretation in which the reasonable meaning of words and phrases is preferred, and in which a consistent meaning is given to different portions of the instrument. In accordance with the principles of consistency treaties should be interpreted in the light of existing international law.

One  thing    may  be noted regarding the  rules of interpretation, that they are not rules of law and are not to be applied like the rules enacted by the legislature in an Interpretation Act. In Maunsel v. Olins Lord Reid observed that U They are not rules in the ordinary sense of having some binding force. They are our servants not our masters. They are aids to construction, presumptions or pointers. Not infrequently one ‘rule’ points in one direction, another in a different direction. In each case, we must look at all relevant circumstances and decide as a matter of judgement what weight to attach to any particular ‘rule”‘.

3.0 Principles  of interpretation as per the Vienna Convention:

The Vienna Convention of 1969 codified the then existing public international law. Worldwide treaties are entered and interpreted taking into account provisions of the Vienna Convention. Even though India is not a signatory to this Convention, it has a great persuasive value as it is the authentic, codified customary public international law. Courts in India have recognised and referred to principles enshrined in this Convention. Some of the important Articles of this Convention which provide great help in interpretation of a tax treaty are as follows:

3.1  Article  26:  Pacta stint  servanda :

Every treaty in force is binding upon the parties to it and must be performed by them in good faith.

3.2  Article  27 : Internal  Law and observance of Treaties:

A party to a treaty cannot invoke the provisions of internal law as justification for its failure to perform a treaty.

In India the concept of ‘Treaty Override’ is well accepted. Moreover S. 90 (2) provides that provisions of domestic tax laws vis-a-vis treaty would be applied to the extent the same are more beneficial to the assessee.

3.3 Article 30: Application of successive treaties relating to the same subject matter:

Sometimes parties to the treaty subject themselves to provisions of other tax treaties that may be entered at a later date; in such cases the provisions of that later treaty shall prevail. For example, MFN Clause in the protocol on DTA with France provided that in respect of Dividends, Interest, Royalties and FTS if India signed a treaty after 1st September 1989 with any OECD country wherein these incomes are taxed at a lower rate or the scope is narrower, then provisions of India-France Treaty would stand modified to. that extent.

3.4  Article 31 : General rules of interpretation:

Treaties should be interpreted in Good Faith in accordance with the ordinary meaning in the light of its Object and Purpose and Context.

As per this Article primacy is given to the ‘ordinary meaning’ and ‘textual approach’ while preserving the role of ‘objects and purpose’. The context for the purpose of the interpretation of a treaty shall comprise in addition to the text, including its preamble and annexes.

In Abdul Razak A. Meman’s case”, the AAR observed that “these recitals’? indicate that the purpose of entering into the treaty is to promote mutual economic relations by concluding an agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital”. (emphasis supplied)

Article 31(3) further provides that there shall be taken into account, together with the context:
    
a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;

b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation; and

c) any relevant rules of international law applicable in the relations between the parties.

Further, Article 31(4) provides that a special meaning shall be given to a term if it is established that the parties so intended.

3.5 Article 33 : Interpretation of Treaties authenticated in two or more languages:

Indian tax treaties invariably provide that both Hindi and English are authentic texts, however in case of divergence, the text in English shall prevail.

4.0 Extrinsic aids to interpretation of a tax treaty:

A wide range of extrinsic material is permitted to be used in interpretation of tax treaties. According to Article 32 of the Vienna Convention the supplementary means of interpretation include the preparatory work of the treaty and the circumstances of its conclusion.

4.1 According to Prof. Starke one may resort to following extrinsic aids to interpret a tax treaty-‘ provided that clear words are not thereby contradicted:

    i) Interpretative Protocols, Resolutions and Committee Reports, setting out agreed interpretations;

    ii) A subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions [Article 31(3) of the Vienna Convention];

    iii) Subsequent conduct of the state parties, as evidence of the intention of the parties and their conception of the treaty;

    iv) Other treaties, in pari materia,in  case of doubt;

Provisions in parallel tax  treaties:

If the language used in two tax treaties (say treaties: X and Y) are same and one treaty is more elaborative or clear in its meaning (say treaty X) can one rely on the interpretation/explanations provided in a treaty X while applying provisions of a treaty Y?

In case of Raymond Ltd.13the Tribunal relied on the examples given in the Memorandum of Understanding concerning Fees for Included Services in respect of Article 12 of the India-US Tax Treaty while interpreting the concept of ‘make available’ under the India-UK Treaty as the language used in both the treaties is similar.

However, the views of the Indian Judiciary are not consistent in this respect. There is contradictory judgments by Indian Courts/Tribunals in this regard as mentioned below:

For:

•      UOI    v. Azadi    Bachao    Andolan,    (2003) 263 ITR 706 (SC)
•     AEG Telefunkenv. CIT, (1998) 233 ITR 129 (Kar.)
•     P. No. 28 of 1999, In re (2000) 242 ITR 208 (AAR)
•     P. No. 16 of 1998, In re (1999) 236 ITR 103 (AAR)
•     DCIT   v.  Boston   ConsultingGroup   Pte.  Ltd., (2005) 93 TTJ 293 (Mum.)

Against:

•     Mashreq Bank PSC v. DOlT, (2007) 108 TIJ 554 (Mum.)
•     CIT v. PV AL Kulandagan Chettiar, (2004) 267 ITR 654 (SC)
•     CIT v. Vijay Ship Breaking Corpn., (2003)261 ITR 113 (Guj.)
•     Essar Oil Ltd. v. JCIT, (2006) 102 TTJ 270 (Mum.)

4.2 Technical explanation on US MC:

    US has published Technical Explanation accompanying the United States Model Income Tax Convention on Nov. IS, 1996. This explanation though refers extensively to the OECD Commentary, it highlights differences and provides basic explanation of US treaty policy for all interested parties.

Similarly, there ‘is a technical explanation for the India-US tax treaty as well.

4.3 International Articles/Essays/Reports:

In DCIT v. ITC Ltd., (2003) 85 ITD 162 (Kol.) the Tribunal referred to an essay to support its observations. Similarly, in case of CIT v. Vishakhapatanam Port Trust, (1983) 144 ITR 146 (AP), the High Court obtained ‘useful material’ through international articles.

4.4  Cahiers published by  IFA, Netherlands:

Cahiers were relied upon in case of Azadi Bachao Andolan’s (supra) case by the sc.

4.5 Protocol:

A protocol is an integral part of a tax treaty and has the same binding force as the main clauses therein.
[Sumitomo Corpn. v. DCIT, (2007) 110 TTJ 302 (Del.)]

Protocol to India-US tax treaty provides many ex-amples to elucidate the meaning of the term ‘make available’. Protocol to India France treaty contains the Most Favoured Nation Clause. Thus, one must refer to protocol before reaching to any final conclusion in respect of any tax treaty provision.

4.6 Preamble:

Preamble to a tax treaty could guide in interpretation of a tax treaty. In case of Azadi Bachao Andolan, the Apex Court observed that ‘the preamble to the Indo-Mauritius Double Tax Avoidance Convention (DTAC) recites that it is for the ‘encouragement of mutual trade and investment’ and this aspects of the matter cannot be lost sight of while interpreting the treaty’. These observations are very significant whereby the Apex Court has upheld ‘economic considerations’ as one ofthe objectives of a Tax Treaty.

4.7  Mutual Agreement Procedure (MAP) :

MAP helps to interpret any ambiguous term/provision through bilateral negotiations. MAP is more authentic than other aids as officials of both countries are in possession of materials/ documents exchanged at the time of signing the tax treaty which would clearly indicate the object or purpose of a particular provision. Successful MAPs also serve as precedence in case of subsequent applications.

5.0 Commentaries on DECD/UN Models:
OECD Model Commentary has been widely used in interpretation of tax treaties. Paragraph 29.3 of the July 2008 version of the Commentary on the OECD Model Convention states that: “the Commentaries have been cited in the published decisions of the courts of the great majority of Member countries. In many decisions, the Commentaries have been extensively quoted and analysed, and have fre-quently played a key role in the judge’S delibera-tions.” Phillip Baker regards the OECD Commen-taries as an aid to tax treaty interpretation in sev-eral countries. In US v. Al Burbank & Co. Ltd.,14 the US Second Circuit Court of Appeal referred to the Commentaries as an ‘aid to interpretation’.

In CIT v. Vishakhapatanam Port Trust’s case,”, the Andhra Pradesh High Court observed that “the OECD provided its own commentaries on the technical expressions and the clauses in the Model Convention. Lord Radcliffe in Ostime v. Australian Mutual Provident Society, (1960) AC 459, 480; 39 ITR 210,219 (HL), has described the language employed in these agreements as the ‘international tax language.’

Both UN and OECD Model Commentaries are great help in interpretation of tax treaties. Their importance in interpretation of tax treaties can hardly be over emphasised. [Credit Lyonnais v. DCIT, (2005)94 ITD 401 (Mum)]

Model Commentaries give the authoritative interpretation of the provisions of DTAAs. [Sonata Information Technology Ltd. v. ACIT, (2006) 103 ITD 324 (Bang.)]

UN Commentary reproduces significant part of the OECD Model Commentary and thus, OECD plays a greater role in providing standardised or systematised approach in interpretation of tax treaties.

6.0 Foreign Courts’ decisions:

In CIT v. Vishakhapatanam Port Trust’s case,”; the Andhra Pradesh High Court observed that, “in view of the standard OECD Models which are being used in various countries, a new era of genuine ‘international tax law’ is now in the process of developing. Any person interpreting a tax treaty must now consider decisions and rulings worldwide relating to similar treaties. The maintenance of uniformity in the interpretation of a rule after its international adoption is just as important as the initial removal of divergences. Therefore, the judgments rendered by courts in other countries or rulings given by other tax authorities would be relevant.”

In undernoted cases, foreign court cases have extensively been quoted for interpretation of treaty provisions:

i) Union of India v. Azadi Bachao Andolan”
 (ii) CIT v. Vishakhapatanam Port Trust”
iii) Abdul  Razak A. Meman’s  case’?

7.0 Ambulatory  v. Static Approach:

Whenever a reference is made in a treaty to the provisions of domestic tax laws for assigning meaning to a particular term, a question often arises as to what meaning is to be assigned to the said term the one which prevailed on the date of signing a tax treaty or the one prevailing on the date of application of a tax treaty. There are two views on,the subject, namely,  Static and Ambulatory.
    
Static:

Static approach looks at the meaning at the time when  the treaty was signed.

Ambulatory:

Ambulatory approach provides that one looks, to the meaning of the term at the time of application of treaty provisions. All Model Commentaries ” including the Technical Explanation on US Model Tax Convention favors ambulatory approach, however with one caution and that is ambulatory approach cannot be applied when there is a radical amendment in the domestic law thereby changing the sum and substance of the term.’

India-Australia Treaty, in para 3(2) adds the expression ‘from time to time in force’ to provide for an ‘ambulatory’ interp retation.

8.0 Ambulatory approach subject to contextual interpretation: –

Paragraph 3 of the OECD Model Convention provides that meaning of the term not defined in the treaty shall be interpreted in accordance with the provisions of the lax laws of the Contracting State that may be applying the Convention. However, this provision is subject to one caveat and that is if the context requires interpreting the term ‘otherwise’, then the meaning should be assigned accordingly. For example, India-US treaty provides that assignment of meaning under the domestic law t9 any term not defined in the treaty shall be according to the common meaning agreed by the Competent Authorities pursuant to the provisions of Article 27 (Mutual Agreement Procedure). And if it is not so agreed then only meaning would be assigned from the domestic tax law that too provided the context  does not require otherwise.

In case of Union of India v. Elphinstone Spinning and Weaving Co. Lid.,”, the Supreme Court observed that “when the question arises as to the meaning of certain provisions in a Statue it is not only legitimate but proper to read that provision in its context. The Context means the statute as a whole, the previous state of law, other statutes in pari materia, the general scope of statute and the mischief that it was intended to remedy.”

In Pandit Ram Narain v. State of Uttar Pradesh”, the Supreme Court observed that the meaning of words and expressions used in an Act must take their colour from the context in which they appear.
 
9.0 Objectives of Tax Treaties:

Objectives for signing a tax treaty also playa significant role in its interpretation as they determine the context in which a particular treaty is signed. For example, OECD and UN Model Conventions have different objectives to achieve. The same are as follows:

9.1  OECD  Model  Convention:

Principal objectives of the OECD Model Convention are as follows:

The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchange of goods and services and the movement of capital and persons. It is also a purpose of tax conventions to prevent tax avoidance and evasion”.

9.2  UN Model  Convention:

Principal objectives of the UN Model Convention are as follows: .

• To protect taxpayers against double taxation (whether direct or indirect)
• To encourage free flow of international trade and investment
• To encourage  transfer  of technology
• To prevent  discrimination  between  taxpayers
• To provide a reasonable element of legal and fiscal certainty to the investors and traders
• To arrive at an acceptable basis to share tax revenues between two States
• To improve the co-operation between taxing authorities in carrying out their duties.

9.3  Indian  Tax Treaties:

S. 90 of the Income-tax Act, 1961 contains the objectives of signing tax treaties in general. The same areas follows :

    a) for the granting  of relief in respect  of :

    i) income on which taxes have been paid, both income-tax under this Act and income-tax in that country; or

    ii) income-tax chargeable under this Act and under the corresponding law in force in that country to promote mutual economic relations, trade and investment”, or

    b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country, or

    c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country, or investigation of cases of such evasion or avoidance, or

    d) for recovery of income-tax under this Act and under the corresponding law in force in that country.

Thus, it can be observed that there are several objectives for entering into tax treaties by the Government of India besides the primary objective of avoidance of double taxation as enumerated in clause (b) above. Besides avoidance of double taxa-tion, Indian treaties are aimed at achieving two more important objectives, namely, ‘prevention of fiscal evasion and recovery of taxes’.

The amendment made by the Finance Act,”2003, to the Indian Income-tax Act, 1961, clarifies that the Government may enter into tax treaty for the purposes of ‘promotion of mutual economic relations, trade and investment’. This amendment is more in the nature of clarification because there are several existing treaties whose preambles suggest that they were entered into for the purposes of encouragement of mutual trade and investments and/ or pro-motion of mutual economic relations. For example, treaties with Mauritius, Turkmenistan, UAE, Germany, Ukraine”, and Switzerland’? are entered into for various economic reasons, besides the main objectives of avoidance of double taxation and prevention of fiscal evasion.

10.0 Conclusion:

Tax Treaties are result of prolonged negotiations between two Contracting States. Ideally, therefore the same should be interpreted keeping in mind the objectives with which they are entered into. Minutes of negotiations, exchange of notes, letters etc. are important material in determining the object of a particular treaty provision. However, absence of any such document in public domain makes the task of interpretation very difficult.

Interpretation of tax treaties is an evergreen subject of controversy considering the complexities involved. Application of international rules of interpretation while giving effect of provisions under the domestic law creates further confusion. Even courts are not unanimous in their rulings. A general technical explanation on the lines of India-USA tax treaty may be published by the Indian Government to reduce the disputes in interpretation of tax treaties.