Section 44 B, Article 7, 22 of Indo-Swiss DTAA. Other Income article, which, inter alia, takes within its ambit income not “dealt with” under the other articles of the India-Swiss DTAA, governs taxation of international shipping profits.
Where right or property in respect of which the shipping income earned by the Taxpayer, is not effectively connected with the Taxpayer’s PE in India, such income will be taxable only in country of residence. The term “effectively connected” will apply only if the “economic ownership” of the ships is with the Taxpayer’s PE in India.
Facts
The taxpayer, a company incorporated in Switzerland, was engaged in the business of operations of ships in international waters through chartered ships. In respect of its activities in India, the Taxpayer had an Indian company (I Co) as its agent which triggered agency PE for the taxpayer. In its return of income for the tax year 2002-03, the Taxpayer declared NIL taxable income on the grounds that under the India-Swiss Double Taxation Avoidance Agreement (DTAA): (i) no article specifically covered the taxation of international shipping profits; (ii) Article 7 specifically excluded taxation of such profits; and (iii) Other Income article gave taxation rights only to Switzerland in absence of effective connection of ship with PE.
The Tax Authority contended that the combined effect of the exclusion of international shipping profits in Article 7 makes it clear that such profits are to be taxed by each country, as per their domestic laws. In any case, the Taxpayer has a dependent agent PE in India and that profits of the Taxpayer are effectively connected with the PE.
At the First Appellate Authority level, income was held to be not taxable in India. Aggrieved, the Tax Authority filed an appeal before the ITAT.
Held
On meaning of the expression “dealt with” under the Swiss DTAA: Coverage by Other Income article.
The purpose of a DTAA is to allocate taxation rights as held, inter alia, by the Supreme Court in the case of Azadi Bachao Andolan [263 ITR 706]. The expression “dealt with” used in Article 22 has to be read in the context of purpose of the DTAA, which is allocation of taxation rights. From this angle, an item of income can be regarded as “dealt with” by an article of DTAA only when such article provides for and, positively, vests the power to tax such income in one or both the countries. Such vesting of jurisdiction should be positively and explicitly stated and it cannot be inferred by implication.
Mere exclusion of international shipping profits from Article 7 cannot be regarded as vesting India with a right to tax international shipping profits and such profits cannot be regarded as “dealt with” as envisaged in Article 22.
Having regard to exchange of letters signed and agreed to between the competent authorities of India and Switzerland, it was clear that shipping profits were intended to be covered by other income Article.
On existence of PE
On facts, I Co was a legally and economically dependent agent, managing and controlling some of the Taxpayer/principal’s operations in India. Furthermore, the scope and authority of I Co is to work exclusively for and on behalf of the Taxpayer and not to accept any other representation without the written consent of the Taxpayer. Thus, the Taxpayer has an agency PE in India.
On whether the profits are “effectively connected” to the PE
The expression “effectively connected” is not defined in the Swiss DTAA or the IT Act, and therefore, it has to be understood using the general principles, keeping in mind the common uses associated with the phrase.
Economic ownership can be taken as basis to apply the concept of “effectively connected with”. 1
A right or property in respect of which income paid will be effectively connected with a PE if the economic ownership of that right or property is allocated to that PE. The economic ownership of a right or property, in this context, means the equivalent of ownership for income tax purposes by a separate enterprise with the attendant benefits and burdens.2
Since the economic ownership of the ships cannot be said to be allocated to the agency PE, it cannot be said that the ships were effectively connected with the PE in India. Accordingly, such income will not be taxable in India, but will be taxable in the country of residence of the Taxpayer, viz., Switzerland.
