THE CONUNDRUM OF ‘MAY BE TAXED’ IN A DTAA

INTRODUCTION

The liability to pay tax on global income of a resident assessee u/s 4 r/w/s 5 of the Income -tax Act, 1961 (the
Act) is subject to Double Taxation Avoidance Agreements (DTAA) entered into by
the Government with foreign countries u/s 90 of the Act.

As per section 90(1), the Government may enter into agreements with
foreign countries for (a) granting of relief in respect of income on which have
been paid both income-tax under the Act and income-tax in that country, (b) for
avoidance of double taxation of income, (c) for exchange of information for the
prevention of evasion or avoidance of income tax, and (d) for recovery of
income-tax under the Act and under the corresponding law in force in that
country.

In order to achieve the object of avoidance of double taxation, two
rules are generally adopted under a DTAA:

•  Allocating taxing rights between contracting States with respect to
  various kinds of income, called distributive rule, and

•  Obligating the State of residence to give either credit of taxes
  paid in the source State or to exempt the income taxed in the source
  State.

In this regard, DTAAs are found to use one or more of the following
phrases:

‘shall be taxable only’

‘may be taxed’

‘may also be taxed’.

The expression ‘shall be taxable only’ indicates that exclusive right
to tax is given to one contracting State. The expression ‘may also be taxed’
indicates that the right to tax is given to both contracting States.

As regards the expression ‘may be taxed’, it has been the subject
matter of interpretation as to whether it would mean the right to tax is given
only to the source State or to both contracting States.

In CIT vs. R.M. Muthaiah [1993] 292 ITR 508
(Kar.), the Honourable Karnataka High Court interpreting Article 6(1) of
the Indo-Malaysia DTAA which provides that ‘Income from immovable property may
be taxed in the contracting State in which such property is situated’ held that ‘when a power is specifically recognised as vesting in one,
exercise of such a power by others, is to be read as not available; such a
recognition of power with the Malaysian Government would take away the said
power from the Indian Government’. Thus, the Court held that as the immovable property is situated in
Malaysia, the power to tax income vested with the Malaysian Government and not
with the Indian Government.

The aforesaid decision is approved by the Supreme Court in UOI vs. Azadi Bachao Andolan [2003] 263 ITR 706
(SC) (see page 724).

In CIT vs. P.V.A.L. Kulandagan Chettiar [2004] 267 ITR 654 (SC), on the basis of the decision in Muthaiah (Supra), it was argued that the expression ‘may be taxed’ should be read as
‘shall only be taxed in the source State’. The Supreme Court held that when a
person resident in India is deemed to be a resident of Malaysia by virtue of his
personal and economic relations, his residence in India will become irrelevant
under the DTAA. The Court held that the assessee is
liable to tax only in Malaysia and not in India as his income from estate is not
attributable to a permanent establishment in India. Thus, the decision was
rendered on an altogether different ground. In fact, the residence of the assessee therein was never put to question before any
appellate authority / court including the Supreme Court. Although the Supreme
Court did not deliberate upon the phrase ‘may be taxed’, it did not upset the
decision in Muthaiah (Supra).

The decision of Kulandagan Chettiar (Supra) was understood [albeit incorrectly, if we may say so with utmost respect] by various Courts
as holding that the term ‘may be taxed’ has to be read as ‘shall be taxed only
in source State’. The following is the illustrative list of such
cases:

Dy. CIT vs. Turquoise Investment & Finance Ltd. [2006] 154 Taxman
80 (Madhya Pradesh) affirmed in Dy. CIT vs. Turquoise Investment & Finance Ltd. [2008] 168
Taxman 107 (SC);

Bank of India vs. Dy. CIT [2012] 27 taxmann.com 335 (Mum.)
upheld in CIT vs. Bank of India [2015] 64 taxmann.com 215 (Bom.);

Emirates Fertilizer Trading Co. WLL, In re [2005] 142 Taxman 127 (AAR);

Apollo Hospital Enterprises Ltd. vs. Dy. CIT [2012] 23 taxmann.com
168 (Chennai);

Daler Singh Mehndi vs. DCIT [2018] 91
taxmann.com 178 (Delhi-Trib.);

Ms Pooja Bhatt vs. CIT
2008-TIOL-558-ITAT-Mum.;

N.V. Srinivas vs. ITO [2014] 45 taxmann.com
421 (Hyderabad-Trib.).

The Legislature introduced sub-section (3) to section 90 by the
Finance Act, 2003 w.e.f. 1^st April, 2004.
As per section 90(3), any term used but not defined in the Act or in the DTAA
shall, unless the context otherwise requires, and is not inconsistent with the
provisions of the Act or the DTAA, have the same meaning as assigned to it in
the Notification issued by the Central Government in the Official Gazette in
this behalf.

In exercise of powers under the aforesaid section, CBDT issued
Notification No. 91 of 2008 dated 28^th August, 2008 wherein it
clarified that where the DTAA provides that any income of a resident of India
‘may be taxed’ in the other country, such income shall be included in his total
income chargeable to tax in India in accordance with the provisions of the Act
and relief shall be granted in accordance with the method for elimination or
avoidance of double taxation provided in such agreement.

In this article, an attempt is made to address the question whether
the decision in Muthaiah (Supra) is upset by the aforesaid Notification.

ANALYSIS

Analysis of Notification 91 of 2008

It may be noted that the scope of section 90(3) is to enable the
Central Government to only ‘define’ any term used but not defined in the Act or
in the DTAA. The memorandum to the Finance Bill, 2003 also clarifies that the
aforesaid provision is inserted to empower the Central Government to define such
terms by way of a Notification.

However, Notification No. 91 of 2008 does not define ‘may be taxed’.
It rather seeks to clarify the stand of the Government when such a phrase is
used. The said Notification in seeking to clarify the stand of the Government
has traversed beyond the scope of section 90(3). The words ‘may be taxed’ are at
best a phrase and not a term so that the definition of a phrase is not even in
the contemplation of section 90. Therefore, the validity of the aforesaid
Notification is open to challenge. Even if its validity is not put to challenge,
its enforceability may be doubted by the Courts.

Certain benches of the Tribunal have held that the legal position
understood as adumbrated in Kulandagan Chettiar (Supra) has undergone a sea change after the issue of the aforesaid
Notification and the words ‘may be taxed’ will not preclude the right of the
State of residence to tax such income. The following is the illustrative list of
such cases:

Essar Oil Limited vs. ACIT [2011] 13 taxmann.com 151
(Mumbai);

Essar Oil Ltd. vs. Addl. CIT [2014] 42 taxmann.com 21
(Mumbai);

Technimont (P) Ltd. vs. Asst. CIT [2020] 116 taxmann.com 996
(Mumbai-Trib.);

N.V. Srinivas vs. ITO [2014] 45 taxmann.com
421 (Hyderabad-Trib.)

As stated earlier, Kulandagan Chettiar did not lay down such principle. In fact, such principle was laid
down in Muthaiah which was approved in Azadi Bachao Andolan
(Supra). Further, as stated earlier, the principle of Muthaiah could not have been upset by the Notification No. 91 of 2008.
Therefore, it is trite to say that the principle of Muthaiah as approved in Azadi Bachao
Andolan holds the field as of date.

IMPACT OF MLI

India has signed Multi-Lateral Convention to Implement Tax
Treaty-Related Measures to Prevent Base Erosion and Profit Shifting
(‘Multi-Lateral Instrument’ or ‘MLI’).

MLI enables the contracting jurisdictions to modify their bilateral
tax treaties, i.e., DTAAs, to implement measures designed to address tax
avoidance. Therefore, the DTAAs have to be read along with the MLI.

MLI 11 deals with ‘Application of Tax Agreements to Restrict a
Party’s Right to Tax its Own Residents’. India has not reserved MLI
11.

The countries which have chosen MLI 11(1) with India (as on
29^th September, 2020) are as under [source:
https://www.oecd.org/tax/beps/mli-matching-database.htm]:

As per MLI 11(1) a Covered Tax Agreement shall not affect the
taxation by a Contracting Jurisdiction of its residents, except with respect to
the benefits granted under provisions of the Covered Tax Agreement which are
listed in clauses (a) to (j).

Clause (j) deals with the provisions of DTAA which otherwise
expressly limit a Contracting Jurisdiction’s right to tax its own residents or
provide expressly that the Contracting Jurisdiction in which an item of income
arises has the exclusive right to tax that item of income.

For example, Article 7(1) of the Indo-Bangladesh DTAA provides that
‘The profits of an enterprise of a Contracting State shall be taxable
only in that State unless the enterprise carries on business in the other
Contracting State through a permanent establishment situated therein. If the
enterprise carries on business as aforesaid, then so much of the profits of the
enterprise as is attributable to that permanent establishment shall be taxable
only in that other Contracting State.’

The aforesaid article expressly takes away the right of the resident
country to levy tax on profits attributable to its PE.

Thus, in the absence of an express provision, the right of the
resident country to tax its residents cannot be taken away under the DTAA.
Therefore, the expression ‘may be taxed’ cannot be construed to mean ‘shall be
taxable only in the source state’, unless it is expressly stated. It may be
noted that the aforesaid proposition would apply only with respect to countries
which have opted for MLI 11 with India. It cannot be applied to countries which
have not chosen MLI 11 and which have not signed the MLI.

Now, the question that arises is whether the decision in Muthaiah would apply with respect to countries which have not chosen MLI 11
or countries which have not signed the MLI.

It may be noted that in certain DTAAs a clarification has been given
to the expression ‘may be taxed’ through protocols by stating that the said
expression should not be construed as preventing the resident country from
taxing the income. For example:

Indo-Malaysia DTAA: In paragraph 3 of the protocol signed on 9^th May, 2012 it
has been stated that the term ‘may be taxed in the other State’ should not be construed as preventing the country of residence from
taxing the income.

Indo-South Africa DTAA: In paragraph 1 of the protocol signed on 26^th July, 2013
it has been stated that wherever there is reference to ‘may be taxed in the other Contracting State’, it should be understood that income may, subject to the provisions
of Article 22 (Elimination of Double Taxation), also be taxed in the
first-mentioned Contracting State.

Indo-Slovenia DTAA: Under paragraph 2 of the protocol signed on 13^th January,
2013 it has been stated that with reference to Article 6(1) and Article 13(1) it
is understood that in case of India income from immovable property and capital
gains on alienation of immovable property, respectively, may be taxed in both
Contracting States subject to the provisions of Article 23.

Thus, with respect to DTAAs like those above, the decision in
Muthaiah would not apply. With respect to the rest of the DTAAs, the decision
in Muthaiah would continue to apply.

CONCLUSION

With respect to countries which have adopted MLI 11, the right of
India to tax its residents cannot be taken away unless such right is expressly
taken away under a DTAA. This would mean that with respect to such cases the
decision in Muthaiah would not apply.

With respect to countries which have not adopted MLI 11 and which
have not signed MLI:

(a) India cannot tax its residents with respect to income derived
from source State, unless such right is expressly provided under the DTAA as in
the Indo-Malaysia DTAA, the Indo-South Africa DTAA, the Indo-Slovenia DTAA, etc.
This would mean that with respect to such cases the decision in Muthaiah would apply.

(b) Notification No. 91 of 2008 does not
apply as the said Notification has been issued beyond the scope of section
90(3).