Tax complexity itself is a kind of tax – Max Baucus, US Senator
This Article seeks to juxtapose the principle of non-discrimination with Article 14(2) of the India – US tax treaty and analyse its fallout. The combined reading of the two provides for the applicability of different tax rates imposed on a permanent establishment of a US corporation vis-à-vis a domestic corporation in India. However, the treaty posits that the tax rate differential shall not exceed fifteen percentage points. In this Article, the author argues that with the reduction of the corporate tax rate in India (albeit through an election), the concession of fifteen percentage points provided by the United States stands breached. Sequitur, the full force of principles of non – discrimination may be applicable notwithstanding the carve-out of Article 14(2).
I. INTRODUCTION
On September 20, 2019 the Government of India enacted a significant reduction of the corporate income tax rate for domestic corporations. On the statute, it was introduced as an election where the domestic corporations could elect to be taxed at 22 per cent1 which was earlier either 25 per cent or 30 per cent2 effective taxable year beginning April 1, 2019. On making this election, the corporation would forgo majority of the tax exemptions and incentives. If the domestic corporation is engaged in manufacturing activity, subject to certain conditions like company formation and commencement of operations, then it could elect a tax rate of 15 percent3. On the other hand, tax rate for a foreign corporation or a Permanent Establishment (“PE”) of a foreign corporation was left unaltered at 40 per cent4.
Article 26 of the India-US Tax Treaty (“Treaty”) enlists the principle of non-discrimination which enjoins nationals of a Contracting State to not be subjected to any taxation that is ‘other or more burdensome’ or ‘less favourable’ than that taxation of nationals in ‘same circumstances’ in the other Contracting State. Article 26(5) of the Treaty creates a carve-out from the general principle in terms of Article 14(2) – Permanent Establishment Tax. To give some context, Article 14 concerns itself with the imposition of a permanent establishment or branch tax5. Article 14(2) while deviating from the general principle of non-discrimination provides for the taxation of United States resident at a tax rate higher than applicable to domestic companies in India. However, the Article posits that the difference in tax rate shall not exceed the ‘existing’ difference of 15 percentage points. The Article therefore, in a certain way, creates a positive obligation on the Contracting State, India, to adhere the domestic tax rates in line with the treaty obligations. Curiously, this is an obligation on the Contracting State and not the taxpayers who are usually stuck in fulfilling conditions for treaty benefits!
1 Effective tax rate of 25.17% including peak surcharge and cess.
2 Effective tax rate of 34.94% including peak surcharge and cess.
3 Effective tax rate of 17.16% including peak surcharge and cess.
4 Effective tax rate of 43.68% including peak surcharge and cess.
5 See, Tech. Ex. to the Convention between United States and India (1991).
This article concerns itself with the above treaty obligation and the gamut of questions that arise therefrom. However, in absence of any previous steep tax rate reduction, this obligation has not been extensively examined by the Judiciary. Nonetheless, an attempt is made to put India’s corporate tax rate reduction in context with the non-discrimination principles and try to shed some perspective on whether the obligation is breached, and if so, the effect of such breach.
II. CONTEXTUALIZING DOMESTIC TAX REGIME WITH TREATY OBLIGATIONS
A. Headline Rate v. Concessional Tax Rate as a base to measure the 15 per cent differential
The subject of how much tax corporations pay in India is a complicated one. Over the last decade, the statutory rate or the headline has fallen down from 35 per cent to 30 per cent and in cases where a certain turnover threshold is met to 25%. Sections 115BAA and 115BAB of the (Indian) Income-tax Act, 1961 (“Act”) accord an election to the taxpayer to elect the tax rate at 22 per cent or 15 per cent respectively for domestic corporations and domestic corporations engaged in manufacturing activities (collectively, “concessional tax regime”). This concessional rate is further increased by a surcharge of 10 per cent and a cess of 4 per cent and the concessional tax regime is applicable from the financial year 2019 – 2020. Once this election is made it cannot be revoked. Further, the corporations opting for the election are exempt from tax liability under Minimum Alternate Tax (“MAT”). The downside, as it were, to this election is forgoing majority of the tax incentives and exemptions. Some of these exemptions may be claimed by foreign corporations too (through their PE’s). The domestic corporations, therefore, undertake a cost-benefit analysis and either elect to be taxed at a concessional rate or maintain status-quo in light of their existing exemptions and incentives (which reduce their effective tax rate below the concessional rate).
The first question which arises in the calculation of the differential tax rate of 15 per cent is whether such rate would be inclusive of surcharge and cess. While generally for this purpose, the definition of ‘taxes covered’ under Article 2 of the Treaty would be inquired into – implying a rate inclusive of surcharge and cess should be considered. However, it is a well-established principle of law in regard to the interpretation of agreements that such interpretation adopted should effectuate the intention of the parties and not defeat it. The term used in Article 14(2) consciously puts an upper cap on percentage points caveating it to the ‘existing’ differential, making historical analysis of the tax rate at the time of signing of the Treaty imperative.
For the assessment year 1990-91 pertaining to the taxable year 1989-90 the rate of tax on the domestic companies was 50 percentage points and the surcharge was payable at the rate of 8 percentage points. The rate of tax in the case of companies other than domestic companies was 65 percentage points. The Treaty takes note of the difference in the tax rates of domestic companies and foreign companies at 15 percentage points. Therefore, the Treaty in measuring the tax rates disregards the surcharge and cess6.
6 The rate of tax referred to in the agreement is the rate of tax chargeable under Article 270 of the Constitution of India. The surcharge is the additional tax, which was not intended to be taken into account for the purpose of placing a limit in the levy of tax in the case of foreign companies, Bank of America v. Deputy Commissioner of Income-tax, [2001] 78 ITD 1 (Mumbai). This view in the context of India – US DTAA/ Treaty has been reiterated by the High Court of Uttarakhand in CIT v. Arthusa Offshore Company, ITA 46 of 2007 decision dated 31.03.2008.
Having analysed the above, the logical question that follows is whether a concessional regime may be taken as a base for measuring the differential? Because only if the concessional regime can be taken as a base would the argument of breach of treaty obligation survive. Otherwise, the headline rate in the Act still remains 30%/ 25% and in either case, 15% rate differential would not get breached in such a scenario.
To put it in perspective, under the terms of the Act, the Assessing Officer is mandated to carry out an assessment of the taxpayer in accordance with the provisions of the Act. The Treaty has statutory recognition under section 90 of the Act. Section 4 of the Act, which is a charging provision, provides that where a Central Act enacts that income-tax it shall be charged at that rate or those rates in accordance with and subject to the provisions of the Act. A concessional tax regime forms part of the Act and as such if elected the charging provision provides for levying tax at a specified (concessional) rate.
However, because the concessional tax regime is not available to foreign companies, they are unable to elect such a rate. This asymmetry merits consideration in light of the principle of ‘quando aliquid prohibetur ex directo, prohibetur et per obliquum’, which means ‘you cannot do indirectly what you cannot do directly’. Accordingly, such an approach, on the first principles, would be unsound in as much as it is well settled in law that the treaty partners ought to observe their treaties, including their tax treaties, in good faith.
B. Invoking Article 26 of the Treaty to provide parity to the rate of tax applicable to US companies
A non-discrimination clause in a tax treaty essentially prevents any discrimination afforded between two taxpayers on the basis of country of origin. There may be various types of protection against discrimination typically provided in tax treaties, that is, inter alia, nationality-based non-discrimination, situs-based non-discrimination, or ownership-based discrimination.
The Pune Bench of the Tribunal in the case of Automated Securities Clearance Inc. v. ITO7, has observed that principles of non-discrimination clause would be available in case of a non-resident in case the different treatment meted out by the other state is considered as unreasonable, arbitrary or irrelevant. However, the rigors laid down in Automated Securities (supra) were overruled by a Special Bench verdict in the case of Rajeev Sureshbhai v. ACIT8. The Tribunal relied upon the following principles to settle the controversy:
- For the application of Article 26(2) of the Treaty, it is sufficient to show that the non-resident taxpayer is engaged in the same business and is treated less favourably, the different circumstances in which the business is being performed are irrelevant;
- There is no scope for “reasonable” discrimination and the concept is alien to treaty law;
- If certain exemptions and deductions are available only for Indian taxpayers and not available for non-resident taxpayers, the same is to be construed as a less favourable treatment.
Flowing from above, the principle of pacta sunt servanda9, disallowing a favourable taxation regime to companies situated in ‘same circumstance’10 may ipso facto be a ground for invocation of the non-discrimination principles11 justifying the need of a carve-out under Article 14(2) in the first place. While there is a carve-out in Article 26(5) of the Treaty, for the rate of tax, the general principles of non-discrimination in Article 26 of the Treaty are still in force. The application of general principles is not estopped but is only subject to the carve-out. Thus, principles under Article 26(1) and (2) still apply. This implies that the Contracting State, i.e., India is still obliged to provide taxation which is not ‘other or burdensome’ or ‘less favourable’ to the residents of the United States. Discrimination is to be seen not only from the viewpoint of Indian law but what the two sovereigns agreed on at the time of signing of the Treaty. This includes ‘indirect’ discrimination12, which appears to be precisely the fallout of adopting a concessional tax regime13 only for domestic taxpayers; putting the residents of the other Contracting State at a significant disadvantage. This prima facie seems to violate the non-discrimination provisions of the Treaty notwithstanding the carve-out.
7 118 TTJ 619
8 129 ITD 145 (Ahd. Trib. – SB)
9 Supreme Court of India recognized the customary status of the Vienna Convention despite India not having ratified the convention yet. The courts in India have been leaning towards the principles of pacta sunt servanda and general rules of interpretation of a treaty, as contained in the Vienna convention to embrace good faith compliance. See, Ram Jethmalani v. Union of India, (2011) 9 SCC 751
10 Non-Indian banks carry out the same activity as Indian banks, ABN Amro Bank N.V v. JCIT, ITA 692/Cal./2000
11 OECD MTC 2017 C-24, para 44, 45 – “As such measures are in furtherance of objectives directly related to the economic activity proper of the State concerned, it is right that the benefit of them should be extended to permanent establishments of enterprises of another State which has a double taxation convention with the first embodying the provisions of Article 24, once they have been accorded the right to engage in business activity in that State, either under its legislation or under an international agreement (treaties of commerce, establishment conventions, etc.) concluded between the two States….It should, however, be noted that although non-resident enterprises are entitled to claim these tax advantages in the State concerned, they must fulfil the same conditions and requirements as resident enterprises.”
12 Id., para 1, 56 “When the taxation of profits made by companies which are residents of a given State is calculated according to a progressive scale of rates, such a scale should, in principle, be applied to permanent establishments situated in that State”
13 Id., para 15 Subject to the foregoing observation, the words “...shall not be subjected...to any taxation or any requirement connected therewith which is other or more burdensome ...” mean that when a tax is imposed on nationals and foreigners in the same circumstances, it must be in the same form as regards both the basis of charge and the method of assessment, its rate must be the same and, finally, the formalities connected with the taxation (returns, payment, prescribed times, etc.) must not be more onerous for foreigners than for nationals.
C. Explanation 1 to section 90 of the Act – whether valid a defence?
Explanation 1 to section 90 of the Act inserted in 2001 with retrospective effect from April 1, 1962, envisages that rate of tax cannot by itself imply less favourable (term used by the Act, akin non-discrimination in the Treaty) treatment to a non-resident. Should this explanation be accepted it would amount to a treaty override. As originally inserted the Explanation acknowledged its existence owing to the difference in the tax treatment of a domestic corporation (in that the domestic corporations in addition to corporate tax pay dividend distribution tax) vis-à-vis a foreign corporation (which only pays corporate tax). Since then the position has changed and the Explanation has been amended. Now it does not mention any ‘reason’ for such treatment.
OECD in its 1989 report on treaty override specifically states that domestic legislation (whether inserted before or after the commencement of the Treaty) in no way affects the continuing international obligation of a State unless it has been specifically denounced14. In this context, the Hon’ble Supreme Court of India in the famous Azadi Bachao15 case held that that a Treaty overrides the provisions of the Act in the matter of ascertainment of income and its chargeability to tax, to the extent of inconsistency with the terms of the Treaty. This view has been reiterated by the judiciary multiple times16. The reasoning behind this principle is to curtail amendments to an international obligation through unilateral measures – something that we have been grappling with in the digital space!
14 See, OECD Report of 1989 on Tax treaty override, para 12
15 Azadi Bachao Andolan v. Union of India, (2003) 184 CTR (SC) 450
16 By virtue of Clause 24(2) of the said agreement and the statutory recognition thereof in section 90(2) of the Act, the permanent establishment of a Japanese entity in India could not have been charged tax at a rate higher than comparable Indian assessees carrying on the same activities. Bank of Tokyo Mitsubishi Ltd. v. Commissioner of Income-tax [2019] 108 taxmann.com 242 (Calcutta), para 5
Pertinently, the Andhra Pradesh High Court in the case of Sanofi Pasteur Holding SA v. Department of Revenue, Ministry of Finance: 354 ITR 316 (AP) gave due consideration to the question whether a retrospective amendment in the domestic law could be considered in interpretation of the tax treaty. The Court while holding tax treaty supremacy referred to the general rule of interpretation postulated in the Vienna Convention and observed as under:
“…Treaty-making power is integral to the exercise of sovereign legislative or executive will according to the relevant constitutional scheme, in all jurisdictions. Once the power is exercised by the authorized agency (the legislature or the executive, as the case may be) and a treaty entered into, provisions of such treaty must receive a good faith interpretation by every authorized interpreter, whether an executive agency, a quasi-judicial authority or the judicial branch. The supremacy of tax treaty provisions duly operationalised within a contracting State [which may (theoretically) be disempowered only by explicit and appropriately authorized legislative exertions], cannot be eclipsed by employment of an interpretive stratagem, on misconceived and ambiguous assumption of revenue interests of one of the contracting States. Where the operative treaty’s provisions are unambiguous and their legal meaning clearly discernible and lend to an uncontestable comprehension on good faith interpretation, no further interpretive exertion is authorized; for that would tantamount to usurpation (by an unauthorized body – the interpreting Agency/Tribunal), intrusion and unlawful encroachment into the domain of treaty-making under Article 253 (in the Indian context), an arena off-limits to the judicial branch; and when the organic Charter accommodates no participatory role, for either the judicial branch or the executors of the Act.”
On the other hand, it may be argued at the instance of the Revenue that Explanation 1 to section 90 is a specific provision aimed at providing different tax regimes for domestic companies vis-à-vis foreign companies. In Chohung Bank17, the Tribunal accepted that there is no conflict between Explanation 1 to section 90 and the India-Korea Tax Treaty. The Court inter-alia observed that the Explanation confirms the proposition that rates of taxes, which are provided under the Finance Act, as opposed to the Act, are out of the purview of the general rule under the Act – provisions to the extent they are more beneficial shall apply to a taxpayer.
17 12 SOT 301 (Mum – Trib.) relying on previous Tribunal order in ITA No. 4948/Mum/05
However, it may not be out of place to mention that the annual tax rates, which are decided as per section 4 of the Act, provide that where a Central Act enacts that income-tax it shall be charged at that rate or those rates in accordance with and subject to the provisions of the Act. Thus, the rates of taxes are subject to the provisions of the Act.
In an AAR Ruling Transworld Garnet Co. Ltd., In Re18 it was observed that terms “taxation” and “tax” are not interchangeable. The AAR went on to observe that the object clause of every agreement uses the expression “taxation” and “tax” where the purpose is stated to be “avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income or wealth”. Further, drawing contradistinction between the two expressions, the AAR held that where the rate of tax is the focus, the language used is “tax so charged shall not exceed”. The discrimination against taxation, therefore, means the procedures by which tax is imposed. While I may not entirely agree with the said proposition, it would still aid the taxpayer since Article 14(2) of the Treaty specifically uses the term “tax rate”.
In Sampath Iyengar’s Law of Income Tax19, the learned author has enunciated that giving effect to Explanation 1 contained in section 90 of the Act, would tantamount to a breach of the non-discrimination clause where the tax treaties themselves mention the differential tax rates. The author has observed:
“…This is a live issue, since a mere provision in domestic law will hardly help without such clarification in the anti-discrimination clause in the Agreement, where India has such an agreement. The solution lies in incorporating this understanding to be explicitly made as part of the Agreement to avoid such controversy. In other words, the Agreement, should itself indicate, whether discrimination is only with reference to nationality or otherwise and whether the differential rate of tax on residents would construe discrimination.”
18. 333 ITR 1
19. 12 Edn. at page 8562
It may further be apposite to state that in the context of discrimination on account of rate of tax, tax treaties signed by India with certain countries such as the UK, Germany, Canada, Russia etc. specifically permit taxation of PE at a rate higher than the rate applicable to domestic companies. In certain tax treaties, however, the tax treaties themselves provide an upper limit/ place a cap on the tax rate. Refer Annexure for the relevant Articles of the respective tax treaties.
Thus, where the Treaty itself acknowledges that the tax rate differential shall not exceed 15 percentage points, following the precedents as laid down by the Supreme Court, the taxpayer has a good case to defend that Explanation 1 shall not override the provisions of the Treaty20. Good faith interpretation as enunciated by VCLT necessitates the treaty provisions to be good law.
D. Prescribed Arrangement under section 2(22A) of the Act – an open question
The Mumbai Bench of the Tribunal in the case of ITO v. Decca Survey Overseas Ltd21 had observed that in absence of a notified “prescribed arrangement” as provided under section 2(22A) of the Act, Explanation 1 to section 90 would not come in the way for the non-resident companies to claim tax rates equal to the resident companies. Thereafter, Rule 27 of the (Indian) Income-tax Rules, 1962 (“the Rules”) was inserted.
20 The priority of two provisions of the same rank can be achieved by the interpretation rules of lex specialis derogate legi generali and lex generalis posterior non-derogat legi speciali priori. The tax treaty provision is seen as the more special provision.
21 ITA No. 3604/Bom/94 dated 27.02.2004
Rule 27 has been reproduced below for easy reference:
“Prescribed arrangements for declaration and payment of dividends within India.
27. The arrangements referred to in sections 194 and 236 to be made by a company for the declaration and payment of dividends (including dividends on preference shares) within India shall be as follows:
(1) The share register of the company for all shareholders shall be regularly maintained at its principal place of business within India, in respect of any assessment year from a date not later than the 1st day of April of such year.
(2) The general meeting for passing the accounts of the previous year relevant to the assessment year and for declaring any dividends in respect thereof shall be held only at a place within India.
(3) The dividends declared, if any, shall be payable only within India to all shareholders.”
The same has been relied upon by the Mumbai Bench of the Tribunal in the case of Shinhan Bank v. DCIT22 to hold that a foreign company could carry out the “prescribed arrangement” to be eligible to be classified as a domestic corporation and hence held that there was no discrimination per se in differential rates of tax.
The observation of the Tribunal are as under:
“As a matter of fact, the terminology used, so far as the tax rate for companies is concerned, in the finance Acts is “domestic company” and “a company other than a domestic company?. Under section 2(22A), a domestic company is defined as “an Indian company or any other company, which in respect of its income liable to tax in India makes prescribed arrangements for declaration and payment of dividends within India”, and Section 2(23A), a foreign company is defined as a company “which is not a domestic company” i.e. which has not made prescribed arrangements for declaration and payment of dividends in India. The basis of different tax rates being applied is thus not the situs of fiscal domicile or incorporation but simply the arrangement for making arrangements for the declaration of payment of dividends within India.”
“If a non-resident company can make arrangements for the declaration and payment of dividends, out of income earned in India, in India, that non-resident company will be subjected to the same rate of tax which is levied on the Indian companies. The taxation of the foreign companies at a higher rate therefore at a higher rate vis-à-vis the domestic companies is thus not considered to be discriminatory vis-à-vis the foreign companies. The sharp contrast in the definition of a foreign company under section 2(23A) vis-à-vis the definition of a non-resident company under section 6(3) makes it clear that so far as the charge of tax is concerned, the critical factor is the situs of the control and management of a company, but so far as the rate of tax is concerned, the critical factor is the arrangements for the declaration of dividends out of income earned in India. Clearly, thus, the mere fact that a company which has not made “arrangements for the declaration of dividends out of income earned in India” is charged at a higher rate of tax in India vis-à-vis domestic company, cannot be treated as discrimination on account of the fact that the enterprise belonged to the other Contracting State, i.e. Korea.”
At first glance, the prescribed arrangement does not seem “other or more burdensome” since even domestic companies are required to withhold tax on dividend payments. However, the above reasoning leaves many open questions:
- The US Company would arguably consolidate its earnings at the US level, it would merit consideration whether the US or any other country of residence of such shareholder grants Foreign Tax Credit (“FTC”) on account of taxes withheld in India.
To elaborate, say a US Company has shareholders which are either US-based or based outside the US, Canada for instance. The US company enters into a prescribed arrangement to withhold taxes on account of dividend payments to its shareholders (qua income derived from India), however would the residence country of the shareholders (Canada in this case) grant FTC to these shareholders on account of taxes withheld in India? Or would the same be in accordance with the Convention between US and Canada (in our illustration). Without the grant of FTC, this arrangement may palpably result in double taxation, which is the first objective, the Tax Treaty is aimed to mitigate!
- Where the US Company enters into the prescribed arrangement and is classified as a domestic company, Revenue in India may allege that as a domestic company, the US Company is not entitled to the benefits of the Treaty.
- Since dividend payments are taxable at the level of the shareholder (as opposed to perhaps a dividend distribution tax) is the prescribed arrangement proportionate to the object sought to be achieved? Especially since payment of tax on dividends is a vicarious liability for the US Company.
- Since Rule 27 would apply regardless of the tax treaty in question, there may be a situation where the corporate law, in the other Contracting State, may restrict moving the share register/ holding a general meeting for passing the accounts, outside that jurisdiction, which is the essence under Rule 27. In that situation, fulfillment of conditions specified in Rule 27 may become an impossibility. Would Rule 27, in that case, be read down?
A similar controversy is pending before the Hon’ble Delhi High Court in the case of Gokwik Commerce Solutions v. DCIT23 wherein the taxpayer has contended that it was a recently incorporated entity and hence could not fulfill the strict conditions, for obtaining lower withholding certificate, specified under Rule 28AA which require the filing of financial statements for four previous years.
E. Effect of breach of the treaty obligation
Tax Treaties do not usually provide for remedies in cases of breach24 since treaties are essentially agreements entered into by sovereign states25. In Sanchez-Llamas v. Oregon,26 the Supreme Court of the United States opined that “where a treaty does not provide a particular remedy, either expressly or implicitly, it is not for the federal courts to impose one on the States through law making of their own.”27. Closer home, in T Rajkumar v. Union of India28, the issue under consideration before the Hon’ble Madras High Court was the constitutional validity of section 94A of the Act and notification and circular issued thereunder, specifying Cyprus as a notified jurisdiction area for the purposes of section 94A of the Act. As per the provisions under section 94A, the executive is empowered to notify any country as a notified jurisdictional area having regard to the other country’s lack of effective exchange of information.
The petitioners in the case, inter alia, argued that basis the doctrine of pacta sunt servanda, the executive could not invoke municipal/ internal law to annul the provisions of a tax treaty. The Court did not entertain the said plea where there was a breach of an obligation from a treaty partner. The Court, inter alia, observed:
“88. But, even if we invoke the rule of Pacta Sunt Servanda contained in Article 26 of the Vienna Convention, on the basis that the same was part of the customary international law, the petitioners would not be better off. This is for the reason that Article 26 of the Vienna Convention obliges both the contracting parties to perform their obligations in good faith. As pointed out earlier, one of the four purposes for which, an agreement could be entered into by the Central Government under Section 90(1), is for the exchange of information. If one of the parties to the Treaty fails to provide necessary information, then such a party is in breach of the obligation under Article 26 of the Vienna Convention. The beneficiary of such a breach of obligation by one of the contracting parties (like the assessee herein) cannot invoke the Vienna Convention to prevent the other contracting party (India in this case) from taking recourse to internal law, to address the issue.”
22 ITA No. 2227 & 2229/Mum/2017 and 139 taxmann.com 563
23 WP (C) No. 199/202, order dated 09.01.2023
24 Lord Arnold McNair, The Law of Treaties 574 (1961)
25 Id.
26 Sanchez-Llamas v. Oregon, 126 S. Ct. 2669 (2006)
27 Id. at 2680
28 239 Taxman 283 (Mad.)
Therefore, while the Treaty does not enlist any repercussion/ fall out of breach of a tax treaty by a Contracting State, an inference may be drawn from the above precedent in T Rajkumar (supra), that the other Contracting State (in this case, United States) is free to utilize its domestic law to remedy the situation and the same would not fall foul of international commitments.
View 1: In light of the preceding, once the ostensible breach takes place and is continuing it may logically follow that the corporate tax rate afforded to a US corporation operating in India should be equal to the domestic (concessional) tax rate as adjusted by the differential as provided in Article 14(2) of the Treaty.
View 2: Article 14(2) is akin to a proviso to Article 26 of the Treaty. Essentially, a concession given by the United States to India on a good-faith basis. The words used, as described in preceding paragraphs, is ‘[the] existing tax rate’, implying thereby that the differential was needed to be maintained with reference to the time of the entry of the Treaty29.
29 Bank of America v. Deputy Commissioner of Income-tax, [2001] 78 ITD 1 (Mumbai)
To take an analogy, in cases of commercial contracts, the offending parts would be severed and the rest would stand up. More generally called the blue pencil doctrine. It owes its existence in the time when Courts were called in question to adjudge equities, where the Court would not re-write the contract but severe the unenforceable clauses. Though the blue pencil doctrine is not an absolute proposition it is generally applied in commercial contracts and finds its statutory basis in the Indian Contract Act, 1872.
The offending part is the proviso to Article 26 and therefore till the existence or continuance of the breach, a view may be taken that the proviso, since it is severed, has no legal effect. In other words, and to borrow constitutional law principles, the clause stands eclipsed till the time the breach is remedied. Once remedied the clause may spring back, however, till such time, the clause has no legal validity.
Assuming therefore, once the ostensible breach takes place and is continuing it would follow that the corporate tax rate afforded to a US corporation operating in India should be equal to the domestic tax rate. This rate should not automatically be adjusted by 15 percentage points since the existence of this particular clause stands severed till the time the breach continues. Sequitur, parity should subsist and the full breadth and scope of the non-discrimination clause should apply to US corporations in ‘same circumstances’ as their domestic counterparts.
The US may adopt the above route/ interpretation and may issue a notification for the same, and in accordance with the precedent in T Rajkumar (supra) till the time the treaty breach survives the said notification would be valid.
III. CONCLUSION
This commentary remains a work in progress and only scratches the surface. The heart of the matter is on first principles – ensuring non-discrimination. The non-discrimination clause of a tax treaty is one of the most important protections that is afforded to non-resident investors. As Rowlatt J. wrote ‘in taxing statute one has to merely look at what is clearly said’30. I hope we start to see more through the lens of the great judge. In the same measure, a global convergence is required in principles of tax treaty interpretation and following observations of the Tribunal in the case of Meera Bhatia v. ITO31 serve as a ready reckoner to that ideal:
“7. In legal matters like interpretation of international tax treaties and with a view to ensure consistency in judicial interpretation thereof under different tax regimes, it is desirable that the interpretation given by the foreign courts should also be given due respect and consideration unless, of course, there are any contrary decisions from the binding judicial forums or unless there are any other good reasons to ignore such judicial precedents of other tax regimes. The tax treaties are more often than not based on the models developed by the multilateral forums and judicial bodies in the regimes where such models are being used to get occasions to express their views on expressions employed in such models. It is only when the views so expressed by judicial bodies globally converge towards a common ground that an international tax language as was visualized by Hon’ble Andhra Pradesh High Court in the case of CIT v. Vishakhapatnam Port Trust [1983] 144 ITR 1461, can truly come into existence, because unless everyone, using a word, or a set of words, in a language, does not understand it in the same manner, that language will make little sense.”
30 Cape Brandy Syndicate v I.R.C. (1 KB 64, 71)
31 38 SOT 95 (Mum. – Trib.)
Annexure
- India – UK Tax Treaty provides:
“ARTICLE 26
NON-DISCRIMINATION
1. The nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.
2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favorably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities in the same circumstances or under the same conditions. This provision shall not be construed as preventing a Contracting State from charging the profits of a permanent establishment which an enterprise of the other Contracting State has in the first-mentioned State at a rate of tax which is higher than that imposed on the profits of a similar enterprise of the first-mentioned Contracting State, nor as being in conflict with the provisions of paragraph 4 of Article 7 of this Convention.”
- India – Germany Tax Treaty carries similar verbiage:
“ARTICLE 24
NON-DISCRIMINATION
1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances and under the same conditions are or may be subjected. This provision shall, notwithstanding the provisions of Article 1, also apply to persons who are not residents of one or both of the Contracting States.
2. The taxation of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This provision shall not be construed as preventing a Contracting State from charging the profits of a permanent establishment which a company of the other Contracting State has in the first-mentioned State at a rate of tax which is higher than that imposed on the profits of a similar company of the first-mentioned Contracting State, nor as being in conflict with the provisions of paragraph 3 of Article 7 of this Agreement. Further, this provision shall not be construed as obliging Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes which it grants only to its own residents.”
- India – Canada Tax Treaty provides a cap on rate of tax:
“ARTICLE 24
NON-DISCRIMINATION
1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.
2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.
3. Nothing in this Article shall be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents.
4. (a) Nothing in this Agreement shall be construed as preventing Canada from imposing on the earnings of a company, which is a resident of India, attributable to a permanent establishment in Canada, a tax in addition to the tax which would be chargeable on the earnings of a company which is a national of Canada, provided that any additional tax so imposed shall not exceed the rate specified in sub-paragraph 2(a) of Article 10 of the amount of such earnings which have not been subjected to such additional tax in previous taxation years. For the purpose of this provision, the term ‘earnings’ means the profits attributable to a permanent establishment in Canada in a year and previous years after deducting therefrom all taxes, other than the additional tax referred to herein, imposed on such profits by Canada.
The provisions of this sub-paragraph shall also apply with respect to earnings from the disposition of immovable property situated in Canada by a company carrying on a trade in immovable property without a permanent establishment in Canada but only insofar as these earnings may be taxed in Canada under the provisions of Article 6 or paragraph 2 of Article 13.
(b) A company which is a resident of Canada may be subject to tax in India at a rate higher than that applicable to Indian domestic companies. The difference in tax rate shall not, however, exceed 15 percentage points.”
- India – Russia Tax Treaty provides a similar cap though more beneficial to the taxpayer:
“PROTOCOL
TO THE AGREEMENT BETWEEN THE GOVERNMENT OF THE REPUBLIC OF INDIA AND THE GOVERNMENT OF THE RUSSIA FEDERATION FOR THE AVOIDANCE OF DOUBLE TAXATION WITH RESPECT TO TAXES ON INCOME
The Government of the Republic of India and the Government of the Russian Federation, Having regard to the Agreement between the Government of the Republic of India and the Government of the Russian Federation for the avoidance of double taxation with respect to taxes on income signed today (in this Protocol called “the Agreement”),
Have agreed as follows :
1. …………….
3. Notwithstanding the provisions of paragraph 2 of Article 24 of this Agreement, either Contracting State may tax the profits of a permanent establishment of an enterprise of the other Contracting State at a rate which is higher than that applied to the profits of a similar enterprise of the first-mentioned Contracting State. It is also provided that in no case the differences in the two rates, referred to above will exceed 12 percentage points.”
