CASE NO.:
Appeal (civil) 8161-8162 of 2003
Appeal (civil) 8163-8164 of 2003
PETITIONER:
Union of India and Anr.
RESPONDENT:
Azadi Bachao Andolan and Anr.
DATE OF JUDGMENT: 07/10/2003
BENCH:
Ruma Pal & B.N. Srikrishna.
JUDGMENT:
J U D G M E N T
(Arising out of S.L.P.(C) Nos.20192-20193 of 2002)
(@ S.L..P.(C) Nos. 22521-22522 of 2002)
SRIKRISHNA,J.
Leave granted.
These appeals by special leave arise out of the judgment of
the Division Bench of Delhi High Court allowing Civil Writ
Petition (PIL)No.5646/2000 and Civil Writ Petition No.2802/2000.
The High Court by its judgment impugned in these appeals
quashed and set aside the circular No.789 dated 13.4.2000 issued
by the Central Board of Direct Taxes (hereinafter referred to as
"CBDT") by which certain instructions were given to the Chief
Commissioners/Directors General of Income-tax with regard to the
assessment of cases in which the Indo - Mauritius Double
Taxation Avoidance Convention, 1983 (hereinafter referred to as
'DTAC') applied. The High Court accepted the contention before
it that the said circular is ultra vires the provisions of Section 90
and Section 119 of the Income-tax Act, 1961(hereinafter referred
to as 'the Act') and also otherwise bad and illegal.
It would be necessary to recount some salient facts in order
to appreciate the plethora of legal contentions urged.
FACTS
A: The Agreement
The Government of India has entered into various
Agreements (also called Conventions or Treaties) with
Governments of different countries for the avoidance of double
taxation and for prevention of fiscal evasion. One such Agreement
between the Government of India and the Government of
Mauritius dated April 1, 1983, is the subject matter of the present
controversy. The purpose of this Agreement, as specified in the
preamble, is "avoidance of double taxation and the prevention of
fiscal evasion with respect to taxes on income and capital gains
and for the encouragement of mutual trade and investment". After
completing the formalities prescribed in Article 28 this agreement
was brought into force by a Notification dated 6.12.1983 issued in
exercise of the powers of the Government of India under Section
90 of the Act read with Section 24A of the Companies (Profits)
Surtax Act, 1964. As stated in the Agreement, its purpose is to
avoid double taxation and to encourage mutual trade and
investment between the two countries, as also to bring an
environment of certainty in the matters of tax affairs in both
countries.
Some of the salient provisions of the Agreement need to be
noticed at this juncture. The Agreement defines a number of terms
used therein and also contains a residuary clause. In the
application of the provisions of the Agreement by the contracting
States any term not defined therein shall, unless the context
otherwise requires, have the meaning which it has under the laws
in force in that contracting State, relating to the words which are
the subject of the convention. Article 1(e) defines 'person' so as to
include an individual, a company and any other entity, corporate or
non-corporate "which is treated as a taxable unit under the
taxation laws in force in the respective contracting States". The
Central Government in the Ministry of Finance (Department of
Revenue), in the case of India, and the Commissioner of Income
Tax in the case of Mauritius, are defined as the "competent
authority". Article 4 provides the scope of application of the
Agreement. The applicability of the Agreement is determined by
Article 4 which reads as under;
"Article 4 Residents
1. For the purposes of the Convention, the term
"resident of a Contracting State" means any person
who under the laws of that State, is liable to
taxation therein by reason of his domicile,
residence, place or management or any other
criterion of similar nature. The terms "resident of
India" and "resident of Mauritius" shall be
construed accordingly.
2. Where by reason of the provisions of
paragraph 1, an individual is a resident of both
Contracting States, then his residential status for
the purposes of this Convention shall be
determined in accordance with the following rules:
(a) he shall be deemed to be a resident of
the Contracting State in which he has
a permanent home available to him; if
he has a permanent home available to
him in both Contracting States, he
shall be deemed to be a resident of the
Contracting State with which his
personal and economic relations are
closer (hereinafter referred to as his
"centre of vital interests");
(b) if the Contracting State in which he
has his centre of vital interest cannot
be determined, or if he does not have
a permanent home available to him in
either Contracting State he shall be
deemed to be a resident of the
Contracting State in which he has an
habitual abode;
(c) if he has an habitual abode in both
Contracting States or in neither of
them, he shall be deemed to be a
resident of the Contracting State of
which he is a national;
(d) if he is a national of both Contracting
States or of neither of them, the
competent authorities of the
Contracting States shall settle the
question by mutual agreement.
3. Where by reason of the provision of
paragraph 1, a person other than an individual is a
resident of both the Contracting States, then it shall
be deemed to be a resident of the Contracting State
in which its place of effective management is
situated."
The Agreement provides for allocation of taxing jurisdiction
to different contracting parties in respect of different heads of
income. Detailed rules are stipulated with regard to taxing of
Dividends under Article 10, interest under Article 11, Royalties
under Article 12, Capital Gains under Article 13, income derived
from Independent Personal Services in Article 14, income from
Dependent Personal Services in Article 15, Directors' Fees in
Article 16, income of Artists and Athletes in Article 17,
Governmental Functions in Article 18, income of students and
Apprentices in Article 20, income of Professors, Teachers and
Research Scholars in Article 21, and other income in Article 22.
Article 13 deals with the manner of taxation of capital gains.
It provides that gains from the alienation of immovable
property may be taxed in the Contracting State in which such
property is situated. Gains derived by a resident of a Contracting
State from the alienation of movable property, forming part of
the business property of a permanent establishment which an
enterprise of a Contracting State has in the other Contracting
State, or of movable property pertaining to a fixed base available
to a resident of a Contracting State in the other Contracting State
for the purpose of performing independent personal services,
including such gains from the alienation of such a permanent
establishment, may be taxed in that other State. Gains from the
alienation of ships and aircraft operated in international traffic and
movable property pertaining to the operation of such ships and
aircraft, shall be taxable only in the Contracting State in which the
place of effective management is situated. With respect to capital
gain derived by a resident in the Contracting State from the
alienation of any property other than the aforesaid is concerned, it
is taxable only in the State in which such a person is a 'resident'.
Article 25 lays down the Mutual Agreement Procedure. It
provides that where a resident of a Contracting State considers
that the actions of one or both of the Contracting State result or
will result for him in taxation not in accordance with this
Convention, he may, notwithstanding the remedies provided by
the national laws of those States, present his case to the competent
authority of the Contracting State of which he is a resident. This
case must be presented within three years of the date of receipt of
notice of the action which gives rise to taxation not in accordance
with the Convention. Thereupon, if the objection appears to be
justified, the competent authority shall attempt to resolve the case
by mutual agreement with the competent authority of the other
Contracting State so as to avoid a situation of taxation not in
accordance with the convention. This Article also provides for
endeavour by the competent authorities of the Contracting States
to resolve by mutual agreement any difficulties or doubts arising as
the interpretation or application of the convention. For this
purpose, the convention contemplates continuous or periodical
communication between the competent authorities of the
Contracting States and exchange of views and opinions.
B : The Circulars
By a Circular No.682 dated 30.3.1994 issued by the CBDT
in exercise of its powers under Section 90 of the Act, the
Government of India clarified that capital gains of any resident of
Mauritius by alienation of shares of an Indian company shall be
taxable only in Mauritius according to Mauritius taxation laws and
will not be liable to tax in India. Relying on this, a large number
of Foreign Institutional Investors s (hereinafter referred to as "the
FIIs"), which were resident in Mauritius, invested large amounts of
capital in shares of Indian companies with expectations of making
profits by sale of such shares without being subjected to tax in
India. Sometime in the year 2000, some of the income tax
authorities issued show cause notices to some FIIs functioning in
India calling upon them to show cause as to why they should not
be taxed for profits and for dividends accrued to them in India.
The basis on which the show cause notice was issued was that the
recipients of the show cause notice were mostly 'shell companies'
incorporated in Mauritius, operating through Mauritius, whose
main purpose was investment of funds in India. It was alleged that
these companies were controlled and managed from countries
other than India or Mauritius and as such they were not
"residents" of Mauritius so as to derive the benefits of the DTAC.
These show cause notices resulted in panic and consequent hasty
withdrawal of funds by the FIIs. The Indian Finance Minister
issued a Press note dated April 4, 2000 clarifying that the views
taken by some of the income-tax officers pertained to specific
cases of assessment and did not represent or reflect the policy of
the Government of India with regard to denial of tax benefits to
such FIIs.
Thereafter, to further clarify the situation, the CBDT issued
a Circular No.789 dated 13.4.2000. Since this is the crucial
Circular, it would be worthwhile reproducing its full text. The
Circular reads as under:
"Circular No.789
F.No.500/60/2000-FTD
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
DEPARTMENT OF REVENUE
CENTRAL BOARD OF DIRECT TAXES
New Delhi, the 13th April, 2000
To
All the Chief Commissioners/ Directors
General of Income-tax
Sub: Clarification regarding taxation of income
from dividends and capital gains under the
Indo-Mauritius Double Tax Avoidance
Convention (DTAC) - Reg.
The provisions of the Indo-Mauritius DTAC
of 1983 apply to 'residents' of both India and
Mauritius . Article 4 of the DTAC defines a
resident of one State to mean any person who,
under the laws of that State is liable to taxation
therein by reason of his domicile, residence,
place of management or any other criterion of a
similar nature. Foreign Institutional Investors and
other investment funds etc. which are operating
from Mauritius are invariably incorporated in
that country. These entities are 'liable to tax'
under the Mauritius Tax law and are therefore to
be considered as residents of Mauritius in
accordance with the DTAC.
Prior to 1st June, 1997, dividends distributed
by domestic companies were taxable in the hands
of the shareholder and tax was deductible at
source under the Income-tax Act, 1961. Under
the DTAC, tax was deductible at source on the
gross dividend paid out at the rate of 5% or 15%
depending upon the extent of shareholding of the
Mauritius resident. Under the Income-tax Act,
1961, tax was deductible at source at the rates
specified under section 115A etc. Doubts have
been raised regarding the taxation of dividends
in the hands of investors from Mauritius. It is
hereby clarified that wherever a Certificate of
Residence is issued by the Mauritian Authorities,
such Certificate will constitute sufficient
evidence for accepting the status of residence as
well as beneficial ownership for applying the
DTAC accordingly.
The test of residence mentioned above
would also apply in respect of income from
capital gains on sale of shares. Accordingly, FIIs
etc., which are resident in Mauritius would not be
taxable in India on income from capital gains
arising in India on sale of shares as per paragraph
4 of article 13.
The aforesaid clarification shall apply to all
proceedings which are pending at various levels."
C: The Writ Petitions
Circular No. 789 was challenged before the High Court of
Delhi by two writ petitions, both said to be by way of Public
Interest Litigation. The petitioner in CWP 2802 of 2000 (Azadi
Bachao Andolan) prayed for quashing and declaring as illegal and
void Circular No.789 dated 13.4.2000 issued by the CBDT. The
petitioner in CWP 5646 of 2000 sought an appropriate
direction/order or writ to the Central Government and made the
following prayers:
"(a) issue such appropriate direction /order / writ
as the Court deem proper, under the circumstances
brought to the knowledge of the Hon'ble Court, to the
Central Government to initiate a process whereby the
terms of the Indo-Mauritius Double Taxation
Avoidance Agreement are revised, modified, or
terminated and /or effective steps taken by the High
Contracting Parties so that the NRIs and FIIs and such
other interlopers do not maraud the resources of the
State.
(b) declare and delimit the powers of the
Central Government under section 90 of the Income
Tax Act, 1961 in the matter of entering into an
agreement with the Government of any country
outside India;
(c) declare and delimit the powers of the
Central Board of Direct Taxes in the matter of the
issuance of instructions through circulars to the
statutory authorities under the Income tax Act,
specially through such circulars which are beneficial
to certain individual taxpayers but injurious to Public
Interest.
(d) declare the illegality of Circular No.789 of
April 13, 2000 issued by the Central Board of Direct
Taxes and to quash it as a matter of consequence;
(e) issue mandamus so that the respondents
discharge their statutory duties of conducting
investigation and collection of tax as per law;
(f) issue appropriate direction/ order or writ of
the nature of mandamus, as the Court deem fit, so that
all remedial actions to undo the effects of the acts
done to the prejudice or Revenue in pursuance of
Circular No.789 are taken by the authorities under the
Income tax Act, 1961"
D : High Court's findings
The High Court has quashed the circular on the following
broad grounds:
(A) Prima facie, by reason of the impugned circular no direction
has been issued. The circular does not show that it has been issued
under section 119 of the Income-tax Act, 1961 and as such it
would not be legally binding on the Revenue;
(B) The Central Board of Direct Taxes cannot issue any
instruction, which would be ultra vires the provisions of the
Income-tax Act, 1961. Inasmuch as the impugned circular directs
the income-tax authorities to accept a certificate of residence
issued by the authorities of Mauritius as sufficient evidence as
regards status of resident and beneficial ownership, it is ultra vires
the powers of the CBDT;
(C) The Income-tax Officer is entitled to lift the corporate veil in
order to see whether a company is actually a resident of Mauritius
or not and whether the company is paying income-tax in Mauritius
or not and this function of the Income-tax Officer is quasi-judicial.
Any attempt by the CBDT to interfere with the exercise of this
quasi-judicial power is contrary to intendment of the Income-tax
Act.
(D) Conclusiveness of a certificate of residence issued by the
Mauritius Tax Authorities is neither contemplated under the
DTAC, nor under the Income-tax Act; whether a statement is
conclusive or not, must be provided under a legislative enactment
such as the Indian Evidence Act and cannot be determined by a
mere circular issued by the CBDT;
(E) "Treaty Shopping", by which the resident of a third country
takes advantage of the provisions of the Agreement, is illegal and
thus necessarily forbidden;
(F) Section 119 of the Income-tax Act, 1961 enables the
issuance of a circular for a strictly limited purpose. By a circular
issued thereunder, neither can the essential legislative function be
delegated, nor arbitrary, uncanalized or naked power be conferred;
(G) Political expediency cannot be a ground for not fulfilling the
constitutional obligations inherent in the Constitution of India and
reflected in section 90 of the Act. The circular confers power to
lay down a law which is not contemplated under the Act on the
ground of political expediency, which cannot but be ultra vires.
(H) Any purpose other than the purpose contemplated by section
90 of the Act, however bona fide it be, would be ultra vires the
provisions of section 90 of the Income tax Act.
(I) While political expediency will have a role to play in terms
of Article 73 of the Constitution, the same is not true when a
Treaty is entered into under the statutory provision like section 90
of the Act.
(J) Avoidance of double taxation is a term of art and means that
a person has to pay tax at least in one country; avoidance of double
taxation would not mean that a person does not have to pay tax in
any country whatsoever.
(K) Having regard to the law laid down by the Supreme Court in
McDowell & Company v C.T.O , it is open to the Income-tax
Officer in a given case to lift the corporate veil for finding out
whether the purpose of the corporate veil is avoidance of tax or
not. It is one of the functions of the assessing officer to ensure that
there is no conscious avoidance of tax by an assessee, and such
function being quasi-judicial in nature, cannot be interfered with or
prohibited. The impugned circular is ultra vires as it interferes with
this quasi judicial function of the assessing officer.
(L) By reason of the impugned circular the power of the
assessing authority to pass appropriate orders in this connection to
show that the assessee is a resident of a third country having only
paper existence in Mauritius, without any economic impact, only
with a view to take advantage of the double taxation avoidance
agreement, has been taken away.
THE SUBMISSIONS
The learned Attorney General and Mr. Salve, for the
appellants, have assailed the judgment of the Delhi High Court on
a number of grounds, while the respondents through Mr.Bhushan,
and in person, reiterated their submissions made before the High
Court and prayed for dismissal of these appeals.
Purpose and consequence of Double Taxation Avoidance
Convention
To appreciate the contentions urged, it would be necessary
to understand the purpose and necessity of a Double Taxation
Treaty, Convention or Agreement, as diversely called. The
Income-tax Act, 1961, contains a special Chapter IX which is
devoted to the subject of 'Double Taxation Relief".
Section 90, with which we are primarily concerned, provides
as under:
"90. Agreement with foreign countries.
(1) The Central Government may enter
into an agreement with the Government of any
country outside India-
(a) for the granting of relief in respect of
income on which have been paid both income-
tax under this Act and income-tax in that
country, 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,
and may, by notification in the Official Gazette,
make provisions as may be necessary for
implementing the agreement.
(2) Where the Central Government has
entered into an agreement with the Government
of any country outside India under sub-section
(1) for granting relief of tax, or as the case may
be, avoidance of double taxation, then, in
relation to the assessee to whom such
agreement applies, the provisions of this Act
shall apply to the extent they are more
beneficial to that assessee."
(Explanation omitted as not relevant)
Section 4 provides for Charge of Income-tax. Section 5
provides that the total income of a resident includes all income
which : (a) is received, deemed to be received in India or (b)
accrues, arises or deemed to accrue or arise in India, or (c) accrues
or arises outside India, during the previous year. In the case of a
non-resident, the total income includes "all income from whatever
source derived" which (a) is received or is deemed to be received
or, (b) accrues or is deemed to accrue in India, during such year. A
person 'resident' in India would be liable to income-tax on the
basis of his global income unless he is a person who is 'not
ordinarily' resident within the meaning of section 6(b). The
concept of residence in India is indicated in section 6. Speaking
broadly, and with reference to a company, which is of concern
here, a company is said to be 'resident' in India in any previous
year, if it is an Indian company or if during that year the control
and management of its affairs is situated wholly in India.
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 a permanent establishment, and so on. A country might choose
to emphasise one or the other of the aforesaid factors for exercising
fiscal jurisdiction to tax the entity. Depending on which of the
factors is considered to be the connecting factor in different
countries, the same income of the same entity might become liable
to taxation in different countries. This would give rise to harsh
consequences and impair economic development. In order to
avoid such an anomalous and incongruous situation, the
Governments of different countries enter into bilateral treaties,
Conventions or agreements for granting relief against double
taxation. Such treaties, conventions or agreements are called
double taxation avoidance treaties, conventions or agreements.
The power of entering into a treaty is an inherent part of the
sovereign power of the State. By article 73, subject to the
provisions of the Constitution, the executive power of the Union
extends to the matters with respect to which the Parliament has
power to make laws. Our Constitution makes no provision making
legislation a condition for the entry into an international treaty in
time either of war or peace. The executive power of the Union is
vested in the President and is exercisable in accordance with the
Constitution. The Executive is qua the State competent to represent
the State in all matters international and may by agreement,
convention or treaty incur obligations which in international law
are binding upon the State. But the obligations arising under the
agreement or treaties are not by their own force binding upon
Indian nationals. The power to legislate in respect of treaties lies
with the Parliament under entries 10 and 14 of List I of the Seventh
Schedule. But making of law under that authority is necessary
when the treaty or agreement operates to restrict the rights of
citizens or others or modifies the law of the State. If the rights of
the citizens or others which are justiciable are not affected, no
legislative measure is needed to give effect to the agreement or
treaty.
When it comes to fiscal treaties dealing with double
taxation avoidance, different countries have varying procedures.
In the United States such a treaty becomes a part of municipal law
upon ratification by the Senate. In the United Kingdom such a
treaty would have to be endorsed by an order made by the Queen
in Council. Since in India such a treaty would have to be
translated into an Act of Parliament, a procedure which would be
time consuming and cumbersome, a special procedure was evolved
by enacting section 90 of the Act.
The purpose of section 90 becomes clear by reference to its
legislative history. Section 49A of the Income-tax Act, 1922
enabled the Central Government to enter into an agreement with
the government of any country outside India for the granting of
relief in respect of income on which, both income-tax (including
super-tax) under the Act and income-tax in that country, under the
Income-tax Act and the corresponding law in force in that country,
had been paid. The Central Government could make such
provisions as necessary for implementing the agreement by
notification in the Official Gazette. When the Income-tax Act,
1961 was introduced, section 90 contained therein initially was a
reproduction of section 49A of 1922 Act. The Finance Act, 1972
(Act 16 of 1972) modified section 90 and brought it into force with
effect from 1.4.1972. The object and scope of the substitution was
explained by a circular of the Central Board of Taxes (No.108
dated 20.3.1973) as to empower the Central Government to enter
into agreements with foreign countries, not only for the purpose of
avoidance of double taxation of income, but also for enabling the
tax authorities to exchange information for the prevention of
evasion or avoidance of taxes on income or for investigation of
cases involving tax evasion or avoidance or for recovery of taxes
in foreign countries on a reciprocal basis. In 1991, the existing
section 90 was renumbered as sub-section(1) and sub-section(2)
was inserted by Finance Act, 1991 with retrospective effect from
April 1, 1972. CBDT Circular No. 621 dated 19.12.1991 explains
its purpose as follows:
"Taxation of foreign companies and other non-
resident taxpayers -
43. Tax treaties generally contain a provision
to the effect that the laws of the two contracting
States will govern the taxation of income in the
respective State except when express provision
to the contrary is made in the treaty. It may so
happen that the tax treaty with a foreign country
may contain a provision giving concessional
treatment to any income as compared to the
position under the Indian law existing at that
point of time. However, the Indian law may
subsequently be amended, reducing the
incidence of tax to a level lower than what has
been provided in the tax treaty.
43.1. Since the tax treaties are intended to
grant tax relief and not put residents of a
contracting country at a disadvantage vis-Ã -vis
other taxpayers, section 90 of the Income-tax
Act has been amended to clarify that any
beneficial provision in the law will not be
denied to a resident of a contracting country
merely because the corresponding provision in
the tax treaty is less beneficial."
The provisions of Sections 4 and 5 of the Act are expressly
made "subject to the provisions of this Act", which would include
Section 90 of the Act. As to what would happen in the event of a
conflict between the provision of the Income-tax Act and a
Notification issued under Section 90, is no longer res-integra.
The Andhra Pradesh High Court in Commissioner of
Income Tax v. Visakhapatnam Port Trust held that provisions of
section 4 and 5 of Income-tax Act are expressly made 'subject to
the provisions of the Act' which means that they are subject to
provisions of section 90. By necessary implication, they are
subject to the terms of the Double Taxation Avoidance Agreement,
if any, entered into by the Government of India. Therefore, the
total income specified in Sections 4 and 5 chargeable to income
tax is also subject to the provisions of the agreement to the
contrary, if any.
In Commissioner of Income Tax v. Davy Ashmore India
Ltd. , while dealing with the correctness of a circular no.333 dated
April 2, 1982, it was held that the conclusion is inescapable that in
case of inconsistency between the terms of the Agreement and the
taxation statute, the Agreement alone would prevail. The Calcutta
High Court expressly approved the correctness of the CBDT
circular No.333 dated April 2, 1982 on the question as to what the
assessing officers would have to do when they found that the
provision of the Double Taxation was not in conformity with the
Income-tax Act, 1961. The said circular provided as follows
(quoted at p.632):
"The correct legal position is that where a
specific provision is made in the Double
Taxation Avoidance Agreement, that provision
will prevail over the general provisions
contained in the Income-tax Act, 1961. In fact
the Double Taxation Avoidance Agreements
which have been entered into by the Central
Government under section 90 of the Income-tax
Act, 1961, also provide that the laws in force in
either country will continue to govern the
assessment and taxation of income in the
respective country except where provisions to
the contrary have been made in the Agreement.
Thus, where a Double Taxation Avoidance
Agreement provided for a particular mode of
computation of income, the same should be
followed, irrespective of the provisions in the
Income-tax Act. Where there is no specific
provision in the Agreement, it is the basic law,
i.e, the Income-tax Act, that will govern the
taxation of income."
The Calcutta High Court held that the circular reflected the
correct legal position inasmuch as the convention or agreement is
arrived at by the two Contracting States "in deviation from the
general principles of taxation applicable to the Contracting States".
Otherwise, the double taxation avoidance agreement will have no
meaning at all.
In Commissioner of Income Tax v. R.M. Muthaiah the
Karnataka High Court was concerned with the DTAT between
Government of India and Government of Malaysia. The High
Court held that under the terms of agreement, if there was a
recognition of the power of taxation with the Malaysian
Government, by implication it takes away the corresponding
power of the Indian Government. The Agreement was thus held to
operate as a bar on the power of the Indian Government to tax and
that the bar would operate on Sections 4 and 5 of the Income Tax
Act, 1961, and take away the power of the Indian Government to
levy tax on the income in respect of certain categories as referred
to in certain Articles of the Agreement. The High Court summed
up the situation by observing (at p.512-513):
"The effect of an "agreement" entered into by
virtue of section 90 of the Act would be : (1) If
no tax liability is imposed under this Act, the
question of resorting to the agreement would not
arise. No provision of the agreement can
possibly fasten a tax liability where the liability
is not imposed by this Act; (ii) if a tax liability is
imposed by this Act, the agreement may be
resorted to for negativing or reducing it; (iii) in
case of difference between the provisions of the
Act and of the agreement, the provisions of the
agreement prevail over the provisions of this
Act and can be enforced by the appellate
authorities and the court."
It also approved of the correctness of the Circular No. 333
dated April 2, 1982 issued by the Central Board of Direct Taxes on
the subject.
In Arabian Express Line Ltd. of United Kingdom and Others
v. Union of India the Gujarat High Court, interpreting section 90,
in the light of circular No.333 dated April 2, 1982 issued by the
CBDT, held that the procedure of assessing the income of a NRI
because of his occasional activities in establishing business in
India would not be applicable in a case where there is a convention
between the Government of India and the foreign country as
provided under Section 90 of the Income-tax Act, 1961. In case of
such an agreement, section 90 would have an overriding effect.
Interestingly, in this case a certificate issued by the H.M. Inspector
of Taxes certifying that the company was a resident of the United
Kingdom for purposes of tax and that it had paid advance
corporate tax in the office of the English Revenue Accounts
Office, was held to be sufficient to take away the jurisdiction of the
Income-tax Officer.
A survey of the aforesaid cases makes it clear that the
judicial consensus in India has been that section 90 is specifically
intended to enable and empower the Central Government to issue a
notification for implementation of the terms of a double taxation
avoidance agreement. When that happens, the provisions of such
an agreement, with respect to cases to which where they apply,
would operate even if inconsistent with the provisions of the
Income-tax Act. We approve of the reasoning in the decisions
which we have noticed. If it was not the intention of the legislature
to make a departure from the general principle of chargeability to
tax under section 4 and the general principle of ascertainment of
total income under section 5 of the Act, then there was no purpose
in making those sections "subject to the provisions" of the Act".
The very object of grafting the said two sections with the said
clause is to enable the Central Government to issue a notification
under section 90 towards implementation of the terms of the DTAs
which would automatically override the provisions of the Income-
tax Act in the matter of ascertainment of chargeability to income
tax and ascertainment of total income, to the extent of
inconsistency with the terms of the DTAC.
The contention of the respondents, which weighed with the
High Court viz. that the impugned circular No.789 is inconsistent
with the provisions of the Act, is a total non-sequitur. As we have
pointed out, Circular No.789 is a circular within the meaning of
section 90; therefore, it must have the legal consequences
contemplated by sub-section (2) of section 90. In other words, the
circular shall prevail even if inconsistent with the provisions of
Income-tax Act, 1961 insofar as assessees covered by the
provisions of the DTAC are concerned.
Though a number of interconnected and diffused arguments
were addressed, broadly the argument of the respondents appears
to be as follows: By reason of Article 265 of the Constitution, no
tax can be levied or collected except by authority of law. The
authority to levy tax or grant exemption therefrom vests absolutely
in the Parliament and no other body, howsoever high, can exercise
such power. Once Parliament has enacted the Income-tax Act,
taxes must be levied and collected in accordance therewith and no
person has power to grant any exemption therefrom. The treaty
making power under Article 73 is confined only to such matters as
would not fall within the province of Article 265. With respect to
fiscal treaties, the contention is that they cannot be enforced in
contravention of the provisions of the Income-tax Act, unless
Parliament has made an enabling law in support. The respondents
highlighted the provisions of the OECD models with regard to tax
treaties and how tax treaties were enunciated, signed and
implemented in America, Britain and other countries. Placing
reliance on the observations of Kier and Lawson , it was
contended that in England it has been recognised that "there are,
however, two limits to its capacity; it cannot legislate and it
cannot tax without the concurrence of the Parliament". It is urged
that the situation is the same in India; that unless there is a specific
exemption granted by the Parliament, it is not open for the Central
Government to grant any exemption from the tax payable under the
Income-tax Act.
In our view, the contention is wholly misconceived.
Section 90, as we have already noticed (including its precursor
under the 1922 Act), was brought on the statute book precisely to
enable the executive to negotiate a DTAC and quickly implement
it. Even accepting the contention of the respondents that the
powers exercised by the Central Government under section 90 are
delegated powers of legislation, we are unable to see as to why a
delegatee of legislative power in all cases has no power to grant
exemption. There are provisions galore in statutes made by
Parliament and State legislatures wherein the power of conditional
or unconditional exemption from the provisions of the statutes are
expressly delegated to the executive. For example, even in fiscal
legislation like the Central Excise Act and Sales Tax Act, there are
provisions for exemption from the levy of tax. Therefore we are
unable to accept the contention that the delegate of a legislative
power cannot exercise the power of exemption in a fiscal statute.
The niceties of the OECD model of tax treaties or the report
of the Joint Parliamentary Committee on the State Market Scam
and Matters Relating thereto, on which considerable time was
spent by Mr. Jha, who appeared in person, need not detain us for
too long, though we shall advert to them later. This Court is not
concerned with the manner in which tax treaties are negotiated or
enunciated; nor is it concerned with the wisdom of any particular
treaty. Whether the Indo-Mauritius DTAC ought to have been
enunciated in the present form, or in any other particular form, is
none of our concern. Whether section 90 ought to have been
placed on the statute book, is also not our concern. Section 90,
which delegates powers to the Central Government, has not been
challenged before us, and, therefore, we must proceed on the
footing that the section is constitutionally valid. The challenge
being only to the exercise of the power emanating from the section,
we are of the view that section 90 enables the Central Government
to enter into a DTAC with the foreign Government. When the
requisite notification has been issued thereunder, the provisions of
sub-section (2) of section 90 spring into operation and an assessee
who is covered by the provisions of the DTAC is entitled to seek
benefits thereunder, even if the provisions of the DTAC are
inconsistent with the provisions of Income-tax Act, 1961.
STARE DECISIS
The learned Attorney General justifiably relied on the
observations of this Court in Mishri Lal v. Dhirendra Nath (Dead)
by Lrs. and Others in which this Court referred to its earlier
decision in Muktul v. Manbhari on the scope of the doctrine of
stare decisis with reference to Halsbury's Law of England and
Corpus Juris Secundum, pointing out that a decision which has
been followed for a long period of time, and has been acted upon
by persons in the formation of contracts or in the disposition of
their property, or in the general conduct of affairs, or in legal
procedure or in other ways, will generally be followed by courts of
higher authority other than the court establishing the rule, even
though the court before whom the matter arises afterwards might
be of a different view. The learned Attorney General contended
that the interpretation given to section 90 of the Income-tax Act, a
Central Act, by several High Courts without dissent has been
uniformally followed; several transactions have been entered into
based upon the said exposition of the law; that several tax treaties
have been entered into with different foreign Governments based
upon this law, hence, the doctrine of stare decisis should apply or
else it will result in chaos and open up a Pandora's box of
uncertainty.
We think that this submission is sound and needs to be
accepted. It is not possible for us to say that the judgments of the
different High Courts noticed have been wrongly decided by
reason of the arguments presented by the respondents. As
observed in Mishrilal even if the High Courts have
consistently taken an erroneous view, (though we do not say that
the view is erroneous) it would be worthwhile to let the matter rest,
since large numbers of parties have modulated their legal
relationship based on this settled position of law.
Effect of circular under Section 119
Much of the argument centred around the effect of the
circular issued by the CBDT under Section 119 of the Act and its
binding nature.
Section 119, strategically placed in Chapter XIII which deals
with 'Income-Tax Authorities' is an enabling power of the
CBDT, which is recognised as an authority under the Income-tax
Act under section 116(a). The CBDT under this section is
empowered to issue such orders instructions and directions to
other income-tax authorities "as it may deem fit for proper
administration of this Act". Such authorities and all other persons
employed in the execution of this Act are bound to observe and
follow such orders, instructions and directions of the CBDT. The
proviso to sub-section (1) of section 119 recognises two
exceptions to this power. First, that the CBDT cannot require any
income-tax authority to make a particular assessment or to dispose
of a particular case in a particular manner. Second, is with regard
to interference with the discretion of the Commissioner (Appeals)
in exercise of his appellate functions. Sub-section(2) of Section
119 provides for the exercise of power in certain special cases and
enables the CBDT, if it considers it necessary or expedient so to
do for the purpose of proper and efficient management of the work
of assessment and collection of revenue, to issue general or special
orders in respect of any class of incomes of class of cases , setting
forth directions or instructions as to the guidelines, principles or
procedures to be followed by other income-tax authorities in the
discharge of their work relating to assessment or initiating
proceedings for imposition of penalties. The powers of the CBDT
are wide enough to enable it to grant relaxation from the provisions
of several sections enumerated in clause (a). Such orders may be
published in the Official Gazette in the prescribed manner, if the
CBDT is of the opinion that it is so necessary. The only bar on the
exercise of power is that it is not prejudicial to the assessee. We
are not concerned with the provisions in clauses (b) and (c) in the
present appeals.
In K.P. Varghese v. Income-Tax Officer, Ernakulam it was
pointed out by this Court that not only are the circulars and
instructions, issued by the CBDT in exercise of the power under
section 119, binding on the authorities administering the tax
department, but they are also clearly in the nature of
contemporanea expositio furnishing legitimate aid to the
construction of the Act.
The Rule of contemporanea expositio is that
"administrative construction (i.e. contemporaneous construction
placed by administrative or executive officers) generally should be
clearly wrong before it is overturned; such a construction
commonly referred to as practical construction, although non-
controlling, is nevertheless entitled to considerable weight, it is
highly persuasive."
The validity of this principle was recognised in Baleshwar
Bagarti v. Bhagirathi Dass where the Calcutta High Court stated
the rule in the following words :
"It is a well-settled principle of
interpretation that courts in construing a statute
will give much weight to the interpretation put
upon it, at the time of its enactment and since,
by those whose duty it has been to construe,
execute and apply it."
The statement of this rule has also been quoted with
approval by this Court in Deshbandhu Gupta & Company v. Delhi
Stock Exchange Association Ltd .
In K.P. Varghese this Court held that the circulars of the
CBDT issued in exercise of its power under section 119 are
legally binding on the revenue and that this binding character
attaches to the circulars "even if they be found not in accordance
with the correct interpretation of sub-section (2) and they depart
or deviate from such construction."
Navnit Lal C. Javeri v. K.K.Sen and Ellerman Lines Ltd. v.
CIT clearly establish the principle that circulars issued by the
CBDT under section 119 of the Act are binding on all officers and
employees employed in the execution of the Act, even if they
deviate from the provisions of the Act.
In UCO Bank v. Commissioner of Incom-Tax , dealing
with the legal status of such circulars, this Court observed:
"Such instructions may be by way of relaxation
of any of the provisions of the sections
specified there or otherwise. The Board thus
has power, inter alia, to tone down the rigour of
the law and ensure a fair enforcement of its
provisions, by issuing circulars in exercise of
its statutory powers under section 119 of the
Income-tax Act which are binding on the
authorities in the administration of the Act.
Under section 119(2) however, the circulars as
contemplated therein cannot be adverse to the
assessee. Thus the authority which wields the
power for its own advantage under the Act is
given the right to forgo the advantage when
required to wield it in a manner it considers just
by relaxing the rigour of the law or in other
permissible manners as laid down in section
119. The power is given for the purpose of
just, proper and efficient management of the
work of assessment and in public interest. It is a
beneficial power given to the Board for proper
administration of fiscal law so that undue
hardship may not be caused to the assessee and
the fiscal laws may be correctly applied. Hard
cases which can be properly categorised as
belonging to a class, can thus be given the
benefit of relaxation of law by issuing circulars
binding on the taxing authorities."
In Commissioner of Income-Tax v. Anjum M.H.Ghaswala
and Others it was pointed out that the circulars issued by CBDT
under Section 119 of the Act have statutory force and would be
binding on every income-tax authority although such may not be
the case with regard to press releases issue by the CBDT for
information of the public.
In Collector of Central Excise Vadodra v. Dhiren Chemical
Industries , this Court, interpreting the phrase 'appropriate',
observed :
"We need to make it clear that, regardless of
the interpretation that we have placed on the
said phrase, if there are circulars which have
been issued by the Central Board of Excise and
Customs which place a different interpretation
upon the said phrase, that interpretation will be
binding upon the Revenue."
While commenting adversely upon the validity of the
impugned circular, the High Court says "that the circular itself
does not show that the same has been issued under Section 119 of
the Income-tax Act. Only in a case where the circular is issued
under Section 119 of the Income-tax Act, the same would be
legally binding on the revenue. The circular does not deal with the
power of the ITO to consider the question as to whether although
apparently a company is incorporated in Mauritius but whether the
company is also a resident of India and/or not a resident of
Mauritius at all." It is trite law that as long as an authority has
power, which is traceable to a source, the mere fact that source of
power is not indicated in an instrument does not render the
instrument invalid.
Is the impugned circular ultra-vires Section 119 ?
It was contended successfully before the High Court that the
circular is ultra vires the provisions of section 119. Sub-section(1)
of section 119 is deliberately worded in general manner so that the
CBDT is enabled to issue appropriate orders, instruction or
direction to the subordinate authorities "as it may deem fit for the
proper administration of the Act". As long as the circular emanates
from the CBDT and contains orders, instructions or directions
pertaining to proper administration of the Act, it is relatable to the
source of power under section 119 irrespective of its nomenclature.
Apart from sub-section(1), sub-section(2) of section 119 also
enables the CBDT "for the purpose of proper and efficient
management of the work of assessment and collection of revenue,
to issue appropriate orders, general or special in respect of any
class of income or class of cases, setting forth directions or
instructions (not being prejudicial to assessees) as to the
guidelines, principles or procedures to be followed by other
income tax authorities in the work relating to assessment or
collection of revenue or the initiation of proceedings for the
imposition of penalties". In our view, the High Court was not
justified in reading the circular as not complying with the
provisions of section 119. The circular falls well within the
parameters of the powers exercisable by the CBDT under Section
119 of the Act.
The High Court persuaded itself to hold that the circular is
ultra vires the powers of the CBDT on completely erroneous
grounds. The impugned circular provides that whenever a
certificate of residence is issued by the Mauritius Authorities, such
certificate will constitute sufficient evidence for accepting the
status of residence as well as beneficial ownership for applying the
DTAC accordingly. It also provides that the test of residence
mentioned above would also apply in respect of income from
capital gains on sale of shares. Accordingly, FIIs etc., which are
resident in Mauritius would not be taxable in India on income
from capital gains arising in India on sale of shares as per
paragraph 4 of Article 13. This, the High Court thought amounts to
issuing instructions "de hors the provisions of the Act".
In our view, this thinking of the High Court is erroneous.
The only restriction on the power of the CBDT is to prevent it
from interfering with the course of assessment of any particular
assessee or the discretion of the Commissioner of Income-Tax
(Appeals). It would be useful to recall the background against
which this circular was issued.
The Income-tax authorities were seeking to examine as to
whether the assessees were actually residents of a third country on
the basis of alleged control of management therefrom.
We have already extracted the relevant provisions of Article
4 which provide that, for the purposes of the agreement, the term
'resident of a contracting State' means any person who under the
laws of that State is liable to taxation therein by reason of his
domicile, residence, place of management or any other criterion of
similar nature. The term 'resident of India' and 'the resident of
Mauritius' are to be construed accordingly. Article 13 of the
DTAC lays down detailed rules with regard to taxation of capital
gains. As far as capital gains resulting from alienation of shares are
concerned, Article 13(4) provides that the gains derived by a
'resident' of a contracting State shall be taxable only in that State.
In the instant case, such capital gains derived by a resident of
Mauritius shall be taxable only in Mauritius. Article 4, which we
have already referred to, declares that the term resident of
Mauritius' means any person who under the laws of Mauritius is
'liable to taxation' therein by reason, inter alia, of his residence.
Clause (2) of Article 4 enumerates detailed rules as to how the
residential status of an individual resident in both contracting
States has to be determined for the purposes of DTAC. Clause(3)
of Article 4 provides that if, after application of the detailed rules
provided in Article 4, it is found that a person other than an
individual is a resident of both the contracting States, then it shall
be deemed to be a resident of the contracting State in which its
place of effective management is situated. The DTAC requires the
test of 'place of effective management' to be applied only for the
purposes of the tie-breaker clause in Article 4(3) which could be
applied only when it is found that a person other than an individual
is a resident both of India and Mauritius. We see no purpose or
justification in the DTAC for application of this test in any other
situation.
The High Court has held, and the respondents so contend,
that the assessing officer under the Income-tax Act is entitled to lift
the corporate veil, but the circular effectively bars the exercise of
this quasi-judicial function by reason of a presumption with regard
to the certificate issued by the competent authority in Mauritius;
conclusiveness of such a certificate of residence granted by the
Mauritius tax authorities is neither contemplated under the DTAC,
nor under the Income-tax Act a provision as to conclusiveness of a
certificate is a matter of legislative action and cannot form the
subject matter of a circular issued by a delegate of legislative
power.
As early as on March 30, 1994, the CBDT had issued
circular no.682 in which it had been emphasised that any resident
of Mauritius deriving income from alienation of shares of an
Indian company would be liable to capital gains tax only in
Mauritius as per Mauritius tax law and would not have any capital
gains tax liability in India. This circular was a clear enunciation of
the provisions contained in the DTAC, which would have
overriding effect over the provisions of sections 4 and 5 of the
Income-tax Act,1961 by virtue of section 90(1) of the Act. If, in
the teeth of this clarification, the assessing officers chose to ignore
the guidelines and spent their time, talent and energy on
inconsequtial matters, we think that the CBDT was justified in
issuing 'appropriate' directions vide circular no.789, under its
powers under section 119, to set things on course by eliminating
avoidable wastage of time, talent and energy of the assessing
officers discharging the onerous public duty of collection of
revenue. The circular no.789 does not in any way crib, cabin or
confine the powers of the assessing officer with regard to any
particular assessment. It merely formulates broad guidelines to be
applied in the matter of assessment of assessees covered by the
provisions of the DTAC.
We do not think the circular in any way takes away or
curtails the jurisdiction of the assessing officer to assess the
income of the assessee before him. In our view, therefore, it is
erroneous to say that the impugned circular No.789 dated
13.4.2000 is ultra vires the provisions of section 119 of the Act.
In our judgment, the powers conferred upon the CBDT by sub-
sections (1) and (2) of Section 119 are wide enough to
accommodate such a circular.
Is the DTAC bad for excessive delegation ?
The respondents contend that a tax treaty entered into
within the umbrella of section 90 of the Act is essentially delegated
legislation; if it involves granting of exemption from tax, it would
amount to delegation of legislative powers, which is bad. The
legislature must declare the policy of the law and the legal principles
which are to control any given case and must provide a procedure to
execute the law.
The question whether a particular delegated legislation is in
excess of the power of the supporting legislation conferred on the
delegate, has to be determined with regard not only to specific
provisions contained in the relevant statute conferring the power to
make rule or regulation, but also the object and purpose of the Act as
can be gathered from the various provisions of the enactment. It
would be wholly wrong for the Court to substitute its own opinion as
to what principle or policy would best serve the objects and purposes
of the Act, nor is it open to the Court to sit in judgment of the
wisdom, the effectiveness or otherwise of the policy, so as to declare
a regulation to be ultra vires merely on the ground that, in the view of
the Court, the impugned provision will not help to carry through the
object and purposes of the Act. This court reiterated the legal
position, well established by a long series of decisions, in
Maharashtra State Board of Secondary and Higher Secondary
Education and another v. Paritosh Bhupeshkumar Sheth and Others :
"So long as the body entrusted with the task of
framing the rules or regulations acts within the
scope of the authority conferred on it, in the
sense that the rules or regulations made by it
have a rational nexus with the object and
purpose of the statute, the court should not
concern itself with the wisdom or
efficaciousness of such rules or regulations. It
is exclusively within the province of the
legislature and its delegate to determine, as a
matter of policy, how the provisions of the
statute can best be implemented and what
measures, substantive as well as procedural
would have to be incorporated in the rules or
regulations for the efficacious achievement of
the objects and purposes of the Act. It is not
for the Court to examine the merits or
demerits of such a policy because its scrutiny
has to be limited to the question as to whether
the impugned regulations fall within the
scope of the regulation-making power
conferred on the delegate by the statute."
Applying this test, we are unable to hold that the impugned
circular amounts to impermissible delegation of legislative power.
That the amendment made in section 90 was intended to empower
the Government to enter into agreement with foreign Government,
if necessary, for relief from or avoidance of double taxation, is also
made clear by the Finance Minister in his Budget Speech, 1953-54
Is the Double Taxation Avoidance Convention 'DTAC') illegal
and ultra vires the powers of the Central Government u/S 90
Although the High court has not made any finding of this
nature, the respondents have strenuously contended before us that
the Indo-Mauritius Double Taxation Avoidance Convention,
1983 is itself ultra vires the powers of the Government under
Section 90 of the Act. This argument deserves short shrift.
Section 90 empowers the Central Government to enter into
agreement with the Government of any other country outside India
for the purposes enumerated in clauses (a) to (d) of sub-section (1)
. While clause (a) talks of granting relief in respect of income on
which income-tax has been paid in India as well as in the foreign
country, clause (b) is wider and deals with 'avoidance of double
taxation of income' under the Act and under the corresponding
law in force in the foreign country. We are not concerned with
clauses (c) and (d).
There are two hurdles against accepting the arguments
presented on behalf of the respondents. Even if we accept the
argument of the respondent that the DTAC is delegated legislation,
the test of its validity is to be determined, not by its efficacy, but
by the fact that it is within the parameters of the legislative
provision delegating the power. That the purpose of the DTAC is
to effectuate the objectives in clauses (a) and (b) of sub-section (1)
of Section 90, is evident upon a reasonable construction of the
terms of the DTAC. As long as these two objectives are sought to
be effectuated, it is not possible to say that the power vested in the
Central Government, under section 90, even if it is delegated
power of legislation, has been used for a purpose ultra vires the
intendment of the section. The respondents tried to highlight a
number of unintended deleterious consequences which, according
to them, have arisen as a result of implementation of the DTAC.
Even if they be true, it would not enable this Court to strike down
the delegated legislation as ultra vires. The validity and the vires
of the legislation, primary, or delegated, has to be tested on the
anvil of the law making power. If an authority lacks the power,
then the legislation is bad. On the contrary, if the authority is
clothed with the requisite power, then irrespective of whether the
legislation fails in its object or not, the vires of the legislation is not
liable to be questioned. We are, therefore, unable to accept the
contention of the respondents that the DTAC is ultra vires the
powers of the Central Government under Section 90 on account of
its susceptibility to 'treaty shopping' on behalf of the residents of
third countries.
The High Court seems to have heavily relied on an
assessment order made by the assessing officer in the case of Cox
and Kings Ltd. drawing inspiration therefrom. We are afraid that it
was impermissible for the High Court to do so. An assessment
made in the case of a particular assessee is liable to be challenged
by the Revenue or by the assessee by the procedure available under
the Act. In a Public Interest Litigation it would be most unfair to
comment on the correctness of the assessment order made in the
case of a particular assessee, especially when the assessee is not a
party before the High Court. Any observation made by the Court
would result in prejudice to one or the other party to the litigation.
For this reason, we refrain from making any observations about the
correctness or otherwise of the assessment order made in Cox and
Kings Ltd. Needless to say, we decline to draw inspiration
therefrom, for our inspiration is drawn from principles of law as
gathered from statutes and precedents.
What is "liable to taxation"
Fiscal Residence
The concept of 'fiscal residence' of a company assumes
importance in the application and interpretation of double taxation
avoidance treaties.
In Cahiers De Droit Fiscal International it is said that
under the OECD and UNO Model Convention, 'fiscal residence' is
a place where a person amongst others a corporation is subjected to
unlimited fiscal liability and subjected to taxation for the
worldwide profit of the resident company. At para 2.2 it is
pointed out :
"The UNO Model Convention takes these two
different concepts into account. It has not
embodied the second sentence of article 4,
paragraph 1 of the OECD Model Convention,
which provides that the term 'resident' does
not include any person who is liable to tax in
that State in respect only of income from
sources in that State. In fact, if one adhered to
a strict interpretation of this text, there would
be no resident in the meaning of the
convention in those States that apply the
principle of territoriality."
Again in paragraph 3.5 it is said :
"The existence of a company from a company
law standpoint is usually determined under
the law of the State of incorporation or of the
country where the real seat is located. On the
other hand, the tax status of a corporation is
determined under the law of each of the
countries where it carries on business, be it as
resident or non-resident."
In paragraph 4.1 it is observed that the principle of
universality of taxation i.e. the principle of worldwide taxation,
has been adopted by a majority of States. One has to consider the
worldwide income of a company to determine its taxable profit. In
this system it is crucial to define the fiscal residence of a company
very accurately. The State of residence is the one entitled to levy
tax on the corporation's worldwide profit. The company is subject
to unlimited fiscal liability in that State. In the case of a company,
however, several factors enter the picture and render the decision
difficult. First, the company is necessarily incorporated and
usually registered under the tax law of a State that grants it
corporate status. A corporation has administrative activities,
directors and managers who reside, meet and take decisions in
one or several places. It has activities and carries on business.
Finally, it has shareholders who control it. Hence, it is opined :
"When all these elements coexist in the same
country, no complications arise. As soon as
they are dissociated and "scattered" in
different States, each country may want to
subject the company to taxation on the basis
of an element to which it gives preference;
incorporation procedure, management
functions, running of the business,
shareholders' controlling power. Depending
on the criterion adopted, fiscal residence will
abide in one or the other country.
All the European countries concerned, except
France, levy tax on the worldwide profit at the
place of residence of the company
considered.
South Korea, India and Japan in Asia,
Australia and New Zealand in Oceania follow
this principle."
In paragraph 4.2.1 it is pointed out that the Anglo-Saxon
concept of a company's 'incorporation test', which is applied in
the United States, has not been adopted by other countries like
Australia, Canada, Denmark, New Zealand and India and instead
the criterion of incorporation amongst other tests has been adopted
by them.
The judgment in Ingemar Johansson et al v. United State of
America , on which the respondent place reliance, is easily
distinguishable. In this case the appellant, Johansson, was a citizen
of Switzerland and a heavyweight boxing champion by profession.
He had earned some money by boxing in the United States for
which he was called upon to pay tax. Johansson floated a company
in Switzerland of which he became an employee and contended
that all professional fee paid for his boxing bouts were received by
his employer company in Switzerland for which he was
remunerated as an employee of the said company. He sought to
take advantage of the DTAT between USA and Switzerland which
provided "an individual resident of Switzerland shall be exempt
from United States Tax upon compensation for labour personal
services performed in the United States.... if he is temporarily
present in the United States for a period or periods not exceeding a
total of 183 during the taxable year..." There was no doubt that
the appellant was not present in the United States for more than
183 days and that he had floated the Swiss company motivated
with the desire to minimise his tax burden. As conclusive proof of
residence he relied upon a determination by the Swiss Tax
Authority that he had become a resident of Switzerland on a
particular date. The United States Court of Appeal rejected the
claim of the appellant pointing out that the term "resident" had not
been defined in the US-Swiss treaty, but under article II(2) each
country was authorised to apply its own definition to terms not
expressly defined 'unless the context otherwise requires'. The
Court, therefore, held that the determination of the appellant's
residence statues by the Swiss tax authority, according to Swiss
law, was not conclusive and that the U.S. tax authorities were
entitled to decide it in accordance with the US laws under the
treaty. Hence, it was held that Johansson was not a resident of
Switzerland during the period in question and that the tax
exemption in the treaty was not available to him.
In our view, this judgment, though relied upon very heavily
by the respondents, is of no avail. The Indo-Mauritius DTAC,
Article 3, clearly defines the term 'residence' in a 'Contracting
State'. Interestingly, even in this judgment, the Court observed :
"Of course, the fact that Johansson was motivated in his actions by
the desire to minimize his tax burden can in no way be taken to
deprive him of an exemption to which an applicable treaty entitles
him", which will have some relevance to the contention of the
respondents with regard to the motivation to avoid tax.
The respondents contend that the FIIs incorporated and
registered under the provisions of the law in Mauritius are carrying
on no business there; they are, in fact, prevented from earning any
income there; they are not liable to income tax on capital gains
under the Mauritius Income-tax Act. They are liable to pay
income-tax under Indian Income-tax Act, 1961, since they do not
pay any income-tax on capital gains in Mauritius, hence, they are
not entitled to the benefit of avoidance of double taxation under the
DTAC.
Some of the assumptions underlying this contention, which
prevailed with the High Court, need greater critical appraisal.
Article 13(4) of the DTAC provides that gains derived by a
resident of a Contracting State from alienation of any property,
other than those specified in the paragraphs 1, 2 and 3 of the
Article, shall be taxable only in that State. Since most of the
arguments centred around capital gains made on transactions in
shares on the stock exchange in India, we may leave out of
consideration capital gains on the type of properties contemplated
in paras 1, 2 and 3 of Article 13 of the DTAC. The residuary clause
in para 4 of Article 13 is relevant. It provides that capital gains
made on sale of shares shall be taxable only in the State of which
the person is a 'resident' taking us back to the meaning of the term
'resident' of a contracting State. According to Article 4, this
expression means any person who under the laws of that State is
"liable to taxation" therein by reason of his domicile, residence,
place of management or any other criterion of a similar nature.
The terms 'resident of India' and 'resident of Mauritius' are
required to be construed accordingly. This takes us to the test to
determine when a company is 'liable to taxation' in Mauritius.
Mauritian Income Tax Act, 1995
Section 4 of the Income Tax Act, 1995 (Mauritian Income-
tax Act) provides that, subject to the provisions of the Act, income-
tax shall be paid to the Commissioner of Income-tax by every
person on all income other than exempt income derived by him
during the preceding year and be calculated on the chargeable
income of the person at the appropriate rate specified in the First
Schedule.
Section 5 defines as to when income is deemed to be
derived.
Section 7 provides that the income specified in the Second
Schedule shall be exempt from income-tax.
Part IV of the Mauritian Income Tax Act deals with
Corporate Taxation.
Section 44 of the Act provides that every company shall be
liable to income tax on its 'chargeable income' at the rate specified
in Part II, Part III or Part IV of the First Schedule, as the case may
be.
Section 51 defines the 'gross income' of a company as
inclusive of income referred to in section 10(1)(b) (income derived
from business), 10(1)(c) (any income from rent, premium or other
income derived from property), 10(1)(d) (any dividend, interest,
charges, annuity or pension other than a pension referred to in
paragraph a(ii)) and 10(1)(e) (any other income derived from any
other source).
Section 73 (b) provides that for the purposes of the Act the
expression 'resident', when applied to a 'company', means a
company which is incorporated in Mauritius or has its central
management and control in Mauritius.
Part II of the First Schedule prescribes the rate of tax on
chargeable income at 15% in the case of Tax Incentive companies
and at other rates for other types of companies. Part V of the First
schedule enumerates the list of tax incentive companies and item
16 is : "a corporation certified to be engaged in international
business activity by the Mauritius Offshore Business Activities
Authority established under the Mauritius Offshore Business
Activities Act, 1992". The second Schedule to the Mauritius
Income-tax Act in Part IV enumerates miscellaneous income
exempt from income-tax. Item 1 reads "gains or profits derived
from the sale of units or of securities quoted on the Official List
or on such Stock Exchanges or other exchanges and capital
markets as may be approved by the Minister".
A perusal of the aforesaid provisions of the Income Tax Act
in Mauritius does not lead to the result that tax incentive
companies are not liable to taxation, although they have been
granted exemption from income-tax in respect of a specified head
of income, namely, gains from transactions in shares and
securities. The respondents contend that the FIIs are not "liable to
taxation" in Mauritius; hence they are not 'residents' of Mauritius
within the meaning of Article 4 of the DTAC. Consequently, it is
open to the assessing officers under the Indian Income-tax Act,
1961 to determine where the taxable entities are really resident by
investigating the centre of their management and thereafter to
apply the provisions of Income-tax Act, 1961 to the global income
earned by them by reason of sections 4 and 5 of the Income-tax
Act, 1961.
It is urged by the learned Attorney General and Shri Salve
for the appellants that the phrase 'liable to taxation' is not the same
as 'pays tax'. The test of liability for taxation is not to be
determined on the basis of an exemption granted in respect of any
particular source of income, but by taking into consideration the
totality of the provisions of the income-tax law that prevails in
either of the Contracting States. Merely because, at a given time,
there may be an exemption from income-tax in respect of any
particular head of income, it cannot be contended that the taxable
entity is not liable to taxation. They urge that upon a proper
construction of the provisions of Mauritian Income Tax Act it is
clear that the FIIs incorporated under Mauritius laws are liable to
taxation; therefore, they are 'residents' in Mauritius within the
meaning of the DTAC.
For the appellants reliance is placed on the judgment of this
Court in Wallace Flour Mills Contracting State. Ltd. v. Collector
of Central Excise, Bombay Division II , a case under the Central
Excise Act. This Court held that though the taxable event for levy
of excise duty is the manufacture or production, the realisation of
the duty my be postponed for administrative convenience to the
date of removal of the goods from the factory. It was held that
excisable goods do not become non-excisable merely because of
an exemption given under a notification. The exemption merely
prevents the excise authorities from collecting tax when the
exemption is in operation.
In Kasinka Trading and Another v. Union of India and
Another this principle was reiterated in connection with an
exemption under the Customs Act. This Court observed :"The
exemption notification issued under section 25 of the Act had the
effect of suspending the collection of customs duty. It does not
make items which are subject to levy of customs duty etc. as items
not leviable to such duty. It only suspends the levy and collection
of customs duty, wholly or partially, and subject to such
conditions as may be laid down in the notification by the
Government in 'public interest'. Such an exemption by its very
nature is susceptible of being revoked or modified or subjected to
other conditions."
We are inclined to agree with the submission of the
appellants that, merely because exemption has been granted in
respect of taxability of a particular source of income, it cannot be
postulated that the entity is not 'liable to tax' as contended by the
respondents.
Effect of MOBA, 1992
The respondents, shifted ground to contend that the fact that
a company incorporated in Mauritius is liable to taxation under the
Income Tax Act there may be true only in respect of certain class
of companies incorporated there. However, with respect to
companies which are incorporated within the meaning of the
Mauritius Offshore Business Activities Act, 1992 (hereinafter
referred to as "MOBA"), this would be wholly incorrect.
MOBA was enacted "to provide for the establishment and
management of the MOBA Authority to regulate offshore business
activities from within Mauritius and for the issue of offshore
certificates, and to provide for other ancillary or incidental
matters", as its preamble suggests. 'Offshore business activity' is
defined as the business or other activity referred to in section 33
and includes activity conducted by an international company.
'Offshore company' is defined as a corporation in relation to which
there is a valid certificate and which carries on offshore business
activity.
In part II, MOBA establishes an Offshore Business Activity
Authority entrusted, inter alia, with the duty of overseeing offshore
business activities and also issuing permits, licences or any other
certificate as may be required, and other authorisation which may
be required by an offshore company through which they may
communicate with any of the public sector companies.
Section 16 of MOBA prescribes the procedure for issuing of
a certificate. Section 15 requires maintenance of confidentiality
and non-disclosure of information contained in applications and
documents filed with it except where such information is bona fide
required for the purpose of any enquiry or trial into or relating to
the trafficking of narcotics and dangerous drugs, arms, trafficking
or money laundering under the Economic Crime and Anti Money
Laundering Act, 2000.
Part II of MOBA contains the statutory provisions
applicable to offshore companies. Section 26 provides that an
offshore company shall not hold immovable property in Mauritius
and shall not hold any share or any interest in any company
incorporated under the Companies Act, 1984, other than in a
foreign company or in another offshore company or in an offshore
trust or an international company. An offshore company shall not
hold any account in a domestic bank in Mauritian Rupees, except
for the purpose of its day to day transactions arising from its
ordinary operations in Mauritius.
Sections 26 and 27 of MOBA are important and read as
under:
"26. Property of an offshore company
(1) Subject to sub-section(2), an offshore
company shall not hold -
(a) immovable property in Mauritius ;
(b) any share, or any interest in any
company incorporated under the
Companies Act, 1984 other than in a
foreign company or in another
offshore company or in an offshore
trust or an international company ;
(c) any account in a domestic bank in
Mauritian Rupee
(2) An offshore company may -
(a) open and maintain with a domestic
bank an account in Mauritian rupees
for the purpose of its day to day
transactions arising from its ordinary
operations in Mauritius ;
(b) open and maintain with a domestic
bank an account in foreign currencies
with the approval of the Bank of
Mauritius ;
(c) where authorised by the terms of its
certificate, or where otherwise
permitted under any other enactment,
lease, hold, acquire or dispose of an
immovable property or any interest in
immovable property situated in
Mauritius ;
(d) invest in any securities listed in the
stock Exchange established under the
Stock Exchange Act 1988 and in other
debentures.
27. Dealings with residents
Notwithstanding any other enactment, the
Minister, on the recommendation of the
Authority may authorise any offshore
company engaged in any offshore business
activities to deal or transact with residents on
such terms and conditions as it thinks fit."
On the basis of these provisions, it is urged by the
respondents that any company which is registered as an offshore
company under MOBA can hardly carry out any business activity
in Mauritius, since it cannot hold any immovable property or any
shares or interest in any company registered in Mauritius other
than a foreign company or another offshore company and cannot
open an account in a domestic bank in Mauritius. The respondents
urge that such a company cannot transact any business whatsoever
within Mauritius as the purpose of such a company would be to
carry out offshore business activities and nothing more. The
respondents contend that when the possibility of such a company
earning income within Mauritius is almost nil, there is hardly any
possibility of its paying tax in Mauritius, whatever be the
provisions of the Mauritian Income-Tax Act.
In our view, the contention of the respondents proceeds on
the fallacious premise that liability to taxation is the same as
payment of tax. Liability to taxation is a legal situation; payment
of tax is a fiscal fact. For the purpose of application of Article 4 of
the DTAC, what is relevant is the legal situation, namely, liability
to taxation, and not the fiscal fact of actual payment of tax. If this
were not so, the DTAC would not have used the words 'liable to
taxation', but would have used some appropriate words like 'pays
tax'. On the language of the DTAC, it is not possible to accept the
contention of the respondents that offshore companies incorporated
and registered under MOBA are not 'liable to taxation' under the
Mauritius Income-tax Act; nor is it possible to accept the
contention that such companies would not be 'resident' in
Mauritius within the meaning of Article 3 read with Article 4 of
the DTAC.
There is a further reason in support of our view. The
expression 'liable to taxation' has been adopted from the
Organisation for Economic Co-operation and Development
Council (OECD) Model Convention 1977. The OECD
commentary on article 4, defining 'resident', says: "Conventions
for the avoidance of double taxation do not normally concern
themselves with the domestic laws of the Contracting States laying
down the conditions under which a person is to be treated fiscally
as "resident" and, consequently, is fully liable to tax in that State".
The expression used is 'liable to tax therein', by reasons of various
factors. This definition has been carried over even in Article 4
dealing with 'resident' in the OECD Model Convention 1992.
In A Manual on the OECD Model Tax Convention on
Income and On Capital, at paragraph 4B.05, while commenting
on Article 4 of the OECD Double Tax Convention, Philip Baker
points out that the phrase 'liable to tax' used in the first sentence of
Article 4.1 of the Model Convention has raised a number of issues,
and observes:
"It seems clear that a person does not have
to be actually paying tax to be "liable to tax"
- otherwise a person who had deductible
losses or allowances, which reduced his tax
bill to zero would find himself unable to
enjoy the benefits of the convention. It also
seems clear that a person who would
otherwise be subject to comprehensive
taxing but who enjoys a specific exemption
from tax is nevertheless liable to tax, if the
exemption were repealed, or the person no
longer qualified for the exemption, the
person would be liable to comprehensive
taxation."
Interestingly, Baker refers to the decision of the Indian
Authority for Advance Ruling in Mohsinally Alimohammed
Rafik. An assessee, who resided in Dubai and claimed the
benefits of UAE-India Convention of April 29, 1992, even though
there was no personal income-tax in Dubai to which he might be
liable. The Authority concluded that he was entitled to the
benefits of the convention. The Authority subsequently reversed
this position in the case of Cyril Eugene Pereira where a contrary
view was taken.
The respondents placed great reliance on the decision by the
Authority for Advance Rulings constituted under section 245-O of
the Income-Tax Act, 1961 in Cyril Eugene Pereira's case .
Section 245S of the Act provides that the Advance Ruling
pronounced by the Authority under section 245R shall be binding
only :
"(a) on the applicant who had sought it;
(b) in respect of the transaction in relation to
which the ruling had been sought; and
(c) on the Commissioner, and the income-tax
authorities subordinate to him, in respect of
the applicant and the said transaction."
It is therefore obvious that, apart from whatever its
persuasive value, it would be of no help to us. Having perused the
order of the Advance Rulings Authority, we regret that we are not
persuaded.
There is substance in the contention of Mr. Salve learned
counsel for one of the appellants, that the expression 'resident' is
employed in the DTAC as a term of limitation, for otherwise a
person who may not be 'liable to tax' in a Contracting State by
reason of domicile, residence, place of management or any other
criterion of a similar nature may also claim the benefit of the
DTAC. Since the purpose of the DTAC is to eliminate double
taxation, the treaty takes into account only persons who are 'liable
to taxation' in the Contracting States. Consequently, the benefits
thereunder are not available to persons who are not liable to
taxation and the words 'liable to taxation' are intended to act as
words of limitation.
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 the parties. A literal or
legalistic interpretation must be avoided when
the basic object of the treaty might be defeated
or frustrated insofar as the particular item
under consideration is concerned."
Gladden was a case where an American citizen resident in
U.S.A. owned shares in two privately controlled Canadian
companies. Upon his death, the question arose as to the capital
gains which would arise as a result of the deemed disposition of
the said shares. The Canadian Revenue took the position that there
was a deemed disposition of the shares on the death of the tax
payer and capital gains tax was chargeable on account of the
deemed disposition. This view of the Revenue was upheld in
appeal by the Tax Court of Canada. Upon further appeal to the
Federal Court it was held that capital gains were exempt from tax
under the Canada-U.S.A. Tax Treaty as Canada had no capital
gains tax when it entered the treaty and it could not unilaterally
amend its legislation. The argument which prevailed with the trial
court in this case was similar to the one which prevailed with the
High Court in the matter before us. Interpreting the relevant Article
of the Double Taxation Avoidance Treaty the trial court held :
"The parties could not have negotiated to avoid double taxation on
a tax which did not exist in Canada". The Federal Court
emphasised that in interpreting and applying treaties the Courts
should be prepared to extend "a liberal and extended construction"
to avoid an anomaly which a contrary construction would lead to.
The Court recognized that "we cannot expect to find the same
nicety or strict definition as in modern documents, such as deeds,
or Acts of Parliament; it has never been the habit of those engaged
in diplomacy to use legal accuracy but rather to adopt more liberal
terms".
Interpreting the Article of the Treaty against avoidance of
double taxation, the Federal Court said (at p.5):
"The non-resident can benefit from the
exemption regardless of whether or not he is
taxable on that capital gain in his own country.
If Canada or the U.S. were to abolish capital
gains completely, while the other country did
not, a resident of the country which had
abolished capital gains would still be exempt
from capital gains in the other country."
The appellants rely on this judgment to contend that,
irrespective of the exemption from income-tax on capital gains
upon alienation of shares under the Mauritius Income-tax Act, the
benefits of the DTAC would apply.
The appellants contend that, acceptance of the respondents'
submission that double taxation avoidance is not permissible
unless tax is paid in both countries is contrary to the intendment of
section 90. It is urged that clause (b) of sub-section(1) of Section
90 applies to a situation to grant relief where income tax has been
paid in both countries, but clause (b) deals with a situation of
avoidance of double taxation of income. Inasmuch as Parliament
has distinguished between the two situations, it is not open to a
Court of law to interpret clause (b) of section 90 sub-section(1) as
if it were the same as the situation contemplated under clause (a).
According to Klaus Vogel "Double Taxation Convention
establishes an independent mechanism to avoid double taxation
through restriction of tax claims in areas where overlapping tax-
claims are expected, or at least theoretically possible. In other
words, the Contracting States mutually bind themselves not to levy
taxes or to tax only to a limited extent in cases when the treaty
reserves taxation for the other contracting States either entirely or
in part. Contracting States are said to 'waive' tax claims or more
illustratively to divide 'tax sources', the 'taxable objects', amongst
themselves." Double taxation avoidance treaties were in vogue
even from the time of the League of Nations. The experts
appointed in the early 1920s by the League of Nations describe this
method of classification of items and their assignments to the
Contracting States. While the English lawyers called it
'classification and assignment rules', the German jurists called it
'the distributive rule' (Verteilungsnorm). To the extent that an
exemption is agreed to, its effect is in principle independent of
both whether the other contracting State imposes a tax in the
situation to which the exemption applies, and of whether that State
actually levies the tax. Commenting particularly on German
Double Taxation Convention with the United States, Vogel
comments: "Thus, it is said that the treaty prevents not only
'current', but also merely 'potential' double taxation". Further,
according to Vogel, "only in exceptional cases, and only when
expressly agreed to by the parties, is exemption in one contracting
State dependent upon whether the income or capital is taxable in
the other contracting state, or upon whether it is actually taxed
there."
It is, therefore, not possible for us to accept the contentions
so strenuously urged on behalf of the respondents that avoidance
of double taxation can arise only when tax is actually paid in one
of the Contracting States.
The decision of Federal Court of Australia in Commissioner
of Taxation v. Lamesa Holdings is illuminating. The issue before
the Federal Court was whether a Netherlands company was liable
to income-tax under the Australian Income Tax Act on profits from
the sale of shares in an Australian company and whether such
profits fell within Article 13 (alienation of property) of the
Netherlands-Australia Double Taxation Agreement, so as to be
excluded from Article 7 (business profits) of that Agreement. One
Leonard Green, a principal of Leonard Green and Associates a
limited partnership established in the United States, became aware
of a potential investment opportunity in Australia. Arimco
Resources and Mining Company NL ('Armico'), a company listed
on the Australian Stock Exchange, which had a subsidiary called
Armico Mining Pty. Limited engaged in gold mining activities,
was the subject of a hostile takeover bid, at a price which Green
was advised was less than the real value of the Armico. With this
knowledge Green decided to mount a takeover offer for the
subsidiary company. Then followed a series of steps of formation
of a number of companies with interlocking share holdings where
each company owned 1005 shares of a different subsidiary
company. Lamesa Holdings was one such intermediary company
of which 100% shares were held by Green Equity Investments Ltd.
The share transactions brought about a profit to Lamesa Holdings
which would be assessable to tax under the Australian Income Tax
Act. Lamesa, however, relied on the provisions of the Article 13(2)
of the Double Taxable Avoidance Convention ('DTAC') between
Netherlands and Australia and claimed that the income was not
taxable in Australia by reason thereof. This income was wholly
exempt from tax in Netherlands by reason of the Income Tax Law
applicable therein. The Federal Court found that under Article
13(2) (a) (ii) of the DTAC shares in a company were treated as
personalty, that since the place of incorporation of a company or
the place of situs of a share may be the subject of choice, the place
of incorporation or the register upon which shares were registered
would not form a particularly close connection with shares to
ground the jurisdiction to tax share profits. It was held:
"It happens to be the case, because of
unilateral relief granted by the law of the
Netherlands, that no tax will be payable in the
Netherlands. That of itself can not affect the
interpretation of the Agreement. If the relevant
mining property had happened to be in the
Netherlands so that the issue was between
taxation there on the one hand and taxation in
Australia on the other, the situation would have
been one where tax would clearly have been
payable on the alienation of the shares in
Australia without the benefit of any exemption.
Yet the Agreement must operate uniformly,
whether the realty is in the Netherlands or in
Australia."
In this view of the matter, it was held that there was no tax
payable in Australia.
Chong v. Commissioner of Taxation holds similarly.
Australia and Malaysia have an agreement to avoid double
taxation. An Australian resident was paid pension by Malaysian
Government for services rendered to Malaysian Government
while he was in service there. This pension was taxed in Malaysia
and the issue was whether the right to tax Government pensions
under the Agreement could be exercised by the Australian
Government and the effect of the domestic law on the agreement.
Article 18 of the double taxation avoidance agreement provided
that pension paid to a resident of a contracting State shall be
taxable only in that State. Upon a proper construction of Article
18(2) of the Treaty it was held that pension paid by Malaysia is
taxable in Australia inasmuch as the said Article did not provide
that Malaysia alone was to have the power to tax Government
pension, nor did it restrict Australia from doing so. Rather it
provided for the Contracting State paying the pension to have the
power to tax the pension if it so desired and did not limit or restrict
the taxing power of the other Contracting State in that respect.
The Federal Court pointed out "Whether one uses the language of
allocation of power or the language of limitation of power, the
result is the same; there is designated or agreed who shall have the
right under the agreement to impose taxation in the particular
area".
The Estate of Michel Hausmann v. Her Majesty The
Queen is another Canadian judgment which throws light on the
principle that the benefits of a double taxation agreement would be
available even if the other contracting State in which a particular
head of income is to be taxed, chooses not to impose tax on the
same.
The central question in this case was whether the pension
received by Mr.Hausmann from the pension office of the Belgium
Government was taxable in Canada. The facts indicated that there
was no tax withheld at source in Belgium. The argument of the
Canadian Tax Authority was that if Belgium was not going to tax
the pension, Canada should. Otherwise, the unthinkable might
occur and the amount might not be taxed by anyone. This would
be anathema. The facts indicated that the payment received by Mr.
Hausmann fell below the prescribed threshold and therefore was
not taxed in Belgium. The Canadian Court rejected the argument
that if Belgium did not tax the payment, it must be taxed by the
Canada as plainly wrong by relying on the terms of the treaty. On
the basis of the material available, the Federal Court came to the
inference that in negotiating the Belgium treaty both Canada and
Belgium unquestionably regarded pensions paid under their social
security legislation, such as the CPP or the corresponding Belgian
statutory scheme, to be taxable only in the country from which
they emanated and not the country of residence of the recipient.
Hence, it was held that the pension payments received by Mr.
Hausmann from the office of Belgium were social security pension
and such allowances could be taxable only in Belgium. The fact
that Belgium did not choose to tax them was held to be totally
irrelevant.
Mr. Salve contended that a profit made by sale of shares
may not invariably amount to capital gains, as for example if the
shares were part of the trading assets of the company. If such be
the case, the gains may amount to trading income of such a
company. He also relied on the observations of this Court in
Commissioner of Income Tax Nagpur v. Sutlej Cotton Mills
Supply Agency Limited . It is not necessary for us to go into this
question as it would depend upon as to whether the shares are held
by a company as an investment or as a trading asset. The
possibility urged by the learned counsel certainly exists and cannot
be ruled out without examination of facts.
Treaty Shopping - Is it illegal ?
The respondents vehemently urge that the offshore
companies have been incorporated under the laws of Mauritius
only as shell companies, which carry on no business therein, and
are incorporated only with the motive of taking undue advantage of
the DTAC between India and Mauritius. They also urged that
'treaty shopping' is both unethical and illegal and amounts to a
fraud on the treaty and that this Court must be astute to interdict all
attempts at treaty shopping.
'Treaty shopping' is a graphic expression used to describe
the act of a resident of a third country taking advantage of a fiscal
treaty between two Contracting States. According to Lord
McNair, "provided that any necessary implementation by
municipal law has been carried out, there is nothing to prevent the
nationals of "third States", in the absence of any expressed or
implied provision to the contrary, from claiming the right or
becoming subject to the obligation created by a treaty" .
Reliance is also placed on the following observations of
Lord McNair :
"that any necessary implementation by
municipal law has been carried out, there is
nothing to prevent the nationals of 'third
States', in the absence of any express or
implied provision to the contrary, from
claiming the rights, or becoming subject to the
obligations, created by a treaty; for instance, if
an Anglo-American Convention provided that
professors on the staff of the universities of
each country were exempt from taxation in
respect of fees earned for lecturing in the other
country, and any necessary changes in the tax
laws were made, that privilege could be
claimed by, or on behalf of, professors of those
universities who were the nationals of 'third
States'."
It is urged by the learned counsel for the appellants, and
rightly in our view, that if it was intended that a national of a third
State should be precluded from the benefits of the DTAC, then a
suitable term of limitation to that effect should have been
incorporated therein. As a contrast, our attention was drawn to the
Article 24 of the Indo-US Treaty on Avoidance of Double
Taxation which specifically provides the limitations subject to
which the benefits under the Treaty can be availed of. One of the
limitations is that more than 50% of the beneficial interest, or in
the case of a company more than 50% of the number of shares of
each class of the company, be owned directly or indirectly by one
or more individual residents of one of the contracting States.
Article 24 of the Indo-U.S. DTAC is in marked contrast with the
Indo-Mauritius DTAC. The appellants rightly contend that in the
absence of a limitation clause, such as the one contained in Article
24 of the Indo-U.S. Treaty, there are no disabling or disentitling
conditions under the Indo-Mauritius Treaty prohibiting the
resident of a third nation from deriving benefits thereunder. They
also urge that motives with which the residents have been
incorporated in Mauritius are wholly irrelevant and cannot in any
way affect the legality of the transaction. They urge that there is
nothing like equity in a fiscal statute. Either the statute applies
proprio vigore or it does not. There is no question of applying a
fiscal statute by intendment, if the expressed words do not apply.
In our view, this contention of the appellants has merit and
deserves acceptance. We shall have occasion to examine the
argument based on motive a little later.
The decision of the Chancery Division in Re F.G. Films
Ltd. was pressed into service as an example of the mask of
corporate entity being lifted and account be taken of what lies
behind in order to prevent 'fraud'. This decision only emphasises
the doctrine of piercing the veil of incorporation. There is no doubt
that, where necessary, the Courts are empowered to lift the veil of
incorporation while applying the domestic law. In the situation
where the terms of the DTAC have been made applicable by
reason of section 90 of the Income-Tax Act, 1961, even if they
derogate from the provisions of the Income-tax Act, it is not
possible to say that this principle of lifting the veil of incorporation
should be applied by the court. As we have already emphasised,
the whole purpose of the DTAC is to ensure that the benefits
thereunder are available even if they are inconsistent with the
provisions of the Indian Income-tax Act. In our view, therefore, the
principle of piercing the veil of incorporation can hardly apply to a
situation as the one before us.
The respondents banked on certain observations made in
Oppenheim's International Law . All that is stated therein is a
reiteration of the general rule in municipal law that contractual
obligations bind the parties to their contracts and not a third party
to the contract. In international law also, it has been pointed out
that the Vienna Convention on the Laws of Treaties ,1969
reaffirms the general rule that a treaty does not create either
obligations or rights for a third party state without its consent,
based on the general principle pacta tertiis nec nocent nec prosunt.
It is true that an international treaty between States A & B is
neither intended to confer benefits nor impose obligations on the
residents of State C, but, here we are not concerned with this
question at all. The question posed for our consideration is: If the
residents of State C qualify for a benefit under the treaty, can they
be denied the benefit on some theoretical ground that 'treaty
shopping' is unethical and illegal ? We find no support for this
proposition in the passage cited from Oppenheim.
The respondents then relied on observations of Philip
Baker regarding a seminar at the IFI Barcelona in 1991, wherein
a paper was presented on "Limitation of treaty benefits for
companies" (treaty shopping). He points out that the Committee
on Fiscal Affairs of the OECD in its report styled as "Conduit
Companies Report 1987" recognised that a conduit company
would generally be able to claim treaty benefits.
There is elaborate discussion in Baker's treatise on the anti
abuse provisions in the OECD model and the approach of different
countries to the issue of 'treaty shopping'. True that several
countries like the USA, Germany, Netherlands, Switzerland and
United Kingdom have taken suitable steps, either by way of
incorporation of appropriate provisions in the international
conventions as to double taxation avoidance, or by domestic
legislation, to ensure that the benefits of a treaty/convention are
not available to residents of a third State. Doubtless, the treatise by
Philip Baker is an excellent guide as to how a state should
modulate its laws or incorporate suitable terms in tax conventions
to which it is party so that the possibility of a resident of a third
State deriving benefits thereunder is totally eliminated. That may
be an academic approach to the problem to say how the law should
be. The maxim "Judicis est jus dicere, non dare" pithily
expounds the duty of the Court. It is to decide what the law is, and
apply it; not to make it.
Report of the working group on non-resident taxation
The respondents contend that anti-abuse provisions need not
be incorporated in the treaty since it is assumed that the treaty
would only be used for the benefit of the parties.
They also strongly rely on the 'Report of the working group
on Non-Resident Taxation' dated 3rd January, 2003. In Chapter 3,
para 3.2 of the report it is stated:
"3.2 Entitlement to avail DTAA benefit:
Presently a person is entitled to claim
application of DTAA if he is 'liable to tax' in the
other Contracting State. The scope of liability to tax
is not defined. The term "liable to tax" should be
defined to say that there should be tax laws in force
in the other State, which provides for taxation of
such person, irrespective that such tax fully or
partly exempts such persons from charge of tax on
any income in any manner."
In para 3.3.1, after noticing the growing practice amongst
certain entities, who are not residents of either of the two
Contracting States, to try and avail of the beneficial provisions of
the DTAAs and indulge in what is popularly known as 'treaty
shopping', the report says :
"3.3.1 ....there is a need to incorporate suitable
provisions in the chapter on interpretation of
DTAAs, to deal with treaty shopping, conduit
companies and thin capitalization. These may be
based on UN/OECD model or other best global
practices."
In para 3.3.2, the working group recommended
introduction of anti-abuse provisions in the domestic law.
Finally, in paragraph 3.3.3 it is stated "The Working
Group recommends that in future negotiations, provisions
relating to anti-abuse/limitation of benefit may be incorporated in
the DTAAs also."
We are afraid that the weighty recommendations of the
Working Group on Non-Resident Taxation are again about what
the law ought to be, and a pointer to the Parliament and the
Executive for incorporating suitable limitation provisions in the
treaty itself or by domestic legislation. This per se does not
render an attempt by resident of a third party to take advantage of
the existing provisions of the DTAC illegal.
J.P.C. Report
Strong reliance is placed by the respondents on the report of
the Joint Parliamentary Committee (hereinafter referred to as
"JPC") on the Stock Market Scam and Matters Relating thereto
which was presented in the Lok Sabha and Rajya Sabha on
December 19, 2002.
While considering the causes which led to the Stock Market
scam, the JPC had occasion to consider the working of the Indo-
Mauritius DTAC. It noticed that area-wise foreign direct
investment inflow from Mauritius increased from 37.5 million
Rupees in 1993 to 61672.8 million Rupees in the year 2001. The
CBDT had approached the Indian High Commissioner at Mauritius
to take up the matter with the Mauritian authorities to ensure that
benefit of the bilateral tax treaty were not allowed to be misused,
by suitable amendment in Article 13 of the agreement. The
Mauritian authorities, however, were of the view that, though the
beneficiaries of such capital funds domiciled in Mauritius may be
residing in third countries, these funds had been invested in the
Indian stock market in accordance with SEBI norms and
regulations and that the Finance Minister of India had himself
encouraged such FIIs as a channel for promoting capital flow to
India in a meeting between himself and the Finance Minister of
Mauritius. The Ministry of finance was willing to have regular
joint monitoring of the situation to avoid possible misuse of the tax
treaty by unscrupulous elements. It was pointed out by the
Mauritian authorities that DTAC between the two countries "had
played a positive role in covering the higher cost of investing in
what was then assessed as 'high risk security' and being decisive
in making possible public offerings in U.S.A. and Europe of
funds investing in India". In the absence of such a facility, as
afforded by the Indo-Mauritius DTAC, the cost of raising such
investment would have been capital prohibitive. The JPC report
points out that the negotiations between the Government of India
and Government of Mauritius resulted in a situation in which the
Mauritius Government felt that any change in the provisions of the
DTAC would adversely affect the perception of potential investors
and would prejudicially affect their financial interests.
The issue still appears to be the subject matter of
negotiations between the two Governments, though no final
decision has been taken thereupon. The JPC took notice of the
facts that MOBA has since been repealed by Mauritius and
Financial Services Development Act has been promulgated with
effect from 1.12.2001, which has to some extent removed the
drawback of MOBA, and led to greater transparency and facility
for obtaining information under the DTAC, which was hitherto not
available.
Taking notice of the facts, and the reluctance of the
Government of Mauritius in the matter to renegotiate the terms of
treaty, the Committee recommended as under (vide para 12.205):
"The Committee find that though the exact
amount of revenue loss due to the 'residency
clause' of the treaty cannot be quantified, but
taking into account the huge
inflows/outflows, it could be assumed to be
substantial. They therefore recommend that
Companies investing in Indian through
Mauritius, should be required to file details
of ownership with RBI and declare that all
the Directors and effective management is in
Mauritius. The Committee suggest that all
the contentious issues should be resolved by
the Government with the Government of
Mauritius urgently through dialogue."
In our view, the recommendations of the Working Group of
the JPC are intended for Parliament to take appropriate action. The
JPC might have noticed certain consequences, intended or
unintended, flowing from the DTAC and has made appropriate
recommendations. Based on them, it is not possible for us to say
that the DTAC or the impugned circular are contrary to law, nor
would it be possible to interfere with either of them on the basis of
the report of the JPC.
Interpretation of Treaties
The principles adopted in interpretation of treaties are not
the same as those in interpretation of statutory legislation. While
commenting on the interpretation of a treaty imported into a
municipal law, Francis Bennion observes:
"With indirect enactment, instead of the
substantive legislation taking the well-known
form of an Act of Parliament, it has the form
of a treaty. In other words the form and
language found suitable for embodying an
international agreement become, at the stroke
of a pen, also the form and language of a
municipal legislative instrument. It is rather
like saying that, by Act of Parliament, a
woman shall be a man. Inconveniences may
ensue. One inconvenience is that the
interpreter is likely to be required to cope
with disorganised composition instead of
precision drafting. The drafting of treaties is
notoriously sloppy usually for very good
reason. To get agreement, politic uncertainty
is called for.
.....The interpretation of a treaty imported
into municipal law by indirect enactment was
described by Lord Wilberforce as being
'unconstrained by technical rules of English
law, or by English legal precedent, but
conducted on broad principles of general
acceptation. This echoes the optimistic
dictum of Lord Widgery CJ that the words
'are to be given their general meaning,
general to lawyer and layman alike... the
meaning of the diplomat rather than the
lawyer."
An important principle which needs to be kept in mind in the
interpretation of the provisions of an international treaty, including
one for double taxation relief, is that treaties are negotiated and
entered into at a political level and have several considerations as
their bases. Commenting on this aspect of the matter, David R.
Davis in Principles of International Double Taxation Relief ,
points out that the main function of a Double Taxation Avoidance
Treaty should be seen in the context of aiding commercial relations
between treaty partners and as being essentially a bargain between
two treaty countries as to the division of tax revenues between
them in respect of income falling to be taxed in both jurisdictions.
It is observed (vide para 1.06):
"The benefits and detriments of a double tax
treaty will probably only be truly reciprocal
where the flow of trade and investment
between treaty partners is generally in
balance. Where this is not the case, the
benefits of the treaty may be weighted more
in favour of one treaty partner than the other,
even though the provisions of the treaty are
expressed in reciprocal terms. This has been
identified as occurring in relation to tax
treaties between developed and developing
countries, where the flow of trade and
investment is largely one way.
Because treaty negotiations are largely
a bargaining process with each side seeking
concessions from the other, the final
agreement will often represent a number of
compromises, and it may be uncertain as to
whether a full and sufficient quid pro quo is
obtained by both sides."
And, finally, in paragraph 1.08:
"Apart from the allocation of tax between the
treaty partners, tax treaties can also help to
resolve problems and can obtain benefits
which cannot be achieved unilaterally."
Based on these observations, counsel for the appellants
contended that the preamble of 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.
Many developed countries tolerate or encourage treaty
shopping, even if it is unintended, improper or unjustified, for
other non-tax reasons, unless it leads to a significant loss of tax
revenues. Moreover, several of them allow the use of their treaty
network to attract foreign enterprises and offshore activities. Some
of them favour treaty shopping for outbound investment to reduce
the foreign taxes of their tax residents but dislike their own loss of
tax revenues on inbound investment or trade of non-residents. In
developing countries, treaty shopping is often regarded as a tax
incentive to attract scarce foreign capital or technology. They are
able to grant tax concessions exclusively to foreign investors over
and above the domestic tax law provisions. In this respect, it does
not differ much from other similar tax incentives given by them,
such as tax holidays, grants, etc.
Developing countries need foreign investments, and the
treaty shopping opportunities can be an additional factor to attract
them. The use of Cyprus as a treaty haven has helped capital
inflows into eastern Europe. Madeira (Portugal) is attractive for
investments into the European Union. Singapore is developing
itself as a base for investments in South East Asia and China.
Mauritius today provides a suitable treaty conduit for South Asia
and South Africa. In recent years, India has been the beneficiary
of significant foreign funds through the "Mauritius conduit".
Although the Indian economic reforms since 1991 permitted such
capital transfers, the amount would have been much lower without
the India-Mauritius tax treaty.
Overall, countries need to take, and do take, a holistic view.
The developing countries allow treaty shopping to encourage
capital and technology inflows, which developed countries are
keen to provide to them. The loss of tax revenues could be
insignificant compared to the other non-tax benefits to their
economy. Many of them do not appear to be too concerned unless
the revenue losses are significant compared to the other tax and
non-tax benefits from the treaty, or the treaty shopping leads to
other tax abuses.
There are many principles in fiscal economy which, though
at first blush might appear to be evil, are tolerated in a developing
economy, in the interest of long term development. Deficit
financing, for example, is one; treaty shopping, in our view, is
another. Despite the sound and fury of the respondents over the so
called 'abuse' of 'treaty shopping', perhaps, it may have been
intended at the time when Indo-Mauritius DTAC was entered into.
Whether it should continue, and, if so, for how long, is a matter
which is best left to the discretion of the executive as it is
dependent upon several economic and political considerations.
This Court cannot judge the legality of treaty shopping merely
because one section of thought considers it improper. A holistic
view has to be taken to adjudge what is perhaps regarded in
contemporary thinking as a necessary evil in a developing
economy.
Rule in McDowell
The respondents strenuously criticized the act of
incorporation by FIIs under the Mauritian Act as a 'sham' and 'a
device' actuated by improper motives. They contend that this
Court should interdict such arrangements and, as if by waving a
magic wand, bring about a situation where the incorporation
becomes non est. For this they heavily rely on the judgment of the
Constitution Bench of this Court in McDowell and Company Ltd.
v. Commercial Tax Officer . Placing strong reliance on
McDowell it is argued that McDowell has changed the
concept of fiscal jurisprudence in this country and any tax
planning which is intended to and results in avoidance of tax must
be struck down by the Court. Considering the seminal nature of
the contention, it is necessary to consider in some detail as to why
McDowell , what it says, and what it does not say.
In the classic words of Lord Sumner in IRC V. Fisher's
Executors ,
"My Lords, the highest authorities have
always recognised that the subject is entitled
so to arrange his affairs as not to attract taxes
imposed by the Crown, so far as he can do so
within the law, and that he may legitimately
claim the advantage of any expressed terms
or any omissions that he can find in his
favour in taxing Acts. In so doing, he neither
comes under liability nor incurs blame."
Similar views were expressed by Lord Tomlin in IRC v.
Duke of Westminster which reflected the prevalent attitude
towards tax avoidance:
"Every man is entitled if he can to order his
affairs so that the tax attaching under the
appropriate Acts is less than it otherwise
would be. If he succeeds in ordering them so
as to secure this result, then, however,
unappreciative the Commissioners of Inland
Revenue or his fellow taxgatherers may be of
his ingenuity, he cannot be compelled to pay
an increased tax."
These were the pre second world war sentiments expressed
by the British Courts. It is urged that McDowell has taken a new
look at fiscal jurisprudence and "the ghost of Fisher (supra) and
Westminster have been exorcised in the country of its origin". It
is also urged that McDowell's radical departure was in tune with
the changed thinking on fiscal jurisprudence by the English Courts,
as evidenced in W.T. Ramsay Ltd. v. IRC , Inland Revenue
Commissioners v. Burman Oil Company Ltd and Furniss v.
Dawson .
As we shall show presently, far from being exorcised in its
country of origin, Duke of Westminster continues to be alive and
kicking in England. Interestingly, even in McDowell , though
Chinnappa Reddy,J., dismissed the observation of J.C. Shah,J. in
CIT v. A. Raman and Company based on Westminster and
Fisher's Executors , by saying "we think that the time has come
for us to depart from the Westminster principle as emphatically as
the British courts have done and to dissociate ourselves from the
observations of Shah J., and similar observations made elsewhere",
it does not appear that the rest of the learned Judges of the
Constitutional Bench contributed to this radical thinking. Speaking
for the majority, Ranganath Mishra,J,(as he then was) says in
McDowell :
"Tax planning may be legitimate provided it
is within the framework of law. Colourable
devices cannot be part of tax planning and it
is wrong to encourage or entertain the belief
that it is honourable to avoid the payment of
tax by resorting to dubious methods. It is the
obligation of every citizen to pay the taxes
honestly without resorting to subterfuges."
(Emphasis supplied)
This opinion of the majority is a far cry from the view of
Chinnappa Reddy,J: "In our view the proper way to construe a
taxing statute, while considering a device to avoid tax, is not to ask
whether a provision should be construed liberally or principally,
nor whether the transaction is not unreal and not prohibited by the
statute, but whether the transaction is a device to avoid tax, and
whether the transaction is such that the judicial process may accord
its approval to it." We are afraid that we are unable to read or
comprehend the majority judgment in McDowell as having
endorsed this extreme view of Chinnappa Reddy,J, which, in our
considered opinion, actually militates against the observations of
the majority of the Judges which we have just extracted from the
leading judgment of Ranganath Mishra,J (as he then was).
The basic assumption made in the judgment of Chinnappa
Reddy,J. in McDowell that the principle in Duke of
Westminster has been departed from subsequently by the House
of Lords in England, with respect, is not correct. In Craven v.
White the House of Lords pointedly considered the impact of
Furniss , Burma Oil and Ramsay . The Law Lords were at
great pains to explain away each of these judgments. Lord Keith
of Kinkel says, with reference to the trilogy of these cases, (at
p.500):
" My Lords, in my opinion the nature of the
principle to be derived from the three cases is
this : the court must first construe the relevant
enactment in order to ascertain its meaning; it
must then analyse the series of transactions in
question, regarded as a whole, so as to ascertain
its true effect in law; and finally it must apply
the enactment as construed to the true effect of
the series of transactions and so decide whether
or not the enactment was intended to cover it.
The most important feature of the principle is
that the series of transactions is to be regarded
as a whole. In ascertaining the true legal effect
of the series it is relevant to take into account, if
it be the case, that all the steps in it were
contractually agreed in advance or had been
determined on in advance by a guiding will
which was in a position, for all practical
purposes, to secure that all of them were carried
through to completion. It is also relevant to
take into account, if it be the case, that one or
more of the steps was introduced into the series
with no business purpose other than the
avoidance of tax.
The principle does not involve, in my opinion,
that it is part of the judicial function to treat as
nugatory any step whatever which a taxpayer
may take with a view to the avoidance or
mitigation or tax. It remains true in general that
the taxpayer, where he is in a position to carry
through a transaction in two alternative ways,
one of which will result in liability to tax and
the other of which will not, is at liberty to
choose the latter and to do so effectively in the
absence of any specific tax avoidance provision
such as s.460 of the Income and Corporation
Taxes Act, 1970.
In Ramsay and in Burmah the result of
application of the principle was to demonstrate
that the true legal effect of the series of
transactions entered into, regarded as a whole,
was precisely nil."
Lord Oliver (at p.518-19) says:
"It is equally important to bear in mind what
the case did not decide. It did not decide that a
transaction entered into with the motive of
minimising the subject's burden of tax is, for
that reason, to be ignored or struck down. Lord
Wilberforce was at pains to stress that the fact
that the motive for a transaction may be to
avoid tax does not invalidate it unless a
particular enactment so provides (see (1981) 1
All ER 865, (1982) AC 300 at 323). Nor did it
decide that the court is entitled, because of the
subject's motive in entering into a genuine
transaction, to attribute to it a legal effect which
it did not have. Both Lord Wilberforce and
Lord Fraser emphasise the continued validity
and application of the principle of IRC v. Duke
of Westminster (1936) AC 1 (19350 All ER
Rep.259, a principle which Lord Wilberforce
described as a 'cardinal principle'. What it did
decide was that that cardinal principle does
not, where it is plain that a particular
transaction is but one step in a connected series
of interdependent steps designed to produce a
single composite overall result, compel the
court to regard it as otherwise than what it is,
that is to say merely a part of the composite
whole."
Lord Oliver (at p.523 ) observes:
"My Lords, for my part I find myself unable to
accept that Dawson either established or can
properly be used to support a general
proposition that any transaction which is
effected for the purpose of avoiding tax on a
contemplated subsequent transaction and is
therefore 'planned' is, for that reason,
necessarily to be treated as one with that
subsequent transaction and as having no
independent effect even where that is
realistically and logically impossible."
Continuing, (at page 524) Lord Oliver
observes:
"Essentially, Dawson was concerned with a
question which is common to all successive
transactions where an actual transfer of
property has taken place to a corporate entity
which subsequently carries out a further
disposition to an ultimate disponee. The
question is : when is a disposal not a disposal
within the terms of the statute ? To give to that
question the answer 'when, on an analysis of
the facts, it is seen in reality to be a different
transaction altogether' is well within the
accepted canons of construction. To answer it
'when it is effected with a view to avoiding tax
on another contemplated transaction' is to do
more than simply to place a gloss on the words
of the statute. It is to add a limitation or
qualification which the legislature itself has not
sought to express and for which there is no
context in the statute. That, however, desirable
it may seem, is to legislate, not to construe, and
that is something which is not within judicial
competence. I can find nothing in Dawson or
in the cases which preceded it which causes me
to suppose that that was what this House, was
seeking to do."
Thus we see that even in the year 1988 the House of Lords
emphasised the continued validity and application of the principle
in Duke of Westminster .
While Chinnappa Reddy, J. took the view that Ramsay ,
was an authoritative rejection of principle in the Duke of
Westminster , the House of Lords, in the year 2001, does not
seem to consider it to be so, as seen from MacNiven (Inspector of
Taxes) v. Westmoreland Investments Ltd . Lord Hoffmann
observes:
"In the Ramsay case both Lord Wilberforce
and Lord Fraser of Tullybelton, who gave the
other principal speech, were careful to stress
that the House was not departing from the
principle in IRC v. Duke of Westminster
(1936) AC 1, (1935) All ER Rep.259. There
has nevertheless been a good deal of
discussion about how the two cases are to be
reconciled. How, if the various juristically
discrete acquisitions and disposals which
made up the scheme were genuine, could the
House collapse them into a composite self-
cancelling transaction without being guilty of
ignoring the legal position and looking at the
substance of the matter?
My Lords, I venture to suggest that some of
the difficulty which may have been felt in
reconciling the Ramsay case with the Duke of
Westminster's case arises out of an
ambiguity in Lord Tomlin's statement that
the courts cannot ignore 'the legal position'
and have regard to 'the substance of the
matter'. If 'the legal position' is that the tax is
imposed by reference to a legally defined
concept, such as stamp duty payable on a
document which constitutes a conveyance on
sale, the court cannot tax a transaction which
uses no such document on the ground that it
achieves the same economic effect. On the
other hand, if the legal position is that tax is
imposed by reference to a commercial
concept, then to have regard to the business
'substance' of the matter is not to ignore the
legal position but to give effect to it.
The speeches in the Ramsay case and
subsequent cases contain numerous
references to the 'real' nature of the
transaction and to what happens in 'the real
world'. These expressions are illuminating in
their context, but you have to be careful about
the sense in which they are being used.
Otherwise you land in all kinds of
unnecessary philosophical difficulties about
the nature of reality and, in particular, about
how a transaction can be said not to be a
'sham' and yet be 'disregarded' for the
purpose of deciding what happened in 'the
real world'. The point to hold on to is that
something may be real for one purpose but
not for another. When people speak of
something being a 'real' something, they
mean that it falls within some concept which
they have in mind, by contrast with
something else which might have been
thought to do so, but does not. When an
economist says that real incomes have fallen,
he is not intending to contrast real incomes
with imaginary incomes. The contrast is
specifically between incomes which have
been adjusted for inflation and those which
have not. In order to know what he means by
'real', one must first identify the concept
(inflation adjustment) by reference to which
he is using the word.
Thus in saying that the transactions in the
Ramsay case were not sham transactions, one
is accepting the juristic categorisation of the
transactions as individual and discrete and
saying that each of them involved no
pretence. They were intended to do precisely
what they purported to do. They had a legal
reality. But in saying that they did not
constitute a 'real' disposal giving rise to a
'real' loss, one is rejecting the juristic
categorisation as not being necessarily
determinative for the purposes of the statutory
concepts of 'disposal' and 'loss' as properly
interpreted. The contrast here is with a
commercial meaning of these concepts. And
in saying that the income tax legislation was
intended to operate 'in the real world', one is
again referring to the commercial context
which should influence the construction of
the concepts used by Parliament."
With respect, therefore, we are unable to agree with the
view that Duke of Westminster is dead, or that its ghost has been
exorcised in England. The House of Lords does not seem to think
so, and we agree, with respect. In our view, the principle in Duke
of Westminster is very much alive and kicking in the country of
its birth. And as far as this country is concerned, the observations
of Shah,J., in CIT v. Raman are very much relevant even today.
We may in this connection usefully refer to the judgment of
the Madras High Court in M.V.Vallipappan and others v. ITO ,
which has rightly concluded that the decision in McDowell
cannot be read as laying down that every attempt at tax planning
is illegitimate and must be ignored, or that every transaction or
arrangement which is perfectly permissible under law, which has
the effect of reducing the tax burden of the assessee, must be
looked upon with disfavour. Though the Madras High Court had
occasion to refer to the judgment of the Privy Council in IRC v.
Challenge Corporation Ltd. , and did not have the benefit of the
House of Lords's pronouncement in Craven , the view taken by
the Madras High Court appears to be correct and we are inclined to
agree with it.
We may also refer to the judgment of Gujarat High Court in
Banyan and Berry v. Commissioner of Income-Tax where
referring to McDowell , the Court observed:
"The court nowhere said that every action or
inaction on the part of the taxpayer which
results in reduction of tax liability to which he
may be subjected in future, is to be viewed
with suspicion and be treated as a device for
avoidance of tax irrespective of legitimacy or
genuineness of the act; an inference which
unfortunately, in our opinion, the Tribunal
apparently appears to have drawn from the
enunciation made in McDowell case (1985)
154 ITR 148 (SC). The ratio of any decision
has to be understood in the context it has been
made. The facts and circumstances which lead
to McDowell's decision leave us in no doubt
that the principle enunciated in the above case
has not affected the freedom of the citizen to
act in a manner according to his requirements,
his wishes in the manner of doing any trade,
activity or planning his affairs with
circumspection, within the framework of law,
unless the same fall in the category of
colourable device which may properly be
called a device or a dubious method or a
subterfuge clothed with apparent dignity."
This accords with our own view of the matter.
In CWT v. Arvind Narottam , a case under the Wealth
Tax Act, three trust deeds for the benefit of the assessee, his wife
and children in identical terms were prepared under section 21(2)
of the Wealth Tax Act. Revenue placed reliance on McDowell .
Both the learned Judges of the Bench of this Court gave separate
opinions.
Chief Justice Pathak, in his opinion said (at p.486):
"Reliance was also placed by learned
counsel for the Revenue on McDowell and
Company Ltd. v. CTO (1985) 154 ITR
148(SC). That decision cannot advance the
case of the Revenue because the language of
the deeds of settlement is plain and admits
of no ambiguity."
Justice S. Mukherjee said, after noticing
McDowell's case, (at page 487):
"Where the true effect on the construction of
the deeds is clear, as in this case, the appeal
to discourage tax avoidance is not a relevant
consideration. But since it was made, it has
to be noted and rejected."
In Mathuram Agrawal v. State of Madhya Pradesh another
Constitution Bench had occasion to consider the issue. The Bench
observed:
"The intention of the legislature in a taxation
statute is to be gathered from the language of
the provisions particularly where the language
is plain and unambiguous. In a taxing Act it is
not possible to assume any intention or
governing purpose of the statute more than
what is stated in the plain language. It is not
the economic results sought to be obtained by
making the provision which is relevant in
interpreting a fiscal statute. Equally
impermissible is an interpretation which does
not follow from the plain, unambiguous
language of the statute. Words cannot be
added to or substituted so as to give a meaning
to the statute which will serve the spirit and
intention of the legislature."
The Constitution Bench reiterated the observations in Bank
of Chettinad Ltd. v. CIT , quoting with approval the observations
of Lord Russell of Killowen in IRC v. Duke of Westminster
and the observations of Lord Simonds in Russell v. Scott
It thus appears to us that not only is the principle in Duke of
Westminster alive and kicking in England, but it also seems to
have acquired judicial benediction of the Constitutional Bench in
India, notwithstanding the temporary turbulence created in the
wake of McDowell .
Hence, reliance on Furniss , Ramsay and Burmah Oil
by the respondents in support of their submission is of no avail.
The situation is no different in United States and other
jurisdictions too.
The situation in the United State is reflected in the following
passage from American Jurisprudence :
"The legal right of a taxpayer to decrease
the amount of what otherwise would be his
taxes, or altogether to avoid them, by
means which the law permits, cannot be
doubted. A tax-saving motivation does not
justify the taxing authorities or the courts in
nullifying or disregarding a taxpayer's
otherwise proper and bona fide choice
among courses of action, and the state
cannot complain, when a taxpayer resorts to
a legal method available to him to compute
his tax liability, that the result is more
beneficial to the taxpayer than was intended.
It has even been said that it is common
knowledge that not infrequently changes in
the basic facts affecting liability to taxation
are made for the purpose of avoiding
taxation, but that where such changes are
actual and not merely simulated, although
made for the purpose of avoiding taxation,
they do not constitute evasion of taxation.
Thus, a man may change his residence to
avoid taxation, or change the form of his
property by putting his money into non-
taxable securities, or in the form of property
which would be taxed less, and not be guilty
of fraud. On the other hand, if a taxpayer at
assessment time converts taxable property
into non-taxable property for the purpose of
avoiding taxation, without intending a
permanent change, and shortly after the time
for assessment has passed, reconverts the
property to its original form, it is a
discreditable evasion of the taxing laws, a
fraud, and will not be sustained."
Several judgments of the US Courts were cited in respect of
the proposition that motive of tax avoidance is irrelevant in
consideration of the legal efficacy of a transactional situation.
We may recapitulate the observations of the Federal Court in
Johansson as to the irrelevance of the motive for Johansson. To
similar effect are the observations of the US Court in Perry R. Bas
v. Commissioner of Internal Revenue :
"we infer that Stantus was created by
petitioners with a view to reducing their
taxes through qualification of the
corporation under the convention. The test,
however, is not the personal purpose of a
taxpayer in creating a corporation. Rather, it
is whether that purpose is intended to be
accomplished through a corporation carrying
out substantive business functions. If the
purpose of the corporation is to carry out
substantive business functions, or if it in fact
engages in substantive business activity, it
will not be disregarded for Federal tax
purposes."
In Barber-Greene Americas, Inc. v. Commissioner of
Internal Revenue it was observed that a corporation will not be
denied Western Hemisphere trade corporation tax benefits merely
because it was purposely created and operated in such way as to
obtain such benefits. Similarly, a corporation otherwise qualified
should not be disregarded merely because it was purposely created
and operated to obtain the benefits of the United States-Swiss
Confederation Income Tax Convention.
Though the words 'sham', and 'device' were loosely used in
connection with the incorporation under the Mauritius law, we
deem it fit to enter a caveat here. These words are not intended to
be used as magic mantras or catchall phrases to defeat or nullify the
effect of a legal situation. As Lord Atkin pointed out in Duke of
Westminster :
"I do not use the word device in any sinister
sense; for it has to be recognised that the
subject, whether poor and humble or wealthy
and noble, has the legal right so to dispose of
his capital and income as to attract upon
himself the least amount of tax. The only
function of a court of law is to determine the
legal result of his dispositions so far as they
affect tax."
Lord Tomlin said :
"There may, of course, be cases where
documents are not bona fide nor intended to
be acted upon, but are only used as a cloak to
conceal a different transaction."
In Snook vs. London and West Riding Investments Ltd.
Lord Diplock L.J., explained the use of the word 'sham' as a legal
concept in the following words:
"it is, I think, necessary to consider
what, if any, legal concept is involved in the
use of this popular and pejorative word. I
apprehend that, if it has any meaning in law, it
means acts done or documents executed by the
parties to the 'sham' which are intended by
them to give to third parties or to the court the
appearance of creating between the parties legal
rights and obligations different from the actual
legal rights and obligations (if any) which the
parties intend to create. One thing I think,
however, is clear in legal principle, morality
and the authorities (see Yorkshire Railway
Wagon Contracting State. V. Maclure (1882)
21 Ch.D.309 ; Stoneleigh Finance, Ltd. v.
Phillips (1965) 1 All ER 513) that for acts or
documents to be a "sham", with whatever legal
consequences follow from this, all the parties
thereto must have a common intention that the
acts or documents are not to create the legal
rights and obligations which they give the
appearance of creating. No unexpressed
intentions of a "shammer" affect the rights of a
party whom he deceived."
In Waman Rao and others v. Union of India & Ors. and
Minerva Mills Ltd. and others v. Union of India and Ors. this
Court considered the import of the word "device' with reference to
Article 31B which provided that the Acts and Regulations specified
Ninth Schedule shall not be deemed to be void or even to have
become void on the ground that they are inconsistent with the
Fundamental Rights. The use of the word 'device' here was not
pejorative, but to describe a provision of law intended to produce a
certain legal result.
If the Court finds that notwithstanding a series of legal steps
taken by an assessee, the intended legal result has not been
achieved, the Court might be justified in overlooking the
intermediate steps, but it would not be permissible for the Court to
treat the intervening legal steps as non-est based upon some
hypothetical assessment of the 'real motive' of the assessee. In our
view, the court must deal with what is tangible in an objective
manner and cannot afford to chase a will-o'-the-wisp.
The judgment of the Privy Council in Bank of Chettinad ,
wholeheartedly approving the dicta in the passage from the opinion
of Lord Russel in Westminster , was the law in this country
when the Constitution came into force. This was the law in force
then, which continued by reason of Article 372. Unless abrogated
by an Act of Parliament, or by a clear pronouncement of this Court,
we think that this legal principle would continue to hold good.
Having anxiously scanned McDowell , we find no reference
therein to having dissented from or overruled the decision of the
Privy Council in Bank of Chettinad. If any, the principle
appears to have been reiterated with approval by the Constitutional
Bench of this Court in Mathuram . We are, therefore, unable to
accept the contention of the respondents that there has been a very
drastic change in the fiscal jurisprudence, in India, as would
entail a departure. In our judgment, from Westminster to Bank
of Chettinad to Mathuram , despite the hiccups of
McDowell , the law has remained the same.
We are unable to agree with the submission that an act which
is otherwise valid in law can be treated as non-est merely on the
basis of some underlying motive supposedly resulting in some
economic detriment or prejudice to the national interests, as
perceived by the respondents.
In the result, we are of the view that Delhi High Court erred
on all counts in quashing the impugned circular. The judgment
under appeal is set aside and it is held and declared that the
circular No. 789 dated 13.4.2000 is valid and efficacious.
We cannot part with this judgment without expressing our
grateful appreciation to the Learned Attorney General, Mr. Harish
Salve, Mr. Prashant Bhushan as also the party in person, Mr. S.K.
Jha, all of whom by their industrious research produced a wealth of
material and by their meticulous arguments rendered immense
assistance.
[1985] 154 ITR 148.
See in this connection Maganbhai Ishwarbhai Patel & Others. v. Union of India & Another
(1970) 3 SCC 400.
[1988] 144 ITR 146.
[1991] 190 ITR 626.
See also in this connection Leonhardt Andra Und Partner, Gmbh v. Commissioner of Income Tax
[2001] 249 ITR 418.
[1993] 202 ITR 508.
[1995] 212 ITR 31.
Cases in Constitutional Law, D.L. Kier and F.H. Lawson, Pg.53-54, 159-163 (ELBS &
Oxford University Press 5th Ed.).
See Section 5A of Central Excise Act, 1944 and Section 8(5) of the Central Sales Tax Act, 1956.
(1999) 4 SCC 11, para 14 to 22.
(1959) SCR 1099.
Supra note 10.
[1981] 131 ITR 597.
Crawford on Statutory Construction, 1940 Ed, as in Supre note 13.
[1908] ILR 35 Cal 701, 713.
[1979] 4 SCC 565.
Supra note 13.
[1965] 56 ITR 198.
[1971] 82 ITR 913.
[1999] 237 ITR 889 at 896.
[2001] 252 ITR 1.
[2002] 2 SCC 127 at para 11.
See in this connection State of Sikkim v. Dorjee Tshering Bhutia and Others (1991) 4 SCC 243 at para 16; N.B.
Sanjana, Assistant Collector of Central Excise, Bombay and Others v. Elphinshone Spinning and Weaving Mills Co.
Ltd.(1971) 1 SCC 337; B. Balakotaiah v. Union of India & Others (1968) SCR 1052 and Afzal Ullah v. State of U.P
(1964) 4 SCR 991.
See in this connection the observations of this Court in Harishankar Bagla and Another v. The
State of Madhya Pradesh 1955 SCR 380 and Kishan Prakash Sharma v. Union of India and
Others (2001) 5 SCC 212.
(1984) 4 SCC 27 at para 14.
Jean-Maic Rivier, Cahiers de droit fiscal international, VolLXXIIa at pp.47-76.
336F.2d.809.
See in this connection Ramanathan Chettiar v. Commissioner of Income Tax, Madras [1973] 88 ITR 169.
(1989) 4 SCC 592.
See also in this connection the judgment of Madras High Court in Tamil Nadu (Madras State)
Handloom Weavers Contracting State-operative Society Ltd. v. Assistant Collector of Central Excise 1978
ELT 57 (Mad HC).
(1995) 1 SCC 274.
[1994] 213 ITR 317.
[1999] 239 ITR 650.
Ibid
85 D.T.C.5188 at 5190.
Ibid
See in this connection Klaus Vogel, Double Taxation Convention, Pg.26-29 (3rd ed).
(1997) 785 FCA.
(2000) FCA 635.
1998 Can. Tax Ct.LEXIS 1140.
[1975] 100 ITR 706.
Lord McNair, The Law of Treaties, Pg.336 (Oxford, at the Clarendan Press, 1961).
Ibid.
53 (1) WLR 483.
L.Oppenheim, Oppenheim's International Law, Article 626 (9th Ed.).
Philip Baker, Double Taxation Convention and International Law, Pg.91 ((1994) 2nd Ed.).
Francis Bennion, Statutory Interpretation, Pg. 461 [Butterworths, 1992 (2nd Ed.)].
David R. Davis, Principles of International Double Taxation Relief, Pg.4 (London Sweet & Maxwell,
1985).
Roy Rohtagi, Basic International Taxationt Pg.373-374 (Kluwer Law International).
Ibid.
Ibid.
Supra note 1.
Ibid.
Ibid.
Ibid .
(1926) AC 395 at 412.
(1936) AC 1; 19 TC 490.
Supra note 1.
Supra note 56.
Supra note 57.
Supra note 1.
(1982) AC 300.
(1982) STC 30.
(1984) 1 All ER 530.
Supra note 57.
Supra note 1.
[1968] 67 ITR 11.
Supra note 57.
Supra note 56.
Supra note 1 at Pg. 171.
Supra note 1.
Ibid
Supra note 57.
(1988) 3 All ER 495.
Supra note 64.
Supra note 63.
Supra note 62.
Supra note 57.
Supra note 62.
Supra note 57.
(2001) 1 All ER 865 at 877-878.
Supra note 57.
Ibid.
Supra note 67.
(1988) 170 ITR 238.
Supra note 1.
(1987) 2 WLR 24.
Supra note 74.
(1996) 222 ITR 831 at 850.
Supra note 1.
(1988) 173 ITR 479.
Supra note 1.
(1999) 8 SCC 667 at para 12.
(1940) 8 ITR 522 (PC).
Supra note 57.
(1948) 2 All ER 15.
Supra note 57.
Supra note 1.
Supra note 64.
Supra note 62.
Supra note 63.
American Jurisprudence (1973 2nd Ed. Vol.71).
See in this connection Gregory v. Helvering 293 US465, 469 55 S.Ct. 226, 267, 78
L.ed.566, 97 ALR 1335; Helvering v. St. Louis Trust Company 296 US 48, 56 S. Ct. 78, 80L;
Becker v. St.Louis Union Trust Company 296 US 48, 56 S.Ct. 78, 80L.
Supra note 27.
(1968) US 50 TC 595.
(1960) 35 T.C.365, 383,384.
Supra note 57.
(1967) All ER 518 at 528.
(1981) 2 SCC 362 at para 45.
(1980) 3 SCC 625 at para 91.
Supra note 94.
Supra note 57.
Supra note 1.
Supra note 94.
Supra note 93.
Supra note 57.
Supra note 94.
Supra note 93.
Supra note 1.
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