1. Introduction

The proliferation of Double Taxation Avoidance Agreements entered into by India with several foreign countries has created a new branch of tax law. These Agreements come into play when a resident of one state has income sourced in another state. For the purpose of such Agreements income is regarded as sourced in a state if the payer is based there. A country’s appetite for taxation being insatiable, both states would like to tax the income arising from the same transaction. It is here that Double Taxation Avoidance Agreements come into play. The Agreements deal with different types of income and some of them have a residual “catch-all” provision. With reference to dif­ferent types of income different modes of avoiding/restricting double taxation are evolved. The Agreement may vest jurisdic­tion to tax a particular type of income in one of the contesting states. The vesting of such right may depend on the fulfi­ment of the prescribed condition/s. For example, business income is generally taxable in the source state if the enterprise has a permanent establishment therein. (By source state is meant the state where the income arises or the state the residents of which make payment to the residents of the other contracting state).

Certain income, for example, interest income may be taxable in both states. In respect of such cases the normal rule is that the state of which the concerned person is a resident has the right to tax his income. However, the source state would also have the right to tax the income. Such taxation by the latter may be subject to a maximum permissible rate. A Double Taxation Avoidance Agreement may effectively provide for avoidance of tax or for relief against double taxation by providing for grant of credit by the state of residence of the tax paid in the source state. Tax Avoidance Agreements may be confined to a particular type of income for example, aviation income or may be general and cover several/all types of income.

It is of interest to note that the first Double Taxation Avoidance Agreement was executed 105 years ago (in 1899 between Prussia and the Austro Hungarian empire). Seligman in “Double Taxation and International Fiscal Co-operation” notes that the problem of double taxation first surfaced in the 13th century regarding property taxes levied in France and Italy – where the property was situated in one country but owned by a resident of the other country. The first concrete step for relieving against double taxation, in so far as India is concerned, was taken in 1939 with the coming into force of the Income-tax (Double Taxation Relief) (Indian States) Rules. Since then India has travelled a long distance. Presently, India has en­tered into over 90 Double Taxation Avoidance Agreements — some of them of limited application but most of them being compre­hensive Agreements.

Double Taxation Avoidance Agreements are treaties between two sovereign states. (Such Agreements can also be between two countries which are not “sovereign” states in the full legal sense). Being Agreements between two contracting states it was found that it would be useful to have a Model Agreement which could be the basis for discussion between two states contem­plating to conclude a Double Tax Avoidance Agreement. The League of Nations first commenced work in this behalf in 1921 and produced in 1928 the first Model Bilateral Convention. These were followed by the Model Convention of Mexico (1943) and the London Model Convention (1946). The Council of the Organisation for European Economic Co-operation, which later became the Organisation for Economic Co-operation and Develop­ment (OECD) set up a fiscal committee in 1956 to formulate a Model Convention. The first draft Double Taxation Convention on income and capital was framed in 1963. This ultimately gave birth to the 1977 OECD Model Convention and Commentaries. On the basis of the recommendation of the Committee on Fiscal Affairs, OECD published the 1992 Model Convention in a loose leaf format to facilitate updating. The present Model Convention and Commentaries are updated as of January 2003.

The OECD Model Convention though primarily meant for use by the OECD countries is often referred to and the Commentaries ap­plied in interpreting Agreements between non-OECD countries also. In addition to the OECD Model, there is the UN Model Convention. Its origin lies in a resolution passed by the Economic and Social Council of the U.N. in August 1967 and was published in 1980 in the form of Model Double Taxation Conven­tion between developed and developing countries. The UN Model is generally considered to be more favourable from the point of view of the developing countries as it places greater emphasis on the right of the source state to tax a transaction having international ramifications. Predictably the United States wanted to have its own Model Convention and published in 1976 the US Model Treaty. In 1996, the US Model was revised. It is accompanied by a most exhaustive technical explanation comment­ing on the various articles in the Model Convention. Unlike the OECD Commentaries which have to take into consideration the views of various states the US Technical Explanation highlights the US point of view and to that extent is more emphatic and clear compared to the OECD Commentaries which are necessarily based on a compromise. Whenever the United States enters into a Double Taxation Avoidance Agreement it also releases a detailed write-up explaining the US view concerning each of the articles in the Agreement entitled “The Treasury Department Technical Explanation”. The thoroughness of the US approach in the matter is shown by the fact that the technical explanation in respect of the Indo-US Double Taxation Avoidance Agreement covers about 50 pages. The US also publishes the Report of the Senate Foreign Relations Committee on each Treaty negotiated by the US . Thus, far more “official” literature is available in respect of agreements concluded by the US than by us.

As noted above, the OECD Model Convention of 1963 was substi­tuted by a fresh Model in 1977. However, the wording of the Commentaries is an on-going process and there may be changes therein without a change in the provision of the Convention. There would of course also be cases where there is a change in the provisions of the Convention which may also result in a change in the Commentaries. The view of the Committee on fiscal affairs is that the revised commentaries should be taken into account even where there is no change in the wording of the Convention. Of course, where there is a change in the wording of the Convention it is only the revised commentary which has to be taken into account. Having said this it must be empha­sised that these are only the views and opinions of the commit­tee and are in no way binding on the judicial authority called upon to interpret the actual Agreement concluded by the two contracting states.

2. Agreement vs. Act

The first and the basic issue which arises in the interpretation of a Double Taxation Avoidance Agreement is what is the position where there is a conflict between the provisions of the statute (the Income-tax Act — hereinafter referred to as the Act) and the provisions of the applicable Double Taxation Avoidance Agreement. It is to be remembered that an assessee cannot be worse off by virtue of any provision in the treaty — ­as the purpose of a treaty is to confer a benefit and not to levy a charge.

Section 90(2) of the Act makes it clear that where an agreement for granting relief of tax or for avoidance of double taxation has been entered into, then, in relation to the assessee to whom such agreement applies, the provisions of the Act to the extent that they are more beneficial as compared to the provi­sions of the Double Taxation Avoidance Agreement would have to be applied. It follows that where the provisions of the applicable Agreement are more favourable, compared to the provisions in the Act, the provisions of the Agreement will prevail. Section 90(2) is a statutory recognition of the rule laid down by the Andhra Pradesh High Court in CIT vs. Visakhapatnam Port Trust 144 ITR 146 which view has now been accepted by the Supreme Court in Union of India vs. Azadi Bachao Andolan 263 ITR 706. Indeed the Central Board of Direct Taxes itself had earlier accepted this position in Circular No. 333 dt. April 2, 1982 reproduced in 137 ITR 1 (st.). The Finance (No. 2) Act, 1991, which inserted sub-section (2) in section 90 with retrospective effect from 1-4-1972, also inserted clause (iii) in section 2(37A) to provide that where tax is deductible at source from payments made to a non-resident the payer could apply the rate as prescribed in the Act or the Finance Act or the rate applicable under the relevant Agreement whichever was lower.

The general principle as enunciated above raises several issues. Whilst it is true that the Agreement would override the Act, would it be open to an assessee depending on the provi­sions in force in different assessment years and the prevailing factual position in each year to opt for being governed by the Act in one year and the applicable Agreement in the other? The view of the writer is that such option is available. The more intricate problem is whether an assessee can choose for the same assessment year to be governed by the provisions of the Act in so far as assessment of a particular type of income is concerned, say, business income, but by the provisions of the Agreement in so far as another type of income is concerned, say, capital gain. In my view this would be permissible as one would, in the language of section 90(2), apply the Act to the extent that the provisions thereof are more beneficial to the assessee. The next issue is whether in respect of the same type of income derived by the assessee from two different states can he opt for being governed by the provisions of the Agreement in so far as state A is concerned but by the provisions of the Act in so far as state B is concerned. For example, an Indian company may have branches (permanent establishments) in state A and state B. The branch in state A makes a profit and the Indian company elects to be governed by the Agreement and takes the stand that the profit is assessable only in country s where there is a permanent establishment, in line with the view taken by the High Courts and the Supreme Court as referred to hereinafter. The permanent establishment in country B makes a loss and the Indian company desires to set off such business loss against its Indian business income as permissible under section 70 of the Act and does not want to be governed by the provisions of the treaty whereunder the income (which term would include loss) is assessable, as noted above, only in state B. Though the matter cannot be said to be free from all doubt, in the writer’s opinion it would be permissible to choose the more beneficial provision “Treatywise.”

A further refinement, which the more blunt would call hair splitting by a bald person, is whether an assessee can claim that the computation of his income should be under say, the Act but the rate of tax should be as per the treaty. According to the writer this is not permissible because a lower rate is often prescribed where, as per the applicable provisions of the Treaty, expenditure is not allowed in computing the particular type of income. One cannot therefore take advantage of computa­tion under, say, the Act where it allows deduction of expendi­ture and then turn to the treaty to apply the lower rate.

As noted above section 90(2) places a Double Taxation Avoidance Agreement at a level higher than the provisions of the Act in that an assessee governed by a treaty can opt for being gov­erned by the provisions of the treaty rather than the Act. As observed by the Supreme Court in Chettiar’s case (267 ITR 654) referred to hereafter), section 90 and the Agreements executed pursuant to the power conferred thereunder were provisos or exceptions to the charge of tax levied by sections 4 and 5. In other words, the Agreements become part of the Indian law.

The issue which arises is whether Parliament can enact legislation subsequent to the signing of a treaty which would override the provisions of a treaty and if so whether such legislation has to be in any particular form. Depending on the provision in a country’s Constitution as to the status of domestic law vis-a-vis provisions in a treaty the conclusion may be different whether a post treaty domestic law can override a provision in an earlier treaty. The French and Dutch Constitutions do not, it appears, permit the overriding of a treaty provision by a subsequent legislation. The position is different in the United States of America and in the United Kingdom . Though Article 51 of our Constitution provides as a directive princi­ple that the state shall endeavour to foster respect for inter­national law and treaty obligations in the dealings of organised peoples with one another the position appears to be that there is no fetter on the power of the Indian Parliament to legislate in a manner which may conflict with or override the provisions of an earlier treaty just as Parliament can over turn or amend an earlier enacted law. An example of such treaty override is provided by the insertion of the Explanation to section 90 of the Act (by the Finance Act, 2001) and subse­quently amending the Explanation by the Finance Act (No. 2) Act, 2004.

To understand the context in which the Explanation was added a few facts may be noted. Some Double Taxation Avoidance Agree­ments provide that tax on a permanent establishment of an enterprise of one of the states in the other state shall not be less favourably levied in such other state than the taxation levied on enterprises of that other state carrying on the same activities. In India a higher rate of tax is charged on non-domestic companies compared to domestic compa­nies similarly engaged, with the result that the permanent establishment of an enterprise of a contracting state suffers tax at a higher rate. In some cases it was judically held that such discrimination was not permissible. The Explanation to section 90 now declares that “the charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign company.” In other words, the Explanation has ruled that rate discrimination is not to be regarded as a less favourable charge of tax obviously for the purposes of Agreements for Avoidance of Double Taxation as only in the case of persons governed by such Agreement would the issue of less favourable rate of tax arise. In so far as tax matters are concerned it has not yet been tested in India whether Parliament can over­ride a provision in an earlier concluded treaty. It is, of course, debatable as to who can have the matter tested as the treaty is between two states. Is it the state which must take up the issue or should it be decided under the mutual agreement procedure or can the affected person challenge the amendment even if the concerned state has not protested? The writer is of the view, which he must confess is not the generally accepted one, that as Double Taxation Avoidance Agreements are agreements between two contracting parties it is not proper for one of the contracting parties unilaterally to change the provi­sions of the bilateral Agreement. A state cannot, unlike Alice in Wonderland say that words will have the meaning which it chooses to confer on them! It may be noted that by the Finance Act, 2003 sub-section (3) has been incorporated in section 90 which entitles the Central Government by notification to pro­vide that any term in the Agreement which is not defined there­in or in the Act shall have the meaning given thereto in the notification so long as such meaning is not inconsistent with the provisions of the Act or the Agreement.

I now consider the position where there is a conflict in the definition of certain terms in the Act and a Double Taxation Avoidance Agreement. The definition of a term (say royalty) plays an important role in appropriately classifying an item of income. Typically Article 3(1) of the Agreements concluded by India contains general definitions. In addition, certain terms are defined in the applicable article. For example, the terms dividends, interest and royalties, normally dealt with, respectively in Articles 10, 11 and 12 of an Agreement, define these terms for the purposes of those articles. There can be no dispute that if there is a conflict between a definition in the Act as existing when a Treaty comes into force and a defini­tion in the Treaty the latter will prevail. The issues which arise are 1) if there is a definition in the Act at the time the treaty comes into force but there is no definition of that term in the treaty will the definition in the Act apply and 2) if there is no definition of the term in the treaty or in the Act when the treaty was concluded but subsequently a defini­tion is introduced in the Act would that definition be applied also for the purposes of interpreting the treaty?

In so far as 1) above is concerned, the position seems to be clear that in the absence of a definition in the treaty the definition in the Act as existing at the time the treaty is made will be applicable unless the context requires otherwise. The position is not completely clear as to what is to happen where a definition is inserted in the Act or an existing definition in the Act is changed subsequent to the coming into force of the Treaty. Article 3(2) of the OECD Model Convention provides “As regards the application of the Convention at any time by a contracting state, any term not defined therein shall, unless the context otherwise requires, have meaning that it has at that time under the law of that state for the purpos­es of the taxes to which the Convention applies, any meaning under the applicable tax laws of that state prevailing over a meaning given to that term under other laws of that state.” It is, therefore, made clear that the definition “at any time” in the local tax law would have to be applied in the absence of a definition in the Convention. If, therefore, a term is defined in the Convention a subsequent change of meaning in the local law will not be applicable but where the term is not defined, then, the meaning under the local tax law as in existence from time to time will have to be applied. This is made clear by the use of the phrases “at any time” and “at that time.” These words are absent in the UN and US Model Conventions. Also, in most of the Treaties entered into by India , the relevant provi­sion does not refer to “at any time” or “at that time.” Never­theless the general view appears to be that ..a subsequent definition in the local tax law will have to be applied in interpreting that term in the Agreement. To the writer this appears strange because an Agreement may have been negotiated on the basis of the meaning of the term as commonly understood. As per the generally held view a unilateral change in the defini­tion may impact on the scope and interpretation of the Agreement. It may also be noted that the OECD Model Convention requires one to have regard to the definition of a term in the Agreement in any local law but preference is to be given to the meaning, if any, under the local tax law. However, as per the US and UN Models as well as the Agreements generally entered into by India it is only the meaning in the local tax law (and not any other local law) which has to be taken into account. The general view mentioned above may lead to the anomalous situation that the two countries may change the meaning of the term under their local laws subsequent to the execution of the Agreement and, therefore, a particular term may be interpreted differently by the Courts of the two states resulting in such income being classified differently by the two states, say, royalty income by one state and only a business income by the other. There is a view that when there is a possibility of such a conflict the definition of the source state would be applica­ble. In Siemens A.G. vs. ITO (1987) 22 ITD 87 (SB) the Special Bench of the Tribunal accepted the static and not the ambulatory rule and, accordingly, did not interpret the term “royalty” in the then existing ( 1959) Indo-German Double Taxation Agreement on the basis of the meaning given to the term from 1976 in section 9 of the Act.

I next consider whether the definition in the local law which one has to have regard to as per article 3(2) referred to above is a reference to the “general” definition in the local tax law or a definition restricted to particular provisions. For example, the definition of royalty in section 9 of the Act is for the purposes of certain sections and is not a “general” defini­tion listed in section 2. The issue appears to be a virgin one. The writer is of the view that a definition for particular provisions in the Act would not strictly apply to other provi­sions in the Act and it would be strange to interpret provi­sions in a Double Taxation Avoidance Agreement in the light of a definition of limited application in the Act.

Earlier a reference has been made to a state’s power to over­ride a treaty provision. Whether in fact the treaty has been overridden would depend on the interpretation to be placed on the language used in the provision said to override the trea­ty. The Court would strain every nerve to give full meaning to the treaty unless it is clear that the legislation in question has indeed overriden the treaty provision. Insofar as the issue of treaty override is concerned, a very useful discussion is found in Chapter 33 of Tax Treaty Interpretation” by Michael Edwardes-Ker and also in Double Taxation Conventions and International Tax Law (Second Edition) by Philip Baker (pages 48 - 54).

3.Treaty shopping

The natural consequence of supremacy of favourable provisions in a tax treaty is the desire to implement a transaction “through a country which has a favourable treaty provision. Insofar as India is concerned, the most glaring Convention in this behalf is the Agreement between India and Mauritius . The Conventions with Cyprus and the Netherlands also have certain advantages compared to other Agreements. Assuming there is a favourable provision in the Indo-Mauritian treaty compared to, say, the Indo-US Treaty it would be the natural desire of the concerned party to structure the transaction so as to be able to claim the benefit of the Indo-Mauritian Double Taxation Avoidance Agreement. For example, a company may be incorporated in Mauritius so that it can take advantage of the Indo-Mauri­tian Double Taxation Avoidance Agreement even though the per­sons interested in the company may be foreign entities based elsewhere. This is generally called “treaty shopping”; i.e., to shop for the most favourable treaty. States frown upon treaty shopping as the general wisdom is that it is a misuse of a treaty provision and is contrary to the intendment of the treaty negotiating partners. A substantial portion of foreign investments into India take the Mauritian route because as per the Indo-Mauritian Double Taxation Avoidance Agreement capital gains are to be assessed as per the law of the state of resi­dence of the party. As under the Mauritian law tax is not levied on capital gains it means that capital gains made by Mauritian entity on transfer of shares in an Indian company go unassessed. One may also indulge in treaty shopping if the law of one of the states taxes the income in question at a lower rate compared to the state of residence of the concerned person.

One of the first cases where the issue of “treaty shopping” came up for judicial consideration in India was before the Authority for Advance Ruling in Ruling No. 9 of 1995 220 ITR 377. Clause (iii) of the proviso to section 245R ( 2) disables the Authority from pronouncing upon a transaction which is designed prima facie for the avoidance of income-tax, which is, of course, what treaty shopping is all about. In that case a company in the United Kingdom had invested in India via the Mauritian route. The Authority was of the view that this was to obtain the advantage of non-taxation in India of capital gains arising to a resident of Mauritius under the Indo-Mauritian Double Taxation Avoidance Agreement, which advantage was not available under the Indo-UK Double Taxation Avoidance Agree­ment. Subsequently, in Advance Ruling No. 10 of 1996 (224 ITR 473) the Authority sanctioned the Mauritian route where investors from several countries were to come together and it was necessary to base the investing company in a particular loca­tion and Mauritius was chosen as such location even though in making the choice the tax advantage was one of the considerations.

The Supreme Court has exhaustively dealt with this issue in Union of India vs. Azadi Bachao Andolan 263 ITR 706 at pages 746 - 753. The Supreme Court appears to have 'blessed’ treaty shopping as according to it “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.” According to the Supreme Court it was for Parliament to take appropriate action in the matter and in the absence of a prohibition one could not deny the benefits of a treaty on the basis of the belief that treaty shopping was not permissible. An anti treaty shopping provision is normally inserted in a Double Taxation Avoidance Agreement by a limitation on benefits clause (see, for example article 24 of the Indo-US Double Taxation Avoidance Agreement which per­mits a non-individual person to avail of treaty benefits only if more than 50% beneficial interest therein is owned by indi­vidual residents of a contracting state).

4. Who can tax income

An issue which often arises in implementing a Double Taxation Avoidance Agreement concerns determination of the question as to which country is entitled to tax a particular income. Ac­cording to the writer the function of a Double Taxation Avoidance Agreement is to determine the jurisdiction of the contracting parties to tax a particular income. It confers jurisdiction on one of the states or on both the states to tax a particular type of income. Classically an article may provide that a particular income may be taxed in the source country or it may provide for a particular income to be taxed by the country of residence at the normal rates and also in the coun­try of source but generally not at a rate in excess of a speci­fied figure. Thus, for example, in dealing with income from immovable property (generally article 6) it is stated that the same “may be taxed in the contracting state in which such property is situated.” The issue which arises is whether the country of residence of the owner of the property can also tax the income in which event the concerned person would have to claim credit in the country of residence for the tax paid in the country where the property is situated. In-so-far as taxa­tion of business profits (generally article 7) is concerned, the position is that the profits of an enterprise of a contracting state shall be taxable only in the state of residence unless the enterprise carries on business in the other contra­cting state (source state) through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other contracting state but only so much of them as is attrib­utable to that establishment. Though the two articles are not identically worded, the Madras and Karnataka High Courts have taken the view (see CIT vs. V.R.S.R.M. Firm & Others 208 ITR 400 and CIT vs. R.M.Muthaiah (1993) 202 ITR 508) that when it is provided that tax may be charged in a particular state in respect of the specified income it is implied that tax will not be charged by the other state. Conventional wisdom seems to be to the con­trary. However, the Supreme Court has in the Azadi Bachao Andolan case 263 ITR 706, 723-4, approved of not only the decision in Muthaiah’s case (which dealt with both immovable property and business income) but also the reasoning of the High Court.

In CIT vs. Kulandagan Chettiar and Other Appeals (2004) 267 ITR 654 (SC) the Supreme Court decided appeals arising from several decisions of different High Courts (including of the Madras and Karnataka High Courts referred to above) wherein it was held that if the concerned assessee was resident in India and had a permanent establishment or owned immovable property in Malaysia it was Malaysia alone which had the right to tax such business or immovable property income. In a judgement which is not the most clearly expressed the Supreme Court appears to have taken the view that the concerned assessees were to be regarded as resi­dents in Malaysia with no permanent establishment in India and, therefore, not chargeable to Indian tax. The Supreme Court, therefore, did not specifically approve nor in any way disap­prove of the view of the High Courts that where it was provided that the source state “may” tax the specified income, without stating that the state of residence may also tax such income, it was the former alone which could tax such income. However, as noted above in the Azadi Bachao Andolan case (which the Supreme Court does refer to in the Chettiar case) the Supreme Court specifically stated that it approved of not only the conclusion but the reasoning for reaching such conclusion.

That the decisions of the Madras and Karnataka High Courts, as approved by the Supreme Court in (2003) 263 ITR 706, lay down the correct proposition is shown by the fact that wherever an Agreement contemplates taxation by both states it is specifi­cally so provided. For example, generally both states are empowered to tax income by way of dividend, interest and royalty (normally articles 10, 11 and 12). The right of taxation is conferred on the state of residence but it is specifically provided that such income may “also” be taxed in the state of source. It may be noted that the OECD in its model convention has framed two alternative articles (23A/23B) for granting benefit by the exemption/credit method.

5. Double non-taxation

As noted above it is this writer’s view that the logical conse­quence of the view that where it is stated that a particular income “may be” taxed in the source state (e.g., income from immovable property and business income as referred to above) is that the state of residence is not entitled to tax the same. Consequently, there may be double non-taxation if that particu­lar income is not subjected to tax in the state wherein it “may be” taxed; i.e., in the source state, because that state does not tax such income or provides an incentive/exemption in respect thereof. Thus, for example, if a resident of India owns immovable property in country X in which country income from immovable property “may be” taxed as per the Agreement but the laws of that state for some reason do not provide for taxation of the income from such immovable property, then, such income would go completely untaxed as the state in which the jurisdic­tion to tax that income has been conferred chooses not to tax the same.

A view which seems to be gaining ground internationally is that a Double Taxation Avoidance Agreement ought not to be inter­preted so as to give rise to double non-taxation, its purpose being only to avoid double taxation. The philosophy underlying this view is that there is always an inherent right in the state of residence to tax the income of the resident and even if, in the above example, country X does not tax income from immovable property, the state of residence would be entitled to tax the same. The writer being a contrarian does not subscribe to this view. An avoidance agreement is to be interpreted on its own terms and if what is regarded as a correct interpreta­tion results in double non-taxation so be it. The cynic would support this view by saying that one must never look a gift horse in the mouth! The Supreme Court has apparently affirmed the view that a possible double non-taxation is irrelevant. In the Azadi Bachao Andolan case (2003) (263 ITR 706) the claim of the Mauritian investors was that as per the article 13 of the Indo­- Mauritius Double Taxation Avoidance Agreement, capital gains arising to them was taxable only in Mauritius. The Court noted that the capital gain was not assessable as per Mauritian law but nevertheless upheld the view of the Mauritian investors.

The decision of the Madras High Court in CIT vs. Laxmi Textile Exporters Ltd. (2000) 245 ITR 521 (Mad) is instructive in this behalf. In that case the Sri Lankan Tax Authorities held that the asses­see, who was a resident of India , carried on business in Sri Lanka through a permanent establishment which income was howev­er exempted from tax by the Sri Lankan Government. The High Court held that this would not give a right to India as the state of residence to tax the income arising to the resident from its permanent establishment in Sri Lanka . The case also laid down that the determination by the Sri Lankan authorities that the Indian resident assessee had a permanent establish­ment in Sri Lanka was binding on the Indian Tax Authorities; i.e., the view of the source state was determinative of the issue whether the assessee had permanent establishment abroad.

6. Entitlement to claim benefit of a Treaty

The normal rule is that the provisions of a Double Taxation Avoidance Agreement apply to persons who are residents of one or both of the contracting states (article 1). Thus, “to enter” the portals of the treaty a person must show that he is a resident of at least one of the states. Generally, a person is regarded as a resident of a contracting state if he is liable to taxation therein by reason of certain prescribed tests, for example, domicile, residence, place of management etc. Thus, for a person to be a resident of state A he must show that he is liable to tax in that state by virtue of any off the pre­scribed criteria. The interpretation of the phrase “liable to tax” has given rise to controversy. There are four possible cases which may arise: 1) the concerned state does not have a law for levying tax on income 2) the concerned state may have a law levying tax on income, which may not apply to a particular class of persons say, individuals and firms but only to corpo­rate entities 3) the state may have a law imposing tax but the tax is leviable only if extended to the particular person or transaction by a Government notification or 4) the state has a law imposing tax in respect of the concerned persons but a particular type of income is not taxed; e.g., capital gains or technical service fees. ­

Insofar as 1) above is concerned, one cannot say that the person is liable to tax in that state and, therefore would not be regarded as a resident of that state entitled to claim benefit of the Double Taxation Avoidance Agreement. The same result may flow in case 2) insofar as the law envisages taxation of only a class of assessees, say, corporate assessees and there is no law under which non-corporate assessees could be subjected to tax.

Case 3) however, is one where the law does provide for taxation of a particular person but it has been, as it were, held in abeyance pending issue of a notification. In such a case the person should be regarded as a resident of that state entitled to claim protection under the treaty. The 4th case is undoubt­edly one where the person is liable to be assessed but the state has decided not to levy tax on a particular type of income. In the Azadi Bachao Andolan case the Supreme Court was concerned with case 4) and held that even so the concerned entity was a resident of Mauritius.

Peculiar problems arise in the case of partnerships where the partnership as such is not liable to tax (as in India from the assessment year 1993-94) but the partners are directly taxable in respect of the income from the firm (as, for example, in the United Kingdom). In such a case whether the partnership is to be regarded as entitled to claim the treaty benefit is a matter of debate.

7. “Life” of a Treaty

Section 90 of the Act empowers the Central Government to enter into Double Taxation Avoidance Agreements and by notification in the Official Gazette to make provision for implementing the same. Such Agreements, therefore, become part of the Act it­self. As already noted above in CIT vs. Kulangadan Chettiar (2004) 267 ITR 654 (SC) the Supreme Court held that such an Agreement acts as an exception to or modification of sections 4 and 5 of the Act. Entry 14 in List I of Schedule VII to the Constitution vests power exclusively in the Union to enter into treaties. The upshot of the decision of the Supreme Court in Meganbhai vs. Union of India AIR 1969 SC 783 is that a tax treaty becomes law without any further legislation having to be enacted (see also Union of India vs. Azadi Bachao Andolan (2003) 263 ITR 706 at 721).

Once a Double Taxation Avoidance Agreement is entered into it would continue to be in force in all its terms unless the covenanting states subsequently execute a protocol to amend the terms of the Agreement or one of the states gives notice of termination to the other state which can normally be done only after the expiry of any minimum prescribed period for the operation of the Treaty. The negotiation of a fresh treaty would also sound the death-knell of the old Agreement.

Agreements entered into by India provide for the date of entry into force of the Agreement. The contracting states have to notify each other of the completion of the procedures required by the respective laws of the state for the bringing into force of the Convention. The Convention normally comes into force after a specified period of time from the receipt of the letter communicating compliance with the prescribed procedures in this behalf referred to above. In India the provisions of the Convention generally apply in respect of income arising in any fiscal year beginning on or after the first of April following the calendar year in which the Agreement comes into force. The same is the position with regard to the coming into force of a protocol amending the Agreement.

A problem arises where residents of the two contracting states have entered into a private contract when a particular Double Taxation Avoidance Agreement was in force and subsequently there is an amending protocol or a new Agreement which affects the assessee adversely. Is it at all open to an assessee to urge that the provisions of the Convention as existing when the private contract was entered into should govern the taxation in respect of income under the said private contract and not the terms of the new Agreement or the amending protocol? The gener­al view is that it is the provisions of the Convention as on the first day of the relevant assessment year which would have to be taken into account and not the provisions of the Conven­tion as in force when the parties entered into the private contract. The rule is the same as when interpreting an amend­ment to the Act — the Act (as amended) existing on 1st April, of the assessment year will apply (see CIT vs. Isthmian Steamship Lines (1951) 20 ITR 572). The Calcutta High Court in Timken India Ltd. vs. CIT (2002) 256 ITR 460 (Kar) has also taken a similar view, namely, that one has to consider the terms of any Convention in exist­ence for the assessment year in which the income is chargeable to tax.

In CIT vs. Tata Iron & Steel Company Ltd. 66 TTJ 463; (2000) 248 ITR 190 (Bom) the Mumbai Bench of the Income-tax Appellate Tribunal in disposing of the Department’s application under section 254( 2) of the Act to rectify its earlier order reported in 62 TTJ 17 held that the subsequently entered into protocol did not affect taxability under an earlier entered private contract. With respect the writer submits that this is not the right view. In 248 ITR 190 the High Court at Bombay (in dismissing the Revenue’s appeal against the Tribunal’s conclusion in 66 TTJ 463 that its earli­er decision in 62 TTJ 17 did not disclose a rectifiable mistake) has only held that the Tribunal’s earlier decision did not reveal any mistake apparent from the record and the Court did not uphold the correctness of the view taken by the Tribunal on the merits in either 66 TTJ 463 or 62 TTJ 17.

A peculiar problem which would arise is where there is an amendment of an Agreement by a protocol which is applied retrospectively. In Tata Iron & Steel Co. Ltd. vs. Dy. Commissioner of Income-tax 62 ITJ 17 (already mentioned above) the Mumbai Bench of the Income-tax Appellate Tribunal has taken the view (whilst considering the protocol which amended the Indo-German Double Taxation Avoidance Agreement of 1959 in respect of income assessable from the assessment year 1984-85 by notifica­tion dated 26th August, 1985) that the amended protocol would not govern the assessment for the assessment year 1985-86. The issue whether an amendment can have retrospective effect so as to make the amended Agreement applicable to a year earlier to the year in which the notification was issued is not yet con­clusively adjudicated upon by a Court.

8. Aids in construing Tax Treaties

Having considered problems concerning interpretation to be placed on particular provisions in Double Taxation Avoidance Agreements I may now refer to certain general rules’ which are applied in interpreting Double Taxation Avoidance Agreements. One view is that rules of interpretation which are applied in interpreting laws in general and taxation laws in particular would equally apply to the interpretation of treaties. These rules are to be covered by distinguished writers who have contributed to the present publication and I need not delve into the same. However, in applying general rules for inter­preting statutes one should bear in mind that in Union of India vs. Azadi Bachao Andolan 263 ITR 706 at 751 the Supreme Court of India held that principles to be adopted in interpreting trea­ties are not the same as those employed in the interpretation of “statutory legislation.” The Court quoted with approval Francis Bennion’s statement in “statutory interpretation” namely, “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 ( is)... unconstrained by technical rules... or... legal precedent but conducted on broad principles of general acceptation’... the words ‘are to be given their general meaning, general to lawyer and layman alike... the meaning of the diplomat rather than the lawyer.” The Court also approved of the observations of David R. Davies in “Principles of International Double Taxation Relief” to the effect that the main function of a Double Taxation Avoidance Agreement is to aid 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. The final Agreement often represents a number of compromises. The Supreme Court rightly observed that in interpreting double taxation treaties it has to be borne in mind that treaties negotiated are entered into at a political level and have several considerations as their bases.

I now refer to certain rules of interpretation which specifi­cally relate to the interpretation of Double Taxation Avoidance Agreement. In May 1969 some countries concluded the Vienna Convention on the law of treaties. Though India is not a party to the Convention the Convention really codifies existing customary law for interpretation of treaties in general. To that extent the rules laid down in the Convention for interpretation of treaties would be equally applicable in interpreting Double Taxation Avoidance Agreements entered into by India . A very instructive analysis of the terms of the Convention is found in Martin Dixon’s Textbook on International Law (first Indian Reprint) at pages 59-80. Part III of the Convention enumerates the rules of interpretation to be applied. Article 26 provides that a treaty is binding upon the parties and must be performed by them in good faith. Article 27 forbids a contracting state from invoking the provisions of its internal law as justifica­tion for failure to perform a treaty obligation unless a rule of internal law of fundamental importance has been violated in concluding the treaty. Article 31 provides that a treaty is to be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. What are the relev­ant circumstances in determining such context are also set out. Article 32 provides that in interpreting the terms of a treaty the preparatory work and the circumstances of its conclusion should be taken into account if the application of the context rule creates ambiguity. This is called the ‘travaux preparatoires’ rule. Article 33 is of particular importance. It provides that when a treaty is authenticated in two or more languages the text in each of the languages is equally authoritative unless the parties have inserted a provision that a particular text shall prevail. A version of the treaty in a language other than the one or ones in which the text was authenticated is not to be considered unless the parties have agreed that it shall be regarded as the authentic text. Fur­ther, the terms of the treaty are presumed to have the same meaning in each authentic test. Article 33.4 lays down the rule that where a particular text is not to prevail but a comparison of the authentic texts discloses a difference of meaning which cannot be resolved the meaning which best reconciles the texts, having regard to the object and purpose of the treaty shall be adopted. For example, the Indo-Uzbekistan Double Taxation Avoidance Agreement records that it has been executed in Hindi, Uzbek and English languages and “all the texts being equally authentic.” It is however, provided that “in case of divergence between any of the texts, the English text shall be the opera­tive one.”

In interpreting Double Taxation Avoidance Agreement what are the other aids which the Court can draw upon? As noted above the Commentaries to the Models are generally regarded as very relevant in interpreting a Double Taxation Avoidance Agreement which uses the identical language as in the applicable Model Convention. The reason for this is that the Commentaries ex­press the understanding of the wording in the Agreement and if one of the contracting parties does not agree with the same it should put in a caveat in this behalf. If it adopts the lan­guage of the Convention, then, the interpretation placed there­on should be regarded as accepted by it. CIT vs. Visakhapatnam Port Trust (1983) 144 ITR 146 is one of the first judgements in India wherein the general principles applicable in the case of Double Taxation Avoidance Agreement were exhaustively considered. Reference is made therein to the OECD Commentaries and the view is expressed that in interpreting a Double Taxation Avoidance Agreement the Court must have regard to the decisions and rulings of Courts in foreign countries. Similarly, in CIT vs. Vijay Ship Breaking Corp. (2003) 261 ITR 113 the Gujarat High Court has placed reliance on the OECD Commentary. This has also been done by the Supreme Court in the all pervasive Azadi Bachao Andolan case (263 ITR 706). Undoubtedly, the commentaries cannot be treated as binding but in the event of any doubt in the meaning of the words used in an article one would have regard to the view taken in the Commentary.

In interpreting any law or any tax law as also in interpreting Double Taxation Avoidance Agreements, the question arises whether one can consider the views of authors of books or interpret the law, as it were, by analogy. Insofar as the former is concerned the strict rule, is that the opinion of a living author cannot be considered. This is on the basis that he may change his views and that it is not his final view. This strict rule is rightly not followed as after all a Court only considers the view expressed and it is open to the Court to agree or disagree with the same.

One of the aids in construing the meaning of words used in a treaty is to refer to another treaty and on the wording thereof to urge that the treaty under consideration not being so worded should be interpreted differently or being similarly worded should be interpreted as per any clarification issued for the purpose of that other treaty or any decision interpret­ing the language of that treaty. One may call this the inter­pretation by analogy rule. For example, in CIT vs. Vijay Ship Breaking Corp. 261 ITR 113 the interest article in the Indo-UK Treaty was sought to be interpreted by reference to the Indo­-Indonesian Treaty. In the latter treaty the term “debt claims” was defined as including interest on deferred payment of sale consideration. It was urged that as in the Indo-UK Treaty the inclusive part in the Indo-Indonesian Treaty was absent, “debt claims” as per the former Treaty did not include deferred payment interest. The Gujarat High Court held that the elabora­tion in the Indo-Indonesian Treaty was clarificatory. On the other hand, in Raymond Ltd. vs. Dy. Commissioner of Income-tax 86 ITD 791 the Tribunal had to consider the provision defining “fees for technical services” in the Indo-UK Treaty as payments which make available technical knowledge, experience etc. In interpreting this term the Tribunal had regard to the explana­tion of this term in the Memorandum of Understanding appended to the Indo-USA Double Taxation Avoidance Agreement which was executed prior to the Indo-UK Agreement and the clarification in the Memorandum was regarded as acceptable to India and, therefore, applicable in interpreting language in the Indo-UK Treaty which was identical to the Indo-US Treaty. The Tribunal also relied on the fact that in the subsequently executed Indo­-Singapore Treaty itself the phrase in question was explained as knowledge etc., “which enables the person acquiring the servic­es to apply the technology contained therein.” The writer feels that when one is arguing by “comparison of language” insofar as two Acts are concerned, one could urge that the purpose and function of the two Acts are different and one cannot argue by comparison particularly when an argument is based on the com­parison of language in a foreign statute. However, rule of interpretation by analogy would have force when India is a party to both the concerned Agreements and one is seeking to rely on the Memorandum of Understanding in one of the Agree­ments or the express language in the other Agreement. If India accepts a particular interpretation, why should it not be applied when interpreting another identically worded Treaty to which India is a party? The argument may not have much force when one is seeking to compare two treaties but India is a party to only one of them.

It goes without saying that a protocol attached to a treaty would have equal force as the treaty (see the decision of the Income-tax Appellate Tribunal in Dy. Commissioner of Income-tax vs. ITC Ltd. 82 ITD 239). The Memorandum of Understanding as noted is also relevant and was relied upon by the Authority for Advance Ruling in P No. 28 of 1999 242 ITR 208 at 225. If at all the protocol may be at a slightly higher level of acceptance for interpretation than a Memorandum of Understanding.

9. Conclusion

In the ultimate analysis the ability to arrive at the correct interpretation of a legal provision, which could also mean the interpretation which the Court will ultimately place thereon, is the real art of a lawyer. It depends on his ability to read what is stated, to read between the lines and to read “through” the provision, things which one can do if he has a wide expo­sure to life as such. These are qualities which R. J. Kolah, in whose memory and honour this publication is being released, possessed in abundance.

The publishers of this issue have undoubtedly undertaken a Herculian task in trying to place within its covers rules of interpretation which would apply in different circumstances and in interpreting different legislations, rules and Agreements etc. Let there be no misinterpretation of my appreciation for their efforts if I end on a somewhat cynical note.

I believe that the rules of interpretation are in a way elastic enough for a judge to be able to support the view which he thinks will further the cause of justice by citing an appro­priate rule of interpretation. If a judge wants to go strictly by the written word he would cite the rule enunciated by Rowlatt J. in Cape Brandy Syndicate vs. IR 1921 (1) KB 64, approved by the Supreme Court in CIT vs. Ajax Products Ltd. 55 ITR 741, 747, which requires that in a tax law one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing to be implied. One can only look at the language used. In Jiwandas vs. CIT 4 ITC 40 it was stated that one cannot extend the scope of a statute by analogy or place upon it what is called a beneficent or equitable construction in order to prevent a real or supposed anomaly.

There is, on the other hand, the directly opposite rule of construction whereunder a judge is exhorted to supplement the written word so as to give force and life to the intention of the legislature though he must not alter the material of which the fabric is woven but he should iron out the creases. By invoking these principles the Supreme Court of India in CIT vs. Bhattachargee (1979) 118 ITR 461 held that in section 245M of the Act the term “assessee” would encompass the department as well! This was done undoubtedly to avoid a result which would have been unjust to the Revenue. In CIT vs. J. H. Gotla (1985) 156 ITR 323 (SC) the boot was, as it were, on the other foot. A literal interpretation would have resulted in a patent injustice to the assessee. In the process the Court observed that where the plain literal interpretation of a statutory provision produces a manifestly unjust result, which could never have been intended by the legislature, the Court might modify the language used by the legislature so as to achieve its intention. To this approach a strict constructionist judge would say that it is not for the Court to make good the lacuna in the legislation.

This contrasting approach is very tellingly illustrated by two decisions of the High Court at Bombay — the gap between the two decisions being just five years. In Elphinstone Spinning and Weaving Mills Co. Ltd. vs. CIT (1955) 28 ITR 811 (Bom) the Court observed that where the language was clear and not capable of any other construction, then, however illogical the position, however, absurd the result, however much the construction put may defeat the object of the Legislature, the statute must be construed according to the plain language used by the Legisla­ture. On the other hand in CIT vs. Kishoresinh Kalyansinh Solanki (1960) 39 ITR 522 (Bom) the same Court observed that the rule of literal interpretation cannot be adhered to if it leads to manifest absurdity.

The pity is that what is “manifest” to one judge is often obscure to another. Therein lies the strength and weakness of rules of interpretation and provide bread, butter and large helpings of jam to the legal fraternity!