India has entered into various agreements (also called conventions or treaties) with different countries for avoidance of double taxation and prevention of fiscal evasion. Such agreements also aim to encourage mutual trade and investment between the two countries, besides bringing an environment of certainty in matters of tax affairs in both countries.
Under the existing Indian law, i.e. the Income Tax Act, 1961, the tax treaties that India has signed with other countries will supersede the domestic tax laws of respective countries. Provisions of the Indian Income Tax Act can of course be applied, but only if and when they are more beneficial to the assessee compared to the provisions of the treaty.
This is an internationally accepted legal position, which has also been confirmed in a large number of court decisions in India. Reference in this connection may be made to the Supreme Court decision in the case of Azadi Bachao Andolan 263 ITR 706. The Supreme Court observed that “the power of entering into a treaty is an inherent part of the sovereign power of the State”.
The apex court clarified that a tax treaty is essentially a bargain between two sovereign States. Therefore, where the tax treaty provides 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 Supreme Court pointed out the advantages of tax treaties in the context of developing countries. “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.”
In developing countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital or technology.
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International practice: The practice of applying tax treaty vis-à-vis domestic law varies from country to country. However, in most of the countries, the treaties supersede the domestic law, a practice which is followed in India also. Wherever the domestic law overrides the tax treaties, such a practice is not considered appropriate under the International Treaty Convention. In this context, reference may be made to the Vienna Convention, which provides: “Every treaty in force is binding upon the parties to it and must be performed by them in good faith” and “A party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.”
Direct Taxes Code Bill, 2009: The new Direct Taxes Code provides that neither a double taxation avoidance treaty nor the Code shall have a preferential status by reason of it being a treaty or law. Therefore, in the case of a conflict between the provisions of a treaty and the provisions of the Code, the one that is later in point of time shall prevail.
The effect of the new tax code is that India’s domestic law of income tax will effectively override the tax treaty. This will be against the principles adopted in international practice.
It is therefore, recommended that the government should rather follow the well reasoned advice of the Supreme Court than to proceed in a wrong direction by refusing to adopt the time-tested international practice.
The author is senior partner in SS Kothari Mehta & Co Email: hp.agrawal@sskmin.com