H P Agrawal: Tax cap on foreign firms

FOREIGN ENTERPRISES

The United Nations Model Convention for avoidance of double taxation spells out the objectives of tax treaties in the following words:-

"Broadly, the general objectives of bilateral tax conventions may today be seen to include the full protection of taxpayers against double taxation (whether direct or indirect) and the prevention of the discouragement, which taxation may provide for the free flow of international trade and investment and the transfer of technology".

In deference to the broad objectives announced by UN, the Government of India has made adequate provisions in the Income-Tax Act for taking an authority to enter into bilateral tax treaties.

Further, Section 90 (2) specifically provides that where the Central Government has entered into an agreement with the Government of any country outside India for granting relief of tax, or, as the case may be, avoidance of double taxation, then, in relation to assessee to whom such agreement applies, the provisions of the Income-tax Act shall apply to the extent they are more beneficial to that assessee.

It is clear that where there is a conflict between the provision as contained in the tax treaty and the provision of the Income-Tax Act, a tax payer can take advantage of that provision, which is more beneficial to him.

This legal position has, however, been seriously affected by insertion of an Explanation to section 90 of Income-tax Act.

The Explanation provides that where a foreign company has not made the prescribed arrangement for declaration and payment within India, of the dividends (including dividends on preference charges) payable out of its income in India, it can be taxed at a rate higher than the rate at which a domestic company is chargeable.

But, for the aforesaid Explanation, inserted retrospectively from 1st April, 1962, the Income-tax department cannot levy tax on a foreign company at a rate higher than what is prescribed for a similarly placed Indian company.

In a recent case before the Income-tax Appellate Tribunal, Mumbai (ITO vs. Decca Survey Overseas Ltd. ITA no. 3604/Bom 294, dated 27th February, 2004), the Assessing Officer charged a higher rate of tax from a foreign company compared to the rate of tax applicable to a similar Indian domestic company.

The plea of the tax department was that because the foreign company had not made prescribed arrangements for the payment of dividends in India, the department was not be prohibited from charging a higher rate from such a company.

The foreign company, on the other hand, argued that no rules had been framed under the Income-Tax Rules, laying down what would amount to "prescribed arrangements" referred to in the Explanation to Section 90.

Therefore, the Income-tax department could not charge a higher rate of tax in the shield of the Explanation.

The Appellate Tribunal agreed with the argument of the foreign company. It was held that in the absence of the Legislature laying down what would be the "prescribed" arrangement for the purpose of the Explanation, it would remain a dead letter and no reliance could be placed on it for the purpose of charging a higher rate of tax in respect of a foreign company.

It is, however, felt that despite the aforesaid case, the foreign companies should make arrangements for declaration and payment of dividend within India for which purpose, until a specific rule is made, guidance may be taken from the provision of Rule 27 of the Income-tax Rules. This will help in avoiding unnecessary litigation with the tax department.