These days, there is hardly a case in international taxation that does not end up in litigation. Income is currently taxed either on the basis of residence or source of income or both. A look at the facts and the judgments in a few cases will highlight the complexities that arise from this multiple basis of taxation. The advent of the internet and mobile connectivity has compounded the confusion. The basic principle of taxation – that it should not skew economic decisions – is being buried in favour of revenue. It is one thing to quote Kautilya, who said tax collectors should be like bees who collect honey but in a manner that the flower is not hurt, and quite another to put his advice into practice.
Consider the case of an assessee who is a resident of India but earned profit on the sale of an immovable property in Malaysia. Owing to the expression “may be taxed” used in the Double Taxation Avoidance Agreement (DTAA), the Indian authorities sought to tax the income on a residence basis. The apex court ultimately decided that the profit can be taxed only in Malaysia on a source basis. In another case, an Indian artist received income from performing stage shows in Canada and claimed exemption on a source basis. The Indian authorities again sought to tax the income on a residence basis owing to the same expression “may be taxed” used in the DTAA with Canada. The tribunal has ruled in favour of the assessee.
In yet another case, a company that is a resident of India provided consultancy, design and engineering services in telecommunications in other countries, where it had permanent establishments (PEs). The Indian authorities taxed its income on the basis of its “residence”. The company contested that it can be taxed only in the other “source” countries where it had PEs. The clause “may be taxed” was, again, variously interpreted. The Income Tax Appellate Tribunal has favoured the department’s claim. The litigation is likely to continue.
Similarly, where the source of income may have absolutely no connection with the country of “residence”, the income is taxed on the basis of stay abroad for less than 182 days. Some countries tax the global income of its citizens, irrespective of their stays abroad. Under the burden of tax, one may even opt to renounce citizenship — the liability to pay tax may far outweigh the benefits of social security provided in the country of citizenship. Does this not amount to a tax on citizenship and a restriction on freedom to move from one country to another to earn one’s income? There appears little justification for residence-based taxation.
The most rational justification for taxation was propounded by Justice Holmes over 50 years ago when he said one pays tax to buy civilisation. He linked taxation with the benefits of civilisation. His proposition is more relevant today when the modern civilisation has made cross-border businesses virtually independent of national boundaries, or “residence”. His justification for taxation points only to source-based taxation, and forms the most appropriate basis for it.
“Civilisation” implies that a state is well-governed. It provides to the people staying within its territory, whether citizens or aliens, security not only to life but also to their property and business. It spends on defence and ensures internal law and order for businesses. It establishes a judicial system that settles disputes over rights and obligations, contracts and settlements and disputes that may arise out of financial transactions, manufacturing activities or mercantile operations. It ensures proper infrastructure, encourages research and development and spends on social welfare for capacity-building of its people. No one would like to do business in an anarchic place. Therefore, only the country providing the source of income is justified to collect the tax.
Let us apply the source test to the case of the Indian artist or the owner of the immovable property in Malaysia in the examples cited at the start of this article. It can be said the role of Indian governance in allowing the artist to learn and practice the art in India or in improving the capability of the person to go to Malaysia and own property there is small compared to their earnings in Canada or Malaysia owing to the roles of governance in those countries. Thus, instead of having a DTAA, we can think of going for a Distributive Income and Tax Agreement (DITA) for division of income to determine direct tax, and for division of tax for collecting indirect tax. This is currently being discussed under the “Unitary Taxation System”. The DITA could say, for example, that 10 per cent of the income of artists or owners of immovable property would be taxed in India and 90 per cent in the other countries. Considering the fact that Canadian artists also visit India, or that foreigners may also earn income from sale of properties in India, it can also be said on the basis of reciprocity that only the country where the art is performed or where the immovable property is located shall tax the entire income. There would be no litigation. The more important advantage of this system of taxation would be that every artist or property owner would know his tax obligations. The decision to own property or to perform will not dither on account of uncertainties in taxation.
The UN model also favours source-based taxation, which benefits developing countries where more international investments and business operations take place. In contrast, the Organisation for Economic Cooperation and Development model favours residence-based taxation, which benefits developed countries from where most of the international funds flow. Source-based taxation, therefore, would also justifiably shift the base of taxation more to developing countries.
The author is a former Chief Commissioner of Income Tax. These views are personal. ak@kurotax.co.in
