Supreme
Court of India
Union
Of India And Anr vs Azadi Bachao Andolan And Anr on 7 October, 2003
Author: Srikrishna
Bench: Ruma Pal, B.N.
Srikrishna.
CASE NO.:
Appeal (civil)
8161-8162 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 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 submissionsmade 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 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 (atp.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 assesses
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 there from 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 there from.
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 noncontrolling, 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 nontaxable 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.
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