BACKGROUND

In cross-border transactions, there is a high possibility that the same income may be taxed twice – in the source country as well as in the residence country. In order to avoid double taxation, the Government of various countries have executed the Double Tax Avoidance Agreement (DTAA or Tax Treaty or Treaty) wherein taxing rights are allocated. India has also executed DTAAs with many countries. As per section 90 of the Income Tax Act, 1961 (IT Act), where India has entered into a DTAA with another country, then, in respect of a taxpayer to whom such treaty applies, the provisions of the IT Act shall apply to the extent they are more beneficial.

Most of the DTAAs have imbibed non-discrimination clauses in them. As per this clause, a non-resident taxpayer will not be put into a condition which is more burdensome as compared to the resident taxpayer. In India, a Permanent Establishment (PE) of a foreign taxpayer is taxed at a higher rate than the tax rate applicable to an Indian Company. Hence, a question may arise as to whether a non-resident taxpayer can invoke a non-discrimination clause or not, especially after the insertion of Explanation 1¹ to section 90 of the IT Act. In this regard, recently, the Calcutta High Court² had an opportunity to examine whether recourse to the non-discrimination clause can be taken even after the introduction of Explanation 1 in Section 90 of the IT Act.

We, at BDO in India, have summarised this ruling and provided our comments on the impact of this decision hereunder:

FACTS OF THE CASE

• The taxpayer, branch of ABN Amro Bank NV (now known as The Royal Bank of Scotland N.V.), is registered in India as a scheduled bank in terms of Schedule-II of the Reserve Bank of India (RBI) Act, 1934.

• The main activities of the taxpayer in India comprised of accepting deposits, giving loans, discounting or collecting bills, issue of letters of credit/ guarantees etc.

• As per Article 7 of India - Netherlands DTAA, where a foreign enterprise carries on business through a PE, the profits attributable to the PE shall be subject to tax in India. Hence, the taxpayer’s profits attributable to its PE were taxable in India.

• During the course of proceedings, the taxpayer contended that pursuant to non-discrimination provision contained in Article 24(2)³ of India – Netherlands DTAA, it is entitled to the income-tax rate at which domestic company is taxed.

• However, the First Appellate Authority (‘CIT(A)’) held that the taxpayer is liable for a tax rate as applicable to foreign companies. Aggrieved, the taxpayer filed an appeal with Calcutta Bench of Income-Tax Appellate Tribunal (Tax Tribunal) who affirmed CIT(A)’s order. Hence, the taxpayer filed an appeal before the Calcutta High Court.

CALCUTTA HIGH COURT RULING

The Calcutta High Court, while affirming the order of the Tax Tribunal, made the following observations:

Re. Determination of status of the taxpayer

• The taxpayer is neither an “Indian Company” nor “any other Company” as it has not made prescribed arrangement in respect of its income liable to income tax under the IT Act for declaration and payment within India of the dividends including dividend on preference shares payable out of such income. Thus, the taxpayer is a company falling under Clause (ii) of Section 2(17) of IT Act.

• Further, the taxpayer in the appeal has admitted being a foreign company i.e. “a company other than a domestic company”.

• As per the IT Act, there are two classes of companies, namely – “Domestic Company” and “Company other than Domestic Company”. The taxpayer does not fall under the definition of a domestic company. Rather, it is a “foreign company” i.e. “Company other than a Domestic Company” as defined under section 2(23A) of the IT Act.

Re. Determination of tax rate applicable to the taxpayer

• Section 4 of the IT Act is a charging provision which provides that tax has to be levied on the total income of a taxpayer in accordance with the rates provided for in the annual Finance Act.

• Section 2(1) of The Finance (No.2) Act, 2004 provides that income tax shall be charged at the rates specified in Part I of the First Schedule.  Paragraph E of the First Schedule to the Finance (No.2) Act, 2004 provides different tax rates for domestic companies and for a company other than a domestic company.

• Section 2(12)(a) of the Finance Act also defines the words “domestic company” similar to the definition given in Section 2(22A) of the IT Act.

• Undisputedly the taxpayer is not a domestic company. Therefore, the taxpayer falls under the other class i.e. “a company other than a domestic company” as classified in paragraph E of the Finance Act. The classification made in paragraph E of the First Part of the First Schedule to the Finance Act has not been questioned by the taxpayer. The classification so made is a valid classification.

• Reliance has been placed on the Hon’ble Supreme Court ruling in the case of Amalgamated Tea Estates Co. Ltd⁴., wherein it was held that the classification of a domestic company and foreign company for rate of tax is valid.

Re. Interpretation of Taxing Statue and Treaty

• In relation to the interpretation of taxing statutes and treaties, the Hon’ble HC has relied on the decision of the Hon’ble Supreme Court in the case of Dilip Kumar & Company & Ors⁵ wherein it was held that it is a well-settled principle that when the words in a statute are clear, plain and unambiguous and only one meaning can be inferred, the courts are bound to give effect to the said meaning irrespective of consequences.

• Reliance was further placed on the Hon’ble Supreme Court’s ruling in the case of V.O. Tractoro Export, Moscow⁶ wherein it was held that once, Parliament has legislated, the Court must first look at the legislation and construe the language employed in it. If the terms of the legislative enactment do not suffer from any ambiguity or lack of clarity, they must be given effect to, even if they do not carry out the treaty obligations. But the treaty or the Protocol or the convention becomes important if the meaning of the expressions used by the Parliament is not clear and can be construed in more than one way.

• Since there is no ambiguity in classification and rates of tax, the taxpayer is liable to tax at the rates prescribed for a company “other than a domestic company”.

Re. Evaluation of conflict between Explanation to Section 90 of the IT Act and Article 24(2) of India-Netherlands DTAA:

• Explanation of section 90 of the IT Act is a part of section 90 of the IT Act. The Explanation itself starts with the words “for the removal of doubts”.

• Further, the said explanation has been inserted to clarify that the charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as a less favourable charge in respect of such foreign company, where such foreign company has not made the prescribed arrangement for declaration and payment within India of the dividends (including dividend in preferential share) payable out of its income in India.

• It is admitted case of the taxpayer that it has not made the prescribed arrangements for the declaration and payment of dividends within India, so as to fall within the “any other company” used in Section 2(22A) of the IT Act. Had the taxpayer complied with the terms of “any other company” as used in Section 2(22A) of the IT Act, the taxpayer would have become a domestic company.

• Therefore, there is no ambiguity at all, with regard to the rate of tax applicable to a “domestic company” and “company other than a domestic company”. Explanation to Section 90 of the IT Act is only clarificatory in nature as is also evident from “Notes on clauses”.

• Reliance in this regard is placed on the Hon’ble Supreme Court’s ruling in the case of Shyam Sunder and Ors.⁷ wherein it was held that the function of a declaratory or explanatory Act is to supply an obvious omission or to clear up doubts as to the meaning of the previous Act and such Act comes into effect from the date of passing of the previous Act.

• Explanation to section 90 of the IT Act has merely reiterated the clear statutory provision for rate of tax emerging from Section 2(22A), 2(23A) of the IT Act read with Section 2(1) and Section 2(12)(a) of the Finance Act and Paragraph E of Part I of the First Schedule to the Finance Act. Even without the said Explanation to Section 90 of the IT Act, the statutory provision for rate of tax remained clear at all relevant points of time.

• Article 24(2) of the India-Netherlands DTAA prevents from less favourable levy between two enterprises falling under one and the same class and not between one falling under one class and the other falling under another class.

• The phrase "shall not be less favourably levied" used in Article 24(2) of the India-Netherlands DTAA simply means that taxation on a company falling under "any other company" under Section 2(22A) of the IT Act shall not be less favourably levied than an "Indian company" which both fall under one and the same class i.e. Domestic Company under Section 2(22A) of the IT Act read with Section 2(1), Section 2(12)(a) and Paragraph "E' of Part I of the First Schedule of the Finance Act, whose provisions existed even prior to the DTAA in question and the clarificatory retrospective insertion of the Explanation in Section 90 by the Finance Act, 2001.

• There is no conflict between Section 90 of IT Act read with the Explanation read with Section 2 (22A) of IT Act, the Finance Act and Article 24(2) of the India-Netherlands DTAA.

Relevance of Circular No. 333 dated 2 April 1982

• Reliance placed by the taxpayer on Circular No. 333 dated 2 April 1982⁸ issued by CBDT and the letter of the CBDT dated 21 November 1994 is not valid.

• The letter dated 21 November 1994 issued by the Joint Secretary and addressed to the Chief Commissioner of Income-tax II, Kolkata was written in response to a D.O. letter of the Chief Commissioner. The letter of the joint Commissioner merely informs that “the matter has been looked into and the board is of the opinion that the tax rate applicable in the case of ABN AMRO Bank would be the same as for an Indian company at the relevant tax rate applicable for this concerned fiscal years. The said letter is a D.O. letter. It is not a circular issued in the exercise of a power conferred under section 119 of the IT Act.

• The said CBDT circular with the situation where there is a specific provision in the DTAA then that provision will prevail over the general provisions contained in IT Act.

• There is no specific provision in the India-Netherlands DTAA providing for rate of tax applicable to a “domestic company” or a “company other than domestic company”. Also, the India-Netherlands DTAA including Article 24(2) does not contain any provision contrary to the provisions of Section 2(22A) and Section 4 of IT Act, Section 2(1), Section 2(12)(a) of the Finance Act and rate of tax as provided in paragraph E of part one of the first schedule to the Finance Act. Therefore, the circular is of no help to the taxpayer.

• Since the expressions used in the aforesaid provisions of the IT Act and the Finance Act are clear and capable of only one construction, there is no ambiguity or lack of clarity. Therefore, the provision of the IT Act and the provision of the Finance Act, are bound to be given full effect.

 

BDO IN INDIA COMMENTS

Calcutta High Court reinforces that the PE of a foreign company cannot take shelter from a non-discrimination article for applying a tax rate relevant to a domestic company. Further, this ruling has overruled the decision of the Calcutta High Court in the case of Bank of Tokyo Mitsubishi⁹ wherein it was held that in DTAAs where any such provision permitting India to levy a tax at a higher rate either with a limit or without is absent, the relevant article must be construed as specifically imposing a bar on either of the two contracting states from levying tax at a rate higher than that which they levy on a domestic enterprise.

Also, it is worthwhile to note that the DTAA between India and the Netherlands DTAA has been amended twice. The Second Amendment was made¹⁰ after the insertion of Explanation to section 90 of the IT Act. It is pertinent to note that no amendment corresponding to the Explanation to Section 90 of the IT Act was made in Article 24 of the India-Netherlands DTAA. On the other hand, India incorporated a clause similar to the said Explanation to Section 90 in its DTAAs with other countries such as the United Kingdom, Singapore, Finland, Bulgaria etc., before as well as after the insertion of the said Explanation.

It is also pertinent to note that India has asserted its stance that a higher tax rate on PE profits compared to similar Indian companies does not violate Article 24.