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TMI Blog2003 (10) TMI 5X X X X Extracts X X X X X X X X Extracts X X X X ..... s ultra vires the provisions of section 90 and section 119 of the Income-tax Act, 1961 (hereinafter referred to as lithe 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 December 6, 1983, issued in exercise of the powers of the Government of India under section 90 of the Act read with section 24A of the Companies (Profits) Surtax Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ermanent 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 State 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 provisions 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent 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 March 30, 1994, issued by the Central Board of Direct Taxes 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 (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. Some time in the year 2000, some of the income-tax authorities issued show cause notices to some FIIs functioning in India calling upon them to sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1961. Under the DTAC, tax was deductible at source on the gross dividend paid out at the rate of 5 per cent. of 15 per cent. 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. 3. 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 should 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come-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 Central Board of Direct Taxes; (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 Central Board of Direct Taxes 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 Central Board of Direct Taxes; (E) "Treaty shopping", by which the resident of a third country takes advantage of the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of grounds, while the respondents through Mr. Bhushan, and in person, reiterated their submissions made 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 investigat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 Parlia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) and sub-section (2) was inserted by the Finance (No.2) Act, 1991, with retrospective effect from April 1, 1972. Central Board of Direct Taxes Circular No. 621 dated December 19, 1991: "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-a-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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 CIT v. R.M. Muthaiah [1993] 202 ITR 508, 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 summe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... argeability 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 weighted 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 the Income-tax Act, 1961, in so far as assessees covered by the provisions of the DTAC are concerned. Thou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xecutive. 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 Stock 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 DT AC 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ir 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 Central Board of Direct Taxes 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 Central Board of Direct Taxes, which is recognised as an authority under the Income-tax Act under section 116(a). The Central Board of Direct Taxes 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 Central Board of Direct Taxes. The proviso to sub-section (1) of section 119 recognises two exceptions to this power. The first, that the Central Board of Direct Taxes cannot require any income-tax authority to make a particular assessment or to dispose of a particular case in a particular manner. The second, is with regard to interferen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 and Co. v. Delhi Stock Exchange Association Ltd. [1979] 4 SCC 565. In K.P. Varghese's case [1981] 131 ITR 597, this court held that the circulars of the Central Board of Direct Taxes 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. laveri v. K.K. Sen, AAC [1965] 56 ITR 198 (SC) and Ellerman Lines Ltd. v. CIT [1971] 82 ITR 913 (SC) clearly establish the principle that circulars issued by the Central Board of Direct Taxes 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. CIT [1999] 237 ITR 889, 896, dealing with the legal status of such circulars, this court observed: "Such instructions may be by way of relaxation of any of the provisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly binding on the Revenue. The circular does not deal with the power of the Income-tax Officer 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 1i9. Sub-section (1) of section 119 is deliberately worded in general manner so that the Central Board of Direct Taxes is enabled to issue appropriate orders, instructions or directions to the subordinate authorities "as it may deem fit for the proper administration of the Act". As long as the circular emanates from the Central Board of Direct Taxes 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 s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ontracting 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 fou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 April 13, 2000, is ultra vires the provisions of section 119 of the Act. In our judgment, the powers conferred upon the Central Board of Direct Taxes 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 e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oidance Convention "DTAC" illegal and ultra vires the powers of the Central Government under section 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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, Jean Maic Riviar, Volume LXXIIa, pages 47-76, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nited State of America 336F 2d 809, on which the respondents place reliance, is easily distinguishable. In this case the appellant, Johansson, was a citizen of Switzerland and a heavy weight 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 DT A T 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 days 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... C 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 Sri 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 with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore 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, the 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 the 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 the MOBA contains the statut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the MOBA are not "liable to taxation" under the Mau ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 [1999] 239 ITR 650 (AAR). 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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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: "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 (a) 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 dist ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an 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. Armico 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 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 shareholdings where each company owned 1005 shares of a different subsidiary company. Lamesa Holdings was one such intermediary company of which 100 per cent. shares were held by Green Equity Investments Ltd. The share transactions brought about a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 [1998] Can. Tax Ct. LEXIS 1140 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent 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: Lord McNair, The Law of Treaties, page 336. "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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 and B is neither intended to confer benefits nor impose obligations on the residents of State C, but, here we are not concerned with this quest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 IPC took notice of the facts that the MOBA has since been repealed by Mauritius and the Financial Services Development Act has been promulgated with effect from December 1, 2001, which has to some extent removed the drawback of the 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: "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 India through Mauritius, should be required to file details of ownership with RBI and declare that all the directors and effective ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tter, 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: "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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the 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 res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... departure was in tune with the changed thinking on fiscal jurisprudence by the English courts, as evidenced in W.T. Ramsay Ltd. v. IRC [1982] AC 300, Inland Revenue Commissioners v. Burmah Oil Company Ltd. [1982] Simon's Tax Cases 30 and Furniss v. Dawson [1984] 1 All ER 530 (HL). As we shall show presently, far from being exorcised in its country of origin, Duke of Westminster's case [1936] AC 1 (HL); 19 TC 490 continues to be alive and kicking in England. Interestingly, even in McDowell's case [1985] 154 ITR 148 (SC), though Chinnappa Reddy J. dismissed the observation of J.C. Shah J. in CIT v. A. Raman and Company [1968] 67 ITR 11 (SC) based on Westminster's case [1936] AC 1 (HL); 19 TC 490 [68] and Fisher's Executors case [1926] AC 395 at 412 (HL), 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 of 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 section 460 of the Inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 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's case [1936] AC 1 (HL). While Chinnappa Reddy J. took the view that Ramsay's case [1982] AC 300 (HL), was an authoritative rejection of the principle in the Duke of Westminster's case [1936] AC 1 (HL); 19 TC 490, the House of Lords, in the year 2001, does not seem to consider it to be so, as seen from MacNiven (H.M. Inspector of Taxes) v. Westmoreland Investments Ltd [2001] 1 All ER 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ht 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 s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reedom 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 [1988] 173 ITR 479 (SC), 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. The Revenue placed reliance on McDowell's case [1985] 154 ITR 148 (SC). Both the learned judges of the Bench of this court gave separate opinions. Chief Justice Pathak, in his opinion said: "Reliance was also placed by learned counsel for the Revenue on McDowell and Co. 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. Mukharji said, after noticing McDowell's [1985] 154 ITR 148 (SC) case: "Where the true effect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therwise 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 non-taxable 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are only used as a cloak to conceal a different transaction." In Snook v. London and West Riding Investments Ltd. [1967] 1 All ER 518 at 528 (CA) 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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