TMI Blog2003 (10) TMI 5X X X X Extracts X X X X X X X X Extracts X X X X ..... ircular No. 789 dated April 13, 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-Mauritious 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 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 "av ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 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 liab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture. 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. 2. 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 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 co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Parliament has power to make laws. Our constitution makes no provision making legislation a condition for the entry into an international treaty in time ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd of Direct Taxes (No. 108 dated March 20, 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 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 exis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... voidance 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o 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 the 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 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 w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n 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 Mishri Lal's case [1999] 4 SCC 11, 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 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 authoriti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wrong before it is overturned; such a construction, commonly referred to as practical construction, although non-controlling, is nevertheless entitled to considerable weight, it is highly persuasive". The validity of this principle was recognised in Baleshwar Bagarti v. Bhagirathi Dass [1908] ILR 35 Cal 701, 713, 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 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 con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Direct Taxes 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0(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 inconsequential matters, we think that the Central Board of Direct Taxes 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. 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 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iny 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 Governments, 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 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). Whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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, 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll 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 Austrialia, 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce 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, plac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 "the MOBA") this would be wholly incorrect. The 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, 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 w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... otwithstanding 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 the 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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, In re [1995] 213 ITR 317 (AAR). An assessee, who resided in Dubai claimed the benefits of the 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, In re [1999] 239 ITR 650 (AAR) 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 [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 resp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h 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 recognised 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: "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 appel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hen 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 the Federal Court of Australia in Commissioner of Taxation v. Lamesa Holdings [1997] 785 FCA 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. Armico Resources and Mining Company NL ("Armico"), a compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... An Australian resident was paid pension by Malaysian Government for services rendered to the 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 s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity 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: Lord McNair, The Law of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on motive a little later. The decision of the Chancery Division in F.G. (Films) Ltd., In re [1953] 1 WLR 483 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 January 3, 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 shopp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 USA 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 IPC 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 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 draw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct 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 C.J. 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: "The benefits and detriments of a double tax treaty wil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 financi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffairs 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 tax payers 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's case [1985] 154 ITR 148 (SC) has taken a new look at fiscal jurisprudence and "the ghost of Fisher's case [1926] AC 395 at 412 (HL) and Westminster's case [1936] AC 1 (HL); 19 TC 490, have been exorcised in the country of its origin". It is also urged that McDowell's case [1985] 154 ITR 148 (SC) 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 [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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Furniss case [1984] 1 All ER 530 (HL), Burma Oil's case [1982] Simon's Tax Cases 30 and Ramsay's case [1982] AC 300 (HL). 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: "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 comple ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g 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, 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to McDowell's case [1985] 154 ITR 148 (SC), 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's case [1958] 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 Naro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... emporary turbulence created in the wake of McDowell's case [1985] 154 ITR 148 (SC). Hence, reliance on Furniss' case [1984] 1 All ER 530 (HL); Ramsay's case [1982] AC 300 (HL) and Burmah Oil's case [1982] Simon's Tax Cases 30 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 States is reflected in the following passage from American jurisprudence's case: "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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Mauritius law, we deem it fit to enter a caveat here. These words are not intended to be used as magic mantras or catch-all phrases to defeat or nullify the effect of a legal situation. As Lord Atkin pointed out in Duke of Westminster's case [1936] AC 1 (HL); [1935] 19 TC 490, 511): "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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 148 (SC), we find no reference therein to having dissented from or overruled the decision of the privy Council in Bank of Chettinad's case [1940] 8 ITR 522 (PC). If any, the principle appears to have been reiterated with approval by the Constitutional Bench of this court in Mathuram's case [1999] 8 SCC 667 at page 12. 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's case [1936] AC 1 (HL); 19 TC 490 to Bank of Chettinad's case [1940] 8 ITR 522 (PC) to Mathuram's case [1999] 8 SCC 667, despite the hiccups of McDowell's case [1985] 154 ITR 148 (SC), 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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