TERM PAPER

ON
DOUBLE TAXATION

Submitted to

Dr. R.Anita Rao

Submitted by
Suchanda Som
Roll no. 1226109149
Section- A
MBA IB (2009-11)
Objective of the Study:
• To have a better understanding of the concept of double taxation and what
kind of relief government is providing and how double taxation can be
avoided.
• To learn its practical implementation through case studies and illustrations.
 EXECUTIVE SUMMARY

Double taxation avoidance is based on a simple principle that a country should tax a
person once i.e. the same income earned by the person should not be taxed twice. In
order to protect and promote international trade by protect the person from double
taxation India has entered into Double taxation avoidance treaties with many
countries.
There are two sections in Income Tax Act 1961 which specifically deal with this
issue; they are Section 90 and Section 91. S90 speaks about agreements with foreign
countries for tax relief. And S91 deals with double taxation relief where there is no
pre-existing contract.
There are certain conditions regarding residential status and taxable income that
needed to be fulfilled before claim is made for relief.
Double taxation relief and avoidance also is different. In former tax has already been
paid where in later assessee will legally avoid payment of tax. There are different
methods to evaluate double taxation relief and avoidance.
The language of the DTAA is interpreted differently by different countries so
carefully observations are required before coming to a conclusion. The reach of
DTAA is very wide i.e. it covers many types of taxes and income.
When two rates are different in the concerned countries, relief is given on lowest rate.
And when rate in both the country are equal Indian rate will be applicable.
Another provision that is given is assessee have an option of choosing to be governed
either by the provisions of particular DTAA or the provisions of the Income Tax Act,
whichever are more beneficial.
Through cases and illustrations a better understanding is obtained about the
applicability of the law and how the individuals are avoiding the double tax levied on
them.
 REVIEW OF LITRETURE

According to Rivier (1983) and Arnold and McIntyre (1995) double taxation can be
defined, in a non-exhaustive way, as the imposition of comparable taxes by two or
more sovereign countries on the same item of income of the same taxable person for
the same taxable period.
Double taxation is generally defined as the imposition of comparable taxes in at least
two countries on the same taxpayer with respect to the same subject matter and for
identical periods (OECD 2005)
Another potential source of twofold taxation could be the fact that both countries
claim either a certain taxpayer as a resident or that an income arises within its country
(Doernberg 2004). Also, different methods for the determination of the internal
transfer price applied in two states can lead to a double taxation, e.g., a company has a
production facility in two countries and delivers intermediate goods from the plant in
country A to the factory in country B. If domestic rules in B set a value of 80 USD as
appropriate, but country A ascertains a value of 100 USD, then revenues of 100 USD
in the source country stand vis-à-vis expenses of only 80 USD in the recipient country
(Lang 2002).
In the words of Egger et al. (2006: 902): “One of the most visible obstacles to cross
border investment is the double taxation of foreign-earned income.” One major
purpose of Double Taxation Treaties (DTTs) is thus the encouragement of FDI. Tax
relief to foreign investors from double taxation is not the only purpose of DTTs,
however. Another important purpose is the exchange of information. DTTs help to
combat tax evasion and tax avoidance and to prevent double non-taxation by making
information from one contracting state available to the other contract partner.
MFN concept can not be well applicable in context of double taxation relief because
countries would be reluctant to agree to reciprocal concessions. An MFN approach to
double taxation could create difficulties for the symmetry of tax treaties (Hughes,
1997).
Recently many developing countries consider tax sparing as an integral part of the
elimination of the double taxation process. Until recently, many developed countries
accepted the granting of tax-sparing credits. There are, however, indications of a
restrictive trend on the part of capital-exporting countries (OECD, 1998a).
INTRODUCTION
India has a well-developed tax structure with a three-tier federal structure, comprising
the Union Government, the State Governments and the Urban/Rural Local
Bodies. The power to levy taxes and duties is distributed among the three tiers of
Governments, in accordance with the provisions of the Indian Constitution. Since
1991 tax system in India has under gone a radical change, in line with liberal
economic policy and WTO commitments of the country like reduction in custom
and excise duties, lowering corporate tax, widening of the tax base and toning up the
tax-administration.
The growth in international trade and commerce and increasing interaction
among nations, citizens, residents and businesses of one country has extended their
sphere of activity and business operations to other countries. To avoid hardship to
individuals and also with a view to ensure that national economic growth does not
suffer, the Central government under Section 90 of the Income Tax Act has entered
into Double Tax Avoidance Agreements with other countries.

Objective of Government behind this step is -

1. Protection against double taxation: These Tax Treaties serve the purpose of
providing protection to tax-payers against double taxation and thus
preventing any discouragement which the double taxation may
otherwise promote in the free flow of international trade, international
investment and international transfer of technology.
2. Prevention of discrimination at international context: These treaties aim at
preventing discrimination between the taxpayers in the international field and
providing a reasonable element of legal and fiscal certainty within a legal
framework.
3. Mutual exchange of information: In addition, such treaties contain
provisions for mutual exchange of information and for reducing litigation
by providing for mutual assistance procedure; and
4. Legal and fiscal certainty: They provide a reasonable element of legal and
fiscal certainty within a legal framework.
DOUBLE TAXATION
Double taxation can be defined as the levy of taxes on income or capital in the hands
of the same tax payer in more than one country, in respect of the same income or
capital for the same period. Double taxation may arise when the jurisdictional
connections, used by different countries, overlap or it may arise when the taxpayer
has connections with more than one country. For e.g. An NRI will have to pay tax on
the income earned in India on source basis i.e. where income accrues or arises. On the
same income, tax will have to be paid in the country of residence on residence basis.
As such, an NRI will end up paying Income-tax twice on the same income. Tax
Treaties provide protection to tax payers against such double taxation.

International double taxation may arise in two ways.

Case 1: The jurisdictional connections used by different countries may overlap with
each other.
For ex, Mr. X, an ordinary resident under the Indian Income tax Act, 1961, has to pay
tax in his world income as citizen in USA (Residential jurisdiction)
Case 2: The taxpayer or his income may have connections with more than one
country.
For ex, Suppose Mr. X gets income from U.K and dividend income from France. “X”
has to pay tax on his world income in India, and also tax on income earned in each
country mentioned above

Kinds of Double Taxation:

Double taxation occurs due to various reasons. Two basic kinds of double taxation are
economic double taxation and juridical double taxation.
- Economic double taxation means the same income is taxed twice in two
persons’ hands, e.g. corporate profit is taxed and then dividend is also taxed.
Or a firm is taxed, and subsequently the partners’ share may also be taxed.
Economic double taxation is not eliminated by a DTAA.
- Juridical double taxation means an income is taxed in one person’s hands –
but in two different jurisdictions (countries). The two connecting factors
(residence and source) lead to taxation of same income in same person’s
hands by two jurisdictions – Country of Residence as well as Country of
Source. A DTAA seeks to eliminate juridical double taxation.
Conditions for applicability of Double Taxation:
- Double taxation may also occur due to the fact that a person may be a resident
of both countries. A DTAA allocates residence to one country with tie-
breaking rules.
- Double taxation may also occur due to the fact that source is in both countries
(and the person is a non-resident of both countries). The DTAA does not
eliminate this kind of double taxation.

Double tax relief Vs. Double tax avoidance

Double tax relief means granting of relief in respect of income on which income tax
has been paid under the Indian tax laws and also in the other country. Where as
Double tax avoidance means avoidance of double taxation of income under the tax
laws of the two countries.
The Supreme Court of India has clearly pointed out the distinction between avoidance
of double taxation and relief against double taxation. One important feature in this
distinction is that in case of avoidance of double taxation the assessee does not have
to pay the tax first and then apply relief in the form of refund, as he would be obliged
to do under a provision for relief against double taxation.

Methods of DTAA -

DTAA can be of two types.

i. Comprehensive - Comprehensive DTAAs are those which cover almost all types of
incomes covered by any model convention. Many a time a treaty covers wealth tax,
gift tax, surtax. Etc. too.

ii. Limited - Limited DTAAs are those which are limited to certain types of incomes
only, e.g. DTAA between India and Pakistan is limited to shipping and aircraft profits
only
Method of double taxation relief –
Unilateral relief:
Under this system of taxation whether the income is subject to tax abroad or not is
immaterial. In Unitary system, relief is given by way of tax credit for the taxes paid
abroad. The countries, which follow this method of tax credit, are U.S, Greece, India,
and Japan to name a few.
For example - A resident in India who has paid income tax in any country with which
India does not have a treaty for the relief or avoidance of double taxation is entitled to
credit against his Indian Income tax for an amount equal to the Indian coverage rate or
the foreign rate whichever is lower applied to the double taxed income. This is done
as follows.
a. Where the foreign tax is equal to Indian tax, the full amount of foreign tax will be
given credit.
b. Where the foreign tax exceeds the tax payable in India, the liability to Indian tax
will be nil. However, no refund in respect of the excess amount is allowed, and
c. Where the foreign tax paid is less than the Indian tax after deducting the foreign tax
would be payable by the taxpayer. The principle is that the credit allowable will never
exceed the amount of Indian income tax, which becomes due or payable in respect of
the doubly taxed income.

Bilateral relief:
Bilateral relief may take any one of the following two forms.
Firstly, the treaty may apply exempting method, the country in question refrain from
exercising jurisdiction to tax a particular income.
For ex, under this exemption method, the country of source in which the Permanent
Establishment (PE) is located is assigned an exclusive jurisdiction to tax the profits of
the establishment. In turn it may agree to refrain from exercising its jurisdiction to tax
the owner on these profits.
Alternatively, the treaty may provide relief from double taxation by reducing the tax
ordinarily due in one or both of the contracting parties on that income which is subject
to double taxation.
For example, the country, which is the source of a dividend, often agrees to reduce the
withholding rate normally applicable to dividends paid to non-residents and the
country of residence agrees to give a tax credit or similar relief for the tax paid to the
country of source. In such a case, both the countries exercise the rights to jurisdiction,
while mutually agreeing for adjustments. This helps in avoiding or at least reducing
the international double taxation on the income in question. Many treaties combine
both the methods of relief

DOUBLE TAXATION AVOIDANCE AGREEMENT:

A person earning any income has to pay tax in the country in which the income is
earned (Source Country) as well as in the country in which the person is resident. As
such, the said income is liable to tax in both the countries. To avoid this hardship of
double taxation, Government of India has entered into Double Taxation Avoidance
Agreements with various countries.
Total exemption is not granted in the DTAAs and the income is taxed in both
countries, the country in which the person is resident and is paying taxed, the credit
for the tax paid by that person in the other country is allowed.
One of the most important clauses of double taxation avoidance treaty between
different nations is the clause of non-discrimination. According to which neither of
the contracting countries gives any preferential treatment in taxing its own residents
or citizens vis-à-vis foreign persons.
A DTAA is an International agreement. Its interpretation is based on the principles of
interpretation of international law (Vienna Convention) as well as interpretations
according to the courts. Essentially, these are contracts between two Governments.
Affected parties are tax payers of those two countries

Position in India:
A typical DTAA Agreement between India and another country usually covers
persons, who are residents of India or the other contracting country, which has entered
into the agreement with India. A person, who is not resident either of India or of
the other contracting country, would not be entitled to benefits under
DTA Agreements.
Provisions of DTAA or Indian Income-tax Act, whichever are more favourable to an
individual would apply. Thus In order to avail the benefits of DTAA, an NRI should
be resident of one country and be paying taxes in that country of residence. India has
entered into DTAA with around 79 countries. These treaties are based on the general
principles laid down in the model draft of the Organisation for Economic Cooperation
and Development (OECD) with suitable modifications as agreed to by the other
contracting countries.
In India, there have been interesting twists to the DTA interpretation.
This for example can be seen through different way of interpreting employment.
According to some country meaning of employment is a consultant is engaged by a
foreign company to work in India. The foreign country considers the income as
professional income and does not consider it to be taxable in India as there is no fixed
base in India.
India considers the consultancy contract as employment due to the terms of the
contract. As the services are exercised in India, the income is considered to be taxable
in India. Both apply the DTA but the understanding of “employment” is different in
both countries.
The Income tax Act, 1961 provides unilateral relief under sec 91 and bilateral relief
under section 90(A). U/s 90(A) government signs treaties with different countries for
following purpose –
a. Double tax relief
b. Double tax avoidance
c. Exchange of information
d. Recovery of tax

The two important sections are explained below:

Section 90
According to this section Government enters into agreement with some countries for
granting relief of tax or avoidance of double taxation. Sec90A says that any income of
a resident of India "may be taxed" in the other country, such income shall be included
in his total income chargeable to tax in India in accordance with the provisions of the
Income-tax Act 1961, and relief shall be granted in accordance with the method for
elimination or avoidance of double taxation provided in such agreement.

Section.91- Relief if there is no DTAA

According to Sec 91 of the Indian Income tax Act, the following is the relief available
if there is no agreement u/s 90 between India and the country in which the income
accrues.
If any person resident in India in any previous year establishes that he has paid
income tax by deduction or otherwise, in any country in respect of his income which
accrued or arose outside India, he shall be entitled to the deduction from the Indian
income tax payable by him such a sum calculated on such doubly taxed income at the
Indian rate of tax or at the rate of tax of the said country, which ever is lower. Where
the tax rates are equal, the Indian rate shall apply.

Through an illustration I would be explaining how this section is applied-

Suppose A is a musician deriving income from foreign concerts performed outside
India, Rs 50,000. Tax of Rs 10,000 was deducted at source in the country where the
concerts were given. India does not have any agreement with that country for
avoidance of double taxation. Assuming that Indian income of A is Rs.2, 00,000 and
we want to find the relief available to him under Sec. 91 for the assessment year
2009-2010.
Average rate of Indian income tax is say 9.9% and average rate of foreign income tax
is 20%.
Thus for the musician, relief is allowed at the average rate of Indian income tax which
is lower among the two.

Origin:
The League of Nations first commenced work in this behalf in 1921 and produced in
1928 the first Model Bilateral Convention. These were followed by the Model
Convention of Mexico (1943) and the London Model Convention (1946). The
Council of the Organisation for European Economic Co-operation, which later
became the Organisation for Economic Co-operation and Development (OECD) set
up a fiscal committee in 1956 to formulate a Model Convention. The first draft
Double Taxation Convention on income and capital was framed in 1963. This
ultimately gave birth to the 1977 OECD Model Convention and Commentaries. On
the basis of the recommendation of the Committee on Fiscal Affairs, OECD published
the 1992 Model Convention in a loose leaf format to facilitate updating. The present
Model Convention and Commentaries are updated as of January 2003.
In addition to the OECD Model, there is the UN Model Convention. Its origin lies in a
resolution passed by the Economic and Social Council of the U.N. in August 1967
and was published in 1980 in the form of Model Double Taxation Convention
between developed and developing countries. The UN Model is generally considered
to be more favourable from the point of view of the developing countries as it places
greater emphasis on the right of the source state to tax a transaction having
international ramifications.

Models on DTAA:
Two models relied on most frequently for understanding of DTAA is the OECD
Model and the UN Model.
OECD Model(Organization of Economic Co-operation and Development)- This
Model is essentially a model treaty between two developed nations. This model
advocates residence principle, which lays emphasis on the right of state of residence
to tax.
UN Model- United Nations Model Double Taxation Convention between Developed
and Developing Countries. The UN Model gives more weight to the source principle
as against the residence principle of the OECD mode

However reality is different. The OECD and UN Models are only “models”. The
actual DTAA are different and based on negotiations between the two countries and
situations existing in the respective countries. Indian treaties are mainly based on UN
model.

Taxes covered by a DTAA:

A DTAA covers all direct taxes on income and capital. Taxes could be levied by any
authority – Central Government, State government, local authority, or any political
division. Different countries levy income-tax in different manners. Hence the DTA
has a wide coverage.
Some DTAAs list down the specific Acts to which the DTAA will apply. The name of
the law is not relevant. It is the nature of levy which is important.
India – U.S. DTAA refers to excise tax imposed on insurance premium paid to foreign
insurance company. In case of U.S.A., the DTAAs apply only to Federal taxes. It does
not apply to state taxes. Therefore credit for state taxes cannot be claimed as per the
DTAA.

DTAA v Income-tax Act:

In India, it is accepted that a DTAA or Income-tax Act, whichever is more beneficial
to assessee, applies. This principle is stated in:

- Section 90(2) of Income-tax Act, 1961,

- CBDT circular No. 333 dated 2.4.1982, and

- Various case laws.

Thus for example, the DTA between India and U.S.A. provides for a tax of 15% on
Royalty. The rate u/s. 115A is 10%. In such a case, the rate as per Income-tax Act
shall apply.
Interest is taxable @ 15% as per the DTA. As per Income-tax Act, the rate is 20% u/s.
115A. In this case, the rate as per the DTA will apply.
This situation however does not prevail in all countries. In U.S.A a DTA becomes a
part of domestic law. Hence any subsequent amendment in the domestic law, can
override the DTA. Normally, this is not considered appropriate under the International
Treaty Conventions.

If any one exempts the income, there cannot be any tax. To illustrate by way of a
chart, if the income falls in the common area (shaded area), it can be taxed.
This operation of DTA and IT Act that “income is taxable if it is taxable under both –
DTA and IT Act”, leads to the observation that “DTA or IT Act whichever is more
beneficial applies”.

Taxability and Residential status for DTAA:

A person has been defined in article 3(1) (a) of the OECD and UN Model. It provides
that the person can be individual, a company and any other body of persons. But
sometime it varies depending on the country.
Also the person has to be a resident of one or both countries to avail of DTAA relief.
If a person is not a resident of any country, he is not entitled to a DTAA relief.

For example-
A person is considered as a resident of Singapore if he stays in Singapore for 182 days
or more in a calendar year. In India, the residential status is for a financial year.
A person was employed in Singapore with a multinational company. He was a
resident of Singapore upto 2006. He had visited India for very short visits during
2006. From 1st January, 2007 he has been deputed to work in the Indian group
company. From 1st January, 2007, he does not go back to Singapore.
Under Singapore tax law, he is a non-resident of Singapore for calendar year
2007.Under the Indian Income-tax act, he is a non-resident for F.Y. 2006-07.
Thus for a period of 1st January, 2007 to 31st March, 2007, he is a non-resident of
both countries. For this period, he cannot get the benefit of India-Singapore DTA.
Interpretation of the meaning of “may” and “shall” under the DTAA:

Under the Indian principles of interpretation of law, “may” can be considered as

“shall”. Thus if the law uses the phrase – “it may be ... “, it means “it shall be ...”.
However this interpretation does not hold in case of DTAA. For example, the article
on dividend states that “Dividend paid by a company which is a resident of a
Contracting State (India) to a resident of the other Contracting State (Germany) may
be taxed in that other state (Germany)”. This means Germany “may” tax dividends or
“may not” tax dividends (as per its law). It does not mean dividends “shall” be taxed
in Germany.

Similarly if an Indian company has a Permanent Establishment in U.K., U.K. may tax
the income attributable to the PE. This only means U.K. may tax or may not tax the
income. It doesn’t mean U.K. shall tax the income, and India cannot tax it. India being
the country of residence always has the right to tax.

But in the below mention case we can see decisions are made which are contrary to
this principle. It was held that if an Indian company has a PE outside India, then the
income attributable to the PE is not taxable in India.

It is thus advisable that under the DTAA, if the income has to be taxed in one country
only, the phrase used should be “shall be taxable only in … “.

CASE
Dy. CIT v. Torqouise Investment & Finance Ltd 300 ITR 1 (SC)
Case Facts:
- The assessee, a company incorporated under the laws of India, claimed refund
of Rs.29,16,660/- being deemed credit of taxes on dividend received from a
Malaysian company – Pan Century Edible Oils, Malaysia. This claim was
based on the ground that such dividends were not taxable in India by virtue of
the Indo-Malaysian DTAA as it stood at the relevant time.
- The Assessing Officer, however, rejected the claim of the assessee on the
ground that the assessee was a tax resident of India and taxable on its global
income in India.
 Issue:
- Whether dividend income received by the assessee from shares held in a
Malaysian company were liable to tax in India in view of Article 10 of the
Indo-Malaysian Treaty was the main issued that need to be addressed by court.

Analysis:
In CIT v. PVAL Kulandagan Chettiar the assessee was an Indian resident who had
gained income from rubber plantations in Malaysia. The CIT in India filed a case
that the income is taxable in India. The agreement between India and Malaysia
on DTAA was held supreme and the appeal was rejected citing the assessee was
an Indian and he had paid taxes in Malaysia. This case has same issue as main
case.
The phrase “may be taxed” interpreted as “shall be taxed” by Indian law. India
may or may not tax the person it is not like that India has to tax that person.

Judgement:
- The CIT allowed the claim of the assessee relying upon the provisions of the
Indo-Malaysian Treaty. On further appeal, the Tribunal confirmed the order of
the CIT.
- The High Court, too, confirmed the order of the CIT and the Tribunal but on
different grounds. The High Court held that, no doubt, the dividend income
from shares held in Malaysia by the assessee was taxable under section 5(1)(c)
of the Act, but the assessee was entitled to relief under the Indo-Malaysian
Treaty.
- The High Court further held that in terms of Article 10 of the Indo-Malaysian
Treaty, dividends were taxable only in the country of residence of the
company from whose shares such dividends arose.

Interpretation of ‘Business Profits’:

Article 7 provides for business profits taxation. Article 7(3) provides that in
computing profits of the PE, all expenses including executive and general
administrative expenses will be allowed as deductions.
Many Indian DTAAs contain a provision that expenses will be allowed “subject to the
limitations of taxation laws of India”.
This has been interpreted by courts that disallowance of expenses is permitted due to
the restriction contained in article 7(3). However, without the restriction, expenses can
be fully allowed.
According to latest published report of OECD on “Attribution of Profits” expenses to
be allowed to the PE will be always as per domestic law.
Thus even without any specific restriction on allow ability of expenses, it was always
understood that expenses are allowable only as per domestic law.

Assessment of situation in which assessee is resident in both the countries:

Take for example-
- Arif, a resident both in India and Malaysia in previous year 2009-2010, owns
immoveable properties (including residential house) at Malaysia and India.
- He has earned income of Rs 50 lakh from rubber estates in Malaysia during
the financial year 2009-2010. He also sold some property in Malaysia
resulting in short-term capital gain of Rs 10 lakh during the year.
- Arif has no permanent establishment of business in India. However, he has
derived rental income of Rs 6 lakh from property let out in India and he has a
house in Lucknow where he stays during his visit to India.

Issue:
- Issue is whether the business income of Arif arising in Malaysia and the
capital gains in respect of sale of the property situated in Malaysia can be
taxed in India.

Analysis:
- Where the Central Government has entered into an agreement with the
government of any other country for granting relief to tax or for avoidance of
double taxation, the provisions of the Income-tax Act, 1961 are applicable in
such case to the extent they are more beneficial to the assessed.
 - Arif has a residential house both in Malaysia and India. Thus, he has a
permanent home in both the countries. However, he has no permanent
establishment of business in India.
- The Double Taxation Avoidance Agreement (DTAA) with Malaysia provides
that where an individual is a resident of both countries, he is deemed to be
resident of that country in which he has a permanent home and if he has a
permanent home in both the countries, he is deemed to be resident of that
country, which is the centre of his vital interests, i.e. the country with which he
has closer personal and economic relations.
- Arif owns rubber estates in Malaysia from which he derives business income.
However, Arif has no permanent establishment of his business in India.
Therefore, his personal and economic relations with Malaysia are closer, since
Malaysia is the place where—(a) the property is located and (b) the permanent
establishment (PE) has been set-up. Therefore, he is deemed to be resident of
Malaysia for AY 2009-2010.

Judgement:
- Thus Arif is not liable to income tax in India for assessment year 2009-2010 in
respect of business income and capital gains arising in Malaysia.

Interpretation of Permanent Establishment:

One important term that occurs in all the Double Taxation Avoidance Agreements is
the term 'Permanent Establishment' (PE), which has not been defined in the Income-
tax Act. There is a consensus that the host country can tax income of foreign
companies only if it maintains a PE. Normally, a PE includes the following:

• A place of management.
• A branch.
• An office.
• A factory

Thus, a PE takes the form of a facility, a construction site or an agency relationship,

all of which require a measure of permanence.
There is difference between business connection and PE. A business connection is
deemed to exist if there is any continuous relationship between a business carried on
in India and, a non-resident person who derives income through this connection.
There must be a continuity of transactions so as to establish a business connection.
Normally, the time period to constitute a PE in the host country is six months.
Another issue is the scope of income earned by a PE in a country, i.e., what is the
portion of the income of PE earned in India that can be taxed. Under the 'Attribution
Rule', only those profits are taxable which are attributable to the PE, computed on the
basis of a hypothesis that the establishment in a country is completely independent of
the head office in another country.

Treaty Abuse:
Treaty abuse means a treaty is used by people for whom it is not meant; or for
purposes for which it is not meant. Abuse of treaty is also known as treaty-shopping.
For example if a company in U.K., invests in India through a Mauritian company to
take advantage of India-Mauritius DTA, it can be considered as abuse of treaty.
The most important treaty shopping in which the Indian Government is losing
considerable revenue is in the Mauritius route. Indo-Mauritius DTA agreement came
into effect from 6th Dec 1983. As per the agreement corporate entity if resident in
Mauritius has the choice to pay income tax in Mauritius at Mauritius tax rates even if
the taxable income accrues in India. India can only impose a law withholding tax of 5
percent of 15 percent on the dividend income paid by the Indian Subsidiary to the
foreign corporation. A foreign corporation, incorporated in Mauritius can repatriate
dividend income received from an Indian Joint venture subsidiary with option to pay
tax in Mauritius at Mauritius rates of income tax instead of the very high corporate
rate of income tax for foreign corporations in India.
Under the Mauritius Offshore Act a corporation known as the MOBA entity has the
privilege to pay income tax on dividend income (from India) repatriated into
Mauritius on a voluntary basis in the sense of paying at a rate choosing from 0 percent
to 35 percent. The following illustration will reveal how fiscal advantage of the
Mauritius route will be availed by the MNC’s.
The DTAA may have provisions to prevent treaty abuse. For example Dividends,
Interest, Royalty and Fees for Technical Services may be taxed at lower rates only if
the recipient is the “beneficial owner”.
 CASES

1. DIT v. Morgan Stanley & Co Inc

This case is under the context of Indo-US DTAA. The case facts are written below –
Case Facts:
- Assessee, a resident of USA was an investment bank providing
financial services. One wholly owned Indian subsidiary Morgan
Stanley Services Pvt. Ltd. ('MSAS'), which agreed to provide a
number of services to this assessee at cost plus certain mark-up.
- Indian Company was providing support services such as business
research, IT support, accounting, and back office.
- It was also agreed that MSCo would send people to India for
stewardship activities to ensure quality standards as set by MSCo
were met. MSCo, at the request of MSAS, would also send people
to work under the control of MSAS for a specified period
(deputationists).
- While the costs of the personnel performing stewardship activities
would be borne by MSCo, the salary cost for the deputationists
would be initially disbursed by MSCo and subsequently re-charged
to MSAS.

Issues before the court of law:

- Whether any permanent establishment of foreign country came into
existence.
- Attribution of profit to such permanent establishment.

Analysis:
Since the first issue was regarding PE. The observations were-
- There is no fixed place PE under article 5(1). Because support services
comprise back office operations and do not amount to carrying on
business of foreign company. Back office operations were preparatory
or auxiliary and get excluded by operation of article 5(3)(e).
 - There is no agency PE since they have no authority to conclude
contracts only implementation of part of contract by way of back office
functions.
- Also there is no service PE on account of Stewardship services.
Activities for protecting foreign company’s own interest cannot be said
to constitute services rendered to Indian company. Service PE comes
into existence in view of employees deputed to Indian company.
Service Rule PE u/s Article 5(2) (l) of the DTAA applies in cases where
the MNE provides services within India and those services are provided
through its employees. The SC states that where the activities of the MNE
entails it to be responsible for the work of deputationists and the
employees continue to be on the payroll of the MNE or they continue to
have their lien on their jobs with the MNE, a service PE can emerge
Regarding attribution of income the SC has observed that income
attribution to a PE should take into account all the risk-taking functions of
the enterprise and if the transfer price does not adequately reflect the
functions performed and the risks assumed by the enterprise, there would
be a need to attribute profits to the PE for those functions/risks that have
not been considered. Therefore, in each case the data placed by the
taxpayer has to be examined as to whether the transfer pricing analysis
placed by the taxpayer is exhaustive of attribution of profits and that would
depend on the functional and factual analysis to be undertaken in each
case.
Also the taxable entity is the foreign entity and not PE. Only those profits
of FC that have economic nexus with Indian PE can be taxed in India
The method for transfer price calculation is Transactional Net Margin
Method (TNMM) is the most appropriate method in the case of Service PE
as TNMM apportions the total operating profit arising from the transaction
on the basis of sales, costs, assets, etc.

Judgement:
- Thus it was held that back office operations do not constitute a PE of
the foreign company in India under the fixed place of business rule
or basic rule PE. Deputation of personnel by the foreign company to
 the Indian company to provide services (other than stewardship
activities) would trigger a PE of foreign company in India (under the
Service PE Rule).
- It is held that the employee lends his experience to MSAS in India as
an employee of MSCo as he retains his lien and in that sense there is
a service PE (MSAS) under Article 5(2) (l). Thus, the SC has upheld
the AAR’s ruling on this aspect - MSCo is rendering services
through its employees to MSAS and this practically the same as to a
Service PE.
- Second issue was profits attributable to tax in India regarding that it
was held under the AAR rule that as long as MSAS being the PE was
remunerated for its services on an arm’s length basis taking into
account all the risk-taking functions of the multinational enterprise,
no further income was attributable in the hands of MSAS in India. So
he can not be taxed further.
.

2. CIT v Hyundai Heavy Industries Co Ltd

This case is in context of Indo-South Korea DTAA.
Case Facts:
- non-resident assessee a foreign company entered into a contract
with an Indian customer, which comprised of two parts:
(i) Designing and fabrication of a platform
(ii) Installation and commissioning of the said platform at
Bombay high
The consideration for both the parts was separate although the
agreement was single.

Issue:
Dispute was over revenue. Contract was in respect of a turnkey project and
was not divisible. Part of the profits from designing and fabrication arising
 in respect of the Korean operations were taxable in India, as it had nexus
with activities of installation in India.

Analysis and Judgement:

- Income relating to designing and fabrication was not taxable in
India. Only income relating to installation and commissioning was
taxable on arms length basis.
- Indian Income Tax act is concerned only with profits earned in
India. Sale of platform was outside India. So no tax on such profit
in India. Thus entire profit from business connection not taxable.
Only profit having economic nexus with PE taxable.
- PE came into existence after the supply of fabricated platforms.
- Profits from supply could not be attributed to the installation PE
- There was no allegation that the sale price of the platform included
any remuneration for services rendered by PE so no taxability in
India as payment on arm’s length basis. PE to be treated as
independent of FC.
- The above would be valid even if supplies were an integral part of
installation

3. Ishikawajma Harima Heavy Industries Limited vs. Director of Income Tax,

Mumbai

This case gave a new dimension on turnkey contracts.

Case Facts:

- The company was incorporated in Japan. It formed a consortium with four

others companies in Japan and entered into an agreement with an Indian firm,
Petro net LNG Ltd for setting up liquefied natural gas receiving and
degasification facility in Gujarat.
 - Each member of the consortium was to receive separate payments. The
contract involved offshore supply, offshore services, onshore supply, onshore
services, construction and erection.
- The price was payable for offshore supply and services in US dollars, whereas
that of onshore supply, construction and erection partly in dollars and partly in
rupees.

Issues:

- The dispute arose whether the amounts received by the Japanese corporation
from Petro net for offshore supply of equipment and materials were liable to
tax under the Indian Income Tax Act and the India-Japan double taxation
avoidance treaty.
- The Authority for Advance Rulings (Income Tax) ruled that the Japanese firm
was liable to pay direct tax, even under the treaty.
- The appellant contended that the contract is a divisible one and that there can
be no tax liability in India for the offshore supply of equipment and services.
As per the Double Taxation Avoidance Agreement between India and Japan,
business income may be taxed in India only when the non-resident has a
permanent establishment in India and only to the extent that such incomes
could be directly or indirectly attributable to the activities of the PE in India.
Therefore the appellant contended that its PE had nothing to do with the
offshore supply of materials and services and that the mere presence of the PE
cannot attract tax liability in India, when the PE is not actually connected with
the offshore supplies
- The government, on the other hand, contended that the contract was a
composite one. The supply of goods, whether offshore or onshore, and
performance of service were attributable to the turnkey project. It contended
that the offshore and onshore elements of the contract are so inextricably
linked, that the breach of the offshore element would result in the breach of
the whole contract. The dominant object of the contract is the execution of a
turnkey project.
Analysis:

- Only such part of the income as attributable to the operations carried out in
this country can be taxed here. If all parts of the transfer of goods as well as
the payment are carried on outside the country, the transaction cannot be taxed
in India. Even though the contract was signed in India, the activities in
connection with the offshore supply were outside the country and therefore
cannot be deemed to accrue or arise in this country.
- Since all parts of the transaction like the transfer of property in goods and
receipt of payment were outside India, the transaction could not have been
taxed in India for the mere reason that the appellant has a PE in India. A PE
cannot be equated to business connection under Section 9(1) (i) of the Act and
the existence of PE would not constitute sufficient business connection.
- The entire transaction having been completed on the high seas, the profits on
sale did not arise in India. Thus it is excluded from the scope of taxation under
the Act; the application of the double taxation treaty would not arise.

Judgement:

- The Supreme Court held that merely because the contract has been designed as
turnkey, it would not mean that the entire contract must be considered as an
integrated one for the purpose of taxation as well. Operations like fabrication
carried out in Korea are not taxable in India. The Supreme Court ultimately
held that the tribunal was wrong and set aside its order. While the Japanese
firm got relief in the case.
 REFERENCES

1. “Principles of Interpretation of issues in Double Taxation Avoidance Treaties”

: Sohrab Erach Dastur, Senior Advocate
2. law.incometaxindia.gov.in
3. IMPORTANT CONCEPTS OF INTERNATIONAL TAXATION AND PRINCIPLES OF TAX TREATY

INTERPRETATION :NARESH AJWANI(2007)

4. Direct Taxes Code : Department of Revenue (August 2009)

5. www.itatonline.org
6. TAXATION: UNCTAD series on issue in International investment agreement
(2000)