Phrase ‘may be taxed’ does not provide exclusive taxing rights: Mumbai ITAT

 

The Mumbai Bench of the Income Tax Appellate Tribunal (“ITAT”) has delivered an important ruling in the case of Essar Oil Limited, wherein the phrase ‘may be taxed’ in the other contracting State appearing in Tax Treaties has been interpreted as not taking away the right of the Country of residence to tax the income, after introduction of section 90(3) of the Income-tax Act, 1961 (“Act”) with effect from Financial Year (“FY”) 2003-04.

Facts of the case

· The taxpayer, a resident company, engaged in the business of exploration of mineral oil & gases, had entered into contracts with Government agencies of Oman and Qatar to undertake drilling of oil works, for which it had established branch offices in the said countries;

· The business income earned by the taxpayer in Oman and Qatar, on which taxes were paid in the respective countries, were not offered to tax in India, relying on Article 7 of the relevant Tax Treaty, on the basis that such income is taxable only in the respective countries and not in India;

· The taxpayer had also earned capital gains on sale of energy division of the company as a going concern, which was allocated amongst various branches of the taxpayer as per the fixed asset ratio of the branches. The gains allocated to the branches in Oman and Qatar were also not offered to tax in India taking shelter under Article 15 and Article 13 dealing with capital gains in the respective Tax Treaties;

· The Assessing Officer (“AO”) observed that while the relevant Articles of the Tax Treaty state that the business income or capital gains ‘may be taxed’ in other contracting State, it merely means that such income could also be taxed in India and credit for the taxes paid in abroad could be claimed in India. Accordingly the AO finalized the assessment, against which the taxpayer appealed to Commissioner (Appeals);

· The Commissioner (Appeals), relying on the ruling of the Karnataka High Court in the case of RM Muthaiah[#_ftn1][1]and Madras High Court in the case of SRM Firm[#_ftn2][2]as approved by the Supreme Court in the case of PVAL Kulandagan Chettiar[#_ftn3][3], overturned the order of the AO holding that use of the phrase ‘may be taxed’ in the Tax Treaties does not allow India to tax such incomes. The Revenue appealed against this ruling to the ITAT.

Issue before the ITAT

· Whether the income earned by the permanent establishment (“PE”) of the taxpayer outside India is to be offered to tax in India, when the taxpayer has paid taxes on such income in the respective countries and whether the phrase ‘may be taxed’ takes away the taxing rights from India?

Revenue’s contentions

· Global income of an Indian resident is taxable in view of section 5(1) of the Act and since the taxpayer company is a resident, its income from PE in the respective countries should also be taxed in India;

· The relevant Articles of the Tax Treaty provide that the income earned in Oman / Qatar may be taxed in such country. Wherever the intention was to provide for one of the States to exclusively tax an income, the Tax Treaty uses the phrase ‘shall be taxed’ as against ‘may be taxed’. The usage of the phrase ‘may be taxed’ signifies that such income could be taxed in the Country of source, but does not take away the taxing rights from the Country of residence;

· The rulings relied on by the taxpayer were rendered prior to the FY 2003-04, when section 90(3) of the Act empowering the Government to issue notifications for clarifying any term used in the Tax Treaty, was not in force. Notification No. 91 of 2008[#_ftn4][4]issued by the Central Board of Direct Taxes (“CBDT”) envisages that where a Tax Treaty provides that any income of a resident in India ‘may be taxed’ in other country, such income shall be offered to tax in India, and credit shall be available for taxes paid abroad as provided in the Tax Treaty;

· Explanation 3 to section 90 inserted by Finance Act, 2012 with retrospective effect from October 1, 2009 provides that if meaning is not assigned to any term in the Tax Treaty, then the meaning assigned to it under a notification under section 90(3) of the Act shall apply and such meaning should assigned to it with effect from the date on which the said Tax Treaty came into force.

Taxpayer’s contentions

· Section 5 of the Act is subject to other provisions of the Act, which includes section 90 of the Act as held by the Supreme Court in the case of Azadi Bachao Andolan[#_ftn5][5]. Once the taxpayer has paid tax in the Country of source, then Indian Government cannot levy tax on the same income. This view has also been approved by the Supreme Court in the case of Azadi Bachao Andolan and Turquoise Investments and Finance Limited[#_ftn6][6];

· Section 90(3) of the Act gives mandate to the Central Government to issue notification for any ‘term’ not defined under the Act or the Tax Treaty. Since ‘may be taxed’ is a phrase, notification issued to define the same is contrary to the provisions of section 90(3) of the Act;

· Once the Supreme Court has interpreted the word ‘may be taxed’, it is the law of the land which is binding under Article 141 of the Constitution and any notification issued contrary to such a law cannot be given any credence;

· Section 90(3) was omitted from the statute vide Finance Act, 2009 and was substituted by the existing section 90(3) with effect from October 1,2009. Though the provision is similarly worded after the substitution, the notification on the phrase ‘may be taxed’ issued on August 28, 2008 under the old provision does not remain in existence after substitution of the provision. The notification, if at all, will apply only from August 28, 2008 to September 30, 2009;

· Even the Explanation 3 to section 90 of the Act, which provides that any notification issued by the Government clarifying a term should have such meaning assigned to it from the date the Tax Treaty was entered into, was inserted by Finance Act, 2012 only with retrospective effect from October 1, 2009 and hence, not applicable to the present case, which involves FY 2003-04 and FY 2004-05;

· There is a marked difference between the phrases ‘may be taxed’ and ‘may also be taxed’. The phrase ‘shall be taxed’ gives right to a State to tax to the exclusion of the other State, whereas when the expression “may also be taxed” is used, the right can be said to have been conferred on both the countries to tax the income. However, where the phrase used is ‘may be taxed’, this cannot be inferred as allowing both contracting States to have a right to tax;

· A protocol was signed between India and Malaysia in 2007, wherein it was specifically agreed that with reference to Article 6(1) where the phrase ‘may be taxed’ was used that it should not be construed as preventing the country of residence to also tax the income. Hence, it is clear that such a right has to be specifically provided for and not generally available. In other words, the phrase ‘may be taxed’ provides an exclusive right to tax to the Country of source.

Ruling of the HC

· OECD commentary on Tax Treaty suggests that only the usage of phrase ‘shall be taxable’ provides an exclusive right to tax. The phrase ‘may be taxed’ provides a State an option or right to tax a particular item of income without impacting the rights of the other contracting State;

· The rulings relied on by the taxpayer was rendered prior to the section 90(3) of the Act coming into force. After the introduction of section 90(3) of the Act with effect from FY 2003-04, there is a clear departure from the earlier position as the Government has specifically interpreted the phrase ‘may be taxed’ explaining the effect of the use of this phrase and what has been the intention of the Government while negotiating the Tax Treaty;

· The clarification given by the Central Government, being one of the parties to the Tax Treaty, on the intent of the parties while entering into Tax Treaty, has to be given precedence over the interpretation given by the Courts. Since the provision under which the notification has been issued, has come with effect from FY 2003-04, the notification will have retrospective effect from FY 2003-04;

· The phrases ‘may be taxed’, ‘shall be taxed only’ and ‘may also be taxed’ have a definite purpose and a definite meaning. Whether it is a term, phrase or expression does not make any significant difference because the contracting parties have given a definite meaning to such a phrase and once the Government of India has clarified such an expression, then it cannot be held that it does not fall within the realm of the word ‘term’in section 90(3) of the Act;

· In the Tax Treaties, ‘shall be taxable only’ is never used while giving the tax right to the country of source and it is only used in the context of taxing right to the State of residence. The phrase ‘may be taxed’ / ‘may also be taxed’ gives the taxing right to the source country, however, this does not in any manner limit the right of tax or extinguish the right to tax of the country of resident which alone has a mandate to tax the global income of its resident under the domestic law. Hence, the income earned by the taxpayer in Oman and Qatar ought to be offered to tax in India, wherein credit would be provided towards taxes paid by the taxpayer in the respective countries.