How countries override bilateral tax treaties unilaterally?

Taxation is a sovereign right of a country/ state.  Each country has a right to levy tax on the person based on the specified connection with the country.  Specified connection which gives right to the country to tax is typically based on factors like residence, nationality, domicile of the tax payer, place of accrual of income earned by the tax payer, situs of the transaction/ asset etc.   



Now the sovereign right of each country to levy income tax based on residence/ source led to double taxation which necessitated the need of development of international tax law which is referred as Double Taxation Avoidance Agreements (DTAA/ Bilateral Tax Treaty).  Bilateral Tax Treaty determines the taxation right between the two contracting nations with an objective to avoid any double tax on the resident of a contracting state earning income from the other contracting state. Bilateral Tax Treaty is a fundamental constituent in the overall international economic policy of a nation, one of the vital objectives of which is to ensure free international flow of capital and technology.
Observance of Tax Treaties
From international law perspective, bilateral tax treaties have reign over domestic law which is evident from the Vienna Convention on Law of Treaties.  Article 26 of the Vienna Convention states that “Every treaty in force is binding upon the parties to it and must be performed by them in good faith”.  Further, it also clearly states that a country may not invoke the provisions of its domestic law as a justification for its failure to perform a treaty.  Furthermore, Article 18 of the Convention states the obligation of a country not to defeat the object and purpose of a treaty prior to its entry into force, and reads as under:
“A State is obliged to refrain from acts which would defeat the object and purpose of a treaty when:

• It has signed the treaty or has exchanged instruments constituting the treaty subject to ratification, acceptance or approval, until it shall have made its intention clear not to become a party to the treaty; or
• It has expressed its consent to be bound by the treaty, pending the entry into force of the treaty and provided that such entry into force is not unduly delayed.”

Accordingly, it is clear that countries needs to respect its bilateral tax treaties and any violation would constitute a violation of international law.
Case of Treaty Override
Treaty override means negating the effect of the treaty, in whole or in part, by a treaty member by means of a deliberate act of impinging domestic legislation.  In most nations, treaties are given status superior to that of ordinary domestic laws.  Issue which arises is that in what circumstances a country can make changes through its domestic law legislation (which represents its sovereign right) which does not override tax treaty which represents a binding contract between the countries.
Now what constitutes treaty override in practice is always a subject matter of debate.  Unfortunately there is no clear consensus on the parameters of what a treaty override is.  Every change in the domestic law cannot be treated as treaty override unless it materially changes the application of the treaty.  Certain situations can definitely not be considered as case of treaty override like:

• Definition of a term used in domestic legislation which is also used in its treaty provision but which is not specifically defined for the purposes of the treaty.
• Defining a term in domestic legislation which is used in the treaty but not defined in the treaty
• Taxation of income in domestic legislation not dealt by the Articles of the treaty.
• Tax Avoidance measures in domestic legislation to the extent not reflected in tax treaty

Relationship between Domestic tax laws and Treaty – perspective from tax laws in India
As in most common law jurisdictions, protection for treaty in inbuilt into domestic tax laws of India (Income Tax Act, 1961).  Section 90 of the said Act provides that where the Government of India has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be then, in relation to the tax payer to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that tax payer.
India has always strongly respected the tax treaties in line with it's Constitution which provides for promotion of international peace and security.  Article 51 of the Constitution of India provides as under:
The State shall endeavour to:
a) promote international peace and security;b) maintain just and honourable relations between nations;c) foster respect for international law and treaty obligations in the dealings of organised peoples with one another
Government of India, has specifically clarified that where a specific provision is made in the double taxation avoidance agreement, that provision will prevail over the general provisions contained in the Income-tax Act.
For this reason, India is renegotiating its tax treaty with countries like Mauritius where it feels that it’s being misused to obtain specified tax benefits.  Further, the specific Anti Avoidance Rules provided in tax treaty like the Limitation of Benefits (LoB) clause under the India Singapore tax treaty should prevail over the general anti avoidance rules under the provisions of the Act.
Equalisation Levy – Can it be considered a case of Treaty Override?
In the Union Budget for 2016 announced by the Government of India, there is a proposal to charge an “Equalisation Levy” – a withholding tax of 6% on gross consideration paid to non-resident for specified digital services.  The proposed levy has been introduced not as part of Income Tax Act but as a separate chapter in the Finance Bill.
Though termed as Equalisation Levy it is in effect income tax on gross consideration as is evident from following aspects of the levy:

1. It’s a tax on gross consideration similar to a withholding tax
2. Various provisions of Income Tax Act has been made applicable to the levy
3. Levy has been equated to Income Tax paid by a Permanent Establishment (PE) i.e. if PE of non-resident pays income tax then this levy is not applicable
4. Cannot be Indirect Tax as specified services is already subject to Service Tax.

The key conflict which this levy can potentially have with Tax Treaty between India and other countries is that the proposed legislation seeks to levy income tax on non-residents without payment being qualified as Royalty/ Fees for Technical Services or without non-resident constituting PE in India under the current provisions of Tax Treaty between India and other countries.
While the challenges of Digital Economy taxation is not unknown but it’s important that the challenges are addressed through treaty negotiation with the country partners.  For this purpose OECD proposed a Multilateral agreement between various countries to modify existing bilateral tax treaties in a synchronised and efficient manner to implement the tax treaty measures developed during the BEPS project, without the need to expend resources individually renegotiating each treaty bilaterally.
Now whether Equalisayion Levy is an income tax and accordingly overrides India’s bilateral tax treaty is a subject matter of legal debate, it is clear any unilateral attempt to materially override tax treaty by any country can, not only lead to violation of International law but also damage reputation of a country as a member of international community.
Accordingly, whenever a need arises for country to take make changes on account of its national interest, instead of resorting to treaty override, country should consider the other alternatives available to them in such situations – namely termination, revision or amendment of a treaty