Pramod Kumar
June 2013
This presentation seeks to present the academic
aspects relating to, and various points of view
about, the concept of non discrimination in tax
treaties. This is not a statement of legal
position, expression of any opinion and it does
support any particular point of view. The views
expressed herein do not reflect the views or the
understanding of the author or author’s
employer i.e. the Government of India, or the
Income Tax Appellate Tribunal.
What is a tax treaty, what are objectives of tax
treaties and whether these objectives travel
beyond avoidance of double taxation as well ?
What is impact of 2004 amendment in Section
90(1) on the treaties provisions travelling beyond
the avoidance of double taxation ?
How is a tax treaty to be interpreted ; is it to be
interpreted the same way a legal provision is
interpreted or in any different manner ?
What is conflict between source rule of
taxation and residence rule of taxation and
how tax treaties resolve this conflict ?
Do tax treaties allocate the taxing rights
between source jurisdiction and residence
jurisdiction or do they simply restrict the
taxing right of source jurisdiction ?
Ensure that residents of one of the treaty partner
jurisdiction are not discriminated against in the
other treaty partner jurisdiction
Restrict the application of domestic tax law in the
treaty partner jurisdiction to the extent it is
discriminatory
Does it mean both the residents are to be treated
as par or is a reasonable differentiation
permissible ?
Limits the application of domestic tax law
provisions, vis-à-vis the residents of treaty
partner country, in the host country
Extends the scope of beneficial domestic tax
law provisions, vis-à-vis the residents of
treaty partner country, in the host country
This also extends to a domestic enterprise
which is owned or controlled by the residents
of the treaty partner country.
Residents (individual or corporate ) of one
jurisdiction while being taxed in the treaty
partner jurisdiction
Enterprise with fiscal domicile in the host
country, but having capital or control by
residents in the treaty partner country, while
being taxed in the domicile jurisdiction
Its origin from Latin words ‘discriminare’ and
‘discernere’ ( to separate) and ‘cerenere’ (to shift)
Differentiation, as classical meaning of the
expression would imply, could be negative, positive
or neutral
Original meaning of the verb ‘to discriminate’ is thus
value neutral
Its contemporary usage, however, generally refers to
‘less’ rather than ‘more’ favour, and unreasonable,
arbitrary or irrelevant differentiation
“The State shall not deny to any
person equality before the law or the
equal protection of the laws within the
territory of India Prohibition of
discrimination on grounds of religion,
race, caste, sex or place of birth .”
"[t]he equal protection of laws: guaranteed by
Article 14 of the Constitution of India does
not mean that all laws will have to be general
in character and universal in application and
that the State is no longer to have the power
of distinguishing and classifying persons or
things for the purposes of classification".
In Kedar Nath Bajoria Vs State of West Bengal
(AIR 1953 SC 404,406)
In order to pass the test of permissible classification, two
conditions must be fulfilled, namely (i) the classification must
be founded on an intelligible differentia which distinguishes
persons or things that are grouped together from others left
out of the group, and (ii) the differentia must have a rational
relation to the object ought to be achieved by the legislation
in question.
State of West Bengal Vs Anwar Ali Sarkar
(AIR 1952 SC 75)
One school of thought is that differentiation,
except when permitted by the relevant bilateral
treaty itself, which subjects persons or capital
belonging to the partner contracting states, to
any taxation or connected requirements, per se
amounts to discrimination
The other school of thought is that it is only
when such differentiation is not on valid
grounds, it does not amount to discrimination
Reverse discrimination is a situation in which
persons or capital belonging to the host
contracting state are subjected to more
burdensome taxation or any connected
requirement, vis-à-vis the persons or capital
belonging to a treaty partner country.
There are no specific reverse discrimination
situations dealt with by the tax treaties, though
this aspect is dealt with in some Indian and
foreign judicial precedents and guidelines issued
by revenue authorities abroad.
In view of the provisions of Section 90(2), treaty
provisions override the provisions of Income Tax Act,
1961, except to the extent these are beneficial to the
assessee. The only rider, as on now, is , with regard
to tax rate. In the proposed Direct Tax Code,
additional exceptions are (a) GAAR, (b) Branch Profit
Tax, and (c) CFC regulations.
When domestic law comes in conflict with the
provisions of the treaty, it ceases to be enforceable in
to that extent. Therefore, if any provision of the
domestic law is seen in conflict with NDC in tax
treaties, to that extent, domestic law is ineffective.
Taxability of an income, or admissibility of
deduction, in the hands of a resident of the other
contracting state.
Deductibility of an expenditure in respect of
payment made to other contracting state.
Treatment to an enterprise in which resident of
other contracting state holds capital or control
Discrimination on the ground of nationality
Discrimination against Stateless persons
(
whether resident in the treaty partner country or not ; not really
relevant in India as Indian tax system does not differentiate on the
basis of nationality -234 ITR 371)
( living in the treaty partner country – not relevant again)
Discrimination against treatment to payments
made to treaty partner resident - Herbalife case
(except in cases of payments to associated enterprises)
Discrimination against Taxability of
Permanent Establishment ( except for personal
allowances, reliefs and reductions for taxation purposes on account
of civil status or family responsibilities which it grants to its own
residents) – Metchem case, Automated Securities case, Rajeev
Gajwani SB 129 ITD 145
Ownership discrimination
– Daimler Chrysler case
discriminating against a business owned or controlled by the
resident of other contracting state – even an Indian resident, owned
or controlled by a resident of treaty partner, can be aggrieved party)
(
Same right for deduction of expenses
Same facilities for depreciation and reserves
Same option for carry forward of losses
Same rules for computation of capital gains
UN /OECD Model Conventions
US Model Convention
No ND clause at all
Restricted ND clause
areas to which NDC will not extend)
NDC missing in several tax treaties)
(i.e. with clarifications on
( e.g. India Australia tax treaty)
(such as deduction related
Taxation or any requirements connected
therewith
which is more burdensome
less favorably levied
requirements to which nationals of the state
concerned are … or may be subjected to ..
Nationals of a Contracting State shall not be subjected
in the other Contracting State to any taxation or any
requirement connected therewith which is other or more
burdensome than the taxation and connected
requirements to which nationals of that other State in
the same circumstances, in particular with respect to
residence, are or may be subjected. This provision shall,
notwithstanding the provisions of article 1, also apply to
persons who are not residents of one or both of the
Contracting States.
Stateless persons who are residents of a Contracting
State shall not be subjected in either Contracting State
to any taxation or any requirement connected therewith
which is other or more burdensome than the taxation
and connected requirements to which nationals of the
State concerned in the same circumstances, in particular
with respect to residence, are or may be subjected.
The taxation on a permanent establishment which an
enterprise of a Contracting State has in the other
Contracting State shall not be less favourably levied in
that other State than the taxation levied on enterprises
of that other State carrying on the same activities. This
provision shall not be construed as obliging a
Contracting State to grant to residents of the other
Contracting State any personal allowances, reliefs and
reductions for taxation purposes on account of civil
status or family responsibilities which it grants to its
own residents.
Except where the provisions of paragraph 1 of article 9,
paragraph 6 of article 11, or paragraph 6 (paragraph 4 in OECD Model
Convention) of article 12 apply, interest, royalties and other
disbursements paid by an enterprise of a Contracting State to
a resident of the other Contracting State shall, for the
purpose of determining the taxable profits of such enterprise,
be deductible under the same conditions as if they had been
paid to a resident of the first-mentioned State. Similarly, any
debts of an enterprise of a Contracting State to a resident of
the other Contracting State shall, for the purpose of
determining the taxable capital of such enterprise, be
deductible under the same conditions as if they had been
contracted to a resident of the first-mentioned State.
Enterprises of a Contracting State, the capital of which
is wholly or partly owned or controlled, directly or
indirectly, by one or more residents of the other
Contracting State, shall not be subjected in the firstmentioned State to any taxation or any requirement
connected therewith which is other or more
burdensome than the taxation and connected
requirements to which other similar enterprises of the
first-mentioned State are or may be subjected.
The provisions of this article shall,
notwithstanding the provisions of article 2,
apply to taxes of every kind and description.
Nationals of a Contracting State shall not be
subjected in the other Contracting State to any
taxation or any requirement connected therewith
which is other or more burdensome than the
taxation and connected requirements to which
nationals that other State in the same
circumstances are or may be subjected. This
provision shall apply to persons who are not
residents of one or both of the Contracting States.
Except where the provisions of paragraph 3 of article 7
(Business Profits) apply, the taxation on a permanent
establishment which an enterprise of a Contracting
State has in the other Contracting State shall not be less
favourably levied in that other State than the taxation
levied on enterprises of that other State carrying on the
same activities. This provision shall not be construed as
obliging a Contracting State to grant to residents of the
other Contracting State any personal allowances, reliefs
and reductions for taxation purposes on account of civil
status or family responsibilities which it grants to its
own residents.
Except where the provisions of paragraph 1 of article 9
(Associated Enterprises), paragraph 7 of article 11
(Interest), or paragraph 8 of article 12 (Royalties and
Fees for Included Services) apply, interest, royalties, and
other disbursements paid by a resident of a Contracting
State to a resident of the other Contracting State shall,
for the purposes of determining the taxable profits of
the first-mentioned resident, be deductible under the
same conditions as if they had been paid to a resident
of the first-mentioned State.
Enterprises of a Contracting State, the capital of
which is wholly or partly owned or controlled,
directly or indirectly, by one or more residents of
the other Contracting State, shall not be subjected
in the first-mentioned State to any taxation or any
requirement connected therewith which is other or
more burdensome than the taxation connected
requirements to which other similar enterprises of
the first-mentioned State are or may be subjected.
Nothing in this article shall be construed as
preventing either Contracting State from imposing
the taxes described in Article 14 (Permanent
Establishment Tax) or the limitations described in
paragraph 3 of Article 7 (Business profits).
One school of thought – no difference at all; in
substance provisions are the same, even though there
may be slight variations in the wordings.
The other school of thought – as long as PE tax is
protected as not covered by the NDC, the differentiation
per se not enough to invoke the NDC. Technical
Explanation further supports this theory when various
differentiations in US laws are justified.
Section 1446 of the Code imposes on any partnership with income that
is effectively connected with a U.S. trade or business the obligation to
withhold tax on amounts allocable to a foreign partner. .... There is no
similar obligation with respect to the distributive shares of U.S. resident
partners. It is understood, however, that this distinction is not a form of
discrimination within the meaning of paragraph 2 of the Article. No
distinction is made between U.S. and non-U.S. partnerships, since the
law requires that partnerships of both U.S. and non-U.S. domicile
withhold tax in respect of the partnership shares of non-U.S. partners.
Furthermore, in distinguishing between U.S. and non-U.S. partners, the
requirement to withhold on the non-U.S. but not the U.S. partner's
share is not discriminatory taxation, but, like other withholding on
nonresident aliens, is merely a reasonable method for the collection of
tax from persons who are not continually present in U.S., and as to
whom it otherwise may be difficult for the U.S. to enforce its tax
jurisdiction..........
There are cases, however; where the two enterprises would not be
similarly situated and differences in treatment may be warranted For
instance, it would not be a violation of the nondiscrimination
protection of paragraph 2 to require the foreign enterprise to
provide information in a reasonable manner that may be different
from the information requirements imposed on a resident
enterprise, because information may not be as readily available to
the Internal Revenue Service from a foreign as from a domestic
enterprise. Similarly, it would not be a violation of paragraph 2 to
impose penalties on persons ,who fail to comply with such a
requirement (see, e.g., sections 874(a) and 882(c)(2)).
Herbalife
Metchem Canada
Automated Securities, Rajeev Gajwani (SB)
Daimler Chrysler
Mashreque Bank , State Bank of Mauritius
Credit Lyonnais
The assessee, an Indian company, paid Rs.5.83
crores to US company Herbalife International Inc.,
as administrative fee as consideration for the
various services received from H Inc.
AO held that held that income was taxable in India
in the hands of H Inc, and since assessee did not
deduct tax at source, it has to be disallowed under
section 40(a)(i) in the hands of the assessee.
In first appeal, action of the AO was confirmed.
In view of Article 26(3) of India US tax treaty, which mandates
that the disbursements by a resident in India “be deductible
under the same conditions as if they had been paid to a
resident of the first-mentioned State”
However, while section 40(a)(i), as it stood at the material
point of time, did not require disallowances of payments to
resident companies while the same could be invoked for
payments to non resident companies.
It amounts to discrimination against the US company. Section
40(a)(i) held to be in applicable. Disallowance deleted.
Whether or not the limitation on deduction
of head office expenditure, as set out in
section 44C of the Indian Income-tax Act,
will apply in the case of non-resident
companies governed by the India-Canada
tax treaty (164 1TR Stat 87), particularly in
the light of non-discrimination clause in the
said DTAA ?
Assessee, a company incorporated in Canada, claimed
deduction in respect of head office overhead expenses
allocated to the work it was carrying on for a project in
India.
The deduction was restricted to 5% of adjusted total
income under section 44C
AO rejected NDC protection on the ground that domestic
Indian enterprise and the non-resident companies cannot
be said to be "in the same circumstances" which is sine
qua non for application of non-discrimination clause.
CIT(A) confirms the restriction on the ground that the treaty
is to be read as a whole and on the basis of, what he
perceived as, fairness in scheme of Section 44 C
ITAT findings
….it is clear that it is in the nature of a disabling provision
which puts a ceiling on the admissibility of a deduction. It
does constitute a restriction - and a restriction which is not
similarly placed for a domestic enterprise. The head office
expenses, to the extent the same can be fairly allocated to
the permanent establishment are admissible as deduction
under section 37(1) …. Fair approach argument rejected on
the basis of Deutsche Bank decision by Bombay HC
What Article 24(2) seeks to remove is the discrimianton to the
permanent residents of Indian and Canadian residents in the
other States vis-a-vis the domestic business entities of that
other State. When domestic tax laws permit such
discrimination, such legal provisions have to be treated as
overridden by the provisions of the Indo-Canadian DTAA
PE must be accorded the same right as resident enterprises to
deduct the trading expenses that are, in general, authorised
by the taxation law to be deducted from taxable profits in
addition to the right to attribute to the PE a proportion of
overheads of the head office of the enterprise. Such
deductions should be allowed without any restriction other
than those imposed on the resident enterprise."
Note the interplay between Article 7(3) and
NDC – specific rider ‘subject to the provisions of’
India’s official position in OECD commentary
India reserves the right to add a paragraph to clarify that this
provision can neither be construed as………nor as being in
conflict with provisions of paragraph 3 of Article 7
Assessee’s case was that since ‘subject to provisions of’
words missing in Article 7 (3) of India UAE tax treaty,
the expenses must be allowed without recourse to
artificial disallowances such as under section 37(2A), 43
B etc.
AO rejected the claim and disallowed the expenses
under provisions of the IT Act. In appeal, CIT(A)
confirmed the disallowance.
ITAT confirmed the action of the AO and CIT(A) on the
ground that it will amount to reverse discrimination.
Canadian Federal Court in Utah Mines vs The Queen 92 DTC
6194 :“The interpretation proposed by the appellant.. would
have the effect of giving US taxpayer with a PE in Canada a
more favourable treatment than its Canadian competitor.
Such a result would not be in accordance with the policy
expressed in the Preamble to the Convention and indeed
would be contrary to it”
UK Revenue’s International Tax Handbook “It would be
inequitable to permit a non resident trading in a territory
through a PE to deduct items which a resident would not be
permitted to deduct. “
Disallowance under section 43 B does not come into play
because there are no restrictions placed, in Article 7(3)
which provides for computation of taxable profits of the
PE, on deductions of expenses incurred for business
if there is no restrictive clause in the treaty, then the
expenditure incurred for the purposes of the business of
permanent establishment has to be allowed in full.
If a DTAA provides for a more liberal mode of computation
of income, then it is this mode of computation, which
needs to be followed notwithstanding any contrary
provision contained in the Act.
The assessee company was partly owned by a
German company which 81.33% shares in the
Indian company. The German company had a
merger with an American company. The ownership
pattern of India company also thus changed as
below.
As a result of this change in ownership pattern,
restrictions for carry forward of loss was invoked.
Section 79 creates a bar on carry forward of
losses
Any Pvt. ltd. Indian co., which could be
subsidiary of a listed company, can escape
the rigors if it could fall under Section 2(18) .
No such level playing field to a the appellant
company though it was subsidiary of a large
public company listed abroad. A foreign
company cannot be covered by Section 2(18).
Bar in Section 79 read down to reconcile with
non discrimination clause in tax treaty.
Can an Indian company be eligible for
benefits of India German tax treaty ?
Appropriate comparator – with another
foreign company or with a domestic company
?
Is a tax treaty only for relieving double
taxation or for more than that ?
What is the role of decisions from foreign
Courts and Tribunals ( particularly when no
decisions on that issue are available from
domestic judicial forums) and whether
decisions from treaty partner country are on a
different footing vis-à-vis other foreign
decisions ?
Canadian Pacific Ltd. Vs. The Queen – (for the
proposition that different countries should not
construe the terms differently)
Delaware case – (for the important proposition that
while comparing a foreign enterprise for ND,
comparison should be with a similar domestic
enterprise)
SA Andriz case – (for knocking down the thin
capitalization rule since in a similar situation, there
was leeway for a french enterprise)
PE of a foreign company exporting software
80 HHE declined as PE not “resident of India”
Discrimination was felt by appellant
ND invoked unsuccessfully since ITAT held, this
benefit appears to be linked to getting FE in India
PE could not satisfy this expectation
ITAT also held that for US treaty at least
differentiation simplictor not enough –
US practices referred to ; reciprocity element
examined
Despite bar in s. 80HHE, Non-Residents
eligible for deduction in view of nondiscrimination clause in DTAA
The assessee, a US citizen and resident,
exported software from his PE in India and
claimed incentive deduction u/s 80HHE
Section 80 HHE provides that only resident
taxpayers eligible for this incentive deduction
Invoked Article 26(2), and claimed that he
was treated less favourably than a taxpayer
resident in India
The provisions of Section 80 HHE read down
to include non residents as well and held to
be discriminatory vis-à-vis non residents
Automated Securities thus overruled
Reasoning adopted
If the provisions contained in the DTAA are capable of clear and
unambiguous interpretation, it is not necessary to refer to the
commentary on the OECD Model Convention, the US Technical
Explanation or decisions of any foreign jurisdiction
In Automate Securities, bench unnecessarily considered the
commentary and the technical explanation. The plain meaning of
the provisions was not considered. Greater stress was placed on
on the heading "non-discrimination" rather than on the contents
of paragraph (2) of article 26, which are clear and unambiguous.
Reference to Article 14 of Constitution of India was irrelevant.
Plain literal meaning is always preferable
A foreign company operating in India, intended to
claim 80M deduction
80M available to domestic companies
Foreign bank invoked ND article
ITAT held against, on the reasoning that the
limitation of 80M (for domestic companies) is not
nationality based
In a given case, even a foreign company can
become a domestic company … hence no
discrimination ….
UnionBanCal Corp v Comr of Internal Revenue (2002) 5
ITLR 912 US
Delaware case (Case No IR 699) Federal Tax Gazette (2004)
Part II 1043 German
NEC Semi-Conductors Ltd v Revenue and Customs Comrs
(2007) 9 ITLR 995
S A Andritz
FCE Bank plc Vs Commissione (2012) EWCA Civ 1290
(French Supreme Administrative Court - 2003)
Law on non discrimination in tax treaties in India is
still in early stages; not many decisions from the
Hon’ble High Courts as yet.
Take recourse to NDC only when you find genuine
discrimination vis-à-vis a resident , your are sure
that it is not express or intended, and you find that
FE has no measures to assume a level playing field.
If you hit the wall, then NDC provides a way out.
After all, equality before law does matter ….
Thank you !
