Non- Discrimination The Sureshbhai Gajwani Case and its implications
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Non- Discrimination The Sureshbhai Gajwani Case and its implications

Bar & Bench

Partner D.D. Nageshwar Rao along with Associate Pranav Bhaskar of Amarchand & Mangaldas analyse the recent Sureshbhai Gajwani case. They further discuss the benefit of tax deduction under the Income Tax Act, and the reasoning of non-discrimination in relation to the non-resident tax-payers.

The recent decision of the Special Bench of the Income Tax Appellate Tribunal in the case of Shri Rajiv Sureshbhai Gajwani vs. ACIT [2011-TII-38-ITAT-AHM-SB-INTL] holding that the benefit of deduction under Section 80HHE is also available to non-resident tax payers in view of the non discrimination article under the India USA Double Taxation Avoidance Agreement may turn out to be another pleasant surprise to the Tax fraternity. The reason for such a view is that a similar observation was made in the context of the decision of the Hon’ble Tribunal in the case of Metchem Canada vs. DCIT [2006-TII-06-ITAT-MUM-INTL] in the commentary on Double Taxation Conventions by Philip Baker.

In the case of Metchem Canada vs. DCIT [2006-TII-06-ITAT-MUM-INTL], the issue before the Hon’ble Mumbai ITAT was whether restrictions on the deduction of head office expenditure of non-residents under Section 44C would attract the non-discrimination clause under the Indo-Canada DTAA. While holding that Section 44C would attract the non-discrimination clause, the court laid out the scope of application of the non-discrimination clause as follows with reference to Metchem Canada Rules:

In any event, on a plain reading of the provisions of the Article 24(2), we are of the considered view that a restriction on admissibility of head office overheads of permanent establishment of a Canadian company, constitutes discrimination against such a PE vis-a-vis a domestic Indian entity because no such restriction is applicable for deduction of head office or controlling office overheads of an Indian, entity. It puts PE of a Canadian company to an unfair disadvantage inasmuch as even legitimate business expenses attributable to the PE and deductible under Section 37(1) cannot be allowed as a deduction in the light of restriction placed under Section 44C of the Act, whereas all the legitimate business expenses of the Indian entity operating in India will be allowed as a deduction”.

Commenting on the interpretation of the non discrimination clause of DTAA in various tax jurisdiction, with reference to Metchem Canada Ruling the author notes as follows:

In a somewhat surprising Indian case the permanent established non discrimination provision was found to override domestic law restrictions on the deduction of head office expenses even though there was specific wording in the business profits article to preserve those domestic restrictions. The non discrimination article was characterized as a special provision which overrode the business profits article.

While one of the fundamental principles for operation and interpretation of treaties continuous to be pacta sunt servanda as mentioned in the Vienna Convention on the Law of Treaties, which means that every treaty in force is binding upon the parties to it and must be performed by them in good faith, one needs to watch for the reaction of the International tax community to the present decision which can be termed as progressive in many ways.

The primary objective of double taxation avoidance agreement is to avoid double taxation and prevent tax evasion and not avoidance of general discrimination.

The non-discrimination clause in a DTAA, which is intended to prevent any discrimination between the tax treatments of two tax payers on the basis of country of origin, is a standard feature of all DTAAs entered into between India and other countries.

It only requires that persons protected must not be treated less favourably in context to certain specific transactions or events by either of the contracting States. Generally a DTAA has been a set of rules negotiated between the countries with the objective of encouraging economic activity between the two countries by agreeing to share taxing rights and avoiding Double Taxation in agreed circumstances. Consequently, benefits extended under such DTAAs are more often expected to be on reciprocal basis. Perhaps such rules and the treaty in general cannot be interpreted to achieve general equality on all aspects.

In the case of Rolls Royce Industrial Power Limited vs. ACIT [2010-TII-139-ITAT-DEL-INTL], the Hon’ble Delhi ITAT commented on the scope of Article 26(2) of the Indo-UK DTAA (which deals with the PE of a non-resident not being treated less favourably than a resident) as follows:

“In view of the above provision taxing of a non-resident U.K. company in a manner which is more burdensome vis-a-vis an Indian company would lead to discrimination. This would also amount to unfavourable treatment being meted out to a U.K. company vis-a-vis the Indian company doing identical business in India”. 

Thus, as per the above observations of the Delhi ITAT, to attract the non-discrimination clause, it must be shown that:

a)      The non-resident company is taxed in a manner that is more burdensome vis-à-vis in Indian company; and

b)      The resident company being compared to must be in an identical business as the non-resident company.

The case of Automated Securities clearance Inc. vs. Income Tax Officer [2008-TII-78-ITAT-PUNE-INTL], the Hon’ble Pune ITAT adjudicated also on the issue of whether a non-resident company could be given the benefit under Section 80 HHE on the basis of the non-discriminatory clause under Article 26(2) of the Indo-US DTAA. Rejecting the claim of the assessee, the Hon’ble ITAT held that S. 80HHE did not attract the non-discrimination clause under Article 26(2) of the Indo-Us DTAA. The ITAT held:

“It is thus clear that in order to establish discrimination, not only that a taxpayer has to demonstrate that he has been subjected to different treatment vis-a-vis other taxpayers, but also that the ground for this differentiation in treatment is unreasonable, arbitrary or irrelevant

In our considered view, irrespective of whether at the end of the day such a differentiation turns out to be a very wise and pragmatic differentiation or not, there is a reasonable basis of this approach of granting tax incentives to exporters only in the cases where exports are made by the resident taxpayers. One of the fairly significant motivations for granting such a fiscal incentive, which is a profit based incentive deduction, is to augment foreign exchange reserves of the country”.

According to this Ruling for the non-discrimination clause under Article 26(2) of the Indo-US DTAA to be attracted, the following criteria must be fulfilled:

1)      The non-resident has to show that its PE has been subjected to a less favourable tax treatment compared to a resident company; and

2)      The ground for differential treatment is unreasonable.

A plain reading of Section 80HHE makes it clear that a non-resident would not be entitled to benefits under this provision. The issue is whether this amounts to subjecting a non-resident to less favourable tax treatment attracting the non-discrimination clause under Article 26(2). According to the tax tribunal ruling, not allowing Section 80HHE benefit does not amount to discriminatory treatment.

Thus, the Automated Securities case laid down certain criteria for the application of the non-discrimination clause under Article 26(2), which would ensure that the differential tax treatment of foreign residents and companies vis-à-vis Indian residents and companies was not totally ruled out while at the same time ensuring that the foreign residents/companies were not unjustly discriminated against.

This view as laid down in the Automated Securities case cited above was rejected by a Special Bench of the Hon’ble Ahmadabad ITAT in the case of Shri Rajeev Sureshbhai Gajwani vs. ACIT [2011-TII-38-ITAT-AHM-SB-INTL]. In this case, the Hon’ble ITAT preferred a literal interpretation of Article 26(2) and held that:

“In simple language and taking into account the facts of our case, the language employed in the provisions means that taxation of a PE of the USA shall not be less favorable than the taxation of resident enterprise carrying on the same activities.…The dispute is in regard to the words “shall not be less favorably levied” and the words “same activities”

the wording of Article 26(2) is to the effect that if a US enterprise is carrying on a business in India, it shall not be treated less favorably than an Indian enterprise carrying on the same business for the purpose of taxation. It follows automatically that exemptions and deductions available to Indian enterprises would also be granted to the US enterprises if they are carrying on the same activities.

the assessee’s case has to be compared with the case of an Indian enterprise engaged in the business of exporting software. If that is done, the assessee would be entitled to deduction under Section 80HHE on the same footing and in the same manner as the deduction is admissible to a resident assessee”.

Thus, as per this Ruling:

1)      If there are certain exemptions and deductions that are not available to a non-resident and would have been available to the non-resident had it been an Indian company, then it can be held that it is less favourably treated.

2)      For the application of article 26(2), it is sufficient to show that the non-resident is engaged in the same business as the resident it is treated less favourably to. The different circumstances in which the business may be being performed is not to be considered.

3)      There is no scope of reasonable differentiation.

While the law on interpretation of treaties is evolving with times and it is a recognized fact that the Indian courts have been making a fair contribution to this progress, it may be worth considering following aspects as it appears these were not brought to the notice of the Hon’ble Courts in the above decisions:

a)      Whether a very broad meaning is required to be attributed to the non-discrimination clause as has been sought to be done or a more contextual meaning needs to be placed while interpreting the non-discrimination clause so as to ensure that the results fall within the overall backdrop of the negotiations of the particular treaty.

b)      Whether the interpretation of non-discrimination clause has to be in the overall context of the other clauses of the treaty as each treaty is a result of protracted negotiations between the countries. This aspect is relevant as a reference to the article dealing with relief from double taxation to be granted to tax payers of the two countries as existing in the Belgium, Denmark, France, Indonesia, Ireland, Korea and Japan DTAA’s would show, that during the negotiation of such treaties a clear understanding is reached on how the two countries would like to deal with incentives granted by one of the countries to further its economic development. For example a reference to clause 23(3) (d)(1) of the Denmark treaty would show that there was specific discussion about incentives granted under the Indian Income Tax Act under Sections 80HH, 80I and 80J etc.

c)       Whether it was the intention of the two countries (in this case India & USA) to dilute the impact of incentives granted to encourage economic development in India by indirectly shifting of taxing rights from one country to another country as would be the result if a non-resident is exempted from tax in India but the relief from double taxation article has not been negotiated on the same lines as in case of some other countries as pointed out above.

d)      Whether the principle that all the clauses of an agreement will have to be harmoniously read to understand the intention of the negotiators of any agreement equally applies in the case of Sovereign agreements.

If the above aspects were also brought to the attention of the Court one can only speculate the impact  the same would have made to ruling  in Sureshbhai Gajwani’s case.

D.D. Nageshwar Rao is a partner at Amarchand & Mangaldas and is a dual-qualified chartered accountant and lawyer. He was assisted by Associate Pranav Bhaskar. 

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