Tax treaties should not become instruments to erode India’s tax sovereignty, national security: Supreme Court

The Supreme Court has cautioned that tax sovereignty is an essential attribute of national sovereignty and must not be diluted through international treaties, external economic pressure, or arrangements that undermine a nation’s right to tax income arising from its own soil. [Authority for Advance Rulings (Income Tax) v. Tiger Global International III Holdings & Ors.]..Justice JB Pardiwala observed that sovereignty in the modern world is no longer confined to territorial control and military strength, but increasingly extends to economic and fiscal autonomy.“Economic sovereignty is gaining importance and in fact occupying centre stage in geo-political affairs.The existence, creation and the influence sought to be generated by several world bodies through a combination of nations and attempts to dictate a global order on economic and commercial matters through such organisations and bodies is quite rampant,” he said.Justice Pardiwala underscored that tax treaties must not become instruments to legitimise tax abuse, erosion of the tax base or economic offences that threaten national security."If tax evasion and tax abuse happen under the umbrella or shield or in the guise of money laundering or trafficking or round tripping, it not only weakens a Nation, it makes it less powerful or even powerless in given circumstances tearing apart the social fabric and texture of a Nation and its people. Every anti abuse law must not only appear to be a deterrent but should be implemented to achieve the underlying goal of preventing an abuse by anyone against one’s Nation and its people," he said.The Court further underlined that tax treaties must align with the Constitution and domestic tax laws, provide for periodic review, and allow renegotiation or exit where misuse or misalignment with national economic goals arises. Treaty-making, it held, must be driven by national interest, supported by cost-benefit analysis, and informed by consultation with experts, industry bodies and parliamentary committees.He made these observations in his concurring judgment in the case in which the bench also comprising Justice R Mahadevan held that Tiger Global is not exempt from taxation for sale of shares it had acquire in FlipkartIn his judgment, Justice Mahadevan held that once a transaction is found to be prima facie designed for avoidance of income tax, the statutory bar under the proviso to Section 245R(2) of the Income Tax Act, 1961 applies and that tax authorities are not required to examine the merits of taxability.In his concurring opinion, Justice Pardiwala delivered an extensive reflection on the constitutional, economic, and geopolitical importance of preserving India’s sovereign taxing powers in an era of cross-border trade and global capital flows..He noted that a nation’s stability and resilience are today closely tied to its ability to independently exercise taxing powers without external interference.“The stability of a nation is slowly getting determined and recognised based on the strength and independence of a nation’s tax sovereignty.”.Drawing a distinction between domestic taxation and international taxation, Justice Pardiwala underlined that while domestic tax powers are subject to constitutional limits and judicial review, the exercise of tax sovereignty in the international domain requires a delicate balance between diplomacy, investment attractiveness and national interest.“Exercising tax Sovereignty in the international domain has to pass through several filters which would include geo-political strengths and equations, diplomacy, making a Nation attractive for investments and at the same time, not compromising either its sovereignty or its interest and core objectives of its people.”.Importantly, he articulated a set of governing principles on tax sovereignty, cautioning that international tax policy must be anchored in national interest and cannot proceed on the assumption that sovereignty may be routinely yielded.Justice Pardiwala underscored that the starting point in treaty-making must be the retention of sovereign taxing power, and that any departure from it must remain exceptional.“Retention should be the golden rule, and yielding should be an exception which is meaningful and not disproportionate and in any view, not at the cost of a Nation’s welfare and interest," the judge said..He warned that sustained or excessive concessions in fiscal matters can have long-term consequences for a nation’s strategic and economic stability.“A long-term compromise leads to erosion, porosity in the ingression, weakening or even destabilising a Nation’s long term strategic and security interest.”.Justice Pardiwala further reaffirmed the source-based foundation of taxing power, emphasising that a country whose economic resources are exploited retains the inherent right to tax the resulting income.“It is natural and imperative that it is a right of a Nation whose soil or source stands used or exploited for generating or earning an income to get the right to tax it," he said in his judgment.The judgment also cautioned that threats to tax sovereignty need not emanate only from foreign states, but may equally arise from private economic actors and global institutions seeking to shape domestic fiscal choices."External expectations and pressures demanding a larger than required yield of Sovereign compromises. There can also be a third factor which is a fast-emerging scenario. Nations, international bodies or even multinational companies and other entities trying to influence or force impactful changes in the tax policy choice of a Nation which may subserve their interest and betterment.".Highlighting the link between tax sovereignty and national security, the Court observed that compromised taxing powers weaken a nation’s ability to combat serious cross-border crimes..As regards tax treaties, the Court tressed that such treaties must be dynamic instruments, capable of review and renegotiation in light of changing economic realities.“Tax treaties, international agreements, protocols and safeguards should be very engaging, transparent and capable of periodical reviews with the power to renegotiate with strong exit clauses to avoid unfair outcomes safeguarding Nation’s strategic and security interests.”Justice Pardiwala concluded by emphasising that tax sovereignty has no inherent limitations except those voluntarily imposed by a nation itself, and that meaningful discretion—not automatic concession—is the true measure of sovereign strength."When agreements need to be entered into between Nations either through its legislative or executive arm, dispute resolution should also be part of the same arm or process and should not be divorced or outsourced or pushed to mandatory arbitrations.".The revenue was represented by Additional Solicitor General N Venkatraman, Senior Advocate Nisha Bagchi with Advocates Raja Bahadur Yadav, Shashank Bajpai, Padmesh Mishra, Venkatraman Chandrashekhara Bharathi and Sachin Sharma..The respondents were represented by Senior Advocates Harish Salve and Porus Kaka with advocates Malak Manish Bhatt, Shashwat Bajpai, Parul Jain, Arijit Ghosh, Manish Kanth, Neeha Nagpal and Samridhi..[Read Judgment].Follow Bar and Bench channel on WhatsAppDownload the Bar and Bench Mobile app for instant access to the latest legal news.