Given its pronouncements in certain recent rulings, the Authority for Advance Rulings (AAR) is fuelling concerns regarding the durability of its views.
Recently the AAR issued a ruling in the case of Mr Cyril Eugene Pereira (Applicant), a resident of Abu Dhabi, United Arab Emirates (UAE) denying him the eligibility to claim relief under the provisions of the Agreement for the Avoidance of Double Taxation between India and UAE on the grounds that since he was not liable to pay any income tax in UAE, he was not a resident of UAE and consequently not entitled to treaty benefit. The ruling contradicts a previous ruling issued by the AAR in the case of MA Rafik, which was further confirmed in the case of Dr Rajnikant R Bhatt. The concern is accentuated by the fact that one judge presiding over the Cyril Pereira case was also a member of the authority which pronounced the Rafik decision. The ruling critically examines the controversy of whether a person needs to be liable to tax in a particular State in order to avail of the beneficial provisions of a treaty. The far reaching implications of the ruling (though not new) will definitely mandate a rethink of the strategy of routing investments into India through tax favoured jurisdictions.
Any ruling issued by the AAR, though binding only on the applicant taxpayer and the concerned Revenue official, has considerable persuasive value. In that sense, the ruling could have potentially adverse implications on the tax positions of investment entities established in tax favourable jurisdictions and which have been extensively used to hold investments in India.
This article deals with the ruling issued by the AAR in the case of Cyril Eugene Pereira and highlights some of the consequences which the ruling may have on various investment structures which operate through the tax favourable jurisdictions.
Facts
Cyril Eugene Pereira, was a permanent resident of Abu Dhabi, UAE since 1977. In the year in question, he spent more than 182 days outside India and hence qualified as a non-resident as per the provisions of the Income-tax Act, 1961 (Act). As per the Act, income sourced from India by a non-resident is taxable in India. Mr Pereira had made investments in India and income in the nature of interest and dividend accruing to him from these investments was subject to deduction of tax at source at the rate of 20% as prescribed by the Act.
Under the provisions of the UAE treaty, dividend income earned by a UAE resident is taxable in India at a beneficial rate of 15% and interest income is taxable at a rate of 12.5% as against the rate of 20% prescribed by the Act. Further gains accruing from the alienation of any capital assets held by a UAE resident in India are taxable only in UAE.
The UAE tax legislation does not levy income tax on individuals. The tax laws provide for the taxation of only certain corporate bodies in the banking and oil business in UAE. Accordingly, Mr Pereira had no liability to tax in his home state ie UAE. Mr Pereira sought relief under the provisions DTAA between India and the UAE for applying a beneficial rate of tax in respect of the portion of his income which was chargeable to tax in India.
Questions posed to the AAR
The following significant questions were raised before the Authority:
l Whether Mr Pereira could claim benefit under the UAE treaty;
l Whether the concessional rate of tax on Indian sourced dividend and interest income as per Articles 11 and 12 of the UAE treaty would apply in determining Mr Pereira's tax liability in India; and
l Whether the capital gains realised by Mr Pereira on the sale/transfer of his movable properties would be taxable only in the UAE as per Article 13 of the UAE treaty.
The ruling
The AAR in the present case ruled that Mr Pereira would not be eligible to claim relief under the UAE treaty and would be liable to pay tax in India as per the provisions of the Act. The important considerations based on which the Applicant was denied treaty relief are discussed below.
Article one of the UAE treaty provides that the benefit of the DTAA would be available only to persons who are residents of one or both the contracting states. Article four of the UAE treaty defines the term resident as follows: ?For the purpose of this Agreement, the term ?resident of a Contracting State' means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature.?
The Authority observed that there is no law in force in the UAE making the Applicant's income liable to tax therein and hence the Applicant would not be a resident of UAE as per Article four of the UAE treaty and consequently not qualify for treaty benefits under Article one of the UAE treaty.
However, the more thought provoking issue which the AAR has left open for debate, concerns the applicability of various other treaties which India has executed with other countries where certain taxpayers are not liable to tax on their income or certain streams of income which falls outside the purview of the taxation laws of that country. In the ruling, the AAR mentions that such treaties are valid but are for future use and would become applicable once the other contracting state levies tax on those taxpayers.
In the AAR's opinion, the Constitution of India does not permit any reduction or waiver of taxes levied by Central statutes (as opposed to individual state statutes), except as authorised by the Statute itself. As per the provisions of section 90 of the Act, the Government is authorised to enter into an agreement with foreign countries for granting relief in respect of income which has suffered double taxation in India and in the country with which the agreement is entered into.
The UAE treaty was signed by the Government of India by virtue of the authority derived from Section 90 of the Act: ?The Central Government may enter into an agreement with the Government of any country outside India:
l for the granting of relief in respect of income on which have been paid both income-tax under this Act and income-tax in that country; or
l for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country; or
l for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country, or investigation of cases of such evasion or avoidance; or
l for recovery of income-tax under this Act and under the corresponding law in force in that country, and may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.?
The additional argument put forward by the AAR for denying treaty relief to Mr Pereira, is that since the income earned by Mr Pereira in India will not be subjected to tax in UAE, double taxation does not arise. Consequently, since the very criterion based on which treaty benefit could be availed of is not met in the present case, the question of granting relief under the treaty does not arise. A precursor to the AAR's thinking on this issue could be inferred from the TVM ruling where the AAR mentioned that a zero-tax Mauritius company would not qualify for treaty relief under the India-Mauritius treaty.
The Rafik case
In this case, the Authority held that notwithstanding the fact that there was no law imposing income tax on individuals in UAE, the applicant was eligible for relief under the UAE treaty.
The Authority had granted treaty relief by relying on the fact that a comprehensive treaty (including provisions applicable only to individuals) was considered necessary despite a clear knowledge that there was no such tax in the UAE can only mean that the Treaty was intended to encourage trade and investment flows between the two countries.
The Authority in Mr Pereira's case contradicted Rafik's case on the following grounds:
l A previously issued ruling is not binding on the Authority;
l The Authority had not taken a literal interpretation of the treaty provisions and had instead taken the liberal view and granted treaty relief to the Applicant; and
l The scope of section 90 of the Act was not considered in Rafik's case, due to which, the Authority held in Mr Pereira's case that, the India-UAE DTAA would be ultra vires section 90 of the Act.
A member judge of the AAR who had, in Rafik's case, ruled that an individual resident in the UAE would qualify for treaty relief, has dissented from his earlier stand, and held that an individual who is not liable to pay tax under the UAE law cannot claim any relief from the only tax on income which is payable in India and the provisions of a DTAA would not apply in any case where the same income is not liable to be taxed twice by the existing laws of both the Contracting States.
Circular no 734
An interesting feature of this ruling is that it has apparently overlooked a circular issued by the Central Board of Direct Taxes (CBDT), the highest authority for tax administration in India. The circular clearly lays down that interest, dividend and other income earned by non-resident Indians ie persons of Indian origin residing in UAE (non residents for purposes of the Income tax Act) would be subject to deduction of taxes at source at the rates provided for in the UAE treaty.
The CBDT is a part of the Ministry of Finance, which in the Indian context, is also the authority that negotiates and executes treaties on behalf of the Government of India. It would thus imply that any circular issued by the CBDT in respect of a treaty entered into by India, would have taken into account the intent of entering into a treaty by India.
Further, as per the provisions of the Income-tax Act, and as confirmed by the Supreme Court, all circulars issued by the CBDT are binding on the tax authorities in India, although it is also a settled position that these are not binding on the judicial authorities.
Implications
The ruling raises a doubt on the applicability of DTAAs entered into by India with various favourable tax jurisdictions, where the foreign country either does not levy tax on certain persons or exempts a particular income stream from its tax ambit. Going ahead with the Pereira ruling, a question which still remains unanswered is whether the liability to tax in the other state is to be viewed in the context of each income stream earned by an entity or whether one is to adopt an holistic view of the scheme of taxation in the other state, where some income streams may be taxable and others may be exempt from tax.
A literal and logical interpretation of the AAR's ruling implies that where the country of residence does not levy tax on a particular stream of income, the source state could tax it on the basis that since no double taxation is suffered by the income in question, the DTAA would not apply to such income, even though the countries have negotiated and contractually agreed on a DTAA.
As mentioned earlier, any ruling issued by the AAR is binding only on the Applicant and the concerned Revenue officials. However, every ruling attaches to itself an element of persuasive value, which the Revenue authorities in India may seek to follow. This could lead to structures wherein investments into India have been routed through tax favoured jurisdictions being reexamined by the Revenue authorities with potentially adverse outcomes.
Another Cyril Pereira
The AAR yet again trailed the path laid down by the Cyril Pereira ruling recently when it (already) denied benefits of the UAE treaty to Machendranath Vishu Palankar.
Please note the views expressed in this article are those of the authors and not necessarily of their employer
