Published Editorial

Impetus on generating extra taxes to bridge deficit

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The Financial Express

by

Rajiv Chugh
Tax Partner
EY

The Finance Minister presenting the Budget said a clarity on tax laws, a stable tax regime, non adversarial tax administration, fair mechanism for dispute resolution and an independent judiciary for greater assurance are the underlying themes of tax proposals.

Interestingly, the impetus seems to be on generating additional taxes to bridge the fiscal deficit. In this article, I would like to highlight a seemingly innocuous provision relating to Tax residency certificate (TRC), which forms part of the budget proposal.

Historically, interpretation of tax treaties has always been marred with problems, mainly on account of considerable ambiguity involved in characterisation of income. Even the orders of Authority for Advance Ruling are being challenged and overruled, thus making it difficult to explore a solution in the plethora of precedents now available these days. Under section 90 of the Income Tax Act, taxpayer has the option to be taxed under the provisions of the tax treaty or the domestic tax laws, whichever are more beneficial. To give impetus to this legislation, CBDT issued circular No.333, which reiterated that specific provisions of tax treaty override general provisions of the domestic tax laws.

The prerequisite to avail the benefit of a tax treaty is to be a resident of one of the country. Both under OECD Model and UN Model, the concept of resident is defined under Article 4, which provides that 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 or any other criterion of a similar nature. Therefore, in the context of availability of treaty benefit the term “liable to tax” has gained significant importance and has been subject matter of interpretation in various judicial forums.

The concept ‘liable to tax’ came up for consideration before the Supreme Court in the case of Union of India versus Azadi Bachao Andolan and Another 263 ITR 706 in the context of examining the validity of CBDT Circular No. 789. The court observed an assessee can be said to be liable to tax despite circumstances of non-payment of tax dues to domestic exemption or due to income being below the threshold limit. The apex court held the liability to tax is a legal situation; whereas payment of tax is a fiscal fact. For the purpose of application of Article 4 of the treaty, what is relevant is a legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax.

Circular 789, whose validity was upheld by the supreme court provided that the provisions of the Indo-Mauritius treaty of 1983 apply to ‘residents’ of both India and Mauritius. Foreign institutional investors and other investment funds, which are operating from Mauritius are invariably incorporated in that country. These entities are "liable to tax" under the Mauritius Tax Law and are, therefore, to be considered as residents of Mauritius in accordance with the treaty.

It was further clarified that wherever a certificate of residence is issued by the Mauritian authorities, such TRC will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for availing the treaty benefit. The test of residence mentioned above would also apply in respect of income from capital gains on sale of shares. Accordingly, Flls, etc., which are resident in Mauritius should not be taxable in India on income from capital gains arising in India on sale of shares as per paragraph 4 of article 13 of the treaty.

It is now proposed to introduce with retroactive applicability (ie FY 2012-13) a provision which provides that submission of TRC is a necessary but not a sufficient condition for availing benefits of the treaty. While this aspect was provided in the Memorandum to Finance Bill 2012, it is now being legislated under the Act and therefore one will have to closely watch its implementation in practice by the Tax Administration, while granting the benefits under the treaty. This proposal is likely to create uncertainty with regard to eligibility of treaty benefits.

Going by the way the markets reacted on the day of the Budget, the finance ministry has on March 1, issued a press release to clarify that the tax department will not look through the TRC and question taxpayers. In fact, they have reiterated that the CBDT Circular No. 789 on Indo-Mauritius treaty is still in force.

It is imperative that the law should be made more certain and less complicated to promote foreign investment in the country. It seems by this press release that the Indian Government is making efforts to speedily address the ambiguities and express a firm view that is expected to be in line with the international thinking on the subject. This hopefully should reduce the need for unwarranted litigation and provide certainty to tax payers. It will be an icing on the cake, if this provision is deleted while passing the Finance Bill 2013.