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Extrinsic aids to Interpretation of Tax Treaties

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June 7, 2021

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25 mins read

EXTRINSIC AIDS TO INTERPRETATION OF A TAX TREATY

There are several extrinsic material used in interpretation of tax treaties including the following : –

  1. Interpretative Protocols, Resolutions and Committee Reports, on agreed interpretations;
  2. Subsequent agreement between parties regarding the interpretation of the treaty (Article 31(3) of the VCLT )
  3. Subsequent conduct of the state parties, as evidence of the intention of the parties;
  4. Other treaties, which relate to the same subject matter, in case of doubt on interpretation of particular provisions of the Treaty

EXTRINSIC AIDS TO INTERPRETATION OF A TAX TREATY – PROVISIONS IN PARALLEL TAX TREATIES

Where the language used in two tax treaties is same, one can rely on the interpretation/explanations provided in the treaty which has elaborated explanations.

The views of the Indian Judiciary are, however, not consistent in this respect.

For example India US Treaty contains certain provisions relating to taxation of fee for included (Technical) Services, wherein such services are taxable only when they “make available” technical or Consultancy Services. There are various examples given in the India US treaty, which provide when the services would be considered as “making available” . Several other treaties, which India has entered into also contains a similar clause in relation to fee for Technical Services. While interpreting, whether, the explanation provided in the India USA Treaty should be applied to such other treaties, the courts have taken different view in favour and against using such  interpretation in the India USA Treaty.

EXTRINSIC AIDS TO INTERPRETATION OF A TAX TREATY – INTERNATIONAL ARTICLES/ESSAYS/REPORTS

In case of CIT v. Vishakhapatnam Port Trust (1983) 144 ITR 146 (AP), the High Court obtained “useful material” through international articles and relied on them to arrive at the decision.

CAHIERS PUBLISHED BY IFA, NETHERLANDS

Every year, International Fiscal Association (IFA) Congress is held in one of the countries,  wherein various issues,  in international taxation are discussed by experts from all over the world . “Cahiers” contain domestic and international material, relating to subjects which are to be discussed at the following  International Fiscal Association (IFA) Congress, including IFA Branch Reports and General Report on two Subjects selected for the Congress of that year.

Cahiers published by INTERNATIONAL FISCAL ASSOCIATION, Netherlands, were relied upon in case of Azadi Bachao Andolan’s (supra) case by the Supreme Court.

EXTRINSIC AIDS TO INTERPRETATION OF A TAX TREATY – PROTOCOL

PROTOCOL : –

Protocol is a supplement to the treaty, but is an integral part of the Treaty. Protocol is incorporated in a treaty to clarify certain matters, or make some amendments to the existing provision in the Treaty.

It has the same binding force as the main clauses of the Treaty.

While it is not necessary that every Treaty should have a protocol , one must refer to Protocol in the Treaty (if any) , before arriving at any final conclusion in respect of any provision contained in a tax treaty.

International Taxation Services

EXAMPLE : –

Protocol to the India-US tax treaty provides many examples on meaning of the term “make available”.

MOST FAVORED NATION (MFN) CLAUSE

MOST FAVORED NATION (MFN) CLAUSE

Most Favored Nation (MFN) clause is generally found in Protocols and Exchange of Notes to Double Tax Conventions.

Under Most Favored Nation clause, the Source Country, provides for Equal tax treatment to two non-resident taxpayers. If the Source country enters into a Tax Treaty with Country X, and any subsequent Treaties entered into by Source country with another Country Y provides for more favorable tax treatment to Country Y, such favorable tax treatment automatically applies to the Treaty with Country X, provided it has an MFN clause. The favorable tax treatment could be in the following form : –

  • Reduced rate of tax on certain incomes ;
  • Restricted scope of an Article (wherein a particular income which is taxable in source state under Treaty with Country X is not taxable under Treaty with Country Y
  • Higher deduction in respect of executive and general administrative expenses of head office under Treaty with Country Y

While generally, the MFN Clause is automatically applicable on signing of a subsequent treaty, some DTAAs may require special notification to give effect of the subsequent treaty to the preceding Treaty.

The MFN clause in the protocol on DTA with FRANCE reads as follows:

“In respect of Articles 11 (Dividends), 12 (Interest) and 13 (Royalties, Fees for Technical Services and Payments for Use of Equipment) If under any Convention, Agreement or Protocol signed after 1st September, 1989 between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties, fees for technical services, payments for the use of equipment to a rate lower; or a scope as provided in that Convention, Agreement or Protocol on the said items of income shall also apply, with effect from the date on which the present Convention or the relevant Indian Convention, Agreement or Protocol, whichever enters into force later.“

If we apply the above provision to the MFN clause, we can notice the following : –

  • It applies to Articles 11 (Dividends), 12 (Interest) and 13 (Royalties, Fees for Technical Services and Payments for Use of Equipment)
  • It covers cases where the tax rates are lower in future treaties;
  • Restricted scope of an Article provided in future Convention, Agreement or Protocol   shall also apply to the India France Treaty

APPLICATION OF MFN CLAUSE :  –

In the following cases, the applicability of the MFN clause has been discussed and upheld by the Indian judiciary : –

Sandvik AB V/s. Dy. CIT (2014) 52 taxmann.com 211 (Pune-Tribunal)

Management fees received by Sandvik AB from its group companies in India is not exigible to tax in India as “fees for technical services”, since the “make available” condition was not satisfied. The Tribunal referred to the protocol attached to the India-Sweden DTAA and invoked the MFN clause to import the “make available” condition from India Portugese Treaty into the India-Sweden tax treaty.

EXTRINSIC AIDS TO INTERPRETATION OF A TAX TREATY – PREAMBLE

Preamble is an introductory and expressionary statement in a document that explains the document’s purpose and underlying philosophy.  In the context of tax Treaties, Preamble is the opening statement  which  explains the reasons,  why the Two States entered into the Treaty. Preamble to a tax treaty could guide in interpretation of a tax treaty.

In  Azadi Bachao Andolan, the Apex Court observed that

‘the preamble to the Indo-Mauritius Double Tax Avoidance Convention (DTAC) recites that it is for the ‘encouragement of mutual trade and investment’ and this aspect of the matter cannot be lost sight of while interpreting the treaty’.

Lets look at the preamble to India-UK tax treaty, which is given hereunder :-

Whereas the annexed Convention between the Government of the Republic of India and the Government of the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains has entered into force on 26th October, 1993 on the notification by both the Contracting States to each other of the completion of the procedures required by their respective laws, as required by Article 30 of the said Convention;

Now, therefore, in exercise of the powers conferred by section 90 of the Income-tax Act, 1961 (43 of 1961), the Central Government hereby directs that all the provisions of the said Convention shall be given effect to in the Union of India.”

MUTUAL AGREEMENT PROCEDURE – EXTRINSIC AIDS TO INTERPRETATION OF A TAX TREATY

MAP helps to interpret any ambiguous term/provision in the tax Treaty, through bilateral negotiations between Treaty partners. Article 25(3) of the OECD MC permits competent authorities to “resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention – [ Detailed discussion on MAP is being made in later part of this chapter and   Chapter 1 of Transfer Pricing]

COMMENTARIES ON OECD/UN MODELS

Commentaries on OECD Model or the U.N. Model, offer clarifications on the Articles (clauses) in the Treaty and can be referred for interpretation and application of various provision contained in a DTAA. OECD Commentary is revised from time to time. UN Commentary is  by and large based on OECD commentary. The clause by clause comparison of the two Commentaries is made in Chapter 6 of this book titled ‘Overview of Tax Treaties’

OECD COMMENTARY

OECD commentary is directly applicable to OECD countries , who adopt text of OECD Model Convention. Where a non OECD  country adopts the text of OECD Model Convention the without any change, the commentary carry immense persuasive value.  While India is not a member of OECD and is only an observer country, it participates in discussion on revision of Model Commentary. However at many places, India has expressed its reservations, indicating disagreement   or right to follow different tax treatment or interpretation, compared to what is given in the OECD Model Commentary.

UN COMMENTRARY

DTAA between developed and developing countries, are generally based on the UN model. Given that the UN Model and UN Commentary are largely based on OECD Model and OECD Commentary respectively, OECD Commentary is also quite helpful in interpretation of treaties based on UN Model.

Courts in India have considered interpretation given by the Commentaries.  In the case of CIT V. Vishakhapatnam Port Trust 144 ITR 146 (A.P.), the High Court referred extensively to the OECD Commentary and decisions of Foreign Courts in giving the decision.

FOREIGN COURTS’ DECISIONS –

In the CIT V. VISHAKHAPATNAM PORT TRUST’S CASE, the Indian Court had quoted foreign courts decision in interpretation of treaty provision. The relevant extract of the judgement is as under : –

“In view of the standard OECD Models which are being used in various countries, a new area of genuine ‘international tax law’ is now in the process of developing. Any person interpreting a tax treaty must now consider decisions and rulings worldwide relating to similar treaties. The maintenance of uniformity in the interpretation of a rule after its international adoption is just as important as the initial removal of divergences. Therefore, the judgments rendered by courts in other countries or rulings given by other tax authorities would be relevant.”

In addition to the above, the foreign court cases have extensively quoted in interpretation of treaty provisions in following cases : –

  • Union of India v. Azadi Bachao Andolan
  • CIT v. Vishakhapatnam Port Trust
  • Abdul Razak A. Meman’s case

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APPROACHES IN INTERPRETATION OF TERMS USED IN A TREATY

STATIC : –

Where a treaty refers to the provision of the domestic laws of a contracting state for assigning meaning to a particular term, and subsequently the domestic law is changed, if the meaning prevailing in the domestic law of the contracting state at the date of signing the treaty is applied, it is called a static interpretation of terms of the Treaty.

AMBULATORY : –

Where a treaty refers to the provision of the domestic laws of a contracting state for assigning meaning to a particular term, and subsequently the domestic law is changed, if the meaning prevailing in the domestic law of the contracting state on the date of application of the treaty is applied, it is called an ambulatory interpretation. OECD model convention commentary 2014 explicitly calls for an ambulatory interpretation.

However, Article 3(2) of the OECD Model Convention dealing with meaning of Terms not defined in Treaty, provides that while the   ambulatory approach can be applied, it is subject to contextual interpretation.

This Article provides that if a term is not defined in the treaty, it shall be interpreted in accordance with the provisions of the tax laws of the Contracting State, that may be applying the Convention, unless the context requires interpreting the term ‘otherwise’.

The application of this approach can be found in India-US treaty, which provides that any term not defined in the treaty, shall be interpreted according to the common meaning agreed by the Competent Authorities pursuant to the provisions of Article 27 (Mutual Agreement Procedure). If there is no such meaning agreed, only then, the meaning would be assigned from the domestic tax law provided the context does not require otherwise. The relevant extract is reproduced as under : –

“As regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires or the competent authorities agree to a common meaning pursuant to the provisions of Article 27 (Mutual Agreement Procedure), have the meaning which it has under the laws of that State concerning the taxes to which the Convention applies”.

INDIAN CONTEXT – TERMS NOT DEFINED IN DTAA

Under the Indian regulations, terms which are not defined in DTAA, but are defined in the Income Tax Act, 1961,  would be assigned the meaning given in the Act , and explanation, if any, given to it by the Central Government – Explanation 4 to Section 90/ Explanation 4 to Section 90A of the Act.

OBJECTIVES OF TAX TREATIES

Objectives for signing a tax treaty play a significant role in its interpretation as they determine the context in which a particular treaty is signed.

OBJECTIVE OF OECD MODEL CONVENTIONS : –

Principal objectives of the Tax Treaties as per the OECD Model Convention are as follows :

The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchange of goods and services and the movement of capital and persons. It is also the purpose of tax conventions to prevent tax avoidance and evasion.

OBJECTIVE OF DTAAs

The main objective of DTAA as per UN Model is to ensure sharing of revenue between States through negotiations and compromise. The other objectives of the DTAA are as under : –

  • Protect tax payers against double taxation.
  • Encourage free flow of international trade and
  • Encourage transfer of technology.
  • Prevent discrimination between tax payers (resident and non-resident).
  • Provide reasonable legal and fiscal certainity to the investors and businessmen.
  • Arrive at an acceptable basis to share tax revenues between two States

PURPOSE OF ENTERING INTO A DTAA INTO INDIAN CONTEXT – SECTION – 90(1)

Section 90(1) provides that the Government of India may enter into DTAA with any foreign country or specified territory outside India for following objectives : –

  1. Granting of relief in respect of income, on which tax has been paid twice, under the IT Act 1961, and income-tax in another country or specified territory, or  income-tax is chargeable under Indian law,  and the law of the overseas country or specified territory l
  2. Avoidance of double taxation of income under Indian income tax provisions and overseas country provisions.
  3. Exchange of information to prevent evasion or avoidance of income tax chargeable under this Act or under laws in force in the country or other specific territory.
  4. Recovery of income tax under Indian/ overseas country law.

For any queries, please write them in the Comment Section or Talk to our tax expert

Arinjay Jain

Bio of author

Arinjay is a Chartered Accountant with more than 20 years of post-qualification experience. He worked as Director, in the M&A Tax Division at KPMG in India. Presently, he is advising several MNCs in UAE on Economic Substance Regulations and impact of the UAE Corporate Tax Law on their business and clients across globe on International Tax issues . He is a well recognised Trainer of International Tax and UAE Corporate Tax. The areas of service include the following : - Advise and Compliance relating to International Tax Issues; Advise relating to UAE Corporate Tax Issues; Advise and Compliance relating to UAE Economic Substance Regulations; Advise and Compliance relating to Indian Income Tax Issues; Other connected matters from a Regulatory perspective.

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