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[2019] 105 taxmann.com 56 (Article)

[2019] 105 taxmann.com 56 (Article)

Date of Publishing: May 4, 2019

Scope and Efficacies of Double Taxation Avoidance Agreements

NUPUR JALAN

1. Introduction –

1.1 Different nations have different mechanism for taxation and taxation mechanism of one nation may
not match with the taxation mechanism of other nation. As a result, the same income of the taxpayer
may get taxed in both the countries (i.e. the home and the host country). Therefore, countries enter into
Double Tax Avoidance Agreement (DTAA's) to prevent such double taxation of income earned in both
countries.

1.2 The design of sensible tax policies requires that due consideration to their international
ramifications. Analysis of tax design in economies entails all of the complications and intricacies that
appear in closed economies, with the addition of many others, since multiple, possibly interacting, tax
systems are involved.

1.3 More than 3000 bilateral income tax treaties are currently in effect and the numbers seems to be
growing with time. Double taxation in tax treaties can be eliminated by either of the following means –

- allocation of sharing taxing rights

- exclusive right to tax
- provision of giving credit for taxes paid in the source state by the residence state
- for providing co-relative adjustment

2. Meaning of tax treaty –

2.1 Treaties per se are international agreements under Public International Law. A treaty is a contact or a
bilateral/ international instruments. Tax treaties are agreements between two sovereign countries
primarily governing the taxation of the residents/ nationals. It takes several years from the initiation to
negotiations between the respective countries to the date when a tax treaty actually comes into force.

2.2 The definition of treaty provided in Article 2 of the Vienna Convention of Law of treaties, 1969
('VCLT') reads as under –

'Treaty means international agreement concluded between states in written form

and governed by international law, whether embodied in a single instrument or in
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two or more related instruments and whatever its particular designation'

2.3 There can be variety of supplemental documents that may form part of the DTAA's and they are
protocols, exchange of notes, agreed minutes and memorandum of agreement etc.

3. Types of DTAA –

3.1 Tax treaties are usually of following types –

a. Bilateral treaty :
These are treaties that are concluded between two states. Ex. – DTAA of India with USA
b. Multilateral treaty :
These are treaties concluded between large number of states. Ex. – convention between
Nordiac countries including Denmark, Finland, Iceland Norway and Sweden, multilateral
instruments
c. Tax Information Exchange Agreements (TIEA) :
These are entered into by certain high tax countries with low or no tax countries with which
they would not otherwise have a tax treaty. Ex. – TIEA of India with Bahamas, Bermuda

Further, apart from tax treaties, there are several types of treaties dealing with non-tax issues. Some of
the non-tax treaties are North American free trade agreement, European community treaty etc.

4. Some of the Model Conventions –

4.1 Mainly, two model tax conventions are followed –

- the OECD Model Convention and

- the United Nations Model Convention

Also, many countries have their own model tax treaties United States Model Convention etc.

4.2 Brief description of each of the model tax conventions are –

a. OECD Model Convention :

Emphasis on residence based taxation. Developed countries adopted this model in case of
treaties with other developed countries
b. UN Model Convention 1:
Emphasis on source based taxation. Developing countries adopted this model in case of
treaties with developing countries or between two developing nations
c. US Model Convention : Used by USA for all treaty negotiations. This model has influence
on existing tax treaty of USA with various countries.

5. Interpretation of DTAA's –

'A word is not a crystal, transparent and unchanged, it is the skin of a living thought
and may vary greatly in color and content according to the circumstances and the
time in which it is used ' 2

5.1 The interpretation of words and expressions used in the tax treaty is of utmost importance. As already
stated, that the aim of tax treaty is to avoid double taxation and to create legal certainty for the benefit of
the contracting state as well as for the taxpayer. The increasing significance of tax treaties and the art of
interpretation of tax treaties has become highly imperative.
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5.2 As per the VCLT, 'The treaty should be interpreted in good faith in accordance with the ordinary
meaning to be given to the terms of the treaty in their context and in light of its object and purpose'

5.3 The interpretation provisions contained in the VCLT should be seen as a means to an end, not as an
end in themselves. Whenever 'rules of interpretation' are dealt with; one should keep in mind that
language as an expression of thought involves a process of free creation; so does any method of
interpretation. In order to reveal the objective content of the term or phrase as may be inferred from the
treaty text, it is crucial to use any materials available in connection with the treaty.

5.4 Certain articles from the VCLT are discussed below –

- Article 26 of the VCLT, tax treaties are binding on the Contracting States and must be
performed by them in good faith. This is called pacta sunt servanta principle. The
expression "must be performed…..good faith" means that a state must implement the
provisions of the tax treaty, irrespective of its constitutional and legal system and the nature of
the treaty.
- Article 31, Article 32 of the VCLT contains guidelines for interpretation of the tax treaties :
- Article 31 of the VCLT provides for the subjective and objective approach to tax treaty
interpretation. It deals with General rules of interpretation and it indicates that there are
equivalent sources of interpretation available to interpreters
- Article 32 of the VCLT provides supplementary means of interpretation of tax treaties

5.5 While a taxing statute is usually interpreted with strictness, the rule are different when it comes to tax
treaties. Supreme Court in Ram Jethmalani v. Union of India [2011] 12 taxmann.com 27/200
Taxman 17/339 ITR 107 observed 'the words are to be given their general meaning, general to lawyer and
layman alike……The meaning of the diplomat rather than the lawyer………The broad principle of
interpretation, with respect to treaties, and provisions therein, would be that ordinary meanings of
words to give effect to, unless the context requires or otherwise.

5.6 Some of the secondary means of interpretation of treaties are :

- Commentaries 3: Commentary reflects the current views on existing provisions and on their
application to specific situations.
- Reference to Domestic Law: Often when terms are not clear in treaties domestic law of the
country is referred to in interpreting the treaties. Reference in this regard can be placed on
Section 90(3) of the Income tax Act, 1961 –
'(3) Any term used but not defined in this Act or in the agreement referred to in sub-section
(1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of
this Act or the agreement, have the same meaning as assigned to it in the notification issued
by the Central Government in the Official Gazette in this behalf'
- Protocols: A protocol may be on any topic relevant to the original treaty and is either used to
further address something in the original treaty, address a new or emerging concern or to add
a procedure for the operation and enforcement of the treaty. Therefore, protocols are also
usually referred for interpretation of treaties. Ex.- protocol of India with US, Swiss etc.
- Expert Opinion: Often expert opinion are used for interpreting the treaties though the same
has only persuasive value.
- Parallel Treaties: Each treaty must be construed individually. Having said that, it is highly
likely that a state will strive for a certain amount of consistency in the interpretation of its
treaties, as one of the key benefits of tax treaties is the degree of certainty which they provide
for international business in cross-border tax matters. Ex. - US technical explanation is often
referred to while analyzing make available clause.

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Moreover, documents from the OECD archives serve to relieve ambiguities in the
determination of substantive scope of tax treaties modelled on the OECD texts.

6. Scope of DTAA's in Indian context–

6.1 Section 90(1) of the Income-tax Act, 1961 provided that the Central Government may enter into an
agreement with the Government of any country outside India or specified territory outside India –

(a) for the granting of relief in respect of—

(i) income on which have been paid both income-tax under this Act and income-tax in
that country or specified territory, as the case may be, or
(ii) income-tax chargeable under this Act and under the corresponding law in force in that
country or specified territory, as the case may be, to promote mutual economic
relations, trade and investment, or
(b) for the avoidance of double taxation of income under this Act and under the
corresponding law in force in that country or specified territory, as the case may be, or
(c) 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
specified territory, as the case may be, or investigation of cases of such evasion or avoidance, or
(d) for recovery of income-tax under this Act and under the corresponding law in
force in that country or specified territory, as the case may be

Further, DTAA's only creates obligation for the states and not the third parties. These are agreements
between two countries and not between two taxpayers and involves negotiated sharing of tax revenues by
the states.

7. Contents of a typical tax treaty –

7.1 Broad content of the tax treaties are discussed below -

- Chapter I consists of Article1 and it identifies the persons whose tax obligations are affected by
the treaty, generally residents of the contracting States, and Article 2, which describes the taxes
covered by the treaty, generally income and capital taxes imposed by the contracting States
and their political subdivisions
- Chapter II provides definitions of important terms used in the treaty including general
definitions in Article 3, a definition of the term 'resident' in Article 4 and 'permanent
establishment' in Article 5
- Chapter III contains what are often referred to as the distributive rules of the treaty. Articles 6
- Article 21 deal with various types of income derived by a resident of one or both of the States.
In general, these provisions determine whether only one or both of the contracting States - the
State in which the taxpayer is resident (the residence country) and the State in which the
income arises or has its source (the source country) - or whether both of them can tax the
income and whether the rate of tax imposed is limited.

The Articles and the types of income are as follows:

Articles Particulars
Article
Income from immovable property
6
Article
Business profits
7
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Article Income from the operation of ships or aircraft in international traffic and boats in inland
8 waterways transport
Article
Profits of associated enterprises and transfer pricing
9
Article
Dividends
10
Article
Interest
11
Article
Royalties
12
Article
Capital gains
13
Article
Income derived from professional and independent services
14
Article
Income from employment
15
Article
Directors' fees and remuneration of top-level managerial officials
16
Article
Income derived by artistes (entertainers) and athletes
17
Article
Pensions and social security payments
18
Article
Income derived by government employees
19
Article
Income derived by students, business trainees and apprentices
20
Article
Other income; in other words, income not dealt with in Articles 6-20
21

- Chapter IV deals with the taxation of capital (not income from capital)
- Chapter V provides two alternative methods for eliminating double taxation: Article 23A
(Exemption method) and Article 23B (Credit method). In general, if the contracting State in
which income arises is entitled by the rules in Article 6 - Article 21 to tax the income, the
contracting State in which the taxpayer is resident is obligated to provide relief from double
taxation. Under the exemption method, the residence country excludes or exempts the income
from residence country tax. Under the credit method, the residence country taxes the income
but provides a deduction from that tax for the tax paid to the source country on the income
- Chapter VI is entitled 'Special provisions'. Article 24 provides protection against various forms
of discriminatory taxation by the source and residence countries. Articles 25, Article 26 and
Article 27 provide for important types of administrative cooperation between the contracting
states. Article 25 provides a mutual agreement procedure (MAP) to resolve disputes
concerning the application of the treaty; Article 26 deals with exchanges of information
between the States; and Article 27 provides rules for the contracting States to assist in
collecting one another's taxes. Article 28 simply provides that nothing in the treaty affects the
'fiscal privileges' enjoyed by diplomats and consular officials under international law or other
international agreements
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- Chapter VII provides rules to govern the entry into force and termination of the treaty

8. Scope of Convention (Article 1 & Article 2)–

8.1 To whom does the Treaty apply

- Article 1 provides for application of tax treaty to persons resident of one or both the
Contracting States
- It does not apply to persons who are not residents of both the Contracting State
- 'Person' defined in Article 3 of the Model Convention

8.2 Taxes covered

- Taxes on income
- Taxes on capital
- Taxes on Central Government and Political sub-divisions
- List of taxes

The provisions are discussed below –

- Article 2(1) of the tax treaty defines the subject of the Convention, stipulating that the treaty
applies respectively to 'taxes on income and on capital' and 'taxes on estates and inheritances
and on gifts' that are 'imposed on behalf of a Contracting State or of its political subdivisions or
local authorities, irrespective of the manner in which they are levied'
- Article 2(2) of the tax treaty gives a somewhat imprecise description of 'taxes on income and
capital' and it states:

There shall be regarded as taxes on income and on capital all taxes imposed on total income, on total
capital, or on elements of income or of capital, including taxes on gains from the alienation of movable
or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as
taxes on capital appreciation

- Article 2(3) of the tax treaty provides that 'The existing taxes to which the Convention shall
apply are in particular …', the contracting states list the taxes covered for each country and
existing at the time of signature of the treaty. The term 'in particular' clearly indicates that the
list is not exhaustive. In contrast, Article 2(3) of the tax treaty in the Estates, Inheritances and
Gifts Model Convention does not contain the phrase 'in particular'; the list therein is thus
exhaustive.

Some treaties do not contain a general description of the taxes covered corresponding to paragraph 1 and
2 and omit the phrase 'in particular' in paragraph 3. In these cases, the enumeration is thus exclusive as
to the taxes covered under the treaty. This option to exhaustively list the taxes covered is explicitly
mentioned in the OECD Income and Capital MC.

The commentary to the OECD MC states that the list of taxes in force shall not be exhaustive but only an
illustrative list to support the preceding Paragraphs of the Article. However, in principle it shall
enumerate all the taxes to which the Tax Treaty applies, which are in force at the time of entering into an
agreement.

- Article 2(4) of the tax treaty aims to prevent the tax treaty from instantly becoming inoperative
in case changes are made to the taxation laws of a contracting party that may affect the taxes
covered by the treaty. The text provides that the tax treaty will automatically apply to all

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identical or substantially similar taxes imposed after the date of signature of the treaty.
However, no criteria are specified regarding the categorization of a tax as 'identical or
substantially similar'.

9. Relationship between tax treaties and domestic law –

9.1 Tax treaties with the national provisions allocate taxable income to taxpayers, so that the context
requires the relevance of domestic law. It is not the intent of the tax treaty to create extra liability or
burden as otherwise exists. Occasionally, some countries have passed legislation to modify or overturn
the interpretation of tax treaty given by a domestic court. Such legislation, adopted in good faith, may
not violate a countries obligation under its tax treaties. The country overriding its tax treaties will consult
its treaty partners to demonstrate good faith and to prevent misunderstandings.

9.2 Section 90(2) of the Act provides the choice whether a taxpayer would like to be governed by a treaty
or by the normal provisions is that of the tax payer. The taxpayer can pick and choose between the
provisions of the treaty or the Act and opt to be governed by those provisions which are beneficial to the
taxpayer.

9.3 The primary need, therefore, is to bring the domestic law to align with what is agreed in the tax
treaties. If it is done, it will bridge the gap between the domestic law and the tax treaties paving the way
for simplification of law relating to international taxation to a significant extent. There need to be no
conflict between the domestic law and the law as to which a country is committed under the DTAAs,
because DTAAs will prevail over domestic law, because of principle of 'Treaty Override' recognized
universally and in India too by the Supreme Court in Union of India v. Azadi Bachao Andolan [2003]
132 Taxman 373/263 ITR 706 and many other subsequent judicial pronouncements.

Conclusion

The concept of income in international tax law hinges upon the concept of income as a tax base in each
respective country. However, the concept of income in tax treaties cannot be equated with domestic
concepts. The primary purpose of income taxes under domestic law is to derive revenue, while bilateral
tax treaties aim at preventing double tax burdens on the same income.

Where a taxable event with respect to 'income' gives rise to possible double tax burdens, the application
of the specific income allocation provisions will lead to workable results that are in line with the object
and purpose of tax treaties to prevent double taxation and tax evasion.

■■

1. India being the developing nations follows mostly UN model convention for its tax treaties
2. Justice Oliver Wendell Holmes in Towne v. Eisner, 245 US 418, 425 (1918)
3. The Australian Tax Office (ATO) takes a position that "the commentaries […] provide guidance
on interpretation and application of the tax conventions and as a matter of practice will often
need to be considered in interpretation of DTA's, at least where the wording is ambiguous
which […] is inherently more likely in treaties than in general domestic legislation".

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