What would prevail in case of conflict between Income-tax Act and the provisions of DTAA?
India follows residence-based tax system under which a resident is taxed on his global income while a non-resident is taxed on his income sourced in India, i.e. ‘received’ or ‘accrued’ in India. A non-resident is also eligible for seeking beneficial tax treatment under the Double Taxation Avoidance Agreements (DTAA) entered into by India with other countries.
A resident will be charged to tax in India on his global income i.e. income earned in India as well as income earned outside India. Thus, in case of resident individuals, there may arise a scenario where the same income is taxable in both the countries i.e. in the source country, where income is earned and the resident country, i.e. India, where individual earning such income qualifies as a resident. This may result in double taxation of the same income as per the domestic tax laws of both the countries.
Double taxation is the levy of tax by two or more countries on the same income, asset or financial transaction. This double liability is mitigated in many ways, one of them being a tax treaty between the countries in question. A tax treaty between two or more countries to avoid taxing the same income twice is known as Double Taxation Avoidance Agreement (DTAA). When a tax-payer resides in one country and earns income in another country, he is covered under DTAA, if those two countries have one in place. Its only focus is to ensure individuals do not end up paying taxes twice. And to enable this, the Foreign Tax Credit system comes into the picture.
If a person who is resident in India in any previous year, in respect of his income, accrued or arose outside India has paid tax on such income in any country outside India, he shall be entitled deduction from the Income Tax payable by him of a sum calculated on such doubly taxed income:
- Under section 90 of the Income Tax Act, if the country in which tax is paid has entered double taxation avoidance agreement with the Government of India.
- Under section 91 of the Income Tax Act, if the country in which tax is paid has not entered into any agreement with the Government of India.
Relief allowed under section 90/ 91 is lower of following accounts:
- Tax paid on double-taxed income outside India.
- Tax payable on double-taxed income under Income Tax Act.
Let us refer to the case of CIT v. P.V.A.L. Kulandagan Chettiar (2004) where the issue under consideration was whether income from business carried on in Malaysia and from sale of an immovable property in Malaysia would be taxable only in Malaysia and not in India or vice versa.
Facts of the Case:
- Assessee was a firm who earned business income from rubber estates in Malaysia.
- During the year, assessee also sold an immovable property situated at Malaysia and earned short term capital gains.
- The Assessing Officer (AO) charged the business income as well as capital gains to tax in India.
- CIT(A) and Tribunal held that:
- business income earned in Malaysia was not taxable in India as the assessee did not have a permanent establishment in India
- capital gain was also not taxable in India as the property was situated in Malaysia.
- High Court (HC) upheld the view of the Tribunal and held that where a DTAA contained a specific provision, laws of any one of the respective Contracting States could not be applied.
- HC also held that as the DTAA provided that the aforesaid incomes ‘may be taxed’ in Malaysia, the tax authorities in India did not have the right to assess the same income
Observations of the Supreme Court (SC)
- SC was concerned with income arising from immovable property.
- SC proceeded on the basis that fiscal connection arose in relation to taxation either by reason of residence of the assessee or by reason of the location of the immovable property which was the source of income.
- The clauses set out in Article IV which stated that in a case where the person was a resident in both the contracting States fiscal domicile would be determined with reference to the fact that if the contracting State with which his personal and economic relations were closer, he would be deemed to be a resident of the contracting State in which he had a habitual abode.
- This implied that tax liability which arose in respect of a person residing in both the contracting State had to be determined with reference to his close personal and economic relations with one or the other.
- The immovable property in question was situated in Malaysia and income was derived from that property.
- Further, it was also held that there was no permanent establishment in India in regard to carrying on the business of rubber plantations in Malaysia out of which income was derived and that finding of fact was recorded by all the authorities and affirmed by the HC.
- SC, therefore, did not propose to re-examine the question whether the finding was correct or not.
- Proceeding on that basis, SC held that business income out of rubber plantations could not be taxed in India because of closer economic relations between the assessee and Malaysia in which the property was located and where the permanent establishment was set up would determine the fiscal domicile.
- Reading the Treaty in question as a whole when it was intended that even though it was possible for a resident in India to be taxed in terms of Sections 4 and 5, if he was deemed to be a resident of a contracting State whether his personal and economic relations were closer, then his residence in India would become irrelevant.
- The Treaty would have to be interpreted as such and prevail over Sections 4 and 5 of the Act.
- The contention put forth by the Attorney General that capital gains was not income and, therefore, was not covered by the Treaty could not be accepted at all because for purposes of the Act capital gains was always treated as income arising out of immovable property though subject to different kind of treatment.
- Therefore, the contention advanced that it was not a part of the Treaty could not be accepted because in the terms of Treaty wherever any expression was not defined the expression defined in the Income Tax Act would be attracted.
- The definition of ‘income’ would, therefore, include capital gains. Thus, capital gains derived from immovable property is income and therefore Article 6 would be attracted
In conclusion, business income arising out of rubber plantations outside India cannot be taxed in India. Capital gains derived from immovable property is not taxable in India if the property is situated outside India. In case of conflict between Income-tax Act and the provisions of DTAA, provisions of DTAA would prevail over the provisions of Income-tax Act