Can a non-resident can claim benefit of DTAA only if he ‘pays tax’ in a Contracting State?

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 UOI v. Azadi Bachao Andolan (2003) where the issue under consideration was whether a non-resident can claim benefit of DTAA only if he ‘pays tax’ in a Contracting State or not.

Facts of the Case:

• In this case, the controversy arose because of the DTAA entered between the Government of India the Government of Mauritius dated 1-4-1983.
• The purpose of this Agreement, as specified in the preamble, was “avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment”.
• CBDT issued Circular No. 789 dt. 13th April, 2000 (2000) 243 ITR (St) 57, clarifying that Certificate of Residence issued by the Mauritian Authorities would constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the India Mauritius DTAA.
• Accordingly, Foreign Institutional Investors who were resident in Mauritius would not be taxable in India on income from capital gains arising in India on sale of shares as per Article 13(4) of the treaty.
• Public interest litigation was filed before Delhi High Court by Shivkant Jhah v. UOI and Azadi Bachoo andolan v. UOI (WP) challenging the aforesaid Circular.

Observations of the Supreme Court (SC)

• SC observed that section 90 of the Act enabled and empowered the Central Government to issue a notification for implementation of the terms of a DTAA.
• It held that a DTAA would operate even if it was inconsistent with the provisions of the Income Tax Act and would override the provisions of the Act for determining the total income and the tax liability.
• Circular no. 789 was a circular within the scope of section 90 and would prevail even if it was inconsistent with the provisions of the Act.
• SC rejected the argument of the respondents that FIIs could not be considered to be ‘residents’ of Mauritius under the DTAA because they were not ‘liable to tax’ in Mauritius on account of tax exemption on sale of shares under the Mauritius Income tax Act.
• SC held that the term ‘liable to tax’ was not the same as ‘pays tax’.
• Therefore, FIIs incorporated in Mauritius were ‘liable to tax’ in Mauritius and were also to be treated as resident of Mauritius under the DTAA.
• SC held that Circular no 789 clarifying that FIIs, etc. which were resident in Mauritius would not be taxable in India on income from capital gains arising on sale of shares was not ultra vires the provisions of the Act.

The decision of the court in Azadi Bacho Andolan Case has played a substantial role in framing the law of the law in terms of legality and application of fiscal statutes and double taxation avoidance agreements.

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