Union Of India and Anr Vs. Azadi Bachao Andolan (Supreme Court)
The double taxation avoidance agreement is an agreement, which helps the taxpayer to get relief from double taxation on the same income. If India has signed any double taxation agreement with any foreign country; it’s meant that the taxpayer of those countries does not have to pay the tax on the same income in both the countries. So, double taxation avoidance agreement is a useful tool which helps the taxpayer to avoid “double taxation”. In case of claiming relief under double taxation avoidance agreement, the country of residence and source country are determining factors to do the same. The law with regards to the DTAA and the powers of Income Tax and other administrative authorities in its implementation have evolved with the development of various judicial trends ranging from the case of McDowell, Azadi Bachao Andolan to Vodafone-Hatchison Case, to name a few.
Factual Background of the case
The case of Union of India v. Azadi Bachao Andolan has played a substantial role in development of the law with regards to the same. In this case, the controversy arises because of the Double Taxation Avoidance Agreement entered between the Government of India the Government of Mauritius dated 1-4-1983. The purpose of this Agreement, as specified in the preamble, is “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”. By the circular issued by Central Board of Direct Taxes (CBDT), Government of India clarified that capital gains of any resident of Mauritius by alienation of shares of an Indian company shall be taxable only in Mauritius according to Mauritius taxation laws and will not be liable to tax in India. This was substantiated by the Circular further issued by CBDT dated 13th April, 2000. Certain income tax authorities also issued show cause notice to those companies that operated in India and Mauritius to justify why they should not be taxed which created panic amongst such FIIs and also led to withdrawal of funds by Foreign Institutional Investors.
The Respondents challenged the circulars and also the DTAA in the Delhi High Court by the way of Special Leave Petitions. They prayed the following before the Court:
i. “For issuing appropriate directions to the Central Government to initiate a process by which the conditions of the Indo-Mauritius DTAA are revised or modified,
ii. For declaring and delimiting the powers of the Central Government under section 90 of the Income Tax Act, 1961,
iii. declare and delimit the powers of the Central Board of Direct Taxes in the matter of the issuance of instructions through circulars to the statutory authorities, and
iv. Issue mandamus against Income Tax authorities for compelling them to undertake revenue collection in a lawful manner.”
“On the basis of the grounds of challenge by the Azadi Bachao Andolan (hereinafter referred to as “ABA”), the High Court decided to quash the circular no. 789 on several grounds as mentioned:
First, The Court held that the said circular was not explicitly issue dunder power of authorities under section 119, this making it not binding in the first place.
Second, relying on the argument of ABA, the court opined that provisions of the agreement, enunciated further in the circular in question, make the Indo-Maurtius investments prone to unethical use of “Treaty Shopping”.
Third, circular no. 789 was ultra vires the powers of both the central government and Income Tax Authorities and provides for excessive delegation of legislative power, which cannot be permissible.”
The respondents in the present case in Hugh Court went to appeal in the Supreme Court against the Judgement of the High Court and a bench of the Supreme Court consisting Justice Ruma Pal and Justice B.N. Srikrishna reversed the judgement of the High Court in the case which is referred as Union of India v. Azadi Bachao Andolan, the analysis of which is given in this case analysis.
Issues/Question of Law
The Court considered the following questions of law in the present case:
I. Whether the provisions of the Income Tax Act, 1961 (special reference to Relief of Double Taxation under Section 90) prevail over the provisions of Double Tax Avoidance Agreement when there is an inconsistency between the two?
II. Whether the Double Taxation Agreement Convention between India and Mauritius illegal and ultra vires the power of Central Government under section 90, Income Tax Act, 1961?
III. Whether Circular 789 issued by the Central Board of Direct Taxes (CBDT) is a valid circular?
In terms of this, two sub-questions arise:
1) Whether Central Board of Direct Taxes (CBDT) holds the power for the issuance of instructions through circulars to the statutory authorities under the Income Tax Act, and more specifically circular no. 789 in the present case?
2) Whether circular no. 789 issued by the CBDT violative of Section 119 of the Income Tax Act? Is the circular a legally valid circular?
Analysis of the Decision of the Court, along with the reasoning applied
In terms of the first question of the case i.e. when an inconsistency arises between provisions Income Tax Act and any provisions of the Double Tax Avoidance Agreement, the court answered that where a specific provision is made in the Double Taxation Avoidance Agreement, that provision will prevail over the general provisions contained in the Income-tax Act, 1961. This was a pure question of law that the court had to answer. It is a prominent rule of interpretation where an inconsistency arises between any general and specific laws/provisions of two statues, the specific shall prevail over the general. In the present case, Provisions of the Income Tax Act are regarded as general rules for avoidance of tax benefit, while the provisions of the Double Tax Avoidance Convention between India and Mauritius are regarded as the specific ones. In light of the rule, it is safe to say that the provisions of the latter will prevail over the former.
In light of the above analysis, let us consider a situation where two sets of different modes are specified for Computation of Income in a Double Tax Avoidance Agreement and the Income Tax Act for a person having residency of one of the two countries between whom the agreement exists. In this case, the rule of the interpretation mentioned above would imply that the mode of computation of income mentioned in the specific agreement between the two countries should be followed and not the general provisions for computation in the Income Tax Act.
Therefore, the court answered the question mentioned above by saying that the application of the above rules of interpretation would imply that in case of any inconsistency between the provisions of the Indo-Mauritian DTAA and Section 90 of the Income Tax Act, the provisions of the DTAA being specific provisions regarding providing tax relief in case of double taxation would override the provisions of the Income Tax Act.
“The second question of law is connected to the first question of law and the court relied of prior judgements and judicial interpretations for answering the same. The question before the court was about the legality of the Double Taxation Avoidance Agreement between India and Mauritius on the grounds of it being ultra vires the powers of the Central Government as under Section 90 of the Income Tax Act, 1961.
The court answered this question on account of two important considerations, namely:
First, what powers are granted to the central government under Section 90 of the Act?
Second, in exercise of the powers granted to the central government under section 90, was the central government empowered to enter into a Double Taxation Agreement with Mauritius according to the terms established in such DTAA or did in doing so, did Central Government go beyond the scope of the powers granted to it?”
Section 90 of the Income Tax Act, titled “Agreement with foreign countries” provides:
“(1) The Central Government may enter into an agreement with the Government of any country … the provisions of this Act shall apply to the extent they are more beneficial to that assessee.”
According to the provisions of section 90, the Central Government is empowered to enter into convention with the Government of any other country for the purposes listed in clauses (a) to (d) of sub-section (1) . While clause (a) talks of granting relief/benefit in respect of income on which income-tax has been paid in India as well as in the foreign country, clause (b) is wider and deals with ‘avoidance of double taxation of income’ under the Act and under the law in force in the foreign country. Court regarded Clauses (c) & (d) of the Section 90 as irrelevant to the application in the present case.
In terms of the third question regarding Circular No. 789 issued by the Central Board of Direct Taxes, two basic questions arose: first, if CBDT was the appropriate authority for issuance of instructions to statutory bodies and, second, if the said circular (Circular No. 789) was a legally valid circular in light of Section 119 of the Income Tax Act.
“In response to the contention whether the CBDT was the appropriate authority to issue such instructions as under circular no. 789 specifically the instruction that “Foreign Institutional Investors etc., which are resident in Mauritius would 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 Double Tax Avoidance Agreement between the two countries”, the court laid emphasis upon sub-section (2) of Section 119, which provides for the exercise of power in certain special cases and enables the Central Board of Direct Taxes, “if it considers necessary so to do for the purpose of adequate management of the work of assessment and collection of revenue, to issue general or special orders in respect of any class of incomes of class of cases, setting forth directions or instructions as to the guidelines, principles or procedures to be followed by other income-tax authorities in the discharge of their work relating to assessment or initiating proceedings for imposition of penalties.” Therefore, it has been settled by the Supreme Court that CBDT, in fact, had the power to issue such instructions as in definition of Section 119 of the Income Tax Act, 1961. Thus, the CBDT holds the competency to issue instructions as issued in circular no, 789.
The court affirmed the judgment with reference to the case of UCO Bank v. Commissioner of Income Tax, and the court pointed out that the circulars issued by CBDT under Section 119 of the Act have statutory force and would be binding on every income-tax authority although such may not be the case with regard to press releases issue by the CBDT for information of the public.”
Other Contentions of the Respondents
“Another contention of the respondents was that circular no. 789 gave excessive power to the Central Board for Direct Taxes and gave the Income Tax Authorities the power to lift corporate veil of the entity in order to decide if they should be awarded the benefit of double taxation under the Income Tax Act. Thus, the contention in light of such power was that the Income Tax Authorities have been excessive delegated such quasi-judicial powers and it is a case of excessive delegation. This contention was accepted by the Delhi High Court and on the grounds, the circular no, 789 was quashed by the High Court of Delhi. The Supreme Court, in appeal, relied on the reasoning of Maharashtra State Board of Secondary and Higher Secondary Education and Anr. v. Paritosh Bhupesh Kumar Sheth & Ors. and stated that in determining whether a delegation of power is excessive the court cannot look into the merits or demierits of the delegation, but only the process of application of such delegation of power. Therefore, the court held that sicne the process of delegation of power in the given case was valid and regulations made by authority (CBDT) have a rational nexus with the object and purpose of the statute, the court held that delegation of power vide circular no, 789 was not excessive and thus not violative of the provisions of section 119 of the Income Tax Act which provide for process of instruction(s) to subordinate authorities.”
In addition to this, the Supreme Court held that the High Court decision to quash circular no. 789 as ultra vires was erroneous and unacceptable. The impugned circular provides that whenever a certificate of residence is issued by the Mauritius Authorities, such certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly. It also provides that the test of residence mentioned above would also apply in respect of income from capital gains on sale of shares.
“The Respondents also emphasised that on the offshore companies have been incorporated under the laws of Mauritius only as shell companies, which carry on no business therein, and are incorporated only with the motive of taking undue advantage of the DTAC between India and Mauritius. The contention was also with regards to the illegality of the same. The court held that if it was intended that a national of a third State should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect should have been incorporated therein. An example of the same is Article 24 of the Indo – US Treaty on Avoidance of Double Taxation where there are no disabling or disentitling conditions under the Indo-Mauritius Treaty prohibiting the resident of a third nation from deriving benefits there under.”
Lastly, the respondents vehemently criticised the act of incorporation by Foreign Institutional Investors under the Mauritian Act as a ‘sham’ and ‘a device’ actuated by improper motives. The respondent strongly relied on the judgment of the Constitution Bench of this Court in McDowell and Company Ltd. v. Commercial Tax Officer, any tax planning which is intended to and results in avoidance of tax must be struck down by the Court. Thus, on this ground they prayed for the circular to be struck down.
Critical Analysis and Similar Judgements
The Court has relied upon a variety of decisions. These include the judgement of Maganbhai Ishwarbhai Patel & Others. v. Union of India & Anr. where he power of Central Government under section 90 and 119 of the Income Tax Act ahs been linked to the constitutional aspect for its derivation from Article 73 of the Constitution and the state sovereignty in terms of formulating laws in such taxation and/or fiscal matters has been discussed. Section 90 and 119 also find mention and have been majorly discussed and analysed above. The Cirt has also relied on judgements of Maharashtra State Board of Secondary and Higher Secondary Education and Anr. v. Paritosh Bhupesh Kumar Sheth & Ors. and UCO Bank v. Commissioner of Income Tax for discussing the validity of circular no. 789 in the present case of Azadi Bachao Andolan in term of the principles with regards to fiscal delegation of legislation, etc. laid down in cases mentioned above.
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 stautues and double taxation avoidance agreeents. One such instance is the case of Vodafone International Holdings BV vs. Union of India where Vodafone International Holding (VIH) and Hutchison telecommunication international limited (HTIL) “were two non-resident companies who entered into transaction by which HTIL transferred the share capital of its subsidiary company based in Cayman Island. The Court heavily relied upon the decision of the Supreme Court in Union of India v. Azaadi Bachao Andolan and as in that case, reversed the judgement of the High Court and held that the sale of CGP share from HTIL to Vodafone does not amount to transfer of capital assets within the meaning of the Income Tax Act and thereby all the rights and entitlements that flow from shareholder agreement etc. that form integral part of share of CGP do not attract capital gains tax. Thus, Court, while relying on the present judgement of Azadi Bachao Andolan granted relief of double-taxation to the parties in the case of Vodafone and HTIL.”
Criticism and Conclusion
The law with regards to the development of Double Tax Laws were framed with the aim of empowering the administrative and other agencies to grant the relief to such assesses of income tax who were/are operating in two countries and if they have paid tax in one country they must be compelled to pay taxes in the other country as well. In other words, the burden of taxation should not be doubled on them. However, this has always opened the system to certain misuses and therefore attracted criticism. One such criticism is in terms of the non-transparent system that has been created where such assesses are not completely accountable to income tax authorities of a single country thereby also leading to tax evasion and corruption through ‘corporate complex structuring’, as exhibited from the implications of the law found in the judgements of Azadi Bacho Andolan and Vodafone Case.
There is another misuse of such law with regards to DTAA. This is done in the form of Treaty Shopping wherein means when an assessee wants to do “a transaction through another country which has most beneficial treaty with India in order to reduce his tax liability.”. The same was also a ground of contention in the case of Azadi Bachao Abdolan.
“Finally, it can be said that Double Taxation Avoidance Agreement is a useful tool for avoiding double taxation and providing of relief to entities engaged in earning income from two or more countries, but it should not be used in order to promote double non taxation or to unnecessarily or illegally reduce the tax liability or treaty shopping. It is essential that the Double Taxation Avoidance Agreements should have a clear provision which prevent DTAA from misuse.”
 154 ITR 148
 (2012) 6 SCC 613.