All the controversies relating to international taxation are about interpretations of the provisions of domestic law and the treaties and conventions concerning double taxation avoidance.
Complex tax laws pose problems both in interpretation and implementation. Which is why tax legislation and treaties should be simple and understandable to the common man and those in trade, reasoned Chief Justice Swatanter Kumar of the Bombay High Court when speaking at the International Tax Conference, organised by IFA (International Fiscal Association) India and the OECD (Organisation for Economic Cooperation and Development).
“International taxation has become too complex an issue. It has made the legal circles rethink the jurisprudence of tax jurisdiction… Innovation in applying settled legal dictum is the need of the hour,” he emphasised.
Here are a few snatches from his speech, on different themes that he touched upon.
On the importance of economic freedom.
Economic freedom is simply a requisite for political freedom. By enabling people to cooperate with one another without coercion or central direction it reduces the area over which political power is exercised. Economic freedom is a necessary condition for the creation of sustainability of civil and political freedoms. Economic reforms have led to stronger economic growth, higher investment flows and growth in trade. Indian and foreign businesses have responded positively to the economic reform process.
Even the Indian laws relating to procedure as well as laws relating to arbitration, mediation and conciliation have been amended so as to make them compatible with accepted international norms and the United Nations Commission on International Trade Law.
On the nexus between international taxation and good governance. Evolution of law relating to taxation is in fact the reflection of principles governing economy and economic policies of a nation. According to renowned lawyer and economist N. A. Palkhiwala, taxes, like water, have a tendency to find the lowest level. Taxes, therefore, ultimately affect the common man.
The issue of international taxation is important for developing countries as they have to perform a balancing act, for good governance. There is a difference between principles of governance in the domestic field and the same at international levels.
Every nation is free to evolve, in international law, principles of governance to best suit its ideals and priorities. At the same time, due to increase in regional cooperative treaties, nations are compelled to rethink about their polity, principles of governance and priorities. Nations cannot ignore common minimum rights of people even across the border.
On the objectives of taxation. In the Wealth of Nations Adam Smith spoke of four main objectives of taxation, viz. equity, convenience of taxpayer, economy, and certainty and clarity.
In the age of market economy our preferences may have changed but the aspects of equity, certainty and clarity shall always remain the basic objectives of taxation.
Consistent with economic policy, smooth administration and revenue adequacy are the modern considerations for taxation.
Developing countries, however, have to consider ‘social justice’ as an additional weighing factor. Underdeveloped countries may face a dilemma while reconciling the objective of social justice with the need of providing fiscal stimulus to promote economic goals. Most advanced countries pursue a fiscal policy of increasing revenue not by increasing the tax rate but by enlarging the tax base.
On double taxation in ancient times.
Need for the avoidance of double taxation was known in ancient times. For instance, in Shukra Niti, it is provided that a class of goods should be levied only once and that tax should not be realised more than once by the king.
On the main problem that international taxation poses before the courts.
Tax treaties may give rise to various tax disputes, which domestic tax forums and courts have to deal with. The main problem before such courts would be that there are often no precedents to be followed, since international tax law is still in its infancy.
The decisions so far in the field do not spell out law in a lucid manner. All the controversies relating to international taxation relate to interpretations of provisions of domestic law and the treaties and conventions concerning double taxation avoidance. The mind of the court is mainly engaged by interpretation of the provisions in the tax treaties aimed at double taxation relief. Courts may look at some commercial issues microscopically when these involve ethico-legal questions such as `treaty shopping.’
On a few guiding principles in interpretation.
As far as interpretation of international treaties is concerned the Vienna Convention on the Law of Treaties (1986) may be treated as the guiding path.
The following decisions are also of help in this regard.
In Pratap Sing vs State of Jharkhand (2005), the Supreme Court observed that international treaties, covenants and conventions although may not be a part of our municipal law, the same can be referred to and followed by the courts, having regard to the fact that India is a party to the said treaties.
In Union of India vs Azadi Bachao Andolan (2004), the Supreme Court clarified the role of the court in the field of tax treaties. It said that the court was not concerned with the manner in which tax treaties are negotiated or enunciated, nor concerned with the wisdom of any particular treaty.
The Supreme Court cited John N. Gladden vs Her Majesty the Queen with approval. This decision states that “contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated…”
In Ishikwajma-Harima Heavy Industries Ltd vs Director of Income Tax, Mumbai (2007), the Supreme Court applied the `territorial nexus doctrine’ and observed: “Income arising out of operation in more than one jurisdiction would have territorial nexus with each of the jurisdictions on actual basis. Therefore, it may not be correct to contend that the entire income `accrues or arises’ in each of the jurisdictions. ”
In Commissioner of Income Tax vs Hyundai Heavy Industries Co Ltd (2007), the apex court laid down the principles for computing profits accruing in India for a non-resident assessee. It said: “The demarcation is necessary in order to earmark the tax jurisdiction over the operations of the non-resident assessee. Unless the permanent establishment (PE) is treated as a separate profit centre, it is not possible to ascertain the profits of the permanent establishment which, in turn, constitutes the profits arising to the non-resident assessee in India.
In DIT vs Morgan Stanley & Co (2007), the apex court upheld the principle of arm’s length price for computation of income arising from international transactions. It held that once a transfer pricing analysis is undertaken there is no further need to attribute profits to the service PE.
On the importance of dispute resolution.
Tax treaties are meant for harmonising the tax systems of two countries. With cross-border trade on the rise there is a need for rationalising the imposition of tax to ensure a fairer and more efficient application of tax laws.
OECD has taken welcome steps for evaluation and improvement of current treaty dispute resolution practice and mechanisms. Effective dispute resolution mechanism including arbitrator may be a positive factor for developing countries and those that are eager to enhance foreign investment.
MAP (mutual agreement procedure) may help substantially in dispute resolution irrespective of remedies available in domestic tax laws. MAP may be an option available before or after any domestic administrative process has commenced.
On the response of Indian judiciary to backlog of cases.
All possible efforts are made by constituting special Benches for different subjects and there is a regular Bench earmarked for taxation matters to ensure expeditious disposal.
Openness to the ADR mechanism has made Indian judiciary explore various modes of speedy disposal of disputes. Within the framework of law, Fast Track tribunal may be explored for tax disputes involving non-residents. A timeframe for resolution of such tax dispute can be fixed.
Tax Ombudsman Scheme may be effectively evolved with the object to resolve disputes. Economic offences should not only be dealt with expeditiously but there should be correct interpretation of laws to achieve the twin objects of severely punishing the offender and advancing the cause of justice.
On the challenges.
The effectiveness of law is tested every time when there is a conflict between the taxpayer and the tax administrators. Innovations of the taxpayers expand the horizon of tax law. Whatever may be the height of innovation of the taxpayer, tax law has to stick to rationality and reasonableness.
The history of Indian law court would show that our legal system has always stood the test of rationality and reasonableness. The approach of Indian courts has and shall always remain progressive. I am sure that Indian judiciary will positively respond to the issues relating to international commerce with the touchstone of rule of law and within the basic structure of the Constitution of India.
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(Republished with Amendments by Team Taxguru)