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CASE NO.:

Appeal (civil) 8161-8162 of 2003

Appeal (civil) 8163-8164 of 2003

PETITIONER:

Union of India and Anr.

RESPONDENT:

Azadi Bachao Andolan and Anr.

DATE OF JUDGMENT: 07/10/2003

BENCH:

Ruma Pal & B.N. Srikrishna.

JUDGMENT:

J U D G M E N T

(Arising out of S.L.P.(C) Nos.20192-20193 of 2002)

(@ S.L..P.(C) Nos. 22521-22522 of 2002)

SRIKRISHNA,J.

Leave granted.

These appeals by special leave arise out of the judgment of

the Division Bench of Delhi High Court allowing Civil Writ

Petition (PIL)No.5646/2000 and Civil Writ Petition No.2802/2000.

The High Court by its judgment impugned in these appeals

quashed and set aside the circular No.789 dated 13.4.2000 issued

by the Central Board of Direct Taxes (hereinafter referred to as

"CBDT") by which certain instructions were given to the Chief

Commissioners/Directors General of Income-tax with regard to the

assessment of cases in which the Indo - Mauritius Double

Taxation Avoidance Convention, 1983 (hereinafter referred to as

'DTAC') applied. The High Court accepted the contention before

it that the said circular is ultra vires the provisions of Section 90

and Section 119 of the Income-tax Act, 1961(hereinafter referred

to as 'the Act') and also otherwise bad and illegal.

It would be necessary to recount some salient facts in order

to appreciate the plethora of legal contentions urged.

FACTS

A: The Agreement

The Government of India has entered into various

Agreements (also called Conventions or Treaties) with

Governments of different countries for the avoidance of double

taxation and for prevention of fiscal evasion. One such Agreement

between the Government of India and the Government of

Mauritius dated April 1, 1983, is the subject matter of the present

controversy. 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". After

completing the formalities prescribed in Article 28 this agreement

was brought into force by a Notification dated 6.12.1983 issued in

exercise of the powers of the Government of India under Section

90 of the Act read with Section 24A of the Companies (Profits)

Surtax Act, 1964. As stated in the Agreement, its purpose is to

avoid double taxation and to encourage mutual trade and

investment between the two countries, as also to bring an

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environment of certainty in the matters of tax affairs in both

countries.

Some of the salient provisions of the Agreement need to be

noticed at this juncture. The Agreement defines a number of terms

used therein and also contains a residuary clause. In the

application of the provisions of the Agreement by the contracting

States any term not defined therein shall, unless the context

otherwise requires, have the meaning which it has under the laws

in force in that contracting State, relating to the words which are

the subject of the convention. Article 1(e) defines 'person' so as to

include an individual, a company and any other entity, corporate or

non-corporate "which is treated as a taxable unit under the

taxation laws in force in the respective contracting States". The

Central Government in the Ministry of Finance (Department of

Revenue), in the case of India, and the Commissioner of Income

Tax in the case of Mauritius, are defined as the "competent

authority". Article 4 provides the scope of application of the

Agreement. The applicability of the Agreement is determined by

Article 4 which reads as under;

"Article 4 Residents

1. For the purposes of the Convention, the term

"resident of a Contracting State" means any person

who under the laws of that State, is liable to

taxation therein by reason of his domicile,

residence, place or management or any other

criterion of similar nature. The terms "resident of

India" and "resident of Mauritius" shall be

construed accordingly.

2. Where by reason of the provisions of

paragraph 1, an individual is a resident of both

Contracting States, then his residential status for

the purposes of this Convention shall be

determined in accordance with the following rules:

(a) he shall be deemed to be a resident of

the Contracting State in which he has

a permanent home available to him; if

he has a permanent home available to

him in both Contracting States, he

shall be deemed to be a resident of the

Contracting State with which his

personal and economic relations are

closer (hereinafter referred to as his

"centre of vital interests");

(b) if the Contracting State in which he

has his centre of vital interest cannot

be determined, or if he does not have

a permanent home available to him in

either Contracting State he shall be

deemed to be a resident of the

Contracting State in which he has an

habitual abode;

(c) if he has an habitual abode in both

Contracting States or in neither of

them, he shall be deemed to be a

resident of the Contracting State of

which he is a national;

(d) if he is a national of both Contracting

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States or of neither of them, the

competent authorities of the

Contracting States shall settle the

question by mutual agreement.

3. Where by reason of the provision of

paragraph 1, a person other than an individual is a

resident of both the Contracting States, then it shall

be deemed to be a resident of the Contracting State

in which its place of effective management is

situated."

The Agreement provides for allocation of taxing jurisdiction

to different contracting parties in respect of different heads of

income. Detailed rules are stipulated with regard to taxing of

Dividends under Article 10, interest under Article 11, Royalties

under Article 12, Capital Gains under Article 13, income derived

from Independent Personal Services in Article 14, income from

Dependent Personal Services in Article 15, Directors' Fees in

Article 16, income of Artists and Athletes in Article 17,

Governmental Functions in Article 18, income of students and

Apprentices in Article 20, income of Professors, Teachers and

Research Scholars in Article 21, and other income in Article 22.

Article 13 deals with the manner of taxation of capital gains.

It provides that gains from the alienation of immovable

property may be taxed in the Contracting State in which such

property is situated. Gains derived by a resident of a Contracting

State from the alienation of movable property, forming part of

the business property of a permanent establishment which an

enterprise of a Contracting State has in the other Contracting

State, or of movable property pertaining to a fixed base available

to a resident of a Contracting State in the other Contracting State

for the purpose of performing independent personal services,

including such gains from the alienation of such a permanent

establishment, may be taxed in that other State. Gains from the

alienation of ships and aircraft operated in international traffic and

movable property pertaining to the operation of such ships and

aircraft, shall be taxable only in the Contracting State in which the

place of effective management is situated. With respect to capital

gain derived by a resident in the Contracting State from the

alienation of any property other than the aforesaid is concerned, it

is taxable only in the State in which such a person is a 'resident'.

Article 25 lays down the Mutual Agreement Procedure. It

provides that where a resident of a Contracting State considers

that the actions of one or both of the Contracting State result or

will result for him in taxation not in accordance with this

Convention, he may, notwithstanding the remedies provided by

the national laws of those States, present his case to the competent

authority of the Contracting State of which he is a resident. This

case must be presented within three years of the date of receipt of

notice of the action which gives rise to taxation not in accordance

with the Convention. Thereupon, if the objection appears to be

justified, the competent authority shall attempt to resolve the case

by mutual agreement with the competent authority of the other

Contracting State so as to avoid a situation of taxation not in

accordance with the convention. This Article also provides for

endeavour by the competent authorities of the Contracting States

to resolve by mutual agreement any difficulties or doubts arising as

the interpretation or application of the convention. For this

purpose, the convention contemplates continuous or periodical

communication between the competent authorities of the

Contracting States and exchange of views and opinions.

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B : The Circulars

By a Circular No.682 dated 30.3.1994 issued by the CBDT

in exercise of its powers under Section 90 of the Act, the

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. Relying on this, a large number

of Foreign Institutional Investors s (hereinafter referred to as "the

FIIs"), which were resident in Mauritius, invested large amounts of

capital in shares of Indian companies with expectations of making

profits by sale of such shares without being subjected to tax in

India. Sometime in the year 2000, some of the income tax

authorities issued show cause notices to some FIIs functioning in

India calling upon them to show cause as to why they should not

be taxed for profits and for dividends accrued to them in India.

The basis on which the show cause notice was issued was that the

recipients of the show cause notice were mostly 'shell companies'

incorporated in Mauritius, operating through Mauritius, whose

main purpose was investment of funds in India. It was alleged that

these companies were controlled and managed from countries

other than India or Mauritius and as such they were not

"residents" of Mauritius so as to derive the benefits of the DTAC.

These show cause notices resulted in panic and consequent hasty

withdrawal of funds by the FIIs. The Indian Finance Minister

issued a Press note dated April 4, 2000 clarifying that the views

taken by some of the income-tax officers pertained to specific

cases of assessment and did not represent or reflect the policy of

the Government of India with regard to denial of tax benefits to

such FIIs.

Thereafter, to further clarify the situation, the CBDT issued

a Circular No.789 dated 13.4.2000. Since this is the crucial

Circular, it would be worthwhile reproducing its full text. The

Circular reads as under:

"Circular No.789

F.No.500/60/2000-FTD

GOVERNMENT OF INDIA

MINISTRY OF FINANCE

DEPARTMENT OF REVENUE

CENTRAL BOARD OF DIRECT TAXES

New Delhi, the 13th April, 2000

To

All the Chief Commissioners/ Directors

General of Income-tax

Sub: Clarification regarding taxation of income

from dividends and capital gains under the

Indo-Mauritius Double Tax Avoidance

Convention (DTAC) - Reg.

The provisions of the Indo-Mauritius DTAC

of 1983 apply to 'residents' of both India and

Mauritius . Article 4 of the DTAC defines a

resident of one State to mean any person who,

under the laws of that State is liable to taxation

therein by reason of his domicile, residence,

place of management or any other criterion of a

similar nature. Foreign Institutional Investors and

other investment funds etc. which are operating

from Mauritius are invariably incorporated in

that country. These entities are 'liable to tax'

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under the Mauritius Tax law and are therefore to

be considered as residents of Mauritius in

accordance with the DTAC.

Prior to 1st June, 1997, dividends distributed

by domestic companies were taxable in the hands

of the shareholder and tax was deductible at

source under the Income-tax Act, 1961. Under

the DTAC, tax was deductible at source on the

gross dividend paid out at the rate of 5% or 15%

depending upon the extent of shareholding of the

Mauritius resident. Under the Income-tax Act,

1961, tax was deductible at source at the rates

specified under section 115A etc. Doubts have

been raised regarding the taxation of dividends

in the hands of investors from Mauritius. It is

hereby clarified that wherever a Certificate of

Residence is issued by the Mauritian Authorities,

such Certificate will constitute sufficient

evidence for accepting the status of residence as

well as beneficial ownership for applying the

DTAC accordingly.

The test of residence mentioned above

would also apply in respect of income from

capital gains on sale of shares. Accordingly, FIIs

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.

The aforesaid clarification shall apply to all

proceedings which are pending at various levels."

C: The Writ Petitions

Circular No. 789 was challenged before the High Court of

Delhi by two writ petitions, both said to be by way of Public

Interest Litigation. The petitioner in CWP 2802 of 2000 (Azadi

Bachao Andolan) prayed for quashing and declaring as illegal and

void Circular No.789 dated 13.4.2000 issued by the CBDT. The

petitioner in CWP 5646 of 2000 sought an appropriate

direction/order or writ to the Central Government and made the

following prayers:

"(a) issue such appropriate direction /order / writ

as the Court deem proper, under the circumstances

brought to the knowledge of the Hon'ble Court, to the

Central Government to initiate a process whereby the

terms of the Indo-Mauritius Double Taxation

Avoidance Agreement are revised, modified, or

terminated and /or effective steps taken by the High

Contracting Parties so that the NRIs and FIIs and such

other interlopers do not maraud the resources of the

State.

(b) declare and delimit the powers of the

Central Government under section 90 of the Income

Tax Act, 1961 in the matter of entering into an

agreement with the Government of any country

outside India;

(c) declare and delimit the powers of the

Central Board of Direct Taxes in the matter of the

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issuance of instructions through circulars to the

statutory authorities under the Income tax Act,

specially through such circulars which are beneficial

to certain individual taxpayers but injurious to Public

Interest.

(d) declare the illegality of Circular No.789 of

April 13, 2000 issued by the Central Board of Direct

Taxes and to quash it as a matter of consequence;

(e) issue mandamus so that the respondents

discharge their statutory duties of conducting

investigation and collection of tax as per law;

(f) issue appropriate direction/ order or writ of

the nature of mandamus, as the Court deem fit, so that

all remedial actions to undo the effects of the acts

done to the prejudice or Revenue in pursuance of

Circular No.789 are taken by the authorities under the

Income tax Act, 1961"

D : High Court's findings

The High Court has quashed the circular on the following

broad grounds:

(A) Prima facie, by reason of the impugned circular no direction

has been issued. The circular does not show that it has been issued

under section 119 of the Income-tax Act, 1961 and as such it

would not be legally binding on the Revenue;

(B) The Central Board of Direct Taxes cannot issue any

instruction, which would be ultra vires the provisions of the

Income-tax Act, 1961. Inasmuch as the impugned circular directs

the income-tax authorities to accept a certificate of residence

issued by the authorities of Mauritius as sufficient evidence as

regards status of resident and beneficial ownership, it is ultra vires

the powers of the CBDT;

(C) The Income-tax Officer is entitled to lift the corporate veil in

order to see whether a company is actually a resident of Mauritius

or not and whether the company is paying income-tax in Mauritius

or not and this function of the Income-tax Officer is quasi-judicial.

Any attempt by the CBDT to interfere with the exercise of this

quasi-judicial power is contrary to intendment of the Income-tax

Act.

(D) Conclusiveness of a certificate of residence issued by the

Mauritius Tax Authorities is neither contemplated under the

DTAC, nor under the Income-tax Act; whether a statement is

conclusive or not, must be provided under a legislative enactment

such as the Indian Evidence Act and cannot be determined by a

mere circular issued by the CBDT;

(E) "Treaty Shopping", by which the resident of a third country

takes advantage of the provisions of the Agreement, is illegal and

thus necessarily forbidden;

(F) Section 119 of the Income-tax Act, 1961 enables the

issuance of a circular for a strictly limited purpose. By a circular

issued thereunder, neither can the essential legislative function be

delegated, nor arbitrary, uncanalized or naked power be conferred;

(G) Political expediency cannot be a ground for not fulfilling the

constitutional obligations inherent in the Constitution of India and

reflected in section 90 of the Act. The circular confers power to

lay down a law which is not contemplated under the Act on the

ground of political expediency, which cannot but be ultra vires.

(H) Any purpose other than the purpose contemplated by section

90 of the Act, however bona fide it be, would be ultra vires the

provisions of section 90 of the Income tax Act.

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(I) While political expediency will have a role to play in terms

of Article 73 of the Constitution, the same is not true when a

Treaty is entered into under the statutory provision like section 90

of the Act.

(J) Avoidance of double taxation is a term of art and means that

a person has to pay tax at least in one country; avoidance of double

taxation would not mean that a person does not have to pay tax in

any country whatsoever.

(K) Having regard to the law laid down by the Supreme Court in

McDowell & Company v C.T.O , it is open to the Income-tax

Officer in a given case to lift the corporate veil for finding out

whether the purpose of the corporate veil is avoidance of tax or

not. It is one of the functions of the assessing officer to ensure that

there is no conscious avoidance of tax by an assessee, and such

function being quasi-judicial in nature, cannot be interfered with or

prohibited. The impugned circular is ultra vires as it interferes with

this quasi judicial function of the assessing officer.

(L) By reason of the impugned circular the power of the

assessing authority to pass appropriate orders in this connection to

show that the assessee is a resident of a third country having only

paper existence in Mauritius, without any economic impact, only

with a view to take advantage of the double taxation avoidance

agreement, has been taken away.

THE SUBMISSIONS

The learned Attorney General and Mr. Salve, for the

appellants, have assailed the judgment of the Delhi High Court on

a number of grounds, while the respondents through Mr.Bhushan,

and in person, reiterated their submissions made before the High

Court and prayed for dismissal of these appeals.

Purpose and consequence of Double Taxation Avoidance

Convention

To appreciate the contentions urged, it would be necessary

to understand the purpose and necessity of a Double Taxation

Treaty, Convention or Agreement, as diversely called. The

Income-tax Act, 1961, contains a special Chapter IX which is

devoted to the subject of 'Double Taxation Relief".

Section 90, with which we are primarily concerned, provides

as under:

"90. Agreement with foreign countries.

(1) The Central Government may enter

into an agreement with the Government of any

country outside India-

(a) for the granting of relief in respect of

income on which have been paid both income-

tax under this Act and income-tax in that

country, or

(b) for the avoidance of double taxation

of income under this Act and under the

corresponding law in force in that country, 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

investigation of cases of such evasion or

avoidance, or

(d) for recovery of income-tax under this

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Act and under the corresponding law in force in

that country,

and may, by notification in the Official Gazette,

make provisions as may be necessary for

implementing the agreement.

(2) Where the Central Government has

entered into an agreement with the Government

of any country outside India under sub-section

(1) for granting relief of tax, or as the case may

be, avoidance of double taxation, then, in

relation to the assessee to whom such

agreement applies, the provisions of this Act

shall apply to the extent they are more

beneficial to that assessee."

(Explanation omitted as not relevant)

Section 4 provides for Charge of Income-tax. Section 5

provides that the total income of a resident includes all income

which : (a) is received, deemed to be received in India or (b)

accrues, arises or deemed to accrue or arise in India, or (c) accrues

or arises outside India, during the previous year. In the case of a

non-resident, the total income includes "all income from whatever

source derived" which (a) is received or is deemed to be received

or, (b) accrues or is deemed to accrue in India, during such year. A

person 'resident' in India would be liable to income-tax on the

basis of his global income unless he is a person who is 'not

ordinarily' resident within the meaning of section 6(b). The

concept of residence in India is indicated in section 6. Speaking

broadly, and with reference to a company, which is of concern

here, a company is said to be 'resident' in India in any previous

year, if it is an Indian company or if during that year the control

and management of its affairs is situated wholly in India.

Every country seeks to tax the income generated within its

territory on the basis of one or more connecting factors such as

location of the source, residence of the taxable entity, maintenance

of a permanent establishment, and so on. A country might choose

to emphasise one or the other of the aforesaid factors for exercising

fiscal jurisdiction to tax the entity. Depending on which of the

factors is considered to be the connecting factor in different

countries, the same income of the same entity might become liable

to taxation in different countries. This would give rise to harsh

consequences and impair economic development. In order to

avoid such an anomalous and incongruous situation, the

Governments of different countries enter into bilateral treaties,

Conventions or agreements for granting relief against double

taxation. Such treaties, conventions or agreements are called

double taxation avoidance treaties, conventions or agreements.

The power of entering into a treaty is an inherent part of the

sovereign power of the State. By article 73, subject to the

provisions of the Constitution, the executive power of the Union

extends to the matters with respect to which the Parliament has

power to make laws. Our Constitution makes no provision making

legislation a condition for the entry into an international treaty in

time either of war or peace. The executive power of the Union is

vested in the President and is exercisable in accordance with the

Constitution. The Executive is qua the State competent to represent

the State in all matters international and may by agreement,

convention or treaty incur obligations which in international law

are binding upon the State. But the obligations arising under the

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agreement or treaties are not by their own force binding upon

Indian nationals. The power to legislate in respect of treaties lies

with the Parliament under entries 10 and 14 of List I of the Seventh

Schedule. But making of law under that authority is necessary

when the treaty or agreement operates to restrict the rights of

citizens or others or modifies the law of the State. If the rights of

the citizens or others which are justiciable are not affected, no

legislative measure is needed to give effect to the agreement or

treaty.

When it comes to fiscal treaties dealing with double

taxation avoidance, different countries have varying procedures.

In the United States such a treaty becomes a part of municipal law

upon ratification by the Senate. In the United Kingdom such a

treaty would have to be endorsed by an order made by the Queen

in Council. Since in India such a treaty would have to be

translated into an Act of Parliament, a procedure which would be

time consuming and cumbersome, a special procedure was evolved

by enacting section 90 of the Act.

The purpose of section 90 becomes clear by reference to its

legislative history. Section 49A of the Income-tax Act, 1922

enabled the Central Government to enter into an agreement with

the government of any country outside India for the granting of

relief in respect of income on which, both income-tax (including

super-tax) under the Act and income-tax in that country, under the

Income-tax Act and the corresponding law in force in that country,

had been paid. The Central Government could make such

provisions as necessary for implementing the agreement by

notification in the Official Gazette. When the Income-tax Act,

1961 was introduced, section 90 contained therein initially was a

reproduction of section 49A of 1922 Act. The Finance Act, 1972

(Act 16 of 1972) modified section 90 and brought it into force with

effect from 1.4.1972. The object and scope of the substitution was

explained by a circular of the Central Board of Taxes (No.108

dated 20.3.1973) as to empower the Central Government to enter

into agreements with foreign countries, not only for the purpose of

avoidance of double taxation of income, but also for enabling the

tax authorities to exchange information for the prevention of

evasion or avoidance of taxes on income or for investigation of

cases involving tax evasion or avoidance or for recovery of taxes

in foreign countries on a reciprocal basis. In 1991, the existing

section 90 was renumbered as sub-section(1) and sub-section(2)

was inserted by Finance Act, 1991 with retrospective effect from

April 1, 1972. CBDT Circular No. 621 dated 19.12.1991 explains

its purpose as follows:

"Taxation of foreign companies and other non-

resident taxpayers -

43. Tax treaties generally contain a provision

to the effect that the laws of the two contracting

States will govern the taxation of income in the

respective State except when express provision

to the contrary is made in the treaty. It may so

happen that the tax treaty with a foreign country

may contain a provision giving concessional

treatment to any income as compared to the

position under the Indian law existing at that

point of time. However, the Indian law may

subsequently be amended, reducing the

incidence of tax to a level lower than what has

been provided in the tax treaty.

43.1. Since the tax treaties are intended to

grant tax relief and not put residents of a

contracting country at a disadvantage vis-à-vis

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other taxpayers, section 90 of the Income-tax

Act has been amended to clarify that any

beneficial provision in the law will not be

denied to a resident of a contracting country

merely because the corresponding provision in

the tax treaty is less beneficial."

The provisions of Sections 4 and 5 of the Act are expressly

made "subject to the provisions of this Act", which would include

Section 90 of the Act. As to what would happen in the event of a

conflict between the provision of the Income-tax Act and a

Notification issued under Section 90, is no longer res-integra.

The Andhra Pradesh High Court in Commissioner of

Income Tax v. Visakhapatnam Port Trust held that provisions of

section 4 and 5 of Income-tax Act are expressly made 'subject to

the provisions of the Act' which means that they are subject to

provisions of section 90. By necessary implication, they are

subject to the terms of the Double Taxation Avoidance Agreement,

if any, entered into by the Government of India. Therefore, the

total income specified in Sections 4 and 5 chargeable to income

tax is also subject to the provisions of the agreement to the

contrary, if any.

In Commissioner of Income Tax v. Davy Ashmore India

Ltd. , while dealing with the correctness of a circular no.333 dated

April 2, 1982, it was held that the conclusion is inescapable that in

case of inconsistency between the terms of the Agreement and the

taxation statute, the Agreement alone would prevail. The Calcutta

High Court expressly approved the correctness of the CBDT

circular No.333 dated April 2, 1982 on the question as to what the

assessing officers would have to do when they found that the

provision of the Double Taxation was not in conformity with the

Income-tax Act, 1961. The said circular provided as follows

(quoted at p.632):

"The correct legal position is 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. In fact

the Double Taxation Avoidance Agreements

which have been entered into by the Central

Government under section 90 of the Income-tax

Act, 1961, also provide that the laws in force in

either country will continue to govern the

assessment and taxation of income in the

respective country except where provisions to

the contrary have been made in the Agreement.

Thus, where a Double Taxation Avoidance

Agreement provided for a particular mode of

computation of income, the same should be

followed, irrespective of the provisions in the

Income-tax Act. Where there is no specific

provision in the Agreement, it is the basic law,

i.e, the Income-tax Act, that will govern the

taxation of income."

The Calcutta High Court held that the circular reflected the

correct legal position inasmuch as the convention or agreement is

arrived at by the two Contracting States "in deviation from the

general principles of taxation applicable to the Contracting States".

Otherwise, the double taxation avoidance agreement will have no

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meaning at all.

In Commissioner of Income Tax v. R.M. Muthaiah the

Karnataka High Court was concerned with the DTAT between

Government of India and Government of Malaysia. The High

Court held that under the terms of agreement, if there was a

recognition of the power of taxation with the Malaysian

Government, by implication it takes away the corresponding

power of the Indian Government. The Agreement was thus held to

operate as a bar on the power of the Indian Government to tax and

that the bar would operate on Sections 4 and 5 of the Income Tax

Act, 1961, and take away the power of the Indian Government to

levy tax on the income in respect of certain categories as referred

to in certain Articles of the Agreement. The High Court summed

up the situation by observing (at p.512-513):

"The effect of an "agreement" entered into by

virtue of section 90 of the Act would be : (1) If

no tax liability is imposed under this Act, the

question of resorting to the agreement would not

arise. No provision of the agreement can

possibly fasten a tax liability where the liability

is not imposed by this Act; (ii) if a tax liability is

imposed by this Act, the agreement may be

resorted to for negativing or reducing it; (iii) in

case of difference between the provisions of the

Act and of the agreement, the provisions of the

agreement prevail over the provisions of this

Act and can be enforced by the appellate

authorities and the court."

It also approved of the correctness of the Circular No. 333

dated April 2, 1982 issued by the Central Board of Direct Taxes on

the subject.

In Arabian Express Line Ltd. of United Kingdom and Others

v. Union of India the Gujarat High Court, interpreting section 90,

in the light of circular No.333 dated April 2, 1982 issued by the

CBDT, held that the procedure of assessing the income of a NRI

because of his occasional activities in establishing business in

India would not be applicable in a case where there is a convention

between the Government of India and the foreign country as

provided under Section 90 of the Income-tax Act, 1961. In case of

such an agreement, section 90 would have an overriding effect.

Interestingly, in this case a certificate issued by the H.M. Inspector

of Taxes certifying that the company was a resident of the United

Kingdom for purposes of tax and that it had paid advance

corporate tax in the office of the English Revenue Accounts

Office, was held to be sufficient to take away the jurisdiction of the

Income-tax Officer.

A survey of the aforesaid cases makes it clear that the

judicial consensus in India has been that section 90 is specifically

intended to enable and empower the Central Government to issue a

notification for implementation of the terms of a double taxation

avoidance agreement. When that happens, the provisions of such

an agreement, with respect to cases to which where they apply,

would operate even if inconsistent with the provisions of the

Income-tax Act. We approve of the reasoning in the decisions

which we have noticed. If it was not the intention of the legislature

to make a departure from the general principle of chargeability to

tax under section 4 and the general principle of ascertainment of

total income under section 5 of the Act, then there was no purpose

in making those sections "subject to the provisions" of the Act".

The very object of grafting the said two sections with the said

clause is to enable the Central Government to issue a notification

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under section 90 towards implementation of the terms of the DTAs

which would automatically override the provisions of the Income-

tax Act in the matter of ascertainment of chargeability to income

tax and ascertainment of total income, to the extent of

inconsistency with the terms of the DTAC.

The contention of the respondents, which weighed with the

High Court viz. that the impugned circular No.789 is inconsistent

with the provisions of the Act, is a total non-sequitur. As we have

pointed out, Circular No.789 is a circular within the meaning of

section 90; therefore, it must have the legal consequences

contemplated by sub-section (2) of section 90. In other words, the

circular shall prevail even if inconsistent with the provisions of

Income-tax Act, 1961 insofar as assessees covered by the

provisions of the DTAC are concerned.

Though a number of interconnected and diffused arguments

were addressed, broadly the argument of the respondents appears

to be as follows: By reason of Article 265 of the Constitution, no

tax can be levied or collected except by authority of law. The

authority to levy tax or grant exemption therefrom vests absolutely

in the Parliament and no other body, howsoever high, can exercise

such power. Once Parliament has enacted the Income-tax Act,

taxes must be levied and collected in accordance therewith and no

person has power to grant any exemption therefrom. The treaty

making power under Article 73 is confined only to such matters as

would not fall within the province of Article 265. With respect to

fiscal treaties, the contention is that they cannot be enforced in

contravention of the provisions of the Income-tax Act, unless

Parliament has made an enabling law in support. The respondents

highlighted the provisions of the OECD models with regard to tax

treaties and how tax treaties were enunciated, signed and

implemented in America, Britain and other countries. Placing

reliance on the observations of Kier and Lawson , it was

contended that in England it has been recognised that "there are,

however, two limits to its capacity; it cannot legislate and it

cannot tax without the concurrence of the Parliament". It is urged

that the situation is the same in India; that unless there is a specific

exemption granted by the Parliament, it is not open for the Central

Government to grant any exemption from the tax payable under the

Income-tax Act.

In our view, the contention is wholly misconceived.

Section 90, as we have already noticed (including its precursor

under the 1922 Act), was brought on the statute book precisely to

enable the executive to negotiate a DTAC and quickly implement

it. Even accepting the contention of the respondents that the

powers exercised by the Central Government under section 90 are

delegated powers of legislation, we are unable to see as to why a

delegatee of legislative power in all cases has no power to grant

exemption. There are provisions galore in statutes made by

Parliament and State legislatures wherein the power of conditional

or unconditional exemption from the provisions of the statutes are

expressly delegated to the executive. For example, even in fiscal

legislation like the Central Excise Act and Sales Tax Act, there are

provisions for exemption from the levy of tax. Therefore we are

unable to accept the contention that the delegate of a legislative

power cannot exercise the power of exemption in a fiscal statute.

The niceties of the OECD model of tax treaties or the report

of the Joint Parliamentary Committee on the State Market Scam

and Matters Relating thereto, on which considerable time was

spent by Mr. Jha, who appeared in person, need not detain us for

too long, though we shall advert to them later. This Court is not

concerned with the manner in which tax treaties are negotiated or

enunciated; nor is it concerned with the wisdom of any particular

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treaty. Whether the Indo-Mauritius DTAC ought to have been

enunciated in the present form, or in any other particular form, is

none of our concern. Whether section 90 ought to have been

placed on the statute book, is also not our concern. Section 90,

which delegates powers to the Central Government, has not been

challenged before us, and, therefore, we must proceed on the

footing that the section is constitutionally valid. The challenge

being only to the exercise of the power emanating from the section,

we are of the view that section 90 enables the Central Government

to enter into a DTAC with the foreign Government. When the

requisite notification has been issued thereunder, the provisions of

sub-section (2) of section 90 spring into operation and an assessee

who is covered by the provisions of the DTAC is entitled to seek

benefits thereunder, even if the provisions of the DTAC are

inconsistent with the provisions of Income-tax Act, 1961.

STARE DECISIS

The learned Attorney General justifiably relied on the

observations of this Court in Mishri Lal v. Dhirendra Nath (Dead)

by Lrs. and Others in which this Court referred to its earlier

decision in Muktul v. Manbhari on the scope of the doctrine of

stare decisis with reference to Halsbury's Law of England and

Corpus Juris Secundum, pointing out that a decision which has

been followed for a long period of time, and has been acted upon

by persons in the formation of contracts or in the disposition of

their property, or in the general conduct of affairs, or in legal

procedure or in other ways, will generally be followed by courts of

higher authority other than the court establishing the rule, even

though the court before whom the matter arises afterwards might

be of a different view. The learned Attorney General contended

that the interpretation given to section 90 of the Income-tax Act, a

Central Act, by several High Courts without dissent has been

uniformally followed; several transactions have been entered into

based upon the said exposition of the law; that several tax treaties

have been entered into with different foreign Governments based

upon this law, hence, the doctrine of stare decisis should apply or

else it will result in chaos and open up a Pandora's box of

uncertainty.

We think that this submission is sound and needs to be

accepted. It is not possible for us to say that the judgments of the

different High Courts noticed have been wrongly decided by

reason of the arguments presented by the respondents. As

observed in Mishrilal even if the High Courts have

consistently taken an erroneous view, (though we do not say that

the view is erroneous) it would be worthwhile to let the matter rest,

since large numbers of parties have modulated their legal

relationship based on this settled position of law.

Effect of circular under Section 119

Much of the argument centred around the effect of the

circular issued by the CBDT under Section 119 of the Act and its

binding nature.

Section 119, strategically placed in Chapter XIII which deals

with 'Income-Tax Authorities' is an enabling power of the

CBDT, which is recognised as an authority under the Income-tax

Act under section 116(a). The CBDT under this section is

empowered to issue such orders instructions and directions to

other income-tax authorities "as it may deem fit for proper

administration of this Act". Such authorities and all other persons

employed in the execution of this Act are bound to observe and

follow such orders, instructions and directions of the CBDT. The

proviso to sub-section (1) of section 119 recognises two

exceptions to this power. First, that the CBDT cannot require any

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income-tax authority to make a particular assessment or to dispose

of a particular case in a particular manner. Second, is with regard

to interference with the discretion of the Commissioner (Appeals)

in exercise of his appellate functions. Sub-section(2) of Section

119 provides for the exercise of power in certain special cases and

enables the CBDT, if it considers it necessary or expedient so to

do for the purpose of proper and efficient 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. The powers of the CBDT

are wide enough to enable it to grant relaxation from the provisions

of several sections enumerated in clause (a). Such orders may be

published in the Official Gazette in the prescribed manner, if the

CBDT is of the opinion that it is so necessary. The only bar on the

exercise of power is that it is not prejudicial to the assessee. We

are not concerned with the provisions in clauses (b) and (c) in the

present appeals.

In K.P. Varghese v. Income-Tax Officer, Ernakulam it was

pointed out by this Court that not only are the circulars and

instructions, issued by the CBDT in exercise of the power under

section 119, binding on the authorities administering the tax

department, but they are also clearly in the nature of

contemporanea expositio furnishing legitimate aid to the

construction of the Act.

The Rule of contemporanea expositio is that

"administrative construction (i.e. contemporaneous construction

placed by administrative or executive officers) generally should be

clearly wrong before it is overturned; such a construction

commonly referred to as practical construction, although non-

controlling, is nevertheless entitled to considerable weight, it is

highly persuasive."

The validity of this principle was recognised in Baleshwar

Bagarti v. Bhagirathi Dass where the Calcutta High Court stated

the rule in the following words :

"It is a well-settled principle of

interpretation that courts in construing a statute

will give much weight to the interpretation put

upon it, at the time of its enactment and since,

by those whose duty it has been to construe,

execute and apply it."

The statement of this rule has also been quoted with

approval by this Court in Deshbandhu Gupta & Company v. Delhi

Stock Exchange Association Ltd .

In K.P. Varghese this Court held that the circulars of the

CBDT issued in exercise of its power under section 119 are

legally binding on the revenue and that this binding character

attaches to the circulars "even if they be found not in accordance

with the correct interpretation of sub-section (2) and they depart

or deviate from such construction."

Navnit Lal C. Javeri v. K.K.Sen and Ellerman Lines Ltd. v.

CIT clearly establish the principle that circulars issued by the

CBDT under section 119 of the Act are binding on all officers and

employees employed in the execution of the Act, even if they

deviate from the provisions of the Act.

In UCO Bank v. Commissioner of Incom-Tax , dealing

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with the legal status of such circulars, this Court observed:

"Such instructions may be by way of relaxation

of any of the provisions of the sections

specified there or otherwise. The Board thus

has power, inter alia, to tone down the rigour of

the law and ensure a fair enforcement of its

provisions, by issuing circulars in exercise of

its statutory powers under section 119 of the

Income-tax Act which are binding on the

authorities in the administration of the Act.

Under section 119(2) however, the circulars as

contemplated therein cannot be adverse to the

assessee. Thus the authority which wields the

power for its own advantage under the Act is

given the right to forgo the advantage when

required to wield it in a manner it considers just

by relaxing the rigour of the law or in other

permissible manners as laid down in section

119. The power is given for the purpose of

just, proper and efficient management of the

work of assessment and in public interest. It is a

beneficial power given to the Board for proper

administration of fiscal law so that undue

hardship may not be caused to the assessee and

the fiscal laws may be correctly applied. Hard

cases which can be properly categorised as

belonging to a class, can thus be given the

benefit of relaxation of law by issuing circulars

binding on the taxing authorities."

In Commissioner of Income-Tax v. Anjum M.H.Ghaswala

and Others it was 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.

In Collector of Central Excise Vadodra v. Dhiren Chemical

Industries , this Court, interpreting the phrase 'appropriate',

observed :

"We need to make it clear that, regardless of

the interpretation that we have placed on the

said phrase, if there are circulars which have

been issued by the Central Board of Excise and

Customs which place a different interpretation

upon the said phrase, that interpretation will be

binding upon the Revenue."

While commenting adversely upon the validity of the

impugned circular, the High Court says "that the circular itself

does not show that the same has been issued under Section 119 of

the Income-tax Act. Only in a case where the circular is issued

under Section 119 of the Income-tax Act, the same would be

legally binding on the revenue. The circular does not deal with the

power of the ITO to consider the question as to whether although

apparently a company is incorporated in Mauritius but whether the

company is also a resident of India and/or not a resident of

Mauritius at all." It is trite law that as long as an authority has

power, which is traceable to a source, the mere fact that source of

power is not indicated in an instrument does not render the

instrument invalid.

Is the impugned circular ultra-vires Section 119 ?

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It was contended successfully before the High Court that the

circular is ultra vires the provisions of section 119. Sub-section(1)

of section 119 is deliberately worded in general manner so that the

CBDT is enabled to issue appropriate orders, instruction or

direction to the subordinate authorities "as it may deem fit for the

proper administration of the Act". As long as the circular emanates

from the CBDT and contains orders, instructions or directions

pertaining to proper administration of the Act, it is relatable to the

source of power under section 119 irrespective of its nomenclature.

Apart from sub-section(1), sub-section(2) of section 119 also

enables the CBDT "for the purpose of proper and efficient

management of the work of assessment and collection of revenue,

to issue appropriate orders, general or special in respect of any

class of income or class of cases, setting forth directions or

instructions (not being prejudicial to assessees) as to the

guidelines, principles or procedures to be followed by other

income tax authorities in the work relating to assessment or

collection of revenue or the initiation of proceedings for the

imposition of penalties". In our view, the High Court was not

justified in reading the circular as not complying with the

provisions of section 119. The circular falls well within the

parameters of the powers exercisable by the CBDT under Section

119 of the Act.

The High Court persuaded itself to hold that the circular is

ultra vires the powers of the CBDT on completely erroneous

grounds. 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. Accordingly, FIIs 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. This, the High Court thought amounts to

issuing instructions "de hors the provisions of the Act".

In our view, this thinking of the High Court is erroneous.

The only restriction on the power of the CBDT is to prevent it

from interfering with the course of assessment of any particular

assessee or the discretion of the Commissioner of Income-Tax

(Appeals). It would be useful to recall the background against

which this circular was issued.

The Income-tax authorities were seeking to examine as to

whether the assessees were actually residents of a third country on

the basis of alleged control of management therefrom.

We have already extracted the relevant provisions of Article

4 which provide that, for the purposes of the agreement, the term

'resident of a contracting State' means any person who under the

laws of that State is liable to taxation therein by reason of his

domicile, residence, place of management or any other criterion of

similar nature. The term 'resident of India' and 'the resident of

Mauritius' are to be construed accordingly. Article 13 of the

DTAC lays down detailed rules with regard to taxation of capital

gains. As far as capital gains resulting from alienation of shares are

concerned, Article 13(4) provides that the gains derived by a

'resident' of a contracting State shall be taxable only in that State.

In the instant case, such capital gains derived by a resident of

Mauritius shall be taxable only in Mauritius. Article 4, which we

have already referred to, declares that the term resident of

Mauritius' means any person who under the laws of Mauritius is

'liable to taxation' therein by reason, inter alia, of his residence.

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Clause (2) of Article 4 enumerates detailed rules as to how the

residential status of an individual resident in both contracting

States has to be determined for the purposes of DTAC. Clause(3)

of Article 4 provides that if, after application of the detailed rules

provided in Article 4, it is found that a person other than an

individual is a resident of both the contracting States, then it shall

be deemed to be a resident of the contracting State in which its

place of effective management is situated. The DTAC requires the

test of 'place of effective management' to be applied only for the

purposes of the tie-breaker clause in Article 4(3) which could be

applied only when it is found that a person other than an individual

is a resident both of India and Mauritius. We see no purpose or

justification in the DTAC for application of this test in any other

situation.

The High Court has held, and the respondents so contend,

that the assessing officer under the Income-tax Act is entitled to lift

the corporate veil, but the circular effectively bars the exercise of

this quasi-judicial function by reason of a presumption with regard

to the certificate issued by the competent authority in Mauritius;

conclusiveness of such a certificate of residence granted by the

Mauritius tax authorities is neither contemplated under the DTAC,

nor under the Income-tax Act a provision as to conclusiveness of a

certificate is a matter of legislative action and cannot form the

subject matter of a circular issued by a delegate of legislative

power.

As early as on March 30, 1994, the CBDT had issued

circular no.682 in which it had been emphasised that any resident

of Mauritius deriving income from alienation of shares of an

Indian company would be liable to capital gains tax only in

Mauritius as per Mauritius tax law and would not have any capital

gains tax liability in India. This circular was a clear enunciation of

the provisions contained in the DTAC, which would have

overriding effect over the provisions of sections 4 and 5 of the

Income-tax Act,1961 by virtue of section 90(1) of the Act. If, in

the teeth of this clarification, the assessing officers chose to ignore

the guidelines and spent their time, talent and energy on

inconsequtial matters, we think that the CBDT was justified in

issuing 'appropriate' directions vide circular no.789, under its

powers under section 119, to set things on course by eliminating

avoidable wastage of time, talent and energy of the assessing

officers discharging the onerous public duty of collection of

revenue. The circular no.789 does not in any way crib, cabin or

confine the powers of the assessing officer with regard to any

particular assessment. It merely formulates broad guidelines to be

applied in the matter of assessment of assessees covered by the

provisions of the DTAC.

We do not think the circular in any way takes away or

curtails the jurisdiction of the assessing officer to assess the

income of the assessee before him. In our view, therefore, it is

erroneous to say that the impugned circular No.789 dated

13.4.2000 is ultra vires the provisions of section 119 of the Act.

In our judgment, the powers conferred upon the CBDT by sub-

sections (1) and (2) of Section 119 are wide enough to

accommodate such a circular.

Is the DTAC bad for excessive delegation ?

The respondents contend that a tax treaty entered into

within the umbrella of section 90 of the Act is essentially delegated

legislation; if it involves granting of exemption from tax, it would

amount to delegation of legislative powers, which is bad. The

legislature must declare the policy of the law and the legal principles

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which are to control any given case and must provide a procedure to

execute the law.

The question whether a particular delegated legislation is in

excess of the power of the supporting legislation conferred on the

delegate, has to be determined with regard not only to specific

provisions contained in the relevant statute conferring the power to

make rule or regulation, but also the object and purpose of the Act as

can be gathered from the various provisions of the enactment. It

would be wholly wrong for the Court to substitute its own opinion as

to what principle or policy would best serve the objects and purposes

of the Act, nor is it open to the Court to sit in judgment of the

wisdom, the effectiveness or otherwise of the policy, so as to declare

a regulation to be ultra vires merely on the ground that, in the view of

the Court, the impugned provision will not help to carry through the

object and purposes of the Act. This court reiterated the legal

position, well established by a long series of decisions, in

Maharashtra State Board of Secondary and Higher Secondary

Education and another v. Paritosh Bhupeshkumar Sheth and Others :

"So long as the body entrusted with the task of

framing the rules or regulations acts within the

scope of the authority conferred on it, in the

sense that the rules or regulations made by it

have a rational nexus with the object and

purpose of the statute, the court should not

concern itself with the wisdom or

efficaciousness of such rules or regulations. It

is exclusively within the province of the

legislature and its delegate to determine, as a

matter of policy, how the provisions of the

statute can best be implemented and what

measures, substantive as well as procedural

would have to be incorporated in the rules or

regulations for the efficacious achievement of

the objects and purposes of the Act. It is not

for the Court to examine the merits or

demerits of such a policy because its scrutiny

has to be limited to the question as to whether

the impugned regulations fall within the

scope of the regulation-making power

conferred on the delegate by the statute."

Applying this test, we are unable to hold that the impugned

circular amounts to impermissible delegation of legislative power.

That the amendment made in section 90 was intended to empower

the Government to enter into agreement with foreign Government,

if necessary, for relief from or avoidance of double taxation, is also

made clear by the Finance Minister in his Budget Speech, 1953-54

Is the Double Taxation Avoidance Convention 'DTAC') illegal

and ultra vires the powers of the Central Government u/S 90

Although the High court has not made any finding of this

nature, the respondents have strenuously contended before us that

the Indo-Mauritius Double Taxation Avoidance Convention,

1983 is itself ultra vires the powers of the Government under

Section 90 of the Act. This argument deserves short shrift.

Section 90 empowers the Central Government to enter into

agreement with the Government of any other country outside India

for the purposes enumerated in clauses (a) to (d) of sub-section (1)

. While clause (a) talks of granting relief 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

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taxation of income' under the Act and under the corresponding

law in force in the foreign country. We are not concerned with

clauses (c) and (d).

There are two hurdles against accepting the arguments

presented on behalf of the respondents. Even if we accept the

argument of the respondent that the DTAC is delegated legislation,

the test of its validity is to be determined, not by its efficacy, but

by the fact that it is within the parameters of the legislative

provision delegating the power. That the purpose of the DTAC is

to effectuate the objectives in clauses (a) and (b) of sub-section (1)

of Section 90, is evident upon a reasonable construction of the

terms of the DTAC. As long as these two objectives are sought to

be effectuated, it is not possible to say that the power vested in the

Central Government, under section 90, even if it is delegated

power of legislation, has been used for a purpose ultra vires the

intendment of the section. The respondents tried to highlight a

number of unintended deleterious consequences which, according

to them, have arisen as a result of implementation of the DTAC.

Even if they be true, it would not enable this Court to strike down

the delegated legislation as ultra vires. The validity and the vires

of the legislation, primary, or delegated, has to be tested on the

anvil of the law making power. If an authority lacks the power,

then the legislation is bad. On the contrary, if the authority is

clothed with the requisite power, then irrespective of whether the

legislation fails in its object or not, the vires of the legislation is not

liable to be questioned. We are, therefore, unable to accept the

contention of the respondents that the DTAC is ultra vires the

powers of the Central Government under Section 90 on account of

its susceptibility to 'treaty shopping' on behalf of the residents of

third countries.

The High Court seems to have heavily relied on an

assessment order made by the assessing officer in the case of Cox

and Kings Ltd. drawing inspiration therefrom. We are afraid that it

was impermissible for the High Court to do so. An assessment

made in the case of a particular assessee is liable to be challenged

by the Revenue or by the assessee by the procedure available under

the Act. In a Public Interest Litigation it would be most unfair to

comment on the correctness of the assessment order made in the

case of a particular assessee, especially when the assessee is not a

party before the High Court. Any observation made by the Court

would result in prejudice to one or the other party to the litigation.

For this reason, we refrain from making any observations about the

correctness or otherwise of the assessment order made in Cox and

Kings Ltd. Needless to say, we decline to draw inspiration

therefrom, for our inspiration is drawn from principles of law as

gathered from statutes and precedents.

What is "liable to taxation"

Fiscal Residence

The concept of 'fiscal residence' of a company assumes

importance in the application and interpretation of double taxation

avoidance treaties.

In Cahiers De Droit Fiscal International it is said that

under the OECD and UNO Model Convention, 'fiscal residence' is

a place where a person amongst others a corporation is subjected to

unlimited fiscal liability and subjected to taxation for the

worldwide profit of the resident company. At para 2.2 it is

pointed out :

"The UNO Model Convention takes these two

different concepts into account. It has not

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embodied the second sentence of article 4,

paragraph 1 of the OECD Model Convention,

which provides that the term 'resident' does

not include any person who is liable to tax in

that State in respect only of income from

sources in that State. In fact, if one adhered to

a strict interpretation of this text, there would

be no resident in the meaning of the

convention in those States that apply the

principle of territoriality."

Again in paragraph 3.5 it is said :

"The existence of a company from a company

law standpoint is usually determined under

the law of the State of incorporation or of the

country where the real seat is located. On the

other hand, the tax status of a corporation is

determined under the law of each of the

countries where it carries on business, be it as

resident or non-resident."

In paragraph 4.1 it is observed that the principle of

universality of taxation i.e. the principle of worldwide taxation,

has been adopted by a majority of States. One has to consider the

worldwide income of a company to determine its taxable profit. In

this system it is crucial to define the fiscal residence of a company

very accurately. The State of residence is the one entitled to levy

tax on the corporation's worldwide profit. The company is subject

to unlimited fiscal liability in that State. In the case of a company,

however, several factors enter the picture and render the decision

difficult. First, the company is necessarily incorporated and

usually registered under the tax law of a State that grants it

corporate status. A corporation has administrative activities,

directors and managers who reside, meet and take decisions in

one or several places. It has activities and carries on business.

Finally, it has shareholders who control it. Hence, it is opined :

"When all these elements coexist in the same

country, no complications arise. As soon as

they are dissociated and "scattered" in

different States, each country may want to

subject the company to taxation on the basis

of an element to which it gives preference;

incorporation procedure, management

functions, running of the business,

shareholders' controlling power. Depending

on the criterion adopted, fiscal residence will

abide in one or the other country.

All the European countries concerned, except

France, levy tax on the worldwide profit at the

place of residence of the company

considered.

South Korea, India and Japan in Asia,

Australia and New Zealand in Oceania follow

this principle."

In paragraph 4.2.1 it is pointed out that the Anglo-Saxon

concept of a company's 'incorporation test', which is applied in

the United States, has not been adopted by other countries like

Australia, Canada, Denmark, New Zealand and India and instead

the criterion of incorporation amongst other tests has been adopted

by them.

The judgment in Ingemar Johansson et al v. United State of

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America , on which the respondent place reliance, is easily

distinguishable. In this case the appellant, Johansson, was a citizen

of Switzerland and a heavyweight boxing champion by profession.

He had earned some money by boxing in the United States for

which he was called upon to pay tax. Johansson floated a company

in Switzerland of which he became an employee and contended

that all professional fee paid for his boxing bouts were received by

his employer company in Switzerland for which he was

remunerated as an employee of the said company. He sought to

take advantage of the DTAT between USA and Switzerland which

provided "an individual resident of Switzerland shall be exempt

from United States Tax upon compensation for labour personal

services performed in the United States.... if he is temporarily

present in the United States for a period or periods not exceeding a

total of 183 during the taxable year..." There was no doubt that

the appellant was not present in the United States for more than

183 days and that he had floated the Swiss company motivated

with the desire to minimise his tax burden. As conclusive proof of

residence he relied upon a determination by the Swiss Tax

Authority that he had become a resident of Switzerland on a

particular date. The United States Court of Appeal rejected the

claim of the appellant pointing out that the term "resident" had not

been defined in the US-Swiss treaty, but under article II(2) each

country was authorised to apply its own definition to terms not

expressly defined 'unless the context otherwise requires'. The

Court, therefore, held that the determination of the appellant's

residence statues by the Swiss tax authority, according to Swiss

law, was not conclusive and that the U.S. tax authorities were

entitled to decide it in accordance with the US laws under the

treaty. Hence, it was held that Johansson was not a resident of

Switzerland during the period in question and that the tax

exemption in the treaty was not available to him.

In our view, this judgment, though relied upon very heavily

by the respondents, is of no avail. The Indo-Mauritius DTAC,

Article 3, clearly defines the term 'residence' in a 'Contracting

State'. Interestingly, even in this judgment, the Court observed :

"Of course, the fact that Johansson was motivated in his actions by

the desire to minimize his tax burden can in no way be taken to

deprive him of an exemption to which an applicable treaty entitles

him", which will have some relevance to the contention of the

respondents with regard to the motivation to avoid tax.

The respondents contend that the FIIs incorporated and

registered under the provisions of the law in Mauritius are carrying

on no business there; they are, in fact, prevented from earning any

income there; they are not liable to income tax on capital gains

under the Mauritius Income-tax Act. They are liable to pay

income-tax under Indian Income-tax Act, 1961, since they do not

pay any income-tax on capital gains in Mauritius, hence, they are

not entitled to the benefit of avoidance of double taxation under the

DTAC.

Some of the assumptions underlying this contention, which

prevailed with the High Court, need greater critical appraisal.

Article 13(4) of the DTAC provides that gains derived by a

resident of a Contracting State from alienation of any property,

other than those specified in the paragraphs 1, 2 and 3 of the

Article, shall be taxable only in that State. Since most of the

arguments centred around capital gains made on transactions in

shares on the stock exchange in India, we may leave out of

consideration capital gains on the type of properties contemplated

in paras 1, 2 and 3 of Article 13 of the DTAC. The residuary clause

in para 4 of Article 13 is relevant. It provides that capital gains

made on sale of shares shall be taxable only in the State of which

the person is a 'resident' taking us back to the meaning of the term

'resident' of a contracting State. According to Article 4, this

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expression means any person who under the laws of that State is

"liable to taxation" therein by reason of his domicile, residence,

place of management or any other criterion of a similar nature.

The terms 'resident of India' and 'resident of Mauritius' are

required to be construed accordingly. This takes us to the test to

determine when a company is 'liable to taxation' in Mauritius.

Mauritian Income Tax Act, 1995

Section 4 of the Income Tax Act, 1995 (Mauritian Income-

tax Act) provides that, subject to the provisions of the Act, income-

tax shall be paid to the Commissioner of Income-tax by every

person on all income other than exempt income derived by him

during the preceding year and be calculated on the chargeable

income of the person at the appropriate rate specified in the First

Schedule.

Section 5 defines as to when income is deemed to be

derived.

Section 7 provides that the income specified in the Second

Schedule shall be exempt from income-tax.

Part IV of the Mauritian Income Tax Act deals with

Corporate Taxation.

Section 44 of the Act provides that every company shall be

liable to income tax on its 'chargeable income' at the rate specified

in Part II, Part III or Part IV of the First Schedule, as the case may

be.

Section 51 defines the 'gross income' of a company as

inclusive of income referred to in section 10(1)(b) (income derived

from business), 10(1)(c) (any income from rent, premium or other

income derived from property), 10(1)(d) (any dividend, interest,

charges, annuity or pension other than a pension referred to in

paragraph a(ii)) and 10(1)(e) (any other income derived from any

other source).

Section 73 (b) provides that for the purposes of the Act the

expression 'resident', when applied to a 'company', means a

company which is incorporated in Mauritius or has its central

management and control in Mauritius.

Part II of the First Schedule prescribes the rate of tax on

chargeable income at 15% in the case of Tax Incentive companies

and at other rates for other types of companies. Part V of the First

schedule enumerates the list of tax incentive companies and item

16 is : "a corporation certified to be engaged in international

business activity by the Mauritius Offshore Business Activities

Authority established under the Mauritius Offshore Business

Activities Act, 1992". The second Schedule to the Mauritius

Income-tax Act in Part IV enumerates miscellaneous income

exempt from income-tax. Item 1 reads "gains or profits derived

from the sale of units or of securities quoted on the Official List

or on such Stock Exchanges or other exchanges and capital

markets as may be approved by the Minister".

A perusal of the aforesaid provisions of the Income Tax Act

in Mauritius does not lead to the result that tax incentive

companies are not liable to taxation, although they have been

granted exemption from income-tax in respect of a specified head

of income, namely, gains from transactions in shares and

securities. The respondents contend that the FIIs are not "liable to

taxation" in Mauritius; hence they are not 'residents' of Mauritius

within the meaning of Article 4 of the DTAC. Consequently, it is

open to the assessing officers under the Indian Income-tax Act,

1961 to determine where the taxable entities are really resident by

investigating the centre of their management and thereafter to

apply the provisions of Income-tax Act, 1961 to the global income

earned by them by reason of sections 4 and 5 of the Income-tax

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Act, 1961.

It is urged by the learned Attorney General and Shri Salve

for the appellants that the phrase 'liable to taxation' is not the same

as 'pays tax'. The test of liability for taxation is not to be

determined on the basis of an exemption granted in respect of any

particular source of income, but by taking into consideration the

totality of the provisions of the income-tax law that prevails in

either of the Contracting States. Merely because, at a given time,

there may be an exemption from income-tax in respect of any

particular head of income, it cannot be contended that the taxable

entity is not liable to taxation. They urge that upon a proper

construction of the provisions of Mauritian Income Tax Act it is

clear that the FIIs incorporated under Mauritius laws are liable to

taxation; therefore, they are 'residents' in Mauritius within the

meaning of the DTAC.

For the appellants reliance is placed on the judgment of this

Court in Wallace Flour Mills Contracting State. Ltd. v. Collector

of Central Excise, Bombay Division II , a case under the Central

Excise Act. This Court held that though the taxable event for levy

of excise duty is the manufacture or production, the realisation of

the duty my be postponed for administrative convenience to the

date of removal of the goods from the factory. It was held that

excisable goods do not become non-excisable merely because of

an exemption given under a notification. The exemption merely

prevents the excise authorities from collecting tax when the

exemption is in operation.

In Kasinka Trading and Another v. Union of India and

Another this principle was reiterated in connection with an

exemption under the Customs Act. This Court observed :"The

exemption notification issued under section 25 of the Act had the

effect of suspending the collection of customs duty. It does not

make items which are subject to levy of customs duty etc. as items

not leviable to such duty. It only suspends the levy and collection

of customs duty, wholly or partially, and subject to such

conditions as may be laid down in the notification by the

Government in 'public interest'. Such an exemption by its very

nature is susceptible of being revoked or modified or subjected to

other conditions."

We are inclined to agree with the submission of the

appellants that, merely because exemption has been granted in

respect of taxability of a particular source of income, it cannot be

postulated that the entity is not 'liable to tax' as contended by the

respondents.

Effect of MOBA, 1992

The respondents, shifted ground to contend that the fact that

a company incorporated in Mauritius is liable to taxation under the

Income Tax Act there may be true only in respect of certain class

of companies incorporated there. However, with respect to

companies which are incorporated within the meaning of the

Mauritius Offshore Business Activities Act, 1992 (hereinafter

referred to as "MOBA"), this would be wholly incorrect.

MOBA was enacted "to provide for the establishment and

management of the MOBA Authority to regulate offshore business

activities from within Mauritius and for the issue of offshore

certificates, and to provide for other ancillary or incidental

matters", as its preamble suggests. 'Offshore business activity' is

defined as the business or other activity referred to in section 33

and includes activity conducted by an international company.

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'Offshore company' is defined as a corporation in relation to which

there is a valid certificate and which carries on offshore business

activity.

In part II, MOBA establishes an Offshore Business Activity

Authority entrusted, inter alia, with the duty of overseeing offshore

business activities and also issuing permits, licences or any other

certificate as may be required, and other authorisation which may

be required by an offshore company through which they may

communicate with any of the public sector companies.

Section 16 of MOBA prescribes the procedure for issuing of

a certificate. Section 15 requires maintenance of confidentiality

and non-disclosure of information contained in applications and

documents filed with it except where such information is bona fide

required for the purpose of any enquiry or trial into or relating to

the trafficking of narcotics and dangerous drugs, arms, trafficking

or money laundering under the Economic Crime and Anti Money

Laundering Act, 2000.

Part II of MOBA contains the statutory provisions

applicable to offshore companies. Section 26 provides that an

offshore company shall not hold immovable property in Mauritius

and shall not hold any share or any interest in any company

incorporated under the Companies Act, 1984, other than in a

foreign company or in another offshore company or in an offshore

trust or an international company. An offshore company shall not

hold any account in a domestic bank in Mauritian Rupees, except

for the purpose of its day to day transactions arising from its

ordinary operations in Mauritius.

Sections 26 and 27 of MOBA are important and read as

under:

"26. Property of an offshore company

(1) Subject to sub-section(2), an offshore

company shall not hold -

(a) immovable property in Mauritius ;

(b) any share, or any interest in any

company incorporated under the

Companies Act, 1984 other than in a

foreign company or in another

offshore company or in an offshore

trust or an international company ;

(c) any account in a domestic bank in

Mauritian Rupee

(2) An offshore company may -

(a) open and maintain with a domestic

bank an account in Mauritian rupees

for the purpose of its day to day

transactions arising from its ordinary

operations in Mauritius ;

(b) open and maintain with a domestic

bank an account in foreign currencies

with the approval of the Bank of

Mauritius ;

(c) where authorised by the terms of its

certificate, or where otherwise

permitted under any other enactment,

lease, hold, acquire or dispose of an

immovable property or any interest in

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immovable property situated in

Mauritius ;

(d) invest in any securities listed in the

stock Exchange established under the

Stock Exchange Act 1988 and in other

debentures.

27. Dealings with residents

Notwithstanding any other enactment, the

Minister, on the recommendation of the

Authority may authorise any offshore

company engaged in any offshore business

activities to deal or transact with residents on

such terms and conditions as it thinks fit."

On the basis of these provisions, it is urged by the

respondents that any company which is registered as an offshore

company under MOBA can hardly carry out any business activity

in Mauritius, since it cannot hold any immovable property or any

shares or interest in any company registered in Mauritius other

than a foreign company or another offshore company and cannot

open an account in a domestic bank in Mauritius. The respondents

urge that such a company cannot transact any business whatsoever

within Mauritius as the purpose of such a company would be to

carry out offshore business activities and nothing more. The

respondents contend that when the possibility of such a company

earning income within Mauritius is almost nil, there is hardly any

possibility of its paying tax in Mauritius, whatever be the

provisions of the Mauritian Income-Tax Act.

In our view, the contention of the respondents proceeds on

the fallacious premise that liability to taxation is the same as

payment of tax. Liability to taxation is a legal situation; payment

of tax is a fiscal fact. For the purpose of application of Article 4 of

the DTAC, what is relevant is the legal situation, namely, liability

to taxation, and not the fiscal fact of actual payment of tax. If this

were not so, the DTAC would not have used the words 'liable to

taxation', but would have used some appropriate words like 'pays

tax'. On the language of the DTAC, it is not possible to accept the

contention of the respondents that offshore companies incorporated

and registered under MOBA are not 'liable to taxation' under the

Mauritius Income-tax Act; nor is it possible to accept the

contention that such companies would not be 'resident' in

Mauritius within the meaning of Article 3 read with Article 4 of

the DTAC.

There is a further reason in support of our view. The

expression 'liable to taxation' has been adopted from the

Organisation for Economic Co-operation and Development

Council (OECD) Model Convention 1977. The OECD

commentary on article 4, defining 'resident', says: "Conventions

for the avoidance of double taxation do not normally concern

themselves with the domestic laws of the Contracting States laying

down the conditions under which a person is to be treated fiscally

as "resident" and, consequently, is fully liable to tax in that State".

The expression used is 'liable to tax therein', by reasons of various

factors. This definition has been carried over even in Article 4

dealing with 'resident' in the OECD Model Convention 1992.

In A Manual on the OECD Model Tax Convention on

Income and On Capital, at paragraph 4B.05, while commenting

on Article 4 of the OECD Double Tax Convention, Philip Baker

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points out that the phrase 'liable to tax' used in the first sentence of

Article 4.1 of the Model Convention has raised a number of issues,

and observes:

"It seems clear that a person does not have

to be actually paying tax to be "liable to tax"

- otherwise a person who had deductible

losses or allowances, which reduced his tax

bill to zero would find himself unable to

enjoy the benefits of the convention. It also

seems clear that a person who would

otherwise be subject to comprehensive

taxing but who enjoys a specific exemption

from tax is nevertheless liable to tax, if the

exemption were repealed, or the person no

longer qualified for the exemption, the

person would be liable to comprehensive

taxation."

Interestingly, Baker refers to the decision of the Indian

Authority for Advance Ruling in Mohsinally Alimohammed

Rafik. An assessee, who resided in Dubai and claimed the

benefits of UAE-India Convention of April 29, 1992, even though

there was no personal income-tax in Dubai to which he might be

liable. The Authority concluded that he was entitled to the

benefits of the convention. The Authority subsequently reversed

this position in the case of Cyril Eugene Pereira where a contrary

view was taken.

The respondents placed great reliance on the decision by the

Authority for Advance Rulings constituted under section 245-O of

the Income-Tax Act, 1961 in Cyril Eugene Pereira's case .

Section 245S of the Act provides that the Advance Ruling

pronounced by the Authority under section 245R shall be binding

only :

"(a) on the applicant who had sought it;

(b) in respect of the transaction in relation to

which the ruling had been sought; and

(c) on the Commissioner, and the income-tax

authorities subordinate to him, in respect of

the applicant and the said transaction."

It is therefore obvious that, apart from whatever its

persuasive value, it would be of no help to us. Having perused the

order of the Advance Rulings Authority, we regret that we are not

persuaded.

There is substance in the contention of Mr. Salve learned

counsel for one of the appellants, that the expression 'resident' is

employed in the DTAC as a term of limitation, for otherwise a

person who may not be 'liable to tax' in a Contracting State by

reason of domicile, residence, place of management or any other

criterion of a similar nature may also claim the benefit of the

DTAC. Since the purpose of the DTAC is to eliminate double

taxation, the treaty takes into account only persons who are 'liable

to taxation' in the Contracting States. Consequently, the benefits

thereunder are not available to persons who are not liable to

taxation and the words 'liable to taxation' are intended to act as

words of limitation.

In John N. Gladden v. Her Majesty the Queen the

principle of liberal interpretation of tax treaties was reiterated by

the Federal Court, which observed :

"Contrary to an ordinary taxing statute a

tax treaty or convention must be given a liberal

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interpretation with a view to implementing the

true intentions of the parties. A literal or

legalistic interpretation must be avoided when

the basic object of the treaty might be defeated

or frustrated insofar as the particular item

under consideration is concerned."

Gladden was a case where an American citizen resident in

U.S.A. owned shares in two privately controlled Canadian

companies. Upon his death, the question arose as to the capital

gains which would arise as a result of the deemed disposition of

the said shares. The Canadian Revenue took the position that there

was a deemed disposition of the shares on the death of the tax

payer and capital gains tax was chargeable on account of the

deemed disposition. This view of the Revenue was upheld in

appeal by the Tax Court of Canada. Upon further appeal to the

Federal Court it was held that capital gains were exempt from tax

under the Canada-U.S.A. Tax Treaty as Canada had no capital

gains tax when it entered the treaty and it could not unilaterally

amend its legislation. The argument which prevailed with the trial

court in this case was similar to the one which prevailed with the

High Court in the matter before us. Interpreting the relevant Article

of the Double Taxation Avoidance Treaty the trial court held :

"The parties could not have negotiated to avoid double taxation on

a tax which did not exist in Canada". The Federal Court

emphasised that in interpreting and applying treaties the Courts

should be prepared to extend "a liberal and extended construction"

to avoid an anomaly which a contrary construction would lead to.

The Court recognized that "we cannot expect to find the same

nicety or strict definition as in modern documents, such as deeds,

or Acts of Parliament; it has never been the habit of those engaged

in diplomacy to use legal accuracy but rather to adopt more liberal

terms".

Interpreting the Article of the Treaty against avoidance of

double taxation, the Federal Court said (at p.5):

"The non-resident can benefit from the

exemption regardless of whether or not he is

taxable on that capital gain in his own country.

If Canada or the U.S. were to abolish capital

gains completely, while the other country did

not, a resident of the country which had

abolished capital gains would still be exempt

from capital gains in the other country."

The appellants rely on this judgment to contend that,

irrespective of the exemption from income-tax on capital gains

upon alienation of shares under the Mauritius Income-tax Act, the

benefits of the DTAC would apply.

The appellants contend that, acceptance of the respondents'

submission that double taxation avoidance is not permissible

unless tax is paid in both countries is contrary to the intendment of

section 90. It is urged that clause (b) of sub-section(1) of Section

90 applies to a situation to grant relief where income tax has been

paid in both countries, but clause (b) deals with a situation of

avoidance of double taxation of income. Inasmuch as Parliament

has distinguished between the two situations, it is not open to a

Court of law to interpret clause (b) of section 90 sub-section(1) as

if it were the same as the situation contemplated under clause (a).

According to Klaus Vogel "Double Taxation Convention

establishes an independent mechanism to avoid double taxation

through restriction of tax claims in areas where overlapping tax-

claims are expected, or at least theoretically possible. In other

words, the Contracting States mutually bind themselves not to levy

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taxes or to tax only to a limited extent in cases when the treaty

reserves taxation for the other contracting States either entirely or

in part. Contracting States are said to 'waive' tax claims or more

illustratively to divide 'tax sources', the 'taxable objects', amongst

themselves." Double taxation avoidance treaties were in vogue

even from the time of the League of Nations. The experts

appointed in the early 1920s by the League of Nations describe this

method of classification of items and their assignments to the

Contracting States. While the English lawyers called it

'classification and assignment rules', the German jurists called it

'the distributive rule' (Verteilungsnorm). To the extent that an

exemption is agreed to, its effect is in principle independent of

both whether the other contracting State imposes a tax in the

situation to which the exemption applies, and of whether that State

actually levies the tax. Commenting particularly on German

Double Taxation Convention with the United States, Vogel

comments: "Thus, it is said that the treaty prevents not only

'current', but also merely 'potential' double taxation". Further,

according to Vogel, "only in exceptional cases, and only when

expressly agreed to by the parties, is exemption in one contracting

State dependent upon whether the income or capital is taxable in

the other contracting state, or upon whether it is actually taxed

there."

It is, therefore, not possible for us to accept the contentions

so strenuously urged on behalf of the respondents that avoidance

of double taxation can arise only when tax is actually paid in one

of the Contracting States.

The decision of Federal Court of Australia in Commissioner

of Taxation v. Lamesa Holdings is illuminating. The issue before

the Federal Court was whether a Netherlands company was liable

to income-tax under the Australian Income Tax Act on profits from

the sale of shares in an Australian company and whether such

profits fell within Article 13 (alienation of property) of the

Netherlands-Australia Double Taxation Agreement, so as to be

excluded from Article 7 (business profits) of that Agreement. One

Leonard Green, a principal of Leonard Green and Associates a

limited partnership established in the United States, became aware

of a potential investment opportunity in Australia. Arimco

Resources and Mining Company NL ('Armico'), a company listed

on the Australian Stock Exchange, which had a subsidiary called

Armico Mining Pty. Limited engaged in gold mining activities,

was the subject of a hostile takeover bid, at a price which Green

was advised was less than the real value of the Armico. With this

knowledge Green decided to mount a takeover offer for the

subsidiary company. Then followed a series of steps of formation

of a number of companies with interlocking share holdings where

each company owned 1005 shares of a different subsidiary

company. Lamesa Holdings was one such intermediary company

of which 100% shares were held by Green Equity Investments Ltd.

The share transactions brought about a profit to Lamesa Holdings

which would be assessable to tax under the Australian Income Tax

Act. Lamesa, however, relied on the provisions of the Article 13(2)

of the Double Taxable Avoidance Convention ('DTAC') between

Netherlands and Australia and claimed that the income was not

taxable in Australia by reason thereof. This income was wholly

exempt from tax in Netherlands by reason of the Income Tax Law

applicable therein. The Federal Court found that under Article

13(2) (a) (ii) of the DTAC shares in a company were treated as

personalty, that since the place of incorporation of a company or

the place of situs of a share may be the subject of choice, the place

of incorporation or the register upon which shares were registered

would not form a particularly close connection with shares to

ground the jurisdiction to tax share profits. It was held:

"It happens to be the case, because of

unilateral relief granted by the law of the

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Netherlands, that no tax will be payable in the

Netherlands. That of itself can not affect the

interpretation of the Agreement. If the relevant

mining property had happened to be in the

Netherlands so that the issue was between

taxation there on the one hand and taxation in

Australia on the other, the situation would have

been one where tax would clearly have been

payable on the alienation of the shares in

Australia without the benefit of any exemption.

Yet the Agreement must operate uniformly,

whether the realty is in the Netherlands or in

Australia."

In this view of the matter, it was held that there was no tax

payable in Australia.

Chong v. Commissioner of Taxation holds similarly.

Australia and Malaysia have an agreement to avoid double

taxation. An Australian resident was paid pension by Malaysian

Government for services rendered to Malaysian Government

while he was in service there. This pension was taxed in Malaysia

and the issue was whether the right to tax Government pensions

under the Agreement could be exercised by the Australian

Government and the effect of the domestic law on the agreement.

Article 18 of the double taxation avoidance agreement provided

that pension paid to a resident of a contracting State shall be

taxable only in that State. Upon a proper construction of Article

18(2) of the Treaty it was held that pension paid by Malaysia is

taxable in Australia inasmuch as the said Article did not provide

that Malaysia alone was to have the power to tax Government

pension, nor did it restrict Australia from doing so. Rather it

provided for the Contracting State paying the pension to have the

power to tax the pension if it so desired and did not limit or restrict

the taxing power of the other Contracting State in that respect.

The Federal Court pointed out "Whether one uses the language of

allocation of power or the language of limitation of power, the

result is the same; there is designated or agreed who shall have the

right under the agreement to impose taxation in the particular

area".

The Estate of Michel Hausmann v. Her Majesty The

Queen is another Canadian judgment which throws light on the

principle that the benefits of a double taxation agreement would be

available even if the other contracting State in which a particular

head of income is to be taxed, chooses not to impose tax on the

same.

The central question in this case was whether the pension

received by Mr.Hausmann from the pension office of the Belgium

Government was taxable in Canada. The facts indicated that there

was no tax withheld at source in Belgium. The argument of the

Canadian Tax Authority was that if Belgium was not going to tax

the pension, Canada should. Otherwise, the unthinkable might

occur and the amount might not be taxed by anyone. This would

be anathema. The facts indicated that the payment received by Mr.

Hausmann fell below the prescribed threshold and therefore was

not taxed in Belgium. The Canadian Court rejected the argument

that if Belgium did not tax the payment, it must be taxed by the

Canada as plainly wrong by relying on the terms of the treaty. On

the basis of the material available, the Federal Court came to the

inference that in negotiating the Belgium treaty both Canada and

Belgium unquestionably regarded pensions paid under their social

security legislation, such as the CPP or the corresponding Belgian

statutory scheme, to be taxable only in the country from which

they emanated and not the country of residence of the recipient.

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Hence, it was held that the pension payments received by Mr.

Hausmann from the office of Belgium were social security pension

and such allowances could be taxable only in Belgium. The fact

that Belgium did not choose to tax them was held to be totally

irrelevant.

Mr. Salve contended that a profit made by sale of shares

may not invariably amount to capital gains, as for example if the

shares were part of the trading assets of the company. If such be

the case, the gains may amount to trading income of such a

company. He also relied on the observations of this Court in

Commissioner of Income Tax Nagpur v. Sutlej Cotton Mills

Supply Agency Limited . It is not necessary for us to go into this

question as it would depend upon as to whether the shares are held

by a company as an investment or as a trading asset. The

possibility urged by the learned counsel certainly exists and cannot

be ruled out without examination of facts.

Treaty Shopping - Is it illegal ?

The respondents vehemently urge that 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. They also urged that

'treaty shopping' is both unethical and illegal and amounts to a

fraud on the treaty and that this Court must be astute to interdict all

attempts at treaty shopping.

'Treaty shopping' is a graphic expression used to describe

the act of a resident of a third country taking advantage of a fiscal

treaty between two Contracting States. According to Lord

McNair, "provided that any necessary implementation by

municipal law has been carried out, there is nothing to prevent the

nationals of "third States", in the absence of any expressed or

implied provision to the contrary, from claiming the right or

becoming subject to the obligation created by a treaty" .

Reliance is also placed on the following observations of

Lord McNair :

"that any necessary implementation by

municipal law has been carried out, there is

nothing to prevent the nationals of 'third

States', in the absence of any express or

implied provision to the contrary, from

claiming the rights, or becoming subject to the

obligations, created by a treaty; for instance, if

an Anglo-American Convention provided that

professors on the staff of the universities of

each country were exempt from taxation in

respect of fees earned for lecturing in the other

country, and any necessary changes in the tax

laws were made, that privilege could be

claimed by, or on behalf of, professors of those

universities who were the nationals of 'third

States'."

It is urged by the learned counsel for the appellants, and

rightly in our view, 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. As a contrast, our attention was drawn to the

Article 24 of the Indo-US Treaty on Avoidance of Double

Taxation which specifically provides the limitations subject to

which the benefits under the Treaty can be availed of. One of the

limitations is that more than 50% of the beneficial interest, or in

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the case of a company more than 50% of the number of shares of

each class of the company, be owned directly or indirectly by one

or more individual residents of one of the contracting States.

Article 24 of the Indo-U.S. DTAC is in marked contrast with the

Indo-Mauritius DTAC. The appellants rightly contend that in the

absence of a limitation clause, such as the one contained in Article

24 of the Indo-U.S. Treaty, there are no disabling or disentitling

conditions under the Indo-Mauritius Treaty prohibiting the

resident of a third nation from deriving benefits thereunder. They

also urge that motives with which the residents have been

incorporated in Mauritius are wholly irrelevant and cannot in any

way affect the legality of the transaction. They urge that there is

nothing like equity in a fiscal statute. Either the statute applies

proprio vigore or it does not. There is no question of applying a

fiscal statute by intendment, if the expressed words do not apply.

In our view, this contention of the appellants has merit and

deserves acceptance. We shall have occasion to examine the

argument based on motive a little later.

The decision of the Chancery Division in Re F.G. Films

Ltd. was pressed into service as an example of the mask of

corporate entity being lifted and account be taken of what lies

behind in order to prevent 'fraud'. This decision only emphasises

the doctrine of piercing the veil of incorporation. There is no doubt

that, where necessary, the Courts are empowered to lift the veil of

incorporation while applying the domestic law. In the situation

where the terms of the DTAC have been made applicable by

reason of section 90 of the Income-Tax Act, 1961, even if they

derogate from the provisions of the Income-tax Act, it is not

possible to say that this principle of lifting the veil of incorporation

should be applied by the court. As we have already emphasised,

the whole purpose of the DTAC is to ensure that the benefits

thereunder are available even if they are inconsistent with the

provisions of the Indian Income-tax Act. In our view, therefore, the

principle of piercing the veil of incorporation can hardly apply to a

situation as the one before us.

The respondents banked on certain observations made in

Oppenheim's International Law . All that is stated therein is a

reiteration of the general rule in municipal law that contractual

obligations bind the parties to their contracts and not a third party

to the contract. In international law also, it has been pointed out

that the Vienna Convention on the Laws of Treaties ,1969

reaffirms the general rule that a treaty does not create either

obligations or rights for a third party state without its consent,

based on the general principle pacta tertiis nec nocent nec prosunt.

It is true that an international treaty between States A & B is

neither intended to confer benefits nor impose obligations on the

residents of State C, but, here we are not concerned with this

question at all. The question posed for our consideration is: If the

residents of State C qualify for a benefit under the treaty, can they

be denied the benefit on some theoretical ground that 'treaty

shopping' is unethical and illegal ? We find no support for this

proposition in the passage cited from Oppenheim.

The respondents then relied on observations of Philip

Baker regarding a seminar at the IFI Barcelona in 1991, wherein

a paper was presented on "Limitation of treaty benefits for

companies" (treaty shopping). He points out that the Committee

on Fiscal Affairs of the OECD in its report styled as "Conduit

Companies Report 1987" recognised that a conduit company

would generally be able to claim treaty benefits.

There is elaborate discussion in Baker's treatise on the anti

abuse provisions in the OECD model and the approach of different

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countries to the issue of 'treaty shopping'. True that several

countries like the USA, Germany, Netherlands, Switzerland and

United Kingdom have taken suitable steps, either by way of

incorporation of appropriate provisions in the international

conventions as to double taxation avoidance, or by domestic

legislation, to ensure that the benefits of a treaty/convention are

not available to residents of a third State. Doubtless, the treatise by

Philip Baker is an excellent guide as to how a state should

modulate its laws or incorporate suitable terms in tax conventions

to which it is party so that the possibility of a resident of a third

State deriving benefits thereunder is totally eliminated. That may

be an academic approach to the problem to say how the law should

be. The maxim "Judicis est jus dicere, non dare" pithily

expounds the duty of the Court. It is to decide what the law is, and

apply it; not to make it.

Report of the working group on non-resident taxation

The respondents contend that anti-abuse provisions need not

be incorporated in the treaty since it is assumed that the treaty

would only be used for the benefit of the parties.

They also strongly rely on the 'Report of the working group

on Non-Resident Taxation' dated 3rd January, 2003. In Chapter 3,

para 3.2 of the report it is stated:

"3.2 Entitlement to avail DTAA benefit:

Presently a person is entitled to claim

application of DTAA if he is 'liable to tax' in the

other Contracting State. The scope of liability to tax

is not defined. The term "liable to tax" should be

defined to say that there should be tax laws in force

in the other State, which provides for taxation of

such person, irrespective that such tax fully or

partly exempts such persons from charge of tax on

any income in any manner."

In para 3.3.1, after noticing the growing practice amongst

certain entities, who are not residents of either of the two

Contracting States, to try and avail of the beneficial provisions of

the DTAAs and indulge in what is popularly known as 'treaty

shopping', the report says :

"3.3.1 ....there is a need to incorporate suitable

provisions in the chapter on interpretation of

DTAAs, to deal with treaty shopping, conduit

companies and thin capitalization. These may be

based on UN/OECD model or other best global

practices."

In para 3.3.2, the working group recommended

introduction of anti-abuse provisions in the domestic law.

Finally, in paragraph 3.3.3 it is stated "The Working

Group recommends that in future negotiations, provisions

relating to anti-abuse/limitation of benefit may be incorporated in

the DTAAs also."

We are afraid that the weighty recommendations of the

Working Group on Non-Resident Taxation are again about what

the law ought to be, and a pointer to the Parliament and the

Executive for incorporating suitable limitation provisions in the

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treaty itself or by domestic legislation. This per se does not

render an attempt by resident of a third party to take advantage of

the existing provisions of the DTAC illegal.

J.P.C. Report

Strong reliance is placed by the respondents on the report of

the Joint Parliamentary Committee (hereinafter referred to as

"JPC") on the Stock Market Scam and Matters Relating thereto

which was presented in the Lok Sabha and Rajya Sabha on

December 19, 2002.

While considering the causes which led to the Stock Market

scam, the JPC had occasion to consider the working of the Indo-

Mauritius DTAC. It noticed that area-wise foreign direct

investment inflow from Mauritius increased from 37.5 million

Rupees in 1993 to 61672.8 million Rupees in the year 2001. The

CBDT had approached the Indian High Commissioner at Mauritius

to take up the matter with the Mauritian authorities to ensure that

benefit of the bilateral tax treaty were not allowed to be misused,

by suitable amendment in Article 13 of the agreement. The

Mauritian authorities, however, were of the view that, though the

beneficiaries of such capital funds domiciled in Mauritius may be

residing in third countries, these funds had been invested in the

Indian stock market in accordance with SEBI norms and

regulations and that the Finance Minister of India had himself

encouraged such FIIs as a channel for promoting capital flow to

India in a meeting between himself and the Finance Minister of

Mauritius. The Ministry of finance was willing to have regular

joint monitoring of the situation to avoid possible misuse of the tax

treaty by unscrupulous elements. It was pointed out by the

Mauritian authorities that DTAC between the two countries "had

played a positive role in covering the higher cost of investing in

what was then assessed as 'high risk security' and being decisive

in making possible public offerings in U.S.A. and Europe of

funds investing in India". In the absence of such a facility, as

afforded by the Indo-Mauritius DTAC, the cost of raising such

investment would have been capital prohibitive. The JPC report

points out that the negotiations between the Government of India

and Government of Mauritius resulted in a situation in which the

Mauritius Government felt that any change in the provisions of the

DTAC would adversely affect the perception of potential investors

and would prejudicially affect their financial interests.

The issue still appears to be the subject matter of

negotiations between the two Governments, though no final

decision has been taken thereupon. The JPC took notice of the

facts that MOBA has since been repealed by Mauritius and

Financial Services Development Act has been promulgated with

effect from 1.12.2001, which has to some extent removed the

drawback of MOBA, and led to greater transparency and facility

for obtaining information under the DTAC, which was hitherto not

available.

Taking notice of the facts, and the reluctance of the

Government of Mauritius in the matter to renegotiate the terms of

treaty, the Committee recommended as under (vide para 12.205):

"The Committee find that though the exact

amount of revenue loss due to the 'residency

clause' of the treaty cannot be quantified, but

taking into account the huge

inflows/outflows, it could be assumed to be

substantial. They therefore recommend that

Companies investing in Indian through

Mauritius, should be required to file details

of ownership with RBI and declare that all

the Directors and effective management is in

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Mauritius. The Committee suggest that all

the contentious issues should be resolved by

the Government with the Government of

Mauritius urgently through dialogue."

In our view, the recommendations of the Working Group of

the JPC are intended for Parliament to take appropriate action. The

JPC might have noticed certain consequences, intended or

unintended, flowing from the DTAC and has made appropriate

recommendations. Based on them, it is not possible for us to say

that the DTAC or the impugned circular are contrary to law, nor

would it be possible to interfere with either of them on the basis of

the report of the JPC.

Interpretation of Treaties

The principles adopted in interpretation of treaties are not

the same as those in interpretation of statutory legislation. While

commenting on the interpretation of a treaty imported into a

municipal law, Francis Bennion observes:

"With indirect enactment, instead of the

substantive legislation taking the well-known

form of an Act of Parliament, it has the form

of a treaty. In other words the form and

language found suitable for embodying an

international agreement become, at the stroke

of a pen, also the form and language of a

municipal legislative instrument. It is rather

like saying that, by Act of Parliament, a

woman shall be a man. Inconveniences may

ensue. One inconvenience is that the

interpreter is likely to be required to cope

with disorganised composition instead of

precision drafting. The drafting of treaties is

notoriously sloppy usually for very good

reason. To get agreement, politic uncertainty

is called for.

.....The interpretation of a treaty imported

into municipal law by indirect enactment was

described by Lord Wilberforce as being

'unconstrained by technical rules of English

law, or by English legal precedent, but

conducted on broad principles of general

acceptation. This echoes the optimistic

dictum of Lord Widgery CJ that the words

'are to be given their general meaning,

general to lawyer and layman alike... the

meaning of the diplomat rather than the

lawyer."

An important principle which needs to be kept in mind in the

interpretation of the provisions of an international treaty, including

one for double taxation relief, is that treaties are negotiated and

entered into at a political level and have several considerations as

their bases. Commenting on this aspect of the matter, David R.

Davis in Principles of International Double Taxation Relief ,

points out that the main function of a Double Taxation Avoidance

Treaty should be seen in the context of aiding commercial relations

between treaty partners and as being essentially a bargain between

two treaty countries as to the division of tax revenues between

them in respect of income falling to be taxed in both jurisdictions.

It is observed (vide para 1.06):

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"The benefits and detriments of a double tax

treaty will probably only be truly reciprocal

where the flow of trade and investment

between treaty partners is generally in

balance. Where this is not the case, the

benefits of the treaty may be weighted more

in favour of one treaty partner than the other,

even though the provisions of the treaty are

expressed in reciprocal terms. This has been

identified as occurring in relation to tax

treaties between developed and developing

countries, where the flow of trade and

investment is largely one way.

Because treaty negotiations are largely

a bargaining process with each side seeking

concessions from the other, the final

agreement will often represent a number of

compromises, and it may be uncertain as to

whether a full and sufficient quid pro quo is

obtained by both sides."

And, finally, in paragraph 1.08:

"Apart from the allocation of tax between the

treaty partners, tax treaties can also help to

resolve problems and can obtain benefits

which cannot be achieved unilaterally."

Based on these observations, counsel for the appellants

contended that the preamble of the Indo-Mauritius DTAC recites

that it is for the "encouragement of mutual trade and investment"

and this aspect of the matter cannot be lost sight of while

interpreting the treaty.

Many developed countries tolerate or encourage treaty

shopping, even if it is unintended, improper or unjustified, for

other non-tax reasons, unless it leads to a significant loss of tax

revenues. Moreover, several of them allow the use of their treaty

network to attract foreign enterprises and offshore activities. Some

of them favour treaty shopping for outbound investment to reduce

the foreign taxes of their tax residents but dislike their own loss of

tax revenues on inbound investment or trade of non-residents. In

developing countries, treaty shopping is often regarded as a tax

incentive to attract scarce foreign capital or technology. They are

able to grant tax concessions exclusively to foreign investors over

and above the domestic tax law provisions. In this respect, it does

not differ much from other similar tax incentives given by them,

such as tax holidays, grants, etc.

Developing countries need foreign investments, and the

treaty shopping opportunities can be an additional factor to attract

them. The use of Cyprus as a treaty haven has helped capital

inflows into eastern Europe. Madeira (Portugal) is attractive for

investments into the European Union. Singapore is developing

itself as a base for investments in South East Asia and China.

Mauritius today provides a suitable treaty conduit for South Asia

and South Africa. In recent years, India has been the beneficiary

of significant foreign funds through the "Mauritius conduit".

Although the Indian economic reforms since 1991 permitted such

capital transfers, the amount would have been much lower without

the India-Mauritius tax treaty.

Overall, countries need to take, and do take, a holistic view.

The developing countries allow treaty shopping to encourage

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capital and technology inflows, which developed countries are

keen to provide to them. The loss of tax revenues could be

insignificant compared to the other non-tax benefits to their

economy. Many of them do not appear to be too concerned unless

the revenue losses are significant compared to the other tax and

non-tax benefits from the treaty, or the treaty shopping leads to

other tax abuses.

There are many principles in fiscal economy which, though

at first blush might appear to be evil, are tolerated in a developing

economy, in the interest of long term development. Deficit

financing, for example, is one; treaty shopping, in our view, is

another. Despite the sound and fury of the respondents over the so

called 'abuse' of 'treaty shopping', perhaps, it may have been

intended at the time when Indo-Mauritius DTAC was entered into.

Whether it should continue, and, if so, for how long, is a matter

which is best left to the discretion of the executive as it is

dependent upon several economic and political considerations.

This Court cannot judge the legality of treaty shopping merely

because one section of thought considers it improper. A holistic

view has to be taken to adjudge what is perhaps regarded in

contemporary thinking as a necessary evil in a developing

economy.

Rule in McDowell

The respondents strenuously criticized the act of

incorporation by FIIs under the Mauritian Act as a 'sham' and 'a

device' actuated by improper motives. They contend that this

Court should interdict such arrangements and, as if by waving a

magic wand, bring about a situation where the incorporation

becomes non est. For this they heavily rely on the judgment of the

Constitution Bench of this Court in McDowell and Company Ltd.

v. Commercial Tax Officer . Placing strong reliance on

McDowell it is argued that McDowell has changed the

concept of fiscal jurisprudence in this country and any tax

planning which is intended to and results in avoidance of tax must

be struck down by the Court. Considering the seminal nature of

the contention, it is necessary to consider in some detail as to why

McDowell , what it says, and what it does not say.

In the classic words of Lord Sumner in IRC V. Fisher's

Executors ,

"My Lords, the highest authorities have

always recognised that the subject is entitled

so to arrange his affairs as not to attract taxes

imposed by the Crown, so far as he can do so

within the law, and that he may legitimately

claim the advantage of any expressed terms

or any omissions that he can find in his

favour in taxing Acts. In so doing, he neither

comes under liability nor incurs blame."

Similar views were expressed by Lord Tomlin in IRC v.

Duke of Westminster which reflected the prevalent attitude

towards tax avoidance:

"Every man is entitled if he can to order his

affairs so that the tax attaching under the

appropriate Acts is less than it otherwise

would be. If he succeeds in ordering them so

as to secure this result, then, however,

unappreciative the Commissioners of Inland

Revenue or his fellow taxgatherers may be of

his ingenuity, he cannot be compelled to pay

an increased tax."

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These were the pre second world war sentiments expressed

by the British Courts. It is urged that McDowell has taken a new

look at fiscal jurisprudence and "the ghost of Fisher (supra) and

Westminster have been exorcised in the country of its origin". It

is also urged that McDowell's radical departure was in tune with

the changed thinking on fiscal jurisprudence by the English Courts,

as evidenced in W.T. Ramsay Ltd. v. IRC , Inland Revenue

Commissioners v. Burman Oil Company Ltd and Furniss v.

Dawson .

As we shall show presently, far from being exorcised in its

country of origin, Duke of Westminster continues to be alive and

kicking in England. Interestingly, even in McDowell , though

Chinnappa Reddy,J., dismissed the observation of J.C. Shah,J. in

CIT v. A. Raman and Company based on Westminster and

Fisher's Executors , by saying "we think that the time has come

for us to depart from the Westminster principle as emphatically as

the British courts have done and to dissociate ourselves from the

observations of Shah J., and similar observations made elsewhere",

it does not appear that the rest of the learned Judges of the

Constitutional Bench contributed to this radical thinking. Speaking

for the majority, Ranganath Mishra,J,(as he then was) says in

McDowell :

"Tax planning may be legitimate provided it

is within the framework of law. Colourable

devices cannot be part of tax planning and it

is wrong to encourage or entertain the belief

that it is honourable to avoid the payment of

tax by resorting to dubious methods. It is the

obligation of every citizen to pay the taxes

honestly without resorting to subterfuges."

(Emphasis supplied)

This opinion of the majority is a far cry from the view of

Chinnappa Reddy,J: "In our view the proper way to construe a

taxing statute, while considering a device to avoid tax, is not to ask

whether a provision should be construed liberally or principally,

nor whether the transaction is not unreal and not prohibited by the

statute, but whether the transaction is a device to avoid tax, and

whether the transaction is such that the judicial process may accord

its approval to it." We are afraid that we are unable to read or

comprehend the majority judgment in McDowell as having

endorsed this extreme view of Chinnappa Reddy,J, which, in our

considered opinion, actually militates against the observations of

the majority of the Judges which we have just extracted from the

leading judgment of Ranganath Mishra,J (as he then was).

The basic assumption made in the judgment of Chinnappa

Reddy,J. in McDowell that the principle in Duke of

Westminster has been departed from subsequently by the House

of Lords in England, with respect, is not correct. In Craven v.

White the House of Lords pointedly considered the impact of

Furniss , Burma Oil and Ramsay . The Law Lords were at

great pains to explain away each of these judgments. Lord Keith

of Kinkel says, with reference to the trilogy of these cases, (at

p.500):

" My Lords, in my opinion the nature of the

principle to be derived from the three cases is

this : the court must first construe the relevant

enactment in order to ascertain its meaning; it

must then analyse the series of transactions in

question, regarded as a whole, so as to ascertain

its true effect in law; and finally it must apply

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the enactment as construed to the true effect of

the series of transactions and so decide whether

or not the enactment was intended to cover it.

The most important feature of the principle is

that the series of transactions is to be regarded

as a whole. In ascertaining the true legal effect

of the series it is relevant to take into account, if

it be the case, that all the steps in it were

contractually agreed in advance or had been

determined on in advance by a guiding will

which was in a position, for all practical

purposes, to secure that all of them were carried

through to completion. It is also relevant to

take into account, if it be the case, that one or

more of the steps was introduced into the series

with no business purpose other than the

avoidance of tax.

The principle does not involve, in my opinion,

that it is part of the judicial function to treat as

nugatory any step whatever which a taxpayer

may take with a view to the avoidance or

mitigation or tax. It remains true in general that

the taxpayer, where he is in a position to carry

through a transaction in two alternative ways,

one of which will result in liability to tax and

the other of which will not, is at liberty to

choose the latter and to do so effectively in the

absence of any specific tax avoidance provision

such as s.460 of the Income and Corporation

Taxes Act, 1970.

In Ramsay and in Burmah the result of

application of the principle was to demonstrate

that the true legal effect of the series of

transactions entered into, regarded as a whole,

was precisely nil."

Lord Oliver (at p.518-19) says:

"It is equally important to bear in mind what

the case did not decide. It did not decide that a

transaction entered into with the motive of

minimising the subject's burden of tax is, for

that reason, to be ignored or struck down. Lord

Wilberforce was at pains to stress that the fact

that the motive for a transaction may be to

avoid tax does not invalidate it unless a

particular enactment so provides (see (1981) 1

All ER 865, (1982) AC 300 at 323). Nor did it

decide that the court is entitled, because of the

subject's motive in entering into a genuine

transaction, to attribute to it a legal effect which

it did not have. Both Lord Wilberforce and

Lord Fraser emphasise the continued validity

and application of the principle of IRC v. Duke

of Westminster (1936) AC 1 (19350 All ER

Rep.259, a principle which Lord Wilberforce

described as a 'cardinal principle'. What it did

decide was that that cardinal principle does

not, where it is plain that a particular

transaction is but one step in a connected series

of interdependent steps designed to produce a

single composite overall result, compel the

court to regard it as otherwise than what it is,

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that is to say merely a part of the composite

whole."

Lord Oliver (at p.523 ) observes:

"My Lords, for my part I find myself unable to

accept that Dawson either established or can

properly be used to support a general

proposition that any transaction which is

effected for the purpose of avoiding tax on a

contemplated subsequent transaction and is

therefore 'planned' is, for that reason,

necessarily to be treated as one with that

subsequent transaction and as having no

independent effect even where that is

realistically and logically impossible."

Continuing, (at page 524) Lord Oliver

observes:

"Essentially, Dawson was concerned with a

question which is common to all successive

transactions where an actual transfer of

property has taken place to a corporate entity

which subsequently carries out a further

disposition to an ultimate disponee. The

question is : when is a disposal not a disposal

within the terms of the statute ? To give to that

question the answer 'when, on an analysis of

the facts, it is seen in reality to be a different

transaction altogether' is well within the

accepted canons of construction. To answer it

'when it is effected with a view to avoiding tax

on another contemplated transaction' is to do

more than simply to place a gloss on the words

of the statute. It is to add a limitation or

qualification which the legislature itself has not

sought to express and for which there is no

context in the statute. That, however, desirable

it may seem, is to legislate, not to construe, and

that is something which is not within judicial

competence. I can find nothing in Dawson or

in the cases which preceded it which causes me

to suppose that that was what this House, was

seeking to do."

Thus we see that even in the year 1988 the House of Lords

emphasised the continued validity and application of the principle

in Duke of Westminster .

While Chinnappa Reddy, J. took the view that Ramsay ,

was an authoritative rejection of principle in the Duke of

Westminster , the House of Lords, in the year 2001, does not

seem to consider it to be so, as seen from MacNiven (Inspector of

Taxes) v. Westmoreland Investments Ltd . Lord Hoffmann

observes:

"In the Ramsay case both Lord Wilberforce

and Lord Fraser of Tullybelton, who gave the

other principal speech, were careful to stress

that the House was not departing from the

principle in IRC v. Duke of Westminster

(1936) AC 1, (1935) All ER Rep.259. There

has nevertheless been a good deal of

discussion about how the two cases are to be

reconciled. How, if the various juristically

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discrete acquisitions and disposals which

made up the scheme were genuine, could the

House collapse them into a composite self-

cancelling transaction without being guilty of

ignoring the legal position and looking at the

substance of the matter?

My Lords, I venture to suggest that some of

the difficulty which may have been felt in

reconciling the Ramsay case with the Duke of

Westminster's case arises out of an

ambiguity in Lord Tomlin's statement that

the courts cannot ignore 'the legal position'

and have regard to 'the substance of the

matter'. If 'the legal position' is that the tax is

imposed by reference to a legally defined

concept, such as stamp duty payable on a

document which constitutes a conveyance on

sale, the court cannot tax a transaction which

uses no such document on the ground that it

achieves the same economic effect. On the

other hand, if the legal position is that tax is

imposed by reference to a commercial

concept, then to have regard to the business

'substance' of the matter is not to ignore the

legal position but to give effect to it.

The speeches in the Ramsay case and

subsequent cases contain numerous

references to the 'real' nature of the

transaction and to what happens in 'the real

world'. These expressions are illuminating in

their context, but you have to be careful about

the sense in which they are being used.

Otherwise you land in all kinds of

unnecessary philosophical difficulties about

the nature of reality and, in particular, about

how a transaction can be said not to be a

'sham' and yet be 'disregarded' for the

purpose of deciding what happened in 'the

real world'. The point to hold on to is that

something may be real for one purpose but

not for another. When people speak of

something being a 'real' something, they

mean that it falls within some concept which

they have in mind, by contrast with

something else which might have been

thought to do so, but does not. When an

economist says that real incomes have fallen,

he is not intending to contrast real incomes

with imaginary incomes. The contrast is

specifically between incomes which have

been adjusted for inflation and those which

have not. In order to know what he means by

'real', one must first identify the concept

(inflation adjustment) by reference to which

he is using the word.

Thus in saying that the transactions in the

Ramsay case were not sham transactions, one

is accepting the juristic categorisation of the

transactions as individual and discrete and

saying that each of them involved no

pretence. They were intended to do precisely

what they purported to do. They had a legal

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reality. But in saying that they did not

constitute a 'real' disposal giving rise to a

'real' loss, one is rejecting the juristic

categorisation as not being necessarily

determinative for the purposes of the statutory

concepts of 'disposal' and 'loss' as properly

interpreted. The contrast here is with a

commercial meaning of these concepts. And

in saying that the income tax legislation was

intended to operate 'in the real world', one is

again referring to the commercial context

which should influence the construction of

the concepts used by Parliament."

With respect, therefore, we are unable to agree with the

view that Duke of Westminster is dead, or that its ghost has been

exorcised in England. The House of Lords does not seem to think

so, and we agree, with respect. In our view, the principle in Duke

of Westminster is very much alive and kicking in the country of

its birth. And as far as this country is concerned, the observations

of Shah,J., in CIT v. Raman are very much relevant even today.

We may in this connection usefully refer to the judgment of

the Madras High Court in M.V.Vallipappan and others v. ITO ,

which has rightly concluded that the decision in McDowell

cannot be read as laying down that every attempt at tax planning

is illegitimate and must be ignored, or that every transaction or

arrangement which is perfectly permissible under law, which has

the effect of reducing the tax burden of the assessee, must be

looked upon with disfavour. Though the Madras High Court had

occasion to refer to the judgment of the Privy Council in IRC v.

Challenge Corporation Ltd. , and did not have the benefit of the

House of Lords's pronouncement in Craven , the view taken by

the Madras High Court appears to be correct and we are inclined to

agree with it.

We may also refer to the judgment of Gujarat High Court in

Banyan and Berry v. Commissioner of Income-Tax where

referring to McDowell , the Court observed:

"The court nowhere said that every action or

inaction on the part of the taxpayer which

results in reduction of tax liability to which he

may be subjected in future, is to be viewed

with suspicion and be treated as a device for

avoidance of tax irrespective of legitimacy or

genuineness of the act; an inference which

unfortunately, in our opinion, the Tribunal

apparently appears to have drawn from the

enunciation made in McDowell case (1985)

154 ITR 148 (SC). The ratio of any decision

has to be understood in the context it has been

made. The facts and circumstances which lead

to McDowell's decision leave us in no doubt

that the principle enunciated in the above case

has not affected the freedom of the citizen to

act in a manner according to his requirements,

his wishes in the manner of doing any trade,

activity or planning his affairs with

circumspection, within the framework of law,

unless the same fall in the category of

colourable device which may properly be

called a device or a dubious method or a

subterfuge clothed with apparent dignity."

This accords with our own view of the matter.

In CWT v. Arvind Narottam , a case under the Wealth

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Tax Act, three trust deeds for the benefit of the assessee, his wife

and children in identical terms were prepared under section 21(2)

of the Wealth Tax Act. Revenue placed reliance on McDowell .

Both the learned Judges of the Bench of this Court gave separate

opinions.

Chief Justice Pathak, in his opinion said (at p.486):

"Reliance was also placed by learned

counsel for the Revenue on McDowell and

Company Ltd. v. CTO (1985) 154 ITR

148(SC). That decision cannot advance the

case of the Revenue because the language of

the deeds of settlement is plain and admits

of no ambiguity."

Justice S. Mukherjee said, after noticing

McDowell's case, (at page 487):

"Where the true effect on the construction of

the deeds is clear, as in this case, the appeal

to discourage tax avoidance is not a relevant

consideration. But since it was made, it has

to be noted and rejected."

In Mathuram Agrawal v. State of Madhya Pradesh another

Constitution Bench had occasion to consider the issue. The Bench

observed:

"The intention of the legislature in a taxation

statute is to be gathered from the language of

the provisions particularly where the language

is plain and unambiguous. In a taxing Act it is

not possible to assume any intention or

governing purpose of the statute more than

what is stated in the plain language. It is not

the economic results sought to be obtained by

making the provision which is relevant in

interpreting a fiscal statute. Equally

impermissible is an interpretation which does

not follow from the plain, unambiguous

language of the statute. Words cannot be

added to or substituted so as to give a meaning

to the statute which will serve the spirit and

intention of the legislature."

The Constitution Bench reiterated the observations in Bank

of Chettinad Ltd. v. CIT , quoting with approval the observations

of Lord Russell of Killowen in IRC v. Duke of Westminster

and the observations of Lord Simonds in Russell v. Scott

It thus appears to us that not only is the principle in Duke of

Westminster alive and kicking in England, but it also seems to

have acquired judicial benediction of the Constitutional Bench in

India, notwithstanding the temporary turbulence created in the

wake of McDowell .

Hence, reliance on Furniss , Ramsay and Burmah Oil

by the respondents in support of their submission is of no avail.

The situation is no different in United States and other

jurisdictions too.

The situation in the United State is reflected in the following

passage from American Jurisprudence :

"The legal right of a taxpayer to decrease

the amount of what otherwise would be his

taxes, or altogether to avoid them, by

means which the law permits, cannot be

doubted. A tax-saving motivation does not

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justify the taxing authorities or the courts in

nullifying or disregarding a taxpayer's

otherwise proper and bona fide choice

among courses of action, and the state

cannot complain, when a taxpayer resorts to

a legal method available to him to compute

his tax liability, that the result is more

beneficial to the taxpayer than was intended.

It has even been said that it is common

knowledge that not infrequently changes in

the basic facts affecting liability to taxation

are made for the purpose of avoiding

taxation, but that where such changes are

actual and not merely simulated, although

made for the purpose of avoiding taxation,

they do not constitute evasion of taxation.

Thus, a man may change his residence to

avoid taxation, or change the form of his

property by putting his money into non-

taxable securities, or in the form of property

which would be taxed less, and not be guilty

of fraud. On the other hand, if a taxpayer at

assessment time converts taxable property

into non-taxable property for the purpose of

avoiding taxation, without intending a

permanent change, and shortly after the time

for assessment has passed, reconverts the

property to its original form, it is a

discreditable evasion of the taxing laws, a

fraud, and will not be sustained."

Several judgments of the US Courts were cited in respect of

the proposition that motive of tax avoidance is irrelevant in

consideration of the legal efficacy of a transactional situation.

We may recapitulate the observations of the Federal Court in

Johansson as to the irrelevance of the motive for Johansson. To

similar effect are the observations of the US Court in Perry R. Bas

v. Commissioner of Internal Revenue :

"we infer that Stantus was created by

petitioners with a view to reducing their

taxes through qualification of the

corporation under the convention. The test,

however, is not the personal purpose of a

taxpayer in creating a corporation. Rather, it

is whether that purpose is intended to be

accomplished through a corporation carrying

out substantive business functions. If the

purpose of the corporation is to carry out

substantive business functions, or if it in fact

engages in substantive business activity, it

will not be disregarded for Federal tax

purposes."

In Barber-Greene Americas, Inc. v. Commissioner of

Internal Revenue it was observed that a corporation will not be

denied Western Hemisphere trade corporation tax benefits merely

because it was purposely created and operated in such way as to

obtain such benefits. Similarly, a corporation otherwise qualified

should not be disregarded merely because it was purposely created

and operated to obtain the benefits of the United States-Swiss

Confederation Income Tax Convention.

Though the words 'sham', and 'device' were loosely used in

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connection with the incorporation under the Mauritius law, we

deem it fit to enter a caveat here. These words are not intended to

be used as magic mantras or catchall phrases to defeat or nullify the

effect of a legal situation. As Lord Atkin pointed out in Duke of

Westminster :

"I do not use the word device in any sinister

sense; for it has to be recognised that the

subject, whether poor and humble or wealthy

and noble, has the legal right so to dispose of

his capital and income as to attract upon

himself the least amount of tax. The only

function of a court of law is to determine the

legal result of his dispositions so far as they

affect tax."

Lord Tomlin said :

"There may, of course, be cases where

documents are not bona fide nor intended to

be acted upon, but are only used as a cloak to

conceal a different transaction."

In Snook vs. London and West Riding Investments Ltd.

Lord Diplock L.J., explained the use of the word 'sham' as a legal

concept in the following words:

"it is, I think, necessary to consider

what, if any, legal concept is involved in the

use of this popular and pejorative word. I

apprehend that, if it has any meaning in law, it

means acts done or documents executed by the

parties to the 'sham' which are intended by

them to give to third parties or to the court the

appearance of creating between the parties legal

rights and obligations different from the actual

legal rights and obligations (if any) which the

parties intend to create. One thing I think,

however, is clear in legal principle, morality

and the authorities (see Yorkshire Railway

Wagon Contracting State. V. Maclure (1882)

21 Ch.D.309 ; Stoneleigh Finance, Ltd. v.

Phillips (1965) 1 All ER 513) that for acts or

documents to be a "sham", with whatever legal

consequences follow from this, all the parties

thereto must have a common intention that the

acts or documents are not to create the legal

rights and obligations which they give the

appearance of creating. No unexpressed

intentions of a "shammer" affect the rights of a

party whom he deceived."

In Waman Rao and others v. Union of India & Ors. and

Minerva Mills Ltd. and others v. Union of India and Ors. this

Court considered the import of the word "device' with reference to

Article 31B which provided that the Acts and Regulations specified

Ninth Schedule shall not be deemed to be void or even to have

become void on the ground that they are inconsistent with the

Fundamental Rights. The use of the word 'device' here was not

pejorative, but to describe a provision of law intended to produce a

certain legal result.

If the Court finds that notwithstanding a series of legal steps

taken by an assessee, the intended legal result has not been

achieved, the Court might be justified in overlooking the

intermediate steps, but it would not be permissible for the Court to

treat the intervening legal steps as non-est based upon some

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hypothetical assessment of the 'real motive' of the assessee. In our

view, the court must deal with what is tangible in an objective

manner and cannot afford to chase a will-o'-the-wisp.

The judgment of the Privy Council in Bank of Chettinad ,

wholeheartedly approving the dicta in the passage from the opinion

of Lord Russel in Westminster , was the law in this country

when the Constitution came into force. This was the law in force

then, which continued by reason of Article 372. Unless abrogated

by an Act of Parliament, or by a clear pronouncement of this Court,

we think that this legal principle would continue to hold good.

Having anxiously scanned McDowell , we find no reference

therein to having dissented from or overruled the decision of the

Privy Council in Bank of Chettinad. If any, the principle

appears to have been reiterated with approval by the Constitutional

Bench of this Court in Mathuram . We are, therefore, unable to

accept the contention of the respondents that there has been a very

drastic change in the fiscal jurisprudence, in India, as would

entail a departure. In our judgment, from Westminster to Bank

of Chettinad to Mathuram , despite the hiccups of

McDowell , the law has remained the same.

We are unable to agree with the submission that an act which

is otherwise valid in law can be treated as non-est merely on the

basis of some underlying motive supposedly resulting in some

economic detriment or prejudice to the national interests, as

perceived by the respondents.

In the result, we are of the view that Delhi High Court erred

on all counts in quashing the impugned circular. The judgment

under appeal is set aside and it is held and declared that the

circular No. 789 dated 13.4.2000 is valid and efficacious.

We cannot part with this judgment without expressing our

grateful appreciation to the Learned Attorney General, Mr. Harish

Salve, Mr. Prashant Bhushan as also the party in person, Mr. S.K.

Jha, all of whom by their industrious research produced a wealth of

material and by their meticulous arguments rendered immense

assistance.

[1985] 154 ITR 148.

See in this connection Maganbhai Ishwarbhai Patel & Others. v. Union of India & Another

(1970) 3 SCC 400.

[1988] 144 ITR 146.

[1991] 190 ITR 626.

See also in this connection Leonhardt Andra Und Partner, Gmbh v. Commissioner of Income

Tax

[2001] 249 ITR 418.

[1993] 202 ITR 508.

[1995] 212 ITR 31.

Cases in Constitutional Law, D.L. Kier and F.H. Lawson, Pg.53-54, 159-163 (ELBS &

Oxford University Press 5th Ed.).

See Section 5A of Central Excise Act, 1944 and Section 8(5) of the Central Sales Tax Ac

t, 1956.

(1999) 4 SCC 11, para 14 to 22.

(1959) SCR 1099.

Supra note 10.

[1981] 131 ITR 597.

Crawford on Statutory Construction, 1940 Ed, as in Supre note 13.

[1908] ILR 35 Cal 701, 713.

[1979] 4 SCC 565.

Supra note 13.

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[1965] 56 ITR 198.

[1971] 82 ITR 913.

[1999] 237 ITR 889 at 896.

[2001] 252 ITR 1.

[2002] 2 SCC 127 at para 11.

See in this connection State of Sikkim v. Dorjee Tshering Bhutia and Others (1991) 4 SCC 2

43 at para 16; N.B.

Sanjana, Assistant Collector of Central Excise, Bombay and Others v. Elphinshone Spinning an

d Weaving Mills Co.

Ltd.(1971) 1 SCC 337; B. Balakotaiah v. Union of India & Others (1968) SCR 1052 and Afzal Ul

lah v. State of U.P

(1964) 4 SCR 991.

See in this connection the observations of this Court in Harishankar Bagla and Another v.

The

State of Madhya Pradesh 1955 SCR 380 and Kishan Prakash Sharma v. Union of India and

Others (2001) 5 SCC 212.

(1984) 4 SCC 27 at para 14.

Jean-Maic Rivier, Cahiers de droit fiscal international, VolLXXIIa at pp.47-76.

336F.2d.809.

See in this connection Ramanathan Chettiar v. Commissioner of Income Tax, Madras [1973] 88

ITR 169.

(1989) 4 SCC 592.

See also in this connection the judgment of Madras High Court in Tamil Nadu (Madras Stat

e)

Handloom Weavers Contracting State-operative Society Ltd. v. Assistant Collector of Central

Excise 1978

ELT 57 (Mad HC).

(1995) 1 SCC 274.

[1994] 213 ITR 317.

[1999] 239 ITR 650.

Ibid

85 D.T.C.5188 at 5190.

Ibid

See in this connection Klaus Vogel, Double Taxation Convention, Pg.26-29 (3rd ed).

(1997) 785 FCA.

(2000) FCA 635.

1998 Can. Tax Ct.LEXIS 1140.

[1975] 100 ITR 706.

Lord McNair, The Law of Treaties, Pg.336 (Oxford, at the Clarendan Press, 1961).

Ibid.

53 (1) WLR 483.

L.Oppenheim, Oppenheim's International Law, Article 626 (9th Ed.).

Philip Baker, Double Taxation Convention and International Law, Pg.91 ((1994) 2nd Ed.).

Francis Bennion, Statutory Interpretation, Pg. 461 [Butterworths, 1992 (2nd Ed.)].

David R. Davis, Principles of International Double Taxation Relief, Pg.4 (London Sweet &

Maxwell,

1985).

Roy Rohtagi, Basic International Taxationt Pg.373-374 (Kluwer Law International).

Ibid.

Ibid.

Supra note 1.

Ibid.

Ibid.

Ibid .

(1926) AC 395 at 412.

(1936) AC 1; 19 TC 490.

Supra note 1.

Supra note 56.

Supra note 57.

Supra note 1.

(1982) AC 300.

(1982) STC 30.

(1984) 1 All ER 530.

Supra note 57.

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Supra note 1.

[1968] 67 ITR 11.

Supra note 57.

Supra note 56.

Supra note 1 at Pg. 171.

Supra note 1.

Ibid

Supra note 57.

(1988) 3 All ER 495.

Supra note 64.

Supra note 63.

Supra note 62.

Supra note 57.

Supra note 62.

Supra note 57.

(2001) 1 All ER 865 at 877-878.

Supra note 57.

Ibid.

Supra note 67.

(1988) 170 ITR 238.

Supra note 1.

(1987) 2 WLR 24.

Supra note 74.

(1996) 222 ITR 831 at 850.

Supra note 1.

(1988) 173 ITR 479.

Supra note 1.

(1999) 8 SCC 667 at para 12.

(1940) 8 ITR 522 (PC).

Supra note 57.

(1948) 2 All ER 15.

Supra note 57.

Supra note 1.

Supra note 64.

Supra note 62.

Supra note 63.

American Jurisprudence (1973 2nd Ed. Vol.71).

See in this connection Gregory v. Helvering 293 US465, 469 55 S.Ct. 226, 267, 78

L.ed.566, 97 ALR 1335; Helvering v. St. Louis Trust Company 296 US 48, 56 S. Ct. 78, 80L;

Becker v. St.Louis Union Trust Company 296 US 48, 56 S.Ct. 78, 80L.

Supra note 27.

(1968) US 50 TC 595.

(1960) 35 T.C.365, 383,384.

Supra note 57.

(1967) All ER 518 at 528.

(1981) 2 SCC 362 at para 45.

(1980) 3 SCC 625 at para 91.

Supra note 94.

Supra note 57.

Supra note 1.

Supra note 94.

Supra note 93.

Supra note 57.

Supra note 94.

Supra note 93.

Supra note 1.

1