2025 (8) TMI 1274 - AT - Income Tax

Section 90(1) notification absent, MLI Articles 6 and 7 not invoked; taxpayer's TRC valid, no PE, Article 8 relief applied

ITAT MUMBAI - AT held that Articles 6 and 7 of the MLI could not be invoked because there was no Section 90(1) notification incorporating those provisions ... Denial of treaty benefits by invoking Articles 6 and 7 of the Multilateral Instrument (“MLI”) - principal purpose of the assessee’s incorporation was to obtain the benefits of the India–Ireland DTAA - applicability of the India–Ireland DTAA in the absence of a separate notified protocol to that DTAA Whether, in view of Articles 6 and 7 of the MLI, the assessee is disentitled to the benefits of the India–Ireland DTAA? - Whether the leases are to be characterised as operating leases or finance leases? - Whether the presence of the leased aircraft in India constitutes a fixed place PE of the assessee? If a PE is held to exist, whether Article 8(1) of the DTAA nevertheless precludes taxation of the income in India. HELD THAT:- The Hon’ble Supreme Court of India in the case of Nestle [2023 (10) TMI 981 - SUPREME COURT] accepting the submission of the Revenue and repelling the submission of the taxpayers, held that a separate notification to effectuate the impact of a subsequent DTAA into an earlier DTAA must be issued. The notification of the subsequent DTAA does not ipso facto and automatically lead to amendment of the earlier DTAA. Articles 6 and 7 of the MLI cannot be invoked against the assessee in the present assessment year, inasmuch as there is no Section 90(1) notification incorporating those provisions into the India–Ireland DTAA. Consequently, the Revenue’s attempt to deny treaty benefits by invoking the MLI’s Principal Purpose Test must, on this ground alone, fail. The assessment must proceed on the footing that the MLI has no application in the absence of a statutorily issued notification under Section 90(1). Having thus resolved the threshold question in favour of the assessee, it bears reiteration that this conclusion is not reached on a technicality divorced from substance, but rests on the very constitutional and statutory architecture governing how international agreements enter the domestic legal order. The Hon’ble Supreme Court in Nestle SA (supra) did not propound an abstract procedural nicety; it articulated a substantive safeguard that treaty modifications altering existing rights or liabilities cannot be judicially enforced until procedure is followed in line with Section 90(1) of the Act. Department’s suggestion that the MLI, once notified in general terms, becomes immediately self-executing vis-à-vis all covered agreements, would in effect render otiose the careful statutory scheme of Section 90(1). That interpretation would also run counter to the binding pronouncement in Nestle SA, which squarely holds that each modification with the effect of altering existing law must itself be the subject of a distinct notification. We are conscious that the MLI was conceived as a swift and efficient vehicle for implementing the BEPS treaty-related measures across jurisdictions without the need to bilaterally renegotiate each covered agreement. However, efficiency in the multilateral sphere cannot displace the domestic rule of law requirement that any such modification be consciously received into municipal law through the statutorily prescribed process. We hold that the absence of a specific Section 90(1) notification incorporating Articles 6 and 7 of the MLI into the India–Ireland DTAA is fatal to the Revenue’s case. Consequently, the invocation of the MLI to deny the treaty benefits otherwise available under the DTAA cannot be upheld in law. Although it is not necessary to deal with the PPT invocation, nonetheless, for the sake of completeness, and because the lower authorities have made detailed factual findings, we proceed, without prejudice to our threshold holding, to briefly examine whether, even assuming Articles 6 and 7 of the MLI applied, the Revenue has discharged its burden under the PPT. Hon’ble Supreme Court in Union of India v. Azadi Bachao Andolan&Anr. [2003 (10) TMI 5 - SUPREME COURT] & Vodafone International Holdings [2012 (1) TMI 52 - SUPREME COURT] has held that TRC is conclusive proof of residency of foreign taxpayers unless it is a case of treaty shopping or fraud. It is inconceivable to presume that Irish tax authorities are not familiar with the principal purpose test and have issued TRCs without application of mind. As a judicial authority, this Tribunal cannot assume any such facts. On the contrary, an act of statutory authority is presumed to be done in accordance with law. Therefore, in the absence of very compelling reasons, the TRC will be presumed to be valid grounds for allowing benefits of the India-Ireland DTAA even after notification of MLI. Principal Purpose Test in Articles 6 and 7 of the MLI cannot be read so broadly as to imply that treaty benefits must automatically be denied in every case where the ultimate parent entity of the taxpayer happens to be resident in a third country. Bona fide commercial investments are meant to be protected and the PPT does not seek to impair them. The AO and the learned DRP failed to appreciate that the assessee is a separate taxable entity from its shareholders and is itself subject to tax in Ireland at 15 percent on its Irish income. The mere fact that the ultimate shareholder resides outside Ireland does not, by itself, furnish a basis to invoke the PPT. To adopt such an approach would result in wholly unintended and absurd consequences, particularly in cases such as the present where the investment is demonstrably driven by legitimate commercial objectives. DRP’s observation that the “ultimate income will also be shifted to tax-free jurisdictions” is, with respect, unsupported by particulars. The accounts placed on record indicate no payment by the assessee to its parent or group entities during the relevant year save and except arm’s-length debt obligations payable to the parent. Expenditure has been incurred on administrative support from Apex Group Limited in Ireland and toward loan servicing/repayment both consistent with ordinary course operations in a leasing SPV. In the absence of cogent material showing siphoning, round-tripping, or below-market transfers, the conjecture of income “shifting” cannot survive judicial scrutiny. Thus, once the assessee has produced a valid TRC and the AO/ld. DRP have not recorded compelling grounds to rebut the applicability of the India–Ireland DTAA, the conclusion that the principal purpose of the assessee’s incorporation was to obtain India–Ireland DTAA benefits is unsustainable. The impugned finding is, therefore, set aside. We hold that relief from source-country taxation of aircraft-leasing activity constitutes a stated and substantive object of the India–Ireland DTAA. Accordingly, even de hors our threshold finding regarding the non-applicability of the Principal Purpose Test on account of the absence of a Section 90(1) notification, the assessee would, in any event, be entitled to treaty protection. The relief claimed aligns squarely with the treaty’s object and purpose. We accordingly so hold. Nature of Lease-Operating Lease v. Finance Lease - Sections 2(ma) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and section 2(ha) of the Recovery of Debts and Bankruptcy Act, 1993 which defined 'finance lease' to mean where the lessee becomes the owner of such assets at the expiry of the term of lease or on payment of the agreed residual amount. Even the RBI in its Circular No.24/2002 categorically stated that a finance lease, which is akin to ECB is one where the lessee has the right to purchase the aircrafts at the end of the lease period and will require prior approval of RBI. Therefore, the finding of the ld. DRP to this effect is patently erroneous and set aside. We are of the view that the ld.DRP grossly erred in holding that the leases in question are not operating lease. We set aside the findings of the ld.DRP in this regard and hold that the leases in question are dry operating lease. Existence of PE And applicability of Article 8 - The assessee does not have a PE in India within the meaning of India-Ireland DTAA. Having reached such a conclusion, it necessarily follows that the assessee is entitled to avail the benefit of Article 8 of the said Convention. Consequently, the issue relating to the existence of a PE, as well as the applicability of Article 8, is decided in favour of the assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether Articles 6 and 7 of the Multilateral Instrument (MLI) (Principal Purpose Test) can be invoked to deny benefits under the India-Ireland DTAA in the absence of a specific domestic notification incorporating MLI modifications. 2. If the MLI is read into the DTAA, whether the Principal Purpose Test (PPT) is satisfied on the facts-i.e., whether one of the principal purposes of incorporation/transactions was to obtain treaty benefits contrary to the object and purpose of the DTAA. 3. Whether the contractual arrangements for aircraft leasing are operating (dry) leases or finance leases for tax characterisation purposes. 4. Whether the presence/use of the leased aircraft in India gives rise to a fixed place Permanent Establishment (PE) of the lessor under Article 5 of the DTAA, and if a PE exists whether Article 8(1) (profits from operation/rental of aircraft in international traffic) nonetheless precludes taxation in India. ISSUE-WISE DETAILED ANALYSIS - 1. Applicability of MLI Articles 6 & 7 to the DTAA (threshold legal question) Legal framework: The MLI modifies Covered Tax Agreements by agreement between Contracting States; domestic effect depends on municipal law and Section 90(1) notification practice for giving effect to treaties and treaty changes. Precedent treatment: The Court applied the Supreme Court's ruling that treaty consequences that alter existing domestic rights/liabilities require an express domestic notification under Section 90(1) before being enforceable domestically; the MLI and any consequential modification must meet that requirement. Interpretation and reasoning: The MLI is not an amending protocol in the traditional municipal-law sense; the synthesised text is an explanatory, non-binding aid. Both the DTAA and the MLI may be notified, but absent a separate statutory notification incorporating the specific MLI consequences into the DTAA, the PPT cannot be treated as having domestic legal effect against taxpayers. Applying the constitutional/statutory architecture and binding precedent, the Court rejected the Revenue's contention that the MLI, once notified, automatically amends the DTAA for domestic application. Ratio vs. Obiter: Ratio - specific notification is mandatory to give domestic effect to MLI modifications that alter rights/liabilities under an existing DTAA. Obiter - comments on OECD syntheses and policy rationale for MLI efficiency. Conclusion: Articles 6 and 7 of the MLI cannot be invoked against the taxpayer because no separate Section 90(1) notification incorporating those Articles into the India-Ireland DTAA was shown; invocation of the PPT to deny treaty benefits therefore fails as a threshold legal matter. ISSUE-WISE DETAILED ANALYSIS - 2. Principal Purpose Test (factual application, alternative finding) Legal framework: PPT is a general anti-abuse rule addressing arrangements where one of the principal purposes is obtaining treaty benefits contrary to the object and purpose of the treaty; application requires holistic factual appraisal and reference to OECD BEPS Action 6 commentary and examples. Precedent treatment: The Court relied on BEPS examples and domestic precedent recognizing that tax-efficient structuring per se does not trigger anti-abuse; TRCs are strong indicia of residence and cannot lightly be impugned absent compelling evidence. Interpretation and reasoning: Even assuming MLI applied, PPT demands proof that obtaining treaty benefit was one of the principal purposes and that grant of benefit would be contrary to treaty object and purpose. The assessee's contemporaneous evidence-incorporation predating MLI, valid TRC, licensed Irish management services, Irish directors/bankers/company secretary, registration and bills of sale, real commercial leasing across multiple jurisdictions, and industry-specific commercial reasons for Ireland-were held to rebut PPT invocation. OECD examples (C, F, G, H, D, E) were applied to show commercially driven choices are consistent with PPT's exclusion. The Revenue's reliance on ultimate parent in tax-neutral jurisdiction and on outsourced administration were found insufficient to establish principal-purpose abuse. The TRC was treated as presumptively valid and not to be disregarded absent strong contrary proof. Ratio vs. Obiter: Ratio - where substantial commercial substance and objective commercial rationale exist, and no cogent evidence of treaty-shopping is shown, PPT will not be satisfied; granting treaty benefit that aligns with the treaty's object cannot be denied merely because tax benefit was a motivating factor. Obiter - extended commentary on role of industry practice and sectoral letters. Conclusion: On the facts, even if PPT were applicable, the Revenue failed to discharge the onus; the PPT would not justify denial of treaty benefits and, alternatively, granting relief would be consistent with the object and purpose of the DTAA. ISSUE-WISE DETAILED ANALYSIS - 3. Characterisation of the leases: operating lease vs finance lease Legal framework: Characterisation derives from contract terms, statutory/administrative definitions and relevant regulatory guidance (DGCA, RBI), and established judicial tests distinguishing finance leases (transfer/option to obtain ownership at term end or residual payment) from operating leases (title retained by lessor, redelivery obligation, lessor's repossession rights). Precedent treatment: The Court relied on prior tribunal/special-bench findings and higher-court dicta emphasising substance over form but also respecting genuine contractual arrangements; previous decisions treating materially identical aircraft lease templates as operating leases were followed. Interpretation and reasoning: Detailed textual analysis of key contractual clauses (express dry operating lease clause, owner designation, registration/nameplate obligations, maintenance/insurance obligations on lessee for term only, redelivery clause, lessor's repossession rights on default, restrictions on representation of ownership, limited inspection rights) showed ownership remained with lessor and no purchase option or residual acquisition mechanism existed. Operational risk allocation to lessee does not equate to transfer of ownership. Irish depreciation rules and foreign tax accounting were held irrelevant to legal characterisation in India. RBI and statutory definitions requiring an option-to-purchase or ownership transfer for classification as finance lease were applied to reject finance-lease classification. Ratio vs. Obiter: Ratio - where contractual terms reserve title and redelivery and no ownership transfer/purchase option exists, the arrangement is an operating lease; operational control/operational risks borne by lessee do not convert operating leases into finance leases. Obiter - remarks on industry-wide practice and regulatory consistency. Conclusion: The leases are operating (dry) leases; the recharacterisation as finance leases by the lower authorities was unsustainable and set aside; lease rentals cannot be treated as interest on finance leases for taxation. ISSUE-WISE DETAILED ANALYSIS - 4. Existence of Permanent Establishment and applicability of Article 8(1) Legal framework: PE under Article 5 requires a fixed place of business at the disposal of the enterprise through which business is wholly or partly carried on (disposal test, stability, productivity, dependence). Article 8(1) of the DTAA allocates taxing rights for profits from operation or rental of aircraft in international traffic to the residence State. Precedent treatment: The Court applied the Supreme Court's tests on PE (disposal test and functional analysis) and relied on authorities holding that mere situs of an asset does not establish a fixed place PE where operational control and business conduct are with the lessee; prior tribunal and High Court authorities on dry leases and bareboat arrangements were followed. Interpretation and reasoning: Contractual obligations (quiet use to lessee, lessee's operational control, maintenance and regulatory compliance obligations on lessee, limited inspection rights for lessor, redelivery) demonstrate that the aircraft were operated and controlled by the lessee. The lessor's protective rights (repossession, inspection) are standard ownership protections and do not amount to disposal of a fixed place for carrying on lessor's business. The Court distinguished cases where an asset was at lessor's disposal. Separately, Article 8(1)'s text disjunctively covers 'operation' and 'rental' and extends exclusive taxation to rental of aircraft in international traffic; given the aircraft were used on international sectors, Article 8(1) applies and, even if a PE were held to exist, profits from such rental would be taxable only in the residence State. Ratio vs. Obiter: Ratio - presence/use of aircraft in lessee's operational control does not create a fixed place PE of lessor; where aircraft are used in international traffic, Article 8(1) allocates taxing right exclusively to the residence State. Obiter - observations on network operation of modern airlines and industry practice. Conclusion: No fixed place PE of the lessor exists in India; alternatively, even if a PE were found, Article 8(1) would preclude Indian taxation of profits from rental/operation in international traffic. The ld. DRP/AO conclusions to the contrary were set aside. OVERALL CONCLUSION The appeals succeed on all principal issues: MLI PPT cannot be invoked without a specific Section 90(1) notification incorporating MLI modifications into the DTAA; on the merits PPT is not established; the leases are operating leases; no fixed place PE exists and Article 8(1) shields rental profits in any event. Consequential grounds (interest, penalty, rate issues) fall away as academic.