2025 (10) TMI 220 - AT - Income Tax

Aircraft lease held operating lease; rentals taxed under India-Ireland DTAA Article 8; MLI cannot amend treaties absent section 90(1) notification

ITAT Delhi (AT) held that the aircraft lease is an operating lease not a financial lease, and lease rentals fall under Article 8 of the India-Ireland ... Operating Lease vs. Financial Lease - whether the lease agreement entered into between the lessees of the aircraft and the lessor(Indigo) is in the nature of Operating Lease or Financial Lease? - HELD THAT:- We find that the issue, whether the lease agreement between the Lessee (assessee) and the Lessor (Indigo) is financial lease or operating lease has been examined in the case of Celestial Aviation Trading [2025 (8) TMI 133 - ITAT DELHI] to hold that the agreement to lease aircrafts is in the nature of operating lease and not financial lease. The issue is thus decided in favour of the assessee and against the department. Applicability of MLI to India-Ireland DTAA - contention of Revenue is that India and Ireland have ratified MLI and India has notified MLI on 9/8/2019 - HELD THAT:- It is an administrative pact to cooperate and share information and does not amend or override existing bilateral tax treaties. Hence, it does not modify /alter substantive rights and obligations under Treaty. Reference has also been made to CBCR. We find that it does not override existing tax treaties. It is administrative arrangement for information exchange. The said MLI was in fact notified u/s 286 of the Act. The provisions of said section provides for notifications of MLI, hence, cannot be equated with the provisions of notification under section 90(1) of the Act. Be that as it may, one relevant fact that needs to be noted here is that omnibus notification in respect of aforementioned MLIs never faced judicial scrutiny. The question of validity of MLI having effect of modifying/altering existing treaty first faced legal test in the cases where MFN protocols were signed and had the effect of amending relevant DTAAs with the other countries. The Hon’ble Apex Court in Nestle SA [2023 (10) TMI 981 - SUPREME COURT] made it clear that any amendment to DTAA would come into force only after notification u/s. 90(1) of the Act. The same analogy has to be applied in the case of MLI which have the effect of amending existing DTAAs. As per global practice, single omnibus notifications are issued for the assimilation of MLI into domestic law - The global practice of single omnibus notification does not determine India legal position on treaty implementation. Section 90(1) of the Act mandates for notification of any treaty. The Hon’ble Apex Court in the case of Nestle SA [2023 (10) TMI 981 - SUPREME COURT] made it explicit that the amendment to DTAA is enforceable only on notification u/s. 90(1) of the Act. We hold that single omnibus notification u/s 90(1) of the Act already issued would not legislate the amendments/modifications in existing DTAA. A specific notification for each country is required u/s. 90(1) of the Act where the MLI has the effect of amending /altering bilateral treaties. Hence, this issue is decided in favour of the appellants and against the Revenue. Application of Article 8 of India-Ireland DTAA - The definition of “international traffic “if applied in context to facts of the instant case, international traffic means any transport by aircraft operated by an enterprise of India, except when aircraft is operated solely between places in Ireland. Accordingly, an aircraft operated by Indian lessee (Indigo) shall be considered as operating in international traffic. The lessee operates aircraft in and outside India and does not operate aircraft solely in Ireland. Further, neither Article 8(1) nor Article 3(1)(f) defining ‘international traffic’ refers to voyage/journey. Therefore, argument of the ld. Special Counsel for the Department referring to voyage/journey to test check international traffic is misplaced, hence, unsustainable. When the meaning are self-explanatory in the DTAA there is no need to travel to OECD Conventions which are only guiding light and have no binding force. Each aircraft has to be seen whether it has flown outside and has operated in international traffic - The assessee earns rentals from lease of aircraft. The lessor has no control on the schedule of the aircrafts or the destination of the aircraft where they are operated. The lessor/assessee does not lay down any restrictions in the lease agreement as to whether the aircraft shall operate in domestic territory or operate internationally. It is the discretion of the lessee to schedule the operation of the aircraft. It is no denying that lessee/Indigo is operating internationally. Therefore, to presume that the aircraft are not operated internationally is superfluous. Nevertheless, the assesses being the lessor of the aircraft would continue to receive rentals even if the aircraft is not put to operation by the lessee. The assessee has filed a certificate of deployment of aircraft issued by the lessee which confirms the fact that leased aircraft has not been deployed anywhere in Ireland during the relevant period and is operated in international traffic. Thus, the condition of Article 8(1) is satisfied. For the reasons mentioned above and in light of order in the case of Sky High Appeal XLIII Leasing Company Ltd. [2025 (8) TMI 1274 - ITAT MUMBAI] we hold the lease rental received by the assessee/appellant are covered by Article 8 of India-Ireland Treaty. Hence, the assessee would get the benefit of Article 8. In the result, this issue is decided in favour of the assessee/appellant and against the Department. Existence of PE in the form of aircraft in India - Assessee/appellant has no PE in India in terms of Article 5 of India92 Ireland DTAA. The issue is decided in favour of the assessee/Appellant and against the Department. 1. ISSUES PRESENTED AND CONSIDERED Whether aircraft lease agreements between foreign lessors and Indian lessees are operating leases or financial leases for tax characterisation purposes. Whether the Multilateral Instrument (MLI) (specifically Articles 6 & 7 / Principal Purpose Test) is applicable to modify the India-Ireland Double Taxation Avoidance Agreement (DTAA) in domestic law absent a treaty-specific notification under Section 90(1) of the Income-tax Act. Whether lease rentals received by a resident of Ireland for leasing aircraft to an Indian lessee fall within Article 8 (shipping and transport: operation or rental of aircraft in international traffic) of the India-Ireland DTAA and therefore are taxable only in the State of residence. Whether presence of aircraft leased to an Indian lessee constitutes a Permanent Establishment (PE) of the foreign lessor in India under Article 5 of the India-Ireland DTAA. Other consequential or procedural issues (taxability as royalty, applicability of domestic withholding/interest provisions, jurisdictional and draft/assessment order defects, penalty and interest), left open or treated as academic given favourable disposition on primary issues. 2. ISSUE-WISE DETAILED ANALYSIS Issue I - Operating Lease v. Financial Lease Legal framework: Income-tax Act lacks statutory definitions of 'financial lease'/'operating lease'; therefore commercial/contractual substance, RBI circulars (RBI Circular No.24 on import of aircraft on lease), DGCA guidance on economic life, and comparative definitions in other statutes (SARFAESI Act, Recovery of Debts Act) inform classification. Tax treaty consequences follow from characterization (rent v. interest). Precedent treatment: Tribunal Coordinate Bench decisions (Celestial Aviation Trading 15 Ltd. and Special Bench in InterGlobe/IndiGo matters) examined substantially identical Aircraft Specific Lease Agreements and Aircraft Lease Common Terms Agreement and held such leases to be operating leases. Interpretation and reasoning: The Court examined the lease documents (ASLA and CTA) and found continuous ownership/title with the lessor during and after lease, express covenants requiring redelivery on expiry, absence of any option or covenant effecting transfer of ownership or vesting in lessee, protective lessor rights (indemnity, insurance obligations, registration of owner/lessor interest, sale/re-lease upon default), and no RBI approvals indicative of financial lease transactions. The hallmark of a financial lease-transfer of ownership or a contractual right to become owner at expiry-was absent. DGCA economic life (20 years or 60,000 cycles) contrasted with lease terms (72-120 months), negating a finding that the lessee enjoyed substantially the whole economic life. DRP and AO reliance on an 8-year economic life determination was found unsupported by record and inconsistent with DGCA circulars. RBI circular distinguishes operating vs financial leases and requires RBI approval for financial leases; no such approval existed. Ratio vs. Obiter: Ratio - where the lease documentation maintains title with lessor, requires redelivery, lacks option to purchase/transfer of ownership, and evidence shows substantial residual economic life post-lease, the lease is an operating lease (not a financial lease). Obiter - factual observations on specific covenant clauses supporting commercial rationale (e.g., nameplates, International Registry) amplify reasoning. Conclusion: The leases were held to be operating leases; therefore lease rentals are not taxable as interest under Article 11. Issue decided for assessee; AO/DRP recharacterisation as financial lease rejected. Issue II - Applicability of MLI (Articles 6 & 7 / PPT) to India-Ireland DTAA Legal framework: MLI is a multilateral treaty that modifies covered bilateral DTAAs under international law; domestic enforceability requires conformity with constitutional and statutory requirements-Section 90(1) of the Income-tax Act and jurisprudence governing incorporation of treaties into domestic law (principles from Article 253, parliamentary role). OECD explanatory materials acknowledge domestic law variation in implementation. Precedent treatment: Supreme Court precedent (Nestle SA) establishes that a protocol or instrument that alters treaty terms acquires domestic enforceability only after notification under Section 90(1). Tribunal decisions (Sky High; Celestial/Sunflower/Sunflower-related coordinate bench orders) analysed and applied Nestle SA principles to MLI context and held that treaty-specific notification is necessary to make MLI modifications operative in domestic law. Interpretation and reasoning: The Tribunal analysed (i) the nature and operational mechanics of MLI (matching principles, synthesised text, requirement of reciprocal positions), (ii) the existence of a general omnibus notification of MLI dated 09.08.2019, and (iii) absence of a separate statutory notification identifying the specific consequences of MLI on the India-Ireland DTAA. Applying Nestle SA, the Tribunal held that mere general notification of MLI or inclusion of a DTAA as a 'covered agreement' is insufficient; the specific modification to a notified DTAA must itself be notified under Section 90(1) to alter domestic rights and liabilities. The Tribunal rejected Revenue's submissions that global practice or prior omnibus notifications for other multilateral instruments obviate this requirement, noting OECD guidance that domestic implementation depends on each jurisdiction's legal framework. The synthesised text and OECD notes are non-binding aids and cannot supplant the statutory notification requirement. Ratio vs. Obiter: Ratio - MLI provisions that purport to modify a specific DTAA cannot be invoked domestically against taxpayers unless the specific consequences of the MLI on that DTAA have been notified under Section 90(1); a general omnibus MLI notification is not a substitute. Obiter - observations on OECD practice and comparative notifications; discussion of Finance Act, 2020 amendments as supportive but not replacing notification requirement. Conclusion: Articles 6 & 7 (PPT) of the MLI were held inapplicable to deny treaty benefits under the India-Ireland DTAA in absence of a DTAA-specific Section 90(1) notification; Revenue's invocation of MLI/PPT fails as a threshold legal matter. Cross-reference: This threshold conclusion on MLI is applied to reject AO/DRP reliance on PPT to recharacterise treaty benefits (see Issues III & IV). Issue III - Applicability of Article 8 (operation or rental of aircraft in international traffic) Legal framework: India-Ireland DTAA text (Article 8(1)) expressly covers 'operation or rental of ships or aircraft in international traffic' and grants exclusive taxing rights to the residence state for such profits; Article 3 defines 'international traffic.' Vienna Convention principles of treaty interpretation (ordinary meaning, context, object and purpose) guide construction; OECD Model and commentary provide context but DTAA language controls. Precedent treatment: Tribunal decisions (Sunflower Aircraft Leasing Ltd., Sky High) interpreted the India-Ireland DTAA's broader Article 8 language as deliberately departing from OECD Model by disjunctively including 'rental' and thereby covering dry leases where aircraft form part of a fleet employed in international traffic. Interpretation and reasoning: The Tribunal emphasised the treaty's wording: 'operation or rental' are independent heads; nothing in the treaty requires the lessor to be an operator (i.e., wet lessor). 'International traffic' excludes only aircraft operated solely between places in the other Contracting State; therefore any fleet usage not solely domestic qualifies. Commercial reality (fleets deployed interchangeably on domestic and international sectors) supports application to dry leases. Revenue's arguments that 'international traffic' should be applied on a per-voyage basis or that the lessor must itself operate the aircraft were rejected as adding conditions absent in the treaty text and contrary to the contracting states' deliberate formulation. The Tribunal noted that factual onus (usage records) lies on taxpayers if disputed, but where lessee is an international carrier and lease contains no restriction on international operation, the Article 8 condition is satisfied; the lease rentals therefore fall within exclusive residence-state taxation. Ratio vs. Obiter: Ratio - under the India-Ireland DTAA, rental income from dry leasing of aircraft that are part of a fleet used in international traffic falls within Article 8(1) and is taxable only in the State of residence; it is not necessary that the lessor be an operator or that rental be ancillary to operation. Obiter - remarks on practical fleet deployment and rebuttal of OECD commentary reliance where treaty language differs. Conclusion: Lease rentals at issue qualify for Article 8 protection and are taxable only in the State of residence (Ireland); this conclusion stands irrespective of PE analysis and is decided for the assessee. Issue IV - Existence of Permanent Establishment (PE) Legal framework: Article 5 of the India-Ireland DTAA (fixed place PE and other PE concepts) requires (i) a 'place of business,' (ii) that it be 'fixed,' and (iii) business be carried on 'wholly or partly through' that place; the 'disposal test' (place at the enterprise's disposal) and tripartite attributes (stability, productivity, dependence) derived from jurisprudence (Formula One, E-Funds, Hyatt) inform assessment. Precedent treatment: Tribunal decisions (Sunflower; Sky High) and relevant case law emphasise economic substance over form and hold that mere location of an asset in the source State or protective/control rights of lessor do not convert the asset into a fixed place PE of the lessor when operational control, scheduling, crewing, and commercial deployment rest with the lessee. Interpretation and reasoning: Applying the disposal test, the Tribunal found no evidence that the lessor had the aircraft at its disposal in India for conducting its leasing business: leasing administration, negotiation and management take place offshore; operational control (deployment, routing, crewing) vests with lessee; lessor's retained rights (inspections, repossession, protective covenants) are consistent with ownership protection, not business conduct through a fixed place in India. Authorities distinguishing wet vs bareboat/dry leases and decisions holding that mere presence of equipment does not create PE were applied. No personnel or infrastructure of the lessor were stationed in India to indicate a fixed establishment. Ratio vs. Obiter: Ratio - mere presence of leased aircraft in India and protective lessor rights do not constitute a fixed place PE of the foreign lessor where the lessee retains operational control and the lessor does not have the aircraft at its disposal for conducting business in India. Obiter - discussion of comparative authorities (Madras HC Van Oord, Formula One) supporting the analysis. Conclusion: No PE of the foreign lessor existed in India; Article 5-based PE assertion rejected. This conclusion reinforces Article 8 outcome but is independently decided in favour of the assessee. Issue V - Other consequential and procedural grounds Legal framework & reasoning: Several subsidiary grounds (taxability as royalty, interest under domestic sections, jurisdictional defects, assessment/draft order irregularities, penalty proceedings, and interest under Sections 234A/234B) were raised. The Tribunal noted that many of these grounds became academic after favourable rulings on substantive treaty and PE issues; interest under Sections 234A/234B is mandatory and consequential; challenge to penalty proceedings premature. Ratio vs. Obiter: Ratio - interest under Sections 234A/234B is chargeable as a statutory consequence; penalty challenges premature at appellate stage where proceedings are ongoing. Obiter - other grounds left open for later adjudication if needed. Conclusion: Appeals allowed pro tanto on primary treaty/PE/lease classification issues; statutory interest charges sustained; penalty challenges dismissed as premature; other grounds reserved.