TaxTMI 
TaxTMI 
2005 (2) TMI 771
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.... Singapore. 2. On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) has erred in not appreciating the facts that as per article 7(3) of the DTAA between India and Singapore, the income of the assessee from business is to be computed in accordance with the provisions of and subject to the limitations of the taxation laws of that State, which includes section 44D which provides for taxation of income on gross basis. 3. Whatever be the wordings of these grounds of appeal, in our considered view, the actual issue we are required to adjudicate in this appeal is whether or not the limitation on deduction for expenses, as set out in section 44D of the Income-tax Act, will apply in a case where the related income is not in the nature of "fees for technical services" so far as meaning of the said expression under the applicable bilateral tax treaty is concerned but, on the tests laid down under Explanation 2 to section 9(1)(vii) of the Act, such an income could be treated as 'fees for technical services'. Learned representatives fairly agree with us that it is this issue which constitutes core of the controversy, and argu....
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....r technical services on gross basis, is applicable on the facts of the case, though, as the section itself sets out, only in the cases of such fees received from Indian concerns and the Government of India. The Assessing Officer thus concluded that so far as the fees received from Indian concerns is concerned, the same is taxable on gross basis, though at a concessional rate of 20% in terms of the provisions of section 115A of the Act. As regards the fees received from foreign companies, however, the Assessing Officer, in the computation of taxable income or, to put it appropriately, in the computation of loss to be carried forward, allowed deduction of related expenses incurred by the assessee. Since the expenses incurred on fees earned from Indian concerns and expenditure incurred on fees earned from foreign concerns could not be segregated, nor could it be allocated on any other basis, these expenses were allocated on the basis of quantum of fees earned on pro rata basis. The Assessing Officer thus completed the assessment in two parts-(i) computing the taxable income of the assessee at Rs. 40,50,000 from Indian companies and taxing the same at concessional rate of 20% in terms ....
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....hether or not the provisions of the India-Singapore Double Taxation Avoidance Agreement will apply to the facts of this case or not. Rightly so, because the law is trite that in a case India has entered into a Double Taxation Avoidance Agreement with any other country, so far as the assessees which are covered by such an agreement are concerned, the provisions of the Income-tax Act, 1961 will apply only to the extent to which the provisions of the Income-tax Act are more beneficial to the assessee. It is a settled legal position that whenever there is a conflict between the provisions of the tax treaty and the domestic law, the provisions of the tax treaty will prevail. These tax treaties have a significant place in the scheme of the Indian income-tax legislation, inasmuch as these treaties lay down an alternate scheme of taxation, so far as the beneficiaries of the applicable tax treaty are concerned. These alternate paradigms are entirely optional to the assessee because it cannot be thrust upon an assessee and the provisions of the Indian Income-tax Act continue to be applicable to the extent these provisions are more favourable to the assessees. Once the assessee chooses to be ....
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....d-more particularly the manner in which "limitations of the taxation laws of the other State (in which the PE is operating)" are to be construed, for the purpose of allowing deduction for the expenses incurred for the PE for determining profits of the PE, under article 7(3). One of the limitations on deduction of expenses in the Indian Income-tax Act is set out in section 44D, which, inter alia, lays down that, notwithstanding anything contained in sections 28 to 44C, a foreign company is not to be allowed any deduction of expenditure "in computing the income by way of royalty or fees for technical services" earned from Indian Government or an Indian concern under an agreement entered into between April 1, 1976 to March 31, 2003. Explanation (a) to section 44D further provides that for the purpose of section 44D, "fees for technical services" shall have the same meaning as in Explanation 2 to section 9(1)(vii). The Revenue's contention is that this limitation on deduction of expenses, which prohibits deduction of any expenses in the computation of income by way of royalties and fees for technical services is applicable in the present case also. It is contended that in view of the p....
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....ment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall, in each Contracting State be attributed to that permanent establishment the profits which might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. 3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions, expenses which are incurred for the purposes of the business of the permanent establishment including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere, in a....
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....and fees for technical services as defined in this article [other than services described in sub-paragraph (b) of this paragraph], 15 percent of the gross amount of the royalties and fees ; (b) in the case of royalties referred to in paragraph 3(b) and fees for technical services as defined in this article that are ancillary and subsidiary to the enjoyment of property for which royalties under paragraph 3(b) are received, 10 percent of the gross amount of the royalties and fees. 3. The term 'royalties' as used in this article means payments of any kind received as a consideration for the use of, or the right to use : (a) any copyright of a literary, artistic or scientific work, including cinematograph film or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right, property or information ; (b) any industrial, commercial or scientific equipment, other than payments derived by an enterprise from activities described in paragraph 4(b) o....
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.... fees for technical services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of article 7 or article 14, as the case may be, shall apply. 7. Royalties and fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, a statutory body or a resident of that State. Where, however, the person paying the royalties or fees for technical services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for technical services was incurred, and such royalties or fees for technical services are borne by such permanent establishment or fixed base, then such royalties or fees for technical services shall be deemed to arise in the State in w....
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.... in Explanation 2 to clause (vi) of sub-section (1) of section 9 ; (d) royalty received from Government or an Indian concern in pursuance of an agreement made by a foreign company with Government or with the Indian concern after the 31st day of March, 1976, shall be deemed to have been received in pursuance of an agreement made before the 1st day of April, 1976, if such agreement is deemed, for the purposes of the proviso to clause (vi) of sub-section (1) of section 9, to have been made before the 1st day of April, 1976." 115A. Tax on dividends, royalty and technical service fees in the case of foreign companies.-(1) Where the total income of- (a) ...... (b) a non-resident (not being a company) or a foreign company, includes any income by way of royalty or fees for technical services received from Government or an Indian concern in pursuance of an agreement made by the foreign company with Government or the Indian concern after the 31st day of March, 1976, and where such agreement is with an Indian concern, the agreement is approved by the Central Government or where it relates to a matter included in the industrial policy for the time being in f....
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....? They must follow the European pattern. No longer must they examine the words in meticulous detail. No longer must they argue about the precise grammatical sense. They must look to the purpose or intent.........." 11. Echoing these views and justifying his departure from the plain meaning of the words used in the treaty, Goulding J. in IRC v. Exxon Corporation [1982] STC 356 (Ch. D.) at page 369, observed : "In coming to this conclusion, I bear in mind that the words of the Convention are not those of a regular Parliamentary draftsman but a text agreed on by negotiations between the two contracting governments. Although I am thus constrained to do violence to the language of the Convention, I see no reason to inflict a deeper wound than necessary. In other words, I prefer to depart from the plain meaning of language only in the second sentence of article XV and I accept the consequence (strange though it is) that similar words mean different things in the two sentences." 12. In a later judgment, Harman J. in Union Texas Petroleum Corporation v. Critchley (Inspector of Taxes) [1988] STC 691, affirmed the above observations of Goulding J. and added (page 707) : ....
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....k 'Statutory Interpretation' (Butterworths, 1992 edition at page 461). Extracts from the said observations are as follows (page 751) : "'With indirect enactment, instead of the substantive legislation taking a well known form of an Act of Parliament, it has the form of a treaty. In other words, 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 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 the broad principles of general acceptation'. This echoes optimistic dictum of Lord Widgery C.J. that the words 'are to be given their general meaning, general to lawyer and laymen alike. . . the meaning of diplomat rather than the lawyer'....
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....e setting in which all appear, and which all collectively create' . . . " When such are the views of the hon'ble Supreme Court on the interpretation of taxing statutes, essentially the tax treaties, which are to be subject to less rigid rules of interpretation, cannot be subjected to literal interpretation in isolation with the context in which the provisions of the treaty are set out. 16. The hon'ble Madras High Court in the case of CIT v. VR. S. R. M. Firm [1994] 208 ITR 400, has held that "tax treaties are ...... considered to be mini legislation containing in themselves all the relevant aspects or features which are at variance with the general taxation laws of the respective countries". It is also important to bear in mind that the provisions of tax treaties are required to be read as a whole and not in isolation with each other. The court's duty is to give effect to the provisions of the treaty in its natural meaning, and not to interpret them in isolation. It is done in their context and in the light of the object and purpose of the treaty. The context in which the words are used is therefore of paramount importance. General words and phrases, therefore, however wide a....
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....ples adopted in the interpretation of statutory legislation are not applicable in interpretation of treaties. A tax treaty is to be interpreted in good faith in accordance with the ordinary meaning given to the treaty in the context and in the light of its objects and purpose. A tax treaty is to required to be interpreted as a whole, which essentially implies that the provisions of the treaty are required to be construed in harmony with each other. The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need not be examined in precise grammatical sense or in literal sense. Even departure from plain meaning of the language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty ut res magis valeat quam pereat, i.e., in such a manner as to make it workable rather than redundant. A literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated in so far as particular items under consideration are concerned. It is inevitable that interpreter of a tax treaty is likely to be required to cope with disorganised ....
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.... fees received under agreements made on or after the April 1, 1976 (other than agreements which though made on or after that date or regarded as having been made before that date as explained in paragraph 26.2) no deduction will be allowed in computing the income from the aforesaid sources, regardless of whether the agreement has been. . . . 36.1 . . . income by way of royalty or fees for technical services received by them from Indian concerns in pursuance of approved agreements made on or after the April 1, 1976, will now be charged to tax at flat rates applicable on the gross amount of such income. The rates of income-tax to be applied in respect of such income have been specified in new section 115A of the Income-tax Act and are as follows :- . . . (iii) Income by way of fees for technical services received by a foreign company from an Indian concern in pursuance of an approved agreement made on or after the 1st April, 1976, will be charged to tax at the rate of 40 percent on the gross amount of such fees." The periodic changes in section 44D have been accompanied by the corresponding changes in section 115A. It is thus clear that non-deduction of expenses ....
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....d on the net basis because of the application of article 12(6) i.e., on account of being attributable to the PE in the other Contracting State. In other words, in case a receipt is held to be not taxable as "royalties and fees for technical services" under the provisions of the India-Singapore tax treaty, the same cannot also be subjected to tax under section 44D, read with section 115A either. 20. In view of the admitted position that the provisions of the India Singapore tax treaty are applicable on the facts of this case, let us examine, on the touchstone of the underlying scheme of things in the said tax treaty, as to what is the nature of receipts in the hands of the assessee and in respect of which profits attributable to Indian PE are to be computed. In the assessment order, there is no finding by the Assessing Officer that the receipts by the assessee could be covered by any of the sub-clauses in article 12(4). To the Assessing Officer, this aspect of the matter did not really seem important because he was of the view, in view of the mandate of article 12(6), that when "royalty and fees for technical services" arise, in the course of business carried on through a permane....
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...., and it certainly is a relevant factor to be taken into consideration in construing the ambit of the section, then these payments mentioned therein are not deductible, according to the statute, in certain circumstances. Therefore, the heading of this section is a clear indication that certain payments and expenses which would be otherwise deductible would not be deductible except in certain circumstances indicated in the section. . . ." (emphasis supplied) Therefore, the heading of a section, in the words of the hon'ble Supreme Court, "certainly is a relevant factor to be taken into consideration in construing the ambit of the section". The heading of section 44D being "Special provisions for computing income by way of royalties, etc., in the case of the foreign companies, this section can come to play only when the income is by way of royalties, etc., i.e., by way of royalties and fees for technical services ("fees for technical services" is perhaps the only other nature of income belonging to the genus of "royalties") in the hands of a foreign company. Unless the income is of such a nature so as to fit the description of title of section 44D, there cannot be any occa....
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....viewing one provision of a tax treaty, due regard is to be given to the scheme of that tax treaty. It cannot be open to take out a provision from the treaty and interpret it as a kind of a stand alone provision. Therefore, when we are to apply the limitation on deduction of expenses so far as "royalties and fees for technical services" are concerned, we have to see whether or not the payments in question do in fact constitute "royalties and fees for technical services" in the light of the principles underlying the scheme of the applicable tax treaty. The deduction under section 44D comes to play only when the income is in the nature of income as royalties and fees for technical services. It would indeed be somewhat inconsistent and certainly unreasonable to, on one hand, hold that the receipts of the assessee are not in the nature of fees for technical services, and then, on the other hand, apply the limitation for deduction of expenses which are applicable only in the case of receipts in the nature of fees for technical services. 22. The hon'ble Supreme Court has, in the case of Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706, observed that (p. 751) "the principles ad....
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....ons of the limitation on deduction of expenses under article 7(3) so far as business profits other than those in the nature of royalties and fees for technical services are concerned. 24. Article 12(4), which is already reproduced above, lays down that the term "fees for technical services" means payments of any kind to any person in consideration for services of a managerial, technical or consultancy nature (including the provision of such services through technical or other personnel) if such services are (a) ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received ; or (b) make available technical knowledge, experience, skill, know-how or processes, which enables the person acquiring the services to apply the technology contained therein ; or (c) consist of development and transfer of a technical plan or technical design, but excludes any service that does not enable the person acquiring the service to apply the technology contained therein. The nature of the assessee's activities being in the nature of "strategy consulting", application of (a) and (c) is clearly ruled out. Such ser....
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....ia-US tax treaty also do not find mention in the India-Singapore tax treaty. The scope of article 12(4)(b) in the India-US treaty, therefore are no wider than the scope of article 12(4)(b) of the India-Singapore tax treaty. Therefore, in case non technical services cannot be covered by the scope of article 12(4)(b) of the India-US tax treaty, these services cannot be covered by the scope of article 12(4)(b) of the India-Singapore tax treaty either. As a matter of fact the aforesaid India-USA tax treaty was the first Indian tax treaty in which this paradigm shift in the scope of fees for technical services was made. The provisions of article 12(4)(b) clearly depart from the normal definition of "fees for technical services" in DTAAs that India had entered into with most foreign countries which is some what on the lines of the definition given in Explanation 2 to section 9(1)(vii) of the Income-tax Act. In the protocol note attached to and forming part of the aforesaid DTAA, Government of India, has confirmed that memorandum of understanding between India and USA with regard to interpretation of article 12 (royalties and fees for included services) also represents the views of the In....
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....ces, such as business strategy, marketing and sales strategy, portfolio strategy, etc., to its clients in India and abroad. The nature of these services is materially similar. The scope of the corresponding provisions in the India-Singapore tax treaty are not any wider in scope. In the India-Singapore tax treaty it is all the more clear that only such services as are technical in nature are covered by the scope of article 12(4)(b) as is evident from the reference to such services "which enables the person acquiring the services to apply the technology contained therein". Unless the services are technical in nature, there cannot be any question of "technology" being contained therein which the person acquiring the services can be enabled to apply. Therefore, so far as the provisions of India Singapore tax treaty, as also the provisions of the India-US tax treaty, are concerned, payments for services which are non-technical in nature, or, in other words, payments for services not containing any technology, are required to be treated as outside the scope of "fees for technical services". 27. It is noteworthy that the Government of India has confirmed that memorandum of understandin....
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....y is not the case here. Accordingly, we are of the considered view that the nature of services rendered by the assessee do not fit into the description of "fees for technical service" under the provisions of the India-Singapore tax treaty. As we have already held, in case the receipts, in respect of which profits are computed under article 7(3), do not fit the description of "royalties and fees for technical services", the limitation on deduction of expenses under section 44D does not come to the play. In the case before us, the receipts in question are such in nature that the provisions of article 12 are not attracted. Accordingly, in our considered view, the limitation under section 44D is not to be applied for the purpose of deduction of expenses, in computing taxable profits, under article 7(3) of the India-Singapore tax treaty. We have already taken note of the position that section 44D, read with section 115A of the Indian Income-tax Act, and article 12 of the India-Singapore tax treaty are, similar in nature and offer alternative but similar models of taxation of income from royalties and fees from technical services, that these are two independent, mutually exclusive, and c....
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....ons set out earlier in this order and in the light of our findings on certain aspects of the matter, which hon'ble Authority had no occasion to consider, we are of the view that the limitation on deduction of expenses under section 44D will not apply in a case where the receipts in question do not answer the description of "royalties and fees for technical services" under the applicable tax treaty. 32. Secondly, in none of the above cases before the hon'ble Authority, the receipts in question were found to be beyond the scope of "royalties and fees for technical services" in the applicable tax treaties. On the contrary, there was a categorical finding in these cases that the receipts clearly fit in the description of "royalties and fees for technical services" under the applicable tax treaties. In the case before us, however, not only that it is unchallenged finding of the Commissioner of Income-tax (Appeals) that the receipts in question do not answer the description of "royalties and fees for technical services", we have, on the merits of the case and for the elaborate reasons set out earlier in this order, come to the conclusion that these receipts do not fit the description ....
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....Denning, in the case of Seaford Court Estates Ltd. v. Asher [1949] 2 All ER 155 (CA) at page 164, had observed that "when a defect appears, a judge cannot simply fold his hands and blame the draftsman" and that "A judge should ask himself the question how, if the makers of the Act had themselves come across this ruck in the texture of it, they would have straightened it out ? He must then do as they would have done. A judge must not alter the material of which the Act is woven, but he can and he should iron out the creases." These observations, which are quoted with approval by the hon'ble Supreme Court in the case of M. Pentiah v. Mudadla Veeramallappa, AIR 1961 SC 1107 (at page 1115), may or may not be any longer relevant in the context of the interpretation of taxing statutes, but, in the light of the principles approved in Azadi Bachao Andolan's case [2003] 263 ITR 706 by the hon'ble Supreme Court, these observations are certainly applicable in the context of interpretation of tax treaties. In our humble understanding, post Azadi Bacho Andolan it is no longer permissible in law to apply the rigid principles of interpretation of statutes on the treaties as well, and in the case ....