Week 10 – 11

 Strict rule of interpretation in tax statutes

 Plain, clear and direct meaning is given to words

 Court cannot give particular meaning to a word which is not clear by making a presumption that
particular meaning is the intention of the legislature.

 Why do we prefer strict rule of interpretation in tax statutes?

 Creates a monetary burden on the taxpayer – penalty.

 Tax liability exists only by reason of a statute, there is no common law obligation to pay tax.

 Thus, courts adopted a stance that if the state wishes to tax a particular entity it must state so ‘clearly
and plainly’; there is no room for ambiguity in taxation.

 Pitfalls of strict interpretation

 At times, leads to absurd or unreasonable results especially if courts only look at form and not
substance of the transaction.

 Certain exceptions have crept into the strict interpretation rule - essential imputation to prevent
unreasonable results - but strict interpretation has not been completely given up.

Mcdowell and Co. Ltd. Vs. CTO (1985)

 Facts: Under the AP Excise Act and Rules, assessee (manufacturer) could remove the liquor from
distillery only on payment of the excise duty.

 Assessee entered into an arrangement with the purchaser of the liquor wherein the purchaser used to
pay the excise duty instead of the assessee and obtain ‘distillery passes’ which permitted them to
remove liquor from the distillery.

 Accordingly, assessee used to prepare sale invoices which only reflected the price of the liquor but
not the amount paid as excise duty.

 Assessee was liable to pay Sales Tax under the AP Sales Tax Act on the basis of its turnover.

 The amount paid as excise duty by the purchasers was not included in the turnover.

 The Assessee was sent a notice asking why the excise duty paid in respect of the liquor should not be
treated part of taxable turnover of the assessee?

 SC 1976

 Intending purchasers are also legally responsible to pay the excise duty which is collected by the
Excise Dept. Thus, tax authorities are not allowed to include excise duty as part of the assessee’s
turnover which was directly paid by the purchasers to the excise department.
 Amendment

 After the 1976 decision, Excise Rules were amended in 1981 to the effect:

 No liquor shall be removed unless excise duty has been paid by the manufacturer of liquor. It was
also clarified that the obligation/liability to pay the excise duty is that of the manufacturer of liquor.

 New notice was sent to the assessee on similar grounds in 1982-83

 HC and SC

 High Court held that the liability to pay excise duty is that of the assessee and the payment of the
excise duty by the purchaser does not mean that it cannot be included in taxable turnover of the
assessee.

 The change in the court’s stance was primarily due to the amendment in the rules which made it clear
that the liability to pay the excise duty is that of the manufacturer and not that of purchaser.

 SC also upheld the High Court’s view and held that the payment of excise duty is the primary and
exclusive obligation of the manufacturer under the rules and if payment is made under an
arrangement by any other person it would amount to meeting the obligation of the manufacturer and
nothing more. There is no reason why it should not be included in the turnover for purpose of
assessing the sales tax of the manufacturer.

 Discussion on tax avoidance and tax evasion (Majority judgement given by Misra)

 SC held that tax planning (tax avoidance) is legitimate provided it is within the framework of law

 Colourable devices cannot be part of tax planning and it is wrong to believe that it is honourable to
avoid payment of tax by resorting to dubious methods.

 On this aspect one of us, Chinnappa Reddy, J., has proposed a separate and detailed opinion with
which we agree.

 Chinnappa Reddy Opinion

 No one can now get away with a tax avoidance project merely with a statement that there is nothing
illegal about it.

 Pointed out harmful effects of tax avoidance and said that judicial approval should not be given for
transactions that lead to tax avoidance.

 And, concluded by saying that he agrees with Ranganath Misra’s opinion!

 Difficulty in Reconciliation

 Misra, J mentioned that

  Colourable devices/ dubious methods/subterfuges employed to reduce tax liability should be
looked into, are not allowed.

 Reddy, J says that

 There is practically no distinction between tax avoidance and tax evasion

 Called for investigation into genuine transactions too if their effect is to reduce the tax
liability of the assessee

 Yet, both in their opinions say that they agree with each other!

UOI v. Azadi Bachao Andolan (2003)

 Context: Art 13(4), Indo-Mauritius DTAA: Capital gains from sale of shares will be taxed in the
‘resident’ state.

 Thus, if A, a resident of Mauritius, made capital gains from sale of shares - the gains are only taxable
in Mauritius.

 India will not be able to tax A since it is the ‘source’ state.

 The catch: Mauritius does not levy capital gains tax.

 The net result is that A does not pay any capital gains tax in either of the two states

 Facts: Relying on this provision a number of FIIs - resident in Mauritius - invested in India with the
hope of earning huge gains.

 In 2000, some income tax authorities issued notices to these FIIs as to why should they not be taxed
in India for their capital gains and dividends.

 Basis of the notice was that the companies in question are ‘shell’ companies and not really residents
of Mauritius - only using Mauritius route to earn tax free capital gains - these companies are actually
controlled from elsewhere.

 To clarify the situation, CBDT issued circular on 13.4.2000 which stated that Residence Certificate
issued by Mauritius constitutes sufficient evidence of residence of the company in Mauritius.

 Circular issued in 2000 was challenged in the Delhi HC

 High Court

 Delhi HC declared the circular as illegal because: After the McDowell decision, AOs are entitled to
lift corporate veil to see if the corporate vehicle is for tax avoidance or not and the circular took away
the power of AO. This function of AO is quasi-judicial and the circular interferes with quasi-judicial
powers of assessing officers.
  "Treaty Shopping" by which the resident of a third country takes advantage of the provisions of the
Agreement, is not the intention behind DTAC and therefore forbidden.

 Supreme Court

 Declared the circular valid: Sec 90: Intended to enable and empower the Central Govt to implement
the DTAA and which would prevail even if inconsistent with the Income Tax Act. The circular falls
within the scope of Sec 90 as it is to facilitate implementation of DTAA entered into by India in
exercise of its powers under Sec 90.

 To claim benefit of the DTAA, one needed to be a resident of either of the two states. Resident under
Article 4, DTAA meant a person ‘liable to pay tax.’ Merely because a resident had been provided
exemption to pay tax does not mean that it was not liable to pay tax. For application of Art 4, DTAA
what is necessary is the legal situation i.e. liability to tax and not actual payment of tax

 The court further held that treaty shopping is legal unless a LOB clause is inserted.

 Many countries - developed and developing encourage treaty shopping - to encourage scarce capital
and foreign enterprise as loss of tax revenue can be insignificant as compared to other non-tax
advantages.

 On Mcdowell Case

 We are unable to read or comprehend the majority judgment in McDowell as having endorsed the
extreme views of Chinnapa Reddy, J which in our view militates against the observations of the
majority of the judges.

 McDowell cannot be read so as to state that every arrangement which is permissible under the law
but has the effect of reducing the tax burden of the Assessee must be looked at with disfavor.

 The only restriction on taxpayer’s liberty in this aspect is that she should not resort to a colourable
device to reduce her tax liability

Vodafone on McDowell and Azadi Bachao

 Revenue’s argument was that Azadi Bachao did not interpret McDowell decision correctly;
Chinappa Reddy’s opinion should be given more weight since the majority agreed with him.

 Court dismissed the argument by stating Azadi Bachao correctly applied McDowell decision

 Indo-Mauritius DTAA

 Indian revenue authorities -

 Incorporation of companies in Mauritius to buy and sell shares of Indian companies is

impermissible tax avoidance/amounts to tax evasion

 It also amounts to treaty shopping

  Court –

 This may be treaty shopping, but the treaty has to specifically provide for and incorporate a
‘Limitation of Benefits’ clause

 Assessee cannot be denied treaty benefits without a good reason

 Azadi Bachao: for all the revenue dept’s fury, this absence of limitation of benefits clause may
be intentional

 Treaty amended in 2016 – LOB Clause added.

 OECD Framework on BEPS

 In 2013, an OECD/G20 project was setup to create an international framework to combat tax avoidance by
MNCs.

 The project was: BEPS Project - BASE EROSION AND PROFIT SHIFTING PROJECT.

 What does BEPS mean? – MNCs earning profits in high tax jurisdictions/big markets and reporting their
earnings in low tax jurisdictions - THUS, ERODING TAX BASE OF HIGH TAX JURISDICTIONS AND SHIFTING
PROFITS TO LOW TAX JURISDICTIONS

 The BEPS package provides 15 Actions that equip governments with the domestic and international

instruments needed to tackle tax avoidance.

 General Anti-Avoidance Rules (GAAR)

 GAAR is a statutory anti-avoidance rule, the case for which gained traction in the aftermath of the
Vodafone case (2012).

 In March 2012, the then Finance Minister of India announced India’s intent to implement GAAR.

 Chapter XA of the Income Tax Act - GENERAL ANTI-AVOIDANCE RULE was added to the
Income Tax Act, 1961 and was amended subsequently multiple times.

 Its implementation was postponed for two years on recommendation of the Shome Panel, and it
eventually came into force from 1 April 2017.

 BEPS Framework suggests domestic Anti-Avoidance rules along with treaty amendments.

 GAAR – SNAPSHOT

 OVERRIDES ALL OTHER PROVISIONS OF THE IT ACT, 1961

 Sec 95: Notwithstanding anything contained in the Act, an arrangement entered into by an assessee
may be declared to be an impermissible avoidance arrangement and the consequence in relation to
tax arising therefrom may be determined subject to the provisions of this Chapter
  Non-obstante clause is being understood to mean: GAAR can be used to override Sec 90(2) [i.e.
benefits of DTAA over IT Act]

 GAAR - SUBSTANTIVE PROVISIONS

 Section 96 : Impermissible Avoidance Arrangement

96. (1)  An impermissible avoidance arrangement means an arrangement, the main purpose of which is to
obtain a tax benefit, and it—

a) creates rights, or obligations, which are not ordinarily created between persons dealing at arm's
length;

b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;

c) lacks commercial substance or is deemed to lack commercial substance under section 97, in whole
or in part; or

d) is entered into, or carried out, by means, or in a manner, which are not ordinarily employed
for bona fide  purposes.

 Section 97 (1) & (4)

 Section 102 (10)

 GAAR Critique:

 Has been criticised as a draconian measure with a wide scope.

 While the criteria are specified, ample scope for subjectivity and uncertainty.

 Overriding of specific anti-avoidance provisions departs from the understanding that general rules
give way to specific rules.

 Equally, the interaction with tax treaties is uncertain and creates scope to deny benefits under tax
treaties even if assessee is able to meet the standards specified under the treaty.

 BEPS

 Action 6 proposes that countries include in their tax treaties either:

 a limitation-on-benefits (LOB) provision or

 a PPT (Principal Purpose Test) alone

 Action 14 (Mutual Agreement Procedure) seeks to improve the resolution of tax-related disputes
between jurisdictions. Party can reach out to either competent authority and initiate dispute
resolution.
  Action 15 allows governments to modify existing bilateral tax treaties to implement the tax treaty
measures developed during the BEPS Project without the need to expend resources renegotiating
each treaty bilaterally.

 States can sign MLI to ensure that provisions of their DTAAs are amended and they need not amend
each of their bilateral DTAAs separately.

 UN and OECD Model Conventions

 UN Model

 Model Convention favours source states

 Source states are typically understood to be capital importing states/ developing states

 OECD Model

 Model Convention favours resident states

 Resident states are typically understood to be capital exporting states/ developed states

• UN and OECD Model Conventions are what are referred to as soft laws

• They are the starting point for negotiations on DTAAs, but not binding on any of the sovereign states

• UN and OECD Model Conventions also contain commentaries - interpretative guides for
Conventions

 LOB Clause

 LOB Clauses are incorporated to prevent residents of third states from taking advantage or claiming
benefits of the double taxation treaty

 The rationale for LOB is that the DTAA has been entered into only for the benefit of residents of the
contracting states

 And, if a resident of a third state incorporates in the other contracting state - where the main purpose
or one of the main purposes is to obtain treaty benefits - it should count as treaty shopping/abuse of
treaty provisions

 Primary purpose test is applied to determine if treaty abuse occurred or not.

 Mutual Agreement Procedure

 If a resident of a Contracting State feels that the actions of one of the Contracting States may result
in double taxation - it may present its case to the tax authorities of the state of which it is a resident

 The tax authority will endeavor to resolve the dispute. If it is unable to do on its own, it may consult
competent authority of the other contracting state to prevent double taxation.

 If any decision is reached under MAP - taxpayer has the right to accept it or reject it.
 If the taxpayer rejects the decision, remedy under a domestic court can be pursued; usually remedy
under domestic court cannot be pursued when dispute pending under MAP.

 MAP has been criticized for being ineffective, opaque and not obliging tax authorities to arrive at a
decision in a timely manner.