Meaning of treaty: If you define treaty in layman’s language, it is a document/agreement formally

concluded between two or more nations. ‘Treaty’ means an international agreement concluded
between States in written form and governed by international law, whether embodied in a single
instrument or in two or more related instruments and whatever its particular designation.

The Double Tax Avoidance Agreement (DTAA): DTAA’s are bilateral treaties between two
sovereign states.4 The basic objective is to promote and foster economic trade and investment
between two Countries by avoiding double taxation. Double taxation means taxing the same
income twice, once in the home country and again in host country.5 It is of relevance to mention
here “No rules of international law prohibit international double taxation.” So it is for the countries
in the international arena to solve double taxation problems.6 Double taxation of income is a great
disincentive as it hampers free flow of capital and becomes a prohibitive burden on taxpayers
leading to decline in foreign investments. Generally it arises because of connections of the
assessee8 to multiple jurisdictions and overlap of their laws. The assessee has to pay tax not
only in the country where he is the resident but also where the income generates, popularly
known as the source country. To avoid this hardship of double taxation, DTAAs provide for
the provisions like reduced rates of tax on dividend, etc., received by residents of one country
from those in the other.
Where tax relief has been given by one country the country of residence generally allows credit
for the tax so spared, to avoid nullifying the relief.11 In the remaining cases, the country where the
gain arises deducts taxation at source and the taxpayer receives a compensating foreign tax credit
in the country of residence to reflect the fact that tax has already been paid.12 Thus in order to avail
the benefits of DTAA, an NRI should be resident of one country and be paying taxes in that country
of residence.13 These treaties are based on the general principles laid down in the model draft
of the Organisation for Economic Cooperation and Development with suitable modifications as
agreed to by the other contracting countries.

Section 9014 and Section 9115 of Income Tax Act 1961 provide specific relief to taxpayers to save
them from double taxation. Section 90 is for taxpayers who have paid the tax to a country with
which India has signed DTAA, while Section 91 provides relief to tax payers who have paid tax
to a country with which India has not signed a DTAA. Thus, India gives relief to both kind of
taxpayers.16

Application of the Principle

Non discrimination rule: One of the most important clauses of DTAA is the clause of non-
discrimination. In simple words it means that neither of the contracting countries gives any
preferential treatment in taxing its own residents or citizens vis-à-vis foreign persons i.e. there is
no discrimination between the local assesses and foreign assesses as far as taxation is concerned.17
Most international tax treaties provide that there will not be any discrimination in taxation between
locals and foreigners. The domestic tax law of India provides that charging a higher rate of tax to
a foreign company as compared to a domestic company is not to be regarded as discrimination. 18
In fact, if there is any discrimination, it will be a positive one and in favours the foreigners. This
may be for several reasons such as incentive for foreign investment in the country, globalization
etc. This can be seen in the model OECD 1977 and U.N Model 1981.19 Article 24 deals with non-
discrimination provisions; nationality non-discrimination, permanent establishment non-
discrimination, and, deduction and ownership non- discrimination.20 It endeavors to prevent
discrimination of the ‘nationals’, ‘residents’ of other Contracting States (“CS”) carrying on
business and ‘enterprises’ owned by the treaty partners.21 It aims at ensuring to nationals of another
CS, residents of any third state, stateless persons, equality of treatment with the nationals of the
contracting state with regard to taxation and any requirement connected therewith22.
Discrimination is also sought to be prevented with regard to taxation on the permanent
establishment, related and controlled companies, and deductibility of expenses by way of interest,
royalties and other disbursements for determination of taxable profits of an enterprise.23 It is
merely a specific enunciation of the general principle of equality.24 This principle requires that
similar situations shall not be treated differently unless differentiation is objectively justified.
Differentiation does not mean discrimination, if there is justification.25 Article 24 does not militate
against justified differentiation.26 What it holds is that similar situations should not be treated
differently unless on justification.27 Different treatment constitutes no discrimination when it is
objectively justified or at least in economic matters not arbitrary.28

Application of the principle: The normal rule is that the provisions of a DTAA apply to persons
who are residents of one or both of the contracting states. Thus, “to enter” the portals of the treaty
a person must show that he is a resident of at least one of the states.29 Generally, a person is
regarded as a resident of a contracting state if he is liable to taxation therein by reason of certain
prescribed tests, for example, domicile, residence, place of management etc.30 The application of
this principle extends all nationals of a contracting State. They are entitled to invoke the benefit of
this provision as against the other contracting State.31 This does not necessarily mean that the
nationals of a contracting State have a right to be treated tax-wise in the other State in absolutely
the same way as nationals of that latter State, because only nationals living in the same
circumstances are entitled to equal treatment. The expression in the same circumstances refers to
taxpayers placed from the point of view of the application of the ordinary taxation laws and
regulations, in substantially similar circumstances, both in fact and in law.

: Case Studies

(A)A couple of recent decisions of the Mumbai ITAT, merit a discussion. The first one is in the
case of Credit Llyonnais v. Deputy Commissioner of IT.32 The main dispute in this case was
assessee’s grievance against CIT confirming the disallowance of deduction u/s 80M. Indian Act is
clear to the effect that deduction u/s 80M is available only to the domestic companies. As far as
the provisions of the IT Act are concerned, the assessee-company being admittedly a foreign
company within meanings of that expression u/s 2(23A) of the Act is not eligible for deduction u/s
80M. The assessee was French Bank. The same was challenged on two. Firstly, it was
discriminatory in nature. Secondly, it violated the provisions of Article XXI of the India France
Double Taxation Avoidance Agreement.33 The observations and conclusion of the ITAT in this
case were as under:

1. A plain reading of the above tax treaty provision34 makes it clear that it deals with
discrimination on the ground of nationality alone. To put it in simple words, it provides that
nationals of France in India will not be subjected to any taxation or any requirement connected
with such taxation which is more burdensome than similar taxation or requirement in connection
therewith on an Indian national in India. The same principle would naturally also apply on Indian
nationals in France vis-à-vis French nationals in France.

2. The non-discrimination clause seeks to ensure that contracting States do not decline any
allowance only on the ground of the taxpayer’s nationality.

3. In applying the non-discrimination clause what is to be seen is whether two persons who are
residents of the same State are being treated differently solely by reason of having a different
 nationality because differential tax status on the ground of residence of the taxpayer, cannot be
construed as non-discrimination.35

4. The question then is as to on what basis is a company classified as a domestic company and
a foreign company under the Income-tax Act. Is it based on nationality, or is it based on some
other criterion? Does this classification depend on requirements connected with residence or is
it the nationality of a company which decides such company being classified as a domestic
company or a foreign company?

5. Section 2(22A)36 and Section 2(23A)37 defines domestic and foreign company. The very
definition of domestic company admits non-Indian companies to be treated as domestic
companies. Therefore the crucial factor for deciding whether a company is a domestic company
or a foreign company is certainly not the nationality. Even a French company which has made
the prescribed arrangements for the declaration and payment within India of the dividends
(including dividend on preference shares) payable out of such income can be treated as a
domestic company under the Indian Income- tax Act and deduction under section 80M will be
available to it.

This kind of classification under the scheme of non-discrimination clause in the applicable
India French DTAA cannot be considered as discrimination on the ground of nationality. Thus the
non- discrimination clause cannot be invoked in such a case

(B) In Chohung Bank v. Dy. Commissioner of IT, the assessee here was a banking company based
at Korea having a branch in India. Appellant’s claim was for the benefit of the non-discrimination
clause of the India-Korea DTAA39 and taxing the appellant’s income at the rate of 48% instead of
at the rate applicable to a domestic company i.e., 35%. The AO rejected the claim of the assessee
arguing that: The matter reached the ITAT was considered by it, which adjudicated as under:

(1) The DTAA gets the trade off only with the provisions of the IT Act and unless so specifically
provided in a particular DTAA, the rate of tax which is prescribed in the annual Finance Act,
cannot give way to the DTAA.

(2) It cannot be said that a Korean Bank is working in the same circumstances as the Indian
banks, because the former has no constraints as an Indian bank has and it is free to operate its
profit making apparatus to the maximum possible extent.

(3) The provision of non-discrimination has nothing to do with the rate of tax, which is dealt
with separately by other articles of the DTAA.40

(4) The DTAA in general does not prevail over the Finance Act and hence over tax rates. Section
90 does not provide so. However, wherever the DTAA has provided the taxation of a particular
category of income at certain rates, then charging of that income at different rates as per the Act,
may come in conflict with the DTAA and hence, the taxes over that category of income will be
levied at that rates, so provided in the DTAA. But where no such rates on an income or a
category of income on the status of an assessee has been prescribed in the DTAA, then there
cannot be any conflict with the Act. The DTAA will therefore not prevail over the Finance
Act and hence the rates of tax applicable to domestic companies cannot be applied to non-
domestic companies.
 (5) A domestic banking company and a non-resident banking company do not function under
the same circumstances and hence the discrimination clause in Article 25 of the Indo Korean
DTAA is not applicable.

(C) In Rajeev Sureshbhai Gajwani v. ACIT44 it was held that despite bar in Section 80HHE,
non- Residents are eligible for deduction in view of non-discrimination clause in DTAA. The
assessee, a citizen of America and a non-resident, exported software from a PE in India and claimed
deduction u/s 80HHE in respect of the profits earned from export of computer software by invoking
the provisions of Article 26(2) of the India-USA DTAA. He claimed that in view of Article 26(2),
he could not be treated less favourably than a resident assessee. Section 80HHE is available only to
domestic companies. HELD by the Special Bench: “Article 26(2) of the India-USA DTAA provides
that the taxation of a PE of an enterprise of a Contracting State in the other Contracting State shall
not be less favorably levied in that other State than the tax levied on enterprises of that other
Contracting State carrying on the same activities. In simple language, Article 26(2) means that
taxation of a PE of a USA resident shall not be less favorable than the taxation of a resident
enterprise carrying on the same activities. The result is that the exemptions and deductions
available to Indian enterprises would also be granted to the US enterprises if they are carrying
on the same activities. As the assessee was carrying on the “same activities” of export of software
as done by residents it was entitled to Section 80HHE deduction as admissible to a resident assessee

Thus, as per this Ruling:

(1) If there are certain exemptions and deductions that are not available to a non-resident and would
have been available to the non-resident had it been an Indian company then it can be held that
it is less favourably treated.

(2) For the application of Article 26(2), it is sufficient to show that the non-resident is engaged in
the same business as the resident it is treated less favourably to. The different circumstances in
which the business may be being performed is not to be considered.

(3) There is no scope of reasonable differentiation.

(D) In the case of Metchem Canada v. DCIT45 the issue was whether restrictions on the deduction
of head office expenditure of non-residents under Section 44C would attract the non-discrimination
clause under the Indo-Canada DTAA. While holding that Section 44C would attract the non-
discrimination clause the court laid out the scope of application of the non-discrimination clause as
follows with reference to Metchem Canada Rules: “In any event on a plain reading of the provisions
of the Article 24(2) we are of the considered view that a restriction on admissibility of head office
overheads of permanent establishment of a Canadian company constitutes discrimination against
such a PE vis-à-vis a domestic Indian entity because no such restriction is applicable for deduction
of head office or controlling office overheads of an Indian entity. It puts PE of a Canadian company
to an unfair disadvantage inasmuch as even legitimate business expenses attributable to the PE
and deductible under Section 37(1) cannot be allowed as a deduction in the light of restriction placed
under Section 44C of the Act whereas all the legitimate business expenses of the Indian entity
operating in India will be allowed as a deduction.

In a somewhat surprising Indian case the permanent establishment non discrimination provision was
found to override domestic law restrictions on the deduction of head office expenses even though
there was specific wording in the business profits article to preserve those domestic restrictions. The
non discrimination article was characterized as a special provision which overrode the business
profits article. While one of the fundamental principles for operation and interpretation of treaties
continuous to be pacta sunt servanda as mentioned in the Vienna Convention on the Law of Treaties
which means that every treaty in force is binding upon the parties to it and must be performed by
them in good faith one needs to watch for the reaction of the International tax community to the
present decision which can be termed as progressive in many ways.

( E ) In Automated Securities clearance Inc. v. Income Tax Officer46, the question was whether a
non- resident company could be given the benefit under Section 80 HHE on the basis of the non-
discriminatory clause under Article 26(2) of the Indo-US DTAA. Rejecting the claim of the assessee
the Hon’ble ITAT held that Section 80HHE did not attract the non-discrimination clause under
Article 26(2) of the Indo-US DTAA. The ITAT held: “It is thus clear that in order to establish
discrimination not only that a taxpayer has to demonstrate that he has been subjected to different
treatment vis-à-vis other taxpayers but also that the ground for this differentiation in treatment is
unreasonable, arbitrary or irrelevant… In our considered view irrespective of whether at the end
of the day such a differentiation turns out to be a very wise and pragmatic differentiation or not
there is a reasonable basis of this approach of granting tax incentives to exporters only in the cases
where exports are made by the resident taxpayers.”.

According to this Ruling for the non-discrimination clause is attracted on the following criteria must
be fulfilled: Firstly, the non-resident has to show that its PE has been subjected to a less favourable
tax treatment compared to a resident company and secondly the ground for differential treatment is
unreasonable. Thus the Automated Securities case laid down certain criteria for the application of
the non-discrimination clause under Article 26(2) which would ensure that the differential tax
treatment of foreign residents and companies vis-à-vis Indian residents and companies was not
totally ruled out while at the same time ensuring that the foreign residents/companies were not
unjustly discriminated against.
Case analysis on AZADI BACHAO ANDOLAN Versus UNION OF INDIA

( 1 ) ALLEGING that certain actions/inactions on the part of the income-tax authorities have
caused huge loss to the public exchequer, this petition stated to be in public interest has been filed.
( 2 ) IN a nutshell, the allegations are that in early 1994 Income-tax Department received reliable
information to the effect that many multinational companies operating in India are not fully
declaring salaries/perks paid to. their expatriate employees posted in India and in particular portion
of the salaries paid to them outside India. Under the Income-tax Act, 1961 (in short the Act) the
entire salaries received by such expatriate employees posted in India are liable to be declared
irrespective of the fact whether it was paid in India or abroad and has to be taxed in India. The only
condition requisite for such declaration was that stay of such. employee in India for the relevant
financial year exceeds 183 days in aggregate. Income-tax authorities issued notices to some foreign
companies seeking information regarding salaries of expatriate employees which were paid to them
outside india. On getting such notice, some of the companies deposited tax and some companies
disclosed that they had earlier not declared, salary paid abroad and thereafter declared that amount
and deposited taxes on it. However, most of the multi-national companies did not do so. Circular
No. 685 was also issued by the central Board of Direct Taxes (in short the Board) on 17/
20/06/1994 highlighting such non-deduction of tax at source on salaries and allowances paid.
However, in order to encourage immediate compliance, the Board decided that procedure under
Sections 221 and 271- C for levy of penalties and proceedings under Section 276b need not be
resorted to in case an employer voluntarily comes forward and pays whole of the tax due under
Section 192 along with interest liabilities under section 201 (1a) on or before 31. 7. 1994. Despite
this circular, few foreign companies expatriate employees came forward and paid taxes. In 1997,
Voluntary Disclosure of Income Scheme, also described as Amnesty Scheme, was launched giving
chance to those- who had not complied with requirements of law. An opportunity was given to pay
tax by declaring concealed/undeclared income under the said Scheme and avoid penalty and
prosecution. Some of the companies disclosed taxes that had been evaded on salaries paid abroad to
their expatriate employees under the scheme and paid taxes; while some of the companies did this
partially, and some others who had been evading payment of such taxes did not even avail of this
scheme. Survey was conducted on premises of various companies in 1998-99. It is alleged that
despite all these actions by giving premium to defaulters, penalties which were leviable have not
been levied; on the other hand, by resorting to Section 273b of the Act orders have been passed not
to levy penalties. A list of 95 cases has been annexed to show that in these cases requisite action has
not been taken. It has also been stated that action against individual employees has not been taken
though available to be taken. It has been urged that such action on the part of the income tax
authorities has resulted in huge loss to public exchequer and has been done under pressure from
Japanese Chamber of Commerce and Industry (in short the Chamber of Commerce ). Further, the
penalties have not been levied/proceedings have been dropped on the basis of a letter written by the
Commissioner of Income-tax, Delhi vi indicating that penalties were not to be levied in non-survey
cases. It is asserted that the letter was written pursuant to an agreement arrived at in a meeting held
in the chambers of Chairman of the Board. In other words, it has been urged that there was no
application of mind and only account of unauthorized interference by the board and other high
placed officials, penalties have not been levied/proceedings have been dropped,
( 3 ) IN the counter-affidavit filed by the Income-tax authorities, allegations of illegal pressure have
been denied. It is, on the other hand, stated that action was bona fide and in many cases penalty has
been levied and in those cases where voluntary and bona fide action was taken by the assessee to
deposit the tax and interest, it was decided not to levy penalties. Each case was considered on merits
and after being satisfied that reasonable cause existed for non-compliance penalty has not been
levied/proceedings have been dropped.
( 4 ) LEARNED Counsel for the petitioner submitted that fine distinction made by the Income-tax
authorities is not available to be drawn. The whole exercise was done on the basis of directive
issued by the higher authorities and there has been no application of mind. Reason which weighed
with the authorities cannot be said to be reasonable so as to warrant non-levy of penalty. Learned
Counsel for the revenue on the other hand submitted that each case has been examined on its merits
and after recording satisfaction that reasonable cause existed penalty has not been levied.
( 5 ) FROM me materials on record we find that that the petition relates to 93 cases and not 95
cases as stated. Two names have been duplicated. It is further seen that in 46 cases penalty has been
levied. In 41 cases either penalty has not been levied, or proceedings have been dropped. In 5 cases
matter is still pending consideration. So far as me case where penalty has been levied, the petitioner
cannot have any grievance. So far as the nonlevy is concerned, we have perused the reasons
indicated by the authorities for such non-levy. In essence the following reasons in each case seem to
have weighed with the authorities for non-levy:
(I) Case where the deductor has voluntarily revised its TDS statements and paid taxes and
interest thereon.
(II) The deductor has co-operated with the Page No. 3 of 5 department in the proceedings.
(III) The deductor was under a bona fide belief that it was not liable to deduct tax at source on
the payments in question.
(IV) The deductor was guided by the Japanese Chamber of Commerce and industry who held
 meetings which Chief Commissioner of Income-tax seeking waiver of penalty and
prosecution if they come forward voluntarily and pay the taxes thereon.

( 6 ) AT this juncture it is necessary to take note of Section 273a and 273b. Section 273a dealt with
power to reduce levy of penalty, etc. by the Commissioner, in a case which relates to penalty under
Section 271 (l) (c) of the Act. Waiver can be done only if the following conditions are satisfied, i.
e. assessee has:
(A) Prior to detection of concealment of particulars of income or of inaccurate particulars furnished
in respect of such income:
(b) Voluntarily and in good faith made full and true disclosure of such particulars.
(c) Cooperated in any enquiry relating to assessment of income. A case of nondeduction of tax at
source cannot prima facie be placed at a higher pedestal than concealment of income or furnishing
inaccurate particulars. The situation is rather reverse. Therefore, application of the
ingredients/criteria applicable to Section 273a to a case governed by Section 273b cannot be held
without logic or justification. The matter may be looked from another angle.
In an hypothetical case, penalty under Section 271c is levied, and the matter is carried to tribunal in
appeal. Tribunal applies the parameters applicable to Section 273a and cancels the penalty levied
holding that reasonable cause existed. In that event a case for reference under Section 256 (1) or (2)
of the Act would not arise. What would constitute reasonable cause cannot be laid down with
precision. It would depend upon factual background and scope for interference in a reference
application or much less in a writ petition is extremely limited and unless the conclusions are
perverse based on conjectures or surmises and/or have been arrived at without consideration of
relevant material and/or taking into account irrelevant material, there is no scope for interference.
Reasonable cause, as applied to human action is that which would constrain a person of average
intelligence and ordinary prudence. The expression "reasonable" is not susceptible of a clear and
precise definition; for an attempt to give a specific meaning to the word "reasonable" is trying to
count what is not number and measure what is not space. It can be described as rational according
to the dictates of reason and is not excessive or immoderate. The word "reasonable" has in law the
prima facie meaning of reasonable with regard to those circumstances of which the actor, called on
to act reasonably, knows or ought to know". Reasonable cause can be reasonably said to be a cause
which prevents a man of average intelligence and ordinary prudence, acting under normal
circumstances, without negligence or inaction or want of bona fides. Above being the position,
action of me authorities in not levying the penalty/ dropping proceedings cannot be said to be
unreasonable. Considering the limited jurisdiction as well as limited scope for interference in a writ
petition, we dp not find any justification to interfere with orders holding that penalty was not
leviable/ dropping the proceedings.
( 7 ) SO far as non-action against individual employees is concerned, certain practical difficulties
have been highlighted by the authorities. It is stated that tax and interest required to be paid by
grossing up relevant amount has been calculated, and collection has been made. Except a negligible
number, others have left the country on completion of projects, and it would be practically
impossible to, lay hands on those employees for further action relating to penalty, etc. While this
practical aspect cannot be lost sight of, nonetheless it would be desirable and appropriate for
Incometax authorities to take action against those who are still available in India in accordance with
law. What particular action would be appropriate is for the concerned Income-tax authorities to
decide. Writ petition is accordingly disposed of. Writ Petition disposed of.
Conclusion

While the law on interpretation of treaties is evolving with times and it is a

recognized fact that the Indian courts have been making a fair contribution to this
progress it may be worth considering following aspects.

(a) Whether a very broad meaning is required to be attributed to the non-

discrimination clause as has been sought to be done or a more contextual
meaning needs to be placed while interpreting the non-discrimination clause so
as to ensure that the results fall within the overall backdrop of the negotiations
of the particular treaty.

(b) Whether the interpretation of non-discrimination clause has to be in the overall

context of the other clauses of the treaty as each treaty is a result of protracted
negotiations between the countries. This aspect is relevant as a reference to the
article dealing with relief from double taxation to be granted to tax payers of the
two countries as existing in the Belgium, Denmark, France, Indonesia, Ireland,
Korea and Japan DTAA’s would show that during the negotiation of such
treaties a clear understanding is reached on how the two countries would like to
deal with incentives granted by one of the countries to further its economic
development. For example a reference to clause 23(3)(d)(1) of the Denmark
treaty would show that there was specific discussion about incentives granted
under the Indian Income Tax Act under Sections 80HH, 80I and 80J etc.

(c) Whether the principle that all the clauses of an agreement will have to be
harmoniously read to understand the intention of the negotiators of any
agreement equally applies in the case of sovereign agreements.

As international taxation increasingly becomes widespread and routine there will be

more and more cases of alleged discrimination between local assessees and foreign
assessees resident in India. Double taxation is an evolving field and the resolution of
each dispute will perhaps add to further clarity on the subject.