Tax Residency Certificate and Benefit of Tax Treaties in India: The Debate Reignited

Introduction

World over, the rules of international taxation are derived based on the tax treaties executed between the Governments. At operational level, however, the tax treaties are supplemented by the provisions of the domestic law which stipulate the mechanics and ground rules for effectuating the tax treaties and the manner in which their benefit can be availed by the persons concerned. A key requirement in the domestic laws is the tax residency certificate (TRC) issued by the competent tax authority of the country of which a person claims to be a resident. It is in terms of the TRC that the benefit of the tax treaty is granted by the competent tax authority of the other treaty partner country. Whether the TRC is merely an enabling document establishing the claim of a person for a treaty or it is a conclusive proof that indeed such person is entitled to the benefit of the treaty, is an issue which has been extensively litigated in India. Notwithstanding the consistent decisions of the courts and also a clarificatory administrative circular issued by the Government of India (GOI), the dispute continues to haunt those non-resident taxpayers in India who seek to avail tax treaty benefits. The issue has, albeit recently, once again reached the Supreme Court, reigniting the debate upon the conclusiveness of the TRC.

Azadi Bachao judgment: The trendsetting decision

The origin of the controversy in the Indian context is best explained by the decision of the Supreme Court in the famous Azadi Bachao case¹. This case came up before the Supreme Court by way of an appeal filed by the GOI against the decision of the Delhi High Court.² It is interesting to note the controversy before the High Court which led to the decision of the Supreme Court. In fact, it was not a regular tax dispute and instead it was a public interest litigation (PIL) challenging an administrative Circular³ issued by the GOI. In this Circular it had been clarified that a TRC issued by Mauritius tax authorities “will constitute sufficient evidence for accepting the status of residence” of a person claiming to be a Mauritius tax resident and seeking the benefit of India-Mauritius Tax Treaty.

In the PIL, it was inter alia contended before the High Court that “mere issuance of a certificate is not determinative and encourages treaty shopping in a case where the company has no base in Mauritius, the non-resident company should not be allowed to take benefit thereof as thereby a fraud would be encouraged”. Accepting the contention and further supplementing it with its own reasons, the Delhi High Court had “quashed” the Circular, inter alia observing that:

38. Conclusiveness of a certificate of residence granted by the Mauritius tax authorities is not contemplated under the treaty or under the Income Tax Act.…

39. An abuse of the treaty or treaty shopping is illegal and thus necessarily forbidden.…

59. … Passing of an appropriate order of assessment is the primary duty of the assessing officer which would include conscious evasion of tax by an assessee. Such a function which is judicial in nature can be regulated but cannot altogether be prohibited. If on a mere production of a purported residential certificate by an authority (which again it would be a repetition to state is not the subject-matter of the treaty), the assessing authority has to put off their hands, the same would render the circular ultra vires.

60. … No law encourages an opaque system to prevail.⁴

Reversing this decision of the Delhi High Court⁵, the Supreme Court in its decision in Azadi Bachao case⁶ extensively examined the underlying purport in which the tax treaties were negotiated and the international law governing tax treaties and their interpretation. Quelling the concerns of treaty shopping flagged by the High Court, the Supreme Court made the following path-breaking observations which are still quoted in international circles as the legal position on the subject:

136. There are many principles in fiscal economy which, though at first blush might appear to be evil, are tolerated in a developing economy, in the interest of long-term development. Deficit financing, for example, is one; treaty shopping, in our view, is another. Despite the sound and fury of the respondents over the so called “abuse” of “treaty shopping”, perhaps, it may have been intended at the time when Indo-Mauritius [Tax Treaty] was entered into. Whether it should continue, and, if so, for how long, is a matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations. This Court cannot judge the legality of treaty shopping merely because one section of thought considers it improper.⁷

As regards the rationale and effect of the Circular issued by the GOI, the Supreme Court made insightful observations, which require advertence, and are to the following effect:

53. … This circular was a clear enunciation of the provisions contained in the [Tax Treaty], which would have an overriding effect over the provisions of Sections 4 and 5 of the Income Tax Act, 1961 by virtue of Section 90(1) of the Act. If, in the teeth of this clarification, the assessing officers chose to ignore the guidelines and spent their time, talent and energy on inconsequential matters, we think that the CBDT was justified in issuing “appropriate” directions vide Circular No. 789, under its powers under Section 119, to set things on course by eliminating avoidable wastage of time, talent and energy of the assessing officers discharging the onerous public duty of collection of revenue. The Circular No. 789 does not in any way crib, cabin or confine the powers of the assessing officer with regard to any particular assessment. It merely formulates broad guidelines to be applied in the matter of assessment of assessees covered by the provisions of the [Tax Treaty]. (emphasis added)⁸

Following the decision of the Supreme Court⁹, the courts consistently applied TRC as the conclusive basis to determine the residence of a taxpayer and its ability to claim the benefit of a tax treaty.

Amendment to the statute and controversy in Blackstone

Subsequent to the decision of the Supreme Court in Azadi Bachao case¹⁰ and a decade thereafter, the Income Tax Act was amended to provide TRC as a mandatory precondition for claiming a tax benefit.¹¹ Simultaneously, it was clarified through an administrative guidance that “submission of a TRC is a necessary but not a sufficient condition for claiming benefits” under the tax treaty.¹² Thus, the GOI sought to change the status quo to stipulate that TRC would not be conclusive. However, this position was shortlived and GOI’s stand turned turtle soon thereafter. Apparently to address the concerns arising from this position, another clarification was issued by the GOI, to the following effect:¹³

… In the explanatory memorandum to the Finance Act, 2012, it was stated that the tax residency certificate containing prescribed particulars is a necessary but not sufficient condition for availing benefits of the Double Taxation Avoidance Agreement (DTAA). The same words are proposed to be introduced in the Income Tax Act as sub-section (5) of Section 90. Hence, it will be clear that nothing new has been done this year which was not there already last year.

However, it has been pointed out that the language of the proposed sub-section (5) of Section 90 could mean that the tax residency certificate produced by a resident of a contracting State could be questioned by the income tax authorities in India. The Government wishes to make it clear that that is not the intention of the proposed sub-section (5) of Section 90. The tax residency certificate produced by a resident of a contracting State will be accepted as evidence that he is a resident of that contracting State and the income tax authorities in India will not go behind the TRC and question his resident status….

This clarification should have nipped the dispute in the bud. However, the issue which had seemingly been settled arose again, in view of the refusal of the field formation of the tax officers who continued to doubt the conclusiveness of the TRC despite multiple judicial decisions reiterating the legal position.

In view of the stand adopted by the Tax Department, the Delhi High Court took up the issue in its decision in Blackstone Capital Partners (Singapore) VI FDI Three PTE Ltd. v. CIT.¹⁴ As the opening paragraph of the decision itself notes,

1. … core issue that [arose was …] whether the respondent Revenue can go behind the tax residency certificate issued by the other tax jurisdiction and issue reassessment notice under Section 147 of the Income Tax Act, 1961 to determine issues of residence status, treaty eligibility and legal ownership.

Apparently resiling from its earlier stand, the GOI submitted before the High Court inter alia that “Press Release dated 1-3-2013 neither qualifies as circular nor statute” and, in any case, the Supreme Court in Azadi Bachao decision¹⁵ had indeed concluded that the administrative circular “does not crib, cabin or confine assessing officer’s jurisdiction to make assessments in individual cases”.¹⁶

Unable to countenance the stand of the GOI, the Delhi High Court returned a clear finding in favour of TRC as the conclusive proof of the taxpayer’s residential status. The following observations of the High Court decision are instructive:

71. This Court is in agreement with the argument of learned Senior Counsel for the petitioner that the entire attempt of the respondent in seeking to question the TRC is wholly contrary to the Government of India’s repeated assurances to foreign investors by way of CBDT circulars as well as press releases and legislative amendments and decisions of the courts in Union of India v. Azadi Bachao Andolan¹⁷, Vodafone International Holdings BV v. Union of India¹⁸, CIT v. JSH (Mauritius) Ltd.¹⁹ and Sanofi Pasteur Holding SA v. Department of Revenue, Ministry of Finance²⁰.

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89. The Punjab and Haryana High Court, in the case of petitioners group company i.e. Serco BPO (P) Ltd. v. Authority for Advance Rulings²¹) after tracing the entire history of CBDT circulars, legislative amendments and judicial pronouncements held that TRC is sufficient to claim relief under the DTAA.…

90. The aforesaid judgment of the High Court has been accepted by the Tax Department and has not been challenged before the Supreme Court.

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93. Accordingly, this Court is of the view that the respondent Revenue cannot go behind the TRC issued by the other tax jurisdiction as the same is sufficient evidence to claim treaty eligibility, residence status, legal ownership and accordingly there is no capital gain earned by the petitioner liable to tax in India. Even the clarificatory Press Release dated 1-3-2013 issued by the Finance Ministry pursuant to the 2013 Amendment makes it clear that a TRC is to be accepted and tax authorities cannot go behind it. Further, since on the basis of repeated assurances by the Government of India which have been upheld by the Supreme Court, the petitioner had invested in India, the respondent is estopped from arguing to the contrary.²²

Thus, the Delhi High Court invalidated the stand of the GOI that despite TRC the residential status of the taxpayer can be questioned. In doing so, as the aforesaid observations reveal, the High Court extensively relied upon the earlier decisions including the clarifications issued by the GOI, thereby invoking the principle of estoppel to opine that it was beyond the remit of the GOI to reverse its position so as to override the TRC’s binding nature.

Notwithstanding these aspects, the GOI has not accepted the decision of the Delhi High Court and challenged it by way of appeal to the Supreme Court.²³ In fact, while admitting the appeal of the GOI, the Supreme Court has stayed the decision of the Delhi High Court.²⁴ Thus, prima facie the Supreme Court appears to give some credence to the claim of the GOI on the conclusiveness of the TRC and the issue has become sub judice again.

Conclusion

It is no doubt true that neither in the tax treaties nor in the domestic law there is any stipulation that “full faith and credit” shall be given to TRC issued by another country. At the same time, however, good faith in the implementation of the treaty forms a pivotal cornerstone of international law. Furthermore, the principle of comity warrants giving due credence to acts of the competent authority by a treaty partner, as reflected by the TRC; after all, GOI would expect the same respect in the treaty country to the TRC issued by its officers. In any case, in view of there being enough ways and means both under the legal and administrative framework, it defies logic why the Indian tax officer who carries doubts over a TRC cannot take up the issue directly with the counterpart authority of the treaty country instead of summarily rejecting the TRC and obliging the non-resident taxpayer to establish independently its claim to the benefit of the tax treaty.

No doubt under the constitutional setup it is the Supreme Court which is the final arbiter of all laws and thus, it is well within its remit to examine the correctness of the High Court’s conclusion. Having said that, there are compelling reasons in the decision of the Delhi High Court²⁵, many of which are not sui generis and in fact based upon the earlier judgments of the Supreme Court itself, which warrant a confirmation of the decision. Furthermore, some sanctity needs to be attached to the word of the Union Finance Minister, whose statement is on record to clarify the issue in favour of the taxpayer, despite which the tax administration appears to litigate the issue further. One would hope that there is certainty in the matter at the earliest, given that the issue practically endangers the entitlement of tax treaty benefits to the taxpayers.