DTAA – Interpretation Techniques

[Submitted by Hemali Deepak Thakkar,
Final CA Student,
Mumbai, Maharashtra]

September 28, 2010

A treaty may be said to be a formally concluded agreement between two or more independent nations. The Oxford Companion to Law defines a treaty as “an international agreement, normally in written form, passing under various titles (treaty, convention, protocol, covenant, charter, pact, statute, act, declaration, concordat, exchange of notes, agreed minute, memorandum of agreement) concluded between two or more states, on subject of international law intended to create rights and obligations between them and governed by international law.”

The Double Tax Avoidance Agreement (DTAA) & Objectives:
The Double Tax Avoidance Agreement (DTAA) is primarily an agreement entered into between two countries. The basic objective is to promote and foster economic trade and investment between the two contracting countries (‘States’) by avoiding double taxation of the same income which would constitute a prohibitive burden on the tax-payer. Mitigating this burden by a unilateral relief in the domestic tax laws is not a satisfactory solution. The tax treaties, thus try to remove tax obstacles that inhibit trade and services and movement of capital and persons between the countries concerned.
The double tax treaties are negotiated under public international law and generally governed by the principles laid down under the Vienna Convention on the Law of Treaties.

Under Section 90 of the Income Tax Act , the Central Government has been authorized to enter into DTAA’s with other countries.

The Need for DTAA

A country’s appetite for taxation being unquenchable, both states would like to tax the income arising from the same transaction, and here the need for a DTAA arises.

1. Granting relief in respect of:
   
   1. Income on which income tax has been paid in both the countries; or
       
      
   2. Income tax chargeable in both the countries to promote mutual economic relations, trade and investment
       
      
2. For the avoidance of double taxation of income in both the countries
    
3. For the exchange of information for the prevention evasion or avoidance of income tax chargeable in both the countries, or investigation of cases of such evasion or avoidance.
    
4. For recovery of income tax in both the countries.
    

Types of DTAA

DTAA can be of two types.

• Comprehensive
• Limited

Comprehensive DTAAs are those which cover almost all types of incomes covered by any model convention. Many a time a treaty covers wealth tax, gift tax, surtax. Etc. too.

Limited DTAAs are those which are limited to certain types of incomes only, e.g. DTAA between India and Pakistan is limited to shipping and aircraft profits only.

Agreement vs. Act

The Provisions of DTAA override the general provisions of taxing statute of a particular country. It is now well settled that in India the provisions of the DTAA override the provisions of the domestic statute. Moreover, with the insertion of Sec.90 (2) in the Indian Income Tax Act, it is clear that assessee have an option of choosing to be governed either by the provisions of particular DTAA or the provisions of the Income Tax Act, whichever are more beneficial.

For example under DTAA between Indian and Germany, tax on interest is specified @ 10% whereas under Income Tax Act it is 20%. Hence, one can follow DTAA and pay tax @ 10%. Further if Income tax Act itself does not levy any tax on some income then Tax Treaty has no power to levy any tax on such income. Section 90(2) of the Income Tax Act recognizes this principle.

The first draft of the Direct Tax Code expressed that neither a DTAA nor the Code shall have a preferential status by reason of its being a treaty or law. In the case of a conflict between the provisions of a treaty and the provisions of the Code, the one that is later in point of time shall prevail. Apprehensions had been raised that the aforesaid proposal would lead to treaty override and the existing DTAAs could be rendered otiose and would result in higher rate of taxation on royalty, fees for technical services and interest income etc, which are taxed in the source country at a concessional rate as per the provisions of the DTAA. However the revised draft of the Code issued in mid June, 2010 proposes to provide that between the domestic law and relevant DTAA, the one which is more beneficial to the taxpayer shall apply. However, DTAA will not have preferential status over the domestic law in the following circumstances:

• when the General Anti Avoidance Rule is invoked, or
• when Controlled Foreign Corporation provisions are invoked or
• when Branch Profits Tax is levied.

Models of the DTAA

There are different models developed over a period of time based on which treaties are drafted and negotiated between two nations. These models assist in maintaining uniformity in the format of tax treaties. They also serve as checklist for ensuring exhaustiveness or provisions to the two negotiating countries.

OECD Model, UN Model, the US Model and the Andean Model are few of such models. Of these the first three are the most prominent and often used models. However, a final agreement could be combination of different models.

Interpretation of Treaties

It was held in James Makintosh & Co (P) Ltd. v ACIT that ‘A tax treaty is to be interpreted in ‘good faith’ in accordance with the ordinary meaning given to the terms of the treaty in their context and in the light of its objects and purpose.’

Good faith: Each of the contracting countries is bound to fulfill faithfully & sincerely the terms of the agreement.

Context: Refers to terms & conditions in a treaty in which they have been incorporated. Such context comprises:

1. Text of treaty
2. Preamble and annexures
3.  Related agreements and instruments made in connection with conclusion of the treaty either prior/ subsequent to the treaty
4. Practices of the tax administrations.

Purposes: Words and phrases being doubtful, their construction should be governed by the general object of the treaty and by their context. It refers to the goals of the treaty as reflected objectively and achieving the objectives of:

1. Avoidance of double taxation
2. Prevention of fiscal evasion
3. Allocation of tax revenues equitably between two states

Aids to Interpretation

1. UN and OECD Model Conventions and commentaries
   The role of the UN and OECD Model Conventions and commentaries in interpretation can hardly be exaggerated. It had been held in Sonata Information technology v ACIT that the Model Commentaries give the authoritative interpretation of the provisions of the DTAA. Such commentaries have to be read in a harmonious manner.
   Though India is not a member of the OECD, such Commentaries have been a widely accepted guide to interpretation.
    
2. Role of UN Commentary in interpretation
   Para 36 of the UN commentary(2001) provides that ‘if the negotiating parties decide to use the treaty wording suggested in the UN Model Convention it is to be presumed that they would also expect to derive assistance in interpretation of that wording from the relevant Commentary.’ Indian judgments too have relied on the UN Commentaries at various instances.
    
   Often an issue arises as to whether the Model Commentaries, as updated over time, can be referred while interpreting a previously concluded treaty. The OECD view states that updated Commentaries may be referred to in interpreting previously concluded treaties having language similar to the Model Convention. However, the AAR has held that without explicitly referring to the OECD view, a usual reference could be made to the revised OECD Commentary.
    
3. OECD Reports
   In DDIT v SET Satellite (Singapore) Pte Ltd., the Tribunal observed that ‘just because a particular interpretation can be better supported by more specific provisions does not mean that the provisions which exist do not support that interpretation.’
    
4. Memorandum of Understanding (MoU)
   An MoU is a manifestation of intention of both the Contracting States. Thus an MoU, as adjudged in Decca Survey Overseas Ltd. v ITO, to an existing treaty can be considered and taken into account for interpreting such a treaty, an earlier treaty or an identically worded treaty enacted subsequently.
    
5. Protocol
   A protocol has the same binding force as the main clauses therein and can be relied upon, as set out in Sumitomo Corpn v DCIT. A protocol to a later treaty between two countries could apply while interpreting the predecessor treaty between the same countries, as held in Decca Surveys Overseas Ltd. v ITO.
    
6. Negotiations and other materials
   The Tribunal has held in British Airways Plc v DCIT that in interpreting international agreements, differences of opinion exist regarding meaning of protocol of negotiations and other materials. In such a case, a recourse could be taken to supplementary means of interpretation, such as prepatory work of the treaty, such as notes of discussion between the Contracting States.
    
7. Parallel treaty or comparative treaty language, and Judgments under other Indian treaties
   The language of a later treaty could be relied upon while interpreting provisions of a predecessor treaty. Eg. in MSEB v DCIT, while interpreting of the India UK DTAA, the Tribunal relied on language of the same Article of the subsequent India UK DTAA.
    
   Reliance may also be placed with reference to the language in another treaty or on basis of absence of a similar provision in another treaty, as was done in CIT v Vijay Ship Breaking Corpn, ITO v Automobile Peuggeot etc.
    
   It is also permissible to rely upon decisions rendered in respect of other Indian treaties, as held in TVS Suzuki ITO.
    
8. International decisions
   The Indian judiciary has dealt with or considered international precedents in a number of cases, which may be broadly classified as:
   
   • Decisions not followed; and
     
   • International decisions relied upon or used to support the conclusions, with or without giving reasons of the reliance or otherwise placed on them
      
9. Revenue rulings/ practice in other countries, Overseas Regulations and International commentaries
   Though overseas regulations are not binding, they have a persuasive value, as held in Motorola Inc. v DCIT.
    
   As regards the applicability of International commentaries, Indian courts have resorted to divergent views. Eg. International commentaries relied upon in UOI v Azadi Bachao Andolan, but not in TATA iron & Steel Co. Ltd(In re (1999) 69 ITD 292)
    
10. Views of the Other Contracting State
    The Chennai Tribunal in TVS Suzuki Ltd. v ITO has observed that if one of the Contracting state views a particular receipt in a particular manner, the other State cannot take resort to a contrary view. Each State should aptly take into account the manner in which such income is recognized by the other State.
     
11. Contemporanea Expositio
    Contemporanea Expositio means ‘the interpretation of a document in the sense in which it is’. It could also be interpreted as ‘the construction of a law, made shortly after its enactment, when the reasons for its passage were then fresh in the minds of the judges, is considered as of great weight.’
    Article 32 of the Vienna Convention on the Law of Treaties embodies that while interpreting treaties, regard should be had to material Contemporanea Expositio.
     

Principles of Interpretation of DTAA

1. Language
   It is believed that treaties are drafted by diplomats who do not use language in the precise manner as a legal draftsperson would. Thus, in a treaty, one ought not to expect the technicality, jargon and strict interpretational definitions that as generally found in Acts and domestic legal appostilles.
    
2. Plain Reading
   Courts have on numerous counts held that:
   
   1. Heed is to be paid at what is clearly said. There is no room for any intendment, as held in British Airways Plc v. DCIT.
       
   2. Words as stated in a treaty cannot be interpreted or understood in a different manner to make it more beneficial to the taxpayer.
       
   3. Resort should be taken as far as possible to stick to and stay as close to literal and strict interpretation of such law. Thus, as far as possible, liberal
       
   However, as against this, Courts have held that the principles of literal interpretation do not apply and that a treaty need not be examined in precise grammatical sense. It has also been adjudged in James Mackintosh & Co (P) Ltd. v ACIT that ‘one can do violence to the language of a Convention, but not inflict a deeper wound than necessary.’
    
3. Holistic & Harmonious Interpretation
   Held in DCIT v Boston Consulting group Pte Ltd that a treaty has to be interpreted in a holistic and harmonious manner. It has to be viewed in its entirety and not as a collection of unconnected and isolated provisions. No provision is to be interpreted as a stand alone provision.
    
4. Reasonable Meaning
   Treaties should be given an interpretation based on basic thought process, with reasonable meaning given to words and phrases. Narrow, artificial or far fledged interpretation is to be avoided. In case of unreasonable results, resort is to be taken to supplementary means of interpretation.
    
5. Purposive Interpretation & Consistency
   The purpose refers to the goals of the treaty and the mission it aims to achieve. The OECD Commentary has stated that a treaty should be given a meaning in line with its object and context. Held in Abdul Razak A Meman, that ‘while interpreting tax treaties, it is not necessary to examine words in a meticulous detail or look into the precise grammatical sens, an effort should be made to harmonise the interpretation of the words of the treaty with its object and purpose.’ It is to be assumed that states entering into a treaty are as a rule unwilling to limit their soverignity save in the most express terms.
    
6. Absurdity
   Interpretation of the wordings of a treaty should not result in absurdity, and departure from the plain meaning of the language may be allowed to avoid such interpretation resulting into an absurdity. Here, recourse may be had to supplementary means of interpretation.
    
7. Effectiveness
   This principle requires that the treaty should be in general given an interpretation which will ‘on the whole’ render the treaty ‘most effective and useful’, thus enabling the provisions of the treaty to work and to have their appropriate effects. This is of prime importance in the construction of multilateral conventions, containing the constituent rules of international organizations.
    

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