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CASE NO.: Appeal (civil)  8161-8162 of 2003 Appeal (civil)  8163-8164 of 2003

PETITIONER: Union of  India and Anr.                                         

RESPONDENT: Azadi Bachao Andolan and Anr.                    

DATE OF JUDGMENT: 07/10/2003

BENCH: Ruma Pal & B.N. Srikrishna.

JUDGMENT: J U D G M E N T

(Arising out of S.L.P.(C) Nos.20192-20193 of 2002) (@ S.L..P.(C) Nos. 22521-22522 of 2002)

SRIKRISHNA,J.

       Leave granted.

These appeals by special leave arise out of the judgment of  the Division Bench of Delhi High Court allowing Civil Writ  Petition (PIL)No.5646/2000 and Civil Writ Petition No.2802/2000.   The High Court by its judgment impugned in these appeals  quashed and set aside  the circular No.789 dated 13.4.2000 issued  by the Central Board of Direct Taxes (hereinafter referred to as  "CBDT") by which certain instructions were given to the Chief  Commissioners/Directors General of Income-tax with regard to the  assessment of cases in which the Indo - Mauritius Double  Taxation Avoidance Convention, 1983 (hereinafter referred to as  ’DTAC’)  applied.  The High Court accepted the contention before  it that the said circular is ultra vires  the provisions of Section 90  and Section 119 of the Income-tax Act, 1961(hereinafter referred  to as ’the Act’) and also otherwise bad and illegal.

It would be necessary to recount some salient facts in order  to appreciate the plethora of legal contentions urged.

FACTS         A: The Agreement          The Government of India has entered into various  Agreements (also called Conventions or Treaties)  with  Governments of different countries for the avoidance of double  taxation and for prevention of fiscal evasion.  One such Agreement   between the Government of India and the Government of  Mauritius  dated April 1, 1983, is the subject matter of the present  controversy.  The purpose of this Agreement, as specified in the  preamble, is "avoidance of double taxation and the prevention of  fiscal evasion with respect to taxes on income and capital gains  and for the encouragement of mutual trade and investment".  After  completing the formalities prescribed in Article 28 this agreement  was brought into force by a Notification dated 6.12.1983 issued in  exercise of the powers of the Government of India under Section  90 of the Act read with Section 24A of the  Companies (Profits)  Surtax Act, 1964.  As stated in the  Agreement, its  purpose is  to  avoid double taxation and to encourage mutual trade and  investment between the two countries, as also to bring an

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environment of certainty in the matters of tax affairs in both  countries.

       Some of the salient provisions of the Agreement need to be  noticed at this juncture. The  Agreement defines a number of terms  used therein and also contains a residuary clause.  In the  application of the provisions of the Agreement by the contracting  States any term not defined therein shall, unless the context  otherwise requires, have the meaning which it has  under the laws  in force in that contracting State, relating to the words which are  the subject of the convention.  Article 1(e) defines ’person’ so as to  include an individual, a company and any other entity, corporate or  non-corporate "which is treated as a  taxable unit under the  taxation laws in force in the respective contracting States". The  Central Government in the Ministry of Finance (Department of  Revenue), in the case of India, and the Commissioner of Income  Tax in the case of Mauritius, are defined as the "competent  authority".  Article 4 provides the scope of  application of the  Agreement.  The applicability of the Agreement is determined by  Article 4 which reads as under;

"Article 4  Residents

1.      For the purposes of the Convention, the term  "resident of a Contracting State" means any person  who under the laws of that State, is liable to  taxation therein by reason  of his domicile,  residence, place or management or any other  criterion of similar nature. The terms "resident of  India" and "resident of  Mauritius" shall be  construed accordingly.

2.      Where by reason of the provisions of  paragraph 1, an individual is a resident of both   Contracting States, then his residential status for  the purposes of this Convention shall be  determined in accordance with the following rules:

(a)     he shall be deemed to be a resident of  the Contracting State in which he has  a permanent home available to him; if  he has a permanent home available to  him in both Contracting States, he  shall be deemed to be a resident of the  Contracting State with which his  personal and economic relations are  closer (hereinafter referred to as his  "centre of vital interests");

(b)     if the Contracting State in which he  has his centre of vital interest cannot  be determined, or if he does not have  a permanent home available to him in  either Contracting State  he shall be  deemed to be a resident of the  Contracting State in which he has an  habitual abode;

(c)     if he has an habitual abode in both  Contracting States or in neither of  them, he shall be  deemed to be a  resident of the Contracting State of  which he is a national;

(d)     if he is a national of both Contracting

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States or of neither of them, the  competent authorities of the  Contracting States shall settle the  question by mutual agreement.

3.      Where by reason of the provision of  paragraph 1, a person other than an individual is a  resident of both the Contracting States, then it shall  be deemed to be a resident of the Contracting State  in which its place of effective management is  situated."

       The Agreement provides for allocation of taxing jurisdiction  to different contracting parties in respect of different heads of  income.   Detailed rules are stipulated  with regard to taxing of  Dividends under  Article 10, interest under Article 11,  Royalties  under Article 12,  Capital Gains under Article 13, income  derived  from Independent Personal Services in Article 14, income from  Dependent Personal Services in Article 15,  Directors’ Fees in  Article 16, income of Artists and Athletes in Article 17,  Governmental Functions in Article 18, income of  students and  Apprentices in Article 20, income of Professors, Teachers and  Research Scholars in Article 21, and other income in Article 22.   

Article 13 deals with the manner of taxation of capital gains.  It provides that gains from the    alienation of  immovable    property may be taxed in the Contracting   State  in which such  property is situated. Gains derived by a  resident of a Contracting  State  from the alienation of   movable property, forming part of  the business property of a permanent establishment which an  enterprise of a Contracting   State  has in the other Contracting  State, or  of  movable property   pertaining to a fixed base available  to a resident of a Contracting State  in the other Contracting State   for the purpose of performing independent personal services,  including such gains from the alienation of such a permanent  establishment,  may be taxed in that other State. Gains from the  alienation of ships and aircraft operated in international traffic  and  movable property pertaining to the operation of such ships and  aircraft, shall be taxable only in the Contracting State in which the  place of effective management is situated.  With respect to capital  gain derived by a resident in the Contracting State from the  alienation of any property other   than the aforesaid is concerned, it  is taxable only in the State in which such a person is a ’resident’.    

Article 25 lays down the Mutual Agreement Procedure. It  provides  that where a resident of a Contracting State considers  that the actions of one or both of the Contracting State  result or  will result for him in taxation not in accordance with this  Convention, he may, notwithstanding  the remedies provided by  the national laws of those States, present his case to the competent  authority of the Contracting State of which he is a resident.  This  case must be presented within three years of the date of receipt of  notice of the action which gives rise to taxation not in accordance  with the Convention.  Thereupon, if the objection appears to be  justified, the competent authority shall attempt to resolve the case  by mutual agreement with the competent authority of the other  Contracting State so as to avoid a situation of taxation not in  accordance with the convention.   This Article also provides for  endeavour  by the competent authorities of the Contracting States  to resolve by mutual agreement any difficulties or doubts arising as   the interpretation or application of the convention.  For this  purpose,  the convention contemplates continuous or periodical  communication between the competent authorities of the  Contracting States and exchange of views and opinions.

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B : The Circulars By a Circular No.682 dated 30.3.1994 issued by the CBDT  in exercise of its powers under Section 90 of the Act, the  Government of India  clarified  that capital gains of any resident of  Mauritius by alienation of shares of an Indian company shall be  taxable only in Mauritius according to Mauritius taxation laws and  will not be liable to tax in India.  Relying on this, a large number  of Foreign Institutional Investors s (hereinafter referred to as  "the  FIIs"), which were resident in Mauritius, invested large amounts of  capital in shares of Indian companies with expectations of making  profits by sale of such shares without being subjected to tax in  India.  Sometime in the year 2000, some of the income tax  authorities issued  show cause notices to some FIIs  functioning in  India calling upon them to show cause as to why they should not  be taxed for profits and for dividends accrued to them in India.   The basis on which the show cause notice was issued was that the  recipients  of the show cause notice were mostly  ’shell companies’  incorporated in Mauritius, operating through Mauritius, whose  main purpose was investment of funds in India. It was alleged that  these companies were controlled and managed from countries  other than India or Mauritius and as such  they were not  "residents" of Mauritius so as to derive the benefits of the DTAC.   These show cause notices resulted in panic and consequent hasty  withdrawal of funds by the FIIs. The Indian Finance Minister  issued a Press note  dated April 4, 2000 clarifying that the views  taken by some of the  income-tax officers pertained to specific  cases of assessment and did not represent or reflect the policy of  the Government of India with regard to denial of tax benefits to  such FIIs.   Thereafter, to further clarify the situation, the CBDT issued  a Circular No.789 dated 13.4.2000.  Since this is the crucial  Circular, it would be worthwhile reproducing its full text.  The  Circular reads as under:            "Circular No.789

F.No.500/60/2000-FTD GOVERNMENT OF INDIA MINISTRY OF FINANCE DEPARTMENT OF REVENUE CENTRAL BOARD OF DIRECT TAXES

New Delhi, the 13th April, 2000

To

All the Chief Commissioners/ Directors General of Income-tax

Sub:    Clarification regarding taxation of income  from dividends and capital gains under the  Indo-Mauritius Double Tax Avoidance  Convention (DTAC) - Reg.

       The provisions of the Indo-Mauritius DTAC  of 1983 apply  to ’residents’ of both India and   Mauritius .  Article 4 of the DTAC defines a  resident of one State to mean any person who,  under the laws of that State is liable to taxation  therein by reason of his domicile, residence,  place of management or any other criterion of a  similar nature. Foreign Institutional Investors and  other investment funds etc. which are operating  from Mauritius are invariably incorporated in  that country.  These entities are ’liable to tax’

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under the Mauritius Tax law and are therefore to  be considered as residents of Mauritius in  accordance with the DTAC.

       Prior to 1st June, 1997, dividends distributed  by domestic companies were taxable in the hands  of the shareholder and tax was deductible at  source under the Income-tax Act, 1961.  Under  the DTAC, tax was deductible at source on the  gross dividend paid out at the rate of 5% or 15%  depending upon the extent of shareholding of the  Mauritius resident.  Under the Income-tax Act,  1961, tax was deductible at source at the rates  specified under section 115A etc. Doubts have  been raised regarding  the taxation of dividends  in the hands of investors from Mauritius. It is  hereby clarified that wherever a Certificate of  Residence is issued by the Mauritian Authorities,  such Certificate will constitute  sufficient  evidence for  accepting the status of residence as  well as beneficial ownership for applying the  DTAC accordingly.

       The test of residence mentioned above  would also apply in respect of income from  capital gains on sale of shares. Accordingly, FIIs  etc., which are resident in Mauritius would not be  taxable in India on income from capital gains  arising in India on sale of shares as per paragraph  4 of article 13.

       The aforesaid clarification shall apply to all  proceedings which are pending at various levels."

C: The Writ Petitions

       Circular  No. 789 was challenged before the High Court of  Delhi by two writ petitions, both said to be by way of Public  Interest Litigation. The petitioner in CWP 2802 of 2000 (Azadi  Bachao Andolan) prayed for quashing and declaring as illegal and  void Circular No.789 dated 13.4.2000 issued by the CBDT. The  petitioner in CWP 5646 of 2000 sought an appropriate  direction/order or writ to the Central Government and made the  following prayers:

"(a)    issue such appropriate direction /order / writ  as the Court  deem proper, under the circumstances   brought to the knowledge of the Hon’ble Court, to the  Central Government to initiate a process whereby the  terms of the  Indo-Mauritius Double Taxation  Avoidance Agreement are revised, modified, or  terminated and /or effective steps taken by the High  Contracting Parties so that the NRIs and FIIs and such  other interlopers do not maraud the resources of the  State.

(b)             declare and delimit the powers of the  Central Government under section 90 of the Income  Tax Act, 1961 in the matter of entering into an  agreement with the Government of any country  outside India;

(c)             declare and delimit the powers of the  Central Board of Direct  Taxes in the matter of the

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issuance of instructions through circulars to the  statutory authorities  under the Income tax Act,  specially through such circulars  which are beneficial  to certain individual taxpayers but injurious to Public  Interest.

(d)             declare the illegality of Circular No.789 of  April 13, 2000 issued by the Central Board of Direct  Taxes and to quash it as a matter of consequence;

(e)             issue mandamus so that the respondents  discharge their statutory duties of conducting  investigation and collection of tax as per law;

(f)             issue appropriate direction/ order or writ of  the nature of mandamus, as the Court deem fit, so that  all remedial actions to undo the effects of the acts  done to the prejudice or Revenue in pursuance of  Circular No.789 are taken by the authorities under the  Income tax Act, 1961"

D :  High Court’s findings         The High Court has quashed the circular on the following  broad grounds: (A)     Prima facie, by reason of the impugned circular no direction  has been issued. The circular does not show that it has been issued  under section 119 of the Income-tax Act, 1961 and as such it  would not be legally binding on the Revenue; (B)     The Central Board of Direct Taxes cannot issue any  instruction, which would be ultra vires the provisions of the  Income-tax Act, 1961. Inasmuch as the impugned circular directs  the income-tax authorities to accept a certificate of residence  issued by the authorities of Mauritius as sufficient evidence as  regards status of resident and beneficial ownership, it is ultra vires  the powers of the CBDT; (C)     The Income-tax Officer is entitled to lift the corporate veil in  order to see whether a company is actually a resident of Mauritius  or not and whether the company is paying income-tax in Mauritius   or not and this function of the Income-tax Officer is quasi-judicial.   Any attempt by the CBDT to interfere with the exercise of this  quasi-judicial power is contrary to intendment of the Income-tax  Act. (D)     Conclusiveness of a certificate of residence issued by the  Mauritius Tax Authorities is neither contemplated under the  DTAC, nor under the Income-tax Act; whether a statement is  conclusive or not, must be provided under a legislative enactment  such as the Indian Evidence Act and cannot be determined by a  mere circular issued by the CBDT; (E)     "Treaty Shopping", by which the resident of a third country  takes advantage of the provisions of the Agreement, is illegal and  thus necessarily forbidden; (F)     Section 119 of the Income-tax Act, 1961 enables the  issuance of a circular for a strictly limited purpose. By a circular  issued thereunder, neither  can the essential legislative function  be  delegated, nor arbitrary, uncanalized  or naked power be conferred; (G)     Political expediency cannot be a ground for not fulfilling the  constitutional obligations inherent in the Constitution of India and  reflected in section 90 of the Act.  The circular confers power to  lay down a law which is not contemplated under the Act on the  ground of political expediency, which cannot but be ultra vires. (H)     Any purpose other than the purpose contemplated by section  90 of the Act, however bona fide it be, would be ultra vires the  provisions of section 90 of the Income tax Act.

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(I)     While political expediency will have a role to play in terms  of Article 73 of the Constitution, the same is not true when a  Treaty is entered into under the statutory provision like section 90  of the Act.   (J)     Avoidance of double taxation is a term of art and means that  a person has to pay tax at least in one country; avoidance of double  taxation would not mean that a person does  not have to pay tax in  any country whatsoever. (K) Having regard to the law laid down by the Supreme Court in  McDowell & Company  v C.T.O , it is open to the Income-tax  Officer in a given case to lift the corporate veil for finding out  whether the purpose of the corporate veil is avoidance of tax or  not. It is one of the functions of the assessing officer to ensure that  there is no conscious avoidance of tax by an assessee, and such  function being quasi-judicial in nature, cannot be interfered with or  prohibited. The impugned circular is ultra vires as it interferes with  this quasi judicial function of the assessing officer.

(L)     By reason of the impugned  circular  the power of the  assessing  authority to pass appropriate orders in this connection to  show that the assessee is a resident of a third country having only  paper existence in Mauritius, without any economic impact, only   with a view to take advantage of the double taxation avoidance  agreement, has been taken away. THE SUBMISSIONS         The learned Attorney General and Mr. Salve, for the  appellants, have assailed the judgment of the Delhi High Court on  a number of grounds, while the respondents through Mr.Bhushan,  and in person, reiterated their submissions made before the High  Court and prayed for dismissal of these appeals.  

Purpose and consequence of Double Taxation Avoidance  Convention

       To appreciate the contentions urged, it would be necessary  to understand the purpose and necessity of a Double Taxation  Treaty, Convention or Agreement,  as diversely called.  The  Income-tax Act, 1961, contains a special Chapter IX which is  devoted to the subject of ’Double Taxation Relief".   Section 90, with which we are primarily concerned, provides  as under:

"90.  Agreement with foreign countries. (1)             The Central Government may enter  into an agreement with the Government of any  country outside India-

(a)             for the granting of relief in respect of   income on which have been paid both income- tax under this Act and income-tax in that  country, or  

(b)             for the avoidance of double taxation  of income under this Act and under the  corresponding law in force in that country, or

(c)             for exchange of information for the  prevention of evasion or avoidance of income- tax chargeable under this Act or under the  corresponding law in force in that country, or  investigation of cases of such evasion or  avoidance, or  

(d)             for  recovery of income-tax under this

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Act and under the corresponding law in force in  that country,  

and may, by notification in the Official Gazette,  make provisions as may be necessary for  implementing the agreement.

(2)             Where the Central Government has  entered into an agreement with the Government  of any country outside India under sub-section  (1) for granting relief of tax, or as the case may  be, avoidance of double taxation, then, in  relation to the assessee to whom such  agreement applies, the provisions of this Act  shall apply to the extent they are more  beneficial to that assessee."

(Explanation omitted as not relevant)

Section 4 provides for Charge of Income-tax. Section 5  provides that the total income of a resident includes all income  which : (a) is received, deemed to be received in India or (b)  accrues, arises or deemed to accrue or arise in India, or (c) accrues  or arises outside India, during the previous year. In the case of a  non-resident, the total income includes "all income from whatever  source derived" which (a) is received or is deemed to be received  or, (b) accrues or is deemed to accrue in India, during such year.  A  person ’resident’ in India would be liable  to income-tax on the  basis of his global income unless he is a person who is ’not  ordinarily’ resident within the meaning of section 6(b).  The  concept of residence in India is indicated in section 6. Speaking  broadly, and with reference to a company, which is of  concern  here, a company is said to be ’resident’ in India in any previous  year, if it is an Indian company or if during that year  the control  and management of its affairs is situated wholly in India.

       Every country seeks to tax the  income generated within its  territory on the basis of one or more connecting factors such as  location of the source, residence of the taxable entity, maintenance  of a permanent establishment, and so on. A country might choose   to emphasise one or the other of the aforesaid factors for exercising  fiscal jurisdiction to tax the entity. Depending on which of the  factors is considered to be the connecting factor in different  countries, the same income of the same entity might become liable  to taxation in different countries. This would give rise to harsh  consequences and impair economic development.  In order to  avoid  such an anomalous and incongruous  situation, the  Governments of different countries enter into bilateral treaties,  Conventions or agreements for granting relief against double  taxation.  Such treaties, conventions or agreements are called  double taxation avoidance treaties, conventions or agreements.

The power of entering into a treaty is an inherent part of  the  sovereign power of the State. By article 73, subject to the  provisions of the Constitution, the executive  power of the Union  extends to the matters with respect to which the Parliament has  power to make laws. Our Constitution  makes no provision making  legislation a  condition for the entry into an international treaty in  time either of war or peace.  The executive power of the Union is  vested in the President and is exercisable in accordance with the  Constitution. The Executive is qua the State competent to represent  the State in all matters international and may by agreement,  convention or treaty incur obligations which in international law  are binding upon the State. But the obligations arising under the

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agreement or treaties are not by their own force binding upon  Indian nationals. The power to legislate in respect of treaties lies  with the Parliament under entries 10 and 14 of List I of the Seventh  Schedule. But making of law under that authority is necessary  when the treaty or agreement operates to restrict the rights of  citizens or others or modifies the law of the State. If the rights of  the citizens or others which are justiciable are not affected, no  legislative measure is needed to give effect to the agreement or  treaty.  When it comes  to fiscal treaties dealing with double  taxation avoidance, different countries have varying procedures.   In the United States  such a treaty becomes a part of municipal law   upon ratification by the  Senate.  In the United Kingdom such a  treaty  would have to be  endorsed by an order made by the Queen  in Council.  Since in India such a treaty would have to be  translated into an Act of Parliament, a procedure which would be  time consuming and cumbersome, a special procedure was evolved  by enacting section 90 of the Act.   The purpose of section 90 becomes clear by reference to its  legislative history. Section 49A of the Income-tax Act, 1922  enabled the Central Government to enter into an agreement with  the government of  any country outside India for the granting of  relief in respect of income on which, both income-tax (including  super-tax) under the Act and income-tax in that country, under the  Income-tax Act and the corresponding law in force in that country,  had been paid.  The Central Government could make such  provisions as necessary for implementing the agreement by  notification in the Official Gazette.  When the Income-tax Act,  1961 was introduced, section 90 contained therein initially was a  reproduction of section 49A of 1922 Act.  The Finance Act, 1972  (Act 16 of 1972) modified section 90 and brought it into force with  effect from 1.4.1972.  The object and scope of the substitution was  explained by a circular of the Central Board of Taxes (No.108  dated 20.3.1973) as to empower the Central Government to enter  into agreements with foreign countries, not only for the purpose of  avoidance of double taxation of income, but also for enabling the  tax authorities to exchange information for the prevention of  evasion or avoidance of taxes on income or for investigation of  cases involving tax evasion or avoidance or for recovery of taxes  in foreign countries on a reciprocal basis.  In 1991, the existing  section 90 was renumbered as sub-section(1) and sub-section(2)  was inserted by Finance Act, 1991 with retrospective  effect from  April 1, 1972. CBDT  Circular No. 621 dated 19.12.1991 explains  its purpose as follows:

"Taxation of foreign companies and other non- resident taxpayers -

43.  Tax treaties generally contain a provision  to the effect that the laws of the two contracting  States will govern the taxation of income in the  respective State except when express provision   to the contrary is made in the treaty. It may so  happen that the tax treaty with a foreign country  may contain a provision giving concessional  treatment to any income as compared to the  position under the Indian law existing at that  point of time. However, the Indian law may  subsequently be amended, reducing the  incidence of tax to a level lower than what has  been provided in the tax treaty.

43.1.   Since the tax treaties are intended to  grant tax relief and not put residents of a  contracting country at a disadvantage vis-Ã -vis

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other taxpayers, section 90 of the Income-tax  Act has been amended to clarify that any  beneficial provision in the law will not be  denied to a resident of a contracting country  merely because the corresponding provision in  the tax treaty is less beneficial."         The provisions of Sections 4 and 5  of the Act are expressly  made "subject to the provisions of this Act", which would include  Section 90 of the Act. As to what would happen in the event of a  conflict between the provision of the Income-tax Act and a  Notification issued under Section 90, is no longer res-integra.

       The Andhra Pradesh High Court  in Commissioner of  Income Tax v. Visakhapatnam Port Trust   held that  provisions of  section 4 and 5 of Income-tax Act are expressly made ’subject to  the provisions of the Act’ which means that they are subject to  provisions of section 90.   By necessary implication, they are  subject to the terms of the Double Taxation Avoidance Agreement,   if any, entered into by the Government of India.  Therefore, the  total income specified  in Sections 4 and 5 chargeable to income  tax is also subject to the provisions of the agreement to the  contrary, if any.

       In Commissioner of Income Tax v. Davy Ashmore India  Ltd. , while dealing with the correctness of a circular no.333 dated  April 2, 1982, it was held  that the conclusion is inescapable that in  case of inconsistency between the terms of the Agreement and the  taxation statute, the Agreement alone would prevail.   The Calcutta  High Court expressly approved the correctness  of the CBDT  circular No.333 dated April 2, 1982 on the question as to what  the  assessing officers would have to do when they found that the  provision of the Double Taxation  was not in conformity with the  Income-tax Act, 1961.  The said circular provided as follows  (quoted  at p.632):

       "The correct legal position is that where a  specific provision is made in the Double  Taxation Avoidance Agreement, that provision  will prevail over the general provisions  contained in the Income-tax Act, 1961.  In fact  the Double Taxation Avoidance Agreements  which have been entered into by the Central  Government under section 90 of the Income-tax  Act, 1961, also provide that the laws in force in  either country will continue to govern the  assessment and taxation of income in the  respective country except where provisions to  the contrary have been made in the Agreement.

Thus, where a Double Taxation Avoidance  Agreement provided for a particular mode of  computation of income, the same should be  followed, irrespective of the provisions in the  Income-tax Act.  Where there is no specific  provision in the Agreement, it is the basic law,  i.e, the Income-tax Act, that will govern the  taxation of income."

       The Calcutta High Court  held that the circular reflected the  correct legal position inasmuch as the convention or agreement is  arrived at by the two Contracting States   "in deviation from the  general principles of taxation applicable to the Contracting States".  Otherwise, the double taxation avoidance agreement will have no

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meaning at all.  

       In  Commissioner of Income Tax v. R.M. Muthaiah  the  Karnataka High Court was concerned with the DTAT  between   Government of India and Government of Malaysia.  The High  Court held that under the terms of agreement, if there was a  recognition of the power of taxation with the Malaysian  Government,  by implication it takes away the corresponding  power of the Indian Government.  The Agreement was thus held to  operate as a bar on the power of the Indian Government to tax and  that the bar would operate on Sections 4 and 5 of the Income Tax  Act, 1961, and take away the power of the Indian Government to  levy tax on the income in respect of certain categories as referred  to in certain Articles of the Agreement.  The High Court summed  up the situation by observing (at p.512-513):

"The effect of an "agreement" entered into by  virtue of section 90 of the Act would be : (1) If  no tax liability is imposed under this Act, the  question  of resorting to the agreement would not  arise. No provision of the agreement can  possibly fasten a tax liability where the liability  is not imposed by this Act; (ii) if a tax liability is  imposed  by this Act, the agreement may be  resorted to for negativing or reducing it; (iii) in  case of difference between the provisions of the  Act and of the agreement, the provisions of the  agreement prevail over the provisions  of this  Act and can be enforced by the appellate  authorities and the court."

       It also approved of the correctness of the Circular No. 333   dated April 2, 1982 issued by the Central Board of Direct Taxes on  the subject.

       In Arabian Express Line Ltd. of United Kingdom and Others  v. Union of India   the Gujarat High Court,  interpreting section 90,  in the light of circular No.333 dated April 2, 1982 issued by  the  CBDT, held that the procedure of assessing the income of a NRI  because of his occasional activities in establishing business in  India would not be applicable in a case where there is a convention  between the Government of India and the foreign country as  provided under Section 90 of the Income-tax Act, 1961. In case of  such an agreement, section 90 would have an overriding effect.   Interestingly,  in this case a certificate issued by the H.M. Inspector  of Taxes  certifying that the company was a resident of the United  Kingdom for purposes of tax and that it had paid advance  corporate tax in the office of the English Revenue Accounts  Office, was held to be sufficient to take away the jurisdiction of the  Income-tax Officer.         A survey of the aforesaid cases makes it clear that the  judicial consensus in India has been that section 90 is specifically  intended to enable and empower the Central Government to issue a  notification for implementation of the terms of a double taxation  avoidance agreement. When that happens, the provisions of such  an agreement, with respect to cases to which where they apply,  would operate even if inconsistent with the provisions of the  Income-tax Act.  We approve of the reasoning in the decisions  which we have noticed. If it was not  the intention of the legislature   to make a departure from the general principle of chargeability to  tax under section 4 and the general principle of ascertainment of  total  income under section 5 of the Act, then there was no purpose  in making those sections "subject to the  provisions" of the Act".   The very object of grafting the said two sections with the said  clause is to enable the Central Government to issue a notification

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under section 90 towards implementation of the terms of the DTAs  which would automatically override the provisions  of the Income- tax Act in the matter of ascertainment of chargeability to income  tax and ascertainment of total income, to the extent of  inconsistency with the terms of the DTAC.

       The contention of the respondents, which weighed with the  High Court viz. that the impugned circular No.789 is inconsistent  with the provisions of the Act, is a total non-sequitur.  As we have  pointed out,  Circular No.789 is a circular  within the meaning of  section 90; therefore, it must have the legal consequences  contemplated by sub-section (2) of section 90. In other words, the  circular shall prevail even if inconsistent with the provisions of  Income-tax Act, 1961 insofar as assessees covered by the  provisions of the DTAC are concerned.  

       Though a number of interconnected and diffused arguments  were addressed, broadly the argument of the respondents appears  to be as follows: By reason of Article 265  of the Constitution, no  tax can be levied or collected except by authority of law.  The  authority to levy tax or grant exemption therefrom vests absolutely  in the Parliament and no other body, howsoever high, can exercise  such power.  Once Parliament has enacted the  Income-tax Act,  taxes must be levied and collected in accordance  therewith  and no  person has power to grant any exemption therefrom.  The treaty  making power under Article 73 is confined  only to such matters as  would not fall within the province of Article 265.  With respect to  fiscal treaties, the contention is that they cannot be enforced in  contravention of the provisions of the Income-tax Act, unless  Parliament has made an enabling law in support.  The respondents  highlighted the provisions of the OECD models with regard to tax  treaties and how tax treaties were enunciated, signed and  implemented  in America, Britain and other countries.  Placing  reliance on the observations of Kier and Lawson  , it was  contended that in England it has been recognised  that "there are,  however, two limits to its capacity; it cannot legislate  and it  cannot tax without the concurrence of the Parliament".  It is urged  that the situation is the same in India; that unless there is a specific  exemption granted by the Parliament, it is not open for the Central  Government to grant any exemption from the tax payable under the  Income-tax Act.   

In our view, the contention is wholly misconceived.    Section 90, as we have already noticed  (including its precursor  under the 1922 Act), was brought on the statute book precisely to  enable the executive to negotiate  a DTAC and quickly implement  it. Even accepting the contention of the respondents that the  powers exercised by the Central Government under section 90 are  delegated powers of legislation, we are unable to see as to why a  delegatee of legislative power in all cases has no power to grant  exemption.  There are provisions galore in statutes made by  Parliament and State legislatures wherein the power of conditional  or unconditional  exemption from the provisions of the statutes are  expressly delegated to the executive.  For example, even in fiscal  legislation like the Central Excise Act and Sales Tax Act, there are  provisions for exemption from the levy of tax.  Therefore we are  unable to accept the contention that the delegate of a legislative  power cannot exercise the power of exemption in a fiscal statute.   The niceties of the OECD model of tax  treaties or the report  of the Joint Parliamentary Committee on the State Market Scam  and Matters Relating thereto,  on which considerable time was  spent  by Mr. Jha, who appeared in person, need not detain us for  too long, though we shall advert to them later.  This  Court is not  concerned with the manner in which   tax treaties are negotiated or  enunciated; nor  is it concerned with  the wisdom of any particular

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treaty.  Whether the Indo-Mauritius  DTAC ought to have been  enunciated in the present form, or in any other particular form, is  none of our concern.  Whether section 90 ought to have been  placed on the statute book, is also not our concern.  Section 90,  which delegates powers to the Central Government, has not been  challenged before us, and, therefore, we must proceed on the  footing that the section is constitutionally valid. The challenge  being only to the exercise of the power emanating from the section,  we are of the view that section 90 enables the Central Government  to enter into a DTAC with the foreign Government. When the  requisite notification has been issued thereunder, the provisions of  sub-section (2) of section 90 spring into operation and an assessee  who is covered by the provisions of the DTAC is entitled to seek  benefits thereunder, even if the provisions of the DTAC are  inconsistent with the provisions of Income-tax Act, 1961.

STARE DECISIS The learned Attorney General justifiably relied on the  observations of this Court in Mishri Lal  v. Dhirendra Nath (Dead)  by Lrs. and Others   in which this Court referred to its earlier  decision in Muktul v. Manbhari  on the scope of the doctrine of  stare decisis with reference to Halsbury’s Law of England and  Corpus Juris Secundum, pointing out that a decision which has  been followed for a long period of time, and has been acted upon  by persons in the formation of contracts or in the disposition of  their property, or in the general conduct of affairs, or in legal  procedure or in other ways, will generally be followed by courts of  higher authority other than the court establishing the rule, even  though the court before whom the matter arises afterwards might   be of a different view.  The learned Attorney General contended  that the interpretation given to section 90 of the Income-tax Act, a  Central Act, by several High Courts  without dissent has been  uniformally followed; several transactions have been entered into  based upon the said exposition of the law; that several tax treaties  have been entered into with different foreign Governments based  upon this law, hence, the doctrine of stare decisis  should apply or  else it will result in chaos and open up a Pandora’s box of  uncertainty.  We think that this submission is sound and needs to be  accepted.  It is not possible for us to say that the judgments of the  different High Courts noticed have been wrongly decided by  reason of the arguments presented by the respondents.   As  observed in Mishrilal   even if  the  High  Courts  have  consistently taken an erroneous view, (though we do not say that  the view is erroneous) it would be worthwhile to let the matter rest,  since large numbers of parties have modulated their legal  relationship based on this settled position of law.

Effect of circular under Section 119  

Much of the argument centred around the effect of the  circular issued by the CBDT under Section 119 of the Act and its  binding nature.  Section 119, strategically placed in Chapter XIII which deals  with  ’Income-Tax Authorities’  is an enabling power of the  CBDT, which is recognised as an authority under the Income-tax  Act under section 116(a).  The CBDT  under this section is  empowered  to issue such orders instructions  and directions to  other income-tax authorities  "as it may deem fit for proper  administration  of this Act".  Such authorities and all other persons  employed in the execution of this Act are bound to observe and  follow such orders, instructions and directions of the CBDT.  The  proviso to sub-section (1) of section 119 recognises  two  exceptions to this power.  First, that the CBDT cannot require any

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income-tax authority to make a particular assessment or to  dispose  of a particular case in a particular manner.   Second, is  with regard  to  interference with the discretion of the  Commissioner (Appeals)  in exercise of his appellate functions.  Sub-section(2) of Section  119 provides for the exercise of power in certain special  cases and  enables the CBDT, if it considers it necessary  or expedient so to  do for the purpose of proper and efficient management of the work  of assessment and collection of revenue, to issue general or special  orders in respect of any class of incomes of class of cases , setting  forth directions  or instructions as to the guidelines, principles or  procedures to be followed by other income-tax authorities in the  discharge of their work relating to assessment or initiating  proceedings for imposition of penalties.  The powers of the CBDT  are wide enough to enable it to grant relaxation from the provisions  of several sections enumerated in clause (a). Such orders may be  published in the Official Gazette in the prescribed manner, if the  CBDT is of the opinion that it is so necessary.  The only bar on the  exercise of power is that it is not prejudicial to the assessee.  We  are not concerned with the provisions in clauses (b) and (c)  in the  present appeals. In K.P. Varghese v. Income-Tax Officer, Ernakulam  it was  pointed out by this Court that not only are the circulars and  instructions, issued by the CBDT in exercise of the power under  section 119, binding on the authorities administering the tax  department, but they are also clearly in the nature of    contemporanea expositio furnishing legitimate aid to the  construction of the Act.   

The Rule of contemporanea expositio is that   "administrative construction (i.e. contemporaneous construction  placed by administrative or executive officers) generally should be  clearly wrong before it is overturned; such a construction   commonly referred to as practical construction, although non- controlling, is nevertheless entitled to  considerable weight, it is  highly persuasive."   

The validity of this principle was recognised in Baleshwar  Bagarti v. Bhagirathi Dass  where the  Calcutta High Court  stated  the rule in the following words : "It is a well-settled principle of  interpretation that courts in construing a statute  will give much weight to the interpretation put  upon it, at the time of its enactment and since,  by those whose duty it has been to construe,  execute and apply it."

       The  statement of this rule has also been quoted with  approval by this Court in Deshbandhu Gupta & Company v. Delhi  Stock Exchange Association Ltd .           In K.P. Varghese  this Court held that the circulars of the  CBDT  issued in exercise of its power under section 119 are  legally binding on the revenue and that this binding character  attaches to the circulars  "even if they be found not in accordance  with the  correct interpretation of sub-section (2) and they  depart  or deviate from such construction."      

Navnit Lal C. Javeri v. K.K.Sen  and Ellerman Lines Ltd. v.  CIT    clearly establish the principle that circulars issued by the  CBDT under section 119 of the Act are binding on all officers and  employees employed in the execution of the Act, even if they  deviate from the provisions of the Act.          In UCO Bank v. Commissioner of Incom-Tax , dealing

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with  the legal status of such circulars, this Court observed: "Such instructions may be by way of relaxation  of any of the provisions of the sections  specified there or otherwise. The Board thus  has power, inter alia, to tone down the rigour of  the law and ensure a fair enforcement of its  provisions, by issuing circulars in exercise of  its statutory powers under section 119 of the  Income-tax Act which are binding on the  authorities  in the administration of the Act.  Under section 119(2) however, the circulars as  contemplated therein cannot be adverse to the  assessee.  Thus the authority which wields the  power for its own advantage under the Act is  given the right to forgo the advantage when  required to wield it in a manner it considers just  by relaxing the rigour of the law or in other  permissible manners as laid down in section  119.  The power is given for the purpose of  just, proper and efficient management of the  work of assessment and in public interest. It is a  beneficial power given to the Board for proper  administration of fiscal law so that undue  hardship may not be caused to the assessee and  the fiscal laws may be correctly applied. Hard  cases which can be properly categorised as  belonging to a class, can thus be given the  benefit of relaxation of law by issuing circulars  binding on the taxing authorities."

       In Commissioner of Income-Tax v. Anjum M.H.Ghaswala  and Others  it was  pointed out  that the circulars issued by CBDT  under Section 119 of the Act have statutory force and would be  binding on every income-tax authority although such may not be  the case with regard to press releases issue by the CBDT for  information of the public.

       In Collector of Central Excise Vadodra v. Dhiren Chemical  Industries , this Court, interpreting the phrase  ’appropriate’,  observed : "We need to make it clear that, regardless of  the interpretation that we have placed on the  said phrase, if there are circulars which have  been issued by the Central Board of Excise and  Customs which place a different interpretation  upon the said phrase, that interpretation will be  binding upon the Revenue."

       While commenting adversely upon the validity of the  impugned  circular,  the High Court says "that the circular itself  does not show that the same has been issued under Section 119 of  the Income-tax Act. Only in a case where the circular is issued  under Section 119 of the Income-tax Act, the same would be  legally binding on the revenue.  The circular does not deal with the  power of the ITO to consider the question as to whether although  apparently a company is incorporated in Mauritius but whether the  company  is also a resident of India and/or not a resident of  Mauritius at all."    It is trite law that as long as an authority has  power, which is traceable to a source, the mere fact that source of  power is not indicated in an instrument does not render the  instrument invalid.    

Is the impugned circular ultra-vires Section 119 ?

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It was contended successfully before the High Court that the  circular is ultra vires the provisions of section 119.   Sub-section(1)  of section 119 is deliberately worded in general manner so that the  CBDT is enabled to issue appropriate orders, instruction or  direction to the subordinate authorities "as it may deem fit for the  proper administration of the Act". As long as the circular emanates  from the CBDT and contains orders, instructions or directions  pertaining to proper administration of the Act, it is relatable to the  source of power under section 119 irrespective of its nomenclature.   Apart from sub-section(1), sub-section(2) of section 119 also  enables the CBDT "for the purpose of proper and efficient  management of the work of assessment and collection of revenue,  to issue appropriate orders, general or special in respect of any  class of income or class of cases, setting  forth directions or  instructions (not being prejudicial to assessees) as to the  guidelines, principles  or procedures to be followed by other  income tax authorities in the work relating to assessment or  collection of revenue or the initiation of proceedings for the  imposition of penalties".  In our view, the High Court was not  justified  in reading the circular as not complying with the  provisions of section 119.  The circular falls well within the  parameters of the powers  exercisable  by the CBDT under Section  119 of the Act.   

The High Court persuaded itself to hold that the circular is  ultra vires the powers of the CBDT on completely erroneous  grounds. The impugned circular provides  that whenever a  certificate of residence is issued by the Mauritius Authorities, such  certificate will constitute sufficient evidence for  accepting the  status of residence as well as beneficial ownership for applying the  DTAC accordingly. It also provides that the test of residence  mentioned above would also apply in respect of income from  capital gains on sale of shares.   Accordingly, FIIs etc., which are  resident in Mauritius would not be taxable in India  on income  from capital gains arising in India on sale of shares as per  paragraph 4 of Article 13. This, the High Court thought amounts to  issuing instructions "de hors the provisions of the Act".

       In our view,   this thinking of the High Court is erroneous.  The only restriction on the power of the CBDT is to prevent it  from interfering  with the course of assessment of any particular  assessee or the discretion of the Commissioner of Income-Tax  (Appeals). It would be useful to recall the background against  which this circular was issued.  

The Income-tax authorities were seeking to examine  as to  whether the assessees were actually residents of a third country on  the basis of alleged control of management therefrom.   We have already extracted the relevant provisions of Article  4 which provide that, for the purposes of the agreement, the term  ’resident of a contracting State’ means any person who under the  laws of that State is liable to taxation therein by reason of his  domicile, residence, place of management or any other criterion of  similar nature.  The term ’resident of India’ and ’the resident of  Mauritius’ are to be construed accordingly.  Article 13 of the  DTAC lays down detailed rules with regard to taxation of capital  gains. As far as capital gains resulting from alienation of shares are  concerned, Article 13(4) provides  that the gains derived by a  ’resident’ of a contracting State  shall be taxable only in that State.  In the instant case, such capital gains derived by a resident of  Mauritius shall be taxable only in Mauritius.  Article 4, which we  have already referred to, declares that the term resident of  Mauritius’ means any person who under the laws of Mauritius is  ’liable to taxation’ therein by reason, inter alia, of his residence.

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Clause (2) of Article 4 enumerates detailed rules as to how the  residential status of an individual resident in both contracting  States has to be determined for the purposes of DTAC.  Clause(3)  of Article 4 provides that if, after application of the detailed rules  provided in Article 4, it is found that a person other than an  individual is a resident of both the contracting States, then it shall  be deemed to be a resident of the contracting State  in which its  place of effective management is situated.  The DTAC requires the  test of ’place of effective management’ to be applied only for the  purposes of the tie-breaker  clause in Article 4(3) which could be  applied only when it is found that a person other than an individual  is a resident both of  India  and Mauritius.  We see no purpose or  justification in the DTAC for application of this test in any other  situation.   

The High Court has held, and the respondents so contend,  that the assessing officer under the Income-tax Act is entitled to lift  the corporate veil, but the circular effectively bars the exercise of  this quasi-judicial function by reason of a presumption with regard  to the certificate issued by the competent authority in Mauritius;  conclusiveness of such a certificate of residence granted by the  Mauritius tax authorities is neither contemplated under the DTAC,  nor under the Income-tax Act a provision as to conclusiveness of a  certificate is a matter of legislative action and cannot form the  subject matter of a circular issued by a delegate of legislative  power.

As early as on March 30, 1994, the CBDT had issued  circular no.682 in which it had been emphasised that any resident  of Mauritius deriving income from alienation of shares of an  Indian company would be liable to capital gains tax only in  Mauritius as per Mauritius tax law and would not have any capital  gains tax liability in India. This circular was a clear enunciation of  the provisions contained in the DTAC, which would have  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  inconsequtial 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 DTAC.

We do not think  the circular in any way takes away or  curtails the  jurisdiction of the assessing officer to assess the  income of the assessee before him.  In our view, therefore, it is  erroneous to say that the impugned circular No.789 dated  13.4.2000 is ultra vires  the provisions  of section 119 of the Act.   In our judgment, the powers conferred upon the CBDT  by sub- sections (1) and (2) of Section 119 are wide enough to  accommodate such a circular.  

Is the DTAC bad for excessive delegation ?

       The respondents contend that a tax treaty entered   into       within the umbrella of section 90 of the Act is essentially delegated  legislation;    if it involves granting of exemption from tax,  it would  amount to delegation of legislative powers,  which is bad. The  legislature must declare the policy of the law and the legal principles

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which are to control  any given case and must provide a procedure to  execute the law.     

The question whether a particular delegated legislation is in  excess of the power of the supporting legislation conferred on the  delegate, has to be determined  with regard not only to specific  provisions contained in the relevant statute conferring the power to  make rule or regulation, but also the object and purpose of the Act  as  can be gathered from the various provisions of the enactment.  It  would be wholly wrong for the Court to substitute its own opinion as  to what principle or policy would best serve the objects and purposes  of the Act, nor is it open to the Court to sit in  judgment of the   wisdom, the effectiveness or otherwise  of the policy, so as to declare  a regulation to be ultra vires merely on the ground that, in the view of  the Court, the impugned provision will not help to carry through the  object and purposes of the Act.  This court reiterated the legal  position,  well established by a long series of decisions, in  Maharashtra State Board of Secondary and Higher Secondary  Education  and another v. Paritosh Bhupeshkumar Sheth and Others :  "So long as the body entrusted with the task of  framing the rules or regulations acts within the  scope of the authority conferred on it, in the  sense that the rules or regulations made by it  have a rational nexus with the object and  purpose  of the statute, the court should not  concern itself with the wisdom or  efficaciousness of such rules or regulations. It  is exclusively within the province  of the  legislature and its delegate to determine, as a  matter of policy, how the provisions of the  statute can best be implemented and what  measures, substantive as well as procedural  would have to be incorporated in the rules or  regulations for the efficacious achievement of  the objects and purposes  of the Act. It is not  for the Court to examine the merits or  demerits of such a policy because its scrutiny  has to be limited to the question as to whether  the impugned regulations fall  within the  scope of the regulation-making power  conferred on the delegate by the statute."

       Applying this test, we are unable to hold that the impugned  circular amounts to impermissible delegation of legislative power.  That the amendment made in section 90 was intended to empower  the Government to  enter into agreement with foreign Government,  if necessary, for relief from or avoidance of double taxation, is also  made clear by the Finance Minister in his Budget Speech, 1953-54

Is the Double Taxation Avoidance Convention ’DTAC’) illegal  and ultra vires the powers of the Central Government u/S 90

       Although the High court has not made any finding of this  nature, the respondents have strenuously contended before us that  the Indo-Mauritius Double  Taxation  Avoidance Convention,  1983 is itself ultra vires the powers of the Government  under  Section 90 of the Act.  This  argument deserves short shrift.   

Section 90 empowers the Central Government to enter into  agreement with the Government of any other country outside India  for the purposes enumerated in clauses  (a) to (d) of sub-section (1)  . While clause (a) talks of granting relief in respect of income on  which income-tax has been paid in India as well as in the foreign  country,  clause (b) is wider and deals with ’avoidance of double

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taxation of income’ under the Act  and under the corresponding  law in force in the foreign country. We are not concerned with  clauses (c) and (d).   

There are two hurdles against accepting the arguments  presented on behalf of the respondents. Even if we accept the  argument of the respondent that the DTAC is delegated legislation,   the test of its validity is to be determined, not by its efficacy, but  by the fact that it is within the parameters of the legislative  provision delegating the power. That the purpose of the DTAC is  to effectuate the objectives in clauses (a) and (b) of sub-section (1)  of Section 90, is evident upon a reasonable construction of the  terms of the DTAC.  As long as these two objectives are sought to  be effectuated, it is not possible to say that the power vested in the  Central  Government, under section 90, even if it is delegated  power of legislation, has been used for a purpose ultra vires the  intendment of  the section. The respondents tried to highlight a  number of unintended deleterious consequences which, according  to them, have arisen as a result of implementation of the DTAC.  Even if they be true, it would not enable this Court to strike down  the delegated legislation  as ultra vires.  The validity and the vires  of the legislation, primary, or delegated, has to be tested on the  anvil of  the law  making power.  If an authority lacks the power,  then the legislation is bad.  On the contrary, if the authority is  clothed with the requisite power, then irrespective of whether the  legislation fails in its object or not, the vires of the legislation is not  liable to be questioned.  We are, therefore,  unable to accept  the  contention  of the respondents that the DTAC is ultra vires the  powers of the Central Government under Section 90 on account of  its susceptibility to ’treaty shopping’ on behalf of the residents of  third   countries.   

The High Court seems to have heavily relied on an  assessment order made by the assessing officer in the case of Cox  and Kings Ltd. drawing inspiration therefrom.  We are afraid that it  was impermissible for the High Court to do so. An assessment  made in the case of a particular assessee is liable to be challenged  by the Revenue or by the assessee by the procedure available under  the Act. In a Public Interest Litigation it would be most unfair to  comment on the correctness of the assessment order made in the  case of a particular assessee, especially when the assessee is not a  party before the High Court.  Any observation made by the Court  would result in prejudice to one or the other party to the litigation.   For this reason, we refrain from making any observations about the  correctness or otherwise of the assessment order made in Cox and  Kings Ltd.  Needless to say, we decline to draw inspiration  therefrom, for our inspiration is drawn from principles of law as  gathered from statutes and precedents.

What is "liable to  taxation" Fiscal Residence

The concept of ’fiscal residence’ of a company assumes  importance in the application and interpretation of double taxation  avoidance treaties.   In  Cahiers De Droit Fiscal International  it is said that  under the OECD and UNO Model Convention, ’fiscal residence’ is  a place where a person amongst others a corporation is subjected to  unlimited fiscal liability and subjected to taxation for the  worldwide profit of the resident company.    At para 2.2 it is  pointed out :

"The UNO Model Convention takes these two  different concepts into account. It has not

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embodied the second sentence  of article 4,  paragraph  1 of the OECD Model Convention,  which provides that the term ’resident’ does  not include any person who is liable to tax in  that State in respect only of income from  sources in that State. In fact, if one adhered to  a strict interpretation  of this text, there would  be no resident in the meaning of the  convention in those States that apply the  principle of territoriality."

       Again in paragraph 3.5 it is said :

"The existence of a company from a company  law standpoint is usually determined under  the law of the State of incorporation or of the  country where the real seat is located.  On the  other hand, the tax status of a corporation is  determined under the law of each of the  countries where it carries on business, be it as  resident or non-resident."

In paragraph  4.1 it is observed that the principle of  universality of taxation i.e. the principle of worldwide taxation,   has been adopted by a majority of States.  One has to consider the  worldwide income of a company to determine its taxable profit. In  this system it is crucial to define the fiscal residence of a company  very accurately. The State of residence is the one entitled to levy  tax on the corporation’s worldwide profit. The company is  subject  to unlimited fiscal liability in that State. In the case of a company,   however, several factors enter the picture and render the decision  difficult.  First, the company  is necessarily incorporated and  usually registered under the tax law  of a State that grants it  corporate status. A corporation has administrative activities,  directors and managers  who reside, meet and take decisions  in  one or several places.  It has activities and carries on business.   Finally, it has shareholders who control it. Hence, it is opined : "When all these elements coexist in the same  country, no complications arise. As soon as  they are dissociated and "scattered" in  different States, each country may want to  subject the company to taxation on the basis  of an element to which it gives preference;  incorporation procedure,  management  functions, running of the business,  shareholders’ controlling power. Depending  on the criterion adopted, fiscal residence will  abide in one or the other country.

All the European countries concerned, except  France, levy tax on the worldwide profit at the  place of  residence of the company  considered.

South Korea, India and Japan in Asia,  Australia and New Zealand in Oceania follow  this principle."

In paragraph 4.2.1 it is pointed out that  the Anglo-Saxon  concept of a company’s  ’incorporation test’, which is applied in  the United States, has not been adopted by other countries like  Australia, Canada, Denmark, New Zealand and India and instead  the criterion of incorporation amongst other tests has been adopted  by them.          The judgment in Ingemar Johansson et al v. United State of

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America , on which the respondent place reliance, is easily  distinguishable. In this case the appellant, Johansson,  was a citizen  of Switzerland and a heavyweight boxing champion by profession.  He had earned some money by boxing in the United States for  which he was called upon to pay tax. Johansson floated a company  in Switzerland of which he became an employee and contended  that all professional fee paid for his boxing bouts  were received by  his employer company  in Switzerland for which he was  remunerated as an employee of the said company. He sought to  take advantage of the DTAT between USA and Switzerland which  provided "an individual resident of Switzerland shall be exempt  from  United States Tax upon  compensation  for labour personal  services performed in the United States.... if he is temporarily  present in the United States for a period or periods not exceeding a   total of 183 during the taxable year..."   There was no doubt that  the appellant was not present in the United States  for more than  183 days and that he had floated the Swiss company motivated  with the desire to minimise his tax burden.  As conclusive proof of  residence he relied upon a determination by the Swiss Tax  Authority that he had become a resident of Switzerland on a  particular date.  The United States Court of Appeal  rejected the  claim of the appellant pointing out that the term "resident" had not  been defined in the US-Swiss treaty, but under article II(2) each  country was authorised to apply its own definition to terms not  expressly defined ’unless the context otherwise requires’.   The  Court, therefore, held that the determination of the appellant’s  residence statues by the Swiss tax authority, according to Swiss  law, was not conclusive and that the U.S. tax authorities were  entitled to decide it in accordance with the US laws under the  treaty. Hence, it was held that Johansson  was not a resident of  Switzerland during the period in question and  that the tax  exemption in the treaty was not available to him.   In our view, this judgment, though relied upon very heavily  by the respondents, is of no avail. The Indo-Mauritius DTAC,  Article 3, clearly defines the term ’residence’ in  a ’Contracting  State’.  Interestingly, even in this judgment,  the Court observed :  "Of course, the fact that Johansson was motivated in his actions by  the desire to minimize his tax burden can in no way be taken to  deprive him of an exemption to which an applicable treaty entitles  him",  which will have some relevance to the contention of the  respondents with regard to the motivation to avoid tax.

The respondents contend that the FIIs incorporated and  registered under the provisions of the law in Mauritius are carrying  on no business there; they are, in fact, prevented from  earning any  income there;  they are not liable to income tax on capital gains  under the Mauritius Income-tax Act. They are liable to pay  income-tax under Indian Income-tax Act, 1961, since they do not  pay any income-tax on capital gains in Mauritius, hence, they are  not entitled to the benefit of avoidance of double taxation under the  DTAC.         Some of the assumptions underlying this contention, which  prevailed with the High Court, need greater critical appraisal.         Article 13(4) of the DTAC  provides that gains derived by a  resident of a Contracting State from alienation of any property,  other than those specified in the paragraphs 1, 2 and 3 of the  Article, shall be taxable only in that State. Since most of the  arguments centred around capital gains made on transactions in  shares on the stock exchange in India, we may leave out of  consideration capital gains on the type of properties contemplated  in paras 1, 2 and 3 of Article 13 of the DTAC. The residuary clause  in para 4 of Article 13 is relevant.  It provides that capital gains  made on sale of shares shall be taxable only in the State of which  the person is a ’resident’ taking us back to the meaning of the term  ’resident’ of a contracting State.  According to Article 4, this

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expression means any person who under the laws of that State is  "liable to taxation" therein by reason of his domicile, residence,  place of management or any other criterion of a similar nature.   The terms ’resident of India’ and ’resident of Mauritius’ are  required to be construed accordingly.  This takes us to the test to  determine when a company is ’liable to taxation’ in Mauritius.  

Mauritian Income Tax Act, 1995

Section 4 of the Income Tax Act, 1995 (Mauritian Income- tax Act) provides that, subject to the provisions of the Act, income- tax shall be paid to the Commissioner of Income-tax by  every  person on all income other than exempt income derived by him  during the preceding year and be calculated  on the chargeable  income of the person at the appropriate rate specified in the First  Schedule.  Section 5 defines as to when income is deemed to be  derived.

Section 7 provides that the income specified in the Second  Schedule shall be exempt from income-tax.   Part IV of the Mauritian Income Tax Act deals with  Corporate Taxation.          Section 44 of the Act provides that every company shall be  liable to income tax on its ’chargeable income’ at the rate specified  in Part II, Part III or Part IV of the First Schedule, as the case may  be.         Section 51 defines the ’gross income’ of a company as  inclusive of income referred to in section 10(1)(b) (income derived  from business), 10(1)(c) (any  income from rent, premium or other  income derived from property), 10(1)(d) (any dividend, interest,  charges, annuity or pension other than a pension referred to in  paragraph a(ii)) and 10(1)(e) (any other income derived from any  other source).         Section 73 (b) provides that for the purposes of the Act the  expression ’resident’, when applied to a ’company’, means  a  company which is incorporated in Mauritius or has its central  management and control in Mauritius.         Part II of the First Schedule prescribes the rate of tax on  chargeable income at 15% in the case of Tax Incentive companies  and at other rates for other types of companies. Part V of the First  schedule  enumerates the list of tax incentive companies and item  16 is : "a corporation certified to be engaged in international  business activity by the Mauritius Offshore Business Activities  Authority established under the Mauritius Offshore Business  Activities Act, 1992".  The second Schedule to the Mauritius  Income-tax Act in Part IV enumerates miscellaneous income  exempt from income-tax. Item 1 reads "gains or profits derived  from the sale of units or of securities  quoted on the Official List   or on such Stock Exchanges or other exchanges and capital  markets as may be approved by the Minister".         A perusal of the aforesaid provisions of the Income Tax Act  in Mauritius does not lead to the result that tax incentive  companies are not liable to taxation, although they have been  granted exemption from income-tax in respect of  a specified head  of income, namely, gains from transactions in shares and  securities.  The respondents contend that the FIIs are not "liable to  taxation" in Mauritius;  hence they are not ’residents’ of Mauritius  within the meaning of Article 4 of the DTAC.  Consequently, it is  open to the assessing officers under the Indian Income-tax Act,  1961 to determine where the taxable entities are really resident by  investigating the centre of their management and thereafter to  apply the provisions of Income-tax Act, 1961 to the global income  earned by them by reason of sections 4 and 5 of the Income-tax

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Act, 1961.         It is urged by the learned Attorney General and Shri Salve  for the appellants that the phrase ’liable to taxation’ is not the same  as ’pays tax’.  The test of liability for taxation is not to be  determined on the basis of an exemption granted in respect of any  particular source of income,  but by taking into consideration the  totality  of the provisions of the income-tax law that prevails in  either of the Contracting States.   Merely because, at a given time,  there may be an exemption from income-tax in respect of any  particular head of income, it cannot be contended  that the taxable  entity is not liable to taxation.  They urge that upon a proper  construction of the provisions of Mauritian Income Tax Act it  is  clear that the FIIs incorporated under Mauritius laws are liable to  taxation; therefore, they are ’residents’ in Mauritius within the  meaning of the DTAC.

       For the appellants reliance is placed on the judgment of this  Court in  Wallace Flour Mills Contracting State. Ltd. v. Collector  of Central Excise, Bombay Division II , a case under the Central  Excise Act.  This Court held that though the taxable event for levy  of excise duty is the manufacture or production, the realisation of  the duty my be postponed for administrative convenience  to the  date of removal of the goods from the factory.     It was held that  excisable goods do not become non-excisable merely because of  an exemption given under a notification.  The exemption merely  prevents the excise authorities  from collecting tax when the  exemption is in operation.          In  Kasinka Trading and Another v. Union of India and  Another   this principle was reiterated in connection with an  exemption under the Customs Act.  This Court observed :"The  exemption notification issued under section 25 of the Act had the  effect of suspending the collection of customs duty. It does not  make items which are subject to levy of customs duty etc. as items  not leviable  to such duty. It only suspends the levy and collection  of customs duty, wholly or partially,  and subject to such  conditions as may be laid down in the notification by the  Government in ’public interest’.  Such an exemption by its very  nature  is susceptible of being revoked or modified or subjected to  other conditions."     

We are inclined to agree with the submission of the  appellants that, merely because exemption has been granted in  respect of taxability of a particular source of income, it cannot be  postulated that the entity is not ’liable to tax’ as contended by the  respondents.

Effect of MOBA, 1992 The respondents, shifted ground to contend that the fact that  a company incorporated in Mauritius is liable to  taxation under the  Income Tax Act there may be true only in respect of certain class  of companies incorporated there.  However, with respect to  companies which are incorporated within the meaning of  the  Mauritius Offshore Business Activities Act, 1992 (hereinafter  referred to as "MOBA"), this would be wholly incorrect.   

MOBA was enacted "to provide for the establishment and  management of the MOBA Authority to regulate offshore business  activities from within Mauritius  and for the issue of offshore  certificates, and to provide for other ancillary or incidental  matters", as its preamble suggests. ’Offshore business activity’  is  defined as the business or other activity referred to in section 33  and includes activity conducted by an international company.  

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’Offshore company’ is defined as a corporation in relation to which  there is a valid certificate and which carries on offshore business  activity.  In part II,  MOBA establishes an Offshore Business Activity  Authority entrusted, inter alia, with the duty of overseeing offshore  business activities and also issuing permits, licences or  any other  certificate as may be required, and other authorisation which may  be required by an offshore company through which they may  communicate with any of the public sector companies.

       Section 16 of MOBA prescribes the procedure for issuing of  a certificate. Section 15 requires maintenance of confidentiality  and non-disclosure of information contained in applications and  documents filed with it except where such information is bona fide  required for the purpose of any enquiry or trial  into or relating to  the trafficking of narcotics and dangerous drugs, arms, trafficking  or money laundering under the Economic Crime and Anti Money  Laundering Act, 2000.   Part II of MOBA contains the statutory provisions  applicable to offshore companies.  Section 26 provides that an  offshore company shall not hold immovable property in Mauritius    and shall not hold any share  or any interest in any company  incorporated under the Companies Act, 1984, other than in a  foreign company or in another offshore company or in an offshore  trust or an international company.  An offshore company shall not  hold any account in a domestic bank in Mauritian Rupees, except    for the purpose of its day to day transactions arising from its  ordinary operations in Mauritius. Sections 26 and 27 of MOBA  are important and read as  under: "26. Property of an offshore company

(1)     Subject to sub-section(2), an offshore  company shall not hold -

(a)    immovable property in Mauritius ;

(b)     any share, or any interest in any  company incorporated under the  Companies Act, 1984 other than in a  foreign  company or in another  offshore company or in an offshore  trust or an international company ;

(c) any account in a domestic bank in  Mauritian Rupee

(2) An offshore company may -

(a) open and maintain with a domestic  bank an account in Mauritian rupees  for the purpose of its day to day  transactions arising from its ordinary  operations in Mauritius ;

(b)  open and maintain with a domestic  bank an account in foreign currencies  with the approval of the Bank of  Mauritius ;

(c)  where authorised by the terms of its  certificate, or where otherwise  permitted under any other enactment,  lease, hold, acquire or dispose of an  immovable property or any interest in

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immovable property situated in  Mauritius ;

(d) invest in any securities listed in the  stock Exchange established under the  Stock Exchange Act 1988 and in other  debentures.

27.     Dealings with residents

Notwithstanding any other enactment, the  Minister, on the recommendation of the  Authority may authorise any offshore  company engaged in any offshore business  activities to deal or transact with residents on  such terms and conditions as it thinks fit."

       On the basis of these provisions, it is urged by the  respondents that any company which is registered as an offshore  company under MOBA can hardly carry out any business activity  in Mauritius, since it cannot hold any immovable property or any  shares or interest in any company registered in Mauritius  other  than a foreign company or another offshore company and cannot  open an account in a domestic bank in Mauritius.  The respondents  urge that such a company cannot transact any  business whatsoever  within Mauritius as the purpose of such a  company would be to  carry out  offshore business activities and nothing more.  The  respondents contend that when the possibility of such a company   earning income within Mauritius is almost nil, there is hardly any  possibility of its paying  tax in Mauritius, whatever be the  provisions of the Mauritian Income-Tax Act.

       In our view, the contention of the respondents proceeds on  the fallacious premise  that liability to taxation is the same as  payment of tax. Liability to taxation is a legal situation;   payment  of tax is a fiscal fact. For the purpose of application of Article 4 of  the DTAC,  what is relevant is the legal situation, namely, liability  to taxation, and not the fiscal fact of actual payment of tax. If this  were not so, the DTAC would not have used the words ’liable to  taxation’, but would have used some appropriate words like ’pays  tax’.  On the language of the DTAC, it is not possible to accept the  contention of the respondents that offshore companies incorporated  and registered under MOBA are not ’liable to taxation’ under the  Mauritius Income-tax Act; nor is it possible to accept the  contention that such  companies would not be ’resident’ in  Mauritius within the meaning of Article 3 read with Article 4 of  the DTAC.

       There is a further reason in support of our view. The  expression ’liable to taxation’ has been adopted from the  Organisation for Economic Co-operation and Development  Council (OECD) Model Convention 1977.  The OECD  commentary on article 4, defining ’resident’, says: "Conventions  for the avoidance of double taxation do not normally concern  themselves with the domestic laws of the Contracting States laying  down the conditions under which a person is to be treated fiscally  as "resident" and, consequently, is fully liable to tax in that State".  The expression used is ’liable to tax therein’, by reasons of various  factors.  This definition has been carried over even in Article 4  dealing with ’resident’ in the OECD Model Convention 1992.

       In  A Manual on the OECD Model Tax Convention on  Income and On Capital,  at paragraph 4B.05, while commenting  on Article 4 of the OECD  Double Tax Convention, Philip Baker

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points out that the phrase ’liable to tax’ used in the first sentence of  Article 4.1 of the Model Convention has raised a number of issues,  and observes: "It seems clear that a person does not have  to be actually paying tax to be "liable to tax"  - otherwise a person who had deductible  losses or allowances, which reduced his tax  bill to zero would find himself unable to  enjoy the benefits of the convention.  It also  seems clear that a person who would  otherwise be subject to comprehensive  taxing but who enjoys a specific exemption  from tax is nevertheless liable to tax, if the  exemption were repealed, or the person  no  longer qualified for the exemption, the  person would be liable to comprehensive  taxation."

       Interestingly, Baker refers to the decision of  the Indian  Authority for Advance Ruling in  Mohsinally Alimohammed  Rafik.   An assessee, who resided in Dubai and claimed the  benefits of UAE-India Convention of April 29, 1992, even though  there was no personal income-tax in Dubai to which he might be  liable.  The Authority concluded that  he was entitled to the  benefits  of the convention. The Authority subsequently reversed  this position in the case of Cyril Eugene Pereira   where a contrary  view was taken.         The respondents placed great reliance  on the decision by the  Authority for  Advance Rulings constituted under section 245-O of  the Income-Tax Act, 1961 in Cyril Eugene Pereira’s case .   Section 245S of the Act provides that the Advance Ruling   pronounced by the Authority under section 245R shall be binding  only : "(a) on the applicant who had sought it; (b) in respect of the transaction in relation to  which the ruling had been sought; and

(c) on the Commissioner, and the income-tax  authorities subordinate to him, in respect of  the applicant and the said transaction."

       It is therefore obvious that, apart from whatever its  persuasive value, it would be of no help to us.  Having perused the  order of the Advance Rulings Authority, we regret that we are not  persuaded.  

       There is substance in the contention of Mr. Salve  learned  counsel for one of the appellants, that  the expression ’resident’ is  employed in the DTAC as a term of limitation, for otherwise a  person who may not be ’liable to tax’ in a Contracting State  by  reason of domicile, residence, place of management or any other  criterion of a similar nature may also claim the benefit of the  DTAC. Since the purpose of the DTAC is to eliminate double  taxation, the treaty takes into account only persons who are ’liable  to taxation’  in the Contracting States.  Consequently,  the benefits  thereunder are not available to persons who are not liable to  taxation and the words ’liable to taxation’ are intended to act as  words of limitation.

In John N. Gladden v. Her Majesty the Queen    the  principle of liberal interpretation of tax treaties was reiterated by  the Federal Court, which observed :

"Contrary to an ordinary taxing statute a  tax treaty or convention must be given a liberal

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interpretation with a view to implementing the  true  intentions of the parties. A literal or  legalistic interpretation must be avoided when  the basic object of the treaty might be defeated  or frustrated  insofar as the particular item  under consideration is concerned."

       Gladden   was a case where an American citizen resident in  U.S.A. owned shares in two privately controlled Canadian  companies. Upon his death, the question arose as to the capital  gains which would arise as a result of the deemed disposition of  the said shares. The Canadian Revenue took the position that there  was a deemed disposition  of the shares on the death of the tax  payer and capital gains tax was chargeable on account of the  deemed disposition.  This view of the Revenue was upheld in  appeal by the Tax Court of Canada. Upon further appeal to the  Federal Court it was held that capital gains were exempt from tax  under the Canada-U.S.A. Tax Treaty as Canada had no capital  gains tax when it entered the treaty and it could not unilaterally  amend its legislation.  The argument which prevailed with the trial  court in this case was similar to the one which prevailed with the  High Court in the matter before us. Interpreting the relevant Article  of the Double Taxation Avoidance Treaty the trial court held :  "The parties could not have negotiated to avoid double taxation on  a tax which did not exist in Canada".  The Federal Court  emphasised that in interpreting and applying treaties the Courts  should be prepared to extend "a liberal and extended construction"  to avoid an anomaly  which a contrary construction would lead to.   The Court recognized that "we cannot expect to find the same  nicety or strict definition as in modern documents, such as deeds,  or Acts of Parliament; it has never been the habit of those engaged  in diplomacy to use legal accuracy but rather to adopt more liberal  terms".         Interpreting  the Article of the Treaty against avoidance of  double taxation,  the Federal Court said  (at p.5): "The non-resident can benefit from the  exemption regardless of whether or not he is  taxable on that capital gain in his own country.  If Canada  or the U.S. were to abolish capital  gains completely, while the other country did  not, a resident of the country which had  abolished capital gains would still be exempt  from capital gains in the other country."

The appellants rely on this judgment to contend that,  irrespective of the exemption from income-tax on capital gains  upon alienation of shares under the Mauritius Income-tax Act, the  benefits of the DTAC would apply. The appellants contend that, acceptance of the respondents’  submission that double taxation avoidance is not permissible  unless tax is paid in both countries is contrary to the intendment of  section 90.  It is urged that clause (b) of sub-section(1) of Section  90 applies to a situation to grant relief where income tax has been  paid in both countries, but clause (b) deals with a situation of  avoidance of double taxation of income. Inasmuch as Parliament  has distinguished between the two situations, it is not open to a  Court of law to interpret  clause (b) of section 90 sub-section(1) as  if it were the same as the situation contemplated under clause (a).

According to Klaus Vogel "Double Taxation Convention  establishes an independent mechanism to avoid double taxation  through restriction of tax  claims in areas where overlapping tax- claims are expected, or at least theoretically possible. In other  words, the Contracting States mutually bind themselves not to levy

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taxes or to tax only to a limited extent in cases when the treaty  reserves taxation for the other contracting States either entirely or  in part. Contracting States are said to ’waive’ tax claims or more  illustratively to divide ’tax sources’, the ’taxable objects’, amongst  themselves."  Double taxation avoidance treaties were in vogue  even from the time of the League of Nations. The experts  appointed in the early 1920s by the League of Nations describe this  method of classification of items and their assignments to the  Contracting States.  While the English lawyers called it  ’classification and assignment rules’, the German jurists called it  ’the distributive rule’ (Verteilungsnorm).  To the extent that an  exemption is agreed to, its effect is in principle independent of  both whether the other contracting State imposes a tax in the  situation to which the exemption applies, and of whether that State  actually levies the tax.  Commenting particularly on German  Double Taxation Convention with the United States, Vogel   comments: "Thus,  it is said that the treaty prevents not only  ’current’, but also merely ’potential’ double taxation".  Further,  according to Vogel, "only in exceptional cases, and only when  expressly agreed to by the parties, is exemption in one contracting  State dependent upon whether the income or capital is taxable in  the other contracting state, or upon whether it is actually taxed  there."    It is, therefore, not possible for us to accept the contentions  so strenuously urged  on behalf of the respondents that avoidance  of double taxation can arise only when tax is actually paid in one  of the Contracting States. The decision of Federal Court of Australia in Commissioner  of Taxation v. Lamesa Holdings  is illuminating.  The issue before  the Federal Court was whether a Netherlands company was liable  to income-tax under the Australian Income Tax Act on profits from  the sale of shares in an Australian company and whether such  profits fell within Article 13 (alienation of property) of the  Netherlands-Australia Double Taxation Agreement, so as to be  excluded from Article 7 (business profits) of that Agreement.  One   Leonard Green, a principal of Leonard Green and Associates a  limited partnership established in the United States, became aware  of a potential investment opportunity in Australia. Arimco  Resources and Mining Company NL (’Armico’), a company listed  on the Australian Stock Exchange, which had a subsidiary  called  Armico Mining Pty. Limited engaged in gold mining activities,  was the subject of a hostile takeover bid, at a price which Green  was advised  was less than the real value of the Armico. With this  knowledge Green decided to mount a takeover offer for the  subsidiary company. Then followed a series of steps of formation  of a number of companies with interlocking share holdings where  each company owned 1005 shares of a different subsidiary  company.  Lamesa Holdings  was one such intermediary company  of which 100% shares were held by Green Equity Investments Ltd.   The share transactions brought about a profit to Lamesa Holdings  which would be assessable to tax under the Australian Income Tax  Act. Lamesa, however, relied on the provisions of the Article 13(2)  of the Double Taxable Avoidance Convention (’DTAC’) between  Netherlands and Australia and claimed that the income was not  taxable in Australia by reason thereof.  This income was wholly  exempt from tax in Netherlands by  reason of the Income Tax Law  applicable therein. The Federal Court found that  under Article  13(2) (a) (ii) of the DTAC shares in a company were treated as  personalty, that since the place of incorporation of a company or  the place of situs of a share may be the subject of choice,  the place  of incorporation or the register upon which shares were registered  would not form a particularly close connection with shares to  ground the jurisdiction to tax share profits.  It was held: "It happens to be the case, because of  unilateral relief granted by the law of the

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Netherlands, that no tax will be payable in the  Netherlands. That of itself can not affect the  interpretation of the Agreement.  If the relevant  mining property had happened to be in the  Netherlands so that the issue was between  taxation there on the one hand  and taxation in  Australia on the other, the situation would have  been one where tax would clearly have been  payable on the alienation of the shares in  Australia without the benefit of any exemption.  Yet the Agreement must operate uniformly,  whether the realty is in the Netherlands or in  Australia."

       In this view of the matter, it was held that there was no tax  payable in Australia.

       Chong v. Commissioner of Taxation   holds similarly.   Australia and Malaysia have an agreement to avoid double  taxation. An Australian resident was paid pension by Malaysian  Government for services rendered to Malaysian Government   while he was in service there.   This pension was taxed in Malaysia  and the issue was whether the right to tax Government pensions  under the Agreement could be exercised  by the Australian  Government and the effect of the domestic law on the agreement.  Article 18 of the double taxation avoidance agreement provided  that pension paid to a resident of a contracting State  shall be  taxable only  in that State.  Upon a proper construction of Article  18(2) of the Treaty it was held that pension paid by Malaysia is  taxable in Australia inasmuch as the said Article did not provide  that Malaysia alone was to have the power to tax Government  pension, nor did it restrict  Australia from doing so.  Rather it  provided for the Contracting State paying the pension to have the  power to tax the pension if it so desired and did not limit or restrict  the taxing power of the other Contracting State  in that respect.   The Federal Court pointed out   "Whether one uses the language of  allocation of power or the language of limitation of power, the  result is the same; there is designated or agreed who shall have the  right under the agreement to impose taxation in the particular  area".

       The Estate of Michel Hausmann v. Her Majesty The  Queen    is another Canadian judgment which throws light on the  principle that the benefits of a double taxation agreement would be  available even if the other contracting  State in  which a particular  head of income is to be taxed,  chooses not to impose tax on the  same.          The central question in this case was whether the pension  received by Mr.Hausmann from the pension office of the Belgium  Government was taxable in Canada. The facts indicated that there  was no tax withheld at source in Belgium.  The argument of the  Canadian Tax Authority was that if Belgium was not going to tax  the pension, Canada should.  Otherwise, the unthinkable might  occur and the amount might not be taxed  by anyone. This would  be anathema.  The facts indicated that the payment received by Mr.  Hausmann fell below the prescribed threshold  and therefore was  not taxed in Belgium.  The Canadian Court rejected the argument  that if Belgium did not tax the payment, it must be taxed by the  Canada as plainly wrong by relying on the terms of the treaty.  On  the basis of the material available, the Federal Court came to the  inference that in negotiating the Belgium treaty both Canada and  Belgium unquestionably regarded pensions paid under their social  security legislation, such as the CPP or the corresponding Belgian  statutory scheme, to be taxable only in the country from which  they emanated  and not the country  of residence of the recipient.  

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Hence, it was held that the pension payments received by Mr.  Hausmann from the office of Belgium were social security pension  and such allowances could be taxable only in Belgium.  The fact  that Belgium did not choose to tax them was held to be totally  irrelevant.   

       Mr. Salve contended that a profit made by sale of shares  may not invariably amount to capital gains, as for example if the  shares were part of the trading assets of the company. If such be  the case, the gains may amount to trading income of such a  company. He also relied on the observations of this Court in   Commissioner of Income Tax Nagpur v. Sutlej Cotton Mills  Supply Agency Limited .  It is not necessary for us to go into this  question as it would depend upon as to whether the shares are held  by a company as an investment or as a trading asset.  The  possibility urged by the learned counsel certainly exists and cannot  be ruled out without examination of facts.  

Treaty Shopping - Is it illegal ?         The respondents vehemently urge that the offshore  companies  have been incorporated under the laws of Mauritius   only as shell companies, which carry on no business therein, and  are incorporated only with the motive of taking undue advantage of  the DTAC between India and Mauritius. They also urged that  ’treaty shopping’ is both unethical and illegal and amounts to a  fraud on the treaty and that this Court must be astute to interdict all  attempts at treaty shopping.           ’Treaty shopping’ is a graphic expression used to describe  the act of a resident of a third country taking advantage of  a fiscal  treaty between two Contracting States.  According to Lord  McNair, "provided that any necessary implementation by  municipal law has been carried out, there is nothing to prevent the  nationals of "third States", in the absence of any expressed or  implied provision to the contrary, from claiming the right or  becoming subject to the obligation created by a treaty" .   Reliance is also placed on the following observations of  Lord  McNair :  "that any necessary implementation  by  municipal law has been carried out, there is  nothing to prevent the nationals of ’third   States’, in the absence of any express or  implied provision to the contrary, from  claiming the rights, or becoming subject to the  obligations, created by a treaty; for instance, if  an Anglo-American Convention provided that  professors on the staff of the universities of  each country were exempt from taxation in  respect of fees earned for lecturing in the other  country, and any necessary changes in the tax  laws were made, that privilege could be  claimed by, or on behalf of, professors of those  universities  who were the nationals of ’third  States’."

       It is urged by the learned counsel for the appellants, and  rightly in our view, that if it was intended that a national of a third  State should be precluded from the benefits of the DTAC, then a  suitable term of limitation to that effect should have been  incorporated therein.  As a contrast, our attention was drawn to the  Article 24 of the Indo-US Treaty on Avoidance of Double  Taxation which specifically provides the limitations subject to  which the benefits under the Treaty can be availed of. One of the  limitations is that more than 50% of the beneficial interest, or in

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the case of a company more than 50%  of the number of shares of  each class of the company, be owned directly or indirectly by one  or more individual residents of one of the contracting States.  Article 24 of the Indo-U.S. DTAC is in marked contrast with the  Indo-Mauritius DTAC. The appellants  rightly contend that in the  absence of a limitation  clause, such as the one contained in Article  24 of the Indo-U.S. Treaty, there are no disabling or disentitling  conditions under the Indo-Mauritius  Treaty  prohibiting the  resident of a third nation from deriving benefits thereunder.  They  also urge that motives  with which the residents have been  incorporated  in Mauritius are wholly irrelevant and cannot in any  way affect the legality of the transaction. They urge that there is  nothing like equity in a fiscal statute. Either the statute applies  proprio vigore  or it does not. There is no question of applying a  fiscal statute by intendment, if the expressed words do not apply.  In our view, this contention of the appellants has merit  and  deserves acceptance. We shall have occasion to examine the  argument based on motive a little later.

The decision of the Chancery Division in Re F.G. Films  Ltd.  was pressed into service as  an example of the mask of  corporate entity being lifted and account be taken of what lies  behind in order to prevent ’fraud’.  This decision only emphasises   the doctrine of piercing the veil of incorporation. There is no doubt  that, where necessary, the Courts are empowered to lift the veil of  incorporation while applying the domestic law. In the  situation  where the terms of the  DTAC  have been made applicable by  reason of section 90 of the Income-Tax Act, 1961, even if they  derogate from the provisions of the Income-tax Act, it is not  possible to say that this principle of lifting the veil of incorporation  should be applied by the court. As we have already emphasised,  the whole purpose of the DTAC is to ensure that the benefits  thereunder are available even if they are inconsistent with the  provisions of the Indian Income-tax Act. In our view, therefore, the  principle of piercing  the veil of incorporation can hardly apply to a  situation as the one before us.

       The respondents banked on certain observations made in  Oppenheim’s  International Law . All that is stated therein is a  reiteration of the general rule in municipal law that contractual  obligations bind the parties to  their contracts and not a third party  to the contract.  In international law also, it has been pointed out  that the Vienna Convention on the Laws of Treaties ,1969   reaffirms the general rule that a treaty does not create either  obligations or rights for a third party state without its consent,  based on the general principle pacta tertiis nec nocent nec prosunt.   It is true that  an international treaty  between States A & B is  neither intended to confer benefits nor impose obligations on the  residents of State C, but, here we are not concerned with this  question at all.  The question posed for our consideration is: If the  residents of State C qualify for  a benefit under the treaty, can they  be denied the benefit on some theoretical ground that ’treaty  shopping’ is unethical and illegal ?  We find no support for this  proposition in the passage cited from Oppenheim.  

       The respondents then relied on observations of Philip  Baker  regarding a seminar at the IFI Barcelona in 1991, wherein  a paper was presented on "Limitation of treaty benefits for  companies" (treaty shopping).  He points out  that the Committee  on Fiscal Affairs of the OECD in its report styled as "Conduit  Companies Report 1987" recognised that a conduit company  would generally be able to claim treaty benefits.

       There is elaborate discussion in Baker’s treatise on  the anti  abuse provisions in the OECD model and the approach of different

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countries to the issue of ’treaty shopping’.  True that several  countries like the USA, Germany, Netherlands, Switzerland  and  United Kingdom have taken suitable steps, either by way of  incorporation of appropriate provisions in the international  conventions as to double taxation avoidance, or by domestic  legislation, to ensure  that the benefits of a treaty/convention are  not available to residents of a third State.  Doubtless, the treatise by  Philip Baker is an excellent guide as to how a state should  modulate its laws or incorporate suitable terms in tax conventions  to which it is party so that the possibility of a resident of a third  State deriving benefits thereunder is totally eliminated.  That may  be an academic approach to the problem to say how the law should  be.  The maxim "Judicis est jus dicere, non dare"   pithily  expounds the duty of the Court. It is to decide what the  law is, and  apply it; not to make it.

Report of the working group on non-resident taxation

       The respondents contend that anti-abuse provisions need not  be incorporated in the treaty since it is assumed that the treaty  would only be used for the benefit of the parties.   They also strongly rely  on the ’Report of the working group  on Non-Resident Taxation’ dated 3rd January, 2003. In Chapter 3,  para 3.2 of the report  it is stated:         "3.2 Entitlement to avail DTAA benefit: Presently a person is entitled to claim  application of DTAA if he is ’liable to tax’ in the  other Contracting State. The scope of liability to tax  is not defined. The term "liable to tax" should be  defined to say that there should be tax laws in force  in the other State, which provides for taxation of  such person, irrespective that such tax fully or  partly exempts such persons from charge of tax on  any income in any manner."

In para 3.3.1, after noticing the growing practice amongst  certain entities, who are not residents of either of the two  Contracting States, to try and avail of the beneficial provisions of  the DTAAs and indulge in what is popularly known as ’treaty  shopping’, the report says :

"3.3.1  ....there is a need to incorporate suitable  provisions in the chapter on interpretation of  DTAAs, to deal with treaty shopping, conduit  companies and thin  capitalization. These may be  based on UN/OECD model or other best global  practices."

In para 3.3.2, the working group recommended  introduction of anti-abuse provisions in the domestic law. Finally, in paragraph  3.3.3 it is stated  "The Working  Group recommends that in future negotiations, provisions  relating to anti-abuse/limitation of benefit may be incorporated in  the DTAAs also." We are afraid that the weighty recommendations of the  Working Group on Non-Resident Taxation are again about what  the law ought to be, and a pointer to the Parliament and the  Executive for incorporating suitable limitation provisions in the

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treaty itself or by domestic legislation.  This per se does not  render an attempt by resident of a third party to take advantage of  the existing provisions of the DTAC illegal.  

J.P.C. Report          Strong reliance is placed by the respondents on the report of  the Joint Parliamentary Committee (hereinafter referred to as  "JPC") on the Stock Market Scam and Matters Relating thereto  which was presented in the Lok Sabha and Rajya Sabha on  December 19, 2002.  While considering the causes which led to the Stock Market  scam, the JPC   had occasion to consider the working of the Indo- Mauritius DTAC.    It noticed  that area-wise foreign direct  investment  inflow from Mauritius increased from 37.5 million  Rupees in 1993  to 61672.8 million Rupees  in the year 2001. The  CBDT had approached the Indian High Commissioner at Mauritius  to take up the matter with the Mauritian authorities  to ensure that  benefit of the bilateral   tax treaty were not allowed to be misused,  by suitable amendment in Article 13 of the agreement. The  Mauritian  authorities, however, were of the view that, though the  beneficiaries of such capital funds domiciled in Mauritius may be  residing in third countries, these funds had been invested in the  Indian stock market in accordance  with SEBI norms and  regulations and that the Finance Minister of India had himself  encouraged such FIIs as a channel for promoting capital flow to  India in a meeting between himself and the Finance Minister of  Mauritius.  The Ministry of finance was willing to have regular  joint monitoring of the situation to avoid possible misuse of the tax  treaty by unscrupulous elements. It was pointed out by the  Mauritian authorities that  DTAC between the two countries "had  played a positive role in covering the higher cost of investing in  what was then assessed as ’high risk security’ and being decisive  in making possible public  offerings in U.S.A.  and Europe of  funds investing in India".  In the absence of such a facility, as  afforded  by the Indo-Mauritius DTAC, the cost of raising such  investment would have been capital  prohibitive. The JPC  report  points out that the negotiations between the Government of India  and Government of Mauritius resulted in a situation in which the  Mauritius Government felt that any change in the provisions of the  DTAC would adversely affect the perception of potential investors  and would prejudicially  affect their financial interests. The issue still appears to be the subject matter of  negotiations between the two Governments, though no final  decision has been taken thereupon. The JPC took notice of the  facts that MOBA has since been repealed by Mauritius and  Financial Services Development Act has been promulgated with  effect from 1.12.2001, which has to some extent removed the  drawback of MOBA, and led to greater transparency  and  facility  for obtaining information under the DTAC, which was hitherto not  available.  

       Taking notice of the facts, and the reluctance of the  Government of Mauritius in the matter to renegotiate the terms of  treaty, the Committee recommended as under (vide para 12.205): "The Committee find that though the exact   amount of revenue loss due to the ’residency  clause’ of the treaty cannot be quantified, but  taking into account the huge  inflows/outflows, it could be assumed to be  substantial. They therefore recommend that  Companies investing in Indian through  Mauritius, should be required to file details  of ownership with RBI and declare that all  the Directors and effective management is in

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Mauritius. The Committee suggest that all  the contentious issues should be resolved by  the Government with the Government of  Mauritius urgently through dialogue."

       In our view, the recommendations of the Working Group of  the JPC  are intended for Parliament to take appropriate action. The  JPC might have noticed  certain consequences, intended or  unintended, flowing from the DTAC and has made appropriate  recommendations. Based on them, it is not possible for us to say  that the DTAC or the impugned circular are contrary to law, nor  would it be possible to interfere with either of them on the basis of  the report of the  JPC.

Interpretation of Treaties The principles adopted in interpretation of treaties are not  the same as those in interpretation of statutory legislation. While  commenting on the interpretation of a treaty imported into a  municipal law, Francis Bennion observes: "With indirect enactment, instead of the  substantive legislation taking the well-known  form of an Act of Parliament, it has the form  of a treaty. In other words the 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 drafting of treaties is  notoriously sloppy usually for very good  reason.  To get agreement, politic uncertainty  is called for.

.....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 broad principles of general  acceptation. This echoes the optimistic  dictum of Lord Widgery CJ that the words  ’are to be given their general meaning,  general to lawyer and layman alike... the  meaning of the diplomat rather than the  lawyer."  

       An important principle which needs to be kept in mind in the  interpretation of the provisions of an international treaty, including  one for double taxation relief, is that treaties are negotiated and  entered into at a political level and have several considerations as  their bases.   Commenting on this aspect of the matter, David R.  Davis in Principles of International Double Taxation Relief ,   points out that the main function of a Double Taxation Avoidance  Treaty should be seen in the context of aiding commercial relations  between treaty partners and as being essentially a bargain between  two treaty countries as to the division of tax revenues between  them in respect of income falling to be taxed in both jurisdictions.  It is observed (vide para 1.06):

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"The benefits and detriments of a double tax  treaty will probably  only be truly reciprocal  where the flow of trade and investment  between treaty partners is generally in  balance.  Where this is not the case, the  benefits of the treaty may be weighted  more  in favour of one treaty partner than the other,  even though the provisions of the treaty are  expressed in reciprocal terms. This has been  identified as occurring in relation to tax  treaties between developed and developing  countries, where the flow of trade and  investment is largely one way.

               Because treaty negotiations are largely  a bargaining process with each side seeking  concessions from the other, the final  agreement will often represent a number of  compromises,  and it may be uncertain as to  whether a full and sufficient quid pro quo is  obtained by both sides."

And, finally, in paragraph 1.08:

"Apart from the allocation of tax between the  treaty partners, tax treaties can also help to  resolve problems and can obtain benefits  which cannot be achieved unilaterally."

       Based on these observations, counsel for the appellants  contended that the preamble of the Indo-Mauritius DTAC recites  that it is for the "encouragement of mutual trade and investment"  and this aspect of the matter cannot be lost sight of while  interpreting the treaty.

Many developed countries tolerate or encourage treaty  shopping, even if it is unintended, improper or unjustified, for  other non-tax reasons, unless it leads to a significant loss of tax  revenues.  Moreover, several of them allow the use of their treaty  network to attract foreign enterprises and offshore activities. Some  of them favour treaty shopping for  outbound investment to reduce  the foreign taxes of their tax  residents but dislike their own loss of  tax revenues on inbound investment or trade of non-residents. In  developing countries, treaty shopping is often regarded as a tax   incentive to attract scarce foreign capital or technology. They are  able to grant tax concessions exclusively to foreign investors over  and above the domestic tax law provisions. In this respect, it does  not differ much from other similar tax incentives given by them,  such as tax holidays, grants, etc.            Developing countries need foreign investments, and the  treaty shopping opportunities can be an additional factor to attract  them. The use of Cyprus as a treaty haven has helped capital  inflows into eastern Europe. Madeira (Portugal) is attractive for  investments into the European Union. Singapore is developing  itself as a base for investments in South East Asia and China.   Mauritius today provides a suitable treaty conduit for South Asia  and South Africa.   In recent years, India has been the beneficiary  of significant foreign funds through the "Mauritius conduit".  Although  the Indian economic reforms since 1991 permitted such  capital transfers, the amount would have been much lower without  the India-Mauritius tax treaty.           Overall, countries need to take, and do take, a holistic view.   The developing countries allow treaty shopping to encourage

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capital and technology inflows, which developed countries  are  keen to  provide to them.  The loss of tax revenues could be  insignificant  compared to the other non-tax benefits to their  economy. Many of them do not appear to be too concerned unless  the revenue losses are significant compared to the other tax and  non-tax benefits from the treaty, or the treaty shopping leads to  other tax abuses.          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 DTAC 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. A holistic  view has to be taken to adjudge what is perhaps regarded in  contemporary thinking as a necessary evil in a developing  economy.

Rule in McDowell         The respondents strenuously criticized the act of  incorporation  by FIIs under the Mauritian Act as a ’sham’ and ’a  device’ actuated  by improper  motives. They contend  that this  Court  should interdict such arrangements and, as if by waving a  magic wand, bring about a situation  where the incorporation  becomes non est.   For this they heavily rely on the judgment of the  Constitution Bench of this Court in McDowell and  Company Ltd.  v.  Commercial Tax Officer .  Placing strong reliance  on  McDowell   it is argued  that McDowell  has changed the  concept  of fiscal jurisprudence in this country and any tax  planning which is intended to and results in avoidance of tax must  be struck down by the Court.  Considering the seminal nature  of  the contention, it is necessary to consider in some detail  as to why  McDowell ,  what it says, and what it does not say.

       In the classic words of Lord Sumner in IRC V. Fisher’s  Executors  ,   "My Lords, the highest authorities have  always recognised that the subject is entitled  so to arrange his affairs as not to attract taxes  imposed by the Crown, so far as he can do so  within the law, and that he may legitimately  claim the advantage of any expressed terms  or any omissions that he can find in his  favour in taxing Acts.  In so doing, he neither  comes under liability nor incurs blame."

       Similar views were expressed by Lord Tomlin in IRC v.  Duke of Westminster   which reflected the prevalent attitude  towards tax avoidance: "Every man is entitled if he can to order his  affairs so that the tax attaching under the  appropriate  Acts is less than it otherwise  would be. If he succeeds in ordering them so  as to secure this result,  then, however,  unappreciative the Commissioners of Inland  Revenue or his fellow taxgatherers may be of  his ingenuity, he cannot be compelled to pay  an increased tax."

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       These were the pre second world war sentiments expressed  by the British Courts.  It is urged that McDowell  has taken a new  look at fiscal jurisprudence  and "the ghost of Fisher  (supra) and  Westminster  have been exorcised in the country of its origin".  It  is also urged that  McDowell’s  radical departure was in tune with  the changed thinking on fiscal jurisprudence by the English Courts,  as evidenced in W.T. Ramsay Ltd. v. IRC , Inland Revenue  Commissioners v. Burman Oil Company Ltd  and  Furniss v.  Dawson .         As we shall show presently, far from being exorcised in its  country of origin, Duke of Westminster  continues to be alive and  kicking in England. Interestingly, even in McDowell ,  though  Chinnappa Reddy,J., dismissed the observation of J.C. Shah,J. in  CIT v. A. Raman and Company  based on Westminster   and  Fisher’s Executors ,  by saying "we think that the time has come  for us to depart from the Westminster principle as emphatically as  the British courts have done and to dissociate ourselves from the  observations of Shah J., and similar observations made elsewhere",  it does not appear that the rest of the learned Judges of the  Constitutional Bench contributed to this radical thinking. Speaking  for the majority, Ranganath Mishra,J,(as he then was) says in  McDowell :  "Tax planning may be legitimate provided it  is within the framework of law. Colourable  devices cannot be part of tax planning and it  is wrong to encourage or entertain  the belief  that it is honourable to avoid the payment of  tax by resorting to dubious methods.  It  is the  obligation of every citizen  to  pay  the  taxes

honestly  without resorting to subterfuges."

                               (Emphasis supplied)

       This opinion of the majority is a far cry from the view of  Chinnappa Reddy,J: "In our view the proper way to construe a  taxing statute, while considering a device to avoid tax, is not to ask  whether  a provision should be construed liberally or principally,  nor whether the transaction is not  unreal and not  prohibited by the  statute,  but whether the transaction is a device to avoid tax, and  whether the transaction is such that the judicial process may accord  its approval to it."   We are afraid that we are unable to read or  comprehend the majority judgment in McDowell   as having  endorsed  this extreme view of Chinnappa Reddy,J, which, in  our  considered opinion,  actually militates against the observations of  the majority of the Judges which we have just extracted from the  leading judgment of Ranganath Mishra,J (as he then was).

       The basic assumption made in the judgment of Chinnappa  Reddy,J. in McDowell   that the principle in Duke of  Westminster  has been departed from subsequently by the House  of Lords in England,   with respect, is not correct. In Craven v.  White    the  House of Lords  pointedly considered the impact of  Furniss ,  Burma Oil  and Ramsay .  The Law Lords were at  great pains  to explain away each of these judgments. Lord  Keith  of Kinkel says, with reference to the trilogy  of these cases, (at  p.500): "     My Lords, in my opinion the nature of the  principle to be derived from the three cases is  this : the court must first construe the relevant  enactment in order to ascertain its meaning; it  must then  analyse the series of transactions in  question, regarded as a whole, so as to ascertain  its true effect in law; and finally it must apply

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the enactment as construed to the true effect of  the series of transactions and so decide whether  or not the enactment was intended to cover it.   The most important feature of the principle is  that the series of transactions is to be regarded  as a whole. In ascertaining the true legal effect  of the series it is relevant to take into account, if  it be the case, that all the steps in it were  contractually agreed in advance or had been  determined on in advance by a guiding will  which was in a position, for all practical  purposes, to secure that all of them were carried  through to completion.  It is also relevant to  take into account, if it be the case, that one or  more of the steps was introduced into the series  with no business purpose other than the  avoidance of tax.

       The principle does not involve, in my opinion,  that it is part of the judicial function to treat as  nugatory any step whatever which a taxpayer  may take with a view to the avoidance or  mitigation or tax. It remains true in general that  the taxpayer, where he is in a position to carry  through a transaction in two alternative ways,  one of which will result in liability to tax and  the other of which will not, is at liberty to  choose the latter and to do so effectively in the  absence of any specific tax avoidance provision  such as s.460 of the Income and Corporation  Taxes Act, 1970.

       In Ramsay and in Burmah  the result of  application of the principle was to demonstrate  that the true legal effect of the series of  transactions entered into, regarded as a whole,  was precisely nil."

Lord Oliver (at p.518-19) says:

"It is equally important  to bear in mind what  the case did not decide. It did not decide that a  transaction entered into with the motive of  minimising the subject’s burden of tax is, for  that reason, to be ignored or struck down.  Lord  Wilberforce  was  at pains to stress that the fact  that the motive for a transaction may be to  avoid tax does not invalidate it unless a  particular enactment so provides (see (1981) 1  All ER 865, (1982) AC 300 at 323). Nor did it  decide that the court is entitled, because of the  subject’s motive in entering into a genuine  transaction, to attribute to it a legal effect which  it did not have. Both Lord Wilberforce and  Lord Fraser emphasise the continued validity  and application of the principle of IRC v. Duke  of Westminster (1936) AC 1 (19350 All ER  Rep.259, a principle which Lord Wilberforce  described as a ’cardinal principle’. What it did  decide was  that that cardinal principle does  not, where it is plain that a particular  transaction is but one step in a connected series  of interdependent steps designed to produce a  single composite overall result, compel the  court to regard it as otherwise than what it is,

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that is to say merely a part of the composite  whole."

Lord Oliver  (at p.523 ) observes:

"My Lords, for my part I find myself unable to  accept that Dawson either established or can  properly be used to support a general  proposition that any transaction which is  effected for the purpose of avoiding tax on a  contemplated subsequent transaction and is   therefore ’planned’ is, for that reason,  necessarily  to be treated as one with that  subsequent transaction and as having no  independent effect even where that is  realistically and logically impossible."

Continuing, (at page 524) Lord Oliver  observes:

"Essentially, Dawson  was concerned with a  question which is common to all successive  transactions where an actual transfer of  property has taken place to a corporate entity  which subsequently carries out a further  disposition to an ultimate disponee. The  question is : when is a disposal not a disposal  within the terms of the statute ? To give to that  question the answer ’when, on an analysis of  the facts, it is seen in reality to be a different  transaction altogether’ is well within the  accepted canons of construction. To answer it  ’when it is effected with a view to avoiding tax  on another contemplated transaction’ is to do  more than simply to place a gloss on the words  of the statute. It is to  add a limitation or  qualification which the legislature itself  has not  sought to express and for which there is no  context in the statute. That, however, desirable  it may seem, is to legislate, not to construe, and  that is something which is not within judicial  competence.  I can find nothing in Dawson   or  in the cases which preceded it which causes me  to suppose that that was what this House, was  seeking to do."

       Thus we see that even in the year 1988  the House of  Lords  emphasised the continued validity and application of the principle  in Duke of Westminster  .  

While Chinnappa Reddy, J.  took the view that Ramsay ,  was an authoritative  rejection of principle in the Duke of  Westminster ,  the House of Lords, in the year 2001, does not  seem to consider it to be so, as seen from MacNiven (Inspector of  Taxes) v. Westmoreland Investments Ltd .  Lord Hoffmann   observes: "In the Ramsay case both Lord Wilberforce  and Lord Fraser of Tullybelton, who gave the  other principal speech, were careful to stress  that the House was not departing from the  principle in IRC v. Duke of Westminster  (1936) AC 1, (1935) All ER Rep.259. There  has nevertheless been a good deal of  discussion about how the two cases are to be  reconciled. How, if the various juristically

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discrete acquisitions and disposals which  made up the scheme were genuine, could the  House collapse them into a composite self- cancelling  transaction without being guilty of  ignoring the legal position and looking at the  substance of the matter?

My Lords, I venture to suggest that some of  the difficulty which may have been felt in  reconciling the Ramsay case with the Duke of  Westminster’s  case  arises out of an  ambiguity in Lord Tomlin’s  statement that  the courts cannot ignore  ’the legal position’  and have regard to ’the substance of the  matter’. If ’the legal position’ is that the tax is  imposed by reference to a legally defined  concept, such as stamp duty payable on a  document which constitutes a conveyance on  sale, the court cannot tax a transaction which  uses no such document on the ground that it  achieves the same economic effect.  On the  other hand, if the legal position is that tax is  imposed by reference to a commercial  concept, then to have regard to the business  ’substance’ of the matter is not to ignore the  legal position but to give effect to it.

The speeches in the Ramsay case and  subsequent cases contain numerous  references to the ’real’ nature of the  transaction and to what happens in ’the real  world’.  These expressions are illuminating in  their context, but you have to be careful about  the sense in which they are being used.  Otherwise you land in all kinds of  unnecessary philosophical difficulties about  the nature  of reality and, in particular, about  how a transaction can be said not to be a  ’sham’ and yet be ’disregarded’ for the  purpose of deciding what happened in ’the  real world’. The point to hold on to is that  something may be real for one purpose but  not for another. When people speak of  something being a ’real’ something, they  mean that it falls within some concept which  they have in mind, by contrast with  something else which might have been  thought to do so, but does not. When an  economist says that real incomes have fallen,  he is not intending to contrast real incomes  with imaginary incomes. The contrast is  specifically between incomes which have  been adjusted for inflation and those which  have not. In order to know what he means by  ’real’, one must first identify the concept  (inflation adjustment) by  reference to which  he is using the word.

Thus in saying that the transactions in the  Ramsay case were not sham transactions, one  is accepting the juristic categorisation of the  transactions as individual and discrete and  saying that each of them involved no  pretence. They were intended to do precisely  what they purported to do.  They had a legal

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reality. But in saying that they did not  constitute a ’real’ disposal giving rise to a  ’real’ loss, one is rejecting the juristic  categorisation as not being necessarily   determinative for the purposes of the statutory  concepts of ’disposal’ and ’loss’ as properly  interpreted. The contrast here is with a  commercial meaning of these concepts. And  in saying that the income tax legislation was  intended  to operate ’in the real world’, one is  again referring to the commercial context  which should influence the construction of  the concepts used by Parliament."

       With respect, therefore, we are unable to agree with the   view that Duke of Westminster  is dead, or that its ghost has been  exorcised in England. The House of Lords does not seem to think  so, and we agree, with respect.  In our view, the principle in Duke  of Westminster   is very much alive and kicking in the country of  its birth.  And as far as this country is concerned,  the observations  of Shah,J., in CIT v. Raman  are very much relevant even today.

       We may in this connection usefully refer to the judgment of  the Madras High Court in  M.V.Vallipappan and others  v. ITO  ,  which  has rightly concluded  that the decision in McDowell   cannot be read as laying down that every attempt  at tax planning   is illegitimate  and must be ignored, or that every transaction or  arrangement which is perfectly permissible under law, which has  the effect of reducing the tax burden of the assessee, must be  looked upon with disfavour.  Though the Madras High  Court had  occasion to refer to the judgment of the Privy Council in IRC v.  Challenge Corporation Ltd. ,  and did not have the benefit of the  House of Lords’s pronouncement in Craven , the view taken by  the Madras High Court appears to be correct and we are inclined to  agree with it.   We may also refer to the judgment of Gujarat High Court in   Banyan and Berry v. Commissioner of Income-Tax  where  referring to McDowell , the Court observed: "The court nowhere  said that every action or  inaction on the part of the taxpayer which  results in reduction of tax liability to which he  may be subjected  in future, is to be viewed  with suspicion and be treated as a device for  avoidance of tax irrespective of legitimacy or  genuineness  of the act; an inference which  unfortunately, in our opinion, the Tribunal  apparently appears to have drawn from the  enunciation made in McDowell case (1985)  154 ITR 148 (SC). The ratio of any decision  has to be understood  in the context it has been  made. The facts and circumstances which lead  to McDowell’s decision leave us in no doubt  that the principle  enunciated in the above case  has not affected the freedom of the citizen to  act  in a manner according to his requirements,  his wishes in the manner of doing any trade,  activity or planning his affairs with  circumspection, within the framework of law,  unless the same fall in the category of  colourable device which may properly be  called a device or a dubious method or a  subterfuge clothed with apparent dignity."  

       This accords with our own view of the matter.  In   CWT v. Arvind Narottam ,  a case under the Wealth

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Tax Act, three trust deeds for the benefit of the assessee, his wife  and children in identical terms  were prepared under section 21(2)  of the Wealth Tax Act. Revenue placed reliance on McDowell  .   Both the learned Judges of the Bench of this Court gave separate  opinions. Chief Justice Pathak, in his opinion said (at p.486):

"Reliance was also placed by learned  counsel for the Revenue on McDowell and  Company Ltd. v. CTO (1985) 154 ITR  148(SC). That decision cannot advance the  case of the Revenue because the language of  the deeds of settlement is plain and admits  of no ambiguity."

Justice S. Mukherjee said, after noticing  McDowell’s case, (at page 487):

"Where the true effect on the construction of  the deeds is clear, as in this case, the appeal  to discourage  tax avoidance is not a relevant  consideration. But since it was made, it has  to be noted and rejected."

       In Mathuram Agrawal v. State of Madhya Pradesh  another  Constitution Bench had occasion to consider the issue. The Bench  observed:  "The intention of the legislature in a taxation  statute is to be gathered from the language of  the provisions particularly where the language   is plain and unambiguous. In a taxing Act it is  not possible to assume any intention or  governing purpose of the statute more than  what is stated in the plain language. It is not  the economic results sought to be obtained by  making the provision which is relevant in  interpreting a fiscal statute. Equally  impermissible is an interpretation which does  not follow from the plain, unambiguous  language of the statute. Words cannot be  added to or substituted so as to give a meaning  to the statute which will serve the spirit and  intention of the legislature."

       The Constitution Bench reiterated the observations in Bank  of Chettinad Ltd. v. CIT ,  quoting with approval the observations  of  Lord  Russell of Killowen in IRC v. Duke of Westminster    and the observations of Lord Simonds in Russell v. Scott  

       It  thus appears to us that not only is the principle in Duke of  Westminster   alive and kicking in England, but it also seems to  have acquired judicial benediction of the Constitutional Bench in  India, notwithstanding the temporary turbulence created in the  wake of McDowell .         Hence, reliance on  Furniss , Ramsay  and Burmah Oil    by the respondents  in support of their submission is of no avail.         The situation is no different in United States  and other  jurisdictions too.          The situation in the United State is reflected in the following  passage from    American Jurisprudence : "The legal right of a  taxpayer to decrease  the amount of what otherwise would be his  taxes,  or altogether to avoid them,  by  means which the law permits, cannot be  doubted. A tax-saving motivation does not

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justify the taxing authorities or the courts in  nullifying or disregarding a taxpayer’s  otherwise proper and bona fide choice  among courses of action, and the state  cannot complain, when a taxpayer resorts to  a legal method available to him to compute  his tax liability,  that the result is more  beneficial to the taxpayer than was intended.  It has even been said that it is common  knowledge that not infrequently changes in  the basic facts affecting liability to taxation  are made for the purpose of avoiding  taxation, but that where such changes are  actual and not merely simulated, although  made for the purpose of avoiding taxation,  they do not constitute evasion of taxation.  Thus, a man may change his residence to  avoid taxation, or change the form of his  property by putting his money into non- taxable securities, or in the form of property  which would be taxed less, and not be guilty  of fraud. On the other hand, if a taxpayer at  assessment time converts taxable property  into non-taxable property for the purpose of  avoiding taxation, without intending a  permanent change, and shortly after the time  for assessment has passed, reconverts the  property to its original form, it is a  discreditable evasion of the taxing laws, a  fraud, and will not be sustained."

Several  judgments of the US Courts were cited in respect of  the proposition that motive of tax avoidance is irrelevant in  consideration of the legal efficacy of a transactional situation.   

We may recapitulate the observations of the Federal Court in  Johansson  as to the irrelevance of the motive for Johansson.  To  similar effect are the observations of the US Court in Perry R. Bas  v. Commissioner of Internal Revenue :

"we infer that Stantus was created by  petitioners with a view to reducing their  taxes  through qualification of the  corporation under the convention.  The test,  however, is not the personal purpose of a  taxpayer in creating a corporation.  Rather, it  is whether that purpose is intended to be  accomplished through a corporation carrying  out substantive business functions.  If the  purpose of the corporation is to carry out  substantive business functions, or if it in fact  engages in substantive business activity, it  will not be disregarded for Federal tax  purposes."

In Barber-Greene Americas, Inc. v. Commissioner of   Internal Revenue  it was observed  that a corporation will not be  denied Western Hemisphere trade corporation tax benefits  merely  because it was purposely created and operated in such way as to  obtain such benefits. Similarly, a corporation otherwise qualified  should not  be disregarded merely because it was purposely created  and operated to obtain the benefits of the United States-Swiss  Confederation Income Tax Convention. Though the words ’sham’, and ’device’ were loosely used in

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connection with the incorporation under the Mauritius law, we  deem it fit to enter a caveat here.  These words are not intended to  be used as magic mantras or catchall phrases to defeat or nullify the  effect of a legal situation. As Lord Atkin pointed out in Duke of  Westminster : "I do not use the word device in any sinister  sense; for it has to be recognised that the  subject, whether poor and humble or wealthy  and noble, has the legal right so to dispose of  his capital and income as to attract upon  himself the least amount of tax.  The only   function of a court of law is to determine the  legal result of his dispositions so far as they  affect tax."

Lord Tomlin  said :

"There may, of course, be cases where  documents are not bona fide nor intended to  be acted upon, but are only used as a cloak to  conceal a different transaction."

In Snook vs. London and West Riding Investments Ltd.    Lord Diplock L.J., explained the use of the word ’sham’ as a legal  concept in the following words: "it is, I think, necessary  to consider   what, if any, legal concept is involved in the  use of this popular and pejorative word.  I  apprehend that, if it has any meaning in law, it  means acts done or documents executed by the  parties to the ’sham’ which are intended by  them to give to third parties or to the court the  appearance of creating between the parties legal  rights and obligations different from the actual  legal rights and obligations (if any) which the  parties intend to create. One thing  I think,  however, is clear in legal principle, morality  and the authorities  (see Yorkshire Railway  Wagon Contracting State. V.  Maclure  (1882)  21 Ch.D.309 ; Stoneleigh Finance, Ltd. v.  Phillips (1965) 1 All ER 513) that for acts or  documents to be a "sham", with whatever legal  consequences follow from this, all the parties   thereto must have a common intention that the  acts or documents are not to create the legal  rights and obligations which they give the  appearance of creating. No unexpressed  intentions of a "shammer" affect the rights of a  party whom he deceived."

       In Waman Rao and others v. Union of India & Ors.  and   Minerva Mills Ltd. and others v. Union of India and Ors.   this  Court considered the import of the word "device’ with reference to  Article 31B which provided that the Acts and Regulations specified  Ninth Schedule shall not be deemed to be void or even to have  become void on the ground that they are inconsistent with the  Fundamental Rights. The use of the word ’device’  here was not  pejorative, but to describe a provision of law intended to produce a  certain legal result.   

If the Court finds that notwithstanding a series of legal steps  taken by  an assessee,  the intended legal result has not been  achieved, the Court might be justified in overlooking the  intermediate steps, but it would not be permissible  for the Court  to  treat the intervening legal steps as non-est based upon some

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hypothetical assessment of the ’real motive’ of the assessee.  In our  view, the court must deal with what is tangible in an objective  manner and cannot afford to chase a will-o’-the-wisp.

       The judgment  of the Privy Council in Bank of Chettinad   ,  wholeheartedly approving the dicta in the passage from the opinion  of Lord Russel  in Westminster ,  was the law in this country  when the Constitution came into force. This was the law in force  then, which continued by reason of Article 372. Unless abrogated  by an Act of Parliament, or by a clear pronouncement of this Court,  we think that this legal principle would continue to hold good.  Having anxiously scanned McDowell , we find no reference  therein to having dissented from or overruled the decision of the  Privy Council in Bank of Chettinad.   If any,  the principle  appears to have been reiterated with approval by the Constitutional  Bench of this Court in Mathuram .  We are, therefore, unable to  accept the contention of the respondents that there has been a very  drastic change in  the  fiscal  jurisprudence, in India,   as would  entail a departure.  In our judgment, from Westminster  to Bank  of Chettinad  to Mathuram , despite the hiccups of  McDowell , the law has remained the same.  

We are unable to agree with the submission that an act which  is otherwise  valid in law  can be treated as non-est merely on the  basis of some underlying motive supposedly resulting in some  economic detriment or prejudice to the national interests, as  perceived by the respondents.   

In the result, we  are of the view that Delhi High Court erred  on all counts in quashing the impugned circular.  The judgment  under appeal is set aside and it is held and  declared  that  the  circular No. 789  dated  13.4.2000 is valid and efficacious.           We cannot part with this judgment without expressing our  grateful appreciation to the Learned Attorney General, Mr. Harish  Salve, Mr. Prashant Bhushan as also the party in person, Mr. S.K.  Jha, all of whom by their industrious research produced a wealth of  material and by their meticulous arguments rendered immense  assistance.

 [1985] 154 ITR 148.    See in this connection Maganbhai Ishwarbhai Patel & Others. v. Union of India & Another  (1970) 3 SCC 400.   [1988] 144 ITR 146.   [1991]  190 ITR 626.    See also in this connection  Leonhardt Andra Und Partner, Gmbh v. Commissioner of Income  Tax    [2001] 249 ITR 418.   [1993] 202 ITR 508.   [1995] 212 ITR 31.   Cases in Constitutional Law, D.L. Kier and F.H. Lawson, Pg.53-54, 159-163 (ELBS &  Oxford University Press 5th Ed.).     See Section  5A of Central Excise Act, 1944 and Section 8(5) of the Central Sales Tax Ac t, 1956.   (1999) 4  SCC 11, para 14 to 22.   (1959) SCR 1099.   Supra note 10.   [1981] 131 ITR 597.   Crawford on Statutory Construction, 1940 Ed, as in Supre note 13.   [1908] ILR 35 Cal 701, 713.   [1979] 4 SCC 565.   Supra note 13.

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 [1965] 56 ITR 198.   [1971] 82 ITR 913.   [1999] 237 ITR 889 at  896.   [2001] 252 ITR 1.   [2002] 2 SCC 127 at para 11.   See in this connection State of Sikkim v. Dorjee Tshering Bhutia and Others (1991) 4 SCC 2 43 at para 16;  N.B.  Sanjana, Assistant Collector of Central Excise, Bombay and Others v. Elphinshone Spinning an d Weaving Mills Co.  Ltd.(1971) 1 SCC 337; B. Balakotaiah v. Union of India & Others (1968) SCR 1052 and Afzal Ul lah v. State of U.P  (1964) 4 SCR 991.   See in this connection  the observations of this Court in Harishankar Bagla and Another v.  The  State of Madhya Pradesh 1955 SCR 380 and  Kishan Prakash Sharma v. Union of India and  Others (2001) 5 SCC 212.

 (1984) 4 SCC 27 at para 14.   Jean-Maic Rivier, Cahiers de droit fiscal international, VolLXXIIa at pp.47-76.   336F.2d.809.   See in this connection Ramanathan Chettiar v. Commissioner of Income Tax, Madras [1973] 88  ITR 169.   (1989) 4 SCC 592.    See also in this connection the judgment of Madras High Court in  Tamil Nadu (Madras Stat e)  Handloom Weavers Contracting State-operative Society Ltd. v. Assistant Collector of Central  Excise 1978  ELT 57 (Mad HC).   (1995) 1 SCC 274.   [1994] 213 ITR 317.   [1999] 239 ITR 650.   Ibid   85 D.T.C.5188 at 5190.    Ibid   See in this connection  Klaus Vogel, Double Taxation Convention,  Pg.26-29 (3rd ed).   (1997) 785 FCA.   (2000) FCA 635.   1998 Can. Tax Ct.LEXIS 1140.   [1975] 100 ITR 706.   Lord McNair, The Law of Treaties, Pg.336 (Oxford, at the Clarendan Press, 1961).   Ibid.   53 (1) WLR 483.   L.Oppenheim, Oppenheim’s International Law, Article 626 (9th Ed.).   Philip Baker, Double Taxation Convention and International Law,  Pg.91 ((1994) 2nd Ed.).   Francis Bennion, Statutory Interpretation, Pg. 461 [Butterworths, 1992 (2nd Ed.)].   David R. Davis, Principles of International Double Taxation Relief,  Pg.4 (London Sweet &  Maxwell,  1985).   Roy Rohtagi, Basic International Taxationt Pg.373-374 (Kluwer Law International).   Ibid.   Ibid.    Supra note 1.   Ibid.    Ibid.   Ibid .   (1926) AC 395 at 412.   (1936) AC 1; 19 TC 490.   Supra note 1.   Supra note 56.   Supra note  57.   Supra note 1.   (1982) AC 300.   (1982) STC 30.   (1984) 1 All ER 530.    Supra note 57.

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 Supra  note 1.   [1968] 67 ITR 11.    Supra note 57.   Supra note 56.   Supra note 1 at Pg. 171.   Supra note 1.   Ibid   Supra note 57.   (1988) 3 All ER 495.    Supra note 64.   Supra note 63.   Supra note 62.   Supra note 57.   Supra note 62.   Supra note 57.   (2001) 1 All ER 865 at 877-878.   Supra note 57.   Ibid.   Supra note 67.   (1988) 170 ITR 238.   Supra note 1.   (1987) 2 WLR 24.   Supra note 74.   (1996) 222 ITR 831 at 850.   Supra note 1.   (1988) 173 ITR 479.   Supra note 1.   (1999) 8 SCC 667 at para 12.   (1940) 8 ITR 522 (PC).   Supra note 57.   (1948) 2 All ER 15.   Supra note 57.   Supra note 1.           Supra note 64.     Supra note 62.    Supra note 63.    American Jurisprudence (1973 2nd Ed. Vol.71).   See in this connection Gregory v. Helvering 293 US465, 469  55 S.Ct. 226, 267, 78  L.ed.566, 97 ALR 1335; Helvering v. St. Louis Trust Company 296 US 48, 56 S. Ct. 78, 80L;  Becker v. St.Louis Union Trust Company 296 US 48, 56 S.Ct. 78, 80L.     Supra note 27.   (1968) US 50 TC 595.   (1960) 35 T.C.365, 383,384.   Supra note 57.   (1967) All ER 518 at 528.   (1981) 2 SCC 362 at para 45.   (1980) 3 SCC 625 at para 91.   Supra note 94.   Supra note 57.   Supra note 1.   Supra note 94.   Supra note 93.   Supra note 57.   Supra note 94.   Supra note 93.   Supra note 1.

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