– By Tushar Chopra, Pankaj Bagri, and Naman Shah
For decades now, several countries across the globe have signed tax treaties with India. The main objective of a tax treaty is to ensure that taxpayers generating cross country income are not taxed twice – in their country of residence and in the country where income is generated.
India’s network of tax treaties will only increase further in light of enhanced economic cooperation and fostering of cross-border trade and investment. With such a trend, guidelines around interpretation of tax treaty provisions will be crucial in the upcoming budget. Differential interpretations of tax treaties often stem from ambiguities in language, evolving business models and varying perspectives on the intended scope of the provisions. Such disagreements can result in double taxation, impacting cross-border relationships, investments and economic growth.
Interpretation issues in India still remain vexed in tax treaties, leading to protracted litigation, few of them slowly being settled at the wisdom of the Hon’ble Supreme Court (Apex Court), without predefined parameters and guiding principles notified by tax authorities.
Recent Supreme Court Ruling on treaty interpretation
Recently, a landmark judgment of the Apex Court in the case of AO v. M/s Nestle SA1, has caused much upheaval in the tax jurisprudence inasmuch as it solicits to upend the basics of treaty interpretation, which for long were seen as settled. The Apex Court, by way of this decision, held that the benefit of a lower rate of tax or restricted scope agreed by India in a subsequent tax treaty, cannot be directly imported to a pre-existing tax treaty by way of Most Favored Nation (MFN) clause, unless the same is separately notified in the Official Gazette. The decision of the Apex Court has rattled the fundamentals of tax position taken by multiple multinational taxpayers who have, over the years benefited by taking non-tax or lower tax position based on the MFN clause.
In the year 2021, on a long-standing income-tax litigation around characterization of payment made towards imported computer software, the Apex Court had pronounced a welcome ruling in the case of Engineering Analysis Centre of Excellence (P.) Ltd. v. CIT1. Despite the ruling by the Apex court, there are still many cases of ongoing litigation on the same/similar issue at various levels of adjudication.
Against both of the aforesaid judgements, review petitions have been filed with the Apex Court, which are currently pending for disposal, thereby amplifying the controversies. Many other disputes on legacy issues of permanent establishment, transfer pricing matters, taxation as fees for technical services (FTS) etc., have also been ongoing for decades.
The visionary approach of the government tells a different story. It is well acknowledged that the Indian government duly recognizes that tax disputes resolved through lengthy and expensive litigation, contribute to an atmosphere of uncertainty in the minds of foreign investors and discourages international transactions. Hence, to clear the long pending litigation / avoid many future litigations arising out of treaty interpretation, the government may introduce a dispute resolution scheme for such cases.
Dispute settlement schemes introduced in the past
Under Union Budget 2020, to resolve pending litigations and disputes, Hon’ble Finance Minister had suggested the “No Dispute but Trust Scheme” or “Vivad se Vishwas Scheme” wherein complete waiver of interest and penalty amounts associated with the disputed tax, was granted to taxpayers. Several taxpayers utilized the opportunity to get relief from vexatious litigation process. This scheme helped the government recover over INR 54,000 crore in taxes and reduced the burden of litigations on various appellate fora.
Subsequently as well, on the contentious issue apropos disallowance of deduction claimed for education cess as business expenditure, the Hon’ble FM had come up with the relief on the imposition of penalty, vide Finance Act 2022.
Expected way out to settle disputes due to treaty interpretation
To address the above challenges and to boost the trust of foreign investors, it is anticipated and also urged, to introduce a settlement scheme for resolving past tax disputes arising from differential treaty interpretations in the upcoming Union Budget 2024. The scheme may provide a one-time window to taxpayers who had claimed the benefit of lower rate (based on MFN clause) to make voluntary payment of differential tax amount with relaxation from levy of any interest or penalty.
For precedents ruled by the Apex Court in the favour of taxpayers in which no additional tax is payable, it is expected from the Finance Ministry to release directives for expeditious rendering of judgements with removal of tax demand and quick release of eligible refund to taxpayers.
Streamlining of ongoing disputes
Mechanism of dispute settlement is commonly present under Article 25 of tax treaties, namely, the Mutual Agreement Procedure (MAP). However, the MAP process is often criticized for its lack of efficiency, lengthy resolution timelines and for its potential to create deadlock between competent authorities.
In response, the Organization for Economic Cooperation and Development (OECD) has already come up with an Action Plan (BEPS Action Plan 14) to make MAP more effective and accessible. Of late, Indian tax authorities have also taken significant steps to reform the MAP framework. As per the latest statistics released, over the last three years, India has been able to resolve a larger number of cases than the applications, which has resulted in reducing the MAP inventory.
Continuing the trend, the government should target increasing awareness and accessibility to the MAP process, with reduction in the existing turnaround time of resolution from twenty-four months and make the timeframe mandatory rather than recommendatory. Increased collaboration and information sharing with tax authorities of other nations to achieve faster resolution, should also be endeavoured.
Issuance of guidelines for future tax disputes
Parallelly, in order to reduce future tax disputes, it is expected that the CBDT should release generic guidelines for interpretation of tax treaties under Union Budget 2024. Guidelines should aim to provide clarity and certainty in the tax treatment to foreign investors. Additionally, CBDT could consider releasing a handbook interpreting important provisions of the tax treaty in detail, specifically for tax officers ruling out on international tax issues at the ground level.
Conclusion
As businesses increasingly operate across borders, the need for a standardised and transparent mechanism to resolve international disputes has become paramount. Such a futuristic approach will help India in attracting overseas investment and support in improving India’s ranking in ease of doing business. Waiver of interest and penal consequences via one-time settlement of past litigative tax disputes, will go a long way in building India’s success story towards continued global interaction, while facilitating efficient collection of taxes from the perspective of tax administration.
(Tushar Chopra, Pankaj Bagri, and Naman Shah are Partners at Deloitte India.)
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