Exploring Section 90(2) of the Income Tax Act in Light of the Morgan Stanley Mauritius Case: Understanding the Right to Choose Beneficial Provisions

The global financial landscape is increasingly complex, especially when it comes to cross-border taxation. One critical area of focus is the right of a taxpayer to select the more beneficial tax provisions under domestic law or an applicable Double Taxation Avoidance Agreement (DTAA). The recent decision in the case of Morgan Stanley Mauritius Company Ltd. by the Income Tax Appellate Tribunal (ITAT), Mumbai, addresses this very issue. The ITAT ruling clarifies that taxpayers are indeed entitled to selectively apply provisions from either the Income Tax Act, 1961, or the DTAA, choosing whichever option results in a more favourable tax outcome.

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This article delves into the case, explaining the provisions of Section 90(2) of the Income Tax Act and the DTAA provisions at the core of the dispute. We will also examine the implications of the tribunal’s ruling for companies with foreign investments in India.

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Understanding Section 90 of the Income Tax Act and the DTAA

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Section 90 of the Income Tax Act, 1961 allows the Indian government to enter into DTAAs with other countries to avoid double taxation of income. These agreements prevent income earned in one country from being taxed twice, providing a clear framework for how various types of income, such as capital gains and dividends, will be taxed.

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·?????? Section 90(2) specifically states that an assessee who is a resident of a country with which India has a DTAA can choose to apply the provisions of either the Indian Income Tax Act or the DTAA, depending on which is more beneficial.

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DTAAs provide certainty for foreign investors, enabling them to manage their tax obligations effectively by choosing the more favourable treatment. In the case of the India-Mauritius DTAA, Article 13(4) specifies that capital gains earned by a Mauritius resident from the sale of Indian securities are taxable only in Mauritius, thus exempting such gains from Indian tax.

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Case Background: Morgan Stanley Mauritius Company Ltd.

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Morgan Stanley Mauritius Company Ltd., a tax resident of Mauritius, is registered as a Foreign Portfolio Investor (FPI) under India’s Securities and Exchange Board of India (SEBI) regulations. During the Assessment Year (AY) 2020-21, Morgan Stanley Mauritius declared long-term capital gains (LTCG) from the sale of shares, claiming exemption from Indian taxation under Article 13(4) of the India-Mauritius DTAA.

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Additionally, Morgan Stanley Mauritius reported short-term capital losses (STCL) brought forward from earlier years under domestic law and sought to carry forward these losses to future years. The tax authorities challenged this, arguing that Morgan Stanley Mauritius could not selectively apply the DTAA for exempting LTCG while simultaneously using the Income Tax Act provisions to carry forward STCL.

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The Core Dispute: Selective Application of Beneficial Provisions

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The primary issue in this case was whether Morgan Stanley Mauritius could claim the benefits of the DTAA for LTCG (resulting in tax exemption) while relying on the provisions of the Indian Income Tax Act to carry forward STCL. The Revenue argued that such selective use of DTAA and Income Tax Act provisions would amount to “treaty shopping,” which goes against the intent of DTAAs.

Morgan Stanley Mauritius argued that Section 90(2) explicitly grants the option to choose the more favourable provisions, which should apply to each type of income independently. As a result, they asserted the right to apply the DTAA to LTCG while using the Income Tax Act for STCL, resulting in carry-forward eligibility.

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ITAT’s Decision and Analysis

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The Mumbai ITAT, in its detailed judgment, held that Morgan Stanley Mauritius was within its rights to apply beneficial provisions selectively under Section 90(2) of the Income Tax Act.

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1.???????? Right to Choose Beneficial Provisions: The ITAT noted that Section 90(2) does not limit the application of the more favourable provisions to all income collectively. Instead, it allows taxpayers to apply the most beneficial provisions for each type of income independently. The tribunal upheld Morgan Stanley’s right to choose the DTAA for LTCG while applying domestic law for STCL.

2.???????? Exemption of LTCG Under the India-Mauritius DTAA: Under Article 13(4) of the India-Mauritius DTAA, LTCG arising from the sale of Indian securities by a Mauritius resident is taxable only in Mauritius. Morgan Stanley Mauritius legitimately applied the DTAA provisions to claim exemption from Indian tax on LTCG.

3.???????? Carry Forward of STCL: The tribunal also ruled that Morgan Stanley Mauritius could carry forward STCL based on domestic law provisions. As long as the DTAA does not mandate the setting off of STCL against LTCG, there is no prohibition against carrying forward STCL for future use under the Income Tax Act.

4.???????? Rejecting Revenue’s Argument on Selective Application: The ITAT rejected the Revenue's position that the selective application of DTAA and Income Tax Act provisions constitutes treaty shopping. The tribunal emphasised that Section 90(2) empowers taxpayers to choose provisions beneficial to them, and this flexibility is integral to India’s tax treaties.

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Key Takeaways from the ITAT’s Ruling

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The ITAT’s ruling in this case sets an important precedent and clarifies several key points for taxpayers:

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1.???????? Independence of Income Streams: The tribunal affirmed that different income streams—such as LTCG and STCL—can be treated independently for the application of beneficial provisions under Section 90(2). This means that the DTAA can be applied to exempt certain income, while domestic provisions can be used for loss carryforward, depending on what is more favourable for the taxpayer.

2.???????? Legitimacy of Selective Treaty Application: The ruling confirms that selective application of treaty provisions and domestic law is permissible, provided that it does not conflict with treaty intent. In other words, Morgan Stanley Mauritius’s approach was a lawful exercise of the choices available under Section 90(2) rather than treaty abuse.

3.???????? Future Implications for Foreign Investors: The decision is significant for foreign investors using DTAAs with India. It reinforces the flexibility for taxpayers to apply DTAAs and domestic law selectively, optimising tax obligations without the risk of penalty for “treaty shopping.” This interpretation aligns with India’s commitment to attracting foreign investment by maintaining a tax regime that provides clear and favourable options for treaty and law application.

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Conclusion

The Morgan Stanley Mauritius ruling by the ITAT provides a clear affirmation of the flexibility available to taxpayers under Section 90(2) of the Income Tax Act. The tribunal’s decision highlights that the application of DTAAs should be broad and adaptable, enabling taxpayers to select provisions that reduce their tax burden legally.

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This ruling will serve as an important reference for future cases involving similar cross-border taxation issues, ensuring that taxpayers can use DTAAs and domestic tax laws independently for different income streams, maximising benefits. For multinational companies and foreign investors, the judgment provides added clarity and reassurance on how to navigate Indian tax laws in alignment with applicable DTAAs.

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In the landscape of global tax compliance, this decision exemplifies India’s support for a tax regime that balances stringent enforcement with reasonable flexibility, making India an appealing destination for investment.

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