Treatment of payments under the Income Tax Act, 1961 and the Double Taxation Avoidance Agreements (DTAA)

As readers are aware, Government of India has entered into several DTAAs for ensuring that a taxpayer will not suffer double-taxation. ?Under section 90(2) of? the Income Tax Act, 1961 (the Act) an assessee can choose between the Income Tax Act, 1961 or the Double Taxation Avoidance Agreements (DTAA) whichever is more beneficial. However, there is a process to be followed.?

In practice , one notices a disturbing tendency to straightaway go (more appropriately, jump) into the DTAAs and apply the provisions as though DTAAs would always be more beneficial to an assessee or the DTAA is the de facto applicable law. It need not be. The Income Tax Appellate Tribunal (ITAT) in the case of? Hughes Systique India (P.) Ltd.? V. Dy.CIT? [2014 ] 50 taxmann.com 25 (Delhi - Trib.)[Ay 2009-10] had an occasion to consider the effect of section 90(2). ?A part of the judgement that deals with the manner of going through this process is reproduced below. In the judgment the learned ITAT puts in simple terms and proper perspective the correct way to go about it.

Excerpts from the judgement

"5.6 Now the question arises as to whether any payment for such Managerial services is chargeable to tax in India in the hands of the foreign AE. The AO has considered such payment as 'Fees for technical services' in terms of Explanation 2 to sec. 9(1)(vii) of the Act. This definition divulges that it is a consideration for rendering of managerial, technical or consultancy services with some exclusions. Since the assessee has paid for payroll services, which are nothing but 'Managerial services', we hold that the amount is covered within the meaning of 'Fees for technical services' as per Expl. 2 to section 9(1)(vii) of the Act. The ld. AR was also fair enough to concede this position.

At this juncture, it is relevant to note the prescription of section 90(2). On going through the mandate of the above provision, it transpires that where the Central Government has entered into a Double Taxation Avoidance Agreement with the Government of any other country for granting of relief in respect of income on which tax is payable both in India as well as the other country or for the purposes of avoidance of double taxation of income under this Act or under the corresponding law in force in that other country, then the assessee to whom such agreement applies, shall be entitled to be governed by the provisions of the Double Taxation Avoidance Agreement (DTAA) or the provisions of the Act, whichever course is more beneficial to it. [Para 5.8]

A plain reading of the above provision points out two things. First thing is that there should be a DTAA entered into between two countries 'for granting relief of tax' and the second thing is the description of the nature of relief, being, 'the provisions of this Act shall apply to the extent they are more beneficial to that assessee'. On a harmonious reading of the provision in entirety, it follows that when a DTAA has been entered into between India and another country for granting a relief of tax, then the provisions of this Act or the DTAA, whichever are more beneficial to the assessee, shall apply.

Ordinarily, an assessee is subjected to tax in India as per the provisions of the Act. If, however, the provisions of the DTAA are applicable and found to be more beneficial to the assessee vis-à-vis the Indian tax provisions, then going by section 90(2), such provisions of the DTAA shall override the corresponding provisions of the Act. To state simply, if a particular income falls under the Indian tax net, the same shall be chargeable to tax in the hands of the assessee as per the Act, unless it is shown that the provisions of the applicable DTAA provide for non-taxability of such income or taxability at a lower rate.

In such a situation, the beneficial provision as contained in the DTAA shall prevail over the provision under the Act. It is discernible that the legislature has given an option to the assessee to be governed by the provisions, either of the Act or of the DTAA, whichever are more beneficial to it. The corollary that follows is that one needs to firstly, examine as to whether a particular sum is chargeable to tax under the Act or not. If it is chargeable under the Act, then it needs to be examined if such income is also taxable as per DTAA. If the income is equally chargeable to tax - both under the Income-tax Act as well as DTAA , then the assessee cannot escape tax on it. If however such income is not chargeable to tax in India under the Act, then the matter ends there. There is no need to consider the provisions of the DTAA as to whether any charge is attracted there on such income. If such income is chargeable to tax in India under the Act, but the provisions of DTAA exempt it, then again there can be no question of taxability of such sum due to the mandate of section 90(2). The essence is that an assessee, to whom the DTAA applies, has been given option to be governed by the Act or the DTAA, whichever is more beneficial to it. [Para 5.9]" (underline provided by the author of this note)

Conclusion

Of late, one notices several cases of payments for ‘royalty’ that would fall under section 9 of the Act “income deemed to accrue or arise in India” which however, escape the tax net since the DTAAs take a different interpretation. The well-known decision of the Supreme Court in the ?Engineering Analysis Centre of Excellence (P.) Ltd . v. Commissioner of Income-tax? [2021] 125 taxmann.com 42 (SC) dealt with the difference between a copyright and a copyrighted article in terms of attracting taxation of royalty in the hands of a non-resident. Analysing Article 12 of the DTAA between India and USA, The Supreme Court ruled that the way Article 12 is structured, payments for usage will not be considered royalty under Article 12 although section 9 did and that in order for a payment to be taxable there should be a sale of copyright. This judgement was applicable to a multitude of cases pending before the Supreme Court. There were no fewer than 18 DTAAs with different countries and 4 types of transactions that were given relief.

The point of the above is that, in case the payment made is for ‘royalty’ under section 9 of the Act and is not under Articles such as Article 12 of the DTAA with USA, could the revenue bring it into the tax net under “Other Income” which is usually around Article 23. The revenue would take the stand that since the payment is not for royalty under the DTAA and there being no other applicable Article in the DTAA, the Article for “Other Income” could be invoked. What would prevent the assessing officer to do so would be the demonstration of royalty being dealt with both by the Act and the DTAA albeit with differently structured provisions. Once the process is followed, the treatment of royalty by Article 12 would ensure that it is a dead-end and the assessing officer cannot take it any further by invoking the Article dealing with “Other Income”.

Please note that the views are my own and I would appreciate if readers would react to it. ?

#Article12ofDTAAwithUSA? #royalty