Procedural Lapses—a Roadblock for Tax Treaty Advantages in India?

Tax treaties are instruments generally entered into bilaterally between countries with the aim of enhancing trade and reducing the incidence of double taxation by seeking to allocate taxing rights on income. India has entered into comprehensive tax treaties with 96 countries including its main trading partners, and eight limited tax treaties.

Article 253 of the Indian constitution has conferred the power on parliament to make any law for the whole or any part of the territory of India including implementation of treaties, agreements, or conventions with any other foreign country or countries. India has negotiated tax treaties exercising this power conferred in the constitution.

Article 51 of the constitution also mentions that the state shall respect all the provisions related to international law and shall make its best efforts to fulfill its treaty obligations. The domestic tax law of India provides that a taxpayer would be eligible to be governed by the tax treaty or the provisions of domestic tax law, whichever are more beneficial to the taxpayer.

The Indian tax law prescribes certain procedural compliance in order to monitor treaty eligibility and counter abuse.

In the recent past there have been instances where eligible taxpayers were denied treaty benefits only for want of procedural compliance.

This article focuses on the recent engagement by the Indian judicial authorities to counter such denials of treaty benefits and to determine the reach of such procedural compliance.

Conditions for Claiming Benefits Under Tax Treaties

Article 1 of a tax treaty defines the conditions for applicability of the tax treaty and their fulfillment and is essentially the gateway for tax treaty benefits. A taxpayer needs to satisfy the twin conditions of being a person and resident of one or both contracting states to be eligible for treaty benefits.

In respect of certain income streams such as dividends, royalty, etc., an additional condition of “beneficial ownership” needs to be satisfied to qualify for the favorable tax treatment of the respective tax treaties. As an anti-avoidance measure, several tax treaties also prescribe a limitation of benefits clause—including the principal purpose test under BEPS—to ensure that tax treaty benefits are not abused.

Procedural Requirements Prescribed in Domestic Law

The domestic tax law has imposed certain procedural requirements on taxpayers seeking to obtain tax treaty benefits. Non-adherence to such procedural requirements has often resulted in denial of tax treaty benefits to taxpayers, even if they satisfy the conditions laid down under the tax treaties. Some of these procedural requirements and the principles emerging in various judicial precedents are discussed below.

Furnishing of Tax Residency Certificate (TRC)

The requirement of furnishing a TRC has been prescribed under domestic tax law, and a TRC has been accepted as documentary evidence (Circular No 789 dated 13-4-2000) for determining residential status to obtain tax treaty benefits in certain cases.

Accordingly, failure to furnish a TRC has often led to tax authorities denying treaty benefits. There have been practical instances where taxpayers struggled to obtain a TRC, for example, due to delay in processing, or non-issuance of a TRC in the prescribed format by the home country tax authorities, or a difference in financial years.

The Indian tax tribunals (Skaps Industries India (P.) Ltd. (94 taxmann.com 448), Sreenivasa Reddy Cheemalamarrim (TS-158-ITAT-2020)) have often taken a practical approach, relying on the intention of the law and adherence to international tax law principles, by granting eligible taxpayers treaty protection in case of genuine procedural hurdles—for example, where the TRC is not provided in the prescribed form, the TRC has not been issued, but the taxpayer provides sufficient circumstantial evidence to prove their residential status and qualification of beneficial ownership of the income.

Furnishing form for claiming Foreign Tax Credit (FTC)

The FTC rules include the requirement to furnish a form to the tax authorities within a prescribed time for claiming FTC in India. Tax tribunals have granted FTC benefits to taxpayers in cases of delay in filing such forms by observing that such requirements can at best be directory in nature, and as tax treaties override the provisions of domestic tax law, the domestic tax rules cannot be contrary to the domestic tax law read with tax treaties (Brinda RamaKrishna (TS-1059-ITAT-2021), Hertz Software India Pvt. Ltd (TS-214-ITAT-2022)).

Circular prescribing requirement of separate notification for invoking MFN clause

Recently, the Indian tax authorities issued Circular 3 of 2022, which prescribed that benefits of the most favored nation (MFN) clause in a tax treaty can only be claimed by taxpayers if a separate notification is issued by India specifically importing the benefits of the MFN clause.

The Delhi High Court in the context of the India-France tax treaty ruled that once the tax treaty has itself been notified, and it contains the Protocol including the MFN clause, there is no need for the Protocol itself to be separately notified (Steria India Ltd. (72 taxmann.com 1)). Recently, a writ petition has also been admitted by the Karnataka High Court challenging the procedural requirements in this Circular.

It can thus be observed that Indian courts have frequently ruled in favor of taxpayers where tax authorities have attempted to deny treaty benefits citing procedural lapses. The Supreme Court of India has in various rulings upheld that whenever a tax treaty is notified, an eligible taxpayer is entitled to claim tax treaty benefits even if inconsistent with the provisions of the Indian Income-tax Act, 1961.

Vienna Convention

India is not an official signatory to the Vienna Convention; however, the courts (Ram Jethmalani, Supreme Court, Jeeja Ghosh & Anr versus Union of India & Ors etc.) have not shied away from relying on the principles of customary international law enshrined therein.

Of particular relevance in this context is article 26 of the Vienna Convention which lays down the principle of pacta sunt servanda (binding nature of treaties and performance in good faith) and article 27 which states that a party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.

These principles of the Vienna Convention reaffirm the premise that procedural defects should not hinder genuine treaty benefits of assessees unless the treaty specifically prescribes certain procedures.

International Precedents

The Philippine Supreme Court, while dealing with an administrative issuance under domestic law, upheld the right of taxpayers not to be deprived of the benefits of a tax treaty (Deutsche Bank AG G.R. No. 188550). The Supreme Court importantly also observed that non-compliance with tax treaties has negative implications for international relations and unduly discourages foreign investors, and such non-adherence is against the general principles of international law embedded in their constitution.

Final Comments

Procedural compliance requirements are inserted into domestic tax law with the intention to ease the applicability of a tax treaty to taxpayers in lieu of an analysis of all transactions by the tax authorities, as well as to monitor lapses and treaty abuse.

Though well intended, procedural compliance requirements should not become unwarranted roadblocks to the claiming of treaty benefits, especially in cases beyond the control of the taxpayer, and where the same result is achieved by the taxpayer by evidencing eligibility to treaty benefits, as it would defeat the principles of adherence to treaty obligations under international law.

That being said, it is imperative for taxpayers to also exercise caution and comply with all the relevant procedures to avoid problems later.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.