Introduction
The bulk of international tax system is based upon bilateral tax treaties which essentially cast the bargain between two countries in respect of distribution of taxing rights. These conventions, internationally referred to as double taxation conventions (DTC), or double taxation avoidance agreements (DTAA) in India, are generally based upon a set pattern of predetermined structures and rules1 governing the avoidance of double taxation. In terms of these treaties, the respective entitlements, and obligations of the two countries is set out, the benefit of which flows to the persons who are eligible to invoke such treaties. The working of most of the provisions comprised in these tax treaties, having been in vogue for many decades, have essentially been nuanced and perfected. However, there are certain provisions which are infrequent in the international tax treaty structure and hence seldom receive advertence. “Tax sparing” clauses are one such species of tax treaty rules which have become rarer in the contemporary paradigm and hence their judicial elocution is sparse. A recent decision of the Delhi High Court2 has examined the role, relevance, and impact of a tax sparing clause in one of India’s DTAA. Hence, this article revisits the subject.
Relieving double taxation as the pivot underlying tax treaties: setting the context
At a conceptual level, the foundational premise of a bilateral tax treaty is to relieve the persons covered within the scope of such treaty from the scourge of double taxation. This is because the working of the treaty is essentially motivated with the desire of the partner countries to promote mutual economic and trade relations by obviating the tax consequences arising from the application of the tax system of both these partner countries vis-à-vis the persons covered within the scope of the treaty.
Double taxation can be relieved from variety of methods. One way of avoiding double taxation is by allocation of taxing rights between the partner countries, whereby a particular species of income is subjected to tax only in one of the two countries.3 Another mechanism to relieve double taxation is by way of exemption or credit mechanism wherein the tax consequences of one of the partner countries is factored in the other partner country to relieve the person of the tax liability in the latter country.4
Having said that, it is noteworthy that the premise of the tax treaty is essentially to address double taxation i.e., permitting taxation only in one partner country. This is at contrast with the paradigm of double non-taxation i.e. a scenario wherein neither of the partner country taxes the income. This aspect emanates both from the domestic law framework as also from within the tax treaty itself. To illustrate, the Indian domestic law sets out the guiding framework for the execution of DTAAs stating that Government may inter alia execute them, “for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country or specified territory, as the case may be, without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in the said agreement for the indirect benefit to residents of any other country or territory)”.5
Similarly, at the treaty level, there is substantial movement to counteract double non-taxation arising as an outcome of the tax treaty. The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), which was ratified by the Government of India in 20196, vide its Article 6 provides that the Preamble of the each of the DTAA (to which MLI applies) shall be modified to specifically provide that the objective of the DTAA is “to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation …”. Consequent to the MLI, various DTAA stand amended to include this specific clarification as their objectives.7
Tax sparing: double non-taxation and other dimensions
Even though the principal objective of the tax treaty is to avoid double taxation (i.e., ensure that a person is taxed only in one of the countries), there are certain provisions which result into double non-taxation (i.e., ensure that a person is taxed in neither of the tax countries). Some of these situations of double non-taxation are intended whereas other situations are unintended consequences arising from the application of the tax treaty to the peculiar facts of the person concerned. There are multiple avenues to address unintended double non-taxation, such as the principal purpose test advocated by the MLI.8 However, tax sparing is an instance of intended double non-taxation. In other words, the partner countries themselves are desirous of ensuring a situation wherein a person is taxed in the jurisdiction of neither of the partner countries. Hence, a tax sparing clause — which runs contrary to the objective of avoiding double non-taxation — is both unique in a tax treaty setting and also, understandably, viewed critically9 as it upsets the foundational premise and working of a tax treaty.
Having noted the background of tax sparing clause, it is expedient to briefly enlist its contours. In order to appreciate it, the regular method of avoiding double taxation i.e. impact of the exemption method and the credit method needs to be appreciated. Under the extant international tax treaties, typically the burden of obviating double taxation is upon the residence country. As part of operational mechanics, the tax paid by a resident of Country A in Country B (i.e. the source country) is factored by Country A in order to relieve the resident from the tax consequences under the domestic laws of Country A. Thereby, the source country retains the tax revenue in these methods and it is the residence country which forgoes its tax in order to operationalise the double-taxation objective of the tax treaty. Thus, the starting point of relieving double taxation in a DTC/DTAA under the exemption method and the credit method is a payment of tax in one country to obtain relief in the other country.
In contrast to these methods, tax sparing clause refers to a situation wherein tax is foregone under a DTC/DTAA by one country even though there is no tax liability of a person in the other country, typically in view of an exemption in the other country. In other words, while no tax is suffered by the person in the first country, still the second country gives relief against the notional tax liability of the person in the first country. Organisation for Economic Cooperation and Development (OECD) describes this aspect in the following terms:10
“72. Some States grant different kinds of tax incentives to foreign investors for the purpose of attracting foreign investment. When the State of residence of a foreign investor applies the credit method, the benefit of the incentive granted by a State of source may be reduced to the extent that the State of residence, when taxing income that has benefited from the incentive, will allow a deduction only for the tax actually paid in the State of source. Similarly, if the State of residence applies the exemption method but subject the application of that method to a certain level of taxation by the State of source, the granting of a tax reduction by the State of source may have the effect of denying the investor the application of the exemption method in his State of residence.
73. To avoid any such effect in the State of residence, some States that have adopted tax incentive programmes wish to include provisions, usually referred to as ‘tax sparing’ provisions, in their conventions. The purpose of these provisions is to allow non-residents to obtain a foreign tax credit for the taxes that have been ‘spared’ under the incentive programme of the source State or to ensure that these taxes will be taken into account for the purposes of applying certain conditions that may be attached to exemption systems.
74. Tax sparing provisions constitute a departure from the provisions of Articles 23-A and 23-B. Tax sparing provisions may take different forms, as for example: (a) the State of residence will allow as a deduction the amount of tax which the State of source could have imposed in accordance with its general legislation or such amount as limited by the Convention (e.g. limitations of rates provided for dividends and interests in Articles 10 and 11) even if the State of source has waived all or part of that tax under special provisions for the promotion of its economic development; (b) as a counterpart for the tax reduction by the State of residence, agrees to allow a deduction against its own tax of an amount (in part fictitious) fixed at a higher rate; and (c) the State of residence exempts the income which has benefited from tax incentives in the State of source.”
The aforesaid extract from the Commentary to the OECD Model Tax Convention has multiple revelations, some of which can be enumerated below:
(a) Tax sparing provisions are a reality, and their existence is duty noted as a prevailing practice in international tax treaty network.
(b) Tax sparing provisions indeed “constitute a departure” from the standard tax treaty provisions directed towards eliminating double taxation.
(c) Tax sparing provisions owe their origin and are intended to supplement the “tax incentive programmes” within the domestic law of the partner countries. In other words, even though these provisions are a part of the tax treaty framework, the purport of their existence is to give impetus to, probably, non-fiscal laws, such as those directed towards “economic development”, etc. Hence, even though they may result in double non-taxation and thereby interfere with the design and structure of the tax treaty, they are nonetheless tolerated and retained within the tax treaty.
(d) Tax sparing provisions can have multiple variations, thereby giving the partner countries to choose a design from amongst various options.
(e) Similar to exemption and credit method, tax sparing is essentially an obligation upon the residence country insofar as a tax sparing clause essentially constitutes a limitation on the taxing right of the residence country.
In the Indian context, there is neither sufficient executive delineation11 nor material jurisprudential discourse on the necessity and contours of tax sparing provisions. Nonetheless, there are illustrations to suggest that the Income Tax Appellate Tribunal (ITAT) has not just accorded deference to the existence of tax sparing clauses in the Indian DTAAs,12 but has also opined that the underlying objective of the tax sparing clause (i.e. “to promote economic development”) must be liberally construed so as to extended the benefit of tax sparing clause as far as possible.13 It is also interesting to note that while tax sparing clauses are found in several Indian DTAAs, the Government of India is on record that it has changed its position and is moving away from having tax sparing clauses in Indian DTAAs.14 Having said that, not all tax sparing clauses have been omitted from the DTAA and thus they continue to form part of India’s international tax rules and thereby exude contemporary relevance.
Delhi High Court decision
TheDelhi High Court was seized of the tax sparing clause in the India-Thailand DTAA. The ITAT had allowed its benefit to Polyplex Corporation15. The relief extended by the ITAT was challenged by the Income Tax Department before the High Court, but only to find the High Court approving the view of the ITAT16. The dispute related to dividend income received by Polyplex Corporation, an Indian tax resident, from its Thai subsidiary. Polyplex Corporation claimed tax rebate in India on the said dividend income, even though no tax was paid by it in Thailand. It was the case of Polyplex Corporation that by virtue of Thai Investment Promotion Act B.E. 2520 (1977) tax on income is exempt under Section 31 in the hands of Thailand subsidiary and under Section 34 in Polyplex Corporation’s hands and therefore Article 23(3) of the India-Thailand DTAA, which was in the nature of a tax sparing clause, tax rebate was available in India to Polyplex Corporation. The relevant provisions of the India-Thailand DTAA provide as under:
“Article 23. Elimination of double taxation.—
1. The laws in force in either of the contracting State shall continue to govern the taxation of income in the respective contracting States except where provisions to the contrary are made in this Convention.
2. The amount of Thai tax payable, under the laws of Thailand and in accordance with the provisions of this Convention, whether directly or by deduction, by a resident of India, in respect of profits or income arising in Thailand, which has been subjected to tax both in India and in Thailand, shall be allowed as a credit against the Indian tax payable in respect of such profits or income provided that such credit shall not exceed the Indian tax (as computed before allowing any such credit) which is appropriate to the profits or income arising in Thailand. Further, where such resident is a company by which surtax is payable in India, the credit aforesaid shall be allowed in the first instance against income tax payable by the company in India and as to the balance, if any, against surtax payable by it in India.
3. For the purposes of the credit referred to in Para 2, the term ‘Thai tax payable’ shall be deemed to include any amount which would have been payable as Thai tax for any year but for an exemption or reduction of tax granted for that year or any part thereof under the provisions of the Investment Promotion Act (B.E. 2520) or of the Revenue Code (B.E. 2481) which are designed to promote economic development in Thailand, or which may be introduced hereafter in modification of, or in addition to, the existing laws for promoting economic development in Thailand.
4. The amount of Indian tax payable under the laws of India and in accordance with the provisions of this Convention, whether directly or by deduction, by a resident of Thailand, in respect of profits or income arising in India, which has been subjected to tax both in India and in Thailand, shall be allowed as a credit against Thai tax payable in respect of such profits or income provided that such credit shall not exceed the Thai tax (as computed before allowing any such credit) which is appropriate to the profits or income arising in India.
5. For the purposes of the credit referred to in Para 4, the term ‘Indian tax payable’ shall be deemed to include any amount which would have been payable as Indian tax for any assessment year but for an exemption or reduction of tax granted for that year or any part thereof by the special incentive measures under the provisions of the Income Tax Act, 1961 (43 of 1961), which are designed to promote economic development, or which may be introduced hereafter in modification of, or in addition to the existing provisions for promoting economic development in India.
6. Where under this Convention a resident of a contracting State is exempt from tax in that contracting State in respect of income derived from the other contracting State, then the first-mentioned contracting State may, in calculating tax on the remaining income of that person, apply the rate of tax which would have been applicable if the income exempted from tax in accordance with this Convention had not been so exempted.”
Conjointly reading the domestic law of Thailand with the aforesaid provisions of the India-Thailand DTAA, the ITAT concluded that it was only on account of the exemption under the Thai Investment Promotion Act that while tax was actually not paid, but for the exemption the dividend paid by the Thai subsidiary to Polyplex Corporation was taxable in Thailand and, therefore, Article 23(3) was triggered. In other words, the ITAT concluded that the tax sparing clause was rightly invoked by Polyplex Corporation. Approving the view of the ITAT, the Delhi High Court extrapolated the impact of the tax sparing clause in Article 23(3) in the following terms:
“.27. Para 3 of Article 23, thus, by employing a device of deeming fiction, includes in the expression ‘Thai tax payable’ as adverted to para 2 of the very same article, that tax which would have been otherwise payable, but for an exemption or reduction of tax granted for that year or any part thereof, under the two statutory enactments referred to therein. Para 3 also alludes to the fact that the said statutes are designed to promote economic development in Thailand. Clearly, the provision is configured to incentivise investments in Thailand, by granting tax credit for that amount which, otherwise, would have been payable as tax to the Thai State, but was not paid due to exemption or reduction granted under the said enactments.
* * *
32. As is seen from a plain reading of Article 23 of the Indo-Thailand DTAA, credit for notional tax is granted to give a fillip and/or incentivise economic development/activity. This is a decision which is taken by contracting States and therefore, unless there is ambiguity, the interpretation which is to be given to the expression ‘Thai tax payable’ or ‘Indian tax payable’ is to be based on a plain reading of what is provided in Paras 3 and 5 of Article 23. The said paragraphs exemplify mutuality of interests in giving stimulus to investment for securing economic development in both countries.
* * *
.34. Having examined the scope of Article 23, it is clear that the facts obtaining in the above captioned appeals would have us agree with the Tribunal, that the respondent/assessee was entitled to claim tax credit on dividend income received from its Thai subsidiary, in respect of ‘Thai tax payable’, which it would have to pay, but for the exemption accorded to it under the provisions of Section 34 of the Investment Promotion Act. In other words, if the exemption available under Section 34 of the Investment Promotion Act had not kicked in, the dividend income would have suffered tax at the rate of 10% under Section 70 of the Thai Revenue Code.”
It is also noteworthy that while the High Court’s decision acknowledges that tax sparing clauses are criticised as they “could lead to double non-taxation”, the High Court nonetheless extended their benefit to Polyplex Corporation. Refusing to the drawn into the debate on the propriety of such clauses, the High Court observed that “[a]s to whether this is a best way forward is not for this court to question” and that “[i]nterdiction of such provisions would, in our view, be detrimental to the larger public interest” given that these clauses were “engrafted in DTAAs to incentivise investment for economic development”. In other words, the High Court refused to accord judicial advertence to debate on tax treaty policy choice qua propriety of tax sparing clauses.
Various implications follow from this decision of the High Court, which can be enumerated below:
(a) At a conceptual level, the dispute before the High Court and the claim of the taxpayer to tax sparing clause reflects that, tax sparing clauses are as much a part of the international tax system as any other clause and are not merely theoretical restatements and instead have pragmatic effects. As a matter of fact, the High Court noted that the tax sparing clause under consideration before it was not exclusive to India-Thailand DTAA and instead there were other Indian DTAAs which incorporated a similar clause. This reveals that there are additional planning and design opportunities for taxpayers and tax-professionals alike, basis such tax sparing clauses, in the course of their manoeuvring through the network of international tax treaties.
(b) The High Court decision17 categorically notes that the effect of the tax sparing clause is to give “credit for notional tax”. This is a significant finding as it firmly establishes that tax sparing clauses are distinct from the exemption and the credit method which are standard techniques for obviating double taxation under the tax treaties. The fact that tax sparing clause is unreservedly linked with the desire to giving fillip to economic development/activity and to incentivise it, clearly reveals that tax sparing clauses are directed towards the larger objectives of the tax treaties which is not just limited to eliminating double taxation but also boosting economic activities and promoting bilateral investment. Thus, at a larger level, tax sparing clauses transcend from fiscal provisions to tools for economic development.
(c) The High Court decision18 also stress upon the fact that tax sparing clauses “exemplify mutuality of interests in giving stimulus to investment for securing economic development in both countries”. This aspect is significant as it implies that such clauses are also to be given similar weightage (if not more) as accorded to other tax treaty clauses. The factum of “mutuality of interests” indicates that the presence of a tax sparing clause in a tax treaty is a conscious choice of both the treaty partners, thereby implying that every effort should be made to give effect to its underlying objective instead of relegating it as an inadvertent inclusion in the tax treaty and thereby bridling its scope.
(d) The reference to “deeming fiction” in the decision of the High Court19 has also interesting connotations. It implies incorporation of principles of statutory interpretation within the tax treaty space, notwithstanding that generally treaties are interpreted under a different standard unlike statutory provisions. To exemplify this distinction, reference can be made to the leading decision of the Supreme Court in Union of India v. Azadi Bachao Andolan20 which obliges the courts to apply a differential standard for interpretation of Indian tax treaties. Nonetheless, the High Court is correct in principle that the terms of the tax sparing clause oblige one to apply the treaty assuming that tax had indeed been paid in the other country which situation is akin to the consequences in a deeming fiction. Having said that, the treaty stands only its own insofar as it specifically includes this state of affairs in the “tax payable” clause and similarly employs the expression “deemed”.21
(e) And finally, — if the obiter of the High Court is considered as the consensus judicial view on the subject — courts would not adjudicate the propriety of tax sparing clauses. The choice of incorporating tax sparing clause, therefore, is a determination made by the executive Government which is privy to the citizens’ pangs for growth and national aspirations and is thereby in a position to appreciate the suitability of tax sparing clause towards effectively utilising the tax treaty as a means for economic growth. The extensive debates at the level of OECD and UN, meticulously documented in the Commentaries to their respective Model Tax Conventions, are thus, rightly, directed towards the Governments while imploring them to undertake detailed impact assessment exercises while negotiating tax sparing clauses in tax treaties.
Conclusion
Recent DTAAs executed by India do not reveal tax sparing clauses therein. In fact, the decision of the Delhi High Court addresses tax sparing clause in the India-Thailand DTAA which stands superseded by a new DTAA between the two countries signed in 2015 and notably without a tax sparing clause. A review of the contemporary debates on the future of international taxation, especially those under the aegis of BEPS22 and Pillar Two23, also reveal a shift in the understanding of the traditional belief regarding the scope and objectives of tax treaties. In such background, it is difficult to assess the future and survival of tax sparing clauses in the international tax system. Nonetheless the discussion in this article is not academic, at least from the perspective of those tax sparing clauses which continue to carry the force of law and, more critically, because it has an important take away regarding the larger objective of the tax treaties, which the domestic law continues to root for i.e. “to promote mutual economic relations, trade and investment”.24 In other words, the learnings qua tax sparing clauses can be gainfully deployed to appreciate and exemplify the impact of those clauses of tax treaties which subserve its larger objectives vis-à-vis those clauses which are limited to the mechanics of obviating double taxation.
† Advocate, Supreme Court of India; LLM, London School of Economics; BBA, LLB (Hons.) (Double Gold Medalist), National Law University, Jodhpur. The author can be reached at mailtotarunjain@gmail.com
1. Predominantly addressed by the OECD Model Tax Convention Model Tax Convention on Income and on Capital: Condensed Version 2017, available at <https://read.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2017_mtc_cond-2017-en> and United Nations Model Double Taxation Convention between Developed and Developing Countries 2017, Economic & Social Welfares, available at <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>.
2. CIT v. Polyplex Corpn. Ltd., 2023 SCC OnLine Del 4190.
3. Example, OECD Model Tax Convention, 2017,Art. 8(1) which provides that “profits of an enterprise of a contracting State from the operation of ships or aircraft in international traffic shall be taxable only in that State”, whereby there is no tax in the source State on the income arising to a non-resident from the operation of ships or aircraft in international traffic.
4. Refer OECD Model Tax Convention, 2017Art. 23-A (Exemption Method) and Art. 23-B (Credit Method).
5. Income Tax Act, 1961, S. 90(1)(b).
6. Government of India, Ministry of Finance, Press Information Bureau, Ratification of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, 12-6-2019, available at <https://pib.gov.in/Pressreleaseshare.aspx?PRID=1574096>.
7. For illustration, see the amended Preamble of the India-France DTAA, available at <https://incometaxindia.gov.in/dtaa/synthesised-text-of-mli-and-india-france-dtac-indian-version.pdf>. Various other DTAA provides similarly, such as the India-UK DTAA and India-Finland DTAA, etc.
8. Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), Art. 7 provides for incorporation of an anti-avoidance provision within the DTAA concerned — referred to as “principal purpose test”. It states “Notwithstanding any provisions of a Covered Tax Agreement (CTA),a benefit under the CTA shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”
9. See generally, OECD, Tax Sparing: A Reconsideration (1997), available at https://read.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-2017-full-version_54682700-en#page1
In this report the OECD has inter alia concluded that “tax sparing is very vulnerable to taxpayer abuse, which can be very costly in terms of lost revenue to both the residence and source country”. (Para 95) See also, Commentary to Art. 23 of the United Nations Model Double Taxation Convention between Developed and Developing Countries, available at <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>, pp. 465-469.
10. OECD Model Tax Convention on Income and on Capital: Condensed Version 2017 available at <https://read.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2017_mtc_cond-2017-en> (link not found), p. 402.
11. See generally, T.N. Pandey, Tax Sparing in Tax Treaties, (1989) 47 TAXMAN 230 and Mahesh C. Bijawat, “Tax Sparing: An Instrument to Retain and Attract Foreign Capital”, (1964) 6 JILI 236 for incisive views on tax treaty considerations affecting the choice of tax sparing clauses in India and other jurisdictions.
12. For illustration, see Valentine Maritime (Gulf ) LLC v. DIT, 2010 SCC OnLine ITAT 2489 following Meera Bhatia v. ITO, ITA No. 1876/MUM/2006, order dated 29-10-2009 (ITAT-Mumbai) (as per ITAT case status order not available) inter alia observing that “[i]t may result in double non-taxation but then we cannot be oblivious to the fact that double non-taxation is also a fact of life, and tax sparings, which find place in several Indian tax treaties, are also a reality in international taxation. To enter or not to enter in a tax treaty which may leave scope for double non-taxation is a conscious decision of the respective contracting State, but once such a tax treaty, as may leave scope for double non-taxation, is entered into, judicial forums have to interpret the provisions of tax treaty as they exist”. See also, Strides Pharma Science Ltd. v. CIT, ITA No. 7370/MUM/2018 dated 7-2-2020 Strides Pharma Science Ltd. v. CIT, ITA No. 7992/MUM/2019, order dated 6-4-2022 (ITAT-Mumbai) extending benefit of tax sparing clause under the India-Cyprus DTAA.
13. Kemwell (P) Ltd. v. CIT, 2019 SCC OnLine ITAT 9022 in context of India-Cyprus DTAA. Elaborating this aspect, the ITAT inter alia observed as follows:“As rightly held by the CIT(A) in the order for AY 2008-2009, the implication of the phrase ‘to promote economic development’ in ordinary parlance refers to sustainable increase in living standards that delivers increase per capital income, better education and health as well as environmental protection. The public policy of any State aims at continuous and sustained economic growth and expansion of national economics so that ‘developing countries’ become ‘developed countries’. Hence the phrase ‘to promote economic development’ would imply measures undertaken to further/bolster the cause of increasing the standard of living of the people by means of sustained growth. Attracting and encouraging new businesses is definitely a tool to implement the cause of economic development and giving incentives in the nature of exemption from liability to tax in respect of dividends is a very elementary method by which resources could be garnered to be invested in new business etc., thereby promoting economic growth and development. The rationale for providing exemption by itself is proof that it was for no other purpose other than to promote economic activity and hence economic development.” See also, Krishak Bharati Coop. Ltd. v. CIT, 2016 SCC OnLine ITAT 4349, which was approved by the Delhi High Court in CIT v. Krishak Bharati Coop. Ltd., 2017 SCC OnLine Del 8001; Indian Farmers Fertilizers Coop. Ltd. v. CIT, 2016 SCC OnLine ITAT 9365 and CIT v. IFFCO Ltd., 2022 SCC OnLine Del 3442 which allow the benefit of tax sparing clauses in context of India-Oman DTAA.
14. “Our earlier treaties used to cover tax sparing provisions where if the income is exempt in one country, the other country used to provide corresponding relief even if such taxes are not paid due to exemption. However, India no longer supports this method and is moving away from profit-based exemption. Tax sparing (to the extent of 10% of interest income) is currently there in the existing DTAA.” Statement of the Minister of Finance, Government of India (late Sh. Pranab Mukherjee) ‘regarding signing of protocol between Republic of India and Swiss Federal Council to amend the existing Agreement for avoidance of double taxation with respect to taxes on income with protocol’ dated 31-8-2010 in Lok Sabha (Session 5, 15th Lok Sabha). See also, Report of the Tax Reforms Committee (1-8-1992), Para 3.44, which urges the Government to reconsider the continued relevance of tax sparing clauses because the “cost of such provisions in terms of revenue foregone is quite high” and also because of implications arising out of lack of reciprocity in the domestic tax law of the partner country as “in the absence of tax sparing by the home country, the beneficiary of the tax concession is not the investor but the treasury of the developed country”.
15. Polyplex Corpn. Ltd. v. CIT, 2019 SCC OnLine ITAT 491.
16. CIT v. Polyplex Corpn. Ltd., 2023 SCC OnLine Del 4190.
17. CIT v. Polyplex Corpn. Ltd., 2023 SCC OnLine Del 4190.
18. CIT v. Polyplex Corpn. Ltd., 2023 SCC OnLine Del 4190.
19. CIT v. Polyplex Corpn. Ltd., 2023 SCC OnLine Del 4190.
20. (2004) 10 SCC 1 which inter alia observes that “[t]he principles adopted in interpretation of treaties are not the same as those in interpretation of a statutory legislation” (para 130) and that “[a]n 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” (para 131). The Supreme Court in this decision further stressed upon the preamble of the DTAA to observe 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” (para 132). It is also expedient to note the wide latitude given by the Supreme Court in the design of the tax treaties in this decision, which has substantial resonance for tax sparing clauses as well. The Supreme Court noted (in para 133) that “[m]any 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 can 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.”
21. One may usefully also make a reference to the newly inserted definition of the expression “liable to tax” in the Income Tax Act, 1961, S. 2(29-A) which similarly includes a person who has “subsequently been exempted”.
22. Base Erosion and Profit Shifting. Refer <https://www.oecd.org/tax/beps/about/>.
23. Global Anti-Base Erosion Model Rules. Refer Tax Challenges Arising from the Digitalisation of the Economy — Global Anti-Base Erosion Model Rules (Pillar Two) — OECD.
