Important point
Circular No. 789 dated 13.4.2000 issued by the Central Board of Direct Taxes by which certain instructions were given to the Chief Commissioners/Directors General of income tax with regard to the assessment of cases in which the Indo-Mauritius Double Taxation Avoidance Convention 1983 applied, held valid and efficacious.

Headnote:Income Tax Act, 1961—Sections 90 and 119—Mauritian Income Tax Act, 1995, Companies (Profits) Surtax Act, 1964—Indo-Mauritius Double Taxation Avoidance Convention, 1983—Purpose to avoid double taxation and to encourage mutual trade—Circular No. 789 dated 13.4.2000 issued by Central Board of Direct Taxes by which certain instructions were given to Chief Commissioners/Directors General of Income Tax with regard to assessment of cases in which DTAC applied—Validity challenged—By a Circular No. 682 dated 30.3.1994 issued by CBDT, Government of India clarified that capital gains of any resident of Mauritius by alienation of shares of an Indian Company shall be taxable only in Mauritius according to Mauritius taxation laws and will not be liable in India—Relying on this, a large number of Foreign Institutional Investors which were resident in Mauritius, invested large amounts of capital in shares of Indian Companies—Shell companies incorporated with main purpose of funds in India—Show cause notices—Issue of Circular No. 789 clarifying that FIIS resident in Mauritius will not be taxation in India or income from capital gains arising in India on sale of shares—Whether Circular No. 789 is valid—(Yes).
       Held : Section 119, strategically placed in Chapter XIII which deals with Income-Tax Authorities is an enabling power of the CBDT, which is recognised as an authority under the Income-tax Act under section 116(a). The CBDT under this section is empowered to issue such orders instructions and directions to other income-tax authorities "as it may deem fit for proper administration of this Act". Such authorities and all other persons employed in the execution of this Act are bound to observe and follow such orders, instructions and directions of the CBDT. The proviso to sub-section (1) of section 119 recognises two exceptions to this power. First, that the CBDT cannot require any income-tax authority to make a particular assessment or to dispose of a particular case in a particular manner. Second, is with regard to interference with the discretion of the Commissioner (Appeals) in exercise of his appellate functions. Sub-section (2) of Section 119 provides for the exercise of power in certain special cases and enables the CBDT, if it considers it necessary or expedient so to do for the purpose of proper and efficient management of the work of assessment and collection of revenue, to issue general or special orders in respect of any class of incomes of class of cases, setting forth directions or instructions as to the guidelines, principles or procedures to be followed by other income-tax authorities in the discharge of their work relating to assessment or initiating proceedings for imposition of penalties. The powers of the CBDT are wide enough to enable it to grant relaxation from the provisions of several sections enumerated in clause (a). Such orders may be published in the Official Gazette in the prescribed manner, if the CBDT is of the opinion that it is so necessary. The only bar on the exercise of power is that it is not prejudicial to the assessee. (Para 36)
       As early as on March 30, 1994, the CBDT had issued circular No.682 in which it had been emphasised that any resident of Mauritius deriving income from alienation of shares of an Indian company would be liable to capital gains tax only in Mauritius as per Mauritius tax law and would not have any capital gains tax liability in India. This circular was a clear enunciation of the provisions contained in the DTAC, which would have overriding effect over the provisions of sections 4 and 5 of the Income-tax Act, 1961 by virtue of section 90(1) of the Act. If, in the teeth of this clarification, the assessing officers chose to ignore the guidelines and spent their time, talent and energy on inconsequential matters, we think that the CBDT was justified in issuing appropriate directions vide circular No.789, under its powers under section 119, to set things on course by eliminating avoidable wastage of time, talent and energy of the assessing officers discharging the onerous public duty of collection of revenue. The circular no. 789 does not in any way crib, cabin or confine the powers of the assessing officer with regard to any particular assessment. It merely formulates broad guidelines to be applied in the matter of assessment of assessees covered by the provisions of the DTAC. We do not think the circular in any way takes away or curtails the jurisdiction of the assessing officer to assess the income of the assessee before him. In our view, therefore, it is erroneous to say that the impugned circular No. 789 dated 13.4.2000 is ultra vires the provisions of section 119 of the Act. In our judgment, the powers conferred upon the CBDT by sub-sections (1) and (2) of Section 119 are wide enough to accommodate such a circular. (Paras 53 and 54)
       The purpose of the DTAC is to effectuate the objectives in clauses (a) and (b) of sub-section (1) of Section 90, is evident upon a reasonable construction of the terms of the DTAC. As long as these two objectives are sought to be effectuated, it is not possible to say that the power vested in the Central Government, under section 90, even if it is delegated power of legislation, has been used for a purpose ultra vires the intendment of the section. The respondents tried to highlight a number of unintended deleterious consequences which, according to them, have arisen as a result of implementation of the DTAC. Even if they be true, it would not enable this Court to strike down the delegated legislation as ultra vires. The validity and the vires of the legislation, primary, or delegated, has to be tested on the anvil of the law making power. If an authority lacks the power, then the legislation is bad. On the contrary, if the authority is clothed with the requisite power, then irrespective of whether the legislation fails in its object or not, the vires of the legislation is not liable to be questioned. We are, therefore, unable to accept the contention of the respondents that the DTAC is ultra vires the powers of the Central Government under Section 90 on account of its susceptibility to treaty shopping on behalf of the residents of third countries. (Para 60)
       In the result, we are of the view that Delhi High Court erred on all counts in quashing the impugned circular. The judgment under appeal is set aside and it is held and declared that the circular No. 789 dated 13.4.2000 is valid and efficacious. (Para 157)
       (ii) ADMINISTRATIVE LAW—Delegation of legislative power—Plea of excessive delegation—Tax treaty—Agreement with foreign Government for relief from or avoidance of double taxation—Indo-Mauritius Double Taxation Avoidance Convention—Whether amounts to impermissible delegation of legislative power—Income Tax Act, 1961—Section 90.
       Held : The question whether a particular delegated legislation is in excess of the power of the supporting legislation conferred on the delegate, has to be determined with regard not only to specific provisions contained in the relevant statute conferring the power to make rule or regulation, but also the object and purpose of the Act as can be gathered from the various provisions of the enactment. It would be wholly wrong for the Court to substitute its own opinion as to what principle or policy would best serve the objects and purposes of the Act, nor is it open to the Court to sit in judgment of the wisdom, the effectiveness or otherwise of the policy, so as to declare a regulation to be ultra vires merely on the ground that, in the view of the Court, the impugned provision will not help to carry through the object and purposes of the Act. (Para 56)
       Applying this test, we are unable to hold that the impugned circular amounts to impermissible delegation of legislative power. That the amendment made in section 90 was intended to empower the Government to enter into agreement with foreign Government, if necessary, for relief from or avoidance of double taxation, is also made clear by the Finance Minister in his Budget Speech, 1953-54 (Para 57)
       (iii) Income Tax Act, 1961—Sections 90 and 119—Mauritian Income Tax Act, 1995—Section 4—Indo-Mauritius Double Taxation Avoidance Convention—Foreign Institutional Investors—Liability to pay tax in Mauritius—What is ‘liable to taxation’—‘Fiscal residence’ of a company, concept of—Test to determine when a company is ‘liable to taxation’ in Mauritius.
       Held : The respondents contend that the FIIs incorporated and registered under the provisions of the law in Mauritius are carrying on no business there; they are, in fact, prevented from earning any income there; they are not liable to income tax on capital gains under the Mauritius Income-tax Act. They are liable to pay income-tax under Indian Income-tax Act, 1961, since they do not pay any income-tax on capital gains in Mauritius, hence, they are not entitled to the benefit of avoidance of double taxation under the DTAC. Some of the assumptions underlying this contention, which prevailed with the High Court, need greater critical appraisal. Article 13(4) of the DTAC provides that gains derived by a resident of a Contracting State from alienation of any property, other than those specified in the paragraphs 1, 2 and 3 of the Article, shall be taxable only in that State. Since most of the arguments centred around capital gains made on transactions in shares on the stock exchange in India, we may leave out of consideration capital gains on the type of properties contemplated in paras 1, 2 and 3 of Article 13 of the DTAC. The residuary clause in para 4 of Article 13 is relevant. It provides that capital gains made on sale of shares shall be taxable only in the State of which the person is a ‘resident taking us back to the meaning of the term ‘resident of a contracting State. According to Article 4, this expression means any person who under the laws of that State is "liable to taxation" therein by reason of his domicile, residence, place of management or any other criterion of a similar nature. The terms resident of India and resident of Mauritius are required to be construed accordingly. This takes us to the test to determine when a company is liable to taxation in Mauritius. (Para 68 and 69)
       We are inclined to agree with the submission of the appellants that, merely because exemption has been granted in respect of taxability of a particular source of income, it cannot be postulated that the entity is not liable to tax’ as contended by the respondents. (Para 77)
       Liability to taxation is a legal situation; payment of tax is a fiscal fact. For the purpose of application of Article 4 of the DTAC, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. If this were not so, the DTAC would not have used the words liable to taxation , but would have used some appropriate words like pays tax . On the language of the DTAC, it is not possible to accept the contention of the respondents that offshore companies incorporated and registered under MOBA are not liable to taxation under the Mauritius Income-tax Act; nor is it possible to accept the contention that such companies would not be resident in Mauritius within the meaning of Article 3 read with Article 4 of the DTAC. There is a further reason in support of our view. The expression liable to taxation’ has been adopted from the Organisation for Economic Co-operation and Development Council (OECD) Model Convention 1977. The (OECD) commentary on article 4, defining resident , says: "Conventions for the avoidance of double taxation do not normally concern themselves with the domestic laws of the Contracting States laying down the conditions under which a person is to be treated fiscally as "resident" and, consequently, is fully liable to tax in that State". The expression used is liable to tax therein , by reasons of various factors. This definition has been carried over even in Article 4 dealing with resident in the OECD Model Convention 1992. (Paras 85 and 86)
       There is substance in the contention of Mr. Salve learned counsel for one of the appellants, that the expression resident is employed in the DTAC as a term of limitation, for otherwise a person who may not be liable to tax’ in a Contracting State by reason of domicile, residence, place of management or any other criterion of a similar nature may also claim the benefit of the DTAC. Since the purpose of the DTAC is to eliminate double taxation, the treaty takes into account only persons who are liable to taxation in the Contracting States. Consequently, the benefits thereunder are not available to persons who are not liable to taxation and the words liable to taxation are intended to act as words of limitation. (Para 91)
       (iv) Income Tax Act, 1961—Sections 91 and 119—Treaty shopping—Indo Mauritius Double Taxation Avoidance Convention—Foreign Institutional Investors—Shell companies—Respondents case that offshore companies have been incorporated under laws of Mauritius only as shell companies, incorporated only with motive of taking undue advantage of treaty—Whether ‘treaty shopping’ is unethical and illegal—(No).
       Held : ‘Treaty shopping’ is a graphic expression used to describe the act of a resident of a third country taking advantage of a fiscal treaty between two Contracting States. According to Lord McNair, "provided that any necessary implementation by municipal law has been carried out, there is nothing to prevent the nationals of "third States", in the absence of any expressed or implied provision to the contrary, from claiming the right or becoming subject to the obligation created by a treaty" (Para 106)
       There is no doubt that, where necessary, the Courts are empowered to lift the veil of incorporation while applying the domestic law. In the situation where the terms of the DTAC have been made applicable by reason of section 90 of the Income-Tax Act, 1961, even if they derogate from the provisions of the Income-tax Act, it is not possible to say that this principle of lifting the veil of incorporation should be applied by the court. As we have already emphasised, the whole purpose of the DTAC is to ensure that the benefits thereunder are available even if they are inconsistent with the provisions of the Indian Income-tax Act. In our view, therefore, the principle of piercing the veil of incorporation can hardly apply to a situation as the one before us. (Para 109)
       While considering the causes which led to the Stock Market scam, the JPC had occasion to consider the working of the Indo-Mauritius DTAC. It noticed that area-wise foreign direct investment inflow from Mauritius increased from 37.5 million Rupees in 1993 to 61672.8 million Rupees in the year 2001. The CBDT had approached the Indian High Commissioner at Mauritius to take up the matter with the Mauritian authorities to ensure that benefit of the bilateral tax treaty were not allowed to be misused, by suitable amendment in Article 13 of the agreement. The Mauritian authorities, however, were of the view that, though the beneficiaries of such capital funds domiciled in Mauritius may be residing in third countries, these funds had been invested in the Indian stock market in accordance with SEBI norms and regulations and that the Finance Minister of India had himself encouraged such FIIs as a channel for promoting capital flow to India in a meeting between himself and the Finance Minister of Mauritius. The Ministry of finance was willing to have regular joint monitoring of the situation to avoid possible misuse of the tax treaty by unscrupulous elements. It was pointed out by the Mauritian authorities that DTAC between the two countries "had played a positive role in covering the higher cost of investing in what was then assessed as high risk security and being decisive in making possible public offerings in U.S.A. and Europe of funds investing in India". In the absence of such a facility, as afforded by the Indo-Mauritius DTAC, the cost of raising such investment would have been capital prohibitive. The JPC report points out that the negotiations between the Government of India and Government of Mauritius resulted in a situation in which the Mauritius Government felt that any change in the provisions of the DTAC would adversely affect the perception of potential investors and would prejudicially affect their financial interests. The issue still appears to be the subject matter of negotiations between the two Governments, though no final decision has been taken thereupon. (Paras 118 and 119)
       In our view, the recommendations of the Working Group of the JPC are intended for Parliament to take appropriate action. The JPC might have noticed certain consequences, intended or unintended, flowing from the DTAC and has made appropriate recommendations. Based on them, it is not possible for us to say that the DTAC or the impugned circular are contrary to law, nor would it be possible to interfere with either of them on the basis of the report of the JPC. (Para 121)
       Many 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 are able to 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. (Para 125)
       Overall, countries need to take, and do take, a holistic view. The developing countries allow treaty shopping to encourage capital and technology inflows, which developed countries are keen to provide to them. The loss of tax revenues could be insignificant compared to the other non-tax benefits to their economy. Many of them do not appear to be too concerned unless the revenue losses are significant compared to the other tax and non-tax benefits from the treaty, or the treaty shopping leads to other tax abuses. There are many principles in fiscal economy which, though at first blush might appear to be evil, are tolerated in a developing economy, in the interest of long term development. Deficit financing, for example, is one; treaty shopping in our view, is another. Despite the sound and fury of the respondents over the so called abuse of treaty shopping , perhaps, it may have been intended at the time when Indo-Mauritius DTAC was entered into Whether it should continue, and, if so, for how long, is a matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations. This Court cannot judge the legality of treaty shopping merely because one section of thought considers it improper. A holistic view has to be taken to adjudge what is perhaps regarded in contemporary thinking as a necessary evil in a developing economy. (Paras 127 and 128)
       (v) INTERNATIONAL LAW—Treaties—Interpretation of—Principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation—Treaties are negotiated and entered into at a political level and have several considerations as their bases—Indo-Mauritius Double Taxation Avoidance Convention recites that it is for the ‘encouragement of mutual trade and investment’—This aspect of the matter cannot be lost sight of while interpreting the treaty. (Paras 123 and 124)

Judgement Key Points

Certainly. Based on the provided legal document, the key points are as follows:

The authority of the Central Board of Direct Taxes (CBDT) to issue circulars under section 119 of the Income-tax Act is broad and includes instructions for the proper administration of the Act, which are binding on income-tax authorities unless specific exceptions apply (!) (!) .
Circulars issued by the CBDT under section 119 are considered legally binding and serve as authoritative aids for interpreting the law, provided they are issued within the scope of the powers conferred by the statute (!) (!) (!) .
The validity of a circular depends on whether it is issued under the correct statutory provision and within the scope of the delegated authority; mere omission of explicit reference in the instrument does not invalidate it if the source of power is traceable (!) (!) .
Circulars can effectively interpret and implement provisions of the law, including treaties and agreements, and are intended to guide authorities in consistent application of the law (!) (!) .
The purpose of entering into double taxation avoidance agreements (DTAAs) is to eliminate double taxation and facilitate mutual trade and investment, which can involve complex interpretations of terms such as "liable to taxation" and "resident" (!) (!) (!) (!) .
The concept of "liable to taxation" is a legal situation indicating the obligation to pay tax under domestic law, rather than the actual payment of tax. This liability is the relevant criterion for determining residence and treaty benefits (!) (!) (!) (!) .
Treaty benefits are generally intended for persons who are liable to tax in the contracting states, acting as a limitation to prevent benefits from being extended to non-residents of either state, including residents of third countries (!) (!) (!) .
Treaty shopping—using entities or arrangements primarily to obtain treaty benefits—is recognized as a practice that is not inherently illegal or unethical, provided the legal requirements are met. The purpose of treaties is to promote mutual trade and investment, and such practices are often tolerated, especially in developing economies (!) (!) (!) (!) (!) .
The interpretation of treaties should be approached with a broad, liberal perspective to fulfill the treaty's primary objectives, and the terms used, such as "resident" and "liable to tax," are to be understood in their context within international norms and conventions (!) (!) .
The principle that a person’s motive for structuring transactions to minimize tax does not automatically invalidate the transaction, provided it is within the law, remains relevant. The focus is on the legal effect and substance of the transaction rather than the motive (!) (!) (!) (!) .
The doctrine that legal steps taken to achieve a particular tax outcome are valid unless they are sham or intended solely for tax evasion continues to be upheld, with courts emphasizing the importance of the legal reality of transactions over perceived motives (!) (!) (!) .
The legal concept of "sham" or "device" involves acts or documents intended to give a false appearance of creating legal rights or obligations, but courts must objectively assess whether the series of transactions as a whole reflects genuine legal and economic substance (!) (!) .
The fundamental legal principles underlying the interpretation and application of tax treaties and domestic law emphasize that the law should be applied as written, respecting the legal substance of transactions, and avoiding subjective assessments of motives or intentions unless explicitly relevant (!) (!) (!) .
The legislative framework and delegated powers allow for the issuance of circulars and instructions that interpret and implement treaties, and such circulars are valid as long as they operate within the scope of the authority granted by the law (!) (!) (!) .
The purpose of treaties like the DTAA is to facilitate international cooperation in taxation, and their interpretation must align with their primary objectives, such as promoting trade and preventing double taxation, rather than restricting legitimate tax planning within legal bounds (!) (!) .
The concept of "residence" and "liability to tax" in treaty law is rooted in the domestic laws of the contracting states and reflects the legal obligation to pay tax, not necessarily the actual payment or collection of tax (!) (!) (!) (!) .
The validity of agreements and treaties depends on their compliance with the supporting legislative framework, and their interpretation should consider the broader purpose of the law and the international context (!) (!) (!) .

Please let me know if you need further elaboration or specific focus on any particular aspect.

Judgment

Srikrishna, J.—Leave granted.

2. These appeals by special leave arise out of the judgment of the Division Bench of Delhi High Court allowing Civil Writ Petition (PIL) No. 5646/2000 and Civil Writ Petition No.2802/2000. The High Court by its judgment impugned in these appeals quashed and set aside the circular No. 789 dated 13.4.2000 issued by the Central Board of Direct Taxes (hereinafter referred to as "CBDT") by which certain instructions were given to the Chief Commissioners/Directors General of Income-tax with regard to the assessment of cases in which the Indo - Mauritius Double Taxation Avoidance Convention, 1983 (hereinafter referred to as DTAC ) applied. The High Court accepted the contention before it that the said circular is ultra vires the provisions of Section 90 and Section 119 of the Income-tax Act, 1961 (hereinafter referred to as the Act’) and also otherwise bad and illegal.

3. It would be necessary to recount some salient facts in order to appreciate the plethora of legal contentions urged.

FACTS

A: The Agreement

4. The Government of India has entered into various Agreements (also called Conventions or Treaties) with Governments of different countries for the avoidance of double taxation and for prevention of fiscal evasion. One such Agreement between the Government of India and the Government of Mauritius dated April 1, 1983, is the subject matter of the present controversy. The purpose of this Agreement, as specified in the preamble, is "avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment". After completing the formalities prescribed in Article 28 this agreement was brought into force by a Notification dated 6.12.1983 issued in exercise of the powers of the Government of India under Section 90 of the Act read with Section 24A of the Companies (Profits) Surtax Act, 1964. As stated in the Agreement, its purpose is to avoid double taxation and to encourage mutual trade and investment between the two countries, as also to bring an environment of certainty in the matters of tax affairs in both countries.

5. Some of the salient provisions of the Agreement need to be noticed at this juncture. The Agreement defines a number of terms used therein and also contains a residuary clause. In the application of the provisions of the Agreement by the contracting States any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the laws in force in that contracting State, relating to the words which are the subject of the convention. Article 1(e) defines person’ so as to include an individual, a company and any other entity, corporate or non-corporate "which is treated as a taxable unit under the taxation laws in force in the respective contracting States". The Central Government in the Ministry of Finance (Department of Revenue), in the case of India, and the Commissioner of Income Tax in the case of Mauritius, are defined as the "competent authority". Article 4 provides the scope of application of the Agreement. The applicability of the Agreement is determined by Article 4 which reads as under:

"Article 4 Residents

1. For the purposes of the Convention, the term "resident of a Contracting State" means any person who under the laws of that State, is liable to taxation therein by reason of his domicile, residence, place or management or any other criterion of similar nature. The terms "resident of India" and "resident of Mauritius" shall be construed accordingly.

2. Where by reason of the provisions of paragraph 1, an individual is a resident of both Contracting States, then his residential status for the purposes of this Convention shall be determined in accordance with the following rules:

(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him

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2003 Supreme(SC) 984

Cases Referred (34)