Madras High Court rules Indian tax provision notifying Cyprus as non-cooperative jurisdiction is not unconstitutional

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1 14 April 2016 EY Tax Alert Madras High Court rules Indian tax provision notifying Cyprus as non-cooperative jurisdiction is not unconstitutional Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Madras High Court (HC) in the case of T. Rajkumar & others [1] (Taxpayers) on the challenge of the constitutional validity of Section 94A of the Indian Tax Laws (ITL) in view of the India-Cyprus Tax Treaty. Section 94A grants power to the Government of India (GOI) to specify any country as a notified jurisdictional area (NJA) having regard to the lack of effective exchange of information by such country. Cyprus was notified as NJA in 2013, under Section 94A of the ITL. The HC held that Section 94A is constitutionally valid and there is no bar to notify a jurisdiction as an NJA merely because there is a tax treaty in effect with such a jurisdiction. A tax treaty is not a limitation on the law-making constitutional powers of the GOI. Furthermore, if the purpose of the tax treaty is defeated due to lack of exchange of information, the breach is done by the defaulting party (Cyprus) and, in such a case, the other party (India) is not prevented from taking recourse to its domestic law to address the issue. Section 94A is not in conflict with the provisions of the India-Cyprus Tax Treaty on exchange of information (EOI) and Mutual Agreement Procedure (MAP), since it governs different circumstances. The HC also rejected the Taxpayers arguments regarding applicability of Section 94A being restricted to non-tax treaty countries. [1] [TS-197-HC-2016(Mad)]

2 Background and facts Legislative background Section 94A of the ITL empowers the GOI to specify, by notification, any country or territory as an NJA having regard to the lack of effective exchange of information with India by such country. Notification as an NJA entails onerous consequences, including withholding at a higher rate of 30% on payments made to a person located in the NJA. In November 2013, vide Notification No. 86/2013, Cyprus had been specified as an NJA under Section 94A (Notification). The Notification and its impact was explained by the GOI by way of an administrative Press Release which was issued along with the Notification (Press Release) [2]. The ITL [3] empowers the GOI to enter into a tax treaty with any country or territory outside India. Furthermore, a taxpayer gets an option to choose between application of the provisions of the tax treaty or the ITL, whichever is more beneficial to the taxpayer. Facts of the case A Cyprus company (C Co) held certain equity shares and compulsorily convertible debentures of an Indian company (I Co). The Taxpayers entered into a tripartite Securities Purchase Agreement with C Co and I Co to purchase shares and debentures of I Co held by C Co and made payment in respect of the same, without withholding any taxes. The Tax Authority invoked Section 94A and held that the Taxpayers had defaulted by not withholding taxes while making payment to C Co (in Cyprus). Aggrieved by the order of the Tax Authority, the Taxpayers filed an appeal before the First Appellate Authority and simultaneously filed a writ petition before the HC challenging the constitutional validity of Section 94A, the Notification and the Press Release. Taxpayer s contentions India has entered into a Tax Treaty with Cyprus, which includes provisions for EOI and MAP. When the tax treaty itself provides for dispute resolution, the GOI cannot take recourse to Section 94A. As per the Constitution of India (Constitution), obligations under a tax treaty should be respected. The tax treaties entered into by the GOI are virtually law. In view of above, the GOI cannot invoke the provisions of the ITL (Section 94A) as a justification to annul a tax treaty. Hence, the powers conferred upon the GOI by Section 94A, to specify any country as an NJA, is unconstitutional. Referring to the Supreme Court (SC) ruling in the case of UoI v. Azadi Bachao Andolan [4], it contended that where there is a tax treaty, the provisions of the tax treaty would operate even if inconsistent with the provisions of the ITL. Powers conferred on the GOI under Section 94A should exclude countries with which India has a tax treaty. Section 94A does not override the ITL s provision enabling the GOI to enter into a tax treaty. A tax treaty is virtually law and no law/action of the GOI should annul the effect of a tax treaty. Hence, Section 94A should be applicable only for non-tax treaty jurisdictions. [2] Refer EY Alert on CBDT notifies Cyprus as Notified Jurisdictional Area as an anti-avoidance measure dated 2 November 2013 [3] Section 90 [4] [(2004) 10 SCC 1]

3 HC s ruling Section 94A (along with the Notification and the Press Release) is constitutionally valid for the following reasons: Referring to several rulings of the SC [5], the HC observed that India follows a dualistic theory, as per which, international and domestic laws are considered as two separate and distinct legal systems. An international law or tax treaty (to which India is a party) can be enforced so long as provisions of such tax treaty are not in conflict with the domestic laws. Conflicting provisions of the tax treaty can come into force only after they are adopted by the domestic laws. As per the SC [6], the provisions of the ITL give an option to a taxpayer to choose between application of the provisions of the tax treaty or the ITL, whichever is more beneficial to the taxpayer. Such an observation of the SC cannot be stretched to conclude that the Parliament does not have the power to make a law in respect of matters covered by a tax treaty. Powers of the GOI to enact Section 94A and to enter into a tax treaty are not in conflict with each other. Once a tax treaty is entered into with a country, it is impossible to think that the GOI loses its power to make a law in respect of a matter covered in the tax treaty. A tax treaty is not a constitutional limitation on the law-making power of the GOI. as per a tax treaty, one party (Cyprus) fails to provide necessary information, then such party is in breach of its tax treaty obligations. In such a case, the Vienna Convention cannot be invoked to prevent the other party (India) from taking recourse to its domestic law to address the issue. Section 94A does not dilute the powers of the GOI under the ITL to enter into a tax treaty. If the purpose of tax treaties is defeated due to lack of exchange of information, the breach is done by one of the contracting parties (Cyprus) and not by India through enactment of defensive measures in terms of Section 94A. The intention behind insertion of Section 94A: Due to increasing incidences of tax avoidance, the leaders of G20 Nations committed [7] to take various steps to curb it, including action against noncooperative jurisdictions and tax havens. Pursuant to the above, Section 94A was inserted by India as a defensive measure and the G20 resolution lends sufficient jurisdiction to such an enactment. Furthermore, Section 94A does not disrespect any tax treaty. India is not the only country which took such defensive measures. An illustrative list of various countries indicate the legislative and non-legislative actions taken to address the issue. For instance, in France, certain jurisdictions are categorized as non-cooperative, even though France had a tax information exchange agreement with them. Similarly, Spain and Russia had earlier issued notifications blacklisting Cyprus. The notifications were later withdrawn after positive developments on the part of Cyprus for exchange of information. India is not a party to the Vienna Convention but the same is recognized as customary international law by the judiciary in India. The Vienna Convention obliges both the parties to a tax treaty to perform their obligations in good faith. If, [5] Illustratively, Jolly George Varghese [AIR 1980 SC 470], Kesavanandhabharathi v. State of Kerala [1973 Supp. SCR 1] [6] SC, in the case of Azadi Bachao (supra), Kulandagan Chettiar [2004 (6) SCC 235] [7] In a summit held at London on 2 April 2009

4 EOI or MAP provisions of the tax treaty do not oust the enactment of Section 94A in the ITL. The Taxpayers argument that application of Section 94A annuls the EOI provision under the tax treaty, which otherwise excludes certain type of information from the exchange process, was rejected. The information sought to be received by India from Cyprus (which resulted in its notification as an NJA) related to evasion of tax. Such information is not excluded from the EOI provision of the tax treaty. MAP provisions of the tax treaty apply only when there is difficulty or doubts as to the interpretation or application of the tax treaty. It does not deal with the failure of one of the contracting parties to honor its commitment under the tax treaty, like in this case. Applicability of Section 94A in respect of tax treaty jurisdictions: Section 94A uses the phrase any country or territory. There is no reason as to why the same should be read as any country or territory other than those covered by Section 90(1). Hence, even countries with which India has entered into a tax treaty under Section 90 can also be specified under Section 94A, if there is lack of effective exchange of information. Comments This ruling is the first ruling to deal with the constitutional validity of Section 94A in light of the existence of a Tax Treaty with Cyprus. The HC has examined, in detail, the interplay of the constitutional powers of the GOI to enter into a tax treaty and to enact a domestic law introducing punitive measures to deal with jurisdictions which do not have an effective EOI with India. Significantly, the HC concludes that Section 94A is not in conflict with the powers of entering into a tax treaty and it is a defensive mechanism to deal with noncooperative jurisdictions, as resolved by the G20. This ruling makes note of the comparable actions taken by several other jurisdictions. This ruling also clarifies that the applicability of Section 94A is not limited to nontax treaty jurisdictions.

5 However, one may note that the HC has merely upheld the constitutional validity of Section 94A and has not dealt with the tax treaty impact on the implications of Section 94A, including tax withholding on capital gains which may be exempt in the hands of Cyprus residents under the Tax Treaty. Notification of Cyprus as an NJA has been a subject matter of several media reports in the past. The Cyprus Government had, in the past, clarified that the India- Cyprus Tax Treaty remains in force even after the notification under Section 94A and it also declared its intention to make every effort to resolve the situation that affects business communities in both countries [8]. However, no official statement has been issued in India in this respect. [8] Source: Press Release dated 7 November 2013 issued by Ministry of Finance of Cyprus (

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