ANALYSIS OF NON DISCRIMINATION ARTICLE

Transcription

1 ANALYSIS OF NON DISCRIMINATION ARTICLE CA Mohit Agarwal 1 1 The author is associated with Ernst & Young LLP and could be reached out at agarwal.mohit52@gmail.com 1

2 Sr No Particulars Page No 1 General Remarks 3 2 Non Discrimination Article An Introduction Article 24 of OECD and UN Model Conventions Analysis of clauses of Model Conventions Article 24(1) Nationality non-discrimination Article 24(2) Non-discrimination for stateless person having nationality Article 24(3) PE Non discrimination Article 24(4) Deduction Non discrimination Article 24(5) Ownership Non discrimination Article 24(6) General (taxes covered) 25 5 Observations in respect of non-discrimination Article in Indian DTAAs Gist of recent important judicial precedents

3 1. General Remarks: In order to avoid double taxation i.e. taxation by both the countries, Source Country as well as Resident Country, or to avoid double non-taxation i.e. not paying any tax in either of the two countries, two countries enter into Double Taxation Avoidance Agreement ( DTAA ). To put a check on the tendency of the Source Country to extract maximum tax from non-residents working on their territory, the two Contracting States decide to agree to avoid discrimination between their own national/residents and national/ Residents of their contracting state. Since, discrimination as such would be a wild charge, they agree to put certain conditions in their DTAA on fulfilment of which, they would like that their nationals /Residents are offered similar treatment when compared to the Residents /nationals of the Source Country. 2. Non Discrimination Article An Introduction: The Article on Non-discrimination is the tool employed by DTAAs to express and achieve this very fundamental principle of taxation and to prevent unfair taxation as distinct from preventing double taxation. Article 24 of the OECD Model Convention represents non-discrimination Article. Article 24 deals with the elimination of tax discrimination in certain precise circumstances. All tax systems incorporate legitimate distinctions based, for example, on differences in liability to tax or ability to pay. The non-discrimination provisions of the article seek to balance the need to prevent unjustified discrimination with the need to take account of these legitimate distinctions. For that reason, the Article should not be unduly extended to cover so called indirect discrimination. For example, whilst clause 1 of the Article 24, which deals with discrimination on the basis of nationality, would prevent a different treatment that is really a disguised form of discrimination based on nationality such as a different treatment of individuals based on whether or not they hold, or are entitled to, a passport issued by the State, it could not be argued that non-residents of a given State include primarily persons who are not nationals of that State to conclude that a different treatment based on residence is indirectly a discrimination based on nationality for purposes of that clause. Article 24 is merely a specific enunciation of the general principle of equality. This principle requires that similar situations shall not be treated differently without valid and objective justification. 3

4 Article 24 has the following clauses: 1. Article 24(1) Nationality non discrimination 2. Article 24(2) Non-discrimination for stateless person having nationality 3. Article 24(3) PE Non discrimination 4. Article 24(4) Deduction Non discrimination 5. Article 24(5) Ownership Non discrimination 6. Article 24(6) General (taxes covered) 3. Article 24 of OECD and UN Model Conventions: In order to extend guidance to the member States, Organization of Economic Corporation and Development ( OECD ) of United Nations has formulated Model Convention and has also provided detailed commentary as to meaning and scope of various expressions used in Model Conventions. Most of the DTAAs between member States are guided by OECD Model Convention. In addition, there is also an UN Model Convention and related Commentary thereon. These Model Conventions also provide non-discrimination clause which are generally as such, or with slight modification, adopted by member States in their DTAAs. Language of clauses of OECD and UN Model Conventions are nearly identical, except for slight difference in clause 4. Article 24 of the OECD Model Convention states as under: 1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall, notwithstanding the provisions of Article 1, also apply to persons who are not residents of one or both of the Contracting States. 2. Stateless persons who are residents of a Contracting State shall not be subjected in either Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of the State concerned in the same circumstances, in particular with respect to residence, are or may be subjected. 3. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same 4

5 activities. This provision shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents. 4. Except where the provisions of paragraph 1 of Article 9, paragraph 6 of Article 11, or paragraph 4 2 of Article 12, apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State. Similarly, any debts of an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State. 5. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first mentioned State are or may be subjected. 6. The provisions of this Article shall, notwithstanding the provisions of Article 2, apply to taxes of every kind and description. 4. Analysis of clauses of Model Conventions: 4.1 Article 24(1) Nationality non-discrimination This clause establishes the principle that for purposes of taxation, discrimination on the grounds of nationality is forbidden, and that, subject to reciprocity, the nationals of a Contracting State may not be less favourably treated in the other Contracting State than nationals of the latter State in the same circumstances 3. 2 UN Model Convention refers to Paragraph 4 of Article 12 which is a non-substantial difference 3 Paragraph 5 of the OECD Commentary

6 Paraphrasing, Article 24(1) applies when the following conditions are satisfied: 1. There is a national of a Contracting State (State N) who may not be resident of State N or other Contracting State (State S). 2. Such national of State N is subjected in State S to any taxation or any requirement connected therewith. 3. Such taxation or connected requirement is: (a) other than the taxation and connected requirements to which nationals of State S are or may be subjected or (b) more burdensome than the taxation and connected requirements to which the nationals of State S are or may be subjected. 4. Nationals of State N and S are in the same circumstances, in particular, with respect to residence. If these conditions are satisfied, nationals of State N cannot be subjected to a discriminatory treatment in State S as compared to nationals of State S. Various terms used in Article 24(1) are analysed as under: Nationals Application of this clause is not restricted by Article 1 to nationals solely who are residents of a Contracting State, but on the contrary, extends to all nationals of each Contracting State, whether or not they be residents of one of them. In other words, all nationals of a Contracting State are entitled to invoke the benefit of this provision as against the other Contracting State. The expression. "national" as per clause 1(g) 4 of Article 3 means all individuals possessing the nationality of a Contracting State; and also all legal persons, partnerships and associations deriving their status as such from the laws in force in a Contracting State. A legal relationship involving allegiance on the part of an individual to a State is termed nationality. Indian DTAAs, like with Belgium, Hungary, Japan, Korea, Libya, Malaysia, Kazakhstan, Armenia, etc define "nationals" similarly in Article 3. Further, there are DTAAs with 4 This clause may be different in various Indian DTAAs 6

7 Bulgaria, Libya, Egypt, etc which define nationals in Article 24(1) itself instead of under Article 3. The DTAA with USA however, confines it "individuals". India - UK DTAA has left the term undefined. In that case, it has to be interpreted in the context of the other provisions of the DTAA itself. 5 The individuals, legal persons, partnership and association are covered under the definition of "national". In view of the legal relationship created between the company and the State under whose law it is constituted, which from certain points of view is closely akin to the relationship of nationality in the case of individuals, it seems justifiable not to deal with legal persons, partnerships and associations in a separate provision, but to assimilate them with individuals under clause 1. This result is achieved through the definition of the term "national" in clause 1(f) of Article 3. 6 In this connection, following the decision of Hon ble Apex Court in the case of State Trading Corporation of India Limited v CTO 7, Mumbai ITAT in the case of Standard Chartered Bank vs. IAC 8 has held that a corporation will have nationality in accordance with the country of their incorporation. The term 'nationality' is distinct from 'citizenship'. The distinction between them lies in the point that, nationality has reference to the jural relationship which may arise for consideration under international law and citizenship has reference to the jural relationship under municipal law. This clause only prohibits discrimination based on nationality and not on any other form of discriminatory treatment whether based on marital status, domicile etc. Having said that, it is important to take note of the fact how the term nationals is defined for the purpose of clause 1. For eg, DTAA with USA defines nationals as any individual possessing the nationality or citizenship of a Contracting State and therefore, even a discrimination based on citizenship might be covered under Article 24(1). Any taxation or requirement connected therewith Article 24(1) prohibits any discrimination of foreign nationals which is other or more burdensome with respect to any taxation or any requirement connected therewith. The expression "taxation" is not defined in Article 24 or Article 3(2) or in the Income-tax Act, 1961 ( the Act ). Article 366(28) of the Constitution of India defines "taxation" in an 5 (1998) 100 Taxman 206 (AAR New Delhi): Advance Ruling Petition No P-6 of 1995, in re 6 Para 16 of OECD Commentary AIR 1963 SC ITD 57 7

8 inclusive manner as "taxation includes the imposition of any tax or post whether general or local or special, and tax shall be construed accordingly". New Webster s Dictionary and Thesaurus (1992) defines it as "Taxation" means the imposition of tax, the system by which taxes are imposed, the revenue obtained by imposing taxes and Black s Law Dictionary defines Taxation as "The process of taxing or imposing a tax". The discrimination against taxation means the procedure by which the tax is imposed that is to say various steps taken to impose it 9. It means in the formalities relating to returns, payment, prescribed times, etc. Paragraph 15 of the OECD Commentary 2014 on Article 24 elaborates on the meaning of taxation which is other or more burdensome to mean that when a tax is imposed on nationals and foreigners in the same circumstances it must be in the same form as regards both the basis of charge and the method of assessment, its rates must be the same and, finally the formalities connected with the taxation (returns, payment, prescribed times, etc.) must not be more onerous for foreigners than for nationals. The non-discrimination requirement thus covers the form as well as the substance of taxation levied on the foreign national - it is not sufficient that the overall result is equality of treatment. One should notice that while the OECD Commentary suggests that "taxation" includes rate of tax, the AAR/ITAT 10 have held that Article 24 does not deal with rates of tax. The AAR has held that to understand "taxation", a comprehensive review of the Act has to be undertaken 11. The expression includes claim for deduction of bad debts reserve 12, special tax imposed on a foreign national 13, claim of depreciation 14, etc. The expression "Connected requirements" of taxation means that formalities connected with taxation, such as returns, payments, prescribed limits, TDS, issue of notices or refunds, or levy of interest, exemption, deduction, credit or other allowance, etc. It, therefore, means the manner and the method of procedure for determination of the tax and its recovery, and all other formalities connected with the taxation and assessment. That is, in short, any requirement which has a close nexus with the taxation of the non- 9 AIR 1966 SC 693 : Municipal Board Hapur v. Raghuvendra Kripal 10 P No 16 of 1998, In re (1999) 236 ITR 103 (AAR), BNP Paribus SA vs. ADIT (IT) (Mumbai ITAT) (135 DTR 202) (2016), Delmas France vs. ADIT (IT) (Mumbai ITAT) (67 SOT 336) (2014) 11 P No 16 of 1998, In re (1999) 236 ITR 103 (AAR) 12 Standard Chartered Bank vs IAC (39 ITD 57) (Mumbai ITAT) 13 Woodend K V ( K V Ceylon) Rubber and Tea Co Ltd vs IRC (1970) 2 All ER 801 (PC) (a quoted by AAR in P No 16 of 1998, In re (1999) 236 ITR 103) 14 Foramer S A V vs DCIT (52 ITD 115) (Delhi ITAT) 8

9 resident can be covered. Such requirement must create a more burdensome taxation. If not then it will be out of scope of connected requirement. No discrimination is made in regard aforesaid examples, between the national and the foreigner, if the circumstances of both are the same. But the circumstances are not the same as regards enforcement and collection methods. The difference justifies discrimination. The absence of requirement to repayment supplement (interest on tax repayment) in the UK, which is not paid to non- residents, was held to be more burdensome connected requirement 15. In contrast, from this point of view, being domestic, or non-domestic company is a classification related to requirements connected with residence and not taxation and hence, will not be covered by the scope of nondiscrimination clause 16. Further, most DTAAs 17 signed by India have defined taxation as "In this Article, the term taxation means taxes which are the subject of this Agreement". The effect is that India wants to restrict the application of DTAAs to ' taxes" as defined therein. There are certain DTAAs 18 wherein the term taxation has been defined under Article 24 in the identical manner as suggested by OECD Model Convention. Further, there are certain DTAAs with countries 19 wherein the term taxation has not been defined under Article 24. Other or more burdensome The expression "other or more burdensome" used in Article 24(1) refers to a higher tax burden or more difficult tax compliance procedure to which nationals of other Contracting State are subjected to in the State of Source. A material tax disadvantage would be more burdensome to the concerned national 20. There will not be a more burdensome tax treatment to a national of other Contracting State, if he is subjected to same tax laws which are applicable to the nationals of Source State. In other words, where provisions of the Act (in particular Section 42) is not more 15 (1991) STC 271 (QBD) : In R 7. IRC ex p. Commerz-bank 16 Credit Llyonnais vs. Dy CIT (94 ITD 401) (Mumbai ITAT) (2005) 17 Swiss Confederation, Columbia, UAE, Brazil, Bhutan, Romania, Nepal, etc. 18 Albania, Armenia, Australia, Austria, Botswana, Croatia, Czech Republic, Finland, Georgia, Fiji, Iceland, Korea, Portugal, Sweden, Mexico, Turkmenistan, Norway, Japan, Turkey, etc 19 France, Germany, Ireland, Israel, Kyrgyz Republic, Libya, Luxembourg, Netherlands, Spain, USA, Uganda 20 US Model Commentary

10 burdensome to a Canadian company, then the same would not be discriminatory within the meaning of Article 24 of India - Canada DTAA 21. The term Other is associated with burdensome i.e. the expression `other or burdensome' would refer to certain requirements imposed by a Source State on a foreign national which is different from the conditions imposed by that State on its own nationals. In Woodend (K. V. Ceylon) Rubber and Tea Company Ltd. v. IRC case (supra) where the Privy Council was dealing with a case, under the law of Ceylon, a tax payer company whose HO was situated in UK, had to pay an additional tax in respect of its profits earned in Ceylon. The Privy Council held that the additional tax was "other taxation" and came within the mischief of discrimination clause of DTAA. In the same circumstances Article 24(1) requires the evaluation of taxation position of two nationals, one of Source State and other of other Resident State. If they are functioning "in the same circumstances" then they would be comparable and accordingly, would require same tax treatment. The Protocol to the India-Turkey DTAA 22 provides that the expression in the same circumstances, refers to taxpayers (individuals, legal persons, partnership and associations) placed from the point of view of the application of the ordinary taxation laws and regulations, in substantially similar circumstances both in law and in fact. Amongst other things, this means that a national of one of the States, resident of a third State and doing business in the other State will be subjected to the same taxation or requirements connected therewith in that other State to which a national of that other State, resident in a third State and doing business in that other State, is or may be subjected. The word same is synonym with identical. Non-resident banks do not function in the same circumstances as the indigenous banks because former has no constraints like working for social and economic object of the State under which Indian banks have to operate Asst CIT vs. Nicco Resources Ltd (2009) 123 TTJ 310 (Ahmedabad ITAT) 22 Similarly, defined in Klaus Vogel's commentary on page 1228 and para 7 of OECD Commentary Chohung Bank vs. Dy. DIT (IT) (102 ITD 45) (Mumbai ITAT) 10

11 Phillip Baker in Double Tax Convention on International Tax Law, 2nd Edition at page 388 has referred to a case of the New Zealand Court of Appeal in Commissioner of Inland Revenue vs. United Dominions Trust Ltd. (1973) 1 NZTC where it has been held that "the word `same' carries the connotation of uniformity, of exactness in comparison. The phrase does not ordinarily mean in roughly similar circumstances: it means in substantially identical circumstances, and in Article xix(i) it means in substantially identical circumstances in all areas except nationality, Can then the difference in residence be accepted in this case as a valid base for applying the different tax rate or must nationality' be seen as the true basis of the distinction made." In view of above, the expression may be read as "analogous" or "similar" in order to prevent negating the non-discriminating provision on the ground of minor differences. It assists in making comparison where the legal and factual circumstances of the two taxpayers are slightly, and not very, different. It is further mentioned that a comparison must be made with the taxation of a notional national (who is otherwise in the identical circumstances as the taxpayer) of the other State to see if the taxation is other or more burdensome. The expression "in particular with respect to residence" makes it clear that the residence of the tax payer is one of the factors that is relevant in determining whether tax payers are placed in "similar circumstances". The expression in the same circumstances would be sufficient by itself to establish that a taxpayer who is a resident of a Contracting State and one who is not a resident are not in same circumstances 24. In applying clause 1, therefore, the underlying question is whether two persons who are residents of the same state are being treated differently solely by reason of having a different nationality. Consequently, if a contracting state while giving relief from taxation on account of family responsibilities distinguishes between its own nationals, it cannot be obliged to give nationals of the other states who do not reside in its territory the same treatment as it gives to its resident nationals. In light of the above, since Article 24(1) prevents different treatment based on nationality but only with respect to persons or entities in the same circumstances, in particular with respect to residence, it is therefore important to distinguish, for purposes of that paragraph, a different treatment that is solely based on nationality from a different treatment that relates to other circumstances and, in particular, residence. Clause 1 only 24 Para 7 of the OECD Commentary

12 prohibits discrimination based on a different nationality and requires that all other relevant factors, including the residence of the entity, be the same. The different treatment of residents and non-residents is a crucial feature of domestic tax systems and of tax treaties; when Article 24 is read in the context of the other Articles of the Convention, most of which provide for a different treatment of residents and nonresidents, it is clear that two companies that are not residents of the same State for purposes of the Convention (under the rules of Article 4) are usually not in the same circumstances. 25 Following cases are highlighted in the OECD Commentary and in Indian judicial decisions to explain the expression in the same circumstances. a. Immunity from the taxation accorded to its own public bodies and services would be justified as they are integral part of the State and cannot be compared to those of the public bodies and services of the other State. However, State Corporation carrying on business would be exception from this immunity. b. To accord taxation privilege to certain private institutions not for profit would be justified because of nature of the institution s activities and the benefits, which the State and its nationals derive from these activities. Thus institution not for profit but belonging to other Contracting State will not be in the same circumstances as the private institution of the Source State. c. A foreign national and a domestic national will not be in the same circumstances if scope of taxation of domestic national is broader than that of a national of other State 26. d. Indian banks operating in rural India and the non-resident banks operating in prime urban area of India were not functioning in the same circumstances or under the same conditions. 27 e. Domestic companies and foreign companies cannot be considered to be in the same circumstances Para 17 of the OECD Commentary ABN AMRO Bank NV vs. JCIT (96 TTJ 1041) (Kolkata ITAT) (2006) 27 Standard Chartered Bank vs. IAC (39 ITD 57) (Mumbai ITAT) (1991) 28 Chohung Bank vs. Dy. DIT (IT) (102 ITD 45) (Mumbai ITAT), P No 16 of 1998, In re (1999) 236 ITR 103 (AAR) 12

13 f. Nationalised bank and Indian schedule -bank or cooperation bank are not in the same circumstances 29. g. FIIs and Indian institutional investor do not operate in the same circumstances because FIIs can undertake only delivery base transactions and do not have any restriction on repatriation of profit out of the country. 30 h. A national of a State, who is also a Resident of that State, cannot be put, under the same circumstances as compared to his residence or national of other State or with person residing in third State. 31 i. The AAR 32 upheld Revenue's contention of taxing a UK Corporation 33 in India for royalties/fts on a gross basis under Section 44D/115A and refused to accept the taxpayer's contention of applying Article 24(1) for being taxed on a net of expenses basis. j. A taxpayer who is a Resident of a Contracting State and one who is not a Resident of that State are not in the same circumstances. 34 The OECD Commentary provides following examples (paras 19 to 25): Example 1: In State A dividends paid by its Resident Company to another Resident company is exempt from tax. If a company is incorporated in State B but has Place of Effective management ( POEM ) in State A, it would be a Resident of State A for the purpose of State A and State B conventions. The dividend paid to such companies having effective management in State A should also get exemption as both are in same circumstances. Example 2: Where in a DTAA, it is provided that if a company is Resident of two States (one because or incorporation and other because of POEM), then it shall be treated as Resident of that State where it is incorporated. Therefore, the dividend paid by company 29 BNP Paribus SA vs. Dy CIT (33 taxmann.com 83) (Mumbai ITAT) (2013), Chohung Bank vs. Dy. DIT (IT) (102 ITD 45) (Mumbai ITAT), P No 16 of 1998, In re (1999) 236 ITR 103 (AAR) 30 Universities Superannuation Scheme Ltd., In re [2005] 275 ITR 434 (AAR), Advantage, Advisors INC v. Dy. DIT [2009] 33 SOT 46 (Mumbai ITAT) 31 Transworld Carnet Cp. Ltd., In re [2011] 197 Taxman 428 (AAR) 32 P No 6 of 1995, In re (1998) 234 ITR 371 (AAR) 33 The applicant did not have a PE in India 34 Dy. CIT V. Gupta Overseas [2014] 42 taxmann.com 42 (Agra ITAT) 13

14 of State A to that company having dual Residence will not be in the same circumstances and can be treated differently for the tax purposes. Example 3: State A levies payroll tax on company that employ Resident employees. It does not make any distinction based on the residence of the employer but provides that company incorporated in State A shall benefit from lower rate of payroll tax. If a company incorporated in State B is also a Resident of State A (because of POEM) then different tax treatment to this company would be violative of clause 1. Example 4: The domestic law of State A provides that the company incorporated and having their POEM in State Aare entitled to consolidate their income for tax purpose, if they are part of the same group that have common shareholders. Company X is incorporated in State B and it belongs to the same group as two other companies incorporated in State A. All these three companies are effectively managed in State A. Since company X was not incorporated in. State A, it is not allowed to consolidate its income with that of other two companies. The agreement between State A and B provided that if a company is Resident of two States, it will be Resident of that State where it is incorporated, therefore, company X is not in the same circumstances as other two companies of the same group. DTAAs with Germany, Spain, UAE, Egypt, Belgium and Italy refer to the comparison between nationals in the same circumstances and same conditions, instead of in the same circumstances. Therefore, threshold in case such DTAAs seem to be lowered down as compared to other DTAAs. 4.2 Article 24(2) Non-discrimination for stateless person having nationality Paraphrasing, Article 24(2) applies when the following conditions are satisfied: 1. There is a stateless person. 2. Such stateless person is a "resident" 35 of a Contracting State (State R). 3. Such person is subjected in either Contracting State to any taxation or any requirement connected therewith. 35 As per Article 4 14

15 4. Such taxation or connected requirement is other than the taxation and connected requirements, to which "nationals" of the concerned State, are or may be subjected or such taxation or connected requirement is more burdensome. 5. Nationals of the concerned State and the stateless person are placed in the same circumstances, in particular with respect to residence. If the above conditions are satisfied, such stateless person cannot be subjected to a discriminatory treatment as compared to nationals of the concerned State. OECD Model convention provides that similar treatment be extended to Stateless persons also i.e. if persons who are not the nationals of two Contracting States but are Resident of one of the Contracting State they should get similar treatment. It excludes those Stateless persons, who are Residents of neither Contracting States. Stateless person is entitled to equality of treatment with nationals of a Contracting State with regard to taxation or any other requirement connected therewith. Thus the scope of clause 1 is extended to stateless persons who are residents of either of the Contracting States. Stateless persons must, therefore, be residents of one of the DTAA States to benefit from the non - discrimination provision. Such a requirement is meant to prevent stateless persons who are not resident in either State from being privileged compared to nationals of the other State, as they could otherwise claim freedom from discrimination in both States. A legal person cannot be stateless, as it derives its status from its incorporation under some system of law. Except DTAAs with Romania and Latvia, Article 24(2) i.e. non-discrimination for stateless person is not found in other Indian DTAAs. Article 24(2) of India Romania DTAA and India Latvia DTAA is identical to the OECD Model Convention. Analysis done in case of clause 1, will be equally applicable in case of clause 2, wherever required. 4.3 Article 24(3) PE Non discrimination The type of discrimination which this clause is designed to end is discrimination based not on nationality but on the actual situs of an enterprise. It therefore affects without 15

16 distinction, and irrespective of their nationality, all residents of a Contracting State who have a PE in the other Contracting State. 36 Paraphrasing, Article 24(3) applies when following conditions are satisfied: 1. There is a PE of an "enterprise" 37 of a Contracting State (State R) in the "other Contracting State" (State S). 2. Such PE is subject to taxation in State S. 3. Such taxation is less favourably levied than taxation levied on enterprises of State S. 4. Enterprises of State S carry on "same activities" as the PE. In the above circumstances, the taxation on the PE cannot be discriminatory as compared to enterprises of State S. However, State S can give its own residents personal allowances on account of civil status/family responsibilities which are more than those given to residents of State R. All Residents of a Contracting State who have a PE in other Contracting State will get similar treatment as Resident of other State. Computation of profits of the PE as per Article 7(2) which provides that profits attributable to a PE are those which a separate and independent enterprise engaged in the same or similar activities, in the same or similar conditions, would have been expected to make, is not violative of clause 3. Distinctions between Article 24(1) and Article 24(3) are tabulated below: Article 24(1) Article 24(3) It prevents taxation or any requirement connected therewith which is other or more burdensome. Methodology, mode and basis can t differ. Comparison of notional national in the same circumstances. It states that taxation can t be less favourable for a PE. Other procedural requirements could differ as expression connected requirements is not mentioned. Mode and manner of taxation can differ. Comparison between PE and domestic enterprise carrying on same activities. 36 Para 33 of the OECD Model Commentary Article 3(1)(c) of the UN Model Convention 16

17 The focus for preventing discrimination has been shifted from nationality to the actual situs of an enterprise in case of Article 24(3). If once the existence of the PE is established, the nationality of the person of which it is the PE is of no relevance for claiming parity with the domestic enterprise which has been carrying on similar activities, with regard to taxation matters connected therewith. The condition precedent for claiming such parity is that both enterprises are engaged in carrying on of the same activities. For purposes of the Article 24(3), the tax treatment in one Contracting State of the PE of an enterprise of the other Contracting State should be compared to that of an enterprise of the first mentioned State that has a legal structure that is similar to that of the enterprise to which the PE belongs. Thus, for example, Article 24(3) does not require a State to apply to the profits of the PE of an enterprise carried on by a non-resident individual the same rate of tax as is applicable to an enterprise of that State that is carried on by a resident company. Article 24(3) is divided into two sentences. By the terms of the first sentence of clause 3, the taxation of a PE shall not be less favourably levied in the State concerned than the taxation levied on enterprises of that State carrying on the same activities. The purpose of this provision is to end all discrimination in the treatment of PEs as compared with resident enterprises belonging to the same sector of activities, as regards taxes based on business activities, and especially taxes on business profits. In this regard, various terms used in first part of the Article 24(3) are analysed as under: Less favourably This expression has not been defined in the convention but generally understood to mean material disadvantageous 38. Article 24(3) has used the expression less favourably' as compared to "other or more burdensome" as used in other clause of Article 24. In Chohung bank vs. Dy. DIT(IT) 39, it has been held that to treat the foreign national favourably or equally would not be `less favourable'. The expression "taxation shall not be less favourably levied" means, in the context of the Act, levy of income-tax on the income of an enterprise, that the charging section and the computation section should not be so drifted as to place a foreign company 38 US model commentary ITD 45 (Mumbai ITAT) (2006) 17

18 in a less favourable position than the Indian company carrying on the same activities 40, and that a tax should not be imposed upon a foreign company from which an Indian company is immune. Thus non-discrimination provision is primarily concerned with the computation of income; and not with the rate of tax. Both should come equally under the tax levied by the Act; and there is no special tax on a foreign company. Levied This expression is used in Article 24(3). As per 6 th edition of black law dictionary, levy means "to assess; raise; execute; exact; tax; collect; gather, take up; seize. The word levy can have a number of meanings. It can simply mean to assess. It can also mean collection of tax. The word has been used in some statutes to describe the entire process of imposing charge, assessment of tax as well as collection of tax. The meaning of the word levy has to be gathered from the context of the statute in which it has been used. Same activities While the expression has not been defined in any DTAA. The OCED Commentary 2014 in para 38 has explained the same illustratively. It states that regulated and unregulated activities would generally not constitute the same activities. Thus, for instance, clause 3 would not require that the taxation on a PE whose activities include the borrowing and lending of money but which is not registered as a bank be not less favourably levied than that of domestic banks since the PE does not carry on the same activities. Another example would be that of activities carried on by a State or its public bodies, which, since they are controlled by the State, could not be considered to be similar to activities that an enterprise of the other State performs through a PE. In the same circumstances 41 / in the same circumstances or under the same conditions Even though Article 24(3) of the OECD Model Convention does not use the expressions in the same circumstances / in the same circumstances or under the same conditions, the expression same activities restricts their scope. As mentioned above, the OECD Commentary provides that for the purposes of Article 24(3), the PE of a foreign enterprise should be compared to a local enterprise that has a similar legal 40 P No 16 of 1998, In re (1999) 236 ITR 103 (AAR) 41 OECD Discussion Draft (2007) on "Application and Interpretation of Article 24 (Non-Discrimination)" para 33, 35, 42 18

19 structure as that of the foreign enterprise (e.g., a PE of a sole proprietor should not be compared to a domestic company), to meet the requirements of the expressions. India has entered into DTAAs with countries which use the expressions on the same activities in the same circumstances 42 or on the same activities in the same circumstances or under the same conditions 43, instead of on the same activities provided in the OECD Model Convention. In the context of Article 26(2) of the India - UAE DTAA 44, the Mumbai ITAT 45 has held as follows: A PE in India belonging to a company incorporated in UAE can only be compared to a domestic enterprise in India which is assessed as a company (domestic company) and is carrying on the same activities in the same circumstances or similar conditions. The tax position of a foreign entrepreneur (individual) who resides in State B, in respect of his PE's income in State A, must be compared to that of a resident individual of State A, who operates a similar enterprise in State A. The tax rates applicable to a PE can be compared to those of domestic co-operative societies carrying on the same business, only when the enterprise of which it is a PE is also of the same form of ownership i.e. of a co-operative society. The second sentence of Article 24(3) specifies the conditions under which the principle of equal treatment set forth in the first sentence should be applied to individuals who are residents of a Contracting State and have a PE in the other State. It is designed mainly to ensure that such persons do not obtain greater advantages than residents, through entitlement to personal allowances and reliefs for family responsibilities, both in the State of which they are residents, by the application of its domestic laws, and in the other State by virtue of the principle of equal treatment. Consequently, it leaves it open to the State in which the PE is situated whether or not to give personal allowances and reliefs to the persons concerned in the proportion which the amount of the PE s profits bears to the world income taxable in the other State. 42 Kuwait, Mauritius, Mongolia, Morocco, Philippines, Ukraine, Uzbekistan, Vietnam, Zambia 43 Bulgaria, China, Cyprus, Denmark, Indonesia, Italy, Malta, Poland, Russia, Singapore, Spain, UAE, UK 44 PE non-discrimination clause 45 Mashreqbank Psc v DDIT (2007) 108 TTJ 554 (Mumbai ITAT) 19

20 Here, it is relevant to mention that in case of DTAAs signed with Mauritius, Mongolia, Morocco, Poland and Philippines, second sentence is not present in PE non-discrimination clause. Instead, there is a separate clause after the PE non-discrimination clause which states as under: 3. Nothing contained in this Article shall be construed as obliging a Contracting State to grant to persons not residents in that State any personal allowances, reliefs, reductions and deductions for taxation purposes which are by law available only to persons who are so resident. 46 Given that Article 24(3) as mentioned above is applicable to whole of the Article 24 instead of only with reference to the PE non-discrimination clause as in case of all other DTAAs which India has entered into, it could be said that the intention is to make Article 24(3) applicable for Article 24(1) as well i.e. Nationality non-discrimination clause. However, since Nationality non-discrimination clause is applicable only in scenario where difference is only with reference to nationality and residential status is same, the separate clause applicable to whole Article 24 may not have any impact different from second sentence as used in other DTAAs. The OECD Commentary 2014 has dealt with six aspects of equal treatment namely: 1. Assessment of tax 47 As regards assessment aspects, the implications of equality of treatment are:- PE must be accorded the same right as resident enterprises to deduct the trading expenses that are permitted under the taxation laws, including proportionate overhead head office expenses 48 ; It must be accorded the same facilities with regard to depreciation and reserves; 46 Given that Article 24(2) for stateless persons is absent in those DTAA, PE non-discrimination clause is 24(2) and therefore, a separate clause is Article 24(3) 47 Para 40 to 47 of the OECD Commentary Metchem Canada Inc vs. DCIT (2006) (99 TTJ 702) (Mumbai ITAT) - the limitation on deduction of HO expenditure as stipulated by Section 44C, is hit by Article 24(3). However, in many DTAAs (like with France, USA, Vietnam, Uzbekistan, Mexico, Ukraine, UK, Sweden, South Africa, Singapore, Netherlands, etc), PE non-discrimination clause is debarred from being in conflict with Article 7(3) which interalia generally refers domestic laws for deduction of expenses for a PE. Thus, in such cases, Section 44C would be given effect and hence, would not be hit by Article 24(3) and therefore, ITAT judgment (given in context of India Canada DTAA) should be applied as per the language of the Article 24(3) of the applicable DTAA. 20

21 It must have the same right as is available to carry forward or backward a loss brought about at the end of an accounting year; It should have the same rules applied to resident enterprises, with regard to taxation of capital gains; The similarity of treatment is restricted to taxation only and not to other activities carried on by the PE such as consolidation, tax-free transfer of property, etc; and The rules of distribution of profits cannot be extended to PE. 2. Special treatment of dividend received in respect of holdings owned by PEs Structure and rate of tax 50 Apart from comments provided in the OECD Commentary, in Indian context, it is relevant to understand whether levy of a higher rate on foreign companies as compared to domestic companies is valid in law or not. In various DTAAs including those with Belarus, China, Cyprus, Finland and Vietnam etc.; it is specifically provided that where a Contracting State charges the profits of a PE of an enterprise of the other Contracting State at a rate of tax which is different from that imposed on the profits of a similar enterprise of the first mentioned Contracting State, it shall not be construed as discrimination under this Article. However, in other DTAAs like Netherlands, Japan, USA, etc; there is no such provision. While dealing with the second types, an Explanation 1 was inserted in section 90(2) of the Act by the Finance Act, 2001 with retrospective effect from 1st April, 1962 to provide that: "For the removal of doubts, it is hereby declared that the charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign company." 49 Para 48 to 54 of the OECD Commentary Para 55 to 61 of the OECD Commentary

22 At this juncture one will have to consider whether the amendment made by the explanation to Section 90 would override the DTAAs which did not exclude the rate of tax from the non-discrimination Article. However, even without the Explanation, the AAR 51 / ITAT 52 denied relief to a foreign bank of a lower tax rate applicable for domestic companies. The ITAT has observed that the said Explanation is clarificatory. Further, as mentioned above, certain Indian DTAAs (e.g. with UK) expressly provide that Article 24(3) cannot be construed to mean that the tax rate in respect of a PE and an Indian company must be the same. It has been held 53 that this provision is clarificatory and merely makes explicit what is implicit in treaties based on the UN Model [e.g. Art 25(2) of the India - Korea DTAA]. In this context, it is to be noted that there are certain DTAAs wherein it is mentioned that higher rate for a PE could not exceed a specific percentage. Such DTAAs are tabulated below: Country Difference should not exceed Remarks Estonia 10% Refer Article 24(2) Iceland 10% Refer Protocol Latvia 10% Refer Article 24(3) Lithuania 10% Refer Article 25(2) Norway 10% Refer Article 25(2) Poland 10% Refer Article 25(2) Portugal 10% Refer Protocol South Africa 10% Refer Article 23(2) Swiss Confederation 10% Refer Protocol Russia 12% Refer Protocol Hungary 13% Refer Protocol Austria 15% Refer Protocol Canada 15% Refer Article 24(4)(b) 51 P No 16 of 1998, In re (1999) 236 ITR 103 (AAR) [reconfirmed in XYZ/ABC Equity Fund (2001) 250 ITR 194 (AAR)] 52 Chohung Bank V DDIT (2006) 6 SOT 144 (Mumbai ITAT); Mashregbank Psc V DDIT (2007) 108 TTJ 554 (Mumbai ITAT) 53 P No 16 of 1998, In re (1999) 236 ITR 103 (AAR), Chohung Bank V DDIT (2006) 6 SOT 144 (Mumbai ITAT) 22

23 Country Difference should not exceed Remarks Romania 15% Refer Article 24(3) Slovenia 15% Refer Protocol USA 15% 54 Article 14(2) 4. Withholding tax on dividends, interest and royalties received by a PE Credit for foreign tax 56 A PE in Source State may receive overseas income (e.g., dividend, interest, etc.) and such income may be taxed in the Source State. It appears that by invoking Article 24(3), a PE may be able to avail of a credit in the Source State for the foreign withholding tax on dividends, interest, etc. if such credit is granted to resident enterprises under the domestic law of the Source State. 6. Extension to PEs of the benefit of the double taxation conventions concluded with third states. In all these categories, the equal treatment principle requires that a PE should enjoy the same benefits, allowances, relieving provisions etc.; that are available to resident enterprises carrying on the same activities Article 24(4) Deduction Non discrimination For the purpose of determining the taxable profits, there should be no discrimination on the basis of the recipients of disbursements between a resident and non-resident as regards deductibility of amounts paid as interest, royalties and other disbursements by an enterprise to the residents of the other Contracting State. Clause 4 suggests to prevent such discrimination unless it could be found that because of the close relationship between the enterprise and non-resident recipient, the transactions are arranged as to avoid payment of taxes and thus, transacted under the circumstances which call for application of Article 9(1), Article 11(6) or Article 12(6) which permit the denial of deductions in certain circumstances in respect of transactions between related parties. 54 Held in Bank of America vs DCIT (2001) (78 ITD 1) (Mumbai ITAT) that tax rate excluded surcharge for the purpose of computing difference between tax rate 55 Para 62 to 66 of the OECD Commentary Para 67 and 68 of the OECD Commentary Para 69 to 72 of the OECD Commentary

24 Not only interest or royalties, in view of the expression other disbursements, clause 4 also prohibits discrimination in the allowance of other deductions, being reasonable allocation of the executive and general administrative expenses, research and development expenses and other expenses incurred for the benefit of a group of related persons that includes the person incurring the expenses 58. Other disbursements connotes something other than interest and royalties. If the intention was that other disbursements should also be in the nature of interest and royalties then the word other should have been followed by such or such like 59. Section 40(a)(i) provides for a disallowance of payment made to a non-resident where TDS is not deducted on such payment. A similar payment to a resident did not result in disallowance in the event of non-deduction of TDS. As per the ITAT, Article 24(4) neutralised such discrimination /rigour of Section 40(a)(i) 60. However, the Protocol to the India-Spain DTAA provides that payments by way of interest, royalties and FTS made by an enterprise of India to a resident of Spain, shall not be allowed as a deduction for the purpose of determining the taxable profits of such Indian enterprise unless tax has been paid or deducted at source from such payments under Indian law and in accordance with the provisions of the said DTAA. Article 24(4) is absent in many DTAAs 60 and also, there are DTAAs 61 where provision related to capital tax is not found i.e. second sentence of the OECD Model Convention which, however, is a logical consequence of the fact that of these DTAAs have no regarding capital. Further, in addition to words interest, royalties and other disbursements (as provided by OECD Model Convention), there are certain DTAAs 62 which also include FTS specifically. 4.5 Article 24(5) Ownership Non discrimination Clause 5 deals with and forbids discrimination of an enterprise on the basis that its capital is owned or controlled wholly or partly, directly or indirectly, by residents of the other 58 Paragraph 355 of the US Technical Explanation 59 CIT vs. Herbalife International India P Ltd (Delhi HC) (96 CCH 0007) (2016), Honda Cars India Ltd vs. DCIT (Delhi ITAT) (47 CCH 0846) (2016) 60 Bangladesh, Belgium, Brazil, Bulgaria, Canada, Cyprus, Indonesia, Libya, Mauritius, Mongolia, Mongolia, New Zealand, UAE, Philippines, Egypt, UK, Ukraine, Uzbekistan, Vietnam, Zambia 61 Australia, Austria, China, Estonia, Ethiopia, Finland, Jordan, Hungary, Ireland, Israel, Korea, Kuwait, Latvia, Kyrgyz Republic, Romania, Russia, etc. 62 Lithuania, Malaysia, Malta, Namibia, Uruguay, Portugal, South Africa, Trinidad and Tobago, Turkmenistan 24