A matter of interpretation

T. C. A. Ramanujam

 

Collaboration agreements are the order of the day. Indian companies enter into technical collaboration agreements with foreign ventures so as to bring in knowhow and expertise into India. These agreements stipulate the terms of the payment.

Question arises whether the payments made to the foreign collaborator will be considered as deductible business expenditure in the hands of the Indian company in its tax assessments. Three decade back, in the celebrated CIBA India case, the Supreme Court laid down the rule that mere access to the technical knowledge and experience which the foreign company commanded will mean that the payment is only revenue in nature.

This will be so if the Indian company does not become entitled to the patents and trademarks of the foreign company. Payments made for use of knowhow leading to increase in the yield of penicillin in the existing plan were considered as revenue expenditure in the Alembic case. Enduring character of the payment is no longer considered a test. The test can break down if the impact of the knowhow is only on running of business. But it will be capital in nature if the knowhow is meant for starting a new venture.

Shriram Pistons case

 

 

One would have thought that the plethora of judicial rulings on the subject in the past 30 years had settled the issue once and for all. Yet, cases continue to arise before High Courts and the Revenue is agitating the matter even in 2008. Shriram Pistons and Rings Ltd (307 ITR 363) entered into a technical collaboration agreement with Riken Piston Ring Ind. Co. Ltd, of Japan for manufacture of piston rings.

The agreement provided for comprehensive technical knowhow and assistance for manufacturing and selling piston rings. It covered manufacturing, drawings and specifications and processes. One of the vital clauses in the agreement stipulated that the Indian licensee will pay to the Japanese licensor 8,820,000 yen in consideration of knowhow sold by the licensor and the payment was subject to appropriate Indian taxes.

The Revenue jumped on the use of the term ‘sold’ in the agreement and started arguing that it was a case of outright sale of knowhow and the payment fell in the capital field. There were other clauses in the agreement enabling the Indian company to sub- license the knowhow to another Indian party with the prior consent of the Japanese collaborator.

Confidentiality was to be maintained. Right of the Indian company to market products manufactured under the agreement would cease upon the expiry of the agreement. Agreement was for a period of five years. The Indian company would have a perpetual non-exclusive right to manufacture the products under the agreement without further payments.

Right to use or sale?

 

 

The question raised was whether what was transferred to the Indian company was only a right to use the knowhow or was it a sale of knowhow in perpetuity.

The Delhi High Court considered various authorities on the subject. It went into the various clauses in the agreement. The agreement was valid only for five years and could be terminated even earlier. The court observed: “There is no magic in the word ‘sold’ used in the agreement because on a reading of the agreement as a whole, it appears to us that what was transferred was only a right to use the technical knowhow and there was no sale of the knowhow which the assessee could exploit. The assesse’s rights were hedged in with all sorts of conditions, clearly making it a case of right to use the technology and not sale of the technical knowhow”.

The Indian company can sub-licence the knowhow only with the prior written permission of the Japanese collaborator. The Indian company was entitled to use the name of the Japanese collaborator in the marketing of its products but that right would cease upon the expiry or termination of the agreement.

The ruling

 

 

Finally, the court concluded that there was no sale of technical knowhow and the payment made by the Indian company to the Japanese collaborator should be allowed as revenue expenditure.

Going through the law reports on the subject, one will find that rarely does the Revenue succeed in its claim for treating payments for collaboration and knowhow as capital expenditure.

The CIBA case of 1968 still holds the field. Possibly, there can be bifurcation of the expenditure into capital and revenue if it can be shown that part of the know-how was for setting up the plant. Even so, as the Supreme Court itself noted in the Scientific Engineering case, that knowhow expenditure falling in the capital field can be considered ‘plant’ under Section 43(3) of the Income-Tax Act, 1961 entitled to depreciation allowance under Section 32. They fall in the category of intangible assets.

It is difficult to understand what the Revenue is fighting for in various High Courts on this issue.

(The author is a former Chief Commissioner of Income-Tax. blfeedback@thehindu.co.in)

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Original Story at:

http://www.thehindubusinessline.com/2008/12/27/stories/2008122750210900.htm

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Published in: on December 30, 2008 at 7:30 am  Leave a Comment  

Hypothetical tax not an income accruing in India

In a recent judgment involving a foreign national, the Mumbai Income Tax Tribunal has held that hypothetical tax paid by an employer on behalf of the taxpayer is not an income accruing in India and can be claimed as a deduction by the employee from the gross salary.

The assessee, Roy Marshall, was an employee of British Airways. In the computation of total income in the tax return, the assessee deducted hypothetical tax withheld by his employer from gross salary. According to the contract agreement, the company had to bear additional tax burden arising out of his services in India and the assessee would bear only that part of the tax which he would have required to pay in his home country.

During the year, the assessee’s salary income was Rs 77 lakh and the company reimbursed Rs 35 lakh towards tax liability. Total income of the assessee thus became Rs 1.12 crore and with the maximum marginal rate of 44.8 per cent, the total tax liability came to Rs 50 lakh. The company had paid Rs 35 lakh, so the balance tax liability of Rs 15 lakh was borne by the assessee.

Though the taxpayer had paid his total tax dues in India, the income-tax assessing officer held that the hypothetical tax (Rs 35 lakh) should also form a part of the salary income. This became a bone of contention as the assessee may take a hit in his home country. According to the provisions of the Double Taxation Avoidance Agreement, the person may have taken a credit of Rs 15 lakh Indian taxes paid on an income of Rs 77 lakh in his home country tax return. However, if he would have to show that his salary income was Rs 1.12 crore in India, there could have been additional tax burden on him in his home country.

The tribunal relied on the judgment on a similar case of Jaydev H Raja, wherein it was held that the hypothetical tax does not form a part of the salary income taxable in India and the appellant was justified in reducing the same from his taxable salary.

It was held by the tribunal that income arising in India in the hands of the taxpayer is the actual salary plus the incremental tax liability arising on account of the Indian assignment. The amount of hypothetical tax withheld from the salary of the taxpayer is not an income accruing to him in India.

The ruling further held that as long as tax is paid on the income accruing in India, it is not relevant if the taxpayer takes credit of Indian taxes in his home country tax return.

Accordingly, the tribunal held that no deduction was actually claimed by the assessee on account of hypo tax as otherwise misconceived by the revenue authorities and deleted the addition made on this count.

Source: Business Standard

Published in: on November 24, 2008 at 2:19 pm  Leave a Comment  
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Transponder capacity lease not taxable: AAR

Transponder capacity lease not taxable: AAR
BS Reporter / New Delhi November 10, 2008, 0:40 IST
 

In a ruling that may give relief to foreign companies, the Authority for Advance Rulings (AAR) has said that payments made by an Indian entity to an overseas company for leasing of navigational transponder capacity is not taxable in India.

It also said that the Indian entity has no obligation to deduct tax at source on payments made in this regard to the overseas company.

Tax payers dealing with foreign companies seek advance rulings to determine their tax liability to avoid litigations. The rulings are binding on the tax authorities and also on the applicant.

The case pertains to Indian Space Research Centre (ISRO) Satellite Centre (the applicant), which has entered into a contract with Inmarsat Global Ltd, UK (IGL) for leasing Immarsat’s navigational transponder capacity for its Global Positioning System (GPS)-aided Geo Augmented Navigation project.

ISRO Satellite Centre had taken on lease two transponders for a fixed annual charge. It sought advance ruling on whether the payment to IGL is not “royalty” under the Income Tax Act 1961 as well as under the Double Taxation Avoidance Agreement and hence not liable for TDS.

ISRO also wanted to know whether IGL is not liable to tax in India and hence not liable to TDS under Section 195 of the Income Tax Act.

In its ruling, the AAR said the transponder capacity at a particular frequency is received by ISRO Satellite Centre at a ground station set up and operated by it. ISRO also adjusts or tunes its system to access the navigational transponder space segment capacity and by doing so ISRO does not get possession or control of the equipment of IGL.

If an advantage is taken from sophisticated equipment instaled and provided by another, it is difficult to say that the recipient or customer used the equipment as such, AAR said. The ruling held that payment for lease of the navigation transponder would not constitute royalty.

The Revenue Department contended that IGL’s regional office in India provides ground support to customers. The applicant said it is not taking any assistance from the regional office.

Taking the facts into account, the AAR ruled that no part of the business profits flowing to IGL from the contract in question is attributable to permanent establishment in India.

AAR ruled that as the income of IGL arising out of the lease of transponders to the applicant is not chargeable to tax in India under both Income Tax Act and DTAA, and that ISRO Satellite has no obligation to deduct TDS.

 

http://www.business-standard.com/india/storypage.php?autono=339699

Published in: on November 10, 2008 at 2:38 pm  Leave a Comment  
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Court rejects move to tax dividend stripping

Court rejects move to tax dividend stripping
Anindita Dey / Mumbai October 03, 2008, 0:01 IST
 

In a major blow to the tax claims of around Rs 2,000 crore on cases of dividend stripping prior to 2002-03, the Bombay High Court has ruled that losses arising from the purchase and subsequent sale of mutual fund units, soon after receiving dividend on the units, can be allowed as an expense for deduction from taxable income.

In all its tax claims, the I-T department was of the view that losses arising from such transactions amounted to artificial or coloured transactions for evading taxes and was not a sound commercial decision.

For the assessment year 2001-02, Mumbai-based broking firm Walfort Share, purchased 4.55 billion units from Chola MF on March 23, 2000, at Rs 17.57 per unit totalling Rs 8 crore. On the same day, Chola MF distributed a dividend amount of Rs 1.8 crore at 40 per cent per unit.

On the next day (March 27, 2000), the assessee sold the units by way of redemption and Chola MF repurchased them at Rs 12.97 each and paid Rs 5.90 crore as the repurchase price. The assessee (Walfort) had also received Rs 2.3 crore as an incentive for purchase and sale of such units. So, against an investment of Rs 8 crore, the assessee received Rs 7.96 crore (in the form of dividend income, incentive income and sale consideration).

At the same time, on the units sale, the broking firm made a loss of around Rs 2.1 crore (Rs 8 crore less Rs 5.90 crore). Since the dividend income was exempt from tax under Section 10(33) of the I-T Act, the assessee claimed business loss of around Rs 2.1 crore to be set off against other income.

However, the tax authorities were of the opinion that the loss was created through pre-designed set of transactions to avoid paying tax and added it back to the trading income of the assessee. However, HC in its ruling in August was of the view that such transactions need to be seen with reference to Section 94(7) that deals with tax avoidance transactions.

The section provides that where the units are purchased and sold within a stipulated time and the income from such units is exempt, then, while computing losses of such persons, the losses to the extent of the income received should be ignored.

Thus, losses in excess of the income should be allowed for deduction.

 

Copyright: The Business Standard

http://www.business-standard.com/india/storypage.php?autono=336192

Published in: on October 3, 2008 at 11:17 am  Leave a Comment  
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The Fundamental Rights Case : KESAVANANDA BHARATI by N.A. Palkhivala

The Fundamental Rights Case : Propositions submitted before the Supreme Court
by N.A. Palkhivala,* 
Senior Advocate

Cite as : (1973) 4 SCC (Jour) 1

WRIT PETITION NO. 135 OF 1970

IN THE MATTER OF :

HIS HOLINESS KESAVANANDA BHARATI . . Petitioner;

Versus

THE STATE OF KERALA AND ANOTHER . . Respondents.

Propositions regarding the true construction of Article 368 as it stood before the Twenty-fourth Amendment in 1971, in support of the submissions that:

(a) Parliament had no power to destroy or impair the essential features, the basic elements or the fundamental principles of the Constitution; and

(b) Article 368 did not prevail over or override Article 13.

1. The whole ratio of the majority judgments as well as the minority judgments in Golak Nath case1, turns entirely on the meaning to be attached to two words — the word ‘law’ in Article 13(2) and the word ‘amendment’ in Article 368. Therefore the crucial question is — what is the precise meaning to be attached to these two words. To start with any assumption that the word ‘amendment’ should be construed in its widest sense is to start with the answer instead of starting with the question.

2. The minority judgments in Golak Nath case, as also the earlier cases, proceeded on the assumption that the power of amendment dealt with by Article 368 was plenary. This assumption is wholly without foundation.

3. Article 368 referred only to the topic of constitutional amendment but was silent as to the subject-matter in respect of which the amending power could be exercised, and was equally silent as to the extent or width of the amending power.

4. It was only the proviso which enumerated the Articles the amendment of which required the concurrence of at least half the States. But even the proviso did not make it clear whether the institutions dealt with by it, e.g., the State legislatures and the High Courts, could be destroyed by Parliament in the exercise of its amending power with the concurrence of half the States.

5. Article 368 used the word “amendment” which is of the most elastic ambit; and the primary question is really of ascertaining the fair and reasonable meaning to be attached to that word in the context of Article 368, having regard to the genesis and general scheme of the Constitution, the basic constitutional structure behind the text of the constitutional document, and all other relevant circumstances which will be adverted to later.

6. It is clear beyond doubt that one of the well-settled meanings of the word “amend” is that which would preclude the power to alter or destroy the essential features, the basic elements, the fundamental principles of the Constitution; and it is submitted that the word “amendment” bore that meaning in Article 368. There is inherent evidence within the Article itself to support this view:

(a) Whereas the Constitution is given by the people unto themselves, the power to decide upon amendments (with or without the concurrence of half the States) is given to the five-year Parliament which is merely a creature of the Constitution. This point is of such profound significance that it will be elaborated later as a separate topic.

(b) Article 368 did not start with the non-obstatne clause “notwithstanding anything in this Constitution”.

(c) Article 368 was drafted in a very low key. It used the word “amendment” simplicitor whereas even less significant amending powers in the other parts of the Constitution use the words “add” “alter” “repeal” or “vary”, in addition to the word “amend”. SeeArticles 31-B; 35(b); 252(2); 372; 372-A(2); V Schedule Para 7 and VI Schedule Para 21. Further, Article 368 merely talked of “an amendment of this Constitution” and did not extend the amending power to “all or any of the provisions of this Constitution”.

(d) On the construction of the word “amendment” suggested by the Respondents, all fundamental rights could be taken away by Parliament by the requisite majority, whereas much less significant matters required the concurrence of at least half the States under the proviso to the Article. The basic human freedoms are of the most fundamental importance to all the States and to all their citizens. For instance, every State is interested in ensuring that Articles 14, 15 and 16 are respected and its citizens are not discriminated against, and that its religious and linguistic minorities are protected under Articles 29 and 30. Likewise, Article 32 is of no less importance to the citizens of the States than Article 226. Is it conceivable that while the Constitution required the States’ concurrence for matters of much less moment, it intended the essential features of the Constitution (which included the basic human freedoms) to be entirely at the mercy of a two-thirds majority at the Centre?

(e) Under Article 368, the assent of the President to the Bill was necessary before the Constitution could stand amended. Under Article 60 the President has to take an oath that he will “preserve, protect and defend the Constitution”. Any proposed amendment which struck at the core of the Constitution would require the President, if he was true to his oath, to refuse his assent. It is reasonable to assume that the Constitution did not intend to create a constitutional crisis by permitting Parliament to destroy all or any of the basic features of the Constitution and by enjoining the President at the same time to be true to his oath and preserve, protect and defend the Constitution by refusing assent. On the other hand, on the construction put by the Petitioners on the word “amendment”, such glaring inconsistency between the President’s oath and the Parliament’s power is avoided.

(f) Article 368 deals only with “amendment of this Constitution”. The preamble is not a part or provision of the Constitution. (1960) 3 SCR 250, 282. (See also Annexure “I” in which the same view is expressed about the preamble to the United States Constitution). Therefore, the preamble cannot be amended under Article 368. Secondly, the very nature and contents of the preamble are such that it is incapable of being amended. It refers to the most momentous event in India’s history and sets out what the people of India resolved to do for their unfolding future. No Parliament can amend or alter past history.

If the preamble is unalterable, it necessarily follows that those features of the Constitution which are necessary to give effect to the preamble, are unalterable. Fundamental Rights are intended to give effect to the preamble, (1959 SCR 995, 1018-9). They cannot be abridged or taken away.

(g) It is most important to note that the provisions of Article 368 itself can be amended under that very Article. If the word “amendment” is to be read in the widest sense contended for by the Respondents, Parliament would have the power to get rid of the requisite majority required by Article 368 and make any constitutional amendment possible by a bare majority. Further, Parliament would have the power to reduce India to a status which is neither sovereign nor democratic nor republican, and where the basic human rights are conspicuous by their absence. After doing that Parliament may —

(i) repeal Article 368 and expressly provide that the Constitution should hereafter be unamendable, or

(ii) amend Article 368 and provide for, say, 99 per cent majority for future amendments of the Constitution including any future amendment of Article 368 itself.

7. For the foregoing reasons, which are based upon the provisions of Article 368 itself, apart from other significant reasons which will be adverted to later, it is submitted that Article 368 should not be read as expressing the death-wish of the Constitution or as a provision for its legal suicide. It is fairly clear that Parliament cannot arrogate to itself under Article 368 the role of the Official Liquidator of the Constitution.

Propositions on behalf of the Petitioners regarding the true construction of Article 13 as it stood before the 24th Amendment in 1971; in support of the submissions that—

(a) constitutional amendment, whether under Article 368 or otherwise, was “law” within Article 13(2) and was void to the extent to which it contravened Fundamental Rights; and

(b) Article 368 did not prevail over or override Article 13.

I. Article 13(1) and (2) is not redundant

It is a misconceived argument that Article 13(1) and (2) is redundant and, therefore, the question whether Parliament can abridge Fundamental Rights by constitutional amendment should be decided without reference to Article 13(2). The observations of Kania, C.J., in the Gopalan case, 1950 SCR 88 at 100, which are passing observations made in discussing the provisions of the Constitution generally, have been explained by Hidayatullah, J., in the Sajjan Singh case (1965) 1 SCR 933 at 961. So far from being redundant, Article 13 serves the most useful purpose of dealing clearly and comprehensively with the four dimensions of the bar which it imposes—

(a) the authorities against whom the bar is imposed;

(b) the categories of law to which it applies;

(c) the laws in point of time which it covers; and

(d) the effect of the bar.

These four aspects are dealt by Article 13 as follows:

(a) The bar is imposed against the State, i.e. the totality of all the forces of the State, even including statutory corporations and autonomous authorities. See Rajasthan State Electricity Board v.Mohanlal, (1967) 3 SCR 377, 385.

(b) All categories of law are covered by the bar — from the highest (constitutional amendments) to the humblest (bye-laws); and all executive Orders and Notifications are equally covered Article 13(2).

(c) All laws in force under Article 372 and all laws to be brought into force at any future date are brought within the scope of the bar.

(d) The effect of the bar is to render the law absolutely void, so as to leave no room for the U.S. theory of a law being “relatively void”Behram Khurshed Pesikaka v. State of Bombay, (1955) 1 SCR 613, 651-4.

To say that Article 13(2) is superfluous in the context of the alleged power to take away Fundamental Rights by constitutional amendments, is to beg the question. The primary purpose of Article 13(2) is to prohibit the making of any law, including constitutional law, which takes away or abridges Fundamental Rights. The Preamble makes it clear that the object of the Constitution is to secure the basic human freedoms, and this security or guarantee would be meaningless if the legislatures against whom the guarantees operate is itself at liberty to abrogate the guarantees.

II. Constitution as by law established

It is clear beyond doubt, and is admitted in the minority judgments in the Golak Nath case, (1967) 2 SCR 762, at 907 and 930, and in the earlier judgments in the Sankari Prasad case, 1952 SCR 89 at 106, and the Sajjan Singh case, (1965) 1 SCR 933 at 950-1, that the word ‘law’ is comprehensive enough to include both ordinary law and constitutional law. But it is sought to be argued that —

(a) the result of an exercise under Article 368 is not a ‘law’, and

(b) that the word ‘law’ in Article 13(2) does not include constitutional law or constitutional amendment.

As regards argument (a) referred to above, it is submitted that the proposition that upon the procedure laid down in Article 368 being followed, the end-product is not a ‘law’, is erroneous.

The forms of oath in the Third Schedule refer to “Constitution as by law established”. These words postulate —

(a) that the Constitution itself was originally established by law; and

(b) that every amendment thereto has likewise to be established by law in order that it may take effect. This necessarily involves and implies that every Amending Act under Article 368 is a ‘law’.

The decisions of the Privy Council in McCawley v. King, 1920 AC 691 and The Bribery Commissioner v. Ranasinghe, 1965 AC 172, establish that constitutional amendment is a ‘law’, whether it is a controlled Constitution or whether there is a sovereign legislature under an uncontrolled Constitution.

As regards argument (b) noted above, it is submitted that there is no basis for the suggestion that the word ‘law’ in Article 13(2) has to be read in a restricted sense so as to exclude constitutional amendments. On the contrary, there are overriding considerations, set out below, which warrant the conclusion that the ‘law’ contemplated by Article 13(1) and (2) is every category of law, including constitutional law.

III. Article 13(1) covers constitutional law

Article 13(1) enacts that all laws in force immediately before the commencement of the Constitution are void to the extent of their inconsistency with the Fundamental Rights. Article 395 repealed the Indian Independence Act, 1947, and the Government of India Act, 1935, but not the constitutional laws of the Indian States or some other constitutional laws of British India. The Privy Purse caseMadhav Rao Scindia v. Union of India,2 establishes that the Covenants and the Merger Agreements entered into by the Rulers with the Dominion of India were constitutional law; in fact, they have been called in the aforesaid case “Constitutions in little”. These Covenants and Merger Agreements were in force at the commencement of the Constitution and they continued to remain in force. Further, in some of the States, the line between constitutional law and non-constitutional law was blurred, since the Ruler has absolute powers to take any legislative or executive action. Several laws of Indian States, constitutional as well as ordinary, continued after the commencement of the Constitution under Article 372:

See AIR 1960 Supreme Court 1312, Paras 3 and 15: (1961) 1 SCR 957, 962-3: AIR 1954 Supreme Court 680: 1953 SCR 404, 412.

It is fairly clear that such constitutional laws, which stood unrepealed, would be void under Article 13(1) to the extent of their inconsistency with Fundamental Rights. This means that the expression “all laws in force” in Article 13(1) would include constitutional law. The word ‘law’ in Article 13(2) could not have a different meaning. Therefore, the word ‘law’ in Article 13(2) included constitutional amendments.

It is further submitted that even assuming there had been no constitutional laws in force at the commencement of the Constitution which would be void under Article 13(1), that would be merely a fortuitous circumstance and would not derogate from the validity of the proposition that the word ‘law’ in ‘Article 13(1) and the word ‘law’ in Article 13(2) included constitutional law. Since quite obviously all former constitutional laws throughout India were not repealed by Article 395, it must be held that when drafting Article 13(1) it was intended that the former constitutional laws should be hit by that Article.

IV. No limitation on the word law in Article 13(2)

The Preamble, the scheme of the Constitution, the historical background, the intrinsic evidence of the solemn guarantees in Part III as well as the intrinsic evidence in other provisions dealing with constitutional amendments, all lead to the inference that the word ‘law’ in Article 13(2) was used in its ordinary sense as embracing constitutional law and there is no reason for reading the word in a restricted sense so as to confine it to ordinary laws. The Petitioner’s argument merely requires the word ‘law’ to be used in its ordinary sense without the addition of any limiting words.

The real question is not whether there are any words of limitation in Article 368, but whether there are any words of limitation in Article 13(2). The minority decisions in the Golak Nath case, which refuse to read a limitation upon the words of Article 368 overlook that their own view reads a limitation upon the wide word ‘law’ in Article 13(2). If a limitation has to be read in either of these two Articles, there is no reason why it should be read in such a way as to enable Parliament to destroy Part III which is the foundation on which the fabric of the Constitution is reared.

V. Constitutional amendments under Articles 4 and 169 and Schedules V and VI

The argument that the word ‘law’ in Article 13(2) excludes constitutional law or constitutional amendment, is inconsistent with the scheme of the Constitution. The Parliament has power under Articles 4 and 169, and Para 7 of Schedule V and Para 21 of Schedule VI, to make amendments to the Constitution by a bare majority and without following the procedure laid down in Article 368. If the word ‘law’ in Article 13(2) does not cover constitutional amendments ex hypothesi it would not cover constitutional amendments made under the aforesaid provisions of the Constitution by a bare majority. The consequences of this view are so starting as to be patently unacceptable:

(a) If Article 13(2) does not operate as a bar, then under Article 4 read with Article 2 or 3 Parliament would have the power to create a new State and amend the Fourth Schedule so as to give the new State no representation in the Council of States or a representation which is indisputably unfair and which denies to the inhabitants of that State equality before the law as compared to the inhabitants of other States.

(b) If Article 13(2) does not apply, amendments could be made in the Fifth Schedule which deals with the administration of Scheduled Areas, to provide that none of the Fundamental Rights shall apply to the Scheduled Areas. Or, a provision could be made in Para 5 of the Fifth Schedule that the Governor shall have the power to make regulations denying to Scheduled Tribes the right to move freely throughout the territory of India and confining them to certain ghettos as Negroes are confined in South Africa, or denying the Scheduled Tribes all religious freedom and prohibiting them from worshipping their Tribal Gods.

(c) The Sixth Schedule which deals with the administration of Tribal Areas in Assam could likewise be amended to enable laws to be made or executive action to be taken in those areas, which may be patently inconsistent with Fundamental Rights.

Thus on the Respondent’s construction of the word “law” in Article 13(2) as excluding constitutional amendments, Parliament would have the power to reduce the Scheduled Tribes under the Fifth Schedule and the Assam Tribes under the Sixth Schedule to the level of second-class citizens and deny them the most elementary civil liberties — and that too by legislation passed by a bare majority like any ordinary law. The Constitution is reduced to an absurdity when an ordinary law of Parliament passed by a bare majority injuriously affecting the aforesaid Tribes would be void as violating Fundamental Rights; but the same law passed by the same bare majority and by exactly the same procedure would be valid if it seeks to incorporate those violations in Schedule V or VI. Correctly speaking, there is no difference between ordinary legislative power and constituent power in such a case. The Indian Constitution is undoubtedly a controlled Constitution. To say that under a controlled constitution a law prohibited by constitutional limitations can yet be passed as a constitutional amendment by a bare majority, is a contradiction in terms.

It is submitted that this is a conclusive argument which clinches the issue. Article 13(2) has necessarily to be read as including constitutional amendments made, for example, in exercise of the power conferred by Para 7 of Schedule V and Para 21 of Schedule VI. If such constitutional amendments were covered by the word ‘law’ in Article 13(2), it must obviously follow that constitutional amendments under Article 368 were also included and that the word ‘law’ in Article 13(2) embraced all constitutional amendments as much as ordinary law.

It is significant to note that even the 24th Amendment has merely added the following clause to Article 13:

“(4) Nothing in this Article shall apply to any amendment of this Constitution made under Article 368.”

This means that constitutional amendments under Articles 4 and 169, Para 7 of the Fifth Schedule and Para 21 of the Sixth Schedule are still within the ambit of Article 13; and consequently the word ‘law’ in Article 13(2) did include and continues to include constitutional amendments.

VI. Consequences of the contrary view

If constitutional law is not covered by the word “law” in Article 13(2), the integrity of India and the “unity of the nation” referred to in the Preamble would be directly at stake. The Fundamental Rights could be amended so as to make them applicable to certain parts of India and not to others, to certain communities of India and not to others. Overtly favourable treatment could be given to the members of a political party, as is done in several other countries, and not to the rest of the citizenry. The South would be at the mercy of the North; minorities at the mercy of the majority; secularism at the mercy of religious fanaticism; and the process of disintegration of the Republic could well begin. The Petitioner’s submission, giving a fair and natural meaning to the word ‘law’ in the context of Article 13(2), denies to Parliament the power of reducing the Constitution to a caricature of its present self.

If Parliament has an unfettered power of amendment, as claimed by the Respondent, even the two-thirds majority in Article 368 could be reduced to a bare majority, and the Fundamental Rights would thereafter be without any safeguard whatsoever. Alternatively, an amendment could be made in Part III to provide that if a Parliamentary Act or a State law starts with a declaration that the Fundamental Rights shall not apply to that law, such a law cannot be challenged on the ground of violation of any of the Fundamental Rights. In fact, the 25th Amendment is one category of such a law.

VII. Evidence of proceedings before the Constituent Assembly

The proceedings before the Constituent Assembly support the Petitioner’s viewpoint:

(a) On April 29, 1947, an interim report on Fundamental Rights was placed before the Constituent Assembly and there was a debate on that interim report (see Constituent Assembly Debates, Vol III, pp. 399 to 436). On April 29, 1947, Shri K. Santhanam moved an amendment in Clause 2 which corresponded to the present Article 13 as follows:

“Shri K. Santhanam: Sir, I gave notice of an amendment but I will move it in a somewhat modified form in terms of a suggestion made by Sardar Patel. I move that in Clause 2 for the words ‘nor shall the Union or any unit make any law taking away or abridging any such right’, the following be substituted:

‘Nor shall any such right be taken away or abridged except by an amendment of the Constitution.’

The only reason is that if the clause stands as it is then even by an amendment of the Constitution we shall not be able to change any of these rights if found unsatisfactory or inconvenient. In some Constitutions they have provided that some parts of the Constitution may be changed by future constitutional amendments and other parts may not be changed. In order to avoid any such doubts I have moved this amendment and I hope it will be accepted.

The Hon’ble Sardar Vallabhbhai Patel: Sir, I accept the amendment” (Constituent Assembly Debates, Vol. III, pp. 415-6).

In the draft prepared by the Constitutional Advisor in October 1947, Clause 9(2) corresponding to the present Article 13(2) was so worded as to exclude constitutional amendments from being rendered void under that article:

“(2) Nothing in this Constitution shall be taken to empower the State to make any law which curtails or takes away or which has the effect of curtailing or taking away any of the rights conferred by Chapter II of this Part except by way of amendment of this Constitution under Section 232 and any law made in contravention of this sub-section shall, to the extent of the contravention, be void.

But the Drafting Committee omitted the words excluding constitutional amendments, and in the draft Constitution as settled by the Drafting Committee, constitutional amendments were not excluded from the bar of Clause 8(2) corresponding to the present Article 13(2):

“(2) The State shall not make any law which takes away or abridges the rights conferred by this Part and any law made in contravention of this clause shall, to the extent of the contravention, be void;”

(b) Pt. Jawaharlal Nehru referred to Fundamental Rights as “something that you want to make permanent in the Constitution” and Dr. Ambedkar referred to them as being excluded from the ambit of Article 368 (1967 Vol. 2 SCR 762 at 791-2)(SeeConstituent Assembly Debates, Vol. III, pp. 465-6 andConstituent Assembly Debates, Vol. IX, p. 1661).

(c) All the living members of the Committee of the Constituent Assembly, which was entrusted with the task of drafting the Chapter on “Fundamental Rights”, are unanimously of the view that they intended the Fundamental Rights to be beyond the reach of parliamentary majorities. (Writ Petition No. 135 of 1970, Vol. II, pp. 99-100).

VIII. Inalienable natural rights

The Fundamental Rights, with very few exceptions, are inalienable natural rights. Since the rights embodied in Part III are inalienable, it must necessarily follow that they cannot be taken away by Parliament by law, whether the law is entitled “Constitution Amendment” or is labelled as ordinary law.

“The very purpose of a Bill of Rights was to withdraw certain subjects from the vicissitudes of political controversy, to place them beyond the reach of majorities and officials and to establish them as legal principles to be applied by the courts. One’s rights to life, liberty and property, to free speech, a free press, freedom of worship and assembly, and other Fundamental Rights may not be submitted to vote; they depend on the outcome of no elections.” Per Jackson in West-Viginia State Board of Education v. Barnette, (1943) 87 L Ed 1628 at 1638: 319 U.S. 624 at 638.

“The great purposes of the Constitution do not depend on the approval or convenience of those they restrain.” Jackson, Erresonv. Board of Education, 330 US 1, 28.

“Man being what he is, cannot safely be trusted with complete immunity from outward responsibility in depriving others of their rights. At least such is the conviction underlying our Bill of Rights.” Frankfurter: Joint Antifascist Ref. Comm.v. McGrath, 341 US 123, 171.

“Our protection against all kinds of fanatics and extremists, none of whom can be trusted with unlimited power over others, lies not in their forbearance but in the limitations of our Constitution.” Jackson:American Comm. Assn.v. Douds, 339 US 382, 439.

When we are dealing with the Fundamental Rights, “we are dealing with principles of liberty and justice ‘so rooted in the traditions and conscience of our people as to be ranked as fundamental’ — something without which ‘a fair and enlightened system of justice would be impossible’.” Frankfurter: West Va. State Board of Education v. Barnette, 319 US 624, 652.

If the basic human rights are to be fundamental and not fragile, it is impossible to hold that they can be abolished by an Act of Parliament merely by being called a Constitutional Amendment Act. A constitutional limitation would be no limitation at all if Parliament can do away with the limitation at its will. Constitutional guarantees which are away from extinction only by a bare majority or a two-thirds majority of a five-year Parliament are no guarantees at all.

Further, the opposite view involves the inexplicable anomaly that a five-year Parliament which even by a unanimous vote cannot abridge a single Fundamental Right by ordinary law, can repeal by a requisite majority the entire Chapter on Fundamental Rights merely by calling the law a Constitutional Amendment.

IX. Freedoms reserved by the people for themselves

Our Constitution is given by the people, in the exercise of their sovereignty unto themselves:

1954 SCR 541 at 555;

(1960) 3 SCR 250 at 281-2.

The Fundamental Rights are merely the expression of the basic freedoms reserved by the people for themselves:

(1967) 2 SCR 762 at 792;

1950 SCR 88 at 198.

If the freedoms are reserved by the people for themselves, all the functionaries and agencies under the Constitution have to respect those freedoms and, ex hypothesi, no functionary or agency can destroy those freedoms.

X. Reference to the State in Article 13(2)

Article 13(2) imposes a limitation on the power of “the State” which is a term of the largest possible import. The significance of the word “State” is vital to the present case. Part III gives protection to the citizen and guarantees him the basic human rights against the totality of all the forces of the State. If the State in its most comprehensive sense cannot make a law to take away or abridge Fundamental Rights, Parliament which is only one of the functionaries or agencies of the State cannot pass such a law under Article 368. In other words, when the State, i.e. the totality of all the legislative and executive forces throughout India, is interdicted from passing a certain law, it is not possible to exclude or exempt constitutional amendments. The all-comprehensive concept of the State harmonises with the all-comprehensive concept of the ‘law’ in Article 13(2). The juxtaposition contemplated by Article 13(2) is not of “Parliament” and “ordinary law”, but of all agencies comprised in the State and all branches of the law.

XI. Fundamental Rights exist even in times of Emergency

Even in times of crisis when a Proclamation of Emergency is issued, all Fundamental Rights continue to be in force except those dealt with by Article 19, and even the provisions of Article 19 are merely suspended and not abrogated during the period of Emergency (Article 358). Further, when the Proclamation of Emergency is in operation, the President has the power under Article 359 to suspend the enforcement of the Fundamental Rights in a court of law, but the Rights continue to exist and can be enforced after the Emergency ceases. It is inconceivable that the same Constitution which intended the Fundamental Rights to remain in existence even during the period of Emergency, at the same time intended to empower any five-year Parliament to take away those Rights altogether in normal times.

Propositions on behalf of the Petitioner on the point that in the exercise of its amending power under Article 368, Parliament cannot alter or destroy the essential features of the Constitution:

1. It has been already submitted that just as there are inherent and implied limitations on the legislative power to make ordinary laws, e.g. the unexpressed limitation which disentitles the legislature to encroach upon the judicial domain, —

(1971) 1 SCR 288, 294-7: (1970) 2 SCC 280;

(1970) 3 SCR 745, 751: (1970) 1 SCC 509;

(1970) 1 SCR 388, 392-3: (1969) 2 SCC 283;

(1967) 1 AC 259, 287, 288, 290 (PC);

1940 IR 136.

1950 IR 67.

Lane’s: The Australian Federal System1972, pp. 4, 94-5.

there are, likewise, inherent and implied limitations on the other species of legislative power, i.e. the power to make amendments to the Constitution.

2. These inherent and implied limitations disentitle Parliament to alter or destroy any of the essential features, basic elements or fundamental principles (hereinafter called “the essential features” or “essential elements”) of the Constitution. However, Parliament may amend them without altering or destroying them.

3. The principle of inherent or implied limitations on Parliament’s power to amend a controlled Constitution stems from three basic features which, by definition, must be present in every controlled Constitution of a Republic:

(a) The ultimate legal sovereignty resides in the people.

(b) Parliament is only a creature of the Constitution.

(c) The power to alter or destroy the essential elements of a Constitution is an attribute of ultimate legal sovereignty.

If Parliament has the power to destroy the essential elements, it would cease to be a creature of the Constitution, the Constitution would cease to be controlled, and all the other institutions and authorities under the Constitution would be entirely at the mercy of a single institution, viz. Parliament.

A power given by the Constitution cannot be construed as authorising a destruction of other powers given in the same instrument — and this rule applies a fortiori to the power of amendment.

4. It is true that the borderline cannot be precisely drawn between amendments which would be valid and those which would be invalid on the principle that the essential features are beyond Parliament’s amending power; nor would it be possible to specify exhaustively the amendments which would be invalid on that principle. But that is no argument against accepting the aforesaid principle:

“. . .In modern times opinions have sometimes been expressed to the effect that natural justice is so vague as to be practically meaningless. But I would regard these as tainted by the perennial fallacy that because something cannot be cut and dried or nicely weighed or measured therefore it does not exist. The idea of negligence is equally insusceptible of exact definition, but what a reasonable man would regard as fair procedure in particular circumstances and what he would regard as negligence in particular circumstances are equally capable of serving as tests in law, and natural justice as it has been interpreted in the courts is much more definite than that. . . .”

Per Lord Reid, Ridge v. Baldwin, 1964 AC 40 at 64-5.

“But such a lack of generality in criminal legislation need not, of itself, involve the judicial function, and Their Lordships are not prepared to hold that every enactment in this field which can be described as ad hominem and ex post facto must inevitably usurp or infringe the judicial power. Nor do they find it necessary to attempt the almost impossible task of tracing where the line is to be drawn between what will and what will not constitute such an interference. Each case must be decided in the light of its own facts and circumstances, . . .”

Per Lord Pearce, Liganage v. Queen, (1967) 1 AC 259 at 289-90.

In re Delhi Laws Act, 1912, 1951 SCR 747, this Hon’ble Court held that the essentials of a legislative function could not be delegated, although it is not possible to enumerate precisely what those essential principles are nor is it possible to specify exhaustively those elements of legislation which cannot be delegated.

5. The following are some of the essential features of the Constitution:

(i) The supremacy of the Constitution. Ours is a controlled “Constitution” par excellence. All institutions, including Parliament, are merely creatures of the Constitution and none of them is its master.

(ii) The Sovereignty of India. This country cannot be made a satellite, colony or dependency of any foreign country.

(iii) The integrity of the country. The unity of the nation, transcending all the regional, linguistic, religious and other diversities, is the bed-rock on which the constitutional fabric has been raised.

(iv) The democratic way of life, which connotes much more than merely the people’s right to vote and elect representatives to power. In totalitarian, authoritarian and Fascist countries also, the people have such a right to vote and elect, but the equal freedom to choose between different parties and the freedom to oppose are denied.

(v) The Republican form of Government. India cannot be transformed into a monarchy.

(vi) The guarantee of basic human rights to all its citizens to ensure JUSTICE, social, economic and political; LIBERTY of thought expression, belief, faith and worship; EQUALITY of status and of opportunity. These rights are categorised and elaborated as Fundamental Rights in Part III of the Constitution. Parliament cannot damage or abrogate the essence of any of these rights. (See, further, the Annexure.)

(vii) A secular State, that is, a State in which there is no State religion.

(viii) A free and independent judiciary. Without it, all other rights would be writ in water.

(ix) The dual structure of the Union and the States. Entries in the Legislative Lists or other powers may be transferred from the Union to the State or vice-versa, but not so as to imperil the existence of either the Union or the States.

(x) The balance between the legislature, the Executive and the judiciary. None of the three organs can use any of its power to destroy the powers of the other institutions, nor can any of them abdicate its power in favour of another.

(xi) A Parliamentary form of Government as distinct from a Presidential form of Government.

(xii) The amendability of the Constitution as per the basic scheme of Article 368. That article itself can be amended but not so as to destroy its basic scheme. For instance, Article 368 cannot be amended so as to —

(a) empower Parliament to alter or destroy any of the essential features of the Constitution;

(b) make the Constitution literally or practically unamendable;

(c) make it generally amendable by a bare majority in Parliament;

(d) confer the power of amendment either expressly or in effect on the State legislatures;

(e) delete the proviso and deprive the States of the power of ratification which is today available to them in certain broad areas.

ANNEXURE 
The Historical Background regarding Fundamental Rights

The historical background is of great importance. The difference in basic approach, which results in some Constitutions having guaranteed fundamental rights and others not having them, “may be traced mainly to the spirit and genius of the nation in which a particular Constitution has its birth” (See McCawley v. King, 1920 AC 691 at 703). The history of India prior to the promulgation of the Constitution, has perhaps not been paralleled in its essential features in any other country:

(a) For several decades the national leaders had been struggling to achieve independence and had envisaged a Constitution for free India which would provide basic human rights which could not be withdrawn under any circumstances. (See Granville Austin’s: “The Indian Constitution: Corner-stone of a Nation“, pp. 52-59, reproduced in the Compilation filed on 23rd November, 1972).

(b) India was to become a free democracy for the first time in its 5000 years old history. Since freedom had not become a way of life in this country, the basic human rights had to be carefully protected and preserved.

(c) The country was welded together into one nation under one Central legislature for the first time in its history. The fundamental rights represented the solemn balance of rights between citizens from various parts of India, “the fundamental conditions on whichinter se they accepted the Constitution” (Cf. Bribery Commissioner v. Pedrick Ranasinghe, 1965 AC 172 at 193-4).

(d) A sense of security and safety had to be created in the minds of the people when there were such tremendous diversities of religion, race, caste, creed, language, culture, etc., particularly in the minds of the religious and linguistic minorities.

(e) Economic and political thinking in the country ranged from antiquated feudalism to extreme leftism, and the necessity arose of putting the Fundamental Rights beyond the reach of the party in power and the State.

Since the question essentially is as to the intention of the founding fathers of the Constitution — did they intend that Parliament should have the power to destroy fundamental rights? — the above background is not only relevant but significant on the question as to the real intention.

The makers of the Constitution had a large number of foreign models before them in which there were provisions for amending the essential features of the Constitution by means of Referendum and other modes of ascertaining the wishes of the people in whom the ultimate legal sovereignty resides. The absence of any such provision in our Constitution clearly shows that the founding fathers of our Constitution did not want to provide in the original Constitution itself any channel for altering or destroying the basic constitutional structure. It is inconceivable that they intended to empower Parliament to destroy any of the essential features of the Constitution. In particular, it is inconceivable that after having provided the most complete and comprehensive guarantees of the basic human freedoms known to any Constitution of the world, the Constitution-makers still intended that any Parliament for the time being in session may take away or abridge all or any of those basic freedoms.

  * * *

 

Propositions on behalf of the Petitioner on the necessity of taking into account the consequences of each of the rival contentions regarding the width of the power of amendment, the question of abuse of power being wholly irrelevant to the issue of the true scope of the power.

The word used in Article 368 is “amendment”, a word of ambiguous import and elastic ambit. The principle of inherent and implied limitations means deducing what is left unsaid from what is said, and perceiving what is implicit in the express provisions and scheme of the instrument. The entire attempt is to fathom the true intention of the Founding Fathers of the Constitution.

The submission of the Petitioner is that —

(a) according to one of the well-settled meanings of the word “amend”, the power of amendment in Article 368 does not comprise the power to alter or destroy any of the essential features, basic elements or fundamental principles of the Constitution (hereinafter called “essential features”);

(b) in any event there are inherent and implied limitations on the power.

The Respondents controvert both (a) and (b). They submit that the power of amendment comprehends the power to alter or destroy the essential features; that there are no inherent or implied limitations; and that the power is absolute and limitless.

Thus this Hon’ble Court has to decide upon; (i) the meaning of the word “amendment” and (ii) the existence of inherent and implied limitations. The conclusion on these two distinct questions would resolve the most crucial issue arising in the case —

the scope and width of the power of amendment.

In ruling on this most crucial issue, it is not only desirable but imperative to consider the consequences of the plea of limited power and also of the plea of limitless power. To form a value judgment on this central point while ignoring the consequences of each rival view, is to form no value judgment at all. The Constitution is an organic whole and presents an integrated scheme; and it is judicially impossible to determine the width of one power without considering its effect on other powers and institutions.

The test of the true width of a power is not how probable it is that it may be exercised, but what can possibly be done under it.

The question of abuse or misuse of power is entirely irrelevant. To say that taking into account consequences involves consideration of abuse of power is to confuse the extent of power with its exercise, and its scope with the manner of its use. When the question is as to the width of the power, the hope and expectation that it will never be used is as wholly irrelevant as an imminent danger of its use.

  * * *

 

Propositions on behalf of the Petitioner regarding the Constitution (Twenty-fourth Amendment) Act, 1971.

The Twenty-fourth Amendment has sought to achieve five results:

(i) It has inserted an express provision in Article 368 to indicate that the source of the amending power will be found in that Article itself.

(ii) It has made it obligatory on the President to give his assent to any Bill duly passed under that Article.

(iii) It has substituted the words “amend by way of addition, variation or repeal. . . . “in place of the bare concept of “amendment” in the original Article 368.

(iv) It makes explicit that when Parliament makes a constitutional amendment under Article 368 it acts “in exercise of its constituent power.”

(v) It has expressly, provided, by amendments in Articles 13 and 368, that the bar in Article 13 against abridging or taking away any of the Fundamental Rights should not apply to any amendment made under Article 368.

The petitioner does not dispute that the amendments covered by (i) and (ii) above are within the amending power of Parliament.

If the amendments covered by (iii) and (iv) above are to be construed as empowering Parliament to exercise the full constituent power of the people themselves, and as vesting in Parliament the ultimate legal sovereignty of the people, and as authorising Parliament to alter or destroy all or any of the essential features, basic elements and fundamental principles of the Constitution (hereinafter called “essential features”), the amendments must be held to be illegal void.

Likewise if the amendment covered by (v) above is construed as authorising Parliament to damage or destroy the essence of all or any of the Fundamental Rights, the amendment must be held to be illegal and void.

If the aforesaid construction is correct, it is submitted that the Twenty-fourth Amendment would be void and illegal for the following reasons:

(1) A creature of the Constitution cannot increase its own constituent power

The limited power of Parliament to amend the Constitution conferred by Article 368 prior to the Twenty-fourth Amendment is hereinafter referred to as “the constituent power”.

A creature of the Constitution, as the Parliament is, can have only such constituent power as is conferred by the Constitution which is given by the people unto themselves. While purporting to exercise that constituent power, Parliament cannot increase that very power. No doubt, Parliament had the power to amend Article 368 itself, but that does not mean that Parliament could so amend Article 368 as to change its own constituent power beyond recognition. A creature of the Constitution cannot enlarge its own power over the Constitution, while purporting to act under it, any more than the creature of an ordinary law can enlarge its own power while purporting to act under that law. The power of amendment cannot possibly embrace the power to enlarge that very power of amendment, or to abrogate the limitation, inherent or implied, in the terms on which the power was conferred. The contrary view would reduce the whole principle of inherent and implied limitations to an absurdity.

(2) A creature of the Constitution cannot arrogate to itself the power to alter or destroy the essential features of the Constitution

In any view of the matter, Parliament as a functionary created under the Constitution had no competence so to amend the Constitution as to empower itself to alter or destroy the essential features of the Constitution. If the Twenty-fourth Amendment does confer such a power on Parliament, it would mean that, instead of the Constitution continuing to be supreme, it is now Parliament which is supreme and the Constitution is made subservient. In other words Parliament which is constituted under the Constitution has purported to make itself the master of the Constitution instead of being the functionary or creature of the Constitution as it was before the amendment, and has converted the controlled Constitution into an uncontrolled Constitution.

On the aforesaid construction, what Parliament has actually purported to do in the Twenty-fourth Amendment is to effect a silent revolution, since it has sought to overthrow the supremacy of the Constitution and make itself supreme. The fact that the revolution has been silent, peaceful and unperceived, does not make it anytheless a revolution. Revolution is the only word to denote the substitution of one supremacy for another and to indicate the transfer of the ultimate legal sovereignty from the people to Parliament which is sought to be done by the Twenty-fourth Amendment. “An attempt by the majority to change the fundamental law in violation of self-imposed restrictions is unconstitutional and revolutionary” (American Jurisprudence, Vol. II, Section 25, pp. 629-30).

(3) Parliament cannot abridge or destroy basic human rights and fundamental freedoms which were reserved by the people for themselves when they gave to themselves the Constitution

The Twenty-fourth Amendment purports to empower Parliament to take away or abridge all or any of the fundamental rights. This means that Parliament is made competent to destroy the basic human rights and the fundamental freedoms which were reserved by the people unto themselves when they gave themselves the Constitution and provided for the functioning of a Parliament. What is reserved by the people for themselves cannot possibly be destroyed by a functionary of the Constitution.

(4) Parliament cannot do indirectly what it was enjoined by the Constitution not to do directly

On a proper reading of the word “amendment” in Article 368 as it stood originally and also on the principle of inherent and implied limitations, Parliament had no power to alter or destroy any of the essential features of the Constitution. If this is the correct position under the Constitution as given by the people unto themselves, it must necessarily follow that Parliament cannot abrogate the limits of its own constituent power. It cannot do in two stages what it could not do in one stage. It cannot first repeal the limitations on its own constituent power and then purport to do what was forbidden by those limitations.

ALTERNATIVE SUBMISSION REGARDING THE TWENTY-FOURTH AMENDMENT

Without prejudice to the above and in the alternative, it is submitted that if the Twenty-fourth Amendment is at all to be held valid, it can only be on a “reading down” of the amended provisions of Articles 13 and 368, which reading would preserve the original inherent and implied limitations on the constituent power. The restricted reading would be that even after the Twenty-fourth Amendment —

(a) Parliament would have no power to alter or destroy the essential features of the Constitution;

(b) fundamental rights are among the essential features of the Constitution and, therefore, the essence of any of the fundamental rights cannot be altered or destroyed even when they are sought to be abridged.

It is submitted that if this Hon’ble Court is at all pleased to hold the Twenty-fourth Amendment to be valid, it should only be on the aforesaid restricted interpretation which would permit amendments only within the basic framework of the Constitution in which all the essential features are preserved.

There are clear authorities for the proposition that the Court may “read down” a statute in order to bring it within the competence of the authority enacting it, when on a wider construction the Statute would have to be held void as being beyond the law-making authority’s competence.

In re:

The Hindu Womens Rights to Property Act, 1941 FCR 12 at 26-32; R.M.D. Chamarbaugwalla v. Union, 1957 SCR 930 at 936-39; Kedarnath Singh v. State of Bihar, 1962 Supp 2 SCR 769 at 810-11; Arora v. State of U.P., (1964) 6 SCR 784 at 797; Shah & Co.v. State of Maharashtra, (1967) 3 SCR 466 at 477; Seshammal v. State of Tamil Nadu, (1972) 2 SCC 11 at 22-25.

Such restricted construction is possible in the present case for the following reasons:

(a) In a broad sense the expression “constituent power” may include the power to amend the Constitution, whether the amending power is limited or unlimited.

(b) While the words “amend by way of addition, variation or repeal” are, generally speaking, words of wide import, in a given context they are capable of being read as not authorising the alteration or destruction of essential features. In other words, these newly inserted words are not necessarily inconsistent with the limitation which enjoins the preservation of essential features, although in other contexts they may well comprehend changes in or abrogation of the essential features. In short, these newly inserted words may involve, but do not necessarily involve, the power to abrogate or destroy the essential features.

(c) The lifting of the bar of Article 13(2) against amendments under Article 368 is again not necessarily inconsistent with the essential features being beyond the amending power. If the bar in Article 13(2) is validly lifted, it can mean that Parliament can abridge any of the fundamental rights but not so as to damage or destroy the essence or core of any of those rights.

(d) The whole point about implied and inherent limitation is that they apply where the empowering words are seemingly wide enough to cover what the limitations prohibit. On the original Article 368, two submissions have been made on behalf of the Petitioner —

(i) the bare word “amendment” is not to be read in the wide sense of “amendment by way of addition, variation or repeal”, and

(ii) even if it is to be read in the aforesaid wide sense, the inherent and implied limitations would still apply.

In other words, if the bare word “amendment” in the original Article 368 were to be read in the wide sense of “amendment by way of addition, variation or repeal”, even then the implied and inherent limitations would have cut down the scope of the amending power prior to the Twenty-fourth Amendment. It is clear that since the inherent and implied limitations would have applied even if what is now enacted explicitly was implicit in the bare word “amendment”, they apply with equal vigour after the change in the language of Article 368.

The inherent and implied limitations can be ruled out only by express words to the contrary. They would cease to apply only if there were compelling words, e.g., an express power conferred on Parliament to alter or abrogate any of the essential features of the Constitution. In that event the Court would have no option but to strike down the conferment of such a power.

ADDITIONAL PROPOSITIONS ON BEHALF OF THE PETITIONER ON 
THE CONSTITUTION (TWENTY-FOURTH AMENDMENT) ACT, 
1971, REGARDING THE LIFTING OF THE BAR IMPOSED 
BY ARTICLE 13(2)

1. First submission

Article 13(2), as it stood before the Twenty-fourth Amendment, had two elements—

(i) the bar against the State making any ordinary law which abridges or takes away any of the fundamental rights; and

(ii) the bar against any constitutional amendment which abridges or takes away any of the fundamental rights.

The first bar is an essential feature of the Constitution and it has been left untouched by the Twenty-fourth Amendment.

The second bar is also an essential feature of the Constitution. The effect of the bar is that while Parliament may add to or amend the fundamental rights, the amendment cannot take the form of abridgment or taking away of any of the fundamental rights. Since the bar against such constitutional amendments is an essential feature of the Constitution, the purported lifting of the bar by the Twenty-fourth Amendment is illegal and void.

II. Second submission in the alternative

An argument may be urged as follows: To distinguish the second bar from the first and to hold that while the first is an essential feature of the Constitution, the second is not. The first is an essential feature, since it is clearly basic to the constitutional scheme that the State should be restrained from abridging or taking away any of the fundamental rights, But the second bar stands on a different footing, since in the working of the Constitution, Parliament may find it necessary to abridge a fundamental right without damaging or destroying its core or essence and in that event it may propose to lift the second bar of Article 13(2) in the exercise of its amending power. Since each fundamental right is itself an essential feature and its core or essence cannot be destroyed or damaged in the exercise of the amending power, no damage could be done to the core and essence of any of the Fundamental Rights by the lifting of the second bar. In other words, it may be urged that the Fundamental principles underlying the original Constitution are the following:

(a) Subject to (b) dealt with below, the “State” as defined in Article 12 should be powerless to abridge or take away any of the Fundamental Rights;

(b) Parliament in the exercise of its amending power should be powerless to damage or destroy the core or essence of any of the Fundamental Rights, and even if it assumes the power to amend any of them, the amendment should not reach the point of such damage or destruction.

In this view of the matter, it would be possible to decide the present case entirely on the principle of inherent and implied limitations and the true construction of the words of Article 368 conferring the amending power, without any reference to Article 13(2) at all.

Without prejudice to the first submission and in the alternative, the Petitioner submits that if the aforesaid second bar against constitutional amendments imposed by Article 13(2) is held not to be an essential feature of the Constitution, then the position after the Twenty-fourth Amendment is as follows:

(a) The provision of the Twenty-fourth Amendment, lifting the bar in Article 13(2) against constitutional amendments under Article 368, should be held to be valid.

(b) However, the bar would continue to apply against constitutional amendments made under other provisions of the Constitution namely Articles 4, 169, 244-A, Para 7 of the Fifth Schedule, and Para 21 of the Sixth Schedule. Any constitutional amendments made under any of these provisions would have to observe the bar of Article 13(2), and such amendments cannot abridge or take away any of the Fundamental Rights. The reason is that it is only amendments made under Article 368 which are exempted from the application of Article 13(2) by the Twenty-fourth Amendment. This difference may be justified on the ground that whereas under Article 368 a special majority is necessary, under the other amending provisions only a bare majority of Parliament is sufficient.

(c) The power to amend the Constitution under Article 368 continues to be subject to the inherent and implied limitations which prevent Parliament from altering, damaging or destroying any of the essential features of the Constitution. Every Fundamental Right is an essential feature of the Constitution. The net result is that a constitutional amendment under Article 368 may abridge a fundamental right but if after the lifting of the bar in Article 13(2), the degree of abridgment is such as to damage or destroy the essence or core of that right, the constitutional amendment would be illegal and void.

Propositions on behalf of the Petitioner regarding the Constitution (Twenty-fifth Amendment) Act, 1971.

The ground for holding the 25th Amendment illegal and void is that, as already submitted, even if the 24th Amendment is held to be valid, it can only be on a restricted interpretation of the power of amendment conferred on Parliament by Article 368 as altered by the 24th Amendment. The restricted the interpretation would be that even after 24th Amendment and even if the bar of Article 13(2) was validly lifted, the inherent and implied limitations continue to attach to Parliament’s amending power under Article 368 with the result that —

(a) Parliament would have no power to alter, damage or destroy the essential features of the Constitution; and

(b) each fundamental right being an essential feature of the Constitution, no constitutional amendment can damage or destroy the essence or core of any of the Fundamental Rights.

It is in the light of this legal position that the validity of the 25th Amendment has to be considered.

The 25th Amendment has made three material changes:

(i) It has amended Article 31(2) in two respects —

(a) it substitutes the word “amount” for the concept of “compensation” for property acquired or requisitioned; and

(b) it has provided that the acquisition or requisition law shall not be called in question on the ground that the whole or any part of the “amount” is to be given otherwise than in cash.

(ii) it has provided that the fundamental right to acquire hold and dispose of property under Article 19(1)(f) cannot be invoked in respect of any such law as is referred to in Article 31(2).

(iii) It has inserted Article 31-C as an overriding Article which makes the various fundamental rights conferred by Articles 14, 19 and 31 in-applicable to certain categories of laws passed by Parliament or by any State legislature.

It is submitted that all the amendments covered by (i), (ii) and (iii) above, damage or destroy the essence or core of the fundamental rights which they deal with; and consequently the whole of the 25th Amendment Act is illegal and void.

The aforesaid three features of the 25th Amendment are dealt with below seriatim:

I. Amendment of Article 31(2)

It is submitted that the right to property is one of the essential features of the Constitution, like all the other fundamental rights. Further, it is the handmaid to various other fundamental rights. A very few examples may suffice to illustrate this point. The right to freedom of the Press under Article 19(1)(a) would be meaningless if a publisher could be deprived of his printing plant and the building in which it is housed without compensation. The fundamental right under Article 19(1)(c) to form trade unions would be denuded of its true content if the property of a trade union could be acquired by the State without compensation. The right to practise any profession or to carry on any occupation, trade or business under Article 19(1)(g) would be merely a right to do forced labour for the State if the net savings from the fruits of a citizen’s personal exertion are liable to be acquired by the State without compensation. The freedom of religion in Article 26 would lose a great deal of its efficacy if the institutions maintained by a community for its religious and charitable purposes could be acquired without compensation. The common man who may have put his life-savings in shares or in other forms of property is directly affected by the denial of the right to compensation. Under the amended Article 31 and amount may be fixed by the State on a basis which need not be disclosed even to members of the legislature which passes the law and which may have no relation to the value of the property sought to be acquired. In other words, the amended Article 31 in substance and effect authorizes confiscation of any citizen’s property, however small that property may be in value. Such a law which has nothing to do with concentration of wealth and permits any common citizen’s property to be virtually confiscated involves destruction of the essence or core of the right to property.

The other amendment of Article 31(2) is that even the “amount” which does not satisfy any of the principles of compensation need not be paid in cash but may be given in the form, say, of a promise to pay at a future date, and that cannot be made a ground of challenge to the validity of the law. This amendment amounts in effect to compounding the injustice. In these days of mounting inflation and the State tendency to repudiate even solemn constitutional guarantees, a Government’s promise to pay at a future date may be almost worthless. This part of the amendment serves to emphasise the point that the change in Article 31(2) effected by the 25th Amendment is really intended to authorise confiscation of the bulk of any property which a State may choose to acquire or requisition. It may be noted that Article 31(2) has nothing to do with estates, zamindaris, land reforms or agrarian reforms which are specifically dealt with by Article 31-A and to which Article 31(2) is wholly inapplicable.

II. Amendment to make Article 19(1)(f) inapplicable to acquisition and requisition laws

The right to acquire, hold and dispose of property under Article 19(1)(f) is subject under Article 19(5) to reasonable restrictions in the interests of the general public. Since all reasonable restrictions in the public interest are already permitted under Article 19(5), the only object of making Article 19(1)(f) inapplicable can be to enable acquisition and requisition laws under Article 31 to contain restrictions and provisions which are unreasonable or not in the public interest.

If Article 19(1)(f) applies, an acquisition or requisition law which permits a property to be taken without the owner being heard where the rules of natural justice would require the owner to be heard, would be void as offending that Article. See R.C. Cooper v.Union, (1970) 3 SCR 530 at 577: (1970) 1 SCC 248. But after the 25th Amendment, such rules of natural justice can be flagrantly violated and a man’s property can be acquired or requisitioned and the “amount” fixed, without giving him a hearing in cases where natural justice would require such hearing to be given; and the Land Acquisition Act can be amended to provide that any man’s land or house can be acquired without any notice to the owner to show cause against the acquisition or to prove what “amount” should be fairly paid to him for the property acquired. This clearly damages the essence or the core of the fundamental right under Article 19(1)(f) to acquire, hold and dispose of property.

III. Article 31-C which validates Constitution-breaking laws

Article 31-C damages or destroys the core or essence of at least seven essential features of the Constitution.

1. There is a fine but vital distinction between two cases —

(a) where the fundamental rights are amended to permit laws to be validity passed which would have been void before the amendment; and

(b) the fundamental rights remain unamended but the laws which are void as offending those rights are validated by a legal fiction that they shall not be deemed to be void.

The question is not one merely of legislative device. In the first case the law is constitutional in reality. In the second case the law is unconstitutional in reality but is deemed by a fiction of law not to be void; with the result that Constitution-breaking laws are validated and there is a repudiation or abrogation of the Constitution pro tanto.

If the second case is permissible as a proper exercise of the amending power, the Constitution would be reduced to a scrap of paper. If Article 31-C is valid, it would be equally permissible to Parliament so to amend the Constitution as to declare all laws to be valid which are passed by Parliament or State legislatures in excess of their legislative competence, or which violate any of the basic human rights enshrined in Part III or the freedom of inter-State trade in Article 301. It would be equally permissible to have an omnibus Article that “notwithstanding anything contained in the Constitution, no law passed by Parliament or any State legislature shall be deemed to be void on any ground whatsoever”. The insertion of only one such Article would toll the death-knell of the Constitution.

The true legal effect of Article 31-C is that it gives a blank charter to Parliament and all the State legislatures to defy and ignore the Constitution.

Article 31-C clearly damages or destroys the supremacy of the Constitution which is one of the essential features of the Constitution.

2. Article 31-C not only subordinates the fundamental rights to the Directive Principles of State policy but virtually abrogates the fundamental rights in respect of laws which the legislature declares to be for giving effect to the Directive Principles. One of the essential features of the Constitution is that the right to enforce the fundamental rights in the Court is guaranteed (Article 32), whereas the Directive Principles are not so enforceable (Article 37). The fundamental rights are clear-cut and precise, in contrast to the vague contours of the Directive Principles. To abrogate the fundamental rights when giving effect to the Directive Principles is to destroy one of the essential features of the Constitution. Ignorance and arbitrariness, injustice and unfairness, would hereafter not be open to challenge on the touchstone of the invaluable basic rights, if Article 31-C is valid.

3. It is one of the essential features of the Constitution that it can be amended only in the “form and manner” laid down in Article 368 and according to that Article’s basic scheme. (Cf. Trethowan case, 1932 AC 526). This essential feature is sought to be abrogated by Article 31-C. That Article has the effect of virtually authorizing abrogation of the fundamental rights while they still remain ostensibly on the Statute Book. The public criticism and debate which would be invoked by a proposal to abridge a particular fundamental right is avoided, although various fundamental rights are effectively silenced. The absurd situation is that, whereas an amendment of a single fundamental right would require a majority of at least 2/3rds of the members of Parliament present and voting (Article 368), a law falling within Article 31-C which overrides and violates several fundamental rights can be passed by a simple majority.

4. Every fundamental right is an essential feature of the Constitution. Article 31-C purports to take away a large number of these fundamental rights altogether in the field covered by that Article. It provides for the wholesale smothering of various rights which are independent of the right to property and are totally irrelevant to the Directive Principles laid down in Article 39(b) or (c). Even the rights to —

equality before the law;

freedom of speech and expression;

to assemble peaceably and without arms;

to form associations or unions;

to move freely throughout the territory of India;

to reside and settle in any part of the territory of India;

to practise any profession or to carry on any occupation, trade or business;

to retain property except when deprived by authority of law;

which are so vital for the survival of democracy, the rule of law, and the integrity and unity of the Republic, can be violated under Article 31-C under the cloak of avoiding concentration of economic power.

5. A citizen is not even permitted to raise the question whether the proposed law will result, or is reasonably calculated to result, in securing the Directive Principles laid down in Article 39(b) or (c). The wrong done to the people who are deprived of their basic freedoms is aggravated by protection to laws, which, in reality, may not be at all calculated to give effect to the Directive Principles. This would be so even on the basis that on a proper construction of Article 31-C, Article 39(b) or (c) must have direct relevance to the law and its subject-matter, because even in such a case a question may still arise whether the law is so framed or conceived that it will secure the Directive Principles in question.

One of the essential features of the Constitution is the right to move the Supreme Court for the enforcement of the other fundamental rights (Article 32). The essence of core of this right is gone when the fundamental rights are made unenforceable for the purpose of giving effect to the Directive Principles and at the same time the Court is precluded from considering whether the law is such that it can possibly secure the Directive Principles in question.

6. One of the essential features of the Constitution is that no State legislature can amend the fundamental rights or any other part of the Constitution. This essential feature is repudiated by Article 31-C which empowers even State legislatures to pass laws which virtually involve a repeal of the fundamental rights. The wholly irrational consequence is, whereas State legislatures cannot abridge a single fundamental right, it is now open to them to supersede a whole series of such rights. In substance, the power of amending the Constitution is delegated to all the State legislatures — which is not permissible under Article 368. See 1919 AC 935, 945 (PC); (1967) 2 SCR 650, 653-4, 659-60; 1951 Canada Law Reports Supreme Court, 31 at 37-38.

7. One of the essential features of the Constitution is the provision for the protection to minorities and their cultural and educational rights. The fundamental rights under Articles 14, 19 and 31 which are sought to be superseded by Article 31-C are necessary to make meaningful the specific rights of the minorities which are guaranteed by Articles 25 to 30. Under the guise of giving effect to Directive Principles, a number of steps can be taken which can seriously affect the position of regional, linguistic, cultural and other minorities.

The proviso inserted by the Twenty-fifth Amendment to Article 31(2) is very telltale. It expressly provides that where the property of an educational institution established and administered by a minority is acquired, the amount fixed for the acquisition should be such as not to restrict or abrogate the right guaranteed under Article 30(1). The clear implication is that when property is acquired in other cases, an amount can be fixed which restricts or abrogates any of the other fundamental rights — for instance, the rights to freedom of speech and expression Article 19(1)(a), to form associations or unions Article 19(1)(c), or to practise any profession or carry on any occupation, trade or business Article 19(1)(g), or the right of religious community to establish and maintain institutions for religious or charitable purposes (Article 26). Further, if a law violates the rights of the minorities under Articles 25 to 30, such a law would be no law at all and therefore deprivation of property under such a law would violate Article 31(1). But since Article 31(1) is one of the Articles abrogated by Article 31-C, minorities can be deprived of their properties, held privately or upon pubic charitable or religious trust, by a law which clearly violates their rights under Articles 25 to 30.

In conclusion, it would be no exaggeration to say that Article 31-C is a monstrous outrage on the Constitution. It has a built-in mechanism for the dissolution of the true democracy that India has been so far, cessation of the rule of law, disintegration of the nation, and the birth of a totalitarian regime.

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Propositions on behalf of the Petitioner regarding the true Construction of Article 31(2) substituted by the Constitution (Twenty-fifth Amendment) Act, 1971.

1. True construction of Article 31(2)

It is significant to note that before the 25th Amendment, Article 31(2) provided for the payment of compensation when any property was acquired or requisitioned for a public purpose and contained the provision inserted by the Fourth Amendment that the adequacy of such compensation should not be called in question in any court. The 25th Amendment substituted the word ‘amount’ for ‘compensation’.

The Petitioner submits that the true construction of Article 31(2) as substituted by the 25th Amendment involves the following:

(a) “Amount” is not a legal concept at all, unlike “compensation”. Therefore the will of the State is the only yardstick for fixing the amount. Thus the amount fixed may be such as may amount to virtual confiscation of the property or the bulk of it.

(b) The Supreme Court held in the Bank Nationalisation case, (1970) 3 SCR 530) that if the principles which were irrelevant to the concept of compensation were adopted, the law would be struck down. But that decision was with reference to the word “compensation” which appeared in Article 31(2) before the 25th Amendment. Since the word “amount” is not a legal concept at all, there is no basic norm by reference to which the relevance or irrelevance of principles can be judged.

(c) Since the amount fixed or the principles adopted may be arbitrary and may have no relation or relevance to the value of the property acquired, the essence or core of the right to property is damaged, if not destroyed, by Article 31(2).

(d) Not only does Article 31(2) virtually abrogate the right to property, but it can have a similar effect on the other fundamental rights, e.g. the rights enumerated in Article 19 and the rights of the minorities and of religious freedom (see the examples on page 3 of the Propositions on the 25th Amendment tendered on 8th December, 1972). This is made clear by the prouiso to Article 31(2) which has also been inserted by the 25th Amendment. The implication of that proviso is that the State may fix such an amount for acquisition of property as may restrict or abrogate any of the other fundamental rights the exercise of which would be affected by the deprivation of the property without just compensation — and the only exception to this power of the State is the case dealt with in the proviso of educational institutions established and administered by a minority referred to in Article 30(1).

It is submitted that what is stated above is the correct interpretation of Article 31(2) substituted by the 25th Amendment and that it must therefore be held to be void on the ground that it damages or destroys the core or essence of the right to property and of several other fundamental rights; and that “reading down” of the Article would not be proper.

II. Alternative submission regarding Article 31(2)

Without prejudice to the above and only in the event of this Hon’ble Court coming to the conclusion that Article 31(2) as substituted by the 25th Amendment should be held valid on a restricted interpretation, it is submitted that the restricted interpretation would have to proceed on the following basis:

(a) Article 31(2) still appears as a fundamental right by reference to which the validity of ordinary laws is to be judged. Therefore it must be read as providing a standard or measure. If the “amount” and the “principles” are entirely at the will or whim of the State, there would be no meaning in keeping Article 31(2) as a fundamental right and in making payment an essential feature of that fundamental right.

(b) The word “amount” is used in the context of a Constitution which specifically continues to provide in Article 19(1)(f) the right to acquire, hold and dispose of property. Further, the word “amount” occurs in Article 31(2) which provides not for expropriation or confiscation but for compulsory acquisition or requisition for a public purpose. Article 31(2) makes it a condition of the validity of the acquisition or requisition law that it must fix an amount or specify the principles for determining the amount. Article 31(2) embodies the principle of eminent domain which necessarily involves the obligation of the State to pay for what is taken. Therefore the amount must be such as would not abrogate the right to property, since such abrogation would be inconsistent with —

(i) the inherent and implied limitations on Parliament’s power under Article 368 to abrogate any fundamental right;

(ii) Article 19(1)(f) which preserves the right to property; and

(iii) the Statement of Objects and Reasons which does not indicate that the right to property was intended to be abrogated by the 25th Amendment.

Consequently, the true standard or measure is that the amount or the principles must have a reasonable relation to the property and its value. In short, the word “amount” which is literally amorphous crystallises into shape and form in the context of Article 31(2).

On the above interpretation, the right to property may be said to have evolved in the Indian Constitution through the following stages of dilution:

(i) Property could be taken by the State only on payment of full compensation, the adequacy of the compensation being justiciable. (This was the Constitution in its original form).

(ii) The State could take property on payment of “compensation” in the legal sense, although that compensation may be inadequate; the adequacy of the compensation being non-justiciable. (This stage was reached by the Fourth Amendment in 1955).

(iii) The State may take property for an amount which may not represent “compensation” in the legal sense, but which must have a reasonable relation to the value of the property taken and which would prevent the acquisition from amounting to confiscation or expropriation. (This is the effect of the 25th Amendment).

(c) The “principles” referred to in Article 31(2) would be such principles as are relevant and appropriate to the determination of such an “amount” as is referred to in (a) above. Just as principles which were irrelevant to the legal concept of “compensation” made the acquisition law invalid prior to the 25th Amendment, if any principles are adopted which are irrelevant to the concept of amount as explained in (a) above, the law would be invalid.

(d) Where the law itself fixes the amount, it may indicate the principles on which it has been arrived at, or the Court may enquire on what broad principles it has been fixed. The contrary view would involve the unacceptable position that Article 31(2) gives the option to the State either to specify principles which cannot be arbitrary or to specify an amount which can be arbitrary. The only correct view can be that whether the law fixes the amount or specifies the principles, the amount or the principles must converge on the same result.

(e) Since Parliament has no power to damage or destroy the core or essence of any of the fundamental rights, the very limits on its amending power would involve the conclusion that the power under Article 31(2) cannot be so exercised, and the amount fixed or determined cannot be so low, as to damage or destroy the core or essence of the other fundamental rights, e.g. the freedom of the Press, the right to form trade unions and the religious freedom and the rights of the minorities in Articles 25, 26 and 29.

On the above construction, the effect of the proviso to Article 31(2) would be as follows:

The proviso would give a wider protection in respect of educational institutions of a minority than would be available under (e) above. The reason is that the proviso requires such an amount to be fixed or determined as would not restrict the right under Article 30(1), which is a higher safeguard than the rule prohibiting damage to the essence or core of the other fundamental rights. If the amount to be paid on acquisition has to be such that it would not restrict the right under Article 30 (1), it would have to be an amount higher than the amount which would be sufficient not to damage the essence of that right. Whereas on the principle of inherent and implied limitations it is only the core or essence of the fundamental rights which is protected, the proviso to Article 31(2) protects the right under Article 30(1) in its full amplitude and not merely its core or essence.

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Additional argument in support of the plea that the “amount” or “principles” under Article 31(2) cannot be arbitrary but have to be reasonable.

Assuming Article 31(2) as substituted by the 25th Amendment is to be regarded as legal and valid, there is an additional reason for holding that the “amount” and “principles” referred to therein have to be reasonable in relation to the property and its value.

Article 31(2) may be regarded as vesting the State with a discretion to fix the amount. It is well-settled that where a discretion is granted by any law, it is implicit in the grant of such discretion that it must be exercised reasonably. If the discretion is exercised arbitrarily or unreasonably, it would mean that the discretion has not been exercised at all. These principles which are well-settled in respect of discretion conferred by ordinary statutes apply a fortiori to Article 31(2) which safeguards the citizen’s fundamental right to property against the State. The condition on which the State is permitted by Article 31(2) to exercise the power of acquiring or requisitioning property is that discretion must be exercised in fixing the amount or specifying principles. If a law fixes an amount unreasonably or if the Court finds that in arriving at the amount the State has adopted principles which are unreasonable or irrelevant to the property and its value, the exercise of the State’s discretion would be arbitrary. In such a case the Court would strike down the law on the ground that the constitutional requirement of the exercise of discretion has not been satisfied.

In Roberts v. Hopwood, (1925) AC 578 the House of Lords held that where a statute permitted a Borough Council to employ such servants as may be necessary on such “wages as (the Council) may think fit”, the discretion conferred upon the Council by the Statute must be exercised reasonably, and that the fixing by the Council of an arbitrary sum for wages without regard to existing labour conditions was not an exercise of that discretion.

Lord Buckmaster’s observations in that case at pp. 587 and 590 are very pertinent. At page 590 Lord Buckmaster says:

“. . . . they did not base their decision upon the ground that the reward for work is the value of the work reasonably and even generously measured, but that they took an arbitrary principle and fixed an arbitrary sum, which was not a real exercise of the discretion imposed upon them by the statute.”

Lord Atkinson’s observations at pp. 597 and 599 are again pertinent. On page 599 Lord Atkinson says that on a fair construction of the statute it means that “in each and every case the payment of all salaries and wages must be ‘reasonable’.” This means that the test of reasonableness is treated as implicit in the conferment of discretion by the law.

Lord Wrenbury’s classic words are at page 613:

“I rest my opinion upon higher grounds. A person in whom is vested a discretion must exercise his discretion upon reasonable grounds. A discretion does not empower a man to do what he likes merely because he is minded to do so — he must in the exercise of his discretion do not what he likes but what he ought. In other words, he must, by use of his reason, ascertain and follow the course which reason directs. He must act reasonably.”

By this test, the legal position is that so long as the discretion is exercised reasonably under Article 31(2), the Court will not interfere even though the return may not amount to compensation in the eye of the law or the principles may not cover all the essential elements of the legal concept of ‘compensation’.

Inadequacy of the amount is non-justiciable, but only where the State action is within the constitutionally permissible limits. Arguments regarding the reasonable exercise of discretion (i.e. the reasonable relation of the amount or principles to the property and its value) and the bar against damaging any of the fundamental rights go to the constitutional limitations upon State action under Article 31(2), and are therefore justiciable. They deal with the constitutional condition which is required to be satisfied before the power of acquisition or requisition can be validly exercised. There is a world of difference between the proposition that adequacy of the amount shall not be called in question and the proposition that arbitrary exercise of discretion or power shall not be called in question.

  * * *

 

Proposition on behalf of the Petitioner in support of the point that the right to property is one of the essential features of the Constitution.

I. Every fundamental right is an essential feature of the Constitution

Every fundamental right is an essential feature of the Constitution. If the Constitution-makers had thought that a particular right was not an essential feature, they would not have included it in the category of fundamental rights. In respect of the rest of the Constitution it is for the Court to decide whether a particular provision or institution constitutes an essential feature or not. But when it comes to the fundamental rights, all controversy is eliminated and what the Constitution-makers specified as fundamental must necessarily be treated as a fundamental feature of our Constitution.

II. The importance of the right to property

Without prejudice to the above and assuming any inquiry is at all possible as to whether the right to property should be treated as one of the basic elements of our Constitution, it is submitted that —

(a) the intrinsic value of the right,

(b) its necessity for the meaningful exercise of various other fundamental rights, and

(c) its importance to the proper functioning of the Constitution as a whole;

leave no doubt that the right to property is one of the basic elements of our Constitution.

Property is necessary for the subsistence and well-being of men. No man would become a member of a community in which he could not enjoy the fruits of his honest labour and industry. The preservation and security of property is one of the primary objects of the social compact that induce men to unite in society. There can be no dispute or debate about this proposition, though there may be different opinions as to the quantum of property that a person should be allowed to hold.

III. Legislative history

(a) Section 299 of the Government of India Act, 1935 recognised the right to property and contained a safeguard against expropriation without compensation or acquisition of property for a non-public purpose.

(b) Article 17 of the Universal Declaration of Human Rights also recognises the right to private property. India is a signatory to that Declaration.

(c) The Constituent Assembly examined the Constitutions of several countries, which guarantee basic rights. In “Constituent Assembly of India, Constitutional Precedents (Third Series1947)”, it is stated as follows:

“Broadly speaking, the rights declared in these Constitutions relate to equality before the law, freedom of speech, freedom of religion, freedom of assembly, freedom of association, security of person and security of property. Within limits these are all well-recognised rights and it may be useful to draw attention to them by embodying them in the Constitutional Charter.”

(d) The debates in the Constituent Assembly when the draft articles corresponding to Article 19(1)(f) and Article 31 came up for discussion clearly indicate that the framers of our Constitution attached sufficient importance to property to incorporate it in the chapter on fundamental rights and rejected suggestions and contentions to the contrary. The provision regarding freedom of trade and intercourse which was originally in the chapter on fundamental rights was later on removed from that chapter and put into a separate part, in view of the suggestions by some members in the Constituent Assembly. It is significant to note that similar suggestions in respect of Article 31 (corresponding to Article 24 of the draft Constitution) were not accepted. Pandit Jawaharlal Nehru categorically stated that in the Indian Constitution there was no room for expropriation or acquisition without compensation. That basic feature of the Constitution was departed from only in the case of legislation regarding abolition of zamindari and land tenure reforms and such legislation was accordingly expressly saved by clauses (4) and (6) of Article 31. Whilst there may be difference of opinion as to the quantum and extent of compensation that should be paid for acquisition of property, it was an essential feature of the Indian Constitution as framed and enacted that there could not be any expropriation of private property or acquisition without compensation.

IV. Right to property necessary for the meaningful exercise of other fundamental rights

The right to property is essential for the effective and meaningful exercise of various other fundamental rights. A very few examples would suffice to illustrate this point. The right to freedom of the Press under Article 19(1)(a) would be meaningless if a publisher could be deprived of his printing plant and the building in which it is housed without compensation. The fundamental right under Article 19(1)(c) to form trade unions would be denuded of its true content if the property of a trade union could be acquired by the State without compensation. The right to reside and settle in any part of the territory of India, which is guaranteed by Article 19(1)(e), would be meaningless if the State could expropriate the citizen’s hut or house or household effects. The right to practise any profession or to carry on any occupation, trade or business under Article 19(1)(g) would be merely a right to do forced labour for the State if the net savings from the fruits of a citizen’s personal exertion are liable to be acquired by the State without compensation. The freedom of religion in Article 26 would lose a great deal of its efficacy if the institutions maintained by a community for its religious and charitable purposes could be acquired without compensation.

V. Necessity of the right to property for the normal working of the Constitution

It would be no exaggeration to say that without the right to property it would be impossible to work the Constitution. For example, many of the legislative Entries, including Entries which set out the subject-matters in respect of which taxes can be levied, necessarily pre-suppose the right to private property. The existence of the separate States would be in direct jeopardy if the right to private property did not exist. The democratic way of life, the very institution of Parliament with its necessary incidents like free elections, freedom to oppose and the right to dissent would all be paralysed if the right to private property did not exist.

Propositions on behalf of the Petitioner regarding the ambit of the amending power in different Constitutions

And

Parliament providing a channel like referendum for ascertaining the people’s will.

I. The amending power in our Constitution must be construed on its own terms

The scope and width of Parliament’s amending power under Article 368 must be determined on its own terms and the other world Constitutions are of no assistance in solving this question. Some of the material features which have a bearing on this issue are:

(a) Our historical background. National leaders struggled for several decades to achieve independence and envisaged a Constitution for free India which would provide inalienable basic human rights; the country became a free democracy for the first time, and was welded together into one State also for the first time, in its five thousand years old history; the necessity of creating a sense of security and safety in the minds of numerous religious, linguistic and regional minorities made it imperative that fundamental rights should be beyond the reach of the party in power.

(b) Amending powers are conferred by different Articles in our Constitution — Articles 4, 169, Para 7 of the Fifth Schedule and Para 21 of the Sixth Schedule — in significantly different terms which have a direct bearing on the scope and width of the amending power.

(c) In the original draft of the Constitution prepared by B.N. Rau, there was a significant contrast between the word ‘amendment’ in the clause corresponding to the present Article 368 and the conferment of amending power in wider term in Clause 238 which was later omitted. Further, Mr Kamath’s amendment which would have widened the scope of the amending power in Article 368 was rejected. Thus the proceedings before the Constituent Assembly clearly support the view that Parliament’s amending power under Article 368 was intended to be restricted as contended by the Petitioner.

(d) Our Constitution has an extraordinarily forceful and meaningful Preamble which contains guarantees reflecting the pledge contained in the Objectives Resolution of 1946.

(e) The people are in no way associated with the amending power in Article 368, but the decision is purely that of a creature of the Constitution, viz. Parliament; and even the States are wholly dissociated from the amending process except in the cases falling within the proviso to Article 368.

There is no other Constitution in the world which affords a parallel to the Indian Constitution as regards the abovementioned cumulative features and other relevant circumstances. Therefore it would be futile to consider the scope of the amending power in other Constitutions.

II. Constitutions of other countries

The amending power has widely varying scope and width in the Constitutions of different countries. Relevant extracts from the Constitutions of 61 countries are given in a separate compilation.

It is most significant to note that where the amending power rests with the people of a Republic, in whom the ultimate legal sovereignty resides, the position is quite different as compared to cases where the amending power resides in a creature of the Constitution, e.g., the Indian Parliament. Inherent and implied limitations which apply to a Parliament constituted under a controlled Constitution do not apply to the people. People may, in the exercise of their ultimate legal sovereignty alter, damage or destroy an essential feature of their Constitution by way of amendment (apart from questions of limitations on the people’s power arising from the Preamble or the principle of inalienable and natural human rights).

III. The U.S.A. Constitution

Article V of the U.S.A. Constitution affords no analogy to Article 368, as is clear from the following:

(a) The features and the historical background peculiar to India, do not exist in the case of the U.S. Constitution.

(b) Article V in the U.S.A. Constitution has been read as associating the people with the amending process, since that article expressly provides for the calling of Conventions for amending the Constitution. The fact that Conventions have been rarely called is not relevant. The necessity of calling Conventions (instead of letting the legislature make the decision) would really arise when the basic human freedoms are sought to be abridged or taken away or any other essential feature of the Constitution is sought to be altered, damaged or destroyed. Such amendments have not been made in the U.S.A. But the very fact that the people are capable of being associated with the exercise of the amending power distinguishes Article V from our Article 368.

(c) The decision to have an amendment is not made by the Congress (corresponding to our Lok Sabha) but is made by 3/4ths of the State legislatures or Conventions. The Congress can only initiate a Proposal.

(d) Two-thirds of the State legislatures may ask for amendments, and in such a case Congress does not even initiate a Proposal.

(e) The decisions of the Supreme Courts of the States in U.S.A. are not relevant, since they turn upon the terms and background of the State Constitutions. For instance, the case reported in Southern Reporter, Second Series, Vol. 81, page 881 is irrelevant, since that case deals with the Constitution under which an amendment would become valid only “when approved by the qualified electors” (see the first para of that Vol. at page 882).

IV. Can Parliament amend our Constitution so as to provide a channel for a decision by the people regarding amendments?

One possible view of the matter is that having regard to the historical background which is referred to above and which is set out in detail in the Annexure to the Propositions No. P-5/12-B, the Constitution-makers did not intend that any essential feature of our Constitution should be permitted to be altered, damaged or destroyed, even by the people, although all amendments may be made by Parliament which do not have such an effect. It may be urged that it was precisely for this reason that the Constitution-makers, having the various constitutional precedents before them, deliberately chose to make no provision for amendment by the people by a referendum or convention. (Ascertainment of the will of the people as regards constitutional amendments may be done in one of the well-settled constitutional modes, of which referendum is a well-favoured example. For the sake of brevity, the word “referendum” is used hereinafter to denote any of the available channels for enabling the people’s will to be expressed as regards constitutional amendments).

The other view of the matter is that a referendum was not provided for originally in the Constitution because it might have made it very difficult to have the Constitution accepted on those terms by the diverse sections of the public who would have viewed a referendum with grave misgivings; but that does not rule out the constitutional possibility of Parliament at any future stage amending the Constitution so as to provide a channel for the decision of the people on a referendum regarding amendments which are beyond the constitutional limits of the Parliament’s amending power.

If the latter view is correct, Parliament can amend the Constitution to provide such a channel for ascertaining the will of the people regarding constitutional amendments. The most important point is that the provision must be such that —

(a) the decision can be made directly by the people on the precise proposal being submitted to them, and

(b) the issue of amendment must be presented to the people in absolute isolation, so that it does not get mixed up with other political questions and with political party affiliations or preferences.

Thus it must satisfy the criteria of directness and speciality of the people’s decision (See Dr. Conrad’s Article, pp. 405, 408 and 412).

If the latter view is right and Parliament can amend the Constitution to provide for a referendum, two views would again be possible as regards the scope of the people’s amending power:

(a) It may be urged that the people would have on a referendum complete and absolute power to deal with any of the essential features of the Constitution.

(b) The other view would be that even the people on a referendum would have their amending power limited in two respects. Firstly, they cannot so amend the Constitution as to make it inconsistent with any part of the Preamble; and, secondly, they cannot take away the natural and inalienable rights or the basic human freedoms.

In this case it is not necessary to decide the questions regarding Parliament’s competence to amend the Constitution so as to provide for a referendum and the extent and scope of the people’s amending power on a referendum. 

http://www.ebc-india.com/lawyer/articles/73v4a1.htm

 

Published in: on September 23, 2008 at 6:11 pm  Comments (1)  
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Caution required in JV, consortium agreements

 
FOREIGN ENTERPRISE
H P Aggarwal / New Delhi September 01, 2008, 22:29 IST
 

A large number of foreign companies take up projects in India in association with other companies. For this purpose, quite frequently, foreign companies enter into a joint venture (JV) or a consortium agreement.

Till recently, the interpretation of the income-tax law of India has been that if the joint venture or consortium agreements properly define the scope of work of each member and if the amount payable to each member is also clearly indicated, and the amount is directly paid to each member against the invoices raised by the member, the income-tax liability of each member to the agreement will be determined separately and individually.

However, in a recent case of Geoconsult ZT GMBH, the Authority for Advance Ruling (AAR) has pronounced a ruling on July, 31, 2008 which will seriously upset the legal interpretation of such agreements.

An Austrian company formed a consortium with two other Indian companies to provide project consultancy services to HPRIDC in Himachal Pradesh.

The Austrian company rendered almost all the services from Austria; it has neither a ‘fixed place of business nor an office’ in India; it does not also perform any substantial activity in India; the employees are also not deputed in India for a considerable length of time; it does not have a ‘permanent establishment’ (PE) in India. Therefore, the income received by the JV constitutes “fees for technical services” (FTS) and should be subjected to tax in accordance with article 12 of the DTAA, i.e., @ 10 per cent.

A ruling was sought from the AAR. The department was of the view that the applicant has a PE in India since the office of the JV is situated in India and also a team of personnel is deputed for project by the foreign company to India. The fee received by the Austrian company is attributable to such PE and is thus taxable in India as “profits & gains of business and profession” under article 7 of the DTAA. Further, the status of the JV should be treated as an “association of persons” (AOP).

The AAR finally observed that “the essential features and stipulations in the two agreements coupled with the background in which the joint venture was formed overwhelmingly point out the existence of ‘association of persons’ as it is understood in law and in ordinary parlance. Common purpose and common action pursued towards the ultimate end of earning income/profits is writ large on the face of the agreements…………the J.V. is to be taxed in the status of an association of persons @ 41 per cent net basis.”

To avoid the constitution of AOP by a JV, certain points may be useful. There should be a clear demarcation of duties between the members of the JV; the members should not be jointly liable for the execution and completion of the work; the members should independently coordinate with the clients in respect of their field of work, the JV should not have a unified management; there should be restricted access to the work carried out by other members; unity of action and common management should not exist; consolidated invoicing should be avoided, i.e., each member should raise the invoices separately to the client so as to avoid sharing of gross remuneration in any agreed proportion.

It is quite clear now that Consortium Agreements need to be very carefully drafted to avoid formation of AOP which is liable to tax in India at maximum marginal rate of tax.

Copyright: Business Standard

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Published in: on September 5, 2008 at 6:10 am  Leave a Comment  

Principles of Interpretation of issues in Double Taxation Avoidance Treaties

Principles of Interpretation of issues in Double Taxation Avoidance Treaties

Sohrab Erach Dastur, Senior Advocate

 

 

 
1. Introduction

The proliferation of Double Taxation Avoidance Agreements entered into by India with several foreign countries has created a new branch of tax law. These Agreements come into play when a resident of one state has income sourced in another state. For the purpose of such Agreements income is regarded as sourced in a state if the payer is based there. A country’s appetite for taxation being insatiable, both states would like to tax the income arising from the same transaction. It is here that Double Taxation Avoidance Agreements come into play. The Agreements deal with different types of income and some of them have a residual “catch-all” provision. With reference to dif­ferent types of income different modes of avoiding/restricting double taxation are evolved. The Agreement may vest jurisdic­tion to tax a particular type of income in one of the contesting states. The vesting of such right may depend on the fulfi­ment of the prescribed condition/s. For example, business income is generally taxable in the source state if the enterprise has a permanent establishment therein. (By source state is meant the state where the income arises or the state the residents of which make payment to the residents of the other contracting state).

Double Taxation Avoidance Agreements are treaties between two sovereign states. (Such Agreements can also be between two countries which are not “sovereign” states in the full legal sense). Being Agreements between two contracting states it was found that it would be useful to have a Model Agreement which could be the basis for discussion between two states contem­plating to conclude a Double Tax Avoidance Agreement. The League of Nations first commenced work in this behalf in 1921 and produced in 1928 the first Model Bilateral Convention.

Certain income, for example, interest income may be taxable in both states. In respect of such cases the normal rule is that the state of which the concerned person is a resident has the right to tax his income. However, the source state would also have the right to tax the income. Such taxation by the latter may be subject to a maximum permissible rate. A Double Taxation Avoidance Agreement may effectively provide for avoidance of tax or for relief against double taxation by providing for grant of credit by the state of residence of the tax paid in the source state. Tax Avoidance Agreements may be confined to a particular type of income for example, aviation income or may be general and cover several/all types of income.

It is of interest to note that the first Double Taxation Avoidance Agreement was executed 105 years ago (in 1899 between Prussia and the Austro Hungarian empire). Seligman in “Double Taxation and International Fiscal Co-operation” notes that the problem of double taxation first surfaced in the 13th century regarding property taxes levied in France and Italy – where the property was situated in one country but owned by a resident of the other country. The first concrete step for relieving against double taxation, in so far as India is concerned, was taken in 1939 with the coming into force of the Income-tax (Double Taxation Relief) (Indian States) Rules. Since then India has travelled a long distance. Presently, India has en­tered into over 90 Double Taxation Avoidance Agreements — some of them of limited application but most of them being compre­hensive Agreements.

Double Taxation Avoidance Agreements are treaties between two sovereign states. (Such Agreements can also be between two countries which are not “sovereign” states in the full legal sense). Being Agreements between two contracting states it was found that it would be useful to have a Model Agreement which could be the basis for discussion between two states contem­plating to conclude a Double Tax Avoidance Agreement. The League of Nations first commenced work in this behalf in 1921 and produced in 1928 the first Model Bilateral Convention. These were followed by the Model Convention of Mexico (1943) and the London Model Convention (1946). The Council of the Organisation for European Economic Co-operation, which later became the Organisation for Economic Co-operation and Develop­ment (OECD) set up a fiscal committee in 1956 to formulate a Model Convention. The first draft Double Taxation Convention on income and capital was framed in 1963. This ultimately gave birth to the 1977 OECD Model Convention and Commentaries. On the basis of the recommendation of the Committee on Fiscal Affairs, OECD published the 1992 Model Convention in a loose leaf format to facilitate updating. The present Model Convention and Commentaries are updated as of January 2003.

The OECD Model Convention though primarily meant for use by the OECD countries is often referred to and the Commentaries ap­plied in interpreting Agreements between non-OECD countries also. In addition to the OECD Model, there is the UN Model Convention. Its origin lies in a resolution passed by the Economic and Social Council of the U.N. in August 1967 and was published in 1980 in the form of Model Double Taxation Conven­tion between developed and developing countries. The UN Model is generally considered to be more favourable from the point of view of the developing countries as it places greater emphasis on the right of the source state to tax a transaction having international ramifications. Predictably the United States wanted to have its own Model Convention and published in 1976 the US Model Treaty. In 1996, the US Model was revised. It is accompanied by a most exhaustive technical explanation comment­ing on the various articles in the Model Convention. Unlike the OECD Commentaries which have to take into consideration the views of various states the US Technical Explanation highlights the US point of view and to that extent is more emphatic and clear compared to the OECD Commentaries which are necessarily based on a compromise. Whenever the United States enters into a Double Taxation Avoidance Agreement it also releases a detailed write-up explaining the US view concerning each of the articles in the Agreement entitled “The Treasury Department Technical Explanation”. The thoroughness of the US approach in the matter is shown by the fact that the technical explanation in respect of the Indo-US Double Taxation Avoidance Agreement covers about 50 pages. The US also publishes the Report of the Senate Foreign Relations Committee on each Treaty negotiated by the US . Thus, far more “official” literature is available in respect of agreements concluded by the US than by us.

As noted above, the OECD Model Convention of 1963 was substi­tuted by a fresh Model in 1977. However, the wording of the Commentaries is an on-going process and there may be changes therein without a change in the provision of the Convention. There would of course also be cases where there is a change in the provisions of the Convention which may also result in a change in the Commentaries. The view of the Committee on fiscal affairs is that the revised commentaries should be taken into account even where there is no change in the wording of the Convention. Of course, where there is a change in the wording of the Convention it is only the revised commentary which has to be taken into account. Having said this it must be empha­sised that these are only the views and opinions of the commit­tee and are in no way binding on the judicial authority called upon to interpret the actual Agreement concluded by the two contracting states.

2. Agreement vs. Act

The first and the basic issue which arises in the interpretation of a Double Taxation Avoidance Agreement is what is the position where there is a conflict between the provisions of the statute (the Income-tax Act — hereinafter referred to as the Act) and the provisions of the applicable Double Taxation Avoidance Agreement. It is to be remembered that an assessee cannot be worse off by virtue of any provision in the treaty — ­as the purpose of a treaty is to confer a benefit and not to levy a charge.

Section 90(2) of the Act makes it clear that where an agreement for granting relief of tax or for avoidance of double taxation has been entered into, then, in relation to the assessee to whom such agreement applies, the provisions of the Act to the extent that they are more beneficial as compared to the provi­sions of the Double Taxation Avoidance Agreement would have to be applied. It follows that where the provisions of the applicable Agreement are more favourable, compared to the provisions in the Act, the provisions of the Agreement will prevail. Section 90(2) is a statutory recognition of the rule laid down by the Andhra Pradesh High Court in CIT vs. Visakhapatnam Port Trust 144 ITR 146 which view has now been accepted by the Supreme Court in Union of India vs. Azadi Bachao Andolan 263 ITR 706. Indeed the Central Board of Direct Taxes itself had earlier accepted this position in Circular No. 333 dt. April 2, 1982 reproduced in 137 ITR 1 (st.). The Finance (No. 2) Act, 1991, which inserted sub-section (2) in section 90 with retrospective effect from 1-4-1972, also inserted clause (iii) in section 2(37A) to provide that where tax is deductible at source from payments made to a non-resident the payer could apply the rate as prescribed in the Act or the Finance Act or the rate applicable under the relevant Agreement whichever was lower.

A further refinement, which the more blunt would call hair splitting by a bald person, is whether an assessee can claim that the computation of his income should be under say, the Act but the rate of tax should be as per the treaty. According to the writer this is not permissible because a lower rate is often prescribed where, as per the applicable provisions of the Treaty, expenditure is not allowed in computing the particular type of income.

The general principle as enunciated above raises several issues. Whilst it is true that the Agreement would override the Act, would it be open to an assessee depending on the provi­sions in force in different assessment years and the prevailing factual position in each year to opt for being governed by the Act in one year and the applicable Agreement in the other? The view of the writer is that such option is available. The more intricate problem is whether an assessee can choose for the same assessment year to be governed by the provisions of the Act in so far as assessment of a particular type of income is concerned, say, business income, but by the provisions of the Agreement in so far as another type of income is concerned, say, capital gain. In my view this would be permissible as one would, in the language of section 90(2), apply the Act to the extent that the provisions thereof are more beneficial to the assessee. The next issue is whether in respect of the same type of income derived by the assessee from two different states can he opt for being governed by the provisions of the Agreement in so far as state A is concerned but by the provisions of the Act in so far as state B is concerned. For example, an Indian company may have branches (permanent establishments) in state A and state B. The branch in state A makes a profit and the Indian company elects to be governed by the Agreement and takes the stand that the profit is assessable only in country s where there is a permanent establishment, in line with the view taken by the High Courts and the Supreme Court as referred to hereinafter. The permanent establishment in country B makes a loss and the Indian company desires to set off such business loss against its Indian business income as permissible under section 70 of the Act and does not want to be governed by the provisions of the treaty whereunder the income (which term would include loss) is assessable, as noted above, only in state B. Though the matter cannot be said to be free from all doubt, in the writer’s opinion it would be permissible to choose the more beneficial provision “Treatywise.”

A further refinement, which the more blunt would call hair splitting by a bald person, is whether an assessee can claim that the computation of his income should be under say, the Act but the rate of tax should be as per the treaty. According to the writer this is not permissible because a lower rate is often prescribed where, as per the applicable provisions of the Treaty, expenditure is not allowed in computing the particular type of income. One cannot therefore take advantage of computa­tion under, say, the Act where it allows deduction of expendi­ture and then turn to the treaty to apply the lower rate.

As noted above section 90(2) places a Double Taxation Avoidance Agreement at a level higher than the provisions of the Act in that an assessee governed by a treaty can opt for being gov­erned by the provisions of the treaty rather than the Act. As observed by the Supreme Court in Chettiar’s case (267 ITR 654) referred to hereafter), section 90 and the Agreements executed pursuant to the power conferred thereunder were provisos or exceptions to the charge of tax levied by sections 4 and 5. In other words, the Agreements become part of the Indian law.

The issue which arises is whether Parliament can enact legislation subsequent to the signing of a treaty which would override the provisions of a treaty and if so whether such legislation has to be in any particular form. Depending on the provision in a country’s Constitution as to the status of domestic law vis-a-vis provisions in a treaty the conclusion may be different whether a post treaty domestic law can override a provision in an earlier treaty. The French and Dutch Constitutions do not, it appears, permit the overriding of a treaty provision by a subsequent legislation. The position is different in the United States of America and in the United Kingdom . Though Article 51 of our Constitution provides as a directive princi­ple that the state shall endeavour to foster respect for inter­national law and treaty obligations in the dealings of organised peoples with one another the position appears to be that there is no fetter on the power of the Indian Parliament to legislate in a manner which may conflict with or override the provisions of an earlier treaty just as Parliament can over turn or amend an earlier enacted law. An example of such treaty override is provided by the insertion of the Explanation to section 90 of the Act (by the Finance Act, 2001) and subse­quently amending the Explanation by the Finance Act (No. 2) Act, 2004.

To understand the context in which the Explanation was added a few facts may be noted. Some Double Taxation Avoidance Agree­ments provide that tax on a permanent establishment of an enterprise of one of the states in the other state shall not be less favourably levied in such other state than the taxation levied on enterprises of that other state carrying on the same activities. In India a higher rate of tax is charged on non-domestic companies compared to domestic compa­nies similarly engaged, with the result that the permanent establishment of an enterprise of a contracting state suffers tax at a higher rate. In some cases it was judically held that such discrimination was not permissible. The Explanation to section 90 now declares 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.” In other words, the Explanation has ruled that rate discrimination is not to be regarded as a less favourable charge of tax obviously for the purposes of Agreements for Avoidance of Double Taxation as only in the case of persons governed by such Agreement would the issue of less favourable rate of tax arise. In so far as tax matters are concerned it has not yet been tested in India whether Parliament can over­ride a provision in an earlier concluded treaty. It is, of course, debatable as to who can have the matter tested as the treaty is between two states. Is it the state which must take up the issue or should it be decided under the mutual agreement procedure or can the affected person challenge the amendment even if the concerned state has not protested? The writer is of the view, which he must confess is not the generally accepted one, that as Double Taxation Avoidance Agreements are agreements between two contracting parties it is not proper for one of the contracting parties unilaterally to change the provi­sions of the bilateral Agreement. A state cannot, unlike Alice in Wonderland say that words will have the meaning which it chooses to confer on them! It may be noted that by the Finance Act, 2003 sub-section (3) has been incorporated in section 90 which entitles the Central Government by notification to pro­vide that any term in the Agreement which is not defined there­in or in the Act shall have the meaning given thereto in the notification so long as such meaning is not inconsistent with the provisions of the Act or the Agreement.

I now consider the position where there is a conflict in the definition of certain terms in the Act and a Double Taxation Avoidance Agreement. The definition of a term (say royalty) plays an important role in appropriately classifying an item of income. Typically Article 3(1) of the Agreements concluded by India contains general definitions. In addition, certain terms are defined in the applicable article. For example, the terms dividends, interest and royalties, normally dealt with, respectively in Articles 10, 11 and 12 of an Agreement, define these terms for the purposes of those articles. There can be no dispute that if there is a conflict between a definition in the Act as existing when a Treaty comes into force and a defini­tion in the Treaty the latter will prevail. The issues which arise are 1) if there is a definition in the Act at the time the treaty comes into force but there is no definition of that term in the treaty will the definition in the Act apply and 2) if there is no definition of the term in the treaty or in the Act when the treaty was concluded but subsequently a defini­tion is introduced in the Act would that definition be applied also for the purposes of interpreting the treaty?

In so far as 1) above is concerned, the position seems to be clear that in the absence of a definition in the treaty the definition in the Act as existing at the time the treaty is made will be applicable unless the context requires otherwise. The position is not completely clear as to what is to happen where a definition is inserted in the Act or an existing definition in the Act is changed subsequent to the coming into force of the Treaty. Article 3(2) of the OECD Model Convention provides “As regards the application of the Convention at any time by a contracting state, any term not defined therein shall, unless the context otherwise requires, have meaning that it has at that time under the law of that state for the purpos­es of the taxes to which the Convention applies, any meaning under the applicable tax laws of that state prevailing over a meaning given to that term under other laws of that state.” It is, therefore, made clear that the definition “at any time” in the local tax law would have to be applied in the absence of a definition in the Convention. If, therefore, a term is defined in the Convention a subsequent change of meaning in the local law will not be applicable but where the term is not defined, then, the meaning under the local tax law as in existence from time to time will have to be applied. This is made clear by the use of the phrases “at any time” and “at that time.” These words are absent in the UN and US Model Conventions. Also, in most of the Treaties entered into by India , the relevant provi­sion does not refer to “at any time” or “at that time.” Never­theless the general view appears to be that ..a subsequent definition in the local tax law will have to be applied in interpreting that term in the Agreement. To the writer this appears strange because an Agreement may have been negotiated on the basis of the meaning of the term as commonly understood. As per the generally held view a unilateral change in the defini­tion may impact on the scope and interpretation of the Agreement. It may also be noted that the OECD Model Convention requires one to have regard to the definition of a term in the Agreement in any local law but preference is to be given to the meaning, if any, under the local tax law. However, as per the US and UN Models as well as the Agreements generally entered into by India it is only the meaning in the local tax law (and not any other local law) which has to be taken into account. The general view mentioned above may lead to the anomalous situation that the two countries may change the meaning of the term under their local laws subsequent to the execution of the Agreement and, therefore, a particular term may be interpreted differently by the Courts of the two states resulting in such income being classified differently by the two states, say, royalty income by one state and only a business income by the other. There is a view that when there is a possibility of such a conflict the definition of the source state would be applica­ble. In Siemens A.G. vs. ITO (1987) 22 ITD 87 (SB) the Special Bench of the Tribunal accepted the static and not the ambulatory rule and, accordingly, did not interpret the term “royalty” in the then existing ( 1959) Indo-German Double Taxation Agreement on the basis of the meaning given to the term from 1976 in section 9 of the Act.

I next consider whether the definition in the local law which one has to have regard to as per article 3(2) referred to above is a reference to the “general” definition in the local tax law or a definition restricted to particular provisions. For example, the definition of royalty in section 9 of the Act is for the purposes of certain sections and is not a “general” defini­tion listed in section 2. The issue appears to be a virgin one. The writer is of the view that a definition for particular provisions in the Act would not strictly apply to other provi­sions in the Act and it would be strange to interpret provi­sions in a Double Taxation Avoidance Agreement in the light of a definition of limited application in the Act.

Earlier a reference has been made to a state’s power to over­ride a treaty provision. Whether in fact the treaty has been overridden would depend on the interpretation to be placed on the language used in the provision said to override the trea­ty. The Court would strain every nerve to give full meaning to the treaty unless it is clear that the legislation in question has indeed overriden the treaty provision. Insofar as the issue of treaty override is concerned, a very useful discussion is found in Chapter 33 of Tax Treaty Interpretation” by Michael Edwardes-Ker and also in Double Taxation Conventions and International Tax Law (Second Edition) by Philip Baker (pages 48 – 54).

3.Treaty shopping

The natural consequence of supremacy of favourable provisions in a tax treaty is the desire to implement a transaction “through a country which has a favourable treaty provision. Insofar as India is concerned, the most glaring Convention in this behalf is the Agreement between India and Mauritius . The Conventions with Cyprus and the Netherlands also have certain advantages compared to other Agreements. Assuming there is a favourable provision in the Indo-Mauritian treaty compared to, say, the Indo-US Treaty it would be the natural desire of the concerned party to structure the transaction so as to be able to claim the benefit of the Indo-Mauritian Double Taxation Avoidance Agreement. For example, a company may be incorporated in Mauritius so that it can take advantage of the Indo-Mauri­tian Double Taxation Avoidance Agreement even though the per­sons interested in the company may be foreign entities based elsewhere. This is generally called “treaty shopping”; i.e., to shop for the most favourable treaty. States frown upon treaty shopping as the general wisdom is that it is a misuse of a treaty provision and is contrary to the intendment of the treaty negotiating partners. A substantial portion of foreign investments into India take the Mauritian route because as per the Indo-Mauritian Double Taxation Avoidance Agreement capital gains are to be assessed as per the law of the state of resi­dence of the party. As under the Mauritian law tax is not levied on capital gains it means that capital gains made by Mauritian entity on transfer of shares in an Indian company go unassessed. One may also indulge in treaty shopping if the law of one of the states taxes the income in question at a lower rate compared to the state of residence of the concerned person.

One of the first cases where the issue of “treaty shopping” came up for judicial consideration in India was before the Authority for Advance Ruling in Ruling No. 9 of 1995 220 ITR 377. Clause (iii) of the proviso to section 245R ( 2) disables the Authority from pronouncing upon a transaction which is designed prima facie for the avoidance of income-tax, which is, of course, what treaty shopping is all about. In that case a company in the United Kingdom had invested in India via the Mauritian route. The Authority was of the view that this was to obtain the advantage of non-taxation in India of capital gains arising to a resident of Mauritius under the Indo-Mauritian Double Taxation Avoidance Agreement, which advantage was not available under the Indo-UK Double Taxation Avoidance Agree­ment. Subsequently, in Advance Ruling No. 10 of 1996 (224 ITR 473) the Authority sanctioned the Mauritian route where investors from several countries were to come together and it was necessary to base the investing company in a particular loca­tion and Mauritius was chosen as such location even though in making the choice the tax advantage was one of the considerations.

The Supreme Court has exhaustively dealt with this issue in Union of India vs. Azadi Bachao Andolan 263 ITR 706 at pages 746 – 753. The Supreme Court appears to have ‘blessed’ treaty shopping as according to it “If it was intended that a national of a third state should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect should have been incorporated therein.” According to the Supreme Court it was for Parliament to take appropriate action in the matter and in the absence of a prohibition one could not deny the benefits of a treaty on the basis of the belief that treaty shopping was not permissible. An anti treaty shopping provision is normally inserted in a Double Taxation Avoidance Agreement by a limitation on benefits clause (see, for example article 24 of the Indo-US Double Taxation Avoidance Agreement which per­mits a non-individual person to avail of treaty benefits only if more than 50% beneficial interest therein is owned by indi­vidual residents of a contracting state).

4. Who can tax income

An issue which often arises in implementing a Double Taxation Avoidance Agreement concerns determination of the question as to which country is entitled to tax a particular income. Ac­cording to the writer the function of a Double Taxation Avoidance Agreement is to determine the jurisdiction of the contracting parties to tax a particular income. It confers jurisdiction on one of the states or on both the states to tax a particular type of income. Classically an article may provide that a particular income may be taxed in the source country or it may provide for a particular income to be taxed by the country of residence at the normal rates and also in the coun­try of source but generally not at a rate in excess of a speci­fied figure. Thus, for example, in dealing with income from immovable property (generally article 6) it is stated that the same “may be taxed in the contracting state in which such property is situated.” The issue which arises is whether the country of residence of the owner of the property can also tax the income in which event the concerned person would have to claim credit in the country of residence for the tax paid in the country where the property is situated. In-so-far as taxa­tion of business profits (generally article 7) is concerned, the position is that the profits of an enterprise of a contracting state shall be taxable only in the state of residence unless the enterprise carries on business in the other contra­cting state (source state) through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other contracting state but only so much of them as is attrib­utable to that establishment. Though the two articles are not identically worded, the Madras and Karnataka High Courts have taken the view (see CIT vs. V.R.S.R.M. Firm & Others 208 ITR 400 and CIT vs. R.M.Muthaiah (1993) 202 ITR 508) that when it is provided that tax may be charged in a particular state in respect of the specified income it is implied that tax will not be charged by the other state. Conventional wisdom seems to be to the con­trary. However, the Supreme Court has in the Azadi Bachao Andolan case 263 ITR 706, 723-4, approved of not only the decision in Muthaiah’s case (which dealt with both immovable property and business income) but also the reasoning of the High Court.

In CIT vs. Kulandagan Chettiar and Other Appeals (2004) 267 ITR 654 (SC) the Supreme Court decided appeals arising from several decisions of different High Courts (including of the Madras and Karnataka High Courts referred to above) wherein it was held that if the concerned assessee was resident in India and had a permanent establishment or owned immovable property in Malaysia it was Malaysia alone which had the right to tax such business or immovable property income. In a judgement which is not the most clearly expressed the Supreme Court appears to have taken the view that the concerned assessees were to be regarded as resi­dents in Malaysia with no permanent establishment in India and, therefore, not chargeable to Indian tax. The Supreme Court, therefore, did not specifically approve nor in any way disap­prove of the view of the High Courts that where it was provided that the source state “may” tax the specified income, without stating that the state of residence may also tax such income, it was the former alone which could tax such income. However, as noted above in the Azadi Bachao Andolan case (which the Supreme Court does refer to in the Chettiar case) the Supreme Court specifically stated that it approved of not only the conclusion but the reasoning for reaching such conclusion.

That the decisions of the Madras and Karnataka High Courts, as approved by the Supreme Court in (2003) 263 ITR 706, lay down the correct proposition is shown by the fact that wherever an Agreement contemplates taxation by both states it is specifi­cally so provided. For example, generally both states are empowered to tax income by way of dividend, interest and royalty (normally articles 10, 11 and 12). The right of taxation is conferred on the state of residence but it is specifically provided that such income may “also” be taxed in the state of source. It may be noted that the OECD in its model convention has framed two alternative articles (23A/23B) for granting benefit by the exemption/credit method.

5. Double non-taxation

As noted above it is this writer’s view that the logical conse­quence of the view that where it is stated that a particular income “may be” taxed in the source state (e.g., income from immovable property and business income as referred to above) is that the state of residence is not entitled to tax the same. Consequently, there may be double non-taxation if that particu­lar income is not subjected to tax in the state wherein it “may be” taxed; i.e., in the source state, because that state does not tax such income or provides an incentive/exemption in respect thereof. Thus, for example, if a resident of India owns immovable property in country X in which country income from immovable property “may be” taxed as per the Agreement but the laws of that state for some reason do not provide for taxation of the income from such immovable property, then, such income would go completely untaxed as the state in which the jurisdic­tion to tax that income has been conferred chooses not to tax the same.

A view which seems to be gaining ground internationally is that a Double Taxation Avoidance Agreement ought not to be inter­preted so as to give rise to double non-taxation, its purpose being only to avoid double taxation. The philosophy underlying this view is that there is always an inherent right in the state of residence to tax the income of the resident and even if, in the above example, country X does not tax income from immovable property, the state of residence would be entitled to tax the same. The writer being a contrarian does not subscribe to this view. An avoidance agreement is to be interpreted on its own terms and if what is regarded as a correct interpreta­tion results in double non-taxation so be it. The cynic would support this view by saying that one must never look a gift horse in the mouth! The Supreme Court has apparently affirmed the view that a possible double non-taxation is irrelevant. In the Azadi Bachao Andolan case (2003) (263 ITR 706) the claim of the Mauritian investors was that as per the article 13 of the Indo­- Mauritius Double Taxation Avoidance Agreement, capital gains arising to them was taxable only in Mauritius. The Court noted that the capital gain was not assessable as per Mauritian law but nevertheless upheld the view of the Mauritian investors.

The decision of the Madras High Court in CIT vs. Laxmi Textile Exporters Ltd. (2000) 245 ITR 521 (Mad) is instructive in this behalf. In that case the Sri Lankan Tax Authorities held that the asses­see, who was a resident of India , carried on business in Sri Lanka through a permanent establishment which income was howev­er exempted from tax by the Sri Lankan Government. The High Court held that this would not give a right to India as the state of residence to tax the income arising to the resident from its permanent establishment in Sri Lanka . The case also laid down that the determination by the Sri Lankan authorities that the Indian resident assessee had a permanent establish­ment in Sri Lanka was binding on the Indian Tax Authorities; i.e., the view of the source state was determinative of the issue whether the assessee had permanent establishment abroad.

6. Entitlement to claim benefit of a Treaty

The normal rule is that the provisions of a Double Taxation Avoidance Agreement apply to persons who are residents of one or both of the contracting states (article 1). Thus, “to enter” the portals of the treaty a person must show that he is a resident of at least one of the states. Generally, a person is regarded as a resident of a contracting state if he is liable to taxation therein by reason of certain prescribed tests, for example, domicile, residence, place of management etc. Thus, for a person to be a resident of state A he must show that he is liable to tax in that state by virtue of any off the pre­scribed criteria. The interpretation of the phrase “liable to tax” has given rise to controversy. There are four possible cases which may arise: 1) the concerned state does not have a law for levying tax on income 2) the concerned state may have a law levying tax on income, which may not apply to a particular class of persons say, individuals and firms but only to corpo­rate entities 3) the state may have a law imposing tax but the tax is leviable only if extended to the particular person or transaction by a Government notification or 4) the state has a law imposing tax in respect of the concerned persons but a particular type of income is not taxed; e.g., capital gains or technical service fees. ­

Insofar as 1) above is concerned, one cannot say that the person is liable to tax in that state and, therefore would not be regarded as a resident of that state entitled to claim benefit of the Double Taxation Avoidance Agreement. The same result may flow in case 2) insofar as the law envisages taxation of only a class of assessees, say, corporate assessees and there is no law under which non-corporate assessees could be subjected to tax.

Case 3) however, is one where the law does provide for taxation of a particular person but it has been, as it were, held in abeyance pending issue of a notification. In such a case the person should be regarded as a resident of that state entitled to claim protection under the treaty. The 4th case is undoubt­edly one where the person is liable to be assessed but the state has decided not to levy tax on a particular type of income. In the Azadi Bachao Andolan case the Supreme Court was concerned with case 4) and held that even so the concerned entity was a resident of Mauritius.

Peculiar problems arise in the case of partnerships where the partnership as such is not liable to tax (as in India from the assessment year 1993-94) but the partners are directly taxable in respect of the income from the firm (as, for example, in the United Kingdom). In such a case whether the partnership is to be regarded as entitled to claim the treaty benefit is a matter of debate.

7. “Life” of a Treaty

Section 90 of the Act empowers the Central Government to enter into Double Taxation Avoidance Agreements and by notification in the Official Gazette to make provision for implementing the same. Such Agreements, therefore, become part of the Act it­self. As already noted above in CIT vs. Kulangadan Chettiar (2004) 267 ITR 654 (SC) the Supreme Court held that such an Agreement acts as an exception to or modification of sections 4 and 5 of the Act. Entry 14 in List I of Schedule VII to the Constitution vests power exclusively in the Union to enter into treaties. The upshot of the decision of the Supreme Court in Meganbhai vs. Union of India AIR 1969 SC 783 is that a tax treaty becomes law without any further legislation having to be enacted (see also Union of India vs. Azadi Bachao Andolan (2003) 263 ITR 706 at 721).

Once a Double Taxation Avoidance Agreement is entered into it would continue to be in force in all its terms unless the covenanting states subsequently execute a protocol to amend the terms of the Agreement or one of the states gives notice of termination to the other state which can normally be done only after the expiry of any minimum prescribed period for the operation of the Treaty. The negotiation of a fresh treaty would also sound the death-knell of the old Agreement.

Agreements entered into by India provide for the date of entry into force of the Agreement. The contracting states have to notify each other of the completion of the procedures required by the respective laws of the state for the bringing into force of the Convention. The Convention normally comes into force after a specified period of time from the receipt of the letter communicating compliance with the prescribed procedures in this behalf referred to above. In India the provisions of the Convention generally apply in respect of income arising in any fiscal year beginning on or after the first of April following the calendar year in which the Agreement comes into force. The same is the position with regard to the coming into force of a protocol amending the Agreement.

A problem arises where residents of the two contracting states have entered into a private contract when a particular Double Taxation Avoidance Agreement was in force and subsequently there is an amending protocol or a new Agreement which affects the assessee adversely. Is it at all open to an assessee to urge that the provisions of the Convention as existing when the private contract was entered into should govern the taxation in respect of income under the said private contract and not the terms of the new Agreement or the amending protocol? The gener­al view is that it is the provisions of the Convention as on the first day of the relevant assessment year which would have to be taken into account and not the provisions of the Conven­tion as in force when the parties entered into the private contract. The rule is the same as when interpreting an amend­ment to the Act — the Act (as amended) existing on 1st April, of the assessment year will apply (see CIT vs. Isthmian Steamship Lines (1951) 20 ITR 572). The Calcutta High Court in Timken India Ltd. vs. CIT (2002) 256 ITR 460 (Kar) has also taken a similar view, namely, that one has to consider the terms of any Convention in exist­ence for the assessment year in which the income is chargeable to tax.

In CIT vs. Tata Iron & Steel Company Ltd. 66 TTJ 463; (2000) 248 ITR 190 (Bom) the Mumbai Bench of the Income-tax Appellate Tribunal in disposing of the Department’s application under section 254( 2) of the Act to rectify its earlier order reported in 62 TTJ 17 held that the subsequently entered into protocol did not affect taxability under an earlier entered private contract. With respect the writer submits that this is not the right view. In 248 ITR 190 the High Court at Bombay (in dismissing the Revenue’s appeal against the Tribunal’s conclusion in 66 TTJ 463 that its earli­er decision in 62 TTJ 17 did not disclose a rectifiable mistake) has only held that the Tribunal’s earlier decision did not reveal any mistake apparent from the record and the Court did not uphold the correctness of the view taken by the Tribunal on the merits in either 66 TTJ 463 or 62 TTJ 17.

A peculiar problem which would arise is where there is an amendment of an Agreement by a protocol which is applied retrospectively. In Tata Iron & Steel Co. Ltd. vs. Dy. Commissioner of Income-tax 62 ITJ 17 (already mentioned above) the Mumbai Bench of the Income-tax Appellate Tribunal has taken the view (whilst considering the protocol which amended the Indo-German Double Taxation Avoidance Agreement of 1959 in respect of income assessable from the assessment year 1984-85 by notifica­tion dated 26th August, 1985) that the amended protocol would not govern the assessment for the assessment year 1985-86. The issue whether an amendment can have retrospective effect so as to make the amended Agreement applicable to a year earlier to the year in which the notification was issued is not yet con­clusively adjudicated upon by a Court.

8. Aids in construing Tax Treaties

Having considered problems concerning interpretation to be placed on particular provisions in Double Taxation Avoidance Agreements I may now refer to certain general rules’ which are applied in interpreting Double Taxation Avoidance Agreements. One view is that rules of interpretation which are applied in interpreting laws in general and taxation laws in particular would equally apply to the interpretation of treaties. These rules are to be covered by distinguished writers who have contributed to the present publication and I need not delve into the same. However, in applying general rules for inter­preting statutes one should bear in mind that in Union of India vs. Azadi Bachao Andolan 263 ITR 706 at 751 the Supreme Court of India held that principles to be adopted in interpreting trea­ties are not the same as those employed in the interpretation of “statutory legislation.” The Court quoted with approval Francis Bennion’s statement in “statutory interpretation” namely, “The drafting of treaties is notoriously sloppy usually for very good reason. To get agreement, politic uncertainty is called for… The interpretation of a treaty imported into Municipal law ( is)… unconstrained by technical rules… or… legal precedent but conducted on broad principles of general acceptation’… the words ‘are to be given their general meaning, general to lawyer and layman alike… the meaning of the diplomat rather than the lawyer.” The Court also approved of the observations of David R. Davies in “Principles of International Double Taxation Relief” to the effect that the main function of a Double Taxation Avoidance Agreement is to aid commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling to be taxed in both jurisdictions. The final Agreement often represents a number of compromises. The Supreme Court rightly observed that in interpreting double taxation treaties it has to be borne in mind that treaties negotiated are entered into at a political level and have several considerations as their bases.

I now refer to certain rules of interpretation which specifi­cally relate to the interpretation of Double Taxation Avoidance Agreement. In May 1969 some countries concluded the Vienna Convention on the law of treaties. Though India is not a party to the Convention the Convention really codifies existing customary law for interpretation of treaties in general. To that extent the rules laid down in the Convention for interpretation of treaties would be equally applicable in interpreting Double Taxation Avoidance Agreements entered into by India . A very instructive analysis of the terms of the Convention is found in Martin Dixon’s Textbook on International Law (first Indian Reprint) at pages 59-80. Part III of the Convention enumerates the rules of interpretation to be applied. Article 26 provides that a treaty is binding upon the parties and must be performed by them in good faith. Article 27 forbids a contracting state from invoking the provisions of its internal law as justifica­tion for failure to perform a treaty obligation unless a rule of internal law of fundamental importance has been violated in concluding the treaty. Article 31 provides that a treaty is to be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. What are the relev­ant circumstances in determining such context are also set out. Article 32 provides that in interpreting the terms of a treaty the preparatory work and the circumstances of its conclusion should be taken into account if the application of the context rule creates ambiguity. This is called the ‘travaux preparatoires’ rule. Article 33 is of particular importance. It provides that when a treaty is authenticated in two or more languages the text in each of the languages is equally authoritative unless the parties have inserted a provision that a particular text shall prevail. A version of the treaty in a language other than the one or ones in which the text was authenticated is not to be considered unless the parties have agreed that it shall be regarded as the authentic text. Fur­ther, the terms of the treaty are presumed to have the same meaning in each authentic test. Article 33.4 lays down the rule that where a particular text is not to prevail but a comparison of the authentic texts discloses a difference of meaning which cannot be resolved the meaning which best reconciles the texts, having regard to the object and purpose of the treaty shall be adopted. For example, the Indo-Uzbekistan Double Taxation Avoidance Agreement records that it has been executed in Hindi, Uzbek and English languages and “all the texts being equally authentic.” It is however, provided that “in case of divergence between any of the texts, the English text shall be the opera­tive one.”

In interpreting Double Taxation Avoidance Agreement what are the other aids which the Court can draw upon? As noted above the Commentaries to the Models are generally regarded as very relevant in interpreting a Double Taxation Avoidance Agreement which uses the identical language as in the applicable Model Convention. The reason for this is that the Commentaries ex­press the understanding of the wording in the Agreement and if one of the contracting parties does not agree with the same it should put in a caveat in this behalf. If it adopts the lan­guage of the Convention, then, the interpretation placed there­on should be regarded as accepted by it. CIT vs. Visakhapatnam Port Trust (1983) 144 ITR 146 is one of the first judgements in India wherein the general principles applicable in the case of Double Taxation Avoidance Agreement were exhaustively considered. Reference is made therein to the OECD Commentaries and the view is expressed that in interpreting a Double Taxation Avoidance Agreement the Court must have regard to the decisions and rulings of Courts in foreign countries. Similarly, in CIT vs. Vijay Ship Breaking Corp. (2003) 261 ITR 113 the Gujarat High Court has placed reliance on the OECD Commentary. This has also been done by the Supreme Court in the all pervasive Azadi Bachao Andolan case (263 ITR 706). Undoubtedly, the commentaries cannot be treated as binding but in the event of any doubt in the meaning of the words used in an article one would have regard to the view taken in the Commentary.

In interpreting any law or any tax law as also in interpreting Double Taxation Avoidance Agreements, the question arises whether one can consider the views of authors of books or interpret the law, as it were, by analogy. Insofar as the former is concerned the strict rule, is that the opinion of a living author cannot be considered. This is on the basis that he may change his views and that it is not his final view. This strict rule is rightly not followed as after all a Court only considers the view expressed and it is open to the Court to agree or disagree with the same.

One of the aids in construing the meaning of words used in a treaty is to refer to another treaty and on the wording thereof to urge that the treaty under consideration not being so worded should be interpreted differently or being similarly worded should be interpreted as per any clarification issued for the purpose of that other treaty or any decision interpret­ing the language of that treaty. One may call this the inter­pretation by analogy rule. For example, in CIT vs. Vijay Ship Breaking Corp. 261 ITR 113 the interest article in the Indo-UK Treaty was sought to be interpreted by reference to the Indo­-Indonesian Treaty. In the latter treaty the term “debt claims” was defined as including interest on deferred payment of sale consideration. It was urged that as in the Indo-UK Treaty the inclusive part in the Indo-Indonesian Treaty was absent, “debt claims” as per the former Treaty did not include deferred payment interest. The Gujarat High Court held that the elabora­tion in the Indo-Indonesian Treaty was clarificatory. On the other hand, in Raymond Ltd. vs. Dy. Commissioner of Income-tax 86 ITD 791 the Tribunal had to consider the provision defining “fees for technical services” in the Indo-UK Treaty as payments which make available technical knowledge, experience etc. In interpreting this term the Tribunal had regard to the explana­tion of this term in the Memorandum of Understanding appended to the Indo-USA Double Taxation Avoidance Agreement which was executed prior to the Indo-UK Agreement and the clarification in the Memorandum was regarded as acceptable to India and, therefore, applicable in interpreting language in the Indo-UK Treaty which was identical to the Indo-US Treaty. The Tribunal also relied on the fact that in the subsequently executed Indo­-Singapore Treaty itself the phrase in question was explained as knowledge etc., “which enables the person acquiring the servic­es to apply the technology contained therein.” The writer feels that when one is arguing by “comparison of language” insofar as two Acts are concerned, one could urge that the purpose and function of the two Acts are different and one cannot argue by comparison particularly when an argument is based on the com­parison of language in a foreign statute. However, rule of interpretation by analogy would have force when India is a party to both the concerned Agreements and one is seeking to rely on the Memorandum of Understanding in one of the Agree­ments or the express language in the other Agreement. If India accepts a particular interpretation, why should it not be applied when interpreting another identically worded Treaty to which India is a party? The argument may not have much force when one is seeking to compare two treaties but India is a party to only one of them.

It goes without saying that a protocol attached to a treaty would have equal force as the treaty (see the decision of the Income-tax Appellate Tribunal in Dy. Commissioner of Income-tax vs. ITC Ltd. 82 ITD 239). The Memorandum of Understanding as noted is also relevant and was relied upon by the Authority for Advance Ruling in P No. 28 of 1999 242 ITR 208 at 225. If at all the protocol may be at a slightly higher level of acceptance for interpretation than a Memorandum of Understanding.

9. Conclusion

In the ultimate analysis the ability to arrive at the correct interpretation of a legal provision, which could also mean the interpretation which the Court will ultimately place thereon, is the real art of a lawyer. It depends on his ability to read what is stated, to read between the lines and to read “through” the provision, things which one can do if he has a wide expo­sure to life as such. These are qualities which R. J. Kolah, in whose memory and honour this publication is being released, possessed in abundance.

The publishers of this issue have undoubtedly undertaken a Herculian task in trying to place within its covers rules of interpretation which would apply in different circumstances and in interpreting different legislations, rules and Agreements etc. Let there be no misinterpretation of my appreciation for their efforts if I end on a somewhat cynical note.

I believe that the rules of interpretation are in a way elastic enough for a judge to be able to support the view which he thinks will further the cause of justice by citing an appro­priate rule of interpretation. If a judge wants to go strictly by the written word he would cite the rule enunciated by Rowlatt J. in Cape Brandy Syndicate vs. IR 1921 (1) KB 64, approved by the Supreme Court in CIT vs. Ajax Products Ltd. 55 ITR 741, 747, which requires that in a tax law one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing to be implied. One can only look at the language used. In Jiwandas vs. CIT 4 ITC 40 it was stated that one cannot extend the scope of a statute by analogy or place upon it what is called a beneficent or equitable construction in order to prevent a real or supposed anomaly.

There is, on the other hand, the directly opposite rule of construction whereunder a judge is exhorted to supplement the written word so as to give force and life to the intention of the legislature though he must not alter the material of which the fabric is woven but he should iron out the creases. By invoking these principles the Supreme Court of India in CIT vs. Bhattachargee (1979) 118 ITR 461 held that in section 245M of the Act the term “assessee” would encompass the department as well! This was done undoubtedly to avoid a result which would have been unjust to the Revenue. In CIT vs. J. H. Gotla (1985) 156 ITR 323 (SC) the boot was, as it were, on the other foot. A literal interpretation would have resulted in a patent injustice to the assessee. In the process the Court observed that where the plain literal interpretation of a statutory provision produces a manifestly unjust result, which could never have been intended by the legislature, the Court might modify the language used by the legislature so as to achieve its intention. To this approach a strict constructionist judge would say that it is not for the Court to make good the lacuna in the legislation.

This contrasting approach is very tellingly illustrated by two decisions of the High Court at Bombay — the gap between the two decisions being just five years. In Elphinstone Spinning and Weaving Mills Co. Ltd. vs. CIT (1955) 28 ITR 811 (Bom) the Court observed that where the language was clear and not capable of any other construction, then, however illogical the position, however, absurd the result, however much the construction put may defeat the object of the Legislature, the statute must be construed according to the plain language used by the Legisla­ture. On the other hand in CIT vs. Kishoresinh Kalyansinh Solanki (1960) 39 ITR 522 (Bom) the same Court observed that the rule of literal interpretation cannot be adhered to if it leads to manifest absurdity.

The pity is that what is “manifest” to one judge is often obscure to another. Therein lies the strength and weakness of rules of interpretation and provide bread, butter and large helpings of jam to the legal fraternity!

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Amortisation of preliminary expenses

Amortisation of preliminary expenses

 


There can be situations when a claim can fall for consideration both under Section 35D and Section 37.


 

 

T. C. A. Ramanujam

Companies have to incur heavy expenditure for commencement or expansion of business.

Questions often arise whether such expenses can be claimed as revenue in nature. If it is revenue expenditure, it can be allowed as a deduction under Section 37 of the Income-Tax Act, 1961.

Revenue expenditure

 

 

If it is not considered as revenue in nature, then it will have to be taken as capital expenditure which can be amortised over a period of years.

It is not that every type of capital expenditure falls in this category. The expenses which can be amortised are specified in Section 35D of the I-T Act.

Expenses in connection with preparation of feasibility reports, project report, survey necessary for the business of the assessee or on engineering services, legal charges, printing of memorandum, registration fees, public issue expenses, etc., relating to the business can all be amortised. Stringent conditions are laid down for claiming amortisation. The expenditure should not exceed 5 per cent of the ‘project cost’ or the ‘capital employed’.

These terms are also defined in the I-T Act. Deduction as revenue expenditure under Section 37 is somewhat more liberal. There can be situations when a claim can fall for consideration both under Section 35D and Section 37. This can arise in the case of a running company.

Claims under two Sections

 

 

Shree Synthetics Ltd was engaged in the business of manufacture of synthetic fibre, yarn fabrics, etc. It undertook modernisation and expansion of spinning line, nylon polymerisation, etc. For financing the expansion, the company raised money by way of issuance of debentures, partly convertible and partly nonconvertible.

The debenture issued resulted in an expenditure of Rs 22.18 lakh. The company claimed that the amount should be allowed under Section 37 as revenue expenditure incurred for raising a loan for running the business.

The assessing officer (AO) took the view that the expenditure squarely fell within the ambit of Section 35D. The matter was taken to the High Court by the company. It was argued that Section 35D referred to ‘extension’ of the industrial undertaking and extension was different from expansion.

The claim for deduction under Section 37 should have been allowed, it was contended, at least with regard to the expenditure relating to the nonconvertible portion of debenture as it represented borrowing of funds.

Extension vs expansion

 

 

The MP High Court (in 303 ITR) considered the matter in some detail; it observed that the word ‘extension’ for the purpose of Section 35D also included ‘expansion’ of the industrial undertaking. Expenditure incurred whether for extension or expansion will fall for consideration under Section 35D.

Section 35D is a special provision for claiming deduction of a specified category of expenditure. It excludes the applicability of general provision dealing with revenue expenditure. The special excludes the general. Section 35D will prevail over Section 37.

The High Court was not impressed by the distinction sought to be made between convertible and nonconvertible debentures. The intention behind Section 35D is to include all kinds of debentures under Section 35D.

Amortisation was being allowed over a period of 10 years up to March 31, 1998. After this date, it is allowed over a period of five successive previous years. Under Section 37, the entire expenditure will fall for consideration in one year.

Finance, service companies

 

 

Will Section 35D apply in the case of finance and service units? This issue arose in the LIC Housing Finance Ltd case. The company made a public issue of equity shares and incurred a total expenditure of Rs 7,08,51,925 against the public issue of Rs 113.50 crore. It claimed one-tenth of this expenditure under Section 35D.

The Income-Tax Appellate Tribunal (ITAT) rejected the claim on the ground that Section 35D referred to an industrial unit which commenced production or operation. It implies that the industrial undertaking or the unit must be engaged in some manufacturing, producing or processing activity. The only business of the company was that of providing housing finance. This was not covered under Section 35D. The Tribunal was considering the LIC Housing Finance Ltd case in respect of the assessment year 1995-96.

 

 

 

 

Till recently, amortisation of preliminary expenditure was allowed under Section 35D only for industrial undertakings. It was not applicable to companies engaged in providing finance or other services.

Responding to repeated calls from industry and business, Section 35D was amended by the Finance Act, 2008 w.e.f. April 1, 2009, that is, from the assessment year 2009-10, the benefit of amortisation is available even for service organisations.

The words ‘industrial undertaking’ were omitted and the word ‘undertaking’ was inserted in Section 35D. The benefit of amortisation of specified post-commencement preliminary expenses will henceforth be available to all sectors of industry. The amendment could have been made retrospective.

 

 

(The author is a former Chief Commissioner of Income-Tax. Responses to blfeedback@thehindu.co.in)

Copyright: The Hindu Business Line

http://www.thehindubusinessline.com/2008/08/23/stories/2008082350270900.htm

AAR Ruling – Construction Consulting Consortium Held to Be Association of Persons

Authority for Advance Rulings (AAR) held on 31 July 2008 that a joint venture (JV) between a nonresident entity and Indian residents that provided construction consulting services to an Indian corporation constituted an association of persons (AOP) subject to tax in India. Under Indian tax law, the profits of an AOP are taxed separately.

Facts

The “Applicant” (Geoconsult ZTGMBH, Austria) formed a JV with two Indian companies (M/s Rites Ltd. (Rites) and M/s. Secon Pvt. Ltd. (Secon)) to provide project consulting services. Himachal Pradesh Road and Other Infrastructure Development Corporation Ltd. (HPRIDC) awarded a contract to the Applicant to provide consulting services for two phases of the development of seven tunnels in India.

The JV agreement allocated the duties and responsibilities of the JV participants, as follows:

  • Each JV partner was responsible for fulfilling its contractual obligations to the satisfaction of HPRIDC;
  • The JV partners were jointly and severally liable for the satisfactory execution and completion of assignments;
  • Gross fees would be distributed between the JV partners in a mutually agreed upon proportion;
  • Rites and Secon were responsible for invoicing the Applicant for their services in accordance with the provisions of the contract (with the Applicant then required to prepare a consolidated invoice to submit to HPRIDC); and
  • Payments were made directly by HPRIDC to the individual JV participants in satisfaction of the invoices issued by the JV participants.

Based on the above, the Applicant initially sought a ruling from the AAR to determine: (1) whether a permanent establishment (PE) existed in India under the India-Austria tax treaty; (2) if so, whether the income was attributable to the PE and was subject to tax as business profits under the treaty; and (3) if no PE existed, whether the applicant’s income was subject to tax as fees for technical services under the royalties article of the treaty. Before the ruling was issued, however, the Director of Income-tax (International Taxation) Mumbai found that the JV was assessable as an AOP and should be taxed on a net basis at a rate of 41%. The Indian tax authorities based its position on the fact that:

  • The JV was an “association” operating for the common purpose, action and management with the intent to produce profits or gains;
  • The JV partners were working in tandem; and
  • The distribution of fees earned by the JV was clearly specified in the agreement.

The Applicant disagreed with the tax authorities’ characterization, arguing primarily that the JV should not be regarded as an AOP because the contract was merely awarded to the consortium as a matter of convenience. Further, the scope of work of each JV participant was separately identified in the agreement and clearly limited the “nature of cooperation” to the extent required for the coordination and completion of the project. The Applicant also argued that the agreement does not provide for the sharing of profits, but rather the sharing of gross revenue and that each participant was acting as a stand-alone operation to independently complete its portion of the contract with HPRIDC. Finally, separate bills and invoices were issued and gross revenue was directly paid to each member.

AAR Ruling

The AAR examined the arrangement between the parties and concluded that the consortium constituted an AOP, a separate entity for tax purposes. In arriving at this conclusion, the AAR noted the following essential elements of an AOP:

• Two or more persons;
• A “voluntary combination”;
• A scheme for common management; and
• A common purpose or common action.

While intent to produce a profit or gain may be evidence that an AOP exists, as a result of a 2002 amendment to Indian tax law, it is not a requirement to be regarded as an AOP.

The AAR found that the JV’s agreement with HPRIDC satisfied all the essential requirements of an AOP and noted that the JV participants associated themselves with a common design to provide consulting services. This was due to factors including:

  • While payments were legally made to the JV, the JV partners authorized HPRIDC to issue checks directly to the individual partners (i.e. Rites and Secon);
  • The JV participants were jointly and severally liable to HPRIDC for their contractual obligations; and
  • The delegation of duties did not affect the integrity of the association as it was simply an internal mechanism to provide services to the client, based on the expertise and experience of the participants.

The AAR observed that the sharing of gross revenue and not profits does not eliminate the unity between the consortium members. Moreover, the requirement that the consortium have a common profit-seeking purpose is no longer necessary to be regarded as an AOP. Thus, the net income of the AOP was held to be taxable at 41%.

In view of the above ruling, taxpayers that have formed a consortium for executing contracts should review existing or contemplated arrangements to mitigate the risk of being regarded as an AOP.

Copyright: www.Deloitte.com

Permanent Link: http://deloitte.12hna.com/newsletters/2008/WTA/a080815_4.pdf

Published in: on August 15, 2008 at 11:35 am  Leave a Comment  

Will OECD guidance bring tax certainty?

Will OECD guidance bring tax certainty?
DIRECT TAX
Mukesh Butani / New Delhi August 11, 2008, 5:45 IST
 

Indian PE Darshan
The term PE ( in India) is more synonym to Permanent establishment than to Private Equity! In my interactions with Tax Directors of MNC’s, I seldom come across a situation where no questions have been asked on Indian PE or rather more specifically, How India interprets the term PE.

The theory of inconsistency applies not just to tax administrators, but also tax advisors. I guess, part of the blame lies in our principle driven ( rather than rule driven) manner of interpreting tax law and part lies with Indian tax administration’s obsession to apply strict source based rules, fearing erosion of tax base.

The Revenue by holding or applying strict source based rules tend to bring to tax profits of a foreign enterprise to India by holding that the foreign enterprise has a PE in India and attributing greater share of such profits.

Recently, the Organization for Economic Cooperation and Development (OECD), a 30 member club of developed nations released its final report on profit attribution to permanent establishments (PE’s).

The report marks the culmination of a long drawn process that began in 1995 with the introduction of an earlier guidance – ‘Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ (OECD Guidelines). Since then, the possibility of applying similar principles for taxing PEs has been the most debated topic in international tax law.

PE and profit attribution linked
As a part of its support role, OECD undertakes research on taxation covering diverse issues ranging from tax evasion to transfer pricing. Its recent most initiatives – ‘Report on the Attribution of Profits to Permanent Establishments’ followed by an ‘Update to Model Tax Convention’ in July 2008 mark the convergence of two separate but related streams of international taxation – ‘transfer pricing’ and ‘profit attribution’. This is most timely given the maze of complex issues India is presently grappling with.

As a sub-discipline of international tax, transfer pricing deals exclusively with valuation of intra-group transactions. A PE on the other hand is a legal fiction that determines tax liability of a foreign enterprise. It is a fundamental principle of international tax that a source State can tax a non resident foreign enterprise only if it has a PE. Equally important but more complex is the next determination — the extent to which profits are attributable to the PE.

New approach to profit attribution
Historically, attribution has been based on guesswork and crude logic in most economies, barring a few. Countries have generally applied a formulaic approach for determining profits attributable to PE (as a percentage of sales or using similar criteria). India has somewhat a similar approach, popularly called Rule 10, though, the authority to apply such method is with the Revenue.

The OECD approach discards the age old practice of apportionment and ushers arm’s length principle as the ‘new approach to attribution’. Its clearly a departure from the arbitrary approach and besides keeping pace with the reality of modern trade and commerce, its rational and scientific.

Application of transfer pricing principles (contained in OECD Guidelines) to a PE constitutes the bedrock of the new approach. A PE is a virtual projection of the foreign enterprise in the source state. Yet for analytical purposes, it is hypothesized as an entity ‘separate and distinct’ from the foreign enterprise and attributed a return commensurate with functions, assets and risks undertaken by it (‘separate entity approach’).

A corollary of the arm’s length principle is that profit shall be attributed to the PE only where facts and circumstances justify and not as a matter of rule. Hence, where an enterprise (that creates a PE) has been adequately remunerated for its functions, no profits may be attributed to the PE.

Indian PE cocktail
Our origin of PE and income attribution debate may be traced to pre-independence era when apportionment principles were applied for determining profits attributable to ‘business connection’ (domestic law concept similar to PE). Hence, in the Anglo-French Textile case as well as Ahmedbhai’s case, the Supreme Court gave its verdict on a rough estimate of taxable profits, having regard to the nature of business operations undertaken in India.

That was an era when transfer pricing tools were absent and reliance on thumb rule was inevitable. However, since then significant strides forward have been made in the municipal and international law. Arm’s length principle is now widely recognised as the most appropriate mode for profit attribution, particularly given that we have comprehensive Transfer Pricing legislation

Recently, the question occupied centre-stage as the Tax Tribunal pronounced a number of rulings on the subject. The trend in these decisions is a pointer towards the fact that perhaps the ghost of attribution continues to haunt Indian Courts.

The thumb rule has been applied repeatedly throwing up arbitrary figures that are not based on any rationale – whether it is 15 percent in Galileo’s case (for online booking services) or 35 percent for marketing services in the case of Rolls Royce.

Surprisingly, intensive reliance on modern concepts of PE in the context of agency business ( for Rolls) and e commerce model ( for Galileo ) have been made use for the determination of existence of PE in India. Having determined that the foreign enterprise has PE, for attribution purposes, principles laid down by the courts (over 5 decades old ) have been used. Foreign investors find this puzzling and misdirected.

Earlier in Sony Entertainment’s case (SET), the Tax Tribunal stretched attribution principle to an extreme holding that profits were attributable to PE despite arm’s length payment to the Indian enterprise. Thankfully, the Supreme Court has seemingly overruled SET principles in ‘Morgan Stanley’ case, aligning Indian law with OECD principles. Even so, Indian Courts are yet to come to terms with the new approach to profit attribution, as borne out from recent decisions.

OECD guidance Implications for India
Though, India is not an OECD member state, OECD guidelines play a supplementary role on issues where Indian legislation is silent. From Morgan Stanley to recent decisions on transfer pricing (Egain Communication, Star TV ), Indian Tax tribunals and Courts have consistently approved reliance on OECD guidance. In a similar vein, one hopes that Revenue and Courts willingly accept and apply OECD principles while deciding questions on attribution.

Not only is the new approach scientific, but implies certainty for taxpayer and reduced risk of double taxation. Moreover, acceptance of OECD principles does not necessarily imply erosion of source based taxation.

Transfer pricing principles may not allow profit attribution as a sweeping rule but they ensure that the exchequer gets its due from economic activity undertaken in India. In fact, so strong is the dictum of arm’s length principle that, in cases, it may even tax a foreign multinational where the enterprise as a whole makes losses. Hence, fears of a treasury run down are ruled out and a consistent application of arm’s length principle augurs well for investment and taxation alike.

In summary, it would be interesting to see how Indian tax policy makers and administrators embrace the OECD principles, given that India has marched ahead of its “ observer status ” and is now engaged in “enhanced dialogue”, a pre cursor to entering the elite OECD member nation club.

The author is a Partner with BMR Advisors. Views expressed herein are personal

Copyright : Business Standard

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Published in: on August 11, 2008 at 12:19 pm  Leave a Comment