Agreements need an update

THE MEDIA has given prominence to the recent instructions of the Central Board of Direct Taxes (CBDT) regarding the treatment to be accorded to capital gains in respect of companies registered in Mauritius. Even political parties have joined the fray, each with a different perception.

It will be interesting to note that one of the earliest judgements of the Bombay High Court ruled that taxes on capital gains on entities other than companies could not be covered under the Constitutional entry in Schedule VII taking into account the British legislative practice. This was because most of the entries in the relevant sections were transferred to Schedule VII in toto from the Government of India Act enacted by the British Parliament. The Supreme Court, however, ruled in the Navinchandra Mafatlal case that the Constitutional entries, being sources of legislative power, should be interpreted, giving the widest amplitude taking into account the supremacy of a sovereign state.

Be that as it may, there are differing perceptions. There is still no uniformity of approach in the treatment of ``tax crimes'' captioned as white- collar crimes. Even the recovery of capital gains tax levied on Delhi Electricity Supply Company which went into liquidation in 1947 following the transfer of power could not be enforced in British courts.

The 29th Report of the Law Commission has made a special mention about white-collar crimes. In regard to companies, Indian courts have permitted the piercing of the corporate veil to ascertain their true nature. The general argument is that most of the dubious companies get formally registered in tax havens to get off the tax hook. In other words, they are fronts to others who use these monies to perpetrate crimes, feudal overlordship, terrorism and the like.

The Bombay High Court had ruled in the Fifties that the control exercised by a company in regard to its affairs, has to be adjudicated, with reference to the following criteria; where the brain, directing power and seat are located. In each case, it is a question of evidence, as used to be the practice, in times yonder, when firms registered in Malaysia or Myanmar (Burma), with partners staying in India, were subjected to Indian taxation after establishing that the control of their affairs was partly exercised from India. All this background is necessary for proper assessment of the matter with due circumspection.

The first double taxation avoidance agreement after India became independent was with Pakistan in 1947. In 1954, the Economic and Social Council (ECOSOC) of the United Nations passed a resolution advocating free flow of trade and technology to developing and underdeveloped countries from developed countries. Conclusion of tax avoidance agreement thus became a necessary concomitant. In 1956, when T. T. Krishnamachari was the Finance Minister, a clause to exempt interest payable on loans taken abroad for specified development purposes in India was incorporated in the Income-tax Act. This was because the report of the Second Planning Commission had an emphasis on foreign capital as well to meet the nation's development needs.

The first stimulus to use tax provisions for development was given by Sir Archibald Rowlands, Finance Member of the Viceroy's Executive Council in 1946. The IT Act is now cluttered with several exemption and incentive provisions, aimed at development of the country.

An Indian delegation went to various European and American countries to negotiate agreements for avoidance of double taxation. The first such agreement was with Sweden, initialled at Stockholm in June 1958, within a record time of 36 hours. This agreement also included a provision for exchange of information for checking evasion.

The Indian law also provided for tax exemption to encourage induction of technicians from abroad, foreign capital and technology. This led to a situation where a country like the U.S. taxes its citizens and corporates on royalty, salary and other income, on the basis of domicile under its laws, relieving double taxation, by giving credit for any foreign tax, under its domestic law provisions.

As no foreign tax was suffered by these entities, this indirectly resulted in the transfer of Indian revenue to the foreign country; without the beneficiary getting any advantage, for working in a hazardous terrain and arduous environment. This often acted as a disincentive in getting foreign assistance.

The concept of the tax sparing was evolved by India, which inter alia required the foreign country to give its assessee a deemed credit, on the footing that the beneficiary would have suffered in India such tax, had the exemption not been available. (Here was thus a case where the beneficiary did not suffer any tax either in the home country or in the country of his operations).

An agreement was signed at government level by India's Ambassador and the U.S. Secretary of State in October 1959. But the U.S. Senate did not ratify it on the ground that tax incentives cannot be a basis for promoting development.

There were elaborate confabulations spanning three decades. The principle was finally accepted with sufficient safeguards and the agreement was ratified in 1989.

This emphasises the point that until the U.N. accepts the tax statutes of different countries as eligible for enforcement of its provisions, on the analogy of laws inflicting punishment on crimes known to humanity, like forgery, treason, rape, perjury and murder, the developing nations are bound to suffer a setback, despite the resolution of the ECOSOC in 1954.

In other words, there should be a reappraisal of the principles governing agreements for avoidance of double taxation. Despite Indian law providing for an authority presided over by a retired Supreme Court judge to give advance rulings to enable a foreign investor/entrepreneur to know the extent of his liabilities, differential interpretations by foreign authorities could sway final investment decisions. It is well known not there are several tax havens which act as conduits for cross country transfers providing a stimulus for trans-border terrorism.

The bull will have to be taken by its horns. Though principles of avoidance treaties were enunciated in the early Thirties on the directives of the League of Nations, laying down criteria of economic allegiance, much water has flowed under the bridge. There have, no doubt, been subsequent enunciations.

Globalisation is the key of the times. The time is therefore ripe for further updating and for redrawing of the contours of double taxation avoidance agreements, without affecting the rights of sovereign nations, so as to fine-tune them to meet the emerging challenges.

Curbing tax avoidance and evasion and abuses such as treaty shopping should remain the prime motive in tackling the problem of laundering of black money, a specific reference to which was made by an earlier U.N. Secretary General.

M. S. Sivaramkrishna (Retired Member, Central Board of Direct Taxes)

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