ON the 22th of May, 2024, the Calcutta High Court - 2024-TII-37-HC-KOL-INTL has decided a bunch of cases involving the same taxpayer but where the dispute that has been festering since the 1990s. The issue in this case though lies in a very narrow conspectus. It is common knowledge that India charges tax at a higher rate on foreign companies than on domestic companies. This is going on since independence. Whether the headline rate should be kept high or not is a different issue altogether. The present case also involves the issue of such higher rate of tax, whether the same is discriminatory in terms of the tax treaty between India and the Netherlands.

The case relates to the Indian branch of ABN Amro Bank NV, Netherlands presently known as The Royal Bank of Scotland N.V. It is registered as a scheduled bank in terms of Schedule-II of the Reserve Bank of India (RBI) Act, 1934. Being a branch of a foreign bank, there is no doubt that it is a permanent establishment of the foreign bank in India and its profits from the operations in India are taxable in India. The only question is the rate at which such income should be taxed.

It is important to remember at the outset that a tax treaty basically limits the taxing rights of source states. Before the signing of a tax treaty a source state has unlimited taxing rights at least theoretically over whosoever it can tax. By entering into a tax treaty, that right is limited in a number of ways. Since the present case concerns the taxation of business income, we may note that the residence state has the basic right to tax the income of a business conducted by its residents except where a PE comes into existence in the source state in the circumstances defined in the tax treaty. The treaty also limits the amount of income that can be allocated to the PE. But, the treaty does not lay down the rate of tax to be levied either by the source state or by the residence state. That is the prerogative of the state levying the tax. Double taxation is avoided by the residence tax either giving a credit for the tax paid in the source state in accordance with the treaty or by exempting the income concerned from the ambit of its taxation.

But then there is an article on non-discrimination contained in article 24 of the tax treaty, more particularly Article 24(2). The India-Netherlands tax treaty in article 24(2) stated as follows:

"2. Except where the provisions of para 3 of Article 7 apply, the taxation on a permanent establishment which an enterprise of one of the States has in the other State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities."

It is in interpreting this apparently innocuous provision that has produced astonishingly diverse results from courts and Tribunals and even from the CBDT.

From the order of the Tribunal delivered in 2005 and against which the appeal was decided by the High Court, it appears that till the Year 1991, the tax department itself took the view that the import of Article 24(2) was that the tax rate on the foreign branch or the PE should be the same as that applied to domestic companies. Apparently, the Embassy of Netherlands also got involved and on a query by the CCIT -II, Kolkata, the Joint Secretary FTD issued a letter as follows:

Letter dt. 21st Nov., 1994:

"Sub: Taxation of ABN--AMRO Bank-Ref. From Embassy of Netherlands.

Please refer to your letter D.O. No. CC-11/HQ Asstt. 4 Misc./93-94/Vol-IV/504, dt. 29th July, 1994, on the above subject. The matter has been looked into and the Board is of the opinion that the tax rate applicable in the case of ABN AMRO Bank would be the same as for an Indian company, at the relevant tax rates applicable for the concerned assessment years." (As quoted in the order of the tribunal 2005).

Of course, in view of the subsequent developments in the domestic law, the said letter was changed in 2000, but we will come to that somewhat later.

Since this is an order from the Calcutta High Court, it is interesting to note another decision by the same court disposing of a reference on the 7th July, 2019 on a similar issue involving the India-Japan tax treaty in the case of The Bank of Tokyo Mitsubishi Ltd v CIT WB-III = 2003-TIOL-886-HC-KOL-IT. The assessment involved was 1991-92.

The India-Japan tax treaty also contained a similar non-discrimination article:

"2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other Contracting State than the taxation levied on enterprises of that other Contracting State carrying on the same activities."

The High Court observed:

It may have been possible for the language of the agreement not to be so convoluted. In simpler language, the clause means that when there is a permanent establishment of a foreign origin in the other contracting State, such permanent establishment will not be taxed on less favourable terms than enterprises carrying on the same activities in the relevant contracting State. That would imply that if a bank of either country had a permanent establishment in the other country then such permanent establishment in the other country would be subjected to tax at a rate not less favourable than the tax applicable on banking companies in such other country. So much is clear from the relevant clause.

In this case, the CITA had, in fact, enhanced the assessment by charging the higher rate for foreign companies and this was upheld by the Tribunal. The tribunal in this case took the view that unlike in the case of ABN Amro, there was no circular from the CBDT in that case. The High Court berated the stand taken by the CITA and the ITAT in the following words:

"When there is no dispute that there is a double taxation avoidance agreement in place between India and the country of origin of the assessee in the present case and when such agreement contains a lucid clause as apparent from Article 24(2) there of quoted above and when Section 90 of the Act itself recognises such an agreement and creates a special status for the relevant permanent establishments, there was no room for either the Commissioner to wait for any dictat from the high command of the CBDT or for the Tribunal to demonstrate similar servile conduct in not appropriately interpreting and giving effect to the clear words of the agreement between the two countries."

The High Court in that case thus found the provision convoluted at one place and lucid in another. Be that as it may, we may now return to the present case and note the developments that had taken place in the domestic law in the meantime.

An Explanation was inserted by the Finance Act, 2001, with retrospective effect from 1st April, 1962 that stated:

"Explanation: For the removal of doubts, it is hereby declared that the charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign company, where such foreign company has not made the prescribed arrangement for declaration and payment within India, of the dividends (including dividends on preference shares) payable out of its income in India."

Discussing the interaction between Section 90 that authorizes the government to enter into tax treaties and section 90(2), the ITAT pointed out that Section 90(2) provides for application of beneficial provisions of the agreement in contrast to the contrary provisions of the IT Act, 1961 in the event of a conflict between the two. When there is no conflict between the provisions of the DTAA and the IT Act, 1961, the effect shall have to be given to the provisions of the IT Act, 1961. It is only when there is a conflict between the provisions of the agreements in contrast with the provisions of the IT Act, 1961, that the beneficial treatment is to be given as per Section 90(2) of the IT Act, 1961. The Tribunal also quoted from CBDT circular no 333 dt, 2nd April, 1982, in particular the 3rd paragraph thereof that is often ignored.

"3. Thus, where a DTAA provides for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the IT Act. Where there is no specific provision in the agreement, it is the basic law, i.e., the IT Act, that will govern the taxation of income."

Elaborating on the Explanation to section 90, the ITAT held that the Explanation provides for two eventualities-one is the charge of tax in respect of a foreign company vis-a-vis an Indian company, (i.e., a domestic company). The second category as per Explanation is the foreign company vis-a-vis the domestic company other than an Indian company. It is noteworthy that the domestic company is defined under the Finance Act.

The ITAT noted the definition of the 'domestic company' as per the Finance (No. 2) Act, 1996 whereunder a "domestic company' means an Indian company, or any other company which, in respect of its income liable to income-tax under the IT Act for the assessment year commencing on the 1st April, 1996, has made the prescribed arrangements for the declaration and payment with in, India of the dividends (including dividends on preference shares) payable out of such income in accordance with the provisions of Section 194 of the Act."

AS for the effect of the letter of the CBDT, the ITAT also took note of a subsequent letter issued on 2000 as follows:

"Subject: Taxation of M/s ABN Amro Bank at the rates as applicable to nonresident companies as per letter No. F.No. 500/5/99-FTD, dt. March 1999-Matter reg = 2005-TII-55-ITAT-AHM-TM-INTL.

I am directed to refer to your letter No. CC/HQ-II/Asstt. 4/Misc/1999-2000/35, dt. 7th April, 1999. It is clarified that M/s ABN Amro Bank should be taxed at the rates applicable to foreign companies under the respective Finance Acts. The AOs may be instructed to take action accordingly except for the years covered by Board's letter dt. 21st Nov., 1994."

In this connection, the ITAT observed that it was futile to suggest that the CBDT circulars would prevail over the conscious amendment of the law by the legislature which overrides the law prevalent before the amendment including the CBDT circulars. The ITAT also relied on the Supreme Court decision in State Bank of Travancore v. CIT = 2002-TIOL-110-SC-IT that the circulars issued by the Board would be binding on all officers and persons employed in the execution of the Act, but no instructions or circular can go against the provisions of the Act. Therefore, the letters issued by the Board, even assuming that they have the effect of circulars issued under Section 119 of the IT Act, 1961, are ineffective and they have to give way to the law passed by the supreme legislature.

In the event, the ITAT dismissed the appeal of the taxpayer in this regard. And, it is against this order that the taxpayer appealed to the High Court and the order of the High Court has now delivered upholding the view of the Tribunal.

Before the High Court various arguments specifically pointing to the elevated status of the treaty provisions were reiterated. Reference was also made to the earlier judgement of the court in the Bank of Tokyo Mitsubishi case. It was essentially urged that the Explanation to section 90 as intraduced in 2001 was a treaty override.

It was pointed out that the treaty with Netherlands was changed twice and even after the amendment, the language of the relevant Article was not changed. It was also pointed out that certain treaties specifically gave the right to tax at a higher rate to India up to a certain limit.

The High Court took note of the various terms as defined in the domestic law and also examined section 90 as amended from time to time. In particular, the court took note of the definition of domestic company as follows:

Section 2 (22A)- "domestic company" means an Indian company, or any other company which, in respect of its income liable to tax under this Act, has made the prescribed arrangements for the declaration and payment, within India, of the dividends (including dividends on preference shares) payable out of such income.

Section 2(23A) "foreign company" means a company which is not a domestic company.

The court also noted Sub-section 12(a) of Section 2 of the Finance (No.2) Act, 2004

"(12) for the purpose of this section and the First Schedule,- a) "domestic company" means an Indian company or any other company which, in respect of its income liable to income-tax under the Income-tax Act for the assessment year commencing on the 1st day of April, 2004, has made the prescribed arrangements for the declaration and payment within India of the dividends (including dividends on preference shares) payable out of such income."

X) Paragraph E of the First Schedule to the Finance (No.2) Act, 2004 "Paragraph E In the case of a company,- Rates of income-tax

I. In the case of a domestic company 35 per cent of the total income;

II. In the case of a company other than a domestic company-

(i) On so much of the total income as consists of- (a) Royalties received from Government (…)or an;

(ii) On the balance, if any, of the total income. 40 per cent.

The court noted that the meaning of "Domestic Company" and the rate of tax as given in Paragraph E of Schedule I to the Finance Act 2004 are similar in Finance Act of other years involved in the appeals except with the change of effective date and applicable rate of tax

A conjoint reading of the provisions indicates that as per the Act, 1961 there are two class of companies,-"Domestic Company" defined under Section 2(22A) and "Company other than Domestic Company".

Undisputedly the taxpayer is not a domestic company. Therefore, it falls under the other class i.e. "a company other than a domestic company" as classified in paragraph E of the Finance Act. Thus, it is admitted case of the taxpayer that it is not a domestic company as it is neither an "Indian Company" nor "any other Company" as it has not made prescribed arrangement in respect of its income liable to income tax under the Income Tax Act for declaration and payment within India of the dividends including dividend on preference shares payable out of such income. The court pointed out that the classification made in paragraph E of the First Part of the First Schedule to the Finance Act, has not been questioned and such classification is a valid classification.

As for the alleged conflict of the explanation to section 90 with Article 24(2), the court observed that Explanatory notes on the provision of the Finance Act of 2001 states that the explanation has been inserted in Section 90 of the Income Tax Act to clarify that the charge of tax in respect of 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, where such foreign company has not made the prescribed arrangement for declaration and payment within India of the dividends, (including dividend in preferential share) payable out of its income in India. It is a fact that the taxpayer has not made the prescribed arrangements for declaration and payment within India of the dividends, payable out of its income in India so as to fall within phrase "any other company" used in Section 2 (22A) of the Act, 1961 defining the term "domestic company".

Had the taxpayer complied with the terms of "any other company" as used in Section 2 (22A), it would have become a domestic company. This position of law regarding domestic company (Indian Company or any other company) has existed at all relevant point of time. Therefore. Explanation to Section 90 of the Act, 1961 is clarificatory in nature. The said Explanation has merely reiterated the clear statutory provision for rate of tax emerging from Section 2 (22A), 2 (23A) of the Act 1961 read with Section 2 (1) and Section 2 (12) (a) of the Finance Act and Paragraph E of Part I of the First Schedule to the Finance Act. That apart even without the said Explanation to Section 90 of the Act 1961, the statutory provision for rate of tax applicable to a company which is not a domestic company, remained clear at all relevant point of time.

The Court elaborated on the interpretation of Article 24 (2) of the DTAA holding that its purpose id to prevent from less favourable levy between two enterprises falling under one and the same class and not between one falling under one class and the other falling under another class. The phrase "shall not be less favourably levied" used in Article 24(2) of the DTAA simply means that taxation on a company falling under "any other company.... " under Section 2 (22A) of the Act, 1961 shall not be less favourably levied than an "Indian company" which both fall under one and the same class i.e. Domestic Company under Section 2(22A) of the Act, 1961 read with Section 2(1), Section 2(12)(a) and Paragraph 'E' of Part I of the First Schedule of the Finance Act, which provisions existed even prior to the DTAA in question and the clarificatory retrospective insertion of the Explanation in Section 90 by the Finance Act, 2001. Thus, there is no conflict between the Explanation to Section 90 of the Act, 1961 and Article 24 (2) of the DTAA.

As for the argument of the taxpayer that Section 90 read with Section 2(22A) requires a foreign company to fulfil requirement of prescribed arrangement for declaration and payment on dividend within India to entitle it for the rate of tax applicable to domestic company, the High Court found that the aforesaid provisions do not use the words "foreign company". That apart, constitutional validity of the said provisions has not been questioned in the appeals.

As for the binding nature of the CBDT circular no 333, the court held that

The circular of the CBDT deals with the situation where there is a specific provision in the DTAA then that provision will prevail over the general provisions contained in the Income Tax Act, 1961. But there is no specific provision in the DTAA providing for rate of tax applicable to a "domestic company" or a "company other than domestic company" as defined under the Act, 1961 and as prescribed in and paragraph E of the First Part of the First Schedule to the Finance Act read with Section 2(1) and Section 2(12)(a) of the Finance Act.

Besides, the circular states that the DTAA also provides that the laws in force in either country will continue to govern the assessment and taxation of income in the respective country except where provisions to the contrary have been made in the Agreement. In this regard, the court found that that the DTAA in question including Article 24(2) does not contain any provision contrary to the provisions of Section 2 (22A) and Section 4 of the Act 1961 and Section 2(1), Section 2(12)(a) of the Finance Act and rate of tax as provided in paragraph E of part one of the first schedule to the Finance Act. Therefore, circular no. 333 dated 02.04.1982 is of no help.

So far as the letter dated 21.11.1994 issued by Joint Secretary and addressed to Chief Commissioner of Income Tax II Kolkata is concerned, it was written in response to a D.O. letter of the Chief Commissioner. The letter of the Joint Secretary merely informs that "the matter has been looked into and the board is of the opinion that the tax rate applicable in the case of ABN AMRO BANK would be the same as for an Indian Company at the relevant tax rate applicable for the concerned assessment years". The said letter is a D.O. letter. It is not a circular issued in exercise of power conferred under Section 119 of the Income Tax Act, 1961. That apart the said letter is in conflict with plain and unambiguous provisions of the Act 1961 and the Finance Act.

Besides, the opinion expressed in the a letter was also changed even before the Explanation was inserted. Accordingly the High Court held hold that the said letter cannot override the plain and unambiguous provision of the Act, 1961 and the Finance Act

Section 2(17) defining the word "Company", Section 2(22A) defining the word "Domestic Company", Section 2(23A) defining the word "Foreign Company" and Section 90 of the Act 1961 read with Explanation and Section 2(1), Section 2(12)(a), Paragraph 'E' of the First Schedule to the Finance Act are plain, unambiguous and leads only to one conclusion that two class of companies namely "Domestic Company" and "Company other than a Domestic Company" are liable to tax at the prescribed rates. When the words used in aforesaid provisions are clear, plain and unambiguous and admits only one meaning, the court is bound to give effect to the words used in the aforesaid provisions, in their natural and ordinary sense. Since the words used are capable of one construction, therefore, it is not open for the court to adopt any other construction.

Once, Parliament has legislated, the Court must first look at the legislation and construe the language employed in it. If the terms of the legislative enactment do not suffer from any ambiguity or lack of clarity they must be given effect to even if they do not carry out the treaty obligations. But the treaty or the Protocol or the convention becomes important if the meaning of the expressions used by the Parliament is not clear and can be construed in more than one way. Since the expressions used in the aforesaid provisions of the Act 1961 and the Finance Act are clear and capable of only one construction and there is no ambiguity or lack of clarity, therefore, the provision of the Act 1961 and the provision of the Finance Act are bound to be given full effect.

Accordingly, the High Court held that the taxpayer is liable to tax at the rate applicable to a company other than a domestic company as provided in the Finance Act.

In the past, there have been peculiar interpretation adopted in some cases involving the non-discrimination article in a tax treaty. The common sense approach adopted by the High court is therefore a welcome change. Whether it will give a quietus to the dispute though remains to be seen.