UNION OF INDIA AND ANR. v. AZADI BACHAO ANDOLAN AND ANR

Citation: [2003] SUPP. 4 S.C.R. 222

Court: Supreme Court of India

Bench: RUMA PAL, B.N. SRIKRISHNA

Judgment text

UNION OF INDIA AND ANR. v. AZADI BACHAO ANDOLAN AND ANR. OCTOBER 7, 2003 [RUMA PAL AND B. N. SRIKRISHNA, JJ. ] Constitution ofIndia-Articles 73 and 265-Fncome Tax Act, 1961- Sections 4, 5 & 90-Indo-Mauritius Direct Tax Avoidance Convention (DTAC) dated 1. 4. 1983-Articles 3, 4 and 13(4)-Exemption to assessees under DTAC on capital gains on sale of shares of Indian companies- Power of Central Government to grant exemption-Validity of-Held, valid DTAC notified under Section 90 of the Income Tax Act-It can override the provisions ofthe Income Tax Act and hence, the principle of piercing the corporate veil cannot be applied-DTAC cannot be held ultra vires on suscepiibility of 'treaty shopping' by third party countries- Income Tax Act, 1922-Section 49A. Section 90-CBDT Circular No. 789 dated 13. 4.

2000 issuing instructions to Revenue to treat an assessee with a 'Certificate ofResidence' issued by Mauritius authorities as 'resident' ofMauritius-Validity of- Held, valid even ifinconsistent with the provisions ofthe Income Tax Act for implementation ofDTAC-Circular does not amount to impermissible delegation ofpower. Section 119-CBDTCircular No. 789 dated 13. 4. 2000-Validity of- Held, valid-Non-indication of the source ofpower does not render the Circular ultra vires-Circular intended to avoid wastage of time and energy ofthe assessing officers and not issued to crib, cabin or confine the powers ofthe assessing officer in particular assessment.

Income Tax Act, I961-Liability to taxation-Grant to exemption under the Mauritius Income Tax Act, 1995-Entitlement ofbenefit under DTAC-Held, they are 'liable to tax' under the latter Act even though granted exemption-Hence, they are entitled to benefit under DTAC being liable to tax under the former Act-Mauritius Offshore Business Activity Act, 1992 (MOBA)-Sections 26 & 27. U. 0. I. v. AZADI BACHAO ANDOLAN 223 'Treaty Shopping'-Etitlement ofthird party nation taking the benefit of DTAC-Held, is entitled since there are no disabling or disentitling conditions under the DTAC-Motive oftaking benefit under the DTAC is irrelevant. Doctrine of stare decisis-Applicability of The Government of India and the Government of Mauritius entered into a Double Taxation Avoidance Convention (DTAC) on 1. 4. 1983 for the avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment.

The DTAC was notified under Section 90 of the Income Tax Act, 1961 on 6. 12. 1983. According to Article 13(4) of the DTAC, the capital gains derived by a 'resident' of a Contractng State from the alienation of any property other than those mentioned in Article 13(1), (2) and (3) shall be taxable only in that State. The Central Board of Direct Taxes (CBDT) issued a Circular No. 682 dated 30th March, 1994 clarifying Article 13(4) of the DTAC that the income derived by a 'resident' of Mauritius by alienation of shares of India companies will be liable to capital gains .. tax only in Mauritius as per Mauritius tax law and will not have any tax liability under the Indian Income Tax Act. Relying on the Circular, a large number of assessees, mainly Foreign Institutional Investors (Fiis) and claiming to be' residents' ofMauritius, invested huge capital in the shares of Indian companies with a view to make profits without attracting capital gains tax in India.

The Revenue issued show cause notices to some Flis functioning in India for taxing profits and dividends accrued to them by sale/ holding of shares under the Income Tax Act holding that the Flis are not eligible for the benefits under the DTAC since they are not true 'residents' of Mauritius and are 'shell companies' incorporated in Mauritius, controlled and managed by third party countries. The show cause notices issued by the Revenue created panic in the Indian stock market and consequent hasty withdrawal of funds by the Flis. CBDT issued Circular No. 789 dated 13. 4. 2000 clarifying to the assessing officers that wherever a 'Certificate of Residence' is issued to an assessee by the Mauritius Authorities, such assessee can claim to be a 'resident' of Mauritius and avail the benefits under the DTAC. Two Writ Petitions, by way of Public Interest Litigation, were itkd before High Court of quashing the CBDT Circular No.

789 (impugned circular), as being ultra vires under the Income Tax Act, 196-.. Besides, appropriate directions were also sought for to revise, modify or terminate the terms of the DTAC to prevent the Flis and Ni! ls to maraud the resources of the country; to declare and delim'it the powers of the Central Government under Section 90 of the Income Tax Act in entering into agreements with the Government of any country; and to declare and delimit the powers ofthe CBDT in issuance of instructions to the statutory authorities under the Income Tax Act which are beneficial to certain individual tax payers and injurious to Public Interest. The petitioners further sought appropriate directions to the Central Government to take all remedial actions to undo the actions done to the prejudice of the Revenue in pursuance of the impugned Circular.

High Court allowed the Writ Petitions and quashed the impugned Circular holding it ultra vires on the grounds that it does not specify that the same was issued under Section 119 of the Income Tax Act and hence is not legally binding on the Revenue; that the CBDT cannot .

issue a Circular ultravires the provisions ofthe Act; that it curtails the quasi-judicial function of the Revenue to lift the corporate veil of the assessee contrary to the Act; that the 'Certificate of Residence' is not contemplated under the DTAC or the Act; that it encourages "Treaty Shopping" whereby a resident of a third country taking advantage of ~he DTAC which is illegal and must be forbidden; that the essential legislative function cannot be delegated to CBDT for issuance of the Circular under Section 119 of the Act; that rolitical expediency cannot be a ground for not fulfilling the constitutional obligations inherent in the Constitution of India; and that it enables the assessee not liable tO tax in both the countries.

In appeal to this Court, the Union oflndia contended that several tax treaties with similar terms entered into with various foreign Governments and notified under the Income Tax Act and since different High Courts interpreted the terms of the agreements in a U. O. I. v. AZADI BACHAO ANDOLAN 225 uniform manner, by application of the doctrine of stare decisis, no interference is warranted.

The respondents contended that DTAC, being a fiscal treaty, is governed by Article 265 of the Constitution of India and hence, it cannot be contrary to the provisions of the Income Tax Act, 1961; that the Central Government, being delegatee of legislative power under Section 90 of the Act, cannot grant exemption in contravention of the Income Tax Act; that the DTAC is ultra vires the powers of the Central Government under Section 90 of the Act since it encourages 'treaty ·shopping', which is unethical and illegal and amounts to a fraud on the DTAC; that the assessees are granted exemption under the Mauritius Income Tax Act, 1995 and are not liable to tax under the Mauritius Act and hence they should be made liable to tax under the Indian Income Tax Act 1961; that the avoidance of double taxation can arise only when tax is actually paid in one of the Contracting States; that the assessees, incorporated and registered under the Mauritius Offshore Busin_ess Activity Act, 1992 (MOBA), are not 'liable to taxation' in Mauritius and hence are not 'residents' of Mauritius under the DTAC; that the assessees, incorporated under the Mauritius laws, are 'shell' companies, a 'sham' or a 'device' incorporated only with the motive of taking undue advantage of the DTAC; and that the DTAC is for the benefit of the Contracting States and hence, the Central Government cannot claim the absence of anti-abuse provisions by the third party countries in the DTAC.

The Union of India contended that the exemption to assessees from income tax on capital gains on alienation ofshares does not mean that they are not 'liable to tax' undr;r the Mauritius Income Tax Act, 1995 and, hence, not 'resident' in Mauritius; that by grant of exemption under the Mauritius Income Tax Act, it cannot be said that the assessees are not entitled to benefits of the DTAC; that there are no disabling or disentitling conditions in the DTAC prohibiting the resident of a third nation from deriving benefits thereunder; and that the motives with which the residents had been incorporated in Mauritius . are wholly irrelevant and could not affect the legality of the transactions. Allowing the appeals, the Court HELD : 1. 1. A special procedure was evolved by enacting Section 90 of the Income Tax Act, 1961 to avoid time consuming and cumbersome procedure of translating the double taxation avoidance treaties into an Act of Parliament.

Section 90 of the Act is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a double ·taxation avoidance agreement. The provisions of such an agreement with respect to cases to which they apply, would operate even if inconsistent with the provisions of the Income Tax Act. If it was not the intention of the legislature to make a departure from the general principle of chargeability to tax under Section 4 and the general principle of ascertainment of total income under section 5 of the Act, then there was no purpose in making those Sections "subjecfto the provisions of the Act".

The very object ofgrafting the said two sections with the said clause is to enable the Central Government to issue a notification under Section 90 of the Act towards implementation of the terms of the DTACs which would automatically override the provisions of the Income Tax Act in the matter of ascertainment of chargeability to income tax and ascertainment of total income, to the extent of inconsistency with the terms of DTAC. (250-C-F) 1. 2. Section 90 of the Act was enacted precisely to enable the Executive to negotiate a DTAC and quickly implement it. The powers exercised by the Central Government under Section 90 of the Act are · delegated powers of legislation. A delegate of legislative p«;>wer has power to grant exemption. There are provisions galore in statutes made by Parliament and State legislatures wherein the power of conditional or unconditional exemption from the provisions of the statutes are expressly delegated to the Executive. (251-E-F) 1. 3.

Section 90 of the Act, which delegates power to the Central Government, has not been challenged. Section 90 enables the Central Government to enter into a DTAC with a foreign Government. When the requisite notification has been issued thereunder, the provisions of sub-section (2) of Section 90 spring into operation and an assessee, who is covered by the provisions of the DTAC, is entitled to seek benefits thereunder, even if the provisions of the DTAC are inconsistent with the provisions of the Income Tax Act, 1961. (252-C-DJ U. O. I. v. AZADI BACHAO ANDOLAN 227 Mc! ganbhai lshwarbhai Patel & Ors. v. Union ofIndia & Anr. , (1970) 3 sec 400, referred to. Commissioner of Income Tax v. Visakhapatnam Port Trust, (1983) 144 ITR 146 AP; Commissioner of Income Tax v. Davy Ashmore India Ltd. , (1991) 190 ITR 626 (Cal. ); Leonhardt Andhra Und Partner, Gmbh v. Commissioner ofIncome Tax, (2001) 249 ITR 418 (Cal. ); Commissioner ofIncome Tax v. R. M Muthaiah, (1993) 202 ITR 508 (Ker.

) and Arabian Express Line Ltd. ofUnited Kindom & Ors. v. Union ofIndia, (1995) 212 ITR 31 (Guj. ), approved. 1. 4. The validity and the vires of the legislation, primary or delegated, has to be tested on the anvil of the law making power. If an authority lacks the power, then the legislation is bad. On the contrary, if the authority is clothed with the requisite power, then irrespective of whether the legislation fails in its object or not, the vires of the legislation is not liable to be questioned. Hence, it cannot be said that the DTAC is ultra vires the powers of the Central Government under Section 90 of the Act on account of its susceptibility to 'treaty shopping' on behalf of the residents of third countries. (261-F-H] 1. 5. The Courts are empowered to lift the veil of the incorporation while applying the domestic law.

In the situation where the terms of the DTAC have been made applicable by reason of Section 90 of the Income Tax Act, 1961, even if they derogate from the provisions of the Income TauAct, it is not possible to say that this principle of lifting the veil of incorporation should be applied by the Court. The whole purpose of the DTAC is to ensure that the benefits are available even if they are inconsistent with the provisions of the Income Tax Act. The principle of piercing the veil of incorporation can hardly apply to a situation in this case. (279-G-H, 280-A) Re F. G. Films Ltd. (53) 1 WLR 483, referred to. 2. The impugned circular is a circular within the meaning of Section 90 of the Act. Therefore, it must have the legal consequences contemplated by sub-section (2) of Section 90 of the Act. In other words, the circular shall prevail even if inconsistent with the provisions of the Income Tax Act in so far as the provisions of the DTAC are concerned.

The impugned Circular does not amount to impermissible delegation of legislative power. r Maharashtra State Board of Seconda1y and Higher Seconda1y Education & Anr. v. Paritosh Bhupesh Kumar Sheth & Ors. , [1984] 4 SCC 27, relied on. Harishankar Bag/a & Anr. v. The State ofMadhya Pradesh, (1955) 1 SCR 380 (CB) and Kishan Prakash Sharma & Ors. v. Union ofIndia & Ors. , (2001) 5 SCC 212 (CB), referred to. 3. 1. The CBDT under Section 119 of the Income Tax Act is empowered to issue orders, instructions· and directions to other income tax authorities. The circulars and instructions issued by the CBDT under the Section are binding on the tax authorities and are also in the nature ofcontemporanea expositio furnishing legitimate aid to the construction of the Act. It is trite law that as long as an authority has power, which is traceable to a source, the mere fact that source ofthe poweris not indicated in impugned Circular does not render the Circular invalid.

As long as the Circular emanates from the CBDT and contains orders, instructions or directions pertaining to proper administration ofthe Act, it is relatable to the source of power under Section 119 of the Act irrespective ~fits nomenclature. The High Court was not justified in reading the Circular as not complying. with the provisions of the Act. The Circular falls within the parameters of the powers exercisable by the CBDT under Section 119 of the Act. [256-G, 257-A) 3. 2. The CBDT Circular No. 682 dated 30. 4. 1994 was a clear enunciation of the porvisions contained in the DTAC, which would have overriding effect over the provisions of Section 4 and 5 of the Income Tax Act by virtue of Section 90(1) of the Act. If, in the teeth of this clarification, the assessing officers chose to ignore the guidelines and spent their time, talent and energy on inconsequential matters, the CBDT is justified in issuing 'appropriate' directions videCircular No.

789 under its powers under Section 119 to set things on course by eliminating avoidable wastage of time, talent and energy of the assessing officers discharging the onerous p,ublic duty of collection of revenue. The impugned Circular does not, in any way, crib, cabin orconfine the powers of the assessing officer with regard to any particular assessment. It merely formulates broad guidelines to be applied in the matter ofassessment of assessees covered by the provisions ofthe DTAC. The impugned Circular u. o. r. V. AZADI BACHAO ANDOLAN 229 does not in any way take away or curtail the jurisdiction ofthe assessing · officer to assess income of the assessees before him. It is erroneous to say the impugned Circular is ultra vires the provisions of Section 119 of the Act. The powers conferred upon the CBDT, by sub-sections (1) and (2) of Section 119 of the Act are wide enough to accommodate such a Circular. [259-D, E] Navnit Lal C. Javeri v. K. K. Sen, (1965) 56 ITR 198 CB; Afzal Ullah v.

State of UP. , [1964] 4 SCR 991 CB; K. P. Varghese v. Income Tax Officer, Ernakulam & Anr. , (1981) 131 ITR 597 SC; Deshbandhu Gupta & Company & Ors. v. Delhi Stock Exchange Association Ltd, [1979] 4 SCC 565; Ellerman Lines ltd. v. CIT, WB-I, (1971) 82 ITR 913 SC; UCO Bank v. Commissioner of Income Tax, (1999) 237 ITR 889 SC; • Commissioner ofIncome Tax v. Anjum MH. Ghaswala & Ors. , (2001) 252 ITR 1 SC; Collector of Central Excise Vadodra v. Dhiren Chemical Industries, [2002] 2 SCC 127; State ofSikkim v. Dorjee Tshering Bhutia & Ors. , (1991] 4 SCC 243; NB. Sanjana, Assistant Collector ofCentral Excise, Bombay & Ors. v. Elphinstone Spinning and Weaving Mills Co. ltd. , [1971] 1 SCC 337 and P. Balakotaiah v. Union of India & Ors. , (1958] SCR 1052; AIR (1958) SC 232, referred to. Baleshwar Bagarti v. Bhagirathi Dass, (1908) ILR 35 Cal. 701, ~~~ Crawfrod on Statutory Construction (1940 Ed. ) referred to. 4. 1.

A perusal of the provisions of the Mauritius Income Tin: Act, 1995 does not lead to the conclusion that tax incentive companies are not liable to taxation although they have been granted exemption from income tax in respect of a specified head of income, namely, gains from transactions in shares and securities. Merely because exemption has been granted in respect of taxability of a particular source of income under the Mauritius Income Tax Act, 1995, it cannot be postulated that the entity is not 'liable to tax' under the Act. [266-H, 267-A, DJ K. V. AL. M Ramanathan Chettiar v. Commissioner ofIncome Tax Madras (1973) 88 ITR 169 SC; Wallace Flour Mills Co. Ltd. v. Collector of Central Excise, Bombay Division III, [1989] 4 SCC 592; Kasinka Trading & Anr. v. Union ofIndia & Anr. , [1995] 1 SCC 274, referred ~ Tamil Nadu (Madras State) Handloom Weavers Co-operative Society Ltd. v. Assistant Collector of Central Excise, Erode, (1978) ELT J57 Mad. , referred to. Ingemar Johansson et. al.

v. United States ofAmerica, 336F. 2d 809, referred to. . Jean Marie Rivi/er, Cahiers De Droit Fiscal International Vol. LXXITa, referred to. 4. 2. 'Liability to taxation' is a legal situation and 'payment of tax' is a fiscal act. For the purpose of Article 4 of the DTAC, the legal situation, namely the liability to taxation is relevant and not the fiscal act of actual payment of tax. If this were not so, tlie DTAC would not have used the words 'liable to taxation' but would have used some appropriate words like 'pays tax'. On the language of the DTAC, it cannot be said that offshore companies incorporated and registered under Mauritius Offshore Business Activity Act, 1992 are neither 'liable to taxation' under the Mauritius Income Tax Act nor that such companies would not be 'resident' in Mauritius within the meaning of Article 3 read with Article 4 of the DTAC. [270-H, 271-A-B) 4. 3. The expression 'resident' is employed in DTAC as a term of limitation.

Otherwise, a person who may not be 'liable to tax' in a Contracting State by reason ofdomicile, residence, place of management or any other criterion of a similar nature may also claim the benefit of the DTAC. Since the purpose of the DTAC is to eliminate double taxation, the treaty takes into account only persons who are 'liable to taxation' in the Contracting States. Consequently, the benefits thereunder are not available to persons who are not liable to taxation and the words 'liable to taxation' are intended to act as words of limitation. The contention of the respondents that avoidance of double taxation can arise only when tax is actually paid in one of the Contracting States is not accepted. [272-E-G, 275-B, CJ Commissioner ofIncome Tax, Nagpur v. Sutlej Cotton Mills Supply Agency Limited, (1975) 100 ITR 706 CB; Mohsinally Alimohammed Rafik, · . , Jn re. (1994) 213 ITR 317 (A. A. R. ) ; Cyril Eugene Pereira, Jn re. (1999) 239 ITR 650 (A. A. R. ), referred to. U. 0. 1. v. AZAD!

BACHAO ANDOLAN 231 John N. Gladden v. Her Majesty the Queen, (85 OTC 5188); Commissioner of Taxation v. Lamesa Holdings, (1997) 785 FCA; Chong v. Commissioner of Tawtion, (2000) FCA 635; The Estate of Michel Hausmann v. Her Majesty The Queen, (1998) Can. Tax Ct. LEXIS 11401 referred to. A Manual on the OECD Model Tax Convention on Income and on Capital; Klaus Vogel, Double Taxation Convention (3rd Ed. ), referred to. 5. 1. 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 the effect should have been incorporated therein. In the absence of a limitation clause, there are no disabling or disentitling .. conditions under the lndo-Mauritius Treaty prohibiting the resident of third nation from deriving benefits thereunder. The motive, with which the residents have been incorporated in Mauritius, are wholly irrelevant and cannot in any way affect the legality of the transaction.

There is nothing like equity in a fiscal statute. Either the statute applies proprio vigore, or it does not. There is no question of applying a fiscal statute by intendment, if the expressed words do not apply. [279-B, D, E) Inda-US Double Taxation Avoidance Convention (Article 24), referred to. ' Lord McNaiJ·, The Law of Treaties (Oxford, at the Calendran Press, 1961), referred to. 5. 2. It is an accademic approach to the problem as \:o how a State should modulate its laws or incorporate suita·ble terms in tax conventions to which it is party so that the possibility of a resident of third State deriving benefits thereunder is totally eliminated. The maxim "Judicis est }us dicere, non dare:" pithily expounds the duty of the Court. It is to decide what the law is and apply it and not to make it.

The various reports are about what the law ought to be and pointers to the Parliament and the Executive for incorporating suitable limitation provisions in the treaty itselfor by domestic legislation. This per se does not render an attempt by resident of a third party to take advantage of the existing provisions of the DTAC illegal. It is neither possible for th~ Court_to ~ay that the DTACor the impugned circular are contrary · to la~ nor_p~ssible to in. terfere,with either oHhem on the'basis of the· Reports. 1280-_ spondents, is of no avail. The Indo-Mauritius DTAC, Article 3, clearly defines the term 'residence' in a 'Contracting State'. Interestingly, even in this judgment, the Court observed : "Ofcourse, the fact that Johansson was 27. 336F. 2d. 809. U. 0. 1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.

) 265 motivated in his actions by the desire to minimize his tax burden can in no way be taken to deprive him of an exemption to which an applicable treaty entitles him", which will have some relevance to the contention of the respondents with regard to the motivation to avoid tax. The respondents contend that the Fiis incorporated and registered under the provisions of the law in Mauritius are carrying on no business there; they are, in fact, prevented from earning any income there; they are not liable to income tax on capital gains under the Mauritius Income-tax Act. They are liable to pay income-tax under Indian Income-tax Act, 196l, since they do not pay any income-tax on capital gains in Mauritius, hence, they are not entitled to the benefit of avoidance of double taxation under the DTAC. Some ofthe assumptions underlying this contention, which prevailed with the High Court, need greater critical appraisal.

Article 13(4) of the DTAC provides that gains derived by a resident of a Contracting State from alienation of any property, other than those specified in the paragraphs I, 2 and 3 of the Article, shall be taxable only in that State. Since most of the arguments centred around capital gains made on transactions in shares on the stock exchange in India, we may leave out ofconsideration capital gains on the type ofproperties contemplated in paras I, 2 and 3 of Article 13 of the DTAC. The residuary clause in para 4 of Article I3 is relevant. It provides that capital gains made on sale of shares shall be taxable only in the State of which the prrson is a 'resident' taking us back to the meaning of the tenn 'resident' of contracting State. According to Article 4, this expression means any person who under the laws of that State is "liable to taxation" therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.

The terms 'resident of India' and 'resident of Mauritius' are required to be construed accordingly. This takes us to the test to detennine when a company is 'liable to taxation' in Mauritius. Mauritian Income Tax Act, 1995 Section 4 of the Income Tax Act, 1995 (Mauritian Income-tax Act) provides that, subject to the provisions ofthe Act, income-tax shall be paid to the Commissioner of Income-tax by every person on all income other than exempt income derived by him during the preceding year and be 266 SUPREME COURT REPORTS [2003] SUPP. 4 S. C. R. calculated on the chargeable income of the person at the appropriate rate specified in the First Schedule. Section 5 defines as to when income is deemed to be derived. ·. Section 7 provides that the income specified in the Second Schedule shall be exempt from income-tax. Part IV of the Mauritian Income Tax Act deals with Corporate Taxation.

Section 44 of the Act provides that every company shall be liable to income tax on its 'chargeable income' at the rate specified in Part II, Part III or Part IV of the First Schedule, as the case may be. Section 51 defines the 'gross income' of a company as inclusive of income referred to in Sections IO(l)(b) (income derived from business), IO(l)(c) (any income from rent, premium or other income derived from property), IO(l)(d) (any dividend, interest, charges, annuity or pension other than a pension referred to in paragraph a(ii)) and IO(l)(e) (any other income derived from any other source). Section 73 (b) provides that for the purposes ofthe Act the expression 'resident', when applied to a 'company', means a company which is incorporated in Mauritius or has its central management and control in Mauritius. Part II of the First Schedule prescribes the rate of tax on chargeable income at 15% in the case of Tax Incentive companies and at other rates for other types of companies.

Pait V of the First schedule enumerates the list of tax incentive companies and item 16 is : "a corporation certified to be engaged in international business activity by the Mauritius Offshore Business Activities Authority established under the Mauritius Offshore Business Activities Act, 1992". The second Schedule to the Mauritius Income-tax Act in Part IV enumerates miscellaneous income exempt from income-tax. Item I reads "gains or profits derived from the sale of units or of securities quoted on the Official List or on such Stock Exchanges or other exchanges and capital markets as may be approved by the Minister". A perusal of the aforesaid provisions of the Income Tax Act in Mauritius does not lead to the result that tax incentive companies are not U. 0. 1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J. ] 267 liable to taxation, although they have been granted exemption from inc6me-tax in respect of a specified head of income, namely, gains from transactions in shares an-d securities.

The respondents contend that the Flis are not "liable to taxation" in Mauritius; hence they are not 'residents' of Mauritius within the meaning of Article 4 of the DTAC. Consequently, it is open to the assessing officers under the Indian Income-tax Act, 1961 to determine where the taxable entities are really resident by investigating the centre of their management and thereafter to apply the provisions of Income-tax Act, 1961 to the global income earned by them by reason of Sections 4 and 5 of the Income-tax Act, 1961. It is urged by the learned Attorney General and Shri Salve for the appellants that the phrase 'liable to taxation' is not the same as 'pays tax'.

The test of liability for taxation is not to be determined on the basis of an exemption granted in respect of any particular source of income, but by taking into consideration the totality of the provisions of the income-tax 28 law that prevails in either of the Contracting States • Merely because, at a given time, there may be an exemption from income-tax in respect of any particular head ofincome, it cannot be contended that the taxable entity is not liable to taxation. They urge that upon a proper construction of the provisions ofMauritian Income Tax Act it is clear that the Flis incorporated under Mauritius laws are liable to taxation; therefore, they are 'residents' in Mauritius within the meaning of the DTAC. - For the appellants reliance is placed on the judgment of this Court in Wallace Flour Mills Contracting State. Ltd. v. Collector of Central 29 Excise, Bombay Division II , a case under the Central Excise Act.

This Court held that though the taxable event for levy of excise duty is the manufacture or production, the realisation ofthe duty my be postponed for administrative convenience to the date of removal of the goods from the factory. It was held that excisable goods do not become non-excisable merely because ofan exemption given under a notification. The exemption merely prevents the excise authorities from collecting tax when the 30 exemption is in operation • 28. See in this connection Ramanathan Chettiar v. Commissioner ofIncome Tax, Madras. (1973] 88 ITR 169. 29. [19891 4 sec 592. 30. See also in this connection the judgment ofMadras High Court in Tamil Nadu (Madras State), Handloom Weavers Contracting State-operative Society ltd. v. Assistant Collector of Central Excise 1978 ELT 57 (Mad HC). 1 In Kasinka Trading andAnother v. Union ofIndia and Another3 , this principle was reiterated in connection with an exemption under the Customs Act.

This Court observed : "The exemption notification issued under Section 25 of the Act had the effect of suspending the collection of customs duty. It does not make items which are subject to levy of customs duty etc. as items not leviable to such duty. Jt only suspends the levy and collection of customs duty, wholly or partially, and subject to such conditions as may be laid down in the notification by the Government in 'public interest'. Such an exemption by its very nature is susceptible of being revoked or modified or subjected to other conditions. " We &re inclined to agree with the submission of the appellants that, merely because exemption has been granted in respect of taxability of a particular source of income, it cannot be postulated that the entity is not 'liable to tax' as contended by the respondents.

Effect of MOBA, 1992 The respondents, shifted ground to contend that the fact that a company incorporated in Mauritius is liable to ta:xation under the Income Tax Act there may be true only in respect of certain class of companies incorporated there. However, with respect to companies which are incorporated within the meaning of the Mauritius Offshore Business Activities Act, 1992 (hereinafter referred to as "MOBA''), this would be wholly incorrect. MOBA was enacted "to provide for the establishment and management . ofthe MOBA Authority to regulate offshore business activities from within Mauritius and for the issue of offshore certificates, and to provide for other ancillary or incidental matters", as its preamble suggests. 'Offshore business activity' is defined as the business or other activity referred to in Section 33 and includes activity conducted by an international company.

'Offshore company' is defined as a corporation in relation to which there is a valid certificate and which carries on offshore business activity. In part II, MOBA establishes an Offshore Business Activity Authority entrusted, inter a/ia, with the duty of overseeing offshore business activities and also issuing permits, licences or any other certificate as may 31. [I995J 1 sec 274. U. 0. 1. v. AZADI BACHAO ANDOLAN [SRlKRISHNA, J. ] 269 be required, and other authorisation which may be required by an offshore company through which they may communicate with any of the public sector companies. Section 16 of MOBA prescribes the procedure for issuing of certificate.

Section 15 requires maintenance of confidentiality and nondisclosure of information contained in applications and documents filed with it except where such information is bona fide required for the purpose of any enquiry or trial into or relating to the trafficking of narcotics and dangerous drugs, arms, trafficking or money laundering under the Economic Crime and Anti Money Laundering Act, 2000. Part II of MOBA contains the statutory provisions applicable to offshore companies. Section 26 provides that an offshore company shall not hold immovable property in Mauritius and shall not hold any share or any interest in any company incorporated under the Companies Act, 1984, other than in a foreign company or in another offshore company or in an offshore trust_ or an international company. An offshore company shall not hold any ac_count in a domestic bank in Mauritian Rupees, except for the purpose of its day to day transactions arising from its ordinary operations in Mauritius.

Sections 26 and 27 of MOBA are important and read as under: "26. Property of an offshore company (I) Subject to sub-section(2), an offshore company shall not hold - (a) immovable property in Mauritius; (b) any share, or any interest in any company incorporated under the Comranies Act, 1984 other than in a foreign company or in another offshore company or m an offshore trust or an international company; (c) any account in a domestic bank in Mauritian Rupee. (2) An offshore company may - (a) open and maintain with a domestic bank an account in Mauritian rupees for the purpose of its day to day transactions arising from its ordinary operations in Mauritius; (b) open and maintain with a domestic bank an account in foreign currencies ·with the approval of the Bank of Mauritius; (c) where authorised by the terms of its certificate, or where otherwise permitted under any other enactment, lease, hold, acquire or dispose of an immovable property ~r .

any interest in immovable property situated in Mauritius; (d) invest in any securities listed in the stock Exchange established under the Stock Exchange Act 1988 and in other debentures. 27. Dealings with residents Notwithstanding any other enactment, the Minister, on the recommendation of the Authority may authorise any offshore company engaged in any offshore business activities to deal or transact with residents on such tenns and conditions as it thinks fit. " On the basis of these provisions, it is urged by the respondents that any company which is registered as an offshore company under MOBA can hardly carry out any business activity in Mauritius, since it cannot hold any immovable property or any shares or interest in any company registered in Mauritius other than a foreign company or another offshore company and cannot open an account in a domestic bank in Mauritius.

The respondents urge that such a company cannot transact any business whatsoever within Mauritius as the purpose of such a company would be to-carry out offshore business activities and nothing more. The respondents contend that when the possibility ofsuch a company earning income within Mauritius is almost nil, there is hardly any possibility of its paying tax in Mauritius, whatever be the provisions of the Mauritian Income-Tax Act. In our view, the contention of the respondents proceeds on the fallacious premise that liability to taxation is the same as payment of tax. Liability to taxation is a legal situation; payment of tax is a fiscal fact. For U. 0. 1. v. AZADl BACHAO ANDOLAN (SRIKRISHNA, J. ] 271 the purpose of application of Article 4 of the DTAC, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax.

If this were not so, the DTAC would not have used the words 'liable to taxation', but would have used some appropriate words like 'pays tax'. On the language of the DTAC, it is not possible to accept the contention ofthe respondents that offshore companies incorporated and registered under MOBA are not 'liable to taxation' under the Mauritius Income-tax Act; nor is it possible to accept the contention that such companies would not be 'resident' in Mauritius within the meaning of Article 3 read with Article 4 of the OTAC. There is a further reason in support of our view. The expression 'liable to taxation' has been adopted from the Organisation for Economic Co-operation and Development Council (OECD) Model Convention 1977.

The OECD commentary on article 4, defining 'resident', says: "Conventions for the avoidance of double taxation do not normally concern themselves with the domestic laws ofthe Contracting States laying down the conditions under which a person is to be treated fiscally as "resident" and, consequently, is fully liable to tax in that State". The expression used is 'liable to tax therein', by reasons ofvarious factors. This definition has been carried over even in Article 4 dealing with 'resident' in the OECD Model Convention 1992. In A Manual on the OECD Model Tax Convention on Income and On Capital, at paragraph 4B. 05, while commenting on Article 4 of the OECD Double Tax Convention, Philip Baker points out that the phrase 'liable to tax' used in the first sentence of Article 4.

1 of the Model Convention has raised a number of issues, and observes: "It seems clear that a person does not have to be actually paying tax'1o be "liabl~ to tax"- otherwise a person who had deductible losses or all@wances, which reduced his tax bill to zero would find himself unabltt to enjoy the benefits of the convention. It also seems ckar th:Jt a person who would otherwise be subject to comprehensive. taxing but who enjoys a specific exemption from tax is nevertheless liable to tax, if the exemption were repealed, or the person no longer qualified for the exemption, the person would be liable to comprehensive taxation. " Interestingiy, Baker refers to the decision of the Indian Authority for Advance Ruling in Mohsinally Alimohammed Rajik. An assessee, who ' resided in Dubai and claimed the benefits of UAE~India Convention of April 29, 1992, even though there was no personal income-tax iri Di. Ibai to which he might be liable.

The Authority concluded that he was entitled to the benefits of the convention. The Authority subsequently reversed this position iri the case of Cyril Eugene Pereira33 where a contrary view was taken. The respondents placed great reliance on the decision by the Authority for Advance Rulings constituted under Section 245-0 of the Income-Tax 34 Act, 1961 in Cyril Eugene Pereira 's case • Section 245S of the Act provides that the Advance Ruling pronounce? by the Authority under Section 245R shall be binding only : "(a) on the applicant who had sought it; (b) in respect of the transaction in relation to which the ruling had been sought; and (c) on the Commissioner, and the income-tax authorities subordinate to him, in respect of the applicant and the said transaction. " It is therefore obvious that, apart from whatever its persuasive value, it would be of no help to us. Having perused the order of the Advance Rulings Authority, we regret that we are not persuaded.

There is substance in the contention of Mr. Salve learned counsel for one of the appellants, that the expression 'resident' is employed in the DTAC as a term of limitation, for otherwise a person who may not be 'liable to tax' in a Contracting State by reason ofdomicile, residence, place of management or any other criterion of a similar nature may also claim the benefit of the DTAC. Since the purpose of the DTAC is to eliminate double taxation, the treaty takes into account only persons who are 'liable to taxation' in the Contracting States. Consequently, the benefits thereunder are not available to persons who are not liable to taxation and the words 'liable to taxation' are intended to act as words of limitation. 32. [1994) 213 ! TR 317. 33. [1999) 239 ! TR 650. 34. Ibid. U. O. I. v. AZAD! BACHAO ANDOLAN [SRIKRISHNA, J. ] 273 In John N. Gladden v.

Her Majesty the Queen , at the principle of liberal interpretation of tax treaties was reiterated by the Federal Court, which observed : "Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions ofthe parti~s. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated insofar as the particular item under consideration is concerned. " 36 Gladden was a case where an American citizen resident in U. S. A. owned shares in two privately controlled Canadian companies. Upon his death, the question arose as to the capital gains which would arise as a result of the deemed disposition of the said shares. The Canadian Revenue took the position that there was a deemed disposition of the shares on the death of the tax payer and capital gains tax was chargeable on account of the deemed disposition.

This view of the Revenue was upheld in appeal by the ·Tax Court ofCanada. Upon further appeal to the Federal Court it was held that capital gains were exempt from tax under the Canada-U. S. A. Tax Treaty as Canada had no capital gains tax when it entered the treaty and it could not unilaterally amend its legislation. The argument which prevailed with the trial court in this case was similar to the one which prevailed with the High Court in the matter before us. Interpreting . the relevant Article of the Double Taxation Avoidance Treaty the trial court held : "The parties could not have negotiated to avoid double taxation on a tax which did not exist in Canada". The Federal Court emphasised that in interpreting and applying treaties the Courts should be prepared to extend "a liberal and extended construction" to avoid an anomaly which a contrary construction would lead to.

The Court recognized that "we cannot expect to find the same nicety or strict definition as in modem documents, such as deeds, or Acts ofParliament; it has never been the habit of those engaged in diplomacy to use legal accuracy but rather to adopt more liberal terms". Interpreting the Article of the Treaty against avoidance of double taxation, the Federal Court said (at p. 5): 35. 85 D. T. C. 5188. 36. Ibid. "The non-resident can benefit from the exemption regardless of whether or not he is taxable on that capital gain in his own country. If Canada or the U. S. were to abolish capital gains completely, while the other country did not, a resident of the country which had abolished capital gains would still be exempt from capital gains in the other country. "' The appellants rely on this judgment to contend that, irrespective of the exemption from income-tax on capital gains upon alienation of shares under the Mauritius Income-tax Act, the benefits of the DTAC would apply.

The appellants contend that, acceptance ofthe respondents' submission that double taxation avoidance is not permissible unless tax is paid in both countries is contrary to the intendment of Section 90. It is urged that clause (b) of sub-section(! ) of Section 90 applies to a situation to grant relief where income tax has been paid in both countries, but clause (b) deals with situation of avoidance of double taxation of income. Inasmuch as Parliament has distinguished between the two situations, it is not open to a Court of law to interpret clause (b) of Section 90 sub-section(! ) as if it were the same as the situation contemplated under clause (a). According to Klaus Vogel "Double-Taxation Convention establishes an independent mechanism to avoid double taxation through restriction of . , tax claims in areas where overlapping tax-claims are expected; or at least theoretically possible.

In other words, the Contracting States mutually bind themselves not to levy taxes or to tax only to a limited extent in cases when the treaty reserves taxation for the other contracting States either entirely or in part. Contracting States are said to 'waive' tax claims or more illustratively to divide 'tax sources', the 'taxable objects', amongst themselves. " Double taxation avoidance treaties were in vogue even from the time ofthe League ofNations. The experts appointed in the early 1920s by the League of Nations describe this method of classification of items and their assignments to the Contracting States. While the English lawyers called it 'classification and assignment rules', the German jurists called it 'the distributive rule' (Verteilungsnorm).

To the extent that an exemption is agreed to, its effect is in principle independent ofboth whether the other contracting State imposes a tax in the situation to which the exemption applies, and of whether that State actually levies the tax. Commenting U. 0. 1. v. AZAD! BACHAO ANDOLAN (SRIKRJSHNA, J. ] 275 particularly on German Double Taxation Convention with the United States, Vogel comments: "Thus, it is said that the treaty prevents not only 'current', but also merely ·potential' double taxation". Further, according to Vogel. "only in exceptional cases, and only when expressly agreed to by the parties, is exemption in one contracting State dependent upon whether the income or capital is taxable in the other contracting state, or 37 upon whether it is actually taxed there.

" It is, therefore, not possible for us to accept the contentions so strenuously urged on behalf of the respondents that avoidance of double taxation can arise only when tax is actually paid in one of the Contracting &~s. The decision of Federal Court of Australia in Commissioner of 38 Taxation v. Lamesa Holdings is illuminating. The issue before the Federal Court was whether a Netherlands company was liable to income-tax under the Australian Income Tax Act on profits from the sale of shares in an Australian company and whether such profits fell within Article 13 (alienation of property) of the Netherlands-Australia Double Taxation Agreement, so as to be excluded from Article 7 (business profits) of that Agreement. One Leonard Green, a principal of Leonard Green and Associates a limited partnership established in the United States, became aware ofa potential investment opportunity in Australia.

Arimco Resources and Mining Company NL ('Annico'), a company listed on the Australian Stock Exchange, which had a subsidiary called Armico Mining Pty. Limited engaged in gold mining activities, was the subject of a hostile takeover bid, at a price which Green was advised was Jess than the real value of the Armico. With this knowledge Green decided to mount a takeover offer for the subsidiary company. Then followed a series of steps of formation of a number of companies with interlocking share holdings where each company owned 1005 shares ofa different subsidiary company. Lamesa Holdings was one such intermediary company of which I00% shares were held by Green Equity Investments Ltd. The share transactions brought about a profit to Lamesa Holdings which would be assessable to tax under the Australian Income Tax Act.

Lamesa, however, relied on the provisions ofthe Article 13(2) Ofthe Double Taxable Avoidance Convention ('DTAC') between Netherlands and Australia and claimed thafthe income 37. See in this connection Klaus r·ogel. Double Taxation Convention. Pg. 26-29 (3rd ed). 38. (1997) 785 FCA. was not taxable in Australia by reason thereof. This income was wholly exempt from tax in Netherlands by reason of the Income Tax Law applicable therein. The Federal Court found that under Article 13(2) (a) (ii) ofthe OTAC shares in a company were treated as personalty, that since the place of incorporation of a company or the place of situs of a share may be the subject ofchoice, the place of incorporation or the register upon which shares were registered would not form a particularly close connection with shares to ground the jurisdiction to tax share profits.

It was held: "It happens to be the case, because ofunilateral relief granted by the law of the Netherlands, that no tax will be payable in the Netherlands. That of itself can not affect the interpretation of the Agreement. If the relevant mining prope1ty had happened to be in the Netherlands so that the issue was between taxation there on Jhe one hand and taxation in Australia on the other, the situation would have been one where tax would clearly have been payable on the alienation of the shares in Australia without the benefit of any exemption. Yet the Agreement must operate uniformly, whether the realty is in the Netherlands or in Australia. " In this view of the matter, it was held that there was no tax payable in Australia. 39 Chong v. Commissioner of Taxation holds similarly. Australia and Malaysia have an agreement to avoid double taxation.

An Australian resident was paid pension by Malaysian Government for services rendered to Malaysian Government while he was in service there. This pension was taxed in Malaysia and the issue was whether the right to tax Government pensions under the Agreement could be exercised by the Australian Government and the effect of the domestic law on the agreement. Article 18 of the double taxation avoidance agreement provided that pension paid to a resident of a contracting State shall be taxable only in that State. Upon a proper construction of Article 18(2) of the Treaty it was held that pension paid by Malaysia is taxable in Australia inasmuch as the said Article did not provide that Malaysia alone was to have the power to tax Government pension, nor did it restrict Australia from doing so. Rather it provided for the Contracting State paying the pension to have the power to tax the pension if it so desired and did not limit or restrict the taxing power of the l ,- 39. (2000) FCA 635. U. 0.

1. v. AZADI BACHAO ANDOLAN [SRJKRISHNA, J. ] 277 other Contracting State in that respect. The Federal Court pointed out "Whether one uses the language of allocation of power or the language of limitation of power, the result is the same; there is designated or agreed who shall have the right under the agreement to impose taxation in the particular area". 40 The Estate of Michel Hausmann v. Her Majesty The Queen is another Canadian judgment which throws light on the principle that the benefits ofa double taxation agreement would be available even if the other contracting State in which a particular head of income is to be taxed, chooses not to impose tax on the same. The central question in this case was whether the pension received by Mr. Hausmann from the pension office ofthe Belgium Government was taxable in Canada. The facts indicated that there was no tax withheld at source in Belgium.

The argument of the Canadian Tax Authority was that if Belgium was not going to tax the pension, Canada should. Otherwise, the unthinkable might occur and the amount might not be taxed by anyone. This would be anathema. The facts indicated that the payment received by Mr. Hausmann fell below the prescribed threshold and therefore was not taxed in Belgium. The Canadian Court rejected the argument that if Belgium did not tax the payment, it must be taxed by the Canada as plainly wrong by relying on the terms of the treaty. On the basis of the material available, the Federal Court came to the inference that in negotiating the Belgium treaty both Canada and Belgium unquestionably regarded pensions paid under their social security legislation, such as the CPP or the corresponding Belgian statutory scheme, to be taxable only in the .. :ountry from which they emanated and not the country ofresidence ofthe recipient. Hence, it was held that the pension payments received by Mr.

Hausmann from the office ofBelgium were social security pension and such allowances could be taxable only in Belgium. The fact that Belgium did not choose to tax them was held to be totally irrelevant. Mr. Salve contended that a profit made by sale of shares may not invariably amount to capital gains, as for example if the shares were part of the trading assets of the company. If such be the case, the gains may amount to trading income of such a company. He also relied on the observations ofthis Court in Commissioner ofIncome Tax Nagpur v. Sutlej 40. 1998 Can. Tax Ct. LEXIS 1140. Cotton Mills Supply Agency Limited. • It is not necessary for us to go into this question as it would depend upon as to whether the shares are held by a company as an investment or as a trading asset. The possibility urged by the learned counsel certainly exists and cannot be ruled out without examination of facts. Treaty Shopping-ls it illegal ?

· The respondents vehemently urge that the offshore companies have been incorporated under the laws of Mauritius only as shell companies, which carry on no business therein, and are incorporated only with the motive of taking undue advantage of the DTAC between India and Mauritius. They also urged that 'treaty shopping' is both unethical and illegal and amounts to a fraud on the treaty and that this Court must be astute to interdict all attempts at treaty shopping. 'Treaty shopping' is a graphic expression used to describe the act of a resident of a third country taking advantage of a fiscal treaty between two Contracting States.

According to Lord McNair, "provided that any necessary implementation by municipal law bas been carried out, there is nothing to prevent the nationals of "third States", in the absence of any expressed or implied provision to the contrary, from claiming the right or 42 becoming subject to the obligation created by a treaty" • Reliance is also placed on the following observations of Lord 3 McNair4 : "that any necessary implementation by municipal law has been carried out, there is nothing to prevent the nationals of 'third States', in the absence of any express or implied provision to the contrary, from claiming the rights, or becoming subject to the obligations, created by a treaty; for instance, if an Anglo- American Convention provided that professors on the staffof the universities ofeach country were exempt from taxation in respect offees earned for lecturing in the other country, and any necessary changes in the tax laws were made, that privilege could be claimed by, or on behalf of, professors of those universities who were the 41.

[1975] 100 ! TR 706. 42. Lord McNair, The law of Treaties, Pg. 336 (Oxford, at the Clarendan Press, 1961). 43. Ibid. U. 0. 1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J. ] 279 nationals of 'third States'. " It is urged by the learned counsel for the appellants, and rightly in our view, that 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. As a contrast, our attention was drawn to the Article 24 of the Indo-US Treaty on Avoidance of Double Taxation which specifically provides the limitations subject to which the benefits under the Treaty can be availed of. One ofthe limitations is that more than 50% ofthe beneficial interest, or in the case ofa company more than 50% of the number of shares of each class of the company, be owned directly or indirectly by one or more individual residents of one of the contracting States. Article 24 of the Indo-U. S.

DTAC is in marked contrast with the Inda-Mauritius DTAC. The appellants rightly contend that in the absence of a limitation clause, such as the one contained in Article 24 of the lndo-U. S. Treaty, there are no disabling or disentitling conditions under the Inda-Mauritius Treaty prohibiting the resident of third nation from deriving benefits thereunder. They also urge that motives with which the residents have been incorporated in Mauritius are wholly irrelevant and cannot in any way affect the legality ofthe transaction. They urge that there is nothing like equity in a fiscal statute. Either the statute applies proprio vigore or it does not. There is no question of applying a fiscal statute by intendment, if the expressed words do not apply. In our view, this contention of the appellants has merit and deserves acceptance. We shall have occasion to examine the argument based on motive a little later. 44 The decision of the Chancery Division in Re F. G. Films Ltd.

was pressed into service as an example of the mask of corporate entity being lifted and account be taken of what lies behind in order to prevent 'fraud'. This decision only emphasises the doctrine of piercing the veil of incorporation. There is no doubt that, where necessary, the Courts are empowered to lift the veil of incorporation while applying the domestic law. In the situation where the tenns of the DTAC have been made applicable by reason of Section 90 of the Income-Tax Act, 1961, even if they derogate from the provisions of the Income-tax Act, it is not possible to say that this principle of lifting the veil of incorporation should be applied by the court. As we have already emphasised, the whole purpose 44. 53 (I) WLR 483 of the DTAC is to ensure that the benefits thereunder are available even if they are inconsistent with the provisions of the Indian Income-tax Act.

In our view, therefore, the principle of piercing the veil of incorporation can hardly apply to a situation as the one before us. The respondents banked on certain observations made in Oppenheim 's 45 International Law • All that is stated therein is a reiteration of the general rule in municipal law that contractual obligations bind the parties to their contracts and not a third party to the contract. In international law also, it has been pointed out that the Vienna Convention on the Laws of Treaties ,1969 reaffirms the general rule that a treaty does not create either obligations or rights for a third party state without its consent, based on the general principle pacta tertiis nee nocent nee prosunt. it is true that an international treaty between States A & B is neither intended to confer benefits nor impose obligations on the residents of State C, but, here we are not concerned with this question at all.

The question posed for our consideration is: If the residents of State C qualify for a benefit under the treaty, can they be denied the benefit on some theoretical ground that 'treaty shopping' is unethical and illegal ? We find no support for this proposition in the passage cited from Oppenheim. 6 The respondents then relied on observations ofPhilip Baker4 regarding a seminar at the IFI Barcelona in 1991, wherein a paper was presented on "Limitation of treaty benefits for companies" (treaty shopping). He points out that the Committee on Fiscal Affairs of the OECD in its report styled as "Conduit Companies Report 1987" recognised that a conduit company would generally be able to claim treaty benefits. There is elaborate discussion in Baker's treatise on the anti abuse provisions in the OECD model and the approach of different countries to the issue of 'treaty shopping'.

True that several countries like the USA, Germany, Netherlands; Switze~Iand and United Kingdom have taken suitable steps, either by way of incorporation of appropriate provisions in the international conventions as to double taxation avoidance, or by domestic legislation, to ensure that the benefits of a treaty/convention are not available to residents of a third State. Doubtless, the treatise by Philip Baker is an excellent guide as to how a state should modulate its laws or 45. L. Oppenheim, Oppenheim's International Law, Article 626 (9th Ed. ) 46. Philips baker,Double Taxation Convention and International Law, Pg. 91 ((1994) 2nd Ed. ) U. 0. 1. v. AZAD! BACHAO ANDOLAN [SRIKRISHNA, J. ] 281 incorporate suitable terms in tax conventions to which it is party so that the possibility of a resident of a third State deriving benefits thereunder is totally eliminated. That may be an academic approach to the problem to say how the law should be.

The maxim "Judicis estjus dicere, non dare" pithily expounds the duty of the Court. It is to decide what the law is, and apply it; not to make it. Report of the working group on non-resident taxation The respondents contend that anti-abuse provisions need not be incorporated in the treaty since it is assumed that the treaty would only be used for the benefit of the parties. They also strongly rely on the 'Report of the working group on Non- Resident Taxation' dated 3rd January, 2003. In Chapter 3, para 3. 2 of the . report it is stated: "3. 2 Entitlement to avail DTAA benefit: Presently a person is entitled to claim application of DTAA if he is 'liable to tax' in the other Contracting State. The scope of liability to tax is not defined.

The term "liable to tax" should be defined to say that there should be tax laws in force in the other State, which provides for taxation ofsuch person, irrespective that such tax fully or partly exempts such persons from charge of tax on any income in any manner. " In para 3. 3. 1, after noticing the growing practice amongst certain entities, who are not residents of either of the two Contracting States, to try and avail ofthe beneficial provisions ofthe DTAAs and indulge in what is popularly known as 'treaty shopping', the report says : "3. 3. 1 .... there is a need to incorporate suitable provisions in the chapter on interpretation ofDTAAs, to deal with treaty shopping, conduit companies and thin capitalization. These may be based on UN/OECD model or other best global practices. " In para 3. 3. 2, the working group recommended introduction of antiabuse provisions in the domestic law. Finally, in paragraph 3. 3.

3 it is stated "The Working Group recommends that in future negotiations, provisions relating to anti-abuse/ limitation 'Of benefit may be incorporated in the DTAAs also. " We -are afraid that the weighty recommendations of the Working Group on Non-Resident Taxation are again about what the law ou_ght to be, and a pointer to the Padiament and the Executive for incorporating suitable limitation provisions in the treaty itself or by domestic legislation. This per se does not render an attempt by resident of a third party to take advantage of the existing provisions of the DTAC illegal. J. P. C. Report , Strong reliance is placed by the respondents on the report of the Joint Parliamentary Committee (hereinafter referred to as "JPC") on the Stock Market Scam and Matters Relating thereto which was presented in the Lok Sabha and Rajya Sabha on December 19, 2002.

While considering the causes which led to the Stock Market scam, the JPC had occasion to consider the working ofthe Inda-Mauritius DTAC. It noticed that area-wise foreign direct investment inflow from Mauritius increased from 37. 5 million Rupees in 1993 to 61672. 8 million Rupees in the year 2001. The CBDT had approached the Indian High Commissioner at Mauritius to take up the matter with the Mauritian authorities to ensure that benefit of the bilateral tax treaty were not allowed to be misused, by suitable amendment in Article 13 of the agreement.

The Mauritian authorities, however, were ofthe view that, though the beneficiaries of such p capital funds domiciled in Mauritius may be residing in third countries, these funds had been invested in the Indian stock market in accordance with SEBI norms and regulations and that the Finance Minister of India had himself encouraged such Fiis as a channel for promoting capital flow to India in a meeting between himself and the Finance Minister of Mauritius. The Ministry of finance was willing to have regular joint monitoring of the situation to avoid possible misuse of the tax treaty by unscrupulous elements. It was pointed out by the Mauritian authorities that DTAC between the two countries "had played a positive role in covering 'the higher cost ofinvesting in what was then assessed as 'high risk security' and being decisive in making possible public offerings in U. S. A. and Europe of funds investing in India". In the absence of such a facility, as I U. 0. 1. v.

AZADI BACHAO ANDOLAN [SRIKRISHNA, J. ] 283 afforded by the Inda-Mauritius DTAC, the cost of raising such investment would have been capital prohibitive. The JPC report points out that the negotiations between the Government of India and Government ofMauritius resulted in a situation in which the Mauritius Government felt that any change in the provisions ofthe DTAC would adversely affect the perception of potential investors and would prejudicially affect their financial interests. The issue still appears to be the subject matter ofnegotiations between the two Governments, though no final decision has been taken thereupon. The JPC took notice of the facts that MOBA has since been repealed by Mauritius and Financial Services Development Act has been promulgated with effect from l. 12. 2001, which has to some extent removed the drawback of MOBA, and led to greater transparency and facility for obtaining information under the DTAC, which was hitherto not available.

Taking notice of the facts, and the reluctance of the Government of Mauritius in ·the matter to renegotiate the terms of treaty, the Committee recommended as under (vide para 12. 205): "The Committee find that though the exact amount ofrevenue loss due to the 'residency clause' of the treaty cannot be quantified, but taking into account the huge inflows/outflows, it could be assumed to be substantial. They therefore recommend that Companies investing in Indian through Mauritius, should be required to file details of ownership with RBI and declare that all the Directors and effective management is in Mauritius. The Committee suggest that all the contentious issues should be resolved by the Government with the Government of Mauritius urgently through dialogue. " In our view, the recommendations of the Working Group of the JPC are intended for Parliament to take appropriate action.

The JPC might have noticed certain consequences, intended or unintended, flowing from the DTAC and has made appropriate recommendations. Based on them, it is not possible . for us to say that the DTAC or the impugned circular are contrary to law, nor would it be possible to interfere with either of them on the basis of the report of the JPC. Interpretation of Treaties The principles adopted in interpretation of treaties are not the same as those in interpretation ofstatutory legislation. While commenting on the interpretation of a treaty impo1ied into a municipal law, Francis Bennion observes: "With indirect enactment, instead of the substantive legislation taking the well-known form of an Act of Parliament, it has the form of a treaty. In other words the form and language found suitable for embodying an international agreement become, at the stroke of a pen, also the form and language of a municipal legislative instrument.

It is rather like saying that, by Act of Parliament, a woman shall be a man. Inconveniences may ensue. One inconvenience is that the interpreter is likely to be required to cope with disorganised composition instead ofprecision drafting. The drafting oftreaties is notoriously sloppy usually for very good reason. To get agreement, politic uncertainty is calle. d for. .... . The interpretation of a treaty imported into municipal law by indirect enactment was described by Lord Wilberforce as being 'unconstrained by technical rules of English law, or by English legal precedent, but conducted on broad principles of general acceptation. This echoes the optimistic dictum of Lord Widgery CJ that the words 'are to be given their general meaning, general to lawyer and layman alike... the meaning of the diplomat rather 47 than the lawyer.

" An important principle which needs to be kept in mind in the interpretation of the provisions ofan international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. Commenting on this aspect of the matter, David R. Davis in Principles of International 48 Double Taxation Relief , points out that the main function of a Double Taxation Avoidance Treaty should be seen in the context of aiding 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. It is observed (vide para 1. 06): 47. Francis Bennion, Statutory Interpretation, Pg. 461 [Butterworths, 1992 (2nd Ed. )]. 48. David R. Davis, Principles of International Double Taxation Relief, Pg. 4 (London Sweet & MaxwelL 1985). U. 0. I. v. AZAD!

BACHAO ANDOLAN [SRIKRISHNA, J. ] 285 "The benefits and detriments of a double tax treaty will probably only be truly reciprocal where the flow of trade and investment between treaty partners is generally in balance. Where this is not the case, the benefits ofthe treaty may be weighted more in favour of one treaty partner than the other, even though the provisions of the treaty are expressed in reciprocal terms. This has been identified as occurring in relation to tax treaties between developed and developing countries, where the flow of trade and investment is largely one way. Because treaty negotiations are largely a bargaining process with each side seeking concessions from the other, the final agreement will often represent a number of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides. " And, finally, in paragraph 1.

08: "Apart from the allocation of tax between the treaty partners, tax treaties can also help to resolve problems and can obtain benefits which cannot be achieved unilaterally. " Based on these observations, counsel for the appellants contended that the preamble of the Indo-Mauritius DTAC recites that it is for the "encouragement of mutual trade and investment" and this aspect of the matter cannot be lost sight of while interpreting the treaty. Many developed countries tolerate or encourage treaty shopping, even if it is unintended, improper or unjustified, for other non-tax reasons, unless it leads to a significant loss of tax revenues. Moreover, several of them allow the use of their treaty network to attract foreign enterprises and offshore activities. Some of them favour treaty shopping for outbound investment to reduce the foreign taxes oftheir tax residents but dislike their own loss of tax revenues on inbound investment or trade of non-residents.

In developing countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital or technology. They are able to grant tax concessions exclusively to foreign investors over and above the domestic tax law provisions. In this respect, it does not differ much from other 49 similar tax incentives given by them, such as tax holidays, grants, etc. 49. Roy Rcihtagi, Basic International Taxation! Pg. 373-374 (Kluwer Law International). Developing countries need foreign investments, and the treaty shopping opportunities can be an additional factor to attract them. The use ofCyprus as a treaty haven has helped capital inflows into eastern Europe. Madeira (Portugal) is attractive for investments into the European Union. Singapore is developing itself as a base for investments in South East Asia and China. Mauritius today provides a suitable treaty conduit for South Asia and South Africa.

In recent years, India has been the beneficiary ofsignificant foreign funds through the "Mauritius conduit". Although the Indian economic reforms since 1991 permitted such capital transfers, the amount would have 50 been much lower without the India-Mauritius tax treaty. Overall, countries need to take, and clo take, a holistic view. The developing countries allow treaty shopping to encourage capital and technology inflows, which developed countries ·are keen to provide to them. The loss oftax revenues could be insignificant compared to the other non-tax benefits to their economy: Many of them do not appear to be too concerned unless the revenue losses are significant compared to the other tax and non-tax benefits from the treaty, or the treaty shopping leads to 51 other tax abuses. There are many principles in fiscal economy which, though at first blush might appear to be evil, are tolerated in a developing economy, in the interest of long term development.

Deficit financing, for example, is one; treaty shopping, in our view, is another. Despite the sound and fury ofthe respondents over the so called 'abuse' of 'treaty shopping', perhaps, it may have been intended at the time when Indo-Mauritius DTAC was entered into. Whether it should continue, and, if so, for how long, is a matter which is best left to the discretion ofthe executive as it is dependent upon several economic and political considerations. This Court cannot judge the legality oftreaty shopping merely because one Section of thought considers it improper. A holistic view has to be taken to adjudge what is perhaps regarded in contemporary thinking as a necessary evil in a developing economy. Rule in McDowell The respondents strenuously criticized the act ofincorporation by Flis 50. Ibid. Sl. Ibid. U. O. I. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J. ] 287 under the Mauritian Act as a 'sham' and 'a device' actuated by improper motives.

They contend that this Court should interdict such arrangements and, as if by waving a magic wand, bring about a situation where the incorporation becomes non est. For this they heavily rely on the judgment of the Constitution Bench of this Court in McDowell and Company Ltd. 52 53 v. Commercial Tax Officer • Placing strong reliance on McDowel/ it is 54 argued that McDowel/ has changed the concept of fiscal jurisprudence in this country and any tax planning which is intended to and results in avoidance of tax must be struck down by the Court. Considering the seminal nature of the contention, it is necessary to consider in some detail 55 as to why McDowel/ , what it says, and what it does not say.

56 In the classic words of Lord Sumner in IRC V Fisher's Executors • "My Lords, the highest authorities have always recognised that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law, and that he may legitimately claim the advantage of any expressed terms or any omissions that he can find in his favour in taxing Acts. In so doing, he neither comes under liability nor incurs blame. " Similar views were expressed by Lord Tomlin in IRC v. Duke of 1 Westminster5 which reflected the prevalent attitude towards tax avoidance: '... -- "Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however, unappreciative the Commissioners oflnland Revenue or :his fellow taxgatherers may be of his ingenuity, he cannot be compelled to pay an increased tax.

" These were the pre second world war sentiments expressed by the 8 British Courts. It is urged that McDowel/5 has taken a new look at fiscal 52. Supra note I. 53. Ibid. 54. Ibid. 55. Ibid. 56. (1926) AC 395 at 412. 57. (1936) AC l; 19 TC 490. 58. Supra note I. jurisprudence and "the ghost of Fisherf' (supra) and Westminster"° have -· 61 been exorcised in the country ofits origin". It is also urged thatMcDowell's radical departure was in tune with the changed thinking on fiscal jurisprudence by the English Courts, as evidenced in WT. Ramsay Ltd v. 2 63 IRC6 , Inland Revenue Commissioners v. Burman Oil Company Ltd. , and 64 Furniss v. Dawson • As we shall show presently, far from being exorcised in its country 5 of origin, Duke of Westminster6 continues to. be alive and kicking in 66 England. Interestingly, even in McDowe// , though Chinnappa Reddy, J. , dismissed the observation of J. C. Shah,J. in CIT v. A.

Raman and 8 69 Compan;P based on Westminster6 and Fisher's Executors , by saying ·~we think that the time has come for us to depart from the Westminster principle as emphatically as the British courts have done and to dissociate ourselves from the observations ofShah J. , and similar observations made elsewhere", it does not appear that the rest of the learned Judges :of,the Constitutional Bench contributed to this radical thinking. Speaking for the majority, 70 Ranganath Mishra, 'J, (as he then was) says in McDowell : • "Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. " (Emphasis supplied) This opinion of the majority is a far cry from the view of p! iinnappa Reddy, J.

: "In our view the proper way to construe a ta}{ing statute, while considering a device to avoid tax, is not to ask whether a provision should be construed liberally or principally, nor whether the transaction is not 59. Supra note 56. 60. Supra note 57. 61. Supra note I. 62. (1982) AC 300. 63. (1982) STC 30. 64. [1984] I All ER 530. 65. Supra note 57. 66. Supra note I. 67. [1968] 67 ITR 11. 68. Supra note 57. 69. Supra note 56. 70. Supra note I at Pg. 171. U. 0. 1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J. ] 289 , ' unreal and not prohibited by the statute, but whether the transacti,on is device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it. " We are afraid that we are unable 1 to read or comprehend the majority judgment in McDowelf as having endorsed this extreme view of Chinnappa Reddy, J.

which, in our considered opinion, actually militates against the observations of the majority of the Judges which we have just extracted from the leading judgment of Ranganath Mishra, J. (as he then was). The basic assumption made in the judgment of Chinnappa Reddy,J. 2 73 in McDowelf that the principle in Duke ofWestminster has been departed - from subsequently by the House of Lords in England, with respect, is not 74 correct. In Craven v. White the House of Lords pointedly considered the 75 6 77 impact of Furniss , Burma Oif and Ramsay • The Law Lords were at great pains to explain away each of these judgments. Lord Keith of Kinkel says, with reference to the trilogy of these cases, (at p.

500): "My Lords, in my opinion the nature ofthe principle to be derived from the three cases is this : the court must first construe the relevant enactment in order to ascertain its meaning; it must then analyse the series oftransactions in question, regarded as a whole, so as to ascertain its true effect in law; and finally it must apply the enactment as construed to the true effect of the series of transactions and so decide whether or not the enactment was intended to cover it. The most important feature of the principle is that the series of transactions is to be regarded as a whole. In ascertaining the true legal effect of the series it is relevant to take into account, if it be the case, that all the steps in it were contractually agreed in advance or had been determined on in advance by a guiding will which was in a position, for all practical purposes, to secure that all of them were carried through to completion.

It is also relevant to take into account, if it be the case, that one or more of the steps was introduced into the series with no business purpose other than the avoidance of tax. 71. Supra note I. 72. Ibid. 73. Supra