Implementing Tax Treaties in Equalisation Levy Law in India

Introduction

The equalisation levy was brought in the statute books in India by Chapter VIII of the Finance Act, 2016 ("FA 2016"). The scope of the levy was substantially expanded by the Finance Act, 2020 through amendment of various provisions in Chapter VIII. Since the EL was brought in, not in the Income-tax Act, 1961 ("ITA"), but through separate legislation, whether the levy is an income-tax and whether a tax covered by double-tax avoidance agreements ("tax treaties") has been hotly debated. If so, whether the non-resident on whom the levy is imposed can access the relevant tax treaty for relief is the second question. The second question can also be rephrased as whether, in the absence of an implementing provision in the EL law similar to section 90 of the ITA, tax treaties can impact the levy.

The first question is dealt with perfunctorily in this paper while the examination is focused on the second question. The paper explores various constitutional provisions and jurisprudence in India on implementing international conventions and attempts to identify the various possible arguments for and against the proposition that EL is impacted by the tax treaties which may aid the reader to discern the correct legal position on the subject.

EL whether "Taxes Covered" in treaties

There are variations in the wordings of Article 2 – Taxes Covered in several of India's tax treaties. In some treaties, the list of taxes for India refer to 'income-tax including surcharge thereon imposed by the Income-tax Act, 1961'. Since the EL is not imposed by the ITA but through separate legislation, it is not an income-tax that is a 'tax covered' under such treaties. In several other treaties, the list of taxes for India refer to merely 'income-tax including surcharge thereon' without qualifying that such tax is imposed by the ITA which leaves open the possibility of EL being included under that entry, provided of course, it is established that the EL is an income-tax.

Further, Article 2 of several tax treaties contain a provision to include same or similar taxes to income-tax if imposed after signing of the relevant treaty. The moot question is, whether the EL is identical or substantially similar to the income-tax. A reference to the relevant portion of the Explanatory Memorandum to FA 2016 is extracted below:

These new business models have created new tax challenges. The typical direct tax issues relating to e-commerce are the difficulties of characterising the nature of payment and establishing a nexus or link between a taxable transaction, activity and a taxing jurisdiction, the difficulty of locating the transaction, activity and identifying the taxpayer for income tax purposes. The digital business fundamentally challenges physical presence-based permanent establishment rules. If permanent establishment (PE) principles are to remain effective in the new economy, the fundamental PE components developed for the old economy i.e. place of business, location, and permanency must be reconciled with the new digital reality.

The Organization for Economic Cooperation and Development (OECD) has recommended, in Base Erosion and Profit Shifting (BEPS) project under Action Plan 1, several options to tackle the direct tax challenges which include modifying the existing Permanent Establishment (PE) rule to include that where an enterprise engaged in fully de-materialised digital activities would constitute a PE if it maintained a significant digital presence in another country's economy. It further recommended a virtual fixed place of business PE in the concept of PE i,e creation of a PE when the enterprise maintains a website on a server of another enterprise located in a jurisdiction and carries on business through that website. It also recommended to impose of a final withholding tax on certain payments for digital goods or services provided by a foreign e-commerce provider or imposition of a equalisation levy on consideration for certain digital transactions received by a non-resident from a resident or from a non-resident having permanent establishment in other contracting state.

Considering the potential of new digital economy and the rapidly evolving nature of business operations it is found essential to address the challenges in terms of taxation of such digital transactions as mentioned above. In order to address these challenges, it is proposed to insert a new Chapter titled "Equalisation Levy" in the Finance Bill, to provide for an equalisation levy of 6 % of the amount of consideration for specified services received or receivable by a non-resident not having permanent establishment ('PE') in India, from a resident in India who carries out business or profession, or from a non-resident having permanent establishment in India." [underlining supplied]

Also, the Finance Minister's Speech moving the Finance Bill, 2016 is relevant to understand the object of the levy:

"151. In order to tap tax on income accruing to foreign e-commerce companies from India, it is proposed that a person making payment to a non-resident, who does not have a permanent establishment, exceeding in aggregate `1 lakh in a year, as consideration for online advertisement, will withhold tax at 6% of gross amount paid, as Equalisation levy. The levy will only apply to B2B transactions." [underlining supplied]

It has been contended that the EL is a direct tax but not an income-tax. This argument prima facie flies in the face of the Speech in the Parliament of the mover of the legislation as well as the Memorandum explaining its provisions.

The levy of interest tax in the past is a good comparison example. Interest tax was brought in the statute books with the object of imposing a special tax on interest in some instances. The charge of this tax was on banks and financial institutions in respect of gross interest income earned by them other than interest on loans and advances made to credit institutions). A doubt may arise whether this tax was similar to income-tax and ought to have been a tax covered under a tax treaty. Like EL, there was no provision in that law to implement tax treaties.

However, if one looks at the overall structure of the Interest Tax Act, though this tax was levied on the interest income of banks and FIs, the tax was available to them as a deduction while computing income-tax under the ITA. Thus, the interest-tax had the characteristics of an indirect tax on interest rather than a tax on income and may not have been an identical or similar tax to income-tax, and the question of implementing treaties in that law would not arise.

Another aspect is the meaning of the term "identical or substantially similar tax" occurring in Article 2 on which there is some jurisprudence emanating from foreign courts. Differences between the income-tax and the EL exist: one significant distinction between the two is that the income-tax is charged under section 4 of the ITA generally on the net income while the EL is taxed on the gross value of the transaction that is subject to the levy. If the taxpayer contends that EL is nothing but a tax on income, there would be equally good views contending the opposite, that is, a direct tax is not an income-tax or that the EL is not identical or substantially similar to existing taxes and consequently it should not be a tax covered under the tax treaties. However, this debate is not the focus of this paper; what is examined here is the consequence if the EL is a tax covered under tax treaties.

Treaty-making and legislative provisions in India

India has entered into several tax treaties with other countries and jurisdictions. Under section 90 of the ITA, the Central Government is empowered to enter into an agreement with the Government of any foreign country for the avoidance of double taxation of income (and capital, in case of some treaties) and to make provisions for implementing the agreement by the issue of a notification in the Official Gazette. Similar provisions existed under the Wealth-tax Act, 1957. Unlike these specific provisions in the ITA and the Wealth-tax Act for implementing a tax treaty notified under those sections, there are no such provisions in ChapterVIII of the Finance Act, 2016 (containing the law on equalisation levy).

As regards the role of section 90 of the ITA, the Supreme Court states:

"26. A survey of the aforesaid cases makes it clear that the judicial consensus in India has been that section 90 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. When that happens, 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. We approve of the reasoning in the decisions which we have noticed….."

The Apex Court described the treaty-making power of the Indian State as follows:

"17. The power of entering into a treaty is an inherent part of the sovereign power of the State. By article 73, subject to the provisions of the Constitution, the executive power of the Union extends to the matters with respect to which the Parliament has power to make laws. Our Constitution makes no provision making legislation a condition for the entry into an international treaty in time either of war or peace. The executive power of the Union is vested in the President and is exercisable in accordance with the Constitution. The Executive is qua the State competent to represent the State in all matters international and may by agreement, convention or treaty incur obligations which in international law are binding upon the State. But the obligations arising under the agreement or treaties are not by their own force binding upon Indian nationals. The power to legislate in respect of treaties lies with the Parliament under entries 10 and 14 of List I of the Seventh Schedule. But making of law under that authority is necessary when the treaty or agreement operates to restrict the rights of citizens or others or modifies the law of the State. If the rights of the citizens or others which are justiciable are not affected, no legislative measure is needed to give effect to the agreement or treaty."

India is a dualist model wherein international treaties do not become part of national law automatically. The two stages in treaty-making, namely, the formation of an obligation and its performance are distinct: the making of a treaty is an executive act, while the performance of its obligations if they entail alteration of existing domestic law requires legislative action.

The Executive of the Union headed by the President derives power from Article 73 of the Constitution to enter into international treaties. This authority to sign a treaty is derived directly from the Constitution itself and not from any legislation of the Parliament as the framers of the Constitution believed that the Executive ought to have full freedom to enter into treaties and decide the same as a matter of policy.

As mentioned earlier, treaties are not self-executing and are not on their own binding upon Indian nationals. Article 253 empowers the Parliament to make laws for implementing a treaty or agreement, and reads as under:

"253. Notwithstanding anything in the foregoing provisions of this Chapter, Parliament has power to make any law for the whole or any part of the territory, of India for implementing any treaty, agreement or convention with any other country or countries or any decision made at any international conference, association or other body."

The power of the Parliament by the provision of Entries 13 and 14, is as follows:

"13. Participation in international conferences, associations and other bodies and implementing of decisions made thereat.

14. Entering into treaties and agreements with foreign countries and implementing of treaties, agreements and conventions with foreign countries."

Article 253 does not add anything to Entries 13 to 14 of the Union List but confers exclusive power of law-making upon Parliament.

An SOP issued by the Ministry of External Affairs states as follows:

"In order to ensure that India is in a position to efficiently discharge all obligations emanating from the treaties/agreements, ratification /accession should be undertaken only after the relevant domestic laws have been amended, or enabling legislation has been enacted in cases where there are no domestic laws on the subject. Therefore, proposal for entering into such treaties/agreements should specifically state that such ratification or accession will be made only after amending the relevant domestic laws, or enacting appropriate legislations."

In the context of tax treaties, section 90 of the ITA is a special procedure for a tax treaty to become applicable without requiring an Act of Parliament on each occasion. Section 90 enables the Central Government to enter into agreements for granting of relief from income that is doubly taxed, for the avoidance of double taxation, for recovery of tax and exchange of information.

International law and municipal law interplay

The Supreme Court, in Gramaphone, was dealing with an issue related to section 53 of the Copyright Act, 1957 which empowers the Registrar of Copyrights to make an order that copies made outside India of any work, which, if made in India would infringe Copyright, shall not be imported. In the facts of that case, pirated music cassettes were found in the Calcutta docks. These cassettes were to be taken across Indian territory to Nepal where such importation was not prohibited. The Apex Court examined several conventions for facilitating trade with landlocked countries to find if there was any mandate permitting transit rights for such countries, and if so, "whether international law is, of its own force, drawn into the law of the land without the aid of a municipal statute, and whether, so drawn, it overrides municipal law in case of conflict?"

After referring to the doctrine of incorporation practised in monist states, the Court then described the doctrine of transformation as operating in dualist States like India in the following words:

There can be no question that nations must march with the international community and the Municipal law must respect rules of International law even as nations respect international opinion. The comity of Nations requires that Rules of International law may be accommodated in the Municipal Law even without express legislative sanction provided they do not run into conflict with Acts of Parliament. But when they do run into such conflict, the sovereignty and the integrity of the Republic and the supremacy of the constituted legislatures in making the laws may not be subjected to external rules except to the extent legitimately accepted by the constituted legislatures themselves.

In the end, the Court did not find any well-established principle of international law on the question of the right of land-locked States to the innocent passage of goods across the soil of another State.

In Vellore Citizens Welfare Forum, the Supreme Court was dealing with a case of a claim for damages from polluters to the environment where there was no specific law in India at that time. The Court held:

"In view of the above mentioned constitutional and statutory provisions we have no hesitation in holding that the precautionary principle and the polluter pays principle are part of the environmental law of the country.

Even otherwise once these principles are accepted as part of the Customary International Law there would be no difficultly in accepting them as part of the domestic law. It is almost accepted proposition of law that the rule of Customary International Law which are not contrary to the municipal law shall be deemed to have been incorporated in the domestic law and shall be followed by the Courts of Law." [underlining supplied].

In G.M. Exports, after examining various judicial precedents, the Apex Court concluded as follows:

"23. A conspectus of the aforesaid authorities would lead to the following conclusions:

(1) Article 51(c) of the Constitution of India is a Directive Principle of State Policy which states that the State shall endeavour to foster respect for international law and treaty obligations. As a result, rules of international law which are not contrary to domestic law are followed by the courts in this country. This is a situation in which there is an international treaty to which India is not a signatory or general rules of international law are made applicable. It is in this situation that if there happens to be a conflict between domestic law and international law, domestic law will prevail.

(2) In a situation where India is a signatory nation to an international treaty, and a statute is passed pursuant to the said treaty, it is a legitimate aid to the construction of the provisions of such statute that are vague or ambiguous to have recourse to the terms of the treaty to resolve such ambiguity in favour of a meaning that is consistent with the provisions of the treaty.

(3) In a situation where India is a signatory nation to an international treaty, and a statute is made in furtherance of such treaty, a purposive rather than a narrow literal construction of such statute is preferred. The interpretation of such a statute should be construed on broad principles of general acceptance rather than earlier domestic precedents, being intended to carry out treaty obligations, and not to be inconsistent with them.

(4) In a situation in which India is a signatory nation to an international treaty, and a statute is made to enforce a treaty obligation, and if there be any difference between the language of such statute and a corresponding provision of the treaty, the statutory language should be construed in the same sense as that of the treaty. This is for the reason that in such cases what is sought to be achieved by the international treaty is a uniform international code of law which is to be applied by the courts of all the signatory nations in a manner that leads to the same result in all the signatory nations."

Of the above conclusions derived in G.M. Exports, the first one as reproduced above is relevant for our examination in the context of EL. As long as there is nothing in the EL law that derogates from the tax treaties (like an intention expressed in the law not to extend treaty benefits to EL), the rules contained in these tax treaties since are not contrary to domestic law will be followed by the courts.

The ruling of the Apex Court in Maganbhai Ishwarlal Patel arose out of an interesting factual background. The Indo-Pak War in 1965 ended in a truce with both countries agreeing to constitute a Tribunal to arbitrate on the conflicting territorial claims of the two countries. The Tribunal gave an award against India requiring India to give up some of the territories which were under dispute. The petitioners were seeking to restrain the Government of India from making over certain areas to Pakistan by sheer executive act and insisted that the necessary change can only be carried out by a constitutional amendment of the territories of India as indicated in the Constitution. Article 3 enables Parliament by law to alter the boundaries of the existing States, and it includes the power (b) to increase the area, of any State (c) diminish the area of any State or to alter the name of any State. The Tribunal award itself was not in challenge before the Supreme Court but only that insofar as the award affected the territorial limits of India, it required a constitutional amendment.

About the constitutional powers of the Executive, the court stated as under:

"The Judicial Committee in Attorney-General for Canada v. Attorney-General for Ontario and Others made some observations in the context of a rule applicable within the British Empire, which are pertinent:

"It will be essential to keep in mind the distinction between (1) the formation, and (2) the performance, of the obligations constituted by a treaty, using that word as comprising any agreement between two or more sovereign States. Within the British Empire there is a well-established rule that the making of a treaty is an executive act, while the performance of its obligations, if they entail alteration of the existing domestic law, requires legislative action. Unlike some other countries, the, stipulations of a treaty duly ratified do not within the Empire, by virtue of the treaty alone, have the force of law. If the national Executive, the Government of the day, decide to incur the obligations of a treaty which involve alteration of law they have to run the risk of obtaining the assent of Parliament to the necessary statute or statutes.....

Parliament, no, doubt, .... has a constitutional control over the Executive: but it cannot be disputed that the creation of the obligation.-. undertaken in treaties and the assent to their form and quality are the function of the Executive alone. Once they are created, while they bind the State as against the other contracting parties, Parliament may refuse to perform them and so leave the State in default." [underlining supplied]

The Court upheld the power of the Executive to enter into a treaty or a compromise giving up India's territorial claims which were disputed by another country as the provision in Article 3 of the Constitution dealt with only the territories over which India held sovereign sway and did not deal with disputed territories. One can draw an interesting parallel between this case with highly charged nationalistic sentiments and the issue of mundane taxing rights given up in treaties by the Executive as a bargain and not dealt with or derogated from in the law.

Article 51 and its significance

Article 51 falls in Part IV of the Constitution, which contains the Directive Principles of State Policy. According to Article 37, these principles cannot be enforced through the Court of law. However, the Directive Principles nevertheless are fundamental in the governance of the country, and there is a non-obligatory duty on the part of the State to apply these principles in making of laws. This Article has been the subject-matter of interpretation by the Supreme Court on various occasions.

In Kesavananda Bharathi, the Hon. CJ A Sikri observed as under:

"Although there is a sharp conflict of opinion whether respect for human dignity and fundamental human rights is obligatory under the Charter (see Oppenheim's International Law; 8th ed. Vol. 1, pp. 740-41; footnote 3), it seems to me that, in view of Article 51 of the directive principles, this Court must interpret language of the Constitution, if not intractable, which is after all a municipal law, in the light of the United Nations Charter and the solemn declaration subscribed to by India." [underlining supplied].

In Jolly George Verghese, the issue before the Supreme Court was whether Article 11 on the law that is to be applied by an Indian Court when there is a specific provision in the Civil Procedure Code, authorising detention for non-payment of a decree debt. The Court looked at Art. 11 of the International Covenant on Civil and Political Rights read as follows:

No one shall be imprisoned merely on the ground of inability to fulfil a contractual obligation.

On the other hand, section 51 of the Criminal Procedure Code provided for arrest and detention in prison of a judgment-debtor for non-payment of a decree debt. The Apex Court took note of Article 51(c) but concluded that, nevertheless, until the municipal law is changed to accommodate the Covenant what binds the court is the former, not the latter. The Court held that "positive commitment of the States Parties ignites legislative action at home but does not automatically make the Covenant an enforceable part of the corpus juris of India."

In Visakha & Ors v State of Rajasthan, the Supreme Court was seized of the issue of the lack of any law that protects women at workplaces. This case arose out of the brutal gang rape of a social worker in a village in Rajasthan. Apart from revealing the hazards working women face at work, the Court was seized of the urgency for introducing safeguards by an alternative mechanism in the absence of legislative measures. The Court observed:

In the absence of domestic law occupying the field, to formulate effective measures to check the evil of sexual harassment of working women at all work places, the contents of International Conventions and norms are significant for the purpose of interpretation of the guarantee of gender equality, right to work with human dignity in Articles 14, 15 19(1)(g) and 21 of the Constitution and the safeguards against sexual harassment implicit therein. Any International Convention not inconsistent with the fundamental rights and in harmony with its spirit must be read into these provisions to enlarge the meaning and content thereof, to promote the object of the constitutional guarantee. This is implicit from Article 51(c) and enabling power of the Parliament to enact laws for implementing the International Conventions and norms by virtue of Article 253 read with Entry 14 of the Union List in Seventh Schedule of the Constitution.

In this respect, the Court noted the rules contained in the Convention on the Elimination of All Forms of Discrimination against Women and drafted the "Visakha Guidelines" for strict observance in all workplaces for the preservation and enforcement of the right to gender equality of the working women until suitable legislation was enacted.

Power of the Executive of the Union

Another aspect that merits attention is the reference in Visakha to Article 73 of the Constitution and the Supreme Court's observation as follows:

Article 73 also is relevant. It provides that the executive power of the Union shall extend to the matters with respect to which Parliament has power to make laws. The executive power of the Union is, therefore, available till the Parliament enacts to expressly provide measures needed to curb the evil.

Interestingly, all the Parties before the Court in the Visakha case supported the exercise performed by the Supreme Court of drafting the Guidelines and Norms which were to be strictly enforced at workplaces despite no legislation existing. In that case, the Court commended the 'common perception shared with the learned Solicitor General and other members of the Bar who rendered valuable assistance in the performance of this difficult task in the public interest'.

However, a tax case like reading a tax treaty provisions into the EL law without specific provisions in the law to implement these treaties may face stronger headwinds from the Government if the Supreme Court wishes to read implementation of DTAA onto the EL law.

Is the consent by the Executive to a provision in a tax treaty that includes as 'taxes covered' identical and similar taxes imposed after signing of the relevant treaty in the nature of power available with it under Article 73? In other words, until the Parliament legislates on that issue, the Executive action as embodied in Article 2 of a tax treaty holds sway, and arguably, is an exercise of its power under Article 73. Alternatively, if a mere provision in an international treaty is not an exercise of Executive power, the moot question is whether it is possible for the Executive not to exercise such power when it is available.

"Executive construction" as an external aid to construction

We have seen that in countries, especially from the Commonwealth, including India, international treaties are executive acts and are not elevated to the stature of law. A question arises whether the executive practice of including 'same or similar taxes to income-tax' as taxes covered in Article 2 of tax treaties can be an external aid to construction to interpret Chapter VIII of Finance Act, 2016. The examination of India's 95 treaties shows that in as many as 88 treaties, Article 2 on "Taxes Covered" contain such a provision to include "identical or substantially similar taxes" imposed after the signing of the relevant treaty as applicable to the relevant Convention. It is safe to state that the executive practice over a long period of time has been to enter into tax treaties which apply to identical or similar taxes imposed after the signing of the relevant treaty. Though a tax treaty is an agreement between two sovereign states, India, as a contracting party, has chosen to include that provision in most of its tax treaties.

It was observed by the Supreme Court while upholding reference to the Finance Minister's Speech to understand the object of an amendment, that interpretation of a statute being an exercise in the ascertainment of meaning, everything which is logically relevant should be admissible. Thus, the utility of external aids to construction and their admissibility was made clear in that ruling.

It was held in Ajay Gandhi v B. Singh that "for the construction of a statute, it is trite that the actual practice may be taken into consideration" . Thus, since Chapter VIII of the Finance Act, 2016 does not contain any provision which denies the application of double tax treaties to EL nor is there any intention expressed therein to prevent their implementation on to the EL law, the principle of 'executive construction' may be relevant and require more in-depth examination. This proposition is not valid for treaties signed after EL was imposed in 2016 (and also, its scope expanded in 2020) because the provision in Article 2 generally applies only to such identical or similar taxes which are imposed after the signing of the relevant Convention. If the EL is not listed as "taxes covered" in a treaty signed after the levy was imposed or expanded, it amounts to a bargain between the Contracting States which is to be respected.

Summary of Conclusions

Since the EL was brought in not in the ITA but through separate legislation, whether the levy is an income-tax and whether covered by tax treaties has been hotly debated. If so, whether the non-resident on whom the levy is imposed can access the relevant tax treaty for relief especially when an implementing provision similar to section 90 of the ITA is absent in the EL law has been examined.

The Speech in the Parliament of the Finance Minister placing the Finance Bill for discussion as well as the Memorandum explaining its provisions reveal that the EL was brought in to tax income accruing to non-resident eCommerce companies weakens the contention that the EL is a direct tax but not a tax on income. If not an income-tax can EL fall under the description of identical or substantially similar tax so that it will be a tax covered under tax treaties is another point of debate for which there are no easy answers. Differences between the income-tax and the EL exist: one significant distinction between the two is that the income-tax is charged under the ITA generally on the net income while the EL is taxed on the gross value of the transaction subject to the levy.

If the EL is a tax covered under tax treaties, the question, whether the non-resident on whom the levy is imposed can access the relevant tax treaty for relief especially in the absence of an implementing provision in the EL law similar to section 90 of the ITA, arises. The paper examines the later question in more detail.

Any International Convention not inconsistent with the fundamental rights and in harmony with its spirit must be read into these provisions to enlarge the meaning and content thereof, to promote the object of the constitutional guarantee. This is implicit from Article 51(c) and enabling power of the Parliament to enact laws for implementing the International Conventions, and norms by virtue of Article 253 read with Entry 14 of the Union List in Seventh Schedule of the Constitution as was held in Visakha case.

Based on the principle enunciated in G.M. Exports, as long as there is nothing in the EL law that derogates from the tax treaties (like an express intention in the law not to extend treaty benefits to EL), the rules contained in these tax treaties since are not contrary to domestic law will be followed by the courts.

The Supreme Court, in Maganbhai Ishwarbhai Patel, upheld the power of the Executive to give up India's territorial claims which were disputed by another country as the provision in Article 3 of the Constitution dealt with only the territories over which India held sovereign sway and did not deal with disputed territories. One can draw an interesting parallel between this case with highly charged nationalistic sentiments and the issue of mundane taxing rights given up in treaties by the Executive as a bargain and not dealt with or derogated from in the law.

In the context of EL, the Govt could argue that EL is not one of the taxes covered in the tax treaties. If EL is established or concluded to be "Taxes Covered", there appears to be a binding obligation of the Government to give effect to the provisions of those treaties. The absence of a provision in law to 'implement' or to give effect to tax treaties has to be remedied by bringing in the necessary legislation. Until such legislation is enacted, Article 73 gives powers to the Executive to give the required effect to avoid double taxation.

Only where the Parliament imposes provisions in law, which are contrary to or derogate from the obligations contained in a tax treaty, that treaty cannot be implemented in the EL law.