by Ashish Goel
In a ruling delivered April 12, India’s Madras High Court has upheld the Indian government’s 2013 decision to classify Cyprus as a non-cooperative jurisdiction for the purpose of applying section 94A of the Indian Income Tax Act. As a result, a special set of burdensome tax rules will continue to apply to transactions between Indian taxpayers and Cypriot individuals and companies.
Section 94A, an anti-avoidance measure, was introduced through the Finance Act 2011, empowering the government to classify a foreign country which fails to effectively exchange tax information with India as a “notified jurisdictional area.”
Transactions carried out with residents of such countries are deemed to be related-party transactions attracting India’s transfer pricing rules, including the obligation to maintain proper documentation. Limits are also placed on deductions in respect of payments made to a notified jurisdictional area’s financial institutions and in respect of expenditures or allowances arising from transactions involving the country’s residents.
In November 2013, the Indian Government notified Cyprus under section 94A (Notification No.86/2013) for failing to provide information requested by the Indian tax authorities under the exchange of information provisions of the India/Cyprus tax treaty.
Subsequently, in October 2014, three Indian resident individuals – T Rajkumar, K Dhanakumar and T K Dhanashekar – purchased shares and debentures in an Indian company from a Cypriot company. The tax authority called upon the individuals to show cause as to why they should not be treated as taxpayers in default under section 201 of the IT Act (failure to deduct or pay tax at source). In response, they petitioned the High Court challenging, among other things, the validity of the notification.
The petitioners contended that Article 28(3)(b) of the India/Cyprus tax treaty excludes exchange of information with respect to documents which are not obtainable under the laws or in the normal course of the administration of either country. The petitioners argued that the government cannot annul an explicit treaty provision by issuing a notification under the IT Act. The Court, however, refused to subscribe to this view and ruled that the lack of exchange of information by Cyprus, which prompted the notification, cannot fall under Article 28(3)(b) of the tax treaty.
The Court specifically pointed out that the Indian government had been making a number of requests to Cyprus to provide information, such as details of the beneficial ownership of persons making huge investments in India and the source of such funding, but no information was forthcoming from Cyprus despite having a tax treaty in place.
“Both contracting parties are obliged to perform their obligations under the tax treaty in good faith. When one of the parties commits a default by failing to provide information, it is not open to the beneficiary of such a default to contend that the other contracting party should honor their obligations,” the Court observed.
The Court rejected the petitioners’ view that India cannot take recourse to section 94A given that the tax treaty itself provides for a mutual agreement procedure (MAP) for resolution of disputes. The Court pointed out that the MAP provision stipulated under Article 27 of the treaty deals with difficulties or doubts arising as to the interpretation or application of the tax treaty and not with the failure of one of the contracting parties to honor its commitment under the tax treaty. The Court went a step further, observing that a MAP provision in the tax treaty “cannot oust the jurisdiction of the Parliament to enact a law and the Executive to issue a Notification in exercise of the power conferred by such a law.”
The petitioners had also argued that Section 94A empowers the government to notify only those countries that have not signed a tax treaty with India. However, the Court dismissed this contention, stating that it “loses sight” of the express language of section 94A, which uses the phrase “any country or territory” and not “any country or territory other than those covered by section 90(1).”
“In a taxing statute, we are not entitled to add or delete any expression. We are not also entitled to re-phrase the provision,” the Court stressed.