Non-discrimination clause in tax treaties – Select issues and recent developments – Part 2

In part 1 of the series, I have given an overview of Article 24 on Non-discrimination. In this part, I will discuss Article 24(1) which deals with Nationality non-discrimination in detail.

Wordings of the Article 24(1) as per OECD and UN model convention are as under –

The above paragraph highlights the principle that for the purpose of taxation discrimination on the grounds of nationality is forbidden, and that, subject to reciprocity, the nationals of a Contracting State may not be less favourably treated in other Contracting State than nationals of the latter State in the same circumstances. Some of the important terms used in Article 24(1) are discussed below –

  • Nationals – Application of this clause is not restricted by Article 1 of the model convention to nationals solely who are residents of a Contracting State, but on the contrary, extends to all nationals of each Contracting State, whether or not they be residents of one of them.
  • Any taxation or any requirement connected therewith – OECD commentary suggests the definition of ‘taxation’ as taxes of every kind and description. The expression ‘connected requirements’ of taxation means that formalities connected with taxation, such as returns, payments, prescribed limits, TDS, issue of notices or refunds, or levy of interest, exemption, deduction, credit or other allowance, etc. ( Relevant to note that the word taxation is not defined in the tax treaty nor in the domestic laws of India. Article 366(28) of the Constitution of India defines ‘taxation’ in an inclusive manner as ‘taxation includes the imposition of any tax or post whether general or local or special, and tax shall be construed accordingly’)
  • Other or more burdensome  – The expression ‘other’ refers to the requirement imposed by the source state on a foreign national which is different from the requirements imposed by source state on its nationals being ‘more burdensome’. These relates to the differences in the tax treatment that materially disadvantage the foreign national.
  • In the same circumstances – If the taxpayers must be in same circumstances, then only they would be comparable and accordingly require same tax treatment. In applying Article 24(1), therefore, the underlying question is whether two persons who are residents of the same state are being treated differently solely by reason of having a different nationality. Certain situations in which the expression ‘in the same circumstances’ is not satisfied (as was found in the OECD commentary and Indian Judicial Pronouncements) –
    • Differences accorded on the basis of residential status
    • Differences in scope of taxation for domestic residents vis-à-vis foreign nationals
    • Institution not for profit but belonging to other Contracting State will not be in the same circumstances as the private institution of the Source State
    • Immunity from the taxation accorded to its own public bodies and services would be justified as they are integral part of the State and cannot be compared to those of the public bodies and services of the other State.

OECD commentary provides for some examples in para 19 to 25 of the Article. Some of them are :

  • Where in a DTAA, it is provided that if a company is Resident of two States (one because or incorporation and other because of POEM), then it shall be treated as Resident of that State where it is incorporated. Therefore, the dividend paid by company of State A to that company having dual Residence will not be in the same circumstances and can be treated differently for the tax purposes.(Hence, a differential treatment by the source state of resident and non-resident companies is allowed by Article 24(1) even where residence and nationality are linked to the criteria of incorporation or registration)
  • State A levies payroll tax on company that employ Resident employees. It does not make any distinction based on the residence of the employer but provides that company incorporated in State A shall benefit from lower rate of payroll tax. If a company incorporated in State B is also a Resident of State A (because of POEM) then different tax treatment to this company would be violative.

Indian Judicial pronouncements and principles emanating from it –

  • The applicability of non-discrimination clause is to be seen at the time of assessment proceedings and once the affected taxpayer files its return of income and takes the plea before the tax officer, but not at the stage of deduction of taxes.
  • (Judgement – Ericsson Telephone Corporation India AB v CIT (1997) 224 ITR 203 (AAR))
  • Benefit of the principle of interpretation could be allowed to an overseas company when two views are available on an issue i.e. the one favourable to the taxpayer should be provided for. (Judgement – DDIT vs Solid Works Corporation (2012) 51 SOT 34 (Mum))
  • Foreign national can claim deduction under section 80R, 80RRA etc. of the Income tax Act, since these provisions allow deduction only to an Indian citizen and consequently, are discriminative vis-à-vis foreign nationals. (Judgement – Credit Llyonnais vs. DCIT (2005) 95 ITD 401 (Mum)
  • Foreign bank (i.e. UK bank) was allowed to claim the benefit of bad debt reserve for loans that was originally granted only to the banks incorporated in India and whose deductibility was restricted based on advances made by rural branches.
  • (Judgement – Standard Chartered Bank v IAC (1991) 39 ITD 57 (Mum.))
  • The expression ‘taxation’ is not defined in Article 24 or Article 3(2) or in the Income-tax Act. The expression ‘taxation’ and ‘tax’ are not inter-changeable. Further, it was held that article 24 which seeks to prevent differentiation solely on ground of nationality and against nationals as such; under this clause State is not obliged to extend same privileges, which it accords to its own residents, to one who is not a resident and no discrimination can be said to have occurred on basis of nationality in such cases. (Judgement – Transworld Garnet Co. Ltd, In re (2011) 333 ITR 1 (AAR))
  • Article 3(1)(g) of the India-Korea Tax Treaty (1985) defines ‘national’ as ‘any individual possessing the nationality of a Contracting State and any legal person, partnership, association or other entity deriving its status as such from the laws in force in the Contracting State.’, the words ‘other entity’ does not include corporate bodies unless they are declared ‘nationals’ under the laws of those States. (Judgement – Chohung Bank v DDIT (2007) 12 SOT 301 (Mum.)
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