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ITAT makes important ruling on phrase 'may be taxed'

19 Sep 2013

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has delivered an important ruling, wherein the phrase ‘may be taxed’ in the other contracting State appearing in tax treaties has been interpreted as not taking away the right of the Country of residence to tax the income. Taxand India investigates the case which led to this ruling. 

Essar Oil Limited, engaged in the business of exploration of mineral oil & gases, had entered into contracts with Government agencies of Oman and Qatar to undertake drilling of oil works, for which it had established national branch offices.

The business income earned by Essar Oil in Oman and Qatar, on which taxes were paid in the respective countries, were not offered to tax in India, relying on Article 7 of the relevant Tax Treaty, on the basis that such income is taxable only in the respective countries and not in India. Essar Oil had also earned capital gains on the sale of energy division of the company as a going concern, which was allocated amongst various branches of the taxpayer as per the fixed asset ratio of the branches. The gains allocated to the branches in Oman and Qatar were also not offered to tax in India taking shelter under Article 15 and Article 13 dealing with capital gains in the respective Tax Treaties.

The Assessing Officer (AO) observed that while the relevant Articles of the Tax Treaty state that the business income or capital gains ‘may be taxed’ in other contracting States, it merely means that such income could also be taxed in India and credit for the taxes paid in abroad could be claimed in India.  Accordingly the AO finalised the assessment, against which Essar Oil appealed to Commissioner. 
The Commissioner (Appeals), relying on the ruling of the Karnataka High Court in the case of RM Muthaiah and Madras High Court in the case of SRM Firm as approved by the Supreme Court in the case of PVAL Kulandagan Chettiar, overturned the order of the AO holding that use of the phrase ‘may be taxed’ in the Tax Treaties does not allow India to tax such incomes. The Revenue appealed against this ruling to the ITAT.

OECD commentary on Tax Treaty suggests that only the usage of phrase ‘shall be taxable’ provides an exclusive right to tax. The phrase ‘may be taxed’ provides a State an option or right to tax a particular item of income without impacting the rights of the other contracting State. In the Tax Treaties, ‘shall be taxable only’ is never used while giving the tax right to the country of source and it is only used in the context of taxing right to the State of residence. The phrase ‘may be taxed’ / ‘may also be taxed’ gives the taxing right to the source country, however, this does not in any manner limit the right of tax or extinguish the right to tax of the country of resident which alone has a mandate to tax the global income of its resident under the domestic law. Therefore, the income earned by Essar Oil in Oman and Qatar ought to be offered to tax in India, wherein credit would be provided towards taxes paid by the taxpayer in the respective countries. 

Discover more: ITAT makes important ruling on phrase 'may be taxed' 

Your Taxand contact for further queries is:
Mukesh Butani
T. +91 124 339 5010 

Also published in Thomson Reuters' Taxnet Pro, 20 September 2013

Taxand's Take

The Delhi Bench of the ITAT has, in the case of Telecommunications Consultants India Ltd, held that the foreign branches of an Indian resident cannot go untaxed in India and that the ruling of the Supreme Court in the case of Kulandagan Chettiar has been misunderstood. It departed from the principles laid down by the coordinate bench of the ITAT in Mumbai in the case of Pooja Bhat, where the phrase ‘may be taxed’ was interpreted as an exclusive taxing right to the Country of Source. The Mumbai ITAT bench itself has now, in the case of Essar Oil, held that none of the rulings is relevant as a consequence of the notification issued by the CBDT laying out the meaning of the phrase ‘may be taxed’.  
It is a disturbing trend that many tax issues relating to international transactions are caught up in the litigation with disagreement in ITAT benches and various Courts.  This ruling also raises certain fundamental issues.  Generally, when a term is not defined under the Treaty, it would assume the meaning provided under the domestic law of the State seeking to apply the Treaty.  

Taxand's Take Author

Mukesh Butani
Taxand Board member