A recent decision of the Pune Bench of the Income Tax Appellate Tribunal in Daimler Chrysler v. DCIT deals with several important issues. One of these was whether the provisions of a Double Taxation Avoidance Agreement would apply in the absence of double taxation. The Tribunal held that given the role DTAAs play in modern economies, the incidence of double taxation cannot be a prerequisite before the beneficial provisions of a DTAA would be available. I had looked at the reasoning of the Tribunal on this issue here. In addition to this, the case also analyses the non-discrimination provisions in DTAAs (the treaty in question in the facts of the case was the Indo-German DTAA) in relation to Section 79 of the Income Tax Act, 1961. This issue is particularly important from the point of view of the taxation of Indian subsidiaries of foreign companies.
Under the Income Tax Act, 1961, Section 79 states that where there is any change in shareholding resulting in a change in more than 51% of the voting rights in the company, not being a company in which the public is substantially interested, no losses incurred in a year before the relevant previous year may be carried forward or set off against the income earned in the previous year.
Under Section 2(18) of the Act, a subsidiary of a public company whose shares are listed in a recognized stock exchange in India is treated as a company in which the public is substantially interested. On the other hand, a subsidiary of a public company which is not listed in a recognized stock exchange in India will not be entitled to be treated as a company in which public are substantially interested. Thus, a subsidiary of a company listed on the BSE will be a company in which the public is substantially interested; while that will not be the case with a subsidiary of a company listed on the NYSE.
In the facts of the case before the Tribunal, the assessee was a company incorporated in India. At the beginning of the relevant financial period, 81% of assessee’s share capital was held by a German company, Daimler Benz; and the balance 19% by an Indian company, TELCO. In the relevant financial period, Daimler Benz and the Chrysler Corporation, USA, decided to merge. A new company called Daimler Chrysler was formed in Germany for this purpose. In the process of the merger, all the assets and liabilities of Daimler Benz were transferred to Daimler Chrysler. One of these assets was the shareholding in the assessee company.
In view of these facts, there was a change in shareholding pattern of the assessee company as the shares held by Daimler Benz were transferred to Daimler Chrysler. Daimler Chrysler was not listed on any recognized stock exchange in India; and the assessee was prima facie not a “company in which public are substantially interested”. Therefore, the Revenue sought to apply the provisions of Section 79 to prevent the assessee from carrying forward and setting off its previous losses.
The assessee claimed that the provisions of Section 79 could not be validly invoked in view of the Indo-German DTAA. In particular, the contention of the assessee was that the invocation of Section 79 violated the “non-discrimination” clause in the DTAA. The contention was, effectively, that the subsidiaries of a foreign company were being discriminated against vis-à-vis the subsidiaries of an Indian company; and this resulted in the non-discrimination provisions of the DTAA being violated.
The relevant provision of the DTAA was Article 24, which read in the relevant parts as follows:
1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any other requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State … are or may be subjected…
…
4. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any other requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned state are or may be subjected…
(Clause 1 is typically known as a “nationality-based non-discrimination clause; while clause 4 is typically known as an ‘ownership-based non-discrimination clause”)
The issue turned on what “other similar enterprise” in Article 24(4) would mean. In determining whether Article 24(4) was violated or not, the Revenue contended that the Tribunal should compare the treatment accorded to the subsidiary of a foreign company with the subsidiaries of another foreign company. They cannot be compared with subsidiaries of a domestic company. In assessing whether any discrimination had occurred, against what class of companies was the assessee to be compared? Vis-à-vis any subsidiary of any foreign company, the assessee had suffered no discrimination. The claim of discrimination was sustainable only if a subsidiary of a foreign company was compared with a subsidiary of a domestic company (which would not be affected by Section 79).
The Tribunal surveyed the case-law on the point from different jurisdictions. American, German and French Courts had taken the position that to determine whether or not there has been any discrimination, what needs to be examined is the “differentiation in treatment of a company which was a subsidiary of a foreign company vis-à-vis a company which is a subsidiary of a domestic company…” On the other hand, a House of Lords judgment in Boake Alleen Ltd. v. HM Revenue (available here) supported the case of the Revenue.
The Tribunal analysed the House of Lords judgment in great depth, and came to the conclusion that the judgment was inaccurate. The House of Lords had assumed incorrectly that an ownership-based non-discrimination clause [Article 24(4)] was conceptually similar to a nationality-based non-discrimination clause [Article 24(1)]. A nationality-based non-discrimination clause seeks to ensure that no discrimination takes place on account of the nationality of a taxpayer in a host country. On the other hand, an ownership-based non-discrimination clause seeks to ensure that the investment of foreign capital is not made disadvantageous to the entity in which the capital is so invested. This rationale of the ownership-based non-discrimination clause would be defeated unless a comparison was made between a subsidiary of a foreign company vis-à-vis a subsidiary of a domestic company. The Tribunal therefore disagreed with the House of Lords, and cited with approval the following passage by an eminent expert, Kees van Raad, with approval:
The qualification “other similar” is not remarkably precise. In view of the fact that the subject of discrimination is a foreign controlled enterprise, it would be obvious to interpret the term “other” in description of the enterprise to which is must be compared, as referring to control by local residents…”
In view of this, the Tribunal rejected the contention of the Revenue. Therefore, according to the Indo-German DTAA, the rigour of Section 79 could not be applied to the assessee in the case. The carefully reasoned decision indicates that within the DTAA regime, foreign-owned subsidiaries must be treated on par with Indian-owned subsidiaries.