UNION OF INDIA AND ANR. v. AZADI BACHAO ANDOLAN AND ANR.

p. 266 Copy page pinpoint

A calculated on the chargeable income of the person at the appropriate rate specified in the First Schedule. Section 5 defines as to when income is deemed to be derived. ·. Section 7 provides that the income specified in the Second Schedule shall be exempt from income-tax. B Part IV of the Mauritian Income Tax Act deals with Corporate Taxation.

Section 44 of the Act provides that every company shall be liable to income tax on its 'chargeable income' at the rate specified in Part II, Part III or Part IV of the First Schedule, as the case may be.

Section 51 defines the 'gross income' of a company as inclusive of income referred to in Sections IO(l)(b) (income derived from business), IO(l)(c) (any income from rent, premium or other income derived from property), IO(l)(d) (any dividend, interest, charges, annuity or pension other than a pension referred to in paragraph a(ii)) and IO(l)(e) (any other income derived from any other source).

Section 73 (b) provides that for the purposes of the Act the expression 'resident', when applied to a 'company', means a company which is incorporated in Mauritius or has its central management and control in Mauritius.

Part II of the First Schedule prescribes the rate of tax on chargeable income at 15% in the case of Tax Incentive companies and at other rates for other types of companies. Pait V of the First schedule enumerates the list of tax incentive companies and item 16 is : "a corporation certified to be engaged in international business activity by the Mauritius Offshore Business Activities Authority established under the Mauritius Offshore Business Activities Act, 1992". The second Schedule to the Mauritius Income-tax Act in Part IV enumerates miscellaneous income exempt from income-tax. Item I reads "gains or profits derived from the sale of units or of securities quoted on the Official List or on such Stock Exchanges or other exchanges and capital markets as may be approved by the Minister".

A perusal of the aforesaid provisions of the Income Tax Act in H Mauritius does not lead to the result that tax incentive companies are not

U.0.1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.] 267

liable to taxation, although they have been granted exemption from A inc6me-tax in respect of a specified head of income, namely, gains from transactions in shares an-d securities. The respondents contend that the Flis are not "liable to taxation" in Mauritius; hence they are not 'residents' of Mauritius within the meaning of Article 4 of the DTAC. Consequently, it is open to the assessing officers under the Indian Income-tax Act, 1961 to determine where the taxable entities are really resident by investigating the centre of their management and thereafter to apply the provisions of Income-tax Act, 1961 to the global income earned by them by reason of Sections 4 and 5 of the Income-tax Act, 1961.

It is urged by the learned Attorney General and Shri Salve for the appellants that the phrase 'liable to taxation' is not the same as 'pays tax'. The test of liability for taxation is not to be determined on the basis of an exemption granted in respect of any particular source of income, but by taking into consideration the totality of the provisions of the income-tax law that prevails in either of the Contracting States28 • Merely because, at D a given time, there may be an exemption from income-tax in respect of any particular head of income, it cannot be contended that the taxable entity is not liable to taxation. They urge that upon a proper construction of the provisions of Mauritian Income Tax Act it is clear that the Flis incorporated under Mauritius laws are liable to taxation; therefore, they are 'residents' E - in Mauritius within the meaning of the DTAC.

For the appellants reliance is placed on the judgment of this Court in Wallace Flour Mills Contracting State. Ltd. v. Collector of Central Excise, Bombay Division II 29, a case under the Central Excise Act. This Court held that though the taxable event for levy of excise duty is the manufacture or production, the realisation of the duty my be postponed for administrative convenience to the date of removal of the goods from the factory. It was held that excisable goods do not become non-excisable merely because of an exemption given under a notification. The exemption merely prevents the excise authorities from collecting tax when the exemption is in operation 30 •

28Copy pinpoint28. See in this connection Ramanathan Chettiar v. Commissioner of Income Tax, Madras. (1973] 88 ITR 169.

29Copy pinpoint29. [19891 4 sec 592.

30Copy pinpoint30. See also in this connection the judgment of Madras High Court in Tamil Nadu (Madras State), Handloom Weavers Contracting State-operative Society ltd. v. Assistant H Collector of Central Excise 1978 EL T 57 (Mad HC).

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A In Kasinka Trading and Another v. Union ofIndia and Another31, this principle was reiterated in connection with an exemption under the Customs Act. This Court observed : "The exemption notification issued under Section 25 of the Act had the effect of suspending the collection of customs duty. It does not make items which are subject to levy of customs B duty etc. as items not leviable to such duty. Jt only suspends the levy and collection of customs duty, wholly or partially, and subject to such conditions as may be laid down in the notification by the Government in 'public interest'. Such an exemption by its very nature is susceptible of being revoked or modified or subjected to other conditions."

C We &re inclined to agree with the submission of the appellants that, merely because exemption has been granted in respect of taxability of a particular source of income, it cannot be postulated that the entity is not 'liable to tax' as contended by the respondents.

D Effect of MOBA, 1992

The respondents, shifted ground to contend that the fact that a company incorporated in Mauritius is liable to ta:xation under the Income Tax Act there may be true only in respect of certain class of companies incorporated there. However, with respect to companies which are E incorporated within the meaning of the Mauritius Offshore Business Activities Act, 1992 (hereinafter referred to as "MOBA''), this would be wholly incorrect.

MOBA was enacted "to provide for the establishment and management . of the MOBA Authority to regulate offshore business activities from within F Mauritius and for the issue of offshore certificates, and to provide for other ancillary or incidental matters", as its preamble suggests. 'Offshore business activity' is defined as the business or other activity referred to in Section 33 and includes activity conducted by an international company. 'Offshore company' is defined as a corporation in relation to which there G is a valid certificate and which carries on offshore business activity.

In part II, MOBA establishes an Offshore Business Activity Authority entrusted, inter a/ia, with the duty of overseeing offshore business activities and also issuing permits, licences or any other certificate as may

31Copy pinpoint31. [I995J 1 sec 274.

U.0.1. v. AZADI BACHAO ANDOLAN [SRlKRISHNA, J.] 269

be required, and other authorisation which may be required by an offshore company through which they may communicate with any of the public sector companies.

Section 16 of MOBA prescribes the procedure for issuing of a certificate. Section 15 requires maintenance of confidentiality and non- disclosure of information contained in applications and documents filed with it except where such information is bona fide required for the purpose of any enquiry or trial into or relating to the trafficking of narcotics and dangerous drugs, arms, trafficking or money laundering under the Economic Crime and Anti Money Laundering Act, 2000. Part II of MOBA contains the statutory provisions applicable to offshore companies. Section 26 C provides that an offshore company shall not hold immovable property in Mauritius and shall not hold any share or any interest in any company incorporated under the Companies Act, 1984, other than in a foreign company or in another offshore company or in an offshore trust_ or an international company. An offshore company shall not hold any ac_count D in a domestic bank in Mauritian Rupees, except for the purpose of its day to day transactions arising from its ordinary operations in Mauritius.

Sections 26 and 27 of MOBA are important and read as under:

"26. Property of an offshore company E (I) Subject to sub-section(2), an offshore company shall not hold -

(a) immovable property in Mauritius; F (b) any share, or any interest in any company incorporated under the Comranies Act, 1984 other than in a foreign company or in another offshore company or m an offshore trust or an international company; G (c) any account in a domestic bank in Mauritian Rupee.

(2) An offshore company may -

(a) open and maintain with a domestic bank an account in Mauritian rupees for the purpose of its day to day H

p. 270 Copy page pinpoint

A transactions arising from its ordinary operations in Mauritius;

(b) open and maintain with a domestic bank an account in foreign currencies ·with the approval of the Bank of Mauritius; B (c) where authorised by the terms of its certificate, or where otherwise permitted under any other enactment, lease, hold, acquire or dispose of an immovable property ~r .any interest in immovable property situated in Mauritius; c ( d) invest in any securities listed in the stock Exchange established under the Stock Exchange Act 1988 and in other debentures.

27. Dealings with residents D Notwithstanding any other enactment, the Minister, on the recommendation of the Authority may authorise any offshore company engaged in any offshore business activities to deal or transact with residents on such tenns and conditions as it thinks fit." E On the basis of these provisions, it is urged by the respondents that any company which is registered as an offshore company under MOBA can hardly carry out any business activity in Mauritius, since it cannot hold any immovable property or any shares or interest in any company F registered in Mauritius other than a foreign company or another offshore company and cannot open an account in a domestic bank in Mauritius. The respondents urge that such a company cannot transact any business whatsoever within Mauritius as the purpose of such a company would be to-carry out offshore business activities and nothing more. The respondents contend that when the possibility of such a company earning income within G Mauritius is almost nil, there is hardly any possibility of its paying tax in Mauritius, whatever be the provisions of the Mauritian Income-Tax Act.

In our view, the contention of the respondents proceeds on the fallacious premise that liability to taxation is the same as payment of tax. H Liability to taxation is a legal situation; payment of tax is a fiscal fact. For

U.0.1. v. AZADl BACHAO ANDOLAN (SRIKRISHNA, J.] 271

the purpose of application of Article 4 of the DTAC, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. If this were not so, the DTAC would not have used the words 'liable to taxation', but would have used some appropriate words like 'pays tax'. On the language of the DTAC, it is not possible to accept the contention of the respondents that offshore companies incorporated and registered under MOBA are not 'liable to taxation' under the Mauritius Income-tax Act; nor is it possible to accept the contention that such companies would not be 'resident' in Mauritius within the meaning of Article 3 read with Article 4 of the OTAC.

There is a further reason in support of our view. The expression C 'liable to taxation' has been adopted from the Organisation for Economic Co-operation and Development Council (OECD) Model Convention 1977. The OECD commentary on article 4, defining 'resident', says: "Conventions for the avoidance of double taxation do not normally concern themselves with the domestic laws of the Contracting States laying down the conditions D under which a person is to be treated fiscally as "resident" and, consequently, is fully liable to tax in that State". The expression used is 'liable to tax therein', by reasons of various factors. This definition has been carried over even in Article 4 dealing with 'resident' in the OECD Model Convention 1992. E In A Manual on the OECD Model Tax Convention on Income and On Capital, at paragraph 4B.05, while commenting on Article 4 of the OECD Double Tax Convention, Philip Baker points out that the phrase 'liable to tax' used in the first sentence of Article 4.1 of the Model Convention has raised a number of issues, and observes: F "It seems clear that a person does not have to be actually paying tax'1o be "liabl~ to tax"- otherwise a person who had deductible losses or all@wances, which reduced his tax bill to zero would find himself unabltt to enjoy the benefits of the convention. It also seems ckar th:Jt a person who would otherwise be subject to G comprehensive. taxing but who enjoys a specific exemption from tax is nevertheless liable to tax, if the exemption were repealed, or the person no longer qualified for the exemption, the person would be liable to comprehensive taxation."

Interestingiy, Baker refers to the decision of the Indian Authority for H

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A Advance Ruling in Mohsinally Alimohammed Rajik. 32 An assessee, who ' resided in Dubai and claimed the benefits of UAE~India Convention of April 29, 1992, even though there was no personal income-tax iri Di.Ibai to which he might be liable. The Authority concluded that he was entitled to the benefits of the convention. The Authority subsequently reversed this B position iri the case of Cyril Eugene Pereira33 where a contrary view was taken.

The respondents placed great reliance on the decision by the Authority for Advance Rulings constituted under Section 245-0 of the Income-Tax Act, 1961 in Cyril Eugene Pereira 's case 34 • Section 245S of the Act C provides that the Advance Ruling pronounce? by the Authority under Section 245R shall be binding only :

"(a) on the applicant who had sought it;

(b) in respect of the transaction in relation to which the ruling had D been sought; and

( c) on the Commissioner, and the income-tax authorities subordinate to him, in respect of the applicant and the said transaction."

E It is therefore obvious that, apart from whatever its persuasive value, it would be of no help to us. Having perused the order of the Advance Rulings Authority, we regret that we are not persuaded.

There is substance in the contention of Mr. Salve learned counsel for one of the appellants, that the expression 'resident' is employed in the DTAC as a term of limitation, for otherwise a person who may not be 'liable to tax' in a Contracting State by reason of domicile, residence, place of management or any other criterion of a similar nature may also claim the benefit of the DTAC. Since the purpose of the DTAC is to eliminate double taxation, the treaty takes into account only persons who are 'liable to taxation' in the Contracting States. Consequently, the benefits thereunder are not available to persons who are not liable to taxation and the words 'liable to taxation' are intended to act as words of limitation.

32Copy pinpoint32. [1994) 213 !TR 317.

33Copy pinpoint33. [1999) 239 !TR 650.

34Copy pinpoint34. Ibid.

U.O.I. v. AZAD! BACHAO ANDOLAN [SRIKRISHNA, J.] 273

In John N. Gladden v. Her Majesty the Queen35, at the principle of liberal interpretation of tax treaties was reiterated by the Federal Court, which observed :

"Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of the parti~s. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated insofar as the particular item under consideration is concerned."

Gladden36 was a case where an American citizen resident in U.S.A. C owned shares in two privately controlled Canadian companies. Upon his death, the question arose as to the capital gains which would arise as a result of the deemed disposition of the said shares. The Canadian Revenue took the position that there was a deemed disposition of the shares on the death of the tax payer and capital gains tax was chargeable on account of the deemed disposition. This view of the Revenue was upheld in appeal by the D ·Tax Court of Canada. Upon further appeal to the Federal Court it was held that capital gains were exempt from tax under the Canada-U.S.A. Tax Treaty as Canada had no capital gains tax when it entered the treaty and it could not unilaterally amend its legislation. The argument which prevailed with the trial court in this case was similar to the one which prevailed with the High Court in the matter before us. Interpreting .the relevant Article of the Double Taxation Avoidance Treaty the trial court held : "The parties could not have negotiated to avoid double taxation on a tax which did not exist in Canada". The Federal Court emphasised that in interpreting and applying treaties the Courts should be prepared to extend "a liberal and extended construction" to avoid an anomaly which a contrary construction would lead to. The Court recognized that "we cannot expect to find the same nicety or strict definition as in modem documents, such as deeds, or Acts of Parliament; it has never been the habit of those engaged in diplomacy to use legal accuracy but rather to adopt more liberal terms". G Interpreting the Article of the Treaty against avoidance of double taxation, the Federal Court said (at p.5):

35Copy pinpoint35. 85 D.T.C. 5188.

36Copy pinpoint36. Ibid. H

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A "The non-resident can benefit from the exemption regardless of whether or not he is taxable on that capital gain in his own country. If Canada or the U.S. were to abolish capital gains completely, while the other country did not, a resident of the country which had abolished capital gains would still be exempt from capital gains in the other country."' B The appellants rely on this judgment to contend that, irrespective of the exemption from income-tax on capital gains upon alienation of shares under the Mauritius Income-tax Act, the benefits of the DTAC would apply. c The appellants contend that, acceptance of the respondents' submission that double taxation avoidance is not permissible unless tax is paid in both countries is contrary to the intendment of Section 90. It is urged that clause (b) of sub-section(!) of Section 90 applies to a situation to grant relief D where income tax has been paid in both countries, but clause (b) deals with a situation of avoidance of double taxation of income. Inasmuch as Parliament has distinguished between the two situations, it is not open to a Court of law to interpret clause (b) of Section 90 sub-section(!) as if it were the same as the situation contemplated under clause (a).

E According to Klaus Vogel "Double-Taxation Convention establishes an independent mechanism to avoid double taxation through restriction of ., tax claims in areas where overlapping tax-claims are expected; or at least theoretically possible. In other words, the Contracting States mutually bind themselves not to levy taxes or to tax only to a limited extent in cases when the treaty reserves taxation for the other contracting States either entirely or in part. Contracting States are said to 'waive' tax claims or more illustratively to divide 'tax sources', the 'taxable objects', amongst themselves." Double taxation avoidance treaties were in vogue even from the time of the League ofNations. The experts appointed in the early 1920s by the League of Nations describe this method of classification of items and their assignments to the Contracting States. While the English lawyers called it 'classification and assignment rules', the German jurists called it 'the distributive rule' (Verteilungsnorm). To the extent that an exemption is agreed to, its effect is in principle independent of both whether the other contracting State imposes a tax in the situation to which the exemption applies, and of whether that State actually levies the tax. Commenting

U.0.1. v. AZAD! BACHAO ANDOLAN (SRIKRJSHNA, J.] 275

particularly on German Double Taxation Convention with the United A States, Vogel comments: "Thus, it is said that the treaty prevents not only 'current', but also merely ·potential' double taxation". Further, according to Vogel. "only in exceptional cases, and only when expressly agreed to by the parties, is exemption in one contracting State dependent upon whether the income or capital is taxable in the other contracting state, or B upon whether it is actually taxed there." 37

It is, therefore, not possible for us to accept the contentions so strenuously urged on behalf of the respondents that avoidance of double taxation can arise only when tax is actually paid in one of the Contracting &~s. C The decision of Federal Court of Australia in Commissioner of Taxation v. Lamesa Holdings 38 is illuminating. The issue before the Federal Court was whether a Netherlands company was liable to income-tax under the Australian Income Tax Act on profits from the sale of shares in an Australian company and whether such profits fell within Article 13 D (alienation of property) of the Netherlands-Australia Double Taxation Agreement, so as to be excluded from Article 7 (business profits) of that Agreement. One Leonard Green, a principal of Leonard Green and Associates a limited partnership established in the United States, became aware of a potential investment opportunity in Australia. A rim co Resources E and Mining Company NL ('Annico'), a company listed on the Australian Stock Exchange, which had a subsidiary called Armico Mining Pty. Limited engaged in gold mining activities, was the subject of a hostile takeover bid, at a price which Green was advised was Jess than the real value of the Armico. With this knowledge Green decided to mount a F takeover offer for the subsidiary company. Then followed a series of steps of formation of a number of companies with interlocking share holdings where each company owned 1005 shares of a different subsidiary company. Lamesa Holdings was one such intermediary company of which I 00% shares were held by Green Equity Investments Ltd. The share transactions brought about a profit to Lamesa Holdings which would be assessable to G tax under the Australian Income Tax Act. Lamesa, however, relied on the provisions of the Article 13(2) Of the Double Taxable Avoidance Convention ('DTAC') between Netherlands and Australia and claimed thafthe income

37Copy pinpoint37. See in this connection Klaus r·ogel. Double Taxation Convention. Pg.26-29 (3rd ed).

38Copy pinpoint38. (1997) 785 FCA. H

p. 276 Copy page pinpoint

A was not taxable in Australia by reason thereof. This income was wholly exempt from tax in Netherlands by reason of the Income Tax Law applicable therein. The Federal Court found that under Article 13(2) (a) (ii) of the OT AC shares in a company were treated as personalty, that since the place of incorporation of a company or the place of situs of a share B may be the subject of choice, the place of incorporation or the register upon which shares were registered would not form a particularly close connection with shares to ground the jurisdiction to tax share profits. It was held:

"It happens to be the case, because of unilateral relief granted by the law of the Netherlands, that no tax will be payable in the c Netherlands. That of itself can not affect the interpretation of the Agreement. If the relevant mining prope1ty had happened to be in the Netherlands so that the issue was between taxation there on Jhe one hand and taxation in Australia on the other, the situation would have been one where tax would clearly have been payable on the alienation of the shares in Australia without the D benefit of any exemption. Yet the Agreement must operate uniformly, whether the realty is in the Netherlands or in Australia."

In this view of the matter, it was held that there was no tax payable in Australia. E Chong v. Commissioner of Taxation 39 holds similarly. Australia and Malaysia have an agreement to avoid double taxation. An Australian resident was paid pension by Malaysian Government for services rendered to Malaysian Government while he was in service there. This pension was taxed in Malaysia and the issue was whether the right to tax Government F pensions under the Agreement could be exercised by the Australian Government and the effect of the domestic law on the agreement. Article 18 of the double taxation avoidance agreement provided that pension paid to a resident of a contracting State shall be taxable only in that State. Upon a proper construction of Article 18(2) of the Treaty it was held that pension G paid by Malaysia is taxable in Australia inasmuch as the said Article did not provide that Malaysia alone was to have the power to tax Government pension, nor did it restrict Australia from doing so. Rather it provided for the Contracting State paying the pension to have the power to tax the pension if it so desired and did not limit or restrict the taxing power of the l ,-

39Copy pinpoint39. (2000) FCA 635.

U.0.1. v. AZADI BACHAO ANDOLAN [SRJKRISHNA, J.] 277 other Contracting State in that respect. The Federal Court pointed out A "Whether one uses the language of allocation of power or the language of limitation of power, the result is the same; there is designated or agreed who shall have the right under the agreement to impose taxation in the particular area".

The Estate of Michel Hausmann v. Her Majesty The Queen 40 is B another Canadian judgment which throws light on the principle that the benefits of a double taxation agreement would be available even if the other contracting State in which a particular head of income is to be taxed, chooses not to impose tax on the same.

The central question in this case was whether the pension received c by Mr. Hausmann from the pension office of the Belgium Government was taxable in Canada. The facts indicated that there was no tax withheld at source in Belgium. The argument of the Canadian Tax Authority was that if Belgium was not going to tax the pension, Canada should. Otherwise, the unthinkable might occur and the amount might not be taxed by anyone. D This would be anathema. The facts indicated that the payment received by Mr. Hausmann fell below the prescribed threshold and therefore was not taxed in Belgium. The Canadian Court rejected the argument that if Belgium did not tax the payment, it must be taxed by the Canada as plainly wrong by relying on the terms of the treaty. On the basis of the material E available, the Federal Court came to the inference that in negotiating the Belgium treaty both Canada and Belgium unquestionably regarded pensions paid under their social security legislation, such as the CPP or the corresponding Belgian statutory scheme, to be taxable only in the ..:ountry from which they emanated and not the country ofresidence of the recipient. F Hence, it was held that the pension payments received by Mr. Hausmann from the office of Belgium were social security pension and such allowances could be taxable only in Belgium. The fact that Belgium did not choose to tax them was held to be totally irrelevant.

Mr. Salve contended that a profit made by sale of shares may not G invariably amount to capital gains, as for example if the shares were part of the trading assets of the company. If such be the case, the gains may amount to trading income of such a company. He also relied on the observations of this Court in Commissioner ofIncome Tax Nagpur v. Sutlej

40Copy pinpoint40. 1998 Can. Tax Ct.LEXIS 1140. H

p. 278 Copy page pinpoint

A Cotton Mills Supply Agency Limited. 41 • It is not necessary for us to go into this question as it would depend upon as to whether the shares are held by a company as an investment or as a trading asset. The possibility urged by the learned counsel certainly exists and cannot be ruled out without examination of facts.

B Treaty Shopping-ls it illegal ?

· The respondents vehemently urge that the offshore companies have been incorporated under the laws of Mauritius only as shell companies, which carry on no business therein, and are incorporated only with the C motive of taking undue advantage of the DTAC between India and Mauritius. They also urged that 'treaty shopping' is both unethical and illegal and amounts to a fraud on the treaty and that this Court must be astute to interdict all attempts at treaty shopping.

'Treaty shopping' is a graphic expression used to describe the act of D a resident of a third country taking advantage of a fiscal treaty between two Contracting States. According to Lord McNair, "provided that any necessary implementation by municipal law bas been carried out, there is nothing to prevent the nationals of "third States", in the absence of any expressed or implied provision to the contrary, from claiming the right or becoming subject to the obligation created by a treaty" 42 •

Reliance is also placed on the following observations of Lord McNair43 :

"that any necessary implementation by municipal law has been carried out, there is nothing to prevent the nationals of 'third States', in the absence of any express or implied provision to the contrary, from claiming the rights, or becoming subject to the obligations, created by a treaty; for instance, if an Anglo- American Convention provided that professors on the staff of the universities of each country were exempt from taxation in respect offees earned for lecturing in the other country, and any necessary changes in the tax laws were made, that privilege could be claimed by, or on behalf of, professors of those universities who were the

41Copy pinpoint41. [1975] 100 !TR 706.

42Copy pinpoint42. Lord McNair, The law of Treaties, Pg.336 (Oxford, at the Clarendan Press, 1961).

43Copy pinpoint43. Ibid.

U.0.1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.] 279

nationals of 'third States'." A It is urged by the learned counsel for the appellants, and rightly in our view, that if it was intended that a national of a third State should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect should have been incorporated therein. As a contrast, our attention was drawn to the Article 24 of the Indo-US Treaty on Avoidance of Double Taxation which specifically provides the limitations subject to which the benefits under the Treaty can be availed of. One of the limitations is that more than 50% of the beneficial interest, or in the case of a company more than 50% of the number of shares of each class of the company, be owned directly or indirectly by one or more individual residents of one of the contracting States. Article 24 of the Indo-U.S. DTAC is in marked contrast with the Inda-Mauritius DTAC. The appellants rightly contend that in the absence of a limitation clause, such as the one contained in Article 24 of the lndo-U.S. Treaty, there are no disabling or disentitling conditions under the Inda-Mauritius Treaty prohibiting the resident of a D third nation from deriving benefits thereunder. They also urge that motives with which the residents have been incorporated in Mauritius are wholly irrelevant and cannot in any way affect the legality of the transaction. They urge that there is nothing like equity in a fiscal statute. Either the statute applies proprio vigore or it does not. There is no question of applying a fiscal statute by intendment, if the expressed words do not apply. In our view, this contention of the appellants has merit and deserves acceptance. We shall have occasion to examine the argument based on motive a little later.

The decision of the Chancery Division in Re F.G. Films Ltd. 44 was pressed into service as an example of the mask of corporate entity being lifted and account be taken of what lies behind in order to prevent 'fraud'. This decision only emphasises the doctrine of piercing the veil of incorporation. There is no doubt that, where necessary, the Courts are empowered to lift the veil of incorporation while applying the domestic law. In the situation where the tenns of the DTAC have been made applicable by reason of Section 90 of the Income-Tax Act, 1961, even if they derogate from the provisions of the Income-tax Act, it is not possible to say that this principle of lifting the veil of incorporation should be applied by the court. As we have already emphasised, the whole purpose

44Copy pinpoint44. 53 (I) WLR 483 H

p. 280 Copy page pinpoint

A of the DT AC is to ensure that the benefits thereunder are available even if they are inconsistent with the provisions of the Indian Income-tax Act. In our view, therefore, the principle of piercing the veil of incorporation can hardly apply to a situation as the one before us.

The respondents banked on certain observations made in Oppenheim 's B International Law 45 • All that is stated therein is a reiteration of the general rule in municipal law that contractual obligations bind the parties to their contracts and not a third party to the contract. In international law also, it has been pointed out that the Vienna Convention on the Laws of Treaties , 1969 reaffirms the general rule that a treaty does not create either C obligations or rights for a third party state without its consent, based on the general principle pacta tertiis nee nocent nee prosunt. it is true that an international treaty between States A & B is neither intended to confer benefits nor impose obligations on the residents of State C, but, here we are not concerned with this question at all. The question posed for our - D consideration is: If the residents of State C qualify for a benefit under the treaty, can they be denied the benefit on some theoretical ground that 'treaty shopping' is unethical and illegal ? We find no support for this proposition in the passage cited from Oppenheim.

The respondents then relied on observations of Philip Baker46 regarding E a seminar at the IFI Barcelona in 1991, wherein a paper was presented on "Limitation of treaty benefits for companies" (treaty shopping). He points out that the Committee on Fiscal Affairs of the OECD in its report styled as "Conduit Companies Report 1987" recognised that a conduit company would generally be able to claim treaty benefits.

F There is elaborate discussion in Baker's treatise on the anti abuse provisions in the OECD model and the approach of different countries to the issue of 'treaty shopping'. True that several countries like the USA, Germany, Netherlands; Switze~Iand and United Kingdom have taken suitable steps, either by way of incorporation of appropriate provisions in G the international conventions as to double taxation avoidance, or by domestic legislation, to ensure that the benefits of a treaty/convention are not available to residents of a third State. Doubtless, the treatise by Philip Baker is an excellent guide as to how a state should modulate its laws or

45Copy pinpoint45. L. Oppenheim, Oppenheim's International Law, Article 626 (9th Ed.)

46Copy pinpoint46. Philips baker,Double Taxation Convention and International Law, Pg.91 ((1994) 2nd H Ed.)

U.0.1. v. AZAD! BACHAO ANDOLAN [SRIKRISHNA, J.] 281

incorporate suitable terms in tax conventions to which it is party so that A the possibility of a resident of a third State deriving benefits thereunder is totally eliminated. That may be an academic approach to the problem to say how the law should be. The maxim "Judicis estjus dicere, non dare" pithily expounds the duty of the Court. It is to decide what the law is, and apply it; not to make it. B Report of the working group on non-resident taxation

The respondents contend that anti-abuse provisions need not be incorporated in the treaty since it is assumed that the treaty would only be used for the benefit of the parties. C

They also strongly rely on the 'Report of the working group on Non- Resident Taxation' dated 3rd January, 2003. In Chapter 3, para 3.2 of the . report it is stated: D "3.2 Entitlement to avail DTAA benefit:

Presently a person is entitled to claim application of DTAA if he is 'liable to tax' in the other Contracting State. The scope of liability to tax is not defined. The term "liable to tax" should be defined to say that there should be tax laws in force in the other E State, which provides for taxation of such person, irrespective that such tax fully or partly exempts such persons from charge of tax on any income in any manner."

In para 3.3.1, after noticing the growing practice amongst certain entities, who are not residents of either of the two Contracting States, to try and avail of the beneficial provisions of the DTAAs and indulge in what is popularly known as 'treaty shopping', the report says :

"3.3.1 .... there is a need to incorporate suitable provisions in the chapter on interpretation ofDTAAs, to deal with treaty shopping, conduit companies and thin capitalization. These may be based on UN/OECD model or other best global practices."

In para 3.3.2, the working group recommended introduction of anti- abuse provisions in the domestic law. H

p. 282 Copy page pinpoint

A Finally, in paragraph 3.3.3 it is stated "The Working Group recommends that in future negotiations, provisions relating to anti-abuse/ limitation 'Of benefit may be incorporated in the DTAAs also."

We -are afraid that the weighty recommendations of the Working Group on Non-Resident Taxation are again about what the law ou_ght to B be, and a pointer to the Padiament and the Executive for incorporating suitable limitation provisions in the treaty itself or by domestic legislation. This per se does not render an attempt by resident of a third party to take advantage of the existing provisions of the DTAC illegal.

C J.P.C. Report

, Strong reliance is placed by the respondents on the report of the Joint Parliamentary Committee (hereinafter referred to as "JPC") on the Stock Market Scam and Matters Relating thereto which was presented in the Lok D Sabha and Rajya Sabha on December 19, 2002.

While considering the causes which led to the Stock Market scam, the JPC had occasion to consider the working of the Inda-Mauritius DTAC. It noticed that area-wise foreign direct investment inflow from Mauritius increased from 37.5 million Rupees in 1993 to 61672.8 million Rupees in E the year 2001. The CBDT had approached the Indian High Commissioner at Mauritius to take up the matter with the Mauritian authorities to ensure that benefit of the bilateral tax treaty were not allowed to be misused, by suitable amendment in Article 13 of the agreement. The Mauritian authorities, however, were of the view that, though the beneficiaries of such p capital funds domiciled in Mauritius may be residing in third countries, these funds had been invested in the Indian stock market in accordance with SEBI norms and regulations and that the Finance Minister of India had himself encouraged such Fiis as a channel for promoting capital flow to India in a meeting between himself and the Finance Minister of Mauritius. The Ministry of finance was willing to have regular joint G monitoring of the situation to avoid possible misuse of the tax treaty by unscrupulous elements. It was pointed out by the Mauritian authorities that DTAC between the two countries "had played a positive role in covering 'the higher cost of investing in what was then assessed as 'high risk security' and being decisive in making possible public offerings in U.S.A. and H Europe of funds investing in India". In the absence of such a facility, as

I U.0.1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.] 283

afforded by the Inda-Mauritius DTAC, the cost of raising such investment A would have been capital prohibitive. The JPC report points out that the negotiations between the Government of India and Government of Mauritius resulted in a situation in which the Mauritius Government felt that any change in the provisions of the DTAC would adversely affect the perception of potential investors and would prejudicially affect their financial interests. B The issue still appears to be the subject matter of negotiations between the two Governments, though no final decision has been taken thereupon. The JPC took notice of the facts that MOBA has since been repealed by Mauritius and Financial Services Development Act has been promulgated with effect from l.12.2001, which has to some extent removed the C drawback of MOBA, and led to greater transparency and facility for obtaining information under the DTAC, which was hitherto not available.

Taking notice of the facts, and the reluctance of the Government of Mauritius in ·the matter to renegotiate the terms of treaty, the Committee D recommended as under (vide para 12.205):

"The Committee find that though the exact amount ofrevenue loss due to the 'residency clause' of the treaty cannot be quantified, but taking into account the huge inflows/outflows, it could be assumed to be substantial. They therefore recommend that E Companies investing in Indian through Mauritius, should be required to file details of ownership with RBI and declare that all the Directors and effective management is in Mauritius. The Committee suggest that all the contentious issues should be resolved by the Government with the Government of Mauritius F urgently through dialogue."

In our view, the recommendations of the Working Group of the JPC are intended for Parliament to take appropriate action. The JPC might have noticed certain consequences, intended or unintended, flowing from the DTAC and has made appropriate recommendations. Based on them, it is G not possible .for us to say that the DTAC or the impugned circular are contrary to law, nor would it be possible to interfere with either of them on the basis of the report of the JPC.

Interpretation of Treaties H

284 SUPREME COURT REPORTS (2003] SU?P. 4 S.C.R.

A The principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation. While commenting on the interpretation of a treaty impo1ied into a municipal law, Francis Bennion observes:

"With indirect enactment, instead of the substantive legislation B taking the well-known form of an Act of Parliament, it has the form of a treaty. In other words the form and language found suitable for embodying an international agreement become, at the stroke of a pen, also the form and language of a municipal legislative instrument. It is rather like saying that, by Act of c Parliament, a woman shall be a man. Inconveniences may ensue. One inconvenience is that the interpreter is likely to be required to cope with disorganised composition instead of precision drafting. The drafting of treaties is notoriously sloppy usually for very good reason. To get agreement, politic uncertainty is calle.d for.

D .... .The interpretation of a treaty imported into municipal law by indirect enactment was described by Lord Wilberforce as being 'unconstrained by technical rules of English law, or by English legal precedent, but conducted on broad principles of general acceptation. This echoes the optimistic dictum of Lord Widgery E CJ that the words 'are to be given their general meaning, general to lawyer and layman alike ... the meaning of the diplomat rather than the lawyer." 47

An important principle which needs to be kept in mind in the interpretation of the provisions of an international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. Commenting on this aspect of the matter, David R. Davis in Principles of International Double Taxation Relief 48 , points out that the main function of a Double Taxation Avoidance Treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling to be taxed in both jurisdictions. It is observed (vide para 1.06):

47Copy pinpoint47. Francis Bennion, Statutory Interpretation, Pg. 461 [Butterworths, 1992 (2nd Ed.)].

48Copy pinpoint48. David R. Davis, Principles of International Double Taxation Relief, Pg.4 (London H Sweet & MaxwelL 1985).

U.0.I. v. AZAD! BACHAO ANDOLAN [SRIKRISHNA, J.] 285 "The benefits and detriments of a double tax treaty will probably only be truly reciprocal where the flow of trade and investment between treaty partners is generally in balance. Where this is not the case, the benefits of the treaty may be weighted more in favour of one treaty partner than the other, even though the provisions of the treaty are expressed in reciprocal terms. This has been identified as occurring in relation to tax treaties between developed and developing countries, where the flow of trade and investment is largely one way.

Because treaty negotiations are largely a bargaining process with each side seeking concessions from the other, the final agreement will often represent a number of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides."

And, finally, in paragraph 1.08: D "Apart from the allocation of tax between the treaty partners, tax treaties can also help to resolve problems and can obtain benefits which cannot be achieved unilaterally."

Based on these observations, counsel for the appellants contended that the preamble of the Indo-Mauritius DTAC recites that it is for the E "encouragement of mutual trade and investment" and this aspect of the matter cannot be lost sight of while interpreting the treaty.

Many developed countries tolerate or encourage treaty shopping, even if it is unintended, improper or unjustified, for other non-tax reasons, unless it leads to a significant loss of tax revenues. Moreover, several of them allow the use of their treaty network to attract foreign enterprises and offshore activities. Some of them favour treaty shopping for outbound investment to reduce the foreign taxes of their tax residents but dislike their own loss of tax revenues on inbound investment or trade of non-residents. In developing countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital or technology. They are able to grant tax concessions exclusively to foreign investors over and above the domestic tax law provisions. In this respect, it does not differ much from other similar tax incentives given by them, such as tax holidays, grants, etc. 49

49Copy pinpoint49. Roy Rcihtagi, Basic International Taxation! Pg.373-374 (Kluwer Law International). H

286 SUPREME COURT REPORTS {2003] SUPP. 4 S.C.R.

A Developing countries need foreign investments, and the treaty shopping opportunities can be an additional factor to attract them. The use of Cyprus as a treaty haven has helped capital inflows into eastern Europe. Madeira (Portugal) is attractive for investments into the European Union. Singapore is developing itself as a base for investments in South East Asia and China. B Mauritius today provides a suitable treaty conduit for South Asia and South Africa. In recent years, India has been the beneficiary of significant foreign funds through the "Mauritius conduit". Although the Indian economic reforms since 1991 permitted such capital transfers, the amount would have been much lower without the India-Mauritius tax treaty. 50

C Overall, countries need to take, and clo take, a holistic view. The developing countries allow treaty shopping to encourage capital and technology inflows, which developed countries ·are keen to provide to them. The loss of tax revenues could be insignificant compared to the other non-tax benefits to their economy: Many of them do not appear to be too concerned unless the revenue losses are significant compared to the other tax and non-tax benefits from the treaty, or the treaty shopping leads to other tax abuses. 51

There are many principles in fiscal economy which, though at first blush might appear to be evil, are tolerated in a developing economy, in the interest of long term development. Deficit financing, for example, is one; treaty shopping, in our view, is another. Despite the sound and fury of the respondents over the so called 'abuse' of 'treaty shopping', perhaps, it may have been intended at the time when Indo-Mauritius DTAC was entered into. Whether it should continue, and, if so, for how long, is a F matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations. This Court cannot judge the legality of treaty shopping merely because one Section of thought considers it improper. A holistic view has to be taken to adjudge what is perhaps regarded in contemporary thinking as a necessary evil in a G developing economy.

Rule in McDowell

The respondents strenuously criticized the act of incorporation by Flis

50Copy pinpoint50. Ibid. H Sl. Ibid.

U.O.I. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.] 287

under the Mauritian Act as a 'sham' and 'a device' actuated by improper motives. They contend that this Court should interdict such arrangements and, as if by waving a magic wand, bring about a situation where the incorporation becomes non est. For this they heavily rely on the judgment of the Constitution Bench of this Court in McDowell and Company Ltd. v. Commercial Tax Officer52 • Placing strong reliance on McDowel/53 it is argued that McDowel/54 has changed the concept of fiscal jurisprudence in this country and any tax planning which is intended to and results in avoidance of tax must be struck down by the Court. Considering the seminal nature of the contention, it is necessary to consider in some detail as to why McDowel/55 , what it says, and what it does not say. c In the classic words of Lord Sumner in IRC V Fisher's Executors56 •

"My Lords, the highest authorities have always recognised that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law, and that he may legitimately claim the advantage of any expressed terms or any omissions that he can find in his favour in taxing Acts. In so doing, he neither comes under liability nor incurs blame."

Similar views were expressed by Lord Tomlin in IRC v. Duke of E Westminster5 1 which reflected the prevalent attitude towards tax avoidance: --... '

"Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however, unappreciative the Commissioners oflnland F Revenue or :his fellow taxgatherers may be of his ingenuity, he cannot be compelled to pay an increased tax."

These were the pre second world war sentiments expressed by the British Courts. It is urged that McDowel/5 8 has taken a new look at fiscal G

52Copy pinpoint52. Supra note I.

53Copy pinpoint53. Ibid.

54Copy pinpoint54. Ibid.

55Copy pinpoint55. Ibid.

56Copy pinpoint56. (1926) AC 395 at 412.

57Copy pinpoint57. (1936) AC l; 19 TC 490.

58Copy pinpoint58. Supra note I. H

288 SUPREME COURT REPORTS (2003] SUPP. 4 S.C.R.

A jurisprudence and "the ghost of Fisherf'9 (supra) and Westminster"° have -· been exorcised in the country of its origin". It is also urged thatMcDowell's61 radical departure was in tune with the changed thinking on fiscal jurisprudence by the English Courts, as evidenced in WT. Ramsay Ltd v. IRC6 2, Inland Revenue Commissioners v. Burman Oil Company Ltd. 63 , and B Furniss v. Dawson64 •

As we shall show presently, far from being exorcised in its country of origin, Duke of Westminster6 5 continues to. be alive and kicking in England. Interestingly, even in McDowe//66 , though Chinnappa Reddy, J., dismissed the observation of J.C. Shah,J. in CIT v. A. Raman and C Compan;P based on Westminster6 8 and Fisher's Executors69 , by saying ·~we think that the time has come for us to depart from the Westminster principle as emphatically as the British courts have done and to dissociate ourselves from the observations of Shah J., and similar observations made elsewhere", it does not appear that the rest of the learned Judges :of ,the Constitutional Bench contributed to this radical thinking. Speaking for the majority, D Ranganath Mishra, 'J, (as he then was) says in McDowell70 : •

"Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges." (Emphasis supplied)

This opinion of the majority is a far cry from the view of p!iinnappa F Reddy, J. : "In our view the proper way to construe a ta}{ing statute, while considering a device to avoid tax, is not to ask whether a provision should be construed liberally or principally, nor whether the transaction is not

59Copy pinpoint59. Supra note 56.

60Copy pinpoint60. Supra note 57.

61Copy pinpoint61. Supra note I.

62Copy pinpoint62. (1982) AC 300.

63Copy pinpoint63. (1982) STC 30.

64Copy pinpoint64. [1984] I All ER 530.

65Copy pinpoint65. Supra note 57.

66Copy pinpoint66. Supra note I.

67Copy pinpoint67. [1968] 67 ITR 11.

68Copy pinpoint68. Supra note 57.

69Copy pinpoint69. Supra note 56.

70Copy pinpoint70. Supra note I at Pg. 171.

_, U.0.1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.] 289 ' unreal and not prohibited by the statute, but whether the transacti,on is a A device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it." We are afraid that we are unable to read or comprehend the majority judgment in McDowelf 1as having endorsed this extreme view of Chinnappa Reddy, J. which, in our considered opinion, actually militates against the observations of the majority of the Judges which we have just extracted from the leading judgment of Ranganath Mishra, J. (as he then was).

The basic assumption made in the judgment of Chinnappa Reddy,J. in McDowelf 2 that the principle in Duke of Westminster 73 has been departed - from subsequently by the House of Lords in England, with respect, is not correct. In Craven v. White 74 the House of Lords pointedly considered the impact of Furniss 75 , Burma Oif6 and Ramsay77 • The Law Lords were at great pains to explain away each of these judgments. Lord Keith of Kinkel says, with reference to the trilogy of these cases, (at p. 500):

"My Lords, in my opinion the nature of the principle to be derived from the three cases is this : the court must first construe the relevant enactment in order to ascertain its meaning; it must then analyse the series of transactions in question, regarded as a whole, so as to ascertain its true effect in law; and finally it must apply the enactment as construed to the true effect of the series of transactions and so decide whether or not the enactment was intended to cover it. The most important feature of the principle is that the series of transactions is to be regarded as a whole. In ascertaining the true legal effect of the series it is relevant to take into account, if it be the case, that all the steps in it were contractually agreed in advance or had been determined on in advance by a guiding will which was in a position, for all practical purposes, to secure that all of them were carried through to completion. It is also relevant to take into account, if it be the case, that one or more of the steps was introduced into the series with no business purpose other than the avoidance of tax. G

71Copy pinpoint71. Supra note I.

72Copy pinpoint72. Ibid.

73Copy pinpoint73. Supra note 57.

74Copy pinpoint74. [1988] 3 All ER 495.

75Copy pinpoint75. Supra not~ 64.

76Copy pinpoint76. Supra note 63.

77Copy pinpoint77. Supni note 62. H

290 SUPREME COURT REPORTS [2003] SUPP. 4 S.C.R.

,~- A The principle does not involve, in my opinion, that it is part of the judicial function to treat as nugatory any step whatever which a taxpayer may take with a view to the avoidance or mitigation or tax. It remains true in general that the taxpayer, where he is in a position to carry through a transaction in two alternative ways, one of which will result in liability to tax and B the other of which will not, is at liberty to choose the latter and to do so effectively in the absence of any specific tax avoidance provision such as s.460 of the Income and Corporation Taxes Act, 1970.

In Ramsay and in Burmah the result of application of the c principle was to demonstrate that the true legal effect of the series of transactions entered into, regarded as a whole, was precisely nil."

Lord Oliver (at p. 5 I 8- I 9) says: (

D "It is equally important to bear in mind what the case did not decide. It did not decide that a transaction entered into with the motive of minimising the subject's burden of tax is, for that reason, to be ignored or struck down. Lord Wilberforce Was at pains to stress that the fact that the motive for a transaction may be to avoid tax does not invalidate it unless a particular enactment so provides [see [1981] 1 All ER 865, (1982) AC 300 at 323]. ; Nor did it decide that the court is entitled, because of the subject's motive in entering into a genuine transaction, to attribute to it a legal effect which it did not have. Both Lord Wilberforce and Lord Fraser emphasise the continued validity and application of the principle of IRCv. Duke of Westminster, (1936) AC I (1935) All ER Rep. 259, a principle which Lord Wilberforce d~scribed as a 'cardinal principle'. What it did decide was that that cardinal principle does not, where it is plain that a particular transaction is but one step in a connected series of interdependent steps designed to produce a single composite overall result, compel the court to regard it as otherwise than what it is, that is to say merely a part of the composite whole."

Lord Oliver (at p.523) observes:

"My Lords, for my part I find myself unable to accept that H Dawson either established or can properly be used to support a

U.0.1. v. AZAD! BACHAO ANDOLAN [SRlKRISHNA, J.] 291 general proposition that any transaction which is effected for the A purpose of avoiding tax on a contemplated subsequent transaction and is therefore 'planned' is, for that reason, necessarily to be treated as one with that subsequent transaction and as having no independent effect even where that is realistically and logically impossible." B Continuing, (at page 524) Lord Oliver observes: •" a· "Essentially, Dawson was concerned with question which is common to all successive transactions where an actual transfer of property has taken place to a corporate entity which subsequently carries out a further disposition to an ultimate disponee. The question is : when is a disposal not a disposal within the terms of the statute ? To give to that question the answer 'when, on an analysis of the facts, it is seen in reality to be a different transaction altogether' is well within the accepted canons of construction. To answer it 'when it is effected with a view to avoiding tax on another contemplated transaction' is to do more than simply to place a gloss on the words of the statute. It is to add a limitation or qualification which the legislature itself has not sought to express and for which there is no context in the statute. That, however, desirable it may seem, is to legislate, not to construe, and that is something which is not within judicial competence. r can find nothing in Dawson or in the cases which preceded it which causes me to suppose that that was what this House, was seeking to do."

Thus we see that even in the year i 988 the House of Lords F emphasised the continued validity and application of the principle in Duke of Westminster 78

While Chinnappa Reddy, J. took the view that Ramsay79 was an authoritative rejection of principle in the Duke of Westminster8°, the House of Lords, in the year 200 I, does not seem to consider it to be so, as seen G from MacNiven (Inspector of Taxes) v. Westmoreland Investments ltd. 81 Lord Hoffmann observes:

78Copy pinpoint78. Supra note 57.

79Copy pinpoint79. Supra note 62.

80Copy pinpoint80. Supra note 57.

81Copy pinpoint81. [2001] I All ER 865 at 877-878. H

292 SUPREME COURT REPORTS [2003] SUPP. 4 S.C.R.

A "In the Ramsay case both Lord Wilberforce and Lord Fraser of Tullybelton, who gave the other principal speech, were careful to stress that the House was not departing from the principle in !RC v. Duke of Westminster, (1936) AC I, (1935) All ER Rep. 259. There has nevertheless been a good deal of discussion about how the two cases are to be reconciled. How, if the various juristically B discrete acquisitions. and disposals which made up the scheme were genuine, could the Hous_e collapse them into a composite self-cancelling trai:i~action witho~t being guilty of ignoring the legal position and l.ooking at t.he substance of the matter?

c My Lords,'! venture to' suggest thaf scime of the difficulty which may have been felt in reconciling the Ramsay case with the Duke of Westminster's case arises out of an ambiguity in Lord Tomlin's statement that the courts cannot ignore 'the legal position' and have regard to 'the substance of the matter'. If 'the legal position' is that the tax is imposed by reference to a legally defined concept, such as stamp duty payable on a document which constitutes a conveyanct: on sale, the court cannot tax a transaction which uses no such document on the ground that it achieves the same economic effect. On the other hand, if the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business 'substance' of the matter is not to ignore the legal position but to give effect to it.

The speeches in the Ramsay case and subsequent cases contain numerous references to the 'real' nature of the transaction and to what happens in 'the real world'. These expressions are illuminating in their context, but you have to be careful about the sense in which they are being used. Otherwise you land in all kinds of unnecessary philosophical difficulties about the nature of reality and, in particular, about how a transaction can be said not to be a 'sham' and yet be 'disregarded' for the purpose of deciding what happened in 'the real world'. The point to hold on to is that something may be real for one purpose but not for another. When people speak of something being a 'real' something, they mean that it falls within some concept which they have in mind, by contrast with something else which might have been thought to do so, but does not. When an economist says that real incomes have fallen, he is not intending to contrast real incomes with

U.0.1. v. AZADI BACHAO ANDOLAN [SRIKRISHNA. J.] 293

imaginary incomes. The contrast is specifically between incomes which have been adjusted for inflation and those which have not. In order to know what he means by 'real', one must first identify the concept (inflation adjustment) by reference to which he is using the word.

Thus in saying that the transactions in the Ramsay case were not sham transactions, one is accepting the juristic categorisation of the transactions as individual and discrete and saying that each of them involved no pretence. They were intended to do precisely what they purpotted to do. They had a legal reality. But in saying that they did not constitute a 'real' disposal giving rise to a 'real' C loss, one is rejecting the juristic categorisation as not being necessarily detenninative for the purposes of the statutory concepts of 'disposal' and 'loss' as properly interpreted. The contrast here is with a commercial meaning of these concepts. And in saying that the income tax legislation was intended to operate 'in the real world', one is again referring to the commercial context which D should influence the construction of the concepts used by Parliament."

With respect, therefore, we are unable to agree with the view that Duke of Westminster8 2 is dead, or that its ghost has been exorcised in E England. The House of Lords does not seem to think so, and we agree, with respect. In our view, the principle in Duke of Westminster83 is very much alive and kicking in the country of its birth. And as far as this country is concerned, the observations of Shah,J., in CIT v. Raman84 are ver" much relevant even today. F We may in this connection usefully refer to the judgment of the Madras High Court in M V. Vallipappan and Ors. v. JTG8 5, which has rightly concluded that the decision in McDowel/8 6 cannot be read as laying down that every attempt at tax planning is illegitimate and must be ignored, or that every transaction or arrangement which is perfectly permissible under law, which has the effect of reducing the tax burden of the assessee, G must be looked upon with disfavour. Though the Madras High Court had

82Copy pinpoint82. Supra note 57.

83Copy pinpoint83. Ibid.

84Copy pinpoint84. Supra note 67.

85Copy pinpoint85. (1988) 170 ITR 238.

86Copy pinpoint86. Supra note I. H

294 SUPREME COURT REPORTS [2003] SUPP. 4 S.C.R.

A occasion to refer to the judgment of the Privy Council in !RC v. Challenge Corporation Ltd. 87 and did not have the benefit of the House of Lords's :.: . pronouncement in Craven 88 , the view taken by the Madras High Court appears to be correct and we are inclined· to agree with it.

We may also refer 'to the judgment of Gujarat High Court in Banyan B and Beny v. Commissioner ofIncome-Tax 89 where referring to McDowe/!9°, the Court observed:

"The court nowhere said that every action or inaction on the part of the taxpayer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and c be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act; an inference which unfortunately, in our opinion, the Tribunal apparently appears to have drawn from the enunciation made in McDowell case (1985) 154 ITR 148 (SC). The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell's decision leave us in no doubt that the principle enunciated in the above ~ase has not affected the freedom of the citizen to .act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity."

This accords with our own view of the matter.

F In CWTv. Arvind Narottam 91 , a case under the Wealth Tax Act, three trust deeds for the benefit of the assessee, his wife and children in identical terms were prepared under Section 21(2) of the Wealth Tax Act. Revenue placed reliance on McDowell9 2 • Both the learned Judges of the Bench of this Court gave separate opinions. G Chief Justice Pathak, in his opinion said (at p. 486):

87Copy pinpoint87. [1987] 2 WLR 24.

88Copy pinpoint88. Supra note 74.

89Copy pinpoint89. (1996) 222 ITR 831 at 850.

90Copy pinpoint90. Supra note I.

91Copy pinpoint91. (1988) 173 ITR 479.

92Copy pinpoint92. Supra note I.

u.o.r. v. AZAD! BACHAO ANDOLAN [SRIKRISHNA. J.] 295

"Reliance was also placed by learned counsel for the Revenue on A McDowell and Company Ltd. v. CTO. (1985) 154 ITR 148 SC. That decision cannot advance the case of the Revenue because the language of the deeds of settlement is plain and admits of no ambiguity."

Justice S. Mukherjee said, after noticing McDowell's case, (at page B 487):

"Where the true effect on the construction of ~e deeds is clear, as in this case, the appeal to discourage tax avoidance is not a relevant consideration. But since it was made, it has to be noted and rejected." C In Mathuram Agrawal v. State of Madhya Pradesh 93 another Constitution Bench had occasion to consider the issue. The Bench observed:

"The intention of the legislature in a taxation statute is to be gathered from the language of the provisions particularly where D the language is plain and unambiguous. In a taxing Act it is not possible to assume any intention or governing purpose of the statute more than what is stated in the plain language. It is not the economic results sought to be obtained by making the provision which is relevant in interpreting a fiscal statute. Equally E impermissible is an interpretation which does not follow from the plain, unambiguous language of the statute. Words cannot be added to or substituted so as to give a meaning to the statute which will serve the spirit and intention of the legislature."

The Constitution Bench reiterated the observations in Bank of F Chettinad Ltd v. CIT94, quoting with approval the observations of Lord Russell of Killowen in !RC v. Duke of Westminster95 and the observations of Lord Simonds in Russell v. Scott96 •

It thus appears to us that not only is the principle in Duke of Westminster 91 alive and kicking in England, but it also seems to have G acquired judicial benediction of the Constitutional Bench in India,

93Copy pinpoint93. [1999] 8 sec 667 at para 12.

94Copy pinpoint94. (1940) 8 !TR 522 (PC).

95Copy pinpoint95. Supra note 57.

96Copy pinpoint96. [1948] 2 All ER 15.

97Copy pinpoint97. Supra note 57. H

296 SUPREME COURT REPORTS [2003] SUPP. 4 S.C.R.

A notwithstanding the temporary turbulence created in the wake of McDowel?.8 •

Hence, reliance on Furniss 99 , Ramsay'°0 and· Burmah 0;1io 1 by the respondents in support of their submission is of no avail.

The situation is no different in United States and other jurisdictions B too.

The situation in the United State is reflected in the following passage .,, from American Jurisprudence 102 :

"The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether to avoid them, by c means which the law permits, cannot be doubted. A tax-saving motivation does not justify the taxing authorities or the courts in nullifying or disregarding a taxpayer's otherwise proper and bona fide choice among courses of action, and the state cannot complain, when a taxpayer resorts to a legal method available to him to compute his tax liability, that the result is more beneficial to the taxpayer ·than was intended. It has even been said that it is common knowledge that not infrequently changes in the basic facts affecting liability to taxation are made for the purpose of avoiding taxation, but that where such changes are actual and not merely simulated, although made for the purpose of avoiding taxation, they do not constitute evasion of taxation. Thus, a man may chan~e his residence to avoid taxation, or change the form of his property by putting his money into non-taxable securities, or in the form of property which would be taxed less, and not be guilty of fraud. On the other hand, if a taxpayer at assessment time converts taxable property into non-taxable property for the purpose of avoiding taxation, without intending a permanent change, and shortly after the time for assessment has passed, reconverts the property to its original form, it is a discreditable evasion of the taxing laws, a fraud, and will not be sustained." G Several judgments of the US Courts were cited in respect of the proposition that motive of fax avoidance is irrelevant in consideration

98Copy pinpoint98. Supra note 1.

99Copy pinpoint99. Supra note 64.

100Copy pinpoint100. Supra note 62. IOI. Supra.note 63.

102Copy pinpoint102. American Jurisp.rudence (1973 2nd Ed. Vol.71).

U.O.I. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.] 297

of the legal efficacy of a transactional· situation. 103 A We may recapitulate the observations of the Federal Court in Johanssonw 4 as to the irrelevance of the motive for Johansson. To similar effect are the observations of the US Court in Peny R. Bas v. Commissioner of Internal Revenue 105 : B "we infer that Stantus was created by petitioners with a view to reducing their taxes through qualification of the corporation under the convention. The test, however, is not the personal purpose of a taxpayer in creating a corporation. Rather, it is whether that • purpose is intended to be accomplished through a corporation carrying out substantive business functions. If the purpose of the C corporation is to carry out substantive business functions, or if it in fact engages in substantive business activity, it will not be disregarded for Federal tax purposes."

In Barber-Greene Americas, Inc. v. Commissioner of Internal D Revenue 106 it was observed that a corporation will not be denied Western Hemisphere trade corporation tax benefits merely because it was purposely created and operated in such way as to obtain such benefits. Similarly, a corporation otherwise qualified should not be disregarded merely because it was purposely created and operated to obtain the benefits of the United States-Swiss Confederation Income Tax Convention. E Though the words 'sham', and 'device' were loosely used in connection with the incorporation under the Mauritius Jaw, we deem it fit to enter a caveat here. These words are not intended to be used as magic mantras or catchall phrases to defeat or nullify the effect of a legal situation. As Lord F Atkin pointed out in Duke of Westminster 107 :

"I do not use the word device in any sinister sense; for it has to be recognised that the subject, whether poor and humble or wealthy and noble, has the legal right so to dispose of his capital and income as to attract upon himself the least amount of tax. The G

103Copy pinpoint103. See in this connection Grego1y v. Helvering 293 US465, 469 55 S.Ct. 226, 267, 7S; L.ed.566, 97 ALR 1335; Helvering v. St. Louis Tnist Company 296 US 48, 56 S. Ct. 7S, SOL; Becker v. St.Louis Union Trust Company 296 US 4S, 56 S.Ct. 7S, SOL.

104Copy pinpoint104. Supra note 27.

105Copy pinpoint105. (196S) US 50 TC 595.

106Copy pinpoint106. (1960) 35 T.C. 365, 3S3, 384.

107Copy pinpoint107. Supra note 57. H

298 SUPREME COURT REPORTS (2003) SUPP. 4 S.C.R.

A only function of a court of law is to determine the legal result of his dispositions so far as they affect tax."

Lord Tomlin said :

"There may, of course, be cases where documents are not bona B fide nor intended to be acted upon, but are only used as a cloak to conceal a different transaction."

In Snook v. London and West Riding Investments Ltd. 108 Lord Diplock L.J., explained the use of the word 'sham' as a legal concept in the following words: c "it is, I think, necessary to consider what; if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the 'sham' which are intended by them to give to third parties or to the court the D appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Contracting State. v. Maclure, E (1882) 21 Ch.D.309; Stoneleigh Finance, Ltd. v. Phillips, (1965) l All ER 5 l 3 that for acts or documents to be a "sham'', with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a F "shammer" affect the rights of a party whom he deceived."

In Waman Rao and Ors. v. Union of India & Ors. 109 and Minerva . Mills Ltd. and Ors. v. Union of India and Ors. 110 this Court considered the import of the word "device' with reference to Article 3 IB which G provided that the Acts and Regulations specified Ninth Schedule shall not be deemed to be void or even to have become void on the ground that they are inconsistent with the Fundamental Rights. The use 6fthe word 'device' here was not pejorative, but to describe a provision of law intended to

108Copy pinpoint108. [1967) All ER 518 at 528.

109Copy pinpoint109. [1981) 2 sec 362 at para 45.

110Copy pinpoint110. [1980] 3 sec 625 at para 91.

_U:O.I. v. AZADI BACHAO ANDOLAN [SRIKRISHNA, J.] 299

produce a certain legal result. • A If the Court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the Court might be justified in overlooking the intennediate steps, but it would not be permissible for the Court to treat the intervening legal steps as non~est based upon some hypothetical assessment of the 'real motive' of the B assessee. In our view, the court must deal with what is tangible in an objective manner and cannot afford to chase a will-o'-the-wisp.

The judgment of the Privy Council in Bank of Chettinadm, wholeheartedly approving the dicta in the passage from the opinion of Lord Russel in Westminster 112 , was the law in this country when the Constitution C came into force. This was the law in force then, which continued by reason of Article 372. Unless abrogated by an Act of Parliament, or by a clear pronouncement of this Court, we think that this legal principle would continue to hold good. Having anxiously scanned McDowell113 , we find no reference therein to having dissented from or overruled the decision of the D Privy Council in Bank of Chettinad1 14 • If any, the principle appears to have been reiterated with approval by the Constitutional Bench of this Court in Mathuram 115 • We are, therefore, unable to accept the contention of the respondents that there has been a very drastic change in the fiscal jurisprudence, in India, as would entail a departure. In our judgment, from E Westminster116 to Bank of Chettinad1 17 to Mathuram 118 , despite the hiccups of McDowel/ 119 , the law has remained the same.

We are unable to agree with the submission that an act which is otherwise valid in law can be treated as non-est merely on the basis of some underlying motive supposedly resulting in some economic detriment or F prejudice to the national interests, as perceived by the respondents.

In the result, we are of the view that Delhi High Court erred on all counts in quashing the impugned circular. The judgment under appeal is

111Copy pinpoint111. Supra note 94. ll2. Supra note 57. G

113Copy pinpoint113. Supra note I

114Copy pinpoint114. Supra note 94.

115Copy pinpoint115. Supra note 93.

116Copy pinpoint116. Supra note 57.

117Copy pinpoint117. Supra note 94.

118Copy pinpoint118. Supra note 93.

119Copy pinpoint119. Supra note I. H

300 SUPREME COURT REPORTS [2003] SUPP. 4 S.C.R.

A•. set aside and it is held and declared that the circular No. 789 dated 13.4.2000 is valid and efficacious.

We cannot part with this judgment without expressing our grateful appreciation to the Learned Attorney General, Mr. Harish Salve, Mr. Prashant Bhushan as also the pa1ty in person, Mr. S.K. Jha, all of whom B by their industrious research produced a wealth of material and by their meticulous arguments rendered immense assistance.

B.S. Appeals allowed.