Tax Treaty not to be affected by retroactive amendments: rules Delhi High Court
In Director of Income Tax v. New Skies Satellite BV and Anr.1 the Delhi High Court held that payments made in consideration for lease of transponder capacity would not be royalties under the India – Thailand Tax Treaty (“Thailand Treaty”) and the India – Netherlands Tax Treaty (“Dutch Treaty”), notwithstanding an amendment to the definition of royalty2 under the ITA (“Amendment”). The Amendment sought to clarify that royalty payments would include, among others, payments for data transmission services provided by satellites. The court held that amendments made to the Income Tax Act, 1961 (“ITA”) cannot be extended to a Double Taxation Avoidance Agreement (“tax treaty”) between India and another nation and consequently, although ITA was amended, tax payers were entitled to claim beneficial treatment under the tax treaty by virtue of Section 90 of the ITA.
The court, without expressing an opinion on whether the Amendment would apply retrospectively, has rightly held that an amendment to a domestic statute cannot unilaterally be deemed to amend an international treaty as doing so would be in violation of certain fundamental principles of public international law.3 The court has also provided clarity on the nature of services in relation to transponder hire charges holding that payments in consideration of the same does not amount to royalty under the Dutch Treaty and the Thailand Treaty.
The background of the case pertains to two separate taxpayers – Shin Satellite Public Co. Ltd. (“SSPCL”) and New Skies Satellite BV (“NSSBV”) (both parties collectively, “Taxpayers”). SSPCL is a company incorporated in Thailand whereas NSSBV is a company incorporated in Netherlands. Both are engaged in the business of providing ‘digital broadcasting services’ and derive income from the lease of transponders of their respective satellites. The transponder capacity of the Taxpayers is hired by resident and non-resident TV channels who pay fees to the Taxpayers for the service provided.
Lease of Transponder – How the process works
The customers of Taxpayers are resident and non-resident TV channels that uplink their signals to the satellite. The satellite receives the content, amplifies it, changes its frequency by undertaking certain processes, and then downlinks it, scattering the signal over its footprint area which includes India. The amplification and shifting of frequency of each signal within the satellite is conducted by an equipment within the satellite called the “transponder”. Finally, the cable operators within the footprint area receive the downlinked signal and relay it to the viewers in their homes. The satellite company merely provides access to the bandwidth of the transponder and the possession and control of the transponder remains with the satellite company.
Revenue sought to tax the respective incomes of the Taxpayers as royalty under the unamended Section 9(1)(vi) of the ITA for Assessment Years 2007-08 and 2008-09. By the time the Taxpayers’ appeals were heard before the Income Tax Appellate Tribunal (“ITAT”), the Delhi High Court pronounced its judgment in Asia Satellite Telecommunications Company Ltd. v. DIT4 (“Asia Satellite”) on an issue identical to the Taxpayers’ where it held that transponder services provided would not be royalty. Accordingly, in the appeals of Taxpayers the ITAT relied on Asia Satellite and held that the payments received by the Taxpayers were not royalties under the ITA and tax treaties. Subsequently, the definition of royalties under the ITA was purportedly amended retrospectively, in an effort to overturn the judgment in Asia Satellite. Based on the Amendment, the Revenue filed appeals before the Delhi High Court against the orders of ITAT, contending that the basis of the ITAT’s decisions had been undone.
Asia Satellite, Amendment to Finance Act / ITA and contentions of Parties
In Asia Satellite, the Delhi High Court held that receipts earned from providing data transmission services through the provision of transponder capacity on satellites do not constitute royalty within the meaning of Section 9(1)(vi) of the ITA. The High Court arrived at this conclusion based on the following rationale:
Consequent upon the decision in Asia Satellite, Parliament by way of Amendment inserted certain clarificatory explanations in Section 9(1)(vi) of the ITA through Finance Act, 2012. These explanations, materially, stated that:
While the Revenue contended that retrospective effect from April 1, 1977 ought to be given to the Amendment, it further contended that the Amendment would have the effect of amending the respective tax treaty as well. Revenue further contended that the ratio in Asia Satellite will not be applicable in light of the Amendment and therefore, the ruling of ITAT was liable to be set aside.
Taxpayers contended that even assuming that the Amendment was retrospective, it did not have the effect of amending the tax treaty itself. Consequently, Taxpayers were entitled to benefit under Section 90 of the ITA.
The court did not specifically rule on the nature of the Amendment – whether it was clarificatory in nature and whether it would be applicable retrospectively since Taxpayers did not press that line of argument and argued assuming the Amendment to be retrospective.
The Delhi High Court held that any amendment in the domestic law cannot be read into the corresponding provisions of a tax treaty, and that the royalty definition in the tax treaties refers to “secret process” and not merely “process”. Finally, the court held that the interpretation given to the term “royalty” in Asia Satellite before the Amendment will continue to apply to the definition under tax treaties irrespective of the Amendment under the ITA.
1. Treaty provisions are not affected by amendments in domestic law
The court held that an amendment to the ITA could not be read in a manner so as to extend its operation to a tax treaty, irrespective of whether the amendment was retrospective prospective or clarificatory.
2. Process must necessarily be “secret process”
ITA defines royalty as consideration for, inter alia:
“the use of any patent, invention, model, design, secret formula or process or trademark or similar property”
Tax treaties, including the Dutch Treaty and the Thai Treaty, generally define royalties as consideration for:
“use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience”(emphasis added)
The court noted that in the tax treaty definitions, the term “process” was followed by a comma, which was not the case of the definition under the ITA. The court held that the test for interpretation of punctuation would be the legal consequences of the same and not whether it made grammatical sense. Where the presence or absence of a punctuation give rise to large variations in taxing powers, as in the present case, it must be assumed that it was carefully punctuated. Hence, the comma which follows the word “process” clearly indicated that “process” was qualified by the term “secret”. The court noted that even the OECD commentary construes the term as “secret process” and held that India’s change in position to OECD commentary would not affect interpretation of a tax treaty.
In conclusion, the court held that since the definition under the tax treaties would apply, the ruling in Asia Satellite would be applicable and consequently, income from data transmission services would not be royalty.
This is an admirable judgment by the Delhi High Court where it has cleared many ambiguities relating to tax treaty interpretation vis-à-vis amendments to the ITA. The Delhi High Court in DIT v. Nokia Networks had previously held, in the context of amendments to the ITA which included payments for use of “copyrighted article” within the definition of royalty, that the same cannot override beneficial provisions of a tax treaty. However, the present case is a landmark judgment in respect of transponder hire charges since it clarifies the nature of such services after the Amendment. This should be seen as a welcome development by the media and telecommunication industry. The court specifically did not rule on whether the amendment was retrospective or clarificatory – it would therefore be open to a tax payer in an appropriate case to contend that Amendment is in fact not retrospective.
The Amendment was one of the many draconian aspects of Finance Act, 2012 which demonstrated an attempt to re-characterise the nature of receipt through amendments ostensibly in order to achieve fiscal objectives. The recommendations of the Expert Committee8 on retrospective amendments relating to indirect transfers set up by the Prime Minister in 2012 stated that retrospective amendments to tax law should occur in exceptional or rarest of rare cases, such as (a) to correct apparent mistakes/anomalies in the statute; (b) to remove technical defects in procedure which vitiate the substantive law; (c) to protect the tax base from highly abusive tax planning schemes – but not to “expand” the tax base. It may therefore be contended that the Amendment is not merely clarificatory in nature since it significantly expands the scope of the definition.
Finally, the court reinforced the importance of internationally accepted interpretation of terms employed in the treaty as laid down in the OECD commentary. It held that the interpretation of the OECD commentary must apply in reading the term “process” in a tax treaty as “secret process”, irrespective of the fact that Indian Parliament has chosen to place no relevance to the term “secret” in construing “process” under the ITA. Any shift from an internationally accepted construction of a tax treaty can only be made by a bilateral amendment in the treaty terms as opposed to a unilateral amendment in the ITA. The court also underscored principles of interpretation of international treaties and has emphasised that international treaties cannot be amended by one state party amending a domestic statute. Tax Authorities failed to appreciate that a similar argument could be raised by foreign tax authorities against tax payers in India. Such interpretation, apart from being contrary to fundamental principles of treaty interpretation, is capable of frustrating cooperation among nations and could lead to more hardship to tax payers in India.
Recent Developments – Union Budget, Finance Bill, 2016
The current Government has been quite vocal about its agenda to curb the menace of retrospective taxation and has assured taxpayers that no new action would be taken based on a retrospective amendment. It has introduced a Direct Tax Dispute Resolution Scheme9 (“Settlement Scheme”) in the recent Finance Bill, 2016 to tackle pending disputes arising out of retrospective amendments. The Settlement Scheme provides for a one time alternative for the taxpayer to settle such disputes by paying the disputed tax amount (without having to pay the interest and penalty), and withdrawing any pending litigation including any appeal, writ, or arbitration under Bilateral Investment Treaties. The scheme is however one-sided and only contemplates settlement by tax-payer through payment of the entire disputed tax amount, and does not provide for withdrawal of appeals filed by Department.
1 ITA Nos. 473 of 2012, 474 of 2012, 500 of 2012 and 244 of 2014
2 Section 9(1)(vi) of the ITA
3 Pacta sunt servanda
4  197 Taxman 263 (Delhi)
5 (2003) 263 ITR 706 (SC)
6 (2013) 354 ITR 316 (AP)
7 2013 (358) ITR 259
8 Accordingly, the committee opined that the retrospective amendments relating to indirect transfer were not clarificatory in nature, and ought be applied prospectively;
9 Direct Tax Dispute Resolution Scheme, 2016, Cl. 198 to 202 of the Finance Bill, 2016