The bigger aspect is the Supervisory Committee’s analytical breakdown of the Income Tax Act to highlight that it is not a charitable act for a benefit to be extended under the tax treaty. Instead, the law should give priority to tax treaties.
By Mukesh Butani and Tarun Jain
Whether the license to use computer software is a transfer of copyright was the central question before the Supreme Court in the technical analysis case and a series of over 80 appeals decided on March 2nd. The question arose with a view to the Karnataka Supreme Court ruling in the affirmative, thereby obliging licensees to deduct taxes from payment in order to obtain the right to use the software, although most other high courts, notably the Delhi High Court who decided the matter in favor of the taxpayer. The Supreme Court overturned the Karnataka decision, stating that such a license does not constitute a transfer of copyright under either copyright or income tax law. If the decision had stopped here, it would have been just another precedent for tax practitioners. However, the March 2 ruling marks a turning point for Indian tax policy in general, and for customary international treaty law in particular. Therefore, this development requires a comment in order to accommodate the 226-page landmark judgment.
The main criticality of the decision is the clear confirmation of the application and primacy of the double taxation treaties that India has signed with more than 80 countries. The Supervisory Committee has exhaustively outlined the scope of tax treaties, albeit in the context of “license fees” under 18 contracts in this case, and has concluded that the tax liability does not lie with a person entitled to the contractual performance. It was also noted that a refusal would produce an absurd result that is far from reality. That decision rejects the High Court’s lukewarm response to the contract performance claim and categorically states that despite the rigor of domestic tax law – not even a retrospective provision – the benefit of the contracts cannot be denied. The decision gives further power to the primacy of the internationally recognized Vienna Convention on the Law of Treaties and its principles as the standard method for the interpretation of treaties (referring to its earlier decision in the Ram Jethmalani case), making India’s commitment and alignment with India clear International standards are expressed. The decision thus restores the constitutional endeavors, anchored as a guideline principle in Article 51, that the government must endeavor to “promote compliance with international law and contractual obligations”.
The bigger aspect is the Supervisory Committee’s analytical breakdown of the Income Tax Act to highlight that it is not a charitable act for a benefit to be extended under the tax treaty. Instead, the law should give priority to tax treaties. Although this principle was not set out for the first time and appeared in the famous Azadi Bachao Andolan case, the present decision goes far beyond stating that the treaties also override subsequent retroactive changes to national tax law. Regarding the principle of amending national law to amend the contractual framework, the court found that it is deceptive to assume that amending national law to remedy a misinterpretation situation could spontaneously promote the tax administration’s case in a contractual situation. This positive declaration protects foreign investors from unilateral changes in Indian tax policy and promises security in their tax treatment.
Another dimension of the decision is the appeal to the “doctrine of impossibility”, that is, if there is a disability that makes compliance with the law impossible, the alleged disobedience of the law is excused. The decision provides that an amendment made in 2012 with retroactive effect from 1976 (i.e. the date on which the relevant provisions were originally enacted) cannot be invoked to hold tax deductions responsible for failure to withhold tax by adding a provision of a law is applied when this is the case was not really and factually based on the code of law. While this cannot prevent parliament from enacting retrospective tax laws, the Supervisory Committee has effectively limited the government’s leeway in prosecuting taxpayers’ bonafid acts that result in violations due to retrospective changes. The Supreme Court was critical of the amendment to the law retrospectively from 1976 when India introduced withholding tax on royalties, noting that it is “just as ridiculous” to apply the 2012 amendment from 1976 as the technology in question comes into being was called decades later. Hopefully this would discourage recklessness, a tool often used as a panacea to fill gaps in tax policy and law.
The decision addresses another sensitive issue in Indian tax policy, which relates to India’s position on international tax principles, as expressed in the OECD Model Tax Treaty, and their commentary with reservations. The government has officially set out its position, which is documented by the OECD, including the “reservations” expressed by India. Although the Tribunals and Supreme Courts have rejected arguments that they do not represent the position of India in a number of judgments, the tax administration routinely refuses to conform to the position it has taken on the OECD Model or its read comments with the respective ones Contracts. This has resulted in a lack of standardization and interpretation principles, although the design of Indian tax treaties is heavily inspired by the OECD model. This decision aligns Indian treaty policy with the international tax brotherhood by approving the “in line with the OECD commentary on which most Indian DTAAs are based”, thereby avoiding the basis for discrepancy. The Apex Court has categorically ruled that India’s change of position on the OECD Commentary cannot be a fact that affects the interpretation (as in this case the definition of royalties) under the respective treaties. In the event that the government deviates from the internationally prevailing standards, it must do so as a formal policy document, and not clandestinely, when officials on the ground refuse to adhere to international standards and thereby trigger repeated appeals before various cases.
In short, the decision of the Supervisory Committee is a welcome realignment of customary international law and Indian international tax policy. a groundbreaking moment. It would be hoped that the government would respect the judgment and follow it verbally and spiritually in order to bring this two-decade-old dispute to an end, which, as the Court noted at the beginning of the judgment, “has a checkered history.”
Incidentally, although the decision was made under tax law, there were also trade-offs in terms of intellectual property rights. The decision deals with difficult questions in the area of copyright and regulates the legal situation, which has so far been precariously dealt with by decisions of the High Court. The Supervisory Committee clarified the “first sale doctrine” and “principle of exhaustion” in relation to copyright and software transactions by implementing the case law on sales tax, customs laws, etc. He quoted the European Court of Justice, the Supreme Court remarking that “a copyright owner exhausts his distribution right in copies of a computer program on the first sale if the copy is made unusable by the first acquirer”. Unfortunately, if our tax officer had followed the court’s earlier decisions, the severity could have been avoided. Nonetheless, the ruling is a substantial flood of case law, aside from engaging lawyers productively.
The authors are partners, BMR Legal
Views are personal
Get live stock quotes from BSE, NSE, US market and the latest net asset value, mutual fund portfolio, read the latest IPO news, best performing IPOs, calculate your taxes with Income Tax Calculator, you know them Top gainers, top losers and best equity funds in the market. Like us on Facebook and follow us on Twitter.
Financial Express is now in the telegram. Click here to join our channel and stay up to date with the latest news and updates from Biz.