DIT vs. New Skies Satellite BV (Delhi High Court)

The Delhi High Court had to consider the following two propositions of law: (i) Whether by a unilateral amendment in the Income Tax Act, an interpretation of the same term in the Double Taxation Avoidance Agreement can be changed? And (ii) Whether by merely terming an amendment as ‘clarificatory’ and making it retrospective infact renders its retrospectivity valid in law? HELD by the High Court:

(i) This Court is of the view that no amendment to the Act, whether retrospective or prospective can be read in a manner so as to extend in operation to the terms of an international treaty. In other words, a clarificatory or declaratory amendment, much less one which may seek to overcome an unwelcome judicial interpretation of law, cannot be allowed to have the same retroactive effect on an international instrument effected between two sovereign states prior to such amendment. In the context of international law, while not every attempt to subvert the obligations under the treaty is a breach, it is nevertheless a failure to give effect to the intended trajectory of the treaty. Employing interpretive amendments in domestic law as a means to imply contoured effects in the enforcement of treaties is one such attempt, which falls just short of a breach, but is nevertheless, in the opinion of this Court, indefensible.

(ii) It takes little imagination to comprehend the extent and length of negotiations that take place when two nations decide to regulate the reach and application of their legitimate taxing powers (Union of India v. Azadi Bachao Andolan (2003) 263 ITR 706 (SC) in the context of the Indo Mauritius Double Tax Avoidance Convention referred).

(iii) The Vienna Convention on the Law of Treaties, 1969 (“VCLT”) is universally accepted as authoritatively laying down the principles governing the law of treaties. Article 39 therein states the general rule regarding the amendment of treaties and provides that a treaty may be amended by agreement between the parties. The rules laid down in Part II of the VCLT apply to such an agreement except insofar as the treaty may otherwise provide. This provision therefore clearly states that an amendment to a treaty must be brought about by agreement between the parties. Unilateral amendments to treaties are therefore categorically prohibited.

(iv) We do not however rest our decision on the principles of the VCLT, but root it in the inability of the Parliament to effect amendments to international instruments and directly and logically, the illegality of any Executive action which seeks to apply domestic law amendments to the terms of the treaty, thereby indirectly, but effectively amending the treaty unilaterally. As held in Azadi Bachao Andolan these treaties are creations of a different process subject to negotiations by sovereign nations. The Madras High Court, in Commissioner of Income Tax v VR. S.RM. Firms Ors [1994] 208 ITR 400 (Mad) held that “tax treaties are…… considered to be mini legislation containing in themselves all the relevant aspects or features which are at variance with the general taxation laws of the respective countries”.

(v) At the very outset, it should be understood that it is not as if the DTAAs completely prohibit reliance on domestic law. Under these, a reference is made to the domestic law of the Contracting States. Article 3(2) of both DTAAs state that in the course of application of the treaty, any term not defined in the treaty, shall, have the meaning which is imputed to it in the laws in force in that State relating to the taxes which are the subject of the Convention.

(vi) The treaties therefore, create a bifurcation between those terms, which have been defined by them (i.e the concerned treaty), and those, which remain undefined. It is in the latter instance that domestic law shall mandatorily supply the import to be given to the word in question. In the former case however, the words in the treaty will be controlled by the definitions of those words in the treaty if they are so provided.

(vii) Though this has been the general rule, much discussion has also taken place on whether an interpretation given to a treaty alters with a transformation in, or amendments in, domestic law of one of the State parties. At any given point, does a reference to the treaty point to the law of the Contracting States at the time the treaty was concluded, or relate to the law of the States as existing at the time of the reference to the treaty? The former is the ‘static’ approach while the latter is called the ‘ambulatory’ approach. One opportunity for a State to ease its obligations under a tax convention comes from the ambulatory reference to domestic law. States seeking to furtively dodge the limitations that such treaties impose, sometimes, resort to amending their domestic laws, all the while under the protection of the theory of ambulatory reference. It thereby allows itself an adjustment to broaden the scope of circumstances under which it is allowed to tax under a treaty. A convenient opportunity sometimes presents itself in the form of ambiguous technical formulations in the concerned treaty. States attempting to clarify or concretize any one of these meanings, (unsurprisingly the one that benefits it) enact domestic legislation which subserves such purpose.

(viii) There are therefore two sets of circumstances. First, where there exists no definition of a word in issue within the DTAA itself, regard is to be had to the laws in force in the jurisdiction of the State called upon to interpret the word. The Bombay High Court seems to accept the ambulatory approach in such a situation, thus allowing for successive amendments into the realm of “laws in force”. We express no opinion in this regard since it is not in issue before this Court. This Court’s finding is in the context of the second situation, where there does exist a definition of a term within the DTAA. When that is the case, there is no need to refer to the laws in force in the Contracting States, especially to deduce the meaning of the definition under the DTAA and the ultimate taxability of the income under the agreement. That is not to say that the Court may be inconsistent in its interpretation of similar definitions. What that does imply however, is that just because there is a domestic definition similar to the one under the DTAA, amendments to the domestic law, in an attempt to contour, restrict or expand the definition under its statute, cannot extend to the definition under the DTAA. In other words, the domestic law remains static for the purposes of the DTAA.

(ix) Consequently, since we have held that the Finance Act, 2012 will not affect Article 12 of the DTAAs, it would follow that the first determinative interpretation given to the word “royalty” in Asia Satellite [2011] 332 ITR 340 (Del), when the definitions were in fact pari materia (in the absence of any contouring explanations), will continue to hold the field for the purpose of assessment years preceding the Finance Act, 2012 and in all cases which involve a Double Tax Avoidance Agreement, unless the said DTAAs are amended jointly by both parties to incorporate income from data transmission services as partaking of the nature of royalty, or amend the definition in a manner so that such income automatically becomes royalty. It is reiterated that the Court has not returned a finding on whether the amendment is in fact retrospective and applicable to cases preceding the Finance Act of 2012 where there exists no Double Tax Avoidance Agreement.