Double Taxation Avoidance Agreement (DTAA) is bilateral economic agreement between two nations aiming to avoid or eliminate double taxation of the same income in two countries. Under the existing provisions of section 90 of the Income Tax Act (the Act), any term used but not defined under the Act or in the DTAA entered into between Government of India and Government of country outside India u/s 90(1)/90A(1) shall have meaning assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf, unless the context otherwise requires, provided the same is not inconsistent with the provisions of the Act or the agreement.
In line with the recommendation of Income tax Simplification Committee in its final report, it has now been proposed to insert Explanation 4 to section 90 and section 90A to provide that where any term used in agreement entered into under section 90(1)/90A(1) of the Act is defined under the said agreement, the said term shall be assigned the meaning as provided in the said agreement and where the term is not defined in the agreement, but is defined in the Act, it shall be assigned meaning as defined in the Act and any explanation issued by the Central government.
As per Memorandum to Finance Bill, 2017, as part of rationalization measures, the proposed amendment has been inserted with a view to bring in more clarity in the Act in respect of interpretation of 'terms' used in DTAA for the purpose of its application in order to reduce the avoidable litigation related to taxation of non-residents. However, there is no specific clarity in Memorandum with respect to the rationale behind the amendment. One of the intentions behind the amendment could be to
import' process royalty' concept existing under the Act to the DTAA where there is no such express definition of process under the DTAAs entered into by India with other countries.
To explicate, royalty is generally defined under DTAA, as payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. The definition under DTAA includes process but the word process is not defined under tax treaties. As per Income tax Act, by Explanation 6 to section 9(1)(vi), it is clarified that process includes transmission by satellite (including uplinking, amplification, conversion for down linking of any signal), cable, optic fibre or by any other technology, whether or not such process is secret). A question would arise whether as per the proposal, tax authorities could resort to meaning of process under the Act to interpret the scope of royalty as per DTAA.
Courts in various cases have analyzed the applicability of process royalty definition under the DTAA and held that any change in the substantive law would not automatically result in a like change in respect of taxability of a transaction or service, which is otherwise tax exempt in terms of a DTAA or which is subject to a lower rate of taxation mandated by a treaty unless DTAA is amended jointly by both parties to incorporate income from process royalty as defined under the Act as royalty under DTAA.It needs to be evaluated whether the proposed amendment would now be applicable to refer to definition prescribed under the Act also where under the judicial precedence, it is consistently held that wider definition under the Act cannot be read into treaty unless the treaty is amended.
Any amendment in taxation laws of one jurisdiction is made applicable to DTAA which is actually negotiated by mutual agreement between two countries. In this connection, it should be observed that as per Article 2 of DTAA entered into by Government of India with Government of other countries, it is agreed that the competent authorities of the Contracting States shall notify each other of any significant changes which have been made in their respective taxation laws and of any official published material concerning the application of the Convention. Under the current scenario, where there are various terms which are not defined under the DTAA but defined under the Act, there is certain possibility of numerous amendments made through Indian tax laws affecting taxability of residents of one or more contracting states, it is relevant in this context, especially after the said amendment is brought in, to notify any significant change made in taxation laws in India and get the taxability agreed upon with the country with which the agreement has been entered into.
At this stage, it is also crucial to take into consideration that as per DTAA, Article 3 states that any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that Contracting State relating to the taxes which are the subject of this Convention. The phrase 'unless the context otherwise requires' is absent under the proposed amendment to the Act. In view of the same, question arises whether can the tax authorities invoke this explanation to refer the definition of a 'term' not defined under treaty but defined under the Act without verifying whether context requires to refer to definition provided under the Act.
It is further worthwhile to note that amendment requires term not defined under the DTAA but 'defined' in the Act. The word 'process' has not been defined in the Act as such, however, Explanation 6 provides an inclusive meaning to the term 'process', whether such a view can be taken that this amendment cannot be made applicable in absence of explicit definition of term 'process' under the Act.
The aforesaid amendment is proposed to apply in relation to assessment year 2018-19 onwards. However, it is pertinent to note here that the explanation begins with the phrase 'for removal of doubts, it is hereby declared that' which indicates that the explanation is intended to be clarificatory in nature and thereby the amendment may be considered to be retrospective by revenue authorities. It is pertinent to note the observations of Hon'ble Supreme Court in the case of Sedco Forex International Drill Inc. v. CIT  279 ITR 310 (SC), in which the Supreme Court reaffirmed the law and held that if an explanation is in its nature clarificatory, then the Explanation must be read into the main provision with effect from the time that the main provision came into force. But if it changes the law it is not presumed to be retrospective, irrespective of the fact that the phrases used are 'it is declared' or 'for the removal of doubts'."Also, Andhra Pradesh High Court in the case of Sanofi Pasteur Holding SA observed that the retrospective amendments which are not fortified by a non obstante clause expressed cannot override tax treaties. Placing reliance on the aforesaid jurisprudence, a view can be taken that the explanation cannot be read as retrospective in nature.
With this proposal being inserted in the Act that terms not defined under the DTAA but defined under Act, it needs to be seen whether it settles the controversy or add on more controversy to the existing one.