India - Constitutional Validity Of Section 94A Of The Income-Tax Act and Notification Of Cyprus Thereunder As Uncooperative Tax Jurisdiction Upheld – Madras High Court In T. Rajkumar Case. - Conventus Law (2024)

1 May, 2016

I. Background

(a) Cyprus was notified by the Government of India as a non-cooperative tax jurisdiction for the purposes of section 94A of the Income-tax Act, 1961 (“Act”)1 on account of lack of its effective exchange of information with India vide notification dated November 01, 2013 (“Cyprus Notification”).

(b) One of the key implications of the notification of Cyprus, in terms of the provisions of section 94A of the Act is that, any sum or income or amount (on which tax is deductible under the provisions of the Act) made to a person located in Cyprus shall be liable for withholding tax at 30% or a rate prescribed in the Act, whichever is higher.

(c) The constitutional validity of section 94A of the Act as well as validity of the Cyprus Notification and the accompanying

press release issued by the Central Board of Direct Taxes of India (“CBDT”) explaining the rationale for notifying Cyprus, was assailed before the Madras High Court, in the case of T. Rajkumar & Ors. v. Union of India & Ors.2.

(d) The Madras High Court, vide its recent ruling dated April 12, 2016, has disposed the above writ petitions and upheld the constitutional validity of section 94A of the Act as well as validity of the Cyprus Notification3.

(e) In this case, the Petitioners had purchased equity shares and debentures of an Indian company from a Cyprus company, which transaction had resulted in a capital loss to the Cyprus seller. The Petitioners made payments of the purchase consideration to the Cyprus seller without withholding any taxes. The income-tax department initiated proceedings against the Petitioners on account of their failure to withhold taxes on payments made to the Cyprus seller and raised a demand levying tax along with interest on the Petitioners. The said demand notices have been challenged by the Petitioners on merits by way of separate and independent writ petitions and appeals and the merits of the matter were not subject matter of consideration in the present ruling.

II. Madras High Court’s ruling

(a) The Petitioners alleged that section 94A of the Act was unconstitutional as it diluted the provisions relating to Double Taxation Avoidance Agreements (“DTAA”) entered into by India with other countries, which ought to prevail over the provisions of section 94A of the Act.

(b) The High Court dismissed the challenge to constitutional validity of section 94A as being without any merit, inter alia, by holding that a DTAA entered into by the Executive is a result of delegated legislation. This shows that the Parliament is supreme and a law made by the Parliament (i.e. section 94A) cannot be subordinated to a DTAA entered into by the Executive. The High Court further observed that while a DTAA provides a benefit to a taxpayer to choose between two alternative taxing provisions, the application of other provisions of the Act are not expressly or impliedly ousted. The High Court held that the provisions of DTAA were, in fact, diluted by one of the contracting parties itself on account of lack of effective exchange of information. Looking at the totality of facts and surrounding circ*mstances, both domestically and globally, the High Court found the impugned section 94A to be constitutionally valid.

(c) As regards the Cyprus Notification, the challenge to its constitutional validity was dismissed by the High Court for the following reasons:

(i) Both the countries are obliged to perform their obligations under the DTAA in good faith. When one of the countries commits a default by failing to provide information, it is not open to the beneficiary of such a default to contend that the other country should honour its obligations.

The argument that the power conferred under section 94A(1) excludes those countries with which the Government has entered into a DTAA, is misplaced as the phrase used in section 94A is “any country or territory” and not “any country or territory other than those covered by section 90”.

The Petitioners had also challenged the press release issued by CBDT explaining the cause and impact of Cyprus Notification on the ground that the language of the press release went beyond the statutory prescription in as much as the press release made “any payment” made to a person located in Cyprus liable to withholding tax at 30% in terms of section 94A(5), whereas section 94A(5) used the expressions “any sum or income or amount on which tax is deductible….”; both of which expressions had different connotations for income-tax purposes. The High Court held that the question of assailing the press release does not arise since the press release is only a note meant for information of the public and benefit of the common man, and it does not have the force of a circular issued by CBDT.

III. Comments

(a) In the present case, the tax authorities had invoked the Cyprus Notification even where the Cyprus seller had incurred a capital loss and, consequently, there was no taxability under the provisions of the Act itself. This is in spite of the established position of law that the withholding tax obligation is only with respect to the taxable amount and not the gross remittance4.

(b) While the merits of the matter were not under consideration in the present case (and are a subject matter of separate appellate and writ proceedings), however, the High Court noted a particular clause of the Securities Purchase Agreement (which had provided that the shares are being transferred at a loss and there is no obligation on the buyer to withhold any tax, and in case any tax is levied the same shall be borne and paid by the seller), and made the following observations:

“120. The above Clause in the Securities Purchase Agreement, exposes the frivolity of the contentions of the petitioners. After having taken care to indicate that if a tax is levied, it should be borne by the Cyprus company, the petitioners appear to have indulged in an adventure in making remittances in full. Actually the petitioners should have deducted tax at source in terms of Clause 6.4 of the Securities Purchase Agreement and thereafter fought a legal battle with the Department for refund. If the petitioners had taken a calculated risk by making the payments, they cannot later turn around and find fault with the statutory prescription and with the Notification and Press Release.”

(c) While the above observations could raise a doubt regarding tax withholding obligation in cases like the present where the Cyprus seller incurs a loss (and consequently there ought not to be any requirement to withhold taxes even under the Act in the absence of any taxable income being derived by the Cyprus seller), in our view, as a matter of law, given that the merit of the demand notices was not subject matter of the present proceedings, the above observations should not fasten any withholding tax obligation on the payer contrary to the provisions of section 195 and section 94A of the Act. However, following this decision, litigation by the tax department even in such cases cannot be ruled out.

1. Section 94A of the Act is an anti-avoidance measure that empowers the Government to specify any country as a notified jurisdictional area on account of lack of its effective exchange of information with India.
2. [2016] 68 taxmann.com 182 (Madras).
3. Even prior to the present challenge, the vires of Cyprus Notification had been challenged before the Hon’ble Uttarakhand High Court, in the case of Expro Gulf Ltd. v Union of India, [2015] 230 Taxman 331 (Uttarakhand), on the ground that domestic legislation cannot supersede a tax treaty. However, those proceedings did not involve a constitutional challenge to section 94A of the Act. The Uttarakhand High Court dismissed the said writ petition, inter alia, on the ground that there was no reason for the High Court to disbelieve the satisfaction recorded by the Indian tax authorities that Cyprus was not providing the information requested by the Indian tax authorities.
4. The Supreme Court, in the case of GE India Technology Centre Private Limited v CIT, (2010) 193 Taxman 234 (SC), held that tax is required to be withheld under section 195 of the Act only when income is chargeable to tax in India. Further, the CBDT issued Instruction No. 02/2014 on February 26, 2014, clarifying that withholding tax obligations under section 195 is only with reference to the portion representing the sum taxable in India.

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For further information, please contact:

Zia Mody, Partner, AZB & Partners

zia.mody@azbpartners.com