In the domain of international taxation, the primary goal of a tax treaty is to prevent the double taxation of income arising from cross-border transactions. Recent amendments introduced by the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) have significantly altered the primary objective. Tax treaties modified under Article 6(1) of the MLI are now perceived as aimed at eliminating double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.
Simultaneously, certain tax treaties, especially those entered into by developing countries, incorporate tax sparing clauses to provide tax incentives for attracting foreign direct investment. For instance, Article 23 of the India-Thailand Double Tax Avoidance Agreement (DTAA) (before its 2015 amendment) includes a tax sparing clause, allowing Indian residents to claim credit for tax 'payable' in Thailand. The recent Polyplex Corporation Ltd v. PCIT case in the Delhi High Court (Polyplex Judgment) explored the validity of such a tax credit claim, particularly concerning dividend income earned in Thailand.
The Polyplex case involved the Indian company claiming credit for notional tax payable in Thailand, even though no tax was paid there due to a statutory exemption. The Delhi High Court allowed the claim, emphasizing that tax sparing clauses aim to boost economic activities, promoting bilateral investment for economic development. While acknowledging critics' concerns about potential double non-taxation, the court did not delve into this contention, leaving the fate of tax sparing principles to contracting states. The Income-tax authority has appealed the Polyplex Judgment to the Supreme Court, awaiting a final decision.
In a similar vein, the Supreme Court, in the case of PCIT v. Krishak Bharti Cooperative Ltd, upheld the tax sparing principle in the context of the India-Oman DTAA. The dispute involved an Indian entity claiming credit for tax not paid in Oman due to an exemption. The Supreme Court, aligning with the principles laid down by the Delhi High Court, recognized the eligibility of the Indian entity for exemption in both Oman and India under the tax sparing clause.
In conclusion, recent judicial decisions in India suggest a recognition of the tax sparing principle, allowing for the claiming of credits for notional taxes under tax treaties, despite concerns about potential double non-taxation. The legal landscape continues to evolve, with the Supreme Court seemingly upholding the principles established by the Delhi High Court.