Interpretation of “May be Taxed” in DTAAs

Interpretation of “May be Taxed” in DTAAs

In the context of Double Taxation Avoidance Agreements (DTAAs), the terminology used to describe taxing rights can significantly impact the taxation process.

The term “may be taxed” in Double Taxation Avoidance Agreements does not grant absolute power to either state to tax the income exclusively. Instead, it allows both states to tax the income, with provisions for relief to avoid double taxation. The clarification by the Central Government ensures that Indian residents are not subject to double taxation and can claim credit for taxes paid in foreign jurisdictions. This approach maintains the balance of taxing rights between the contracting states and protects the taxpayer from undue tax burdens. Here’s an exploration of the implications of the term “may be taxed” and its interpretation:

1. “Shall be taxed” vs. “May be taxed”

• “Shall be taxed”: This term implies exclusive taxing rights, indicating that only the specified state has the authority to tax the income in question. There is no ambiguity, and the income must be taxed solely in that state.
• “May be taxed”: This term introduces a degree of flexibility, leading to questions about the allocation of taxing rights between the contracting states.

2. Beneficial Provisions of DTAAs

• DTAAs are aimed at avoiding double taxation and providing relief to taxpayers. They are designed to be more beneficial to taxpayers compared to local tax laws alone. When a DTAA provides a more beneficial treatment for an income, those provisions take precedence over the domestic tax laws of the contracting states.

2. Clarification by Central Government Notification

• The Central Government issued Notification No. 91, dated 28-08-2008, to address the ambiguity associated with the term “may be taxed.” The notification clarified that: When the term “may be taxed” is used in a Double Taxation Avoidance Agreements, the income in question shall be included in the total income chargeable to tax in India. Relief from double taxation shall be provided by allowing tax credit for the taxes paid in the foreign country.

3. Judicial Interpretation: Essar Oil v. ACIT (28 ITR (Trib.)

In the case of Essar Oil v. ACIT (28 ITR (Trib.) 609 (Mum.) 2014), the Mumbai Tribunal examined the Indo-Oman Double Taxation Avoidance Agreements. The key points from the tribunal’s ruling include: The phrase “may be taxed” grants non-exclusive taxing rights, allowing both states to potentially tax the income. This interpretation aligns with Section 90 of the Income Tax Act and the 2008 Notification. Tax credit must be provided for taxes paid in the foreign country, ensuring the elimination of double taxation. The tribunal held that ‘may be taxed’ provides non-exclusive taxing rights, allowing both states to potentially tax the income. The credit for taxes paid in the foreign country must be provided under the treaty.

4. Implications for Indian Residents

For residents of India, the implications of “may be taxed” are clear:  Income that “may be taxed” in another state is also taxable in India. India will provide credit for taxes paid in the other state, thereby preventing double taxation.

This ensures that even if an income is taxable in another state, India retains the right to tax it, while providing relief to avoid double taxation. When the term ‘may be taxed’ is used in a DTAA, and the income is also taxable under Indian law, India retains the right to tax that income. However, if the income is taxed in the other state, India must provide relief to avoid double taxation.

The term implies that the income in question could be subject to tax in the state mentioned, depending on the local tax laws of that state. This means that there is no mandatory obligation for that state to tax the income; it has the option to do so. This flexibility ensures that if the income is not taxed in the state where it ‘may be taxed,’ it can still be taxed in the other state, ensuring that the income does not escape taxation altogether

5. Purpose of the Notification No. 91/2008

The primary objective of Notification No. 91/2008 is to remove ambiguity in Double Taxation Avoidance Agreements caused by the term “may be taxed.” It ensures a consistent approach to taxing such income for Indian residents: Clarifies that India has the right to tax the income. Mandates providing tax credit for foreign taxes paid.

Conclusion

The term ‘may be taxed’ in DTAAs introduces flexibility in taxation by allowing income to be potentially taxed in either or both of the contracting states, depending on local laws. The key points to understand are:

‘May be taxed’ means the income might be subject to tax in the other state, depending on its local tax laws. Government notifications serve as interpretive aids rather than binding rules. The term “may be taxed” should be interpreted by considering the overall purpose of the DTAA and the specific context in which it is used. Taxpayers can leverage the purposive rule and the contextual flexibility allowed by Section 90(3) to argue for the most beneficial interpretation of terms like “may be taxed.”

DTAAs are designed to be more beneficial than local laws, ensuring that taxpayers do not face double taxation and receive favorable treatment. India retains the right to tax income that ‘may be taxed’ in the other state, while providing relief through tax credits to avoid double taxation.

Cases like Essar Oil v. ACIT provide judicial interpretation, reinforcing the non-exclusive nature of taxing rights associated with ‘may be taxed.’

Overall, the term ‘may be taxed’ ensures that income is taxed appropriately while providing mechanisms to prevent double taxation, reflecting the core objectives of DTAAs.