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Indian Tribunal rules domestic/foreign company classification under Indian tax legislation does not contravene non-discrimination clause of India-France treaty

The Indian Income Tax Appellate Tribunal (ITAT) delivered a ruling dated 28 February 2004 (reported in July 2005) in the case of Credit Lyonnais v. Deputy Commissioner of Income Tax (94 TTJ 1074) on whether a foreign company could claim a deduction for dividends received and re-distributed to its shareholders.

(a) Facts. The taxpayer (i.e. Credit Lyonnais), a company resident in France, claimed a deduction under Sec. 80M of the Indian Income Tax Act 1961 (ITA) in respect of certain inter-corporate dividends. Sec. 80M of the ITA grants a deduction to a domestic company for dividends received from investments in other companies, to the extent that the dividends received are re-distributed by the domestic company to its own shareholders. The tax authorities disallowed the deduction claimed by the taxpayer on the ground that the deduction was only available to domestic companies and not to foreign companies.

The taxpayer contended that in view of the provisions of Art. 21 of the India-France tax treaty (the Treaty) concerning non-discrimination, and in view of the fact that the provisions of Sec. 80M of the ITA seek to discriminate against foreign companies by only allowing a deduction for domestic companies, the deduction under Sec. 80M of the ITA had to be extended to the foreign companies due to the provisions of Art. 21. The Commissioner of Income Tax (Appeals) rejected the taxpayer's argument. The taxpayer proceeded to appeal to the ITAT.

(b) Issue. The issue before the ITAT was whether a foreign company was entitled to a deduction under Sec. 80M of the ITA in light of the non-discrimination clause in a tax treaty.

(c) Decision. The ITAT held that deduction under Sec. 80M of the ITA cannot, despite the non-discrimination clause in a tax treaty, be extended to foreign companies as the deduction was only available to domestic companies in India.

The ITA defines a domestic company as "an Indian company, or any other company which, in respect of its income liable to tax under this Act has made the prescribed arrangements for the declaration and payment within India of the dividends (including dividends on preference shares) payable out of such income", while a foreign company is defined as "a company which is not a domestic company".

The ITAT observed that a company incorporated under the laws of France can, in certain situations, be treated as a domestic company in India thus enabling it to claim a deduction under Sec. 80M of the ITA. Therefore, the crucial factor for deciding whether a company was a domestic company or a foreign company was not the nationality of such company. A French company could make the prescribed arrangements for the declaration and payment of the dividends in India, and thus be treated as a domestic company under the ITA. The true test for deciding whether or not a company was eligible for deduction under Sec. 80M of the ITA was whether or not the company had made the prescribed arrangements for the declaration and payment of the dividends in India.

The ITAT held that this kind of a classification cannot be considered to be "discrimination" against the taxpayer on the grounds of nationality under Art. 21 of the Treaty. The ITAT held that Art. 21 of the Treaty deals with discrimination on the grounds of nationality alone, i.e. it provides that nationals of France in India will not be subjected to any taxation or any requirement connected with such taxation, which is more burdensome than similar taxation or requirement in connection therewith on an Indian national in India. In applying this non-discrimination clause, what is to be determined is whether or not two persons, who are residents of the same State, are being treated differently solely by reason of having a different nationality, because differential tax status on the ground of residence of the taxpayer cannot be construed as non-discrimination. In other words, when taxpayers are subject to different tax treatments on the basis of a criterion connected with requirements regarding residence of the taxpayer, it will not be covered by the scope of non-discrimination clause in a tax treaty.

Additionally, the non-discrimination clause in the Treaty cannot be invoked in the cases where provisions of ITA are more favourable to domestic companies vis--vis foreign companies.

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