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International shipping profits - Taxability under Indo-Swiss DTAA

23rd November, 2012

The Income Tax Appellate Tribunal (ITAT), Mumbai, in its recent decision dated 6-11-2012 while considering the question of taxability of international shipping profits in India or Switzerland under the agreement for avoidance of double taxation and prevention of fiscal evasion with Swiss Confederation (Indo-Swiss DTAA), interpreted the terms ‘dealt with’ and ‘effectively connected’ and held that profits from operation of ships in international traffic in case of a non-resident shipping company are taxable only in country of residence – Switzerland and not in India.  

As per amendments to Article 7 and Article 8 of the Indo-Swiss DTAA in 2011, profits from operation of ships in international traffic were made taxable only in state of residence. During the period of the dispute, Article 7 on business profits contained an exclusion for shipping profits and Article 8 applied to profits from operation of aircraft in international traffic. For the relevant period, Article 22 of the DTAA provided that any item of income ‘not dealt with’ in the earlier Articles would be taxable in the state of residence except if the right or property in respect of which the income is paid ‘is effectively connected with such permanent establishment’ (PE).  

The Department contended that by excluding shipping profits in Article 7, it has been dealt with and therefore Article 22 was not applicable to decide which State could tax the income. The combined effect of Article 7 and 8 (as applicable) was to deny the exclusive right of taxation to the country of residence and shipping profits were to be taxed according to the domestic laws of the state. that is under Section 44B of the Income Tax Act, 1961. It also argued that in the alternative even if Article 22 was applicable since the assessee had a permanent establishment and income from rights or property was effectively connected to the PE, the income was taxable in India. The department also argued that ‘effectively connected’ should not be taken to mean ‘owned’ which is a wider term.  

The Tribunal however found force in the assessee’s argument that shipping profits have not been ‘dealt with’ by merely mentioning them in Article 7. In the context of a double tax avoidance agreement, which is, allocation of taxing jurisdiction for an item of income to be regarded as ‘dealt with’ there must be a positive action and not a lack of action. Hence Article 22 would be applicable.  But Article 22(2), brought profit of the PE within the scope of Article 7 only if the relevant income of the PE arose from a right or property ’effectively connected with’ such PE. 

The Tribunal agreed with the assessee’s contention that the right or property must necessarily refer to the ship itself since the property which generates the income is the ship. Applying the economic ownership as the criteria to apply the concept of effectively connected as per Sumitomo Mitsui Banking Corporation & Ors. v. DDIT [136 ITD 66] , the Tribunal in this case  [ADIT (International Taxation) v. Mediterranean Shipping] held that ships which did not form part of the assets of PE in India could not be said to be effectively connected to such PE. Thus, as per provision of Article 22 (1) the income (shipping profits) was taxable only in the state of residence of the assessee company.  
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