1. The appeals by the Revenue and the Cross Objections by the assessee for the years under consideration have been heard together and are being disposed off by the common order for the sake of convenience. The issue arising from the appeals of Revenue is whether assessee is eligible for the benefit of Article 9 of Indo-U.K. Treaty.
2. Briefly stated, the facts giving rise to these appeals are these.
The assessee is a non-resident company incorporated in UK which was engaged in transportation of goods in international traffic by ships.
M/s. NLS Agency (India) Pvt. Ltd., Mumbai was the agent of the non-resident in India. In respect of assessment year 2001-02, it filed the income-tax return declaring the total income of Rs. 3,00,25,837/- against the total freight receipt of Rs. 40,03,44,489/- by applying net profit rate of 7.5% prescribed Under Section 44B of Income-tax Act, 1961 (the Act). However, the tax liability was declared nil by claiming exemption under Article 9 of Indo-Uk Treaty. The copy of Tax Residency Certificate (TRC) was also filed. In the similar manner, the assessee declared the total income of Rs. 5,34,45,380/- against the total freight receipt of Rs. 71,27,91,727/- for assessment year 2002-03 and claimed exemption from payment of tax under Article 9 of the said Treaty.
3. In the course of assessment proceedings for the assessment year 2001-02, the Assessing Officer examined the Charter Hire Agreement between the assessee and M/s. Littleton Services Inc. for the vessel 'Orient Aishwarya' as well as Connecting Carrier Agreement between the assessee and the Orient Express Lines Ltd. Mauritius (the carrier),. It was revealed that the carrier operated its feeder services from/to ports in Indian sub-continent to/from UAE, Colombo and Singapore.
Clause 2 of this agreement provided that the carrier had offered containers slots space to the assessee and the assessee had accepted to use such space on as/when required basis. However, agreement with Littleton Services Inc. showed that the entire ship was chartered by the assessee and the same was operated by the assessee. The Assessing Officer after referring to the commentary on Double Taxation Convention by Klaus Vogel held that receipts from the operation of the vessel "Orient Aishwarya" was covered by Article 9 of Indo-UK Treaty and consequently, the gross receipt amounting to Rs. 1,73,83,818/- on this account was to be excluded from the taxation in view of the said treaty, however, in respect of the cargo transported through the ship of the carrier, it was held by the Assessing Officer that the assessee could not be said to be engaged in the business of operation of ships and consequently, the income arising to the assessee in, this regard was assessable Under Section 44B of the Act. Before coming to this conclusion, the Assessing Officer had given the reasons at page A of the assessment order which are reproduced below: Thus, in the final analysis, the matter rests on the determination of the following question of fact: "Whether the assessee operates a ship(s) in international traffic of goods etc, or not?". AH other issues depend upon the resolving of this basic issue. As has been shown above, the assessee can be said to be operating ships in international traffic, in the case of the vessel Orient Aishwarya only. As regard to its receipts from freight etc., pertaining to other vessels, it has to be mentioned that those vessels are not operated by the assessee. The assessee is not using its containers as an independent business, but those containers are integral part of its business of transporting the containers on slots provided by the Connecting Carrier. Thus, separate income of the assessee on this account cannot be quantified. Even otherwise, such quantification has not been provided by the A.R. of the assessee.
In view of the above, the Assessing Officer held that Article 9 of the said Treaty was not applicable in the case of the assessee except in the case of receipts arising from the operation of the vessel "Orient Aishwarya". Subsequently, it has been observed by him that the assessee had permanent establishment (PE) in India as NLS Agency (India) Pvt.
Ltd. at Mumbai was the agent of the non-resident assessee.
Consequently, the assessee could not avail the benefit of Article 7 of the said Treaty also. Accordingly, he computed the income at Rs. 2,87,22,050/- by applying the net profit rate of 7.5% on the total freight of Rs. 38,29,60,671/-.
4. In respect of assessment year 2002-03, the facts are almost similar.
However, certain new facts were noted by the Assessing Officer which are being narrated. It was noticed that the assessee owned 4760 containers of 20 ft size and 466 containers of 40 ft size. In addition, 2767 containers had been taken on lease. These containers were used in the transportation of cargo in the international traffic. It was also noted that the assessee does not operate any ship. It was further noted that the risk in operating the ships was borne by the carrier and the assessee was responsible for its own containers as well as the material loaded in the containers. Considering the facts that (i) it did not operate any ship and (ii) no operating risk was borne by the assessee, it was held by him that the assessee was not eligible for the benefit of Article 9 of the said Treaty. It appears that the assessee had also claimed exemption under Article 9(4) which provides that the income from use, maintenance or rental of containers could be taxed only in the State of residence and not in India. After referring to OECD commentary, it was observed by him that the Treaty benefit is extended only on income earned as lease rental by an enterprise who owns a container and gives the same to another enterprise on lease. According to him, such activity must be supplementary/incidental to the operation of ships in the international traffic. Since the main activity of operation of ships was not carried on by the assessee, the benefit under Article 9(4) of the Treaty was also denied. The benefit under Article 7 was also denied for the reasons given in earlier year order.
Accordingly, he determined the total income at Rs. 7,12,79,173/- by applying the net profit rate of 10% against the total freight receipt of Rs. 71,27,91,727/-. In this year, the Assessing Officer had increased the net profit rate on the ground that the assessee had not borne any risk regarding operation of ships.
5. The assessments for both the years were challenged before the CIT(A). The CIT(A) while disposing of appeal for A.Y. 2001-2002, examined the terms of Article 9 of the said Treaty and observed as under According to Article 9 of the DTAA between India and UK, profits of an enterprise of a Contracting State from the operation of ships in international traffic shall be taxable only in that State. It means that an enterprise has to fulfil two criteria. Firstly, the enterprise should be engaged in 'international traffic' and, secondly, the enterprise should be engaged in 'Operation of Ships.
In the light of the above observations, the CIT(A) considered the correctness of the assessment made by the Assessing Officer and then observed as under: The A.O. has contradicted himself in his order by stating that appellant has not derived 'income from operations of ships' whereas he himself has concluded that freight receipts from Orient Aishwariya are eligible for the benefits of Article 9 of DTAA as the same pertain to income from operation of ships in international traffic. Thus, the A.O. has concluded differently while granting benefit of DTAA and computing income of the appellant. In the present case, it is a consolidated business where appellant has been deriving income from operation of ships. It has been established beyond doubt that the appellant is a shipping company which operate through own or connecting carriers engaged in international traffic.
Nowhere is the requirement that tog et the benefits under DTAA the appellant has to own or charter vessels.
In view of the above, it was held by him that the assessee was entitled to the benefit of Article 9 of the said Treaty since some part of the connected shipping activity was carried out through connecting carriers not owned or chartered by the assessee. Consequently, the income from the entire freight receipts of the assessee was excluded from taxation Under Section 44B of the act.
6. However, the CIT(A) examined the legal position in detail while adjudicating the grounds raised by the Revenue relating to assessment year 2002-03. After referring to Article 9(1) of the said Treaty, he observed as under: The business activity is a organised activity with a motive to earn profit. It is not that each and every activity of the business should be necessarily and directly linked with the main goal of the business. It is sufficient if the transactions carried out by a business are with a purpose to achieve the objective of the business. It is established that the appellant is engaged in the business of operation of ships. Whether a component of the main shipping business relating to carriage of freight through 'slot arrangement' in ships neither owned nor leased by the appellant, amounts to a separate business or not is required to be examined.
The benefit of paragraph (1) of Article 9 of the DTAA can be denied only when it is established that the activities of the business even though carried out along with the business of operation of ships are the reality amounting to a separate business.
After referring to the commentary on Double Taxation Conventions (Third Edition) of Klaus Vogel, he observed as under: From these observations, it is apparent that while considering the computation of profits of business from operation of ships what is to be kept in mind is whether a different activity carried out amounts to a separate and distinct business or it is indeed a part of main business of operation of ship. If this test is applied to the case of the appellant, it is clear beyond any doubt that the incidental use of ships belonging to others for transportation of a fraction of the freight through the ships neither owned nor leased by the appellant, does not amount to a separate business. Under these circumstances, it is to be held that the incidental use of feeder vessel belonging to others for transportation of cargo from Indian ports is only a part of the shipping business of the appellant. It is not necessary to carry out all the activities of the business of shipping through the ships owned or chartered by the appellant himself. Incidental use of ships belonging to others is only an auxiliary or ancillary part of the main business and therefore benefit of DTAA cannot be denied to the operations.
It is not necessary to establish one to one connection of voyage-wise details of the feeder vessels with the mother vessels.
No where any condition has been prescribed that for the purpose of availing of benefit of the DTAA, it is necessary to carry out the business of operation of ships only through self owned or chartered ships.
7. Coming to the facts of the case, the CIT(A) examined the nature of activities and observed as under: In this regard the AO foiled to examine as to how the business operation is being carried on by the appellant. The appellant company is collecting cargo from Indian port and is drawing Bill of Lading for the entire transportation i.e., from the port of loading to the port of destination. The Charterer ship of the appellant company do not always come to the Indian port but the cargo is being collected from India port and transported to the hub port at Dubai.
For this purpose, connecting carrier agreements have been entered into with several parties including Orient Express Lines. The agreements with OEL is for the use of vessel from Indian ports to hub port only. The OEL Mauritius is company operating its feeder services from/to ports in the Indian sub-continent to/from UAE. Colombo & Singapore as mentioned in the definition of the agreement.
Thereafter, the appellant company has agreed that OEL will operates its feeder vessels from/to Indian sub-continent ports to/from UAE, Colombo & Singapore. For this purpose Orient Express Lines has provided container slot on its feeder vessels.
Undoubtedly, the feeder vessels are being operated by the connecting carrier viz., OEL therefore the risk is of the appellant company only in respect of such feeder vessel regarding its own containers.
Clause 5(a) of the agreement provides that the Line shall issue its own bill of lading and other appropriate documents to the shipper to the extent of actual units loaded. In addition the carrier shall issue a service bill of lading in respect of containers carried on board. The feeder vessels provided by the connecting carrier are being operated by such connecting carrier and the responsibility of operation of such ships rests on them. Nevertheless, the appellant company has taken transportation of cargo from Indian ports to various ports of destination across the globe.
8. On examination of the materials placed before him, it was found by the CIT(A) that the assessee had actually chartered two ships viz., 'Orient Stride' and 'Treadfast' and, therefore, it was observed that it could not be said that the assessee was not operating the ships.
Further, it was observed that the assessee had transported the goods in the international traffic through feeder vessels owned by Orient Express Lines Ltd., Mauritius, Bengal Tiger Line GMBH, Germany, Oram Shippins Pvt. Ltd. Singapore, and Shreyas Shipping Ltd. 9. In view of the facts and legal position stated above, the CIT(A) observed as under: The appellant having succeeded in establishing that it is engaged in the business of operation of ships, it is not required that each and every transaction of the vessel is examined to verify whether every operation is being performed through ships owned/chartered by the appellant only. What is to be seen is whether the appellant is engaged in the business of operation of ship. Ancillary and auxiliary activities connected with the business even f ho ugh performed through the ships belonging to someone else have to be treated as part of the business of operation of ships. As mentioned above, even hotels for night accommodation, travel agency can be treated as part of the business of operation of ships, if they are inter linked with the business of ships. In the absence of any requirement anywhere in the DTAA or in the Income-tax Act, it is not necessary to insist on one to one linkage of the feeder vessel with the mother vessel. The carriage of freight though the feeder vessel belonging to others being integral part of the business of the appellant of ships, such activity is to be treated as part of the business of the appellant 10. Regarding Article 9(4) of the said Treaty, it was observed by the CIT(A) as under: Article 9(4) provides that "Income of an enterprise of a Contracting Stage from the use, maintenance or rental of containers (including trailers and related equipment for the transport of containers) used for transport of goods or merchandise." Is entitled to the benefit of Article 9(1). The proper meaning is, to be given to the words, use, maintenance or rental. The AO has limited the meaning only to the lease. The lease of containers is covered by rental. However, the use of container for transporting the goods is much wider term than the rental or leasing. In the case of appellant, the use of container is a integral part of its shipping. The containers are being used for the transport of the cargo. The appellant is not using containers for separate business. Further containers are only used to transport cargo and as such I am of the opinion that the income from the use of containers used for transport of goods or merchandise by the appellant is entitled to the benefit of Article 9(1).
11. In view of the above discussion, it was held by him that the assessee company was engaged in the business of operation of ships in respect of the entire cargo/freight collected from Indian ports whether transported by its own chartered ships or by other feeder vessels.
Consequently, the entire freight income was eligible for the benefit of the Article 9 of the said Treaty. Aggrieved by the aforesaid orders of the CIT(A), the Revenue has preferred these appeals before the Tribunal.
12. The learned D.R. appearing for the Revenue has vehemently assailed the orders of the learned CIT(A) by making the following submissions as per the written submissions filed before us: a. Article 9 of the Indo-UK Treaty is applicable only when income accrues from the operation of ships in the international traffic.
The term 'Operation of Ship' has not been defined in Article 9 of the Treaty and therefore the general meaning of such expression should be applied.
b. The assessee can be said to be to be engaged in the operation of ships if the ship is placed at the disposal of the assessee and the assessee performs all the functions necessary for the purpose of running a ship and earns the profit out of the same. In such case, the assessee undertakes the risk of not earning any profits if it is unable to load the ship fully or operate the ship properly. All the costs of running and maintaining the ship have to be incurred by the assessee as a charterer. On the other hand, when slot space is purchased by the assessee, the assessee is not involved in any manner with the operation or running of the ships since it does not incur any expenditure in this regard. The only cost incurred by it in such a situation is the slot fees paid by it and its profit is the difference between the purchase and sale price of the space.
Consequently, slot chartering would not fall within the scope of the term 'Operation of Ship'.
a The term 'International traffic' is defined in Article 3 which means transport by ship operated by an enterprise except when the ship is operated solely between places in the other contracting state. Thus, the emphasis is on the undertaking of actual transportation of goods by the enterprise and not merely purchase of slot space on bulk basis and re-sale of the same on retail basis.
d. Paragraphs 3 to 6 of Article 9 specifically includes certain incomes which are to be considered as 'operation of ships' as: a) Income from rental on the bareboat basis of the ships when such rental income is incidental to the income from operation of ships; b) Income from use or maintenance of containers; c) Income derived from participation in a pool or a joint business; and d) Income from alienation of ships. The income earned by the assessee by purchase and sale of space in the ship operated by others cannot be said to be covered by the above paras.
e. Guidance can be taken from commentary of OECD as well as the commentary of Klause Vogel. As per para 4 of the OECD commentary, the profit covered by such Article are the profits directly obtained by the enterprise from transportation of goods by ships whether owned, leased or otherwise at the disposal of the enterprise. Where no ship is in the possession or disposal of the enterprise, it cannot be regarded as engaged in the operation of ship in the international traffic. In case of slot purchase, the ship is not at the disposal of the assessee as is evident from the agreement and therefore, Article 8 of the Treaty would not apply.
f. According to the commentary by Klause Vogel, it would be very difficult to apportion the total income from operation of ship towards each of the permanent establishments in various countries and it is for this reason, most of the treaties provide that profits arising from the operation of ship in the international traffic would be taxable in the state of residence only. In the opinion of the author, this reasoning should be kept in mind when determining whether an activity constitutes operation of ship. If this logic is applied to the activity undertaken by the assessee then Article 9 cannot be applied since the profits arising to the assessee is on account of booking of the space in bulk and selling the same in piecemeal to different customers in India.
g. As far as domestic law is concerned, the provisions of Section 44B applicable to non resident do not define the scope of operation of ships. However, Chapter XXIIG has been inserted w.e.f. 01.04.2005 which is applicable to income of the shipping companies. The perusal of Section 115VB shows that assessee should first have some income from operation of ship whether owned or chartered by it and only then income from slot charter of ships can be considered under this Chapter/Further, Section 1I5VI envisages a clear cut demarcation between income earned by company from operation of ships and the income earned by the company from slot charter or space charter.
Later category of income has been regarded as income of trading nature and not income from operation of ship. Further, Section 115VD stipulates that a company who owned at least one qualifying ship is eligible for computation of income under this Chapter. If such provisions are applied to non-resident then the assessee not being the owner of any ship will not qualify for the scheme under this Chapter. Lastly, this Chapter should be read in its entirety and the context. Since in the case of domestic companies, the entire global income is taxable in India this Chapter includes even the non-operating income. If any of the provision of this Chapter is to be applied to non-resident then the distinction made in Section 115VI cannot be ignored.
h. Since almost the entire income of the assessee was derived from the purchase of space on slot basis and not from the operation of ships, the learned CIT(A) was not justified in holding that relief under Article 9 of the treaty was available to the assessee. The learned CIT(A) was not justified in granting relief merely on the ground that activity of operation of ship as a charterer and income from slot chartering formed part of the common business carried on by the assessee. In this case, it is easy to segregate income which qualify for the benefit of the treaty and therefore the concept of common business has been wrongly extended by the learned CIT(A) to the entire activity of the assessee particularly when the other activities do not fulfil the conditions of the treaty. Similar view has been expressed by the learned author, Kluase Vogel, in his commentary on page 448 para 39.
i. Even as per OECD commentary, the benefit of the treaty can be given when the assessee is primarily engaged in the operation of ship in the International Traffic and the activity of slot chartering is directly connected to its operation of ships in International Traffic. Thus, independently, the activity of slot chartering is not eligible for the benefit of the treaty. In the case of the assessee, the activity of slot charter is an independent activity and is the main business of the assessee. This is apparent from the fact that the freight income from the ship 'Orient Aishwarya' is a minor amount.
j. Ancillary activities have been described as activities that an enterprise does not need to carry on for the purpose of its own operation of ships but which make a minor contribution relative to such operation and are so closely related to such operation that they should not be regarded as a separate business or a source of income (para 4.1 of OECD). In this case, it is evident that the slot charter arrangement is the main source of income and the freight earned from Orient Aishwarya constitutes a minor contribution in the same. Hence, in the facts of the present case, the slot charter arrangement cannot be regarded as ancillary to the operation of ships in international traffic.
k. Article 9(4) of the Indo-UK treaty provides that the provisions of paragraphs 1 & 2 of the said Article shall likewise apply to income of an enterprise from the use, maintenance and rental of containers used for the transport of goods or merchandise. Para 4 of the article cannot be read in isolation and must be read in the context of para 1 & 2. Further, in order to apply the said para, the assessee should have earned income from the use, maintenance or rental of containers. It is an undisputed fact that the assessee in this case has earned only freight income and no income has been shown in the Return of income filed towards use, maintenance or rental of containers. The assessee in its letter dated 09.03.2004 addressed to the AO has stated categorically that it is not possible to give information about the income from the use of their own containers under Article 9(4).
i. The perusal of US Model Convention and Indo-US Treaty shows that the language of these two provisions is not identical. Further, even the relevant para of Indo-US Treaty is not on the line of US Model convention. Therefore, any technical explanation relating to the same cannot have any direct application in the given case. (Clause Vogel in his commentary has explained that great restraint must be observed while referring to the technical explanation issued as the same are unilateral explanations of domestic authorities and express the views of only one treaty partner. Reference can be made to para 82f at page 48 of the commentary of Klause Vogel.
13. On the other hand, the learned Counsel for the assessee has vehemently opposed the contentions raised by the learned D.R. by making various submissions. He has also filed written submissions which are briefly narrated as under: a) That 'slot chartering arrangement' with other international shipping companies is nothing but an integral part of its business of operation of ships in the international traffic which is akin to 'code sharing arrangement' in the airline industry. A shipping company may own/charter very few ships and at the same time avail slot spaces on ships of other companies meant for carriage of cargos internationally. This is because - (i) it may not be commercially viable to own a ship due to the huge cost involved; and (ii) the shipping company cannot be expected to shut down its business operations till the time its owned/chartered ship comes back to the Indian port after a long voyage in the international waters. He tried to explain by giving example of Air India which offers transportation services to its passengers to approximately 16 destinations in Europe while it operates only for three destinations i.e. London, Paris and Frankfort which shows that only 19% of the time it operates its owned/chartered air craft where as 81% of the time it would enter into code sharing arrangement with other international airlines but on that account it cannot be said that Air India does not operate its aircraft internationally. According to him, the case of Air India would be covered by the specific Article 9 of the Indo-UK Treaty and for the similar reasons the case of the assessee would also be covered by the aforesaid Article.
b) The term operation of ships has not been defined in the Indo-UK Treaty and therefore its scope has to be understood according to the laws of the contracting states. Reference has also been made to the commentary on international taxation by Klause Vogel. In this connection, he drew the attention to the provisions of Chapter 12G of I.T. Act 1961 popularly known as 'Tonnage Tax Scheme' regarding the taxability of the income of Indian shipping companies and the attention was drawn to the provision of Section 115VB which defines the term 'operation of ship'. According to this definition, a company shall be regarded as operating a ship if it operates in ship whether owned/chartered by it and includes a case where even a part of a ship has been chartered by it in an arrangement such as slot charter, space charter or joint charter. It was also pointed out by him that AO himself applied the provisions of Section 44B of I.T. Act, 1961 in respect of freight income from connecting Carrier agreement with Orient Express Lines which support the view that slot charter in shipping business as an integral part of the operation of ships.
c) That the language used in tax treaty should be understood in the light of the object and the purpose of this activity. Reliance was placed on the judgment of the Hon'ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan reported in 263 ITR 706 wherein it has been held that tax treaty has to be interpreted in a holistic manner keeping in mind the object and purpose of the treaty. Accordingly, the term 'operation of ship' should be understood in the manner in which it has been defined by the various commentaries. Further, reliance has also been placed on the decision of the Tribunal in the case of Metchem Canada Inc. v. DCIT reported in 100 ITD 251 and Graphite India Ltd. v. Dy. CIT [2003] 86 ITD 384 (Kol.) d) That according to OECD commentary as well as commentary by Klause Vogel, the scope of the term operation of ships is not restricted one but has been understood in a broader sense so as to include chartering of part of ship which is owned as slot chartering and also includes other activities which are incidental to the operation of ships. Therefore, a narrow view canvassed by the revenue cannot be accepted.
14. Alternatively, it is pleaded that the case of the assessee falls under the provisions of Article 9(4) of Indo-US Treaty which exempts income of an enterprise by a contracting state from use, maintenance or rental of containers (including trailers and related equipment for transportation of containers) used for the transport of goods or mercantiles. Admittedly, the assessee has several owned/leased containers which it uses on its chartered vessels or slot basis on vessels of other operators. Thus, the income of the assessee would fall under the aforesaid provisions and consequently, the same cannot be taxed in India. Reliance was also placed on the technical explanation on Article 8(3) of the US Model Convention released by the Treasury department of US.15. The decision of the Tribunal in the case of A.P. Moller Maersk Agency India Pvt. Ltd. 89 ITD 563 relied upon by the revenue is distinguishable for the reasons that the assessee's counsel himself conceded that slot fee constituted to be income derived from operation of ships and therefore, there was no occasion for the Tribunal to adjudicate on this aspect of the issue. Consequently, the said decision cannot be an authority for the proposition that slot charter is not internationally viewed to be core part of international shipping income. It was further pointed out by him that in the above decision the Tribunal held that slot fee can be taxed in India as per Section 44B of the I.T. Act, 1961 which provides for taxation of profits of non-resident shipping companies engaged in the business of operation of ships. This also shows impliedly that slot charter is part of operation of ships.
16. Rival submissions of the parties have been considered carefully in the light of the material placed before us. There is no dispute between the parties before us that the assessee is entitled to the benefit of treaty with reference to freight income qua the transportation of cargo in the international traffic by the ships chartered by the assessee inasmuch as the Assessing Officer himself had allowed such benefit in assessment year 2001-02. However, no such benefit was allowed by the Assessing Officer in assessment year 2002-03 since the assessee could not file evidence regarding ships chartered by it. On appeal, CIT(A) found that the assessee had chartered two ships in this year. The learned DR also has admitted that the assessee is entitled to such benefit with reference to freight income in respect of cargo transported by the assessee by ships chartered by it. The dispute before us is, therefore, restricted to the freight income in respect of cargo transported by the assessee in international traffic by the ships in which slot is hired by it. According to the Revenue, the assessee cannot be said to have earned such income by operating ships while according to the assessee, the business of operation of ships would include income derived from all incidental or auxiliary activities. So the answer to the question centres round the scope of the expression "operation of ships" used in Article 9 of the Indo UK Treaty.
17. The contention of the revenue is that in the absence of any definition, such expression should receive its plain and natural meaning. The expression, if so construed, would not include the transportation of goods by the ships not owned or chartered by it.
According to the learned DR, slot chartering cannot be equated with chartering of complete ship inasmuch as, in the case of slot chartering, the control and possession of ship does not vest in the assessee. On the other hand, the contention of the assessee is that in case of treaties, in the absence of any definition, the expression used in the treaty should be understood in the sense in Which it was understood by the contracting parties at the time when treaty was executed. If so construed, then commentaries on the subject would play a key role in understanding the scope of such expression.
18. At this stage, it would be appropriate to refer to the following observations of their Lordships of the hon'ble Supreme Court in the case of Azadi Bachao Andolan 263 ITR 706 (SC) at pages 751-753.
The principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation.
An important principle which needs to be kept in mind in the interpretation of the provisions of an international, treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. Commenting on the aspect of the matter, David R. Davis in Principles of International Double Taxation Relief, (see David R. Davis, Principles of International Double Taxation Relief, page 4 (London, Sweet and Maxwell 1985), points out that the main function of a Double Taxation Avoidance Treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenue between them in respect of income falling to be taxed in both jurisdictions.
A holistic view has to be taken to adjudge what is perhaps regarded in contemporary thinking as a necessary evil in a developing economy.
In view of the above observations, it is clear that tax treaty between two countries is not to be interpreted in the sense in which a statute is to be interpreted but the treaty is to be interpreted in the sense in which parties to the agreement understand at the time when treaty was signed. This view was also taken by the co-ordinate Bench in the case of Metachem Canada Inc. 100 ITD 251 (Mum) wherein it was observed as under: As the provisions of Article 24(2) of the Indo-Canadian DTAA and the provisions of Article 24(3) of the OECD Model Convention are in pari materia, the OECD Model Convention Commentary has a key role in determining the scope and connotations of Article 24(2) of the Indo-Canadian DTAA.19. We are also aware of the judgment of Hon'ble Supreme Court in the case of P.V.A.L. Kulandagan Chettiar 267 ITR 654 (SC) which is often referred to by the revenue for the following observations made by their Lordships in the penultimate para of the judgment: Taxation policy is within the power of the Government and Section 90 of the Income-tax Act enables the Government to formulate its policy through treaties entered into by it and even such treaty treats the fiscal domicile in one State or the other and thus prevails over the other provisions of the Income-tax Act, it would be unnecessary to refer to the terms addressed in the OECD or in any of the decisions of foreign jurisdiction or in any other agreements.
However it is pertinent to note that in the same judgment, the following observations were also made at the same page: Therefore, the contention advanced by the learned Attorney-General that it is not a part of the treaty cannot be accepted because in the terms of the treaty wherever any expression is not defined the expression defined in the Income-tax Act would be attracted. The definition of 'income' would, therefore, include capital gains.
Thus, capital gains derived from immovable property is income and therefore Article 6 would be attracted.
The above judgment is, therefore, an authority for the proposition that if a particular word or expression is defined in the treaty then the treaty has to be understood in that sense only. If such word or expression is not defined in the treaty but the same has been defined in the local law then it should be understood in accordance with such definition. However, if any word or expression is not defined either in the treaty or under the local law then scope of the same is to be understood in accordance with the rule of contemporaneous thinking as laid down by the apex court in the case of Azadi Bachao Andolan (supra). This aspect of the matter has been recently considered by us in the case of Safamarine Shipping Co. in ITA No. 3701/Mum/2005 vide order dated 18th July, 2008 at para 10 has held as under: 10. Now, we will examine the amount in dispute in the context of DTAA. Both the sides have taken shelter of commentary on Article 8 by OECD and Klause Vogel. At this juncture, it would be relevant to note that the DTAA is the main document and has to be considered for examining the taxability or otherwise of an item of income in the respective States. If the language of DTAA is clear and does not admit of any doubt, there is no need for referring to the OECD Model and commentaries etc. The Hon'ble Supreme Court in CIT v. P.V.A.L.
Kulandagan Chettiar (deed., through legal representatives) has held in penultimate para that "taxation policy is within the power of the Government and Section 90 of the Income-tax Act enables the Government to formulate its policy through treaties entered into by it and even such treaty treats the fiscal domicile in one State or the other and thus prevails over the other provisions of the Income-fax Act. It would be unnecessary to refer to the terms addressed in the OECD or in any of the decisions of foreign jurisdiction or in any other agreements." The review petition filed against this judgement also stands dismissed in (2008) 300 ITR 5 (SC). Under these circumstances, we are of the considered opinion that the commentary on the Model Convention can be taken assistance of only if the language of the treaty is drafted loosely or in an inclusive way or it does not unearth the intention of the Contracting States in a lucid manner.
13. We have considered the rival submissions and perused the relevant material on record. From the language of Article 8 it clearly emerges that the income derived from the operation of ships in international traffic shall also include income from "any other activity directly connected with such transportation". This expression has not been further elaborated in the DTAA in as much as such other activities have not been exhaustively spelt out. Under these circumstances, it is imperative to go by the Commentaries for ascertaining the true purport of this expression.
20. In view of the above discussion it is held that - (i) rule of interpretation for interpreting a statute are not applicable for interpreting the covenants of tax treaties between the contracting states; (ii) the words or expression used in the treaties, if not defined in the treaties itself, should be understood in the sense in which the contracting states understood at the time the treaty was executed i.e. contemporeous thinking; and (iii) contemporeous thinking can be gathered from the provisions of domestic laws of the contracting states and in the absence thereof from the various commentaries available at the time of such contract.
21. In the present case, we are concerned with the scope of the expression 'operation of ships' used in Article 9 of Indo-UK Treoly.
This expression is neither defined in such treaty nor in the Indian Income Tax law as existed at the time when the treaty was executed.
Reference to the provisions of Chapter XIIG in the Income Tax Act, 1961 by the learned Counsel for the assessee has no relevance in ascertaining the contemporeous thinking since this chapter was inserted w.e.f. 1.4.2005. Nothing has been brought to our notice about the domestic law of UK. Thus, contemporaneous thinking can be gathered from the commentaries available at the time of contract. We shall now discuss the same hereafter for determining the scope of the expression operation of ships'.
22. At this stage, it would be appropriate to refer to the provisions of Article 9 of Indo-UK Treaty which reads as under: 1. Income of an enterprise of a Contracting State from the operation of ships in international traffic shall be taxable only in that State.
2. The provisions of paragraph I of this Article shall not apply to income from journeys between places which are situated in a Contracting State.
3. For the purposes of this article, income from the operation of ships includes income derived from the rental on a bareboat basis of ships if such rental income is incidental to the income described in paragraph I of this article.
4. Notwithstanding the provisions of Article 7 (Business profits) of this Convention, the provisions of paragraphs 1 and 2 of this Article shall likewise apply to income of an enterprise of a Contracting State from the use, maintenance or rental of containers (including trailers and related equipment for the transport of containers) used for the transport of goods or merchandise.
5. The provisions of this Article shall apply also to income derived from participation in a pool, a joint business or an international operating agency.
6. Gains derived by an enterprise of a Contracting State from the alienation of ships or containers owned and operated by the enterprise shall be taxed only in that State if either the income from the operation of the alienated ships or containers was taxed only in that State, or the ships or containers are situated outside the other Contracting State at the time of the alienation.
A perusal of the above Article shows that the income from operation of ships is taxable only in the state of residence. Article 3 which contains various definitions of the words used in the treaty does not define the expression 'operation of ships'. Thus, in the absence of any definition under the domestic law of either of the contracting States as discussed earlier, the guidance can be taken from the OECD commentary wherein the scope of such expression has been discussed vide para Nos. 4 to 14. The same are being reproduced as under: 4. The profits covered consist in the first place of the profits directly obtained by the enterprise from the transportation of passengers or cargo by ships or aircraft (whether owned, leased or otherwise at the disposal of the enterprise) that it operates in international traffic. However, as international transport has evolved, shipping and air transport enterprises invariably carry on a large variety of activities to permit, facilitate or support their international traffic operations. The paragraph also covers profits from activities directly connected with such operations as well as profits from activities which are not directly connected with the operation of the enterprise's ships, or aircraft in international traffic as long as they are ancillary to such operation.
4.1 Any activity carried on primarily in connection with the transportation, by the enterprise, of passengers or cargo by ships or aircraft that it operates in international traffic should be considered to be directly connected with such transportation.
4.2 Activities that the enterprise does not need to carry on for the purposes of its own operation of ships or aircraft in international traffic but which make a minor contribution relative to such operation and are so closely related to such operation that they should not be regarded as a separate business or source of income of the enterprise should be considered to be ancillary to the operation of ships and aircraft in international traffic.
4.3 In light of these principles, the following paragraphs discuss the extent to which paragraph J applies with respect to some particular types of activities that may be carried on by on enterprise engaged in the operation of ships or aircraft in international traffic.
5. Profits obtained by leasing a ship or aircraft on charter fully equipped, crewed and supplied must be treated like the profits from the carriage of passengers or cargo. Otherwise, a great deal of business of shipping or air transport would not come within the scope of the provision. However, Article 7, and not Article 8, applies to profits from leasing a ship or aircraft on a bare boat charter basis except when it is an ancillary activity of an enterprise engaged in the international operation of ships or aircraft.
6. Profits derived by an enterprise from the transportation of passengers or cargo otherwise than by ships or aircraft that it operates in international traffic are covered by the paragraph to the extent that such transportation is directly connected with the operation, by that enterprise, of ships or aircraft in international traffic or is an ancillary activity. One example would be that of an enterprise engaged in international transport that would have some of its passengers or cargo transported internationally by ships or aircraft operated by other enterprises e.g., under code-sharing or slot-sharing arrangements or to take advantage of an earlier sailing. Another example would be that of an airline company that operates a bus service connecting a town with its airport primarily to provide access to and from that airport to the passengers of its international flights.
7. A further example would be that of an enterprise that transports passengers or cargo by ships or aircraft operated in international traffic which undertakes to have those passengers or that cargo picked up in the country where the transport originates or transported or delivered in the country of destination by any mode of inland transportation operated by other enterprises. In such a case, any profits derived by the first enterprise from arranging such transportation by other enterprises are covered by the paragraph even though the profits derived by the other enterprises that provide such inland transportation would not be.
8. An enterprise will frequently sell tickets on behalf of other transport enterprises at a location that it maintains primarily for purposes of selling tickets for transportation on ships or aircraft that it operates in international traffic. Such sales of tickets on behalf of other enterprises will either be directly connected with voyages aboard ships or aircraft that the enterprise operates (e.g.
sale of a ticket issued by another enterprise for the domestic leg of an international voyage offered by the enterprise) or will be ancillary to its own sales. Profits derived by the first enterprise from selling such tickets are therefore covered by the paragraph.
8.1 Advertising that the enterprise may do for other enterprises in magazines offered aboard ships or aircraft that it operates or at its business locations (e.g. ticket offices) is ancillary to its operation of these ships or aircraft and profits generated by such advertising fall within the paragraph.
9. Containers are used extensively in international, transport. Such containers frequently are also used in inland transport. Profits derived by an enterprise engaged in international transport from the lease of containers are usually either directly connected or ancillary to its operation of ships or aircraft in international traffic and in such cases fall within the scope of the paragraph.
The same conclusion would apply with respect to profits derived by such an enterprise from the short-term storage of such containers (e.g. where the enterprise charges a customer for keeping a loaded container in a warehouse pending delivery) or from detention charges for the late return of containers.
10. An enterprise that has assets or personnel in a foreign country for purposes of operating its ships or aircraft in international traffic may derive income from providing goods or services in that country to other transport enterprises. This would include (for example) the provision of goods and services by engineers, ground and equipment-maintenance staff, cargo handlers, catering staff and customer services personnel. Where the enterprise provides such goods to, or performs services for, other enterprises and such activities are directly connected or ancillary to the enterprise's operation of ships or aircraft in international traffic, the profits from the provision of such goods or services to other enterprises will fall under the paragraph.
10.1 For example, enterprises engaged in international transport may enter into pooling arrangements for the purposes of reducing the costs of maintaining facilities needed for the operation of their ships or aircraft in other countries. For instance, where an airline enterprise agrees, under an International Airlines Technical Pool agreement to provide spare parts or maintenance services to other airlines landing at a particular location (which allows it to benefit from these services at other locations), activities carried on pursuant to that agreement will be ancillary to the operation of aircraft in international traffic.
12. The paragraph does not apply to a shipbuilding yard operated in one country by a shipping enterprise having its place of effective management in another country.
14. Investment income of shipping or air transport enterprises (e.g.
income from stocks, bonds, shares or loans) is to be subjected to the treatment ordinarily applied to this class of income, except where the investment that generates the income is made as an integral part of the carrying on of the business of operating the ships or aircraft in international traffic in the Contracting State so that the investment may be considered to be directly connected with such operation. Thus, the paragraph would apply to interest income generated, for example, by the cash required in a Contracting State for the carrying on of that business or by bonds posted as security where this is required by law in order to carry on the business: in such cases, the investment is needed to allow the operation of the ships or aircraft at that location. The paragraph would not apply, however, to interest income derived in the course of the handling of cash-flow or other treasury activities for permanent establishments of the enterprise to which the income is not attributable or for associated enterprises, regardless of whether these are located within or outside the Contracting State, or for the head office (centralisation of treasury and investment activities), nor would it apply to interest income generated by the short-term investment of the profits generated by the local operation of the business where the funds invested are not required for that operation.
23. Let us now consider whether freight income of the assessee on account of transportation of cargo in international traffic through slot charter arrangement by the ships operated by other enterprises can be said to be profits from operation of ship under Article 9 of Indo-UK Treaty in view of the OECD Commentary. Perusal of paragraph A of the said commentary shows that two kinds of profits are covered by Article 8 of OECD Commentary which is similarly worded. In the first category are those profits which are directly obtained by the enterprise from the transportation of cargo/passengers in the international traffic by the ships whether owned or leased or at the disposal of such enterprise. It also covers profits from activities directly connected with such operation. In the second category are the profits from the activities which are not directly connected with operation of ship but are ancillary to such operation. Paragraph 4.2 defines the scope of ancillary activities. According to this para, ancillary activity is that activity which makes a minor contribution relative to the activity of operation of ship and such activity must be so closely related that it should not be regarded as separate business or source of income.
Paragraphs 5 onwards discuss about various activities to which paragraph 1 can be applied. Paragraph 6 covers the profits derived by an enterprise from the transportation of passengers/cargo otherwise than by ships that it operates in the international traffic to the extent such transportation is directly covered with the operation of ships in the international traffic by that enterprise. This covers a situation where the assessee is unable to transport the passengers/cargo from its own ship but transports the same through ships operated in international traffic operated by the other enterprises. This has been explained by giving an example also.
According to this example, some of the passengers/cargo may be transported internationally by ships operated by other enterprises under slot chartering arrangement. In our view, this paragraph would cover the fact of the present case since the assessee not only transports its cargo through the ships chartered by it but also transports the cargo in the international traffic by the ships operated by other enterprises under slot chartering arrangement. Since Article 8 of OECD Model Convention and Article 9 of Indo-UK Treaty are similarly worded, Paragraph 6 of OECD Commentary discussed above would apply in defining the scope of Article 9(1) of Indo-UK Treaty as per the rule of contemporaneous exposition discussed in the earlier part of the order.
Accordingly it is held that the freight income earned by the assessee on account of transportation of cargo in the international traffic by ships operated by other enterprises under slot chartering arrangement would be taxable only in the state of residence and consequently, such income would be exempt from taxation under the Indian Income-tax Law.
24. Before parting with this order, we would like to mention that the reason given by the CIT(A) for granting relief to the assessee is not in conformity with the OECD commentary. The test laid down by him was whether the activity carried on by the assessee forms part of main business of operation of ships or was a separate and distinct business (page 10 of the order of the CIT(A) for the assessment year 2002-03).
As already discussed, Article 9(1) of Indo-UK Treaty would include either the direct activity i.e. operation of ships or the ancillary activity. The concept of two activities constituting the same business as applied by the learned CIT(A) is not the criteria for bringing the case of the assessee under Article 9(1) of the Treaty. The case of the assessee would fall under Article 9(1) if it is found that activity is either directly connected or incidental to the main activity. Hence the reason given by the learned CIT(A) is hereby vacated.
25. However, we are in agreement with the final conclusion arrived at by him for the reason given by us in the preceding para.
26. In view of the above discussion, the orders of CIT(A) are upheld though for different reasons.
27. Since the orders of the learned CIT(A) are upheld, the cross objections filed by the assessee have become infructuous.
28. In the result, the appeals filed by the revenue and the cross objections by the assessee are dismissed.