Swiss tax treaty benefits not to apply to shipping profits: Recent advance ruling
In a recent decision, the Authority for Advance Rulings (“AAR”) has held that profits derived from the transportation of ships in international traffic are not covered under the double tax avoidance agreement between India and the Swiss Federation.1 Such profits earned by a resident of Switzerland from Indian sources would, however, be taxable under the Income Tax Act, 1961 (“ITA”).
The taxpayer, Gearbulk AG is a Swiss resident engaged in the business of transporting cargo worldwide and in this connection, enters into agreements with port agents, brokers and stevedores. During the years 2007-2009, Gearbulk chartered a Dubai based shipping company for the purpose of transporting goods from India to China. From the profits derived by it, a commission was paid to the Dubai company and a UK based broker. Gearbulk sought an advance ruling on the taxation of these profits under the provisions of the India-Swiss tax treaty.
The ITA prescribes a special presumptive tax regime for profits generated from a shipping business that differs from the ordinary framework for taxation of business profits.2 Under this regime, 7.5% of the shipping revenues is deemed to be the taxable profits. Such notional profits would be taxed at the applicable rate (which is 42%, for non-resident companies). The taxpayer may also opt to be taxed under the ordinary regime, where the taxable profits would be calculated after taking into account various available deductions. The taxation of such profits may also differ depending on the beneficial provisions of an applicable tax treaty.
In several treaties, apart from the ‘business profits’ Article, there is a separate provision dealing with the taxation of profits derived from the transportation of ships in international traffic. Such profits are usually taxable in the country of residence of the shipping enterprise. The India-Swiss tax treaty (“Treaty”), however, does not separately provide for the taxation of shipping profits. Further, the ‘business profits’ Article specifically excludes profits from the operation of ships in international traffic.3
Gearbulk argued that due to the absence of a separate provision for shipping profits and the exclusion from the ‘business profits’ Article, such profits would be taxable under the provisions of the Treaty dealing with ‘other income’. The ‘other income’ Article of the Treaty is a residuary provision covering forms of income that are not dealt with under the other Articles of the Treaty.4 Such income would be taxable only in the country of residence of the taxpayer unless any part of it is attributable to a permanent establishment (“PE”) of the taxpayer in the source country. Accordingly, Gearbulk sought to establish that since it did not have a PE in India, the income earned by it from its shipping operations would not be taxable in India.
The AAR rejected Gearbulk’s views on the basis that from an overall reading of the Treaty, it was clear that shipping profits were not intended to be covered under the Treaty. According to the AAR, shipping profits were dealt with under the ‘business profits’ Article in the form of a specific exclusion. Hence, profits of this nature would not be covered under the residuary Article. The AAR also noted that the residuary Article was incorporated into the Treaty at a later point in time. The exclusion of shipping profits from the scope of the ‘business profits’ Article indicated that there was never an intention to extend Treaty benefits to profits derived from the operation of ships in international traffic. Making a reference to other tax treaties signed by India, the AAR concluded that wherever it was intended cover shipping profits, separate provisions have been made to this effect in the treaties.
Since the profits earned by Gearbulk were not covered under the Treaty, the AAR held that such profits would be taxable in India under the provisions of the ITA. The issue of the existence of a PE in India consequently did not arise.
The ruling brings out interesting issues relating to the role of a contracting party’s intention in treaty interpretation and the extent to which such intention can be discerned from the plain words of the treaty. Considering that a treaty has a separate provision dealing with taxes covered, which in the India-Swiss Treaty includes income tax charged under the ITA, the treaty should logically also cover income tax levied under the ITA on shipping profits. It may also be argued that the incorporation of the ‘other income’ article in the Treaty was specifically aimed at capturing streams of income such as shipping profits that are otherwise not covered by the Treaty. Further, since the object of the Treaty is to eliminate double taxation, it may be useful to re-examine the overall scope of the treaty before making any exclusion.