Tax treaties under scanner as Australia court says Tech Mahindra to be taxed

MUMBAI: The fundamental feature of tax treaty — a bilateral pact between two countries to resolve issues of double taxation — has come under question. According to a ruling by the Federal Court of Australia, the payments received by an Indian company from its clients in Australia will be taxed in Australia. The Australian superior court has treated such payments as ‘royalty’ — which can be taxed, even though such proceeds cannot be taxed under local Australian laws.

The verdict — relating to one of India’s leading companies Tech Mahindra — goes against the underlying tenet of tax treaties which, as is widely accepted, should be used as shield for the taxpayer and not as sword by the taxman. A tax treaty is used to provide relief and not aimed at imposing tax.

“It’s an accepted principle that standalone provision in a treaty does not give the power to impose tax. On the other hand, whenever treaty provisions are beneficial than the provisions in the tax laws, then only the treaty provisions apply. Not only will the ruling apply to all companies providing software services to Australia but could influence other countries to take a similarly aggressive stand by interpreting treaty provision to tax an amount,” said senior chartered accountant Dilip Lakhani.


Since this stand by the court stems from provisions of the treaty (and not local laws), the two countries may not be able to sit across the table to sort it out as is possible under the ‘mutual agreement procedure’ of a tax treaty, said Lakhani.

According to Hitesh D Gajaria, partner & head of tax, KPMG (India), “One will need to wait and see if judicial thinking in other countries supports the view canvassed by Australian federal court.”

Unless an Indian company derives significant tax advantage by operating from special economic zones, such court rulings would not impact its profitability; the tax paid abroad (in this case, Australia) would be offset by a lower tax outgo in India, as per the double taxation avoidance agreement between the two countries.

The services provided by Tech Mahindra were partly performed by employees located in Australia and partly by its staff in India. It’s the payments received for services provided by employees in India that was the subject matter of dispute. The company argued that while the Australia has the right to tax the royalties in line with the bilateral treaty, such a right can be exercised only if Australia has the right to tax such amounts under its local law. Since Australia’s domestic law does not give such right, no tax can be levied in Australia by treating the payments as royalties. The argument was rejected by the Australian court.

“It was good of TechM to raise the issue of the interpretation that the tax treaty can fasten a tax charge even when the domestic law did not support such a tax charge. The position in India as interpreted by the highest court has always been that the tax treaty cannot fasten any additional charge, when the domestic law does not bring such income in the purview of its own taxing rights. However, the Federal Court of Australia has interpreted that the tax treaty itself deems such income as also being chargeable to tax in Australia,” said Gajaria.

Japan too interprets its treaty with India to tax payments made by Japanese entities to Indian software companies. “However, an Indian tax appellate authority has taken a contrary view in a related matter.

In the case of Sumitomo Mitsui Banking Corporation, a special bench of Mumbai ITAT had held that Article 23 of the tax treaty between India and Japan cannot be interpreted by Indian IT department to tax the interest earned by the head-office in Japan because under Indian law the said amount is not taxable in India,” said Lakhani. But no such dispute has boiled over to any Japanese court.

The Australian Federal Court has analysed the provisions of tax treaty between India and Australia, International Tax Agreement Act’53, and the Indian and Australian tax laws.