Non-Discrimination Clause in US-France Tax Treaty of 1967 - Square D Co & Subsidiaries v Commissioner of IRS (US Court of Appeals - 7th Circuit)

            In Square D Company and Subsidiaries v Commissioner of the Internal Revenue Service, the 7th Circuit of the United States Court of Appeal had occasion to deal, inter alia, with the Non-Discrimination Clause in the US-France Tax Treaty of July 28, 1967.

            Facts

2.         Square D Company, a US Corporation with a French parent, claimed to deduct certain amounts of interest payable by Square D to its French parent, in the years in which such amounts accrued, i.e., in 1991 and 1992, in the face of Treasury Regulation § 1.267(a)-3, which provides for the cash method of accounting for deductions for payments to foreign related persons.

3.         Square D rested its claim on two grounds :

(i)     Treas. Reg. § 1.267(a)-3 constituted a flawed interpretation of the statutory mandate contained in Internal Revenue Code ("IRC") § 267(a)(3) and was invalid. [ IRC § 267(a)(3) provides that the "Secretary shall by regulations apply the matching principle of [§ 267(a)(2)] in cases in which the person to whom the payment is to me is not a United States person.". ]

(ii)     Alternatively, Treas. Reg. § 1.267(a)-3 violated the Non-Discrimination Clause of the US-France Tax Treaty of July 28, 1967.

[ The Non-Discrimination Clause ran thus :

"A corporation of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation which is other or more burdensome than the taxation and connected requirements to which a corporation of that first-mentioned Contracting State carrying on the same activities, the capital of which is wholly owned by one or more residents of the first-mentioned State, is or may be subjected.".

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            Reasoning and Decision

4.         Upholding the decision of the Court below (viz., the Tax Court), the 7th Circuit held that the Commissioner properly concluded that Square D had to take deductions for payments to a foreign related party on the cash method, rather than on the accrual method. The 7th Circuit's rulings on the 2 grounds aforesaid raised by Square D are as follows :

(i)     On the validity of Treas. Reg. § 1.267(a)-3 :

Treas. Reg. § 1.267(a)-3, on which the Commissioner relied, was a reasonable interpretation of ambiguous statutory provisions and was hence a valid provision.

(ii)     On whether Treas. Reg. § 1.267(a)-3 was violative of the Non-Discrimination Clause in the US-France Tax Treaty of 1967 :

"..... In order to violate a nondiscrimination clause in a treaty, the additional burden must be directed at nationality. See Klaus Vogel, Klaus Vogel on Double Taxation Conventions 1290 (3d ed. 1997). Put differently, "discrimination against foreign-owned subsidiaries is all that the nondiscrimination clause at issue protected against." See Union BanCal Corp., 305 F.3d at 986. Such discrimination is absent here. The regulation requires that all interest payments to a foreign related party must use the cash method of accounting without regard to the nationality of the owner. The regulation does not impose the cash method simply because of foreign ownership, which would be prohibited, but rather for payments to a foreign related party. Even if a corporation were owned by a United States parent, it still appears all interest payments to one of these foreign related parties would lead to the use of the cash method. The requirement, therefore, hinges on the nationality of the related party to whom the payment goes and does not fluctuate based on nationality of the ultimate owner. It is merely fortuitous that, in this case, the foreign related party to which the payment was made also happened to be the owner. The regulation does not discriminate based on foreign ownership, and thus, does not violate the nondiscrimination clause.".

(All emphases in the original, except that of the portion commencing with the words "Even if" and ending with the words "ultimate owner".)

Comment : In an opinion which is otherwise extremely carefully crafted, what is intriguing in the portion emphasised by me above, is the employment of the expression "it still appears" and, more particularly, the word "appears". One would have thought that the conclusion from the relevant statutory provisions is clear, i.e., that even a US corporation with a US parent can deduct interest payable to a foreign related party only on the cash basis. However, the employment of the said expression (and in it the word "appears") would indicate that the Court is in some doubt as to the correctness of this conclusion. If, therefore, by employing that expression, the Court is saying that it is possible that a US corporation with a US parent can deduct interest payable to a foreign related party  when such interest accrues,   then,   surely,   no clearer case of discrimination between such a corporation and a US corporation with a foreign parent such as Square D can cogently be made out !!

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OECD - TAG's Final Report - Are Current Treaty Rules for Taxing Business Profits E-Commerce Compatible ?

          The  Technical Advisory Group on Monitoring the Application of Existing Treaty Norms for Taxing Business Profits ("TAG")  of the  Organisation for Economic Co-operation and Development ("OECD")  has just released its  Final Report  on  "Are the Current Treaty Rules for Taxing Business Profits Appropriate for E-Commerce ?"

Marks & Spencer plc v David Halsey (Her Majesty's Inspector of Taxes) (Judgment dated December 13, 2005 of European Court of Justice in Case C-446)

          By a long-awaited judgment delivered on Tuesday, December 13, 2005 in Marks & Spencer plc v David Halsey (Her Majesty's Inspector of Taxes), the European Court of Justice has ruled as follows on the 2 questions raised in the case :

Question No 1 :
1) In circumstances where:
– Provisions of a Member State, such as the United Kingdom provisions on group relief, prevent a parent company which is resident for tax purposes in that State from reducing its taxable profits in that State by setting off losses incurred in other Member States by subsidiary companies which are resident for tax purposes in those States, where such set off would be possible if the losses were incurred by subsidiary companies resident in the State of the parent company;

– The Member State of the parent company:

– subjects a company resident within its territory to corporation tax on its total profits, including the profits of branches in other Member States, with arrangements for the availability of double taxation relief for those taxes incurred in another Member State and under which branch losses are taken account of in those taxable profits;

– does not subject the undistributed profits of subsidiaries resident in other Member States to corporation tax;

– subjects the parent company to corporation tax on any distributions to it by way of dividend by the subsidiaries resident in other Member States while not subjecting the parent company to corporation tax on distributions by way of dividend by subsidiary companies resident in the State of the parent;

– grants double taxation relief to the parent company by way of a credit in respect of withholding tax on dividends and foreign taxes paid on the profits in respect of which dividends are paid by subsidiary companies resident in other Member States;

is there a restriction under Article 43 EC, in conjunction with Article 48 EC? If so, is it justified under Community law ?

Court's Ruling :
59 Accordingly, the answer to the first question must be that, as Community law now stands, Articles 43 EC and 48 EC do not preclude provisions of a Member State which generally prevent a resident parent company from deducting from its taxable profits losses incurred in another Member State by a subsidiary established in that Member State although they allow it to deduct losses incurred by a resident subsidiary. However, it is contrary to Articles 43 EC and 48 EC to prevent the resident parent company from doing so where the non-resident subsidiary has exhausted the possibilities available in its State of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods and where there are no possibilities for those losses to be taken into account in its State of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party.

Question No 2 :
2) (a) What difference, if any, does it make to the answer to Question 1 that, depending on the law of the Member State of the subsidiary, it is or may be possible in certain circumstances to obtain relief for some or all of the losses incurred by the subsidiary against taxable profits in the State of the subsidiary?

(b) If it does make a difference, what significance, if any, is to be attached to the fact that:

– a subsidiary resident in another Member State has now ceased trading and, although there is provision for loss relief subject to certain conditions in that State, there is no evidence that in the circumstances such relief was obtained;

– a subsidiary resident in another Member State has been sold to a third party and, although there is provision under the law of that State for the losses to be used under certain conditions by a third party purchaser, it is uncertain whether they were so used in the circumstances of the case;

– the arrangements under which the Member State of the parent company takes account of the losses of UK resident companies apply regardless of whether the losses are also relieved in another Member State?

(c) Would it make any difference if there were evidence that relief had been obtained for the losses in the Member State in which the subsidiary was resident and, if so, would it matter that the relief was obtained subsequently by an unrelated group of companies to which the subsidiary was sold?

Court's Ruling :
60 In the light of the answer to the first question, there is no need to answer the second question.

Sanjeev Woollen Mills v CIT (SC) - Valuation of Closing Stock at Market Value - Validity of Tax Officer's Invocation of 1st Proviso to Section 145(1)

          In  Sanjeev Woollen Mills v CIT, the question before the Supreme Court of India was whether, in a case in which the taxpayer had valued its closing stock of finished goods at market value, the Assessing Officer had jurisdiction to invoke and apply the first proviso to Section 145(1) of the (Indian) Income-tax Act, 1961 [ i.e., Section 145(1) as it stood prior to its amendment with effect from April 1, 1997 by the Finance Act, 1995 ], on the ground that, in the opinion of the Assessing Officer, the income of the taxpayer could not properly be deduced from such method of valuation.

2.          By a judgment dated November 24, 2005, P P Naolekar, J, speaking for the Court, held as follows :

(i)     The recognized and settled accounting practice is that closing stock "..... has to be valued on the cost basis or at the market value basis if the market value of the stock is less than the cost value.".

(ii)     In the instant case, the taxpayer had not adopted the "established and settled practice" (i.e., the accounting practice aforesaid), inasmuch as the market value of the closing stock had been taken into consideration while arriving at the chargeable income although such market value was greater than the cost thereof.

(iii)     Since there was no transfer of the goods constituting the closing stock, having regard to the fact that such closing stock constituted the opening stock of the succeeding year, the "..... profit earned is only notional.".

(iv)     Income (i.e., the "notional" profit aforesaid) which has not been "derived at by the assessee" cannot be said to be income chargeable to tax.

(v)     Consequently, the "..... rejection of the accounts maintained by the assessee for the valuation of the closing stock by the assessing officer and confirmed by the High Court ....." was in accordance with law.

(vi)     Accordingly, the "..... power exercised by the assessing officer under Section 145 (being) as per the principles enunciated by various authorities and the courts .....", there was no good or sufficient reason to interfere with the order passed by the High Court.

3.          The Court, therefore, dismissed the taxpayer's appeal.

Sedco Forex International Drill, Inc v CIT (SC) - Salary paid outside India for field break in the UK NOT taxable in India

           In an important judgment delivered on November 17, 2005 in Sedco Forex International Drill, Inc v CIT, the Supreme Court has, reversing the judgment of the Uttaranchal Pradesh High Court, held that the salaries paid outside India (i.e., in the United Kingdom) by the Appellant-taxpayer to its employees (who were tax residents of the United Kingdom) in respect of periods of "field break(s)" undertaken outside India (i.e., in the United Kingdom) (which employees had, prior to undergoing such "field break(s)", rendered services in India under a wet lease of oil rigs by the Appellant-taxpayer to the Oil and Natural Gas Commission, India) were not chargeable to Indian income-tax in the hands of the concerned employees under Section 9(1)(ii) of the Income-tax Act, 1961 ("Act"), inasmuch as such salaries were not paid for "service rendered in India".

2.           The Supreme Court held that the first clause in the contracts entered into by the Appellant-taxpayer with the concerned employees relating to the payment of salaries for services to be rendered in India was distinct from the second clause relating to the payment of salaries for the "field break(s)". While the first clause clearly fell within the extended meaning given to the words "earned in India" in Section 9(1)(ii) of the Act, the second clause did not; accordingly, since the phrase "earned in India" is part of the statutory fiction created by Section 9(1)(ii), "(t)here is no question of introducing a further fiction by extending the Explanation" (i.e., the Explanation to that Section as such Explanation stood prior to its amendment with effect from April 1, 2000) "to include whatever has a possible nexus with service in India.". (emphases supplied)

3.           Although the High Court had not referred to the 2000 amendment to the Explanation aforesaid, the Supreme Court proceeded to deal with the question of whether such Explanation was clarificatory in nature and hence applicable with retrospective effect from the date on which the provision [Section 9(1)(ii)] to which it was an Explanation came into force, since that question was raised by the Respondent-Revenue. The Court ruled against the Revenue on this issue by holding that "(w)hen the Explanation seeks to give an artificial meaning (to the phrase) 'earned in India' and bring about a change effectively in the existing law and in addition is stated to come into force with effect from a future date, there is no principle of interpretation which would justify reading the Explanation as operating retrospectively.". (emphasis supplied)

Discussion Paper on Tax Avoidance and Section 103 of the (South African) Income Tax Act, 1962 - South African Revenue Service

The South African Revenue Service ("SARS") has recently posted on its website, a "Discussion Paper on Tax Avoidance and Section 103 of the Income Tax Act, 1962 (Act No 58 of 1962)". The Background to, and the Purpose of, the Discussion Paper are best described in the following extract from the Introduction to the Paper :

"Section 103 of the Income Tax Act, 1962 (Act No. 58 of 1962), contains the Act's General Anti-Avoidance Rule (GAAR). In its current form, the GAAR has proven to be an inconsistent and, at times, ineffective deterrent to the increasingly complex and sophisticated tax "products" that are being marketed by banks, "boutique" structured finance firms, multinational accounting firms and law firms. ..... The pernicious effects of aggressive tax avoidance are manifold. They include not only the obvious short-term revenue loss, but longer term damage to the tax system and economy as well. These other effects include a corrosive effect upon the taxpayer compliance, the uneconomic allocation of resources, upward pressure on marginal tax rates, an unfair redistribution of the tax burden, and a weakening of the ability of Parliament and National Treasury to set and implement economic policy. Both SARS and National Treasury firmly believe that the vast majority of South Africans are honest, hard working and willing to pay their fair share of tax. ..... Unfortunately, those who engage in impermissible tax avoidance pose a problem for everyone else. It is the purpose of this Paper to start a discussion of these issues and of how best to address them on behalf of all South African taxpayers ..... ."

(emphasis supplied)

2. The Discussion Paper is a veritable treasure-trove of resources and materials on Tax Avoidance and has annexed to it, inter alia, the Australian GAAR, the Canadian GAAR, the New Zealand GAAR and the Spanish Anti-Avoidance Rule.

German Remedies Ltd v DyCIT (Bom) - Duty of Authority Granting Sanction under Section 151 of Income-tax Act, 1961

By a judgment dated October 28, 2005 in the case of German Remedies Ltd v DyCIT (in Writ Petitions No 621 of 2005 and 619 of 2005), the Bombay High Court has held that, while granting sanction under Section 151 of the Income-tax Act, 1961 ("Act") for the issue of a Notice under Section 148 of the Act [ for reopening an income-tax assessment under Section 149(1)(b) of the Act ], it was obligatory on the part of the the sanctioning income-tax authority to --

(i) "..... verify whether there was any failure on the part of the assessee to disclose full and true relevant facts in the return of income filed for the assessment of income of that assessment year ....." and

(ii) "..... consider whether or not power to reopen is being invoked within a period of 4 years from the end of the assessment year to which they relate .....".

2. Since, in the above case, the sanctioning income-tax authority had failed to carry out its obligations aforesaid, the High Court held that such failure was "..... sufficient to justify the contention raised by the petitioner that the approval granted suffers from non-application of mind .....". Accordingly, on account of such failure as also for other reasons, the High Court quashed and set aside the Notices issued under Section 148.