Non-enforceability of Multilateral Instrument for Tax Treaty benefit denial without valid notification

The Assessee, tax resident of Ireland, entered into dry operating leasing agreements with airline operator based in India. The Assessee’s claim in the Tax return based on the beneficial treatment under the India-Ireland Double Taxation Avoidance Agreement (DTAA/Tax treaty) was refuted by the Tax Authorities by invoking Articles 6 and 7 of the Multilateral Instrument (MLI) asserting principal purpose of the Assessee’s incorporation in Ireland was obtaining benefits of India-Ireland DTAA.

The Hon’ble Mumbai Tribunal observed that the revenue’s arguments that Articles 6 and 7 (i.e., the Principal Purpose Test (PPT) suite) automatically apply since the MLI has been duly notified and the India-Ireland DTAA is a ‘Covered Tax Agreement’ were contrary to the Revenue’s own description of the MLI that it “modifies existing treaties”.

The Tribunal relied on the dicta laid down by the Hon’ble Supreme Court  in Assessing Officer (International Taxation) v. Nestle SA [2023] [2023] 458 ITR 756 (SC)(Nestle Ruling) , wherein the Hon’ble Supreme Court was faced with a situation where the taxpayers sought to invoke the “Most Favoured Nation” clauses contained in earlier DTAAs in order to import into those treaties certain more favourable provisions contained in subsequent DTAAs with other Organization for Economic Co-operation and Development (OECD) member states. In this case, revenue was rebutting the taxpayer’s contention that the MFN clause operated automatically once the latter DTAA was notified. The Supreme Court in the said case held that: The notification of the subsequent DTAA does not ipso facto and automatically lead to amendment of the earlier DTAA. A notification under section 90(1) is necessary and a mandatory condition for a court, authority, or Tribunal to give effect to a Double Taxation Avoidance Agreement, or any protocol changing its terms or conditions, which has the effect of altering the existing provisions of law.

Applying the ratio laid in the Nestle Ruling to the present case, Hon’ble Tribunal rejected the revenues arguments and held that merely notifying the MLI or identifying India-Ireland DTAA as a Covered Tax Agreement would not suffice.

The Tribunal further observed that synthesised text which incorporates the MLI provisions into the covered tax agreement is nothing more than an expository compilation intended to facilitate understanding and in the absence of a mandatory separate notification for the MLI-based modifications such synthesised text cannot be treated as a source of enforceable law.

The Tribunal, without prejudice to above findings, chose to examine the said structure assuming that Article 6 and 7 of the MLI were applicable to the present facts for sake of completeness and to examine if the lower authorities had discharged their burden under PPT. The Tribunal observed that the that the Assessee, which was managed by duly licensed management company, Apex Group Limited in Ireland and held that the conclusion that the principal purpose of the Assessee’s incorporation was to obtain India-Ireland DTAA benefits is unsustainable based on the following:

1. Irish Tax Authorities have issued a Tax Residency (TRC) to the assessee and inconceivable to presume that Irish tax authorities are not familiar with the principal purpose test and have issued TRCs without application of mind. In the absence of very compelling reasons, the TRC will be presumed to be valid grounds for allowing benefits of the India-Ireland DTAA even after notification of MLI.

2. The true enquiry is whether one of the principal purposes of entering into the relevant arrangement or transaction was to obtain that treaty benefit, divorced from genuine commercial considerations.

3. The PPT under the MLI cannot be read so broadly as to imply that treaty benefits must automatically be denied in every case where the ultimate parent entity of the taxpayer happens to be resident in a third country. Bona fidecommercial investments are meant to be protected and the PPT does not seek to impair them.

4. The Irish entity had been established and maintained to carry out substantive commercial functions, that it was adequately staffed with personnel, that it incurred genuine expenditure in the ordinary course of its business. The choice of Ireland was driven by the broader aviation ecosystem and Ireland’s well-known leasing infrastructure, rather than by an India-specific intention to access the India-Ireland DTAA. 

Conclusion

The judgement clarifies the ambiguity with respect to the application of MLI to the Covered Tax Agreement and applied the very the principle laid down by the Hon’ble Supreme Court in the Nestle Ruling  to negate the Departments stance and it further reaffirms that PPT evaluation is a granular  exercise which takes into account various business/commercial considerations.