International tax conventions, deals: SC says role of state more of an implementer than an interpreter

ISLAMABAD: The Supreme Court held that international tax conventions or agreements or treaties are of a special nature and the role of a state is more of implementing the terms of such agreement rather than that of interpreting them in a unilateral manner.

The judgment authored by Justice Syed Mansoor Ali Shah settled the primary issue of interpretation of international taxation treaties for the avoidance of double taxation under Pakistani jurisdiction.

A three-judge bench, headed by Chief Justice Umar Ata Bandial, and comprising Justice Syed Mansoor Ali Shah and Justice Munib Akhtar ruled that on the appeal of Snamprogetti Engineering BV, which entered into an engineering contract with Engro Chemicals Pakistan Limited to provide “engineering services” for the plants and for the procurement of spare parts regarding the project, i.e., construction of a fertiliser complex at Daharki, district Ghotki, Pakistan.

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The paragraph 7 of the judgment mentioned that international tax conventions or agreements or treaties are of a special nature and the role of a state (being party to such a bilateral agreement) is more of implementing the terms of such agreement rather than that of interpreting the same and that too in a unilateral manner.

Treaty interpretation rules differ from domestic tax rules for the following among other reasons: a) as international treaties, the VCLT governs double tax agreements. Therefore, their interpretation is based on the rules of interpretation under customary international law. As these principles and procedures of interpretation of agreements differ from rules applied to domestic legislation, an interpretation under the domestic law as a taxing statute may be misleading and unsuitable;

b) Unlike the domestic law which contains highly technical legislative language relevant to a specific jurisdiction, tax treaties are based on the mutual understanding among two or more contracting states. Moreover, more than one language may be involved. They must be applied by the tax authorities and the courts in each contracting state in uniform way (common interpretation) that may differ from the domestic laws and practices in each state;

c) Tax treaties are primarily relieving in nature and do not impose tax, while the domestic tax law seeks to impose tax in specific circumstances. A treaty specifies general taxing principles to avoid double taxation. Moreover, as the life of a treaty can be long it must be flexible enough to adapt to changes in the domestic law while continuing to reflect the original negotiated balance of obligations and concessions;

d) Tax treaties tend to be less precise and require a broad purposive “substance over form” interpretation. Therefore, they are often interpreted more liberally than domestic law in the context of their object and purpose. On the other hand, in states that prefer a liberal, purposive interpretation of their domestic law, the interpretation of the tax treaties may be stricter under the statutes.

In both cases, a neutral interpretation and common understanding requires the use of an international fiscal language, which may not be found in the domestic laws and may provide a definition quite independent from domestic laws;

Treaty interpretation is a subject in itself and not merely an extension of statutory interpretation despite the fact that treaties may be enforceable only when made part of the domestic law under a statute in certain countries.

Treaty interpretation is a subject in itself and not merely an extension of statutory interpretation despite the fact that treaties may be enforceable only when made part of the domestic law under a statute in certain countries. Therefore, tax treaties should be kept as free as possible from the interpretation rules under domestic law, unless specified in the treaty itself.

The guidelines, which represent international best practices for interpretation of treaties, depict the understanding of the superior judiciary on the important matter of overriding aspects of the treaty. The words “treaty interpretation” is a subject in itself and not merely an extension of statutory interpretation despite the fact that treaties may be enforceable only when made part of the domestic law under a statute in certain countries.

Therefore, tax treaties should be kept as free as possible from the interpretation rules under domestic law, unless specified in the treaty itself“, are the guidelines for all subsequent decisions on these matters.

The second matter settled was the practical recognition of the concept of permanent establishment (PE) under the treaty. PE is a fundamental concept under the treaty. This decision has settled once for all that:

a. The income under Article 7 is exempt from tax in the country of source if the non-resident person does not have a Permanent Establishment as defined under Article 5 of the treaty between Pakistan and Netherlands in the source country.

b. ‘Engineering fee’ in case of a Dutch treaty is a business income;

c. Taxability of a non-resident entitled to a treaty concession is to be made within the ambit of the treaty and for that purposes the definition of PE and chargeability under Section 101 of the Income Tax Ordinance, 2001 is to be governed by the treaty provision and not the domestic law;

d. Where under the treaty physical presence of the employees of the non-resident is the determining factor, the counting will be made on the basis of actual physical presence of those persons and not the duration of the contract. If the duration of the contract is more than physical presence, the physical presence is to be taken as the determining factor.

Copyright Business Recorder, 2023