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AGREEMENT RULES
12. Agreement rules are "rules of
limitation of law"
The double taxation agreement between two Contracting States does not provide for the
application of tax laws of one State by the other State. The purpose of these is to limit
or restrict the application of domestic laws with a view to avoiding double taxation or
preventing fiscal avoidance. Rules of double taxation agreements are, therefore,
"rules of limitation of law". These operate either to exclude application of the
domestic law of one of the States where it would otherwise apply or to oblige the State to
grant credit against its own tax in respect of taxes paid in the other State. A tax
obligation exists as prescribed by the domestic law of the State, but only to the extent
as confined or combined or defined by the tax agreements. Thus, the tax agreement rules
are formulated separately. and independently of domestic laws and have independent origin
or legal foundation. In their effect and origin these are comparable to
"international administrative law" as the tax agreement "rules are rules of
limitation of law." Tax agreements, unlike conflict rules in international law, do
not. choose between domestic and foreign law. Each State applies its own domestic laws.
The tax agreement rules limit the Contracting States' application to that law. The
limitation may consist of the waiver of tax claim in favour of the other State (exemption
method) or of granting credit of tax paid in other State against the tax due in accordance
with the domestic laws (credit method).
13. Conflict between domestic laws of contracting States
When an expression has not been defined in an agreement or has been defined
inadequately, controversy about what it conveys may arise in relation to the agreement if
it is understood or interpreted differently under the domestic laws of the Contracting
States. This controversy becomes more pronounced when the agreement uses local terms which
are also the terms of the substantive law of the Contracting States. It may relate to
whether income received as dividend or interest or from property could be said to have
been done from carrying on business and computed accordingly or be said to have been done
from investment, shares, bonds and securities or from immovable property and, therefore,
be computed under the respective Articles of the double taxation agreement; or whether
remunerations paid to an architect is relied under Article 12 of the OECD Model or
compensation for personal services; or whether a commission agent or trading agent carries
on a business or has income from independent personal services; or whether interest paid
to a partner of the firm constitutes business profit of the Partners represent interest
income and so on. These illustrations are reflective of the conflict which may appear when
such issues are dealt with within the jurisdiction with their domestic laws in the absence
or adequacy of an expression definition of various terms and expressions.
13.1. Characterization - The conflict lies in the minds of the
tax authorities as to which system of law apply to the facts before them. The tax
agreements do not provide that the State must apply domestic or foreign law, but rather
imposes their own rules in addition to the rules of the contracting States. In the absence
of an express definition or an expression or a term in any agreement, always a question of
characterization (qualification or classification to some writers) arises.
Characterization refers to the situation in which the contracting States attach different
interpretation to the term under their domestic laws. The problem of Characterization is
resolved through various theories and concept which are discussed below:
13.1-1 Lexi fori - This expression means the local or the
domestic law of the country to which a court wherein the action is brought or other legal
proceedings are taken belongs. According to this
doctrine, each State qualifies the agreement terms according to the requirements of its
own domestic law. The main arguments in favour of this doctrine is that if a foreign law
is allowed to determine in what circumstances it is to be applied, then the domestic law
would loose its control over the application of its own conflict rules. The tax
authorities, courts an the subject are well conversant with and they understand their own
law best, as evidenced by statute books or established by courts. Its subjugation to the
foreign law can be permitted to the extent an agreement permits. The absence of the
express definition of an expression or terms will not subordinate the sovereignty of State
as to interpret in the manner as dictated by the foreign law.
The argument against it is that its application in complete disregard to the foreign law
may not result in arriving at a conclusion for a situation, which is not intended by the
agreement or which is against its objects and purposes; such a retaining certain types of
taxation that the agreement intends to avoid or creating a situation where an income
cannot be taxed in either of the State. The former result could be avoided through mutual
agreement while the latter could not be so avoided as there could be no possibility of
double non-taxation agreement.
13.1-2 Les Cause - This expression means that every legal
rule takes its classification from the legal system to which it belongs. According to it,
the contracting States should interpret the term and expression of the agreement with
their domestic laws in regard to income which accrues or arises in their states
respectively. The principle is also sometimes called "source country
qualification". Recognition of this principle is given in the agreement itself when
Article 3(2) of the OECD Model states inter-alia, that in application of the provisions of
the agreement by a contracting State, the terms which is not defined in it will have the
meaning which they have assigned under the laws in force in that State or when it provides
for taxation of income from immovable property according to their location.
The emphasis is on the "source" and the concept of "residence" is
likely to be relegated into obliviation whereas the traditional approach of the tax
agreements is to lay emphasis on "residence" rather than the source, for the
taxability of income. The concept of "residence", therefore, finds an elaborate
discussion in all the tax agreements providing for how to determine the residential status
of the recipient of the income under all circumstances which possibly could exist. In case
a conflict still persists it is resolved on the basis of mutual agreement procedure.
13.2. How to resolve the conflict - None of the above method is
sufficient. The choice depends upon the purpose for which interpretation is sought.
Sometimes a combination of these is resorted to, if the context so require. The method
which conforms to the character of the agreement as an independent rule, must apply. The
rules are only aids to instructions, presumptions or pointer. Not infrequently one
"rule" points in one direction, and the other in a different direction. In each
case we must look at all relevant circumstances and then decide as a matter of judgement
what weight to attach to any particular rule.
13.3. Context is important - The context is very important. The
facts that general words are used is not itself conclusive reason why every case falling
literally within them. should be governed by that enactment and the context of the
enactment may well indicate that wide or general words should be given restrictive meanings. Words and Particularly general words cannot
be read in isolation; therefore, colour and contents are derived from their context.
General words and phrases, therefore, however, wide and comprehensive they may be in their
literal sense, must not be construed as being limited of the actual objects of the Act and
so of the agreement. All general words are open to debate and they demand debate, to see
whether they really bear their widest possible meaning. The qualification appropriate to
the agreement is to be developed step by step from case to case. The application of the law, whether the lexi fori or lex clause, or any
other rules should be decided in the context of the agreements as applicable to a
particular case. The reconciliation between the conflicting legal systems should be
attempted under the mutual agreement clause. Till then, reference to the law of State
applying the agreement in the end is necessary as an interpretation source. Article 3(2)
of OECD Model supports such reference.
13.4. Harmonious interpretation of tax agreement - The words in
the Act of Parliament are not to be construed in a sense which would create a breach of an
agreement between contracting States unless such words are so explicit as to allow of no
other interpretation. If any provision of the Act does any violation or interference with
the agreements made between the two Contracting States and embodied in agreement, the
matter cannot be cured by a process of interpretation which is apparently illicit. It must
be done either by diplomatic means or by legislation. If an agreement has been
incorporated and thereby becomes part of the statute law losing its superior status and
therefore to be construed in its context alongwith the rest of the law, it has to be
qualified by those cannons of interpretation of law as are normally applicable to taxation
laws, i.e., the words of the statute must be taken to mean what they say so that their
meaning must be ascertaining with no regard to any ulterior consequences of so
incorporating them. No exposition of this
principle, is better known than the speech of Viscount Simonds in the case of Attorney
General v. Prince of Earnest Augustus of Hanover,
"I, reject, therefore, the arguments in favour of restricting the meaning of the
enacting words so far as it is based on any other consideration than that of the words of
statute itself".
Under the same general presumption that the legislature does not intend to exceed its
jurisdiction every statute is to be interpreted and applied, so far as its language
admits, as not to be inconsistent with the comity of nations or with the well established
rules of international law. If, therefore, it designs to effectuate any such object, it
must express its intention with unquestionable clearness to induce a court to believe that
it entertained it, for, if any other construction is possible, it would be adopted to
avoid imputing such intention to the Legislature. All general terms must be narrowed in
construction to avoid it. But if the statute is unambiguous, its provisions must be
followed even if they are contrary to international law.
13.4-1 Agreement to be read as a whole - Division of a statute
into parts or chapters is merely a matter of convenience. The object of such division is
not that each part or chapter should be read independently of each other or as a complete
code by itself. It is a fundamental principle of interpretation that a statute must be
read and construed as a whole, notwithstanding that every section in all statute is
substantive enactment in itself. Interpretation of
double tax agreement provisions cannot be made differently.
13.5 Interpretation of agreement and decision of foreign courts -
For the efficient and fair application of tax agreement, the courts world over should
interpret its provision consistently avoiding collision. Inconsistencies in the decisions
may result in double taxation, which the agreement intends avoiding. Decision of the
foreign courts though may not be binding on the domestic courts, may have pursuasive
influence on them. These courts should persuade themselves in accepting them, and should
interpret the agreement in the same way, as far as
possible. But the concept of pursuasive nature of the foreign decisions does not mean that
the courts should surrender their judgement completely to it and follow those decisions
blindly even if it contains any inconsistencies. The pursuasive value of a decision
depends, among other things, on the reputation and rank of the foreign court in question.
It does not command more respect than the decision of another court of equal
competence in the same country. It cannot be placed at the same pedestal as that of the
Supreme Court of Pakistan, whose verdict prevails over and is binding on all the lower
courts in Pakistan, in terms of Article 189 of the Constitution of Pakistan.
14. Constitutional validity
An important question that is usually debated is as to how the provisions of the
double taxation agreements should be analyzed when they are in conflict with statutory
law. The crux of the debate is how the provisions of the double taxation agreement prevail
over the statutory law and how the Federal Government can confer benefits which are not
provided in the act of Parliament and whether conferment of such benefits vis-a-vis
residents and other assessees would not be discriminative and thus violative of the
Constitution of Islamic Republic of Pakistan.
14.1 Subordinate legislation - The notification u/s 163 of the
Income Tax Ordinance, 1979 issued by the Federal Government making provisions for the
implementation of agreement concluded by it with the Government of another country for the
avoidance of double taxation and prevention of fiscal evasion, amounts to a piece of
subordinate legislation. Subordinate legislation can be questioned on any of the grounds
on which plenary legislation is questioned. In addition it may also be questioned on the
ground that it does not conform to the statute under which it is made. It may further be
questioned on the ground that it is contrary to some other statute, that is, because
subordinate legislation may yield to plenary legislation. It may also be questioned on the
ground that it is unreasonable, not in the sense of not being reasonable, but in the sense
that it is manifestly arbitrary and discriminatory. In U.K., judges would say
"Parliament never intended authority to make such rules. They are unreasonable and
ultra-vires". In Pakistan any enquiry into the vires of delegated legislation must be
confined to the grounds on which plenary legislation may be questioned, to the ground that
it is contrary to the statute under which it is made, to the ground that it is contrary to
the other statutory provisions or that it is so discriminatory and arbitrary that it could
not be said to be in conformity with the statute or that it offends Article 25, of the
Constitution of the Islamic Republic of Pakistan. A distinction has to be made between
delegation of a legislative function in the case of which the question of reasonableness
cannot be enquired into and the right enjoyed by the Authority to exercise particular
discretionary powers. In the later case, the question may be considered on all ground on
which administration action may be questioned, such as non-application of mind, taking
irrelevant matters into consideration etc.
On the facts of a case, a subordinate legislation may be struck down as arbitrary or
contrary to the statute if it fails to take into account very vital facts which either
expressly or by necessary implication are required to be taken into consideration by the
statute or say, the Constitution. This can only be done on the ground that it does not
conform to the statutory or constitutional requirements or that it offends certain
Articles of the Constitution relating to equality and consistency in laws. It cannot be
done merely on the ground that it is not reasonable or that it has not taken into account
a relevant circumstances which the court considers relevant. Any notification issued under
a statute is also a 'law'.
14.2. Violative of constitution - The pattern of law imposing
income tax and the manner in which it is operated in relation to non-residents and
foreigners in so far as they relate to avoidance of double taxation or to prevention of
fiscal evasion, exposes the assessee who are likely to pay income tax both in the country
of source of income as also in the other where their fiscal residence exists, to the
vagaries of the executive discretions of the Governments of both the countries. While the
parliament has imposed tax by enacting a particular law at the Federal level known as
Income Tax Ordinance, 1979, the Federal Government has been given wide powers by virtue of
section 163 of that Ordinance to enter into an agreement with the Government of an other
country to grant relief from the levy of income tax but no provision could be held
unconstitutional on the ground of discrimination and inequality with or the contravention
with the Income Tax Ordinance, 1979 to the extent that it is reasonably required in the
public interest. To answer the question whether a statute or any of its provisions is
reasonably required, one has to approach the issue with the presumption that until the
contrary appears or is shown, all acts or any of its provisions is reasonably required.
This presumption will be rebutted if the statutory provision in question is so arbitrary
as to compel a conclusion that it does not involve an exertion of the taxing period to
constitute insubsistance and effect, the direct execution of a different and forbidding power.
14.2-1 Constitutional guarantees. - In the Constitution of
Pakistan there are explicit Articles which forbid any discriminative construction of
statute. The constitutional guarantee is available against discrimination and the
Parliament cannot pass any enactment which either violates fundamental rights guaranteed
in the Constitution or which portray any sort of discrimination. The Supreme Courts of
Pakistan and India have unanimous opinion on this issue which could be summarised below:-
1. Constitution condemns discrimination not only by substantive law but also by a law of
procedure.
2. Constitution forbids class legislation but does not forbid classification.
3. In permissible classification, mathematical nicety and perfect equality are not
required.
4. The classification may be founded on different basis, namely, geographical or according
to objects and occupation or the like
5. If a law deals equally with members of a well-defined class, it is not obnoxious and it
is not open to the charge of denial of equal protection on the ground that it has no
application to the other persons.
6. Even a single individual may form a class by himself on account of some special
circumstances or reason applicable to him and not applicable to others.
7. Classification need not to be constituted by an exact or scientific exclusion or
inclusion of persons or things; "the court should not insist on delusive exactness or
apply doctrinaire tests for determining the validity of classification in any given case.
8. The law can make and set apart the classes according to the needs and requirements of
the society and as suggested by experience. It can recognize even a degree of evil, but
the classification should not be arbitrary, artificial or evasive.
9. the classification must not be arbitrary but must be rational i.e., to say it must not
only be based on some equalities or characteristics which are to be found in all the
persons grouped together and not in others who are left out but those qualities or
characteristics must have a reasonable nexus with the objects of the legislation.
The constitutional provisions relating to fundamental rights and providing safeguards
against discrimination are nearly the same in Indian and Pakistani constitutions and
frequently Pakistani Courts while deciding constitutional issues have relied upon verdicts
given by the Indian Supreme Court. In this context the references quoted here from the
Indian Courts can be helpful while examining constitutional validity of double taxation
agreements concluded by the Federal Government of Pakistan by virtue of powers derived by
it under section 163 of the Income Tax Ordinance, 1979. Perhaps the most important
constitutional principle is that legislation should not be arbitrary and it should ensure
fairness and equality of treatment. Equality and arbitrariness are sworn enemies one
belonging to the rule of law while the other to the whim and caprice of an absolute
monarch. It is a tragic dichotomy that Income Tax Ordinance, 1979 which was promulgated by
the then Chief-Martial-Law-Administrator became a law of the undisputedly
unconstitutional. It is a sad reflection land though his own rule was on constitutional
history of Pakistan that even after so many years we have failed to give this Ordinance
the shape of an Act having the consent of the Parliament being true representative of the
people of Pakistan. The reality remains that nobody after the dawn of democracy (so
called!) tried to give a serious thought to this anomaly. The Income Tax Ordinance, 1979
is reminiscent of a dark, unconstitutional era in our history, yet it is operative as a
valid law of the land under which the Federal Government enjoys delegated powers to
conclude a double taxation agreement with any country of the world even to the extent of
overruling the very provisions of this Ordinance. The students of constitutional law will
find it difficult to reconcile themselves with this dichotomy which in itself is violative
of basic principles embodied in the Constitution of Pakistan. Where a statute is in itself
unconstitutional, it is implicit that it is unequal both according to political logic and
constitutional law and is, therefore, violative of Article 25 of the Constitution. It is
hoped that Parliament (Majlis-e-Shoora) in Pakistan will take note of this dichotomy and
will review the Income Tax Ordinance, 1979 with the intention of converting it in to an
Act having the sanction of the elected body of Islamic Republic of Pakistan. Till that
time it is almost impossible to reconcile as to how an act of an absolute monarch can be
upheld as fair and equal.
14.2-2 Article 25 of the Constitution and Tax Laws - Though a
tax law ex facie appears to treat all that fall within a clause alike, if in fact it
operates unevenly on persons or property similarly situated, it may be said that the law
offends the equity clause. It is not the phraseology of a statute that governs the
situation but the effect of the law that is decisive. If there is equality and uniformity
within each group, the law will not be condemned as discriminative, though due to some
fortuitous circumstances arising out of a peculiar situation some included in a class get
advantage over others, so long as they are not singled out for special treatment. Taxation
law is not an exception to this doctrine. But in
the application of the principles, the course, in view of the inherent complexity of
fiscal adjustment of diverse elements, permit a larger discretion to the Legislature in
the matter of classification, so long as it adheres to the fundamental principles
underlying the said doctrine. The competence of the Legislature to classify is of
"wide range and flexibility" so that it can adjust its system of taxation in all
proper and reasonable ways. Equal protection of the law is denied if in achieving a
certain object, persons, objects or transactions similarly circumstanced are differently
treated by law and the principle underlying the different treatment has no relation to the
object sought to be achieved by the law. Article 25 of the Constitution strikes at the
discrimination in the application of the laws between the persons similarly circumstanced,
and it does not strike at a differentiation which may result by the enactment of a law
between transactions governed thereby and those which are not governed thereby.
14.2-3 Article 25 of the Constitution and double taxation
agreements -
The reason and object of all agreements for the avoidance of double taxation or the
prevention of fiscal evasion is mainly to remove constraints on the flow of capital and
technology from one country to another, so that the developing country could have access
to the expertise and technical know-how of the developed countries for economic
development and in the process may not unreasonably be derived of its legitimate share in
the income as also to prevent evasion of taxes due to it on account of manipulations at
international level. The executive is, therefore, empowered to grant exemption from tax or
to permit taxation of certain income at a concessional rate. Such exercise of powers is in
conformity with Article 77 of the Constitution. This Article lays down that no tax can be
levied and collected except by the authority of law. Hence, the levy of taxes can only be
done by the authority of law and not by executive order. Unless the executive is
specifically empowered by law to give an exemption, it cannot say that it will not enforce
the law in case of a particular person.
Section 163 of the Income Tax Ordinance, 1979 empowers the Federal Government to enter
into agreements with the Government of another country to grant relief or to avoid double
taxation. In pursuance of such power, exemption from tax is provided to certain categories
of persons or in respect of income in its entirety or part, such concession cannot be said
to have been extended contrary to the Constitution.
Relief to a resident of another State with which Pakistan has double taxation agreement
may not be available at all or available differently to resident of another country with
which no such agreement exists. It may pose a question whether the discrimination between
the two persons similarly placed is not in contravention of Article 25 of the
Constitution, which lays down that the State shall not deny to any person equality before
the law or equal protection of law within the territory of Pakistan. The violation of this
Article may be on the account of the State treating two assessees differently and there is
no basis for such different treatment.
It is not in dispute that taxation laws must also stand the test of Article 25. But in
deciding whether taxation law is discriminatory or not, it is necessary to bear in mind
that the Parliament has a wide discretion in selecting persons or objects it will tax, and
the statute is not open to attack on the ground that it taxes some persons or objects and
not others. It is only when within the range of its selection, the law operates unequally
and that cannot be justified on the basis of any valid classification that it would be
violative of Article 25. A Parliament does not have to tax everything in order to tax
something. It is allowed to pick and choose persons, objects, methods and even rates for
taxation, if it does so reasonably. Article 25 does not forbid the Parliament from making
classification of and the differentiation between persons and things but in order to have
permissible classification the Legislature is required to fulfill certain pre-requisites,
namely, the classification must be found on reasonable differentiation and secondly the
differential must have a reasonable nexus with the object sought to be achieved.
Thus it is not essential for the validity of the tax that it must attain absolute equality
and abstract justice, the reason being that it is unattainable in tax proceedings.
Determination of the rate at which certain income is to be taxed is incidental to the
powers of imposition o tax. Scope for the exercise of the larger discretion has been
admitted for this branch of legislation as well as on the same principle that absolute or
perfect equality or uniformity in taxation is impossible. If the classification is
rational, the Legislature is free to choose objects of taxation, impose rates, exempt
classes of property from taxation, subject different classes of property to tax in
different ways and adopt different modes of assessment. A taxing statute is, therefore,
not exposed to attack on the ground of discrimination merely because different rates of
taxation are prescribed for different categories of persons, transactions, occupations or
objects.
The constitutional validity of a double taxation agreement cannot be questioned on the
grounds of its extending the benefits to the residents of the foreign contracting States
which are not available to other non-residents.
15. Validity of agreements prior to promulgation of Income Tax
Ordinance, 1979
Section 166 of the Income Tax Ordinance, 1979 deals with 'Repeal and Savings'. It
categorically says: "The Income-tax Act, 1922 (XI of 1922) is hereby
repealed". This phrase gives rise to a question: What about the double taxation
agreement concluded under the said Act? The answer is provided in section 166(2)(p) of the
Ordinance which reads as under:
"any agreement entered into, appointment made, approval given, recognition
granted, direction, instruction, notification, notice, order or rule issued or made under
any provision of the repealed Act and in force or valid at the commencement of
this-Ordinance shall, so far as it is not inconsistent with the corresponding provision of
this Ordinance or any agreement, appointment, approval, recognition, direction,
instruction, notification, notice, order or rule entered into, made, given, granted,
issued or made under this Ordinance, be deemed to have been entered into, made, given,
granted, or issued or made, as the case may be, under the corresponding provision
aforesaid and shall, unless revoked, cancelled or replaced by, or under, this Ordinance,
continue in force accordingly; and
This saving clause gives continuity to agreements entered into with other States prior to
the repeal of the Income-tax Act, 1922. 'The Income Tax Ordinance, 1979 shall come into
force on the first day of July 1979', says section 1(3). The correct language of section
1(3), therefore, should have been "save as otherwise provided it shall come into
force on the first day of July, 1979." The omission of words "save as otherwise
provided" in section 1(3) can be of serious consequences because although sub-section
(2) of section 166 says "notwithstanding the repeal of Income Tax Act, 1922 (XI of
1922) and without prejudice to the provision of section 6 or section 24 of the General
Clauses Act, 1897", saving are provided from clause (a) to (q), yet the conflict is
apparent between section 1(3) and section 166(2). Section 1(3) is not drafted with
appropriate legal skill. In all the repealing enactments, the enforcement clause always
starts from "save as otherwise provided". The Legislature must take note of this
serious legal lacuna in the Income Tax Ordinance, 1979.
