[Opinion] Understanding the Non-Discrimination Clause in Double Taxation Avoidance Agreements

CA Harleen Kaur – [2024] 161 taxmann.com 802 (Article)

Introduction

The India Model of the Bilateral Investment Treaty encompasses principles of non-discrimination. The non-discrimination rule in Double Taxation Avoidance Agreements (DTAAs) ensures that no preferential treatment is given in taxation to residents or citizens compared to foreign individuals or entities. Most international tax treaties include clauses to prevent such discrimination. The domestic tax law of India provides that charging a higher rate of tax to a foreign company as compared to a domestic company is not to be regarded as discrimination. This article deals with non-discrimination provisions; nationality non-discrimination, permanent establishment non-discrimination, and deduction and ownership non- discrimination. It emphasizes that similar situations should not be treated differently without justification.

Non-discrimination regulations encompass principles addressing situations where the domestic laws of a country unfairly discriminate against specific groups of individuals. The fundamental goal is to promote equality, ensuring that individuals are not treated differently due to their distinct characteristics. The objective is to address issues of discrimination through fair and impartial treatment. These principles are reflected in taxation laws within tax treaties.

Understanding Non-Discrimination clause

Paragraph 1 addresses tax non-discrimination based on nationality. It asserts that discrimination based on nationality for tax purposes is prohibited, meaning individuals from one country cannot face additional taxation compared to those from the source country, provided they are in similar circumstances in the source country. Unlike other sections of the tax treaty, this paragraph focuses on the nationality of individuals rather than their residency status. Consequently, an individual may be a national of one country without being a resident there, and vice versa. Furthermore, this paragraph extends to individuals who are nationals of one country but may not be residents of either of the two countries involved.

Paragraph 2 pertains to individuals who are stateless, meaning they are not recognized as nationals of either country within a specific tax treaty. This paragraph stipulates that stateless individuals should not face heavier taxation burdens compared to nationals of the relevant country. However, it emphasizes the importance of stateless individuals and comparable nationals being in similar circumstances, particularly regarding their residency status.

Paragraph 3 addresses non-discrimination in taxation concerning Permanent Establishments (PEs). It stresses that the tax imposed on a PE of a foreign enterprise within its source country should not be more favorable than the taxation applied to domestic enterprises engaging in equivalent activities. The source country has the option, but not the obligation, to provide personal tax allowances or reductions to non-resident individuals’ PEs, which it may have extended to its own residents. The paragraph does not forbid this practice.

This paragraph ensures parity between PEs and resident entities, with significant implications. It does not mandate same tax rates for foreign company PEs and resident companies. This stems from residents typically being taxed on their worldwide income, while non-residents are taxed solely on income sourced within a country. India has asserted its prerogative to clarify, in the OECD commentary, that imposing a higher tax rate on PE profits compared to similar Indian companies does not violate this provision.

Paragraph 4 addresses discriminatory tax practices where deductions for certain expenses are allowed for residents but restricted or prohibited for non-residents. It also discusses the possibility of bilateral agreements to address this issue. Additionally, it clarifies that while domestic thin capitalization rules can apply, they must align with international agreements and must not discriminate against non-resident creditors. Furthermore, the paragraph allows for additional information requirements for payments to non-residents to ensure equitable compliance standards. However, it prohibits any discriminatory treatment against non-resident creditors and emphasizes the need for fair treatment in tax matters.

Paragraph 5 addresses non-discrimination based on ownership. Its aim is to guarantee fair treatment for resident taxpayers regardless of the ownership or control of capital. However, this benefit is not extended to non-residents who own or control capital. To elaborate, consider a hypothetical scenario involving an Indian company with Italian shareholders. This company should not face heavier taxation or related obligations compared to an Indian company with Indian shareholders.

Paragraph 6 asserts that Article’s scope is not limited by Article 2’s provisions. Thus, it extends to all taxes imposed by the State, its political subdivisions, or local authorities, regardless of their nature or description.

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