Recent news reports mention that the Indian and UAE governments are likely to address ambiguities arising out of the current provisions of the India-UAE tax treaty. The applicability of the India-UAE tax treaty to resident individuals of the UAE has been a subject matter of debate since the past several years.

The crux of the controversy is whether an individual resident in the UAE is eligible for the benefits of the India-UAE treaty, even if such resident does not actually pay any tax in the UAE.

Tax treaties as we know, tend to offer certain benefits, which are not available, if the tax laws of the relevant countries were to be applied. Are the provisions of the India-UAE tax treaty beneficial?

Just as in the case of the more published India-Mauritius tax treaty, the right to tax capital gains vests with the country of residence. Further, as in the case of Mauritius, capital gains are not subject to tax in the UAE.

To illustrate: If a UAE resident individual invests in shares of an Indian company and earns capital gains, only the country of residence i.e. UAE, can subject such gains to tax (as per article 13 of the India-UAE tax treaty). Further, this individual does not suffer any income tax in the UAE also, since there is no system of personal taxation in the UAE.

Of course, today, after introduction of the security transaction tax, long term capital gains arising on transfer of equity shares/units of an equity fund on a recognised stock exchange in India are exempt from tax in India. This, to an extent has diluted the attractiveness of Article 13 of the India-UAE treaty.

However, short-term capital gains (e.g.: arising when shares are sold prior to a holding period of twelve months) are still subject to capital gains tax in India. Gains arising on sale of shares of say private companies, other than those traded on the stock exchange, would also be subject to tax in India.

As mentioned above, the contentious issue in the context of the India-UAE tax treaty was whether a treaty can be applied to individuals resident in the UAE, in the absence of there being any double tax incidence.

The provisions of tax treaties are applicable to individuals who are ‘resident’ of one of the two countries to the tax treaty. To be treated as resident of one of the two countries, tax treaties provide that the individual has to be ‘liable to tax’ by reason of his domicile, residence etc.

Let us examine two contrary rulings given by the Authority for Advance Rulings (AAR) in the case of MA Rafique, followed by Cyril Eugene Pereira. Since then, there have been other rulings and judicial decisions. However, the ambiguity sought to be addressed is the one clearly brought out in these two diverse rulings.

At the very outset it must be remembered that such rulings do not set a precedent. These are binding only on the applicant who has sought the advance ruling and on the tax authorities in relation to the transaction for which the ruling was sought. However, these rulings tend to have a persuasive value in the course of tax assessments.

In the first ever ruling on the subject, the AAR in the case of MA Rafique (213 ITR 317) held that the applicant was eligible to the benefits of the India-UAE tax treaty and that the capital gains, in question, would not be subject to tax in India.

The AAR inter alia observed as follows: “That though there was no income-tax or wealth tax on individuals in any of the UAE nations, the fact that a comprehensive agreement (tax treaty) was considered necessary in spite of a clear knowledge that there was no such tax on individuals in UAE could only mean that the agreement was intended to encourage the inflow of funds from Dubai and other Emirates to India for investment.” Read in this background, Article 13 clearly left it to the UAE to deal with the capital gains on movable property realised by all UAE investors.

In other words, the AAR held that definition of the term ‘resident’ should be construed broadly and that the term ‘liable to tax’ does not connote an ‘actual taxation measure’.

Subsequently, a contrary ruling in the case of Cyril Pereira (239 ITR 650) was issued by the AAR. In this ruling, the term ‘liable to tax’ as laid down in the definition of a resident was construed narrowly and was equated with the term ‘subject to tax’ or actual payment of tax. As individuals do not pay tax in the UAE, it was held that the applicant Cyril Pereira was not a tax resident of the UAE and was entitled to the beneficial provisions of the India-UAE tax treaty.

Since then, there has been a notable change in the provisions of the Income Tax Act, 1961. Section 90 has been expanded to further empower the Indian government to enter into tax treaties to promote mutual economic relations, trade and investment.

Further, the Supreme Court in the case of Azadi Bachao Andolan's case (263 ITR 706) did not accept the contention that the a ance of double taxation can arise only when tax is actually paid in one of the countries to the tax treaty. Unlike the rulings given by the AAR, the Supreme Court orders set a precedent.

Recently, the Mumbai Tribunal in the case of Assistant Director of Income Tax v. Green Emirate Shipping and Travels (100 ITD 203) also observed that clearly there is no meeting ground between the ruling given in Cyril Pereira’s case and the order of the apex court in Azadi Bachao Andolan's case.  Supreme Court orders are binding on lower courts.

Accordingly, the Mumbai Tribunal adopted the tenet set by the Supreme Court and granted the benefit of the India-UAE tax treaty. It is also interesting to note that the recently notified India-Saudi Arabia tax treaty, the protocol specifically provides that an Indian national who is present in Saudi Arabia for a period aggregating 183 days in the fiscal year would be regarded as a “resident” of Saudi Arabia, even though he may not be liable to tax in that country’s domestic tax law.

In this backdrop, perhaps it would augur well for the Indian government to issue clarifications on the subject and stem litigation relating to this issue.

Author: Gaurav Taneja, national tax director and partner, Ernst & Young, India