Introduction

The issue of taxation of foreign Sovereigns in India, does not spring up very often. The principle that a Sovereign is immune from taxation laws, has evolved over the centuries. With the Union Budget, 2020 proposing an exemption to Sovereign Wealth Funds (SWFs) in respect of certain income earned from India, the issue as to whether such entities are subject to tax in the first place has been reignited. A question arises as to whether the exemption now granted is clarificatory in nature or implies that these entities and other similarly placed entities shall be liable to tax in India, but for the exemption.

Tax on income of the Sovereigns (Union and State)

Article 285 and 289 of the Constitution of India provide for immunity to the Union and State Governments from taxation in India. No specific exemption has been extended to a Foreign Sovereign. The liability to tax under the provisions of the Income-tax Act, 1961 (“the ITA”) arises only if the ‘person’ (as defined in Section 2(31) of the ITA) is made subject to tax under Section 4 of the ITA. The definition of ‘person’ is inclusive, not restricted to the persons listed in that Section but also extends to other entities. On the question of whether the Government falls within the definition of a ‘person’, the court in CIT v. Dredging Corp. of India[1], based on a concession of the Revenue Authorities, concluded that the Government cannot be regarded as a ‘person’.

However, the House of Lords in Commissioner for London v. Gibbs[2] held that a sovereign is undoubtedly a person in the eyes of general law. The impact of this decision has been extended to hold that the Union Government would also be a ‘person’ for the purposes of the ITA[3].

On the other hand, in Madras Electricity Supply Corporation v. Boarland[4] the House of Lords, observed that a Government would be exempt from income tax in respect of its assets and incomes by virtue of sovereign prerogative, unless the charge to tax is created by express words or necessary implication. This ratio is expounded in Halsbury’s Laws of England[5], stating that property owned and occupied by the Crown is exempt from taxation unless rendered liable to tax by express word or necessary implication.

Thus, the position as it stands today is that the sovereign, i.e. the Government, is not liable to tax on its properties and incomes, due to the common law principle of sovereign prerogative. As discussed earlier, this privilege is extended to the Union Government as well as the State Government. The privilege, however, does not extend to any statutory corporation established by the Central or State Government.

Taxation of Foreign Sovereigns

In Hall's International Law[6], the author observes that within a foreign territory, a sovereign is immune from all local laws, in his capacity of a sovereign. A foreign sovereign cannot be proceeded against in any civil or criminal tribunal and is also exempt from payment of all dues and taxes.

Oppenheim, in his book on International Law[7], has observed that one sovereign cannot have any power over another, conforming with the principle, ‘par in parem non habet imperium’[8]. He must, therefore, in every point be exempt from taxation, rating and every fiscal regulation and likewise, from civil jurisdiction, except when he himself is the plaintiff”. In Halsbury’s Laws of England[9], Lord Halsbury observes that the immunity enjoyed by a sovereign from the jurisdiction of another is derived from the rules of international law and upon broad considerations of public policy, and comity.

A similar principle of absolute sovereign immunity from taxation existed prior to 1926 in British India. The then Government of India enacted the Government Trading Taxation Act, 1926, whose objective was to bring to tax, income arising out of trade and business carried on in British India by the Government of other Dominions of the British Empire. This Act expressly provided that business and trading income of a foreign sovereign would be liable to tax in British India. However, there was no provision, express or implied, extending the charge of tax to other sources of income, which continued to remain exempt. With the introduction of this Act, there was a conscious shift of position from a doctrine of absolute sovereign immunity to a doctrine of restrictive immunity. This also introduced, for the first time, broadly two categories of income of a sovereign, namely:

1. Income from business or commercial activities conducted by the sovereign in the other State, in respect of which a foreign sovereign could be taxed; and
2. Other income, such as dividends and interest, derived by the sovereign in another State, in respect of which such foreign sovereign was exempt from tax.

Internationally as well, the doctrine of absolute sovereign immunity has now given way to the doctrine of restrictive immunity, by which a foreign state is allowed immunity in respect of exercise of public functions traditionally associated with States, and no immunity is granted in respect of any trading activities of the State.[10] Sovereign Functions of a State, as explained in P&O Steam Navigation Co. v. Secretary of State[11] are those actions of the State for which it is not answerable before the Court of Law, such as defence of the country, raising and maintaining armed forces, making peace or war, foreign affairs, acquiring and retaining territory, levy of taxes, etc.

In Krajina v. Tass Agency[12], the respondent was the telegraphic department of the Government of the USSR, carrying out business activities in the UK as a separately registered entity. The House of Lords held that the agency was entitled to sovereign immunity in English Courts, being a department of the Government of the USSR, even where such a department has a separate juristic personality and has the rights of a legal entity according to the law of the foreign State.

This principle of absolute sovereign immunity is also elaborated in Halsbury’s Laws of England[13], stating that the immunity granted to sovereign governments is not limited to actions arising out of official governmental transactions (acta imperia) only, but also covers actions arising out of commercial contracts (acta gestionis).

However, following the doctrine of restrictive sovereign immunity, a different stand has been taken in India. The Special Bench of the Delhi Tribunal, in the case of DCIT v. Royal Jordanian Airlines[14] has held that the income derived by a department of the Government of Jordan, would be liable to income-tax in India, since the assessee was engaged in trade and commerce in India.

Though there is nothing contained in the ITA exempting a sovereign from taxation, it is a well-established rule of construction that a statute will not be construed as overriding international law unless the words of the statute compel the court to put such a construction upon it. In Maxwell's Interpretation of Statutes[15], the author comments that every statute is to be interpreted and applied, as far as its language admits, as not to be inconsistent with the comity of nations, or with the established rules of international law.

Justice G.P. Singh, in Principles of Statutory Interpretation[16], notes that if the terms of a statute are clear and unambiguous, they must be given effect to, whether or not they carry out the State’s treaty obligations, for the sovereign power of legislation extends to breaking treaties. However, if the terms of the legislation are not clear, and are reasonably capable of more than one meaning, the treaty itself becomes relevant, for there is a prima facie presumption that Parliament does not intend to act in breach of International Law.

This rule was followed by High Court of Calcutta in Maharaja Bikram Kishore Of Tripura v. Province of Assam[17], wherein the agricultural income of the Ruler from land situated in British India was sought to be taxed under the Assam Agricultural Income-tax Act, 1939. The Revenue contended that the Act was framed in such a way to cover all persons deriving income in Assam from agriculture. Applying the aforementioned principles, the Court held that a statute will not be construed as overriding international law unless the words of the statute compel the Court to put such as construction upon it and held that the Maharaja would not be subject to tax under the said Act.

In the case of A.H. Wadia v. Commissioner of Income-tax[18], the State of Gwalior received certain income through investments and activities in British India. When such income was sought to be taxed in India under the provisions of the Indian Income-tax Act, 1922, it was held by the Federal Court that the Gwalior Durbar, being the government of a sovereign State, is outside the purview of the Indian Income-tax Act.

V.S. Sundaram, in his book, The Law of Income Tax in India[19], states that the liability of foreign states to taxation is a difficult question of international law on which there appears to be a difference of opinion. One school of jurists believes that if a foreign government trades in the country, it is certainly liable to tax, though the liability will become unenforceable if the foreign State refuses to voluntarily discharge its liability; while another school seems to believe that there is no liability to taxation at all.

In light of the above discussion, it can be said that generally, foreign sovereigns are immune from the application of local/municipal laws of another country. Such local laws, including taxation laws, would thus generally not apply to any sovereign, or any department of the government of such sovereign. However, in certain countries, including India, such immunity would be restrictive upon the of the nature of function, and no immunity may be extended for trading and business activated engaged in by such sovereign authority.

Taxation of Sovereign Wealth Funds

The Union Budget, 2020 has introduced an exemption for certain Sovereign Wealth Funds, vide the insertion of new clause (23FE) to Section 10 of the ITA. However, the term ‘sovereign wealth fund’ itself is not defined anywhere in the ITA. Black’s Law Dictionary[20] defines the term as “a fund through which government monies are invested in securities issued by foreign companies or sovereigns”. Oxford[21] defines a SWF as “an investment fund owned by a sovereign government and managed by a central bank, pension fund or official investment company”. The World Economic Forum[22] describes a SWF as “a mechanism through which countries make investments in areas of potential growth” as well as[23] “a government-affiliated investment vehicle that manages a substantial pool of assets”.

Generally, a SWF is a state-owned investment fund, or an entity established by a statute, which comprises pools of money derived from the country’s foreign exchange reserves. Since a SWF is an arm of the Government, or a corporation established under a statute, the question whether such a fund would be chargeable to tax under the provisions of the ITA (as they stood before the insertion of Section 10(23FE)) will be decided on the basis of the discussion on taxability of foreign sovereigns above.

Before determining whether such a fund is chargeable to tax or not, it is to be seen whether such fund engages in any business or trading activity. Here is where the anomaly kicks in. Part (b) of Explanation to Section 10(23FE) provides for conditions which a SWF must fulfil to claim the exemption. One of the conditions prescribed is that such a fund must not undertake any commercial activity within or outside India. It is a settled position that the meaning of ‘commercial activity’ is wider in scope than ‘business’ or ‘trading activity’[24]. Thus, while the Section purports to grant an exemption to an SWF, it just follows the already established doctrine of restrictive immunity for foreign sovereigns.

Further, the Section exempts only the income arising on account of dividend, interest and capital gains to a SWF. Since 1926, when for the first-time foreign sovereigns were brought under the ambit of local taxation by the Government Trading Taxation Act, foreign sovereigns have been taxed only on the business and trading income arising out of activities carried on by them in British India, and any other income (i.e. dividend, interest etc.) has always been exempt. Thus, the new Section just clarifies an already existing position of law. It is, however, possible to contend that post the repeal of the 1926 Act in 2000, and with the Constitution of India not providing for any exemption from taxation to a foreign sovereign, even such other income of sovereigns becomes chargeable to tax under the ITA.

Where, however, an SWF is a legal entity separable from the government of the foreign state under the laws of that country, its income shall be chargeable to tax under the provisions of the ITA, and the new exemption granted will be beneficial to such SWF’s.

Conclusion

The new exemption introduced for certain incomes of a SWF can only be treated as being clarificatory in nature, since under the established principle of International Law, sovereigns can claim immunity from domestic laws of another country in respect of non-commercial activities. Considering that the new Section also exempts only such SWF’s which do not engage in any commercial activity, it only follows such established principles. The grant of the exemption cannot lead to the automatic conclusion that de hors such an exemption, the income of a SWF would be chargeable to tax under the ITA.[25]

A potential source of litigation could be the meaning of ‘commercial activity’, and whether ‘investment activity’ can be possibly covered within the such meaning. Such an interpretation would, however, defeat the purpose of the Section.

The biggest beneficiaries of the new exemption would be SWFs which function as separate corporations, having a distinct juridical personality from that of their government. These SWFs can now claim the exemption in respect of the specified income derived from investments in India.

[The author is an Associate, Direct Tax Team, Lakshmikumaran & Sridharan Attorneys, Mumbai]

1. [1] [1988] 174 ITR 682 (AP).
2. [2] [1942] 1 All ER 415 (HL).
3. [3] Law of Income Tax, Sampath Iyengar, 11th Edition Page 44.
4. [4] [1955] 27 ITR 612 (HL).
5. [5] 4th Edition, Vol. 8, Para 1446.
6. [6] 8th Edition, Pg. 220.
7. [7] 5th Edition, Vol. 1, Page 590.
8. [8] "equals have no sovereignty over each other”.
9. [9] 4th Edition, Vol. 18, Para 1548.
10. [10] Private International Law by Cheshire, North & Fawcett, 14th Ed., Pg. 496; Principles of Statutory Interpretation, Justice G.P. Singh, 7th Ed., Pg. 443.
11. [11] [1868] 5 Bom HCR App. 1.
12. [12] [1949] 2 All ER 274.
13. [13] 4th Edition, Vol. 18, Para 1553.
14. [14] [2006] 98 ITD 1 (Del) (SB).
15. [15] 7th Ed., Pg. 127.
16. [16] 7th Ed., Pg. 444.
17. [17] [1949] 17 ITR 220 (Cal).
18. [18] [1949] 17 ITR 63 (FDC).
19. [19] 6th Edition, Page 43.
20. [20] 10th Ed., Pg. 788.
21. [21] Oxford’s Dictionary of Accounting, 4th Ed., Pg. 388.
22. [22] https://www.weforum.org/agenda/2017/10/what-you-need-to-know-about-sovereign-wealth-funds/.
23. [23] https://www.weforum.org/agenda/2019/12/sovereign-wealth-funds-sdgs/.
24. [24] U.S. v. Patterson, 55 Fed 605; Advanced Law Lexicon, P. Ramanatha Aiyar, 3rd Ed., Pg. 4726.
25. [25] Rani Amrit Kunwar v. CIT, [1946] 14 ITR 561 (All) (FB).