The Income Tax Appellate Tribunal, Mumbai Bench, in Sky High Appeal XLIII Leasing Company Ltd. v. Assistant Commissioner of Income-tax (International Tax) and connected appeals, examined the taxability of lease rentals received by Irish aircraft leasing companies from Indian airline operators and the applicability of the Multilateral Instrument (MLI) to the India–Ireland Double Taxation Avoidance Agreement (DTAA).

The assessees, tax residents of Ireland and part of an international aircraft leasing group, had entered into dry operating lease agreements with Indian airline operators for leasing aircraft. For the relevant assessment year, returns were filed declaring nil taxable income in India, claiming that the lease rentals were business profits taxable exclusively in Ireland under Articles 7 and 8 of the India–Ireland DTAA, and did not constitute “royalty”. It was further contended that the assessees had no permanent establishment in India.

The Assessing Officer, invoking Articles 6 and 7 of the MLI embodying the Principal Purpose Test (PPT), denied treaty benefits on the ground that the principal purpose of incorporation in Ireland was to obtain DTAA benefits. The lease rentals were characterised as royalty and, alternatively, profits attributable to an alleged permanent establishment in India. The Dispute Resolution Panel upheld the application of the MLI and the denial of treaty benefits.

On appeal, the Tribunal undertook an extensive examination of the constitutional and statutory framework governing the application of tax treaties in India. Relying heavily on the Supreme Court judgment in Assessing Officer v. Nestlé SA (458 ITR 756), the Tribunal held that although both the India–Ireland DTAA and the MLI had been separately notified, the consequential modification of the DTAA by the MLI had not been notified under Section 90(1) of the Income-tax Act, 1961. In the absence of such specific notification, Articles 6 and 7 of the MLI could not be read into or applied to the India–Ireland DTAA.

The Tribunal rejected the Revenue’s reliance on the “synthesised text” of the DTAA as modified by the MLI, holding that such text is merely an explanatory aid with no independent legal force. It was observed that treaty modifications affecting rights and liabilities of taxpayers can be enforced domestically only through a conscious and express act of incorporation by way of notification under Section 90(1).

Having held that the MLI was inapplicable, the Tribunal concluded that the denial of treaty benefits on the basis of the Principal Purpose Test was unsustainable. Without prejudice, the Tribunal also noted that, on facts, the incorporation of the assessees in Ireland was supported by strong commercial rationale, consistent with globally accepted aircraft leasing practices, and did not constitute treaty abuse.

Accordingly, the Tribunal held that the lease rentals could not be taxed in India by invoking the MLI, and the assessments denying DTAA benefits were not sustainable in law. The appeals were allowed in favour of the assessees

Source- https://itat.gov.in/public/files/upload/1755685447-a2gpJx-1-TO.pdf

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