KARACHI: A full bench of Supreme Court of Pakistan comprising Justice Syed Mansoor Ali Shah, Justice Jamal Khan Mandokhel and Justice Athar Minallah dismissed a bunch of petitions filed by Commissioner In-Land Revenue, Zone IV, Karachi challenging consolidated judgment passed by High Court of Sindh. The respondent include M/s A.P. Moller Maersk and M/s Safmarine Container Line. The petition involves question that whether income arising from container detention charges (“CDC”), container service charges (“CSC”) and terminal handling charges (“THC”) falls within the category of “profits from the operation of ships in international traffic” in the context of double taxation conventions concluded between Pakistan and Denmark, as well as between Pakistan and Belgium.
AS per details respondents are non-resident companies, one incorporated in Denmark and the other in Belgium. They are involved in cargo shipping activities, conducting their business operations within Pakistan through the authorized agent, M/s Maersk Pakistan (Private) Limited. The respondents filed income tax returns, accounting for income derived from freight charges, CDC, CSC and THC. They claimed entitlement to tax benefits under Article 8 of the Convention between the Islamic Republic of Pakistan and the Kingdom of Denmark for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income CP No.560-K/2019, etc 2 (“Pakistan-Denmark Convention”), and similarly, under Article 8 of the Convention between the Kingdom of Belgium and the Islamic Republic of Pakistan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (“Pakistan-Belgium Convention”), as the case may be.
The controversy began when Deputy Commissioner Inland Revenue disagreed with the aforementioned assessment, asserting that CDC, CSC, and THC were not eligible under the beneficial provisions of the Pakistan Denmark Convention and the Pakistan-Belgium Convention. The Deputy Commissioner reasoned that these charges were not explicitly covered under Article 8 of either Convention, which addresses beneficial taxation in relation to “profits from the operation of ships in international traffic”.
The respondents remained unsuccessful both in the appeal before the Commissioner Inland Revenue (Appeals) and in the subsequent appeal before the Appellate Tribunal Inland Revenue.
The matter then came to the High Court which in its decision given in Income Tax References filed by the respondents, concluded that profits arising from CDC, CSC, and THC fell within the scope of the term “profits from the operation of ships in international traffic” as stipulated in Article 8 of the two Conventions. Consequently, such profits were deemed eligible for the benefit of favourable taxation.
The Department filed the instant leave to appeal against the consolidated judgment passed by the High Court of Sindh, determining, challenging the inclusion of CDC, CSC, and THC under the umbrella of “profits from the operation of ships in international traffic” and their eligibility for beneficial taxation envisaged in Article 8 of the two Conventions. 4.
The apex court bench after detailed hearing passed the following judgment
Text of the Judgment
“We have heard the arguments of the learned counsel for the parties and have carefully gone through the record. 5. The respondents, being tax residents of Denmark and Belgium, are entitled to the benefits and concessions under the Pakistan-Denmark Convention and the Pakistan-Belgium Convention, as the case may be, in line with the provisions of Section 107 of the Income Tax Ordinance 2001 (“Ordinance”). Under subsection 2(c) of Section 107 of the Ordinance, the taxability of the respondents’ income is to be determined under the provisions contained in the two Conventions which override the Ordinance. These Conventions provide for allocation of taxing jurisdiction to the CP No.560-K/2019, etc contracting States in respect of different heads of income. With respect to the income falling under the head of “profits from the operation of ships in international traffic” which is dealt with under Article 8 in both the Conventions, the allocation of jurisdiction to the contracting States is not identical. The Pakistan-Belgium Convention assigns the sole right to tax profits from operating ships in international traffic to the residence State. In contrast, the Pakistan Denmark Convention permits the source State to tax these profits, but only to the extent derived from sources within that State, in accordance with its domestic law. However, this difference is not relevant for the purposes of the dispute before us. The issue before us, common to both the Conventions, relates to the nature of profits arising from CDC, CSC, and THC: whether these profits fall within the scope of the term “profits from the operation of ships in international traffic” or not. If this question is decided in the affirmative, the respondents’ profits resulting from CDC, CSC, and THC will be subjected to taxing provisions contained in Article 8 of the respective Conventions. Otherwise, profits resulting from CDC, CSC, and THC will not be considered as shipping income eligible to be dealt with under Article 8 of the two Conventions. 6. Notably, the matter at hand involves the interpretation of international tax conventions. Recently, this Court in Snamprogetti 1 emphasized the distinctiveness of international tax treaties, their specific interpretive framework, and the importance of equitable outcomes in cross-border taxation. International tax treaties, conventions or agreements, given their unique nature, require a distinct interpretive approach compared to the one used while interpreting domestic legislation. These agreements being international treaties are governed by the rules of interpretation outlined in the Vienna Convention on the Law of Treaties. Tax treaties differ from domestic tax laws in language, application, and purpose. These treaties are relieving in nature and seek to avoid double taxation, while domestic tax law imposes tax in specific situations. Tax treaties require a broad purposive interpretation, and their interpretation may be more liberal than domestic law. Treaty interpretation is a separate subject from statutory interpretation, accentuating the need to interpret tax treaties independently of domestic law. The role of a State in a bilateral agreement is more of implementing the terms of such agreement rather than that of interpreting the same and that too in a unilateral manner. Given that the primary purpose of tax treaties is to avoid and relieve double taxation through equitable and acceptable distribution of tax claims between the countries, it is important that the provisions of these treaties are interpreted in a common and workable manner, taking into account international tax language, legal decisions of other countries, model treaties along with their commentaries, developed by the Organization for Economic Cooperation and Development (“OECD”) and the United Nations (“UN”), and scholarly academic works where appropriate. We see that the operation of ships in international traffic has been given special tax treatment in Pakistan-Denmark Convention and the Pakistan-Belgium Convention in accord with the OECD Model Convention (“OECD MC”) and the UN Model Convention (“UN MC”). The general policy underlying the special rule for international shipping and the deviation from the allocation of taxing rights based on the permanent establishment principle has its roots at the very beginning of tax treaty law. Maritime shipping was viewed as an activity that warrants a special rule. Having regard to the distinct nature of activities carried on by shipping (air transport was also added to this category later) entities which operate across different routes spread across several countries and the complexity of apportioning profits arising from such business across numerous countries, it was felt that general provisions dealing with business profits would result in taxation of fragmented profits in numerous countries, thereby possibly leading to double taxation. Accordingly, it was considered necessary to introduce a separate provision in the OECD MC, and also in the UN MC, to specifically deal with profits from operations of shipping and air transport business in international traffic. The provision relating to shipping and air transport takes precedence over the general rule relating to business Model treaties provide standard frameworks of guidance for treaty negotiation and are of high persuasive value in terms of defining the parameters of double taxation treaties and have world-wide recognition as basic documents of reference in the negotiation, application and interpretation of multilateral or bilateral tax conventions. OECD Model Tax Convention on Income and on Capital. 4 United Nations Model Double Taxation Convention between Developed and Developing Countries. Profits and the permanent establishment principle is not applied to profits falling within its scope of application i.e. profits arising from the operation of ships and aircraft in international traffic. More importantly, this provision also takes into account the fact that shipping and air transport enterprises invariably carry on a large variety of activities to permit, facilitate or support their international traffic operations. The issue before us pertains to the characterization of income arising from CDC, CSC, and THC. Let us have a look at the meaning of CDC, CSC, and THC in order to understand the nature of these incomes. The High Court has observed, and there exists no contention between the parties on this point, that CDC is the amount collected on account of rent of container, which is charged if a customer holds the said container beyond the stipulated time required to discharge the goods at the intended port of disembarkation; CSC is collected by shipping lines on account of services in respect of containers which may be required due to discharge of goods at the destination; and THC is collected by shipping lines on account of terminal charges incurred at the port of disembarkation. With this understanding of the aforementioned sources of income viz. CDC, CSC and THC, we proceed to examine whether such income aligns with the expression “profits from the operation of ships in international traffic”. The Commentary on Article 8 of the OECD MC provides guidance about qualifying activities and related profits with respect to income falling under the head of “profits from the operation of ships in international traffic”. It provides that the profits covered consist in the first place of the profits directly obtained by the enterprise from the transportation of passengers or cargo by ships that it operates in international traffic such as any activity carried on primarily in connection with the transportation, by the enterprise, of passengers or cargo by ships that it operates in international traffic. It is then recognized that with the evolution of international transport, shipping enterprises invariably carry on a large variety of activities to permit, facilitate or support their international traffic operations. The expression “profits from the operation of ships in international traffic” therefore also covers profits from activities directly connected with such operations as well as profits from activities which are not directly connected with the operation of the enterprise’s ship in international traffic as long as they are ancillary to such operation – activities that the enterprise does not need to carry on for the purposes of its own operation of ships in international traffic but which make a minor contribution relative to such operation and are so closely related to such operation that they should not be regarded as a separate business or source of income of the enterprise should be considered to be ancillary to the operation of ships in international traffic.6 We also note that since 2017, the UN MC Commentary fully reproduces the OECD guidance. 10. The objective scope of Article 8 of the OECD MC and the UN MC with its reference to “profits from the operation of ships in international traffic” covers not only profits directly obtained by the enterprise from the transportation of passengers or cargo by ships that it operates in international traffic, but also, profits from activities directly connected with such operations as well as profits from activities which are not directly connected with the operation of the enterprise’s ships in international traffic as long as they are ancillary to such operation. Activities are to be considered ancillary to the operation of ships in international traffic if (i) the enterprise does not need to undertake them for the purposes of its own operation of ships in international traffic but which otherwise (ii) make a minor contribution relative to such operation and (iii) are so closely related to such operation that they should not be regarded as a separate business or source of income. Article 8 OECD and UN MC therefore applies not only to profits directly obtained in international traffic e.g. transport of passengers or cargo, sales of tickets of the enterprise, leasing of ships, but also to profits directly connected with international traffic and to profits ancillary to international traffic e.g. inland transport, interest, code sharing and slot chartering, haulage services and catering services, provision of goods and services to other enterprises, sales of tickets on behalf of other enterprises, advertising on behalf of other enterprises, letting of immovable property, rental of containers. The issue in question concerns income arising from three sources: CDC, CSC, and THC. Notably, two of these sources involve charges imposed for services related to containers, whereas the third pertains to charges associated with terminal services for cargo handling. In the context of such income sources, Vogel, a recognized authority, emphasizes the widespread use of containers in international transport. Profits arising from short-term storage of containers or from detention charges for the late return of containers, according to Vogel, are covered within the purview of “profits from the operation of ships in international traffic”. Further, special remuneration for services ancillary to container operations are covered within the ambit of shipping income from international traffic. Income derived from services provided for cargo handling is also considered part of shipping income from international traffic when directly connected or ancillary to the operation of ships in international traffic. We thus reach the conclusion that profits arising from CDC, CSC and THC are connected with and ancillary to the operation of ships in international traffic. Consequently, these profits squarely fall within the purview of the expression “profits from the operation of ships in international traffic”. Therefore, CDC, CSC, and THC collected by the respondents are part of the revenue earned in shipping in international traffic and are to be dealt with in accordance with the provisions of the Pakistan-Denmark Double Taxation Convention and the Pakistan-Belgium Double Taxation Convention, as the case may be. As a result, we do not feel inclined to interfere with the judgment of the High Court. These petitions are therefore dismissed.