Novation in International Tax Treaties

The jurisprudential interpretation of the principle of novation in tax treaties and its procedural implications under domestic tax laws was critically analysed in the Delhi High Court’s decision in Sneh Lata Sawhney v. CIT [TS-592-HC-2025(DEL)] [1]. This judgment underscores the relevance of treaty amendments in determining the validity of information exchange requests and the consequential limitation under Section 153B of the Income Tax Act, 1961. The ruling provides clarity on the binding nature of substituted treaty provisions and reinforces the doctrine of finality in fiscal assessments.

International tax treaties serve as essential instruments for cross-border cooperation in tax matters, particularly for the exchange of information (EOI) between sovereign states. The Indo-Swiss Double Taxation Avoidance Agreement (DTAA) has evolved over time, notably with the Amending Protocol signed on 30 August 2010 [2], which substituted Article 26 relating to the EOI. This development has had significant procedural consequences under the Indian Income Tax Act, especially in the context of Section 153A and the computation of limitation under Section 153B[3].

The facts of the case reveal that the Revenue had initiated proceedings under Section 153A based on information alleging that the assessee maintained an undisclosed bank account in HSBC Bank, Geneva. In pursuit of this, the Revenue made a reference to Swiss authorities under the erstwhile Article 26 of the Indo-Swiss DTAA to obtain administrative assistance. The assessment order was challenged on the ground that the request for information was invalid, and hence, the benefit of exclusion of time under Explanation (ix) to Section 153B could not be availed.

The principle that the substitution of a provision results in the removal of the existing provision applies not only to legislative instruments but also to agreements. In the context of legislation, unless a saving clause expressly preserves them, all rights and liabilities under the substituted law cease to exist. Similarly, in agreements, the substitution of a covenant operates as a novation, discharging the prior agreement unless the parties explicitly intend to preserve the rights and obligations under the original agreement. This principle is well established: novation inherently terminates the preceding agreement, and any preservation of prior rights must be clearly stated rather than inferred. The reasoning applied in legislative amendments is equally instructive for interpreting contractual novation.

Section 153B governs the time limit for completing assessments under Section 153A. Explanation (ix) allows for exclusion of the period during which the competent authority seeks information under an agreement referred to in Section 90 or 90A, subject to a maximum of one year. However, the Court ruled that since the request made by the Revenue pertained to years prior to April 1, 2011, and was not permissible under the substituted Article 26, it could not qualify as a valid reference under the DTAA. Hence, the period could not be excluded under Section 153B.

The High Court referred to multiple precedents reinforcing the strict interpretation of limitation statutes:

This judgment offers the following significant takeaways:

The ruling serves as a judicial milestone in reaffirming the legal consequence of novation in international agreements. It affirms that treaty provisions, once substituted, nullify prior obligations unless expressly preserved.