The recent Mumbai Income Tax Appellate Tribunal ruling in Sky High Leasing has brought much-needed clarity to aircraft leasing from Ireland and the availability of benefits under the India–Ireland double taxation avoidance agreement.
By addressing a crucial question about the availability of treaty benefits to Irish lessors, the ruling not only provides relief in similar disputes. It also reduces the likelihood of future disputes being raised by Indian tax authorities regarding the taxability of lease rentals paid to Irish lessors.
The Indian aviation sector depends significantly on leased aircraft. Meanwhile, Ireland has emerged as a hub for aircraft financing and leasing, not only for Indian airlines but also globally.
When Indian carriers enter leasing contracts with Irish companies, the tax treatment of lease rentals under such agreements becomes crucial to both parties.
In this ruling, the Indian tax authorities argued that Irish lessor entities were primarily structured to obtain benefits under the India–Ireland treaty, and that lease payments should be taxed in India by applying the principal purpose test as provided under the OECD BEPS multilateral instrument.
The tribunal disagreed with this argument, rejecting this line of reasoning. It held that multilateral instrument provisions can’t override the existing India–Ireland treaty unless they have been incorporated in domestic law under a separate notification by the government, echoing the Indian Supreme Court’s earlier judgment in Nestlé.
The tribunal’s analysis yielded some key findings. It underscored that the principal purpose test is designed to prevent treaty abuse, but also noted that invoking the test requires evidence of artificial arrangements or treaty shopping. Mere incorporation in Ireland and conducting leasing activities from there doesn’t suggest a tax avoidance motive.
The tribunal concluded that the principal purpose test should be applied narrowly, targeting convoluted structures rather than legitimate global aircraft financing and leasing hubs such as Ireland.
Another central issue was the characterization of the leases. The Indian Revenue argued that the contracts resembled financing arrangements, effectively functioning as “finance leases,” and that payments could be treated as royalties or interest under the India–Ireland treaty.
The tribunal disagreed. After reviewing the contracts, it found that the arrangements were dry operating leases—agreements for the temporary use of aircraft without transfer of ownership, crews, or control. This distinction is vital because the India–Ireland treaty explicitly excludes payments for using aircraft from the definition of royalty.
The tribunal firmly rejected the revenue’s contention that the Irish lessors had a permanent establishment in India. It reasoned that the mere presence of aircraft in India doesn’t create a fixed place of business for the Irish entities. A permanent establishment requires permanence, and the foreign entity’s business operations must be carried out within the country.
The tribunal also considered Article 8 of the India–Ireland treaty, which explicitly grants taxing rights over aircraft leasing income to the state of residence of the lessor, that is, Ireland.
It noted that that the deliberate deviation of this provision from Article 8 of the Organization for Economic Cooperation and Development Model Convention, which provides such benefit only for “operation” of aircraft and not “rental,” indicates a conscious call to exclude such income from being taxed in India.
By upholding this understanding, the tribunal has reinforced the treaty’s policy intent. Taking a contrary view of taxing lease rentals in India would have undermined the very purpose of Article 8, which has possibly been incorporated in the India-Ireland treaty to incentivize Irish aircraft lessors to conduct business with India.
Broader Implications
For Ireland-based lessors, the ruling is reassuring. It confirms that India will respect treaty protections and not unilaterally recharacterize leasing income. This reduces the risk premium (in terms of uncertainty) associated with doing business with Indian airlines, and aligns with the policy call to provide specific benefit to Irish lessors by the special carve out made under the India-Ireland treaty.
That said, the revenue may appeal the ruling. High-value international tax cases rarely end at the tribunal stage, and further litigation could prolong uncertainty.
The judgment has a broader resonance with India’s treaty network. The tribunal has set a strong precedent by reinforcing discipline in treaty interpretation, emphasizing that treaty obligations necessitate domestic notification, and that provisions such as the principal purpose test must be applied narrowly.
This should provide a sense of confidence in the tribunal’s commitment to upholding treaty obligations.
As an appeal may follow, the Sky High Leasing ruling will unlikely be the final word. But for now, it establishes clear principles:
- The principal purpose test can’t be invoked in the absence of contrived arrangements or a specific notification giving effect to multilateral instrument provisions in the context of the treaty.
- The presence of aircraft in India doesn’t create a permanent establishment.
- Operating leases aren’t royalties or interest.
- Article 8 of the India–Ireland treaty reflects a deliberate policy to encourage leasing.
For lessors in Ireland, this is a victory; for Indian airlines, a reprieve from rising costs.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.
Author Information
Aditya Singh Chandel is partner and Akshat Jain is an associate with AZB & Partners in India.
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