SECTION 9 l INCOME DEEMED TO ACCRUE OR ARISE IN INDIA
[CORRESPONDING TO SECTION 42 OF THE 1922 ACT]

41. Income accruing or arising through or from business connection in India - Non-residents - Liability to tax under clause (i) of sub-section (1)

CLARIFICATION 1

1. Section 9 provides, inter alia, that income accruing or arising, directly or indirectly, through or from any business connection in India, shall be deemed to be income accruing or arising in India and, hence, where the person entitled to such income is a non-resident, it will be includible in his total income. Clarifications1 issued in the past by the Board on the scope of the provisions of section 42 of the 1922 Act and their applicability in certain types of cases are hereby consolidated and restated for the information and convenience of the public.

2. What constitutes business connection - The expression “business connection” admits of no precise definition. The import and connotation of this expression has been explained by the Supreme Court in their judgment in CIT v. R.D. Aggarwal & Co. [1965] 56 ITR 20. The question whether a non-resident has a “business connection” in India from or through which income, profits or gains can be said to accrue or arise to him within the meaning of section 9 has to be determined on the facts of each case. However, some illustrative instances of a non-resident having business connection in India, are given below :

   o Maintaining a branch office in India for the purchase or sale of goods or transacting other business.

   o Appointing an agent in India for the systematic and regular purchase of raw materials or other commodities, or for sale of the non-resident’s goods, or for other business purposes.

   o Erecting a factory in India, where the raw produce purchased locally is worked into a form suitable for export abroad.

   o Forming a local subsidiary company to sell the products of the non-resident parent company.

   o Having financial association between a resident and a non-resident company.

3. The following clarifications would be found useful in deciding questions regarding the applicability of the provisions of section 9 in certain specific situations :

  (1)  NON-RESIDENT EXPORTER SELLING GOODS FROM ABROAD TO INDIAN IMPORTER2 - (i) No liability will arise on accrual basis to the non-resident on the profits made by him where the transactions of sale between the two parties are on a principal-to-principal basis. In all cases, the real relationship between the parties has to be looked into on the basis of agreement existing between them, but where—

  (a)  the purchases made by the resident are outright on his own account,

  (b)  the transactions between the resident and the non-resident are made at arm’s length and at prices which would be normally chargeable to other customers,

  (c)  the non-resident exercises no control over the business of the resident and sales are made by the latter on his own account, or

  (d)  the payment to the non-resident is made on delivery of documents and is not dependent in any way on the sales to be effected by the resident,

        it can be inferred that the transactions are on the basis of principal-to-principal.

  (ii)  A question may arise in the above type of cases whether there is any liability of the non-resident under section 5(1)(a) on the basis of receipt of sale proceeds including the profit in India. If the non-resident makes over the shipping documents to a bank in his own country which discounts the documents and sends them for collection to the bankers in India, who present the sight or usance draft to the resident importer and deliver the documents to him against payment or acceptance by the latter, the non-resident will not be liable to tax on the profit arising out of the sales on receipt basis. Even if the shipping documents are not discounted in the foreign country, but are handed over in India against payment or acceptance, no portion of the profits will be chargeable to tax under the Income-tax Act, if this is the only operation carried on in India on behalf of the non-resident.

  (2)  NON-RESIDENT COMPANY SELLING GOODS FROM ABROAD TO ITS INDIAN SUBSIDIARY - (i) A question may arise whether the dealings between a non-resident parent company and its Indian subsidiary can at all be regarded as on a principal-to-principal basis since the former would be in a position to exercise control over the affairs of the latter. In such a case, if the transactions are actually on a principal-to-principal basis and are at arm’s length and the subsidiary company functions and carries on business on its own, instead of functioning as an agent of the parent company, the mere fact that the Indian company is a subsidiary of the non-resident company will not be considered a valid ground for invoking section 9 for assessing the non-resident.

        1(ii) Where a non-resident parent company sells goods to its Indian subsidiary, the income from the transaction will not be deemed to accrue or arise in India under section 9, provided that (a) the contracts to sell are made outside India, (b) the sales are made on a principal-to-principal basis and at arm’s length, and (c) the subsidiary does not act as an agent of the parent company. The mere existence of a “business connection” arising out of the parent-subsidiary relationship will not give rise to an assessment, nor will the fact that the parent company might exercise control over the affairs of the subsidiary.

(3)  SALE OF PLANT AND MACHINERY TO AN INDIAN IMPORTER ON INSTALMENT BASIS - Where the transaction of sale and purchase is on a principlal-to-principal basis and the exporter and the importer have no other business connection, the fact that the exporter allows the importer to pay for the plant and machinery instalments will not, by itself, render the exporter liable to tax on the ground that the income is deemed to arise to him in India. The Indian importer will not, in such a case, be treated as an agent of the exporter for the purposes of assessment.

  (4)  FOREIGN AGENTS OF INDIAN EXPORTERS - A foreign agent of Indian exporter operates in his own country and no part of his income arises in India. His commission is usually remitted directly to him and is, therefore, not received by him or on his behalf in India. Such an agent is not liable to income-tax in India on the commission.1

2(5)  NON-RESIDENT PERSON PURCHASING GOODS IN INDIA - A non-resident will not be liable to tax in India on any income attributable to operations confined to purchase of goods in India for export, even though the non-resident has an office or an agency in India for this purpose. Where a resident person acts in the ordinary course of his business in making purchases for a non-resident party, he would not normally be regarded as an agent of the non-resident under section 163. But, where the resident person is closely connected with the non-resident purchaser and the course of business between them is so arranged that the resident person gets no profits or less than the ordinary profits which might be expected to arise in that business, the Income-tax Officer is empowered to determine the amount of profits which may reasonably be deemed to have been derived by the resident person from that business and include such amount in the total income of the resident person.

  (6)  SALES BY A NON-RESIDENT TO INDIAN CUSTOMERS EITHER DIRECTLY OR THROUGH AGENTS - (a) Where a non-resident allows an Indian customer facilities of extended credit for payment, there would be no assessment merely for this reason provided that—(i) the contracts to sell were made outside India; and (ii) the sales were made on a principal-to-principal basis.

        (b) Where a non-resident has an agent in India and makes sales directly to Indian customers, section 9 of the Act will not be invoked, even if the resident pays his agent an overriding commission on all sales to India, provided that (i) the agent neither performs nor undertakes to perform any service directly or indirectly in respect of these direct sales and the making of these sales can, in no way, be attributed to the existence of the agency or to any trading advantage or benefit accruing to the principal from the agency; (ii) the contracts to sell are made outside India; and (iii) the sales are made on a principal-to-principal basis.

        (c) Where a non-resident’s sales to Indian customers are secured through the services of an agent in India, the assessment in India of the income arising out of the transaction will be limited to the amount of profit which is attributable to the agent’s services, provided that (i) the non-resident principal’s business activities in India are wholly channelled through his agent, (ii) the contracts to sell are made outside India, and (iii) the sales are made on a principal-to-principal basis. In the assessment of the amount of profits, allowance will be made for the expenses incurred, including the agent’s commission, in making the sales. If the agent’s commission fully represents the value of the profit attributable to his service; it should prima facie extinguish the assessment.

        (d) Where a non-resident principal’s business activities in India are not wholly channelled through his agent in India, the assessment in India will be on the sum total of the amount of profit attributable to his agent’s activities in India and the amount of profit attributable to his own activities in India, less the expenses incurred in making the sales.

  (7)  EXTENT OF THE PROFIT ASSESSABLE UNDER SECTION 9 - Section 9 does not seek to bring into the tax net the profits of a non-resident which cannot reasonably be attributed to operations carried out in India. Even if there be a business connection in India, the whole of the profit accruing or arising from the business connection is not deemed to accrue or arise in India. It is only that portion of the profit which can reasonably be attributed to the operations of the business carried out in India, which is liable to income-tax.

        To constitute a business connection, some continuity of relationship, between the person in India who helps to make the profits and the person outside India who receives or realises the profits, is necessary. Where all what has happened is that a few transactions of purchases of raw materials have taken place in India and the manufacture and sale of goods have taken place outside India, the profits arising from such sales cannot be considered to have arisen out of a business connection in India. Where, however, there is a regular agency established in India for the purchase of the entire raw materials required for the purpose of manufacture and sale abroad and the agent is chosen by reason of his skill, reputation and experience in the line of trade, it can be said that there is a business connection in India so that a portion of the profits attributable to the purchase of raw materials in India can be apportioned under Explanation (a) to section 9(1)(i).1 [The taxability of such portion of the profits will, however, be subject to the exemption provided in clause (b) of the Explanation to section 9(1)(j).]

Circular : No. 23 [F. No. 7A/38/69-IT(A-II)], dated 23-7-1969.

Judicial analysis

Distinguished in - The above circular was distinguished on facts in Performing Rights Society Ltd. v. CIT [1977] 106 ITR 11 (SC), with the following observations :

“Mr. Dutt relied upon a circular of the Central Board of Direct Taxes being Circular No. 23/F, 1969, dated 23rd July, 1969, regarding liability to tax on income accruing or arising to a non-resident under section 9 of the Act. Mr. Dutt contended that this circular has statutory force under section 119 of the Act. For our present purpose, however, we are not required to consider whether the circular has any statutory force or not because the circular relates to income accruing or arising through or from business connection in India. Paragraph 7 of the said circular is as follows :

**                                                                   **                                                               **

This circular, therefore, contemplates a situation quite different from that in the present case.” (pp. 17-18)

Applied in - The above circular was referred to and applied in CIT v. Gulf Oil (Great Britain) Ltd. [1977] 108 ITR 874 (Bom.), with the following observations :

“. . . . However, Mr. Joshi was fair enough to invite our attention to a circular bearing No. 23 of 1969, dated July 23, 1969, issued by the Central Board of Direct Taxes, where certain clarifications have been issued by the Board on the scope of provisions of section 42 (section 9 of the Income-tax Act, 1961), and their applicability in certain types of cases and he fairly conceded that the question raised in the instant reference may have to be considered having regard to the guidelines or clarifications that have been issued by the Board in the said circular. Paragraph 2 of the circular runs thus :

**                                                                   **                                                               **

 “Having regard to this illustrative instance, which has been given in paragraph 2 of the aforesaid circular, it is quite clear that in the instant case the business connection could be said to have been established, inasmuch as the Indian subsidiary company which is a hundred per cent subsidiary owned by the non-resident company has been formed to effect sales of the products of non-resident company . . . .”

**                                                                   **                                                               **

 “In this view of the matter, it seems to us clear that in view of the illustrative instances and guidelines furnished by the Board under its aforesaid circular, there is no scope for applying the provisions of section 42(3) of the Act . . . .”

CLARIFICATION 2

1. Attention is invited to para 3(7) of Board’s Public Circular No. 23, dated 23-7-1969 [Clarification 1] , wherein it has been stated as follows :

“. . . where, however, there is a regular agency established in India for the purchase of the entire raw materials required for the purpose of manufacture and sale abroad and the agent is chosen by reason of his skill, reputation and experience in the line of trade, it can be said that there is a business connection in India so that a portion of the profits attributable to the purchase of raw materials in India can be apportioned under Explanation (a) to section 9(1)(i).”

2. The above sentence may convey the impression that a non-resident is liable to be taxed on a portion of the profits attributable to the purchase of raw materials required for the purposes of manufacture and sale abroad, if the purchases are made in India through a regular agency established in India for this purpose. By virtue of clause (b) of the Explanation to section 9(1)(i), the correct legal position is that in the case of a non-resident, no income shall be deemed to accrue or arise in India through or from operations which are confined to purchase of goods in India for the purpose of export. Accordingly, the mere existence of an agency established by a non-resident in India will not be sufficient to make the non-resident liable to tax, if the sole function of the agency is to purchase goods for export. This legal position has also been explained in para 3(5) of the Board’s Public Circular cited above.

3. To remove any possible misunderstanding of the legal position, the following sentence may be added at the end of para 3(7) of the said circular:

“The taxability of such portion of the profits will, however, be subject to the exemption provided in clause (b) of the Explanation to section 9(1)(i).”

Circular : No. 163 [F. No. 488/23/73-FTD], dated 29-5-1975.

41A. Application of section 9(1)(ii) to Sikkim

Though the Indian Income-tax Act, 1961 has not yet been extended to Sikkim by any notification under Article 371F(n) of the Constitution and for the purpose of Indian Income-tax Act, 1961, Sikkim will have to be treated as outside India under section 9(1)(iii) of the Indian Income-tax Act, 1961.

Letter : E/275/118A/77-II(B), dated 7-11-1978

[See Bakulesh T.Shah v. Dy. CIT [2002] 81 ITD 89, 100 (Mum.) (SB)]

42. Liability to Indian income-tax of non-resident exporters of goods to India and of foreign agents of Indian exporters under section 42 of 1922 Act

It seems necessary to remove any doubts or misapprehensions regarding the liability of non-resident exporters of goods to India and of foreign agents of Indian exporters. The correct position is as follows:

NON-RESIDENT EXPORTERS - Where the transactions of sales and purchases are as between principal and principal, no liability of the exporter arises in India on accrual basis, and the resident importer cannot be held to be the agent of the exporter on the basis of such transactions. It is difficult to lay any hard and fast criteria for determining whether the transactions are between principal and principal. The real relation between the parties will have to be looked into from any agreement existing between them, but where—

   a.  the purchases made by the resident are outright on his own account,

   b.  the transactions between the resident and non-resident are made at arm’s length at prices which would be normally chargeable to other customers,

   c.  the non-resident exercises no control over the business of the resident and sales are made by the latter on his own account, or

   d.  the payment to the non-resident is made on delivery of documents and is not dependent in any way on the sales to be effected by resident,

it can be inferred that the transactions are as between principal and principal.

The only other question that may arise in such a case is whether there is any liability of the non-resident under section 4(1)(a) of the 1922 Act [corresponding to section 5(2)(a) of the 1961 Act] on the basis of receipt of sale proceeds, including profits, in India. Here again, the main question is whether the agent took all the risks attendant on the import and no part of the risk in trading was taken up by the principal. If, for instance, the non-resident made over the shipping documents to a bank in his own country which discounted the documents and sent them for collection to bankers in India who presented the sight or usance draft to the resident importer and delivered the documents to him against payment or acceptance by the latter, no attempt should be made to assess the non-resident on receipt basis. In such a transaction, the non-resident, in effect, receives, the value of the documents in his own country.

FOREIGN AGENTS OF INDIAN EXPORTERS - A foreign agent of an Indian exporter operates in his own country and no part of his income arises in India - Usually, his commission is remitted directly to him; and is, therefore, not received by or on his behalf in India. Such an agent is not liable to Indian income-tax.

Circular : No. 17(XXXVII-1) [F. No. 26(26)-IT/53], dated 17-7-1953.

43. Goods purchased in India for export to non-residents through commission agents - Liability to tax under section 42 of 1922 Act

1. A reference is invited to the Board’s letter No. F. 56(5)-IT/48, dated 21-6-1949, in which it was laid down that where a resident commission agent who purchases goods for and on behalf of a non-resident principal shows in his account a net profit of at least 3 per cent, no attempt should be made to assess the non-resident principal under section 42 of the 1922 Act. It has been represented to the Board that conditions in the export trade have changed considerably since the above instructions were issued and the figure of 3 per cent prescribed in 1949 is not now likely to be realised in many cases. The Board are of the view that a change in the present practice is called for and have, therefore, decided that the criterion of 3 per cent need not be applied in such cases in future. Where it is clear that the resident person acts in the usual course of his business in making purchase for the non-resident party, no attempt should be made to treat the resident commission agent as an agent of the non-resident party under section 42 merely on the ground that the net profit shown by the resident party is less than 3 per cent.

2. The provisions of section 42 would, of course, continue to be applied to cases in which a non-resident party sets up a purchasing agency in India and cases in which the so-called commission agent is closely connected with non-resident purchaser and the course of business between them is so arranged that the resident party gets no profits or loss than the ordinary profits which might be expected to arise in that business.

3. This decision should be given effect from the assessment year 1958-59.

Circular : No. 4(XLIII-8), dated 24-2-1958.

44. Assessment of British and other foreign companies - Section 42(1) of 1922 Act read with rule 33 of 1922 Rules [corresponding to rule 10 of 1962 Rules]

CLARIFICATION 1

1. The Board has decided that the instructions which appeared in paragraphs 112 and 113 of the Income-tax Manual (7th Edition) and which have been substantially reproduced at pages 348-350 (excepting the last two paragraphs at page 350) of the Income-tax Manual (8th Edition) should be followed in respect of the assessment of foreign shipping companies from 1940-41 onwards. These instructions, inter alia, allow a foreign shipping company furnishing annual accounts for the whole of its business, Indian and foreign, to adopt the U.K wear and tear allowance for the purpose of the computation of its income in accordance with the second method provided by rule 33 of the 1922 Rules [corresponding to rule 10 of the 1962 Rules] and allow a British shipping company to elect to be assessed on the basis of a ratio certificate granted by the U.K authorities regarding the income or loss and the wear and tear allowance.

2. The bearing of the provisions of sections 10(2)(vii) and 24(2) of the 1922 Act [corresponding to sections 32(1)(iii) and 41(2), respectively, of the 1961 Act], however, requires to be considered in this connection. As no record of any depreciation allowance has been kept in India in respect of the companies assessed in accordance with either of the methods noted above, it will not be possible to work out the written down value without which the provisions of section 10(2)(vii) cannot be applied. If, therefore, any foreign shipping company desires to follow the method of electing the U.K. wear and tear allowance for the purpose of its Indian assessment, it must agree either to forgo the allowance under section 10(2)(vii)—the Government also agreeing, in such a case, to forgo the tax on the ‘excess’ described in the second proviso to section 10(2)(vii)—or to give particulars (agreed with the U.K authorities) in respect of (i) the original cost of the asset sold or discarded, (ii) the aggregate U.K wear and tear allowance in respect of that asset, and (iii) its scrap value or sale price. The ‘excess’ or the loss computed on the basis of these particulars will, in that case, be added to or deducted from the whole world income computed for the purpose of the second method in rule 33. As regards companies electing to be assessed on the basis of the U.K ratio certificates it will not be possible to apply the provisions of section 10(2)(vii) to such cases and the companies concerned will have to accept this position.

3. As regards section 24(2), there will be no difficulty in respect of companies electing the U.K wear and tear allowance only. It will, however, not be possible to work out correctly the loss to be carried forward in respect of the companies electing to be assessed on the basis of the U.K ratio certificate unless the certificate in respect of the assessment from 1939-40 onwards contains the following particulars in place of the particulars furnished for assessments up to and including the year 1938-39 :

    i.  the ratio of profits (before deduction of any previous loss) of any accounting period as computed for the purposes of the U.K income-tax, computed without making any allowance for wear and tear, to the gross earnings of the company’s whole fleet;

   ii.  the ratio of loss (before including any previous loss) of any accounting period computed as above;

   iii  the ratio of U.K allowance for wear and tear to the gross earnings of the whole fleet.

4. Thus, either certificates (i) and (iii) or certificates (ii) and (iii) will apply to a particular case. The relative ratios being applied to the Indian “gross earnings”, it will be possible to work out separately the proportionate Indian profit or loss and depreciation and there will be no difficulty in carrying forward the loss or the depreciation or both, as the case may be.

Circular : No. 7 [C. No. 27(17)-IT/41], dated 10-2-1942.

JUDICIAL ANALYSIS

Reviewed in - The above circular was reviewed by the Supreme Court in Ellerman Lines Ltd. v. CIT [1971] 82 ITR 913. The Court observed that it is clear from the language of this circular that it does not in terms at all include destination earnings and, therefore, this circular, by any process of interpretation, cannot exclude the destination earnings. The Court further held that income or loss referred to in the circular meant net income or net loss.

The Court also held that the fact that the proviso to section 10(2)(vib) of the 1922 Act was inserted after the Board had issued its instruction did not affect either the validity of rule 33 or the force of the circular issued by the Board because neither rule 33 nor the circular issued by the Board were strictly in accordance with section 10(2) of the 1922 Act: they merely laid down just and fair methods of approach to a difficult problem.

CLARIFICATION 2

1. This rule [rule 33] provides the manner of ascertaining the income, profits or gains of a non-resident person, when the actual amount of his income, profits or gains chargeable to tax in British India cannot be arrived at.

2. In respect of foreign shipping companies carrying on business in British India, the following methods will be followed for the purpose of calculating their income from shipping business in respect of assessment for the year 1939-40 and for earlier years:

1. If a company furnishes annual accounts for the whole of the business, Indian and foreign, the second method provided by rule 33 will reasonably be applied. Depreciation has only to be considered in calculating the world profits. These are to be calculated according to the Indian Income-tax Act. Profits calculated according to the United Kingdom Act will, therefore, require certain adjustments. Deductions permitted in the U.K but not permitted in India will have to be added back and deductions permissible in India but not permissible in the U.K. will have to be allowed. If any company, however, prefers to claim the depreciation allowed by the U.K. Income-tax authorities, the Commissioners of Income-tax may adopt that figure. Otherwise, depreciation will have to be calculated according to the Indian rules. What follows applies to the calculation of depreciation according to the Indian rules. For this purpose, a complete depreciation record has to be maintained for the entire fleet. Depreciation begins to run from the first year in which the company is “assessed” in India, that is, the first year in which its profits or loss were determined for the purpose of deciding whether it was liable to Indian income-tax. Unabsorbed depreciation, i.e., any balance of depreciation which cannot be allowed in any year owing to the profits not being sufficient to cover the full amount permissible under the Indian rules will be carried forward and allowed as far as possible in calculating the world profits according to the Indian method in the following year and if necessary in subsequent years provided that unabsorbed depreciation for 1938-39 and earlier years cannot be set off against an assessment for 1939-40 or any subsequent year. The proportion of Indian receipts to total receipts is applied to the world profits calculated according to the Indian method (if there are any such profits) and the result is the Indian income liable to tax. No further deduction is permissible from the amount thus arrived at on account of depreciation (unabsorbed or otherwise) or anything else. The due proportion of all allowances permissible is automatically set off against the Indian profits by the above method.

This method is equally applicable whether a company works out the profits for each voyage or follows any other method of account provided that it prepares complete annual accounts for the whole business, Indian and foreign, and furnishes the accounts of gross receipts, Indian and foreign.

Some lines do not furnish complete annual accounts for their world business. They keep separate complete annual accounts for their Indian trade, that is, for all “round voyages” to and from Indian ports. The proper course is then to apply the method just described treating the profits of the Indian trade and the gross receipts of the Indian trade as though they were the “world profits” and the ‘world receipts’ respectively. In fact, the business other than the Indian trade is ignored.

2. A difficulty sometimes arises in such cases owing to the fact that the ships employed in the Indian trade are constantly being changed. Unless U.K. depreciation is accepted as indicated above, a depreciation record will have to be kept for every ship employed at any time in the Indian trade. Depreciation must be allowed on each ship employed in the Indian trade in a given year and the allowance must be a proportion of the annual rate calculated with reference to the number of days spent in the Indian trade, whether at sea or in harbour. Any unabsorbed depreciation in any year must be distributed among the ships in the Indian trade in that year in proportion to the capital cost of each and the unabsorbed depreciation thus allotted to any ship can only be allowed in any subsequent year against the same ship.

The allowance should cease :

   a.  on ships which were included in the fleet in the first year in which the company becomes liable to assessment in India (irrespective of whether it was actually found to have a taxable income in that year or not), after the twentieth year beginning with that year;

   b.  on ships subsequently added to the company’s fleet, after they have been borne on the fleet for 20 years.

3. In both cases the period may be extended proportionately where the U.K. depreciation is allowed in calculating the ‘profits of the Indian trade’ which take the place as already explained of the “world profits”.

Obsolescence cannot be allowed in these cases :

BRITISH SHIPPING COMPANIES - ASSESSMENT OF - When assessing British Shipping Companies, the ITO should accept a certificate granted by the Chief Inspector of Taxes in the U.K. stating, (i) the ratio of the profits of any accounting period as computed for the purposes of the U.K. income-tax computed without making any allowance for wear and tear to the gross earnings of the company’s whole fleet, and their ratio of the U.K. allowance for wear and tear to the gross earnings of the whole fleet, or (ii) the fact that there were no such profits. The expression “gross earnings of the company’s whole fleet” means the total receipts of the shipping company, excepting only receipts from non-trading sources, such as income from investments.

ASSESSMENT FOR 1940-41 ONWARDS - The above instructions should also be followed in respect of the assessments of foreign shipping companies for1940-41 onwards. These instructions, inter alia, allow a foreign shipping company furnishing annual accounts for the whole of its business, Indian and foreign, to adopt the U.K. wear and tear allowance in lieu of the depreciation allowance under the Indian Income-tax Act, for the, purpose of the computation of its income in accordance with the second method provided by rule 33, and also allow a British shipping company to elect to be assessed on the basis of a ratio certificate granted by the U.K. authorities regarding the income or loss and the wear and tear allowance.

Instruction : Quoted in CIT v. Wilh. Wilhelmen [1978] 115 ITR 10 (Cal.) at pp. 18-19.

Judicial Analysis

EXPLAINED IN : Wilh, Wilhelmsen [1996] 87 Taxman 269 (SC) with the following observations :

“14. It would be evident from a perusal of the above provisions that section 10(2)(vi) does not specifically provide for allowance of depreciation on foreign ships trading with India. Rule 33 also does not specifically provide for the situation except that the last portion of the rule empowers the ITO to arrive at the actual amount of income, profits or gains accruing or arising to any person residing outside taxable territories in such other manner as he deems suitable where such ascertainment cannot be done according to the first two methods indicated therein. It is precisely to provide for certain specific situations that the Central Board issued the aforesaid instructions under rule 33. The instructions specifically lay down the method and the manner in which depreciation has to be worked out on ships owned by a foreign shipping line carrying on business in British India. In this case, it is admitted that the appellant-company did not prepare and furnish the complete annual accounts for its entire business, Indian and foreign, along with an account of its gross receipts, Indian and foreign. It kept a separate annual account in respect of its Indian trade and submitted the same to the income-tax authorities. The instructions provide, inter alia, for such a situation as well. The instructions issued by the Central Board under rule 33 merely elucidate and elaborate the manner in which the business income of such foreign shipping lines are to be ascertained. These instructions are relatable to the last/third alternative provided by rule 33. We are, therefore, in agreement with the High Court that the aforesaid instructions do not run counter to rule 33 or for that matter to section 10(2)(vi). Evidently, these instructions were issued in view of the problems faced and experience gained by the department and to meet situations not expressly provided for by the Act or the Rules. They are in the nature of guidance to the Assessing Officers. We are also in agreement with the High Court that the instructions are clear and unambiguous and that the ITO was bound to follow them. The instructions specifically provided that depreciation must be allowed on each ship employed in the Indian trade in a given year and that the allowance must be a proportion of the annual rate calculated with reference to the number of days spent in the Indian trade whether at sea or in harbour. They further provided that any unabsorbed depreciation in any year must be distributed among the ships in the Indian trade in that year in proportion to the capital cost of each ship and that the unabsorbed depreciation thus allotted to any ship can only be allowed in any subsequent year against the same ship. The instructions also provide clearly that the allowance shall cease on ships after the expiry of twenty years. It is not disputed by the learned counsel for the assessee before us that the instructions have been correctly understood or followed by the ITO. The complaint rather is that the instructions themselves are inconsistent with the statutory provisions. Since we have held that the instructions are not inconsistent with nor can be said to be outside the purview of rule 33 read with section 5(8), no further question arises. . . .”

45. Foreign insurance companies doing re-insurance business in India - No uniform principle could be laid down - ITO to examine each case and decide about taxability

The Central Board of Revenue recently reviewed the position regarding the taxability of a foreign company on its profits of re-insurance with companies in India. It was decided that no uniform principle could be laid down which would be applicable in all cases of re-insurance, whether they may be cases in which each single risk is offered separately by the ceding company (i.e., the insurer) to the accepting company or companies (i.e., the re-insurer) or there may be cases in which re-insurance is effected in accordance with a standing agreement. Liability to tax on foreign re-insurer will depend on various factors, such as, the existence of reciprocity between the Indian insurer and the foreign re-insurer, the magnitude of local retention as compared with the re-insurance premium paid by the Indian insurer to the foreign re-insurer and so on. The Income-tax Officers will, therefore, have to examine each case in the light of its facts and decide, where tax liability is attracted, what portion of the income from the re-insurance should be assessed under section 42 of the 1922 Act.

Circular : No. 35(XXXIII-7) of 1956 [F. No. 51(5)-IT/54], dated 3-9-1956.

46. Pensions received from abroad by pensioners residing in India - Taxability under clause (iii) of sub-section (1)

1. Under section 9(1)(iii), pension accruing abroad is taxable in India only if it is earned in India. Pensions received in India from abroad by pensioners residing in this country, for past services rendered in the foreign countries, will be income accruing to the pensioners abroad, and will not, therefore, be liable to tax in India on the basis of accrual. These pensions will also not be liable to tax in India on receipt basis, if they are drawn and received abroad in the first instance, and thereafter remitted or brought to India.

2. It is only in cases where in pursuance of a definite agreement with the employer or former employer, the pension is received directly by the pensioner in India that the pension would become taxable in India on receipt basis.

3. While the pension earned and received abroad will not be chargeable to tax in India if the residential status of the pensioner is either “non-resident” or “resident but not ordinarily resident”, it will be so chargeable if the residential status is “resident and ordinarily resident”. The aforesaid status of “ordinarily resident” cannot, however, be acquired by a person unless he has been resident in India in at least nine out of the preceding ten years.

Circular : No. 4 [F. No. 73A/2/69-IT(A-II)], dated 20-2-1969.

Judicial analysis

Applied in - The above circular was referred to and applied in Fifth ITO v. Mrs. Lalitha Chettur [1991] 38 ITD 294 (Mad. - Trib.), with the following observations :

“. . . There is a circular of Central Board of Direct Taxes which is unequivocal in its terms dated 20-2-1979 in Circular No. 4 [F. No. 73-A/2/69-IT(A-II)]. It was fully extracted in the impugned order passed by the Commissioner (Appeals). In that circular it is stated that pensions will not also be liable to tax in India on receipt basis, if they are drawn and received abroad in the first instance and thereafter remitted or brought to India. In the case of Ms. Padmini Chettur, one of the legal heirs of the deceased, the Income-tax Officer while making the assessment for 1982-83 already agreed that the Paymaster General was acting as agent of the assessee and in his capacity as agent, first received the pension of the recipient from the Department of National Health Service and the same pension received by him was remitted to the assessee in India through post (vide page 17 of the paper book filed by the assessee, representing assessment order dated 7-2-1986, for the assessment year 1982-83, in the case of Padmini Chettur). Thus it can be seen that the amount of family pension was not directly received by the assessee in India but it was first received by the Paymaster General as agent of the assessee and later it was sent to India through post to the assessee and therefore on receipt basis the family pension was not assessable in India as per the categorical terms of the CBDT circular mentioned above. In the same CBDT circular mentioned above, it was stated that pension received in India, from abroad, by pensioners residing in this country for past services rendered in the foreign country, will be income accruing to the pensioners abroad and the same will not, therefore be liable to tax in India on the basis of accrual. Late Balakrishna Chettur was employed in the National Health Service, U.K. He died in 1976 and by the order dated 29-9-1976 passed by the Department of Health and Social Security, the following allowances were granted to the wife as well as the children of late Balakrishna Chettur (vide page 4 of the paper book filed by the assessee):—

Widow’s injury allowance

£ 2,664.27 p.a.

Children’s allowance for

 

Krishnan and Padmini

£ 307.42 p.a. for each child

Lump sum payment

£ 2,049.43

It is stated that the allowances are payable with effect from 25th May, 1976 and are in addition to the benefits, the assessee and her children are receiving, under the National Health Service Superannuation Scheme. It is further stated that the then minor son, Krishnan, and daughter, Padmini, will remain payable until they attain 16 years of age and beyond that date if full time education continues. Therefore, it is clear that the family pension and allowance due to the assessee were received abroad for the services rendered by late Balakrishna Chettur in Department of Health and Social Security in U.K. Therefore as per the CBDT circular quoted above this amount received in India cannot be taxed even on accrual basis. . . .” (pp. 297-298)

Applied in - Maganlal Ranchhodbhai Chhaya v. ITO [1985] 11 ITD 432 (Ahd. – Trib.).

47. Taxation of shares of Indian companies allotted to non-residents in consideration for the purchase of machinery and plant delivered abroad under clause (vi)/(vii) of sub-section (1)

1. Clauses (vi) and (vii) have been inserted in sub-section (1) of section 9 by the Finance Act, 1976, with effect from 1-6-1976. As a result, income by way of royalties and fees for technical services is deemed to accrue or arise in India in the cases specified under these provisions.

There are, however, two exceptions to the above general position. Firstly, lump sum consideration paid under approved agreements made before 1-4-1976 for the transfer outside India of, or the imparting of information outside India in respect of, any date, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark, or other similar property is not deemed to accrue or arise in India, and secondly, income by way of fees for technical services under approved agreements made before that date is not deemed to accrue or arise in India.

2. In this context, certain questions have been raised as to whether the clarifications contained in Public Circular No. 21 of 1969 would be applicable. In para 11 of this circular, it was stated that in a case where, shares are issued at the time of incorporation of an Indian company in consideration for the transfer abroad of technical know-how or services, or delivery abroad of machinery and plant, and the payment is not taxable under section 5(2)(b) as income accruing or arising or deemed to accrue or arise in India, no attempt should be made by the department to bring to tax the profits or gains on such transactions merely on the ground that the situs of the shares is in India.

3. As a result of the amendments brought about by the Finance Act, 1976, royalties or fees for technical services paid in pursuance of collaboration agreements entered into on or after April 1, 1976, are chargeable to tax under section 5(2)(b). The contents of para 11 of Circular No. 21 of 1969 would cover only cases where shares in Indian companies are allotted to a non-resident for delivery abroad of machinery and plant. Where shares in Indian companies are allotted in consideration for the machinery and plant, the income embedded in the payments would be received in India as the shares in the Indian companies are located in India and would accordingly attract liability to income-tax as income received in India.

4. In view of the legal position, the concessions in paragraph 11 of the said circular are in the nature of extra legal concessions and the Board have decided to withdraw the same. Paragraph 11 of the Public Circular No. 21,1 may, therefore, be treated as withdrawn with immediate effect.

Circular : No. 382 [F. No. 484/12/78-FTD], dated 4-5-1984.

 

48. Taxation of Business Process Outsourcing Units in India

A non-resident or a foreign company is treated as having a permanent establishment or business connection in India under article 5 of the Double Taxation Avoidance Agreements or under section 9 of the Income-tax Act, 1961, if the said non-resident or foreign company carries on business in India through a branch, sales office etc., or through an agent (other than an independent agent) who habitually exercises an authority to conclude contracts, or regularly delivers goods or merchandise, or habitually secures orders in India, on behalf of the non-resident principal. In such a case, the profits of the non-resident or foreign company attributable to the business activities carried out in India becomes taxable under the Income-tax Act, 1961.

2. During the last decade or so India has seen a steady growth of outsourcing of business processes by non-residents or foreign companies to IT-enabled entities in India. Such entities are either branches or associated concerns of the foreign enterprise or an independent Indian enterprise. Their activities range from mere procurement of orders for sale of goods or provision of services and answering sales related queries, to the provision itself of services like software maintenance service, debt collection service, software development service, credit card/mobile telephone related service etc. In some cases the entire or major portion of the revenue generating activities of the non-resident enterprise is performed by the BPO (Business Process Outsourcing) unit in India. The extent to which global profits of a non-resident enterprise is to be attributed to the activities of the BPO unit in India in these various circumstances, has been under consideration in the Board.

3. The manner and extent of such attribution of profits will evidently depend on the facts of each case and the nature of services rendered by the BPO unit, and the same has to be determined in accordance with the provisions of the treaty applicable and the domestic law. The Board is, however, of the view that in a case where a non-resident, carrying on manufacture and sale of goods or merchandise or provision of services outside India, outsources some of its incidental activities viz. conclusion of contracts and procurement of orders (which enable the core activities to be carried on abroad) to an IT-enabled entity in India, which constitutes a permanent establishment of the non-resident principal, then the insignificant profit which is difficult to determine and attributable to the conclusion of such contracts or procurement of such orders can be considered to be embedded in the income of the permanent establishment taxable in India, if the price charged in respect of the above services by the permanent establishment is an arm’s length/fair market price. In such a situation, therefore, no income shall separately accrue or arise or be deemed to accrue or arise to the non-resident principal in India.

4. An example of such services by an IT-enabled entity in India could be a case where a foreign company manufacturing computers abroad and also selling such computers to customers abroad, engages or sets up a call centre in India to procure orders from or conclude contracts with customers abroad and also to answer sales related queries on telephone. In such a case, no income shall accrue or arise or be deemed to accrue or arise to the non-resident in India, apart from the income of the call centre. Similarly, where a foreign insurance company insuring risks in countries other than India appoints or sets up a call centre in India to attend to calls from customers outside India regarding acquisition of new insurance policy or revision of existing policy, to disseminate relevant information and accept insurance proposals from the customers, while actual policy issuance as well as collection of premium is done outside India by the foreign insurance company, no profits of the non-resident shall be taxable in India, apart from the income of the call centre if the charges paid to the call centre for its services are at arm’s length/fair market price. Another example of such services could be the case of a foreign credit card company issuing credit cards to customers living in countries other than India, which appoints or sets up a call centre in India to attend to calls from customers outside India seeking to acquire a new credit card, disseminate relevant information and accept the request for issue of a credit card from the customer, while the actual card issuance, the delivery of the card and collection of charges are being done outside India by the foreign credit card company, and the charges paid to the Indian call centre for its services are at arm’s length/fair market price.

5. On the other hand, where a non-resident or a foreign company outsources the whole or part of its core revenue generating business activities to an IT-enabled entity in India, such as the services of a travel agent, software developer, software maintenance, investment consultant, debt collection service, etc., and the IT-enabled entity in India renders the services either directly to the customers abroad or through the non-resident principal, a considerable portion of the profits derived by the non-resident or the foreign company from its customers abroad would certainly be attributable to the activities performed by the IT-enabled entity in India. If such entity constitutes a permanent establishment of the non-resident or foreign company in India, such attributed profits would be taxable under the Income-tax Act, 1961 in accordance with the provisions of the relevant tax treaty.

Circular : No. 1/2004, dated 2-1-2004.