Taxing with connection or without?
Posted on November 11, 2010 | Author: Aseem Chawla & Surabhi Singhi | View 395
The domestic tax laws recognise the concept of nexus in the most widely interpreted and complex connotation termed as a business connection.
The general rule of imposotion of tax hinges on the connection of the taxpayer with the taxing state and/or the relationship of the taxpayer with the taxing state based on his residence or nationality.
In the case of non-residents, the jurisdiction of a state to tax them would, therefore, be based on the existence of such connection of the person sought to be taxed.
The activities of such nonresidents may enure incidence of tax either as a result of physical presence or by virtue of application of the source rule, where the income earned by the non-resident has a source in the taxing state.
This concept of ‘nexus’ for taxing non-residents in the country is gaining momentum because of the notable tax disputes, legislative proposals and amendments.
Under the existing income-tax framework, as regards nexus arising from source, tax can be imposed on income that
(i) is received in India, (ii) accrues and arises in India, and (iii) is deemed to accrue or arise in India.
Such situation resulting in incidence of tax in the country would only arise when there is some nexus with India.
The domestic tax laws recognise the concept of nexus in the most widely interpreted and complex connotation termed as business connection.
The expression business connection has been explained and interpreted by several courts denoting something that produces profit or gain and not just a situation that is conducive of earning such profit.
The term business connection was given an inclusive, but not exhaustive, explanation through an amendment to section 9 of the Income-Tax Act introduced in the Finance Act, 2003.
Earlier, the circular number 23 of July 23, 1969, had provided sufficient guidance to the befuddled taxpayer from the labyrinth of tax laws.
Drafted in an easy-tounderstand style, the clarificatory circular provided the taxpayer guidance on whether they have a business connection in the country and whether an income accrued in their hands through that business connection, giving specific instances.
But this circular was withdrawn in 2009 vide circular 7 of 2009 to reaffirm the mandate of section 9, which, according to the CBDT, was vehemently ignored by taxpayers to claim relief.
According to CBDT, the new circular puts the rationale of section 9 back on track.
The irony of circular 7 of 2009 is that it fails to provide clarity about the implication of the circular vis-à-vis different situations that the circular did touch upon.
Thus, the complexities existing in the interpretation of the term business connection and taxation of non-residents have been amplified by the manner in which the circular has been withdrawn without providing alternate means of interpreting the specific situations.
Amendments through the Finance Act, 2010, that have retrospective effect from June 1, 1976, to tax services of a non-resident utilised in the country regardless of whether rendered in India or not has not helped either.
The Direct Taxes Code Bill, 2010, has increased uncertainties as it includes many activities of nonresidents that are not considered as business connection under the law.
These include collection of news from India for transmission abroad by a nonresident news agency or publishers of newspapers, magazines or journals, and shooting of cinematograph films in the country.
Existing ambiguities have also increased following the removal of the proviso that clarified that a broker or a commission agent, where acting wholly on behalf of the non-resident or those subject to common control, would constitute a business connection.
The extant Act incorporates the principle of apportionment, i.e., taxes only such income attributable to operations carried out in India that has been imbibed into the provisions of the code on as-is basis.
Moreover, taxing mergers between foreign companies having underlying Indian subsidiaries may be taxed in India where not sanctioned under the domestic corporate law regime and expanding the tax net to offshore share acquisitions where the target foreign company holds direct or indirect assets in India that are more than 50% of the fair market value of all assets held by the company at any time within 12 months preceding the transfer also depicts an intention of taxing offshore transaction having ‘some’ connection with India.
Here, the Vodafone case and its likes may in future clearly fall under the tax net in the country, thereby expanding its ambit expansively.
Further, the ramifications of such changes in the domestic direct-tax laws would also merit consideration while interpreting use of similar expressions like that of fixed establishment for provisions relating to service tax payable on a reverse-charge basis.
Thus, with the ever-increasing pursuit of the country’s tax department to tax overseas activities having some connection with India and the legislative mandate, it needs to be seen if India can deviate from the source principle to the extent of modifying the concept of business connection and, thereby, widening its tax footprint.
Such keen and vigorous envisaged initiatives would need to be examined on the touchstone of principle of territoriality and sovereignty, being inherent for every nation.
The authors are partner and associate, respectively, at Amarchand Mangaldas