Amendments in Taxability of Non-resident by CBDT

15 November 2009

Lately, the Central Board of Direct Taxes or CBDT
 (which is the highest ranking executive authority for
 income taxes in India) has withdrawn several of
its circulars / instructions, which NRI4were relied
 upon by foreign companies and non resident taxpayers.

In July this year, the CBDT withdrew its Instruction
No. 1829 dt. 21 September 1989, which relaxed
the taxability of consortium of foreign companies
 engaged in execution of turnkey power projects.
n yet another such instance, the CBDT has recently
issued Circular No. 7/2009 on 22 October 2009,
withdrawing its following circulars:

• Circular No. 23 dt. 23 July 1969,

• Circular No. 163 dt. 29 May 1975; and

• Circular No. 786 dt. 7 February 2000.

The CBDT has cited that such withdrawal is on account
of their interpretation by some taxpayers, seeking to
 claim relief, which was not in accordance with the
 provisions of the Indian Income Tax Act (Act) or the
 intention behind these circulars. Circular No. 23
was issued by the CBDT to provide clarifications
 regarding taxability of foreign companies and
non-residents, engaged in specified business activities.

It provided that no tax shall be payable by non-residents
 in India, where they are engaged only in
principal-to-principal (P2P) sale of goods from
abroad to Indian importer(s), or to their Indian
subsidiary on an arm’s length basis, or in case of similar
P2P sale of plant and machinery to Indian importers on
installment basis. It also provided for non-taxability of
certain other incomes such as commission received by
foreign agents (of Indian exporters) operating in their
 own country, where the same is remitted directly
outside India. Another important aspect clarified by
 this circular (and subsequently, by Circular No. 163)
 was as regards the exemption of foreign companies
having a procurement office or agency in India,
where their operations were limited to purchase
of goods in India for the purpose of export.

Circular 23 emphasized that the Act does not seek to tax
the entire profits of a non-resident, where it carried out
 only a part of its business activities in India – and only
 that portion of the profits of a non resident is liable to
 tax in India, which can be reasonably attributed to the
 Indian operations of its business.

Yet another clarification was issued vide Circular No. 786,
regarding taxability of export commission earned by non-resident agents.

It was explained that where the services of such
an agent are rendered outside India, its commission
 income (in respect of export of goods from India) cannot
be taxed in India.

Over the last 40 years, various judicial
 authorities and courts placed reliance on these circulars
while pronouncing their judgments. One such landmark
decision was passed by the Supreme Court in the case
of Morgan Stanley and Co. Inc. (292 ITR 416), where it
was held that if an Indian enterprise is remunerated on
 an arm’s length basis, no further income would be left
to be attributed to the foreign enterprise and, therefore,
such enterprise would not be liable to tax in India.

Similarly, in the case of SET Satellite (Singapore) Pte Ltd.
(307 ITR 205) the Mumbai High Court, relying on the decision
 of Morgan Stanley and Co. Inc. and Circular No. 23,
affirmed the aforesaid proposition.

As a principle, circulars issued by CBDT are binding on
 the income tax authorities. But in the aforesaid cases
(and various others which are still pending for adjudication),
 the tax department challenged the applicability
of the CBDT circulars before the courts.

Circular No. 7/2009 also states that even when Circular 23 was in force,
 the revenue authorities have argued that it does not actually apply
to a particular case, or it cannot be interpreted to allow such a relief,
which is not in accordance with the provisions of the Act or the
intention behind the issue of the Circular.

Withdrawal of Circular 23 is likely to boost and complement
the case of revenue authorities in such other matters which
are pending adjudication. With the withdrawal of the
Circular No. 23, taxpayers will be unable to place direct
reliance on it. It is important to note that such withdrawal
does not necessarily mean that non-residents would be
 liable to tax in India, in situations described in these
circulars. Even so, in the absence of these circulars,
taxability of non-resident taxpayer needs to be evaluated
independently having regard to the provisions of the Act,
provisions of tax treaties and relevant judicial precedents.

Taxpayers may, therefore, need to evaluate and assess the
 impact of the withdrawal of the above circulars on their
transactions. It will be worthwhile to examine whether the
judicial interpretation on this subject materially different
from the interpretation adopted in the CBDT circular, and
will the principles set out in the CBDT circular continue to
apply in appropriate cases? The question is still open,
whether such withdrawal is in line with the principle of
justice, equity and good conscience, particularly when a
number of cases are pending adjudication on the subject matter.

It would also be interesting to witness further developments
on this issue, especially considering that a similar circular
issued in 2004 (dealing with taxability of non-residents which
outsource services to BPO units in India) continues to be in force
and is not sought to be withdrawn. Nonetheless such changes in
domestic tax laws may cause doubt about Indian tax regime
among non-resident tax payers. Considering the current
economic scenario, the Government must try to build
confidence in the stability of Indian tax regime and economic
 climate, particularly for foreign investors.