The Income-tax department can tax even a payment made to a foreign entity outside India, if the transaction has a business connection within
the country, according to a verdict passed last week by the Income Tax Appellate Tribunal, Mumbai.

In this case, the ITAT gave an order favouring the I-T departments decision to levy tax on $1 million (about Rs 4.5 crore) paid by an Indian company to a Chinese firm for services rendered in China.

In order to tax such payments, ITAT held, it is not necessary that the party has a business activity in India (territorial nexus). A division bench of ITAT, comprising Pramod Kumar and R S Padvekar, held that tax is payable in India on any income which is either sourced from India or which arises to a person domiciled in India.

The ITAT virtually dismissed the theory of territorial nexus, a concept of taxation by which tax is levied in the territory in which business activity took place.

The ITAT said that even if the business activity is not located in India, tax can be levied in India, the only prerequisite being a business connection.

In this case, the income being subject to tax is $I million paid by Indian company Ashapura Minechem to China Aluminium International Engineering Corp. The payment was made for services rendered by the Chinese company for bauxite testing. The final report of the bauxite testing was prepared by the Chinese company in China.

The Indian company claimed before the ITAT, that since the Chinese company did not have any business activity within India, it is not liable to pay tax in India either under the Indian Income-Tax Act or under the Double Taxation Avoidance Agreement.

The Indian company claimed before the ITAT that to be liable to pay tax in India, the Chinese company should have a territorial nexus in the country.

The latter did not have a permanent establishment in India, the Indian company pointed out. The concept of territorial nexus merely means that tax can be levied in the territory where the business activity had taken place. In this case, the payment was made outside India for service rendered outside India.

Therefore, going by the theory of territorial nexus, the Chinese company is not liable to pay tax in India. And hence the Indian company is not liable to withhold tax from the payment made to the Chinese company.

The ITAT negated the claim saying that India does not follow territorial taxation method in its income-tax. The ITAT said: It is thus fallacious to proceed on the basis that territorial nexus to a tax jurisdiction being sine qua non to taxability, in that jurisdiction is a normal international practise in all tax systems.

The ITAT drew support for its decision from the amendment made in the relevant I-T laws in the Finance Act 2010.