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Taxing non-residents The source rule principle
August, 19th 2006
Non-residents are subject to tax in India in respect of any income received in the country or accrues or is deemed to accrue or arise in it. Section 5(2) of the Income-Tax Act, 1961 has so defined the contours of the tax net as applicable to non-residents. Section 9(1) lays down the parameters for considering the scope and ambit of the deeming provision. The most common condition for taxing deemed income in the hands of non-residents is where a business connection is established in India. Section 9(1) also brings within the net income accruing or arising through or from any property or asset or source of income in India. All taxable income must necessarily have a definite source, as held by the Privy Council in C.I.T. v. Shaw Wallace (6 I.T.C. 178). "Source" is not a legal concept. It is something, which a commercial man would regard as a real source of income. This has been held in several cases. Source of profit The Supreme Court held in C.I.T. v. Sterling Foods (237 I.T.R. 579) that the source of profits from sale of import entitlements was the export promotion scheme of the Central Government. Hence, receipts from sale of the entitlements were not income from an industrial undertaking, which qualified for exemption under Section 80-HH. Exemption under this provision can only be granted in respect of profits, the source of which is the industrial undertaking. In a recent ruling of the Authority for Advance Rulings (AAR), the provisions of Section 9(1) were invoked to tax commission earned by a French company, though all the services were rendered by this company outside India. The facts that were considered by the AAR in the Rajiv Malhotra case, (284 I.T.R. 564) pertain to a French agency, which was responsible for planning and executing a sales campaign to attract foreign participants for a food and wine show in India that was being organised by the applicant, Rajiv Malhotra. Sourcing business in France The French agent was responsible for canvassing business among foreign participants desiring to book space in the Indian exhibition. The French company was appointed by the applicant's proprietary concern, Lotus Exhibition Marketing Services (LEMS) to assist it during its meeting with potential French exhibitors and export promotion bodies. Several other services were rendered in France by the French concern to LEMS to ensure the success of the food and wine show in India. The French concern was not authorised to accept any payments. The participants were to pay LEMS directly. LEMS, in turn, was to pay a commission to the French company for the services rendered by it in France. Tax withholding The question, before the AAR was whether the French company was liable to tax in India on the commission earned by it for rendering services in France. Consequently, the applicant desired a ruling on the question whether there would be any tax withholding while paying commission to the French agent. The AAR ruled that the source of income for the French agent was linked with foreign participants in a show in India. Though the French agent rendered services abroad and pursued and solicited exhibitors in his territory, the right to receive the commission arose in India as the exhibitors participated in the exhibition held in India. Hence, according to the AAR, the commission was taxable under Section 5(2)(b) read with Section 9(1)(i) of the Act. The AAR emphasised that the fact that the agent rendered services in France by soliciting participants there, was wholly irrelevant for determining the situs of his income. The crucial factor, according to the AAR, was that the source of income, namely, the participation of exhibitors in the food and wine show, was situated in India. Double taxation issue In other words, the source rule under Section 9(1)(i) was invoked to make the non-resident liable to tax. The AAR further ruled that the provisions of the Double Tax Avoidance Agreement between India and France did not override the provisions of Sections 5 and 9 of the Act in the facts and circumstances of this case. For this purpose, the AAR referred to Article 23 of the tax treaty, pertaining to income arising to a resident of France where the income is not dealt with by the other Articles of the treaty. Article 23.3 of the Indo-French Tax Avoidance Agreement states that the income of a resident of a Contracting State not dealt with in any other Article of the Agreement, would be taxed in the Contracting State in which the income arises. The AAR, therefore, ruled that Article 23.3 was in conformity with the provisions of Section 5(2) read with Section 9(1) of the Act. Hence, the Agreement did not exempt the commission income received in France by the French agent because the commission arose in India. Consequently, tax was held to be deductible at source under Section 195 of the Act when the applicant paid the amount to the French agent. The AAR further held that its earlier ruling in Ind Telesoft P. Ltd case (267 I.T.R. 725) was not applicable to the facts in this case. It is submitted with respect that this ruling isincorrect.The provisions of the Agreement would exempt the commission earned by the French agent because the commission that the French agent earned in India and which was received in France, was in the nature of business income. Commission is specie of business income. Since business income is covered by Article 7 of the Agreement, Article 23 does not come into operation. The French agent's business was to canvass among prospective French participants and to induce them to participate in the food and wine show in India. Hence, under Article 7, the profits earned by the French agent would be taxable in France unless the agent carries on a business in India through a permanent establishment situated in India. Facts before AAR In this case, the French agent had no permanent establishment in India on the facts, which were before the AAR. Further, LEMS was an entity of independent status, which had business association with several other foreign concerns for organising various exhibitions in India. Therefore, under Article 5.6 of the Agreement, the French concern would not be deemed to have a permanent establishment in India. Hence, under Article 7, the business profits earned by the French agent in respect of the activities undertaken in France could only be taxed in that country and not in India. In conclusion, it may be mentioned that when a person or party is aggrieved by the ruling of the AAR, the only remedy available to the applicant would be to file a writ petition under Article 226 of the Constitution, because no appeal is provided against a ruling of the AAR in the Act. Since the AAR is based in Delhi, the writ would lie before the Delhi High Court. H. P. Ranina (The author, a Mumbai-based advocate specialising in tax laws)
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