WITHDRAWAL OF RECENT CIRCULARS – IMPACT

1. WITHDRAWAL OF RECENT CIRCULARS – IMPACT International Fiscal Association – Western Region 6th November 2009 Anish Thacker

2. Discussion Outline • Background to the issue of Circular 23 • Contents of Circulars 23,163 and 786 in brief • Decisions where these circulars have been applied. • Stated reasons for withdrawal of the circulars. • Does withdrawal of these circulars result in automatic taxability? • Does the withdrawal have retrospective or propective application? • Impact on taxability of non-residents for A.Y. 2010 – 11 and consequent tax withholding. • Impact on pending assessments / appeals. • Other issues.

3. Background to the issue of the Circulars. • Section 9(1)(i) – Income accruing or arising directly or indirectly through or from a business connection in India, deemed to accrue or arise in India. • ‘Business Connection’ – No precise defination • Explanation 2 to section 9(1)(i) uses ‘shall include’ • SC in CIT v. R. D. Aggarwal & Co (56 ITR 120) • Need for existence of ‘relation’ between business of non-resident and activity in India, • ‘Element of Continuity’ between the non-resident’s business and activity in India. • A stray or isolated transaction not regarded as ‘business connection’ • Existence of a ‘business connection’ to be determined on the basis of facts in each case.

4. Circular No.23 dated 23 July 1969 • Gives illustrative instances of business connection and clarifications. • Clarifications would be found useful in deciding questions regarding the applicability of section 9 in certain specific situations. • Illustrative instances of business connection • Branch office in India for purchase/ sale of goods or other business purposes. • Appointing an agent in India for systematic and regular purchase of raw materials/ other commodities or for sale of goods or other business purposes. • Erecting a factory in India where raw produce purchased locally is worked into a form suitable for export. • Forming a local subsidiary in India to sell products of non – resident parent. • Having a ‘financial association’ between a resident and a non-resident company.

5. Circular No.23 dated 23 July 1969 (contd…) • Clarifications on applicability of Section 9 Non – resident exporter selling goods from abroad to Indian importer – No tax liability where transactions are on ‘principal to principal basis’ i.e:- • Purchases made by resident are outright on his own account • Transactions between non-resident and resident are at arm’s length • Non – resident exercises no control over business of the resident • Payment to non – resident made on delivery of documents and not dependent on sales made by resident • Also clarifies that no taxability under section 5(1) on ‘receipt’ will occur if non-resident’s banker in the course of discounting the bills/ shipping documents, sends these to bankers in India and purchaser pays Indian bankers on acceptance/ delivery of documents

6. Circular No.23 dated 23 July 1969 (contd…) • Non-resident parent selling goods to Indian subsidiary • Income not deemed to accrue / arise in India if:- • Contracts of sale made outside India • Sales are made on a principal to principal basis and at arms length • Subsidiary does not act as an agent of the parent. • The mere existence of a business connection arising out of parent – subsidiary relationship will not give rise to an assessment nor will the fact that the parent company might exercise control over the subsidiary.

7. Circular No.23 dated 23 July 1969 (contd…) • Sale of a plant and machinery to an Indian importer on installment basis – Not taxable if no other connection between the parties and the transactions on a principal to principal basis – Indian importer not to be treated as the agent of exporter. • Foreign agent of Indian exporter – operates in his own country and no part of his income arises in India – The commission is remitted to him directly and so, not received in India – Commission not liable to tax in India. • Non – resident purchasing goods in India – Not taxable even where he has an office/ agent in India for this purpose. Exception:- Where resident purchasing goods on behalf of non-resident is closely connected with non-resident and course of business between them arranged as to give resident either no profits or less than ordinary profits.

8. Circular No.23 dated 23 July 1969 (contd…) • Sale by non-resident to Indian customers directly/ through agents:- • No taxability on credit sales if (i) Contracts of sale made outside India (ii) Sales made on principal basis • Overriding commission paid to Indian agent on direct sales – No taxability of non-resident if:- (i) agent neither performs nor undertakes to perform any service in respect of these direct sales and sales cannot be attributed to existence of the agency (ii)contracts to sell made outside India (iii) Sales on principal to principal basis. • Where sales of non-resident secured through Indian agent – Taxable income arising out of the transaction will be limited to profit attributable to agent’s services if (a) Non-residents’ Indian activities wholly channeled through agent (b) contracts to sell made outside India (c ) sales made on principal to principal basis.

9. Circular No.23 dated 23 July 1969 (contd…) • In the assessments of profits, allowance will be made for the expenses incurred including the agents’ commission in making the sales. • If the agents’ commission fully represents the value of profit attributable to his service, it should prima facie extinguish the assessment. • Where a non-resident’s business activities in India are not wholly channeled through its Indian agent – Taxability will be on the sum total of profits attributable to (a) agent’s activities and (b) own activities – less expenses for making the sales.

10. Circular No.163 dated 29 May 1975 • Issued in context of paragraph 3(7) of Circular No 23 dated 23 July 1959 • Clarifies that ‘by virtue of clause (b) of the Explanation to section 9(1)(i) of the Act, the correct legal position is that in 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. • 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 procure goods for export.

11. Circular No.786 dated 7 February 2000 • Issued in context of audit objection by CAG auditors in a case where export commission was not disallowed under section 40(a)(i) • Refers to Circular No 23 dated 23 July 1969 • States – ‘The relevant sections, namely section 5(2) and section 9 not having undergone any change in this regard, the clarification in Circular No 23 still prevails’ • GAG have agreed to drop the audit objection on being apprised of the position.

12. Recent Decisions where the circulars have been referred • Export Commission not taxable in India:- • Spahi Projects in re(315 ITR 374) (AAR) • Contrary view by AAR in Rajiv Malhotra in re (274 ITR 564) • No tax if arm’s length payment made to an agent / back office service provider • SET satellite (Singapore) Pte Ltd v. DDIT(IT) (307 ITR 205) (Bom) • DDIT(IT) v. Galileo International Inc (180 Taxman 357) (Del)

13. CBDT Circular 7 of 2009 dated 22 October 2009 • CBDT has withdrawn circulars 23, 163 and 786 with immediate effect. • Stated reason for withdrawal – Interpretation placed by some taxpayers seeking to claim relief was not in accordance with the provisions of the Act or the intention behind the circulars • Clarifies that the withdrawal will in no way prejudice the following arguments which the tax authorities have taken or may take in any appeal, reference or petition • Circular 23 does not apply to a particular case • Circular 23 cannot be interpreted to allow relief to the taxpayer which is not in accordance with the provisions of section 9 or intention behind the issue of the circular

14. Impact of withdrawal of circulars • Section 19 empowers CBDT to issue orders, instructions and directions to subordinate authorities. • CBDT issues circulars which are binding effect on tax authorities so long as they are not in conflict with the provisions of the Act or interpretation provided by the Supreme Court. • CBDT Circulars are in the nature of (contemporanea exposito) italics and aid in the proper construction and interpretation of statutory provision. • Principles laid down in section 9 and Supreme Court decision in R.D. Aggarwal and other decisions should prevail. • Withdrawal does not necessarily mean that a non – resident automatically is taxable in India in the situations described circular. • Taxability evaluated independent of the provisions of the circular.

15. Does the withdrawal of the circular have retrospective operation? • Paragraph 3 of Circular 7 – Withdrawal of Circular 23 with ‘immediate effect’ • Paragraph 4 – Withdrawal shall in no way be prejudice that the Department ‘has taken’ or may take’ • Circulars issued under section 119 are in the nature of instructions/ guidelines and do not constitute law. The withdrawal of these can therefore operate only prospectively. Refer to UTI v. P.K. Unny (249 ITR 612) (Bom) • Withdrawal should therefore operate prospectively and NOT retrospectively.

16. Implications of withdrawal on pending assessments/appeals/revisions • Courts have consistently taken a view that circulars in force of the first day of the assessment year are applicable for that assessment year. • Where a circular affecting taxpayers’ rights is withdrawn after the end of the assessment year the instructions in the circular, govern the assessment for that year irrespective of when the withdrawal happens • CIT v. Edward (BM) India Sea Foods (119 ITR 334) (Ker) • CIT v. Geeva Films (141 ITR 632) (Ker) • CIT v. BASF India Ltd (280 ITR 136) (Bom) • Withdrawal should not impact assessments for assessment years upto and including assessment year 2009 -10.

17. Impact of the Withdrawal for Assessment Year 2010 -11 • Based on the view that law applicable on 1 April of the assessment year applies, the protection of the circular may not be available • A view can however be taken that for transactions upto 21 October 2009, the circular was valid and in force in particular when we consider tax withholding • Reliance can be placed on the UTI decision cited earlier • Caution for issue of CA certificates post 22 October 2009 – clearly document basis for view taken.

18. Would payment for plant and machinery, a resident, in installments, now create a taxable position for a non-resident • Withdrawal of circular 23 ought not to imply the existence of a business connection. • Independent of Circular 23, the Karnataka HC has taken a similar view in CIT v. Fritz Werner P. Ltd (118 ITR 1018)

19. Taxability of procurement activities of a non-resident, post withdrawal of Circular 23 • As per the Explanation 1(b) to section 9(1)(i), no income deemed to accrue or arise in India to a non – resident, through or from operations confined to purchase of goods for export. • No income taxable if non-resident has a liasion office which merely purchases goods in India – Refer to Ikea Trading (HongKong)Ltd in re (308 ITR 422) (AAR) • Delhi High Court in CIT v. N.K.Jain (206 ITR 692)took a similar view relying on CBDT Circular No 24 dt 7 July 1964 which is still operative. • It may be noted that Explanation 1(b) applies only to Section 9(1)(i) and not section 5

20. Taxability of sales through an Indian agent where agent is paid arms length remuneration • Circular 23 provides that income will be limited to the amount of profit attributable to the agent services if the following conditions are satisfied: • The non-resident Indian activities are wholly channelised through the agent • Sale contracts are made outside India • Sales are made on ‘principal to principal’ basis • Circular further provides that if the agent's commission fully represents the ‘value’ of the profits attributable to the agents service, the assessment should be prima facie extinguished • Single taxpayer approach advocated followed in SET Satellite Galileo • Another view possible – ‘Dual tax payer approach’ – Payment of arms length commission does not necessarily extinguish profit attribution in the hands of the non-resident

21. Taxability of sales through an Indian agent where agent is paid arms length remuneration • Dual tax payer approach recognized by Delhi Tribunal in case of Rolls Royce Plc v. DDIT (122 TTJ 359) (AT) – Additional income attribution extinguished only where the remuneration takes into account ‘all risk taking functions of the non-resident’ • Case by case examination required to see which approach can be followed

22. Taxability of BPO operations • Where BPO is a third party BPO – no impact of withdrawal of Circular 23 • Where BPO is a ‘deponent agent’ • No reliance on Circular 23 possible • Taxability to be looked at independently • Circular 5 of 2004 may still protect taxpayer • Treaties may afford beneficial treatment

23. Extent of profits taxable in India • Clause (a) of Explanation 1 to Section 9(1)(i) – only income reasonably attributable to operations carried on in India • Explanation 3 to Section 9(1)(i) – even when business connection arises on account of dependant agent, only income attributable to operations in India, taxable in India • No attribution if no operations carried out in India – CIT v Toshoku Ltd (125 ITR 525)(SC) • Conclusion should remain same post withdrawal of Circular 23

24. Treaty Scenario • No impact of withdrawal of circular on interpretation of tax treaties • If treaties provide for no attribution/no PE if arms length remuneration paid to a dependent agent, that position should still hold good • In other case, attribution should be based on provisions of applicable treaty

25. Thank You