Section 9 of the Income Tax Act, 1961 and the Doctrines Surrounding Its Extra- Territorial Applicability

Article for Blog Post Writing Competition 2011 | by Karan Singh


April 8th, 201110:23 pm


“…if Nazi Germany had not invaded other countries but had simply sought to eliminate the entire Jewish population within its own territorial borders, this would not have constituted a violation of international law, as incredible as this now seems.” – Mark Gibney in his book “International Human Rights Law: Returning to Universal Principles

The territorial nature of law is an argument not only about law but also about sovereignty. And not only sovereignty of a state in its own territory but also the sovereignty practised by a state above its citizens; wherever they may roam.

What follows below is a brief look at the extra-territorial applicability and doctrines surrounding the oft debated Section 9 of the Indian Income Tax Act, 1961.

International taxation is based on political, residential or economic allegiance between the taxpayer and the taxing state[1].The general principle, flowing from the sovereignty of States[2], is that laws made by one State can have no operation in another State[3] unless given a sufficient territorial connection or nexus between the person sought to be charged and the country seeking to tax him. Thus, even under the Indian Income Tax Act, 1961 such a distinction exists vide Section 4, section 5 and Section 9.

Section 4 and 5 of the Income Tax Act impose a general charge, which is given a particular application in respect of non-residents by Section 9 which enlarges the ambit of taxation by deeming income to arise in India in certain circumstances.[4] Thus, Indian income-tax may extends to a foreign citizen or to income earned abroad only in respect of certain cases where a “connection” between the income sought to be taxed and the India can be established. Once, this “connection” is established and the case of the assessee falls within the ambit of Section 9, only then can the income earned abroad be taxed[5].

This “connection” too should be based on (1) the residence of the person; or  (2) “business connection”[6] within the territory of India. This “connection” involves a consideration of two  basic elements viz.:

(a) the connection must be real and not illusory;[7] and

(b) the liability sought to be imposed must be pertinent[8] to that territorial connection[9]

There, however, exist various theories with regards to the taxing power of states in cases of International Taxation all of which pertain to different aspects of the underlying territorial nature of taxation laws.  A few of the main theories are described below:

  1. Principle of Source Jurisdiction: As per Finance Act, 1976, through insertion of clauses (v), (vi) and (vii) in s.9 (1) for income by way of interest, royalty or fees for technical services respectively, a source rule was inserted. It means that the situs of rendering of services is not relevant but the situs of the payer and utilization of services to determine taxability of such services in India.[10] Thus, Income having its source in India may be taxed regardless of the residence of the tax payer.[11] It is a multi-faceted concept[12] where utilization of services serves as a concept of taxation under this principle. But non-resident companies may only be taxed on those profits which arise from a source within the taxing country’s jurisdiction.[13] However, some countries may consider the source country where the services are utilized and others might treat the country where services originate as the source. In India vide the Finance Act, 2010 and the “Explanation” inserted in Section 9 (1) (vii), only the rendering of services in India is pre-requisite to tax under this rule.
  2. Theory of Equivalence: Also known as the exchange theory[14], this is followed in many countries, such as the United States of America. It is a four-pronged approach to determine taxability. A state’s tax passes[15] if it (1) is assessed against a taxpayer with whom the state has substantial nexus,[16] (2) is “fairly apportioned,” (3) is non-discriminatory, and (4) is “fairly related to the services provided by the State.” The elements of this test were articulated in Complete Auto Transit, Inc. v. Brady[17].
  3. Effects Doctrine: Any state may impose liabilities, even upon persons not within its allegiance, for conduct outside its borders that has consequences within its borders which the state represents.[18] For example, a simple perusal of section 5(2) denotes that the words “all income from whatever source derived”, have a very wide connotation to include any effect of a transaction felt in India.[19] Like the extra-territorial application of the MRTP Act, 1969, if the service is utilized in India, there shall be enough effect felt in India for the authorities to levy tax.[20] International law accepts that a state may levy tax so long as there is some kind of real and not illusory link between the state and the proposed taxpayer based on nationality or domicile. Non-resident corporations and individuals are subject to income tax on any income effectively connected with their domestic business[21] subject to a simple three-fold test for determining sufficient territorial nexus: the business must be of a (1) regular nature, (2) it must be continuous, and (3) it should be of a substantial nature.[22]
  4. Taxing E-commerce: . Electronic commerce is defined as “the ability to perform transactions involving the exchange of goods or services between two or more parties, using electronic tools and techniques”,[23] which includes physical telecommunications networks, cable television, mobile, and cellular networks.[24] Permanent establishment based on the use of an internet service provider (ISP), software agent, server, telecommunications device, cable, computer terminal, or web page, are recognized as legally valid.[25] The taxation of transactions conducted entirely via electronic means is a recent trend in International Taxation and thus has many theories with regards to who has the power to tax a certain transaction. However, the OECD supports the principle of “value creation”- only activities, which create value, are relevant in determining a state’s right to impose an income tax. The mere fact that an enterprise is able to sell into a jurisdiction’s marketplace does not indicate that the foreign enterprise is creating value in the state. [26] Accessibility to a market does not necessarily entail an enterprise’s participation in the economic life of a country, but simply reflects the enterprise’s participation with the economic life of a country. It remains appropriate therefore to limit the right of income taxation to those jurisdictions that serve as the origin of that income by virtue of providing the economic life that made possible the yield or the acquisition of the wealth[27].

Thus, these are the main jurisprudential theories with regards to taxation and its territorial nature. As can be seen not all these theories rigidly adhere to the principle of territorial nexus for the purposes of taxation, however, most of them intend to levy tax based on some form of territorial connection or other.


[1] Schanz, Zur Frage Der Steuerpflicht, 9 Finanz-Archiv 365, 372 (1892)

[2] British Columbia Electric Railway Co.Ltd. Vs. King, (1946) AC 527 (PC) p. 533

[3] Electronics Corporation of India Limited v. Commissioner of Income Tax and Anr. , AIR 1989 SC 1707, ¶ 8

[4] CIT, New Delhi v. M/s. Eli Lilly and Company (India) Pvt. Ltd, (Appeal No. 5114 of 2007), decided on: 25/3/2007, ¶ 29

[5] Sheraton International Inc. v. Deputy Director Of Income Tax, [2007] 293 ITR 68 (Delhi), ¶ 40

[6] Shyamal Mukherjee , Attribution of Profits To Permanent establishments: A Developing Country’s Perspective, 10 Geo. Mason L. Rev. 785

[7] The Tata Iron & Steel Co. Ltd. v. State of Bihar, AIR 1958 SC 452,¶ 40

[8] International Tourist Corporation and Ors. v. State of Haryana and Ors, AIR 1981 SC 774

[9] The State of Bombay v. R.M.D. Chamarbaugwala, AIR 1957 SC 699, ¶ 27

[10] Tarunkumar G. Singhal & Anil D. Dosh, Taxation of Non-Residents – Income deemed to accrue or arise in India, Finance Bill 2010, AIFTP Journal, March 2010 (para 1.3) available at <http://www.aiftponline.org/journal/March10/Finance%20Bill%202010%20_2.htm> visited 18th February, 2011.

[11] Julie Rogers-Glabush (ed.), IBFD International Tax Glossary, 6th edn, p. 294, 394.

[12] K. Vogel, Worldwide vs. Source Taxation Income – A Review And Re-Evaluation Of Arguments,(Part I, Intertax 1988). pp. 216, 223.

[13] Adrian Ogley, The Principles Of International Tax-A Multinational Perspective, Interfisc Publishing. (London, 1996) p.33-35.

[14] League of Nations, Report On Double Taxation, by Bruins, Einaudi, Seligman and Sir Josiah Stamp 18 (1923)

[15] John A. Swain, State Income Tax Jurisdiction: A Jurisprudential And Policy Perspective, 45 Wm. & Mary L. Rev. 319

[16] Quill Corp. v. North Dakota, 504 U.S. 298, 312-13 (1992)

[17] 430 U.S. 274, 276-78 (1977)

[18] Haridas Exports v. All India Float Glass Mfrs. Association and Ors., (2002) 6 SCC 600 (para 60).

[19] Vodafone International Holdings B.V. v. UOI, WP No. 1325 of 2010, Decided on: Sept. 8, 2010 (para 137).

[20] Man Roland Druckimachinen AG v. Multicolour Offset Ltd. and Anr., (2004) 7 SCC 447 (para 25).

[21] Internal Revenue Code, §§ 871 to 877, Internal Revenue Code, §§ 881 to 884. I.R.C.

[22] Spermacet Whaling & Shipping Co. v. Commissioner, 30 T.C. 618, 634 (1958).

[23] U.S. DEP’T OF TREASURY, Selected Tax Policy Implications of Global Electronic Commerce< http:www.ustreas.gov/treasury/internet.html> last visited 2nd February 2011 (para 3.2.1).

[24] Howard E. Abrams & Richard L. Doernberg, How Electronic Commerce Works, 15 TAX NOTES INT’L 1573 (1997), p. 1574.

[25] James D. Cigler et al., Cyberspace: The Final Frontier for International Tax Concepts?, 7 J. INT’L TAX’N 340, 346 (1996) p. 347.

[26] The Technical Advisory Group on Treaty Characterization of Electronic Commerce Payments, Tax Treaty Characterization Issues Arising From E-Commerce-Report To Working Party No. 1 Of The OECD Committee On Fiscal Affairs, 2001, ¶35

[27] See, e.g., Professors Bruins, Einaudi, Seligman and Sir Joshia Stamp, Report on Double Taxation at 23, submitted to the Financial Committee of the League of Nations, April 5th 1923 (Doc. E.F.S.73.F.19) (the “1923 Report”).  See also Report of Technical Experts, Double Taxation and Tax Evasion, Report and Resolutions, submitted to Financial Committee of the League of Nations, February 7th 1925 (the “1925 Report”).

 

Article by-

Karan Singh

Fourth Year Student (Corporate Law Hons.)

National Law University, Jodhpur

[Submitted as an entry for the MightyLaws.in Blog Post Writing Competition, 2011]

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