CBDT withdrawn circulars related to taxability of foreign companies and non-residents, engaged in specified business activities
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Central Board of Direct Taxes or CBDT (which is the highest ranking executive authority for income taxes in India) has withdrawn several of its circulars / instructions, which were relied upon by foreign companies and non resident taxpayers.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. In 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.