What is a Business Connection under Income Tax Act- [An analysis of Volkswagen Decision of ITAT]
Recently Hon’ble ITAT decided a matter in case of Volkswagen Finance Pvt Ltd vs. ITO [ITA No. 2195/Mum/2017; Assessment year: 2015-16]. The Hon’ble Tribunal decided on the meaning of “business connection” within the meaning of Section 9(i) of the Income Tax Act. I was shocked with the decision, and this article is an attempt to understand and analyse the decision so that if needed, it can be corrected.
Facts of the case:
“The assessee is an Indian company. The assessee had made a payment of in respect of a celebrity appearance at Dubai, and the assessee did not withhold any tax from the said remittance. It was found that assessee planned an event in Dubai for launch of vehicle. The purpose of this event was launch of a new model for the Indian market, but the launch event took place Dubai. A company incorporated in the USA, agreed to facilitate the appearance of a non-resident celebrity and that the assessee paid to the US company. The assessee had full rights to use the event. The event was designed for Indian customers and Indian market. The assessee company claimed the expense of the event as deduction.”
The question is “can it be said that the US company has a business connection in India”. Section 5(2)(b) needs to be read with, inter alia, Section 9(1)(i) of the Act which extends the scope of income accruing or arising in India by including, in the deeming fiction, “all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India”. What essentially follows is that an income which, directly or indirectly, accrues or arises to a non-resident, though or from any business connection in India, is also chargeable to tax in India.
Explanation 3 to Section 9(1)(i) clarifies “that the expression ‘through’ shall mean and include and shall be deemed to have always meant and included ‘by means of’, ‘in consequence of’ or ‘by reason of’.” To put it in simple words, when an income accrues or arises to a non-resident outside India but by means of, in consequence of, or by reason of, any business connection in India, it will also be taxable in India under section 5(2).
Hon’ble Tribunal quoted and relied upon Hon’ble Supreme Court judgment in case of CIT v. R.D. Aggarwal & Co., [(1965) 1 SCR 660 : AIR 1965 SC 1526 : (1965) 56 ITR 20], wherein the Supreme Court held that “a relation to be a “business connection” must be real and intimate and through or from which income must accrue or arise whether directly or indirectly to the non-resident”. Finally, the court held,
“Turning to the facts of the present case, as found by the Revenue Authorities, contracts for the sale of goods took place outside the taxable territories, the price was received by the non-residents outside the taxable territories, and delivery was also given outside the taxable territories. No operation such as procuring raw materials, manufacture of finished goods, sale of goods, or delivery of goods against price took place within the taxable territories: the assessees merely procured orders from merchants in Amritsar for the purchase of goods from the non-resident companies. The orders were offers which the assessees had no authority to accept on behalf of the non-residents. Some commercial activity was undoubtedly carried on by the assessees in the matter of procuring orders which resulted in contracts for sale by the non-residents of goods to merchants at Amritsar. But on this account, no business connection of the assessees with the non-residents within the taxable territories resulted.”
A business association or a business dealing is not a “business connection”. “a business connection may take several forms: it may include carrying on a part of the main business or activity incidental to the main business of the non-resident through an agent, or it may merely be a relation between the business of the non-resident and the activity in India, which facilitates or assists the carrying on of that business.”
The Bombay High Court held [CIT v National Mutual Life Association of Australia  I ITR 350, 361 (Bom)] that all that is necessary for a Business Connection to existing is that there should be:
(i) a business in India;
(ii) a connection between non-resident person or company and that ‘business’; and
(iii) that the non-resident person or company has earned an income through such connection.
After examining various judgments, Hon’ble Andhra Pradesh High Court, in the case of M/s GVK Industries v. ITO [(1997) 228 ITR 564] held,
“From the above discussion the following principles emerged:
(i) Whether there is a business connection between an Indian company and a non-resident (company) is a mixed question of fact and law which has to be determined on the facts and circumstances of each case;
(ii) The expression ‘business connection’ is too wide to admit of any precise definition; however, it has some well-known attributes;
(iii) The essence of ‘business connection’ is the existence of close, real, intimate relationship and commonness of interest between the NRC and the Indian person;
(vi) Where there is control of management or finances or Substantial holding of equity shares or sharing of profits by the NRC of the Indian person, the requirement of principle (iii) is fulfilled;
(v) To constitute ‘business connection’ there must be continuity of activity or operation of the NRC with the Indian party and that a stray or isolated transaction is not enough to establish a business connection.”
The above judgment of the AP HC was affirmed by the Supreme Court as reported [(2015) 11 SCC 734].
From various judgments, it can be inferred that the following are the fundamental ingredients of a business connection-
(ii) Real and Intimate connection
(iii) Attribution of income
(iv) Common Control
A single transaction would not fall within the ambit of the BC. There must be some element of continuity in the relationship between the parties, and in every case, one has to look at the particular facts of the case to see whether it falls within the ambit of the section. To constitute a BC some continuity of relationship between the person in India who helps to make the profits and the person outside India who receives or realizes the profits is necessary.
In order to have a BC, there must be a real and intimate connection between the activity carried on by the non-resident outside India and the activity carried out in India. BC undoubtedly would be a commercial connection but all commercial connections will not necessarily constitute BC within the meaning of the concept unless the commercial connection is really and intimately connected with the business activity of the non-resident in India and is contributory to the earning of profits in the said trading activity.
Precisely a business transaction is not a business connection unless such transactions are continuous and intimate. A business connection is a continuous and intimate relationship between two businesses resulting in a profit to a non-resident entity. Unless such a business connection is established, it cannot be held that the profit earned by a non-resident business entity is taxable in India. In the present case, none of these ingredients exist or have even been discussed in the impugned decision.
Further, the explanation 1(a) of Section 9 provides that in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. Thus, even if there is a business connection, and profit is earned by a non-resident entity and income is deemed to accrue or arise in India; only that part is taxable which relates to the operation carried out in India. It follows that if no business operation is carried in India, income attributable to the operations carried in India shall be zero.
In fact, there can be no business connection without some activity in India. The business connection may take several forms it may include carrying on a part of the main business or activity incidental to the main business of the non-resident through an agent, or it may merely be a relation between the business of the non-resident and the activity in the taxable territories, which facilitates or assists the carrying on of that business. In such cases, the question of whether there is a business connection from or through which income, profits, or gains arise or accrue to a non-resident must be determined upon the facts and circumstances of the case. The expression ‘business connection’ postulates a real and intimate relation between the trading activity carried on outside the taxable territories and the trading activity within the territories, the relation between the two contributing to the earning of income by the non-resident in his trading activity.
Mumbai High Court held in Blue Star Engineering Co. (Bombay)(P.) Ltd. v. Commissioner of Income-Tax, [1968 SCC OnLine Bom 133: (1969) 73 ITR 283]
“It would thus be seen that in order to constitute a “business connection” as contemplated by section 42, there must be an activity of the non-resident in the taxable territories having an intimate and real relation of a continuous character with the business of the non-resident and contributing to the earning of profits by the non-resident in his business. The business connection must undoubtedly be a commercial connection but all commercial connections will not necessarily constitute business connection within the meaning of the concept unless the commercial connection is really and intimately connected with the business activity of the non-resident in the taxable territories and is contributory to the earning of profits in the said trading activity.”
Reasons given in the impugned decision for holding “business connection” is completely extraneous to the settled position of law. The benefit to an entity buying services from a non-resident cannot be treated as a business connection. On this logic, as every business transaction results in some benefit to the business paying for the services, every business transaction is a “business connection”. Had this been the intention of the legislature, they could have easily expressed it in simple words.
In view of this, the reasons given by the Hon’ble Tribunal for holding that the non-resident has a business connection in India merely because the (i) Indian entity is getting benefit or (ii) Indian entity is making payment or (iii) Goods are being marketed in India are extraneous and erroneous and needs to be corrected on the first opportunity.