CA Anuja Garg

DIT (IT) v. Copal Research Limited, Mauritius and Ors, W.P. (C) 2033, 2470, 2590, 2597/ 2013 dated 14/8/2014 (Delhi HC)

Explanation 5 to section 9(1)(i) of the Income-tax Act, 1961 (“the Act”) introduced by the Finance Act 2012 is no longer res integra in view of the pronouncement by the Delhi High Court. In its recent judgement in the case of DIT vs. Copal Research Limited And Ors.: W.P. 2033/2013, the Delhi High Court has held that gains arising from sale of shares of a company incorporated overseas, which derives less than 50% of its value from assets situated in India would not be taxable under section 9(1)(i) of the Act.

The High Court has given a restrictive interpretation to Explanation 5 to section 9(1)(i) of the Act holding that the said Explanation is clarificatory and the same can, at best, cover situations where in substance the assets in India are transacted by transacting in shares of overseas holding companies. The Explanation cannot be said to cover transactions where assets situated overseas are transacted which also derive some value on account of assets situated in India.

The High Court observed that a legal fiction must be restricted to the purpose for which it was enacted inasmuch as the object of Explanation 5 was not to extend the scope of section 9(1)(i) of the Act to income which does not have territorial nexus with India, but to tax income that has a nexus with India irrespective of whether the same is reflected in a sale of an asset situated outside India.

In view of the fact that the word “substantial” in Explanation 5 to section 9(1)(i) of the Act is not defined, the High Court has taken recourse to external aids of interpretation, viz., the dictionary meaning of the term, followed by the recommendations of the Shome Committee in its draft report which stated that the word “substantially” used in Explanation 5 should be defined as a threshold of 50% of the total value derived from assets of the company or entity and also on OECD and UN Models of Tax Convention which provide that the taxation rightsin case of sale of shares are ceded to the country where the underlyingassets are situated only if more than 50% of the value of such shares isderived from such property.

Scope of Legal Fiction

It is a trite law that legal fiction is created for a definite purpose, the same are limited to that purpose alone and should not be extended beyond the legitimate field of operation. The scope of Explanation 5, therefore, cannot be extended to tax income arising from transfer of assets located overseas not deriving major value from assets in India. The Supreme Court in the case of CIT vs.VadilalLallubhai: 86 ITR 2, held that the fiction operates only within the field of the definite purpose for which the fiction is created.

Without prejudice to the aforesaid, Explanation 5 to section 9(1)(i) of the Act cannot be extended to extra-territorial jurisdiction since the same would render absurd results. The scope of Explanation 5 as held to be operating within the circumference of the legitimate field is also in line with the theory of ‘doctrine of nexus’ which is a recognized and an accepted principle for the purpose of determining tax jurisdiction of income,which has been upheld in a catena of judgments mentioned hereunder–

  • Electronics Corporation of India Ltd.: 183 ITR 43
  • CIT v. Eli Lilly and Co. (India) P. Ltd. and Ors.: 312 ITR 225 (SC);
  • Hoechst Pharmaceuticals Ltd. v. State of Bihar: 154 ITR 64 (SC).

The apex Court has reiterated the same in GVK Industries Ltd. vs. ITO: 332 ITR 130 wherein the Constitutional Bench was to determine the extent to which laws enacted by Parliament can have extra-territorial effect under Article 245.The Supreme Court concluded that it may not be proper to assume that the powers of law making vested in parliament are unfettered or that the parliament possesses a capacity to make laws that have no connection whatsoever with India. In other words, the powers of the parliament are circumscribed to aspects that have a nexus with India.

Interpretation of the word “substantial”

The meaning of the word ‘substantial’ has been examined by the Supreme Court in the case of Santosh Hazari vs. Purushotham Tiwari: 25 ITR 84, as mentioned in section 260A of the Act. The apex Court held that the word ‘substantial’ as qualifying question of law means having substance, essential, real, of sound worthy, important or considerable. The apex Court held that the question of law will be a substantial question of law where there is a room for difference of opinion. Hence, if the chances of interpretation of a specific section are 50% on either side then the question of law involving such interpretation will be a substantial question of law.

The High Court in the case of Copal Research Limited (stated supra) has also relied upon the dictionary meaning of the term, recommendations of the Shome Committee and OECD and UN Models of Tax Convention to delve on the meaning of the word ‘substantial’, inasmuch as words, which are not specifically defined, must be taken in their legal sense or their dictionary meaning or their popular or commercial sense as distinct from their scientific or technical meaning, unless a contrary intention appears.

Furthermore, there are no fetters placed for use of certain external aids like works of prominent authors, dictionaries, legislative debates, etc., by the Courts to interpret a statute correctly. When internal aids available in the statute itself are not adequate, the court has to take recourse to external aids which may be parliamentary material, historical background, reports of a committee or a commission, official statement, dictionary meanings, foreign decisions, etc.

It has been observed by the Supreme Court in the case of B. Prabhakar Rao and Ors vs. State of A.P. and Ors: 1985 AIR 210 that where internal aids are not forthcoming, recourse to external aids to discover the object of the legislation can always be had. External aids are notruled out and this is now a well settled principle of modern statutory construction.

Resolving the ambiguity

Stroud’s Judicial Dictionary gives the first meaning of the word “substantial” as – a word of no fixed meaning, it is an unsatisfactory medium for carrying the idea of some ascertainable proportion of the whole.

Further, the term ‘substantial interest’as defined in explanation to section 40A(2)(a) of the Act reads as – where a person who is having voting power of not less than twenty percent in the case of the company, is deemed to have substantial interest in the business of the company. Similarly, for the purposes of section 2(22)(e) of the Act, a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty percent of the income of such concern

The term ‘substantial interest’ being so defined as aforesaid can lead to ambiguity creeping in owing to the fact that interpretation is not a precise science. A term or an expression used in a statute can have different shades of meanings and ascertaining that which of the particular meanings is represented at a particular place can be an arduous exercise. The Courts, in such a situation, have to go beyond the statute and yet sticking to the literal meaning of the term as done by the Delhi High Court in the case of Copal Research (stated supra). The Court, in addition to the dictionary meaning, also referred to draft report submitted by the Shome Committee to report on theretrospective amendment relating to indirect transfer of assets, wherein it was noted that the meaning of the expression ‘substantially’ needs to be imported from the Direct Tax Code Bill, 2010. The High Court also placed reliance on the OECD and UN Model Tax Convention which define the term ‘substantially’ in a contextual perspective.

The external aids of interpretation resorted to by the Delhi High Court to resolve the ambiguity in defining the term ‘substantial’ derive force from the observations of the apex Court in the case of District Mining Officer and others vs. Tata Iron & Steel Co. and Anr: (2001) 7 SCC 358, wherein it washeld that it is a cardinal principle of construction that external aids are brought in by widening the concept of context as including not only other enacting provisions of the same statute, but its preamble, the existing state of law, other statutes in parimateria and the mischief which the statute was intended to remedy.

Further, the Supreme Court in the case of K.P. Varghese vs. ITO: (1982) SCR (1) 629, has stated that interpretation of statute being an exercise in the ascertainment of meaning, everything which is logically relevant should be admissible.


The art of correct interpretation, therefore, dependsupon the ability to read what is stated in plain language, read between the lines, read ‘through’ the provision, examining the intent of the Legislature and call upon case laws and other aids to interpretation.

It is pertinent in this context to take note of the observations ofL.J. Denning in Seaford Court Estates v. Asher [1949] 2 All ER 155which states as under:

 “A Judge must not alter the material of which the Act is woven but he can and should iron out the creases. When a defect appears, a Judge cannot simply fold his hands and blame the draftsman. He must set to work on the constructive task of finding the intention of the Parliament and then he must supplement the written words so as to give force and life to the intention of the Legislature.”

It would be, however, interesting to note as to how the Explanation 5 to section 9(1)(i) of the Act is interpreted by other Courts and whether the rationale of the Delhi High Court sustains the test of time.

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(Author is working as Senior Executive – Corporate Tax with Wipro Limited at Bangalore)

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  1. vswami says:

    To perforce revert:

    “It would be, however, interesting to note as to how the Explanation 5 to section 9(1)(i) of the Act is interpreted by other Courts and …”
    That is,of course,one way of looking at it.

    However, it would be much more interesting, rather purposive and useful, if tax law experts were to choose and care to accord further insightful thoughts, keeping in sharp focus the recent amendment(s) of section 9 (1); to be precise, the added Explanation 6. as proposed in the 2015 Budget.

    The poser is this: Should not the new Explanation,as proposed, and if and when eventually enacted,- most likely to happen before long- by itself be the pivotal point/main plank, which seemingly provides enough ammunition for judicial and quasi judicial authorities to decide and settle the dispute, wherever pending,once forc all, only one way- that is,in favor of taxpayers?

    What one has in mind are those often-urged, by and large successfully, settled principles of interpretation, -one of which is the so called ‘beneficial interpretation’ (-recommend to read the text book expert commentary and supporting case law)

    (More to share)

    1. vswami says:

      In re. Tax Notice to Cairne India (since reported)
      Looking at or through the instant case, that has received, for obvious reasons, as ever before in the media, some critical posers arise, not merely from a strictly legal angle, but also from a legitimate common law principle of natural justice:

      1.The taxation year is 2006-07, whereas the sec 9(1) amendments invoked by the Revenue, though, purportedly, retrospective, came into being and brought on the statute long thereafter; that is, by the 2012 FA. As such, the rationale behind the action initiated on the ground of default in compliance with TDS requirement in (previous) year 2005-06 is not understood; on the contrary, seems to be logically faulty and patently misconceived.

      2.The 2015 Budget proposes a further amendment of sec 9 (1) through insertion of an additional Explanation 6. The said proposal happens to have been triggered by the Delhi HC judgment adverse to Revenue. If closely read, as understood, the HC view has been pivoted principally on the lacuna, in the preceding Explanation 5 inserted in 2012; in that, the term ‘substantially’ , as held by the court, suffered from the malady of ‘ambiguity’. In essence, the decision is to the effect that the said term was so inept /inadequate as to lend scope for resolving the dispute in Revenue’s favor.

      3.So far as is critically analyzed , or even if were to be wildly imagined, by any sound or sane reasoning, there appears to be no way to read the ‘substantive’ amendment (hence the proposal itself is, in all fairness,to give it only a prospective effect),into the preceding Explanation 5; despite its purported retro- active operation.

      The foregoing line of thinking is intended to amplify the related comment as earlier posted herein.

      Over to eminent tax law experts at large, in active practice, expected to have an intimate expertise and exposure , for further deliberation and sharing own independently formed incisive opinion.

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