No escape for services rendered from abroad but utilised in India from income tax - Finance Bill amends Explanation inserted in 2007

By TIOL News Service

NEW DELHI, FEB 26, 2010: SERVICES Sector comprises the largest chunk of GDP in India. At present, India is a provider of services. It is also a recipient of services. Big ticket composite projects always contain a service element. The rules of international taxation are such that business income can only be taxed in the source country only if there is a permanent establishment. It is also a fact that business can be so structured that existence of permanent establishment can be avoided. It is also a fact that domestic legislation must be capable of taxing such services in the first place. It is with this object in view that long back in the year 1976, a source rule was introduced in the Income tax Act in the form of section 9(1)(vii) whereby it was deemed that fees for technical services payable by a resident would be deemed to be accrue or arise in India. The understanding was that such fees would be taxable in India even if the services were rendered from outside so long as the services were utilized in India .

This view was in fact challenged in the case of Electronic Corporation of India Vs CIT (2002-TIOL-692-SC-IT), the Bombay High Court having rejected the contention that in absence of sufficient territorial nexus the same could not be taxed in India . The matter stood referred to a Constitution Bench. No decision was available.

The issue cropped up again in the year 2003 in the case of Ishikawajima-Harima Heavy Industries Co. Ltd (2004-TIOL-17-ARA-IT). Ishikawajma, a Japanese company won a turnkey contract for execution of a project in India for Petronet. For the purpose of the execution of contract, it entered into a consortium arrangement with some other non-resident entities and an Indian coy. The contract involved offshore supply, offshore services, onshore supply, onshore services and construction and erection. It sought a ruling from the AAR to ascertain its India tax liabilities. The AAR held that in a case of transaction of sale of goods by the non-resident to an Indian resident which is a part of a composite contract involving various operations within and outside India, income from such sale shall be deemed to accrue or arise in India if it accrues or arises through or from any business connection in India.

This decision was challenged before the Supreme Court through an SLP and the Supreme Court in its decision in Ishikawajima-Harima Heavy Industries Co. Ltd vs DCIT (2007-TIOL-03-SC-IT) held that for Section 9(1)(vii) to be applicable, it is necessary that the services are not only utilized within India, but must also be rendered in India or have such a “live link” with India that the entire income from fees as envisaged in Article 12 of DTAA becomes taxable in India. This decision thus upset the general understanding of the law on the subject. The import of the SC decision, if taken to its logical end, would have made taxation of any income from services impossible since in this age and time services can be rendered easily from abroad.

The matter having been brought to the notice of the authorities, an amendment was made in section 9(1)(vii) by adding an explanation through the Finance Act 2007 to clarify that where income is deemed to accrue or arise in India under clauses (v),(vi),(vii) of section9(1), such income shall be included in the total income of the non-resident , regardless of whether the non-resident had a residence or place of business or business connection in India.

It was indeed a very circuitous way of saying that income from fees for technical services would be deemed to arise in India if the services are utilized in India . The language in the amendment left a lot to be desired and commentators pointed out even in 2007 that perhaps the language of the amendment would not cover all situations.

This is what happened in the case of Jindal Thermal Power Company Limited Vs Dy CIT (2009-TIOL-302-HC-KAR-IT). The Karnataka High Court in this case held that the criteria of rendering services in India and utilization of services in India remain untouched and unaffected by the explanation.

To overcome the defective drafting, the Finance Bill now proposes to amend the explanation with retrospective effect by adding that whether or not the services have been rendered in India , income of a non-resident would be deemed to accrue In India. While this is certainly an improvement, the intention of the legislature could very well have been made clear by using a language which is easily understandable, to wit - something to the effect that income by way of fees for technical services shall be deemed to accrue or arise in India even if the services are rendered outside India provided that such services are utilized in India.