The Central Board of Direct Taxes (CBDT) has withdrawn one of the oldest and most important circulars i.e Circular no 23, of July 23, 1969, and consequently Circulars no 163 dated May 29, 1975, and no 786 dated February 7, 2000, which provided certain further clarifications with respect to Circular no. 23.
These circulars dealt with the concept of income accruing or arising from India through or from business connections in India. Though this concept is well established by various courts, the CBDT found fit to withdraw the old circular on the ground that it was being misused.
Reasons cited by CBDT for withdrawal
The Central Board of Direct Taxes (CBDT) has cited the following reasons for withdrawal of the earlier circular:
- The interpretation of the circular by some of the taxpayers to claim relief is not in accordance with the provisions of Section 9 of the Income-tax Act 1961 (Act) or the intention behind the issuance of circular.
- Even when the circular was in force, the Income-tax department has argued in appeals, references and petitions that (a) the circular does not apply to a particular case, or (b) that the circular cannot be interpreted to allow relief to the taxpayer which is not in accordance with the provisions of Section 9 of the Act or with the intention behind the issuance of the circular.
Section 9 of the Act
Section 9 defines income deemed to accrue or arise in India. Section was amended with an insertion of explanation to sub-section 2 with retrospective effect from 1st June 1976 in the Finance Act, 2007.
“Explanation – For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India.”
Hence it was made clear that business connection in India is not a pre-requisite to be an income deemed to accrue or arise in India for the clauses referred to in above explanation. Still it has been held by various courts that for Section 195 will be attracted, only when the services should have been rendered in India.
To overcome the impact of various judgements the Government amended explanation to sub-section 2 of section 9 of the Income-tax Act, 1961 (‘Act’) retrospectively from 1st June 1976 in the Finance Bill 2010 as follows:
“Explanation – For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not,
(i) the non-resident has a residence or place of business or business connection in India; or
(ii) the non-resident has rendered services in India.”.
Clauses referred in the above explanation to Section 9 (2) of the Act:
Clause (v) income by way of interest payable
Clause (vi) income by way of royalty payable
Clause (vii) income by way of fees for technical services payable
What was referred in Circular 786 dated 7th February 2000?
The deduction of tax at source under section 195 would arise if the payment of commission to the non-resident agent is chargeable to tax in India. In this regard attention to CBDT Circular No 23 dated 23.7.1969 is drawn, where the taxability of ‘Foreign Agents of Indian Exporters” was considered along with certain other specific situations. It had been clarified then that where the non-resident agent operates outside the country, no part of his income arises in India. Further, since the payment is usually remitted directly abroad it cannot be held to have been received by or on behalf of the agent in India. Such payments are therefore held to be not taxable in India.
Does withdrawal of circular negate the principle of law?
40 year old circular No. 23 dated July 23, 1969 which explained the applicability of the provisions of Section 9 of the Income-tax Act 1961 and the principles of attribution of profits and principles of business connection was withdrawn.
Circular no 23 and Circular no 786 has clarified that where the non-resident agent operates outside the country, no part of his income arises in India. Further, since the payment is usually remitted directly abroad it cannot be held to have been received by or on behalf of the agent in India. Such payments were therefore held to be not taxable in India.
Since the circular has been withdrawn the question arises, whether payment of commission to non-resident are tax deductible? Does withdrawal of circular changes the principle of law?
The Supreme Court observed in CIT vs Toshoku Limited (125 ITR 525) held that, the non-resident assessees did not carry on any business operations in the taxable territories. They acted as selling agents outside India. The receipt in India of the sale proceeds of tobacco remitted or caused to be remitted by the purchasers from abroad does not amount to an operation carried out by the assessees in India as contemplated by cl. (a) of the Explanation to s. 9(1)(i) of the Act. The commission amounts which were earned by the non-resident assessees for services rendered outside India cannot, therefore, be deemed to be incomes which have either accrued or arisen in India. The said decision of Supreme Court was not based on the provisions of the circular but based on the principles of income deemed to accrue or arise in India and outside India.
The Mumbai High Court in UTI vs PJ Unny (249 ITR 612) concluded that the benevolent circular is binding and even if they are withdrawn, they cannot operate retrospectively, because circulars do not constitute law, which can be retrospectively undone, since they are only in the nature of instructions or guidelines.
The Supreme Court judgement in N.N.Bhagwathi vs CIT (247 ITR 6) supports the view that the circulars cannot override the judicial precedents.
Payment of marketing commission
The relevant sections, namely section 5(2) and section 9 (1) (i) of the Act not having undergone any change in this regard.
The Supreme Court has held that in this case that Section 195 gets attracted only when the amount paid by the resident to the non-resident wholly bears the character of ‘income’ (such as salaries, dividends, interest on securities, etc) but also to gross sums the whole of which may not be income or profits of the recipient, such as payments to contractors and sub-contractors, insurance commission, etc. Nowhere has it been stated in the decision of the Supreme Court that Section 195 gets attracted even in cases where there is no ‘income’ arising or accruing to the non-resident in India.
Amendment to explanation of section 9 (2) of the Act holds good only for the clauses (v), (vi) and (vii) of section 9 (1) of the Act. In our view, for other clauses referred to in the section 9 (1) of the Act for the purpose of income deemed to accrue or arise in India there must be a business connection in India and income actually arises out of India by virtue of business connection in India.
Hence in our view and based on judicial rulings cited above mere withdrawal of the circular does not negate the principles of income deemed to accrue or arise in India or outside India. Since the principles of income deemed to accrue or arise in India has been well established by courts in various judicial precedents, a mere withdrawal of circular does not negate the principles.
Further amendment to explanation of section 9 (2) of the Act is only with reference to clause (v), Clause (vi) and clause (vii) of section 9 (1) of the Act and not for all the clauses referred in Section 9(1) of the Act.