The power of parliament to make law with respect to extra-territorial aspects or causes — Part i

1.2 Section 9(1) of the Income-tax Act, 1961 (the Act) provides a deeming fiction to effectively treat foreign income of an assessee as deemed to accrue or arise in India under certain circumstances in the situations provided therein. Technically, section 9 applies to resident as well as the non-resident assessees. However, applicability thereof to a resident is not of much relevance in the context of taxability of income in India, except in case of an assessee, who is not ordinarily resident. Where income actually accrues or arises in India, such a fiction is not needed to create a situation which exists in reality and therefore, in such cases, this fiction has no relevance. This also effectively does not apply to the income received in India, as such income are chargeable u/s. 5 in case of resident as well as non-resident assessees irrespective of the place of accrual of income. Therefore, effectively, a foreign income of a non-resident assessee, which is not received in India would not be chargeable to tax under the Act, unless it accrues or is deemed to accrue in India.

1.3 Clauses (i) to (iv) of section 9 provide for such deeming fiction in respect of certain income under the circumstances specified therein, such as income accruing or arising, directly or indirectly, through or from any business connection in India or from any property in India, etc. These provisions are considered valid as varieties of nexus set out therein are based on sufficient and real territorial connection. This is mainly based on the general principle that once there is a sufficient territorial connection or nexus between the persons sought to be taxed and the country seeking to tax, the income-tax may appropriately be levied on that person in respect of his foreign income. Primarily, we are not concerned with these provisions in this write-up, though they have continued in section 9(1) with some changes even after introduction of clauses (v) to (vii).

1.4 Clauses (v) to (vii) were inserted by the Finance Act, 1976 (w.e.f. 1-6-1976) deeming interest, royalty and Fees for Technical Services (FTS) to accrue or arise in India effectively making the non-resident recipient of such income chargeable to tax in cases where such non-resident had no tax liability in respect of such income under the pre-existing provisions (hereinafter income specified in these clauses is referred to as the Specified Income). Under these provisions, the law also seeks to charge a non-resident in respect of his income outside India merely because the payment thereof is made by Indian resident with some exceptions. Accordingly, the residential status of the payer became relevant to detriment the situs of income. Further, under these provisions, the law also seeks to charge Specified Income arising from transactions between two non-residents outside India under certain circumstances and so on. This had raised doubts as to the validity of these provisions which came up for consideration before the Courts in India, mainly in the context of provisions relating to FTS.

1.5 In the context of taxability of FTS under clause (vii)(b) of section 9(1), a new dimension was given by the Apex Court in the case of Ishikawajima- Harima Heavy Industries Ltd. (288 ITR 408) wherein while dealing with the taxability of income from offshore services, the Court, inter alia, held that for such income to be regarded as accruing or arising in India, it is necessary that services not only are utilised within India, but also are rendered in India. Such a condition for taxability of such income was by and large not considered as relevant prior to this judgment and the same was also found against the very object for which these provisions were introduced by the Finance Act, 1976. Accordingly, Explanation to section 9 has been inserted/sustituted by the Finance Act, 2010 with retrospective effect from 1-6-1976 to overcome the possible effect of the position emerging from this part of the judgment of the Apex Court. Some doubts have also been raised with regard to validity of this new Explanation.

1.6 In the context of validity of the provisions contained in clauses (v) to (vii) of section 9(1), the debate continued with regard to extent of the Parliament’s powers to enact a law having extra-territorial operations.

1.7 Recently, the Constitution Bench of the Apex Court has dealt with this issue and decided the scope of powers of the Parliament to enact a law having extra-territorial operations. In this context, this has settled the general principle in this regard. This judgment will have implications not only with regard to the Income-tax Act, but also with regard to other laws enacted by the Parliament. In this write-up, we are only concerned with the effect of this judgment in the context of the above-referred deeming fiction provided in the Act in respect of the Specified Income.

Electronics Corporation of India Ltd., (ECIL) v. CIT & Anr. — 183 ITR 44 (SC):

2.1 The issue referred to in para 1.6 above came up before the Andhra Pradesh in the context of section 9(1)(vii). In this case, the brief facts were:

The assessee company (ECIL) had entered into an agreement with Norwegian Co. (NC) under which, for the agreed consideration, the N.C. was to provide technical services including facilities for training of personnel of the ECIL in connection with the manufacture of computers by ECIL. For the purpose of remitting the amount payable to NC, the ECIL had approached the Income Tax Officer (ITO) for grant of No Objection Certificate (NOC) as contemplated in section 195(2) of the Act for remittance without deduction of tax at source (TDS). When ITO expressed inability to issue such NOC, the ECIL approached the Commissioner of Income Tax (CIT) for directing ITO to issue the NOC. The CIT declined to issue such direction as according to him, the said payment was income which is deemed to accrue or arise in India u/s.9(1)(vii) and was liable to TDS u/s.195. Against this, ECIL had filed a writ petition before the High Court.

2.2 Before the High Court, various contentions were raised including validity of provisions of section 9(1)(vii) on the ground that it has extraterritorial operation without any nexus between the persons sought to be taxed (i.e., NC) and the country (i.e., India) seeking to tax under a fiction of deemed income arising in India. In this write-up, we are not concerned with the other contentions raised in this case. For the purpose of deciding the issue, the Court referred to historical background of the Income-tax Act and noted that the Indian Income-tax Act, 1922 was passed by the Indian Legislature in exercise of its powers conferred by the British Parliament under the Government of India Act, 1915-1919 which was replaced by the Government of India Act, 1935. The Court then noted that section 99 of the Government of India Act, 1935, inter alia, empowered the Federal Legislatures to make law for the whole or any part of British India. Comparing these provisions with provisions of Article 245 of the Constitution, the Court noted that there was no provision like Article 245(2) in the Government of India Act. The Court then pointed out that the Income-tax Act, 1961 is a post-Constitution law made by the Parliament.

2.3 It was contended on behalf of the ECIL that the NC does not have any Office in India, nor does it have any business activity in this country. The Parliament is not competent to enact section 9(1)(vii)    as it has extra-territorial operation by creating a fiction of income accruing in India without any nexus between the NC and India. For this, reliance was placed on various judgments including the judgment of the Apex Court in the case of Carborandum Co. (108 ITR 335) as well on the commentary given in the book (i.e., Law and Practice of Income Tax) written by the learned authors Kanga & Palkhivala.

2.4 For the purpose of deciding the issue, the Court stated that various judgments relied on by the counsel of the petitioner were rendered under the Indian Income-tax Act, 1922. The Court also noted that the facts of the case under consideration show that the payment is made by an Indian company to a foreign company for FTS and know-how, which is to be used by the Indian company in its business in India. For the purpose of the Income-tax Act, the fiction of income deemed to arise in the country where tax is levied is not uncommon. The narrow test of territorial nexus evolved by the courts in England may not be suitable for application by a developing country like India in the developments which are taking place. The language and spirit of Article 245(2) of the Constitution is clear. The Court will be slow in striking down the law made by the Parliament merely on the ground of extra-territorial operation. India has entered into agreements with several other nations providing for double taxation relief and if there is a real apprehension of deterrence to foreign collaborations as contended on behalf of the petitioner, it will be expected that the Government will take suitable action. Finally, the Court did not agree with the contention of the petitioner that the impugned provisions are beyond the legislative competence of the Parliament.

2.5 When the above judgment of the High Court came up for consideration before the Apex Court, the Court noted that the Revenue is proceeding on the basis that the NC is liable to tax and therefore, the ECIL is obliged to deduct tax at source while making the payment. The case of the Revenue rests on section 9(1)(vii)(b) of the Act and the question is whether, on the terms in which the provision is couched, it is ultra vires.

2.5.1 To decide the issue, the Court noted the constitutional scheme to make laws which operate extra-territorially and referred to the provisions contained in Article 245 and stated that considering provisions of Article 245(2), which provides that no law made by the Parliament shall be deemed to be invalid on the ground that it will have extra-territorial operation, a Parliamentary statute having extra-territorial operation cannot be ruled out from contemplation. Therefore, according to the Court, the operation of the law can extend to persons, things and acts outside the territory of India and for this purpose, the Court also noted the judgment of the Privy Council in the case of British Colombia Electric Railway Co. Ltd. wherein it was held that the problem of inability to enforce the law outside the territory cannot be a ground to hold such law invalid. The nation enacting a law can order that the law requiring any extra-territorial operation be implemented to the extent possible with the machinery available. This principle clearly falls within the ambit of pro-visions of Article 245(2). The Court then observed as under (page 55):

“In other words, while the enforcement of the law cannot be contemplated in foreign State, it can, none the less, be enforced by the courts of the enacting State to the degree that is permissible with the machinery available to them. They will not be regarded by such courts as invalid on the ground of such extra-territoriality.”

Accordingly, the Court drew the distinction between the power to ‘make Laws’ and ‘operation’ of laws. The Court also took the view that the operation of the law enacted by the Parliament can extend to persons, things and acts outside the territory of India.

2.5.2 Finally, the Court felt that the issue should be decided by the Constitution Bench considering its implications and held as under (page 55):

“But the question is whether a nexus with some-thing in India is necessary. It seems to us that, unless such nexus exists, the Parliament will have no competence to make the law. It will be noted that Article 245(1) empowers the Parliament to enact laws for the whole or any part of the territory of India. The provocation for the law must be found within India itself. Such a law may have extra-territorial operation in order to subserve the object and that object must be related to something in India. It is inconceivable that a law should be made by the Parliament in India which has no relationship with anything in India. The only question then is whether the ingredients, in terms of the impugned provision, indicate a nexus. The question is one of substantial importance, specially as it concerns collaboration agreements with foreign companies and other such arrangements for the better development of industry and commerce in India. In view of the great public importance of the question, we think it desirable to refer these cases to a Constitution Bench, and we do so order.”

2.5.3 From the above, it would appear that the Court held the view that the Parliament does not have power to make extra-territorial law unless a nexus exists with something in India. In the context of Article 245(1), the observations of the Court that the provocation for the law must be found within India itself and the object for which the law having extra -territorial operation is made must be related to something in India, raised an issue as to whether this could mean that such provocation and object must arise only within India.

2.5.4 It seems that the petitioner (i.e., ECIL) did to pursue the above matter further and hence the issue remained to be decided by the Constitution Bench.