Commission to Non-resident Agents – Whether Accruing or Arising in India

The taxability of such commission in India had been an issue that had arisen long back, and the CBDT as far back as 1969, had issued a circular no. 23 dated 23.7.1969, clarifying that such commission was not taxable in India. Further, vide circular no. 786 dated 7.2.2000, the CBDT had again reiterated that such commission was not taxable in India u/s. 5(2) and 9, and that therefore no tax was deductible at source u/s. 195 from such commission. However, vide circular no. 7 of 2009 dated 22.10. 2009, the CBDT has withdrawn both the above referred circulars, no. 23 as well as no. 786, besides the circular no. 163 dated 29.5.1975 which dealt with an agent engaged in the activity of purchase of goods for export. The ostensible reason behind withdrawal of the said circulars was that the interpretation put on the said circulars by some of the taxpayers to claim relief in the opinion of the Board was not in accordance with the provisions of section 9, or the intention behind the issue of the circulars.

In the light of the withdrawal of the above circulars, the question has arisen as to whether such commission to foreign agents is subject to tax in India, and whether tax is accordingly deductible u/s. 195 from such commission. In case of agents who are tax residents of countries with which India has Double Taxation Avoidance Agreements, such income may not be taxable in India on account of the applicability of Article 7 of the DTAA dealing with Business Profits, as business profits are not taxable in India in the absence of a permanent establishment in India. The issue would however assume significance in the case of agents who are tax residents of countries with which India does not have DTAAs, and who would be governed by the provisions of the Income Tax Act.

While the Authority for Advance Rulings has recently taken a view that such commission is chargeable to tax in India under the provisions of the Income Tax Act, the Hyderabad bench of the tribunal has taken a contrary view of the matter.

SKF Boilers & Driers’

Case The issue came up before the Authority for Advance Rulings (AAR) in the case of SKF Boilers and Driers Pvt Ltd, in re, 343 ITR 385.

In this case, the applicant was an Indian company engaged in the manufacture and supply of rice par boiling and dryer plants as per customer requirements. It had received an order from a Pakistani company through two Pakistani agents. The plant was shipped to the Pakistani customer, and on completion of the export order, the commission became payable to the agents as per the agreed terms. A ruling was sought from the AAR as to whether such commission income of the nonresident agents could be deemed to accrue or arise in India and whether tax was required to be deducted at source u/s. 195.

On behalf of the revenue, it was pointed out that there was no DTAA with Pakistan which covered such payment, nor was there any other tax exemption available. It was also stated that circular no. arising to the agents on account of export commission fell u/s. 5(2)(b), as the income had accrued in India when the right to receive the income became vested.

On behalf of the applicant, it was argued that the agents had rendered services abroad and would be entitled to receive commission abroad for the services rendered to foreign clients of the applicant. As services were rendered outside India, and the payment was receivable by the agents abroad, no income would arise u/s. 5(2)(b) read with section 9(1).

The AAR considered the provisions of sections 5 and 9, and observed that they proceeded on the assumption that income had a situs, and the situs had to be determined according to the general principles of law. According to the AAR, the words ‘accrue’ or ‘arise’ occurring in section 5 had more or less a synonymous sense, and income was set to accrue or arise when the right to receive it came into existence. The AAR expressed the view that no doubt the agents had rendered services abroad and had solicited orders abroad, but the right to receive the commission arose in India when the order was executed by the applicant in India. According to the AAR, the fact that the agents had rendered services abroad in the form of soliciting the orders and that the commission was to be remitted to them abroad were wholly irrelevant for the purpose of determining the situs of their income.

The AAR therefore held that the income arising on account of commission payable to the two agents was deemed to accrue and arise in India and was taxable in India in view of the specific provisions of section 5(2)(b) read with section 9(1)(i), and that the provisions of section 195 would therefore apply.

Avon Organics’ case

The issue again came up recently before the Hyderabad bench of the tribunal in the case of ACIT v Avan Organics Ltd., 28 taxmann.com 170.

In this case, the assessee was engaged in the activity of manufacture and sale of chemicals and bulk drugs. It paid commission to foreign agents for services rendered by them in connection with effectuating export sales, and such payments were made by telegraphic transfer directly to the overseas bank accounts of the agents. Such payments were made without deducting tax at source. It was claimed by the assessee that the foreign agents operated in their respective countries and no part of the income arose in India, and hence no tax was required to be deducted at source on the payments made to the foreign agents.

The assessing officer rejected the assessee’s contention by observing that the non-residents were paid by way of telegraphic transfer obtained from banks in India, that the banks acted as agents of the non-residents, and therefore, the non-residents had received the payment in India. He accordingly disallowed the payment of the commission u/s. 40(a)(i). The Commissioner (Appeals) reversed the order of the assessing officer.

Before the tribunal, it was argued on behalf of the revenue that the commission payment being for services rendered by the foreign agents in connection with business activities arising in India, was taxable in the hands of the foreign agents, and therefore the assessee was required to deduct tax at source.

On behalf of the assessee, it was argued that the foreign agents did not render any part of the services in India, did not have an establishment in India and therefore, commission was not deemed to have arisen in India as per section 5(2)(a). It was further argued that the mere fact of transmission of the commission to foreign agents through telegraphic transfer did not make the banks as agents of the foreign commission agents, amounting to receipt of payment on their behalf in India.

The tribunal therefore held that the assessee was justified in not deducting tax at source from the commission paid to the foreign agents.

A similar view had been taken earlier by the AAR in the case of SPAHI Projects (P) Ltd, in re 183 Taxman 92 and by the Tribunal earlier in the case of DCIT v Divi’s Laboratories Ltd 131 ITD 271 (Hyd). In the latter case, the Tribunal has expressly taken the view that the withdrawal of earlier circulars by the CBDT did not assist the Department in disallowance of such expenditure.

Observations

The controversy to an extent revolves around the question whether the withdrawal of the said circulars changed the legal position, as it was understood that the said circulars only confirmed the legal position that such commission was not taxable in India. Circular nos. 23 and 786, clarified the legal position and confirmed that even the interpretation of the CBDT was that, where the non-resident agent operated outside the country, no part of his income arose in India, and since the payment was usually remitted directly abroad, it could not be held to have been received by or on behalf of the agent in India. The CBDT confirmed that this was its interpretation of sections 5(2) and 9, and this view prevailed within the CBDT right till 22.10. 2009, when circular no. 7 of 2009 was issued for withdrawing the above circulars.

The position stated by the earlier circulars is the correct legal position, and the circulars merely clarified this position, a fact that has been confirmed by the number of tribunal and High Court decisions which, in the past, have upheld the validity of the reasoning and conclusion given in the said circular nos. 23 and 786. Therefore, the mere withdrawal of a circular which clarified the correct legal position would not change the legal position in this regard and if that is so , the stand now taken by the CBDT under the said circular 7 of 2009 has to be taken as the one that is contrary to the true legal position under the Act for taxation of such commission.

The AAR in SKF Boilers & Driers case perhaps erred holding that the place of accrual of an income is to be determined w.r.t the time of its accrual. While it is true that the point of time when commission arises is the time when the export of goods takes place, the AAR, in SKF Boilers & Driers case, erred in taking the view that even the situs of accrual of the income was the place from where the goods were exported. Under tax laws in India, it has been generally accepted that the place where the work is actually done is normally the situs of accrual of the income. For instance, in the case of salary income, the place of rendering of services is regarded as the place of accrual of income. The commission agent did not carry on any activity in India, and just the fact that the moment of accrual of income was linked to the moment of export of goods from India, did not mean that the commission income also accrued in India. The income from the export of goods was not the same as the income by way of commission. The linkage between the quantum or time of accrual between two events does not necessarily imply a linkage between the place of accrual of the two events. For instance, the value of a derivative is derived from its underlying fact, but the place of its accrual would be the place where the contract is entered into, and not the

place where the delivery of the underlying goods takes place. The AAR seems to have mistaken the linkage between the two events vis-a -vis the moment of accrual, to also imply a linkage in the place of accrual.

The AAR in the SKF Boilers & Driers case seems to have overlooked clause (a) of explanation 1 to section 9(1)(i). This clause provides that in the case of a business of which all the operations are not carried out in India, the income of the business that is deemed under this clause to have accrued or arisen in India is only such part of the income as is reasonably attributable to the operations carried out in India. This clause supports the view that the Income Tax Act treats the place where the activity is carried out as a place of accrual of income. This effectively means that if a business is only partly carried out in India, only that part of the income attributable to the business activity carried out in India would be taxable in India. This position is further reiterated by explanation 3 to section 9(1)(i) of the Act. That being the case, if no part of the business activity is carried out in India, as in the case of a foreign commission agent, then no part of the income can be taxed in India.

Further, the Supreme Court, in the case of CIT v Toshoku Ltd 125 ITR 525, considered a situation where an Indian exporter had appointed a non-resident sales agent for exports. The commission was credited in the books of the Indian exporter, and was subsequently paid. While holding that such credit did not constitute receipt of the commission in India, the Supreme Court also considered whether the commission accrued or arose in India. The Supreme Court observed as under:

“The second aspect of the same question is whether the commission amounts credited in the books of the statutory agent can be treated as incomes accrued, arisen, or deemed to have accrued or arisen in India to the non-resident assessees during the relevant year. This takes us to section 9 of the Act. It is urged that the commission amounts should be treated as incomes deemed to have accrued or arisen in India as they, according to the department, had either accrued or arisen through and from the business connection in India that existed between the non-resident assessees and the statutory agent. This contention overlooks the effect of cl. (a) of the Explanation to cl. (i) of s/s (1) of section 9 of the Act, which 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 that clause to accrue or in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. If all such operations are carried out in India, the entire income accruing therefrom shall be deemed to have accrued in India. If however, all the operations are not carried out in the taxable territories, the profits and gains of business deemed to accrue in India through and from business connection in India, shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in the taxable territories. If no operations of business are carried out in the tax-able territories, it follows that the income accruing or arising abroad through or from any business connection in India cannot be deemed to accrue or arise in India.

In the instant case, 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 section 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.”

From the above decision of the Supreme Court, it is clear that in the absence of any activity being carried out in India by a non-resident commission agent, the commission does not accrue or arise in India, and is not taxable in India.

A view similar to the view taken in the case of Avon Organics in favour of the assessee has been taken by the Hyderabad tribunal in the case of Priyadarshini Spinning Millls (P) Ltd. , 25 taxmann. com 574. The tribunal in this case took a view that no tax was deductible at source u/s. 195 on payment of such commission and that expenditure on commission could not be disallowed u/s. 40(a) (i) of the Act.

In view of the discussion here, it is appropriate to hold that the said Circular No. 7 of 2009 is without the authority of the law and shall have no application in determining the taxability of income by way of commission in the hands of a foreign commission agent rendering services outside India.