A Living Law – ‘Intangible’ Business Connection
[Mohit and Vibhore are students at Institute of Law, Nirma University.]
As we move more towards the digitalized world having physical presence as a prerequisite for exercising a right to tax, the business income is bound to dilute in the source state. Under the current regime, Article 7 of the India-US Double Taxation Avoidance Agreement treaty provides that the source country can exercise its right to tax the business income of the non-resident entity only when such entity has a permanent establishment (PE) in the source jurisdiction. Under the Income Tax Act 1961 (IT Act), Section 9(1)(i) through a deeming fiction provides the right to tax income which may arise outside India if such income accrues or arise through ‘business connection’. In simple terms, it is equivalent to business presence, yet the concept of business connection is much broader than PE as it follows a fact-based approach varying on case to case basis. Further, no fixed place of business is required for Indian business connection and, therefore, any form of business can create a nexus under Indian taxation law as long as there remains a ‘real and intimate’ business connection of the non-resident in India.
The scope of business connection saw a significant deviation from the established position in the recent decision by Income Tax Appellant Tribunal, Mumbai bench (Tribunal) in the matter of Volkswagen Finance Private Limited (VSPL) v. Income Tax Officer. VSPL, an Indian company, along with its affiliate company Audi India, organized an event in Dubai for the launch of Audi’s new car for the Indian market. For the event, organizers coordinated with a company in the US to facilitate the appearance of an international celebrity (Nicolas Cage) and made payment in respect of the celebrity appearance in Dubai without withholding any tax from the said remittance. It is pertinent to mention here that VSPL along with Audi India had the exclusive right over the use of event footage, interview, stills etc. for below the line publicity.
The Assessing Officer (AO) imposed a withholding tax obligation upon the assessee by characterizing the appearance fees as royalty. The Commissioner of Income Tax (Appeals) ordered in consonance with the AO and upheld the withholding tax, but it also asserted that the purpose of organizing an India-centric event in Dubai was to avoid business connection provision in the domestic law.
The assessee, in appeal, claimed that since neither the payment nor the services were rendered in India, the income did not accrue or arise in India. The assessee claimed that to fall under the ambit of business connection, the performance of some economic activity in India is a must. Moreover, neither the celebrity nor his agent carried out any activity in India in relation to the appearance fee received.
The Tribunal in this unprecedented ruling held that though none of the activities were carried out in India, the event has some intangible business connection and, therefore, payment made to a non-resident celebrity would be subject to withholding-tax in India. The Tribunal expanded the horizon of business connection and ruled in favor of the revenue by making the following noteworthy observations:
Benefit’s principle – The purpose of the event was to facelift the Audi A8L car specifically for the Indian market, and the assessee along with Audi India had exclusive right over use of event footage, interview, stills etc. for below the line publicity on the internet. Accordingly, a business connection was established based on the benefit’s principle.
The definition of business connection is inclusive and not exhaustive in nature; therefore, instances mentioned under the accessible literature are only illustrative. In the words of the Kanga and Palkhiwala, “the categories of business connection are incapable of exhaustive enumeration”.
The assessee contended that the expenses incurred were claimed as deduction under Section 37(1), thereby implying that the expenses were incurred solely and exclusively for the purpose of business, and the business of the assessee was only in India.
Non-application of judicial precedents – The Tribunal disregarded the application of established judicial precedents in the current case on the ground of a different factual situation as none of them had any occasion to examine ‘intangible business connection’. Regarding the business connection, the Tribunal referred to the case of CIT v. RD Aggarwal & Co., wherein the Supreme Court had observed that the review of the judicial precedents is not for evolving a definition applicable generally to all cases but with a view to illustrate what relations between the non-resident and the activity in the taxable territories which contributed to the earnings of the income may or may not be regarded as business connections.
The Tribunal approached the matter from a very different perspective and dealt with it on the first principle as there exists no such judicial precedent concerned with a similar issue. The judgment can be considered controversial in nature since it expanded the scope of business connection very widely; it seems to be deviating from the well-settled position under Section 5(2)(b) read with Section 9(1)(i) of the IT Act. The judgment highlights the problems related to deeming fiction in law; the question is how far a deeming fiction can be stretched. The Tribunal disregarded all the previous contours associated with business connection established by the judiciary – real and intimate connection, continuity of such connection and attribution of income of non-resident to such connection. Moreover, under Section 9(1)(i), the phrase used is 'business connection in India'. The authors agree that there was a business connection ‘with’ India as the event was India-centric, but the same cannot be treated as business connection ‘in’ India.
The approach of the Tribunal is quite proactive and the judgment reflects how the law has not evolved with technology. The anomaly in law has been highlighted as though the expenditure was incurred solely for the purpose of business in India for which even deduction was claimed but the income/benefit which may arise out of such transaction would not be taxed in India. The Tribunal went on to say that disregarding such model as business connection because the learned judges could not have visualized such business models several decades ago would be a travesty of justice.
Taking into account the expanded definition as interpreted by the Tribunal, the concept of business connection will widen so much that it will cause a spur in tax-related cases in India.
For example, it is common to see advertisements of Indian brands on the hoardings behind the boundary lines in a foreign cricket stadium. In our opinion, following this judgment, the Indian advertiser will be required to deduct tax before payment to the foreign entity as the advertisement is solely meant for Indian viewers only.
The ruling could have far more implications because under the current provisions of the law and under most of the treaties, a non-resident must earn income in India in order to be taxed but after this ruling, entertainers have to be mindful of Indian tax implication even when they are performing outside India, so long as the target is the Indian audience. Similarly, the ruling will create a burden on the production houses since they will have to withhold tax while making payments to non-resident entities so long as the target audience is based in India (which has become quite common).
Here, we agree that there needs to be a framework to tax these types of transactions. Moreover, as observed in the judgment, business models are constantly evolving and the law has to be seen in tandem with the ground realities of the business world. But in our opinion, adjusting these transactions in the existing framework can be troublesome, especially when done by the judiciary. Such judicial activism is against the basic canon of tax laws – certainty. Inclusion of the impugned transaction under the purview of the current ambit of business connection in our opinion is not valid as –
Test of continuity - As observed by the Supreme Court in the Anglo-French judgment, for establishing business connection, continuity is imperative, and in the present case, there was only a one-off transaction.
Real and intimate connection - As previously mentioned, the activity was carried out of India though it had some implications in India; this does not grant sufficient nexus to the activity to be taxed in India. The event impacted Indian consumers, but under the current legal framework, we do not have market presence as the basis for taxation.
On reading the judgment, one can see how it is influenced by the recent developments in international tax affairs. The inclusion of Explanation 3A in Section 9(1) of the IT Act, significant economic presence (SEP) as well as discussions around Pillar I approach of the Organisation of Economic Co-operation and Development (share of the market economy) have, in our opinion, impacted the judicial mind in the current ruling.
The digital economy debate has brought an argument for having market as the basis for taxation, and in the near future, we might see its presence along with production factors. India in recent years has been at the forefront in terms of expanding the prospect of digital taxation and particularly devising rules and regulations in order to tax non-residents who are doing business in India without any physical presence. The slew of amendments to address digital tax issues includes equalisation levy (2016 and 2020), amended PE definition, and expanded scope of business connection by introducing the concept of SEP.