[Vaishnavi is a student at Hidayatullah National Law University.]
In the recent case of BCCI v. Dy. Commissioner of Income Tax, the Income Tax Appellate Tribunal (ITAT) in Mumbai has ruled that the compensation payment made to Cricket South Africa (CSA) under the termination agreement by BCCI is not subject to taxation, in accordance with the provisions outlined in the India-South Africa Double Taxation Avoidance Agreement (DTAA).
This piece delves into the intricate facets of the judgment, with an analysis focusing on two pivotal aspects: the 2018 amendment that transformed the taxability of compensation previously deemed as capital receipts and the revised definition of 'business connection' under the Finance Act 2018, aligning it with the modified PE rule of the OECD Multilateral Instrument (MLI) and the Base Erosion and Profit Shifting (BEPS) Action Plan 7.
Facts of the Case
From 2008 to 2014, the BCCI (the appellant/assessee) organized an annual cricket tournament called Champions League T20 (CLT20), in which domestic teams of various countries participated. In collaboration with CSA, the assessee devised an arrangement wherein CSA ensured the participation of winning and runner-up cricket teams from their domestic Twenty20 Cricket competition in CLT20. As part of this agreement, the assessee committed to paying a predetermined participation fee to CSA each year for the participation of teams from their jurisdiction.
Consequently, the assessee and CSA entered into a termination agreement in 2015, cancelling the previous arrangement which required CSA to guarantee the participation of teams from South Africa in CLT20. Clause 5 of the agreement stipulated that if the assessee organizes a similar tournament within four years, CSA will facilitate the participation of at least two South African teams. Clause 6 explicitly prohibits CSA from involvement in any tournament similar to CLT20.
The assessee agreed to pay CSA a compensation amount of USD 22,696,000 for the termination of CLT20 and CSA’s obligations. The Commissioner of Income Tax (Appeals) (CIT(A)) held that this payment of compensation should be taxed as 'income from business' under Section 28(va) of the Income Tax Act 1961 (Act). The assessee appealed this decision before the ITAT. The central issue in this appeal is whether the compensation amount is taxable.
Delving into the Contours of the Judgement
The ITAT has ruled that the compensation payment made to CSA under the termination agreement is not subject to taxation and TDS deduction under Section 195 of the Act.
Amidst delivering the verdict, the court expounded upon the intricacies of the following facets:
The receipt of compensation by CSA is not attributable to any operation carried out in India
The assessee argued that CSA had no obligation to ensure team participation after the termination of the arrangement, resulting in no services provided by CSA in India. They also claimed that the non-compete clause under clause 6 of the agreement, if applicable, would apply outside India. This is because if the assessee organizes any tournaments in India, under clause 5, CSA would be required to ensure the participation of teams in such tournaments.
The court considered the arguments and relevant sections of the Act. Section 5(2)(a) mentions the total income of a non-resident which includes income received in India. However, it was deemed inapplicable as the compensation was not received in India. Regarding Section 5(2)(b), it is explained in Section 9 that income deemed to accrue or arise in India includes income derived from business connections, property, assets, or sources in India. However, Explanation 1(a) to Section 9(1)(i) clarifies that only the portion of income reasonably attributable to operations carried out in India is deemed to accrue or arise in India for taxation purposes.
The court concluded that the arrangement between CSA and the assessee for team participation in the T20 league was terminated. No matches of CLT20 took place anywhere, including in India. Therefore, no services were rendered for facilitating team participation.
Regarding compensation as non-compete fees, the court held that the non-compete clause applied outside India. Since the payment did not arise from operations in India, it is not taxable under Section 9(1) of the Act. The court concluded that the compensation paid to CSA for terminating the arrangement is a non-taxable capital receipt.
CSA’s lack of permanent establishment in India in view of Article 7 of the DTAA between India and South Africa
The CIT(A) held that the assessee acted as a Dependent Agent Permanent Establishment (DAPE) for CA, CSA, and other teams participating in CLT20, making CSA's income taxable in India. The assessee argued that as regards DAPE, the revenue failed to prove the fulfilment of conditions under the tax treaty. Additionally, the assessee is not an agent of CSA and lacks the authority to finalize contracts on their behalf. Hence, without a permanent establishment (PE) of CSA in India, the compensation for discontinuing CLT20 cannot be taxed in India.
The court delved into the relevant articles of DTAA between India- South Africa. According to Article 7 of the DTAA, the income of an enterprise is taxable in the contracting state if it operates through a PE in the other state. The revenue claimed that CSA had a dependent agent in India, making the compensation taxable. To determine if CSA had a DAPE in India under the DTAA, the court analysed Article 5(5), which states that for an enterprise to be deemed to have a PE, a person acting on its behalf must have the authority to conclude contracts in the contracting state and habitually exercise that authority.
In the present case, the revenue failed to provide evidence that the assessee had the authority to conclude contracts on behalf of CSA and habitually exercised that authority. Thus, the revenue did not meet the burden of proof required to establish the fulfilment of the twin conditions stated in Article 5(5) of the DTAA. Therefore, the court held that the payment of compensation to CSA under the termination agreement is not taxable under the DTAA, and the assessee is not required to deduct tax at source under Section 195 of the Act.
Evaluating Taxation Implications: Analysis of Compensation Receipts and Modified PE Rule
Navigating the 2018 amendment: Impact on taxation of compensation receipts
The argument put forth by revenue is that the agreement is a non-compete agreement, as CSA had agreed not to engage in any tournament like CLT20. Therefore, the payment is taxable as business income/non-compete fee under Section 28(va) of the Act.
However, the grounds as to the taxable nature of compensation under Section 28(ii)(e) were not raised in the case. The omission can be attributed to the fact that the assessment year in the above case is 2016-17, and clause (e) was inserted in Section 28(ii) by the 2018 amendment (with effect from 1 April 2019). This raises an intriguing aspect of the case, as it necessitates an analysis from this perspective. The 2018 amendment had a significant impact that altered the taxation of compensation previously considered capital receipts and overturned numerous judicial precedents.
In the present case, the court held that compensation paid to CSA for terminating the arrangement is a capital receipt, hence not taxable. In the case of CIT v. Raj Bahadur Jairam, it was held that the compensation received for the termination of a business agreement should be treated as taxable business income unless the termination leads to the loss of the income source. In the present case, CLT20 was terminated entirely, hence there was the loss of a source of income. Therefore, it is undisputed that compensation was a capital receipt.
However, according to Section 28(ii)(e), any compensation received by a person in connection with the termination or modification of a business contract is taxable under the head 'profits and gains of business or profession'. Before 2018 amendment, compensation received for breach of contract was treated as a capital receipt and was not liable to be taxed. However, with the inclusion of clause (e) in Section 28(ii), compensation received or expected for terminating a contract is now taxable, regardless of whether it is a capital receipt or a revenue receipt.
Further, in a similar case of Sai Mirra Innopharm Private Limited v. ITO, the court determined that the compensation received for the premature termination of a contract manufacturing agreement was considered a capital receipt, representing the loss of profit from the business or investment. The ruling further clarified that until the assessment year 2019-20, compensation received for the termination of any agreement was not subject to taxation under section 28(ii)(e) of the Act.
Therefore, per the author, considering the current jurisprudence, the defence of compensation being a capital receipt might not stand, given the impact under Section 28(ii)(e).
Redefined business connections: Analysing the modified PE rule and its implications
The CIT(A) concluded that the assessee qualifies as the DAPE of CSA based on factors such as representation in the CLT20 Governing Council and acting as an agent for multiple teams participating in CLT20. The CIT(A) deemed the income of CSA to have accrued and arisen in India.
According to Section 9 of the Act, income derived from business connections, property, assets, or sources in India is deemed to accrue or arise in India for taxation purposes. However, Explanation 1(a) to Section 9(1)(i) clarifies that only the portion of income reasonably attributable to operations carried out in India is taxable. The court rightly held that since CLT20 was discontinued and no services were rendered in facilitating the participation of teams in the Tournament, therefore no operations were carried out in India and the assessee is not a DAPE of CSA.
However, the scope of 'business connection' was amended by the Finance Act of 2018 to align with the MLI and BEPS Action Plan 7. The amended definition includes 'business activities carried on by a non-resident through dependent agents and any business activities carried through a person acting on behalf of the non-resident, who habitually concludes contracts by the non-resident'. Therefore, it becomes interesting to analyse the present case from the perspective of this modified definition.
Considering the law, the amended definition of 'business connection' includes the requirement of habitually concluding contracts or playing the principal role leading to the conclusion of contracts by the non-resident. According to Taxation scholar, Klaus Vogel, a general authority cannot be assumed if the agent's authority is limited to pre-determined prices and terms set by the principal, without any decision-making power. However, there is no evidence provided by the Revenue to establish that the assessee had the authority to conclude contracts on behalf of CSA and habitually exercised that authority.
In similar cases of SAS Institute (India) Private Limited v. ACIT and In Re AL NISR Publishing, it was held that compensation received by foreign companies for loss of business/profit would be considered business receipts, but no TDS would be deducted if the foreign companies do not have a PE in India. Furthermore, the AL NISR Publishing case establishes that an agent representing multiple principals and providing similar services without exclusivity does not have an agency PE in India.
Applying these principles, the assessee's role as an agent for multiple teams in CLT20 and the absence of authority to conclude contracts on behalf of CSA, it can be concluded that even when considering the amended definition of 'business connection,' the assessee would not be deemed as a DAPE of CSA.
The 2018 tax law amendments have brought about significant changes to taxation jurisprudence, expanding the scope of taxable income, and redefining the concept of business connection. These amendments align with international standards and aim to tackle tax avoidance. Overall, the amendments have necessitated a revaluation of tax positions and increased compliance requirements in line with the revised framework.