India is in the midst of a radical economic transition, and globalisation is affecting the administration of fiscal policy. Business transactions in which India is a reference point, for example, now take place between residents, a resident and non-resident, and even between non-residents. Any transaction that involves a flow of goods or services to or from India, or transfer of ownership of capital assets relatable to India, assumes a domestic revenue relevance.
Indian tax authorities have experience in dealing with tax issues arising from international trade transactions, as they usually involve at least one resident party, and so the issues of territorial jurisdiction and legislative competence are easy to resolve. The problem, however, assumes a wholly different character if there is a large one-time capital transaction executed outside India involving two non-residents transferring shares in a company incorporated outside India which may have made downstream investments in an Indian company. On account of its large size, the transaction gets reported to regulators in various countries under applicable laws. What Indian tax authorities need to consider are issues of (a) extra-territoriality (b) limits on the tax rights of sovereign states under international law vis-?-vis subjects of other states, and (c) responsibility of each state to ensure that the global tax treaty network works in a manner which facilitates global trade and commerce, with every sovereign state having subordinated its own interest to the collective interest of all.
In a case relating to the transfer of shares of an overseas company between two non-residents, a non-resident is liable to pay tax in India under Section 5(2), read with Section 9, of the Income Tax Act, 1961, in respect of income that accrues or arises or is deemed to accrue or arise in India, or in respect of income that is received or is deemed to be received in India. In a case where money is not actually earned or received in India, the authorities can invoke deeming principles, which involve inference. In such cases, a great deal of circumspection is required.
A leading precedent on extraterritorial fiscal levies is the Supreme Court (SC) decision in the case of Electronics Corp of India Ltd vs CIT 183 ITR 43, where it was held that ?in view of Article 245(1) of the Constitution of India, it is clearly envisaged therein that the Parliament in India may make laws which operate extra-territorially, but unless there exists a nexus with something in India, Parliament will not have competence to make the law. The provocation for the law must be found within India itself.? Now, in the case of non-residents selling shares in an overseas firm to one another, neither the seller nor buyer has an India nexus. Nor does the subject matter of the transaction, even if its assets are located in India. So, it is not subject to tax in India. Such an interpretation is also in consonance with the cardinal tenets of international law, whereby the laws of sovereign countries are understood to apply only to subjects within the territory of that State.
Revenue authorities, however, often claim the right to examine the actual motive of a transaction in order to determine the tax consequences in India. Consider the decision of the Punjab & Haryana High Court in the CIT vs Om Prakash Behl case (132 ITR 342), where it was held that ?the facts are to be taken as they are. It is not open in law to investigate the motive of the assessee. The Court is concerned with the actual action on the part of the assessee and not the action which the assessee should have taken under the circumstances. It is not permissible in law to bring in suppositions and then to find out whether the claim is allowable or not.?
Also, there?s the landmark SC decision in the case of Union of India and Another vs Azadi Bacho Andolan and Another 263 ITR 706. The SC made the following observations: ?If the Court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the court might be justified in overlooking the intermediate steps, but it would not be permissible for the court to treat the intervening legal steps as non established upon some hypothetical assessment of the ?real motive? of the assessee… The Court must deal with what is tangible in an objective manner and cannot afford to chase a will-o?-the-wisp. We are unable to agree with the submission that an act which is otherwise valid in law can be treated as ?non-est? merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interest…?
In view of the above discussion, it is imperative that complex problems of international tax should be resolved by tax authorities in India with due regard given to well-settled principles of international law, the decisions of the apex court and good sense. India has already achieved prominence as a long-term investment destination in the world, and for the rule of law in India to operate in consonance with well established principles, we must not be muddled about such matters of tax liability.
?The author is former chairman of the Central Board of Direct Taxes. These are his personal views
