Law Street in The Economic Times (December 2009) - Withdrawal of CBDT circulars

Dear Readers,

Zenobia Aunty, with her entire family (which includes this blogger) and her dog Spot will be moving back to home-town, Mumbai. She may take time to re-settle, after all, Mumbai has changed in the nine years that she and her family have been away.
Thus, please look up the print and online edition (as you please) of The Economic Times, on December 25, as it may not be possible for Zenobia Aunty to order her niece to upload it pronto.

Merry Xmas and a great 2010.

Photograph courtesy: Wikimedia

Warm regards,
Lubna

PS: Zenobia Aunty and clan are still in Bangalore, they will be in Mumbai from Sunday onwards, December 27, hopefully for ever. Relocating is a pain and Zenobia Aunty promises to stay away from this ordeal in the years to come. Of course, her ambition is to buy a strawberry farm in Panchgani and settle down there - perhaps someday.....

So, here is the column online and as always you can scroll below as well.

MERRY XMAS AND A GREAT 2010.

Best wishes,
Lubna

City roads, CBDT Circulars and more…

- Withdrawal of CBDT’s circulars have led to uncertainty
- Transfer pricing provisions should be followed
- Safe harbours and advance pricing mechanisms are the way forward

By the time, you dear Readers, get to read this column, Zenobia Aunty and her family will probably be back home. It was in late 2000 that Aunty stepped in Bangalore, learnt to love it and stayed on. But, there is something about Mumbai that prompted her, her favourite niece, assorted family members and her dog Spot to make the big move again, this time back home.

At least we will now not have to hear Zenobia Aunty take a cue from John Denver and sing: “City roads, take me home; to the place I belong, aamchi Mumbai, crowded streets, vada-pav and sea breeze, take me home, city roads….”You all know by now, that when Zenobia Aunty decides to sing, Spot dives beneath the bed hoping to be out of hearing distance and we all remember some urgent errands and dash off.

But facts come first. Zenobia Aunty is dictating this column several weeks in advance, to make sure that in all the chaos which a move entails; she does not miss her strict editor’s deadline. Nine years is a long time to be away and Mumbai may seem a tad unfamiliar. Familiarity is always comforting, be it the city roads, which one grew up in or CBDT circulars that one relied upon and took their existence for granted.

The Central Board of Direct Taxes (CBDT), has recently withdrawn a forty year old circular, viz: Circular no 23, dated July 23, 1969. Tax circulars as we all know, are binding on the tax authorities.

Section 9, of the I-T Act, 1961, deals with income accruing or arising, through or from a ‘business connection’ in India. There is no definition of a business connection in the I-T Act. However, judicial decisions have interpreted it to mean a relation between a business carried on by a non-resident which yields profits and some activity in India which contributes to the earning of such profits.

However, Circular no 23, mitigated the impact of the broad sweeping definition of a ‘business connection’ and provided respite to those non-residents who were not covered by tax treaty provisions (the Permanent Establishment clause in a tax treaty provides for a comparatively narrow definition and mitigates risk of tax exposure in India).

As per this Circular, if the commission received by the Indian agent was fully representative of the value of the profits attributable to his service, no further income was assessessable in the hands of the non-resident. The Supreme Court in the case of Morgan Stanley (which of course was an instance where treaty provisions were applicable) has taken the same approach.

The intention for withdrawal of this circular appears to be that tax payers relied on it to claim relief beyond what was originally intended. With it, the CBDT has also withdrawn two other circulars, viz. Circular no 786, dated February 7, 2000, and Circular no 163 dated May 29, 1975. These circulars also provided instances where non-residents would not be subject to tax in India and no income would be deemed to accrue or arise in the hands of the non-resident.

What now? Well, tax payers can still rely on judicial decisions including that of the SC in the case of Morgan Stanley and can argue that the arm’s length payment to an Indian agent extinguishes its tax liability in India.

On one hand, the MoF has tried to be proactive and keep abreast with international norms by announcing the safe harbour provisions in the Finance Bill, 2009 and also by seeking to introduce advance pricing mechanisms as enshrined in the Tax Code. On the other hand, with the withdrawal of the Circular one gets the message that it has put paid to the transfer pricing principles that an arm’s length payment to an Indian agent will extinguish the liability of the foreign tax payer. Withdrawal of this circular and two others has just led to more uncertainty in the minds of the foreign tax payers.

It is not just those tax payers who aren’t covered by a treaty that are left wondering, but all foreign investors, as it could signify a trend towards more litigation, during assessment proceedings.

An allied insight: The provisions of the Tax Code have amended the definition of income deemed to accrue and arise in India to even include income accruing or arising from the transfer, directly or indirectly of a capital asset situate in India.

This can result in an absurd scenario. Shares of a listed overseas company listed and traded on an overseas stock exchange could result in an indirect transfer of a capital asset situate in India, if such overseas company has a subsidiary in India. This provision of the Tax Code and now the withdrawal of these circulars has certainly added fuel to the fire of uncertainty.

I can hear, Zenobia Aunty now taking a cue from Bill Joel and singing: Income tax Act, Tax Code, CBDT Circulars, tax treaties, Interpretation issues and uncertainty galore! We didn’t start the fire; It was always burning – since the day taxes have been imposed; We didn’t start the fire, No, we didn’t light it, but we tried to fight it…Well, I must be off, I suddenly remembered an urgent errand. Wishing you all a Happy 2010.