The Hindu Business Line : Extraterritorial jurisdiction: Has the solution arrived?

Does Indian tax apply extraterritorially? Does it make a foreign entity liable to deduct taxes on payments made outside India to a foreign entity? These are the questions which have been bothering foreign investors planning to invest in India. Some hold the belief that the regulations for deducting taxes do not extend beyond the territory of India. This is one of the issues in the Vodafone case.

Recently, the Supreme Court settled the above issue in its decision dated March 25, 2009, in the Eli Lilly Inc, Netherlands and Others case.

Facts of the case

The basic facts are that Eli Lilly Inc had a JV (joint venture) in India, which was a company incorporated in India. The non-resident company seconded a few employees to work with the JV. Part remuneration of the expatriates was paid by the JV and part remuneration was paid by the foreign company outside India. The services were rendered to the JV only and not to the foreign company.

The Indian JV had deducted taxes on remuneration paid by it, but no withholding of tax was made by the Indian JV on the part of salary paid outside India by the foreign company (referred to as ‘home salary’). The taxes on the home salary were paid by the expatriates themselves via the advance tax mode.

The Tribunal and the High Court had held that the Indian JV was not under statutory obligation to deduct tax at source on the salary paid by the foreign company as it was not paid/payable by the Indian JV.

The issue before the Supreme Court was whether the Indian JV had defaulted on its obligations regarding withholding of tax as per the Indian tax law on the part of remuneration paid in the foreign country. Accordingly, the contention of the department was that the TDS provisions have extraterritorial operation.

Apex court’s observations

The Supreme Court has made several important observations in its judgment. On the question of extraterritorial operation of tax law, the Supreme Court observed that “the general concept as to the scope of income-tax is that, given a sufficient territorial connection or nexus between the person sought to be charged and the country seeking to tax him, income-tax may extend to that person in respect of his foreign income. The connection can be based on the residence of the person or business connection within the territory of the taxing state; and the situation within the state of the money or property from which the taxable income is derived”.

Further, the court observed that “on the question of extraterritorial operation of the Income- tax Act, 1961, it may be noted that the 1961 Act has extraterritorial operation in respect of the subject-matters and the subjects which are permissible under Article 245 of the Constitution and the provisions are enforceable within the area where the 1961 Act extends through the machinery provided under it.”

Based on the above, the Supreme Court held that if the home salary payment made by the foreign company abroad is for rendition of services in India and if no work was found to have been performed for the foreign company, then such payment would certainly come under the provisions of the I-T Act. Thus, the Indian JV was required to comply with the withholding tax provisions even in the case of salary paid overseas by foreign company.

Effect on Vodafone case

The above decision of Eli Lilly may have an impact on the ongoing dispute between the I-T Department and Vodafone where one of the crucial issues is whether Vodafone, Netherlands was under an obligation to deduct tax when it made payment outside India to Hutchison Telecommunication International Ltd, Hong Kong for indirectly acquiring controlling interest in Hutch-Essar Ltd, an Indian company.

It is interesting to refer to the observation by the Bombay High Court on the issue of extraterritorial operation of the I-T Act, which reads as: “The very purpose of entering into agreements between the two foreigners is to acquire the controlling interest which one foreign company held in the Indian company, by the other foreign company. This being the dominant purpose of the transaction, the transaction would certainly be subject to municipal laws of India, including the Indian Income-Tax Act.”

A similar view was expressed by the Supreme Court in an earlier ruling in the Electronic Corporation of India case.

A combined reading of the aforementioned observations of the Supreme Court and the Bombay High Court would mean that if the income in question is liable to taxation in India then the regulations regarding withholding tax may have extraterritorial jurisdiction.

(The authors are with Deloitte Haskins & Sells. New Delhi.)

Related Stories:
Expat salary TDS: SC rules against penalty on foreign cos
Vodafone case: Policy response required
When the taxman tethers TDS to a time machine

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