Thursday, December 9, 2010

Interpretation of the Constitution: The New Way Forward

Here is an interesting observation by the Supreme Court in a recent case of CPIO, Supreme Court of India v. Subhash Chandra Agrawal dated 26.11.2010. The observation is of great significance in our times. Here are the relevant extracts from the judgement:

"13. The Constitution is fundamentally a public text--the monumental character of a Government and the people-- and Supreme Court is required to apply it to resolve public controversies. For, from our beginnings, a most important consequence of the constitutionally created separation of powers has been the Indian habit, extraordinary to other democracies, of casting social, economic, philosophical and political questions in the form of public law remedies, in an attempt to secure ultimate resolution by the Supreme Court. In this way, important aspects of the most fundamental issues confronting our democracy finally arrive in the Supreme Court for judicial determination. Not infrequently, these are the issues upon which contemporary society is most deeply divided. They arouse our deepest emotions. This is one such controversy. William J. Bennan, Jr. in one of his public discourse observed:
We current Justices read the Constitution in the only way that we can: as twentieth-century Americans. We look to the history of the time of framing and to the intervening history of interpretation. But the ultimate question must be, what do the words of the text mean in our time? For the genius of the Constitution rests not in any static meaning it might have had in a world that is dead and gone, but in the adaptability of its great principles to cope with current problems and current needs. What the constitutional fundamentals meant to the wisdom of other times cannot be the measure to the vision of our time. Similarly, what those fundamentals mean for us, our descendants will learn, cannot be the measure to the vision of their time. This realization is not, I assure you, a novel one of my own creation. Permit me to quote from one of the opinions of our Court, Weems v. United States 217 U.S. 349, written nearly a century ago:
Time works changes, brings into existence new conditions and purposes. Therefore, a principle to be vital must be capable of wider application than the mischief which gave it birth. This is peculiarly true of constitutions. They are not ephemeral enactments, designed to meet passing occasions. They are, to use the words of Chief Justice John Marshall, "designed to approach immortality as nearly as human institutions can approach it." The future is their care and provision for events of good and bad tendencies of which no prophesy can be made. In the application of a constitution, therefore, our contemplation cannot be only of what has been, but of what may be.
14. The current debate is a sign of a healthy nation. This debate on the Constitution involves great and fundamental issues. Most of the times we reel under the pressure of precedents. We look to the history of the time of framing and to the intervening history of interpretation. But the ultimate question must be, what do the words of the text mean in our time?"

Thursday, November 18, 2010

Copyright vs. Copyrighted Article: Guest Post

( This article is contributed by Megha Mishra. Megha is a final year Charted Accountant Student and is also working as an analyst at PriceWaterHouseCoopers. Needless to state that the views expressed here are personal)

 Payment made for the use of software has been, for sometime now an area of ambiguity and has attracted a lot of controversy. There are various judicial precedents which have held time and again, that the payment made for purchase of “off- the- shelf” software is not a payment for ‘royalty’. However, in a recent ruling in M/s Gracemac Corporation v. ADIT, the Delhi ITAT has held that consideration for the sale/ purchase of “off-the-shelf” software is treated as Royalty.

This ruling in Gracemac is a significant departure from the position laid down by the Indian courts in several cases like Tata Consultancy Services , Motorola Inc, Sonata Information Technology v ACIT, and others, wherein a distinction was drawn between ‘copyright’ and ‘ copyrighted article’. However, in Gracemac, the ITAT held that the term ‘copyrighted article’ has not been defined either in the Income Tax Act, 1961 or under the copyright Act, 1957; the term ‘copyrighted article’ had originated in the US Regulations and then found its way into the OECD commentary. Further, the ITAT observed that the term ‘copyrighted article’ was independently defined only for the sake of drawing out a meaning for the same; hence there was/is no need in importing the expression’ copyrighted article’ for the interpretation of the term ‘royalty’. Alternatively, the Tribunal also stated that as per the definition of the term ‘royalty’ in section 9(1)(vi) of the Income Tax Act,1961, a copyright subsists in a computer programme and therefore any sale of software amounts to ‘royalty’.

However, in my opinion, when a license to use the generalized software is issued by the owner to the end user, the payment made for the same should not be treated as a ‘royalty’, since the end user does not get the right to commercially exploit the said software. Thus, as also held in various judicial precedents, the sale of ‘off-the-shelf’ software should be treated as sale of an article and not as royalty.

Wednesday, November 17, 2010

Industry Jargon Explained

In this blog, we would be giving links to articles in business newspapers / websites which explain industry terminology. Often, as law students and law industry practitioners, we are not aware of several terms that are used in the day-to-day life of business. Hence, we would be giving links to articles in the newspapers on commonly used terms in the industry but of which law students are generally not aware. on Net Asset Value in Mutual Funds

Business Line on contractual terms in Health Insurance Policies
In the above article, terms such as the "sum assured", "benefits", conditions such as exclusion of alternative therapies from the cover of insurance, exclusion of cover for organ transplants are explained.

Business Line on How to Arrive at the Enterprise Value
Enterprise Value is the index used to compare two firms (in the economic sense) in the same sector. The article explains how to calculate enterprise value, combination of enterprise value and other comparison systems, and the limitations of using enterprise value in the comparison of firms.

Business Line on Non-Compete Fee
The issue of Non-Compete Fee became famous because of the proposed acquisition of Cairn India by Vedanta. This article explains what a Non-Compete Fee is and briefly maps the legal position pertaining to it. [the latest news on the Cairn-Vedanta deal can be accessed from here.]

Wednesday, November 10, 2010

Extend Transfer Pricing Laws to Domestic Transactions: Suggests the SC

In CIT v. Glaxo Smithkline, the Supreme Court has suggested/recommended the Ministry of Finance and the CBDT to look into the prospect of extending the transfer pricing laws to "domestic transactions" involving "related parties". The Judgement and a summary is available here.

I shall explore this possibility in a later post.

Sunday, November 7, 2010

Rights of a Patient

Dr. Shaila Shenoy in this article in the Hindu writes on the rights of the patient. She lists, among other things, the following as the rights of a patient:
  • Right to know the identity of the doctor treating the patient
  • Right to know the probable diagnosis
  • Right to know the probable treatment
  • Right to be informed of the possible financial implications of the proposed treatment
  • Right to demand transfer to another facility
  • Right to accept or refuse treatment after being informed of the risks
  • Right to be informed before research protocol is initiated and to refuse to be a part of it
  • Right to demand photocopy of the patient's entire medical records.
Following are some of the randomly googled articles that might be of interest on this topic.

Informed Consent and the Anesthesiologist
Doctrine of Informed Consent and the Patient: Different Aspects
Informed Consent Process
Informed Consent and Clinical Trials
Seeking patients' consent: The ethical considerations
Patients' Rights

Saturday, November 6, 2010

The Nobel Peace Price and Politics

According to the Nobel prize website, the '[t]he Nobel Peace Prize 2010 was awarded to Liu Xiaobo "for his long and non-violent struggle for fundamental human rights in China".' The Frontline (Volume 27, Number 22, Oct 23-Nov 5, 2010) carries an article by John Cherian on the selection of the Chinese dissident Liu Xiaobo for the 2010 Nobel Peace Prize. Cherian gives a few examples of controversial nobel peace prizes including those to Henry Kissinger, Barack Obama (2009), Menachem Begin (1978). Cherian points out that during the cold war, the "dissidents in Eastern Europe" were given the Nobel Prize. He also states that even the Nobel Prize for Literature has not been without controversy on a similar issue. Do check out the Frontline article from here. An interesting novel, The Prize, by Irving Wallace, is based on the Nobel Prize.

Wednesday, September 29, 2010

FDI and Issue of Shares For Consideration Other Than Cash: Discussion Paper

The DIPP has released a discussion paper on the subject of "Issue of shares For Consideration Other Than Cash" with specific reference to Foreign Direct Investment. The paper has considered the following issues:

  • issue of shares against import of capital goods, machinery or equipment including second hand equipment
  • issue of shares against services
  • issue of shares against import of raw materials and trade payables.
  • issue of shares against pre-operative or pre-incorporation expenses.
  • share swaps
  • issue of shares against intangible assets including franchisee agreements
  • issue of shares against one time extraordinary payment including arbitral awards
The discussion paper has also outlined some specific issues that may arise in this regard.

Tuesday, September 14, 2010

GE India Technology: Interesting observation on 'Territorial Nexus'

In GE India Technology v. CIT, the Supreme Court has laid to rest the controversy surrounding the interpretation of s. 195 of the IT Act, 1961. The controversy had arisen through the judgment of the Karnataka High Court in CIT v. Samsung. In Samsung the Karnataka High Court had held that a resident Indian would necessarily have to deduct tax at source u/s 195(1) of the Act while remitting money to a non resident irrespective of the sum eventually not being chargeable to tax in India. The High Court had further held that the only way by which a resident can remit the entire sum to a non resident is by obtaining a “No Objection certificate” (a declaration that the sum in question is not chargeable to tax in India) from the department u/s 195(2) of the Act.

However in GE India the Supreme Court has effectively overruled Samsung and has held that tax has to be deducted at source only when the remitting sum is eventually chargeable to tax in India. The court has further held that s. 195(2) is based on the “principle of proportionality” and it only gets attracted incases of composite payment in which only a certain proportion of payment has an element of “income” chargeable to tax in India. In other words a resident Indian has to make an application when the payment is certainly chargeable to tax but the Resident is unsure about which portion of the payment is chargeable to tax. In case the Resident fails to apply for an application in cases enumerated above, he has to then necessarily deduct tax at source u/s 195(1). In my humble opinion the Supreme Court has arrived at the correct conclusion.

In arriving at the above mentioned conclusions, Kapadia, C.J. has made to an interesting observation:

The interpretation of the Department, therefore, not only requires the words “chargeable under the provisions of the Act” to be omitted, it also leads to an absurd consequence. The interpretation placed by the Department would result in a situation where even when the income has no territorial nexus with India or is not chargeable in India, the Government would nonetheless collect tax”(emphasis mine)

This observation though an obiter can potentially be used to argue that the principle of “Territorial Nexus” forms an essential element of the Indian Tax jurisprudence. The observation also manifests that the finding in Linklaters (discussed here) and Ashapur wherein the ITAT, Bombay had held that the principle of “Territorial Nexus” is only limited to territorial tax systems, is incorrect. However this observation can also be used to argue that no territorial nexus is required to tax an income of a non resident. Kapadia C.J. above observes that “......even when the income has no territorial Nexus or is not chargeable to tax in India, the government can nonetheless collect tax.” This implies that the Government can collect tax when the income of the non resident has a territorial nexus with India or is specifically chargeable to tax under any of the provisions of the Act (even though the provision is not based on any territorial nexus test).

Concluding, though two contrasting interpretations are possible of the above observation, nonetheless the latter interpretation as stated above would open the doors for a constitutional challenge of the provision  which seeks to tax the income of a non resident without their being sufficient territorial nexus.

Saturday, September 11, 2010

CCI v. SAIL: Conclusions of the SC

Here are some of the important conclusions reached by the Supreme Court in the CCI v. SAIL &Anr.(civil appeal no. 7779 of 2010):

“In terms of Section 53A(1)(a) of the Act appeal shall lie only against such directions, decisions or orders passed by the Commission before the Tribunal which have been specifically stated under the provisions of Section 53A(1)(a). The orders, which have not been specifically made appealable, cannot be treated appealable by implication. For example taking a prima facie view and issuing a direction to the Director General for investigation would not be an order appealable under Section 53A (emphasis mine).”

Neither any statutory duty is cast on the Commission to issue notice or grant hearing, nor any party can claim, as a matter of right, notice and/or hearing at the stage of formation of opinion by the Commission, in terms of Section 26(1) of the Act that a prima facie case exists for issuance of a direction to the Director General to cause an investigation to be made into the matter.”(emphasis mine)

The Commission, in cases where the inquiry has been initiated by the Commission suo moto, shall be a necessary party and in all other cases the Commission shall be a proper party in the proceedings before the Competition Tribunal. The presence of the Commission before the Tribunal would help in complete adjudication and effective and expeditious disposal of matters. Being an expert body, its views would be of appropriate assistance to the Tribunal. Thus, the Commission in the proceedings before the Tribunal would be a necessary or a proper party, as the case may be.” (emphasis mine)

“During an inquiry and where the Commission is satisfied that the act is in contravention of the provisions stated in Section 33 of the Act, it may issue an order temporarily restraining the party from carrying on such act, until the conclusion of such inquiry or until further orders without giving notice to such party, where it deems it necessary. This power has to be exercised by the Commission sparingly and under compelling and exceptional circumstances. The Commission, while recording a reasoned order inter alia should : (a) record its satisfaction (which has to be of much higher degree than formation of a prima facie view under Section 26(1) of the Act) in clear terms that an act in contravention of the stated provisions has been committed and continues to be committed or is about to be committed; (b) It is necessary to issue order of restraint and (c) from the record before the Commission, it is apparent that there is every likelihood of the party to the lis, suffering irreparable and irretrievable damage or there is definite apprehension that it would have adverse effect on competition in the market.” (emphasis mine)

In consonance with the settled principles of administrative jurisprudence, the Commission is expected to record at least some reason even while forming a prima facie view. However, while passing directions and orders dealing with the rights of the parties in its adjudicatory and determinative capacity, it is required of the Commission to pass speaking orders, upon due application of mind, responding to all the contentions raised before it by the rival parties.” (emphasis mine)

At first blush the finding of the Supreme Court seems to be correct. However I shall analyze the decision in greater detail in a subsequent post.

Thursday, September 9, 2010


The Supreme Court has delivered its judgement in the dispute between the CCI and COMPAT. I will discuss the judgement in a subsequent post.

The order of the COMPAT has been previously discussed on this blog here.

Tuesday, September 7, 2010

News and Reflections

The Law News E-Media had reported that a professor and two students of the National University of Juridical Sciences had written a letter to the Editors-in-Chief of the Outook and the India Today news mags expressing their displeasure on the law school rankings. In case you have not already read the newsreports and the letter, do check 'em out from these links below:

You can access any of these links above to read the letter reportedly sent to those mags.

There was a specific complaint in the said letter that the said mag had invited NUJS to place ads. I quote and italicise the relevant portion of the letter:

(pardon the long quote)

"We wish to bring to your notice the fact that NUJS had received such an offer to advertise in your magazine in that particular issue by one Manish Kumar <> (who claims to be the Assistant Manager of OUTLOOK) for varying rates starting from Rs. 1,00,000 and going up to Rs. 5,00,000.

The text of his email reads as below:

“From: manisk kumar []

Sent: Tuesday, May 18, 2010 10:40 AM

To: ''

Subject: Proposal for professional college issues.

Dear Sir,

Outlook – India’s Best Professional Colleges Survey – 2010

Outlook, India’s most popular and respected English news magazine is bringing out its eagerly awaited annual survey and ranking of The Best Professional Colleges in India, through a special issue in June 2010. For the past four years, Outlook’s ranking of the leading engineering and medical colleges has set the benchmark for tracking academic excellence. This year, we are expanding the breadth of the survey by covering six other professional streams – architecture, fashion design, hotel management, law, mass communication, and social work.

For parents and students, this special issue is an invaluable guidebook. For colleges and institutes, it’s a matter of prestige to be featured in this survey -- there is high peer recall of Outlook’s ranking.

The survey is based on both objective and perceptual data across relevant parameters. Conducted by leading market research firm MDRA, the survey would also undertake a random physical audit of institutes. Authenticity and evaluation process would be the key elements of this survey. Our research team is contacting close to 1,300 colleges and institutes for the survey. A brief on the categories:

Engineering – More than 600 institutes recognized by AICTE.

Medical – Over 300 (MCI approved) and approximately 100 of Dentistry (DCI approved).

Mass Communication – 60+ institutes are being contacted.

Hotel Management – More than 60 institutes.

Law – Around 50, recognized by Bar Council of India and All India Bar

Social Welfare – 50+ institutes are being contacted.

Architecture – 50+ institutes are being contacted.

Fashion Design – 60 institutes.

The survey will be based on the following parameters:

Selection Process


Industry Exposure/Placements



We invite you to advertise in this special issue dated: June 28th. Released on: June 18th. Deadline: June 10th

Full Page : Card Rate -Rs. 490,000 Special Rate: Rs. 2,00,000

Half Page : Card Rate: Rs. 3,00,000 Special Rate: Rs. 1,00,000

We look forward to your participation. Thanking you and with warm regards

Yours truly,

Manish Kumar

Assistant Manager

Outlook Group

(The entire email chain is attached as Annexure A.)

Was this email and its offer to advertise for a heavy sum in the very same issue where the rankings were to appear, done with a view to subtly inform the college that if it advertised, it faced the prospect of a better ranking? We would appreciate a clarification from you in this regard.

NUJS did not place any advertisement with your magazine. However, NLIU Bhopal did (see attachment: Annexure B). Both colleges had similar marks in the ranking i.e., 779.4: however, NLIU Bhopal was ranked at number 4, while NUJS was ranked at number 5. On what basis does one get precedence over the other? Shouldn’t both have been ranked at number 4 and the next in line should have been number 6. Isn’t this the standard practice? Please elaborate.

In any case, we hope that you will desist from this questionable practice in future. Sponsorships and paid advertisements in the very same issue in which you rank colleges taint the objectivity of ranking and create an impression of bias."

DTC: Concern for FIIs

In the economic times there is an interesting article carrying the title DTC: Cause of Worry for FIIs. Some aspects relating to the taxability of FIIs has been a matter of previous discussions on this blog. Here are some of the excerpts of the article in the economic times:

"The Bill provides that the income earned by FIIs will be deemed as capital gains. This would not have much impact on the FIIs as most FIIs at present offer their income to tax as capital gains. The deemed characterisation under the Bill implies that income from derivative transactions, which are currently treated as business income, will now be taxed as capital gains. Considering that most derivative contracts have a maturity period of between 30-90 days, the income from the derivative transactions will be subject to tax at 15%. "

"For FIIs investing from favourable treaty jurisdictions, all capital gains will be tax exempt. Though, structures without much commercial substance are likely to face challenges with the advent of general anti-avoidance rule ('GAAR'). As per the proposed GAAR, if the structure has been set up to obtain an unintended 'tax benefit' or involves treaty shopping, the Indian tax authorities will have the ability to lift the corporate veil or deny the treaty benefits. While the detailed rules and safe harbours are still to be announced, it is apprehended that holding structures set up in tax favourable jurisdictions such as Mauritius and Cyprus will be presumed to be set up for tax avoidance and the onus to prove otherwise will be on the taxpayers. This uncertainty might tilt the balance in favour of certain well established jurisdictions such as Singapore, which already have an objective substance test built into their tax treaty with India. For those FIIs who have traders based in jurisdictions from where they invest, it may be easier to meet the commercial substance test."

"The significant impact on the FIIs will be as regards the taxation of their investors. The Bill deviates from the current law and has sought to tax offshore transfer of shares in companies which hold at least 50% or more investment in the form of Indian assets. As a consequence, non-residents investing in an open-ended offshore fund set up as a company may be subject to Indian tax upon redemption of offshore shares. This might create unintended cascading tax burden on the investors in the offshore funds set up as collective investment vehicles, and which have more than 50% asset allocation to India."

I shall explore some of the points in detail at a latter point.

Thursday, September 2, 2010

Changes Proposed to be Brought by The Direct Tax Code Bill, 2010

The Direct Tax Code is proposed to be brought in to consolidate and amend the regime relating to Direct Taxes in India so as to establish an economically efficient, effective and equitable direct tax system which will facilitate voluntary compliance and help increase the tax-GDP ratio. Also the secondary purpose of the Code is to reduce disputes and minimize litigation. The Code proposes to bring all forms of Direct Taxes under a single code. A Discussion Paper was released in August 2009; subsequently a revised discussion paper was brought out in June 2010 which incorporated certain suggestion made with regard to the Discussion Paper. Finally, the Bill was tabled in the Parliament on 30th August, 2010. The post highlights certain changes which are to be brought by the Direct Tax Code Bill, 2010.

  • Tax Rates
The tax slabs have been widened (First Schedule Paragraph A). The lowest tax rate of 10% is applicable to salary income of Rs2-5 lakh, 20% on income of Rs5-10 lakh and 30% on income above Rs10 lakh.

  • Residential Status of Individuals
Residential Status of Individual under the Direct Tax Code has undergone a significant change. The requirement of being present in India for 730 days in the preceding seven years, essential for qualifying as an ordinary resident and the categorization of Resident but not ordinary Resident has been done away with (Clause 4).

  • Residence of Companies
Under the Direct Tax Code a company would be treated as a Resident if it is an Indian Company or if its place of ”effective management” at any time of the year is in India (Clause 4) in contrast to the requirement of being “wholly” situated in India under the Income Tax Act. 'Place of effective management' under Clause 314(192) is defined as either the place where the Board/Executive directors of a company make their decisions or, in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company or the place where such executive directors or officers of the company perform their functions. This has been done to enlarge the scope of taxability of companies by bringing in more number or Companies under the banner or Resident Companies.

  • Income from Salary
The broad head of Income from Salary under the Income Tax Act has been renamed to “Income from Employment” under the Direct Tax Code. Clause 23 (e) has removed the cap of 1 lakh towards the Employer’s contribution towards approved Superannuation fund.

  • House Property
No taxation on deemed income basis. The concept of fair market value (S.23) for calculation of income from house property has been done away with primarily because computation of notional rent has been a predominant cause of litigation. Income from the letting of house property will be computed on the basis of contractual rent (Clause 26), i.e. the amount of rent received or receivable, directly or indirectly for the financial year less specified deductions (Clause 27). Standard deduction on account of repairs and maintenance has been reduced from 30% to 20% [Clause 27 (1) (b)].

  • Branch Profit Tax
The Direct Tax Code introduces a Branch Profit Tax (BPT) on branch profits of foreign companies in addition to the income tax on income attributable to a Permanent Establishment (PE) or an immovable property in India, as reduced by the income tax payable on such attributable income. The Rate of Tax as proposed in the Second Schedule Para D (4) is 15%.

  • DTAA
The Direct Tax Code in Clause 291(8) lays down that between the Code and a DTAA the provisions of the Code will apply to the extent that the provisions of the Code are more favorable to the assessee.

  • Wealth Tax
The existing exemption limit (30 lakh) for the chargeability of Wealth Tax under the Act has been increased to 1 Crore. (Second Schedule Para E).

  • Minimum Alternate Tax
The Direct Tax Code has brought in the concept of Minimum Alternate Tax so as to overcome the problem of excessive tax incentives. Where the normal income-tax payable for a financial year by a company is less than the tax on book profit, the book profit shall be deemed to be the total income of the company for such financial year and it shall be liable to income-tax on such total income (Clause 104 Direct Tax Code).

Friday, August 13, 2010

Daga Capital: S.14A, Rule 8D

The Bombay high court has pronounced the much awaited judgement in Godrej & Boyce v. DCIT, the lead matter challenging the judgement of the ITAT special bench in Daga Capital. The ITAT decision in daga capital has been discussed here.

I will discuss the judgement of the Bombay high court in a subsequent post.

Thursday, August 12, 2010

News and Reflections

The Indian Express reports that the Minister of Corporate Affairs, Mr. Salman Khurshid wants companies to properly disclose to their shareholders the details of political contributions. He is reported to have stated:

"I think when we are looking at greater corporate governance and shareholder democracy, this area itself is a very important issue. Who you are giving money to, what purposes you are giving money for, how much is permissible under the law, how much is to be disclosed... these are very, very important issues, which I hope will reflect in the new Companies Bill as well"
As a matter of corporate governance, this is a good proposal. But as a matter of political governance, wouldn't it be nice if political parties are bound by rules similar to companies for maintaining their accounts and placing before its stakeholders (mainly public) such accounts? On the face of it, this may seem ridiculous and far-fetched, but when the CAG could be empowered to audit the accounts of certain Non-Governmental Organisations (NGOs), why can't political parties be subject to a similar kind of audit?

Check out today's column of Shailaja Bajpai in the Indian Express. The article is sub-titled:
"There are three sides to every event- the Doordarshan version, the private network version, and the truth"
Her article is about how the news media tries to give its own take on the events. She has written about how the news networks try to show our parliamentarians to be hooligans disrupting the House when in the Lok Sabha/ Rajya Sabha channels, lively and informed debates are telecast. I am reminded of this.

[Added after posting: On the propaganda model and related aspects, check out the below resources/ articles:

Edward Herman & Noam Chomsky, Manufacturing Consent: A Propaganda Model
Edward Herman, The Propaganda Model: A Retrospective
Edward Herman, The Propaganda Model Revisited
Chomsky, Necessary Illusions: Thought Control in Democratic Societies
Resources/ Bibliography on the Propaganda Model]

BTW: By the way, Jawaharlal Nehru, an alumnus of Trinity College, Cambridge University was, according to today's Mint (page 4, box titled "Leaving a Legacy"), a "charismatic Oxford-educated lawyer-politician".

Thursday, July 29, 2010

The Force of Attraction principle

In an earlier post, Ankit had discussed on the findings of the ITAT in the Linklaters judgement on the application of the principle of territorial nexus and subsequently on extension of Treaty benefits to fiscally transparent entities. A third dimension to the judgement discusses the computation of profits attributable to a Permanent Establishment in consonance with the Force of attraction principle. The objective of this post is to understand the nature and recognition of this principle.
The underlying principle of the Force of Attraction rule envisages that when an entity has a Permanent establishment in another country, the host country will have the right to tax the PE for all its activities which take place either inside its territory or in other territories in so far as it is either directly or indirectly attributable to the P.E. In other words it expands the Source rule for taxability. Illustration- a Company X has a P.E in India which is involved with construction work. It undertakes a contract with a party outside India for undertaking a construction business. The profit which may generate from the contract is liable to be taxed in India on the basis of this principle.
Pertinent to note is the fact that this principle is amorphous in its applicability in the International platform. In this regard attention needs to be paid to two key points of debate. Firstly, most developed countries subscribe to the view that the principle is absurd as it unnecessarily expands the scope of taxation under the Source rule whereby it gives the right of taxation to a country which is not concerned with the activity undertaken by the P.E. The other point of contention being that there still exists a lacuna in so far as the existence of the P.E. is concerned to which the activity can be extended to. Thus most recent tax treaties have abandoned the use of this principle. On the flipside, the basic contention for upholding the principle is that the country in which the P.E is located provides an opportunity to the P.E to undertake transactions thereby creating a territorial nexus between the activities of the P.E and income generated. The principle has a varied applicability In the U.N Model Convention and the OECD Model Report. The OECD does away completely with the application of this principle whereas the U.N Model Convention allows for restrictive use of the principle. The Restrictive use of this principle under the Model Convention states that the rule will apply only to business profits and not to income from capital. To put it simply according to the U.N Model Convention( Article 7(b) and (c) ) the source country will have the right to tax the P.E. in so far as sales are made of goods or merchandise of the same or the similar kind as those sold through the P.E, irrespective of it being effected by the P.E. These will be deemed to have an economic nexus to the source country thereby making it taxable by the source country. A similar approach will be undertaken if the P.E is involved in other business activities and the same or similar activities are performed without any connection to the P.E.
The use of the principle has been undergoing a paradigm shift globally. However it is interesting to note that India has adhered to the use of the Force of Attraction rule in both its pure application as well as in its restrictive application. In the Roxon case, the AAR had the opportunity to discuss at length the application of the Force of Attraction rule in India. In a nutshell, it held that the basis of this principle was that the as long as a Permanent Establishment was not set-up in the source state, no right of taxation could be attributed to the same. Further the scope of the Indo- Finnish treaty is restricted to the sale of ‘same or similar’ goods. Only those sales of goods which are same or similar to the business of sale of goods by the P.E in India will be taxable in India. It can therefore be concluded that the treaty uses the restrictive rule of Force of Attraction. Concluding, only those business profits which have an economic nexus to the P.E in India will be taxable in India.
In the Linklaters judgment, the Force of attraction rule was strictly adhered to. Article 7 of the Indo-U.K tax treaty explicitly states that only profits of the enterprise which are directly or indirectly attributable to the P.E will be taxed by the source state. Therefore it can be inferred that the Indo-U.K treaty embodies the Force of Attraction principle and does not limit its applicability to the restrictive use of the aforementioned principle. In effect all the profits which are generated by the P.E irrespective of the service being rendered or utilised in another country, India being the host country will have a right to tax the P.E.
In today’s globalised economy, tax treaties do not subscribe to the principle of the Force of Attraction in its pure form as it has become increasingly difficult to justify its application. It would only result in unfair tax advantages to the source country which would thereby result in lowering investment for such countries which subscribe to an unrestricted use of this principle. In effect this principle tries to expand the principle of territorial nexus. Further there seems to be an inconsistency in its application in so far as its incorporation in tax treaties is concerned. Although countries have started adopting the restrictive use of this principle there still exists no threshold for determining under which circumstances can this principle be applied in its pure form or its restrictive form. This has led to countries applying the principle without any uniformity in different treaties. Ultimately what needs to be determined is whether the application of this principle in its pure form is justified and if not then whether there should be a uniform application of the two forms of this principle as adopted by a country.

Wednesday, July 28, 2010

Arbitration Act Extends to Civil Disputes: H Srinivas Pai

In H Srinivas Pai v. H.V.Pai, (dated 9.07.2010) the Supreme Court has observed that the Arbitration and Conciliation Act, 1996 extends to "civil disputes" and is not limited merely to "commercial disputes". Here is the relevant extract from the order:

"There is absolutely no basis for the observation of the High Court that Arbitration and Conciliation Act, 1996 will not apply to 'civil disputes', but will apply only to 'commercial disputes' or international commercial disputes. The Act applies to domestic arbitration's, international commercial arbitration's and conciliation's. The applicability of the Act does not depend upon the dispute being a commercial dispute. Reference to arbitration and arbitability depends upon the existence of an arbitration agreement, and not upon the question whether it is a civil dispute or commercial dispute. There can be arbitration agreements in non-commercial civil disputes also."- para. 5

Saturday, July 24, 2010

Linklaters: Fiscally Transparent Entities

In my previous post I had discussed one of the findings in Linklaters (one relating to S. 9 and territorial nexus). In this post I shall discuss the finding in linklaters with regard to treaty benefits extended to fiscally transparent entities. The case is extremely important in this respect due to the absence of any specific adjudication on this point in India and very few in other jurisdictions.

The fundamental question before the tribunal was whether the partnership firm (linklaters LLP) which is treated as a fiscally transparent entity in the UK but is taxable as a separate entity in India under the Income Tax Act, 1961 eligible for the India UK treaty benefits. Before discussing the findings of the tribunal it is important to briefly elucidate on why this issue had arisen at the first place. Art. 1(1) of the India UK treaty stipulates that the convention shall apply to “persons who are resident of one or both the contracting states”. Further, Art 3(2) stipulates that a “partnership firm” which is a taxable unit in India shall be “treated as a person” for the purposes of the India UK treaty. It is very clear from the aforementioned provisions that a partnership firm is treated as a person under the impugned treaty. Thus, the only point that needs to be established for a partnership firm to avail treaty benefits is to essentially show that it is a resident of atleast one of the contracting states. For this purpose Art. 4(1) is important and it reads as under:

For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.

On the basis of this provision the question that the tribunal had to address inorder to answer the larger question of treaty benefits was whether Linklaters meets the test embodied under art.4(1) of the treaty. The tribunal answering in favour of the assesse held that fiscally transparent entities or specifically partnership firms are entitled to treaty benefits. In reaching this conclusion the tribunal adopted two distinct lines of reasoning.

The first line of reasoning was primarily based on the contextual interpretation of art.4(1) of the treaty. The tribunal after citing several authorities on the interpretation of tax treaties stated that if the literal interpretation of a provision in a treaty leads to unreasonable results, the courts or tribunals should resort to contextual interpretation. In this case if art. 4(1) was to be interpreted literally then linklaters would not have qualified as a resident of UK as the income of the firm was taxed at the hands of the firm and the firm was not taxed per se in the UK (resident country). This interpretation in the tribunal’s opinion and correctly so would have been unreasonable as even though there would be no juridical double taxation (same entity taxed twice), there would in substance be an economic double taxation (same income taxed twice). As a result the tribunal adopted a contextual reading of art.4(1) and held that test embodied under the said article was that the “income of the person should be subjected to residence based taxation on account of some locality related attachment” in that contracting state. The following observations are apposite:

“Viewed in the light of the detailed analysis above, in our considered view, it is the fact of taxability of entire income of the person in the residence state, rather than the mode of taxability there, which should govern whether or not the source country should extend treaty entitlement with the contracting state in which that person has fiscal domicile. In effect thus, even when a partnership firm is taxable in respect of its profits not in its own right but in the hands of the partners, as long as entire income of the partnership firm is taxed in the residence country, treaty benefits cannot be declined.”

The second line of reasoning adopted by the tribunal proceeded on the premise that the actual payment of tax in one of the contracting states is not a condition precedent to avail the benefits of the tax treaty in the other contracting state. In light of this principle the tribunal held that the test laid down under art.4(1) is embodied to ascertain the fiscal domicile of an person (see heading to art.4), hence it is sufficient to show that the resident state has a right to tax the income of the partnership firm irrespective of the fact whether such a right is exercised by the resident state. The following observations are apposite in this regard:

“In our humble understanding, as long as de facto entire income of the enterprise or the person is subjected to tax in that tax jurisdiction, whether directly or indirectly, the taxability test must be held to have been satisfied. Of course, the other possible approach to such a situation is that as long as the tax jurisdiction has the right to tax the entire income of the person resident there, whether or not such a right is exercised, the test of fiscal domicile should be satisfied.”

In my view though the final conclusion reached by the tribunal on this point seems to be correct and will surely encourage professional services, the second line of reasoning requires further investigation as it is against the OECD report on partnerships.

Wednesday, July 21, 2010

Linklaters LLP: Territorial Nexus and International Tax Regime

In Ashapur Minichen ITAT Mumbai had confirmed that Ishikawajima-Harima ([2007] 288 ITR 408) does not continue to be good law in light of the retrospective amendment brought about by the Finance act, 2010.

In another case Linklaters LLP v. ITO the Mumbai ITAT has reiterated that the amendment made by the Finance Act, 2010 has negated the judgment in Ishikawajima. The important point though is that the court in Linklaters has stated that rendering of service in India is no more an essential ingredient for taxability of service in India u/s 9 of the IT Act, 1961. In other words the service can be taxed in India even if it is only “utilized” in India. However some of the observations in Linklaters can also be possibly interpreted to mean that “no territorial nexus” is required at all. For instance the court observes as under:

“It is fallacious to proceed on the basis that territorial nexus to a tax jurisdiction being sine qua non to taxability in that jurisdiction is a normal international practice in all tax systems”- Para. 17

“ ………in consonance with the school of thought discussed above and these amendment unambiguously negate the principle of territorial nexus which is the understructure of the line of reasoning adopted by the honorable courts above”- Para. 18

An interesting point that emerges is again with regard to India’s compliance with the international tax regime. In Ishikawajima Harima the court had noted that territorial nexus (utilized+ rendered) is a well accepted international tax principle. The court had further noted that “having regard to the internationally accepted principle and DTAA, no extended meaning can be given to the words ‘income deemed to accrue and arise’ in India. Considering this observation and the subsequent ruling in Linklaters where the court holds that Ishikawajima Harima is not good law, it is submitted that the impugned amendment in the Finance Act, 2010 is against well accepted international principles. However, this is subject to an investigation whether at the first place the concept of territorial nexus as suggested in Ishikawajima Harima (utilized+rendered) is indeed a well accepted international tax principle.
India’s compliance with the international tax regime has been a matter of previous discussion on this blog here. A further analysis of linklaters and Ashapur is available on the legal developments blog here and here.

Wednesday, July 14, 2010

Introduction of the Controlled Foreign Corporations Regime in India: Necessity and Limitations

In an expedition to enlarge the scope of taxation of Residents, the revised discussion paper on the Direct Tax Code has yet again instituted a platform for debate with the introduction of taxation for Controlled Foreign Corporations( hereinafter CFC ). On an ongoing debate the legal fraternity has been divided amongst those who opine that India does not still require such a change as they believe in the existence of two different and distinct legal entities; those incorporated within and those incorporated outside the country. On the flipside others propagate that the Revenue is suffering losses as the recent trend shows an increase in outward investment, thereby making it necessary to introduce such laws for taxation. In my opinion there is a necessity to examine the proposal as laid down under the DTC, secondly to put forward the shortcomings of the proposal and finally to determine whether India has adhered to the principles recognised by most developed jurisdictions for taxation of the CFC’s.

In the Indian context, Controlled Foreign Corporations are understood as Companies which have been incorporated abroad, in countries with low tax jurisdictions, controlled directly or indirectly by Residents in an attempt to accumulate income without having to pay tax in India. It can therefore be concluded that such a structure is an added method for legally avoiding the payment of taxes in India.

The present proposal can be seen as yet another attempt by the Revenue to overcome the recognition given to the principle of Tax Avoidance in Azadi. It has sought to tax the Resident controlling such a Foreign Corporation on the passive income earned by the same. Furthermore in order to check the deferral of taxes from dividend earned by the CFC’s which are not distributed in India to the shareholders, the DTC(Chapter 8) proposes to tax such dividends as deemed dividend from the Foreign Corporation. The effective test laid down under the DTC is the ‘place of effective management’ of the corporation which is an internationally recognised principle for determining the residence of the Corporation. The DTC defines the term ‘place’ as being the country in which the ‘ key management’ and ‘commercial decisions’ are made for the ‘entity as a whole’. Therefore in substance it widens the ambit of residence of a Foreign Company if it is managed wholly or partially in India unlike the present law which limits a Foreign Corporation liable to tax only if the management and control are wholly in India (s.9 Income Tax Act, 1961). Further the DTC lays down a two-fold test for determining the Place of effective management under Schedule 10 of the code-

(i) The place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or

(ii) in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions.”

In order to understand the true nature of the applicability of laws governing CFC’s, it is necessary to analyse the limitations of the provisions relating to its induction within the tax structure. Pursuant to the above definition of place of effective management, there should essentially be a bracket which categorises the term ‘ routinely’( clause ii) in such a manner that no further room for interpretation is left. This would check a series of litigation which may arise subsequently. Furthermore the code should specify the ambit of passive income such that there is no ambiguity to the jurisdiction in which such an income arises. There should also exist provisions which specifically limit the applicability to only passive income and does not affect active income. Another issue which arises is in the definition of a Controlled Foreign Income. The DTC should encompass within the meaning of a CFC, structured requisites for determining what would constitute a CFC. By doing so it would thus prevent persons from interpreting the term to their advantage and avoiding tax. Since the concept of CFC’s is not yet developed in India and since this is the first composite legislation governing the same, it lays a higher burden on the drafters to fully analyse the benefits and the limitations, thereby structuring the legislation by according well defined definitions, explanations, exceptions and its effect on the DTA Agreements which India shares with several foreign jurisdictions.

Over the years the developed countries have extensively advanced several principles relating to the taxation of CFC’s as a result of which there has come to exist a set of uniform global principles which have been adopted. A glance at some of the provisions under foreign jurisdictions and the proposal under the DTC makes it evident that India needs to make its law more comprehensive. Illustrating further, most jurisdictions have adopted the principle of determining ‘control’ under the control/ ownership test where a definite percentage is specified which determines if such a corporation could be subject as a Controlled Foreign Corporation. Secondly most of these jurisdictions follow the 50% Shareholder test according to which a Corporation is taxed as a CFC only if 50% of its shareholders are residents of India or have voting power comprising 50%. Such a threshold ensures that there are no two ways in interpreting the provision. Most countries which have adopted this regime do not impose these provisions on Corporations which have their residence in countries with a high tax rate. Therefore it can be inferred that as long as there is bona fide intention for not evading tax, the Corporation will not be taxed. Further, certain exemptions are also granted in favour of these corporations such as the application of the De minimis rule which is prevalent in the UK and the U.S. whereby an exemption is granted only when no part of the gross income of the corporation exceeds a specific limit under the governing laws. In the case of the United States the limit is specified as 1 million dollars.

It is pertinent to take into account that the Indian law still needs to develop a lot further before it has a fully functional system to tax CFC’s. First and foremost the Government should take into consideration the necessity for such legislation. The justification given by the Government for instituting such a provision is that there is a trend for outbound investments which is causing the Revenue to incur losses as it is not being able to tax these entities. However it is vital to understand that a fundamental difference exists between being an economy which has advanced to making outbound investments on a large scale and an economy which is progressively increasing its outbound investments. India today largely depends on inward flow of funds; therefore such legislation would be highly premature. Some considerations are needed to be taken by the Government which largely consists in determining the functioning of the Indian market. Rather than inducting a premature legislation the Government should study the market pattern for a few years such that it is in a position to frame proper laws applicable to the Indian markets than making regular amendments to such provisions. This would be highly ineffective and would lead to a series of unnecessary litigations. A consequent effect of such law would prevent Corporations having Holding Companies in India which would largely affect Mergers and Acquisitions made by Indian Residents.

Concluding, the Government needs to prioritise the needs of the Indian market which would enable the advancement of the Indian economy. Arguendo, the Government should not enact a legislation justifying it as precautionary if there exists no proper framework for its governance. This would entail hardship on a number of Companies which are trying to develop and expand. Therefore a thorough understanding is necessary not only at the domestic level but also the impact on an International platform. Only then can a proper legislation can be brought into effect.