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.