The Hindu Business Line : Laws and their extra-territorial applicability

THE fringe benefit tax (FBT) provisions have been challenged in various courts. The Andhra Pradesh High Court, for instance, has stayed the provisions on the ground that the lower valuation percentage provided for some of the industries has resulted in discrimination qua taxpayers. In another ruling, the Madras High Court questioned the very applicability of the provisions. These matters, it is said, will be referred to a specially-constituted Bench of the Supreme Court.

Amidst the legal wrangling, the August 29 circular of the Central Board of Direct Taxes (CBDT) has attempted to clarify some of the FBT provisions as applicable to cross-border transactions, especially with regard to foreign companies (FCs).

Applicability to FCs

The applicability of the Indian Income-tax Act to FCs has always been a matter of dispute, especially when FCs do not have a presence in the country. It is argued that the I-T Act cannot have "extraterritorial jurisdiction" and FCs cannot be forced to comply with the Act. This issue often crops up with regard to withholding of tax when FCs make payments to residents as well as non-residents. The basis of this argument lies in Section 1 of the I-T Act, which provides that the Act applies to the territory of India.

The Supreme Court examined the issue of "extraterritorial jurisdiction" in Pannalal Nandlal vs CIT, 41 ITR 76 (SC) and Electronics Corp. of India vs CIT (183 ITR 43 SC). In the Pannalal case, the apex court held that the Constitution of India does permit lawmakers to enact a tax law which can have extraterritorial jurisdiction. Accordingly, it held that even a non-resident is required to file the return of income in India.

In the Electronics Corporation case, it was held that though, the general principle is that laws made in one country cannot have operation in any other country, the court of a country pronouncing the law can still enforce an extraterritorial law to the extent provided. However, the requirement is that the provocation for the law must be found in India (that is, some nexus has to be there with India)

Interestingly, the Authority for Advance Rulings (AAR) has held in the following cases that non-residents are liable to comply with the I-T provisions concerning filing of return of income and tax withholding from various payments.

TCW/ICICI (250 ITR 194): A non-resident is required to file returns if conditions prescribed under Section 139 are satisfied and even if there is no liability to pay income-tax;

Microsoft Inc, US (235 ITR 565): The procedural provisions of tax withholding apply even to a non-resident/foreign company. Further, a foreign company responsible for paying salary to an employee of an Indian company is under obligation to withhold tax under Section 192 of the I-T Act.

Bechtel, France (228 ITR 473): The term "any person" used in Section 195 of the I-T Act includes even a non-resident or foreign company and, therefore, such non-resident/foreign company is required to adhere to the procedural provisions dealing with tax withholding.

In view of these rulings, the judicial thinking that emerges is that a foreign company is required to comply with the I-T Act, this despite the Supreme Court laying down that the provocation for the law must be found in India. The tax authorities, in fact, insist that FCs are subject to and need to comply with the I-T Act. However, one can contend that the taxing statute (that is, Section 1) should be interpreted literally (strictly), relying on the series of apex court decisions.

The Law and Practice of Income-tax, by Kanga, Palkhiwala and Vyas, explains (page 2105) that Section 195, dealing with tax withholding from payments to non-residents, does not apply to payments made outside India by one non-resident to another even if the latter has rendered services in India.

The CBDT explains in its circular that the FBT provisions apply to FCs as well.

Cardinal principles

A careful reading of the CBDT's answers to the various questions reveals the following cardinal principles:

* Employer-employee relationship is a must for FBT levy;

* There must exist an employee based in India;

* Expenses incurred for Indian operations to be considered for FBT levy, with place of incurring of those expenses — whether in India or outside — not being relevant;

* Non-resident employee not taxable in India has some bearing on FBT levy on FCs;

* FBT payable irrespective of whether employer is liable to pay income-tax or not;

* In respect of reimbursement of expenses by the client to the service provider, the latter is liable to FBT and not the client reimbursing the expenses.

In the light of these principles, the fundamental issue that arises is the meaning of the term "employee based in India". The circular is silent on this and, as a result, different interpretations emerge. Should the criteria for determining whether an employee is based in India or not be residential status, nationality or duration of stay?

Different criteria can be applied depending on the employer being an Indian company or an FC. The nationality of the employee certainly cannot be a relevant factor at all.

In the case of an Indian subsidiary or an affiliate of a foreign company, an issue that could arise is: Can an expatriate deputed to such Indian company at the fag end of the year be said to have an employee based in India and subject to FBT especially when it did not have any employee in India for the entire year?

Another issue is, where an Indian company deputes all its employees to an overseas office during the year, can the company be said to have an employee based in India and subject to FBT, especially when it did not have any employee in India for the subsequent period of the year. Similar issues can arise for foreign companies.

(To be concluded)

(The author is Director, Deloitte Haskins & Sells, India.)

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