The Hindu Business Line : No bargains break that are not this day made

MARK Twain assures, "Truth is tough. It will not break, like a bubble, at a touch; nay, you may kick it about all day, like a football, and it will be round and full at evening." So too with disputes, which get tossed about at various levels, till truth gets a chance to be uncovered at the highest forum, such as the apex court. Thus it was with Sedco Forex International Drill. Inc. and Others vs Commissioner of Income Tax, Dehradun, a case that the Supreme Court decided last week.

Sedco, a company incorporated in Panama, entered into a wet lease (defined by www.worldcargoalliance.com as "an arrangement for renting an aircraft under which the owner provides crews, ground support equipment, fuel and so on") with ONGC.

It was not about renting aircraft, but "oil rigs and employees to man the rigs, to enable ONGC to carry on offshore drilling within the territorial waters of this country". Sedco also entered into agreements (executed in the UK) with each of its employees who are UK residents.

"The schedule of work as specified in the agreements envisaged 35 days or 28 days work in a foreign location (in this case India) followed by 35 days or 28 days `field break' in the UK," informs the text of the judgment.

The agreements defined `field break' to include, but not limited to, undergoing training by attending classes at such places as may be specified, on-the-spot demonstration to update the knowledge in the latest techniques, and attending to the offshore drilling work on any project of Sedco in any part of the world.

"The agreements further provided that such assignments would be obligatory and compulsory and that the employee would have no option to deny or reject the same.

"The alternative schedule of time at location and at field breaks was to be repeated continuously during the period of the agreements. The employees were to be paid the same monthly salaries for the alternating periods."

Brakes on breaks

Drilling went on, and breaks were utilised. Then came the taxman to apply the brakes. He wondered if the salary of Sedco's employees payable for field breaks outside India would be subjected to tax under Section 9(1)(ii) read with the Explanation thereto in the Income-Tax Act 1961 for the assessment years 1992-93 and 1993-94.

Section 9(1) reads, "The following incomes shall be deemed to accrue or arise in India... " And (ii) therein reads, `income which falls under the head `salaries' if it is earned in India... '

When the employees found the assessing authority levying tax on their field break salary, they appealed before the Commissioner. But he dismissed their appeal.

At the Tribunal, however, the decision went in favour of Sedco's employees. Then, the Department appealed to the Uttaranchal High Court.

The court reasoned that the `Off' and `On' periods formed an integral part of the agreement between Sedco and its employees and that it was not possible to give separate tax treatment to the two periods. During field breaks, employees had to remain fit and undergo demonstration and training; all that had a nexus with the services the employees had to render in India, said the High Court.

Also, the training during field breaks was directly connected with the works on the rigs in India, observed the High Court, to emphasise that the field break salary is taxable as income earned in India.

One more ground that the court mentioned for reversing the view taken by the Tribunal was that the assessment records showed that Sedco had paid the salary of the employees, including salary for the `Off period', out of income of the Indian operations.

When off became on

Aggrieved by the High Court's decision, Sedco's employees approached the Supreme Court, and argued through H. N. Salve, Porus F. Kaka, and a host of other counsels. They pointed out that the Finance Act, 1999 amendment that came in Section 9(1)(ii), to include salary for `Off periods' outside India for the first time, was with effect from April 1, 2000. The court's decision gives a retrospective effect to the same, said the employees.

The new explanation had clarified `for the removal of doubts' that "the rest period or leave period which is preceded and succeeded by services rendered in India and forms part of the service contract of employment shall be regarded as income earned in India."

The employees contended that during field breaks, they were "kept on standby in the UK for serving anywhere in the world, which was not necessarily in India".

For the taxman, Mohan Parasaran, the Additional Solicitor-General, argued that Sedco's employees were paid salary during the field breaks "only as a consequence of and in relation to the services rendered by them during the period that they actually worked in India."

Therefore, the salary received for the `Off period' was taxable as arising out of services rendered in India, he said. "There was a reasonable nexus between salary earned for the `Off periods' and the services rendered in India," he added. On the 1999 amendment, Parasaran submitted that it was retrospective, being clarificatory in nature.

Apex court on legislative history

Justices Ruma Pal and Tarun Chatterjee heard the case and said, "In our view, the opinion of the High Court is contrary to the legislative history, context and construction of Section 9(1)(ii)."

Section 5(2) defines the scope of total income as far as non-residents are concerned, as all income from whatever source derived which (a) is received or deemed to be received in India by or on behalf of such person, or (b) accrues or arises or is deemed to accrue or arise to him in India in such year, said the court.

By clause (ii) of sub-section (1) of Section 9 income that falls under the head `Salaries', if it is earned in India, is included in such income.

"In 1980, the Gujarat High Court, in Commissioner of Income-Tax vs S. G. Pgnatale, held that the words `earned in India' occurring in Clause (ii) must be interpreted as `arising or accruing in India' and not `from service rendered in India'... To overcome this decision, Section 9 (1)(ii) was amended by the Finance Act, 1983 with effect from April 1, 1979, to include an Explanation to Section 9(1)(ii) which read, `For the removal of doubts, it is hereby declared that income of the nature referred to in this clause payable for service rendered in India shall be regarded as income earned in India,'" educates the judgment.

"Therefore with this Explanation, irrespective of where the contract was entered into or where the liability to pay arose or where the payment was actually received, if the service was rendered in India, the salary for such service was exigible to tax as income under the Act," said the apex court.

What the High Court had not considered

The apex court pointed out the following flaws in the reasoning of the High Court:

The High Court proceeded on the incorrect hypothesis that the field breaks were limited to the training of the employees to render them more fit for service in India.

That was not what the agreements between the appellant and its employees said and there was no ground for the High Court to have so assumed.

The High Court did not address itself to the other aspects of the field break, namely, the readiness of the employees for service anywhere.

The employees in this case had not in fact `served' in India during the field break period, but they earned the income in UK as UK residents — the consideration for the salary being the undergoing of training or updating of knowledge and being in a state of readiness to serve anywhere at all.

The contract does not mention that the salary was for a well-earned rest. That was a presumption that the High Court raised, but which was based on no evidence.

The clause in the contract relating to salary for service in India was distinct from the clause relating to payment of salary for field breaks. The first clause clearly fell within the extended meaning given to the words `earned in India' in the main provision.

But the second clause relating to the salary paid by the appellants to its UK employees for the field break was not `earned in India'.

Since it did not fall within the phrase, which is part of the statutory fiction created by Section 9(1), there is no question of introducing a further fiction by extending the Explanation to include whatever has a possible nexus with service in India (CIT vs Moon Mills Ltd, M. P. Ahmed vs Kuthiravattam Estate Receiver).

Therefore, the salary paid for the field breaks in the UK was not for `service rendered in India' within the meaning of the 1983 Explanation to Section 9(1)(ii) of the Act, said the Supreme Court.

What about the 1999 amendment? It could not apply to assessment years in the present case, for the simple reason that it had not come into effect then, said the apex court. There was also a circular from the CBDT issued in September 1999 stating that the amendment would apply `in relation to the assessment year 2000-2001 and subsequent years'.

A cardinal principle of the tax law is that the law to be applied is that which is in force in the relevant assessment year unless otherwise provided expressly or by necessary implication, reminded the apex court, citing the Goslino Mario case.

An explanation that changes the law is not presumed to be retrospective, irrespective of the fact that the phrases used are `it is declared' or `for the removal of doubts', clarified the court.

Doubtful `rest'

The penultimate paragraph in the judgment holds interest for later assessment years too. It reads thus:

"Even if it were to be held that the 1999 Explanation to Section 9(1)(ii) were applicable to the facts of the present case, it is doubtful whether in the facts of this case the activity of the employees in the UK could be said to be `rest' period or `leave' period within the meaning of the words in Clause (b) of the 1999 Explanation.

"However, it is not necessary to decide the issue as we are satisfied that the 1999 Explanation would not apply to the assessment years in question."

An assuring quote from King John to wrap: "On this day let seamen fear no wreck; no bargains break that are not this day made."

Tailpiece

"Whenever I hear the jingle, `This over was sponsored by... '"

"You take a quick break?"

"No, I wish somebody told me, `Your tax is sponsored by... '"

Detaxification@TheHindu.co.in

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