The Hindu Business Line : `Source rule' reaffirmed

The Finance Bill, 2007 proposes to insert an explanation in Section 9 to provide that where income is deemed to accrue or arise in India under clauses (v) [interest], (vi) [royalty] and (vii) [fees for technical services] of Section 9(1), such income will be includible in the total income of the foreign company, whether or not the non-resident has a residence or place of business or business connection in India. The explanation is proposed to be retrospective in nature and applicable from June 1, 1976, that is, the date of insertion of the above clauses.

The explanatory Memorandum to the Finance Bill, 2007 refers to recent judicial opinion (judgment in the Ishikawajma case) and indicates that the rationale of inserting the explanation is to reaffirm the source rule, that is, the situs of the payer and the situs of utilisation of services will determine the tax jurisdiction, irrespective of the situs of the services.

The proposed amendment will restore the `source rule' principle and the Indian tax law would be in line with internationally accepted practices. The Supreme Court had recently delivered a landmark judgment in the Ishikawajma-Harima Heavy Industries Ltd case, wherein it held that income for services rendered abroad by a foreign company could not be taxed in India in the absence of territorial nexus or `live link' with India.

Under the provisions of clause (vii) of Section 9(1) of the I-T Act, 1961, fees for technical services payable by an Indian company to a foreign company is liable to tax in India if the services are utilised in India, regardless of the place where the services are performed.

Similar provisions exist for interest [Section 9(1)(v)] and royalty [Section 9(1)(vi)]. These provisions were introduced by the Finance Act, 1976 with effect from June 1, 1976.

The aforesaid provision of taxing interest/royalty/fees on the basis of the location of the payer of income is referred to as taxation based on the `source rule' principle in international tax terminology and is a commonly adopted approach by countries for taxing non-residents.

It is pertinent at this juncture to note that tax treaties entered into by India with various countries also contain similar provisions. It is also relevant to note that generally speaking, tax treaties do not contain the exemption provided under the I-T Act in respect of utilisation of services. Accordingly, the scope of taxation under the tax treaties is broader than the I-T Act inasmuch as under the tax treaties, mere existence of the payer of income in India is sufficient to attract tax liability of the foreign company in India, regardless of the place of utilisation of services.

The Supreme Court in the Ishikawajma case has laid down certain principles for taxation of fees for technical services.

(The author is Partner, Deloitte Haskins & Sells.)