Basic structure of Income-Tax Act under threat

MOHAN R. LAVI | Updated on June 03, 2013 Published on June 03, 2013

Not an easy ride for Nokia. — A. M. Faruqui

Retrospective amendments make a mockery of taxing global income annually.

At first blush, the word ‘royal’ brings to mind images of kingdoms and lavish living. The meaning of the word has been tarnished a bit, thanks to three cricketers from Rajasthan Royals whose avarice for things other than cricket opened up a Pandora’s box of betting. This ended up confusing everyone as to who kingpin is, who is guilty and who is not.

Unfortunately, the word ‘royalty’ under the Income-Tax Act has also become equally confusing — the Indian unit of Nokia would tend to agree.

Nokia and the tax department have been at each other for sometime now on deducting taxes on royalty paid to the parent company. The tax department feels that the nature of work being done by Nokia falls within the definition of royalty under the Income-Tax Act, while Nokia is probably taking shelter under the Double Tax Avoidance Agreement (DTAA), where the ‘royalty’ appears to take a different colour.

The exchanges between them took on a serious dimension after Budget 2011-12 when Section 9 of the Income-Tax Act was amended with retrospective effect from almost the inception of the Act. The visit from the tax office also included visits from computer experts and chats with auditors. While the Delhi High Court gave some relief to Nokia by asking it to take the matter to the Commissioner of Income Tax (Appeals) — with a diktat to the latter to decide on the matter before the end of May — the appeal was dismissed on the last day of May in favour of the tax office.

Nokia appears to be contemplating knocking on the doors of the Delhi High Court again and has also sought political intervention. Finland is invoking the Mutual Agreement Procedure between the two Governments. The amount at stake is Rs 2,058 crore, but more than the amount involved, it is critical is to decide on the case on principle.

Delhi High Court

It is not that this is new territory to both Nokia and the Delhi High Court. Less than a year ago, the Court, deciding for the Assessment Years 1997-98 and 1998-99, ruled that consideration for supply of software was not taxable as ‘royalty’ either under Section 9(1)(vi) or relevant provision of DTAA. The Court had done enough groundwork earlier in the case of Ericsson AB to arrive at this conclusion.

The premise on which this decision was made was that Nokia supplied GSM equipment with both hardware and software manufactured in Finland to Indian telecom operators from outside India on a principal-to-principal basis under independent buyer-seller arrangements. Installation activities were undertaken by its Indian unit under its independent contracts with Indian telecom operators. The tax office was of the view that there were permanent establishments in India, giving rise to a need to withhold taxes on payments.

Retrospective Amendment

To some extent, the aggression of the tax office to collect these taxes can be seen to arise from the amendment in Budget 2011-12 to Section 9(i)(vi). This clarifies that the consideration for use or right to use of computer software is royalty.

Transfer of all or any rights in respect of any right, property or information as mentioned in Explanation 2, includes, and has always included, transfer of all or any right for use or right to use a computer software (including granting of a licence), irrespective of the medium through which such right is transferred.

The retrospective amendment to the law (1976) has given the tax office the ammunition to seek tax for past years.

In a democratic state, one does not question the powers of the Government to levy taxes by amending the Income Tax Act. However, doing so retrospectively from 36 years back seems to alter the basic structure of the Income Tax Act to an extent that anything can get taxed from any time.

It does not appear to be long before we get a Kesavananda Bharati case in Income Tax to bring some sanity to proceedings — the basic structure of income tax law that a person is taxed every year on his global income on a reasonable and fair basis cannot be tampered with.


Many of the problems in transfer pricing can also be attributed to a conflict between the provisions of the Income-Tax Act and the Double Tax Avoidance Agreements that India has signed with many countries. There seems to be unanimity of opinion that in case there is a conflict, the provisions of the DTAA would prevail.

The Government can do two things to prevent tax payers and the tax office from firing salvos at each other — issue a binding Circular that the provisions of the DTAA would apply in case of a conflict and resist the temptation to reinvent the Income-Tax Act from time immemorial.

It could probably look up all the DTAAs once to ensure that the latest and greatest provisions are in place there. Without being taxed twice, a reasonable levy applied consistently would not meet with resistance; it could also earn the Government a few brownie points internationally.

(The author is Director, Finance, Ellucian.)

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Published on June 03, 2013
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