At a time when the government is emphasizing India’s image as an attractive business destination and a service exporter, certain observations by the Supreme Court in its March decision in the case of Eli Lilly and Co. (India) Pvt. Ltd could have a deterrent effect by imposing possibly unintended obligations on non-resident hirers of Indian service providers. The possible implications of this decision may not have been widely understood.
The debate on extra-territorial operation of tax statutes is not new. The proposition that a non-resident who derives income having nexus with India should be subject to Indian taxes is well-accepted. However, whether a non-resident who has no presence in India should be subject to machinery provisions of withholding taxes merely because he makes a payment outside India, or from outside India, to a resident or a non-resident who is taxable in India, was far from clear. The observations of the apex court in the Eli Lilly decision seem to suggest that withholding tax obligations would so apply.
While the judgement suggests it applies to salaries alone (it was a case of secondment of employees by a foreign company to an Indian company), the observations clearly have possibly unintended consequences even to other withholding tax provisions.
Illustration: Jayachandran / Mint
Consider the following situation—a non-resident entity avails the services of a resident Indian doctor, architect, accountant or investment adviser, and pays him for the professional services rendered outside India or from India, through normal banking channels in India. If the Indian withholding provisions were to be applied to such a non-resident, startling consequences would follow—this non-resident would not only have to withhold tax on such payments and arrange to have it deposited in India, but would have to undertake various procedural compliances, such as obtaining a permanent account number, tax-deduction account number and file withholding tax returns in India, etc. Failure to comply with this would expose it to penal consequences, including interest and penalty. If this was to be applied in reverse, it would mean that every Indian company which engaged a foreign adviser will need to not only withhold taxes as required by Indian tax laws but also (those) which may be imposed on payers by the foreign country of the payee’s tax residence.
This issue was considered by a five-judge bench of the House of Lords in Agassi v. Robinson (inspector of taxes) case, May 2006. The case concerned tennis player Andre Agassi’s tax liability in the UK with respect to payments received by a non-UK company owned by him, from non-resident companies, for promotion of their goods on account of participation in UK tournaments.
The UK tax authorities sought to tax the payments in the hands of Agassi under the UK law, which provided that a sports person was taxable in UK with respect to his UK-related income even though he and the foreign payers had no presence in the UK. The law also imposed a withholding tax obligation on the non-resident payers with respect to such payments. However, it is important to note that the matter before the court was Agassi’s taxability, not whether the non-resident payers were liable to withhold taxes.
Lord Scott, agreeing that Agassi was taxable in the UK since his income had a nexus with the UK, upheld the withholding tax provisions in their applicability to non-UK entities on the assumption that taxability of the recipient was inter-linked with the obligation of the non-UK companies to withhold (a somewhat curious conclusion but admittedly the UK law was a fairly complex construct).
Lord Mance, on the other hand, while agreeing with the taxability of Agassi, had serious reservations about the withholding tax liability of non-residents.
In his words, “It may, and in my view probably would, be incongruous if a payer without any United Kingdom presence were to be treated as under any liability to make and account for such a deduction. But this conclusion should have, and in my view has no bearing on the primary liability of the sportsman or entertainer to pay both the basic and any higher rate tax due in respect of the payment.” Lord Nicholas and Lord Hope agreed with the opinions of Lord Scott and Lord Mance without it being clear as to whose specific reasoning they agreed with. Clearly one of the Lords, whose opinion they concurred with, had serious reservations about the withholding tax liability of non-residents without any UK presence. Lord Walker disagreed with both contentions, i.e. the chargeability of Agassi to UK income tax as well as the withholding tax liability of non-resident payers.
The complexity of the issue has been recognized by the Supreme Court in the Electronics Corp. of India decision (May 1989), where it observed that the question of extra-territoriality was of “great public importance” as “it concerns collaboration agreements with foreign companies and other such arrangements for the better development of industry and commerce in India”, and accordingly referred the matter to a constitutional bench. Unfortunately, the matter did not proceed further.
In light of such uncertainty on the legal position, it is important that Indian courts keep these factors in consideration while applying the observations of the apex court in Eli Lilly. Clearly, before the Indian tax authorities issue a barrage of notices for potential withholding violations, the matter requires appropriate consideration. Incidentally, this issue resurfaces in the Vodafone matter, where the taxability of transfer of shares of a Cayman Island company (which held majority-stake in an Indian company through another Mauritian company) by one non-resident to another non-resident, and the related question of withholding tax, are under scrutiny.
However, it may be too late to wait for the Vodafone controversy to reach the Supreme Court for the issue to be sorted out.
This column is contributed by Abhinav Ashwin of AZB & Partners, Advocates & Solicitors. Send your comments to email@example.com