Section 9 of Indian Income Tax Act

Section 9 of the Income Tax Act, 1961(hereinafter referred to as ‘Act’) is a sort of a legislation which may be extra-territorial, and time and again, its validity has been challenged which proved of no avail. Section 9 brings to tax income accruing or arising through or from any business connection, property asset or source of income or a capital asset situated in India. [1]

Section 9 is not merely a machinery section, and thus has to be read along with Section 5. It is applicable to both residents and non-residents, but practically, its effect is more prominent in the case of non-residents. [2]

The said section is concerned with the income which is arises out side India but by a fiction of law, is deemed to accrue or arise in India. Now, for the fiction to take effect the income which has arisen or accrued in India has to be due to a business connection and it is the assessees in India who is targeted by the Tax officials. [3]

The term business connection is not restricted by the definition of the term business which is contained in Section 2(13) of the Act as business connection is not the same as carrying on a business.

There is no definition of the term “business connection” in the Act, and the explanation which has been given merely mentions the apportionment of income on the basis of the operation carried out in India. [4]

The Finance Bill, 2003 has inserted two more explanations to Section 9(1)(i) to clarify the meaning of the term “business connection” which we will look into during the course of this paper.

The term “business connection” time and again has been subjected to judicial interpretations and there are a number of Supreme Court judgments like CIT v R.D. Aggarwal & Co., CIT V Barenbra Prasad Roy, CIT v Carborandum Co.etc. In each of the judgements, while trying to define the term “business connection”, the judges have ultimately made the subject matter confusing. [5]

During the course of this paper, the researcher shall thoroughly review the case of CIT v R.D. Aggarwal and Co. and its impact on “Business Connection”.

Facts of CIT v/s R.D. Aggarwal and Company

R.D. Aggarwal and Company (hereinafter referred to as ‘assessees’) were a registered firm having their place of business at Amritsar. The assessees carried on business in the form of imports and as commission agents of non-resident exporters. Two of such exporters, Comptoirs Lainiers Osterieth s.a. Anvers (Belgium) and Filature Tessitura Di Tollengno Biella (Italy), are relevant expoters in the present case. Both the abovementioned exporters export and manufacture worsted woollen yarns. The assessees used to examine and communicate orders to the exports and it resulted in a contract and the price for the goods is paid by the Amritsar dealer to the exporter, the assessees were entitled to a commission varying between 1 ½ and 2 ½ % of the price. [6]

By a letter dated 24th March 1951, the assessees were appointed as “sole agents” by the Italian Company “for sale” of woollen yarns in the Indian territories terminable by one month’s notice. The assessees were to be paid 2 ½% commission on the net cash amounts arising from the accepted business “concluded by the mediation” of the assessees or directly by the Italian company with the customers. Also, the assessees were supposed to maintain the existing customers and secure new customers “conforming to their general terms of sale”. [7]

The assesses were apoointed by the Belgian company as their representative for the whole of India. This was with the condition that the assesses will not represent any other Belgian Mill or yarn producer and will not sell Belgian yarn in India on their own account. [8]

While assessing the tax for the assessment year of 1952-1953, the Income-tax officer ‘C’ ward, Amritsar, added Rs. 54,558 in the total income of the assesses as 5% of net total value of yarn sold by the non-resident companies to Indian merchants in the previous year. The reason for this was that the tax officer believed that there existed a business connection between the non-resident exporters and the assessees. [9]

Opinion of the High Court

The Income-tax Appellate Tribunal submitted a statement of case to the High Court of Punjab on the following two questions [10] :

Whether the relationship between the assessee and the non-resident fell within the meaning of the expression “business connection” as used in section 42(1) of the Indian Income-tax Act?

If the answer is in affirmative whether on the facts and in the circumstances of this case any profits or gains accrued or arose or could be deemed to have accrued or arisen to the non-resident on account of the business connection of the non-resident with the assessee during the precious year under consideration

The High court answered the first question in negative and refused to answer the second question which led to the Commissioner of Income-tax to appeal to the Supreme Court against the opinion of the High Court. [11]

Decision of the Supreme Court

The Supreme Court while deciding the present case referred to a number of cases , eg. CIT v/s Remington Typewriters Co. [12] , CIT v/s Currimbhoy Ebrahim and Sons Ltd. [13] , Abdullabhai Abdul Kadar v/s CIT Bombay City [14] , Hira Mills Ltd. Cawnpore v/s Income-tax officer, Cawnpore [15] etc. while deciding the present case discussed various important characteristics of the term “business connection” which are

Element of Continuity

Real and intimate connection

Mere purchase abroad and use in India is not “continuing business”

Element of Continuity

The Supreme Court in the instant case discussed how the Act contains no definition of the expression “business connection” and its precise connotation is vague and indefinite. It said that the expression “business connection” undoubtedly means something more than the term “business”. The Court said that [16] :

“A business connection in section 42 involves a relation between a business carried on by a non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in the taxable territories a stray or isolated transaction is normally not to be regarded as a business connection. Business connection may take several forms it may include carrying on a part of the main business or activity incidental to the main business of the non-resident though an agent, or it may merely be a relation between the business of the non-resident and the activity in the taxable territories which facilitates or assists the carrying on of that business.”

Real and Intimate connection

In the present case, the Court held that for a business relation to fall under the ambit of business connection, it must be “real and intimate”. Also the income, whether directly or indirectly, must accrue or arise to the non-resident. The exact words used by court were:

“Income received or deemed to be received, or accruing or arising or deemed to be accruing or arising within the taxable territories in the previous year is taxable by S. 4(1)(a) & (c) of the (1922) Act, whether the person earning is a resident or non-resident. If the agent of a non-resident receives that income or is entitled to receive that income, it may be taxed in the hands of the agent by the machinery provision enacted in S.40(2) (of the 1922 Act). Income not taxable under S.4 of the Act of a non-resident becomes taxable under S.42(1)(of the 1922 Act) [corresponding to S.9 of the 1961 Act] if there subsists a connection between the activity in the taxable territories and the business of the non-resident, and if through or from that connection income directly or indirectly arises.”

Also, while pronouncing the judgement, the Court used the terms “real and intimate” rather strictly while stating it as “gains and profits” in order to restrict the scope of the term which can have wide interpretations. The Court stated [17] :

“…the assessees merely procured orders from merchants in Amritsar for purchase of goods from the non-resident companies. The orders were offers which the assessees had no authority to accept on behalf of the non-residents. Some commercial activity was undoubtedly carried on by the assessees in the matter of procuring orders which resulted in contracts for sale by the non-residents of goods to merchants at Amritsar. But on this account no business connection of the assessees with the non-residents within the taxable territories resulted. The activity of the assessees in procuring orders was not as agents of the non-residents in the matter of sale of goods manufactured by the latter, nor of procuring raw materials in the taxable territories for their manufacturing process. Their activities led to the making of offers by merchants in the taxable territories to purchase goods manufactured by the non-residents which the latter were not obliged to accept. The expression “business connection” postulates a real and intimate relation between trading activity carried on outside the taxable territories and trading activity within the territories, the relation between the two contributing to the earning of income by the non- resident in his trading activity. In this case such a relation is absent.”

Mere purchase abroad and use in India is not “continuing business”

It was held the case of CIT v Fried Kupp Industries [18] that if a person purchases the machinery abroad and then uses it in India to gain profits, there in no “business connection”. The court basically looked into the question whether a principal to principal connection amounts to a “business connection”. It was said that if a foreigner was selling his goods abroad to an Indian who was using it in India to gain profits, then this relationship falls out of the definition of “business connection”. It basically meant that if a person is buying his goods abroad, but using them in India to gain profits, than the income is wholly his own and the foreigner does not come into the picture at all. [19]

The same decision was referred to and upheld in the case of CIT v Tata Chemicals Ltd [20] , where it was held that it must be important that some of the operations are being carried out in India due to which any income or profits accrue or arise. [21]

Position after CIT v R.D. Aggarwal

As stated earlier, The Finance Bill, 2003 has inserted two more explanations to Section 9(1)(i) to clarify the meaning of the expression “business connection”

If a person is acting on behalf of a non-resident and is exercising a right in India habitually to conclude contracts on behalf of the non-resident, then this relationship shall amount to a “business connection”. However, if his activities are jus limited to merely purchasing merchandise or goods for the non-resident, then in that case, there is absence of a “business connection”. [22]

But if there is a stock of goods or merchandise, which is habitually maintained by the agent on behalf of the non-resident, and such a stock is used for delivering goods, or if the agent is constantly procuring orders on behalf of the non-resident, then this shall fall within the ambit of the term “business connection”. [23]

However, the business conducted by agents of independent status during the ordinary course of business will not establish “business connection”. [24]

Thus, this amendment, for the first time, has brought in the concept of Permanent Establishment into the meaning of business connection. This has resulted into every agent examining the fact whether he is a dependent or independent agent. If an agent is a dependent one, then he automatically attracts “business connection”. If an agent is independent, it will need to be examined whether his activities are during the normal course of business or an extension of the business activities of the non-resident.

Conclusion

The term “business connection” has no particular or precise definition. The judgement pronounced by CIT v/s R.D. Aggarwal [25] , which explains the import and connotation of this expression still holds good. The judgement gives some relief as far as the confusion regarding the term “business connection” is concerned, the question whether a non-resident has a business connection in India from or through which income or profits arise or accrue still has to be answered on a case to case basis. Confusion has always prevailed in the cases where the raw material was purchased in India and the manufacture and sale of the goods was taking place abroad. The profits arising from such cases were said to be income accruing or arising out of a business practice in India, which was a wrong practice. Thus, the term “business connection” has been rationalized with the help of judicial interpretation and been successful to a large extent in resolving various complications related to transaction unlike a few years back. [26]