Clarification regarding Explanation 5 to clause (i) of sub-section (l) of section 9 of Income-tax Act, 1961

CIRCULAR No. 4 /2015 Dat­ed 26^th March, 2015

Sec­tion 9 of the Income-tax Act pro­vides for incomes which are deemed to accrue or arise in India. Clause (i) of sub-sec­tion (1) of the said sec­tion reads as under:-

“9. (1) The fol­low­ing incomes shall be deemed to accrue or arise in India:-

(i) all income accru­ing or aris­ing, whether direct­ly or indi­rect­ly, through or from any busi­ness con­nec­tion in India, or through or from any prop­er­ty in India, or through or from any asset or source of income in India, or through the trans­fer of a cap­i­tal asset sit­u­ate in India.”

1. The Finance Act, 2012 insert­ed Expla­na­tion 5 to clause (i) of sub-sec­tion (1) of sec­tion 9. The said expla­na­tion reads as under:-

” Expla­na­tion 5.-For the removal of doubts, it is here­by clar­i­fied that an asset or a cap­i­tal asset being any share or inter­est in a com­pa­ny or enti­ty reg­is­tered or incor­po­rat­ed out­side India shall be deemed to be and shall always be deemed to have been sit­u­at­ed in India, if the share or inter­est derives, direct­ly or indi­rect­ly, its val­ue sub­stan­tial­ly from the assets locat­ed in India”

1. A num­ber of rep­re­sen­ta­tions have been received by the Board stat­ing that the pur­pose of intro­duc­tion of Expla­na­tion 5 was to clar­i­fy the leg­isla­tive intent regard­ing the tax­a­tion of income accru­ing or aris­ing through trans­fer of a cap­i­tal asset sit­u­ate in India. Appre­hen­sions have been expressed about the applic­a­bil­i­ty of the Expla­na­tion to the trans­ac­tions not result­ing in any trans­fer, direct­ly or indi­rect­ly of assets sit­u­at­ed in India. It has been point­ed out that such an extend­ed appli­ca­tion of the pro­vi­sions of the Expla­na­tion may result in tax­a­tion of div­i­dend income declared by a for­eign com­pa­ny out­side India. This may cause unin­tend­ed dou­ble tax­a­tion and would be con­trary to the gen­er­al­ly accept­ed prin­ci­ples of source rule as well as the object and pur­pose of the amend­ment made by the Finance Act 2012.

2. The mat­ter has been exam­ined in the Board. The Explana­to­ry Mem­o­ran­dum to the Finance Bill 2012 explains the pur­pose of the amend­ment to sec­tion 9 (1)(i) in the fol­low­ing words:-

“Sec­tion 9 of the Income-tax Act pro­vides cas­es of income, which are deemed to accrue or arise in India. This is a legal fic­tion cre­at­ed to tax income, which may or may not arise in India and would not have been tax­able but for the deem­ing pro­vi­sion cre­at­ed by this sec­tion, Sub-sec­tion (1)(i) pro­vides a set of cir­cum­stances in which income accru­ing or aris­ing, direct­ly or indi­rect­ly, is tax­able in India. One of the limbs of clause (i) is income accru­ing or aris­ing direct­ly or indi­rect­ly through the trans­fer of a cap­i­tal asset sit­u­ate in India. The leg­isla­tive intent of this clause is to widen the appli­ca­tion as it cov­ers incomes, which are accru­ing or aris­ing direct­ly or indi­rect­ly. The sec­tion cod­i­fies source rule of tax­a­tion where­in the state where the actu­al eco­nom­ic nexus of income is sit­u­at­ed has a right to tax the income irre­spec­tive of the place of res­i­dence of the enti­ty deriv­ing the income. Where cor­po­rate struc­ture ls cre­at­ed to route funds, the actu­al gain or income aris­es only in con­se­quence of the invest­ment made in the activ­i­ty to which such gains are attrib­ut­able and not the mode through which such gains are real­ized. Inter­na­tion­al­ly this prin­ci­ple is rec­og­nized by sev­er­al coun­tries, which pro­vide that the source coun­try has tax­a­tion right on the gains derived of off­shore trans­ac­tions where the val­ue is attrib­ut­able to the under­ly­ing assets.….….….……

.….….…Cer­tain judi­cial pro­nounce­ments have cre­at­ed doubts about the scope and pur­pose of sec­tions 9 and 195. Fur­ther, there are cer­tain issues in respect of income deemed to accrue or arise where there are con­flict­ing deci­sions of var­i­ous judi­cial authorities.

There­fore, there is a need to pro­vide clar­i­fi­ca­to­ry ret­ro­spec­tive amend­ment to restate the leg­isla­tive intent in respect of scope and applic­a­bil­i­ty of sec­tion 9 and 195 and also to make oth­er clar­i­fi­ca­to­ry amend­ments for pro­vid­ing cer­tain­ty in law.”

1. The Explana­to­ry Mem­o­ran­dum clear­ly pro­vides that the amend­ment of sec­tion 9(1) (i) was to reit­er­ate the leg­isla­tive intent in respect of tax­a­bil­i­ty of gains hav­ing eco­nom­ic nexus with India irre­spec­tive of the mode of real­i­sa­tion of such gains. Thus, the amend­ment sought to clar­i­fy the source rule of tax­a­tion in respect of income aris­ing from indi­rect trans­fer of assets sit­u­at­ed in India as explic­it­ly men­tioned in the Explana­to­ry Mem­o­ran­dum. Viewed in this con­text, Expla­na­tion 5 would be applic­a­ble in rela­tion to deem­ing any income aris­ing out­side India from any trans­ac­tion in respect of any share or inter­est in a for­eign com­pa­ny or enti­ty, which has the effect of trans­fer­ring, direct­ly or indi­rect­ly, the under­ly­ing assets locat­ed in India, as income accru­ing or aris­ing in India.

2. Dec­la­ra­tion of div­i­dend by such a for­eign com­pa­ny out­side India does not have the effect of trans­fer of any under­ly­ing assets locat­ed in India. It is there­fore, clar­i­fied that the div­i­dends declared and paid by a for­eign com­pa­ny out­side India in respect of shares which derive their val­ue sub­stan­tial­ly from assets sit­u­at­ed in India would not be deemed to be income accru­ing or aris­ing in India by virtue of the pro­vi­sions of Expla­na­tion 5 to sec­tion 9 (1) (i) of the Act.

3. This-his may be brought to the notice of all con­cerned for strict compliance.