Present article explains Section 9 of the Income Tax Act, 1961 in detailed manner. Various legal precedents have been used for the same.
Introduction
Tax is considered to be the cost of living in a society. The Government levies tax in order to meet the common expenditure of society. Tax can also be termed as the basic source of income of the government.
Taxes can be broadly divided into two types –
- Direct Taxes: the incidence and impact of a direct tax fall on the same person. For example – income tax.
- Indirect Tax: the incidence and, the impact falls on different persons. For example – Goods & Services tax.
Section 2(24) of the Income Tax Act, 1961 provides the definition of Income, it is an inclusive and non-exhaustive definition wherein not only the items mentioned in the section are income but also the items which fall under the general meaning of the term “income”.
Tax is levied on persons under Section 2(31) of the Income tax Act, 1961:
- Individuals,
- Hindu Undivided Family,
- Firms,
- Company,
- Association of Persons or Body of Individuals,
- Local Authorities, and
- Artificial Judicial Persons.
Tax is levied on a person who was a resident of India in the previous year. In order to understand the scope of total income, we need to go through Section 5 of the Income Tax Act, 1961.
Scope of Total Income – Section 5
The Income Tax Act levies taxes on the income of foreign companies or non-residents to the extent of their income which accrues or arises in India. Section 5 of the Income Tax Act, 1961 provides that a foreign company or a non-resident is required to pay taxes in India for the income which is received or is deemed to be received in India.
In order to further understand who is liable to pay taxes, it is imperative to understand the following three terms:
- Resident & Ordinarily Resident – If a citizen of India or person of Indian Origin stays in India for a period of 182 days in the previous year, s/he will be termed as a Resident & Ordinarily Resident.
- Resident but Not Ordinarily Resident – An individual would qualify as a Not Ordinarily Resident if in the previous 9 out of 10 years, he has been a non-resident or has been in India for less than 729 days in the previous 7 years.
- Non-Resident – An Individual would qualify as a non-resident if he does not exceed his/her stay in India by 181 days.
Now, income under section 5 is divided into 3 types and accordingly, an individual is taxed:
| Particulars | Resident & Ordinarily Resident | Resident but Not Ordinarily Resident | Non-Resident |
| Income received or deemed to be received in India | Taxable | Taxable | Taxable |
| Income accruing or arising or deemed to accrue or arise in India | Taxable | Taxable | Taxable |
| Income accruing or arising outside India | Taxable | Not taxable | Not taxable |
While Section 5 mentions the total scope of income, Section 9 specifies the various categories of income that are deemed to accrue or arise in India.
Income deemed to accrue or arise in India – Section 9
Section 9 talks about the categories of income deemed to accrue or arise in India. This is important because only those income which accrue or arise or are deemed to accrue or arise in India are liable to tax. This section provides for taxation on both, residents as well as non-residents.
Section 9 essentially brings a “source income” rule of taxation, ranging from income from a business connection to royalty paid by the government as accruing or deeming to accrue from India for the purposes of taxation. Due to its nature of taxing non-resident corporations as well, this section has been challenged as ultra vires the Constitution of India on the grounds of it being outside the legislative competence of the legislature as well as violative of fundamental rights.
Originally Section 9 of the Income Tax Act, 1961 dealt with taxation of the following categories only – business connection, transfer of assets, income from property, dividend and salary. Then in the Finance Act of 1976, Section 9 was amended, and the following categories were included – interest, royalty and fees for technical services.
Nani Palkhivala criticized the additions to Section 9 which were made in 1976. He said that the additions proceeded on a grossly inadequate territorial nexus and were ultra vires. In his book – The Law and Practice of Income Tax – he writes: if the Indian Parliament can increase their territorial nexus so wide as to include any transaction of a foreign resident with a resident of India under the purview of our taxation laws, then they should also levy tax on a hotel in a foreign country for transacting with an Indian.
Now, let’s begin to understand the bare text of Section 9 of the Income Tax Act, 1961:
- Section 9(1)(i) talks about income arising or accruing through or from a business connection in India or source of income or through the transfer of a capital asset which is situated in India.
- For a business which does not have all its operations in India, only that part of the income which accrues or is deemed to accrue in India will be taxable.
- For a non-resident, the following shall not be considered as business connection in India – transactions limited to export of goods, operations confined to the collection of news and views for transmission outside India or operations confined to shooting of cinematographic films.
- Business connection shall mean any business activity carried on by an individual on behalf of the non-resident who habitually exercises the authority to finalize contracts in India on the non-resident’s behalf, who habitually maintains stock and manages the delivery of the goods and someone who is basically not an independent agent.
- C.I.T v R.D. Aggarwal & Co[i] – In this case, the Supreme Court discussed the meaning of the term “business connection” and said that though the Income Tax Act, 1961 defines the term “business” in Section 2(13), it has failed to define the term “business connection.” R.D Aggarwal & Co. was a registered company with its head office in Amritsar and were carrying on the business of importers and as commission agents from non-resident individuals from other parts of the world.
The question before the Supreme Court was whether the business relationship between the non-resident individuals and the company could be termed as “business connection.”
The Supreme Court went on to provide a list of essential characteristics for the existence of a “business connection.” These are: Element of Continuity, Existence may vary from case to case, A Real and Intimate Connection, Mer Purchase Abroad to Use in India is not a Business Connection, Capital Gains arising out of India are Excluded.
- Later in the Finance Act of 2003, two new explanations were added to make the interpretation of the term “business connection” easier.
- Ishikawajima-Harima Heavy Industries Ltd v Director of Income Tax, Mumbai[ii]: The Supreme Court in this case held that two conditions are required to be met – the services which are the source of income which is to be taxed in rendered in India and also needs to be utilised in India, to be taxable in India.
- Section 9(1)(ii) talks about income under the head “salaries” if it is earned in India or is payable for a service rendered in India.
- Section 9(1)(iii) talks about salary payable by the Government of India to an Indian citizen for a service rendered outside India.
- Section 9(1)(iv) talks about interest paid by an Indian company outside India.
- Section 9(1)(v) talks about income by way of interest payable by – the government of India, or by a resident or a non-resident in certain situations.
- Section 9(1)(vi) talks about income by way of royalty which is payable by – the government, resident or by a non-resident.
Conclusion
Section 9 is a very important section as it increases the territorial nexus of the Income Tax Act, 1961. Till now there have been many confusing judgements and situations where understanding whether a business connection or not has been difficult. Different scholars and jurists have given different interpretations of Section 9 and some are in favour of it while some are against it.
Section 5 also is imperative in understanding the scope of Section 9. Section 5 provides for a source rule and courts heavily depend upon that in order to ascertain questions under Section 9 of the Income Tax Act, 1961.
[i] C.I.T v R.D. Aggarwal & Co, 1965 AIR 1526
[ii] Ishikawajima-Harima Heavy Industries Ltd v Director of Income Tax, Mumbai [2007] 288 ITR 408 (SC)
Nicely elucidated.