India's Section 9 Source Rules: A continuing source of confusion

In a bizarre reminder that the Indian tax department and some members of the income tax tribunal still have some ways to go in correctly interpreting and applying the international tax provisions of the Income Tax Act, 1961 (“ITA”), a Delhi bench Indian income tax tribunal, in a recent decision[1], found that a cloud-based e-invoicing service provider in the UK was taxable in India on payments made by an Indian company under the provisions of the ITA read with the India-UK tax treaty (“UKT”).

The facts. Under a 2009 master services agreement with Genpact International Inc., the taxpayer executed a statement of work with Genpact India Private Limited (“Genpact India”). Under the SoW, Genpact India received a license to use the taxpayer’s e-invoicing portal. Genpact India used the portal to raise e-invoices on GlaxoSmithKline Services Unlimited and its subsidiaries (“GSK”). None of the invoices pertained to GSK’s operations in India. For these services, the taxpayer received approx. ?29,300,000 from Genpact India (the “Payments”) in the relevant assessment year.

The Assessing Officer and the Dispute Resolution Panel characterized the Payments as “fees for technical services (or FTS)” and invoked Section 9(1)(vii) of the ITA to deem the Payments as having accrued or arisen in India. Before the tribunal, the taxpayer argued that (a) the UKT applied, and therefore the Payments should be classified as business income, not FTS, which would not be taxable in India in the absence of a permanent establishment; and (b) the exception under Section 9(1)(vii)(b) applied to take the Payments outside the deeming fiction of Section 9(1)(vii).

In a decision that reflects an unsteady grasp of the relevant law, the tribunal held in favor of the tax department. The tribunal made two glaring errors.

Applicability of the UK treaty. First, the tribunal blithely sidesteps any discussion concerning the applicability of the UKT. The UKT allocates taxing rights over various items of income between the UK and India. Three such allocations are relevant here. Firstly, UKT Art.13 (Royalties and Fees for Technical Services) provide that that FTS may be taxed in India, but if the beneficial owner of the FTS is a UK resident, then the tax shall not exceed 10% - 15%.[2] Secondly, UKT Art.7 (Business Profits) provides that the business profits of a UK enterprise shall be taxable only in the UK unless the enterprise carries on business in the India through a permanent establishment situated in India. Finally, UKT Art.23 (Other Income) provides that items of income of a UK resident not otherwise addressed in the UK treaty, and arising in India may be taxed in India.

In an ideal world, the tribunal should have first examined whether the Payments could correctly be characterized as FTS under UKT Art.13. Nothing in the record suggests that the payments were ancillary or subsidiary to any intellectual property or equipment licensed to Genpact India. Therefore, the tribunal should have determined whether the Payments were for services that “made available” any technical knowledge, experience, skill know-how or processes to Genpact India. The term “make available” is a term of art and Indian courts have consistently interpreted the term in line with international practice i.e., to mean to enable the recipient of the services to apply the knowledge or skill independently in the future without requiring further assistance from the service provider.[3] Nothing in the record suggests that the services provided by the taxpayer made available any technical knowledge and therefore the Payments would not have been characterizable as FTS under UKT Art.13.

Next, the tribunal should have examined whether the Payments could correctly be characterized as business profits under UKT Art.7. Given that the taxpayer is engaged in the business of providing cloud-based e-invoicing services, the answer would probably have been yes. Since nothing in the record suggests that the taxpayer had a permanent establishment in India, the Payments should have been taxable only in the UK and the tribunal should have so held.

Instead, the tribunal nonchalantly failed to address any of the questions above and proceeded directly to characterize the Payments as “Other Income” under UKT Art.23. This is plainly incorrect considering that UKT Art.23 applies only to items of income not otherwise addressed in the UKT, and the Payments are clearly addressed under UKT Art.7.

Sourcing FTS and the principle of territoriality. Second, even assuming this case was to be decided under domestic law (which, for the reasons above, it is not), the tribunal still gets it wrong by simply ignoring the source rules under ITA S.9(1). Under ITA Ss. 4 and 5, a person who is not tax resident in India i.e., a non-resident, is taxable on income that is received or deemed to be received in India, or that accrue or arises or is deemed to accrue or arise in India. In other words, a non-resident is only taxable on income that has its source in India.

ITA S.9 also deems certain incomes to have their source in India. For example, under ITA S.9(1)(vii), payments received for technical services are deemed to accrue or arise in India if payable by the (a) the Indian government, (b) a person who is a resident, except where the fees are payable in respect of services utilized by such person in a business or profession carried on outside India or for the purposes of making or earning any income from any source outside India, and (c) a person who is a non-resident, where the fees are payable in respect of services utilized in a business or profession carried on by such person in India?or for the purposes of making or earning any income from any source in India.

ITA S.9(1)(vii) is framed in a manner that suggests that the location of the payor is of paramount importance. While that may be true where the payor is the Indian government – it is otherwise misleading. In my view, the effect of ITA. S.9(1)(vii(b) and (c) is to distinguish between businesses carried on in India (and earning income from sources in India) and businesses carried on outside India (and earning income from sources outside India). Payments for services utilized for the former are deemed to accrue or arise in India. Payments for services utilized for the latter are not. Implicit in this distinction is recognition that a country's authority to tax is fundamentally based on the principle of territoriality, one of the key principles under international law that governs a state's authority to legislate and enforce.

This distinction was lost on the tribunal. Instead, the tribunal falsely relies on GVK Industries v ITO[4], a landmark constitution bench decision of the Supreme Court of India addressing the extent of Parliament’s power to legislate extraterritorially (TLDR: It’s very extensive!), to suggest that the location of the payor is determinative of whether the Payments are India-sourced. Again, this is plainly incorrect.

The ‘source’ of an item of income seldom depends solely on the location of the payor.[5] Instead, the source will, depending on the kind of income, depend on a variety of factors. For example, the source of salary income is typically the place where the employment is performed[6], while royalty income is linked to the location where the intellectual property is used or exploited[7]. Business income is usually sourced based on a number of factors, including where sales take place or business operations are located[8], and dividend income is generally tied to the place where the dividend is declared[9]. Interest income is often sourced to the country of residence of the debtor[10] or the place where the loan agreement was negotiated and signed.[11]

Some of the critical questions the tribunal should have addressed regarding the source of the FTS should have been: Did Genpact India utilize the taxpayer’s services for a business conducted outside India or to generate income from sources outside India? What significance does the fact that the invoices were raised exclusively on non-resident affiliates of GSK hold? Were these invoices linked to services rendered, and if so, where were those services performed? Does Genpact India’s headquarters being located in India have any relevance? These are the issues the tribunal should have examined but failed to address.

Instead, and most gallingly, the tribunal placed such (unwarranted) significance on the location of the payor that it completely disregarded the nuances of ITA S.9(1) and summarily declared that the Payments had accrued or arisen in India under ITA S.5(2)! Why bother delving into the complexities of when the ITA deems income to accrue or arise in India when, with no substantive analysis and mere proclamations, one can simply declare it so. Sheer brilliance!

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The views expressed in this article are solely my own and do not represent the views or opinions of my employer or any affiliated organizations.

[1] ITA Nos. 2237 & 2238/Del/2024

[2] UKT Art.13(4) deals with three broad categories of FTS i.e., payments for technical or consultancy services that (a) are ancillary and subsidiary to the enjoyment of intellectual property licensed to the payor, (b) are ancillary and subsidiary to the enjoyment of industrial, commercial, or scientific equipment licensed to the payor, and (c) make available to the payor technical knowledge, experience, skill know-how or processes.

[3] International Management Group (UK) Ltd. v. Comm’r of Income-tax, [2024] 164 taxmann.com 225 (Delhi)

[4] [2011] 197 Taxman 337 (SC)

[5] G.E. India Technology Center v Comm’r of Income Tax, [2010] 193 Taxman 234 (SC)

[6] In re., VG Every, [1937] 5 ITR 216 (Calcutta); Comm’r of Income Tax v Eli Lilly, [2009] 178 Taxman 505 (SC); ITA S.9(1)(ii)

[7] Performing Right Society v Comm’r of Income Tax, [1977] 106 ITR 11 (SC); ITA S.9(1)(vi)

[8] Comm’r of Income Tax v Ahmedbhai Umedbhai, [1950] 18 ITR 472 (SC); Anglo French Textile v Comm’r of Income Tax, [1954] 25 ITR 27 (SC)

[9] Kusumben Mahadevia v Comm’r of Income Tax, [1963] 47 ITR 214 (Bom.)

[10] ITA S.9(1)(v)

[11] Johnson Matthey v Comm’r of Income Tax, [2024] 162 taxmann.com 865 (Delhi); Kanchanganga Sea Foods v Comm’r of Income Tax, [2010] 192 Taxman 187 (SC)