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Section 195, DTAA and Business Connection

Posted @ February 3, 2014, 2:58 am under (International Taxation Services)

Business Connection (BC) : BC is the Indian equivalent of PE and also broader in connotation and is used effectively to tax the income of Non-Residents in India. Business connection may be in several forms e.g. branch or subsidiary in India carrying on business of its head office or parent company located outside India would also be a business connection in India. Any profit of non -resident which can be reasonably attributable to the such part of operations carried out by its business connection in India are deemed to be earned in India [Explanation 1 to Section 9].
The landmark judgment of the Andhra Pradesh High Court in GVK Industries Ltd. v. ITO 2003-TII-239-HC-AP-INTL has laid down following principles which needs to be satisfied in order to constitute BC:
  • Existence of close, real and intimate relationship
  • Commonness of interest
  • Continuity of activity or operation
  • A stray or isolated transaction is not enough to establish a business connection [Anglo French Textile Co Ltd v CIT - (2002-TII-09-SC-LB-INTL)]
In Blue Star Engineering Co. (Bom) Pvt. Ltd. Vs CIT - (2003-TII-75-HC-MUM-INTL) it was held that the expression �Business connection" is a expression of wide and indefinite import and is different from the expression �business" as defined under the Act .
It has been clarified by Circular No. 23 dated 23-7-1969 that the income from the transaction will not be deemed to accrue or arise in India under section 9 provided that the sales are made on a principal-to-principal basis and at arm's length price.
One of the most complex situations may arise if one considers the warp and weft of the interplay of section 195 along with the provisions of a Double Tax Avoidance Agreement with the embroidery of Section 9 , dealing with Business Connection thrown in for good measure.
Initially one must consider the distinction between a legal liability to tax as opposed to a fiscal Liability. Even in this sphere there is no clarity. In Abdul Razzaq’s case 146 Taxman115 (AAR), it was held that a person was not entitled to claim the benefits of the  earlier Indo UAE Tax treaty since there was no liability to tax in the UAE , and hence the income would be subject to tax in India. However in another case of Green Emirates Shipping, the exact opposite was decided.  Currently there is a new India UAE DTAA in place which addresses this anomaly.
Another issue to be considered in this context is that taxability in the case of an airline and shipping Company is based on the theory of effective control also known as the “head & Brain” theory. The question of residence versus control and management is to be considered, Again a distinction needs to be made for effective management against mere operational management to determine the question of the situs of taxation .
Further the question of a Permanent Establishment (“PE”) as per the relevant DTAA and the attribution of income to it (different under various treaties) also needs to be considered
Taxability , if no DTAA  is subsisting, will depend on whether there is a business connection under section 9 of the act, as a business connection is wider in scope than a PE (Western Union’s case). Further the Apex court has  held that there needs to be a territorial nexus in order to constitute a PE as held in Ishiwajimakarma Harima industries case 2007 158 Taxman 259 SC.  The territorial nexus clause as a necessity for a business connection has been removed from Finance Act 2007 and the definition of India is also sought to be widened with the inclusion of the airspace.

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