Whether A Liability Exists For Filing Return Of Income In Case Of A Foreign Company Earning Non Taxable Income?

Chirag Wadhwa has analyzed the raging controversy as to whether a foreign company is liable to furnish a return of its income under section 139(1) of the Income-tax Act, 1961 even though its income is admittedly not chargeable to tax. He has analyzed the conflicting rulings of the Authority for Advance Rulings and explained the controversy in its correct perspective

The case of whether there is an obligation of filing return of income after claiming treaty benefit has been covered vide my article Heads you Quote PAN, Tails you obtain a PAN. Due to a recent ruling on the concerned matter, the issue has again propped up thereby creating unnecessary confusion & uncertainty. An attempt has been made to provide clarity on the subject matter by analysing several judicial precedents and the statute.

Recently the Authority for Advance Rulings (‘AAR’) in the case of Dow Agro Sciences Agricultural Products Ltd 65 taxmann.com 245 (‘Dow Agro’) held that if there is no tax liability in India there is no requirement of filing return of income, irrespective of the fact that the non taxability is by virtue of treaty benefits. On coming to such a conclusion, the AAR relied on its own judgments in case of Factset Research Systems Inc. 317 ITR 169 (‘Factset’)& Veneburg Group B.V. 159 Taxman 219 (‘Veneburg’).While delivering the judgment in case of Veneburg, the AAR had inturn relied on the ruling of Federal Court in case of Chatturam v. CIT (‘Chatturam’) 15 ITR 302.

Therefore a question arises as to whether the aspect of the ruling dealing with the obligation to file return of income needs reconsideration keeping in view the principles emanating from judicial precedents delivered by AAR itself.

It is important to first analyse the judgments on which reliance was placed by the AAR for arriving at such a deceptive conclusion.

The AAR in its ruling in case of Veneburg held that the liability of payment of taxes is fastened by the charging sections i.e section 4 and 5 of the Act and section 139 being machinery in nature determines the amount of tax.The AAR further stated that there would be no occasion to call a machinery section in aid where there is no liability at all. Reference to the judgment of the Federal Court in case of Chatturam was made.

According to me, the reliance on the judgment of Chatturam is misplaced. The judgment delivered by the Federal Court was in context to Income Tax Act, 1922(‘Old Act’). The provisions of section 22 of the Old Act are not similar to the provisions of section 139 of the Income Tax Act, 1961(‘Act’).Under section 22 of the old act, there was an obligation on the Assessing Officer to issue notice to the assessee to file return of income. In case of Chatturam, the issue was with respect to the powers of the Governor to bring an excluded area into the purview of tax and that too with a retrospective effect. The federal Court affirming the powers further stated that the issue or receipt of a notice was not the foundation of the jurisdiction of the Income-tax Officer to make the assessment or the liability of the assessee to pay the tax. It was based on this principle that the federal court had stated that the liability to pay the tax is founded on Section 3 and 4 of the Old Act which are the charging sections whereas section 22 and others are the machinery sections which determine the amount of tax . The federal court explained that it would not be correct to contend that an Assessing Officer is not entitled to assess the assessee or that the assessee is not liable to pay any tax just because notice had not been issued to him. Thus what the federal court explained was that a mere lapse in issuing of notice, being a procedural fault, would not absolve a person from its liability under the Act. It can be said that any omission to serve or any defect in the service of notices provided by procedural provisions does not efface or erase the liability to pay tax where such liability is created by distinct substantive provisions [charging sections]. Any such omission or defect may render the order made irregular-depending upon the nature of the provision not complied with-but the same cannot be held to be void or illegal

To apply the principle stemming from the ruling of Chatturam in the present scenario, it can be said that in a case where there is no proper or valid service of notice under section 143(2), the liability to pay tax which is founded on the charging provisions of the statute cannot be nullified as such. Thus the liability to pay tax is not dependent on notices. The ruling nowhere stresses on non filing of return of income. In fact the ruling can be interpreted to say that even if Return of Income is not filed, the liability to pay tax would still exist. Filing of return of income does not have any impact on the taxability of income. Ideally it is the taxability of income that has an impact on filing of income i.e. in deciding whether return is to be filed or not. Thus it can be said that placing reliance on the ruling of Chatturam was misplaced and unwarranted.

The AAR also relied on the ruling of Factset. The reliance on the ruling of Factset is also not correct because the facts in the case of Factset were different. Incase of Factset, there was no taxability either under the Act or under the treaty. Accordingly the AAR ruled that there is no obligation to file return of income. However, in case of Dow Agro, the receipt was taxable under the Act and only after availing treaty benefits the amount was considered as not taxable.

During the course of proceeding of the Dow Agro case, revenue had placed reliance on the judgment of Castleton investment Ltd 24 taxmann.com 150 (‘Castleton’), however, the AAR refused to follow the Castleton judgment on the footing that the ruling in case of Castleton had not considered the precedence established by Factset and Vanenburg group B.V (‘Vanenburg’).Since the facts incase of Factset are totally different and reliance on Chatturam is misplaced, not following the ruling of Castleton by stating that it did not consider the above judgments does not seem to be correct.

A question which then arises is whether foreign companies are required to file return of income in India?

There are several rulings which have considered the above aspect:

The AAR vide its judgment in AAR No. 556 of 2002 dated 27th September 2004 had established that if treaty benefits are claimed, the entity would be under an obligation to file return of income. It is unfortunate that neither Veneburg nor Factset relied on the above judgment of the AAR.

The above principle of filing return of income if treaty benefits are claimed was reiterated in the following judgments of the AAR:

XYZ 20 taxmann.com 88, SmithKline Beecham port Louis ltd 24 taxmann.com 153.

The above judgments were rendered in the year 2012 much after the judgment of Veneburg which was rendered in 2007. However,in the above judgments there was no reference of either Factset or Veneburg.

The AAR ruling in case of VNU International B.V (‘VNU’) 198 Taxman 454 had considered the Veneburg ruling. In the case of VNU it was argued by the assessee that 139 is a machinery provision and the same cannot be applied in absence of tax liability. It was also contended by the assessee that if it is burdened with the obligation of filing return of income it would face hardships and the whole purpose of making an AAR application would get defeated. The AAR did not concur with assessee’s contention and analysed the provisions of section 139. The AAR observed that while casting obligation to file return of income by a company, the Legislature in its wisdom has omitted to include the expression ‘exceeded the maximum amount which is not chargeable to income-tax’. Since company is included in the definition of the ‘Person’ as provided under section 2(31) of the Act and a foreign company is included in the definition of ‘Company’ as provided under section 2(17)of the Act, it was held that foreign companies are liable to file return of income in India.

In the case of Deere & Co. 11 taxmann.com 388 the assessee had placed reliance on the rulings of Factset, Veneburg and contended that there is no obligation to file return of income in India. The AAR placing reliance on the judgment of VNU held that irrespective of taxability, foreign companies are liable to file return of income in India.

it is pertinent to analyse the position prior to amendment made by the Finance Act 2001. Earlier, the provisions of section 139(1) provided that if the income exceeds maximum amount not chargeable to tax, then the person would be liable to file return of income. Thus filing of return of income was applicable to all persons (including non residents) if their income exceeded maximum amount not chargeable to tax.

The AAR in case of XYZ Equity Fund 116 taxman 719 had ruled that even a foreign company would be liable to file return of income if its total income exceeds maximum amount not chargeable to tax. AAR analysed the concept of total income and held that it is in computing final income that the assessee claims deduction and exemptions. However the same remains income for the assessee. The AAR explained that it is for the Assessing Officer to decide whether a deduction or exemption is permissible/ allowable.

For the concept of exemption, reference may also be made to the judgment of UOI v. Azadi Bachao Andolan 263 ITR 706 wherein it was held by the Supreme Court that just because an income is exempt it would not mean that the same is not taxable. It is possible for the exemption to be withdrawn. Accordingly even if an income is considered as exempt, the same would continue to be taxable.

While analysing the position prior to amendment made to section 139 by Finance Act 2001, the Supreme Court in the case of Pannalal Nandlal Bhandari v. CIT 41 ITR 76 categorically stated that the provisions of section 139(1) have application to non resident if the income assessable in their hands exceeds the maximum amount not chargeable to tax for the relevant assessment year.

Post the amendment by Finance Act 2001, the provisions of section 139(1) are made steeper by making them applicable to every company irrespective of whether the income exceeds maximum amount not chargeable to tax. Thus the liability of filing return of income existed earlier also and the same exists currently also.

The A.P.Shah committee in its Report on Applicability of MAT on FIIs/FPIs for period prior to 01.04.2015 in para 5.1.1, 5.1.2 have stated the inconsistency in the AAR rulings with respect to MAT. Similar is the case with current issue of filing return of income. The AAR in its rulings is not giving due importance to precedents. Till date, none of the AAR rulings have considered the Supreme Court ruling of Pannalal Nandlal Bhandari . The aspect of return filing is important and interconnected because if the return filing liability is fastened, then the foreign companies would be obliged to obtain PAN.This would inturn result in provision of section 206AA being rendered academic, as there might not be a case where foreign companies may not have a PAN, thereby putting a rest to the controversy of whether the machinery provisions of section 206AA can override the beneficial provisions of section 90. Also non filing of return inturn brings other liability of payment of penalty and prosecution.

The decision of Dow Agro can be considered as a welcome ruling, however the same cannot be said to be unerring and hence with all due respect it requires reconsideration. Also with due regard to the Supreme Court ruling in Pannalal Nandlal Bhandari, to provide the benefit to foreign companies from non filing return of income, an amendment under the Act is required.

So in the current scenario whether a foreign company needs to file return of income in India or not, the answer would depend on the facts of the case. Considering various permutations and combinations there arises 4 situations. First – the foreign companies have no business or economic activities in/with India, second – the foreign companies have business in India but the same is not taxable, third – the operations of foreign company give rise to income which is taxable under the Act but by virtue of treaty the same is not taxed and fourth – the income is taxable both under the Act as well as treaty.

The first situation would cover a company established outside India and not having any business activities in/with India. In such a case by no stretch of imagination can such a company be expected to file return of income in India however by plain reading of the provisions, the Act seems to put an obligation on such companies. However the same does not seem to be a proper interpretation of the provision.

The second situation would be when there are commercial activities of the foreign company in India but the same are not taxable. This might arise in situation like earning business income in absence of PE etc. In my opinion in such a case also there would not be any liability to file return of income. The ruling in case of XYZ Equity Funds can be distinguished. The taxability is decided by provisions of section 4,5 read with section 9 of the Act. If it is said that an particular income does not fall within the gamut of the provisions of section 4,5 read with section 9, then that income is not taxable at all. The concept of exemption of income is totally different because to qualify as an exemption, the income has to first be taxable. If the income is not taxable itself, then there arises no question of exemption. Accordingly, if an income is not taxable, there would not arise any liability of filing return of income. However considering the ruling of the Supreme Court in case of Pannalal Nandlal Bhandari and the provisions of section 139(1) of the Act, it seems that an obligation to file return of income is fastened.

The third situation would arise in a case where the income is taxable under the Act and by taking benefit of DTAA, the income becomes not taxable. In such a case placing reliance on the ruling of Castleton it can be said that liability to file return of income arises on the foreign company.

Under the fourth situation, the income of the company would be taxable under the Act as well as under the DTAA. In such a case, undoubtedly there would be liability to file return of income.

The provision of section 139(1) needs to be amended so as to settle this prodigal controversy.

Before concluding, it is important to bring into notice the provision of sections 115A, 115AC, 115BBA & 115G of the Act. They absolve the liability of non residents/foreign companies to file return of income subject to fulfillment of certain prescribed conditions. The conditions provided are that the total income of the non residents shall comprise of only such income as is prescribed in the relevant section and the tax deductible at source under the provisions of Chapter XVII-B of the Act has been duly deducted.

In context of non filing of return of income section 115A provides that the total income of the non resident should include only dividend (other than those referred in section 115-O) and/ or certain specified interest income. Section 115AC provides for income from bonds or Global Depository Receipts in the form of interest income, dividends (other than those referred in section 115-O).On the same context section 115BBA provides income of non resident sportsmen, sports association and entertainers earned from participation in games or sports or performance in India and Section 115G provides income earned by non residents as investment income or income by way of Long term capital gains or both.

Since the requirement is that only such income needs to be earned as is provided in the relevant section, it would not be possible for the non resident/foreign company to simultaneously earn income referred to in more than one section and not file return of income. Accordingly on a literal interpretation of the provisions, even if a foreign company has earned some bank interest over and above the income specified in the relevant sections, the foreign company would be liable to file return of income as in such a case the condition would be considered as not fulfilled. However it would not be correct to give such a strict interpretation to these sections.

The next condition of deduction of tax at source also consists of ambiguity. This is for the reason that the language used by the provision is tax ‘deductible’ as per provisions of Chapter XVII-B of the Act. Thus it would not be wrong to assume that department would take a stand that 206AA would prevail the ‘rates in force’ and there by for non holding a PAN tax would have to be deducted at a higher rate. The same would be possible because section 206AA also fall under Chapter XVII-B of the Act. However,the same situation would not arise when the foreign company would have a PAN. Also on a reference to the favorable judgments of DCIT v. Serum Institute of India Ltd 56 taxmann.com 1 (Pune tribunal), DCIT v. Infosys BPO Ltd ITA No. 8(B) of 2013 (Bang tribunal) and Article 51(c) of the Constitution of India, the issue seems to be rather settled.

The benefit of the above provisions providing for non filing of return of income would be limited since it does not include income in the nature of royalty, fees for technical services etc. The only income which is included is dividends, interests, capital gains and only for non resident sports persons and other income from sports activities in India. Accordingly a non resident earning business income along with capital gains would be under an obligation to file return of income. Also a non resident earning business income (not consisting of the above specified incomes) would be liable to file return of income as it would not be satisfying the prerequisite condition of earning only specified income.

Thus on an even note it can only be expected that the government brings in amendments to the respective sections thereby clearing the ambiguity on the matter.