DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES?

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DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

ABSTRACT
Jurisdiction is a sine-qua-non of sovereignty. Its an expression of power which the sovereign expresses over its subjects. While this principle is unambiguous, the power of a sovereign to legislate matters beyond its jurisdiction is a debatable one. There is no express prohibition with regard to the same in international law. But However states have to adhere to the doctrine of territorial nexus in order to rule out the probability of arbitrariness. The enforcement of taxing statutes beyond its territorial limits also functions on same principle. In Indian context, in recent times this issue has resurfaced especially with regards to Income Tax Act, 1961. There is no express provision at disposal which lays down that the Act shall have extra-territorial operation or application. However, parliament has been granted power under Article 245 of Constitution of India and it can be also inferred that an Act having extra-territorial operation cannot be declared to be illegal. Therefore it can be purported that if an Act operates extra-territorially if and only if some nexus can be established between the subject matter and the object to be achieved thereupon. This article seeks to explore this proposition with valid arguments, authorities and logical deductions.

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

INTRODUCTION
It would be a wrong assumption that the doctrine of territorial nexus came into existence after the International bodies preached about the same but this principle traces its origin since the time when colonies and provinces under the British were empowered to make laws coupled with strict restrictions. In order to keep the clonies under the authority of the Crown, it was the law that nonsovereign legislatures such as Canadian Provinces, Australian States and British colonies could only legislate with regard to their own territory and were debarred from legislating with extra-territorial effect1. Hence the principle originally stemmed from the need to keep the colonys powers to legislature under check2. However, as the time took its leap and as the colonial rule collapsed the principle proliferated into the jurisprudence of other nations, and found its way into the Constitutions of various nations of the world; with some modifications and rationale behind it has been altered too; for instance Article 245 of Constitution of India. Lord Halsbury gave a reasonable justification for its employment by stating, The more reasonable theory is that the language was used, subject to the well known and well considered limitation that they were only legislating for those who were actually within their jurisdiction and within the limits of the colony3 In this paper, I seek to analyse the applicability of this doctrine in todays world. In this regard, I have relied on various commentaries, articles, legal opinions of lawyers and most importantly recent trend in the way judicial pronouncements have been delivered by courts in India and UK. The reasons of its adoption in present scenario under the Constituion of India from
1 2

Mr. Avtar Singh, Introduction to Interpretation of Statutes, (2001) at p. 156. Maxwell on Interpretation of Statutes at p. 173. 3 Macleod v. Attorney General of New South Wales, (1891) AC 455 (PC).

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former colonial rule. To analyse this, I have attached core attention to taxing statutes that deal with the situation of the property and the nexus to be established with respect to legislation pertaining to foreigners. This would clear the clouds as to how much nexus needs to be actually established for a statute to e upheld as valid. Whether the court should look into the extent of liability, when nexus has been established has also been considered. A brief overview of this principle with regards to criminal legislation has also been dealt with. Though the primary aim of this paper is to holistically understand the Doctrine of Territorial Nexus in toto and its applicability in Indian taxing statutes.

CONSTITUTION OF INDIA VIS-A-VIS DOCTRINE OF TERRITORIAL NEXUS

Prior to the Constitution of Indias existence , Section 99 (1)4 of the Government of India Act, 1935 codified this principle, while Section 99 (2) enumerated certain matters for which federal alws can be made, even with extra-territorial operation. Apart from the matters so enumerated, both the Federal and Provincial legislatures had o abide by the principle of territorial nexus 5. The principle also enumerates that a law made by a legislature must bear a real territorial connection with the subject-matter with which it is dealing. An important case where the direct application of this principle is evident is the recent Enrica Lexie case where in the Indian Penal laws were applied to Italian navy personnel
4

Subject to the provisions of this Act, the Federal Legislature may make laws for the whole or any part of British India and a Provincial Legislature may make laws for the Province or for any part thereof 5 S.D. Sharma, Applicability of the Doctrine of Extra-territoriality to Legislation by the Indian Legislature, 28 (3/4), Journal of Comparative Legislation and rd International Law, 3 Series, Vol. 28, No. (1946), pp. 91-95.

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

deployed on a foreign ship having killed Indian fishermen assuming them mistakenly as Pirates, as the test of universality6 comes into play which enumerates on universal crimes against humanity or universal offences against which a State can enforce jurisdiction outside its territories as well. The same principle had been applied long back to Canadian Case of Croft v. Dumphy.7 In this case, the Canadian Customs Act, 1927 that authorised seizure of vessels and cargo hovering within twelve miles from the coast was challenged as ultra vires, as the Parliament was operating beyond its territories. However, the Privy Council held that, despite the general principle that States can operate only within their own territory, the Act was held not to be ultra vires. The reasoning behind this can be derived from Lord Uthwhatts judgement in a leading case8 wherein he stated No doubt the enabling statute to be read against a background that only a defined territory has been committed to the charge of the legislature. Concern by subordinate legislature with affairs or person outside its own territories may, therefore, suggest a query whether the legislature is in truth minding its own business. It does not compel the conclusion that it does not This brings us to a inference though not a prerequisite but as to there must be some extent of nexus between the statute and the territory to which it seeks to apply and compels us to ponder upon the question as to what is the extent and importance of this principle, and how far this nexus must be established for the statute to be upheld. However, Section 6 of the Independence Act, 1947 the principle was modified to a considerable extent and confined in very different light. It stated that the Legislature of the Dominion of India was concerned with full power to make laws for that Dominion including laws having extra-territorial effect. The reason for the
6 7

Section 404 of Restatement (Third) Foreign Relations Law, (1987). AIR 1933 PC 16 8 Wallace Bros v. CIT, Bombay , AIR 1948 PC 118

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

change in the language that codified this principle was that the British realised that they no longer have control over India, and that it was no longer a colony. Taking greater cognizance of the fact that India was soon going to be a sovereign the legislation sought to remove the generally accepted limitation of colonial legislative jurisdiction, a limitation that only the Courts of a colony are bound to recognise. After such a dramatic change in the political structure, resulting in practically a reversal in the law, it is interesting to analyse how the courts have evolved the principle. Article 245 (2): No law made by Parliament shall be deemed to be invalid on the ground that it would have extra-territorial operation. Thus, it is clear that the Parliament may make laws with extra-territorial operation. However, the Courts are under certain restrictions as to when they can exercise such jurisdiction. Some of these restrictions were laid down in Vishwanathan v. Abdul Wajid. Looking at the nature of these restrictions, one can see that they are merely situations that are outside the Courts power to enforce. However, the privilege of making laws with extra-territorial operation is not given to the State Legislatures. The most evident illustrations on this point are the cases that deal with situation of the property A State can effectively legislate only with regard to those properties which are clearly situated within the boundaries of that State. This applies even to trusts which administer such properties. However, if a nexus can be established as regards the income generated from the property, or though persons connected with the functioning of the property, or through persons connected with the functioning of the property, the statutes governing such properties may be upheld. This was made clear in the case of State of Bihar v. Charusiladasi. In this case, the Bihar Hindu Religious Trusts Act, 195, which applied to all trusts in Bihar, so long as they have some and not necessarily all property in the State, was challenged on the ground that it lacks territorial nexus. The Supreme Court rejected

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

this argument stating that when the endowments themselves are situated in Bihar, and the trustees who run the trust are also situated in Bihar, there is sufficient nexus established between the religious trusts and the property. The real nature of this nexus led the Court to uphold the statute, even though the properties themselves might be situated outside the State. Now to undertake an analysis of what are the requirements for a sufficient nexus, and what amounts to a real one?

THE TWO-PRONG TEST FOR ESTABLISHING THE EXISTENCE OF NEXUS In State of Bombay v. R.M.D. Chamanbaugwala9, the test for testing the sufficiency of territorial connection was laid down. These were: 1. The connection must be real and not illusory. 2. The liability sought to be imposed must be pertinent to the connection. The meaning of real and not illusory can be analysed by looking at taxing statutes that have incorporated this principle in their ratios.10 In the above-mentioned case, a company incorporated in the State of Mysore, printed and published its newspaper there, but circulated them in the State of Bombay. The State of Bombay sought to levy tax on the money made by the citizens by winning crossword puzzle competitions that the newspaper sponsored. It was argued was as per Entry 62 of List II of Schedule VII of the India Constitution. The Company argued that it was not entitled to pay this state tax as it violated the Principle of Territorial Nexus as the company was incorporated outside the State. The
9

10

AIR 1957 SC 699 State of Bihar v. Charusiladasi, AIR 1959 SC 1002.

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

Apex Court rejected this argument and held that as the standing invitations, filing up of the forms and the payment of money took place within the State of Bombay, there was sufficient territorial nexus and that entitles the State of Bombay to levy this tax, and the statute imposing such tax cannot be struck down on the grounds of extra-territoriality.11 In Wallace Bros. v. CIT, Bombay12, Section 4-A that added to the Income Tax Act, 1922 by way of an amendment to the Act in 1935, was challenged. This section made a company incorporated and managed exclusively form oustside British India liable to be assessed for income tax in British India on entirety of its income, if the income of the company is accrued in British India was greater than that it accrued from its operation outside British India in that particular year. Relying on the reasoning mentioned, the Privy Council upheld the impugned amendment. In State of Bombay v. United Motors (India) Ltd.,13 the territorial cope of Entry 54 of List II of schedule VII on the Indian Constitution was analysed. A. 246(3) reads, Legislature of any state specified in Part A or Part B of the First Schedule has exclusive power to make laws for such state or any part thereof with respect to any of the matters enumerated in List II in the Seventh Schedule The Apex Court held that for such State or any part thereof only means that the statute must be for the purpose of that State and further ruled that the activities within the State concerning buying and selling of the goods were held to be sufficient basis to tax the goods, even if the actual sale and purchase was not14.

11 12

State of Bombay v. R.M.D.C., AIR 1957 SC 699 AIR 1948 PC 118 13 AIR 1953 SC 252 14 S.R. Bhansali, The Constitution of India, First Edition (2007) Vol. II, India Publishing House, Jodhpur.

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

RULES OF CONSTRUCTION: THE PRESUMPTION OF TERRITORIALITY

Usually, there is a presumption that the legislation is territorial, i.e. that the statute is not intended to apply to persons or situations outside the territories to which the statute is expressed to apply to.15 This is rule even when no express limitation or restriction on the basis of territorial nexus is imposed on the legislative competence. Thus, the usual rule of construction is that the legislature is presumed to be within its constitutional powers and is not expressly violating the principle of territorial nexus. This implies that when there are two possible constructions, the one which leads to a conclusion that does not violate this principle will be preferred.

CORRELATION BETWEEN TERRITORIAL NEXUS AND EXTENT OF LIABILITY

As per the Governement of India Act, 1935 so long as a nexus was established between the provisions of a statute and the territory where it is sought to apply, the proportionality of the liability so imposed could bot be looked into.16 Even postindependence, this position was reiterated in State of Bombay v. R.M.D.Chamanbaugwala.17 Although the GOI Act, 1935 has been repealed and the Constitution of India is silent on this point, it is argued that the present position is that articulated in R.M.D.Chamanbaugwala. The reasoning behind this position is
15

Cross, Statutory Interpretation (3 Ed., J. Bell and G. Engle eds., 1995), at pg. A. Singh, supra note 1, at pg. 157 AIR 1957 SC 699.

rd

16 17

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

that it is only the validity of the legislation that is being tested on the benchmark of the Principle of Territorial Nexus, and not the policy itself, which concerns the nature and extent of liability imposed.18 This proposition is also supported by the UK case law. 29 thus the current position is that when the court looks into existence of nexus to determine whether the statute is intra vires or not, it will not look into the extent of liability that the statute seeks to impose which would form a different question altogether.

THE PRESUMPTION OF CONSTITUTIONALITY

There most of the debates that have taken place as to the Constitutionality and applicability of the Section 9 of the Income Tax Act, 1960. While examining the constitutionality of a statute, the first and most basic obstacle encountered is the strong presumption in favour of the con-stitutionality of a statute,18a presumption which the Supreme Court itself has stated, only the clearest and weightiest evidence can displace.19 This presump-tion is taken even further in matters involving economic policy and exercise of discretion in fiscal matters. The interference of the Court in such matters must not happen unless the exercise of legislative judgment appears to be palpably arbitrary 20 the view reflected in the legislation is not possible to be taken at all.21 Similarly, in the matter of the constitutionality of 9 of the Act, there is definitely a presumption in favour of the benevolent aspect of the legislator, 22 one which must be sustained taking into consideration matters of common knowledge, matters of common report, the history of the times and assuming every state of facts which can be conceived existing at the time of legislation.23
18

G.G. in Council v. Raleigh Investment Co. Ltd., AIR 1944 FC 51

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

At the same time it is just as well settled that such a presumption is a rebuttable one 24 and if it is in fact shown that a certain legislation is unfair to the point of palpable arbitrariness, the Courts may strike down such legislation as unconstitutional. It is submitted that 9 of the Act, as it stands, is unconstitutional and rebuts the presumption of constitutionality since firstly, it is beyond the legislative competence of the Parliament to the extent that it seeks to tax fees for technical services that were not rendered in India and secondly, as it offends Art. 14 of the Constitution by treating dissimilar entities similarly.

EXTRA TERRITORIAL OPERATION SANS TERRITORIAL NEXUS: PARLIAMENTS COMPETENCE

Taxes are the lifeblood of the government, but it cannot be over emphasized that the blood is taken from the arteries of the taxpayers and, therefore, the transfusion has to be accomplished in accordance with the principles of justice and fair play.19 -Nani Palkhivala CONSTITUTIONAL POSITION OF EXTRA TERRITORIAL LAWS To explore the validity of legislations having extra territorial op-eration, due consideration of the history of Art. 245 is required. 65 of the Government of India Act, 1915, dealt with the legislative power of the Indian legislature at that time. Clause (a) was strictly territorial; while clauses (b) and (c) allowed the legislature to make laws with extraterritorial effect, provided that the nexus requirements (all subjects of His Majesty and all native Indian subjects respectively) were satisfied. The inclusion of clauses (b) and (c) was necessitated by a few decisions which imposed a strict

19

Kanga & Palkhivala, The Law and Practice of Income Tax, IX (Dinesh Vyas Ed., 2004)

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nexus requirement.20 Thus, clauses (b) and (c) widened the requirement of a nexus to that extent. 99(1)21 of the Government of India Act, 1935, which conferred legislative power, modified the position of law in so far as it permitted legislation only for the whole or any part of British India. It, however, also provided in 99(2) for certain exceptions to this rule.22 The Privy Council in the Wallace Brotherscase23 clarified the position of law, clearly laying down the necessity of a definite territorial nexus. In A.H.Wadiav. CIT,24 however, while further impressing on the need for territorial nexus, the Bombay High Court declared that there was nothing unconstitutional about an extra territorial legislation as long as such nexus requirement is fulfilled. More recently, 6(1) and 6(2) of the Indian Independence Act, 1947, provided that the legislature of each of the New Dominions shall have full power to make laws for that Dominion, including laws having extra-territorial operation.

20

Blackwood v. The Queen, (1882) 8 AC 82; Provincial Treasurer of Alberta v. Kerr, (1933) AC 710. 21 99(1), Government of India Act, 1935: Subject to the provisions of this Act, the Federal Legislature may make laws for the whole or any part of British India or for any Federal State and a Provincial Legislature may make laws for the Province or for any part thereof. 22 99(2), Government of India Act,1935: Without prejudice to the generality of the powers conferred by the preceding sub-section, no Federal law shall, on the ground that it would have extra-territorial operation, be deemed to be invalid insofar as it applies (a) to British subjects and servants of the Crown in any part of India or (b) to British subjects who are domiciled in any part of India wherever they may be or (c) to or to persons on, ships or aircraft registered in British India or any Federated State wherever they may be. 23 Wallace Bros. & Co. Ltd. v. CIT, (1947-48) 75 IA 86. Speaking for a three judge bench, Uthwatt, J. stated that the general conception as to the scope of income tax is that given a sufficient territorial connection between the person sought to be charged and the country seeking to tax him, income tax may properly extend to that person in respect of his foreign income. 24 (1949) 17 ITR 63 (FC).

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

Today, under our present constitutional scheme, the Parliament may make laws which operate extra-territorially.25 Arts. 245 (1) and (2)26 of the Constitution prescribe the extent of laws made by Parliament and it is declared that no law made by Parliament shall be invalid on the ground that it would have extra-territorial operation.27 Therefore, the Parliament undoubtedly has power to enact law having extra-territorial application.28 On the face of it, it would appear that the law as it stands is clear and precise in disregarding any previous requirement of territorial nexus. This interpretation would also seem the most logical, keeping with the principle of sovereignty as enshrined in the Preamble, since the Government of India Acts gave law-making power to the legislatures of British India, while the Constitution gives such power to a sovereign and independent India.

JUDICIAL EXPOSITION OF EXTRATERRITORIAL TAXATION LAWS

The view taken by the Supreme Court in this regard, in consonance with principles of international law and sovereignty, is that a legislature which passes a law having extra-territorial operation may find that what it has enacted cannot be directly enforced but the Act is not invalid on that account, and the courts of its country must

25

Vodafone International Holdings B.V. Union of India, (2010) 7 Taxmann 13 (Bom). 26 The Constitution of India, 1950, Art. 245(1): Subject to the provisions of this Constitution, Parliament may make laws for the whole or any part of the territory of India, and the Legislature of a State may make laws for the whole or any part of the State. (2) No law made by Parliament shall be deemed to be invalid on the ground that it would have extra-territorial operation. 27 Electronics Corporation of India Ltd. v. CIT, 1989 Supp (2) SCC 642: 83 ITR 43 (SC). 28 Maneka Gandhi v. Union of India, (1978) 1 SCC 248: AIR 1978 SC 597.

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enforce the law with the machinery available to them.29 In other words, while the enforcement of law cannot be contemplated in a foreign State, it can, nonetheless, be enforced by the courts of the enacting State to the degree that is permissible with the machinery available.30 Therefore, the question that arises is whether a nexus with something in India is necessary to establish tax liability in such cases. The Supreme Court has stated that unless such a nexus exists, Parliament has no competence to make such extra-territorial law. The provocation for an extra-territorial law must be found within India itself and while a law may have extra-territorial operation in order to serve a certain object, that object must be related to something in India in the first place. It is absolutely inconceivable that a law should be made by Parliament which has no relationship with anything in India.31 It is just as true that this connection must be a real one and the liability sought to be imposed must be pertinent to that connection.32 Therefore, the presence of Art. 245(2) notwithstanding, there must be a territorial nexus between the transaction sought to be taxed and India, for a tax liability to be placed on such a transaction happening outside India. The question of the validity of 9 had arisen previously, in Electronics Corporation of India Ltd. v. CIT,33 and the Supreme Court had referred the question of constitutionality to a Constitution Bench. The case, however, was withdrawn on settlement and never came up for hearing. While discussing the challenge on the constitutional validity of 9, the Court stressed on the necessity of a territorial nexus, but also went
29

British Columbia Electric Railway Company Limited v. The King, (1946) AC 527, approved in Electronics Corporation of India Ltd. v. CIT, 1989 Supp (2) SCC 642: (1990) 183 ITR 43 30 G.V.K. Industries Ltd. v. ITO, 228 ITR 564 31 Electronics Corporation of India Ltd. v. CIT, 1989 Supp (2) SCC 642. 32 The State of Bombay v. R. M. D. Chamarbaugwala, 1989 Supp (2) SCC 642: AIR 1957 SC 699. 33 1989 Supp (2) SCC 642: (1990) 183 ITR 43 (SC).

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on to state that if, due to such extra territorial application, unenforceability arises as a consequence, this in itself cannot be found as sufficient basis to challenge the validity of the statute.

INTERNATIONAL PERSPECTIVE ON REQUIREMENT OF NATIONALITY The argument of the authors that the words any person must be read to mean any residents is also supported by many countries and their statutes. The authors would first give examples of a few countries with similar provisions and then deal extensively with U.K. decisions which provide effective guidelines in the Indian situations. WITHHOLDING TAX PROVISIONS IN STATUTES OF VARIOUS COUNTRIES In various countries, withholding tax in case of non-residents applies only when payments are made by residents to nonresidents. According to the Japanese Income Tax Act and its withholding provisions, withholding tax applies only if they are paid in Japan or if they are paid abroad and the payer also has an office, residence within Japan.34 As per the French Tax Code, only that interest paid by a French debtor to a non-French tax resident is subject to French withholding tax.35 A similar provision exists in the Russian and Singaporean system as well.36
34

Japan, Income Tax Act, Act No. 33 of March 31, 1965, Chapter V: Withholding at Source of Income of Nonresidents or Corporation, Art. 212. See also Japan External Trade Organization, available at http://www.jetro.go.jp/en/invest/setting_up/ laws/section3/page4.html (Last visited on September 2, 2011). 35 See Tax Directorate, The French Tax System, available at http://www.impots.gouv.fr/ portal/ deploiement/p1/fichedescriptive_1006/fichedescriptive_1006.pdf (Last visited on September 2, 2011. 36 Withholding Tax on Interest on Corporate Debt, available at http:// us.practicallaw.com/7-385-8420 (Last visited on October 2, 2010)

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

Thus, these examples from a few other countries suggest that it is generally followed that withholding tax is applicable only when payments of whatever nature are made from a resident, either a person or a corporation to a non-resident. Although the authors agree that this would vary from statute to statute, examples of these countries should serve as effective guidelines to the Indian legislature and judiciary in resolving certain confusions regarding application of 195.

U.K. CASE LAWS ON TEST OF NATIONALITY In a decision of the House of Lords in Clark v. Oceanic Contractors,37 followed in Andre Agassi v. Robinson38 their Lordships had to directly consider the question of whether chargeability is ipso facto sufficient nexus to attract TDS provisions. A TDS provision for payments made outside England, was not given extraterritorial application, based on principles of statutory interpretation. In these English cases, the provisions in question were 18 and 555 of their taxing Act called Corporation Taxes Act, 1988. 18 read as clearly as to say that it applies to any person, whether a Commonwealth citizen or not, although not resident in the United Kingdom from any trade profession or vocation exercised within the United Kingdom. Further, even 555 was apparent enough to state that where a payment is made (to whatever person) and it has a connection of a prescribed kind with the relevant activity , the person by whom it is made shall on making it deduct out of it a sum representing income tax and shall account to the Board for the sum.

37 38

Clark v. Oceanic Contractors, [1983] 2 WLR 94 Andre Agassi v. Robinson, (2006) 1 W.L.R. 1380.

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

Even in light of these clearly worded provisions which indicate the scope of the provisions, the Court in the Agassi case applied the principles mentioned above to hold it inapplicable outside the territorial boundary. They held this on the basis of the fact that transaction was entered into between non-resident companies; the provisions could not be attracted.43 555 (2) is a TDS provision and this was held inapplicable extraterritorially. If this case is to be followed, clearly, the High Court should have excluded the applicability of 195 as well in the Vodafone case. In the above cases, the famous ruling in Ex parte Blain39 was quoted to say that [i]f a foreigner remains abroad, if he has never come into this country at all, it seems impossible to imagine that the English legislature could ever have intended to make such a man subject to particular English legislation. It lay down, categorically that the dilemma of extraterritoriality of a provision is a series of questions, of statutory construction. These principles are that: The meaning adopted should be that which advances the overall purpose of the legislation. This is to say that the words of an Act are to be read in their entire context and in harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament. Further, results that would lead to absurdity or to frustration of the objective of the legislation should be avoided. If the words are ambiguous and open to two interpretations, the benefit of interpretation is given to the subject. Nothing must be implied in a taxing statute.

TERRITORIALITY OF 195 IN LIGHT OF THE PENALTIES UNDER THE INCOME TAX ACT

39

Ex Parte Blain, 12 Ch. D. 522. (C. A. I879)

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

It is a widely accepted principle that unlike remedial provisions which can be dealt with a little leniently, penal provisions, including civil and criminal tax penalties, are to be strictly construed. This means that if it is not clear whether the language of a penal provision applies to the tax-payer s conduct, then the statute will be interpreted narrowly in favour of the tax-payer.40 This was quoted with approval by Lord Esher MR in Tuck v. Priester41 where he said that If there is a reasonable interpretation which will avoid the penalty in any particular case we must adopt that construction. If there are two reasonable constructions we must give the more lenient one. That is the settled rule for penal sections. The reason is that imposing penalties interferes with the liberty of the subject by taking the subjects money or property by fines or forfeitures. The penal terms must be sufficiently explicit to inform those who are subject to it what conduct on their part will render them liable to its. The citizen cannot be held to answer charges based upon penal statutes whose mandates are so uncertain that they will reasonably admit of different constructions. This is the reason why if the statutory words are ambiguous or obscure, a construction should be placed on them that is least restrictive of the individuals rights.42

40

See Saurabh Soparkar, Interpretation of Penal Provisions under Direct Taxes, available at http://www.itatonline.org/interpretation/interpretation14.php (Last visited on September 12, 2011). See also, State of West Bengal vs. Kesoram Industries Ltd., (2004) (266 ITR 721); Cape Brandy Syndicate vs. IRC; 1921 (1) KD 64, 71. See also Somendra Chandra Bose, Interpretation of Revenue Statutes , available at http://www.itatonline.org/interpretation/interpretation6.php, (Last visited on September 12, 2010) 41 Tuck v. Priester, (1887) 19 QBD 638 42 SeeJohn L. Freeze, Extraterritorial Enforcement of Revenue Laws, 23 WASH. U. L. Q. 321 (1937-1938); Lawrence Robertson, Extraterritorial Enforcement of Tax Obligations, 7 ARIZ. L. REV. 219 (1965-1966); Robert A. Leflar, Extrastate Enforcement of Penal and Governmental Claims, 46 HARV. L. REV.193-225 (1932); B.J. George, Extraterritorial Application of Penal legislation, 64 MICH. L. REV609-638 (1966)

DOCTRINE OF TERRITORIAL NEXUS WHETHER CONFINED TO TAXING STATUTES

Under the Act, there are certain penalties enumerated for failure to deduct tax at source under Chapter XVIIB. One of the most significant penalties imposed is that the assessee is treated as an assessee-in-default under 201 in case he defaults on TDS payments. Further, 271C stipulates a penalty of the amount of tax which has not been deducted. V arious other sections also impose penalties which are in the nature of civil fines.43 276B in particular is extremely stringent as it enforces a penalty of rigorous imprisonment for a term which shall not be less than 3 months but which may extend to 7 years and with fine. This is enforced when there is failure to pay the tax deducted at source under Chapter XVII-B to the credit of Central Government. Thus, failure to deduct tax at source under 195 can lead to such a harsh penalty as well. Furthermore, another roadblock in this respect is that of enforcement. Enforcing such penal provisions against nonresidents can prove to be an area of difficulty for the income tax department as well as the other authorities in question. Thus, it is observed that in light of these penal provisions, which are both civil and criminal in nature, it would be quite unfair to tax payments made outside India by non-residents to other non-residents. It would attract international denigration and can prove to be harmful to Indias growth in the global corporate market.

9 OF THE INCOME TAX ACT, 1961 VIS-A-VIS DOCTRINES ENCOMPASSING ITS EXTRA-TERRITORIAL OPERATION if Nazi Germany had not invaded other countries but had simply sought to eliminate the entire Jewish population within its own territorial borders, this would not have constituted a violation of international law, as incredible as this now seems. Mark Gibney in his book International Human Rights Law: Returning to Universal Principles
43

The Income Tax Act, 1961, 221 read with 201; 272A(2)(c); 272A(2)(g); 272A(2)(i).

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The territorial nature of law is an argument not only about law but also about sovereignty. And not only sovereignty of a state in its own territory but also the sovereignty practised by a state above its citizens; wherever they may roam. What follows below is a brief look at the extra-territorial applicability and doctrines surrounding the oft debated Section 9 of the Indian Income Tax Act, 1961. International taxation is based on political, residential or economic allegiance between the taxpayer and the taxing state44.The general principle, flowing from the sovereignty of States45, is that laws made by one State can have no operation in another State46 unless given a sufficient territorial connection or nexus between the person sought to be charged and the country seeking to tax him. Thus, even under the Indian Income Tax Act, 1961 such a distinction exists vide Section 4, section 5 and Section 9. Section 4 and 5 of the Income Tax Act impose a general charge, which is given a particular application in respect of non-residents by Section 9 which enlarges the ambit of taxation by deeming income to arise in India in certain circumstances.47 Thus, Indian income-tax may extends to a foreign citizen or to income earned abroad only in respect of certain cases where a connection between the income sought to be taxed and the India can be established. Once, this connection is established and the case of the assessee falls within the ambit of Section 9, only then can the income earned abroad be taxed48

44 45

Schanz, Zur Frage Der Steuerpflicht, 9 Finanz-Archiv 365, 372 (1892) British Columbia Electric Railway Co.Ltd. Vs. King, (1946) AC 527 (PC) p. 533 46 Electronics Corporation of India Limited v. Commissioner of Income Tax and Anr. , AIR 1989 SC 1707, Para. 8 47 CIT, New Delhi v. M/s. Eli Lilly and Company (India) Pvt. Ltd, (Appeal No. 5114 of 2007), decided on: 25/3/2007, 29 48 Sheraton International Inc. v. Deputy Director Of Income Tax, [2007] 293 ITR 68 (Delhi), 40

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This connection too should be based on (1) the residence of the person; or (2) business connection49 within the territory of India. This connection involves a consideration of two basic elements viz.: (a) the connection must be real and not illusory;50 and (b) the liability sought to be imposed must be pertinent51 to that territorial connection.52 There, however, exist various theories with regards to the taxing power of states in cases of International Taxation all of which pertain to different aspects of the underlying territorial nature of taxation laws. A few of the main theories are described below: 1. Principle of Source Jurisdiction: As per Finance Act, 1976, through insertion of clauses (v), (vi) and (vii) in s.9 (1) for income by way of interest, royalty or fees for technical services respectively, a source rule was inserted. It means that the situs of rendering of services is not relevant but the situs of the payer and utilization of services to determine taxability of such services in India.[10] Thus, Income having its source in India may be taxed regardless of the residence of the tax payer. 53It is a multi-faceted concept54 where utilization of services serves as a concept of taxation under this principle. But nonresident companies may only be taxed on those profits which arise from a source within the taxing countrys
49

Shyamal Mukherjee , Attribution of Profits To Permanent establishments: A Developing Countrys Perspective, 10 Geo. Mason L. Rev. 785 50 Tata Iron & Steel Co. Ltd. v. State of Bihar, AIR 1958 SC 452, 40 51 International Tourist Corporation and Ors. v. State of Haryana and Ors, AIR 1981 SC 774 52 The State of Bombay v. R.M.D. Chamarbaugwala, AIR 1957 SC 699, 27 53 Julie Rogers-Glabush (ed.), IBFD International Tax Glossary, 6th edn, p. 294, 394. 54 K. Vogel, Worldwide vs. Source Taxation Income A Review And ReEvaluation Of Arguments,(Part I, Intertax 1988). pp. 216, 223.

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jurisdiction.55However, some countries may consider the source country where the services are utilized and others might treat the country where services originate as the source. In India vide the Finance Act, 2010 and the Explanation inserted in Section 9 (1) (vii), only the rendering of services in India is pre-requisite to tax under this rule. 2. Theory of Equivalence: Also known as the exchange theory56, this is followed in many countries, such as the United States of America. It is a four-pronged approach to determine taxability. A states tax passes57 if it (1) is assessed against a taxpayer with whom the state has substantial nexus,58 (2) is fairly apportioned, (3) is non-discriminatory, and (4) is fairly related to the services provided by the State. The elements of this test were articulated in Complete Auto Transit, Inc. v. Brady59. 3. Effects Doctrine: Any state may impose liabilities, even upon persons not within its allegiance, for conduct outside its borders that has consequences within its borders which the state represents.60 For example, a simple perusal of section 5(2) denotes that the words all income from whatever source derived, have a very wide connotation to include any

55

Adrian Ogley, The Principles Of International Tax-A Multinational Perspective, Interfisc Publishing. (London, 1996) p.33-35. 56 League of Nations, Report On Double Taxation, by Bruins, Einaudi, Seligman and Sir Josiah Stamp 18 (1923)
57

John A. Swain, State Income Tax Jurisdiction: A Jurisprudential And Policy Perspective, 45 Wm. & Mary L. Rev. 319 58 Quill Corp. v. North Dakota, 504 U.S. 298, 312-13 (1992) 59 430 U.S. 274, 276-78 (1977) 60 Haridas Exports v. All India Float Glass Mfrs. Association and Ors., (2002) 6 SCC 600 (para 60).

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effect of a transaction felt in India.61 Like the extra-territorial application of the MRTP Act, 1969, if the service is utilized in India, there shall be enough effect felt in India for the authorities to levy tax.[20] International law accepts that a state may levy tax so long as there is some kind of real and not illusory link between the state and the proposed taxpayer based on nationality or domicile. Non-resident corporations and individuals are subject to income tax on any income effectively connected with their domestic business62 subject to a simple three-fold test for determining sufficient territorial nexus: the business must be of a (1) regular nature, (2) it must be continuous, and (3) it should be of a substantial nature.63 4. Taxing E-commerce: Electronic commerce is defined as the ability to perform transactions involving the exchange of goods or services between two or more parties, using electronic tools and techniques,64 which includes physical telecommunications networks, cable television, mobile, and cellular networks.65 Permanent establishment based on the use of an internet service provider (ISP), software agent, server, telecommunications device, cable, computer terminal, or web page, are recognized as legally valid.66 The taxation of transactions conducted entirely via electronic means is a
61

Vodafone International Holdings B.V. v. UOI, WP No. 1325 of 2010, Decided on: Sept. 8, 2010 (para 137). 62 Internal Revenue Code, 871 to 877, Internal Revenue Code, 881 to 884. I.R.C. 63 Spermacet Whaling & Shipping Co. v. Commissioner, 30 T.C. 618, 634 (1958). 64 U.S. DEPT OF TREASURY, Selected Tax Policy Implications of Global Electronic Commerce< http:www.ustreas.gov/treasury/internet.html> last visited th 15 August 2012 (para 3.2.1). 65 Howard E. Abrams & Richard L. Doernberg, How Electronic Commerce Works, 15 TAX NOTES INTL 1573 (1997), p. 1574. 66 James D. Cigler et al., Cyberspace: The Final Frontier for International Tax Concepts?, 7 J. INTL TAXN 340, 346 (1996) p. 347.

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recent trend in International Taxation and thus has many theories with regards to who has the power to tax a certain transaction. However, the OECD supports the principle of value creation- only activities, which create value, are relevant in determining a states right to impose an income tax. The mere fact that an enterprise is able to sell into a jurisdictions marketplace does not indicate that the foreign enterprise is creating value in the state.67 Accessibility to a market does not necessarily entail an enterprises participation in the economic life of a country, but simply reflects the enterprises participation with the economic life of a country. It remains appropriate therefore to limit the right of income taxation to those jurisdictions that serve as the origin of that income by virtue of providing the economic life that made possible the yield or the acquisition of the wealth68 Thus, these are the main jurisprudential theories with regards to taxation and its territorial nature. As can be seen not all these theories rigidly adhere to the principle of territorial nexus for the purposes of taxation, however, most of them intend to levy tax based on some form of territorial connection or other.

CRIMINAL LEGISLATION AND THE PRINCIPLE OF TERRITORIALITY

67

The Technical Advisory Group on Treaty Characterization of Electronic Commerce Payments, Tax Treaty Characterization Issues Arising From ECommerce-Report To Working Party No. 1 Of The OECD Committee On Fiscal Affairs, 2001, 35 68 See, e.g., Professors Bruins, Einaudi, Seligman and Sir Joshia Stamp, Report on Double Taxation at 23, submitted to the Financial Committee of the League of Nations, April 5th 1923 (Doc. E.F.S.73.F.19) (the 1923 Report). See also Report of Technical Experts, Double Taxation and Tax Evasion, Report and Resolutions, submitted to Financial Committee of the League of Nations, February 7th 1925 (the 1925 Report).

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The general principle is that a State has the jurisdiction to punish criminal acts done within its territory by citizens and foreigners alike. It may also punish the acts of its citizens, irrespective of where the acts were committed.69 This also supported by S. 2 and S. 4 of the Indian Penal Code, 1860. 70 In this regard, there is a presumption that a statute creating a criminal offence doe not, in the absence of clear and specific words to the contrary, make an Act done by a foreigner outside the territorial jurisdiction of the State an offence triable in the criminal court of the State.71 An interesting aspect of the law here is that of Universal Jurisdiction with respect to certain crimes. For instance, certain offences such as genocide and piracy are those that can be tried by any State, irrespective of where such a crime has been committed.72

CONCLUSION

69 70

Sessex Peerage Case, (1844) 11 CI & Fin 85. Indian Penal Code, 1860, Section 2: Every person shall be liable to punishment under this Code and not otherwise for every act or omission contrary to the provisions thereof, of which he shall be guilty within India. Section 4: The provisions of this Code apply also to any offence committed by: (1) any citizen of India in any place without and beyond India; (2) any person on any ship or aircraft registered in India wherever it may be. 71 Air India v. Wiggins, (1980) 2 All ER 593 (HL). 72 Universal Jurisdiction, Amnesty International, available at, http://www.amnestyusa.org/international_justce/ pdf/UniversalJurisdiction.pdf. Last accessed on 17th August, 2012.

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In India, the principle of territorial nexus has gone through a variety of changes. Starting with the British restriction on extraterritorial legislation, it has evolved into one where the Parliament has a free hand to do so. However, this free reign is also subject to certain limitations; and States annot undertake extra-territorial legislation at all, as per the Indian Constitution. This principle has particular application in raltion to taxing and property related statutes, where there needs to be a direct territorial nexus between the property/activity so taxed and the statute that taxes it. The principle is essentially one that tests the competence of the legislature to enact a particular statute, and RMD Chamanbaugwala is the leading case that laid down the real and direc requirement of this principle. As regards whether the courts, while testing a statute on grounds of nexus, may also look into the proportionality of liability so imposed, the conclusion is a resounding no, as principle only seeks to test the competence of a legislation and its merits. This is also supported by the position in the UK. the the the not

The general presumption is that a statute will have nexus and that the legislature did not intend to violate this principle, unless expressly provided for. Hence, when a statute is unclear or ambiguous, effect will be given to it, such as in keeping with this principle. The Parliament is also competent to make laws relating to foreigners, and relating to Indian Citizens outside the territory of India. However, the prime restriction and general principle is that no legislature may make laws relating to non-citizens who are not within the territorial limits of the State. There is also a presumption that a statute was not drafted intending to violate principles of international law; and while this cannot be a consideration when the

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statute is unambiguous to start with; it is certainly a consideration when it is not.73 Also as regards criminal legislation, while in the ordinary course of things a State has prime responsibility to punish the acts of its citizens, there are exceptional circumstances in which other states may also undertake investigation or prosecution. These are situations like genocide that warrant such universal jurisdiction. The approach of the Courts has continuously reflected the political atmosphere at the time, the widest interpretation being preferred, so as to uphold the questionable statute, so long as it may be enforceable. Although the change in the law began with legislative amendment, it is both enactment and interpretation that have contributed to the meaning of the principle today. Though it would seem like the courts are, in reality, trying to find a nexus in most cases, to save the statute, determining it on a case-specific basis, thus taking into account many factors while reading the enactment, the final result shows much more consistency. They have continuously upheld the broadest interpretations of the principle, the presumption of it being satisfied always paramount, only curbing the States power to legislate when it is not practicable. Thus even though the enacted law has undergone severe changes, the Courts have played a vital role in maintaining stability in the principles application

73

Salmon v. Commissioner of Customs and Excise, (1966) 3 All ER 871.

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Ask SIR as to how should you incorporate Wadia Case GVK case and VIH case???

http://www.mehta-mehtaadvisory.com/territorialnexus-revisited-gvk-industries-v-union-of-india/

Territorial Nexus Revisited: GVK Industries v. Union of India

Posted on May 4, 2011 by Team - Mehta & Mehta

We have previously discussed issues surrounding the application of the territorial nexus doctrine to income tax law in several posts (here, here, here and here). In its recent decision in GVK Industries v. Union of India, a Constitution Bench of the Supreme Court has confirmed that the doctrine applies to Parliamentary laws. The precise question of the constitutionality of Section 9(1)(vii) of the Income Tax Act, 1961 was not answered by the Constitution bench. In GVK, the following questions were referred to the Constitution bench: (1) Is the Parliament constitutionally restricted from enacting legislation with respect to extra-territorial aspects or causes that do not have, nor expected to have any, direct or indirect, tangible or intangible impact(s) on, or effect(s) in, or consequences for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, wellbeing of, or security of inhabitants of India, and Indians? (2) Does the Parliament have the powers to legislate for any territory, other than the territory of India or any part of it? The Court explained the constitutional scheme by holding, The grant of the power to legislate, to the Parliament, in Clause (1) of Article 245 comes with a limitation that arises out of the very purpose for which it

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has been constituted. That purpose is to continuously, and forever be acting in the interests of the people of India. It is a primordial condition and limitation Clause (2) of Article 245 carves out a specific exception that a law made by Parliament, pursuant to Clause (1) of Article 245, for the whole or any part of the territory of India may not be invalidated on the ground that such a law may need to be operated extraterritorially. Nothing more. It was specifically held that any laws enacted by Parliament with respect to extra- territorial aspects or causes which have no impact on or nexus with India would be ultra vires Article 245 of the Constitution of India. In a few Tribunal decisions such as Ashapura Minichem (discussed here and here), there were remarks that the doctrine of territorial nexus may not necessarily be relevant in tax laws (It is thus fallacious to proceed on the basis that territorial nexus to a tax jurisdiction being sine qua non to taxability in a jurisdiction is a normal international practice in all systems. This school of thought is now specifically supported by the retrospective amendment to section 9). GVK impliedly confirms that those observations must be read in their context. The issue of whether in particular Section 9(1)(vii) especially after the recent amendments satisfies the nexus requirements, is still unanswered. As Ashapur Minichem held, the render + utilize formula of Ishikawajima and Clifford Chance is now statutorily overridden by the Finance Act, 2010. Perhaps, Courts may now again insist on a factual live link to be established before the provisions of S. 9(1)(vii) can be invoked.

BIBLIOGRAPHY BOOKS:Avtar Singh, INTRODUCTION TO INTERPRETATION OF STATUTES, (New Delhi:Wadhwa and Co., 2001).P. St. J. Langan ed., MAXWELL ON THE INTERPRETATION OF STATUTES, (London:Sweet & Maxwell, 12th edn., 1969).Cross,

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STATUTORY INTERPRETATION (J. Bell & G. Engle eds., London: Butterworths,3rd edn., 1995),F.A.R. Bennion, STATUTORY INTERPRETATION: A CODE, (London: Butterwoths, 3rdedn., 1997).G.P. Singh, PRINCIPLES OF STATUTORY INTERPRETATI ON, (New Delhi:Butterworths Wadhwa, 10th edn., 2010).William N. Eskridge, LEGISLATION AND STATUTORY INTE RPRETATION,(Foundation Press, 2nd edn., 2006)