Mumbai tribunal affirms territorial nexus as essential in determining attributable profits

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Mumbai tribunal affirms territorial nexus as essential in determining attributable profits

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The Mumbai Income Tax Appellate Tribunal (tribunal) has held that a territorial nexus is necessary for determining profits attributable to operations carried out in India. Agency commission accrued, or arising, outside of India is not taxable under domestic laws.

Under the provisions of the Income-tax Act of 1961, income that has arisen directly or indirectly from a business connection is considered taxable in India. In business cases where not all operations are carried out in India, the income deemed taxable is considered 'reasonably attributable' to operations carried out in India. The applicability of this provision has been upheld in several judicial precedents.

In the case dealt with by the tribunal, the taxpayer is a foreign company (tax resident of Hong Kong) and is appointed by a television channel as an agent to:

  • Sell advertising air-time on the channels;

  • Distribute the channels in the territories where the channels are broadcast; and

  • Procure syndication revenues from the content on the channels.

In a particular year, the taxpayer earned agency commission on advertising services in India, as well as outside India. However, at that particular time, India did not have a tax treaty with Hong Kong.

It appears that the foreign company had a business connection in India and income attributable to the business operations. As a result, the taxpayer was compensated with an amount equal to the profit earned by the channel companies and overseas entities that had merged into an Indian group entity.

Profit attribution was determined on sound transfer pricing (TP) principles and by applying a global profitability percentage.

The tax authorities accepted the TP methodology and profit margin. However, the tax authorities made an adjustment on the amount taxable by the taxpayer (i.e. commission received towards services rendered outside India). It was also argued that under the Act, certain offshore income earned by a non-resident (i.e. by way of interest/royalty/fees for technical services) is taxable in India, irrespective of the place of rendition of the services or the presence of a business connection in India.

Subsequently, the tribunal rejected the position of the tax authorities. In this case, reliance on the provisions relating to the taxation of certain offshore income was not applicable to the agency commission earned by the taxpayer.

The tribunal held that the income taxable in India will only be part of the income as 'reasonably attributable' to the operations carried out in India. The income which could be said to be taxable in India should have a 'territorial nexus'.

Since the commission fee was paid to the taxpayer outside India for services rendered outside India, the tribunal held that it was not attributable to operations in India and hence not taxable in India.

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