Clarification regarding Explanation 5 to clause (i) of sub-section (1) of section 9 of Income-tax Act, 1961

CIRCULAR No. 4 /2015

Government of
India

Ministry of Finance

Department of Revenue

Central Board
of Direct Taxes

North Block, New Delhi
Dated 26th March, 2015

Subject: Clarification regarding
Explanation 5 to clause (i) of sub-section (1) of section 9 of Income-tax Act, 1961 (`Act’) – regarding

Section 9 of the Income-tax Act provides for incomes which are
deemed to accrue or arise in India. Clause (i) of sub-section (1) of the said section reads as under:-

“9. (1) The following incomes shall be deemed to accrue or arise in India:—

(1)

the transfer of a capital asset situate in India.”

2.                 
The Finance Act, 2012 inserted Explanation 5 to clause (i) of
sub-section (1) of section 9. The said explanation reads as under:-

“Explanation

3.                 
A number of representations have been received by the Board stating that
the purpose of introduction of Explanation 5 was to clarify the legislative intent
regarding the taxation of income accruing or arising through transfer of a capital asset situate
in India. Apprehensions have been expressed about the applicability of the Explanation to the
transactions not resulting in any transfer, directly or indirectly of assets situated in
India. It has been pointed out that such an extended application of the provisions of the
Explanation may result in taxation of dividend income declared by a foreign company outside India.
This may cause unintended double taxation and would be contrary to the generally
accepted principles of source rule as well as the object and purpose of the amendment made by
the Finance Act 2012.

4.                 
The matter has been examined in the Board. The Explanatory Memorandum
to the Finance Bill 2012 explains the purpose of the amendment to section 9
(1)(i) in the following words:- 

“Section
9 of the Income-tax Act provides cases of income, which are deemed to accrue or
arise in India. This is a legal fiction created to tax income, which may or may
not arise in India and would not have been taxable but for the deeming provision
created by this section, Sub-section (1)(i) provides a set of circumstances in which
income accruing or arising, directly or indirectly, is taxable in India. One of
the limbs of clause (i) is income accruing or arising directly or indirectly
through the transfer of a capital asset situate in India. The legislative
intent of this clause is to widen the application as it covers incomes, which
are accruing or arising directly or indirectly. The section codifies source
rule of taxation wherein the state where the actual economic nexus of income is
situated has a right to tax the income irrespective of the place of residence
of the entity deriving the income. Where corporate structure is created to
route funds, the actual gain or income arises only in consequence of the investment
made in the activity to which such gains are attributable and not the mode through
which such gains are realized. Internationally this principle is recognized by several
countries, which provide that the source country has taxation right on the gains
derived of offshore transactions where the value is attributable to the
underlying assets……………………..Certain
judicial pronouncements have created doubts about the scope and purpose of
sections 9 and 195. Further, there are certain issues in respect of income deemed
to accrue or arise where there are conflicting decisions of various judicial
authorities.

Therefore,
there is a need to provide clarificatory retrospective amendment to restate the
legislative intent in respect of scope and applicability of section 9 and 195 and
also to make other clarificatory amendments for providing certainty in
law.”

5.         The Explanatory Memorandum clearly
provides that the amendment of section 9(l)

(i) was to
reiterate the legislative intent in respect of taxability of gains having economic
nexus with India irrespective of the mode of realisation of such gains. Thus,
the amendment sought to clarify the source rule of taxation in respect of
income arising from indirect transfer of assets situated in India as explicitly
mentioned in the Explanatory Memorandum. Viewed in this context, Explanation 5
would be applicable in relation to deeming any income arising outside India
from any transaction in respect of any share or interest in a foreign company or
entity, which has the effect of transferring, directly or indirectly, the
underlying assets located in India, as income accruing or arising in India.

6.         Declaration of dividend by such a
foreign company outside India does not have the effect of transfer of any
underlying assets located in India. It is therefore, clarified that the dividends
declared and paid by a foreign company outside India in respect of shares which
derive their value substantially from assets situated in India would not be
deemed to be income accruing or arising in India by virtue of the provisions of
Explanation 5 to section 9 (1 ) (i) of the Act.

7. This may
be brought to the notice of all concerned for strict compliance.

8.
Hindi version to follow.

     Sd/-

Anup Singh

                                                                                    Under
Secretary
to the
Government of
India

(F.No. 500/17/2015-FT&TR-IV)

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