Volkswagen Finance – An unusual interpretation of Business Connection

May 23, 2020 [2020] 116 taxmann.com 685 (Article)

The Mumbai Tribunal in Volkswagen Finance P Ltd. v. ITO [2020] 115 taxmann.com 386 recently decided on the taxability of income earned by a Non Resident whose entire operations were carried on outside India. The decision was path breaking as the Tribunal did not follow the existing jurisprudence on the subject and deemed the payment made to the Non Resident u/s 9(1)(i) based on the amorphous nature of the term 'business connection'.

The case:

Volkswagen Finance Private Ltd. ('VW' in short) was part of the Volkswagen group of companies engaged in manufacture and sale of automobiles. VW organized a lavish event in UAE, to launch the group's new AUDI 8L specifically for potential Indian customers. VW flew in a number of Indian customers to UAE and also roped in Celebrity Star and Oscar award winner, Jonathan Cage of US to stage an appearance in the event. It was a mega event organized outside India where Cage, a resident of US participated for 3 consecutive hours to socialize with the guest, posing for photographs, interviews with select members of the Indian media. Important to note that as per the terms of agreement with Jonathan Cage, VW had full rights to use free non-exclusive promotional usage of all the event footage, material, films, still, interviews etc capturing celebrity's presence across all platform for below the line publicity on internet, in press releases, news reports, social media, Audi Magazine, etc for a period of 6 months from the date of launch event, and for an unlimited period of time only for internal usage within the Volkswagen Group".

VW paid US$ 440,000 to Jonathan Cage as consideration for making this appearance in the event besides reimbursement of expenses of travel, hair, makeup and local transportation. VW did not withhold any taxes as according to VW, no part of the income accrued or arose, nor was deemed to accrue or arise in India. Department contended that the payment was in the nature of Royalty presumably because there was a transfer of rights in respect of the footages. CIT (appeals) upheld the view of the department.

Tribunal Order:

On appeal to the Tribunal, the Tribunal made the following observations:

1.		The Income was not received or deemed to be received in India;
2.		The Income did not accrue or arise in India because the event itself was held outside India
3.		The income however was deemed to accrue or arise in India particularly so because the income arose 'by means of', 'as a consequence of' or 'by reasons of' a business connection in India relying on Explanation 4 to Sec 9(1).

The tribunal noted and rightly so, that categories of 'business connection' are not capable of exhaustive enumeration ('Kanga and Palkhivala') and that the term has been defined in an inclusive and not exhaustive manner in the Income Tax Act. Reference was made to the celebrated decision of the Supreme Court in R.D. Aggarwal v. ITO [(1965) 56 ITR 20 (SC)] to reiterate that one cannot evolve general definition of the term Business connection from past cases but could only be used to infer what relations between the Non-Resident and the activity in India could constitute Business connection. Analysing the facts of the instant case, the Tribunal found that the event, though held in UAE constituted a business connection as:

a.		The predominant benefit of the event was 'below the line publicity on internet, press releases and social media' - i.e., highly targeted advertisement, for audit 8L facelift in India;
b.		The event was 'India Centric';
c.		The targeted audience and potential customers were in India; and
d.		The intended benefits were in India

Tribunal also observed that the entire expenditure was claimed as deduction u/s 37(1) as wholly and exclusively incurred for the purpose of business in India and that 'once the expenses for holding this event is in connection with business in India, it is only natural corollary thereto that income from participation in this event, has a business connection in India.

It appears that the Tribunal refused to be persuaded by earlier decisions as the facts of the case were peculiar in so far as the concept of 'below the line publicity' was never dealt with in any of the earlier decisions.

Analysis:

It is an established proposition that it is income from business connection in India that is deemed to accrue or arise in India, and having a business connection by itself would not bring all incomes under the fold of Sec 5(2)(b). Even post insertion of Explanation 4 expanding the meaning of the term 'through' appearing in sub-section (1), Explanation 1(a) to Sec 9(1) continues to be relevant - "In the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. It should therefore follow that in the instant case, given that no operations were carried out in India, no part of the income should be deemed to accrue or arise in India. In a case involving inter alia Offshore supply of services, the Supreme Court in Ishikawajima Harima Heavy Industries v. CIT in [2007] 158 Taxman 259(SC) held that "there exists a difference between the existence of a business connection and the income accruing or arising out of such business connection". Furthermore, the fact that the payment to Non Resident was tax deductible u/s 37(1) and was wholly and exclusively for the purposes of business in India by itself should not lead to the conclusion that the income arose from business connection in India. Perhaps, the requirement of business connection 'in India' in contrast to 'with India' was not appreciated.

Unsettling settled matters:

The Tribunal's decision can unsettle settled propositions. Even if a business connection with India could be inferred, Courts have consistently held that the income earned by an Overseas Export Agent is not derived from the business connection in India. In CIT v. Toshuku [1980] 125 ITR 525 (SC), it was urged by Revenue that the overseas agent commission amounts should be treated as incomes deemed to have accrued or arisen in India as they, had either accrued or arisen through and from the business connection in India that existed between the non-resident assessees and the statutory agent. Justice Venkataramaiah speaking on behalf of the bench observed that "This contention overlooks the effect of cl. (a) of the Explanation to cl. (i) of sub-s. (1) of s. 9 of the Act which provides that in the case of a business of which all the operations are not carried out in India, the income of the business deemed under that clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. If all such operations are carried out in India, the entire income accruing therefrom shall be deemed to have accrued in India. If, however, all the operations are not carried out in the taxable territories, the profits and gains of business deemed to accrue in India through and from business connection in India shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in the taxable territories. If no operations of business are carried out in the taxable territories, it follows that the income accruing or arising abroad through or from any business connection in India cannot be deemed to accrue or arise in India(See CIT v. R.D. Aggarwal and Co. [1965] 56 ITR 20 (SC) and Carborundum Co. v. CIT [1977] 108 ITR 335 (SC)".

It was of course not the Tribunal's view that any part of the activity of Jonathan Cage was carried out in India. The only issue that turned the decision in favour of Revenue is the unique and fundamentally new concept of 'below the line publicity' targeted at Indian customers which was not encountered in any of the earlier decisions. The Tribunal felt that the operations outside India had a direct effect or nexus to Indian operations and hence the payment made to the Non-Resident had a 'business connection'. With due respects, one would submit that the overriding and well established criterion for taxing income from business connection, is operations by or on behalf of the non-resident within India, and not if any of the operations outside India had an effect on the Indian tax payer. Unless the domestic law is amended to rope in such intangible connections, taxing payments to Non-Residents for operations wholly outside India would not be sustainable. Recent amendments through the Finance Act to introduce Equalisation levy are illustrations of how the law is being amended to rope in business models that were hitherto beyond the scope of the Income Tax Act.

The Treaty angle:

Article 18 of the Indo-US Treaty on 'Income earned by Athletes and Entertainers' may not apply as the event was not staged in India. However, it is not clear as to why the Permanent Establishment angle was not invoked in the given case. If it was indeed business income, the fact that he did not have a PE in India may have settled the issue in favour of the Non Resident.

Conclusion:

The Ruling clearly has unsettled the existing understanding on the subject. Till the issue is settled one way or the other in the superior court, the Tribunal Ruling can have a chilling effect on similar transactions.