Finance Act 2010 amendment to Section 9 cannot retrospectively tax offshore technical-service payments, Karnataka HC rules

The Appellant entered into agreements dated 20 September 1995 with Raytheon Ebasco Overseas Ltd. (REOL), Badger Energy Inc. and Energy Overseas International Inc. for offshore equipment supply, engineering, transportation, erection and related services.

The Appellant deducted tax at source on certain payments to REOL, but the Assessing Officer subsequently treated the payments as fees for technical services taxable in India under Section 9(1)(vii) of the Income-tax Act, 1961, and raised substantial demands for assessment years 1996–97 and 1997–98 under Section 201(1).

The Commissioner (Appeals) and the Income Tax Appellate Tribunal upheld the demands, holding that the services were utilised in a business carried on in India and were therefore taxable under Section 9(1)(vii) and Article 12 of the India–USA DTAA.

During the pendency of the appeals, the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd. v. Director of Income Tax held that, for fees for technical services to be taxable in India, the services had to be both rendered and utilised in India.

The Finance Act, 2007 amended Section 9 retrospectively, and a Coordinate Bench of the High Court thereafter granted the Appellant partial relief, holding that the requirement of rendering services in India remained unaffected.

Subsequently, the Finance Act, 2010 amended the Explanation to Section 9(2), with retrospective effect from 1 June 1976, to provide that taxability would arise whether or not the non-resident had rendered services in India.

The Department obtained review of the earlier High Court judgment, while the Appellant separately challenged the constitutional validity and retrospective operation of the Finance Act, 2010 amendment through W.P. No. 192 of 2011.

1. Whether the High Court’s earlier judgment dated 16 March 2009 was liable to be reversed or modified in light of the amendment to Section 9 introduced by the Finance Act, 2010.

2. Whether the retrospective application of the Finance Act, 2010 amendment to Section 9 from 1 June 1976 was unconstitutional and legally invalid.

3. Whether the payments made by the Appellant for offshore technical services could be subjected to tax and tax-deduction obligations for the relevant assessment years on the basis of the retrospective amendment.

The Court applied Sections 4, 5(2), 9(1)(vii), 9(2) and 195 of the Income-tax Act, 1961.

Section 9(1)(vii)(c), as interpreted in Ishikawajima-Harima Heavy Industries Ltd. v. Director of Income Tax, required the technical services to be both rendered and utilised in India before the resulting income could be deemed to accrue or arise in India.

The Court held that an Explanation described as being “for the removal of doubts” is retrospective only when genuinely clarificatory; if it changes or enlarges the scope of the charging provision, it cannot ordinarily operate retrospectively, relying on Sedco Forex International Drill Inc. v. CIT and M.M. Aqua Technologies Ltd. v. CIT.

It further relied on Union of India v. Martin Lottery Agencies Ltd., which held that an Explanation widening the taxing net cannot be treated as retrospective merely because it is labelled clarificatory.

The Court also applied the principle that tax liability is ordinarily determined by the law in force during the relevant assessment year, as recognised in Sedco Forex and CIT v. Goslino Mario.

Under Section 90(2), where the domestic law and the applicable tax treaty permit competing interpretations, the interpretation more beneficial to the assessee must prevail; the Court therefore considered Article 12 of the India–USA DTAA.

The Court found that the Finance Act, 2010 amendment expressly removed the requirement that the non-resident must have rendered services in India, thereby enlarging the taxability of offshore technical services beyond the twin-condition test established in Ishikawajima-Harima.

In the Court’s view, this was not a mere clarification of an existing ambiguity but a substantive alteration of Section 9(1)(vii), creating or widening a tax charge on transactions that were not taxable under the law as interpreted for the relevant years.

Since the Appellant’s services were rendered outside India, the twin conditions were not satisfied under the law applicable at the time of payment, and the subsequent retrospective amendment could not be used to impose a new withholding or tax liability for the past period.

The Court also held that the withdrawal of beneficial CBDT Circulars could operate only prospectively, as the later circular was oppressive rather than beneficial to taxpayers.

In addition, the Court observed that Article 12 of the India–USA DTAA supported the more favourable interpretation for the Appellant.

It held that the Finance Act, 2010 amendment to Section 9, although framed as clarificatory and stated to operate from 1 June 1976, could not be applied retrospectively to impose tax liability on the Appellant for offshore technical services rendered during the relevant assessment years.

The amendment was therefore read down as operating prospectively, and the earlier High Court decision granting relief to the Appellant was not displaced retrospectively.

The Department’s Review Petitions in R.P. Nos. 317–319 of 2010 were dismissed, and pending interlocutory applications were disposed of as having become infructuous.