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DOCTRINE OF TERRITORIAL

NEXUS WHETHER CONFINEDTO TAXING STATUTES?


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DOCTRINE OF TERRITORIAL NEXUSWHETHER 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 logicaldeductions.


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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 non-

sovereign 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, Themore 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 itsadoption in present scenario under the Constituion of India from

1Mr. Avtar Singh,Introduction to Interpretation of Statutes, (2001) at p. 156.

2Maxwell on Interpretation of Statutesat p. 173.

3Macleodv. 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-VISDOCTRINE OF TERRITORIAL NEXUS

Priorto 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 nexus5. 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 Lexiecase where in the

Indian Penal laws were applied to Italian navy personnel

4Subject 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 lawsfor the Province or for any partthereof5

S.D. Sharma, Applicability of the Doctrine of Extra-territoriality to Legislation bythe Indian Legislature, 28 (3/4), Journal of Comparative Legislation andInternational Law, 3

rdSeries, Vol. 28, No. (1946), pp. 91-95.


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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 ofCroftv. 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 reasoningbehind 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 asto 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

6Section 404 of Restatement (Third) Foreign Relations Law, (1987).

7AIR 1933 PC 16

8Wallace Bros v. CIT, Bombay , AIR 1948 PC 118


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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 ofthe 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


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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 Bombayv. 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 bylooking 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 entitledto pay this state tax as it violated the Principle of Territorial

Nexus as the company was incorporated outside the State. The

9AIR 1957 SC 699

10State of Bihar v. Charusiladasi, AIR 1959 SC 1002.


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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 Bro s. v. CIT, Bomb ay12, 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 hasexclusive 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 ScheduleThe 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.

11State of Bombay v. R.M.D.C., AIR 1957 SC 699

12AIR 1948 PC 118

13AIR 1953 SC 252

14S.R. Bhansali, The Constitution of India, First Edition (2007) Vol. II, India

Publishing House, Jodhpur.


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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 principleof 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

LIABILITYAs 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 post-

independence, 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

15Cross, Statutory Interpretation (3

rdEd., J. Bell and G. Engle eds., 1995), at pg.

516

A. Singh, supra note 1, at pg. 15717

AIR 1957 SC 699.


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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 intoconsideration 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

18G.G. in Council v. Raleigh Investment Co. Ltd., AIR 1944 FC 51


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At the same time it is just as well settled that such a presump-

tion 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 SANSTERRITORIAL 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 EXTRATERRITORIAL 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 Indiansubjects respectively) were satisfied. The inclusion of clauses (b)

and (c) was necessitated by a few decisions which imposed a strict

19Kanga & 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 Courtdeclared 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.

20Blackwood 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 Indiaor for any Federal State and a Provincial Legislature may make laws for theProvince or for any part thereof.22

99(2), Government of India Act,1935: Without prejudice to the generality ofthe powers conferred by the preceding sub-section, no Federal law shall, on theground that it would have extra-territorial operation, be deemed to be invalidinsofar as it applies (a) to British subjects and servants of the Crown in any partof India or (b) to British subjects who are domiciled in any part of India whereverthey 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 judgebench, Uthwatt, J. stated that the general conception as to the scope of incometax is that given a sufficient territorial connection between the person sought tobe charged and the country seeking to tax him, income tax may properly extendto that person in respect of his foreign income.24

(1949) 17 ITR 63 (FC).


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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 ap-

pear 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 EXTRA-

TERRITORIAL 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 thisConstitution, Parliament may make laws for the whole or any part of the territoryof India, and the Legislature of a State may make laws for the whole or any partof the State. (2) No law made by Parliament shall be deemed to be invalid on theground 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 some-

thing 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 some-

thing 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 transactionhappening 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) SCC642: (1990) 183 ITR 4330

G.V.K. Industries Ltd. v. ITO, 228 ITR 56431

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, un-

enforceability 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 non-

residents. 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

34Japan, 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 CorporateDebt, available at http://us.practicallaw.com/7-385-8420 (Last visited on October 2, 2010)


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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. 18read 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.

37Clark v. Oceanic Contractors, [1983] 2 WLR 94

38Andre Agassi v. Robinson, (2006) 1 W.L.R. 1380.


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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

39Ex Parte Blain, 12 Ch. D. 522. (C. A. I879)


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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

40See Saurabh Soparkar, Interpretation of Penal Provisions under Direct Taxes,

available at http://www.itatonline.org/interpretation/interpretation14.php (Lastvisited on September 12, 2011). See also, State of West Bengal vs. KesoramIndustries Ltd., (2004) (266 ITR 721); Cape Brandy Syndicate vs. IRC; 1921 (1)KD 64, 71. See also Somendra Chandra Bose, Interpretation of RevenueStatutes , available at http://www.itatonline.org/interpretation/interpretation6.php,(Last visited on September 12, 2010)41 Tuck v. Priester, (1887) 19 QBD 63842

SeeJohn L. Freeze, Extraterritorial Enforcement of Revenue Laws, 23 WASH.U. L. Q. 321 (1937-1938); Lawrence Robertson, Extraterritorial Enforcement ofTax Obligations, 7 ARIZ. L. REV. 219 (1965-1966); Robert A. Leflar, ExtrastateEnforcement 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)


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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 deducttax 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 non-

residents 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 harmfulto 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 sou ght to el iminate the ent ire Jewish p opulat ion w ith in

its own terr i tor ial borders, th is would n ot have const i tuted aviolat ion of internat ional law, as incredib le as this now

seems. Mark Gibney in his book International Human Rights

Law: Returning to Universal Principles

43The 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.Andnot 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 givena 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

44Schanz, Zur Frage Der Steuerpflicht, 9 Finanz-Archiv 365, 372 (1892)

45British Columbia Electric Railway Co.Ltd. Vs. King, (1946) AC 527 (PC) p. 53346

Electronics Corporation of India Limitedv. Commissioner of Income Tax andAnr. , AIR 1989 SC 1707, Para. 847

CIT, New Delhiv. M/s. Eli Lilly and Company (India) Pvt. Ltd, (Appeal No. 5114of 2007), decided on: 25/3/2007, 2948

Sheraton International Inc. v. Deputy Director Of Income Tax, [2007] 293 ITR68 (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 betaxed 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 non-

resident companies may only be taxed on those profits which

arise from a source within the taxing countrys

49Shyamal Mukherjee ,Attribution of Profits To Permanent establishments: A

Developing Countrys Perspective, 10 Geo. Mason L. Rev. 78550

Tata Iron & Steel Co. Ltd. v. State of Bihar, AIR 1958 SC 452, 4051International Tourist Corporation and Ors. v. State of Haryana and Ors, AIR1981 SC 77452

The State of Bombayv. R.M.D. Chamarbaugwala, AIR 1957 SC 699, 2753

Julie Rogers-Glabush (ed.), IBFD International Tax Glossary, 6th edn, p. 294,394.54

K. Vogel, Worldwide vs. Source Taxation Income A Review And Re-Evaluation 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

Explanationinserted 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 taxpasses57 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 hasconsequences 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

55Adrian 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)

57John A. Swain, State Income Tax Jurisdiction: A Jurisprudential And Policy

Perspective, 45 Wm. & Mary L. Rev. 31958

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) 6SCC 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 substantialnature.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 internetservice 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

61Vodafone 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).64U.S. DEPT OF TREASURY, Selected Tax Policy Implications of GlobalElectronic Commerce< http:www.ustreas.gov/treasury/internet.html> last visited15

thAugust 2012 (para 3.2.1).

65Howard E. Abrams & Richard L. Doernberg, How Electronic Commerce Works,

15 TAX NOTES INTL 1573 (1997), p. 1574.66

James D. Cigleret al., Cyberspace: The Final Frontier for International TaxConcepts?, 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.67Accessibility to a

market does not necessarily entail an enterprises

participation in the economic life of a country, but simply

reflects the enterprises participationwith the economic life of

a country. It remains appropriate therefore to limit the right ofincome 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

67The Technical Advisory Group on Treaty Characterization of Electronic

Commerce Payments, Tax Treaty Characterization Issues Arising From E-Commerce-Report To Working Party No. 1 Of The OECD Committee On FiscalAffairs, 2001, 3568

See, e.g., Professors Bruins, Einaudi, Seligman and Sir Joshia Stamp, Reporton Double Taxation at 23, submitted to the Financial Committee of the League ofNations, April 5th 1923 (Doc. E.F.S.73.F.19) (the 1923 Report). See alsoReport of Technical Experts, Double Taxation and Tax Evasion, Report andResolutions, 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

69Sessex Peerage Case, (1844) 11 CI & Fin 85.

70Indian Penal Code, 1860, Section 2: Every person shall be liable to

punishment under this Code and not otherwise for every act or omission contraryto 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 extra-

territorial 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 the

grounds of nexus, may also look into the proportionality of the

liability so imposed, the conclusion is a resounding no, as the

principle only seeks to test the competence of a legislation and not

its merits. This is also supported by the position in the UK.

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 presumptionthat 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 withlegislative 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

73Salmon 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/territorial-

nexus-revisited-gvk-industries-v-union-of-india/

Territorial Nexus Revisited: GVK

Industries v. Union of IndiaPosted onMay 4, 2011byTeam - 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
http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/http://www.mehta-mehtaadvisory.com/author/admin/http://www.mehta-mehtaadvisory.com/author/admin/http://www.mehta-mehtaadvisory.com/author/admin/http://www.mehta-mehtaadvisory.com/author/admin/http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/http://www.mehta-mehtaadvisory.com/territorial-nexus-revisited-gvk-industries-v-union-of-india/


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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 (discussedhere and here), there were remarks that the doctrine of territorial

nexus may not necessarily be relevant in tax laws (I t 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)

consti - iii project

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