Last month the Central Board of Direct Taxes or CBDT withdrew circular 23 of 1969, an administrative circular that provided clarity on taxation on non-residents in India. The CBDT claimed that a circular had been withdrawn, “The interpretation of the circular by some of the tax payers to claim relief was not in accordance with provisions of section 9 of the Income Tax act or the intention behind the issuance of the circular, so what does the withdrawal of this circular mean for non-resident tax payers. Sudhir Kapadia, Partner at E&Y discusses the issue.

Here is a verbatim transcript of the exclusive interview on CNBC-TV18. Also watch the accompanying video.

Q: Can you give me a quick background of what circular 23 did and therefore what the withdrawal of it is likely to be?

A: This is a 40 year old circular in the days where there was no transfer pricing, it gave a great deal of certainty and direction. In situations where a foreign company carried out business in India; one of the examples, through an Indian agent and a simple example, lets say the value of the goods sold in India by the foreign company was 100 and the agent got a commission of 5 as a remuneration for his sales and marketing efforts in India so if you take that example, what the circular said is that as long as the assessing officer is satisfied that the amount of commission paid of 5 in a scenario like this is fair and reasonable. Nothing more needs to be attributed to the so called business connection also created by the foreign company because remember when a foreign company sells good on a regular basis in India, it does create a taxable presence of its own regardless of the agents activities which is a separate entity. So technically a question could arise that is anything above 5 also attributable, so the circular said no, let’s keep matters simple and certain that in a situation like this nothing further needs to be attributed. So I think that has served an important purpose of giving directions in situations like this and affording certainty. Since this circular now is sought to be withdrawn, take the same example and in a given case where a foreign company is also helping the Indian company, after all in business and in day to day scenario, that is quite seamless working together, lets say a few people come here from the parent company to basically discuss marketing strategies sales strategies etc. So the question will now arise that these so called additional activities performed by the foreign company is anything over and above 5 to be attributed and that becomes  a contentious issue and a subjective issue.

So I think theis is one aspect of it.

The second aspect would be where you have a treaty country where in case the foreign company belongs to a treaty country where the question is of permanent establishment, even there when you contribute profits attributed to the establishment, the circular was useful in actually revolving a principle, to say that as long as from a transfer pricing perspective, the amount attributed for the activities in India was arms length and nothing more was required to be done. So the circular, though 40 years old served a useful purpose even when we are now in a transfer pricing era and we are now increasingly in treaty country situation, so I would say that was the main gist and the main objective of this circular.

Q: What kind of complications is this absence of circular likely to create for foreign companies in India, one is the scope of which activity which we likely carried out in India is deemed to be beyond the scope of the remuneration being paid to the agent in India, what else?

A: For example other cases could be where there is any activity being carried out in India for which remuneration is already paid to an Indian subsidiary of the parent or any other Indian agent and lets us say that if some services are performed by the Indian company by way of sending people here on the ground in relation to their activities. In many situations of treaty countries, there is a service permanent establishment clause in addition to the agency clause. So again, technically a question arises that are services being rendered by the foreign companies in India. The correct view would be that if you are not rendering services to the third parties then there ought not to be any further determination of profits attributable for those activities, but the fact is that the revenue has been raising the contention that as long as services are rendered, even if they are rendered as an example to a whole subsidiary or to a zone agent in India selling a good zone on your behalf, then that also creates an additional basis for attribution in India because of service PE so again this could be another situation where uncertainty arises again this circular helped atleast in arguing that nothing more needs to be attributed even if supposedly some kind of a PE is created. From a simplicity point of view and a certainty point if view as long as arms length is established whatever maybe the situation, I think that should have been sufficient.

Q: So is this going to impact cases like the SET transfer pricing case because I believe the Bombay high court ruling in this case was partly predicated on circular 23 and now that the case is pending in Supreme Court ion what direction is it likely to go?

A: In any case, see there are two things here, one is the circular doesn’t supplant the law, it is only an administrative direction given by the tax authority.

Circulars perform the important function before assessments are framed to give guidance and directions to both the tax payers and the tax officer. So that is a more proactive role in administrative circular performance, legally speaking the circular anyways cannot supplant the law or the legal position so this circular by the way in my view enunciated the correct position in law. So its not as if the law has changed or its not as if a new charge has been brought to tax so from a legal perspective for cases which are still pending, it shouldn’t impact greatly, the argument has already been unfolded. Also remember at the time those transactions were entered into, the circular was still valid it is only prospectively withdrawn, so perhaps for the past cases, there shouldn’t be a cause for worry because as I said, the cause for worry is proposed transaction where during the audits when they are undertaken this reliance will not be available for assessment.

Q: So for the lack of certainty but that judgments still continue to be in the same direction?

A: Certainly for the past cases because the circular was enforced and even for the future the principle doesn’t change but the disputes will raise, the factual disputes, practically speaking the number of judgments may rise because of this uncertainty.