The Central Board of Direct Taxes (CBDT) has withdrawn a contentious tax circular regarding taxability of a non-resident's income arising from a business connection in India.

Circular No 23 of 1969 provided the possibility to claim relief from Indian income tax under Section 9 of the Income-tax Act, 1961 for non-resident companies with Business Process Outsourcing (BPO) or other commercial units in India.

The Circular stated that relief was allowable to non-resident entities with business interests in India “if the (Indian) agent’s commission fully represented the value of the profits attributable to his service”.

When the Circular was in force, the Income Tax Department was faced with arguing in appeals that the Circular was not applicable to a particular case, or that the Circular could not be interpreted to allow relief contrary to the provisions of Section 9 of the Income-tax Act. The CBDT explained that the circular had been withdrawn because, although it was supposed to clarify Section 9, it considered that it had had the opposite effect.

Circular 23 was used to justify a decision in the Mumbai High Court in August 2008 which granted Sony Entertainment Television (SET) Singapore relief from tax in India, as the Singapore parent had paid its local agent in India, Multi Screen Media (MSM) on terms that were considered to be 'arms length'. However the case was reopened in April 2009 by the Income Tax Department with a petition to the Supreme Court, in which the validity of Circular 23 was specifically denied. The case has not yet been concluded.

Although the withdrawal of the Circular has spread a degree of uncertainty and confusion among tax professionals, the issue is very much related to transfer pricing policies which have been revamped in the Indian government's last budget; trade bodies have reportedly indicated that they rely much more nowadays on recent 'safe harbour' provisions than on a 40 year old circular.

The CBDT has also withdrawn Circulars No. 163 dated May 29, 1975 and No. 786 dated February 7, 2000 which clarified Circular No 23 further with regard to Indian exporters' commissions paid outside India for overseas agent services.

by Mary Swire