The charge to Income Tax – Part 2

Thursday, 13 October 2011 00:00 -     - {{hitsCtrl.values.hits}}

6.1.3    TVBI, a HK based company, carrying on business in HK, having acquired films and rights of exhibition thereof, exploited those rights by granting sub-licences to overseas customers. The relevant business of TVBI was the exploitation of film rights exercisable overseas and it was a business carried on in HK. The fact that the rights exploited were only exercisable overseas was irrelevant in the absence of any financial interest in the subsequent exercise of the rights by the sub-licensee. The proper approach is to ascertain what were the operations which produced the relevant profits and where those operations took place.

The PC therefore held that the profits of TVBI arose in HK and were derived therefrom. The Hang Seng case was distinguished on the principal ground that there, the bank was buying and selling in well defined foreign markets in circumstance that were wholly different from those in the TVBI case.

6.1.4 The foregoing cases afford legitimate tax planning possibilities for overseas companies with branches established in Sri Lanka.

7.    It has already been mentioned that the scope of the charge of income tax on every person other than a resident person includes profits and income from services rendered in Sri Lanka, or from property in Sri Lanka, or from business transacted in Sri Lanka.

Services rendered

in Sri Lanka

As regards services it is important to stress that profits or income arise at the place where the services are rendered and not at the place where the contract of, or, for services, is concluded. The use of the word rendered implies that the law envisages the actual performance of the services in Sri Lanka.

Property in Sri Lanka

In the Act, property is defined to include “any interest in any movable or immovable property.” “Interest” bears the general legal meaning of “a right, claim, title, or legal share in something. More particularly it means a right to have the advantage accruing from anything; any right in the nature of property, but less than title.” ( per Black’s Law Dictionary)

What is intended by the phrase “property in Sri Lanka” will obviously exclude services rendered in Sri Lanka and business transacted in Sri Lanka. The term “business”, in general terms, is wide enough to include a trade, profession or vocation. “Business” is defined in the Act to include “an agricultural undertaking, the racing of horses, the letting or leasing of any premises including any land by a company and forestry”.

“Trade” is defined in the Act to include “every trade and manufacture and every adventure and concern in the nature of trade”. It is thus possible to infer that what is intended by “property in Sri Lanka” must comprise all forms of property that yield unearned income (i.e., income earned other than through the personal exertions of the taxpayer, such as rents and annual values of property, dividends, interest, discounts, charges, annuities, royalties, premiums, winnings from lotteries/gaming/betting and unearned income from any other property but excluding such receipts as bear the characteristics of business.

In National Bank of India v CIT (1939, CTC Vol. I p 137) the facts were that the appellant bank was established in England and carrying on business there. An individual, while resident in England, secured an overdraft from the bank. Later he became resident in Ceylon and continued to remit to the bank the interest due on the overdraft.

The assessor in Ceylon assessed the interest paid as income of the bank. The bank successfully appealed against the assessment.

The SC of Ceylon held that the assessed income neither arose in Ceylon nor was it derived from Ceylon. The Court observed that “it is a fallacy to treat an overdraft incurred in England by a person at the time resident in England as something in the nature of an investment in Ceylon when the debtor becomes resident in Ceylon” – emphasis supplied by the author - and that “legal fictions cannot be applied to the Ceylon Income Tax Ordinance.” This decision has not debarred Parliament from enacting legal fictions by express provisions in the Act. For example, lottery winnings are now treated as income! Whether it is fair fiscal governance to tax the luck of the country’s citizens is a good question.

Business transacted in Sri Lanka

It is well settled that the terms “business transacted”, “trade exercised” and “business carried on” substantially mean the same thing. In Erichsen v Last (1881, 4 TC 422 at 425) Brett, L.J. laid down a timeless guideline that helps one to ascertain whether a business is exercised/transacted/carried on in a country: “Now, I should say that wherever profitable contracts are habitually made in England, by or for a foreigner with persons in England, because those persons are in England, to do something for or supply something to those persons, such foreigners are exercising a profitable trade in England, even although everything done by or supplied by them in order to fulfil their part of the contract is done abroad.”

The fact that that view was laid down by an English judge in a tax case in England does not in any way detract from its compelling generality.

8.    In the Anglo Persian case (see paragraph 6 above) the Supreme Court considered also whether or not the taxpayer would be chargeable to tax in terms of section 34 of the 1932 Income Tax Ordinance (section 80 of the Act).

The reason for this cautionary step taken by the Court lay in the view of the Court that section 34 imposed a charge to tax, supplementary to the charge imposed by section 5 (section 2 of the Act) and it served no purpose to hold only that the taxpayer was not chargeable under section 5, without examining the taxpayer’s possible liability under section 34.

Section 34 prescribed that where a person in Ceylon acting on behalf of a non-resident person effected or was instrumental in effecting any insurance, or sale or disposal of property, then, subject to certain prescribed conditions (mentioned in the section) being satisfied, the profits from such insurance or sale or disposal of property should be deemed to be derived by such non-resident person from business transacted by him in Ceylon.

The Court held that (a) “…the word disposes connotes clear and intelligible contractual relations between the agent in Ceylon and the disposee and was not intended to refer to such a detail as a mere delivery. If the agent in Ceylon did not actually effect the contract, or if he was not instrumental in effecting it, the non-resident would not be liable on the profits arising on the contract; (b) section 34 is intended to include contracts which have been entered into as a result of efforts of agents in Ceylon of a foreign principal even when such contracts have been finally concluded outside Ceylon. (Italics used by the author for emphasis.) For those reasons, the company was not chargeable to tax on the profits from the mere delivery of oil in Ceylon.

In contrast with the Anglo Persian case, in Chivers & Sons Ltd., (UK) v CIT (CTC Vol. I p 124) the appellant was deemed to transact the business in Ceylon of selling goods through the instrumentality of their indenting agent in Ceylon, F.X. Pereira & Sons.

The agent kept a stock of goods belonging to Chivers, displayed samples, canvassed for orders from local buyers such orders, once obtained, were sent to Chivers for their acceptance and execution. The goods were then delivered from the agent’s stock or, if not so available, were dispatched by Chivers.

In those circumstances, the SC of Ceylon held inter alia, that Chivers were carrying on business in Ceylon through the instrumentality of the agent in Ceylon. (This decision may not apply now to a UK company because there is a double tax avoidance convention – DTAC – in force between Sri Lanka and the UK, provided the instrumental agent in Sri Lanka does not possess the authority to enter into contracts in Sri Lanka habitually on behalf of the UK company.)

(The writer is a tax consultant and past President of the Sri Lanka Institute of Taxation. He has taught taxation to the professional students of the institute and served as an examiner for the professional examinations. He is a writer on tax topics and his articles have been published locally in some newspapers as well as the Sri Lanka Tax Review journal. His specialised articles have been published internationally in the Reports of the Annual Congresses of the International Fiscal Association based in The Hague, The Netherlands. He is the Immediate Past Chairman of IFA – Sri Lanka Branch. He can be contacted on email at: [email protected].)

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