DIRECT TAXATION

Comprehensive Study Notes

Semester VIII | Batch of 2026 | Dr. Manoj Kumar Singh
Prepared by: Krati Gupta | Organised & Simplified for Exam Revision

COURSE STRUCTURE AT A GLANCE

Module 1-2: Introduction, Income, Assessee, Residential Status, Cross-border (Section 9)
Module 3: Equalization Levy, Assessments, Returns
Module 4: Procedures - Self Assessment, Summary Assessment
Module 5: Exemptions & Deductions (KEY DISTINCTION)
Module 6: Appeal Procedures, Commissioner Appeals
Module 7: Advanced - Virtual Digital Assets, Global Minimum Corporate Tax, Digital Services
Tax, Advance Payment, TDS vs Withholding Tax

MODULE 1: FOUNDATIONAL CONCEPTS

1.1 Direct Tax vs Indirect Tax

The fundamental distinction lies in who bears the incidence of tax and who pays it.

Direct Tax Indirect Tax

Same person bears and pays tax. No Incidence and liability fall on different persons.
intermediary between taxpayer and Example: GST — seller pays but passes
government. Example: Income Tax. burden to buyer.

1.2 What is a Tax?

Tax is a compulsory burden levied by the government (or its authority) for a public purpose, without
the consent of the payer, enforced by law.
 ⚑ NOTE: Article 265 of the Constitution: No tax or levy shall be collected without authority of law.
The Constitution does not grant power to tax — that is a sovereign power. The Constitution only
limits that power (Entry 82, List I: Income Tax other than agricultural income).

📋 CASE: Mafatlal Industries Ltd. v. Union of India, 1997 5 SCC 536 & A. Venkata Subbarao v.
State of A.P., AIR 1965 SC 1773
Principle: Defined 'tax' as a compulsory burden on income/property by government under authority of
law for a public purpose.

Tax vs Fees vs Cess vs Surcharge

• Tax: No quid pro quo; goes to Consolidated Fund of India; compulsory.
• Fees: Quid pro quo attached (benefit to payer); separate legislative entry.
• Cess (Art. 270): For a specific purpose (e.g., Education Cess, Swachh Bharat Cess). Not
transferred to Consolidated Fund — used for that specific purpose only.
• Surcharge (Art. 271): Tax on tax. Imposed when government wants more revenue without
changing basic tax rate. Calculated on tax liability, not on income.

⚑ NOTE: Overruled case — General Stainless Steel v. State of Haryana (2017) 12 SCC 1:
Overruled 50-year-old theory of 'compensatory tax' (previously in Automobile Transport Rajasthan
Ltd. v. State of Rajasthan).

1.3 Principles of Taxation (Adam Smith / Kautilya's Arthashastra)

Principle Explanation & Indian Context
1. Ability to Pay Progressive tax slabs for individuals. For indirect taxes, implemented
indirectly via different GST rates (5% essentials → 28% luxury). NOT
applicable to GST directly.
2. Benefit Approach Tax in exchange for protection, roads, services. In India, unlike developed
countries, there are no direct social security schemes for taxpayers — a
criticism.
3. Certainty Tax should be certain. India has 22,000+ amendments since 1960.
Retrospective taxation (Vodafone) creates uncertainty = 'tax terrorism'. ITA is
amended only once a year through Finance Act. GST amended by notification
on GST Council recommendation.
4. Administrative Convenient for both collector and payer. TDS ensures collection but causes
Convenience hardship (excess deduction + waiting for refund). Advance tax, faceless
assessment (from 2020) are steps toward this.
5. International Cannot draft tax laws in isolation. Must comply with DTAA, WTO, OECD.
Compatibility Corporate tax rate reduction (post-2019) reflects this. GAAR, BEPS, Transfer
Pricing all flow from this principle.
1.4 Four Components of Tax (Mandatory for Liability)
⚑ NOTE: If any one of these components is missing, tax liability CANNOT arise.

• 1. Object of Tax: What is being taxed? (Taxable event — e.g., 'income' for Income Tax). Liability
arises at a different point than the duty to pay.
• 2. Measure of Tax: How is it valued/computed? (If no computation method exists, no tax. Key
case: V. Srinivas Shetty v. CIT — no capital gain on self-generated goodwill since no 'cost of
acquisition'. Later nullified by amendment.)
• 3. Taxable Person: Who is liable to pay? (Person vs. Assessee — every assessee is a person
but not every person is an assessee.)
• 4. Rate of Tax: What percentage or amount?

MODULE 2: PERSON, ASSESSEE & INCOME

2.1 Financial Year vs Assessment Year

IMPORTANT: Time Framework Under ITA
Financial Year (FY): 1 April to 31 March — the year in which income is EARNED. Also called
Previous Year.
Assessment Year (AY): The year FOLLOWING the FY — when return is FILED and tax is
ASSESSED.
Example: FY 2023-24 (Previous Year) → AY 2024-25 (Assessment Year)
Tax must be PAID before 31 March (end of Previous Year). For companies: by 15 March. If paid
in AY → pay with fine + interest.
Exceptions (PY = AY in same year): Sections 172, 173, 174, 174A, 176 — applies when
business is being wound up or assessee is leaving India.

2.2 Who is a 'Person'? [Section 2(31)]

The definition of 'person' is inclusive. It includes:
• (i) Individual (male or female, resident or non-resident)
• (ii) Hindu Undivided Family (HUF)
• (iii) Company (Indian or foreign)
• (iv) Firm (including LLP)
• (v) Association of Persons (AOP) or Body of Individuals (BOI) — whether incorporated or not
(e.g., JVs, societies)
• (vi) Local Authority
• (vii) Every Artificial Juridical Person not falling in any above category (residuary) — e.g., NLU,
Bar Council of India, UGC, religious institutions like temples, mosques, churches.

⚑ NOTE: IMPORTANT DISTINCTION: Being a 'person' makes one LIABLE to tax. But being
SUBJECT to tax (actually paying) depends on exemptions. Example: Temples, political parties are
 'persons' → liable to tax → but exempted → not subject to tax. This distinction matters critically in
DTAA.

2.3 Who is an 'Assessee'? [Section 2(7)]

An assessee is a person by whom any tax or sum is payable under the Act. Three types:

Type Explanation
1. General Assessee Person who owes tax or a sum under ITA proceedings.
2. Deemed Assessee E.g., legal heirs. Person assessed on behalf of another.
(Representative Assessee)
3. Deemed Assessee in Has not fulfilled statutory obligation. E.g., Vodafone — failed to
Default withhold tax (TDS) before paying Hutchinson. Registrar who fails to
deduct TDS on employee salary becomes assessee in default.

2.4 Heads of Income

• 1. Salary: Income from employer-employee relationship. Retained professional income is NOT
salary. Director can be both employee and RP — depends on agreement.
• 2. House Property: Thin line between rental income and business income from renting. New
2024 amendment + judgments on this.
• 3. Business/Profession: Includes composite income. Income Tax Act OVERRIDES accounting
standards (e.g., depreciation treatment differs). MAT (Minimum Alternate Tax) applies to zero-
profit companies.
• 4. Capital Gains: Tax on transfer of capital assets. Needs: (a) cost of acquisition and (b) sale
proceeds. Cost Inflation Index (CII) used to adjust for inflation. No capital gain if CII makes gain
zero.
• 5. Other Sources (Residuary): All income not covered above — interest, dividend, lottery
winnings, KBC prize money. Capital gains CANNOT fall here.

2.5 Definition of Income [Section 2(24)]

Income is NOT defined in the ITA — it is an INCLUSIVE definition. Key characteristics:
• Regularity is NOT required — even one-time receipts can be income.
• Legality/illegality of source is irrelevant — illegal income is also taxable.
• Income can be in cash or kind — non-monetary benefits are converted to cash value.
• Income must be REAL, not fictional. Contingent income is not taxable until the contingency
arises.
• Capital can also be income (e.g., capital gains).
• Loss is NEGATIVE income — companies must file returns even for loss years.
• NO income = still taxable (Notional Income) — e.g., deemed rent on house property beyond two
self-occupied properties.
 • Presumptive income is taxable — appreciation in value of gold/land can be deemed income
without actual transfer.

⚑ NOTE: CRITICAL RULE: All REVENUE RECEIPTS are taxable unless expressly exempted. All
CAPITAL RECEIPTS are exempt unless expressly taxable. How to identify? Look at the NATURE
of what the compensation is for: loss of profit = revenue receipt; loss of a capital asset = capital
receipt.

⚑ NOTE: Principle of Res Judicata does NOT apply to Income Tax. Each assessment year is
independently assessed.

Key Judicial Definitions of Income

📋 CASE: CIT v. Shaw Wallace & Co., AIR 1932 PC 138
Principle: Income connotes a periodical monetary return with regularity from a definite source.
Note: Later expanded — regularity is NOT essential.

📋 CASE: ELEL Hotels & Investments v. UOI (1989)

Principle: Income is an elastic word of wide connotation. Even gross receipts/turnover can be income.
The word income in Entry 82 must be given its widest meaning.
Applied in: CIT v. GR Kartikeyan — Rs. 22,000 won in a motor car rally held taxable as income under
Section 2(24)(ix).

📋 CASE: Naveen Chandra Mafatlal v. CIT, 1954 26 ITR 758 SC

Principle: Scope of 'income' should not be restricted to the technical concept — even capital can be
income under ITA.

📋 CASE: CIT v. Hind Construction Ltd., 1972 83 ITR 211 SC

Principle: Relief from expenses or obligations is generally NOT income — but exceptions exist (e.g.,
deemed profit under Section 40 for business and profession).

Receipt vs Accrual — Point of Taxation

Tax liability arises on WHICHEVER COMES FIRST: receipt or accrual.
• Accrual/Due: Right to receive arises. Example: salary earned in March even if paid in April —
accrues in March.
• Receipt: Actual control over money. Example: salary received in advance — received basis
applies.
• Mercantile system: Even amounts due but not received are taxable.
• Cash system: Only actual receipts/payments noted.
• Deemed receipt [Section 7]: PF interest accreted annually is deemed received even though
actually received at retirement.
2.6 Diversion of Income vs Application of Income
This concept determines who pays tax when income passes through multiple hands.

CORE DISTINCTION
Diversion of Income: Income belongs to someone ELSE by reason of an OVERRIDING TITLE.
The recipient never really owns it. Tax falls on the true owner.
Application of Income: Income first belongs to YOU, and you then apply/spend it for someone
else. Tax falls on YOU.

⚑ NOTE: SHORTCUT: Controlled by government/third party with overriding title = DIVERSION.

Controlled by the assessee = APPLICATION.

Types of Obligations — When is it Diversion vs Application?

• Statutory Obligation (e.g., CSR): CSR is mandatory under Companies Act but company
CONTROLS how much and where it is spent → APPLICATION, not diversion. Pre-2013, CSR
was voluntary and allowed as deduction under Section 37. Now Section 37 exemption
withdrawn; only specific deductions allowed.
• Legal/Court Decree (e.g., Maintenance): Court only enforces an existing obligation — does not
create a NEW one → APPLICATION. Husband still pays tax on salary; wife does not file return
on maintenance.
• Contractual Obligation: Most complex — must test on ANTI-AVOIDANCE principle (post-
McDowell's case). If source is also transferred = Diversion. If only income transferred (source
remains) = test for genuineness.

📋 CASE: CIT v. Sunil Jeevanlal Kinariwala, (2003) 1 SCC 660

Principle: Assignment of income (50% partnership share to a trust) is NOT diversion because the
SOURCE (partnership share) was not transferred. Must be tested on anti-avoidance principle. Rights
of assignee ≠ rights of partner (Section 29, Partnership Act).
Key takeaway: Transfer income without source = test anti-avoidance. Transfer source + income =
could be diversion.

📋 CASE: Institute of Franciscan Missionaries of Mary v. Union of India (2024 SC —

Chandrachud's last judgment)
Principle: Salary received by nuns/fathers under oath of poverty still taxable in their hands. Canon
law does NOT override ITA. State government obligated to deduct TDS. Civil death under religious
oath does not negate tax liability.
Latest case on diversion — religious/personal obligation cannot override ITA.

📋 CASE: Rajkot District Gopalak Cooperative Milk Producers Union v. CIT, (1993) Gujarat HC
Principle: Profit from government project first used to set off government's accumulated losses →
held as diversion. CRITICISM: Court did not test on anti-avoidance principle — may not be good law.

📋 CASE: Bhumisudhar Nigam v. CIT, (2005) Allahabad HC

Principle: Interest earned on bank deposits where government stipulated interest belongs to them —
 held NOT diversion. Cannot create overriding title on interest through a contractual term alone.
Difference between diversion and exemption discussed.

MODULE 3: AGRICULTURAL INCOME

3.1 Why Agricultural Income Matters

• Agricultural income is EXEMPT under Section 10(1) — Agriculture is a State subject; Centre
cannot tax it.
• HOWEVER: Agricultural income is integrated with non-agricultural income to determine the TAX
SLAB (not to tax it directly). This is the concept of Partial Integration — an indirect way of
increasing tax on non-agricultural income.
• Definition: Section 2(1A) — restrictive and specific. Not all income from land qualifies.

3.2 What Counts as Agricultural Income?

THREE CATEGORIES under Section 2(1A)
(a) Any rent or revenue derived from land situated in India used for agricultural purposes.
(b) Income derived from such land by: (i) agriculture; or (ii) ordinary process to make
produce market-fit; or (iii) sale of such produce without extraordinary processing.
(c) Income from farm building — if it is on/in immediate vicinity of agricultural land, used
by cultivator/receiver as dwelling/storehouse, and land is subject to land revenue OR in
rural area.

3.3 Key Tests & Concepts

'Agricultural Purpose' — Basic & Subsequent Operations
📋 CASE: CIT v. Benoy Kumar Sahas Roy, AIR 1957 SC 768 (Justice Bhagwati)
Principle: Two-step test: (1) Basic Operation — human labour on land: tilling, preparing soil, sowing,
irrigation. MANDATORY. (2) Subsequent Operation — post-basic operations: fertilisation, pesticides,
harvesting. Only qualifies as agriculture if Basic Operation was also done.
Outcome: Income from spontaneously grown trees (no basic operation done) = NOT agricultural
income. Sericulture, fisheries, horticulture = NOT agricultural income (no basic operation on land).

'Derived From Land' — Immediate Source Test

📋 CASE: CIT v. Kamakhya Narayan Singh, (1948) 16 ITR 55 (Privy Council)
Principle: The word 'derived' requires tracing genealogy of income but stops as soon as the
IMMEDIATE/EFFECTIVE source is found. Land need not be the first-degree source.
Interest on arrears of rent: immediate source = rent agreement, NOT land → NOT agricultural income.
 📋 CASE: Baccha F. Gujdar v. CIT (1955)
Principle: Dividend received by shareholder of a company doing agricultural activity = NOT
agricultural income. Immediate source = shareholding, not land.
The 'derived from land' test requires land to be the IMMEDIATE, effective source.

Two Tests for Section 2(1A)(b)

• Ordinary Process Test: Process must be what cultivators/receivers customarily do. Mechanical
value-adding processes are NOT ordinary. Converting paddy to polished rice = NOT
agricultural; converting sugarcane to jaggery when no sugar mill nearby = MAY be ordinary
(necessity-based).
• Market Fitness Test: Is the produce fit to be taken to the market as-is? Market = not just a
physical marketplace — includes buyers like Pepsi/Reliance purchasing directly from farmers.
• Both tests are CONNECTED — nature of produce, transportability, and availability of market
determine which applies.

📋 CASE: K. Laxmanan & Co. v. CIT, 1998 9 SCC 537

Principle: Growing Mulberry leaves = agricultural income. Rearing silkworms using those leaves =
NOT agricultural income (market exists for leaves; silkworm rearing = separate business activity).

Commercial Crops — Composite Income Rules

Crop Agricultural Business Rule
Tea 60% 40% Rule 8
Coffee (grown & 75% 25% Rule 7B
pruned)
Coffee (with external 60% 40% Rule 7B
substance)
Rubber 65% 35% Rule 7A
Other crops Varies Varies Rule 7 (general)

📋 CASE: CIT v. RM Chidambaram Pillai, AIR 1977 SC 489

Principle: Partner's salary from a tea estate firm: since partners have no separate existence from the
firm, salary is treated same as firm's composite income — same 60-40 split applies.

Nursery Income — Deemed Agricultural Income

Explanation III to Section 2(1A) (added by Finance Act 2001): Income from saplings/seedlings grown
in a nursery is DEEMED to be agricultural income.
📋 CASE: CIT v. Soundarya Nursery, 2000 241 ITR 530 (Madras HC)
Principle: Precipitated the 2001 amendment — nursery plants grown in pots are NOT on 'land' but the
amendment now deems such income as agricultural.
3.4 Partial Integration of Agricultural Income (Finance Act 1976)
Basis: 49th Law Commission Report (Aug 1972) under Justice Gajendragadkar (members: Krishna
Iyer, PK Tripathi, SS Dhawan, PM Bakshi). Concluded: No constitutional amendment required for
integration.

Who Does This Scheme Apply To?

Applies to: Individuals, HUF, AOP, BOI, Artificial Juridical Persons.
Does NOT apply to: Companies, Firms, Local Authorities.
Condition 1: Net agricultural income > Rs. 5,000 per year.
Condition 2: Non-agricultural income exceeds basic exemption limit for that year.

Method of Integration (3-Step Calculation)

• Step 1: Add net agricultural income + non-agricultural income. Compute tax on combined total.
• Step 2: Add basic exemption limit + net agricultural income. Compute tax on this.
• Step 3: Final tax liability = Step 1 minus Step 2.

⚑ NOTE: Effect: Agricultural income pushes non-agricultural income into higher slabs, increasing
effective tax rate. Constitutional validity upheld — Parliament is not taxing agricultural income, but
using it to determine slab for non-agricultural income (within Entry 82).

MODULE 4: RESIDENTIAL STATUS

4.1 Why Residential Status Matters

Residential status determines the SCOPE OF TAXABLE INCOME under Section 5.
Category Income received in Income accruing in Income accruing
India India outside India

Resident (ROR) ✓ Taxable ✓ Taxable ✓ Taxable

(worldwide income)

Non-Ordinary Resident (RNOR) ✓ Taxable ✓ Taxable ✓ Only if from Indian

business/profession

Non-Resident (NR) ✓ Taxable ✓ Taxable ✗ Not taxable

4.2 Residential Status for Individuals [Section 6(1)]

Basic Conditions (need to satisfy EITHER)
• Rule 1: Present in India for 182 or more days in the previous year.
• Rule 2: Present in India for 60 or more days in the previous year AND 365 or more days in the
preceding 4 years.
Additional Conditions [Section 6(6)] — for Ordinary Resident status
• Condition 1: Resident in India in at least 2 out of 10 preceding previous years.
• Condition 2: Present in India for 730 or more days in the preceding 7 previous years.

Ordinary Resident (ROR) Non-Ordinary Resident Non-Resident (NR)

(RNOR)
Both basic conditions + Both Both basic conditions + Only Neither basic condition satisfied
additional conditions ONE additional condition

⚑ NOTE: Section 6(1A) [2020 amendment]: Indian citizen with Indian income > Rs. 15 lakh who is
not liable to tax in ANY country → deemed resident in India. Anti-avoidance measure targeting
stateless individuals exploiting tax havens.

4.3 Residential Status of Other Entities

• HUF, Firm, AOP [Section 6(2)]: Resident in India UNLESS control and management of affairs is
WHOLLY outside India. Presumption favours residence in India — assessee must prove
otherwise.
• Company [Section 6(3)]: Resident if (i) it is an Indian company (place of incorporation), OR (ii)
its Place of Effective Management (POEM) is in India.

POEM — Place of Effective Management [2017 Amendment]

POEM = Place where KEY MANAGEMENT AND COMMERCIAL DECISIONS necessary for
conduct of business are IN SUBSTANCE made.
ABOI (Active Business Outside India): If passive income < 50% of total income AND employees <
50 total → POEM likely outside India.
Circular 6/2017 (Feb 24, 2025 reference): Adopted from OECD. A company can have only one
POEM even if it has multiple places of management. Based on where the most senior
persons/group make key decisions.

MODULE 5: DOUBLE TAX AVOIDANCE AGREEMENTS

(DTAA)

5.1 Overview — Section 90

The Central Government may enter agreements with foreign governments for:
• (a) Relief in respect of income taxed twice (bilateral relief);
• (b) Avoidance of double taxation WITHOUT creating non-taxation opportunities (treaty shopping
prevention);
• (c) Exchange of information for prevention of tax evasion;
 • (d) Recovery of income tax.

⚑ NOTE: CRITICAL: Section 90(2) — Where DTAA exists, ITA provisions apply only to the extent
MORE BENEFICIAL to the assessee. DTAA OVERRIDES ITA. Charge is created under ITA but
relief is given under DTAA. DTAA is a BENEFICIAL legislation (interpreted
purposively/beneficially). ITA is a FISCAL legislation (strict interpretation).

5.2 Who Can Claim DTAA Benefit? (Article 4 — Residence)

To claim DTAA benefit, a person must be:
• A RESIDENT of a contracting state (based on domicile, residence, place of management, or
similar criteria), AND
• LIABLE TO TAX in that state.

⚑ NOTE: LIABLE TO TAX ≠ SUBJECT TO TAX. Being exempted in a country does not mean you
are not 'liable to tax' there. Sovereign power creates the liability; exemption is a policy choice.
Section 2(29A) ITA (amended 2020): 'Liable to tax' means there must be a law imposing liability,
even if exempted.

📋 CASE: Union of India v. Azadi Bachao Andolan, 2003 SC 736

Principle: India-Mauritius DTAA: Certificate of residence from Mauritius is sufficient proof of residency
for DTAA purposes. Government cannot challenge its own circular (Circular 789/2000). Liability to tax
≠ actual payment of tax. Treaty shopping was upheld as legal (controversial). India-Mauritius DTAA
amended in 2016; capital gains now taxable in India from 2017.
BACKGROUND: 1994 circular exempted Mauritius-resident companies from Indian capital gains tax.
2000 circular (789) said TRC = sufficient proof of residence. Delhi HC quashed this. SC reversed HC.
FIIs were withdrawing from India after IT dept notices.

5.3 Tie-Breaker Rules for Dual Residence (Article 4)

If an individual is resident of BOTH contracting states, apply in hierarchy:
• 1. Permanent Home: Resident where permanent home is. If homes in both states → go to step
2.
• 2. Centre of Vital Interests: Where personal AND economic relations are closer. If cannot
determine → step 3.
• 3. Habitual Abode: Where person resides for more days. If habitually in both or neither → step
4.
• 4. Nationality: If national of only one state → that state's resident. If both or neither → step 5.
• 5. Mutual Agreement: Competent authorities of both states negotiate.

5.4 Treaty Shopping & Anti-Avoidance

• Treaty Shopping: Using a shell/post-box company in a low-tax country to claim DTAA benefits
without genuine presence.
 • BEPS (Base Erosion & Profit Shifting): OECD action plans adopted by India. Includes GAAR,
MLRI, equalization levy, global minimum corporate tax.
• PPT (Principal Purpose Test): If principal purpose of a transaction is to minimize tax liability →
treaty benefit denied.
• Blacklisting: Countries not sharing tax information can be blacklisted (e.g., Cyprus was
blacklisted for 2 years).

📋 CASE: McDowell & Co. Ltd. v. CTO (1985 SC — Constitution Bench)

Principle: Tax avoidance through colorable devices is ILLEGAL. Mere tax avoidance ≠ illegal, but tax
avoidance through artificial/sham transactions = illegal. This is the foundational anti-avoidance
principle in India.

MODULE 6: SECTION 9 — INCOME DEEMED TO

ACCRUE OR ARISE IN INDIA

6.1 Overview
Section 9 creates a DEEMING FICTION — it shifts the place of receipt/accrual to India for tax
purposes. This is the SOURCE-BASED TAXATION mechanism.
Apply Section 9 FIRST to create liability, THEN check DTAA for relief.

6.2 Section 9(1)(i) — Business Connection, Property, Assets

Four Bases of Deemed Accrual
• Income through or from BUSINESS CONNECTION in India
• Income through or from PROPERTY in India
• Income through or from any ASSET or SOURCE OF INCOME in India
• Income through TRANSFER OF CAPITAL ASSET situated in India

Business Connection [Explanation 2]

Business with India ≠ Business in India. Need an active nexus — business connection requires:
• Agent with authority to habitually conclude contracts on behalf of non-resident, OR
• Agent who habitually maintains stock in India for delivery, OR
• Agent who habitually secures orders in India for non-resident.
• EXCEPTION: Independent broker/general commission agent acting in ordinary course of own
business → NOT a business connection.

📋 CASE: CIT v. RD Agarwal & Co., AIR 1965 SC 1526

Principle: Business connection requires: (1) real and intimate relation between non-resident's
business and activity in India, (2) element of CONTINUITY (not a stray transaction), (3) India-based
activity must CONTRIBUTE to earning of profits.
Significant Economic Presence [Explanation 2A, Finance Act 2018]
Even without physical presence in India, non-residents are deemed to have business connection if:
• (a) Transactions in goods/services/property (including downloads of data/software) exceed
prescribed threshold, OR
• (b) Systematic and continuous interaction with prescribed number of Indian users through digital
means.
⚑ NOTE: This is the basis for taxing digital companies like Netflix, Google etc. But DTAA
amendments have not kept pace — hence Equalization Levy was introduced as a separate
mechanism under Finance Act.

Capital Asset Transfer — Explanations 4, 5, 6

📋 CASE: Vodafone International Holdings v. UOI (2012 SC)
Principle: Transfer of shares of Cayman Islands company (which ultimately owned Indian assets) was
held NOT taxable in India. SC reversed HC. BUT Legislature immediately nullified by adding
Explanations 4, 5, 6 to Section 9 (2013 amendment).
Explanation 5: Share or interest in company incorporated OUTSIDE India is deemed situated in India
if it derives its value SUBSTANTIALLY from assets located in India.

📋 CASE: In re: Pfizer Corporation (AAR, 2004) & Foster Australia (AAR, 2006)
Principle: Situs of intangible assets (IP): Owner's place of registration/residence determines situs,
NOT where the market is. US company's trademark = situs in US = not taxable in India. Explanations
4, 5, 6 deal only with SHARES, not IP — so these cases remain good law for IP transactions.
Obiter: Apportionment may be possible for rights deriving value from Indian market.

6.3 Section 9(1)(ii) to (iv) — Salary, Embassies, Dividends

• 9(1)(ii) Salary: Taxable in India if services are RENDERED in India. Even if salary deposited
abroad, deeming provision applies.
• 9(1)(iii) Pensions of government employees working abroad: Taxable in India.
• 9(1)(iv) Dividends paid by INDIAN companies: Always deemed to accrue in India.

6.4 Section 9(1)(v)(vi)(vii) — Interest, Royalty, FTS

These are PASSIVE INCOMES. They are taxable in India based on the PLACE OF UTILIZATION,
not place of payment.

Payer Section 9(1)(v)(b) — Interest Notes

Government Always taxable in India No exceptions

Resident (payer) Presumed taxable in India; Default = taxable in India

exceptions: (1) used outside India
for business/profession, (2) for
income from source outside India.
 Burden on RESIDENT to prove
exception.

Non-resident (payer) Taxable in India ONLY IF used for Default = not taxable in India
business/profession carried on IN
India. Burden on DEPARTMENT
to prove.

Section 9(1)(vi) — Royalty

Royalty = taxable at place of UTILIZATION of rights/property/information.
• Biggest dispute: Computer software — is downloading software a transfer of copyright (royalty)
or sale of copyrighted article (business income)?
📋 CASE: Engineering Analysis Centre of Excellence v. CIT (2021 SC)
Principle: Sale/downloading of software = sale of COPYRIGHTED ARTICLE, NOT a transfer of
copyright → NOT royalty → Business Income. Four categories of software transactions identified as
sale of copyrighted article.
Royalty: transfer of ALL or PARTIAL rights (including licensing) in patent, invention, model, design,
secret formula, process, trademark. If complete transfer = capital gains. Partial/limited use = royalty.

Section 9(1)(vii) — Fees for Technical Services (FTS)

FTS = consideration for managerial, technical, or consultancy services (including provision of
technical personnel). Excludes: salary income, construction/assembly/mining project income.

📋 CASE: Ishikawajima-Harima Heavy Industries Ltd. v. DIT, 2007 SC

Principle: Both place of utilization AND place of rendering of service must be in India for FTS to be
taxable. [NOTE: Later partially overturned by 2007 and 2009 legislative amendments]
2007 Amendment (post-Ishikawajima): Added that FTS is taxable whether or not non-resident has
residence/business connection in India. 2009 Amendment: Added 'whether or not non-resident has
rendered services in India' — making only UTILIZATION relevant.

📋 CASE: Bharati Cellular case (2011)

Principle: Human intervention is required for FTS — managerial, technical, consultancy all require
human element. Automated services without human involvement = NOT FTS.

⚑ NOTE: DTAA v. Section 9 on FTS: DTAA uses 'Make Available' clause (only if technology/skill is
transferred to payer) and restricts definition to technical + consultancy only (NOT managerial). So
DTAA definition of FTS is NARROWER than Section 9 definition.
MODULE 7: PERMANENT ESTABLISHMENT (PE)

7.1 Overview — PE under DTAA (Article 5)

PE = Fixed place of business through which business of enterprise is wholly or partly carried on.
RULE: If non-resident has a PE in India → business connection automatically established → income
attributable to PE is taxable in India (Article 7).
KEY DIFFERENCE from Business Connection: TIME factor matters for PE (except Fixed Place PE).
No time limit for business connection.

7.2 Types of Permanent Establishment

Type Definition Key Feature
1. Fixed Place PE Branch, office, factory, workshop, mine. A No minimum time requirement
specific geographic location at the disposal
of the enterprise.

2. Agency PE Dependent agent with authority to conclude Dependent vs Independent

contracts on behalf of non-resident agent distinction crucial (see
habitually in India. SET Satellite case)

3. Service PE Employee/deputation present in India Trigger: 90+ days (or 60+ days
rendering services for a specified period. in some DTAAs)

4. Construction/Project PE Construction, installation, assembly projects. Trigger: 6+ months (varies by

DTAA)

5. Subsidiary as PE Subsidiary treated as PE based on level of Based on dependency — not

control and activities. automatic

7.3 Leading Cases on PE

📋 CASE: Formula 1 World Championship Ltd. v. CIT (2017 SC), 474 SCC
Principle: Buddh International Circuit (Noida) constituted a Fixed Place PE for Formula 1. F1
exercised FULL CONTROL over the circuit during race events — deciding participants, duration,
regulations. Control and disposal of the place = key test for Fixed Place PE. JP (Indian promoter) was
mere organizer, not controller.
Royalty question: Payment for race promotion rights = business income (NOT royalty). JP obligated to
withhold tax under Section 195.

📋 CASE: Vishakhapatnam Port Trust v. CIT, (1983) 144 ITR 146 (AP HC)
Principle: PE = substantial element of an enduring/permanent nature of a foreign enterprise in
another country, amounting to virtual projection of the foreign enterprise into the soil of the other
country.

📋 CASE: DIT v. Morgan Stanley (2007 SC)

Principle: Whether seconded employee creates Service PE. Also discussed profit attribution rule —
 FAR analysis (Functions, Assets, Risk) used to determine how much profit is attributable to Indian PE.

📋 CASE: SET Satellite Singapore v. DDIT (2009, Bombay HC)

Principle: Agency PE: Distinction between dependent agent (creates PE) and independent agent
(does not create PE). Independent agent must act in ordinary course of own business and for multiple
principals.

📋 CASE: Barendra Prasad Ray v. ITO, (1981) 129 ITR 295 SC

Principle: Business connection includes PROFESSIONAL connection. UK barrister arguing in Indian
patent suit = taxable in India under Section 9. No separate category for 'professional connection' —
both treated alike.

📋 CASE: Pilcom v. CIT (2020) 271 Taxman 200 SC

Principle: Cricket World Cup 1996 joint committee (BCCI/Pakistan/Sri Lanka). Income from matches
in India deemed to accrue in India under Section 9. Broadcasting/TV rights income for India-based
matches = taxable in India.

📋 CASE: Volkswagen Finance Pvt. Ltd. v. IT (2020) 115 Taxman 386 Mumbai ITAT
Principle: Payment to celebrity for appearance at Dubai product launch targeting Indian customers =
taxable in India. Effect/benefit derived in India = deemed to accrue in India. 'Through or from' = 'by
reason of' or 'in consequence of.'

MODULE 8: TAXING THE DIGITAL ECONOMY

8.1 The Challenge

Digital companies (Google, Netflix, Amazon) operate globally without physical presence in source
countries. Traditional PE + Business Connection rules fail to capture these. Solutions developed:

8.2 Equalization Levy (Finance Act 2016)

• 6% levy on gross receipts from online advertising services received by non-residents from
Indian residents.
• Withheld by Indian payer (not paid by digital company directly).
• WHY Finance Act, not ITA? — Amending ITA would require amending DTAAs. Equalization
levy is OUTSIDE the scope of DTAA.
• India was the FIRST country to introduce equalization levy (2016).

8.3 Equalization Levy 2.0 (2020 — Digital Services Tax/DST)

• Extended EL to e-commerce operators (downloading, streaming, etc.) at 2%.
• Status: NOT fully implemented — US threatened trade tariffs in response.
 • Now being subsumed into Global Minimum Corporate Tax framework.

8.4 Significant Economic Presence (SEP) — Section 9 Explanation 2A

• Non-resident deemed to have business connection if: (a) transactions exceed threshold, OR (b)
systematic interaction with prescribed number of Indian users.
• LIMITATION: DTAAs have NOT been amended to include SEP as PE. So while domestic law
creates liability, DTAA still provides relief. Practically, cannot tax until DTAAs amended.

8.5 Global Minimum Corporate Tax (Pillar Two — OECD/BEPS)

• Minimum 15% effective tax rate on MNCs with revenue > EUR 750 million.
• If a company pays less than 15% in one country, the home country can 'top up' the tax.
• Aims to end the race to the bottom on corporate tax rates and prevent profit shifting to tax
havens.

QUICK CASE REFERENCE TABLE

All important cases summarised for rapid revision:

Case Name Topic Key Principle

Mafatlal Industries v. UOI, 1997 Definition of Tax Compulsory burden, public
purpose, authority of law
General Stainless Steel v. State of Compensatory Tax Overruled 50-yr compensatory
Haryana, 2017 tax theory
Shaw Wallace & Co., AIR 1932 PC Income Definition Periodical monetary return from
definite source
ELEL Hotels & Investments v. UOI, Income Definition Wide, elastic meaning of income;
1989 turnover = income
CIT v. GR Kartikeyan, 1993 SC Income Definition Rally prize = income under
Section 2(24)(ix)
V. Srinivas Shetty v. CIT, 1981 Capital Gains No computation method = no tax
(self-generated goodwill)
CIT v. Hind Construction, 1972 SC Income Relief from obligation ≠ income
(with exceptions)
Sunil Jeevanlal Kinariwala, 2003 SC Diversion Assignment without source
transfer = not diversion; test on
anti-avoidance
Franciscan Missionaries v. UOI, 2024 Diversion Canon law cannot override ITA;
SC salary of nuns taxable
Rajkot Gopalak Cooperative v. CIT, Diversion Profit applied to settle govt losses
1993 Guj HC — held diversion (controversial)
Bhumisudhar Nigam v. CIT, 2005 All Diversion Contract cannot create overriding
HC title over interest income
Benoy Kumar Sahas Roy, AIR 1957 SC Agricultural Income Basic + subsequent operations
test; spontaneous growth ≠
agriculture
Kamakhya Narayan Singh, 1948 PC Agricultural Income Immediate source test; interest on
rent arrears ≠ agri income
Baccha F. Gujdar v. CIT, 1955 Agricultural Income Dividend from agri company ≠
agri income (shareholding =
immediate source)
K. Laxmanan & Co. v. CIT, 1998 SC Agricultural Income Mulberry = agri; silkworm rearing
= not agri
RM Chidambaram Pillai, 1977 SC Agricultural Income Partner salary from tea estate =
60-40% composite income rule
applies
Soundarya Nursery, 2000 Madras HC Agricultural Income Nursery income → prompted
2001 amendment (deemed agri
income)
Azadi Bachao Andolan, 2003 SC DTAA / Mauritius Liable ≠ subject to tax; TRC
sufficient; treaty shopping upheld
(overturned by 2016 DTAA
amendment)
McDowell & Co. v. CTO, 1985 SC Anti-Avoidance Tax avoidance via colorable
device = illegal
Vodafone International v. UOI, 2012 SC Section 9 / Capital Asset Indirect transfer of Indian assets
via offshore share transfer = NOT
taxable (overturned by
Explanation 5)
Pfizer Corporation, AAR 2004 IP Situs Situs of IP = owner's location;
NOT market location
Foster Australia, AAR 2006 IP Situs Same as Pfizer — IP situs =
owner's jurisdiction
RD Agarwal & Co., AIR 1965 SC Business Connection Continuity + real relation +
contribution to Indian income =
business connection
Barendra Prasad Ray, 1981 SC Business Connection Professional connection =
business connection for Section 9
Ishikawajima-Harima, 2007 SC FTS / Section 9(vii) Both utilisation AND rendering
must be in India (partially
overturned by 2007, 2009
amendments)
Bharati Cellular, 2011 FTS Human intervention required for
FTS — automated services
excluded
Formula 1 v. CIT, 2017 SC PE / Fixed Place Race circuit = Fixed Place PE;
control and disposal = key test
Morgan Stanley, 2007 SC PE / Service PE Secondment can create Service
PE; FAR analysis for profit
attribution
SET Satellite Singapore, 2009 Bom HC PE / Agency PE Dependent vs Independent agent
distinction for agency PE
Pilcom v. CIT, 2020 SC Section 9 / Deemed Accrual Joint committee income from
India matches = taxable in India
Volkswagen Finance v. IT, 2020 Section 9 Benefit/effect in India = deemed
Mumbai ITAT to accrue in India (Dubai event for
 Indian market)

EXAM QUICK REFERENCE — KEY DISTINCTIONS

10 MOST IMPORTANT DISTINCTIONS TO REMEMBER

1. Liable to Tax vs Subject to Tax
Liable = legal obligation exists (sovereign power). Subject = actually paying (fiscal fact). Exempt
persons are STILL liable but not subject. Crucial for DTAA eligibility.
2. Revenue Receipt vs Capital Receipt
Revenue receipt = taxable (unless exempted). Capital receipt = exempt (unless expressly taxable).
Test: compensation for loss of profit = revenue; compensation for loss of asset = capital.
3. Diversion vs Application of Income
Diversion: overriding title of third party → income never belonged to assessee. Application: income
first belongs to assessee, then applied. Key: who CONTROLS the quantum and use.
4. Basic Operation vs Subsequent Operation
Both needed for agricultural income. Basic = tilling, sowing, irrigation. Subsequent = fertilising,
harvesting. Without basic operation = NOT agricultural income.
5. Business WITH India vs Business IN India
Business with India (export/import) = NO business connection. Business in India (through an
agent/PE) = YES, business connection.
6. Business Connection vs PE
Business connection: ITA concept, creates Section 9 charge. PE: DTAA concept (Article 5), provides
relief. Time factor critical for PE (not for business connection). PE automatically establishes business
connection.
7. Royalty vs Business Income
Transfer of ALL rights in IP = capital gains or business income. Transfer of LIMITED/PARTIAL rights =
royalty. Downloading software = sale of copyrighted article = business income (Engineering Analysis,
2021 SC).
8. FTS under ITA vs DTAA
ITA: Managerial + Technical + Consultancy. DTAA: Technical + Consultancy only (no managerial).
DTAA adds 'Make Available' clause (technology must be transferred to recipient). DTAA definition is
NARROWER.
9. AOP vs BOI
AOP: persons join together for a common purpose; can include legal entities. BOI: only individuals;
must be working together. Both can be 'persons' under Section 2(31).
10. Assessment Year vs Previous Year
Previous Year = year of EARNING income. AY = year of FILING return and ASSESSMENT. Tax must
be PAID in previous year (before 31 March). Not AY.

Best of luck for your exam! 📚