Determining the Place of Accrual of Income under Indian Law: A Scholarly Analysis

Introduction

The concept of "accrual of income" is a cornerstone of the Indian income tax framework, particularly under the Income Tax Act, 1961 (hereinafter "the Act"). Section 5(2) of the Act, which defines the scope of total income for non-residents, and Section 5(1) for residents, hinges significantly on whether income "accrues or arises" or is "deemed to accrue or arise" in India. The determination of the place of accrual is thus critical for ascertaining tax liability, especially in an increasingly globalized economy with prevalent cross-border transactions. The Act itself does not provide an exhaustive definition of "accrues" or "arises," leading to a substantial body of jurisprudence that has evolved to interpret these terms. This article seeks to provide a comprehensive analysis of the principles governing the determination of the place of accrual of income under Indian law, drawing extensively from the provided reference materials, including landmark judicial pronouncements and statutory interpretations.

Conceptual Foundations of "Accrual" of Income

The Meaning of "Accrues" or "Arises"

The terms "accrues" and "arises" are often used synonymously in the context of income tax law to denote a right to receive income. The Supreme Court of India in Seth Pushalal Mansinghka Private Ltd. (In Both The Appeals) v. Commissioner Of Income Tax, Delhi, Rajasthan And Madhya Pradesh (In Both The Appeals) (1967) clarified that income may accrue to an assessee without actual receipt; if the assessee acquires a right to receive the income, the income can be said to have accrued. This principle was reiterated by the Delhi High Court in The Commissioner Of Income Tax Delhi-Iv, New Delhi v. Eon Technology P. Limited (2011), stating that income is said to have "accrued" or "arisen" immediately when the right to receive the said income becomes vested in the assessee. The Madras High Court in Commissioner Of Income-Tax v. Anamallais Timber Trust Ltd. (1949) observed that the words “accrue” or “arise” with reference to profits denote a stage anterior to the receipt of such profits. The Orissa High Court in Rahim v. Commissioner Of Income-Tax (1948) noted that these expressions denote the same idea or ideas very similar. Thus, the fundamental characteristic of accrual is the acquisition of a right to receive income, which is distinct from the actual receipt of that income (Deputy Commissioner Of Income Tax v. Curls & Curves India Ltd., 2010).

As observed by the Judicial Committee in CIT v. Chunilal B. Mehta (6 ITR 521), cited in Seth Pushalal Mansinghka Private Ltd. (In Both The Appeals) v. Commissioner Of Income Tax, Delhi, Rajasthan And Madhya Pradesh (In Both The Appeals) (1967): "I think, therefore, that the words ‘arising or accruing' are general words descriptive of a right to receive profits.”

The Principle of Real Income

A significant qualifier to the concept of accrual is the "real income" principle. The Supreme Court has consistently held that income tax is a tax on real income, not on hypothetical or theoretical income (Commissioner Of Income Tax v. Excel Industries Limited, 2013; Godhra Electricity Co. Ltd., Ahmedabad v. Commissioner Of Income Tax, Gujarat-Ii, Ahmedabad, 1997). In Godhra Electricity Co. Ltd. (1997), the Court, referencing State Bank of Travancore v. CIT ((1986) 158 ITR 102 (SC)), emphasized that "The accrual must be real taking into account the actuality of the situation. Whether an accrual has taken place or not must, in appropriate cases, be judged on the principles of real income theory." This implies that the probability or improbability of realization, viewed realistically, is a relevant factor in determining if income has truly accrued.

Accrual versus Deemed Accrual

Section 5 of the Act distinguishes between income that "accrues or arises" and income that is "deemed to accrue or arise" in India. While actual accrual generally involves a direct territorial nexus, such as the situs of the income-generating activity within India, the deeming provisions of Section 9 of the Act expand the tax net to include certain incomes as arising in India even if they might not strictly meet the criteria for actual accrual. As noted in The Commissioner Of Income Tax Delhi-Iv, New Delhi v. Eon Technology P. Limited (2011), "When one states ‘accrual of income’ it is basically an absolute concept when both the situs and receipt of such income is within the territories of the country. However, if such conditions are not met fully and completely, then the deeming concept comes into play." The Authority for Advance Rulings in Mustaq Ahmed Mustafa Gold Mart v. Director Of Income-Tax (2008) also discussed the role of deeming provisions (referring to Section 42 of the 1922 Act, analogous to Section 9 of the 1961 Act) in bringing income within the ambit of taxation. The Bombay High Court in Clifford Chance v. Deputy Commissioner Of Income-Tax (2008) highlighted that a sufficient territorial nexus with India is essential for imposing tax, and Section 9 incorporates various heads of income deemed to accrue or arise in India.

Judicial Perspectives on the Situs of Accrual

The Historical Dichotomy: Source v. Right to Payment

The courts have historically grappled with two primary lines of approach in determining the place of accrual. According to one view, the place where the income springs, grows, or has its source is the place of accrual. The alternative view considers the place where the result of business activities is transmuted into money or where there is a right to demand payment as the place of accrual (Commissioner Of Income-Tax v. Anamallais Timber Trust Ltd., 1949; Rahim v. Commissioner Of Income-Tax, 1948). While these views appear conflicting, judicial interpretation has often sought to identify the location of the core income-generating activity or the vesting of the right to receive income based on the specific nature of the transaction.

Income from Business Operations

General Principles

The determination of where business profits accrue is highly fact-dependent. As the Judicial Committee noted, and as cited in Seth Pushalal Mansinghka Private Ltd. (In Both The Appeals) v. Commissioner Of Income Tax, Delhi, Rajasthan And Madhya Pradesh (In Both The Appeals) (1967), "it is impossible to lay down any general test to determine the place where the profits of the business accrue." While the place of contract formation can be a factor, "other matters — for instance the place where the contract is carried out or acts are done under the contract — may be decisive in certain circumstances."

Manufacturing and Sale of Goods

In cases involving composite businesses of manufacturing and selling, profits may be apportioned. Manufacturing profits are generally considered to accrue or arise where the manufacturing operations take place, i.e., where the mills, plant, and machinery are situated (Commissioner Of Income-Tax v. Anamallais Timber Trust Ltd., 1949). This principle was central to the Supreme Court's decision in Commissioner Of Income Tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay (1950), where profits attributable to manufacturing operations in Raichur (Hyderabad State) were held to accrue there, even if the goods were sold in Bombay. For profits from the sale of goods, the general rule is that they accrue at the place where the contracts of sale are made or where sales are effected (Commissioner Of Income-Tax v. Anamallais Timber Trust Ltd., 1949; Seth Pushalal Mansinghka Private Ltd. v. CIT, 1967). The passing of title and risk in goods is a critical determinant. If the title in goods passes to the buyer in India, the income from such sale accrues in India (Nortel Networks India International Inc. v. Deputy Director of Income-tax, Circle-2(1), International Taxation, New Delhi, 2014, referencing Ishikawajima-Harima Heavy Industries Ltd. v. DIT). Conversely, for offshore supplies where title passes outside India, income may accrue outside India (Director Of Income Tax v. Ericsson A.B, New Delhi, 2011).

Rendering of Services

A consistent line of judicial thought establishes that if income accrues or arises as a result of work done or services performed under a contract, the place where such services are performed is the place where the income accrues or arises (Commissioner Of Income-Tax v. Anamallais Timber Trust Ltd., 1949). This was affirmed in The Commissioner Of Income Tax Delhi-Iv, New Delhi v. Eon Technology P. Limited (2011), where it was held that by performing services as envisaged in an agreement, the service provider earns the right to receive income, and if such services have their situs/origin in India, the income is taxable in India. The Bombay High Court in Commissioner Of Income-Tax v. Avtar Singh Wadhwan (2000) also emphasized that for salary income, the place where services are rendered is relevant for accrual, not necessarily the place of contract execution. This principle extends to technical services; if foreign technical personnel work in India and impart training as part of an agreement, the income attributable to such services rendered in India accrues in India (Commissioner Of Income-Tax, Madras-I v. Carborundum Company, 1973).

Commission Income

The situs of accrual for commission income is generally the place where the agent performs the services that entitle them to the commission. In Commissioner Of Income Tax, Andhra Pradesh v. Toshoku Ltd., Guntur And Others (1980), the Supreme Court held that commissions paid to non-resident agents for services rendered entirely outside India did not accrue or arise in India, and mere book entries in India did not constitute receipt or accrual in India. Conversely, as held in The Commissioner Of Income Tax Delhi-Iv, New Delhi v. Eon Technology P. Limited (2011), where a non-resident entity acts as a selling and marketing agent for an Indian assessee and renders services in India, the commission income earned for such services accrues in India. The Supreme Court in Commissioner Of Income Tax, Punjab (In Both The Appeals) v. R.D Aggarwal And Co. And Another (1965) clarified that mere procurement of orders in India by an agent for non-resident exporters, without deeper involvement in the execution of contracts or other significant business operations in India, might not establish a "business connection" that would lead to the accrual of the non-resident's profits in India. The accrual of the agent's commission itself would depend on where the agent's services are predominantly performed.

Royalties and Fees for Technical Services (FTS)

Income from royalties, such as those for performing rights, accrues where the underlying rights are exploited or used. In Performing Right Society Ltd. And Another v. Commissioner Of Income Tax And Others (1976), the Supreme Court held that royalties received from All India Radio for broadcasting musical works accrued in India because the performances and broadcasting occurred within Indian territory, irrespective of the agreement being executed in England. Similarly, for fees for technical services (FTS), if services like providing technical know-how, training personnel, or lending technical experts are rendered in India, the portion of the fee attributable to such services rendered in India is considered to accrue or arise in India (Commissioner Of Income-Tax, Madras-I v. Carborundum Company, 1973). While the concept of "business connection" is often relevant for the taxation of non-residents under Section 9, the principle for actual accrual under Section 5 still points to the location of service performance or utilization.

Income from Investments and Other Receipts

For income from investments, such as interest, the Madras High Court in Commissioner Of Income-Tax v. Anamallais Timber Trust Ltd. (1949) indicated that it accrues where the monies are lent or placed at the disposal of borrowers. In the case of non-cash receipts, the Supreme Court in Kanchanganga Sea Foods Limited v. Commissioner Of Income Tax (2010) held that where a non-resident company received its charter fee in the form of a share of fish catch, and this share was valued, certified, and came under its control within India (specifically, the Exclusive Economic Zone, treated as part of India for tax purposes), the income was considered to have been received or accrued in India, making it taxable therein.

The Role of Contractual Stipulations

While contractual terms are relevant, the place of formation of a contract is not the sole or conclusive determinant of the place of accrual of income. The Judicial Committee's view in CIT v. Chunilal B. Mehta, as cited in Seth Pushalal Mansinghka Private Ltd. v. CIT (1967) and Stanmore (Anamallay) Estates Ltd. v. Inspecting Assistant Commissioner (1991), was that "the place of formation of the contract prevails against everything else. In some circumstances it may be so, but other matters - acts done under the contract, for example - cannot be ruled out a priori." The emphasis is often on the place where the contract is substantially performed or where the income-generating acts are done. The Delhi High Court in Director Of Income Tax v. Ericsson A.B, New Delhi (2011), referencing Skoda Export, also noted that the signing of a contract in India may not be a relevant circumstance to determine taxability if the core income-generating activities occur elsewhere.

Accrual, Accounting Methods, and Right to Receive

Mercantile System and Accounting Standards

Under the mercantile system of accounting, income is recognized and taxed when it accrues, regardless of when it is actually received (Deputy Commissioner Of Income Tax v. Curls & Curves India Ltd., 2010). Accrual, as an accounting concept, signifies 'earning' in relation to income (Mahindra Telecommunications Investment Private Limited Gateway Building, Apollo Bunder, Mumbai-400 001 v. Income Tax Officer, 2(2)(3), Aaykar Bhavan, Mumbai-400 020, 2016). Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI), which are binding on companies, also recognize accrual as a fundamental accounting assumption (Mahindra Telecommunications Investment Private Limited v. Income Tax Officer, 2016). However, as observed in Commissioner Of Income Tax And Another v. Canfin Homes Ltd. (2011), while an assessee's accounts under the mercantile system showing accrued income are important, the tax authorities must ascertain if the amount has really accrued, reflecting the true state of affairs, especially in contexts like interest on Non-Performing Assets (NPAs).

Vesting of the Right to Receive

The recurring theme in judicial pronouncements is that the critical test for accrual is the vesting of the right to receive income in the assessee (Seth Pushalal Mansinghka Private Ltd. v. CIT, 1967; The Commissioner Of Income Tax Delhi-Iv, New Delhi v. Eon Technology P. Limited, 2011). The place of accrual of income is, therefore, the place where the right to receive that income arises, coupled with a corresponding liability on the payer to make the payment there (The DCIT Circle-1(1)(1), Ahmedabad v. M/s. Aarvee Denims & Exports Ltd., Ahmedabad, 2023, referencing Eon Technology).

The Assessing Officer in The Commissioner Of Income Tax Delhi-Iv, New Delhi v. Eon Technology P. Limited (2011) noted: "As per previous judicial pronouncement, it has been clearly established that income can be said to be received when it reaches the assessee but it can be said to have “accrued” or “arisen” immediately when the right to receive the said income becomes vested in the assessee. By performing the functions as envisaged in the agreement, the ETUK has earned the right to receive the income, thereby attracting the provisions of section 5 of the Act."

Conclusion

The determination of the place of accrual of income under Indian income tax law is a nuanced exercise, profoundly shaped by judicial interpretation of the principles enshrined in the Income Tax Act, 1961. It is evident from the analysis of the provided reference materials that no single, universally applicable test exists; rather, the situs of accrual is ascertained based on the specific facts and circumstances of each case. Key considerations include the nature of the income, the location where the income-generating activities are performed (such as rendering services, manufacturing, effecting sales, or exploiting rights), and the point at which the assessee acquires a legally enforceable right to receive the income. The "real income" principle serves as an important check, ensuring that only genuinely accrued income is subjected to tax. While contractual terms provide context, the substance of the transaction and the location of essential business operations or services often carry greater weight than the mere place of contract execution. A thorough understanding of these judicially evolved principles is indispensable for taxpayers, particularly non-residents and entities involved in cross-border transactions, to navigate their tax obligations in India effectively and ensure compliance.