Revisiting Section 9(1)(ii) of the Income-tax Act, 1961: Deeming Accrual of Salary Income in India

Revisiting Section 9(1)(ii) of the Income-tax Act, 1961: Deeming Accrual of Salary Income in India

1. Introduction

Section 9(1)(ii) of the Income-tax Act, 1961 (“the Act”) embodies a legislative fiction which deems salary income to accrue or arise in India when it is “earned in India”.[1] Although the provision appears concise, its application has generated complex controversies concerning territorial nexus, extraterritorial operation, taxation of expatriate employees, and interaction with the machinery provisions governing tax deduction at source (“TDS”). The Supreme Court’s decisions in Sedco Forex and Eli Lilly, among others, together with a line of High Court and Tribunal rulings, have progressively delineated the contours of the deeming clause. The present article critically analyses the statutory framework, legislative evolution, and the rich jurisprudence that has emerged around Section 9(1)(ii), highlighting doctrinal tensions and identifying areas necessitating legislative or judicial clarification.

2. Statutory Framework

2.1 Text of the Provision

Section 9(1)(ii) provides that income falling under the head “Salaries” shall be deemed to accrue or arise in India if it is earned in India. An Explanation inserted by the Finance Act, 1983, with retrospective effect from 1 April 1979, clarifies that salary “payable for services rendered in India” shall be regarded as income earned in India.[2] The deeming rule thus hinges on two variables:

  • the head of income (“Salaries” under Section 15), and
  • the situs of service—rendered in India.

2.2 Integration with Section 5

Section 5(2) charges a non-resident in respect of income “received” or “deemed to accrue or arise” in India. Section 9 expands this charge by deeming certain incomes to accrue in India even where classical concepts of accrual or receipt fail. The Supreme Court in Mustaq Ahmed Mustafa Gold Mart emphasised that Sections 5 and 9 must be read harmoniously: where income is actually received or accrued in India, Section 5 suffices; the deeming fiction in Section 9 supplements, but does not supplant, Section 5.[3]

2.3 Legislative Evolution

The 1983 Explanation was enacted to neutralise the Gujarat High Court’s view in CIT v. S.G. Pgnatale that “earned in India” required the creation of a debt in India, thereby excluding retention remuneration paid abroad.[4] Subsequent amendments, including the 1999 insertion of Explanation 1(b) (later omitted), largely reinforced the legislative intent to tax salary for services rendered in India irrespective of the place of payment, contract or receipt.

3. Judicial Trajectory

3.1 Early Construction: Territorial Nexus and “Place of Earning”

Even before the 1983 Explanation, courts adopted a purposive approach to territorial nexus. In Ahmedbhai Umarbhai, the Supreme Court, dealing with excess profits tax, articulated the principle that profits accrue where economic activities generating them take place.[5] Although not a salary case, the reasoning foreshadowed subsequent salary jurisprudence: location of economic activity, not contract or payment, is decisive.

3.2 The Pgnatale Paradigm (1980)

The Gujarat High Court held that retention salary paid abroad to a French expatriate was not taxable in India because no debt was created in India, and the allowances were reimbursements rather than perquisites.[4] The decision exposed lacunae in Section 9(1)(ii) by equating “earned” with “accrual” in the traditional sense. Parliament’s reaction—retrospective insertion of the Explanation—underscores the dynamic interplay between judicial interpretation and legislative response.

3.3 Sedco Forex and the “Field-Break” Controversy

In Sedco Forex International Drill. Inc. v. CIT, expatriate employees worked 28/35 days offshore India followed by equivalent “field breaks” abroad. The Uttarakhand High Court held that on-period and off-period salaries formed “an integral whole” and were taxable under Section 9(1)(ii); the Supreme Court reversed.[6] Ruma Pal J. reasoned that the Explanation covers only salary “payable for services rendered in India”. Field breaks fell outside this description because no services were rendered in India during that period. The Court rejected the High Court’s “nexus” test as impermissibly expanding the fiction beyond its purpose, citing the settled canon that a legal fiction must be confined to the purpose for which it is created.[7]

3.4 Halliburton, Reading & Bates and the Unified-Contract Argument

Both the Uttarakhand High Court and the ITAT, in Halliburton Offshore Services Inc. and Reading & Bates Exploration, had earlier adopted the unified-contract approach later disapproved in Sedco Forex.[8] Their view—that alternating on/off periods are inseparable—ignored the statutory language requiring actual rendering of services in India. Sedco Forex accordingly realigned the law with statutory text.

3.5 TDS, Machinery Provisions and Section 9(1)(ii): The Eli Lilly Integration

The Supreme Court in CIT v. Eli Lilly & Co. addressed whether home salaries paid abroad to expatriates seconded to India attracted TDS under Section 192.[9] The Court affirmed the “integrated code” thesis: charging provisions (Sections 4, 5, 9) and machinery provisions (Chapter XVII-B) are interwoven. If salary is deemed to accrue in India under Section 9(1)(ii), the payer (whether Indian JV or foreign parent) must deduct TDS notwithstanding the payment being made outside India. Failure triggers Sections 201(1) and 271C liabilities.

3.6 Post-Sedco Developments

  • Avtar Singh Wadhwan (Bombay HC) held that a marine engineer’s salary earned largely in foreign waters was not taxable in India; mere Indian ownership of the vessel was irrelevant.[10]
  • Goslino Mario (Gauhati HC) upheld taxability where salary was paid abroad but services rendered in India, relying on the Explanation.[11]
  • Recent ITAT rulings (e.g., Deepak Lakhani) reaffirm that Section 68 or 69 cannot enlarge the Section 5/9 charge on non-residents, preserving doctrinal coherence.[12]

4. Doctrinal Themes and Unresolved Issues

4.1 Meaning of “Services Rendered”

Sedco Forex implicitly adopts a literal approach—physical presence and actual performance in India. However, modern work practices (tele-working, virtual secondments) raise questions about whether remote rendering for an Indian project satisfies the test. Legislative clarification, akin to OECD commentary on “place of employment”, may be warranted.

4.2 Extraterritorial Reach and Constitutional Limits

In Eli Lilly, the Court relied on A. H. Wadia to uphold extraterritorial taxation where sufficient nexus exists.[9] Yet Article 245(2) permits extraterritorial legislation only with such nexus. The degree of nexus—rendering of services—appears settled, but ancillary payments (stock options vested abroad, social-security contributions) await authoritative pronouncement.

4.3 Interaction with Double Taxation Avoidance Agreements (“DTAAs”)

While this article focuses on domestic law, DTAAs often override Section 9(1)(ii) where the employee qualifies for exemption under Article 15 (Dependent Personal Services) based on days-of-stay thresholds. Courts have generally respected treaty overrides, but ambiguities persist where the treaty is silent on remuneration for stand-by periods.

4.4 Non-Monetary Perquisites and Employer-Paid Tax

The Uttarakhand High Court in DIT v. Sedco Forex International Drilling Inc. considered whether employer-paid tax constitutes a non-monetary perquisite exempt under Section 10(10CC).[13] Although not directly under Section 9(1)(ii), the decision illustrates the complex overlay between salary accrual rules and perquisite valuation, a matter amplified when cross-border employments involve tax-equalisation clauses.

5. Critical Assessment

Section 9(1)(ii) exemplifies legislative reliance on legal fiction to secure India’s taxing rights over economic activity within its territory. Judicial decisions, especially Sedco Forex, have appropriately policed the boundaries of that fiction, preventing an over-expansive reading that would offend the principle that deeming provisions must be strictly construed.[7] At the same time, Eli Lilly rightly integrates charging and machinery provisions, ensuring the fiction’s efficacy in tax collection.

Nonetheless, three concerns remain:

  1. Technological Evolution: The statute and precedent are anchored in a paradigm of physical presence. Guidance is needed for remote work scenarios.
  2. Treaty Synchronisation: Greater alignment between domestic deeming provisions and treaty clauses would enhance certainty for multinational employers.
  3. Timing Mismatches: Monthly TDS obligations may arise before residency or DTAA tests can be applied, creating compliance friction. Administrative circulars could moderate this rigour by permitting reasonable estimates subject to annual true-up.

6. Conclusion

The jurisprudence on Section 9(1)(ii) reveals a careful judicial balancing act: safeguarding the legislative intent to tax salaries for services rendered in India while restraining the deeming fiction within textual confines. Sedco Forex and Eli Lilly stand as doctrinal lodestars—one delimiting the fiction, the other operationalising it through integrated machinery provisions. Future disputes will likely pivot on digital modes of service delivery and treaty interplay, areas where statutory amendments or CBDT guidance would be salutary. For now, the controlling proposition remains clear: where, and only where, services are physically rendered in India, salary is deemed to accrue in India, triggering concomitant TDS obligations.

Footnotes

  1. Income-tax Act, 1961, s. 9(1)(ii).
  2. Finance Act, 1983, s. 11; Explanation to s. 9(1)(ii).
  3. Mustaq Ahmed Mustafa Gold Mart v. DIT, AAR No. 748/2008 (2008).
  4. CIT v. S.G. Pgnatale, (1980) 124 ITR 391 (Guj).
  5. CIT v. Ahmedbhai Umarbhai & Co., AIR 1950 SC 134.
  6. Sedco Forex International Drill. Inc. & Ors. v. CIT, (2005) 12 SCC 717.
  7. CIT v. Quantas Airways Ltd., (2002) 256 ITR 84 (Del) (on limits of legal fiction).
  8. CIT & Anr. v. Halliburton Offshore Services Inc., (2004) 271 ITR 395 (Utt); CIT & Anr. v. Reading & Bates Exploration Co., (2004) 271 ITR 496 (Utt).
  9. CIT v. Eli Lilly & Co. (India) Pvt. Ltd., (2009) 312 ITR 225 (SC).
  10. CIT v. Avtar Singh Wadhwan, (2001) 247 ITR 260 (Bom).
  11. CIT v. Goslino Mario, (1993) 202 ITR 989 (Gau).
  12. Deepak Lakhani v. DCIT, ITA No. 1260/JP/2019, ITAT Jaipur (2023).
  13. DIT (Intl. Tax) v. Sedco Forex International Drilling Inc., (2012) SCC Online Utt 1571.