Payer residence alone not enough to tax non-resident income under Sec 5(2)(b) | Quashes notices, directs Rs 783 crore TDS refund : Delhi HC

The Delhi High Court quashed reassessment notices issued under Section 148 of the Income Tax Act, 1961, holding that mere payment by an Indian resident to a non-resident does not constitute income accruing or arising in India under Section 5(2)(b) of the Act. The Court set aside the Authority for Advance Rulings' order declining to rule on taxability and directed refund of tax deducted at source amounting to approximately Rs. 783 crores with applicable interest within two months.

Background & Facts

The Genesis of the Dispute

The dispute arises from agreements between entities of the Ranbaxy and Teva groups concerning the commercial exploitation of Atorvastatin (generic Lipitor) in the United States. Ranbaxy India, through its US subsidiary Ranbaxy Pharmaceuticals Inc., USA, had filed an Abbreviated New Drug Application (ANDA) for Atorvastatin. Teva USA, the US subsidiary of Teva Israel, subsequently filed its own ANDA. Under US regulatory regime, the first filer of an ANDA is entitled to 180 days of exclusivity to market the generic drug.

Key Facts

• On 07.12.2010, Ranbaxy India, Ranbaxy USA, and Teva USA entered into an agreement whereby Ranbaxy India agreed to transfer its Sole First to File Exclusivity (SFFE) rights to Teva USA upon issuance of a valid Ready Date Notice (Annexure A-4 to W.P.(C) 12721/2019).
• The Ready Date Notice required Teva USA to have initial launch quantities ready for sale and obtain either tentative approval or written confirmation from the US FDA for final approval.
• Teva USA served a Ready Date Notice on Ranbaxy on 23.11.2011, claiming that a PLAIR approval email from the FDA on 21.11.2011 constituted written confirmation of eligibility for final approval.
• Ranbaxy disputed the validity of the Notice, asserting that the twin conditions for issuance had not been fulfilled.
• Teva USA initiated proceedings in the US District Court on 29.11.2011 seeking an injunction to prevent Ranbaxy from launching its product.
• The parties settled the dispute within twenty-four hours, entering into a fresh agreement on 07.12.2011 (effective from 30.11.2011) under which Ranbaxy agreed to pay Teva 50% of the contract margin on sales of Atorvastatin during the exclusivity period.
• Teva USA assigned its rights under this arrangement to Teva Israel, its parent company, and Ranbaxy India remitted the payment directly to Teva Israel from India.
• On 30.11.2011, Ranbaxy obtained FDA approval for its ANDA and commenced commercial sale of Atorvastatin in the USA market, earning approximately USD 700 million in profits over the 180-day exclusivity period.
• As per the settlement agreement, 50% of the profits (amounting to Rs. 1,851.07 crores) was paid by Ranbaxy India to Teva Israel in three instalments:
  • Assessment Year 2012-13: Rs. 1,434,429,559 (USD 281.84 million approx.)
  • Assessment Year 2013-14: Rs. 417,316,974 (USD 71.27 million approx.)
  • Assessment Year 2014-15: Rs. 25,091,179 (USD 411 thousand approx.)
• Tax was deducted at source by Ranbaxy India at approximately 42% under Section 195 of the Income Tax Act, 1961, totaling Rs. 783,831,1687 across the three assessment years.
• Teva Israel filed returns under the Income Tax Act, 1961 declaring 'Nil' income and claimed refund of the TDS deducted by Ranbaxy India.

Procedural History

• 15.04.2013: Teva Israel filed Application No. 1476/2013 before the Authority for Advance Rulings (AAR), New Delhi, seeking a ruling on whether the payment received from Ranbaxy India was chargeable to tax in India.
• 25.10.2019: The AAR passed an order declining to give a ruling on taxability, observing that the income belonged to Teva USA and that the transaction was prima facie designed for avoidance of income tax.
• 29.03.2016: The Assessing Officer issued notices under Section 148 of the Income Tax Act, 1961 for Assessment Years 2012-13 and 2013-14, initiating proceedings against Teva USA.
• 30.06.2021: Original notice under Section 148 issued for Assessment Year 2014-15.
• 02.06.2022: Show cause notice issued under Section 148A(b) following the petitioner's reply.
• 16.06.2022: Petitioner filed its reply to the show cause notice.
• 28.07.2022: Order passed under Section 148A(d).
• 29.07.2022: Notice under Section 148 issued.
• 15.09.2026: Judgment pronounced by the High Court of Delhi.

Relief Sought

The petitioners sought:

• Quashing of the impugned notices issued under Section 148 for Assessment Years 2012-13, 2013-14, and 2014-15.
• Setting aside of the AAR order dated 25.10.2019.
• Direction to the respondents to refund the entire TDS amount deducted by Ranbaxy India along with applicable interest.

The Legal Issue

The central question was whether the payment made by Ranbaxy India (an Indian resident) to Teva Israel (a non-resident) constitutes income accruing or arising in India under Section 5(2)(b) of the Income Tax Act, 1961, merely because the payer is located in India, without any requirement to demonstrate actual accrual or arising of income in India.

Arguments Presented

For the Petitioners

The petitioners, led by Mr. Harish Salve and Mr. Sachit Jolly, contended that:

• The payment was received by Teva Israel for business profits earned from the sale of Atorvastatin in the United States market, with no business connection existing in India as the entire transaction pertained to US ANDA exclusivity rights and marketing.
• Under Section 9(1)(i) of the Act, income is deemed to accrue or arise in India only through a business connection in India, which was absent here as the underlying contractual rights, ANDA regulatory framework, litigation, and market were all situated outside India.
• The AAR exceeded its jurisdiction under Chapter XIX-B of the Act by examining the tax liability of Teva USA (a non-applicant) and making findings regarding commercial wisdom and alleged collusion, which it was not empowered to do.
• The AAR's reliance on the opinion of the US Attorney General (OAG) to label the agreement as 'illegal' was misplaced, as such opinion does not constitute a judicial finding of illegality.
• Even assuming the non-compete clause was unlawful under US law, the character of income as business income does not change merely because it arises from an illegal source, and Section 5(2)(b) requires actual accrual or arising in India, not merely the payer's residence.
• The Revenue's reliance on GVK Industries Ltd. v. ITO was misplaced as that case dealt specifically with fees for technical services under Section 9(1)(vii) and did not establish a universal payer-location rule.

For the Respondents

The respondents, led by Mr. Himanshu S. Sinha, argued that:

• The payment was towards illegal consideration (the non-compete clause), rendering the income taxable in India under the source rule as the payer (Ranbaxy India) was located in India.
• Under Section 5(2)(b), income accrues or arises in India if the payer is situated in India, constituting a default source rule for cross-border payments not covered by specific deeming provisions in Section 9.
• The AAR was justified in examining whether the transaction was designed for tax avoidance under the proviso to Section 245R(2), and its finding of prima facie tax avoidance was sustainable.
• The payment constituted 'other income' taxable under Section 56(1) as it did not fall under any specific head of income, and the mere location of the payer in India sufficed to confer taxing jurisdiction on India.
• Teva Israel had wrongly filed its return claiming Nil income, as the income in substance belonged to Teva USA, which was obligated to file a return in India.

The Court's Analysis

The Court commenced its analysis by noting that the AAR, under Section 245R(4), is empowered only to examine the material placed before it and pronounce a ruling on the question specified in the application. It cannot embark on a roving inquiry into commercial wisdom or determine the tax liability of third parties not before it.

"The Authority proceeding under a specific statutory mandate to determine the question of an applicant's tax liability has no jurisdiction to determine, in those very proceedings, the tax liability or the entitlement to income of a third party, who has neither approached it nor is such party before it. The finding of the Authority that 'income accrued to Teva USA' is therefore a finding recorded without jurisdiction and is, therefore, a nullity."

The Court emphasized that Section 5(2)(b) requires income to actually accrue or arise in India, and the mere fact of payment by an Indian resident to a non-resident does not satisfy this condition. It held that the statutory scheme militates against an unqualified payer-location rule, given the enactment of specific source rules and deeming provisions in Section 9.

"Indeed, the enactment of specific source rules and deeming provisions in Section 9 of the Act of 1961 militates against acceptance of such an unqualified proposition. The Revenue was therefore required to establish, independent of mere location of Ranbaxy India, a sufficient nexus between India and the income-producing right or activity so as to constitute actual accrual or arising in India, or alternatively to bring the receipt within one of the statutory deeming provisions."

Examining the transaction, the Court found that:

• The underlying contractual rights concerned the marketing and sale of pharmaceutical products in the United States.
• The ANDA and associated regulatory rights arose out of arrangements between pharmaceutical companies under US law.
• The disputed Ready Date Notice, litigation preceding settlement, alleged obligations of forbearance, and the market whose exploitation generated the economic return were all substantially situated outside India.
• There was no business connection in India as the payment was not for services rendered in India, nor did it relate to any asset, property, or source of income in India.

The Court rejected the respondents' reliance on the OAG's opinion, stating:

"An opinion expressed in the course of anti-trust proceedings, particularly one not resulting in any admission of guilt, cannot be elevated to a judicial finding of illegality for the purposes of Section 148 proceedings."

It further held that the AAR's findings of a 'sham and make-believe arrangement' and 'collusive arrangement' were unsustainable as they were based on speculative inferences about tacit understandings between Teva USA and Ranbaxy, without any evidentiary foundation or reference to applicable foreign law.

"The AAR first proceeded on a hypothesis or conjecture that there 'might have been a tacit understanding' between Teva USA and Ranbaxy that Teva USA would refrain from entering the market even after expiry of Ranbaxy's exclusivity period, and proceeded to observe that 'only such an understanding' could explain the enhancement of Teva's share from 15% to 50%. Then, based on this conjecture, the AAR premised its conclusion that the arrangement was collusive and constituted a 'sham and make belief arrangement'."

The Court concluded that the Revenue failed to demonstrate any real and substantive nexus between the impugned receipt and the territory of India, and that the jurisdictional foundation for issuance of notice under Section 148 collapsed in the absence of the receipt falling within any specific deeming provision under Section 5(2)(b) or Section 9.

The Verdict

The petitioners succeeded in their writ petitions. The Court:

• Quashed the impugned notices dated 29.03.2016 issued under Section 148 of the Income Tax Act, 1961 for Assessment Years 2012-13 and 2013-14.
• Quashed the order under Section 148A(d) dated 28.07.2022 and the notice under Section 148 dated 29.07.2022 for Assessment Year 2014-15.
• Set aside the order of the Authority for Advance Rulings dated 25.10.2019.
• Directed the respondents to forthwith refund the entire amount of TDS deducted by Ranbaxy India, aggregating to Rs. 783,831,1687, along with applicable interest, within a period of two months from the date of judgment (15.09.2026).

What This Means For Similar Cases

Nexus Requirement for Section 5(2)(b) Taxation

Practitioners must now demonstrate an actual nexus with India for taxing cross-border payments under Section 5(2)(b). The mere residence of the payer in India is insufficient; there must be proof that the income actually accrues or arises in India through business connection, property, or asset situated in India. This judgment reinforces that Section 5(2)(b) is not a default source rule but requires factual accrual or arising in India.

Limits of Advance Ruling Jurisdiction

Authorities for Advance Rulings must confine their inquiry to the specific question raised in the application. They cannot examine the tax liability of third parties not before them, assess commercial wisdom of contracting parties, or make findings regarding alleged collusion or tax avoidance without evidentiary basis. Any order exceeding this scope is liable to be set aside as without jurisdiction.

Burden of Proof for Tax Avoidance Claims

Revenue authorities cannot rely on speculative inferences or opinions from foreign regulatory bodies (such as the US Attorney General) to establish tax avoidance or illegality of underlying transactions. To invoke the proviso to Section 245R(2) regarding tax avoidance, there must be a demonstrable nexus with India and evidence of actual tax avoidance under Indian law, not merely hypothetical arrangements under foreign jurisdictions.