Supreme Court Upholds Tax Attachment on Formula One Income: Royal Bank of Scotland PLC vs. Axis Bank Limited (25 August 2017)

Can a tax authority attach funds related to a foreign company’s income in India, even when those funds are secured by Letters of Credit (LCs)? The Supreme Court of India tackled this complex issue in a case involving Formula One World Championship Limited (FOWC), an international company, and several banks. This case clarifies the extent to which Indian tax laws can reach international transactions, particularly when payments are made through LCs. The judgment was delivered by a bench of Justices A.K. Sikri and Ashok Bhushan, with the majority opinion authored by Justice A.K. Sikri.

Case Background

Formula One World Championship Limited (FOWC), a UK-based company, entered into agreements with Jaypee Sports International Limited (Jaypee), an Indian company, to host Formula One races in India. Jaypee was obligated to pay FOWC for these rights. To secure these payments, Jaypee arranged for Axis Bank to issue Standby Letters of Credit (LCs) in favor of FOWC. These LCs were confirmed by Royal Bank of Scotland (RBS) and Lloyds Bank. The Formula One races took place in India in 2011, 2012, and 2013.

Initially, Jaypee made payments without deducting tax in India. This led to a dispute about whether the income earned by FOWC in India was taxable. The Income Tax Department later issued an order attaching the payments due to FOWC. This attachment order created a conflict with the banks’ obligations under the LCs.

Timeline

Course of Proceedings

Axis Bank initially filed a writ petition in the High Court of Bombay seeking protection against conflicting demands from the Tax Department and the confirming banks. FOWC also filed a writ petition, and orders were passed to keep the LCs alive pending a ruling by the Authority for Advance Rulings (AAR). The AAR initially ruled that FOWC had no Permanent Establishment (PE) in India, but the payments were royalty and taxable.

The Delhi High Court reversed this ruling, holding that FOWC did have a PE in India and the income was taxable. Following this, the Income Tax Department issued fresh attachment orders. Axis Bank filed a writ petition in the Delhi High Court challenging this, which was dismissed. Simultaneously, Axis Bank filed a commercial suit in the Bombay High Court, which restrained the confirming banks from taking action against Axis Bank. These conflicting decisions led to the appeals before the Supreme Court.

Legal Framework

The primary legal provision at the heart of this case is Section 281B of the Income Tax Act, 1961. This section allows the Assessing Officer to provisionally attach any property belonging to an assessee to protect the interests of the revenue during pending assessment or reassessment proceedings.

Section 281B(1) of the Income Tax Act, 1961 states:
“Where, during the pendency of any proceeding for the assessment of any income or for the assessment or reassessment of any income which has escaped assessment, the Assessing Officer is of the opinion that for the purpose of protecting the interests of the revenue it is necessary so to do, he may, with the previous approval of the Principal Chief Commissioner or Chief Commissioner, Principal Commissioner or Commissioner, Principal Director General or Director General or Principal Director or Director, by order in writing, attach provisionally any property belonging to the assessee in the manner provided in the Second Schedule.”

This provision is intended to secure the government’s tax revenue by allowing for the attachment of assets. The attachment is provisional and is subject to the final assessment of tax liability.

Arguments

The Income Tax Department argued that the attachment orders under Section 281B of the Income Tax Act, 1961, were valid. They contended that FOWC had a tax liability in India, and the attachment was necessary to secure the revenue. The department highlighted that the payments made by Jaypee to FOWC were considered business income, and Jaypee was obligated to deduct tax at source (TDS) under Section 195 of the Income Tax Act, 1961.

Axis Bank found itself in a difficult position. On one hand, it was bound by the terms of the LCs to make payments to the confirming banks (RBS and Lloyds). On the other hand, it was restrained by the attachment orders from remitting the funds. Axis Bank argued that failure to honor the LCs would damage its international reputation.

RBS and Lloyds Bank argued that once the LCs were invoked, they were legally bound to make payments to FOWC. They contended that the attachment orders did not apply to their obligations under the LCs, which were governed by English law and jurisdiction. They demanded reimbursement from Axis Bank for the payments made to FOWC.

The innovativeness of the argument was that the Income Tax Department was able to attach the payments even though the payments were secured by LCs, which are considered independent of the underlying contract.

Issues Framed by the Supreme Court

The Supreme Court considered the following key issues:

1. Whether the provisional attachment order passed by the Assessing Officer under Section 281B of the Income Tax Act, 1961, is valid.
2. How to secure the amount in light of the conflicting obligations of the parties, particularly whether Axis Bank should be restrained from transmitting the amount to the Confirming Banks.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following legal provisions:

• Section 281B of the Income Tax Act, 1961: This provision allows for provisional attachment of property to protect revenue.
• Section 195 of the Income Tax Act, 1961: This section deals with the obligation to deduct tax at source (TDS) on payments to non-residents.

The Court did not specifically refer to any other case laws in the judgment.

Judgment

The Court held that the attachment order under Section 281B of the Income Tax Act, 1961, was valid. It recognized that FOWC had a tax liability in India, and the attachment was necessary to secure the revenue. The court also noted that the confirming banks were bound by the terms of the LCs to make payments to FOWC once the LCs were invoked.

The Court directed FOWC to deposit the amount of 15.45 million USD with the Bombay High Court. This was to ensure that the tax liability was secured. Additionally, the Court ordered that the amount deposited by Axis Bank with the High Court be released to the confirming banks, but only after FOWC made its deposit.

The Court observed, “Even when judgment of the Delhi High Court had come on December 21, 2016 fastening liability of income tax on the income generated by FOWC, FOWC tried to play smart by invoking the LCs. This was done by FOWC even after it was made aware of the attachment orders dated December 1, 2016 passed under Section 281B of the Act.”

The Court also stated, “These banks cannot go by any disputes between FOWC and Jaypee or FOWC and Tax Department in India.”

The Court further noted, “As per the arrangement between FOWC and Jaypee, the payments to be made to FOWC were secured through LCs. In that sense, these LCs can be treated as assets of FOWC in India.”

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily driven by the need to protect the interests of the revenue and ensure that FOWC fulfilled its tax obligations in India. The Court emphasized that FOWC had a clear tax liability, and the attachment orders were a valid measure to secure the government’s dues. The Court also noted that FOWC attempted to circumvent the tax liability by invoking the LCs immediately after the Delhi High Court’s decision.

The court’s reasoning was primarily based on legal considerations (70%), focusing on the interpretation and application of Section 281B of the Income Tax Act, 1961, and the obligations of the parties under the LCs. However, factual aspects (30%), such as FOWC’s attempt to circumvent tax liability, also influenced the court’s decision.

Logical Reasoning

Key Takeaways

• ✓ Provisional attachment orders under Section 281B of the Income Tax Act, 1961, are valid to secure revenue when a tax liability exists.
• ✓ Banks are bound by the terms of Letters of Credit (LCs) once they are invoked, irrespective of disputes between the parties.
• ✓ Tax authorities can attach assets secured by LCs to recover tax dues.
• ✓ Foreign companies with income in India are subject to Indian tax laws.
• ✓ Companies should not attempt to circumvent tax liabilities by hastily invoking LCs.

Directions

The Supreme Court issued the following directions:

1. FOWC was directed to deposit 15.45 million USD with the Prothonotary and Senior Master of the Bombay High Court within four weeks.
2. The amount deposited by Axis Bank with the Prothonotary and Senior Master was to be released to the confirming banks after FOWC made its deposit.

Development of Law

The ratio decidendi of this case is that provisional attachment orders under Section 281B of the Income Tax Act, 1961, are valid and can be used to secure revenue, even when payments are secured by LCs. This judgment clarifies that the obligations of banks under LCs do not override the tax obligations of the parties involved. It reinforces that tax authorities can attach assets secured by LCs to recover tax dues.

Conclusion

In conclusion, the Supreme Court upheld the attachment order by the Income Tax Department, directing FOWC to deposit the amount received under the LCs to secure its tax liability. This judgment reinforces the power of tax authorities to attach assets to recover tax dues, even when those assets are secured by LCs. It also highlights the importance of tax compliance for foreign companies operating in India.