Territorial nexus in income tax law supports deeming foreign-paid dividends as Indian-source income and assessment through a statutory agent.

Explanation 3 to Section 4(1)(c) was treated as valid because it rested on a real territorial nexus: dividends paid outside British India could be deemed to accrue in British India to the extent they were paid out of profits already taxed there. The provision was therefore within legislative competence. On the assessment question, dividend income of a non-resident could be brought to tax in the hands of the Indian company as statutory agent under Section 42, since the income was held to arise from profits earned in British India and thus from an Indian source. The legal principle applied was that deemed accrual is sustainable where the income has a sufficient territorial connection with the taxing territory.

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Issues: (i) Whether Explanation 3 to Section 4(1)(c) of the Indian Income-tax Act was within legislative competence and could validly deem dividends paid outside British India to be income accruing in British India to the extent paid out of profits taxed in British India; (ii) whether the dividend income of the non-resident company was assessable in the hands of the Indian company as its agent under Section 42 of the Indian Income-tax Act.

Issue (i): Whether Explanation 3 to Section 4(1)(c) of the Indian Income-tax Act was within legislative competence and could validly deem dividends paid outside British India to be income accruing in British India to the extent paid out of profits taxed in British India.

Analysis: The charging provision for a non-resident turned on income that accrued, arose, or was deemed to accrue or arise in British India. Explanation 3 treated dividends paid outside British India as income accruing and arising in British India to the extent they were paid out of profits already subjected to Indian tax. The decisive test was territorial nexus. A sufficient nexus existed where the dividend derived from profits earned in British India, because the source of the dividend was the Indian business profits. The earlier Federal Court ruling upholding the same explanation was treated as binding and consistent with the approach later recognised in other authorities on territorial connection.

Conclusion: Explanation 3 was intra vires and valid.

Issue (ii): Whether the dividend income of the non-resident company was assessable in the hands of the Indian company as its agent under Section 42 of the Indian Income-tax Act.

Analysis: Section 43 provided the machinery for appointment of an agent, while Section 42 fixed the liability where income of a non-resident accrued or arose, directly or indirectly, through a source of income in British India. The dividends were held to arise from the profits earned in British India, and in that sense they came directly from an Indian source. Since the income fell within Section 42, assessment in the hands of the statutory agent was permissible.

Conclusion: The dividend income was assessable in the hands of the Indian company as agent of the non-resident company.

Final Conclusion: The reference was answered in a manner upholding the taxability of the dividend income and sustaining the levy against the statutory agent.

Ratio Decidendi: A statutory provision deeming dividend income of a non-resident to arise in India is valid where there is a real territorial nexus between the income and the taxing territory, and dividend income derived from profits earned in British India may be assessed through the non-resident's statutory agent.

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