Case Law Details
Case Name : Linklaters LLP Vs ITO (ITAT Mumbai)
Appeal Number : ITA Nos. 4896/Mum/03 and 5085/Mum/03
Date of Judgement/Order : 16/07/2010
Related Assessment Year : 1995- 96
- The assessee is a UK based partnership firm engaged in the practice of law. The assessee did not have any branch office or other similar form of presence in India.
- During the financial year 1995- 96, the assessee rendered services (partly from London and partly from India) to certain clients in connection with projects in India. The assessee?s partners / staff were present in India for a period exceeding 90 days.
- The assessee filed a nil return of income claiming that it did not have a permanent establishment (PE) or fixed base in India and therefore, its income from services rendered in India could not be brought to tax in India either as business profits or income from independent personal services.
- The Assessing Officer (AO) however maintained that the assessee had a business connection in India and that the income from professional services rendered is taxable as business profits. Without prejudice to this line of reasoning, the AO also held that the income earned by the assessee is also taxable as income from independent personal services.
- Notwithstanding its contention regarding non- tax ability of its income in India, the assessee contended that as per the India-UK Double Taxation Avoidance Agreement (DTAA), the profits of the PE would have to be computed as if the PE were a distinct and separate enterprise and dealing wholly independently with the enterprise of which it is a PE. Accordingly, in computing the profits of the PE, hypothetical market rates were applied to the actual man hours devoted in India. The direct costs were allocated on the basis of number of hours spent at the pro-rated UK salary cost and the overheads were allocated at 5% of the income.
- The AO held that there was no justification for adopting hypothetical amounts in computing the PE profits and that irrespective of whether the services are rendered from India or from outside India, the entire income in connection with projects in India is required to be taxed in India.
- Accordingly, the AO computed the income of the assessee by considering the overall amounts invoiced by the assessee in respect of services for Indian projects.
- The first appellate authority, viz, the Commissioner of Income tax (Appeals) [CIT(A)] upheld the AO?s order with regard to existence of PE. The CIT(A) further held that only income in respect of such work can be brought to tax in India as has been carried out in India.
Ruling of the Tribunal
1. Taxability of professional fees under the domestic law:
- The issue was whether the income of the assessee is taxable under the domestic tax law only to the extent the work has been carried out in India.
- In view of the retrospective amendment in Section 9 (See Note 1 Below) of the Income tax Act, 1961 (“the Act”) by the Finance Act, 2010, utilisation of the services in India is sufficient to attract tax ability of the income in India. It is no longer necessary that the services must also be rendered in India.
- Therefore the entire fees for professional services earned by the assessee, in connection with the projects in India and which is thus sourced from India is taxable in India under the domestic law.
- The tax treatment of the income was thereafter examined in light of the DTAA and the Tribunal also addressed the question of whether the assessee is entitled to the treaty benefits.
2. Partnership’s entitlement to the benefits of the DTAA:
- For the purposes of the DTAA, the term „resident of a Contracting State? means “any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature”.
- In its contextual sense, the expression „liable to tax by reasons of his domicile, residence, place of management or any other criterion of similar nature? refers to a situation in which a person is liable to tax in a tax jurisdiction by virtue of a locality related attachment which leads to residence type taxation.
- From a country perspective, what really matters is whether the income, in respect of which treaty protection is being sought, is taxed in the treaty partner country or not. That is clearly the underlying principle on which residence definition is modelled.
- In effect, even when a partnership firm is taxable in respect of its profits not in its own right but in the hands of the partners, as long as the entire income of the partnership firm is taxed in the residence country, treaty benefits cannot be declined.
- Therefore the assessee is eligible to the benefits of the DTAA.
- The Tribunal acknowledged that its conclusion is not in line with the OECD report, „the Application of OECD Model Convention to Partnerships? which recommends that treaty benefits should accrue to the partners in the partnership firm.
3. Existence of assessee’s PE in India under the DTAA:
- Article 5(1) of the DTAA (See Note 2 Below) refers to a fixed place of business through which the business of the enterprise is wholly or partly carried on, being the basic rule PE.
- Article 5(2) consists of two heterogeneous categories of PEs. The first category consists of illustrations of what would constitute a PE even under the basic rule and the second category consists of what can be termed as extensions of the basic rule and deemed PEs. The service PE clause under the DTAA falls under the second category.
- Tribunal rejected the assessees contention that it did not have a service PE in India since it has not fulfilled the conditions of basic PE rule i.e continuity of activities in India.
- The description in these two categories is listed under separate sub articles in OECD Model Conventions, UN Model Convention and US Model Convention. The very fact that these two categories have been segregated in these conventions shows that these categories belong to different genus.
- Article 5(2) cannot be read as a bunch of illustrations of PE under the basic rule set out in Article 5(1).
- The assessee has fulfilled the duration test envisaged in the Service PE clause of the DTAA.
- The Tribunal agreed that the income in the present case will not attract the provisions of „Independent Personal Services under Article 15 of the DTAA as these provisions apply only to individuals and not to partnership firms.
- The assessee had a PE in India under Article 5 and accordingly profits attributable to the PE are taxable under Article 7 of the DTAA (See Note 3 Below).
4. On attribution of profits to the PE on the basis of prevailing market prices of similar services in India
- In terms of Article 7(2) of the DTAA, the profits of the PE which are to be taxed are those which the PE might be expected to make “if it were a distinct and separate enterprise engaged in the same or similar activities in same or similar conditions and dealing wholly independent with the enterprise of which it is a PE”.
- The fiction of hypothetical independence is confined to a PE?s transactions with its general enterprise (GE) – i.e. enterprises of which it is a PE, other PE belonging to the same GE and other specified associated enterprises. This fiction of hypothetical independence has no role to play in adjusting the actual revenues with independent enterprises.
- The arms length price as embedded in scheme of computation of PE profits in tax treaties was a precursor to the transfer pricing legislation. It is in this backdrop that one needs to understand the scheme of Article 7(2). The adjustments contemplated in Article 7(2) are to prevent manipulation of tax base and neutralise any efforts to vitiate computation of PE profits by way of inappropriate valuation of transaction values in respect of intra group transactions.
- When actual bills in respect of services rendered are raised in respect of the work done by the PE and the same are realized from an outside party, it cannot be contended that these actual realisations should be substituted by some hypothetical figures merely because if the assessee had to do the same work for its GE, it would have accounted for such hypothetical amount. The adjustments can at best be made for actual GE-PE and for PEs inter se transactions.
- The end purpose of PE profit computation is a fair allocation of tax ability of income in related tax jurisdictions and not computation of possible profits of the PE in perfect market conditions.
- The revenues earned by the assessee are to be taken at actual figures and no adjustments based on market rates are permissible in the same.
5. Application of “force of attraction” principle in computation of profits attributable to the PE:
- Article 7 of the DTAA provides that if the enterprise carries on business through a PE, the profits of the enterprise may be taxed in the other State, but only so much of then as is “directly or indirectly attributable to that PE”.
- The basic philosophy underlying the force of attraction rule is that when an enterprise sets up a PE in another country, it brings itself within the fiscal jurisdiction of that another country to such a degree that such another country can properly tax all profits that the enterprise derives from that country – whether the transactions are routed and performed through the PE or not.
- The connotations of “profits indirectly attributable to PE” do indeed extend to incorporation of the force of attraction rule being embedded in Article 7(1) of the DTAA. In effect, the entire profits relating to services rendered by the assessee, whether rendered in India or outside India, in respect of Indian projects is taxable in India.
The Ruling recognizes that a partnership firm, albeit a fiscally transparent entity, can be regarded as an entity liable to tax and hence eligible for benefits under the DTAA. The Tribunal has also observed that the fiction of deeming the PE to be a distinct and separate enterprise is for the limited purpose of preventing the manipulations that may arise in intra-group transactions. The Tribunal has also held that income from services rendered offshore for Indian projects are taxable in India in the hands of the PE even if they are not directly connected to the PE by interpreting the “direct or indirect profits attribution rule” in the India-UK DTAA in a wide manner.
Source: Linklaters LLP Vs ITO- International Taxation, Ward 1(1)(2), Mumbai, ITA Nos 4896/Mum/03 and 5085/Mum/03 dated July 16, 2010.
- Section 9 of the Act contains the provisions in respect of income deemed to accrue or arise in India
- Article 5 deals with the definition of “permanent establishment”
- Article 7 of the DTAA contains the provisions for taxation of business profits.