Case Law Details
In a recent ruling Mumbai Income Tax Appellate Tribunal in the case of Ashapura Minichem Ltd. (ITAT) [2010] 5 taxmann 57 (Mum.-ITAT)] on the issue of tax ability of payments made by the Taxpayer for services rendered outside India, under the provisions of the Indian Tax Laws (ITL) as well as the India- China Tax Treaty (Tax Treaty) held that such payments are taxable in India both under the ITL as well as the Tax Treaty and the Taxpayer is liable to withhold taxes (WHT) from such payments.
Facts
- The Taxpayer, a company resident of India, was in the process of building an alumina refinery using bauxite from the state of Gujarat. It engaged a Chinese company (China Co) for providing bauxite testing services in its laboratories and for preparing test reports which would be used by the Taxpayer to define the process parameters. China Co rendered the services from China and a consideration of USD 1m was agreed to be paid to China Co.
- The test reports of bauxite samples were to cover complete chemical composition of bauxite, physical phase constitution of bauxite, performance tests etc.
- The Taxpayer was of the view that no taxes were required to be withheld from the payments made to China Co. Accordingly, the Taxpayer moved an application for obtaining a nil withholding certificate from the Tax Authority.
- The Tax Authority took a view that the payments made for services rendered by China Co were taxable as ‘fees for technical services’ (FTS) under the ITL as well as the Tax Treaty.
- The Taxpayer appealed before the first appellate authority which upheld the Tax Authority’s view. Aggrieved by the above, the Taxpayer appealed before the ITAT.
- Under the ITL, any income by way of FTS payable to a non-resident by a resident of India is generally taxable in India. FTS is defined as any consideration for rendering any managerial, technical or consultancy services. A Supreme Court (SC) decision rendered in 2004 had held that, for FTS to be taxable in India, the services should not only be utilised in India but should have also been rendered in India. The Finance Act, 2010 introduced a retrospective amendment in the ITL, with effect from 1 June 1976, to clarify that FTS would be taxable in India even if rendered from outside India.
- Under the Tax Treaty, FTS is defined as consideration for provision of managerial, technical or consultancy services by a resident of one country in the other country. FTS is generally deemed to be taxable in the country where the payer is a resident (Source Rule).
Issue before the ITAT :- Whether the payments made for services rendered by China Co are taxable in India and whether the Taxpayer is required to WHT while making such payments.
Taxpayer’s contentions
- Under the ITL, in order to attract tax ability of FTS in India, the services should be utilised as well as rendered in India. Reliance was placed on the SC’s decision in the case of Ishikawajima Harima Heavy Industries Ltd. [288 ITR 408] (Ishikawajima) and the jurisdictional Bombay High Court’s decision in the case of Clifford Chance [318 ITR 297] . In the present case, no part of the testing services was rendered in India by China Co.
- Under the Tax Treaty, for taxation of FTS in the source country (India), there is an additional requirement of place of performance of services in India. In view of the unique wordings used in the definition of FTS and by a literal interpretation of the same, provision of services in India should be construed as rendition of services in India.
- As per the Source Rule under the Tax Treaty, FTS is deemed to arise in India if the payer is a resident of India. However, the Source Rule is applicable only on the payments covered within the definition of FTS which requires the services to be rendered in India.
- It is not necessary that the source rule must be extended to all payments for managerial, technical or consultancy services.
- The receipts may be characterized as business profits of China Co. Since China Co does not have a permanent establishment in India, the same may not be taxable in India under the Tax Treaty.
Tax Authority’s contentions
- Under the ITL, FTS is taxable in India when services are utilized in India. The above view is clarified and supported by the amendment by the Finance Act, 2010. Hence, the Ishikawajima and Clifford Chance decisions are no longer good in law.
- Under the Tax Treaty, the Source Rule is clear that when a payment is made by a resident of India, FTS is deemed to have arisen in India. The deeming provision would be rendered meaningless, if one were to proceed on the basis that the Source Rule can be invoked only when services are rendered in India, as one cannot deem something which exists in reality.
ITAT ruling
Tax ability under the ITL
- Payments received by China Co are covered within the definition of FTS under the ITL. The Clifford Chance’s decision which relies on the Ishikawajima’s decision rests on: (i) The legal premise that services must be utilised and rendered in India. (ii) The conceptual premise that territorial nexus for determining tax liability is an internationally accepted principle.
- In light of the amendment by the Finance Act, 2010, the legal proposition stated above is no longer good in law. It is not necessary that in order to attract tax ability of FTS in India under the ITL, services must also be rendered in India.
- Income of China Co for services rendered to the Taxpayer is taxable as FTS in India under the ITL.
Tax ability under the Tax Treaty
- The definition of FTS covers payments for provision of managerial, technical or consultancy services by a resident of one country in the other country. The expression ‘provision of services’ is not defined or elaborated anywhere in the Tax Treaty.
- As per the Source Rule, FTS will be deemed to have accrued in the country where the payer is a resident, irrespective of the situs of technical services having been rendered.
- A literal interpretation of the definition of FTS as provision of service to mean rendition of service would render the Source Rule meaningless. Such an interpretation of a tax treaty, which renders a provision unworkable or is contrary to the clear and unambiguous scheme of the tax treaty, has to be avoided.
- Reliance was placed on an earlier decision Hindalco Industries Ltd. [94 ITD 242] of the ITAT which laid down certain principles of interpretation of tax treaties stating that the language used in a tax treaty need not be examined in literal sense and a departure from plain meaning is permissible where the context so requires.
- The payments received by China Co are taxable as FTS under the Tax Treaty as well as the ITL and the Taxpayer is liable to WHT from such payments.
Comments
Tax ability of offshore services in India has been a subject matter of persisting controversies in the past. With a view to remove any doubts regarding the legislative intent and the scope of the Source Rule on FTS under the ITL, a retrospective amendment was brought in by the Finance Act, 2010. The present ruling of the ITAT reiterates the law as amended.
The FTS clause of the Tax Treaty uses language that is unique as compared to a number of India’s other tax treaties, which had resulted in certain doubts about the scope of the clause being narrow. The present ruling clarifies the interpretation of this clause. Even though not expressly referred to, this ruling relies on the treaty interpretation principles contained in the Vienna Convention on Law of Treaties. This ruling also confirms that, in appropriate circumstances, it may be possible to deviate from the literal or legalistic interpretation if the basic object of a tax treaty may be defeated by such an interpretation.
Good decision by ITAT, Mumbai.