It’s not breaking news. It affects sectors and professions other than the legal industry. But the fact is that two globally eminent law firms were targeted by the Indian tax authorities in relation to services provided to Indian entities with retrospective effect. The issue involves the interpretation of two successive amendments to Section 9 of the Income Tax Act, 1961.
The 2007 amendment added the following in an Explanation: “fees for technical services” means any consideration “for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include” which would be income of the recipient chargeable under the head “Salarie”.
The Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd., held that only the income from the services rendered and utilised in India and this was followed by the Mumbai High Court in the case of Clifford Chance vs DCIT, which proceeded on the premise that the Explanation did not apply to services rendered offshore and the execution of the contract in India was inconsequential. The test of residence was of the taxpayer and not the recipient.
The Mumbai High Court in the Clifford Chance case following the Ishikawajima Ruling held that Section 9(1) could not be interpreted except in the context of Article 15 of the India —UKDTTA and India, which provides for aggregation of members of a firm for the purpose of the 90 days resident test. The High Court held that endeavor should be made by the tax authorities to continue taxability in case of non-residents taking into account, the issue of nexus in the context of the receipt which is an internationally accepted principle. Accordingly, Clifford Chance was taxed only on the income billed for hours expended in India. Clifford Chance’s appeal is pending before the Supreme Court.
The Finance Act, 2010, introduced a further amendment seeking to reinforce the intent of introducing the source rule to bring all fees for technical services, including fees for rendition of legal services, making the situs of the payer the paramount factor for determining taxability in India to read as follows: “For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not.-
(i) the non-resident has a residence or place of business or business connection in India; or
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(ii) the non-resident has rendered services in India” Pursuant to and armed by this amendment, the Mumbai ITAT held Linklaters to be assessable in India as a Permanent Establishment (PE). While the merits of the assessee’s submissions and the ITAT’s interpretation involve extensive interpretations of international taxation principles, what is of concern are certain implications, which in brief are as follows :
ITAT has assumed powers for the first time in considering issues not agitated before the authorities below.
ITAT in dealing with the earlier decisions of the Courts, distinguished both Isihikawajiama and Clifford Chance to be unacceptable , in view of the 2010 amendment.
The distinction made between the UK Partnership, a person resident and liable to be taxed in the UK, from its individual staffers rendering “personal services” in India, under Article 15, by applying the residency test and making the application of profits indirectly attributable to the PE. Attribution rule is usually applied in reference to transactions between, countries which have no tax agreement on the operations of a business .
Though Linklaters did not have any office in India and services were rendered to clients engaged in projects in India, with Linklater Staffers visiting India to provide such services sporadically, ITAT’s interpretation of Linklater having a PE in India ignores the basic rules of interpretation to incorrectly hold, that the illustrations of Article 5 (2) of the DTTA,are absolute and prevail over that of Article 5(1).
The “force of attraction approach” has also been applied for the first time by the ITAT. Focussing on the actual economic connection between a particular item of income and the PE, this approach subjects, all domestic sourced income irrespective of connection.
Effectively, for all overseas professional services and law firms in particular, the repercussions are critical, particularly if read in the context of the Lawyers Collective judgement. Hopefully, the SupremCourt will follow the Ishikawajiama approach to restore the sanctity of DTTAs.
Kumkum Sen is a Partner in Rajinder Narain & Co. and can be reached at kumkumsen@rnclegal.com