This is a landmark decision which has extensively dealt with and analysed the relationship between Articles 5(1) and 5(2) of a Tax Treaty. This decision would not only have an impact on foreign law firms rendering services in relation to Indian projects, but the findings related to territorial nexus can be applied by the Revenue in bring to tax several composite service arrangements that involve services being rendered from India and outside India. It seems likely that the taxpayer will appeal the decision and hence, the findings of the Higher Courts will be eagerly watched.
Tribunal holds that services rendered by a law firm results in a Service PE
The Mumbai Bench of the Income-tax Appellate Tribunal ("Tribunal") has delivered a significant ruling in the case of Linklaters LLP holding that the rendering of professional services by a foreign law firm results in a Service Permanent Establishment ("Service PE") for the firm and the profits relating to such services, whether rendered in India or not, are chargeable to tax in India.
Facts of the case
Linklaters LLP ("the taxpayer") is a UK based law firm. During the relevant year, the taxpayer rendered professional services to some of its clients whose operations extended to India. For rendering such services, lawyers from the firm were sent to India and the aggregate period of stay of the lawyers in India exceeded 90 days. Services to the clients were rendered by the lawyers in India and also from outside India. The taxpayer filed a return of income in India and claimed that its income arising from work done in India was not chargeable to tax in India on the basis that Article 15 of the Tax Treaty between India and the UK ("Tax Treaty") dealing with Independent Personal Services does not apply to a firm, and that it does not have a fixed place of business in India.
Question before the Tribunal
Whether the professional services rendered by the taxpayer would constitute a Service PE in India under Article 5(2)(k) of the Tax Treaty and if so, whether income pertaining to services rendered from outside India should also be attributable to the PE in India?
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• It relied on the decision of the Bombay High Court in the case of Clifford Chance and argued that only income from services rendered in India should be charged to tax under the Income-tax Act, 1961 ("the Act") and income related to services rendered from outside India should not be charged to tax in India. The retrospective amendment to section 9 of the Act by the Finance Act, 2010 relates to the taxability of fees for technical services and not professional services.
• The taxpayer was assessable as a partnership firm in UK even though the tax is computed with reference to the tax liability of the partners. It cannot be held that the taxpayer was not 'liable to tax' and consequently, the benefit of the tax treaty cannot be denied.
• The basic conditions of Article 5(1) have to be satisfied to result in a PE and Article 5(2) merely provides an illustrative list which is to be read with Article 5(1) of the Tax Treaty. Since there was no continuity of activities in India, the partners and staff members of the taxpayer visited India only as and when required and the activities were sporadic or isolated, it cannot result in a PE for the taxpayer in India.
• The Article dealing with Independent Personal Services in a Tax Treaty should apply in respect of the income arising from services of a law firm. Since Article 15 of the Tax Treaty does not apply to a firm, but only to individuals, the income should be considered as not chargeable to tax in India. In such a case, the income should not even be considered under Article 7 of the Tax Treaty.
• Article 5 of the Tax Treaty refers to commercial and industrial establishments and it cannot cover the rendition of professional services. Further, the services provided by the taxpayer cannot be held as 'furnishing of services' as the taxpayer is an international professional enterprise rendering services directly to its clients. The term 'furnishing of services' does not cover 'rendering of services' by lawyers.
• As per Article 7(2) of the Tax Treaty, the PE must be assessed to tax on the basis of value of services rendered by the PE at the market value of such services in India and not on the basis of the price charged by the taxpayer to its clients. If appropriate adjustments are not carried out, the language of Article 7(2) of the Tax Treaty would become redundant. Revenue's contentions
• The entire fees for services rendered by the taxpayer in India and abroad are chargeable to tax in India as the services have been utilized in India.
• Since a partnership firm was not 'liable to tax' in UK, the partnership firm cannot avail the benefit of the Tax Treaty between India and UK. The expression 'liable to tax' covers only such entities which are subject to tax in respect of their income.
• Article 5(1) and Article 5(2) are not to be read together and Article 5(1) does not restrict the application of Article 5(2) of the Tax Treaty. Article 5(2) would become redundant if it is concluded that it conditions of Article 5(1) of the Tax Treaty should also be satisfied. Once the duration test is satisfied, the permanence test envisaged under Article 5(1) of the Tax Treaty need not be satisfied.
• As per Article 7(2) of the Tax Treaty, income and expenditure of an enterprise as a whole are to be allocated to the PE to the extent they are relatable to the PE. Article 7(2) of the Tax Treaty does not envisage revenue billings relatable to the PE to be substituted by the market value of such services.
• The Bombay High Court decision in the case of Clifford Chance was not good law due to the retrospective amendment to section 9 of the Act by Finance Act, 2010. It was no longer necessary that the services must be rendered in the India for taxing the income arising from such services in India.
• The Tax Treaty benefits cannot be denied to the taxpayer, since the profits of the partnership firm is taxable, though not in its own hands, but in the hands of the partners. As long as entire income of the partnership firm is taxed in the Country of residence, Tax Treaty benefits cannot be denied.
• The terms 'rendering of services' and 'furnishing of services' are used interchangeably and are not relevant for the purpose of deciding the existence of PE.
• Article 5(2) of the Tax Treaty has to be applied on a standalone basis. Clauses (a) to (i) of Article 5(2) are illustrative of the basic rule of a PE, whereas clauses (j) and (k) are extensions of the basic rule. Items falling under these clauses would not constitute a PE under the basic rule, but should be treated as a PE on account of the deeming fiction provided in such clauses.
• The Commentary on the OECD Model Convention ("MC") shows that income derived from professional services or other activities of independent character have to be dealt with under Article 7 of the Tax Treaty as business profits. Accordingly, even professional services are covered by Article 5(2)(k) of the Tax Treaty.
• The Commentary on UN MC provides that professional services rendered by an individual are governed by Article 15 while such services rendered by an enterprise are governed by Article 5(2)(k) read with Article 7 of the Tax Treaty.
• Article 7(1) of the Tax Treaty provides for the taxability of profits 'directly or indirectly attributable' to the PE which incorporates 'force of attraction' rule and income from services similar to those rendered to an Indian project should also be taxed in India irrespective of whether such services are rendered through the PE or directly by the taxpayer.