Linklaters LLP vs. ITO (ITAT Mumbai)

Professional Firms can have a ‘service PE’. The words “indirectly attributable to the PE” encompass the “force of attraction” principle and even services rendered offshore for Indian projects are assessable in India

The assessee, a UK based law firm, rendered services to clients with operations / projects in India. The assessee did not have an office in India and to render the services, its’ partners and employees visited India. The assessee took the view that as it did not have a permanent establishment (PE) or fixed base in India, its income was not assessable to tax under Articles 7 or 15 of the India-UK DTAA. The AO took the view that as the assessee had furnished services in India for more than 90 days, it had a PE under Article 5(2)(k) of the DTAA. On the quantum, he held that the entirety of the invoices raised by the assessee was assessable in India. On appeal, the CIT (A) upheld the existence of the PE though he held that only the income attributable to the PE was assessable to tax. On appeal to the Tribunal, HELD:

(a) As regards taxability under the domestic law, the argument on the basis of Ishikawajima 288 ITR 408 (SC) & Clifford Chance 318 ITR 237 (Bom) that only services rendered in India are assessable is not acceptable in view of the retrospective amendment to s. 9(1) by the Finance Act, 2010. The result of the amendment is that utilization of the services in India is sufficient to attract taxability in India. The said judgements are no longer good law. (Concept of territorial nexus and source rule discussed);

(b) As regards the DTAA, the question whether a partnership being a “fiscally transparent entity” is entitled to the benefits under the DTAA is entitled to be raised for the first time by the Tribunal suo moto though not raised by the AO or CIT (A). Under Rule 11 of the Tribunal Rules, while the Tribunal cannot enlarge the scope of ‘subject matter of appeal’ inasmuch as a disallowance or addition not made by the lower authorities cannot be made by the Tribunal, within the subject matter of appeal, the Tribunal can examine any aspect of the matter irrespective of whether the same has been examined by the lower authorities or not. There are no restrictions on the Tribunal as to on what grounds the Tribunal decides the appeal provided it hears the affected party before doing so. (Tata Telecommunications 121 ITD 384 (SB) & Morgan Stanley 39 DTR 240 followed);

(c) On merits, though a UK partnership is a “person” under Article 3(2), the question is whether it is a “resident of UK”. Article 4(1) defines a “resident of a Contracting State” to mean a person “liable to tax in that State by reasons of domicile, residence, place of management or any other criterion of similar nature”. According to the OECD Report on Partnerships, mere computation of income at the level of partnership is not sufficient to hold that the partnership firm is ‘liable to taxation’ in the residence country. However, this view is not correct and has also been rejected by India. A partnership is eligible to the benefits of the DTAA provided the entire profits of the firm are taxed in UK – whether in the hands of the firm (after determining taxable income in relation to the personal characteristics of the partners) or in the hands of the partners directly. (International law on the subject discussed in detail);

(d) The argument that a PE cannot be constituted under Article 5(2)(k) if the basic conditions of Article 5(1) are not fulfilled is not acceptable. While clauses (a) to (i) of Article 5(2) are illustrative of the basic rule of a PE (fixed place of business), clauses (j) and (k) are an extension of the basic rule. The items included in the said clauses (j) & (k) are such as would not constitute a PE under the basic rule of Article 5(1), and it is only on account of the deeming fiction provided in Article 5(2)(j)/(k), that it can be treated as a PE;

(e) The argument that the term “furnishing of services” in Article 5(2)(k) of the DTAA does not cover “rendering of services” by lawyers is not acceptable because both terms are used interchangeably in normal course of business;

(f) The argument that as Article 5 refers to commercial and industrial establishments, it cannot cover the rendition of professional services is not acceptable. The Commentary on the OECD Model Convention shows that income derived from professional services or other activities of independent character have to be dealt with under Article 7 as business profits. Accordingly, even professional services are covered by Article 5(2)(k);

(g) The argument that income from professional services can only be taxed under Article 15 (which applies to individuals and not firms) and in case chargeability under Article 15 fails, it cannot be assessed under Article 7 is not acceptable. While professional services rendered by an individual are governed by Article 15, professional services rendered by an enterprise are governed by Article 5(2)(k) read with Article 7. This view is supported by the UN Model Convention Commentary;

(h) As regards the quantum of profits attributable to the PE, the argument that by virtue of Article 7(2), the PE must be assessed by taking the value of services rendered by the PE at the market value of such services in India and not the price at which the assessee billed its’ clients is not acceptable. The fiction of hypothetical independence in Article 7(2) is confined to a PE’s transactions with its head office and branches and does not extend to transactions with third parties. The fiction of hypothetical independence has no role to play in adjusting actual revenues with independent entities. The arms length principle in Article 7(2) is relevant only for intra organization transactions or transactions with associated enterprises. Accordingly, the revenues earned by the assessee are to be taken at actual figures and no adjustments are permissible in the same;

(i) Further, as regards the quantum of profits attributable to the PE, Article 7 (1) provides for the taxability of profits “directly or indirectly attributable” to the PE. The words “profits indirectly attributable to the PE” incorporates the “force of attraction” principle. To give effect to the “force of attraction” principle, in addition to taxability of income in respect of services rendered by the PE in India, any income in respect of the services rendered to an Indian project, which is similar to the services rendered by the PE is also to be taxed in India in the hands of the assessee – irrespective of whether such services are rendered through the PE or directly by the GE. There cannot be any professional services rendered in India which are not, at least indirectly, attributable to carrying out professional work in India. This indirect attribution is enough to bring the income from such services within ambit of taxability in India. The two conditions to be satisfied for taxability of related profits are (i) the services should be similar or relatable to the services rendered by the PE in India; and (ii) the services should be ‘directly or indirectly attributable to the Indian PE’ i.e. rendered to a project or client in India. The result is that the entire profits relating to services rendered by the assessee, whether in India or outside, in respect of Indian projects is taxable in India.