After Clifford Chance, now Linklaters in the tax net: ITAT rules delivering services to clients in India is taxable; new angle to A.K. Balaji v. Ashurst et al?

Bar & Bench News Network

Jul 19, 2010

In a landmark ruling, the Mumbai bench of the Income Tax Appellate Tribunal (ITAT) held that Linklaters, a UK law firm delivering services to clients in India is taxable. Senior Counsels and tax experts S.E. Dastur and P.J. Pardiwala appeared for the UK firm who were assisted by Advocate Neeraj Sheth. Advocate Narendra Singh represented the Government.

The two-member Bench of Pramod Kumar and R.S. Padvekar rendered a 111-page judgment, which quotes the ongoing dispute between Clifford Chance (CC) and Department of Income Tax. CC dispute with the tax authorities has now reached the Supreme Court, on some of the similar issues covering the Linklaters dispute including the India-UK Double Taxation Avoidance Agreement (DTAA).

The dispute is related to assessment of income by Linklaters in the year 1995-96. It is related to certain advisory services provided by Linklaters to several of its clients in India. Although the advisory services were rendered both in India and outside India, the facts indicate that the partners from the London office of Linklaters travelled to India to render services. From the judgment (page 2 and 3) most of the transactions were Global Depositary Receipt (GDR) transactions and power project related transactions.

Linklaters filed its income tax returns as ‘nil’ as it did not have a fixed place of business in India. Since Linklaters did not have an office in India and rendered service only on an “as and when required basis,” the UK law firm claimed that its activities in India were sporadic and isolated. Linklaters also took the view “as it did not have a permanent establishment (PE) or fixed base in India its income was not subject to tax under Articles 7 or 15 of the DTAA”.

The Income Tax (IT) department however differed and said “since Linklaters 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, the IT department held that the entirety of the invoices raised by Linklaters was assessable in India. The IT department quoting the Clifford Chance’s ITAT judgment held that income earned by Linklaters is taxable pursuant to Article 15 under ‘independent personal service’.

On appeal, the Commissioner of Income Tax upheld the existence of a PE by Linklaters, however it also held that only the income attributable to the PE was assessable to tax.

Linklaters appealed to the ITAT, which held as follows*:

As regards taxability under the domestic law, the argument on the basis of Ishikawajima and Clifford Chance 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 judgments are no longer good law.
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.
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.
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.
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).
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.
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.
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 PE. 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.

It will be interesting to see if these judgments will be of any value to the petitioner in A.K. Balaji v. Ashurst et al to strengthen petitioner’s argument that firms like Linklaters and Clifford Chance are practicing Indian law. If these foreign law firms are rendering services in India, they are most likely practicing Indian law and not just advising on foreign legal matters.

*Summary of the Judgment has been obtained by the ITAT website.

Click here to download the judgment.

Comments(6)

1. "Each passing day shows what a bloody joke the Nehruvian advocates act is in today's day and age. ". Guest, India
2. "Why cant we open up the legal market. Its not like Linklaters and CC coming in will affect the Indian litigating lawyers. It will affect some corporate lawyers and a very small bunch. Why not have a open debate on this issue where the real concerns can be addressed instead of having random open remarks saying opening of legal sector is bad for the economy. ". Guest, Delhi
3. "Ashurts?and i noticed names being clearly misspelt (letters transposed) in an earlier article. what's up with the proofreading?". Robby, UK
4. "Thanks Robby for letting us know. We made a mistake. We have corrected this error. ". Editor, Bangalore
5. "on the same day as this judgement the govt says it will take the foreign law form PILs to the SC. certainly not a coincidence! Link". Guest, Mumbai
6. "B&B the ITAT ruling and the government's decision to refer the issue of foreign law firms practising to the Supreme Court are very important developments. David Cameron is also expected to bring some Magic circle lawyers with his delegation. I hope you will have experts commenting on these developments. ". Guest, Delhi

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