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How Linklaters tax ruling affects foreign professionals: 'wide ramifications', 'questionable', more litigation 'certain'


Friday's Mumbai Income Appellate Tax Tribunal (ITAT) ruling against Linklaters makes potentially all overseas professional services and law firms subject to income tax in India for the last six years or more if their staff visit India for 90 days in aggregate per year. The repercussions could be serious, according to Indian tax lawyers.

"It is no longer necessary that, in order to invite taxability under [the Income Tax] Act, the services must be rendered in the Indian tax jurisdiction," ruled the tribunal on Friday July 16 in the case Mumbai ITA 4896/5085/Mum/03.

"The judgment has an impact not only on the legal sector but it has wide ramifications on all service sectors where foreign service providers are providing services to Indian residents," said Nishith Desai Associates managing partner Nishith Desai told wire service Bloomberg.

"The judgment, in line with the Finance Act, 2010, has removed the requirement of territorial nexus with India in the form of physical presence in India for services to be considered taxable in India," noted Desai.

The Finance Act 2010 amended section 9 of the Income Tax Act 1961, which in turn would affect the Supreme Court judgment in Ishikawajima Harima Heavy Industries Ltd vs DIT (288 ITR 408) and the currently ongoing Supreme Court case Clifford Chance vs DCIT (82 ITD 106), which were both referred to by the ITAT in the Linklaters decision.

"This is along the lines of expected decisions," commented Economic Laws Practice associate partner Pranay Bhatia on the ITAT ruling. "Once the amendment was in place this was due to happen – in fact this is what we were expecting, both Ishikawajima and Clifford Chance were both in a fix in that sense once the amendment had gone through."

The decision could now apply to all overseas professional services firms whose staff spend more than a certain number of days in India, said Bhatia, including accountancy firms that were also doing a lot of referral work and a lot of whom were "currently not liable to withholding taxes or income tax in India due to absence of a territorial nexus between rendition and Indian territory.

Falling into the tax net

For a foreign professional services firm to be liable to pay income tax in India under the Linklaters ITAT ruling, two main heads have to be satisfied: doing work for Indian individuals or companies and finding that a firm is deemed to have a "permanent establishment" in India by spending time in the country.

"Earlier one had a very strong defence under Income Tax Act itself to say I never came to India to render the service therefore you would never go to the [Double Taxation Avoidance] Treaty but you would say that under domestic law there is a shelter," explained Bhatia to Legally India.

"This has been done away with – so long as the services which are rendered by a foreign service provider are used by a business in India there is a tax liability on the foreign service provider," Bhatia added. "This is the principle with the retrospective amendment."

Therefore, prima facie, under the amended Income Tax Act a firm will be liable to pay Indian income tax when doing work for Indian clients unless it can find an exemption under a Double Taxation Avoidance Agreement (DTAA) by not having a "permanent establishment" or a "fixed base" in India.

If a firm's staff including partners spent at least 90 different "man days" per year in India on business this would be deemed a "fixed base" under the UK's and US' DTAA with India, said Bhatia, although these rules could vary according to the respective double taxation treaties another jurisdiction has with India.

In India's treaties with countries such as China, Canada, France, Germany or Australia that period is 183 days or more.

Under guidance to DTAA rules such 90 days would have to be separate days that any representatives of a firm spend in India on aggregate and would include time spent by associate secondees sent from international firms to Indian firms or companies, said Bhatia, although days that two different representatives spent in India concurrently would not be counted double.

Fine lines

The new Income Tax Requirement that income has to be attributable to India even if rendered outside of India could cause further complications.

"If you have a fixed base available and there is a referral going from India to the UK for example – will the income of that referral be taxable in India?" asked Bhatia. "The answer seems to be yes, because it is arising out of the permanent establishment."

"But if there is a global acquisition which was initiated by the US and one of the acquisition entities was in India and some tax advice was rendered in a UK office," said Bhatia, things were less clear. "That's a matter of detailing."

Retrospective consequences

Firms that are caught under the above rules could face several serious consequences. The Indian income tax rate on foreign companies or partnerships is 40 per cent, which would be withheld directly in India and could create a loss for the firm if their home income tax rates are lower.

Most foreign firms such as Linklaters are structured as limited liability partnerships (LLPs), which are tax transparent and where income tax is usually paid by the partners directly.

The ITAT also decided that the taxable income should be computed at rates actually billed by foreign firms, rather than how much it would have cost to procure equivalent services in India.

Linklaters said it had billed only £691,190 based in India in the 1995-96 tax year, according to the ITAT ruling, making a profit of £468,419.

However, the assessing officer had held that Linklaters' total taxable income related to India should in fact be Rs 23.7 crore (£3.32m), out of total amounts invoiced of Rs 25.8 crore (£3.62m).

The Income Tax Act also provides for the Indian tax authorities to claw back income tax for six years or more if an assessment is currently ongoing as in the case of Clifford Chance or Linklaters.

"The Income Tax Act itself provides a limitation of six years to tax the income which is not assessed to tax that can be brought to tax by Income Tax authorities," said Bhatia although he added that there was no time limit if an earlier assessment was currently in the courts.

In addition, explained Bhatia, the income tax authorities had available to them the power of "rectification" if a court or tribunal judgment on taxes was passed within the last four years but was contrary to existing law even if the ruling at the time was correct in law.

This means that cases such as Clifford Chance's more than 10-year-old tax dispute along similar lines, which is currently in the Supreme Court but was expressly ruled to be contrary to current law by the Linklaters ITAT tribunal, would also be subject to be re-examined under the new rules.

Linklaters and Clifford Chance spokespersons declined to comment.

Future moves

Nishith Desai said that the "constitutionality of the retrospective amendment brought about by the Finance Act 2010 is questionable, keeping in mind international law obligations and of course the fundamental rights".

"We have certainly not seen the end of the story in this regard and this matter would definitely be the subject matter of further litigation," he added.

"The matter can be appealed before the High Court in respect of substantial question of law involved in the case regarding taxable income, whether it includes the income generated directly in India or it also includes income generated from the projects in India for which the PE was established, whether rendered from outside or not," explained Mumbai-based lawyer Rishabh Mastaram, adding that the Supreme Court could also be approached if the High Court granted a certificate or a Special Leave Petition was applied for.

Even affected firms other than Linklaters might be able to challenge the retrospective effect of the Finance Act 2010 provisions under a writ petition against the government.

"Going forward you may also want to explore whether individual [sole proprietorship] or partnership is the right structure to render services," suggested Bhatia, explaining that different treaties may have different "permanent establishment" or other criteria for companies and partnerships.  

Also, countries such as Israel for example did not have any permanent establishment clause for companies providing services at all in their DTAA with India, said Bhatia.

"It is important to note that the tribunal has recognised that even a partnership entity would be eligible for the treaty benefits, so long as either the partnership or the partners are taxed in the country of residence," added Desai. "However at the same time, it is surprising that the tribunal has proceeded to rule that the partnership will have a permanent establishment in India rather than considering the more specific provision relating to independent professional services. It may be noted that article 15 of the India UK treaty specifically extends the benefits of the independent personnel services provision even to partnerships."

"Now foreign law firms providing services to Indian residents would have to be mindful and cognizant of the Indian tax implications when they render services," added Desai.

Perhaps that is putting it mildly - the Linklaters ITAT ruling could very well prove to be another major headache for firms operating in India in years to come.

The ITAT ruling can be downloaded here.

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