For Income to be taxed in India, services should be
"rendered" and "utilized" in India! Foreign
entities rendering technical, consulting and other professional
services in India may receive a shot in the arm following this
judgment of the Bombay High Court where it has been held that the
income of such entities will be taxable in India only to the extent
of their operations in India.
What Triggered This Judgment?
UK-based law firm Clifford Chance ("the law firm") had
provided advisory services for clients executing projects in India.
Five of these six clients were non-residents and one was a resident
under Indian tax laws. During the year 1996-97, the law firm was
appointed to advise these clients involved in three major power
projects. In the subsequent financial year, it began work on a
fourth power project as well. The law firm primarily advised
non-Indian participants on English law aspects of the projects, and
much of the work was handled outside of India. The firm had billed
its clients for the work it had done in India separately from the
work done outside India. The law firm was remunerated on an hourly
rate basis with each of its partners and employees maintaining
detailed timesheets. This was a record of the time spent on doing
work both in India and outside. The bills raised were paid by the
clients outside India.
The Bombay High Court took up the case after India's Income
Tax Appellate Tribunal ruled in September 2001 that the nature of
the work should determine its taxability in India. The issue before
the Bombay High Court was whether the entire fees received by the
law firm was taxable in India, or whether only that part of the
fees which was received for the services rendered in India was
subject to tax in India.
At the first instance the Income-Tax Department held that the
entire fee received by the law firm from its clients for the four
projects was taxable in India. This was irrespective of the fact
that this fee was received for services rendered by it outside
India. On an appeal to the Income Tax Appellate Tribunal, the
tribunal stated that the "territorial nexus" between the
firm's fees and the projects in India meant all of the fees,
wherever billed, accrued or arose in India and was thus taxable in
India. It contended that the determining factor has to be the place
where the firm's services were utilized and not the place where
the services were performed.
Aggrieved by the decision of the tribunal, the law firm appealed
to the Bombay High Court. The law firm argued that under the
provisions of the Indian Income-Tax Act, 1961 and the Double
Taxation Avoidance Agreement ("DTAA") between India and
UK, only that portion of its income from the clients which was
attributable to the services performed by it in India could be
subjected to Indian taxation. It further argued that, in the case
of legal professionals and law firms rendering advisory services,
the services could only be considered to have been rendered at a
place where the professional is personally present. Any other rule
would create chaos and uncertainty. On the contrary, the income tax
department said that the law firm had received over Rs. 170 million
in legal fee for acting as advisors on the four power projects and
it was immaterial whether the advice was given in India, UK or any
other country. It argued that the entire income was taxable in
In its verdict the Bombay High Court reasoned that income
arising out of operations in more than one jurisdiction would have
territorial nexus with each of the jurisdictions on an actual
basis. The court took the view that although the service was
utilized in India, part of it was not rendered in India and was
therefore not chargeable to tax in India. It ruled that under
statutory provisions, services which are to be taxed must be both
"rendered in India'' and "utilized in
India'' for them to fall under the income tax bracket.
So What Does This Mean For International Businesses?
Many international firms can derive some comfort from this
judgment. With the legal services market on the brink of opening
its doors to foreign law firms, many must undoubtedly have followed
this case with great interest. The link between the concept of
territorial nexus and tax liability has been debated in this case
thus making it all the more important for foreign firms operating
in India even without a permanent physical presence to carefully
consider any tax liability that may inadvertently arise. Tax
liability ensues when income is earned for services which have been
rendered and utilized in India. Accordingly, execution of projects
that require even a partial physical presence in India, will need
to be carefully planned.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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On January 24, 2017, the Central Board for Direct Taxes issued a circular enumerating the Guidelines for Determining the Place of Effective Management (hereinafter referred to as "POEM Guidelines") of a company.
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