Friday, January 9, 2009

Clifford Chance v. DCIT: Territorial nexus in international taxation

A recent decision of the Bombay High Court in Clifford Chance v. DCIT revisits interesting legal issues connected to the taxation of non-residents under Section 9 of the Income Tax Act, 1961. Section 9(1) deals with “income deemed to accrue or arise in India”. The relevant part of the Section read – prior to 2007 – as follows:


Section 9(1). The following incomes shall be deemed to accrue or arise in India:

(vii) income by way of fees for technical services payable by –

(c) a person who is a non-resident, where the fees are payable in respect of services utilized in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India…


This Section was interpreted in a relatively recent decision of the Supreme Court of India, Ishikawajima-Harima. There, the Apex Court held:


Reading the provision in its plain sense, it can be seen that it requires two conditions to be met – the services which are the source of the income that is sought to be taxed, has to be rendered in India, as well as utilized in India, to be taxable in India. In the present case, both these conditions have not been satisfied simultaneously, therefore, excluding this income from the ambit of taxation in India. Thus, for a non-resident to be taxed on income for services, such a service needs to be rendered within India, and has to be part of a business or profession carried on by such person in India. The petitioners in the present case have provided services to persons resident in India, and though the same have been used here, they have not been rendered in India.”


Thus under Ishikawajima, it was not the mere place where a service was utilized which was determinative of the taxability of the fees received in lieu of the service. For the fees to be taxable, the services rendered to non-residents must have been both rendered in India and utilized in India. In effect, a territorial nexus requirement was sought to be established before the income would come within the purview of the Indian tax net.

Following this decision, the Finance Act 2007 inserted a retrospective amendment which provided:



Explanation. For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India.


A Memorandum explaining the rationale behind the amendment made it clear that the legislative intent behind the provisions was to clarify that the requirement of territorial nexus was irrelevant under clauses (v), (vi) and (vii) of Section 9(1). In considering the effect of this amendment, the Bombay High Court in November 2008 in the case of CIT v. Siemens held that the ratio of Ishikawajima was overcome by the amendment.


The decision in Clifford Chance (decided in December 2008) seems to throw doubt on this latest proposition.

Clifford Chance – a leading UK-based law firm – had provided certain advisory services for certain resident and non-resident clients who were engaged in certain projects in India. The firm had separately billed its clients for the work it had done in India and the work done outside India. The issue was whether the whole of the fees received for the services were chargeable in India, or whether only that part of the fees which was received for the services rendered in India was chargeable to tax in India. Under the law as laid down in Ishikawajima, although the service was utilized in India, part of it was not rendered in India and was therefore not chargeable to tax in India. The Department contended (following the line seemingly adopted in Siemens, although not specifically citing that case) that the ratio of Ishikawajima must be considered as having been overruled. Therefore, only the place where the service was utilized would be relevant, not the place where it was rendered. The non-residents by whom the fees were payable were clearly using the services in India – as such, the fees should have been taxable.


However, the Court relied on Ishikawajima and held that the fees would be taxable only where the service was both utilized and rendered in India. Surprisingly, the Court did not cite Siemens at all (perhaps the arguments in the case were concluded before the decision in Siemens). Furthermore, although the Revenue’s contention (that the 2007 amendment nullified the effect of the Apex Court decision) was noted, the Court did not substantively address this contention except for noting that the provisions of Section 9 were clear and unambiguous.


The Court’s decision may perhaps be read in two ways. The Court might have intended to say that under principles of statutory interpretation, an explanation cannot curtail the clear scope of a section. This reading appears to be a difficult one to sustain on the wording of the particular Section or on the basis of legislative intent.

Alternatively, the Court’s decision may be explained by arguing that the explanation does away only with “residence or place of business or business connection in India”, and not with all the requirements of territorial nexus. Thus, while the nexus need not be as deep as “residence or place of business or business connection in India”, it was still essential that the services should be rendered in India. Thus, the explanation only intended to avoid a strong nexus, but did not entirely do away with nexus.This approach would require a differentiation between rendering services in India and maintaining a business connection in India, and would also require Siemens to be adequately distinguished.


The former should not be too difficult a task. The leading decision on the concept of business connection under the Income Tax Act, CIT v. R.D. Aggarwal (AIR 1965 SC 1526), notes that a business connection “involves a relation between a business carried on by a non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in the taxable territories.” Mere rendering of services, it appears, will not lead to a conclusion of the existence of business connection. On the issue of reconciliation with Siemens, it is possible to contend that what that case actually held in its factual context is that in the post-amendment scenario, it was not necessary for the assessee to have a PE or a business connection. On its facts, however, Siemens was decided in favour of the assessee on the ground that the assessee was entitled to relief under the relevant DTAA in that case. Thus, the interpretation of Section 9 was not actually in question in that case, and the statement that Ishikawajima’s ratio was overturned by the amendment was only tentative statement and not a reasoned conclusion.


Although the purpose behind the 2007 amendment might well have been to get over Ishikawajima, the decision in Clifford Chance shows that this purpose has not actually been achieved by the wording of the explanation. Ishikawajima continues to be good law on the issue, subject to the fact that the territorial nexus requirement need not be as deep as “residence or place of business or business connection in India.” Nonetheless, mere use of services in India will not attract Section 9; the services should be both used and rendered in India.


7 comments:

Anonymous said...

Is Ishikawajima itself correctly decided? I have a feeling that the Court in Ishikawa mixed up "payable by" to refer to payee instead of payer... I look forward to what you think about this issue, and what impact that might have on any further decision on this aspect?

Abhyudaya said...

I have a doubt on your second way of reconciliation of the case of Clifford Chance with the Explanation inserted by the Finance Act, 2007 to S.9 of the Income Tax Act. Your method of reconciliation involves that a business connection requires a higher level of nexus which is not established merely by rendering of services in India. But I think it is quite the opposite, at least after reading the quote from R.S. Agarwal's case on the point. That is, a business connection requires a much lower level of nexus, which can be satisfied even if a service is not rendered in India. In any case, it is definitely satisfied if a service is rendered in India.

To elucidate it, I shall requote CIT v. R.D. Aggarwal (AIR 1965 SC 1526) from your post,stating, that a business connection “involves a relation between a business carried on by a non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains."
This sentence seems to imply that if a non-resident renders services outside india to a company who has india operations, then the india operations of that company (as affected by the foreigner's advice) have indirectly led to the profits or gains of the non-resident, and he should be taxable on that ground, even if he does not render service in India.

Looking at the second sentence in R.S. Agarwal,
"...It predicates an element of continuity between the business of the non-resident and the activity in the taxable territories.” Clearly, this continuity between the business of the non-resident and the activity in the taxable territories is established when a service is rendered in India.

Therefore, I do not think that the Clifford Chance case can be reconciled with the Explanation.

Mihir Naniwadekar said...

@ Anonymous,


Thank you for pointing this out. I agree with you, although it now seems to be the settled position of law.

@ Abhyudaya

"Clearly, this continuity between the business of the non-resident and the activity in the taxable territories is established when a service is rendered in India."

I do not agree with this statement. The "continuity" implies that I carry on business over a period of time as such; a mere one-time sale of goods is not sufficient; a mere one-time rendering of service is not sufficient. So, rendering services over a period of time may be sufficient, because there will be contimuity in the activity. I will elaborate a bit more with additional case-laws a bit later.

Thanks,

Mihir

V Swaminathan said...

As I see it, in iscussing/dwelling on any such matter, one has to necessarily bear in mind the following:

1. In a case where there is a tax treaty in force, the implications of its provisions are required to be duly taken into account, and applied, if so, and to the extent, called for.

Now, the expression “residence or place of business or business connection” OR any of the words therein, require to be understood / interpreted, not dehors/ without but having due regard to the corresponding but different/inconsistent peculiarly inbuilt concepts under a tax treaty; which, briefly, are, –‘Resident’, ‘Permanent establishment’ (‘fixed place of business’, etc. - see the special definition).

2.“Place where the services are rendered”: In today’s scenario, how one should construe the real purport and import of the seemingly innocuous expression? – Especially, keeping in view that, ‘electronic media’ has come to play an increasingly important role in the rendering of cross border services.

V Swaminathan

Anonymous said...

Was the payment that was sought to be taxed by the Income Tax Department officials in the Clifford Chance case really referring to payment TO the non-resident? Because it seems that it was referring to payment BY the non-resident client of Clifford Chance.

"The non-residents by whom the fees were payable were clearly using the services in India – as such, the fees should have been taxable."

Maybe it's just me, but could you explain how that case is dealing with payment TO a non-resident. Thank you.

Anonymous said...

My bad. I was referring to the Clifford Chance case and others were referring to the Ishikawajima case. An honest error.

Anonymous said...

your post says "Clifford Chance – a leading UK-based law firm – had provided certain advisory services for certain resident and non-resident clients who were engaged in certain projects in India. The firm had separately billed its clients for the work it had DONE IN INDIA and the work done outside India."


So, the rendering of services can be to two types of clients. One who is non-resident and the other who is resident. And there are two types of work done here. One in India and the other outside of India.

So some of the possibilities is that they could have:

a) done work for a non-resident client, OUTSIDE of India.

b) For a resident client, had work done IN India

c) For a resident client, had work done OUTSIDE of India

d) For non-resident client had work done IN India.

Category a) is clearly outside the scope of such taxation. What about 'c' and 'd'? In 'c' the service is rendered outside India and in 'd' the service would be utilised outside of India.

All very confusing.