Wednesday, September 9, 2009

Taxation of non-residents: More controversy

This blog has covered the controversy surrounding the taxation of Indian companies for engaging services from abroad. A recent decision of the Karnataka High Court has made the law even more difficult to ascertain. The decision is that of a Division Bench of the Court, in Jindal Thermal Power Co. Ltd. v. Deputy Commissioner of Income Tax.

To briefly recapitulate, taxable income under the Income Tax Act must either accrue/arise in India or must be deemed to accrue or arise in India. s. 9(1)(vii)(c) provides that income by way of fees and technical services payable by a person who is a non-resident is deemed to accrue and arise in India, where the fees are in respect of services utilized in a business or profession carried on by that person in India or for making or earning income from any source in India. In other words, this deals with cases where a non-resident engages a service provider in India for his business – the provision deems that the payment made by the non-resident is deemed to accrue or arise in India. This, therefore, has no relevance for the opposite case – where a non-resident service provider is engaged by a resident and is paid fees for technical services. However, in one of those interesting coincidences that has materially altered this area of law, the Supreme Court appears to not have noticed this, and held in Ishikawajima Harima that s. 9(1)(vii) applies in the reverse case as well. The Court further imposed a territorial nexus requirement by holding that the services must have been both “rendered” and “utilized” in India. Following this decision, an Explanation was added by the Finance Act, 2007, providing that income would be deemed to accrue or arise whether or not the non-resident has a residence or place of business or business connection in India. The Bombay High Court in Siemens held that this amendment did away with the ratio of Ishikawajima’s case, but held in Clifford Chance that it did not. Subsequently, the Authority for Advance Rulings in Worley Parsons distinguished Ishikawajima, but without noticing the amendment to the Finance Act.

That is where the law stood when the Karnataka High Court heard Jindal Thermal Power. The contractual arrangement in the case, concerning a power plant in Bellary, involved four parties - Jindal Thermal Power Co. Ltd. [JTPL], Raytheon – Ebasco [REOL], two of REOL’s subsidiaries, and BHEL, the Government undertaking. JTPL entered into a separate contract with each of these undertakings for different aspects of their commercial relationship. BHEL was the principal supplier of boilers, generators etc., BEI (one of the subsidiaries) was obliged to provide local services, while REOL was required to provide various off-shore services. The contract specified that REOL provided three types of services to JTPL: (a) technical services rendered entirely outside India, (b) “start up services” i.e. REOL instructing local contractors on start up procedure and (c) overall responsibility and management. The total fees payable was close to $50 million, and JTPL did not deduct TDS, claiming it was not required to do so, as the income was not taxable in the first place.

Before the High Court, the assessee relied principally on Ishikawajima, and on Clifford Chance for the proposition that the Explanation inserted in 2007 did not affect its ratio. The Revenue argued that the Memorandum to the Finance Act, 2007 clearly indicated that the purpose of the amendment was to negate the effect of Ishikawajima, and relied on Siemens to support this proposition. Unfortunately, in a 9 page order of which contentions occupy the first seven pages, the High Court did not consider these difficulties in detail. It observed that the amendment only does away with the criteria of “place of business, residence or business connection” and not with the decision in Ishikawajima. With respect, this conclusion is somewhat unconvincing – there may be a case for the proposition that Ishikawajima survives the amendment, but not on the basis that its ratio was not expressly referred to in the amendment. Having found that Ishikawajima is good law, the High Court correctly held that component (a) of the contract referred to above i.e. technical services was outside the scope of taxation, since it was rendered entirely outside India. However, with respect to components (b) and (c), i.e. start up services and overall responsibility, it held that the two subsidiaries of REOL visited the Indian site often and were merely acting as REOL’s agents, with the result that service was both rendered and utilised in India.

In sum, Jindal Thermal Power lays down two propositions – first, that Ishikawajima survives the 2007 Explanation in its entirety, and that a subsidiary that renders services in India for which fees are paid to the parent company will not be sufficient to avoid tax liability. The second proposition is particularly interesting, since it implies that the holding-subsidiary relationship may not be significant for the purposes of s. 9(1)(vii). It is unfortunate that the Court did not consider these matters in detail, and it seems certain that the controversy is set to continue.


vswaminathan said...

1. In any such matter of dispute, for well known and commonly accepted reasons / principles, the relevant provisions of the applicable tax treaty ought not to be by passed or overlooked, but duly considered, and given proper effect.
2. For settling any tax dispute of this kind, the deciding court has to necessarily take into account all or any of the provisions in the treaty, which specially cover(s) / govern(s) the taxation of the “type of income’ under consideration. And, in doing so, the court has to have particular regard to the points/areas of difference / inconsistency, if any, between the domestic law and the treaty.
3. Most importantly, in deciding whether or not any ‘precedent’ (case law OR its ratio, cited/relied on by either party) has to be necessarily applied / followed, the court requires to ascertain / fully satisfy itself that the “FACTS AND CIRCUMSTANCES” of the case on hand are “ON ALL FOURS” with those as in the ‘precedent’.
Now, in the case on hand, the dispute pertains to taxation of consideration for ‘services’. While, in general, the existing tax treaties specially provide for /deal with taxation of “fees for technical services”, that is not uniformly so. For instance, in contrast, the Indo–US treaty uses a different nomenclature namely,– “FEES FOR INCLUDED SERVICES”, and the applicable provisions as also their implications are materially different.
No doubt, as per the Explanation added by the Finance Act, 2007, income is deemed to accrue or arise (in India) whether or not the non-resident has a “RESIDENCE OR PLACE OF BUSINESS OR BUSINESS CONNECTION IN INDIA”. However, for ascertaining the legal effect of the newly inserted Explanation, in a proper perspective, one ought not to but is bound to bear in mind among others the following:
(A) The concepts of, - “RESIDENCE” “PLACE OF BUSINESS” and “BUSINESS CONNECTION” (for that matter, even the terms as such) are, if compared with those in the treaties, patently different; and hence, require to be differently understood, that is-in accordance with what are provided in the treaty.
(B) The perceptibly grave doubt on the legal / constitutional validity of the new Explanation, -that too with retrospective effect, and further, unilaterally, - which, in essence, seeks to change the very tenor and purport of the corresponding treaty provisions.
It calls for no special emphasis that, going by one’s experience, any tax dispute / controversy, more so of this nature, are sure to remain – TO BE CONCLUDED, for ever/all times (especially, with enactment of the newly publicised DIRECT TAX CODE in the offing).

vswaminathan said...

In continuation of my eartlier POST:
Going by one’s reading of the DTC, there is no clue as to how the ‘fall out’ problems are going to be effectively tackled, rather adequately, though not fully, taken care of. Relatively, it is those special sections in the DTC in which are covered the Revenue’s powers to 'make rules' for inter alia removal of difficulties/ anomalies and ‘repeals and savings’, which call for a closer but truly insightful study by experts (to be precise, ones having no vested interest of any kind); that too, in the context of everyone of the other sections therein.

Be that as it should, the legal fraternity, it seems, stands reassured of yet another fresh series of long drawn but inconclusive court litigation on, besides the whole lot of issues most likely to arise out of the ‘simplified code’ itself, the referred 'fall out' problems.

It is anybody's guess whether on the above mentioned and / or similar aspects any useful suggestions have at all been put forth to the Revenue. Though , of course, the final outcome is entirely in the hands of the Authority.


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