Back Ground
The Hon’ble Income Tax Appellate Tribunal Mumbai ( ITAT Mumbai ) in ITA no 2508/Mumbai/08 in the case of Ashapura Minichem Limited Vs Assistant Director of Income Tax, Mumbai has delivered a landmark decision on the issue of income deemed to accrue and arise in India and it’s taxability in the light of recently amended provisions of section 9(1)(vii) of Income Tax Act 1961 “the Act” vide Finance Act 2010. By way of this article an attempt has been made to understand the decision and its implication on the assessee in future.
A- Facts
Ashapura Minichem Limited, an resident Indian Company (hereinafter referred to as “Indian Company” ) entered into an agreement in the year 2007 with China Aluminum International Engineering Corp Limited, (hereinafter referred to as “Chinese Company”) for provisions of various services in it’s laboratory situated in China in connection with testing chemical composition, constitution, abradability and other performance test of bauxite, herein after called the “Services”
All the services were performed by the Chinese company in China and the test report etc. were handed over to Indian Company in China.
Under the contract the total payment to be made by Indian Company to Chinese Company was $ 1 Million.
At the time of making payment the Indian Company made an application u/s 195(2) to AO for certifying that the income of the Chinese company is not taxable in Indian and there is no withholding tax liability of the Indian Company either in the light of provisions of the Act or the provision of Article 12 of Double Taxation Avoidance Agreement “DTAA” between India and China. The Indian company contend as following -
1- The income of the Chinese company can be taxed under the provisions of Article 12 of DTAA between India and China which being more beneficial to a non resident, shall override the provisions of the Act.
2- The income received by the Chinese Company by providing services to Indian Company are in the nature of “business income” and can not be taxed in India unless the Chinese company has a permanent establishment in India.
3- No withholding is required in India from the payment made for services as the Chinese company does not have any tax liability in India.
However the AO did not agree with the contention of the Indian Company and held that the payment made by Indian company is nothing but “fees for technical services” within the meaning of section 9(1)(vii) and provisions of article 12 of DTAA between India and China, hence the Chinese company is liable to pay tax in India and the Indian company is under obligation to withhold tax under section 195 of The Act. The Indian Company filed an appeal before CIT(A) and CIT(A) upheld the decision of the AO.
A - Contention of the Indian Company before ITAT.
The Indian Company made an application before Hon’ble Mumbai ITAT for giving the decision and made the following plea before the Court –
1 To attract the taxability under section 9(1)(vii) of the act the services should both be utilized and provided in India. The assessee cited the decision of Hon’ble Supreme Court in the case of Ishikawajima Harima Heavy Industries Limited Vs DIT and the Decision of Hon’ble Mumbai High Court in the case of Clifford Chance vs DCIT.
2 The article 12 of DTAA between India and China can not apply in this case as the article 12(4) of DTAA specifically provides that the fees for technical services can only be taxed in the other contracting state if provided in that contracting state. The deeming provisions of article 12(6) dose not come in to play till the condition mentioned in article 12(4) are met.
3 The treaty between India and China provides for an additional “Place of Performance Test” to make any FTS taxable in the source state, hence the at the best the income of the Chinese company can be taxed under article 7 of the treaty as business income, which again in absence of permanent establishment can not be taxed in India.
4 The deeming provisions of article 12(6) of DTAA between India and China create an absurdity, hence should not prevails.
C - Departmental Plea
1- The interpretation that the deeming provision of DTAA will be applied only if the services are provided in India, will render the deeming provisions useless which is not an acceptable position.
2- The case laws relied upon by the Indian company are contrary to legislative intent and any doubt in this regards has been put to rest by the retrospective amendment made in section 9 (1)(vii) of the Act.
D - Decision of ITAT, Mumbai
The ITAT, Mumbai after hearing both the parties decided the matter in the favour of revenue approving the decision of the CIT(A). The ITAT advanced the following arguments while framing its decision –
1- The legal position on this issues does not hold good. The retrospective amendment made by the in section 9(1)(ii) of the Act makes it amply clear that in order to be liable to be taxed in India there is not need that that the “service” be rendered in India. Such income is taxable in India even if rendered outside India.
2- The Income of the Chinese company is taxable in India within the provision of article 12 of DTAA between India and china as the deeming provisions of the article 12(6) provide that the fees for technical services will be deemed to have accrued in the tax jurisdiction in which the person making the payment is located.
E- Analysis of the decision
The ITAT, Mumbai observed there are two issues to be decided in the present case, one is whether the income of the Chinese company is taxable in India with in the meaning of section 9(1)(vii) of the Act and second whether the income is taxable in India within the provisions of article 12 of DTAA between India and China. While framing it’s decision the ITAT Mumbai, analyzed principal of determination of taxability of income and principal of interpretation of double taxation avoidance agreements in great detail.
The ITAT Mumbai, in its order analyzed the decision of Hon’ble Mumbai High Court and in the case of Clifford Chance and that the decision of Hon’ble Supreme court in the case of Ishikwajima Harima. The Court observed that the Apex court in its decision has interpreted the section 9 (1) (vii) of IT Act to require the two condition to be met first viz.(a) the services are utilized in India (b) services are rendered in India in order to be liable to be tax in India on the basis of then prevailing legal position as per section 9 (1) (ii) of the Act. This position no longer holds good in the light of recent retrospective amendment in section 9(1)(ii) with effect from 01/04.2010 by Finance Act 2010. The effect of the amendment is that “fees for technical services” are chargeable to tax in India even if rendered outside India.
The ITAT Mumbai further stated that the apex court in the said decision has advocated the “territorial rule” for determining the taxability of income, which according to the Apex court is a globally accepted principal over the “Source and residence” rule of determination of taxability of any income, which is followed in almost all the countries of the world expect certain tax heaven. The ITAT observed that Source and residence” is an integral part of the taxation system of all the advance countries and the amendment in section 9(1)(vii) has further emphasized that principle.
“Source and residence” rule is an integral part of the taxation system. It is thus fallacious to proceed on the basis that territorial nexus to a tax jurisdiction being sine qua non to taxability in that jurisdiction is a normal international practice in all tax systems.
With regards to the taxability of fees for technical services under the DTAA, the ITAT Mumbai observed that Article 12(4) of the treaty defines “fees for technical services” as following “.
“4. The term "fees for technical services" as used in this Article means any payment for the provision of services of managerial, technical or consultancy nature by a resident of a Contracting State in the other Contracting State, but does not include payment for activities mentioned in paragraph 2(k) of Article 5 and Article 15 of the Agreement”.
Article 12(6) provides that such technical services shall be deemed to arise in a Contracting State when the payer is a resident of that State; The relevant part of the article 12(6) is reproduced as following.
“6. Royalties or fees for technical services shall be deemed to arise in a Contracting State when the payer is the Government of that Contracting State, a political sub-division a local authority thereof or a resident of that Contracting State. Where, however………….fixed base is situated”.
The ITAT Mumbai observed that the it is not acceptable that due to usage of the words “in the Contracting State”, in article 12(4) of the DTAA, the treaty between India and china becomes a special treaty in comparison to treaties with other countries and it incorporate the “place of performance test” in Article 12(4) negating the “source and residence rule”. Accordingly the services rendered in china are not taxable in India. This contention is not acceptable for two reasons. Firstly, because the expression “provision for services” is wider than the term “provision for rendering of services” and covers services rendered in the one State but used in the other State. Secondly, because the interpretation will render Article 12(6) redundant which provides for the deeming provisions that the fees from services shall be deemed to accrue and arise in the state in which the payer is resident of. Further the ITAT Mumbai observed that if a literal interpretation to a tax treaty which renders a treaty provision unworkable should be avoided and laid emphasis on the principles governing interpretation of tax treaties can be broadly summed up as follows:
1- A tax treaty is an agreement and not taxing status, even though it is an agreement about how taxes are to be imposed, the principles adopted in the interpretation of statutory legislation are not applicable in interpretation of treaties.
2- A tax treaty is to be interpreted in good faith in accordance with the ordinary meaning given to the treaty in the context and in the light of its objects and purpose.
3- A tax treaty is to required to be interpreted as a whole, which essentially implies that the provisions of the treaty are required to be construed in harmony with each other.
4 The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need not examined in precise grammatical sense or in the literal sense. Even departure from plain meaning of the language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty in such a manner as to make it workable rather than redundant.
5 A literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated insofar as particular items under consideration are concerned. Words are to be understood with reference to the subject-matter,
6 It is inevitable that interpreter of a tax treaty is likely to be required to cope with disorganized composition instead of precision drafting. Therefore, the words employed in the treaty are to be given a general meaning – general to lawyers and general to layman alike.
7 When a tax treaty does not define a term employed in it, and the context of the treaty so requires, it can be given a meaning different from domestic law meaning thereof. The meaning of the undefined terms in a tax treaty should be determined by reference to all of the relevant information and all on the relevant context. There cannot, however, be any residual presumption in favour of the domestic law meaning of a treaty term.
F - Conclusion
With the above interpretation of the law a long drawn on controversy has been put to rest by ITAT where the various courts including Apex court has held that the services rendered outside India and used in India does not accrue and arise in India and thus are not taxable in India. This decision of the court has provided another armor in the kitty of the tax authorities that may be used by the tax authorities to bring to tax net the income of non resident tax payers and unsettled various concluded cases. Apart from this the payer of such income also run the risk of being assessee in default under section 201 and section 40(2)(ia) and may face the heat of penal provisions of the Act for non deduction of tax on such payments.
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