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 Case!
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 India.
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.
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