Force of Attraction rule cannot be imported in Article 7 of Indo-UK DTAA

ADIT vs Clifford Chance (Mumbai Special Bench-IT Appeal. NOs. 5034,5035,7095 (Mum) of 2004 dated 13/05/2013)           

ISSUES INVOLVED :-

1. Whether amendment by Finance Act,2010 to Section 9(1)(v),(vi),(vii) changes the position of law as far as assessee is concerned ?
2. Whether Force of Attraction rule can be imported in Article 7(1) of the India UK DTAA by referring to Articles 7(1)(b) and 7(1)(c) of the UN Model Convention?

 

DTAA INVOLVED :-

INDIA UK DTAA                                                    

FACTS OF THE CASE:-

A)    The assessee is a UK based partnership firm of Solicitors engaged in providing international legal services

B)    During the years under consideration, it rendered legal consultancy services in connection with different projects in India. Although it did not have an office in India, some part of the work relating to the projects in India was performed in India by its partners and employees during their visits to India.  

C)    For assessment years 1999-2000, 2000-01, 2001-2002 and 2003-04, the returns of income were filed by the assessee declaring NIL income on the ground that the aggregate period or periods of stay of its partners and employees during the said years did not exceed 90 days and its income, therefore, was not taxable in India in these years placing reliance on Article 15 relating to 'Independent Personal Services' of the India-UK Treaty.

D)    AO ,however, rejected assessee's claims for exemption based on Article 15 of Indo-UK DTAA and taxed profits based on Article 7(1) of Indo-UK DTAA to tax them as business profits.

E)     CIT(A),however, allowed the claim of the assessee.

REVENUE'S CONTENTIONS :-

 

a)      That Article 15 of the India-UK Treaty is not applicable in the case of the assessee since it did not cover partnership firms within its ambit.

b)      That that the case of the assessee ,even otherwise, was covered by Article 7 of the India-UK DTAA read with Article 5 thereof. Reference in this regard was made  to the terms of Article 5(2)(k) of the India-UK DTAA which provided that the term 'Permanent Establishment' (PE) shall include, inter alia, the furnishing of services including managerial services other than those taxable under Article 13 (Royalties and fees for technical services) within a Contracting State by an enterprise through employees or other personnel but only if the activities of that nature continued within that state for a period or periods aggregating to more than 90 days within any 12 months period. That the test of 90 days stipulated under Article 5(2)(k) was satisfied in the case of the assessee and the assessee thus had a PE in India in terms of the "duration of stay" test provided in the treaty. That the assessee also was having fixed place PE in India in the years under consideration through which services were rendered by its partners and employees during their stay in India. That the assessee had a PE in India and also a business connection in India, hence, the profit earned by the assessee from the rendering of services in India was in the nature of business profit covered under Article 7 of the India-UK DTAA.

c)      That the legal premise, "services, which are the source of income sought to be taxed in India, must be utilized in India and rendered in India", did not hold good any longer in view of amendment made in section 9 by the Finance Act, 2010 w.r.e.f. Ist June, 1976 whereby Explanation to section 9(1) was amended to provide that the income of the non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of section 9(1) and shall be included in his total income, whether or not (a) the non-resident has a residence or place of business or business connection in India or (b) the non-resident has rendered services in India.

d)      That since the assessee was carrying on business in India through the said PE, the profits to the extent they are directly or indirectly attributable to PE in India are taxable in India as per Article 7 of the India-UK DTAA. That Article 7(1) of Indo UK DTAA should be interpreted in the light of Article 7(1) of the UN Model Convention relying upon the decision of Division Bench of Mumbai Tribunal in the case of Linklaters LLP .

ASSESSEE'S CONTENTIONS :-

a)      That the assessee's case fall under Section 9(1)(i) and not section 9(1)(vii), hence amendments made by Finance Act ,2010 to clauses (v),(vi),(vii) of Section 9(1) does not come into play in the case of the assessee.              

b)      That Article 15 of the Indo UK treaty is applicable to the assessee and not Article 5 read with Article 7 and since aggregate period of stay of the partners and employees did not exceed 90 days, its income derived from the services rendered in connection with the projects in India was not taxable.

c)       That,even otherwise, as per the said Article 7(1), profit attributable directly or indirectly to the PE in India is taxable in India. That ,what is directly and indirectly attributable to the PE in India is defined in Article 7(2) and 7(3) of the Treaty and referring to the UN Model Convention to come to the conclusion that the force of attraction rule is incorporated in Article 7(1) of the India-UK DTAA is not justified and erroneous.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
HELD:-
Hon'ble Special Bench of The Mumbai Tribunal discussed the provisions of  Income Tax Act,1961 and relevant Articles of  Indo-UK DTAA and observed and held as under :-

a)      That the case of the assessee is covered by Section 9(1)(i) and not Section 9(1)(vii).

b)      That assessee's case is duly covered by Article 15 of the Indo-UK DTAA as contended by the assessee and not Article 5 read with Article 7 of the DTAA.

c)      That even otherwise Article 7(1) of India UK DTAA read with Article 7(3) thereof is not similar to provisions of Section 7(1)(b) and Section 7(1)(c) of the UN Model Convention and  it would not be correct to say that  the connotations of "profits indirectly attributable to permanent establishment" extend to the two categories of income as specified in clause (b) and clause (c) of Article 7(1) of the UN Model Convention and incorporate a force of attraction rule as held by the Division bench of this Tribunal in the case of Linklaters LLP.

d)     That when the connotations of "profits indirectly attributable to permanent establishment" are defined specifically in Article 7(3) of the India-UK DTAA which clearly explains the scope and ambit of the profits indirectly attributable to the PE and the provisions of said article being unambiguous and capable of giving a definite meaning, there is really no need to refer to the provisions of Article 7(1) of UN Model Convention which are materially different from the provisions of Article 7(1) of the India-UK DTAA read with Article 7(3) thereof.

Comments  :-

The main contention of the assessee in this case was that he is covered by Article 15 of the Indo UK DTAA relating to "Independent Personal Services" and not by Articles 5 read with Article 7 of the said DTAA. Further he contended that Section 9(1)(i) is applicable to him and not Section 9(i)(vii). The Hon'ble tribunal held both the issues in favour of the assessee.

Since the main contentions abovesaid were held in favour of the assesse , the Hon'ble Tribunal itself in the order said that since Article 15 has been held to be applicable in the case of assessee and now issue ,whether 'force of attraction' would apply in case of assessee or not has become infructuous and academic only. But since the said question was specifically referred for consideration of Special Bench, the Hon'ble Bench went on to decide this issue in detail.

'Force of attraction' concept lays down that when an enterprise sets-up a permanent establishment ('PE') in another country, it brings itself within the fiscal jurisdiction of that another country to such a degree that such another country can tax all profits that the enterprise derives from that country - whether through the Permanent Establishment (PE) or not. Therefore, under the 'force of attraction rule' mere existence of PE in another country leads all profits derived from that another country being treated as taxable in that another country.

UN Model of Convention supports this philosophy clearly in Article 7(1). However OECD Model Convention does not support this philosophy. Though Indian Tax Treaties are largely based on UN Model Convention but each DTAA in itself lays down the intent of both the countries. In respect of Indo UK Treaty also the extent of profits attributable to PE directly or indirectly has been laid down in Article 7(1) read with Article 7(3) . However the Division Bench of the Tribunal in the case of Linklaters LLP  held that the provisions of Article 7(1) in the DTAA include the same results as are sought to be achieved by Article 7(1)(c) of the UN Model Convention and relying on the UN Model Convention commentary on the issue, a considered view was taken by the Tribunal that the connotation of 'profits indirectly attributable to permanent establishment' would extend to incorporation of the 'force of attraction' rule being embedded in Article 7(1).

However in this case the Hon'ble Special Bench has overruled the decision of Division Bench and held that when language of the treaty wasn't ambiguous ,there was no need to take meaning of this term from the UN Model convention. This ruling would save the tax payers from force of attraction rule to be applied on them and creating unwarranted  tax liabilities on them.

 

 

CA.ARUN GUPTA
Ex-Chairman Ludhiana Branch of NIRC of ICAI
Ex-Secretary,District Taxation Bar Association,Ludhiana
arunaru@yahoo.com
arun@cagds.in
09814104273