Taxing Foreign Law Firms in India

Pathik sends us another interesting post on the recent ruling of the Bombay High Court in Clifford Chance v. DCIT.

The extent to which services provided by foreign law firms such as Clifford Chance are taxable for their services are taxable in India.

The Bombay High Court, in a recent decision (Clifford Chance v. DCIT) clarified the position by stating that the income earned by foreign firms from Indian clients shall be taxable only to the extent of their income earned from their operations in India. The Income-tax department sought to invoke Section 9 of the Income tax Act which defines the income “deemed to accrue or arise in India”. This position has been amended by the Finance Act, 2007, which added an explanation.

This particular provision (Section 9(1)) of the Income Tax Act has been the subject-matter in a plethora of disputes decided by the Supreme Court of India. Sinha and Bhandari JJ., in a recent decision in Ishikawajma-Harima Heavy Industries Ltd. v. Director of Income Tax, Mumbai, emphasizing on the need for territorial nexus clarified the issue concerning taxation of non-residents under Section 9(1) of the Income-Tax Act. The Hon’ble Supreme Court made it abundantly cleared that the following conditions need to be satisfied simultaneously:

1. the services which are the source of the income that is sought to be taxed, has to be rendered in India
2. the services which are the source of the income that is sought to be taxed, have to be utilized in India.

This decision was followed by the above-mentioned amendment (which reads as follows: “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.”) and the decision of the Bombay High Court in CIT v. Seimens in November 2008.

Now let us understand the situation in the present case. Clifford Chance, a UK based firm was appointed as legal advisors for three transactions in India (1996-97), namely, the Bhadravati power project, Vizag power project and Ravva oil and gas fields project.

In the subsequent financial year, it began work on the Vemagiri power project as well. Only the Bhadravati project had an Indian firm – Ispat Industries – which was the JV partner for construction of the power plant. The partners for the other projects were not resident in the country. Clifford Chance was remunerated on an hourly rate basis with each of its partners and employees maintaining detailed time sheets. This was a record of the time spent on doing such work in India and outside it. The bills so raised were paid to Clifford Chance by the clients outside India. The law firm filed a return showing an income liable to Indian taxation of Rs 5.08 crore. The Income Tax department disputed this amount and claimed tax amounting to Rs. 17.26 crores. The argument advanced by the Department, which was accepted by the Income Tax assessing officer, appellate authorities and the Tribunal was that even though services rendered by Clifford Chance outside India had to be excluded while computing tax, the advice given by the legal firm was for projects that were to be executed in the country.

However, before the Bombay High Court, Harish Salve eloquently advanced the proposition that as per the provisions of Section 9(1) of the Income Tax Act a person, the tax on professionals who have been in the country for over 90 days would be taxable under the Income-Tax Act. In order to be taxed here, the income must accrue or arise in India. Applying this to a legal professional rendering advisory services, his presence at the time of rendering advice would be the basis for determining where income is taxable. He placed reliance on Article 15 of the India-UK DTAA read with Section 9(1) of the Income Tax Act according to which, fees from professional services may be taxed in India only if the services are performed in India and the assessee is present in India for more than 90 days in the relevant fiscal year. The Bombay High Court upheld this argument and held that if the services are rendered for more than 90 days, then Section 9(1) would be attracted, wherein, the requirement of a territorial nexus (the above-mentioned two conditions are laid down in the Ishikawajma Case)  has to be fulfilled for Section 9(1)(vii) to be invoked. It can be argued that no reliance was placed on the Seimens decision by the Bombay High Court in this case, however the distinguishing factor, that is, the invokation of Article 15 of the India-UK DTAA in the Seimens case and its non-application in the present case is material and pertinent to note. Therefore, the Bombay High Court relied on the decision of the Supreme Court in Ishikawajma and limited the ambit of taxable services as offerered by non-residents (Clifford Chance) under Section 9(1) of the Act by holding that “for a nonresident 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.”

Readers may also read this post on Law and Legal Developments cross posted from Indian Corporate Law Blog.