Partnership firms, though assessed as fiscally transparent entities1 in the country of residence, are eligible to claim treaty benefits under the India-UK DTAA.

• Partnership firms,
  though assessed as fiscally transparent entities1 in the country of residence,
  are eligible to claim treaty benefits under the India-UK DTAA.

• A Service PE is a
  deemed PE and, therefore, does not need to satisfy requirement of Basic PE
  rule. The presence of personnel in excess of the specified time-threshold,
  triggers service PE in India.

• By providing for
  coverage ‘profits indirectly attributable to permanent establishment’ Article
  7 of India-UK DTAA incorporates Force of Attraction (FOA) rule. Profits
  relating to services rendered outside India in respect of Indian projects are
  also taxable in India.

• The taxpayer, was a
  UK-based limited liability partnership, engaged in law practice. It did not
  have a branch or any other similar form of presence in India, but rendered
  legal services to certain clients whose operations extended to India. These
  services were rendered partly from the UK and at times, by partners and staff
  visiting India. During the financial year under consideration, the taxpayer’s
  partners/staff were present in India for more than 90 days.

• The taxpayer
  disclosed ‘nil’ taxable income in Indian tax return by claiming treaty benefit
  and by contending that it has no PE presence (including service PE) in India.
  

• Without prejudice,
  the taxpayer also claimed that as per DTAA, profits of PE were to be computed
  having regard to the market conditions in India. Arm’s-length income of PE is
  based on fiction of independence and is required to be calculated having
  regard to the rates that would have been charged by Indian
  lawyers/professionals for similar services.

• The Tax Department
  rejected the taxpayer’s arguments and concluded that the taxpayer had a
  service PE in India. Entire income in relation to Indian projects (including
  services rendered from the UK office) was taxed on the ground that no details
  about overseas work was furnished.

• On appeal, the CIT(A)
  agreed with the AO on the applicability of service PE Rule, but restricted
  taxation only to the extent of services rendered in India.

• The UK legal firm is
  a person under the treaty definition of the term.

• The difference in
  taxation system applicable to the partnership firm in the source jurisdiction
  [(India) and residence country (UK)] results in economic double taxation
  though not juridical double taxation. The philosophy of DTAA which supports
  merits of avoiding juridical double taxation should equally be applicable to a
  situation of economic double taxation.

• The decision of
  Canadian Court in the case of TD securities (USA) LLC v. Her Majesty the
  Queen, (2010 TCC 186) supports that the treaty benefit can be given even in a
  situation involving asymmetrical taxation. In this case, single-member LLC of
  the USA was given the benefit of USA-Canada treaty despite the fact that in
  Canada, assessment was in the names of LLC whereas in the USA, due to the
  option exercised, the assessment was in the name of the member of the LLC. The
  decision also supports that the treaties need to be interpreted on a
  contextual basis rather than based on strict principles of interpretation as
  applicable to tax laws. The treaty interpretation is not subjected to literal
  interpretation in isolation with the objects and the purpose for which the
  treaty provisions are made.

• The treaty benefit is
  available to a person who is a treaty resident of the other country. In terms
  of the treaty, an entity is resident of the UK if it attracts tax liability in
  the UK on account of criteria such as domicile, residence, place of
  management. Though the modalities or mechanism of taxation may vary, facts of
  taxation need to be decided in an objective and uniform manner.

•     In a situation where the entire income of a partnership firm is taxed in its own hands or in the hands of a partner, the definition of residence should be regarded as fulfilled. The Canadian decision in TD Security’s case supports that the term ‘liable to taxation’ needs to be interpreted in a pragmatic manner so as to extend the treaty benefits to fiscally transparent entities. The test of fiscal domicile relevant for treaty residence purpose is fulfilled so long as the country of residence has right to tax income of the firm, irrespective of whether such right is actually exercised by the resident state or not.

•     As a result, the taxability of entire income in the country of residence is more relevant rather than the mode of taxability i.e., whether the tax is levied in the hands of the firm or in the hands of the partners. The treaty benefit therefore cannot be denied to the firm so long as entire income of the firm is taxed in the residence country, not in its own right but in the hands of the partners.

•     Incongruent result arising on account of asymmetrical result needs to be avoided and the benefit of the treaties is to be given so long as income of the enterprise is subjected to taxation in the other jurisdiction either directly or indirectly.

•     The OECD report dealing with applicability of DTAA to partnership has indicated that in case of asymmetrical taxation, benefit should be available to the partners and not to the partnership firm. The ITAT consciously took the decision of adopting a view different from that by the OECD report which suggested grant of treaty benefit to the members of the firm. Reference was made by the ITAT to the reservation of India on the OECD commentary to conclude that the Government had rejected the stand of the OECD.

Other issues :

•     The firm had a fictional service PE in view of presence of its partners/personnel in excess of the specified threshold.

•     Actual revenues earned by taxpayer needs to be considered in respect of third-party dealings. It is not correct to apply hypothetical rates of earnings based on what could be the earnings of other Indian legal firms.

•     The UK treaty provides for taxation of profits in the state to the extent they are directly or ‘indirectly attributable’ to that PE. The inclusion of profits indirectly attributable to the PE incorporates a force of attraction principle in the UK treaty.

•     This permits taxability of overseas income in respect of services rendered for an Indian project if it is similar or relatable to the services rendered by the PE.