Clifford Chance Scores A Victory Against Tax Department
The concept of a virtual permanent establishment needs deliberation and debate before it can be applied to actual situations, say experts.
Law firms based in Singapore can now serve Indian clients without tax worries. The Delhi tax tribunal has set aside the Revenue Department’s attempt to tax Clifford Chance, a global law firm, on income from Indian clients.
The ruling could benefit accounting firms, educational service providers, BPOs and the like, servicing Indian clients from overseas, experts said.
The case came before the Delhi Income Tax Appellate Tribunal after the Revenue Department asked Clifford Chance LLP to show cause as to why its earnings from Indian clients should not be taxed in India. Clifford Chance is a tax resident of Singapore and is governed by the provisions of the India-Singapore Double Taxation Avoidance Agreement.
It was the department's contention that Clifford Chance constituted a permanent virtual service establishment in India for rendering services to its Indian clients.
According to the provisions of the India-Singapore tax treaty, a foreign enterprise can be taxed in India only if its business is carried on through a PE situated in India. To constitute a service PE, employees of the foreign entity must be present in India for more than 90 days.
The tax department said that Clifford Chance had a total revenue of Rs 15.55 crore for assessment year 2020–21 and Rs 7.76 crore for AY 2021–22 from rendering services to its Indian clients.
It was an undisputed fact that during AY 2020–21, part of the advisory services were rendered remotely outside India and the other part was rendered in India for a period less than 90 days. In AY 2021-22, the entire service was rendered remotely.
In its tax claim, the department took a novel approach and relied on a 2018 OECD report. It said that to constitute a service PE, what is important is the aggregate duration of services provided by the non-resident to its Indian clients, and the duration of the physical presence of the employees in India is not material.
In essence, it said that the physical presence of Clifford Chance’s employees was irrelevant since there is no mandate in the tax treaty that the employees providing services must be stationed in India.
Since the India-Singapore tax treaty doesn’t speak about the concept of a virtual service PE for the purposes of taxation, the tax department cannot rely on it to claim tax from a foreign enterprise, the Income Tax Appellate Tribunal held.
The tribunal ruled that a foreign enterprise must provide a physical service in India to be subject to taxation in India. Further, it stated that the concept of virtual service PE as a measure to combat the issues arising from the digitisation of the economy has not yet been endorsed in India, and there are no judicial precedents for the same.
The tax department has tended to be aggressive in its interpretation of tax treaties, but the ruling has correctly interpreted the treaty in rejecting the department’s stance.Dr. Dhruv Janssen-Sanghavi, partner, Nishith Desai Associates
If the department’s stance were to be accepted, any foreign service provider rendering services from their resident country to different jurisdictions would lead to a virtual permanent establishment in all those jurisdictions, perpetuating unintended tax consequences and litigation, said Gaurav Mehndiratta, partner at KPMG India.
Service sector firms, especially law firms, accounting firms, educational service providers, BPOs, entities engaged in providing technology and technological support, etc., rendering services to Indian clients from abroad, have now attained clarity on the constitution of a virtual service PE in India, according to Rahul Charkha, partner at Economic Laws Practice.
However, the ruling is likely to be challenged in higher courts and therefore, the taxpayers should factor in potential litigation on this aspect before following the judicial precedent, he said.
Virtual PE: An Idea That Needs More Deliberations
The framework of ‘virtual permanent establishment’ focuses on the complete removal of the requirement for a physical, fixed place of business in the source country.
The OECD Interim Report 2018 under the OECD/G20 BEPS project, titled 'Tax challenges arising from Digitalisation', discusses the concept of virtual service PE, wherein the requirement of physical presence is no longer relevant for the application of service PE.
The concept of virtual PE needs to be debated and deliberated upon before it can be applied to actual situations. A broad-brush virtual PE formula for all sectors and businesses will not be viable for taxation purposes, Mehendiratta said.
A virtual PE could be a good approach theoretically when it comes to thinking of how tax treaties could evolve to meet the challenges of the digitised economy, said Dr. Dhruv Janssen-Sanghavi, partner at Nishith Desai Associates.
Such a concept cannot, and should not, be built by creative interpretation of existing tax treaties, but by undertaking a global economic impact assessment, he said. This assessment would also require new rules on how to attribute profit to such a virtual PE, so that there is no double taxation in various source jurisdictions.