In the recent ruling of Worley Parsons Services Pty. Ltd.1
(“Applicant”) the Authority for Advance Rulings
(“AAR”) has revisited the principles of
international taxation governing the treatment of royalty
payments made for services rendered by a non-resident in India
and the well established principles of territorial nexus
governing the taxation of such payments.
Facts of the case:
The Applicant in the present case was an Australian Company
which had entered into 3 agreements for the provisioning of 3
services being (i) engineering and procurement services (ii)
project management services and (iii) construction advisory and
commissioning advisory services respectively.
The characteristics feature of the services rendered under the
first agreement (agreement for rendering engineering services)
were that the majority of these services were performed in Perth
and to the extent of 20% were performed in India. As regards the
services rendered under the second agreement (agreement for
rendering project management services), these were in nature of
co-ordination and were partly performed from Perth and partly
from India. There were no services which could be rendered under
the third agreement (agreement for rendering advisory services)
as the project had to be terminated mid way. The Applicant never
disputed the fact that it had a permanent establishment (“PE”)
in India.
 |
| |
|
A -
Agreement for Engineering Services
B -
Agreement for Project
Management
C -
Agreement for Advisory Services (no services were rendered)
|
|
Issues Considered:
The moot point for consideration before the AAR was whether the
services performed under the first agreement were effectively
connected to the PE in India. The Applicant
stated that in the event such a connection was established the
services would be taxable as business profits and thereby making
only that part of the profits attributable to the PE to be
liable to tax in India.
In the alternative, it was also contended by the Applicant that
as per the principle of territorial nexus laid down by the
Supreme Court in the case of Ishikawajima Heavy Industries2
only that portion of the services should be taxed which has a
territorial nexus with India and therefore only 20% of the
services would be taxed in India.
Ruling
The AAR held that the pre-requisite for making the services
liable to be taxed as business profits was that the services in
respect of which the royalties are paid should be effectively
connected with the permanent establishment. The connection
envisaged was a “real and intimate connection” between
the royalty generating services and the permanent establishment.
It is not enough that there is a permanent establishment of the
non-resident in the source country carrying out some activities
in connection with the project or the work.
Therefore on the basis of the test laid by the AAR, which is an
established principle of international taxation, since the
services rendered by the Applicant were not effectively
connected with the PE, the services cannot be categorized as
being in nature of business profits. Further, the AAR held that
the provisions applicable to business profits and royalty
payments are mutually exclusive and as the services rendered are
not effectively connected, they were liable to be taxed as
royalty on the gross amount of services rendered by the
Applicant.
As regards the contention raised by the Applicant on the basis
of the Apex Court’s ruling in Ishikawajima Heavy Industries
that only those services rendered by the Applicant should be
liable to be taxed which have a territorial nexus with India, it
questioned the logic provided by the Apex Court in the said
ruling. The AAR, however, ruled that on account of the binding
nature of the Apex Court’s judgment, it had no option but to
give effect to Ishikawajima Heavy Industries judgment.
However on account of the distinctive feature of the services
performed in India under the first agreement, which were the pre
requisite for the services which had been performed in Perth,
the AAR ruled that services rendered inside and outside India
had a territorial nexus with India and were therefore liable to
tax in India.
In respect of the service rendered under the 2nd Agreement, the
AAR held that since these services were effectively connected
with the PE in India, they were governed by the provisions of
business profits and liable to be taxed only to the extent of
profit attributable to the PE.
Conclusion
The above ruling of the AAR has questioned the very basis of the
doctrine of territorial nexus which had been laid down by the
Supreme Court in its ruling of Ishikawajima and
developed by the recent ruling of Clifford Chance3
The doctrine has till now been regarded as sacrosanct and it is
indeed surprising to see the AAR question the same. Though the
rulings of the AAR are binding only on the applicant and the tax
authorities, its rulings do have a persuasive value and hence
developments in this arena would have to be watched carefully.
The concept of territorial nexus that has been established so
far in India is in line with the international approach and any
deviation in approach should be made with caution and
circumspection.
|
Advance rulings are generally available to
non-residents and foreign companies for providing
clarity with respect to their Indian tax liability in
connection with transactions undertaken or proposed to
be undertaken. These rulings are binding on the
applicant and the revenue, but are not binding on
others. However, they do carry persuasive value.
Statutorily advance rulings are to be provided within 6
months. |
_____________________________
1. 2008-TIOL-05-ARA-IT
2. AIR 2007 SC 929
3. 2009(111)BomLR428
