Tax Hotline

November 25, 2013

Fiscally Transparent Entities Eligible to Claim Treaty Benefits

A.P.Moller, Mumbai v. Department of Income Tax

  • Benefits of Double Tax Avoidance Agreements cannot be denied to fiscally transparent entities merely owing to non-taxability of entities in the State of residence
  • Managing Owners of a business cannot be treated as the real owners for the purpose of income tax
  • Costs attached to software and IT systems intrinsic to the conduct of the operations of entities may not be separately taxable as ‘royalties’ or ‘fees for technical services’


Earlier this month, the Mumbai Bench of the Income Tax Appellate Tribunal ruled on a matter concerning management fees received by an entity that was fiscally transparent in its State of residence, in respect of the operations of its owners in India. The Tribunal held the fiscal transparency of the entity in the residence State would be immaterial to claims of treaty benefits as long as the income on which such benefits were being claimed was subject to tax in such State of residence. The brief facts of the case may be stated as follows.

A.P.Moller (“the Taxpayer”) is a partnership firm resident under the laws of Denmark. As per the Memorandum of Articles of Association of Danish companies namely, Svendborg and Dampskibsselskbet 1912 (“1912”) (“the Companies”), which were public limited companies incorporated and registered under Danish law, the Taxpayer had been appointed as the managing owner of these two companies (“Managing Owner”).

The main activities of the Companies related to engaging shipping operations globally even while the effective place of control and management of these companies was in Denmark. In accordance with Danish laws, the Companies appointed the Taxpayer as their Managing Owner for managing their shipping operations globally and represented them in all their matters of business over the world. This entailed that the Taxpayer also had the authority to bind the Companies in any contract and in such representative capacity is a signatory to most of the agreements and legal documents pertaining to the companies.

As the Managing Owner, the Taxpayer manages the shipping business of the Companies all over the world and has also filed corporate tax returns on their behalf on the income of these two companies in each country of operations, including India. In consideration of management services rendered by the Taxpayer in respect of the global operations of the Companies, the taxpayer is entitled to charge certain fees (“Management Fees”) based on the Gross Registered Tonnage of all the ships owned per annum.

On income from freight receipts of the shipping operations conducted in India, the Taxpayer had been filing nil returns on income with the tax authorities owing to the benefit of Article 9 of the Income Tax Treaty between Denmark and India (“Tax Treaty”) which exempts income from payment of tax in India as long as tax on such income was paid in Denmark.

For the conduct of its shipping operations globally, the Companies also employed certain software and global IT systems that were utilized by all agencies and employees of the Companies across the world where it’s shipping operations were conducted. In lieu of utilization of these services in India, such agencies would reimburse the Companies for the costs of such services. Accordingly, two entities in India, namely M/s. Maersk India Pvt. Ltd., ("MIPL") and Maersk Logistic India Ltd. ("MLIL") made payments to the Companies for their share of the costs of the services which were sought to be taxed as payments in the nature of royalties or fees for technical services by the Indian tax authorities.


Based on the facts of the case, the main issues were framed by the Mumbai Income Tax Appellate Tribunal (“Tribunal”) for adjudication were:-

  1. Whether a taxpayer was entitled to the benefits of the Tax Treaty, even though it was not per se a taxable entity in its resident country;
  2. Whether the Management Fees received by the taxpayer from the Companies was chargeable to tax in India;
  3. Whether payments made by MIPS and MLIL towards dates share of the cost of software and global telecommunication facilities developed by the Companies for shipping operations would be taxable as royalties or fees for technical services under Indian law.


1. Whether a taxpayer was entitled to the benefits of the Tax Treaty, even though it was not per se a taxable entity in its resident country?

The benefits of the Tax Treaty were denied to the Taxpayer by the authorities on the ground that the Taxpayer was set up under Danish laws as a partnership, which as such, is a fiscally transparent entity treated as non-taxable under Danish laws.

Under Article 4 of the Tax Treaty, the term “resident of a contracting State” is construed to mean any entity under the laws of that State, which is liable to tax either by reason of domicile, residence, place of management or any other criterion of a similar nature. The benefits of the Tax Treaty, it was argued should accordingly be denied to the Taxpayer since it was an entity that could not be considered a “resident” under Danish laws.

However the Tribunal relied on provisions of the OECD Commentary on Double Taxation Avoidance Agreements (“DTAAs”) (“OECD Commentary”) as well as the ruling of its coordinate bench of the Mumbai Tribunal in Linklators LLP1, to hold that it was the “taxability of the income” in the resident State, rather than the mode of taxability, which should govern eligibility to Treaty benefits. Therefore, even though a partnership firm may be a fiscally transparent entity, as long as its profits were taxed in the hands of its partners in the resident country, benefits of the Tax Treaty could not be denied to the Partnership.

It was the taxability of the income then, and not the entity, that would determine eligibility to treaty benefits under Article 4.

2. Whether Management Fees received by the taxpayer from the companies was chargeable to tax in India?

The argument of the revenue authorities here was that in so far as Management Fees was paid by the Companies to the Taxpayer in relation to freight receipts earned in India, it should be liable to tax to the extent of such income received, as royalties under the provisions of section 9(1)(i) and section 9(1)(vii)(c) of the Income Tax Act, 1961 (“Act”).

Striking down these arguments, the Tribunal relied on an analysis of Article 13(6) of the Tax Treaty to establish the inapplicability of the above provisions of the Act and to hold that Management Fees received by the Taxpayer from the Companies could not be taxable in India even to the extent of receipts earned from its India operations. Based on a reading of Article 13(6), in order to tax royalty and fees for technical services in case of a non-resident under the Tax Treaty, the basic condition to be fulfilled is that there should exist a Permanent Establishment of the taxpayer in India or a fixed base in connection with which such income was earned. The payments in this case were made by one non-resident entity to another non-resident entity in connection with the entire global operations of the Danish shipping companies, and neither entity had a Permanent Establishment in India. Furthermore, since Management Fees paid to the Taxpayer by the companies was in terms of the Gross Registered Tonnage of all the vessels of the companies and not in respect of the income earned from India no part of the Management Fees paid to the Taxpayer could be attributable to India operations.

Fees payable to the Taxpayer in respect of services rendered by it globally could not be taxed in the absence of a Permanent Establishment of the Taxpayer in India or a fixed base in connection with such business.

3. Whether payments made by MIPS land MLIL towards dates share of the cost of software and global telecommunication facilities developed by the companies for shipping operations would be taxable as royalties or fees for technical services (“FTS”) under Indian law?

The Tribunal observed that payments made were in respect of the software and telecommunications facilities which were used globally for the international shipping operations of the companies. The cost of these facilities was shared by all group entities and agents of the Companies globally. This issue had already been decided by the Tribunal in a case concerning the Companies where the Tribunal had held that these facilities and the software were an integrated part of the shipping operations and could not be segregated from the main business of the companies so as to hold them to be rendering any independent technical services.

The Tribunal relied on Article 9(1) of the Tax Treaty, which provides that profits derived from operations of ships in international traffic would be taxable at the place where the effective management of the enterprise was situated. The Tribunal held that the term “profit” should be construed broadly so as to include not only the activities directly connected with the shipping operations but also activities which facilitate or support such operation as well as ancillary activities. Such a view, it was held, also found support in Article 8 of the OECD Commentary. Therefore, given that the profits of the companies included the cost of the software and IT systems recovered from MPIL and MLIL in India, they could be taxed only if and to the extent that the Companies had a Permanent Establishment or a fixed base of operations in India.

Costs ancillary to the main business of the Taxpayer and that cannot be segregated from the operations of the entity should not be construed as providing any independent technical services, and could not be taxes as FTS.


This ruling of the Mumbai Tribunal is significant for the fact that it reaffirms the eligibility of fiscally transparent entities to benefits of exemptions and lower tax rates under tax treaties. In a reaffirmation of the principle laid down in the ITAT ruling in Linklaters, the Tribunal holds that as long as the income is subject to tax in the State of residence, regardless of the manner in which it has been taxed, or the entity in whose hands it has been taxed, it would be eligible to the benefits of the Tax Treaty. Borrowing from the ruling in Linklaters, the Tribunal noted:

"71. Viewed in the light of the detailed analysis above, in our considered view, it is the fact of taxability of entire income of the person in the residence State, rather than the mode of taxability there, which should govern whether or not the source country should extend treaty entitlement with the contracting state in which that person has fiscal domicile. In effect thus, even when a partnership firm is taxable in respect of its profits not in its own right but in the hands of the partners, as long as entire income of the partnership firm is taxed in the residence country, treaty benefits cannot be declined."

The Court also drew from the OECD Report on Partnerships to observe that where a State disregards a partnership for tax purposes and treats it as fiscally transparent, so as to tax its income in the hands of its partners, the partnership itself is not liable to tax and may not, therefore, be considered to be a resident of that State. In such a case however, since the income of the partnership "flows through" to the partners under the domestic law of that State, the partners would be liable to tax on that income and thus the eligible to claim the benefits of the Tax Treaty. By interpreting the OECD Commentaries in a manner that should not result in double taxation of the same income, the Tribunal took the view that as long as the income of the partnership is taxed in the country of residence, the benefits of the Tax Treaty could not be denied on the income. Accordingly, the income, and not the entity was the subject of the Tax Treaty. This is an interesting view taken by the Tribunal in light of India’s reservations to OECD Report on Partnerships as well as the ruling of the Authority for Advance Ruling in SchellenbergWittmer2. India had not accepted the position taken in the reporting that partnerships are to be denied treaty benefits where they are considered non-taxable in the residence State, and instead would be allowed to the partners. Linklaters made a slight departure from this position as evidenced above. Furthermore, given the recently emerging model of partnerships formed over multiple jurisdictions where the partnership may or may not be fiscally transparent, it remains to be seen how tax adjudicatory forums would respond to such challenges in the future.

However, this principle is significant for several reasons. It opens up the possibilities of doing business in India through several forms of corporate entities. Very often, in organisations engaged in cross-border operations in industries not limited to shipping, business is done through commercially viable entities that may or may not be liable to tax in the resident State. In such cases, denying the benefits of a tax treaty to such entities merely because the income is not taxed in their hands per se, even though tax may be eventually levied on the same income, would be contrary to the spirit of double tax avoidance treaties. This principle is evident in the OECD Commentaries, as well as the practice followed in several countries in Europe and the US. The affirmation of the Linklaters ruling by the Mumbai Tribunal is therefore welcome in the Indian tax conspectus of cross border transactions.

Adhitya Srinivasan, Gautam Swarup & Rajesh Simhan

You can direct your queries or comments to the authors

1 [2012] 132 TTJ (Mum) 20.

2 AAR No. 1029 of 2010.


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