Delhi ITAT rejects tax claim for virtual services provided by global law firm
Mumbai, March 17, 2024
Global firms providing legal, technology and education services from certain countries outside India to benefit from the ruling
The Delhi Income Tax Appellate Tribunal (ITAT) has rejected the concept of virtual service permanent establishment (PE) in a matter related to a global law firm governed by the provisions of India-Singapore Double Taxation Avoidance Agreement (DTAA).
The 22-page ruling that came in last week will benefit firms providing legal, technology and education services from certain countries outside India who have similar treaty arrangements and who have chosen to do remote work, especially in the aftermath of Covid.
The assessee Clifford Chance, a law firm, is a tax resident of Singapore and provides legal advisory services to international clients including those in India. As per Article 7 of India-Singapore DTAA, the profits of a foreign enterprise can be taxed in India only if business is carried on through a PE situated in India.
The tax authorities were of the view that the assessee constituted virtual service PE in India for AY20-21 and AY21-22. The authorities relied on the concept of virtual PE mentioned in OECD Interim Report 2018 which favours the view that physical presence is no longer relevant for the application of service PE in a digitized economy.
The ITAT, however, observed that there was no provision regarding the establishment of virtual service PE under the India-Singapore DTAA. So, only the present service PE provision, which requires physical rendition of service in India, should be applied. This view, it said, is supported by the OECD Interim Report 2018 which says that in the absence of any amendments to the tax treaty provisions, the virtual service PE measures can be challenged by the tax payers before the courts.
“The Tribunal’s ruling makes it clear that for any law to be applicable it needs to be codified into law and cannot be read into law basis certain developments or acceptance of the concept in other parts of the world,” said Ashish Sodhani, Co-founder and Partner, Parakram Legal.
To determine the service PE, the ITAT excluded vacation days, business development visits and common days for its duration test for AY21. Since the 90-day threshold provided under Article 5(6)(a) of the India-Singapore DTAA for constitution of service PE in India was not met, it ruled that the assessee did not constitute a service PE in India.
“This is one of the first distinct decisions addressing the debate on virtual service PE existence in the source country,” said Ashish Karundia, Founder, Ashish Karundia & Co. “However, one should not place a blanket reliance on this decision since it has been rendered in the context of the India-Singapore DTAA. There are variations, for instance, in the text of service PE provisions between different Indian treaties such as India-Mauritius DTAA.”
The matter
The assessee filed its tax return declaring nil income and claiming credit of taxes for AY20-21 and AY21-22. It had entered into legal advisory contracts with Indian clients during these assessment years. For AY21, part of the advisory services were rendered remotely outside India and in some instances employees travelled to India. In AY22, the services were rendered remotely with no employee visits to India.
The assessee was asked to show cause as to why the gross receipts of ₹15.55 crore for AY21 and ₹7.76 crore for AY22 should not be taxed as it constituted service PE/virtual service PE in India.
The firm’s employees were in India for 120 days in AY21, of which 36 were vacation days, 35 business development days and five common days, implying only 44 days of service in India, well below the service PE threshold. Since no employees were physically present in India during AY22, there was no service PE that year as well, the ITAT ruled.
“The taxpayer was able to demonstrate that it did not meet the 90-day threshold under the service PE clause only because of the data that was presented before the Tribunal. This highlights the need for sufficient documentation and evidence before filing return of income to avoid adverse tax consequences,” said Sodhani.
Karundia added that it would be relevant to analyse whether this ratio of excluding vacation days would also extend to gazetted holidays and weekly holidays such as Saturday and Sunday.
[The Hindu Business Line]
