Herbert Smith Freehills LLP vs Assistant Commissioner Of Income Tax, International Taxation, Circle 2(1)(1)

11.

We have heard the submissions made by the rival sides and have examined the orders of the lower authorities. We have also considered the decisions referred to by the ld. Counsel for the assessee during the course of his submissions. The issue for consideration in the instant appeal is with respect to taxability of receipts in hands of the assessee to the extent attributable to non-UK based partners of the assessee firm. Undisputedly, the assessee partnership firm engaged in providing legal services is based in the UK. The assessee has partners from the UK and other countries, namely, Australia, France, Belgium, China, Japan and Germany. The firm has partners from the UK and other countries. The percentage of profit-sharing of the partners from various countries has already been tabulated in para 4 of this order. The partners of the firm based in the UK have share in profit to the extent of 82.121%, whereas non-UK partners have share in profit of 17.88% of the revenue earned by the assessee from Indian engagements. In so far as partners based in Germany having 3.627% share in the profits is concerned, the assessee has offered the same to tax in accordance with India-Germany DTAA and the same has been accepted by the AO. Further, the AO has accepted that the share of profit of partners based in the UK is also not liable to tax in India in accordance with the India-UK DTAA. The dispute is only with respect to the share of profit of the partners of the assessee firm from Australia, France, Belgium, China and Japan, which aggregates to 14.25% of the total receipts. During the period relevant to the assessment year under appeal, the assessee received revenue from provision of legal services on Indian engagements amounting to GBP 27,49,936. The AO made addition of Rs.3,59,02,752/- i.e to the extent of 14.25% of the said receipts attributable to non-UK based partners (excluding Germany). According to the AO, the amount attributable to non-UK resident partners of the assessee firm is in the nature of FTS u/s 9(1)(vii) of the Act.

12.

Before, we proceed to decide the issue in the instant appeal, it would be imperative to understand the taxability of income of partnership firms or Limited Liability Partnerships (LLPs) in the UK. Partnership firms or LLPs in the UK are “tax transparent”, which means that each member of the partnership firm is assessed to tax on his share of the partnership income or gains. Though there is an obligation on partners firm to file tax return but there is no tax liability on the partnership firm. Any non-UK source profits or gains made by a partnership firm are subject to tax in the UK in hands of the partners resident in the UK. There is no restriction on non-residents of the UK or nationals of other countries becoming partners in a partnership firm based in the UK. The share of profit of non-UK partners in the partnership firm is not subject to taxation in the UK. UK based partnership firm being tax transparent, non-UK resident partners cannot avail benefit of the India-UK DTAA.

13.

The India-UK DTAA, as amended by Notification No. 10/2014 (supra), defines the term “person”, which, inter alia, includes a “body of persons”. Thus, a partnership firm is included within the meaning of the term “person”. Further, Article 4 of the DTAA defines ‘resident of a contracting state. The relevant extract thereof is reproduced herein below:-:

“1.

For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that: xxxx

(b)

in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries.” A bare perusal of Article 4(1)(b) would show that any person who is a resident of the UK is liable to tax in the UK by reason of his domicile, residence, place of management, place of incorporation or any other criteria of a similar nature. Since, partnership firms are tax transparent the treaty benefit is extended to partnership firm to the extent of income of partnership firm is attributable to its partners in the UK. Thus, it is evident that the income of a partnership firm is taxable in the State of residence only to the extent of income derived by the partners in proportion to their share in the profits of the firm. To put it differently, the income of a partnership firm based in UK is taxed in the hands of the individual partners depending upon the residential status of each partner of the firm. Therefore, in our considered view that partners of the UK partnership firm who are not residents of UK would be subject to tax on their respective share of profits from partnership firm in the state of their residence. Accordingly, DTAA of each partners country of resident will have to be examined.

14.

As pointed earlier, the AO has accepted that the share of profit of partners based in the UK is not taxable in India in light of the India-UK DTAA. The AO has also accepted the income offered by the assessee to tax with regard to the partners of the firm based in Germany in light of the India-Germany DTAA. Thus, the AO has himself accepted that taxability of each partner of the partnership firm has to be determined on the basis of partners State of residence.

15.

The AO has taxed the share of profit attributable to the partners based in Australia, France, Belgium, China and Japan, aggregating to 14.25%, by treating such receipts as FTS under the provisions of section 9(1)(vii) of the Act. The Tribunal in the case of ACIT vs. Subramanium Hariharan (supra), where the AO held that payments made to foreign legal professionals for services rendered to Indian clients is in the nature of FTS, and on account of non-deduction of tax at source the AO made disallowance u/s 40(a)(ia) of the Act, the Tribunal held that payments to non-resident foreign law firms for professional services do not fall within the meaning of FTS under section 9(1)(vii) of the Act. For the sake of completeness, the relevant findings of the Tribunal are extracted herein under:-

“11.

Elaborating it further, our attention was invited to section 194J of the Act which provides for tax deduction at source in respect of “Fees for professional or technical services”. It is submitted that the distinction between “Fee for professional services” and “FTS” is statutorily recognised, in as much as, under the aforesaid section, Legislature in its wisdom has created two separate classes of income, viz., “Fees for professional services” and “Fees for technical services”. The said expressions have also been separately defined in Explanation to section 194J. Relevant extracts of section 194J along with Explanation thereof, are reproduced as under:

“194J. Fees for professional or technical services.

(1)

Any person, not being an individual or a Hindu undivided family, who is responsible for paying to a resident any sum by way of—

(a)

fees for professional services, or

(b)

fees for technical services, or ………………. shall, at the time of credit of such sum to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct an amount equal to ten per cent of such sum as income-tax on income comprised therein: ………………………

Explanation.—For the purposes of this section,—

(a)

“professional services" means services rendered by a person in the course of carrying on legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or advertising or such other profession as is notified by the Board for the purposes of section 44AA or of this section;

(b)

"fees for technical services" shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9.” (emphasis supplied)

12.

ITAs No.600/Del/2020, 9832/Del/2019 & 2134/Del/2018 In this context we are of considered view that the controversy can be best resolved by reference to provision of law u/s 44AA of the Act, which mandates for maintenance of accounts by certain persons carrying on profession or business. The relevant sub-section (1) is reproduced below;

“44AA. (1) Every person carrying on legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or any other profession as is notified by the Board in the Official Gazette shall keep and maintain such books of account and other documents as may enable the Assessing Officer to compute his total income in accordance with the provisions of this Act.”

13.

Very apparently term ‘technical consultancy’ used in section 44AA of the Act has to be read ejusdem generis along with the words ‘professional’ activities based on certain skills acquired by study of particular domain of studies and which have some regulatory bodies to oversee the conduct of practitioner of the those skills and the same, very much distinguishes it, with generic term ‘technical services’, read ejusdem generis with managerial or consultancy services (including the provision of services of technical or other personnel), falling in category of FTS. Thus these afore-reproduced provisions of the Act, make it crystal clear that “professional services”, which includes legal services, is a separate category of services, recognized as distinct from FTS, which is primarily “managerial, technical or consultancy” services as referred to in section 9(1)(vii) of the Act, by the Legislature itself. If “FTS” as defined in Explanation 2 to section 9(1)(vii) were to include “professional services” as referred to in section 44AA, it would not have been necessary to refer to the latter specifically in Explanation (a) to section 194J of the Act, and Explanation (b) to that section would have been sufficient. xxxx

15.2

However, it is pertinent to note that section 40(a)(i) only provides for tax deduction in respect of payments made to non-resident of “fees for technical services or other sum chargeable under the Act” and accordingly, while the Explanation to that section provides the definition of “fees for technical services”, no mention is made about “fees for professional services”. It was submitted that the Legislature has deliberately not defined the expression “fees for professional services” in Explanation to section 40(a)(i) for the reason that payment of such nature being made to a non-resident does not accrue or arise in India or is not deemed to accrue or arise in India, in terms of section 5 or section 9 of the Act and therefore, the same is not covered within the expression “other sum chargeable under this Act” and no tax is required to be deducted on such payments being made to non-residents.

15.3

Aforesaid, establish unequivocally that the Legislature has notably and deliberately created two separate classes of income, viz., fee for technical services and fee for professional services. Whereas the former is defined in Explanation 2 to section 9(1)(vii), the latter draws its meaning from Explanation (a) to section 194J of the Act. Reliance in this regard is also placed on the decision in the case of NQA Quality Systems Registrar Ltd vs DCIT: 92 TTJ 946 (Del Trib.), wherein it was held as under:

“17………… There is a marked difference between fees for technical services and fees for professional services. Professional services are a category distinct from technical services. Even under the provisions of section 194J of the Act requiring deduction of tax at source, the definition of professional services includes the legal, medical, engineering, accountancy, technical consultancy and interior decoration, whereas the expression ‘fees for technical services as given in Expln. 2 to section 9(1)(vii) of the Act do not include within its fold the professional services as explained in section 194J of the Act…………” (emphasis supplied)

15.4

Similarly, the Mumbai bench of the Tribunal in the case of Deloitte Haskins & Sells v. ACIT:[2017] 184 TTJ 801 (Mum Trib.) observed as under:

“19.……………………………………………………………… ……………. Separate definitions of "professional services" and "technical services" under the Act inter alia indicates that the Statute makes clear distinction between these two terms. The term "profession" alludes to some kind of vocation or occupation which requires special, advanced education, knowledge or skill etc. A person professing any kind of profession requires extensive training and study and mastery of specialized knowledge. A professional person has to conduct himself within specified code of conduct or ethical conduct which is required from his field of profession like legal, medical, accountancy etc. In the case of rendering of technical services, the emphasis is more on giving services which are technical in nature and alludes to some kind of giving advice or consultancy in the field of technology or imparting of technical skills, knowledge, experience, know-how etc. Here 'consultancy' also means some kind of technical consultancy because it is preceded by the word 'technical'. The term 'managerial' is indicative of management of business or something like which is distinct from profession or rendering of professional services. Here in this case, professional services were rendered by DTT Canada in respect of providing information of the Global environment in dairy sector in respect of the markets, competition, regulations and other best practices followed by global players. Thus, the impugned payment cannot be reckoned as fees for rendering of technical services in terms of Section 9(1)(vii).”

16.

As contended by ld. Sr. counsel, it will not be out of place to consider that section 28 of the Act refers to the income head “profits and gains of business or profession”, which, too, demonstrates that profession is distinct from business. Even under the Double Taxation Avoidance Agreements which India has entered into with various countries, there are separate Articles/provisions relating to taxation of “Fee for Technical Services” and “Independent Personal Services” (“IPS”), like that of lawyer, doctors and other professionals and the special provisions relating to taxation of professionals, it is submitted, override the general provision relating to taxation of FTS.

17.

The reason for the aforesaid is also not far to seek. A professional’s services have geographical limitations regulated by certain statues, as in case of Lawyers, the Bar Council of India. Lawyer, registered as an Advocate can practice in Indian courts, but for representing Indian clients his qualifications as an Advocate may not be sufficient to represent the Indian client in courts or proceedings abroad. Thus here in the case in hand the recipients of the income were individual lawyers or law firms. They were only competent to practice in respective jurisdiction of which they were residents. Their services were vital for Indian clients for protecting their IPRs in foreign jurisdictions. The role of assesse was to engage with these non-resident lawyers and law firm and to work with them, in ensuring necessary compliances and following regulatory framework in those jurisdictions for protection of IPRs of Indian customers. The services so rendered may be technical in sense that it needs expertise but expertise alone is not sufficient to deliver these services before statutory and regulatory authorities or courts in foreign jurisdictions, the professional status these lawyers and law firms hold to represent clients, is the most vital element and make them only eligible to deliver the professional services, but that does not give rise to FTS.

17.1

Thus that justifies that under the domestic tax laws, e.g., under the Income-tax Act, 1961 and also under the respective DTAAs, professional services, as lawyers, are subjected to taxation in the country of residence of such professional service provider. It is supported by the contention of ld. Sr. Counsel that it is for that reason, under the Income-tax Act, 1961, while, payment made for professional services to residents is subjected to deduction of tax at source under section 194J of the Act, in case of non-residents, such payments are not regarded as income accruing or arising in India under section 9(1)(vii) of the Act and therefore, not subjected to tax withholding under section 195 of the Act.”

16.

The Tribunal after examining the provision of the Act with specific reference to section 194J of the Act, came to the conclusion that professional services and technical consultancy services are distinct. Similar view has been taken in the case of Chander Mohan Lall vs. ACIT (supra). In the said case the Tribunal held that payments for providing legal/professional services to non-residence are distinct from FTS as defined u/s.9(1)(vii) of the Act and the payments made to non-resident attorneys are not in the nature of FTS, hence, there was no obligation on the assessee to deduct tax at source on payment of legal professional service charges.

17.

Here it would be relevant to refer to the provisions of Article 13 of the India-UK DTAA, that deals with royalties and FTS. Clause 5 of said Article defines FTS. The definition of FTS specifically excludes payments to individuals or partnership firms for professional services covered under Article 15 such as services rendered by teachers, physicians, surgeons, layers, engineers, architects, dentists and accountants. The professional services rendered by above category of specialized professionals are distinct from services that form part of FTS. Similar professional services have been excluded from the preview of FTS/Royalty in the DTAAs with other countries viz. Belgium, Japan, Australia, etc. Hence, the services which are in the nature of professional services have been excluded from FTS. Ergo, the professional/legal services rendered by law, firms do not fall within the meaning of FTS. From perusal of Article 13 of India-UK DTAA and the aforesaid decisions of the Tribunal it is unambiguous that the payments made to the assessee for Indian engagements by no stretch can be brought under the definition of FTS u/s.9(1)(vii) of the Act. Since, UK partnership firm are tax transparent, the tax liability in the hand of each partner has to be examined. Accordingly, tax liability of each partner of the assessee firm has to be examined with reference to DTAA with country of their respective residence. In light of above findings, we deem it appropriate to restore this issue back to the AO to examine tax liability of non UK resident partners of the assessee firm with reference to the DTAA of the country of which they are resident. The addition made by AO u/s.9(1)(vii) of the Act is unsustainable, hence, the same is deleted. The facts germane to the issue in the impugned assessment year are identical, therefore, findings of the Tribunal in assessee’s case for AY 2015-16 in ITA No.2281/Del/2019 (supra) would mutatis mutandis apply to the impugned assessment year as well. Thus, for parity of reasons ground of appeal no. 2 is allowed for statistical purpose.