Clifford Chance v. DCIT: Territorial nexus in international taxation

A recent decision of the Bombay High Court in Clifford Chance v. DCIT revisits interesting legal issues connected to the taxation of non-residents under Section 9 of the Income Tax Act, 1961. Section 9(1) deals with “income deemed to accrue or arise in India”. The relevant part of the Section read – prior to 2007 – as follows:

Section 9(1). The following incomes shall be deemed to accrue or arise in India:

…

(vii) income by way of fees for technical services payable by –

…

(c) a person who is a non-resident, where the fees are payable in respect of services utilized in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India…

This Section was interpreted in a relatively recent decision of the Supreme Court of India, Ishikawajima-Harima. There, the Apex Court held:

“Reading the provision in its plain sense, it can be seen that it requires two conditions to be met – the services which are the source of the income that is sought to be taxed, has to be rendered in India, as well as utilized in India, to be taxable in India. In the present case, both these conditions have not been satisfied simultaneously, therefore, excluding this income from the ambit of taxation in India. Thus, for a non-resident to be taxed on income for services, such a service needs to be rendered within India, and has to be part of a business or profession carried on by such person in India. The petitioners in the present case have provided services to persons resident in India, and though the same have been used here, they have not been rendered in India.”

Thus under Ishikawajima, it was not the mere place where a service was utilized which was determinative of the taxability of the fees received in lieu of the service. For the fees to be taxable, the services rendered to non-residents must have been both rendered in India and utilized in India. In effect, a territorial nexus requirement was sought to be established before the income would come within the purview of the Indian tax net.

Following this decision, the Finance Act 2007 inserted a retrospective amendment which provided:

Explanation. For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India.

A Memorandum explaining the rationale behind the amendment made it clear that the legislative intent behind the provisions was to clarify that the requirement of territorial nexus was irrelevant under clauses (v), (vi) and (vii) of Section 9(1). In considering the effect of this amendment, the Bombay High Court in November 2008 in the case of CIT v. Siemens held that the ratio of Ishikawajima was overcome by the amendment.

The decision in Clifford Chance (decided in December 2008) seems to throw doubt on this latest proposition.

Clifford Chance – a leading UK-based law firm – had provided certain advisory services for certain resident and non-resident clients who were engaged in certain projects in India. The firm had separately billed its clients for the work it had done in India and the work done outside India. The issue was whether the whole of the fees received for the services were chargeable in India, or whether only that part of the fees which was received for the services rendered in India was chargeable to tax in India. Under the law as laid down in Ishikawajima, although the service was utilized in India, part of it was not rendered in India and was therefore not chargeable to tax in India. The Department contended (following the line seemingly adopted in Siemens, although not specifically citing that case) that the ratio of Ishikawajima must be considered as having been overruled. Therefore, only the place where the service was utilized would be relevant, not the place where it was rendered. The non-residents by whom the fees were payable were clearly using the services in India – as such, the fees should have been taxable.

However, the Court relied on Ishikawajima and held that the fees would be taxable only where the service was both utilized and rendered in India. Surprisingly, the Court did not cite Siemens at all (perhaps the arguments in the case were concluded before the decision in Siemens). Furthermore, although the Revenue’s contention (that the 2007 amendment nullified the effect of the Apex Court decision) was noted, the Court did not substantively address this contention except for noting that the provisions of Section 9 were clear and unambiguous.

The Court’s decision may perhaps be read in two ways. The Court might have intended to say that under principles of statutory interpretation, an explanation cannot curtail the clear scope of a section. This reading appears to be a difficult one to sustain on the wording of the particular Section or on the basis of legislative intent.

Alternatively, the Court’s decision may be explained by arguing that the explanation does away only with “residence or place of business or business connection in India”, and not with all the requirements of territorial nexus. Thus, while the nexus need not be as deep as “residence or place of business or business connection in India”, it was still essential that the services should be rendered in India. Thus, the explanation only intended to avoid a strong nexus, but did not entirely do away with nexus.This approach would require a differentiation between rendering services in India and maintaining a business connection in India, and would also require Siemens to be adequately distinguished.

The former should not be too difficult a task. The leading decision on the concept of business connection under the Income Tax Act, CIT v. R.D. Aggarwal (AIR 1965 SC 1526), notes that a business connection “involves a relation between a business carried on by a non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in the taxable territories.” Mere rendering of services, it appears, will not lead to a conclusion of the existence of business connection. On the issue of reconciliation with Siemens, it is possible to contend that what that case actually held in its factual context is that in the post-amendment scenario, it was not necessary for the assessee to have a PE or a business connection. On its facts, however, Siemens was decided in favour of the assessee on the ground that the assessee was entitled to relief under the relevant DTAA in that case. Thus, the interpretation of Section 9 was not actually in question in that case, and the statement that Ishikawajima’s ratio was overturned by the amendment was only tentative statement and not a reasoned conclusion.

Although the purpose behind the 2007 amendment might well have been to get over Ishikawajima, the decision in Clifford Chance shows that this purpose has not actually been achieved by the wording of the explanation. Ishikawajima continues to be good law on the issue, subject to the fact that the territorial nexus requirement need not be as deep as “residence or place of business or business connection in India.” Nonetheless, mere use of services in India will not attract Section 9; the services should be both used and rendered in India.