Fees for Technical Services – Ashapura Minechem

We have discussed at length the controversy last year over taxation of fees for technical services. In brief, the Supreme Court had taken the view in Ishikawajma that s. 9(1)(vii) of the Income Tax Act, 1961 applies only when services by a non-resident are both rendered and utilized in India. This appeared inconsistent with the plain text of the provision, and with a subsequent Explanation inserted by the Finance Act, 2008. However, the Explanation was not sufficiently unambiguous to conclude the matter, and High Courts and Tribunals across the country differed on whether it had the effect of nullifying Ishikawajma. The 2010 Finance Act seemed to have finally put the matter to rest, by providing expressly that s. 9(1)(vii) applies even when services are not rendered in India.

Recently, the first opportunity to test the scope of the new Explanation arose before the Mumbai ITAT, in Ashapura Minechem v. ADIT. Ashapura Minechem entered into an agreement with a Chinese company – China Aluminum International Engineering Corp Ltd [“CAIEL”] – whereby it agreed to pay a fee of $1 million in consideration for bauxite testing services performed by CAIEL. Ashapura Minechem contended that it was not liable to deduct tax at source under s. 195, because the principal sum of $1 million was not exigible to tax under s. 9(1)(vii). For this proposition, Ashapura relied principally on the decisions in Ishikawajma and Clifford Chance. Ashapura also argued, in the alternative, that the sum did not qualify for taxation under Art. 12 of the Indo-China Double Taxation Avoidance Agreement [“DTAA”].

The Tribunal correctly rejected the submission that Ishikawajma continues to be good law. Noting that the retrospective amendment inserted by the 2010 Finance Act is free from any ambiguity, the Tribunal held that the law in India is that fees for technical services paid to a non-resident are taxable when those services are utilized in India, regardless of where they are rendered. The Tribunal clearly demonstrated that this is not inconsistent with the principle of “territorial nexus”, observing that there are broadly three models of taxation of non-residents – “territorial tax systems”, such as France, Belgium and the Netherlands, where tax liability is fastened only on income earned within the borders of that country; “source” taxation, where the source of income is located within the country levying tax, and “residence” taxation, where the taxpayer is resident in the country levying tax. Most countries follow a combination of source and residence taxation, and the ensuing conflict is sought to be resolved internationally by a network of bilateral agreements, known as Double Taxation Avoidance Agreements or DTAAs. In the absence of such a treaty, there is nothing to prevent both countries from taxing the same transaction, and no legal principle is available to a taxpayer to challenge such a levy. Thus, as the Tribunal noted:

It is thus fallacious to proceed on the basis that territorial nexus to a tax jurisdiction being sine qua non to taxability in a jurisdiction is a normal international practice in all systems. This school of thought is now specifically supported by the retrospective amendment to section 9.

The second contention that Ashapura Minechem raised was far closer, and raised an interesting question as to whether Indo-Sino treaties treat fees for technical services differently. Art. 12(4) of the Indo-China DTAA defines “fees for technical services” as “any payment for the provision of services of managerial, technical or consultancy nature by a resident of a Contracting State in the other Contracting State…” [emphasis mine] Art. 12(6), the deeming provision, provides that “royalties or fees for technical services shall be deemed to arise in a Contracting State when the payer is … a resident of that Contracting State.” Ashapura argued that Art. 12(4) is a peculiar provision that applies only when services are both rendered and utilized in India, and based this submission on the expression “provision of services… in the other Contracting State”. It contrasted this with other treaties that omit a deeming provision for fees for technical services. The Tribunal rejected this submission by noting that such transactions are in any case taxable under Art. 12(6) and noted that Ashapura’s view of Art. 12(4) would render Art. 12(6) meaningless, for every transaction to which it could conceivably apply would be covered by Art. 12(4).

In sum, the controversy over taxation of non-residents for fees for technical services appears to have been finally settled.