The
entitlement of partnerships to the benefits of a double taxation avoidance
agreement [“DTAA”] is a contentious
issue. The main reason is asymmetry in the manner in which partnership income
is taxed in the two Contracting States – India, for example, in certain
circumstances taxes the income of a partnership in the partnership’s hands, but
the Contracting State with which it has a DTAA (for example the UK) may tax such
income in the hands of the partner directly, treating the partnership as “fiscally transparent”. In such cases, it
is possible that the entity assessed in the UK does not qualify as a “person”
or a “resident” under (typically) articles 3 and 4 of the DTAA. A consequence
of this is that the income of a partnership from the same transaction may be
taxed in the United Kingdom (in the hands of its partners) and in India (in the
hands of the partnership), India taking the view that those “liable to tax” in the UK are not
assessed in India, and those who are assessed in India are not liable to tax in
the UK.
entitlement of partnerships to the benefits of a double taxation avoidance
agreement [“DTAA”] is a contentious
issue. The main reason is asymmetry in the manner in which partnership income
is taxed in the two Contracting States – India, for example, in certain
circumstances taxes the income of a partnership in the partnership’s hands, but
the Contracting State with which it has a DTAA (for example the UK) may tax such
income in the hands of the partner directly, treating the partnership as “fiscally transparent”. In such cases, it
is possible that the entity assessed in the UK does not qualify as a “person”
or a “resident” under (typically) articles 3 and 4 of the DTAA. A consequence
of this is that the income of a partnership from the same transaction may be
taxed in the United Kingdom (in the hands of its partners) and in India (in the
hands of the partnership), India taking the view that those “liable to tax” in the UK are not
assessed in India, and those who are assessed in India are not liable to tax in
the UK.
The
question whether a partnership firm is a “resident” is a more complex issue
than whether it is a “person”. In general, there are two approaches to this
problem. The OECD’s view is that a partnership is not a resident under article 4 if it is treated as transparent in
the State of residence, but that the source State (India, in our example) must
extend the benefit of the treaty to the individual partners, in respect of
their share of the partnership income. In the leading Indian decision on the
point, Linklaters v ITO, this
solution has been rejected. In an elaborate judgment that repays study on a
number of important questions of international tax law, Pramod Kumar, AM gave
two reasons for the conclusion that the partnership firm is itself entitled to
the benefit of the treaty. The first was that it is the fact of taxation that is significant, and not its mode, and that if the “entire income” of
the firm is taxed in the hands of its partners, the firm is itself a “resident”
under article 4. The second was that India defines “liable to tax” more widely than does the OECD, which (virtually)
makes fiscal transparency a non-issue. This, of course, is because the Supreme
Court, in Azadi Bachao Andolan, held
that the words “liable to tax” “by reason of domicile…” refer to the right of a State to tax a person on
those yardsticks (as Pramod Kumar, AM, has put it in a subsequent case, a “locality-related attachment”). Whether
the State exercises the right or not is irrelevant, as is the fact that the
assessee is not even a taxable entity in
the other Contracting State. While the view the AAR took in Cyril Eugene Pereira was incorrect, the
Supreme Court’s approach goes further than the generally accepted international
view (see, for example, Mr Baker QC’s Commentary at ¶4B.06). In Linklaters,
the Tribunal held that the UK partnership, on this view of “liable to tax”, was a UK resident and
entitled to the benefit of the treaty.
question whether a partnership firm is a “resident” is a more complex issue
than whether it is a “person”. In general, there are two approaches to this
problem. The OECD’s view is that a partnership is not a resident under article 4 if it is treated as transparent in
the State of residence, but that the source State (India, in our example) must
extend the benefit of the treaty to the individual partners, in respect of
their share of the partnership income. In the leading Indian decision on the
point, Linklaters v ITO, this
solution has been rejected. In an elaborate judgment that repays study on a
number of important questions of international tax law, Pramod Kumar, AM gave
two reasons for the conclusion that the partnership firm is itself entitled to
the benefit of the treaty. The first was that it is the fact of taxation that is significant, and not its mode, and that if the “entire income” of
the firm is taxed in the hands of its partners, the firm is itself a “resident”
under article 4. The second was that India defines “liable to tax” more widely than does the OECD, which (virtually)
makes fiscal transparency a non-issue. This, of course, is because the Supreme
Court, in Azadi Bachao Andolan, held
that the words “liable to tax” “by reason of domicile…” refer to the right of a State to tax a person on
those yardsticks (as Pramod Kumar, AM, has put it in a subsequent case, a “locality-related attachment”). Whether
the State exercises the right or not is irrelevant, as is the fact that the
assessee is not even a taxable entity in
the other Contracting State. While the view the AAR took in Cyril Eugene Pereira was incorrect, the
Supreme Court’s approach goes further than the generally accepted international
view (see, for example, Mr Baker QC’s Commentary at ¶4B.06). In Linklaters,
the Tribunal held that the UK partnership, on this view of “liable to tax”, was a UK resident and
entitled to the benefit of the treaty.
Significantly,
the question whether a partnership is a “person”
for the purposes of a treaty did not arise in Linklaters, because of specific provisions in the India-UK treaty. In
a ruling given earlier this week in Schellenberg
Wittmer, the Authority for Advance Rulings has held that a Swiss partnership
firm which was engaged by an Indian party in relation to a foreign arbitration
was not entitled to invoke the India-Switzerland DTAA, because it is not a “person”.
The definition of “person” in the Swiss treaty is:
the question whether a partnership is a “person”
for the purposes of a treaty did not arise in Linklaters, because of specific provisions in the India-UK treaty. In
a ruling given earlier this week in Schellenberg
Wittmer, the Authority for Advance Rulings has held that a Swiss partnership
firm which was engaged by an Indian party in relation to a foreign arbitration
was not entitled to invoke the India-Switzerland DTAA, because it is not a “person”.
The definition of “person” in the Swiss treaty is:
(d) the term “person” includes an individual, a
company, a body of persons, or any other entity which is taxable under the laws
in force in either Contracting State;
company, a body of persons, or any other entity which is taxable under the laws
in force in either Contracting State;
The
AAR held that a partnership, which was treated as transparent under Swiss
domestic law, is not a “person” because it is not “taxable under the laws in force in either Contracting
State (Switzerland)”. Unfortunately, the AAR, with respect, appears to have overlooked one
point: that the words “which is taxable
under the laws in force…” qualify the words “or any other entity” but
not the words “individual,
company, a body of persons”. There are two reasons in support of this
construction: (i) that there is no “comma”
after the words “other entity”, and the word “which” is used to describe the class to which the following words
were intended to apply; and (ii) the
words “other entity” imply
that “individual, company, a body of persons” are deemed to be entities, perhaps
on the assumption that these entities are taxable under the laws in force in
the Contracting States. If this were not the case, the treaty would not use the
word “other”, and there is no room for applying an independent taxability
analysis to the three designated entities.
AAR held that a partnership, which was treated as transparent under Swiss
domestic law, is not a “person” because it is not “taxable under the laws in force in either Contracting
State (Switzerland)”. Unfortunately, the AAR, with respect, appears to have overlooked one
point: that the words “which is taxable
under the laws in force…” qualify the words “or any other entity” but
not the words “individual,
company, a body of persons”. There are two reasons in support of this
construction: (i) that there is no “comma”
after the words “other entity”, and the word “which” is used to describe the class to which the following words
were intended to apply; and (ii) the
words “other entity” imply
that “individual, company, a body of persons” are deemed to be entities, perhaps
on the assumption that these entities are taxable under the laws in force in
the Contracting States. If this were not the case, the treaty would not use the
word “other”, and there is no room for applying an independent taxability
analysis to the three designated entities.
The
AAR also rejected the alternative argument (based on the OECD Model) that the partners are entitled to invoke the
Swiss treaty if a “partnership” is not considered a “person”, for the reason
that India has entered a reservation, and because what India seeks to tax is
not the income the partner derives from the partnership, but the income the
partnership derives from India. With respect, the second reason does not appear
to be correct, because the rationale for the OECD’s view is that the source
State must take into account the residence State’s characterisation of a
partnership – if the partnership is transparent, there is no distinction
between the income of the firm and the income derived by the partners from the
firm. The AAR would also have had to consider whether this reasoning is
consistent with the Supreme Court’s approach to “liable to tax”, since there was a finding in this case that the
individual partners were also residents
of Switzerland.
AAR also rejected the alternative argument (based on the OECD Model) that the partners are entitled to invoke the
Swiss treaty if a “partnership” is not considered a “person”, for the reason
that India has entered a reservation, and because what India seeks to tax is
not the income the partner derives from the partnership, but the income the
partnership derives from India. With respect, the second reason does not appear
to be correct, because the rationale for the OECD’s view is that the source
State must take into account the residence State’s characterisation of a
partnership – if the partnership is transparent, there is no distinction
between the income of the firm and the income derived by the partners from the
firm. The AAR would also have had to consider whether this reasoning is
consistent with the Supreme Court’s approach to “liable to tax”, since there was a finding in this case that the
individual partners were also residents
of Switzerland.
Ultimately,
two questions arise when any court or tribunal asked to decide whether a
partnership is entitled to the benefit of a DTAA is this:
two questions arise when any court or tribunal asked to decide whether a
partnership is entitled to the benefit of a DTAA is this:
- Is
the definition of “person” in the treaty in question qualified by a residence
taxability condition as to both “body of persons” and the residuary class? If the
answer is in the negative, the partnership is a “person”. - Is
the partnership “liable to tax”
under article 4? The answer, applying Azadi
Bachao Andolan, is that it always is (as the Tribunal points out in Linklaters, though it may be that
the Supreme Court perhaps did not envisage this consequence of its “liable to tax” analysis when it
decided Azadi). If Azadi is distinguished on this
ground, the question is whether the treaty applies to the partnership
because of the fact/mode analysis, or to the individual partners.
Thanks for the update.
With reference to my article titled "Applicability of Double Taxation Avoidance Agreements to Fiscally Transparent Entities: An Indian Perspective" INTERTAX,Volume 39, Issue 11, please give your views on the following two aspects:
1. Do you believe the Linklaters Judgment is consistent with the judgment of the Hon'ble Supreme Court in the case of Azadi Bachao Andolan.
2. From a strategic point of view, do you think India as a country should allow treaty benefits to fiscally transparent entities in absence of special provision to that effect as is given in Indo-US DTAA. Please consider that OECD itself is of opinion that fiscally transparent entities would not be entitled to the treaty benefits. (Reference to the old OECD commentaries is required as India has made a reservation to the changes made in the New OECD Commentary.)
Please let me know if you do not have access to article. ([email protected])