EY Tax Alert

26 March 2020 EY Tax Alert Madras High Court rules payment to foreign law firm in connection with acquisition of business abroad taxable as FTS, not eligible for source rule exclusion under domestic law Tax Alerts cover significant tax Executive summary news, developments and changes in legislation that affect Indian This Tax Alert summarizes a decision of the Madras High Court (HC), dated 13 March 2020, in the case of Shriram Capital Ltd. (Taxpayer)[1]. The issue adjudicated by the HC was businesses. They act as technical whether the payment made by the Taxpayer to a law firm in Indonesia (Indonesian Firm) for summaries to keep you on top of the purpose of acquisition of an insurance business in Indonesia, is taxable as “Fees for the latest tax issues. For more Technical Services” (FTS) under the Indian Tax Laws (ITL), as well as the India-Indonesia double taxation avoidance agreement (DTAA). information, please contact your EY advisor. [1] [TS-178-HC-2020(MAD)] The Taxpayer sought to claim source rule exclusion ► The Indonesian Firm provided services from under the ITL, as per which FTS paid by a resident to a Indonesia in relation to all regulatory and legal non-resident (NR) for earning a source of income compliances for the business acquisition, outside India, would not be taxable in India. In the illustratively, obtaining all necessary regulatory present case, FTS was paid for services procured for a approvals, services in relation to share purchase future business to be carried on by the Taxpayer agreement, notarial share transfer deed, powers of outside India and the same is not taxable in India. attorney, public announcements in respect of the acquisition, form in respect of share transfers, amended articles of association of the insurance The HC rejected the Taxpayer’s contention and held company etc. that the payments constituted FTS and the same are taxable in India under the ITL. As per the HC, the source of income of the Indonesian Firm is where the payer is located i.e., the Taxpayer and the services are also utilized in India. If the services were utilized by the Taxpayer abroad for a pre-existing business outside Indonesian India, the Taxpayer could have legitimately stated that Firm the service provided was utilized for a business or Services to profession carried out outside India or for the purpose of making or earning any income from any source from acquire business Payment outside India, which is not the case. in Indonesia of FTS Outside India India Background ► Under the ITL, an NR is taxable in India if income is I Co either received in India or accrues or arises in India or is deemed to accrue or arise in India. It also includes income in the nature of FTS when it is paid by an Indian resident. ► The ITL provides for a deeming source rule providing taxability condition for FTS income of an NR in India. As per the source rule, FTS paid by a resident to an NR is taxable in India if the services in respect of which the FTS is paid are utilized for the purpose of ► The Taxpayer filed an application with the Indian tax a business carried on in India or for earning income authorities to exempt withholding provisions on from any source in India. Conversely, where the payments made to the Indonesian Firm since such services are utilized for the purpose of business payment was not taxable in India. However, the said carried on outside India or for earning any income application was rejected. from any source outside India, FTS would not be taxable in India (“source rule exclusion”). ► Aggrieved, the Taxpayer filed a writ petition before the HC. ► FTS is defined in the ITL to mean any consideration paid for rendering service which is managerial, technical or consultancy in nature. Taxpayer’s contentions Facts ► The Taxpayer, an Indian company, availed services ► The services rendered by the Indonesian Firm were of the Indonesian Firm for acquiring an insurance neither technical nor consultancy in nature and, business in Indonesia. The Taxpayer did not have hence, not covered by the FTS provision of the any existing business in Indonesia. DTAA. ► Additionally, income had not been received in India by the Indonesian Firm. Furthermore, the income was not deemed to have accrued or arisen in India under the ITL, as the payment was made outside India and the services were provided and used outside India. HC’s ruling ► The income gets covered by the source rule exclusion under the ITL, as the payments were made The HC upheld the Tax Authority’s position that for the purpose of making or earning any income payment made to the Indonesian Firm would qualify as from a source outside India i.e., expenditure was FTS and the same would be taxable in India under the incurred for services procured for a future business ITL. This is based on the following: to be carried on by the Taxpayer outside India. Tax Authority’s contentions ► The term “technical, managerial[2] and consultancy services[3] ” as used in the FTS definition is of very wide import. Various meanings of the above term were noted, based on which, the services provided ► Services rendered by the Indonesian Firm were in by the Indonesian Firm were “consultancy” in the nature of consultancy services and payments nature. made for such services would qualify as FTS under the ITL, as well as the DTAA. ► Reference was made to the decision of the Supreme Court (SC) in the case of GVK industries Ltd. v. ITO[4] ► Neither the ITL nor the DTAA provides that services where, in the context of the FTS source rule, it was should only be rendered in India to be taxed in India. observed that the income of the recipient is charged FTS can be taxable in India irrespective of the place or chargeable in the country where the source of of rendition of the services. payment is located; to clarify, where the payer is located. Furthermore, it requires that the services ► Payment was not made to the Indonesian Firm for should be utilized in India. earning any income outside India. This is supported by the following: ► If the services were utilized by the Taxpayer abroad for a pre-existing business outside India, the ► Services of the Indonesian Firm were towards Taxpayer could have legitimately stated that the acquisition of a foreign business, which is a part of service provided was utilized for a business or the investment of the Taxpayer. Hence, the profession carried out outside India or for the payment does not have any nexus with the income purpose of making or earning any income from any earned abroad, but is towards investment which is source from outside India. In the present case, there a part of the business of the Taxpayer that it is no source existing in Indonesia. operated from India. ► The present case is of a mere proposal for acquiring a business and the said firm provided consultancy ► If the Taxpayer were to abandon the proposed services in this regard. acquisition of the insurance company in Indonesia after availing consultancy/advisory services, in such situation, the payments were not for the The DTAA referred before the HC was the one notified purpose of earning any income from outside India in 2016. As per the HC, the relevant DTAA, in the even on a future date. present case (depending on year of taxability), would be the DTAA notified in 1988. Since the same was not produced for the HC’s perusal, taxability under the ► The Taxpayer does not have any business activity in DTAA was not tested by it. Indonesia and, hence, the place of utilization of services is wholly in India where the Taxpayer is located. [2] The term “management” as defined in Black's Law Dictionary (10th ed.) published by Thomson Reuters and Oxford Advanced Learner's Dictionary, New 9th ed. [3] As defined in Oxford Advanced Learner's Dictionary, New 9th ed. [4] [(2015) 11 SCC 734] – Refer EY Alert “Constitutional bench of the Supreme Court adjudicates on law-making powers of the Indian parliament on ‘extra-territorial’ aspects of Indian tax law” dated 2 March 2011. C omments The present HC ruling interprets the scope of the FTS source rule exclusion i.e., services utilized for earning any income from a source outside India. The HC denies the benefit to FTS paid to a service provider for rendering services outside India for acquiring a new business outside India. As per the HC, a new business cannot be treated as a source and the source of income would be where the payer is located. It has rejected the contention that source includes future source of income. Furthermore, it has ruled that in the absence of any business outside India, the services are utilized by the payer in India only. It may be recollected that in the case of Havells India Ltd., the Delhi HC had explained that source of an income would be located where the activity giving rise to such income is fulfilled and where the legal contract for such activity is concluded. It is not located at the place of the payer of such income[5] . This HC ruling appears to accord strict application of the source rule exclusion. Taxpayers are required to assess the impact of this HC ruling on their current and future business arrangements. [5] Refer EY Alert “Delhi HC rules on ‘source’ of FTS paid in connection with export activity” dated 29 May 2012 Our offices Ahmedabad Ernst & Young LLP Hyderabad 22nd Floor, B Wing, Privilon, THE SKYVIEW 10 Ambli BRT Road, Behind Iskcon Temple, EY | Assurance | Tax | Transactions | Advisory 18th Floor, "Zone A" Off SG Highway, Survey No 83/1, Raidurgam Ahmedabad - 380 015 Tel: + 91 79 6608 3800 Hyderabad – 500032 About EY Tel: + 91 40 6736 2000 EY is a global leader in assurance, tax, transaction Bengaluru and advisory services.

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