Under OECD Model Tax Convention (‘MTC’), income from professional services was taxed in terms of Article 14 titled ‘Independent Personal Services’ (‘IPS’). However, Article 14 was deleted from the OECD MTC with effect from 29th April 2000 and the taxation of income from professional services was brought at par with taxation of business profits as provided in Article 7 of OECD MTC [see Endnote 1]. Even after its deletion from OECD MTC, Article 14 continues to find place in UN MTC and the tax treaties entered by India.
It has always been a dispute internationally as to whether Article 14 applies only to natural persons (individuals) or even to artificial persons (like partnership firms, companies, etc.). Countries have adopted different position on this issue. While Mexico and Turkey share the view that Article 14 should apply to artificial persons as well, it was explained in commentary to US MTC that the scope of Article 14 (as it existed before its deletion from US MTC) is restricted to individuals alone.
In order to better appreciate the scope of Article 14, it is necessary to first discuss the scope of professional/technical services.
Taxation of income of non-resident from professional services
Under Income-tax Act, 1961 (‘IT Act’), the consideration received by a non-resident in the form of ‘fee for technical services’ (‘FTS’) is taxable in India. As per the IT Act, the term FTS has been defined to mean consideration for rendering any managerial, technical or consultancy service [see Endnote 2]. As observed by Supreme Court [see Endnote 3], the definition of FTS is wide enough to encompass the professional income within its ambit. Therefore, as per the IT Act, the income earned by a non-resident from provision of professional services in India should be exigible to tax in India.
In most of the tax treaties entered by India, there is an article relating to taxation of FTS wherein the source state is given a right to tax income from FTS. Moreover, IPS is excluded from the scope of FTS in these treaties to avoid overlapping between taxation of IPS and FTS.
Therefore, if one were to conclude that Article 14 is not applicable to an artificial person, the professional income of such person will fall within the scope of ‘FTS’ and the same would be taxable in the source country. Let us now examine the provisions relating to IPS in the treaties entered into by India.
Provisions of IPS in treaties entered by India
As per the tax treaties entered by India, the source state gets the right to tax professional income only if such income is earned through a fixed base or in some cases, if the period of stay of service provider exceeds 183 days. While there is consistency in these criteria, there is a contrast in terms of person covered by the article. Certain treaties (for example Article 15 of India-Denmark DTAA) specifically provide that the provisions relating to IPS are applicable to an individual and there are other treaties (for example Article 14 of India-UK DTAA) wherein the provisions have been extended to Individual and partnerships. Therefore, in these cases, wherein the scope of provisions has been specifically curtailed by the contracting parties to certain categories of tax payers, there is no room for ambiguity.
However, in many treaties entered by India the provisions relating to IPS applies to ‘resident’ of a contracting state. The question is whether the term “resident” can cover both natural as well as artificial persons.
Commentaries on the scope of IPS
While the commentary on Article 14 in OECD MTC did not directly deal with the scope of provisions relating to IPS, the Commentary on Article 14 in UN MTC provided that the payment made to artificial person was not covered within Article 14 [see Endnote 4]. However, the commentary also states that the contracting parties are open to provide any further clarification in this regard.
Further, as noted by the working group of OECD [see Endnote 5], the understanding stated in UN MTC can be attributed to the 183 day rule in the UN MTC which was not present in OECD MTC. Thus, if one were to rely on this understanding alone, it can be interpreted that in treaties where India has agreed to the 183 days rule, the reference to resident of contracting state, should be understood to apply only to individuals. But the number of days rule test is also present in Article 5 (relating to permanent establishment) of tax treaties and applies to both natural and artificial person. Thus, if the interpretation of working group of OECD is accepted for Article 14, such interpretation should also apply to Article 5, which will vitiate the already settled and followed practise of application of Article 5 to natural and artificial persons. Therefore, the comments in commentary to UN MTC and working group of OECD do not seem to clear the ambiguity surrounding the issue.
It is pertinent to mention that the working group of OECD did conclude [see Endnote 6] that there is no justification for imposing different rules to services depending on whether they were provided by a company or an individual.
Significantly, Prof. Klaus Vogel [see Endnote 7] has cited OECD and UN MC to opine that companies and other artificial persons are also capable of deriving income from professional services and should be covered within the Article 14. On the other hand, Philip Baker [see Endnote 8] has cited the judgment of German Bundesfinanzhof [see Endnote 9] to the effect that companies cannot perform personal services.
Therefore, different authors and Courts have expressed a divergent view on this issue. Though a part of the conflict can be attributed to the difference in how the Article 14 in worded in OECD and UN MTC, a major part of conflict seems to be pure difference in interpretation.
Judicial Precedents in India
The issue regarding scope of Article 14 has been subject to judicial scrutiny in India. The ITAT [see Endnote 10], had held that the use of the word ‘his’ in the article implies that the provisions relating to IPS are applicable to an individual alone.
It is apposite to mention that in the aforesaid case, the Bench was interpreting the erstwhile India-Denmark DTAA and the Para 1 of Article XIV (relating IPS) of then India-Denmark DTAA which specifically provided that the provisions of DTAA are applicable to an ‘individual’. Therefore, it can be argued that the aforesaid interpretation cannot be supplied to a case where the contracting parties have agreed to extend the scope of the article to the ‘resident of a contracting state’.
Further, it may also be appreciated that Para 1 Article 4 of DTAA refer a resident as ‘his’. If the interpretation of Mumbai Bench of ITAT is accepted, then an artificial person may never be covered in the DTAA, which is clearly not the intention of contracting parties considering the fact that the para 3 of Article 4 clearly refers to persons other than individuals. Therefore, the use of the word ‘his’ in Article 14 need not be seen as an intent of the contracting parties to restrict the scope of article to individuals.
It is also worth discussing the findings of Hon’ble High Court of Delhi [see Endnote 11] wherein the Court while interpreting the provisions of section 194J of the IT Act held that the provisions of section 194J of the IT Act mandate that tax has to be deducted at source on payment of income in the nature ‘professional services’ to a person. The Court emphasised on the fact that the ‘person’ is wide enough to cover an artificial person and that the professional services cannot be restricted an individual providing such services in the course of carrying his profession. The aforesaid understanding was also upheld by Bombay High Court [see Endnote 12]. The provisions of section 194J of the IT Act are pari-materia with Article 15 of India-Spain DTAA, in as much as, in both cases, the underlying services are professional services and taxpayers covered are artificial as well as natural persons. Therefore, the judicial authorities in India seem to accept the fact that the professional services can be provided by artificial person as well.
Internationally, it is very common for professionals to incorporate themselves into an entity, rather than practicing as individuals. In many cases, the incorporated professional entities provide consultancy, registration, certification and similar services to Indian residents. Owing to divergent views on the scope of Article 14, both domestically and internationally, it is likely that these entities may end up facing litigation wherein the tax authorities will contest that the income earned by such entity is taxable as FTS and the tax payer may want to claim benefit of Article relating to IPS. Therefore, it is important that the tax implications on these transactions are planned in advance to avoid subsequent litigation and surprises.