Linklaters: Fiscally Transparent Entities

In my previous post I had discussed one of the findings in Linklaters (one relating to S. 9 and territorial nexus). In this post I shall discuss the finding in linklaters with regard to treaty benefits extended to fiscally transparent entities. The case is extremely important in this respect due to the absence of any specific adjudication on this point in India and very few in other jurisdictions.


The fundamental question before the tribunal was whether the partnership firm (linklaters LLP) which is treated as a fiscally transparent entity in the UK but is taxable as a separate entity in India under the Income Tax Act, 1961 eligible for the India UK treaty benefits. Before discussing the findings of the tribunal it is important to briefly elucidate on why this issue had arisen at the first place. Art. 1(1) of the India UK treaty stipulates that the convention shall apply to “persons who are resident of one or both the contracting states”. Further, Art 3(2) stipulates that a “partnership firm” which is a taxable unit in India shall be “treated as a person” for the purposes of the India UK treaty. It is very clear from the aforementioned provisions that a partnership firm is treated as a person under the impugned treaty. Thus, the only point that needs to be established for a partnership firm to avail treaty benefits is to essentially show that it is a resident of atleast one of the contracting states. For this purpose Art. 4(1) is important and it reads as under:

For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.

On the basis of this provision the question that the tribunal had to address inorder to answer the larger question of treaty benefits was whether Linklaters meets the test embodied under art.4(1) of the treaty. The tribunal answering in favour of the assesse held that fiscally transparent entities or specifically partnership firms are entitled to treaty benefits. In reaching this conclusion the tribunal adopted two distinct lines of reasoning.

The first line of reasoning was primarily based on the contextual interpretation of art.4(1) of the treaty. The tribunal after citing several authorities on the interpretation of tax treaties stated that if the literal interpretation of a provision in a treaty leads to unreasonable results, the courts or tribunals should resort to contextual interpretation. In this case if art. 4(1) was to be interpreted literally then linklaters would not have qualified as a resident of UK as the income of the firm was taxed at the hands of the firm and the firm was not taxed per se in the UK (resident country). This interpretation in the tribunal’s opinion and correctly so would have been unreasonable as even though there would be no juridical double taxation (same entity taxed twice), there would in substance be an economic double taxation (same income taxed twice). As a result the tribunal adopted a contextual reading of art.4(1) and held that test embodied under the said article was that the “income of the person should be subjected to residence based taxation on account of some locality related attachment” in that contracting state. The following observations are apposite:

“Viewed in the light of the detailed analysis above, in our considered view, it is the fact of taxability of entire income of the person in the residence state, rather than the mode of taxability there, which should govern whether or not the source country should extend treaty entitlement with the contracting state in which that person has fiscal domicile. In effect thus, even when a partnership firm is taxable in respect of its profits not in its own right but in the hands of the partners, as long as entire income of the partnership firm is taxed in the residence country, treaty benefits cannot be declined.”

The second line of reasoning adopted by the tribunal proceeded on the premise that the actual payment of tax in one of the contracting states is not a condition precedent to avail the benefits of the tax treaty in the other contracting state. In light of this principle the tribunal held that the test laid down under art.4(1) is embodied to ascertain the fiscal domicile of an person (see heading to art.4), hence it is sufficient to show that the resident state has a right to tax the income of the partnership firm irrespective of the fact whether such a right is exercised by the resident state. The following observations are apposite in this regard:

“In our humble understanding, as long as de facto entire income of the enterprise or the person is subjected to tax in that tax jurisdiction, whether directly or indirectly, the taxability test must be held to have been satisfied. Of course, the other possible approach to such a situation is that as long as the tax jurisdiction has the right to tax the entire income of the person resident there, whether or not such a right is exercised, the test of fiscal domicile should be satisfied.”

In my view though the final conclusion reached by the tribunal on this point seems to be correct and will surely encourage professional services, the second line of reasoning requires further investigation as it is against the OECD report on partnerships.