Recent Developments

The Companies Bill, 2011 has been introduced in the Lok Sabha. A copy of the bill is available here. Some aspects of the bill has been discussed here, here, here and here. The report of the parliamentary standing committee on finance which had carried out detailed deliberations on the Companies Bill, 2009 is available here.

SEBI has released a concept paper on regulation of investment advisors.As per the paper, the regulation intends to "regulate the activity of providing investment advisory services is various forms by a wide range of entities including independent financial advisors, banks, distributors, fund managers etc.".

On 12 October, 2011, the OECD's Centre for Tax Policy and Administration introduced a public discussion draft on proposed changes to the Commentary on Article 5 (Permanent Establishment) of the OECD Model Tax Convention. Public Comments are invited on the discussion draft before 10 February, 2012. 

The Force of Attraction principle

In an earlier post, Ankit had discussed on the findings of the ITAT in the Linklaters judgement on the application of the principle of territorial nexus and subsequently on extension of Treaty benefits to fiscally transparent entities. A third dimension to the judgement discusses the computation of profits attributable to a Permanent Establishment in consonance with the Force of attraction principle. The objective of this post is to understand the nature and recognition of this principle.

The underlying principle of the Force of Attraction rule envisages that when an entity has a Permanent establishment in another country, the host country will have the right to tax the PE for all its activities which take place either inside its territory or in other territories in so far as it is either directly or indirectly attributable to the P.E. In other words it expands the Source rule for taxability. Illustration- a Company X has a P.E in India which is involved with construction work. It undertakes a contract with a party outside India for undertaking a construction business. The profit which may generate from the contract is liable to be taxed in India on the basis of this principle.

Pertinent to note is the fact that this principle is amorphous in its applicability in the International platform. In this regard attention needs to be paid to two key points of debate. Firstly, most developed countries subscribe to the view that the principle is absurd as it unnecessarily expands the scope of taxation under the Source rule whereby it gives the right of taxation to a country which is not concerned with the activity undertaken by the P.E. The other point of contention being that there still exists a lacuna in so far as the existence of the P.E. is concerned to which the activity can be extended to. Thus most recent tax treaties have abandoned the use of this principle. On the flipside, the basic contention for upholding the principle is that the country in which the P.E is located provides an opportunity to the P.E to undertake transactions thereby creating a territorial nexus between the activities of the P.E and income generated. The principle has a varied applicability In the U.N Model Convention and the OECD Model Report. The OECD does away completely with the application of this principle whereas the U.N Model Convention allows for restrictive use of the principle. The Restrictive use of this principle under the Model Convention states that the rule will apply only to business profits and not to income from capital. To put it simply according to the U.N Model Convention( Article 7(b) and (c) ) the source country will have the right to tax the P.E. in so far as sales are made of goods or merchandise of the same or the similar kind as those sold through the P.E, irrespective of it being effected by the P.E. These will be deemed to have an economic nexus to the source country thereby making it taxable by the source country. A similar approach will be undertaken if the P.E is involved in other business activities and the same or similar activities are performed without any connection to the P.E.

The use of the principle has been undergoing a paradigm shift globally. However it is interesting to note that India has adhered to the use of the Force of Attraction rule in both its pure application as well as in its restrictive application. In the Roxon case, the AAR had the opportunity to discuss at length the application of the Force of Attraction rule in India. In a nutshell, it held that the basis of this principle was that the as long as a Permanent Establishment was not set-up in the source state, no right of taxation could be attributed to the same. Further the scope of the Indo- Finnish treaty is restricted to the sale of ‘same or similar’ goods. Only those sales of goods which are same or similar to the business of sale of goods by the P.E in India will be taxable in India. It can therefore be concluded that the treaty uses the restrictive rule of Force of Attraction. Concluding, only those business profits which have an economic nexus to the P.E in India will be taxable in India.

In the Linklaters judgment, the Force of attraction rule was strictly adhered to. Article 7 of the Indo-U.K tax treaty explicitly states that only profits of the enterprise which are directly or indirectly attributable to the P.E will be taxed by the source state. Therefore it can be inferred that the Indo-U.K treaty embodies the Force of Attraction principle and does not limit its applicability to the restrictive use of the aforementioned principle. In effect all the profits which are generated by the P.E irrespective of the service being rendered or utilised in another country, India being the host country will have a right to tax the P.E.

In today’s globalised economy, tax treaties do not subscribe to the principle of the Force of Attraction in its pure form as it has become increasingly difficult to justify its application. It would only result in unfair tax advantages to the source country which would thereby result in lowering investment for such countries which subscribe to an unrestricted use of this principle. In effect this principle tries to expand the principle of territorial nexus. Further there seems to be an inconsistency in its application in so far as its incorporation in tax treaties is concerned. Although countries have started adopting the restrictive use of this principle there still exists no threshold for determining under which circumstances can this principle be applied in its pure form or its restrictive form. This has led to countries applying the principle without any uniformity in different treaties. Ultimately what needs to be determined is whether the application of this principle in its pure form is justified and if not then whether there should be a uniform application of the two forms of this principle as adopted by a country.

Linklaters LLP: Territorial Nexus and International Tax Regime

In Ashapur Minichen ITAT Mumbai had confirmed that Ishikawajima-Harima ([2007] 288 ITR 408) does not continue to be good law in light of the retrospective amendment brought about by the Finance act, 2010.


In another case Linklaters LLP v. ITO the Mumbai ITAT has reiterated that the amendment made by the Finance Act, 2010 has negated the judgment in Ishikawajima. The important point though is that the court in Linklaters has stated that rendering of service in India is no more an essential ingredient for taxability of service in India u/s 9 of the IT Act, 1961. In other words the service can be taxed in India even if it is only “utilized” in India. However some of the observations in Linklaters can also be possibly interpreted to mean that “no territorial nexus” is required at all. For instance the court observes as under:

“It is fallacious to proceed on the basis that territorial nexus to a tax jurisdiction being sine qua non to taxability in that jurisdiction is a normal international practice in all tax systems”- Para. 17

“ ………in consonance with the school of thought discussed above and these amendment unambiguously negate the principle of territorial nexus which is the understructure of the line of reasoning adopted by the honorable courts above”- Para. 18

An interesting point that emerges is again with regard to India’s compliance with the international tax regime. In Ishikawajima Harima the court had noted that territorial nexus (utilized+ rendered) is a well accepted international tax principle. The court had further noted that “having regard to the internationally accepted principle and DTAA, no extended meaning can be given to the words ‘income deemed to accrue and arise’ in India. Considering this observation and the subsequent ruling in Linklaters where the court holds that Ishikawajima Harima is not good law, it is submitted that the impugned amendment in the Finance Act, 2010 is against well accepted international principles. However, this is subject to an investigation whether at the first place the concept of territorial nexus as suggested in Ishikawajima Harima (utilized+rendered) is indeed a well accepted international tax principle.
India’s compliance with the international tax regime has been a matter of previous discussion on this blog here. A further analysis of linklaters and Ashapur is available on the legal developments blog here and here.

International Tax Regime: Mihir's Comments

In my previous post I had briefly discussed the international tax regime and India's compliance. Subsequently Mihir had posted a very interesting and informative comment. For the benefit of the readers I reproduce the same as a post. Here is the comment:

"the Courts in India have noted the existence of 'international tax law' from time to time. For instance, in CIT v. Vishakapatnam Port Trust 144 ITR 146, the AP High Court observed as far back as in 1983, "In view of the standard O. E. C. D. models which are being used in various countries, a new area of genuine 'international tax law' is now in the process of developing"


However, most of the Indian judiciary's reliance on 'international tax law' is really more of a reliance on decisions of foreign courts. For instance, the Pune Bench of the Tribunal has observed in Daimler Chrysler, "Undoubtedly, judicial precedents from judicial bodies abroad cannot have any binding value, but these precedents surely deserve due and careful consideration. This is a truly two way traffic now and not only that Indian judicial forums are taking note of and following the judicial precedents abroad, even the foreign judicial bodies are taking due note of judicial precedents from India… On the subject of using foreign judgments to achieve uniformity of interpretation, Lord Denning, in the case of Corocraft, said: 'If such be the view of the American courts, we surely should take the same view. This convention should be given the same meaning throughout all the countries who were parties to it'… The importance of uniformity of interpretation of expressions which are used in global treaty networks can thus hardly be overemphasized"

Arguably, perhaps, the last sentence of the quote above refers to customary international law

International Tax Regime and India's Compliance

In this post I shall put forth some questions in regard to India’s compliance with the international tax regime. However before I proceed with any analysis three important questions needs to be addressed; firstly Is there any International tax regime, arguendo, does this regime qualify as international customary law and lastly if there exists a regime then what is the nature of such a regime.


These questions have been a matter of intense debate and controversy over the years amongst leading scholars and tax practitioners. One of the leading scholars H. David Rosenbloom relies heavily on the archaic state of cross border transactions (anecdotal evidence) to argue that international tax regime is an “imaginary” and “utopian” idea. He argues that due to the varying socio-economic situation of states, it is impossible to imagine that all states will adopt the same rules of taxation (See H. David Rosenbloom, International Tax Arbitrage and the “International Tax System,” 53 TAX L. REV. 137, 166 (2000); See also Nancy H. Kaufman, Fairness and the Taxation of International Income, 29 LAW & POL’Y INT’L BUS. 145, 148 n.23 (1998)). Per Contra, Reuven Yonah relies on experiences of various countries but primarily the United States to argue that indeed an “international tax regime” does exist ( Reuven S. Avi Yonah INTERNATIONAL TAX AS INTERNATIONAL LAW (Cambridge, 2007)). Let us assume for the purposes of this post that Reuven is correct.

Now, I shall move to the second question that I had outlined above i.e. does this regime qualify as international customary law. Simply put, an international rule qualifies as customary international law if the states practice the rule (state practice) and they do so under the notion of a legal obligation (opinio juris). Reuven agrues that international tax regime does indeed qualify to be customary international law. Reuven reasons that though the international tax regime is spread over myriad of bilateral treaties, they incorporate harmonized rules as they are based on primarily the UN or the OECD model tax treaty. To illustrate this Reuven investigates the rules relating to Jurisdiction to tax, non discrimination (Mihir’s article on this blog on non discrimination) and transfer pricing and concludes that these rules are primarily the same or atleast have the same underlining principles across all the bilateral tax treaties. Reuven also discusses some of the legislative and policy changes in the US and how the US found it difficult to adopt certain rules which were against basic international principles; hence recognizing the presence of a harmonized international tax regime.

But merely putting forth an argument that an international tax regime exists and it qualifies as customary international law is not enough. Having established both these points it is imperative now discuss the nature of international tax law. Reuven points out that the nature of the international tax regime is broadly based on two principles namely single tax principle and the benefits principle. Single tax principle postulates that an income should be taxed only once (no less and no more). In other words both double taxation and double nontaxation is undesirable under the international tax regime. On the other hand the benefits principle stipulates that the active income (business income) should be taxed at source and the passive income (investment income) should be taxed at residence.

In light of this background we need to ponder upon the question, whether India has complied with the above discussed international tax regime. Let us take a contemporary example to further discuss this issue. The first draft of the DTC proposed that in case of a conflict between the tax treaty and domestic tax law whichever came latter in time shall prevail (“latter in time” doctrine). This was a massive divergence from the current position under the income tax act, 1961 wherein in case of a conflict between the tax treaty and domestic law whichever is beneficial prevails. Although, the revised direct code proposes to restore the current position of law, it also stipulates that treaty provisions can be overridden in cases when the provisions relating to GAAR and CFC are invoked. The exceptions to when a treaty can be overridden are too wide (see the discussion on GAAR provisions here and here) and it is submitted that if that be the case then India certainly does not recognize any international tax regime, leave alone complying with the principles embodied therein. One may argue that the correction in the revised tax code i.e. the restoration of the “beneficial” doctrine was a manifestation of India recognizing its international obligation, but in my view the correction in the code was made based on pragmatic economic consideration (after the release of the first code it was feared that there would be a heavy outflow of foreign capital) and not on any international legal obligation.

Concluding, whether India has complied with the international tax regime (if there exists one) needs closer scrutiny. Nevertheless I have attempted to argue in the course of this post that there exists a prima facie case that India does not recognize any so called “international customary tax law”.