Global Tax Alert | 15 November 2013
India's Mumbai Tribunal rules on eligibility of a Danish fiscally transparent partnership for tax treaty benefits
This Tax Alert summarizes a recent ruling of India’s Mumbai Income Tax Appellate Tribunal (Tribunal) in the case of M/s A.P. Moller1 (Taxpayer), a fiscally transparent partnership established under Danish law. One of the issues before the Tribunal was the eligibility of the fiscally transparent entity for benefits of the India-Denmark Double Taxation Avoidance Agreement (treaty). According to the Tribunal, once the income of a partnership is taxed in Denmark, irrespective of the fact that the same is taxed in the hands of the partners, the entity should be treated as a resident of Denmark and, thereby, entitled to benefits of the treaty. The Tribunal, thereafter, held that the shipping income arising from the activity of the “managing owner” performed by the Taxpayer should be taxed in the hands of the shipping companies and not the Taxpayer. The shipping companies, being Danish tax residents, were not taxable in India under the treaty on income earned from international shipping operations. The management fees earned by the Taxpayer, as the managing owner of the businesses of the shipping companies, was also not taxable in India in the absence of a permanent establishment (PE) of the Taxpayer in India.
The Taxpayer is a partnership firm established under the laws of Denmark. As per the tax laws of Denmark, the partnership firm is regarded as a fiscally transparent entity. It is not taxed at the entity level but its partners are taxed on the income earned by the partnership firm.
The Taxpayer is the “managing owner” of two shipping companies incorporated under Danish law and listed on the Copenhagen stock exchange. The shipping business and the vessels belong to these two companies which are engaged in the shipping business in international traffic at the global level. These companies are tax residents of Denmark and also have their place of effective management (POEM) in Denmark.
Management of the entire business operation is carried out by the Taxpayer as the representative of these two companies from Denmark. The Taxpayer earns “management fees,” determined on the basis of the carrying capacity of the ships per annum.
As per Article 9 of the treaty, profits derived from the operation of ships in international traffic are taxable only in the country in which the POEM of the enterprise is situated.
The Taxpayer had filed two separate sets of return of income in India. One for management fees received by it and another in the name of these two companies showing the gross receipts from the shipping income on which benefit of non-taxation has been claimed under Article 9 of the treaty.
The Tax Authority contended that management fees, as well as income from the shipping business, is taxable in the hands of the Taxpayer as there is no difference between these entities and the Taxpayer which was acting as the former’s beneficial owner. Since the Taxpayer is a fiscally transparent entity, the treaty benefits are not available to it.
The Taxpayer appealed to the Tribunal after the First Appellate Authority ruled in favor of the Tax Authority.
Whether shipping income can be taxed in the hands of the Taxpayer
As per the Articles of Association, the Taxpayer acts as a representative of the two companies and, in that capacity, it acts and carries out obligations on behalf of the two companies and also files corporate tax return in India on their behalf. Also, the relevant documents such as port clearance certificate, bill of lading, freight receipts and tax residency certificates issued indicate that the Taxpayer is merely managing the business on behalf of these two companies. Thus, the shipping income belongs to these companies only and not to the Taxpayer.
Accordingly, exclusion from taxation in India on the shipping income, as per Article 9 of the treaty, was upheld in the hands of the two Danish companies.
Whether Taxpayer is entitled to claim the Danish DTAA benefits
A person who is a resident of a contracting state is entitled to treaty benefits if the person is liable to tax in that state. As per Danish laws, the partnership firm, as such, is not taxable. However, the entire income of the partnership firm is taxed in the hands of its partners and, therefore, the entire income earned by the partnership firm can be said to be fully taxable in the resident state.
As long as income of the partnership is taxed, albeit, in the hands of the partners in the resident state, the treaty benefits cannot be denied. The basic purpose is whether or not the entire income is taxable in the resident state. The mode of taxability, whether in the hands of partnership or the partners, cannot be given much credence so long as the income is fully taxed in the resident state.
If the income of the partnership firm is fully taxed in the source country (India) and the same income is also taxed in the hands of the partners in the resident state (say, Denmark), then it will result in double taxation. This cannot be the mandate of the treaty, specifically when the shipping income is to be taxed entirely in the resident state (i.e., POEM).
Reliance was placed on the Tribunal’s ruling in the case of Linklaters LLP2 to conclude that, even though the partnership firm is a transparent entity, once its income and profit is taxed in the hands of the partners, the treaty benefits should be extended to the partners.
The Taxpayer is entitled to the treaty benefits and, if any such income of the Taxpayer is not liable for tax under the Articles of the treaty, the benefits have to be given. Once the resident state has the right to tax the income of the partnership firm, irrespective of the fact that the same is being taxed from the partners, then it suffices that it has to be treated as fiscal domicile of that state within the provisions of the treaty.
Taxability in India of management fees received by the Taxpayer
With respect to taxing fees for technical services (FTS) in the case of a nonresident under the treaty, the basic condition is that there has to be a PE in connection with which such a liability has been incurred. Not only this, such FTS should be borne by such PE. If that is not the case, the same cannot be taxed in the hands of the nonresident.
In this case, admittedly, this payment has not been made by any PE to the Taxpayer. Payment has been made by a nonresident company i.e., two Danish companies to another nonresident i.e., a partnership firm established under the laws of Denmark in connection with the entire global business.
Thus, the payment cannot be taxed as FTS in case of the Taxpayer as the Taxpayer is entitled to the treaty benefits.
Bilateral tax treaties serve principally to avoid or minimize instances of double taxation within the context of cross-border transactions. Tax relief is achieved mainly by allocating certain taxing rights to the contracting states. Treaties, inevitably, fall short of adequately addressing income attribution whenever a conflict in classifying a particular entity exists between the source and resident states. That is particularly true for flow-through or fiscally transparent entities deriving income. Under a typical cross-border scenario, an entity will be regarded, for tax purposes, as a separate entity under a particular country’s domestic law, yet viewed as fiscally transparent in another country. As most of India’s tax treaties do not contain specific provisions to deal with such situations, an issue that has often been raised in cross-border partnership taxation in India is whether a fiscally transparent foreign partnership can be regarded as a resident of the state where the partnership is organized. This ruling upholds entitlement to treaty benefits in such a case of conflict in qualification.
2. See EY Tax Alert dated 19 July 2010 Mumbai ITAT rules on the possibility of a transparent entity to avail tax treaty benefits.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India), Mumbai
- • Sudhir Kapadia
+91 22 6192 0900
Ernst & Young LLP (India), Hyderabad
- • Jayesh Sanghvi
+91 40 6736 2078
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
- • Nachiket Deo
+44 20 778 30862
Ernst & Young Solutions LLP, Indian Tax Desk, Singapore
- • Gagan Malik
+65 6309 8524
Ernst & Young LLP, Indian Tax Desk, New York
- • Tejas Mody
+1 212 773 4496
EYG no. CM3965