Typically, in many countries, partnership firms are considered pass-through entities for tax purposes. Hence, in such cases, it is the partners of the partnership firm who are subject to tax in respect of their share of income from the partnership firm. An interesting issue which arises for consideration in such situations is whether such foreign partnership firms are eligible to claim the benefit of the double tax avoidance agreements.
Illustration: Malay Karmakar / Mint
Under the provisions of such tax treaties, benefits are normally available only to persons/entities that are considered tax residents of their respective countries. The tax treaty provisions dealing with tax residency inter-alia provide that the term “resident of a contracting state” means any person who under the laws of that respective country is liable to tax therein by reason of domicile, residence, place of management or any criterion of similar nature.
The Mumbai tax tribunal, in a decision dated 4 July in the case of Chiron Behring GmbH and Co., held that a German partnership firm (the partners of which are subject to tax ), which itself only pays a trade tax, should be eligible for the benefits of the India-Germany tax treaty.
Facts of the case
Chiron was a limited partnership firm incorporated under Germany’s laws and had earned royalty and fees for technical services from an Indian company. The income earned by Chiron was offered to tax in India at the beneficial rate of 10%, as stipulated under the India-Germany tax treaty.
The revenue authorities, after considering the commentary of the Organization for Economic Cooperation and Development (OECD), indicated that in Germany, tax on limited partnerships was the liability of the partners and not of the firm. Also, on the basis of a reply given by Germany to OECD that in the case of limited partnerships only the partners were liable to pay tax and not the firm itself, the revenue authorities concluded that “limited partnerships” were not considered liable to tax in Germany. The trade tax which Chiron was liable to pay in Germany was considered a type of tax on turnover and could not be treated as equivalent to income tax. Accordingly, the benefits of the India-Germany tax treaty were denied to Chiron. Consequently, the royalty and fees for technical services earned by Chiron were taxed at a higher rate of 20% under the provisions of the Income-tax Act, 1961.
In light of the above facts, a couple of key issues were raised before the tax tribunal.
One, the trade tax payable by Chiron can be said to be a tax as covered under the India-Germany tax treaty. Two, Chiron, a German partnership firm, could be considered a tax resident of Germany and consequently be eligible for the benefits of the India-Germany tax treaty.
The primary basis for the revenue authorities in denying the treaty benefits was on grounds that Chiron was not liable to tax in Germany. In this connection, reliance was placed on the OECD commentary which, among other things, mentions that the tax on limited partnerships was the liability of the partners and not that of the firm. Further, the trade tax paid by Chiron is a type of tax on turnover and not income. Chiron contended that the revenue authorities’ stand that the trade tax is a tax on turnover was misplaced since, as per the provisions of the German Trade Tax Act, the basis of taxation for trade tax is income from the business. The India-Germany tax treaty lists income tax, corporation tax, trade tax and capital tax as the four taxes covered by the treaty. As such, the trade tax is specifically included among the taxes covered by the India-Germany tax treaty.
The tax tribunal held that for an assessee to be entitled to the benefits of the tax treaty, the assessee should be a person as defined in the tax treaty, be a resident of either India or Germany (in the present context) and should be liable to pay tax in its residence country by reason of domicile, residence, place of management, etc.
Article 3(d) of the India-Germany tax treaty provides that the term “person” includes an individual, a company and “any other entity” which is treated as a taxable unit under the taxation laws in force in either India or Germany. In the present case, the tax tribunal held that Chiron was a “person” covered under the India-Germany tax treaty as “any other entity”.
Further, the tax tribunal also held that Chiron was a resident of Germany, as the revenue authorities had accepted that Chiron was a “limited partnership” under German law.
The tribunal further observed that the revenue authorities were swayed by the commentary of the OECD publication and had not appropriately considered the provisions of the tax treaty relating to residency. In this connection, relying on the decision of the Supreme Court in the case of Kulandagan Chettiar (267 ITR 654), the tribunal held that it would be unnecessary to refer to the other terms addressed in OECD, or in any other decision of foreign jurisdiction, when the language of the tax treaty is unambiguous and does not admit any doubt. Regarding the revenue authorities’ contention that Chiron is not liable to pay tax in Germany, the tribunal held that Article 6 of the German Trade Tax Act states that “the basis of taxation for trade tax is the income from the business” and indeed, that Chiron having filed a trade tax return under German law in its own name, the trade tax is a tax covered by the India-Germany tax treaty.
In view of this, Chiron was held to be entitled to claim benefit of the India-Germany tax treaty. Accordingly, the royalty and fees for technical services earned by Chiron should be subject to tax at the beneficial rate provided in the India-Germany tax treaty, that is, 10%.
This decision is a welcome one and gains significance in view of the upcoming limited liability partnership regulations in India, whereby on similar footing, like in Germany, limited liability partnership is treated as a pass-through entity, such that its partners pay income tax on their share of profits.
In view of this, one would hope that in similar cases, revenue authorities should determine tax residency of a limited liability partnership independent of the pass-through status.
Also read Ketan Dalal’s earlier columns, www.livemint.com/groundrules
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at email@example.com