THE conference on tax treaty case laws around the globe took place in Vienna this year. As in earlier years, the most important case laws decided in different parts of the world were discussed. It is quite fascinating to observe the differing attitudes of the tax administrations and the tax courts in different parts of the world. Some of the LLM students from India who could attend the conference believe that Indian tax courts seem to be much too lenient.

The outcome of the deliberations during the conference come out in the form of a book. So, it is not possible to discuss all the interesting cases.

Quite unexpectedly, this year there were cases from five Asian countries - China, India, Israel, Kazakhstan and Japan. Case laws are almost non-existent in China. No one wins against the revenue. So, it is futile to litigate. This year, one case each from China and Japan were discussed and the result was predictable. It is also interesting to note that more and more Indian companies are now getting involved in disputes abroad. Often times, it is seen that the arguments that prevailed in India are being relied on by the Indian companies only to be rejected by the courts of the other jurisdictions. One such case was from Kazakhstan that we plan to discuss in this short write up.

Kazakhstan

We start with the Kazakh case first. Here, it was two Indian companies rendering engineering services to a Kazakh company in the development of oil fields and the issue that arose was regarding the liability of the local company to deduct tax at source from such payment. The local company did not withhold any tax as it was of the opinion that no income arose to the Indian company in Kazakhstan. It may be noted that the India-Kazakhstan tax treaty has a combined article on royalties and fees for technical services as follows:

Article 12

1. Royalties or fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

2. However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties, or fees for technical services, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties or fees for technical services.

3. (a) …

(b) The term "fees for technical services" means payment of any kind in consideration for the rendering of any managerial, technical or consultancy services including the provision of services by technical or other personnel but does not include payments for services mentioned in Articles 14 and 15 of this Convention.

More importantly, the protocol to the treaty has a most favoured nation clause as follows

With reference to Articles 10, 11 and 12:

In respect of Articles 10, 11 and 12, if under any Convention, Agreement or Protocol between the Governments of Republic of Kazakhstan and the Republic of India with a third State, either Kazakhstan or India limit their taxation on dividends (single rate), interest, royalties or fees for technical services to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention, Agreement or Protocol on the said items of income shall also apply under this Convention.

The main argument of the taxpayer was two fold - first, the services rendered were engineering services and hence were not covered by the definition of fees for technical services, the services were also not rendered from India and there was no presence of Indian employees in Kazakhstan. The second argument was that in view of the protocol, since some of Kazakhstan's tax treaties do not contain an FTS clause that would mean that Kazakhstan has treaties that have more limited scope in respect of this clause and hence no FTS could be charged.

The Kazakh tax authorities however took the position that engineering services were also covered by the term 'consulting services' that was covered by specific source rule in the domestic law and was taxable in that country irrespective of the place of performance of the services. (Provision somewhat analogous to section 9(1) (vii)). The court of first instance agreed with the revenue but this was overturned by the court of second instance but the Supreme Court again agreed with the revenue.

It may be noted that there is an article on independent personal services in Article 14 of the treaty that defines the term "professional services" to include "especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, surgeons, dentists and account­ants." It may also be noted that there are a number of case laws in India that engineering services being specifically included in the said definition, will prevail over the article on fees for technical services since that would be more favourable to the taxpayer. Although the full English text of the various judgments in the case is not available, it is obvious that the Kazakh judiciary does not subscribe to such a view.

As for the issue of the MFN clause, the presenter mentioned that the court of first instance noticed its existence but gave a peculiar argument to the effect that since article 12 also stated that Kazakhstan had the right to tax the income in the nature of royalties and FTS at a rate not exceeding 10%, the same was rightly taxable in Kazakhstan notwithstanding the MFN clause. This is indeed a strange interpretation apparently upheld by the Supreme Court without any discussion. The Indian court cases in this regard are exactly opposite. There are many cases where not only the rate but the scope of tax treaties have been limited by referring to the more restrictive clauses in other tax treaties.

China

The multinationals that scream hoarse about the highhandedness of Indian tax administration and litigate at every opportunity, do not do so in China. One of the reasons for the same is of course the fact that India offers too many opportunities to litigate to everyone. In China, MNCs generally depend on the administrative circulars issued by the SAT. Talking of Court cases in China, one can think of the famous PanAmSAT case decided sometime in 2006 and now in 2016, one case has been decided, of course against the taxpayer.

This was the case of one Mr. Macdonald-Hardie who was a citizen of the UK but claimed to be tax resident of the USA. He was the CEO of a Chinese company during the relevant time. He had stayed in China for 259.5 days, 289 days and 286 days in the years of 2005-2007.

He had duly paid the taxes on his remuneration from the Chinese company. However, since he was responsible for overseas project management, he also had an employment contract with an affiliated American company from where he received remuneration. He claimed to have paid tax in the USA in respect of the aforesaid income.

Chinese tax residency rules seem to be fairly complicated. Under the Chinese domestic law, one is a tax resident in China if one has domicile in China or even if he has no domicile , he has resided in China for more than one year. If an individual spends more than 30 continuous days or more than 90 days (cumulative) outside of Mainland China in any given calendar year, he will not be resident.

Under the Chinese rules, while Chinese nationals are taxed on their foreign earned income, foreign nationals are only taxed on their income earned from a Chinese source.  However, if a taxpayer has been a resident in China for more than five years, his worldwide income will be taxable. [https://www.greenbacktaxservices.com/blog/us-expat-taxes-china-country-guide/)]

Following an audit, the tax authorities included the taxpayer's American income also in his taxable income.

Although for the first year, the taxpayer would not normally be resident of China, the tax administration held that since he was the CEO of a Chinese company, in terms of the circulars issued by the SAT, the scope of his liability in China would be broader. And since his stay in China was more than 183 days, in terms of Article 14 of the China-USA tax treaties, he would be taxable in China in respect of his income from employment even in respect of the remuneration from the American company. The taxpayer having disputed his liability to tax in respect of his American income, the issue was agitated before the first tier court, which decided against the taxpayer. The taxpayer then appealed the issue further to the intermediate court pointing that the lower court had wrongly applied the domestic law as also the treaty provision and pointing out that his employment with the American company was quite different and separate from his position as CEO of the Chinese company; that his American salary was paid in the USA and the work was also performed there.

The appeals court also held in favour of the revenue. The reasonings are not very clear. It seems that the tie breaker rule for determining residence was not applied and the claim that the US salaries were due to activities rendered abroad was not also addressed.

There are of course reports that China wants to crack down on its residents not reporting foreign income and of curbing the use of split dual employment arrangement that MNCs often adopt to compensate their executives.

Japan:

The Japanese case concerns the Japan-US tax treaty and concerns the important topic of internet sales of motor parts through a website. The company maintained a warehouse in Japan from where deliveries were effected. In fact the taxpayer maintained an apartment and a warehouse adjacent to the same. Customers in Japan placed orders that were transmitted to the apartment and instructions were inserted in Japanese. The address of the warehouse was given as the address of communication in case any defective item was to be returned. The issue involves the interpretation of the exceptions (a) to (f) mentioned in article 5(4) in relation to a permanent establishment. The tax authorities saw a permanent establishment in Japan in the apartment and the warehouse.

The taxpayer however argued that under the OECD Model a facility solely used for the purpose of storage, display or delivery of goods belonging to the enterprise would not constitute a permanent establishment.

Article 5(4) of the treaty stated as follows:

4. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include:

a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;

b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;

c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;

e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;

f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a ) to e ), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character

The issue was whether the preparatory and auxiliary nature is required to be fulfilled in situation covered by 5(4)(a).

The taxpayer had referred to the 2012 OECD discussion draft on permanent establishment that took the view that situations mentioned in a) to e) should be considered as preparatory and auxiliary and argued that since the same was also written by OECD CFA, it should be used as a supplementary means of interpretation and treated as contemporaneous exposition of law. The High Court pointed out that the 2012 report in this regard was not carried out in practice and no change was effected in the 2014 model or commentary and therefore there could be no reliance on the 2012 discussion draft.

It is interesting to note that the same issue was also the subject matter of discussion in the BEPS report. Although the judgement of the Tokyo High Court was rendered in 2016, there is no discussion of the BEPS report in this regard. The BEPS final report on artificial avoidance of PE status has discussed the issue of artificial avoidance of PE status through the specific exceptions contained currently in Article 5(4). The report stated that when the exceptions to the definition of permanent establishment were first introduced, the activities covered by these exceptions were generally considered to be preparatory and auxiliary in nature. However, the report acknowledges that there have been dramatic changes in the way business is conducted these days as detailed in the action 1 report relating to digital economy and depending on the circumstances, activities that were previously considered to be merely preparatory and auxiliary may now a days correspond to core business activities. Therefore, the report suggests that in order to ensure that core activities performed in a country can be taxed in that country, Article 5(4) needs to be suitably modified to ensure that each of the exceptions included therein is restricted to activities that are otherwise of a preparatory or auxiliary character.

The report mentions: Where, for example, an enterprise of State R maintains in State S a very large warehouse in which a significant number of employees work for the main purpose of storing and delivering goods owned by the enterprise that the enterprise sells online to customers in State S, paragraph 4 will not apply to that warehouse since the storage and delivery activities that are performed through that warehouse, which represents an important asset and requires a number of employees, constitute an essential part of the enterprise's sale/distribution business and do not have, therefore, a preparatory or auxiliary character .

The report however also mentions that not everyone accepts this interpretation and they may therefore continue to adopt a different formulation so long as they include anti-fragmentation rule that was subsequently prescribed.