In the Indian context, Tax authorities often challenge the Tax treaty benefits to the fiscally transparent entities such as foreign partnership firms on the premise that such entities do not qualify as a tax resident of that country and are not liable to tax in their home country.
In the given case, a US-based LLC was in receipt of Fees for Technical Services (FTS) from an Indian company and the LLC in their Indian tax return claimed the concessional tax rate of FTS under India-USA Tax treaty as opposed to the higher tax rate as per the provisions of the ITA. The Indian Tax authorities questioned such a claim and rejected Tax treaty benefit on account of the LLC being a fiscally transparent entity for which income is not subject to tax in its own hands and the LLC is not liable to tax in the USA and does not qualify as a ‘resident’ of the USA as per Article 4(1)(b) of the treaty.
As per Article 1 of the India-US Tax treaty, the Tax treaty applies to the persons who are residents of one or both of the Contracting States. Further, the definition of resident outlined in Article 4 of the India US Tax treaty states that the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature. However, in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries.
The Hon’ble Tribunal in the case dwelled into various facets including Instruction for Form 8802 which is for applying for a Residency Certification, Publication 3402 of the Department of the Treasury, International Revenue Service of the Government of USA on Taxation of Limited Liability Company, TRC dated 30.03.2015 as received from the United States Internal Revenue Service to observe:
- that Limited Liability Company is a business entity recognized by the United States under State law and an LLC may be classified for federal income tax purposes as a partnership, corporation or an entity disregarded as separate from its owner
- under US federal income tax law, an LLC with a single owner is disregarded as separate from its owner unless the LLC elects to be treated as a corporation for US federal income tax purposes. This ability of the LLC to elect its tax classification under US federal income tax law also supports the legal situation or aspect of the LLC being liable to tax
- where a LLC is disregarded as separate from its tax owner for US federal income tax purposes, the LLC is essentially ‘liable to tax’ but the income is attributed to its tax owner and such tax is imposed and paid by its respective tax owner
- LLC qualifies as a person by virtue of a separate existence from its Member and a perpetual existence distinct from its Members which can be corroborated from the tax Residency Certificate as received from the United States Internal Revenue Service in accordance with the requirement of the law as applicable to the assessee, being an LLC, which is organized as body corporate.
The Tribunal averred that the intent of the India-US tax treaty has to be given precedence wherein the concept of a fiscally transparent entity is duly recognized by way of the phrase ‘liable to tax’ which is to be interpreted in the way that the assessee is liable to tax under the authority of the US Income-tax law. Further, it also concluded that an exclusion provision can only exclude something if it was included at the outset. The provision determined the scope of eligibility of such fiscally transparent entity by excluding income which is not ultimately ’subject to tax’ in the US.
The welcome judgment provides some more clarity and respite with respect to Tax treaty benefit claim by fiscally transparent entities and can be relied on in similar cases for construing the phrase ‘liable to tax’ based on the underlying fact pattern and respective applicable Tax treaty.