Most of our tax treaties with other countries contain provisions for taxability of ‘fees for technical services’ (FTS), including a comprehensive code for allocating the rights for taxing such income among the contracting States. According to the rule of tax allocation, the State in which the income recipient resides will have the primary right of taxation. However, the contracting State in which the income arises (source State) shall also have right of taxation, subject to limits.

In April 2010, India revised its tax treaty with Finland and added certain deeming provisions in Article 12. FTS shall be deemed to arise in a contracting State when the payer is the State itself, or a resident. However, FTS related to services provided in a contracting State shall be deemed to arise there.

The new provisions are subject to various interpretations.

Let us assume a situation in which an Indian tax-resident pays FTS to a Finnish tax-resident for technical services performed in that country. The payer’s residence nexus rule establishes India as the source State. However, the literal reading of the nexus rule of performance would establish Finland as the source State.

One of the interpretations suggests that as the services are performed in Finland, they should be taxed there. However, applying the nexus rule of performance, the new FTS provisions are not applicable. This leads to a situation where FTS arising in Finland is paid to a tax resident of Finland.

On the other hand, applying the payer’s residence nexus rule makes the new FTS provisions workable. It entitles India, as the State of payer’s residence, to tax the Finnish tax-resident who is the income recipient.

It must be noted that the nexus rule of performance would restrict the scope of the new FTS provisions. If the contracting States intended the nexus rule of performance to take FTS outside the scope of the new provisions, Finnish tax-residents may not be taxed in India on such FTS.

Let’s assume another situation where a Finnish tax-resident or a tax-resident of a third State pays FTS to another Finnish tax-resident, who receives income for performing technical services in India. The payer-residence nexus rule makes the new FTS provisions inapplicable, leading to a situation where FTS arising in Finland is paid to a Finland tax-resident.

On the other hand, the nexus rule of performance makes the provisions workable, entitling India as the State of performance to tax the Finnish tax-resident as the income recipient. Here, the nexus rule of performance broadens the scope of the new FTS provisions.

From the examples, clearly two views emerge. If the nexus rule of performance is accepted, the scope of FTS under the India-Finland tax treaty would be narrowed. It would be interesting to examine the impact on the ‘most favoured nation’ clause in various tax treaties, including Sweden, Spain, France, Hungary, The Netherlands, and Belgium. If the payer-residence nexus rule is accepted, the scope of FTS would widen under the India-Finland tax treaty.

As both views are equally plausible, the Government should clarify on it.

Punit Shah is Co-Head of Tax, and Mrugen Trivedi is Director — Tax, KPMG in India

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