This is a topic near and dear to my heart, as it affects my own personal wallet.
Consider me sitting in the U.S., doing work for a client in another country. I do all of the work in the U.S. I do not travel to the other country. The client pays me. Which country gets to tax my income–the U.S. or the other country? (Or, God forbid, both?)
At least for India, the answer is now clear, courtesy of a 29 March 2005 ruling by India’s Income Tax Appellate Tribunal.
A U.S. law firm did work for an Indian client. The lawyers never stepped foot in India, doing all of the work in the U.S. The Indian client paid the U.S. law firm, and a withholding tax was imposed by the Indian tax authorities.
The U.S. law firm applied for a refund of the withholding tax. The Indian tax authorities denied the application. Next stop, the courts. The Indian court ruled in favor of the law firm and awarded a refund.
The debate in the Indian court turned on which of two competing provisions of the India-United States Income Tax Treaty applied in this situation. The law firm claimed that Article 15 applied (a special provision applicable to professional services) making the income exempt from tax in India. The Indian tax authorities in contrast claimed that Article 12 applied–a more general provision–making the India-source income taxable to the U.S. law firm.
General versus Specific
In the 22 April 2005 edition of Worldwide Tax Daily (2005 WTD 77-1), Sanjay Sanghvi, chartered accountant, RSM & Co., Mumbai writes:
The tribunal found that article 15 is a specific provision for lawyers, accountants, and other professionals. It observed that article 12(5)(e) stipulates that fees for included services do not include amounts paid to any individual or firm of individuals (other than a company) for rendering professional services as defined in article 15. Since the U.S. firm in this case is a firm of solicitors that had rendered predominantly legal services to its Indian client, it fell within the purview of article 15, which prevails over the more general article 12.
The tribunal noted that the U.S. firm did not have a fixed base available to it in India for carrying out its activities. Also, the firm had rendered all its services to the Indian client from the United States through its attorneys and staff in the United States, and no visit was made to India. Accordingly, the tribunal concluded that, in the absence of a fixed base in India, the fees of the U.S. firm were not taxable in India under article 15 of the India-U.S. tax treaty, and, consequently, the firm was entitled to a refund of taxes already withheld in India.
A service provider should look very carefully at the Income Tax Treaty between the country where services are performed and the country where the customer is located. In this case the result depended on the Indian tax court deciding which of two competing provisions of the India/U.S. income tax treaty controlled the situation.
But as a general rule it always makes sense to avoid a permanent base in a country. Once you have a permanent base of operations, you give that country much more ability to claim the right to tax you.