BACKGROUND

With a view to mitigate double taxation in case of cross-border transaction(s), countries have entered into Double Taxation Avoidance Agreement (‘DTAA’ or ‘tax treaty’). A tax treaty allocates the taxing rights among the Treaty Countries. One of the main conditions that need to be satisfied to access the tax treaty is that the taxpayer should be a tax resident (i.e. taxable unit) of either or both the Treaty Countries and is liable to tax.

A question may arise as to whether a Limited Liability Corporation, which is a Fiscally Transparent Entity (FTE)¹ can claim the tax treaty benefit or not, since such an entity may not be a taxable unit in one or both the Treaty Countries. For example, a Limited Liability Corporation (LLC) is treated as a pass-through entity and thereby the income of the LLC is taxable in the hands of the shareholders under certain conditions.

Recently, the Delhi Tax Tribunal² had an occasion to analyse whether the benefit of the India-USA Double Tax Avoidance Agreement (India-US Tax Treaty) can be claimed by an LLC or not. We, at BDO in India, have summarised this ruling and provided our comments on the impact of this decision hereunder:

FACTS OF THE CASE

• Taxpayer, a US LLC, had received fees for technical services from two Indian entities. The taxpayer offered the said receipts to tax at the rate of 15% by applying the India-US Tax Treaty rate. However, the tax officer opined that since the taxpayer is an FTE, it is not entitled to India-US Tax Treaty not being a “person” and/ or “liable to tax” and thereby denied the concessional rate of 15%. The tax officer also observed that LLC does not come under the special clause of partnerships and trusts laid down in Article 4(1)(b) of the DTAA. Accordingly, the tax officer proceeded to levy tax at 25% as per section 115A³ of the IT Act.

• Aggrieved, the taxpayer filed an appeal before the Dispute Resolution Panel (DRP) which upheld the order of the tax officer. Hence, the taxpayer filed an appeal before the Delhi Tax Tribunal.

DELHI TAX TRIBUNAL RULING

While permitting the US LLC to access the India-US Tax Treaty and thereby granting the Tax Treaty rate, the Delhi Tax Tribunal made the following observations:

VARIOUS PUBLICATION & INSTRUCTION OF IRS;

• As per Publication 3402 of the Department of the Treasury, International Revenue Service (IRS) of the Government of USA on Taxation of LLC, LLC is a business entity recognised by the United States (US) under State law. An LLC may be classified for federal income tax purposes as a partnership, corporation or entity disregarded as separate from its owner.

• LLC with at least two members is classified as a partnership for federal income tax purposes. LLC with only one member is treated as an entity i.e. disregarded as separate from its owner for income tax purposes. If an LLC has only one member and is classified as an entity disregarded as separate from its owner, its income, deductions, gains, losses and credits are reported in the owner’s income tax return.

• Instructions for Form 8802⁴ issued by IRS, US provides that under a tax treaty, an individual or entity is a resident of the US if the individual or entity is subject to US tax by reason of residence, citizenship, place of incorporation, or other similar criteria. Further, if an FTE organised in the US (i.e. a domestic partnership, domestic grantor trust, or domestic LLC disregarded as an entity separate from its owner) does not have any US partners, beneficiaries, or owners then such entity is not entitled to residency certification (Form 6166).

VALIDITY OF TAX RESIDENCY CERTIFICATE

• The residency certificate (TRC) issued to the taxpayer has been issued in terms of these instructions. TRC, as received from the US IRS, is in accordance with the requirement of the law as applicable to the taxpayer, being an LLC, which is organised as a body corporate as it fulfils all the requirements of a body corporate in the form of legal recognition of a separate existence of the entity from its member and a perpetual existence distinct from its members. Therefore, the taxpayer being a resident under Article 4 of the India-US Tax Treaty by virtue of incorporation and its recognition as a separate existence from its members qualifies as a ‘person’.

• 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. LLC is given the option to either be taxed as a corporation or be taxed as a disregarded entity or partnership. The ability of the LLC to elect its tax classification under US federal income tax law supports the legal situation or aspect of the LLC being liable to tax.

• Further, where LLC is disregarded as separate from its tax owner for US federal income tax purposes, the tax owner of the LLC pays tax on the tax owner's share of the taxable income attributed from the LLC. This further supports the legal situation of an LLC being liable to tax, i.e., the LLC is essentially 'liable to tax' but the income is attributed to its owner and such tax is imposed and paid by its respective tax owner.

“LIABLE TO TAX” AS PER TREATY

• The phrase ‘liable to tax’ has to be interpreted in the way that the taxpayer is liable to tax under the authority of the US Income-tax law. The intent of the India-US Treaty has to be given precedence wherein the concept of FTE is the recognised way of recognising the phrase ‘liable to tax’.

• Reliance placed by the taxpayer on the Mumbai Tax Tribunal’s ruling in the case of Linklaters LLP⁵ is accepted wherein it was held that while the modalities or mechanism of taxation may vary from jurisdiction to jurisdiction, what really matters is whether the income, in respect of which treaty protection is being sought, is taxed in the treaty partner country or not and thus held that even when a partnership firm is taxable in respect of its profits not in its own right but in the hands of the partners, as long as the entire income of the partnership firm is taxed in the residence country, treaty benefits cannot be declined.

• Relying on the AAR ruling in the case of General Electric Pension Trust⁶, an exclusion provision can only exclude something if it was included at the outset. Hence, a fiscally transparent partnership was already regarded as 'liable to tax' for the purposes of the India-US tax treaty and this provision determines the scope of eligibility of such fiscally transparent partnership by excluding income which is not ultimately 'subject to tax' in the US.

BDO IN INDIA COMMENTS

Whether FTE can access the tax treaty has always been a contentious issue. This ruling will further strengthen/ support the contention that the Tax Treaty benefit should not be denied to FTE, especially when its owners/ partners/ shareholders are from the same country.

Importantly relying on the findings laid down by the Mumbai Tax Tribunal in the case of Linklater LLP and reiterated that to the extent that the income derived by such partnership (i.e. FTE) is subject to tax in the country of its incorporation as the income either in the hands of the partnership itself or in the hands of its partners or beneficiaries, the said partnership shall be treated as ‘Resident’ for the purpose of the Tax Treaty. While Linklaters Ruling was rendered with respect to the UK Partnership Firm, this Ruling will help LLC have transactions with Indian entities.