INDEPENDENT PERSONAL SERVICES – ARTICLE 14 OF
UN MODEL CONVENTION
P.V.S.S. Prasad
B.Com., F.C.A.,D.I.S.A.(ICA)
E-mail:
1.0Article 14 of the UN Model Convention 2001 deals with Independent Personal Services (IPS). OECD Model Convention 2000 has deleted this article and the provisions of this article have been clubbed with the provisions of Article 7 (Business profits) on an assumption that the distinction between business and profession has become thin and the commercial atmosphere of the modern times has taken away the distinction between two to a great extent. However, in almost all the treaties India entered with the other countries, Article 14 has been very much in existence and we need to carefully analyze the provisions of this article.
1.1Professional services rendered by independent professionals like lawyers, doctors, engineers, accountants etc. are covered by the provisions of this article. It is important to note that professional services rendered even by a company are covered in most of the situations except where it is specifically excluded by the treaties like Indo-Singapore and Indo-US etc.
1.2This article, however, does not cover
a)Professional services performed in employment – will be covered by Article 15.
b) Independent activities of artistes and sportsmen – which will be covered by Article 17.
c) Income from immovable property, which was used in the course of rendering professional services, which will be dealt with Article 6 and Article 13, if there is any capital gains on sale of such immovable property.
d)Income from industrial and commercial activities.
e)Income from professional services derived in the form of royalty by exploitation of rights and similar intellectual property etc. where the receiver has no fixed base in the source country. These items would be covered by Article12.
2.0Basic Concepts:
2.1Evolution & Applicability: OECD Model Convention brought a separate Article 14 to deal with IPS. It is provided to tax such services in the source State, if such professionals have fixed base in the source country. The very concept of the fixed base was introduced for the first time in 1963. Subsequently in 1977, OECD MC, 2000 was amended to bring in three concepts, which are as under.
a) The services that would be covered under Article 14 have been extended from the scope ‘professional services or other independent activities of a similar character’ to ‘professional services or other activities of an independent character’.
b) It was provided in the commentary that Article 7 provide guidance for interpreting provisions of Article 14.
c) The concept of a fixed base was brought in line with the concept of Permanent Establishment (PE).
2.1.1Ultimately, Article 14 had been deleted in OECD MC,2000. However, the article remains in UN MC, 2001 IPS would be brought to tax in the source state, if the professional has a fixed base, which is regularly available to him or if his stay in the source State is for a period or periods amounting to or exceeding in the aggregate 183 days in any 12 month period. Thereby, the charging criteria was brought in UN MC, 2001 with respect to period of stay.
2.1.2In addition to these two criteria, UN MC also carried the third one to provide taxation in the source country, if professional services rendered by a resident of the other contracting State are borne by a Permanent Establishment or a fixed base of the source country. A threshold limit in respect of such remuneration was also part of the criteria. However, this third criteria has been withdrawn by UN MC, 2001. India has still got such a clause in the treaties signed with Canada, Jordan and Zambia.
2.2Characteristics of ‘professional services or other activities of an independent character’: Para 2 of Article 14 provides an inclusive definition covering especially independent scientific literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants. The wording ‘other activities of an independent character’ would provide that the definition would encompass many other services not specifically mentioned in the article.
2.2.1It is in this context, we need to carefully look at the basic characteristics or criteria that need to be satisfied to classify a particular activity of service as covered under this article. Basically two important characteristics should be present to treat the activity as an IPS under this article.
2.2.2Firstly, unlike commercial or business activities where capital requirement is significant and critical, IPS do not require huge layout of capital. Whereas IPS require high amount of intellectual capital and personal expertise to render services. Secondly, a professional to render services is required to possess certain special qualifications and training. This is indicative from the categories mentioned in para 2 of Article 14 covering doctors, lawyers, architects etc. unless a person acquires a recognized qualification, he may not be a professional of a particular discipline.
2.2.3Klaus Vogel in his commentary highlights both the above conditions in the following words.
All this taken together allows the term ‘other activities of an independent character’, as used in Article 14 MC, to be summed up in the form of two conditions. What is involved must (first) be a service – as distinct from the manufacture or processing of goods by industrial methods or by craftsmanship, and distinct from commercial activities – where (second) the input of capital is of no more than secondary importance. MC 63 laid down a further (third) condition, viz. that the ‘other independent activities’ had to be ‘similar’ to professional services. In other words, the services involved had to require a certain qualified training or creative ability.
2.2.4Amendments in OECD MC in 1977 were interpreted to mean that the definition of professional services has been broadened so as to dispense with requirement of special training and creative abilities for performing these services.
2.2.5Klaus Vogel held that as per the changed wording special training and creative abilities were no longer required. This argument was explained by mentioning that a beautician or photographer’s model, who under German Domestic Law would be considered to be engaged in a trade, may consequently be engaged in independent activities for the purposes of OECD MC 1977.
2.2.6However, other scholars hold a view that amplifying the scope of Article 14 by OECD MC 1977 did not result in dispensing with the requirement of special qualified training and creative abilities.
2.2.7The basic characteristic that activity of IPS does not require a large amount of capital became questionable in the advent of growing trend of international accounting firms and international law firms, which invariably require substantial capital.
2.3Article 14 vs. Article 7: UN MC relies on the commentary of OECD MC with respect to the commentary of Article 7 dealing with business profits for interpretation of the provisions of the Article 14. Especially, principles of allocation of profits between head office and PE under Article 7 could be applied in apportioning income between state of residence of a person performing IPS and the state of source from where such services are performed from a fixed base.
2.3.1Thereby commentary on Article 7 of OECD MC would be an aid of interpretation of provisions of Article 14 and the principles laid down in Article 7 could not be transferred to Article 14 in all those instances where the nature of professional services differs from that of business operations. This is as per Klaus Vogel commentary, wherein it was further observed that what must therefore, at all events be examined is whether and, if so, to what extent principles of Article 7 are suited for adoption.
2.4Whether only natural persons covered? : The next issue which needs deliberation is the coverage of this article. In other words, whether applicability of this article to juristic and legal persons is an issue of debate. It is commonly understood that professional services are always rendered by individuals or group of individuals. Such group of individuals can be a partnership firm or they may incorporate themselves into a company. Now the issue is whether a company rendering professional services can be covered by the provisions of Article 14.
2.4.1Prof. Klaus Vogel in his commentary observes “According to OECD and UN MCs, companies and other bodies of persons, too, may thus be capable of deriving income from professional services, irrespective of whether or not domestic law- for instance, under the substance vs. from principle – would attribute income of the type in question to a non-individual (unclear:OstVwGH40 OstZb 279 (1987). However, the situation is different under the US MC that restricts to individuals its rule on the taxation of income from personal services.’”
2.4.2Same issue came up before Mumbai Bench of the Hon’ble Tribunal in the case of Christiani & Nielsen (1991) 39 ITD 355 (Bom) in the context of Article 15 of the India-Denmark Tax Treaty, wherein it was held that the word ‘he’ and his presence for 183 days could only be referred to a living person not to an artificial person like the assessee-company. Again, the term ‘remuneration for labour or personal services’ could be only by an individual and not by an artificial person. It is true that a ‘person’ may include a company but the personal services would mean the services of a human being or a living person as, in our opinion, no personal services could be rendered by a person other than individual or a living person.
2.4.3Another renowned international tax expert Phillip Bakerin his treatise ‘Double Taxation Conventions’ published in 2003 by Sweet & Maxwell Ltd. commented as follows.
“There is a ruling of German Bundesfinanzhof to the effect that companies cannot perform personal services(Footnote 4 – July 7, 1971, I.R. 41/70 (1971) BStB1, II, 771).”
2.4.4UN Model Commentary, 2001 also supports the view that IPS Article is attracted only when an individual renders services and not otherwise. Para 9 of the commentary dealing with Article 14 of IPS reads as under.
“The Group discussed the relationship between Article 14 and subparagraph 3(b) of Article 5. It was generally agreed that remuneration paid directly to an individual for his performance of activity in an independent capacity was subject to the provisions of Article 14. Payments to an enterprise in respect of the furnishing by that enterprise of the activities of employees or other personnel are subject to Articles 5 and 7.”
2.4.5In view of the same, UN MC supports the view that companies and other body corporates are excluded from the coverage of Article 14. However, Mexico considers that this article is applicable even to companies that render professional services. According to US MC companies and other bodies of persons rendering professional services are covered by the Article 7 dealing with business profits. It is therefore essential to verify the particular treaty and the wording of the article to arrive at the inference in respect of this issue.
2.4.6As an example, looking at the Indo-Netherlands Treaty, Article 14 needs to be consulted in conjunction with Article 12 dealing with royalties and fees for technical services. As per Protocol to this treaty, Article 12 got revised with effect from 1st April, 1997 vide Notification No. S.O.693(E) dated 30th August, 1999. Further, as per Notification No.11050/F No.501/2/83-FTD, it is provided that the Memorandum of Understanding and the Confirmation of Understanding dated 12th September, 1989 with reference to paragraph 4 of Article 12 of the Indo-USA Double Taxation Avoidance Convention (DTAC) will apply mutatis mutandis for the purpose of paragraphs III, IV, V and VI of the Notification No.S.O.693(E) (supra). Accordingly, in case of Indo-Netherlands Treaty, Article 14 would apply only to individuals and partnership firms and not to companies. This view is further supported by the exclusion clause of Article 12(6)(e) which mentions about only individuals and partnerships and not companies.
2.5Article 14 vs. Article 12: It is possible that fees for technical services (FTS) might also include professional services. In such context, whether Article 12 would apply or would Article 14 has precedence is an issue of debate. In this context, it is pertinent to consult the judicial precedence.
2.5.1It is held by the Kolkata Bench of the Tribunal in the case of Graphite India Ltd. vs. CIT (2003) 86 ITD 384 that once the services are covered as IPS under Article 14 then it is immaterial whether or not the same is covered by the FTS of Article 12. In other words, if more beneficial provisions are available to a tax payer, application of lesser beneficial provisions would be irrelevant, even though the services might have been covered by the definition of such lesser beneficial provisions. The same proposition has been upheld by the Authority of Advance Ruling (AAR) in D.E. Gustav Van Der Mark vs. CIT (1999) 235 ITR 698.
2.6Fixed Base vs. Permanent Establishment: It is important to examine what are the basic differences of ‘fixed base’ and ‘permanent establishment’.
2.6.1It is also a widely debated issue whether ‘fixed place of business through which business of an enterprise is carried on’ under Article 5 and ‘regularly available fixed base’ under Article 14 are different. In other words, usage of such fixed place of business or fixed base in a regular basis is of relevance to appreciate distinction between PE and fixed base. Longer duration of a place of business may be essential to demonstrate that such place has become a fixed one. Whereas shorter duration of existence of a professional base may be sufficient to establish the same as fixed base. Klaus Vogel in his commentary observes that Tax Authorities have required shorter times for IPS compared with business and industrial activities. Obviously, this indicates fixed base for IPS is of a lower degree of permanence.
2.6.2The wording used in Article 14 with respect to fixed base regularly available to the professional for applicability is an item of discussion in comparison with Article 5 dealing with PE. As per Article 5, the business of an enterprise must be carried on in the fixed place of business whereas under Article 14 fixed base must be regularly available to the person rendering professional services. Thereby, it is apparent that regular usage of the fixed base is not compulsory under Article 14. Klaus Vogel in his commentary observes the fixed base must be ‘regularly’ available to the person performing the independent personal services. In this regard, it differs considerably from the permanent establishment. For the latter, one requirement is that the business of the enterprise must be carried on in the fixed place of business. In contrast, the fixed base need only be available for his purposes to the person performing the services. In other words, it is not necessary for the fixed base to be used by him continually. It is further observed more over ‘to be available’ does not mean that the person providing the services must be the owner of the fixed base.
2.6.3Physical presence of a person rendering services through fixed base is an issue of debate. Unlike requirement of Article 7 dealing with business profits where a PE can exist in the form of machines or pipelines, IPS under Article 14 requires individual persons to render services. Klaus Vogel observes - As a rule services or activities cannot be performed at any place other than the one at which the person performing them is physically present. It was further observed by him - However, where activities are purely mental, or complex ones combining mental and physical activities, the peculiarity of the activity concern must be taken into consideration. It is critical to examine where the creative or the most essential parts of the services are performed. It is immaterial where the creative act was prepared or where in such a case the work so created was sold. The physical presence need not be of the professional person himself but could be his assistants and juniors who could accomplish the work in the source country either in part or full, if attribution of income arising out of such services is to the fixed base.
2.6.4Agency rule applicable to PE under Article 5 should not be made applicable to Article 14 dealing with IPS. Professional services and related contracts are not usually concluded by agents in the manner what is practised in business activities.
2.7Length of stay calculation: One of the criteria to charge IPS in the source State is the period of stay of the professional for 183 days or whatever be the length of time as per the treaty. Length of stay is to be calculated by aggregating different periods of stay during the 12 month period. In this context, it is to be noted that multiple counting of the common days, when the members of the partnership firm should be avoided. That is, when two or more partners were present in India together should be counted only once and not each member-wise. Multiple counting could result in a stay exceeding even 365 days in a year. The same is not permitted as held by the Hon’ble Mumbai Bench of the Tribunal in the case of Clifford Chance, United Kingdom vs. DCIT 82 ITD 106. Even stay of employees would be counted on the basis that such persons would be treated as ‘members’ as per the wording in treaty, as held by the Tribunal.
2.8Attribution of income: In respect of IPS under Article 14, whether it is net income or gross income that is attributable to the fixed base for taxation was an issue of debate. However, UN MC in the para 10 of the commentary imports the commentary of OECD MC with respect to attribution of income to a fixed base in the following words.
Thus the principles laid down in Article 7 for instance as regards allocation of profits between head office and permanent establishment could be applied also in apportioning income between the State of residence of a person performing independent personal services and the State where such services are performed from a fixed base. Equally, expenses incurred for the purpose of a fixed base, including executive and general expenses, should be allowed as deductions in determining the income attributable to a fixed base in the same way as such expenses incurred for the purposes of a permanent establishment.
2.7.1Klaus Vogel in his commentary also observed equally, expenses should also be allowed as deduction in determining the income attributable to a fixed base. It is obvious that both Article 7 and Article 14 refer to net income and not gross income.
2.7.2 Attribution of income to a fixed base may occur in a different manner in respect of a partnership firm, wherein only one of the four partners has a fixed base regularly available to him in the source country. A fixed base of a partner need not necessarily become fixed base of the other partners, if they do not have a right to use it for providing their services. In view of the same, only such profit as is attributable to such partner’s fixed base would be liable for tax in the source country. The other partners income derived from such fixed base would not be liable for tax in the source country, if such partners do not have a fixed base. The same is not the case with the principles of attribution of income to a PE. Once a partner constitutes PE in the source country, it would be a PE for the firm. This is as per Arvid Skaar’s commentary on Article 5 of OECD MC.
3.0Impact of withdrawal of Article 14 in OECD MC on source country taxation: