Territorial nexus limits Indian taxation to services performed in India despite retrospective amendment and permanent establishment presence.
Territorial nexus confines taxation under section 9(1)(i) to income reasonably attributable to operations and services performed in India. The retrospective Finance Act 2010 amendment to the Explanation to section 9(1), being confined to clauses concerning specified categories of income, does not alter that position where income is assessed under section 9(1)(i). Under Article 7 of the India-UK DTAA, profits directly attributable to a permanent establishment are those it would earn as a distinct enterprise, while indirect attribution depends on its active contractual role and proportionate contribution. Services performed outside India cannot enter the Indian tax base merely because an Indian permanent establishment exists.
Issues: (i) Whether the retrospective amendment to the Explanation to section 9(1) by Finance Act, 2010 altered the legal position settled by the High Court that the assessee's income was chargeable in India only under section 9(1)(i) and only to the extent attributable to services performed in India; (ii) whether, on a construction of Article 7(1) read with Articles 7(2) and 7(3) of the India-UK DTAA, consideration referable to services rendered outside India could nevertheless be taxed in India as profits directly or indirectly attributable to the permanent establishment.
Issue (i): Whether the retrospective amendment to the Explanation to section 9(1) by Finance Act, 2010 altered the legal position settled by the High Court that the assessee's income was chargeable in India only under section 9(1)(i) and only to the extent attributable to services performed in India.
Analysis: The earlier High Court decision had proceeded on section 9(1)(i) and the territorial nexus doctrine, holding that where operations are carried on in more than one jurisdiction, only that part of the income reasonably attributable to operations in India can be taxed in India. The retrospective Explanation inserted by Finance Act, 2010 was held to impact only clauses (v), (vi) and (vii) of section 9(1). The assessee's income had not been brought under those clauses by the Revenue; on the contrary, the assessment orders and appellate findings proceeded on section 9(1)(i) and excluded fees for technical services treatment. Therefore, the amendment did not displace the earlier binding legal position applicable to the assessee.
Conclusion: The retrospective amendment did not alter the settled position, and the assessee's income remained taxable in India only to the extent attributable to services performed in India.
Issue (ii): Whether, on a construction of Article 7(1) read with Articles 7(2) and 7(3) of the India-UK DTAA, consideration referable to services rendered outside India could nevertheless be taxed in India as profits directly or indirectly attributable to the permanent establishment.
Analysis: Article 7(2) deems as directly attributable only the profits a PE would earn if it were a distinct and separate enterprise, which excludes profits from services rendered outside India by the other part of the enterprise. Article 7(3) specifically defines indirectly attributable profits by reference to the PE's active role in negotiating, concluding or fulfilling contracts and requires apportionment according to the PE's contribution. The provision is self-contained and materially different from the broader force of attraction model in the UN Model Convention. Accordingly, profits from the overseas part of the services cannot be expanded into the Indian tax base merely because a PE exists in India.
Conclusion: Consideration attributable to services rendered outside India was not taxable in India as profits directly or indirectly attributable to the PE.
Final Conclusion: The special bench held that the assessee succeeded on both referred questions, and the income attributable only to services performed in India could be brought to tax in India under the treaty and the Act.
Ratio Decidendi: A retrospective amendment to the deeming provision in section 9(1) that is confined to clauses (v), (vi) and (vii) does not affect taxation of income governed by section 9(1)(i), and under Article 7 of the India-UK DTAA only the portion of profits attributable in accordance with the treaty's own apportionment rules can be taxed in the source State.