ITAT Delhi Deletes FTS Addition on Income of UK-Based Law Firm: Non-UK Partners' Taxability Must Be Examined Under Respective DTAAs

Overview of the Case

The Income Tax Appellate Tribunal, Delhi Bench, recently adjudicated three appeals filed by Herbert Smith Freehills LLP, a solicitors' firm registered and headquartered in the United Kingdom, against the order of the Commissioner of Income Tax (Appeals). The appeals pertained to Assessment Years 2015-16, 2018-19, and 2021-22, all of which raised identical questions of law and fact concerning the taxability of income earned from Indian legal engagements.

Since the core issues were common across all three appeals, the Tribunal designated the appeal for AY 2015-16 as the lead case, with the findings thereof being applied uniformly to the remaining two assessment years.

Background and Nature of the Assessee

Herbert Smith Freehills LLP is a globally operating solicitors' firm, rendering professional legal services to clients across multiple jurisdictions. As a fiscally transparent entity under UK domestic tax law, the firm itself does not bear any direct tax liability. Instead, its income is allocated among its partners in accordance with their respective profit-sharing ratios, and the tax obligation is discharged by each partner individually based on their country of tax residence.

The firm's partnership structure, as relevant to the assessment years in question, comprised partners belonging to multiple national tax jurisdictions. The profit-sharing ratio of partners across these jurisdictions was as follows:

Return Filed and Exemptions Claimed

For Assessment Year 2015-16, the assessee filed its return of income declaring a total income of Rs. 91,37,540/- and claimed a refund of Rs. 9,12,40,740/-. The total revenue received from legal services rendered on Indian engagements amounted to GBP 27,49,936/-.

In its return, the assessee took the position that:

• Income attributable to UK-resident partners (82.121%) was exempt under the India-UK Double Taxation Avoidance Agreement (DTAA), as amended by Notification No. 10/2014 dated 10.02.2014.
• Income attributable to non-UK resident partners from Australia, France, Belgium, China, and Japan was not taxable in India by virtue of the DTAAs executed between India and the respective countries of residence of those partners.
• Income attributable to German partners (3.627%), however, was voluntarily offered to tax under the India-Germany DTAA, since that treaty lacks a "make available" clause.

Assessment and Addition by the Assessing Officer

The Assessing Officer accepted the assessee's position with respect to two categories:

1. UK-resident partners – The share of profits attributable to partners domiciled in the UK was held to be exempt from taxation in India under the India-UK DTAA.
2. German partners – The income voluntarily offered to tax under the India-Germany DTAA was accepted as correctly offered.

However, the Assessing Officer rejected the claim of treaty protection for partners residing in Australia, France, Belgium, China, and Japan, holding that the assessee — being a UK-registered firm — could only derive treaty benefits under the India-UK DTAA, and since that treaty's protection extended only to UK residents, the non-UK resident partners could not independently claim relief under their respective country-specific DTAAs through the medium of the UK firm.

Treating the income attributable to these non-UK resident partners as Fees for Technical Services (FTS) under Section 9(1)(vii) of the Income Tax Act, 1961, the Assessing Officer made an addition of Rs. 3,59,02,752/-, representing 14.25% of the total Indian receipts.

The CIT(A) upheld this addition, prompting the assessee to file appeals before the Tribunal.

Arguments Advanced by the Assessee

Treaty Eligibility of Non-UK Resident Partners

The assessee's counsel submitted that the lower authorities had fundamentally misread the scope and operation of the India-UK DTAA. The key arguments were: