Foreign law firms have received a shot in the arm following a judgement from the Bombay High Court which clearly states that their income will be taxable in India only to the extent of their operations in India.

An early beneficiary of the judgement has been Clifford Chance, a UK-based legal firm which during 1996-97 was appointed as legal advisors for three projects in India Bhadravati power project, Vizag power project and Ravva oil and gas fields project.

In the subsequent financial year, it began work on the Vemagiri power project as well. Only the Bhadravati project had an Indian firm Ispat Industries which was the JV partner for construction of the power plant. The partners for the other projects were not resident in the country.

Clifford Chance was remunerated on an hourly rate basis with each of its partners and employees maintaining detailed time sheets. This was a record of the time spent on doing such work in India and outside it. The bills so raised were paid to Clifford Chance by the clients outside India. The law firm filed a return showing an income liable to Indian taxation of Rs 5.08 crore.

According to the Income-Tax Department, the entire fee received by Clifford Chance from its clients for the four projects was taxable in India. This was irrespective of the fact that such fee was received for services rendered by it outside. The determining factor has been the place where the legal firms services were utilised and not the place where the services were performed. As such, the taxable income calculated by the department was Rs 17.26 crore.

Clifford Chances contention was that under the provisions of the Income-Tax Act and the Double Taxation Avoidance Agreement between India and UK, only that portion of its income from the clients which was attributable to the services performed by it in India could be subjected to Indian taxation.

The Income-Tax Tribunal as well as the Appellate Authority ruled in favour of the department. This was on the grounds that even though services rendered by Clifford Chance outside India had to be excluded while computing tax, the advice given by the legal firm was for projects that were to be executed in the country.

Senior counsel Harish Salve argued before the Bombay High Court that the tax on professionals who have been in the country for over 90 days would be taxable under the Income-Tax Act. In order to be taxed here, the income must accrue or arise in India.

Applying this to a legal professional rendering advisory services, his presence at the time of rendering advice would be the basis for determining where income is taxable, he contended. He further submitted that the income of an individual from professional services, therefore, is taxable in the state of residence. It is additionally taxable in the other contracting state if the services are performed in that other state.