The Bombay High Court has ruled that a foreign law firm may only be taxed in India on work performed in the country, supporting an appeal by Clifford Chance (CC).

CC had previously been ordered by India's Commissioner of Income Tax to pay taxes on all of the fees – around $3m (£2.04m) – it earned on work performed on four energy infrastructure projects undertaken in India between 1996 and 1998.

The magic circle firm primarily advised non-Indian participants on UK law aspects of the projects and much of the work was handled outside of India. CC challenged the assessment, arguing that only around $871,000 (£592,000) in fees actually billed in India should be taxable.

The Bombay High Court (pictured) took up the case after India's Income Tax Appellate Tribunal ruled in September 2001 that the nature of the work should determine its taxability in India. In rejecting CC's appeal, the tribunal determined that the "territorial nexus" between the firm's fees and the projects in India meant all of the fees, wherever billed, accrued or arose in India and were taxable nationally.

But in a decision dated 19 December, the court reasoned that "[i]ncome arising out of operations in more than one jurisdiction would have territorial nexus with each of the jurisdictions on actual basis. If that be so, it may not be correct to contend that the entire income 'accrues or arises' in each of the jurisdictions."

CC's lawyer, former Indian Solicitor General Harish Salve, argued that, in the case of a legal professional rendering advisory services, the services could only be considered to have been rendered at a place where the professional is personally present. Any other rule would create chaos and uncertainty, Salve maintained.

The court agreed, ruling that "for a non-resident to be taxed on income for services, such a service needs to be rendered within India, and has to be part of a business or profession carried on by such person in India".

Decisions by the Bombay High Court and other Indian high courts are appealable to the Supreme Court of India.

The issue of taxation has been a sore point for international law firms targeting key developing markets such as India and China. In both countries authorities and local Bar groups have occasionally floated broader taxation on work handled abroad but tied to matters or transactions within those countries' borders.

Anthony Lin is Incisive Legal's chief Asia correspondent.

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