R. Kumar, B.Com. MBA (Finance)
Internationally, two basic principles of taxation are followed- the residence based taxation and the source based taxation. Most of the countries, including India, tax their residents on their global income under residence based taxation. They tax non-residents on their income sourced in that country under source based taxation.
When a resident of one country earns income from a source in another country, the possibility of double taxation arises because one country may tax that income on the source principle whereas the other country may tax it on the residence principle. Generally, following the source based taxation, the Source Country is allocated the right to tax the income arising therein. While the Residence Country also taxes the income following the residence based taxation. The Residence Country mitigates the effect of double taxation either by way of tax exemption or by way of tax credit.
Concept of Permanent Establishment:-
The most important issue in the treaty based international fiscal law is the concept of Permanent Establishment (PE).All the three model conventions namely, UN (United Nations) Model, OECD (Organisation for Economic Co-operation and Development) Model and US (United States of America) Model use PE as the main instrument to establish taxing jurisdiction over a foreigner’s business activities.
Same need to be under stand in depth with following:
According to the concept of PE, the profits of an enterprise of one Contracting State are taxable in the other state, only if the enterprise maintains a PE in the later state and only to the extent that profits are attributable to the PE. Thus, a legal concept, PE is a compromise between source state and residence state for purposes of taxation of business profits. The term must be understood so as to arrive at that degree of economic penetration, which according to treaty partners, justifies a nation in treating a foreign person in the same manner as domestic persons. Profit attributable to a PE, in the State of Source are either exempted in State of Residence or the State of Residence allows credit of taxes paid by the PE on such profits. To this extent, the taxing jurisdiction by the State of Residence is said to be transferred to the State of Source, where the person needs to file his return of income and comply with domestic tax laws.
In a landmark decision i.e. CIT Vs. Vishakhapatnam Port Trust [(1983), 144-ITR-146 (AP)] on the subject of “Permanent Establishment”, the Andhra Pradesh High Court has observed as under:
“The words “Permanent Establishment” postulate the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another, which can be attributed to a fixed place of business in that country. It should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country onto the soil of another country.”
The UN Model not only re-affirms the concept but also supplements it with the new concept of a “fixed base”, to be used in the case of professional services or other activities of an independent character.
Structure of Article 5:-
Article 5(1) defines a permanent establishment and lays down the basic rule that a business activity carried on through a fixed place of business would constitute the PE of the tax payer. Article 5(2) mentions several examples of fixed place of business. These examples could also be said to form the ‘positive list’. Article 5(3) includes certain construction related activities and service related activities within the scope of PE if such activities continue for certain period. Article 5(4) mentions that a PE shall be deemed not to include certain activities. These could be said to form the ‘negative list’. Article 5(5) stipulates rules for determining when an enterprise represented by an agent would have a PE. Article 5(6) deals with the case of an enterprise carrying on insurance business. Article 5(7) and Article 5(8) set out rules in respect of an enterprises represented by an agent or an enterprises related to it.
v Article 5(1)- Basic Rule of PE:-
Article 5(1) defines PE as “a fixed place of business through which the business of an enterprise is wholly or partly carried on”. This is what is commonly referred to as ‘basic rule PE’.
The existence or otherwise of a PE is determined by applying the following tests.
- Objective Tests
v The place of business test
v The location test
- Subjective Tests
v The right of use test
v The permanence test
- Functional Tests
v The business activity test
v The business connection test
- Objective Test:-
Objective tests have two folds. First, there must be a “place of business”. Second, the place of business must be “fixed” in terms of location of the place of business. Normally, a place of business would postulate not merely a place but a place together with physical objects, which would be required to carry on business activity. It may be noted that a place of business could exist even if no employees are employed there. Illustratively, any equipment (such as, vending machines, telephone exchange, pipeline etc.) which is installed and which can function without the presence of any employee could constitute a PE provided the other conditions for a PE that are mentioned in Article 5(1) are satisfied. The place of management, though considered a PE, requires existence of an office or similar facility in order to constitute a PE and the management activities should be conducted through such fixed place. In other words, to constitute a PE, the existence of physical presence is must.
The “location test” has its roots in the ‘base theory’, which requires a fairly fixed place of business in the other country. It should be linked to a specific geographical point in the Source State. Location test would exclude place of business that are mobile. At the same time, however, it would not exclude a movable place of business. Thus, a petroleum drilling rig may constitute a PE even if it is moved rather frequently from one location to another.
- Subjective Test:-
The normal rule is that the place of business should be that of the non-resident enterprise and not of any one else. The requirement is that the place of business should be at the disposal of the enterprise. As a corollary, what is material is the right to use the place and not the manner in which such right has been secured; i.e., whether the place is owned, rented or otherwise at the disposal of the enterprise.
The right to use could be legal right to use and factual right to use. The enterprise should have the premises or facilities at its disposal. This implies that the place should be available to the enterprises for carrying on its business without any hindrance. e.g. A chartered accountant or Advocate were to use the facilities of his client, it would be doubtful whether he could be considered to have the place at its disposal and consequently, it is not likely to be considered as his PE. It may be noted that mere user of a place of business would not be sufficient to constitute that place as a PE since there would not be a legal right. However, if the chartered accountant or advocate has entered into an arrangement with the client whereby the chartered accountant or advocate would handle the assignment from a particular place in the client’s premises, such place may be considered to be at its disposal and consequently, it may be considered to have PE. This may be so even if the assignment being handled is of that particular client. Similarly, a person who carries on business from a room in the house or a hotel where he is staying, may also be considered to have PE notwithstanding that there may not be a specific agreement between him and the landlord or the hotel to use the house or the hotel room for business, or that such user is contractually or legally prohibited.
In case of permanence test, the place of business should have a certain degree of permanence. A place, which is purely of a temporary nature, would not constitute a PE. However, if the intention at the time when the place of business was set up for a fairly long time, it could constitute PE even if the activities terminated after a short period of time.
The term “permanence” should be understood as continuing for an indefinite period and not something that would continue or last for ever. In other words, it is not necessary that the right to use the place of business should be perpetual.
While there is no specific time period that would bring in ‘permanence’, in several countries, even a period of six months may be sufficient to constitute a PE.
- Functional Test:-
The mere existence of a fixed place of business or the ownership of assets (say, office and equipment) by itself would not be sufficient to constitute a PE. The place of business should actually carry on business activities.
The activity performed through the place of business should be the business of the enterprise. This requires four separate tests to be satisfied.
Firstly, the activity conducted by the enterprise must be business under the domestic law of the State where the activity is performed. It should be distinguished from other income generating activities or investments.
Secondly, even if the activity is classified under the domestic law of business activities, it should be treated as business activity under the Article dealing with business profits (Article 7 in case of UN Model Convention).
Thirdly, the activity should not be of a preparatory or auxiliary character which is referred to in Article 5(4) of the Model.
Fourthly, the business activity must have a certain connection to the place of business.
v Article 5(2)- Specific Inclusion:-
Article 5(2) specifically includes certain establishments within PE. These establishments are:
- Place of management
- Mine, oil or gas, quarry or any other place of extraction of natural resources
The establishments mentioned are more by way of illustration. Hence, even an establishment which is not mentioned therein could well constitute a PE.
It may be noted that merely because an establishment is of the nature mentioned in Article 5(2), it need not be treated as PE. For such an establishment to be treated as PE, it should first have the indicia of a PE that are set out in Article 5(1).
v Article 5(3) –Construction rule PE and Service rule PE:-
Article 5(3) specifically includes two kinds of activities, which together with an establishment would constitute PE. These activities constitute what are commonly referred to as ‘construction’ and ‘service’ and the rules which determine the existence of the PE are referred to as ‘construction rule’ and ‘service rule’. Under these rules, a PE comes into existence if the enterprise is carrying on the activities mentioned in the respective rules for certain period.
Under Construction rule PE if an enterprise has a building site, a construction, assembly or installation project or supervisory activities in connection therewith, a PE would come into existence if such site, project or activities continue for more than six months.
Under Service rule PE if an enterprise furnishes services (including consultancy services) through employees or other personnel engaged by it for furnishing such services, a PE would come into existence if such activities continue for a period or periods aggregating more than six months within any twelve month period.
v Article 5(4)- Specific Exclusion:-
Article 5(4) provides that use of the facilities for certain kinds of activities would not constitute a PE. These are:
- Use of facilities for storage or display of goods(the OECD Model Convention also includes delivery together with storage and display).
- Maintenance of stock of goods solely for storage or display.
- Maintenance of stock of goods solely for processing by another enterprise.
- Maintenance of fixed place for purchasing merchandise or for collecting information.
- Maintenance of fixed place of business for carrying out activities of preparatory or ancillary character.
- Maintenance of fixed place of business solely for any combination of above activities provided the overall activity of fixed place of business resulting from this combination is of preparatory or ancillary character.
v Article 5(5)- Agency PE:-
Under Article 5(5) where an enterprise doesn’t have its own establishment, it could have a PE through an agent provided the following tests are satisfied.
- Objective Tests:-
Against the requirement of a place of business under the basic rule, the agency rule requires the presence of an agent. Any person, whether an individual or a company, could be an agent. It is not necessary that the agent should be resident of the Source Country.
The agent should be authorised to conclude contracts on behalf of the principal. The authority may be general or specific or limited. However, it should be such that the agent’s action would bind the enterprise. The authority should be with respect to business of the enterprise. Normally, solicitation of business and negotiation of contracts that are subject to the approval of the principal would not constitute agency PE. The authorisation should be construed in substance and not in form. Thus, if an agent has the authority to negotiate all parts of the contract in a manner, which is binding on the principal but the contract is signed outside the Source Country, the agent could be said to have the authority to conclude contract.
Under Article 5(b), agency PE could come into existence even if the agent has no authority to conclude contracts but he habitually maintains stock of goods from which he regularly delivers goods on behalf of the enterprise. Again, the term ‘habitually’ indicates that the stocking should be repeated. Also, the term ‘regularly’ indicates that the delivery should not be on an exceptional basis.
- Subjective Tests:-
Only agent who are dependent upon the principal may constitute a PE. The dependency would, generally, be commercial dependency. Thus, assurance as regards the agent’s expenses, minimum guaranteed remuneration, etc. would indicate commercial dependency. Another instance would be a case where the agent has only one principal and devotes all his time to this principal.
- Functional Tests:-
The authority to bind the principal should be for the purposes which are essential and significant to the principal’s business and not for administrative purposes such as conclusion of contracts for stationery, rent, office, cleaning or manpower contracts.
Mere fact that the agent has the authority to conclude contract would result in agency PE. It is also necessary that the agent habitually exercise such authority. The term ‘habitually’ indicates that the authority should be used repeatedly and not merely in isolated instances.
v Article 5(6)- PE in case of Insurance Business:-
Article 5(6) doesn’t have a corresponding provision under the OECD Model Convention. It provides that an enterprise carrying on insurance business shall be deemed to have a PE in the Source Country if:
- It collects premium in the territory of the Source Country; or
- If it insures risks situated in the Source Country through a person other than an independent agent referred to in Article 5(7).
v Article 5 (7)-Absence of Arm’s Length Relationship:-
Article 5(7) provides for an exception to agency rule PE. An enterprise is not deemed to have a PE in the Source Country merely because it carries on business in that country through a broker, general commission agent or any other agent of an independent status if such person is acting in the ordinary course of business.
The exception mentioned above would , however, not apply in a case where the activities of such person are devoted wholly or almost wholly on behalf of that enterprise and conditions are made or imposed between that enterprises and the agent in their commercial and financial relation which differ from those which would have been made between two independent enterprises.
v Article 5(8)- No PE by virtue of Relationship:-
Article 5(8) clarifies that the company which controls, or is controlled, by another company which is resident of the source state would, by itself, not constitute either company a PE of the other. Thus, a subsidiary company would not constitute a PE of the holding company merely because it is controlled by the holding company or a holding company would not constitute a PE of the subsidiary company merely because it controls the subsidiary company.
Permanent Establishment (Part-II)
Case Study-1 Motorola Inc Vs. Deputy Commissioner of Income Tax[(2005) 95-ITD-269(SB)]
In the cases of Motorola Communication Inc(‘Motorola’), Ericsson Radio Systems AB (‘Ericsson’) and Nokia Networks OY(‘Nokia’) (2005) 95-ITD-269 (SB), the ITAT ruled on the cases of three telecommunication companies in the light of three different sets of facts.
The decision deals with a number of issues, which mainly affect taxation of non-resident in India. One such issue is whether the activities of the non-residents, in the facts of the case, result into a business connection/ Permanent Establishment (‘PE’) in India, merely because the non-residents had wholly owned subsidiary in India.
In this context, the following significant observations of the Tribunal are relevant:
No income is deemed to accrue in India to a non-resident from the sale of hardware and software if such sale is effected outside India to an Indian purchaser even tough the non-resident supplier, along with other group companies, has entered into a turnkey contract for supply and installation of equipment in India and the non-resident supplier assumes overall responsibility for the proper execution of said turnkey contract. In such a situation, as the sale of the equipment is effected outside India and the title and the risk therein passes to the Indian purchaser outside India, there is no business connection in terms of domestic tax law between the Non-resident supplier and the Indian purchaser.
A PE i.e., a fixed place of business of a non-resident would exist in India if one is able to point to a physical location at the disposal of the non-resident through which its business is carried on in India. Employees of the non-resident supplier having use of its Indian subsidiary’s office as a matter of right would constitute a PE of the non-resident supplier in India.
The existence of a liaison office in India, of a non-resident does not, in itself, constitute its PE in India.
A wholly owned subsidiary of a non-resident in India would constitute its PE in India if, their mutual relationship leads to the distinction between these two corporate entities becoming blurred and a reasonable inference can be drawn that the subsidiary was a virtual projection of the supplier in India.
In the case of Ericsson, the special bench held that it did not have a PE in India on account of there being no ‘fixed place of business’. Also, there was no ‘Agency PE’ as the subsidiary of Ericsson’s group company could not be said to be a ‘dependent agent’ of Ericsson as it had no authority to conclude contracts on Ericsson’s behalf. Also, as the profits in respect of the installation had already been taxed in the hands of the Indian subsidiary, the same could not be taxed once again in the hands of supplier (i.e. Ericsson).
In case of Motorola, the facts of the case showed that the employees of the Motorola was using the premises of the subsidiary not only for the work of Motorola but were also working for Motorola’s Indian subsidiary. While Motorola paid salaries to these employees, its Indian subsidiary provided them perquisites, which Motorola reimbursed to the subsidiary with a mark up. The special bench held without discussion that this led to a perception of the subsidiary being a projection of the activities of Motorola in India and hence a PE of Motorola could be said to be constituted in India. On facts it was however established that the activities carried on by the employees (the PE) were preparatory and auxiliary in character and because, as per Article 5(3) (e) of the DTAA between India and USA, there was a specific exclusion from the constitution of a PE by the carrying on of such activities, the Special Bench held that no PE of Motorola was constituted in India.
In case of Nokia, the Special Bench held that its liaison office would not constitute its PE in India as it was not carrying on commercial activities. In fact it was specifically barred by the Reserve Bank of India from doing so. The case of its subsidiary was different however, as the facts led to a perception of the subsidiary being a projection of the activities of Nokia in India.
The Special Bench held that it need not be established that there was actually a projection of the activities of the Non-resident in India. It was enough if the facts of the case resulted in a perception of the subsidiary being a projection of the non-resident in India. The facts which were found to be relevant in this context by the Special Bench in Nokia’s case are set out below:
The contracts for the supply of equipment and software were signed in India by an employee of Nokia’s liaison office. The same person took up employment with Nokia’s Indian subsidiary the very next day and signed the contracts for the installation also.
Nokia had given an undertaking to the Indian operators that it would not dilute its stake in the Indian subsidiary to below 51 percent.
Case Study-2 Deputy Director of Income Tax Vs. SET Satellite (Singapore) Pte. Ltd. [(2007) 106-ITD-175]
In the case of SET Satellite (Singapore) Pte. Ltd. 106 ITD 175, a question arose as to how the income of a resident of Singapore was to be computed, while applying the India-Singapore tax treaty, in a case where the non-resident had a dependent agent in India. It was urged on behalf of the assessee that once the agent was paid on arm’s length basis, the question of attributing any further income in India to the resident of Singapore should not arise at all. The Tribunal negated this submission and held that further income was assessable in the hands of non-resident. In the course of discussion, the Tribunal made the following observations on how the income attributable to a PE is to be computed:
“ The income attributable to the permanent establishment in the host country is the income attributable to foreign company’s operations in the host country, which, in turn, implies the income attributable to the activities carried on by the foreign enterprise in the host country. The income, is the income arrived at by taking into account revenues generated by the PE and deducting there from the expenditure incurred by the foreign enterprise to earn those revenues. However, it is open to the foreign enterprise to claim appropriate adjustment for the foreign enterprise’s overheads and even a reasonable charge, on account of activities of the foreign enterprise carried on outside the host country, by treating the foreign enterprises as a fictionally separate entity.”
Case Study-3 ABN Amro Bank Vs. Income Tax Appellate Tribunal [ 97-ITD-89]
In the case of ABN Amro Bank 97 ITD 89 (SB), a question arose as to whether the bank, while computing the income of its Indian Branches ( ‘PE’), was eligible to claim deduction for amounts debited to the profit and loss account of the Indian branches representing interest payable to overseas offices of the bank.
The Tribunal held: “The proposition of law is well settled that nobody can make profit out of self nor can trade with self nor earn from self.”
The Tribunal also held that no deduction was allowable since “the local law does not allow any deduction of the payment of expenditure to self. Nor does it assume the interest receipt from self through a branch or PE as its income and charges it to tax”.
The Tribunal also observed “As there is only one assessment in the case of the assessee bank both for the profit earned by the PE as well as the income earned by the head office in India. The result would be that on one hand, an expenditure by way of payment of interest by PE to head office would be allowable as a deduction and on the other, the receipt by the head office from PE would have to be charged to tax because the interest has been earned by, and arisen and accrued to the head office in India”.
The following cases were cited in support of the proposition that one cannot make a profit from oneself:
- Sir Kikabhai Premchand vs. CIT [(1953) 24-ITR-506 (SC)]
- Betts Hartley Huett & Co. Ltd. [(1978) 116-ITR-425 (Cal)]
- Ram Lal Bechai Ram vs. CIT [(1946) 14-ITR-1(All.)]
Case Study-4 Galileo International Inc Vs. Deputy Commissioner of Income Tax [(2008) 19-SOT-257(Del.)]
Facts of the Case:-
Galileo International Inc (‘Galileo’ or ‘assessee’) a resident of USA is engaged in the provision of services to hotels, airlines etc pertaining to reservations, booking etc through its Computerized Reservation System (‘CRS’). The services provided by it are as follows:
• Receipt of requests from Travel Agents of airlines etc (or TA) for information display (as stored in CRS), ticket booking etc;
• Forwarding the aforesaid requests from TA’s to Airline servers, receiving responses thereupon from Airlines Server, forwarding the same to TA’s etc;
• Generating reports on booking status for Airlines in set format etc.
• Display of real time status qua flight schedules, fares etc.
For this purpose, it maintains and operates a huge master computer system (MCS) consisting of 18 mainframe computers with its main server located in USA. This main computer is connected to the airline servers’ to/from which data is continuously sent and obtained. All the input processing and output is managed, processed and stored by the appellant through the MCS in USA.
In aforesaid connection, the appellant has entered into agreements (referred as participating carrier agreements or PCA) with various airlines etc. (referred to as ‘participants’ in the ruling) to provide them with the CRS services. The appellant earns booking fees from Airlines for services listed in relevant agreement including the above mentioned services.
The appellant in order to market and distribute the CRS services to the TAs appoints distributors and pays a distribution fees to them for their services. In India the appellant has entered into a distribution agreement (DA) dated 25th February 1995 with Interglobe Enterprises Pvt. Ltd., an unrelated party to market and distribute CRS services to the TAs in India.
The appellant is also responsible for securing the telecommunication network to enable the TAs to access the CRS.
In the course assessment and first level appellate proceeding it was decided that Galileo has a business connection in India and income chargeable to tax as per income tax act 1961, as well as a PE under Article 5 of the DTAA with USA. Galileo has decided to file an appeal with second level appellate authority against the aggrieved order of first level appellate authority.
Ground for Appeal:-
The appellant filed its return of income for 4 years for the AY 1995-96 to 1998-99, pursuant to a notice issued by the income tax department and contended as follows:
• No income accrued or arose to it in India nor could any such income be deemed to accrue or arise in India under section 5(2) or 9(1)(i) of the Income Tax Act,1961 and so it did not have any taxable income in India.
• It did not have any permanent establishment (PE) in India within the meaning of Article 5 of the DTAA between India and USA (treaty) and so the booking fees which is in the nature of the ‘business profits’ are not liable to tax in India under article 7(1) of the treaty.
Issues Before The ITAT:-
1) Whether Galileo had a Business Connection (BC) in India under section 9(1)(i) of the Act ?
2) Whether the appellant has any taxable income under section 5(2) of the act?
3) As regards DTAA, whether Galileo had a PE in India (fixed place or agency PE etc) as per article 5 of the DTAA entered between India and USA? As regards agency PE under DTAA, whether appellant is eligible to immunity provided under Para 5 of Article 5 thereof?
4) How much attribution of the income earned by the Galileo is chargeable to tax in India?
Decision Of The ITAT:-
1) Business connection under section 9(1)(i)of the Income Tax Act.
• The meaning of the word business connection is not exhaustive in nature in fact it includes some of the activities to be termed as business connection. It has a wide though uncertain meaning. thus in order to determine the business connection the facts of each particular case need to be analyzed.
• As regards accrual of income to assessee under the Act, ITAT ruled that income accrued to assessee inIndia and there existed a business connection for that in India, in view of the following:
• Computer/hardware as well as connectivity via nodes etc. (hired from SITA) was provided to TA’s etc in India by assessee (which were not dumb or in nature of Kiosk);
• Booking takes place in India through seamless CRS system of assessee;
• Booking constituted important limb of assessee’s overall operations and without the same, no income could have accrued to assessee.
• So income which is pertaining to bookings which takes place from the equipment in India can be deemed to accrue or arises in India and hence taxable in India.
2) Income accruing or arising under section 5(2) of the Income Tax Act.
• In the case of the business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be such part of the income as is reasonably attributable to the operations carried out in India.
• In the given case a majority of work which generates revenue (income) for the Galileo is carried outside the India. In India only generations of request and receiving of end results activities is carried on.
• Thus in the case of Galileo lion’s share of the appellants operations took place outside India, only miniscule portion, adjudicated at 15% of the appellants income, was held to have accrued in Indian territories. The extent of work carried out in India is in relation to generating requests and receiving the end result of the process in India.
• The ITAT held all the expenses in the form of the remuneration to the Interglobe are held as an allowable deduction and shall be reduced while computing the income of the appellant and since the payment to the agent in India is more than what is the income attributable to the PE in India, it extinguishes the assessment as no further income is taxable in India.. In this connection, ITAT placed reliance on SC ruling in Morgan Stanley (supra) and CBDT Circular No. 23 of 1969 (supra).
3) Permanent establishment under DTAA.
Fixed place rule which is stated in article 5(1) Article 5(1) gives a general definition of the permanent establishment i.e. it is a fixed place of business through which the business of an enterprise is partly or wholly carried on.
The ITAT held that Galileo has a fixed place of business in the form of the computers installed in the premises of the subscribers (travel agents) through which it carries its business partially. The justification for this ruling is as under: -
1. In the case of Galileo, CRS is the main source of revenue, which is partially existent in the various computers installed at the premises of the subscribers. These computers perform the functions of reservation and ticketing and form an integral part of the entire CRS.
2. The computers so installed cannot be shifted from one place to another even within the premises of the subscriber. Thus the appellant exercises complete control over the computers installed at the premises of the subscribers.
3. In some cases the appellant itself has placed those computers and in all the cases the appellant through its agent installs the telecommunication network.
4. The ITAT ruled the same).
_ Exceptions to the above rule which is stated in article 5(3)
1. Article 5(3) lists a number of activities, which are preparatory and auxiliary in nature, these activities act as exceptions to the general definition laid in article 5(1) and which are not regarded as PE’s even when the activity is carried through a fixed place of business.
2. The activity of the appellant is developing and maintaining a fully automatic reservation and distribution system with the ability to perform comprehensive information, reservation, communication, ticketing, distribution and related function on a world wide basis. Thus, ITAT ruled that since appellant’s activities in India contributed directly to revenue generation, it do not fall in umbrella of ‘preparatory or auxiliary’ clause of subject DTAA.
_ Agency rule stated in Article 5(4)
1. Under the said article, an agent is a person employed to do any act for another or to represent another in the dealing with the third person. Thus, any agent can be considered PE only and only if when a person other than agent of independent status,
i) Has and habitually exercise in that state an authority to conclude contract, or
ii) Though it has no such authority but habitually maintains stock of goods from which he regularly deliver goods on the behalf of the enterprise.
2. In the present case Interglobe is completely dependant on the appellant in respect of rendering services to the subscribers. Thus that part of the income, which earns its revenue by rendering services to the subscribers, is carried on solely by the appellant. Even though the distributor may have other business activities, in respect of the CRS business the distributor acts only for the appellant and not for any other person. Thus the tribunal said that Interglobe is a dependant agent (DA) of the appellant.
3. Also, although the distributor is responsible for entering into the contracts with the subscribers, yet the appellant through the PCA ensures that the subscribers are authorized to use the ‘Galileo system’. Therefore, Interglobe is a DA of the appellant who has habitually exercised the authority to conclude contracts on the behalf of the appellant.
4. In the case of Galileo, if the agent is to deliver the goods either the goods should be such in which the enterprise deals in or which are regularly hired out which may be considered as given on bailment from which the revenue is generated. But in the present case the computers supplied by Interglobe to the subscribers are not dealt with by the appellant or which is by itself is the source of revenue. Thus clause (b) of paragraph 4 of article 5 does not apply to consider the dependant agent as PE of the appellant in India.
5. In a nutshell, the ITAT held that the distributor is a DA of the appellant to the extent that it exercises the authority to conclude contracts on behalf of the appellant.
_ Attribution of profits under article 7 of the DTAA.
• Having considered that the appellant had a PE in India under two forms- fixed place PE and agency PE the ITAT examined as to what is the profit attributable to the PE under the said article.
• Article 7 of the treaty postulates that only that much of profit as are arising due to assets and activities of the PE can be brought to tax and if the whole of the business activities are not apportioned between that arising in India and outside India.
• Since the entire activity of Galileo is not carried out in India where the PE is situated so, only that much of the profit is attributable to the functions carried through the PE, and only this much of the attributed profit can be taxable in India.
• On attribution front under subject DTAA, ITAT after deliberating upon Para 5 of Article 7 thereof (supra) reiterated its findings that 15% of ‘booking’ revenue generated to assessee is taxable in India and since assessee remunerated Interglobe (agent in India) more than what is attributable to PE in India, it extinguishes any further assessment.
This ruling enhances the possibility of identified as a PE for the companies using internet and information technology in the business. This ruling creates difficulties for the MNC’s for managing the risk of PE. It also needs to review the importance of this ruling and its effects.
Case-5 DIT (International Taxation) Vs. Morgan Stanley and Co. Inc.[(2007) 292-ITR-416 (SC)]
In Morgan Stanley and Co. (2007) 292-ITR-416 (SC), the Supreme Court has revisited the ruling of the AAR on the issue of PE.
The brief facts that case were that the non-resident, an investment bank, was a wholly owned subsidiary of Morgan Stanley US. The non-resident, Morgan Stanley and Co. (‘MSCo’) provided financial advisory services, corporate lending and securities underwriting services through various divisions. Morgan Stanley Advantage Services Private Limited (‘MSAS’) was a group of company set up in India to support the Morgan Stanley group’s front office and infrastructure unit functions by providing support services. MSCo entered into an agreement with MSAS to outsource support services, under which it proposed to send its employees to India to acquaint MSAS with the global standards and requirements of services expected of MSAS to meet the global benchmarks of the Morgan Stanley group. MSCo also . planned to send staff on deputation to MSAS at the latter’s request. The employees would remain on the payroll of the MSCo and the actual cost of these employees was to be reimbursed by MSAS to MSCo. MSCo would pay MSAS costs (both direct and indirect) plus a mark up based on a transfer pricing study using the Transactional Net Margin Method (‘TNMM’) for the services rendered by MSAS. MSAS was registered with the Software Technology Park of India for providing information technology enabled services to the Morgan Stanley Group and had claimed exemption under section 10A of the Act in respect of its income.
MSCo sought a ruling from the AAR on the issue of whether MSAS would constitute a PE of MSCo in India, having regard to the provisions of Article 5 of the India-USA Tax Treaty and if so what would be the amount of income attributable to such PE.
The AAR held that MSCo did not have a ‘fixed place’ PE in India as per Article 5(1) of the treaty. Further, MSAS could not be regarded as an agency PE under Article 5(4) of the treaty. However, MSCo would be regarded as having a service PE in India under Article 5(2)(i) as it proposed to send its employees to India for undertaking stewardship activities or on deputation in the employment of MSAS. However, as MSAS was remunerated at an arm’s length, no further could be attributable to MSCo’s Indian PE.
In this context, the Supreme Court examined, inter alia, the applicability of Article 5(1). The Supreme Court observed as follows:
at page 421, in para 6
“A general definition of P.E. in the first part of Article 5(1) postulates the existence of a fixed place of business where the second part of Article 5(1) postulates that the business of the MNE is carried out in India through such fixed place.”
at page 425, para 8
“ In our view, the second requirement of Article 5(1) of DTAA is not satisfied as regards back office functions. We have examined the terms of the Agreement along with the advance ruling application made by MSCo inviting the AAR to give its ruling. It is clear from reading of the above agreement/application that MSAS in India would be engaged in supporting the front office functions of MSCo in fixed income and equity research and in providing IT enabled services such as data processing support centre and technical service as also reconciliation of accounts. In order to decide whether a P.E. stood constituted one has to undertake what is called as a functional and factual analysis of each of the activities to be undertaken by an establishment. It is from that point of view, we are in agreement with the ruling of the AAR that in present case Article 5(1) is not applicable as the said MSAS would be performing in India only back office operations. Therefore to the extent of the above back office functions the second part of Article 5(1) is not attracted.”
at page 443,para 33
“As regards attribution of further profits to the PE of MSCo where the transaction between the two are held to be at arm’s length, we hold that ruling is correct in principle provided that an associated enterprise (that also contribute a PE) is remunerated on arm’s length basis taking into account all the risk taking functions of the multinational enterprise. In such a case nothing further would be left to attribute to the PE. The situation would be different if the transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise. In such a case, there would be need to attribute profits to the PE for those functions/risks that have not been considered.”
The concept of Permanent Establishment is one of the most important concepts in International Taxation. The existence of a Permanent Establishment or otherwise, would in most cases determine the exposure to domestic tax liability in the country of source. It is, therefore, imperative to understand the concept fully before embarking on the structuring of activities in another jurisdiction. Attribution of profits to a Permanent Establishment has also been one of the major issues both for taxpayer as well as tax advisers.
(Author can be reached at email@example.com)