Mumbai Ruling: In order to constitute a fixed place permanent establishment (PE), three criteria have to be satisfied viz. (a) the physical criterion (existence of physical location) (b) subjective criterion (right to use that place) and (c) functional criterion (carrying on business through that place). It is only when the three conditions are satisfied that a PE under the basic rule can be said to have come into existence. The onus is on the Revenue to show that the assessee has a PE (Airlines Rotables Limited v JDIT).
Facts:
Airlines Rotables Limited (the assessee / ARL), a resident of United Kingdom (UK), was engaged in providing spares and component support for aircraft to the aircraft operators. The assessee entered into an agreement with Jet Airways Limited (the airline), an Indian company engaged in the business of air transportation, for providing certain support services in respect of Boeing 737 aircraft.
As per the agreement, when the airlines discovered that an aircraft component became operationally unserviceable (not in a condition to be used or was not airworthy), the same was to be repaired or overhauled by the assessee and the assessee also had to ensure that airworthiness directives in respect of the same were to be complied with. In addition to repairs and overhauling, the assessee also had to provide a replacement component which could be used by the airline during the period its original equipment was under repairs or overhauling by the assessee. The assessee was also responsible for providing replacement rotables (see Note- 1), on exchange basis, required for an aircraft as a result of operational unserviceablity.
In order to ensure availability of replacement components and no interruption of the flight operations due to repairs and servicing of the components, the assessee company had provided stock of such components, as agreed with the airlines, at the operating bases of the airlines. In addition to this, the assessee had also maintained a stock of components at its main depot in the UK from which the assessee used to provide replacement components within time limits specified in the agreement and which varied depending upon the urgency of requirements. As the assessee did not have any storage or support facilities in India, the stock in India were in the possession of the airlines itself, though as a bailee.
During the course of assessment proceedings, the Assessing officer (AO) did not accept the claim of the assessee that it did not have a PE in India. The AO noted that the store staff of airline was acted as agent of the assessee and this relationship had resulted in a PE coming into existence. In this regard, he relied upon Article 5(4) of India-UK Double Tax Avoidance Agreement (tax treaty) – dependent agent on account of habitual maintenance and regular supply of goods therefrom. Further, he was of the view that assessee’ s stock were permanently kept at fixed places in India, with clear identification of each of stock item and therefore, the assessee had a fixed placed of business in India. He also noted that the exclusions clauses in Article 5(3) of the tax treaty were not applicable in the instant case. Accordingly, he concluded that the assessee had a PE in India as per Article 5 of the tax treaty and hence, receipts would be taxable in India as business profits. He further estimated 10% of gross receipts as its profits liable to be taxed in India.
On appeal, the Commissioner of Income tax (Appeals) [CIT(A)] held that the assessee had a fixed place of business within the meanings of Article 5(1) and 5(4) of the tax treaty since the assessee was having a fixed place of business in which goods were kept as stock for sale. He also observed that “the issue of sale has to be understood in its widest meaning in relation to business transactions” and added that “the assessee is engaged in the business or providing repairs to the faulty components of Boeing”. The CIT(A) thus justified that delivery of such repaired parts amount to sales as income is arising out of such delivery of goods and the repaired parts.
The assessee therefore preferred an appeal before the Income tax Appellate Tribunal (Tribunal). Questions before the Tribunal:
- Whether the assessee had a PE in India?
- Whether an adhoc rate of 10% can be applied for determining the profits attributable to alleged PE in India?
Tribunal’s observation and Ruling:
- In terms of Article 5(1), i.e. the basic rule, a PE is said to exist in the other contracting state when an enterprise of one of the contracting states has a fixed placed of business, in that other contracting state, through which business is carried out – wholly or partly.
There are three criterions embedded in this definition-
(i) physical criterion i.e. existence of physical location,
(ii) subjective criterion i.e. right to use that place and
(iii) functionality criterion i.e. carrying out of business through that place. It is only when these conditions are satisfied, a PE under the basic rule can be said to have come into existence.
- Undoubtedly, the consignment stock of the assessee was stored at specific physical locations; but this storage was under control of the airline and the assessee did not have place at its disposal in the sense that it could carry out his business from that place.
- The consideration for the services rendered by the assessee was divided into two parts: one segment as a consideration for repairing and overhauling of rotables and other segment as consideration for use, or right to use, of the replacement equipment.
As for the consideration for repairs and overhauling of equipment, no part of the profits thereon could be taxed in India for the reason that these activities were carried outside India and, even if there is a PE, only such profits as attributable to PE can be taxed in India under Article 7(1).
As far as the consideration for use or right to use the replacement equipment are concerned, the location of such equipments so given for use or right to use cannot be viewed as a place of carrying on its business, which is limited to, qua that consignment, the consignment so having been given for use or right to use. The business with regard to that consignment is over when that consignment is given for standby purposes to the airline. Accordingly, the Tribunal has observed that not only that the assessee did not any right to use the location of consignment stock, such a location was also not used for the purposes of assessee’s business.
- There is also no projection of the assessee at this physical location in the sense that the business is carried out, or sought to be carried out or even projected, from these locations. When the physical locations at which consignment stock is kept do not project the assessee, it cannot be said that these locations constitute PEs of the assessee.
- The Tribunal has not found any substance in the argument of the Revenue that the assessee was storing the goods and using the place for securing the orders, and for this reason, the physical location of storing consignment stock should be treated as a PE.
- The Tribunal has observed that unless it is a warehouse and the storage of goods is for outsiders, which certainly not in the instant case, therefore, the storage of goods cannot lead to a PE. That apart, it is not the case of storage of goods even, since the consignment stock is handed over to the airline for use as standby replacement components. There is something more than storage simplicitor involved in this exercise, and that is the right to use the stock for the airline’s operational requirements on as and when required basis.
- As regards using the place of storage as a location to securing the sale orders, the components stored are for standby use of the airline and it is not even the business of the assessee to sell those components.
- As regards the dependent agent PE, the Tribunal has observed that no business is carried out through the agent, even if there be an agent in keeping the consignment stock, because this consignment stock with the airline is the end result of the assesee’ s business and not an intermediate step to get business. What the assessee was paid for, vis-à-vis the consignment stock, is consideration for so placing the consignment stock at the disposal of the airline. The only part of the consideration received by the assessee is for repairs and overhauling of aircraft rotables, a work which is entirely carried outside India and no part of profit thereon could be taxed in India as attributable to PE. It would be absurd to contend that the airline is dependent agent of its suppliers for the purposes of giving out replacement component.
There is no material whatsoever to establish, or even indicate, that airline or it staff constitute dependent agent of the assessee. Even if one assumes that airline can be treated as an agent of the assessee for this purpose, airline will at best be an independent agent and custodian of the consignment stock, covered by the first limb of Article 5(5). Unless second limb of Article 5(5) is satisfied (i.e. authority to negotiate and conclusion of contact, maintainance of stock for delivery purpose for and on behalf of the enterprise and securing of order on behalf of), taxability as a dependent agent PE will not arise. The CIT(A) has also erred in observing that the delivery of repairs part amounts to sales because the assessee is being paid for repairing the components owned by the airlines. The Tribunal has failed to understand how can one sell something to a person who already owns that thing. The delivery is for standby use of equipment and not for its sales.
- The onus is on the Revenue to demonstrate that a PE of the foreign enterprise exists in India. That onus is not discharged in the instant case and therefore, the business model of the assessee is such that in the above arrangements, a PE in the source location does not come into existence.
- In view of the above, the Tribunal has held that the assessee did not have any PE in India and accordingly, the entire income attributable to the India operations could not have been taxed in India.
- The Tribunal has, however, noted that its finding that the assessee did not have a PE in India, by itself, would not take the assessee out of ambit of tax ability in India. While the consideration for use or right to use the consignment stock of equipment is taxable under Article 7(1) read with Article 13(6), in a situation when the assessee has a PE in the contracting state, even when the assessee does not have PE, its tax ability is still required to be considered in the light of Article 13(3)(b) (Royalty – for use of, or right to use of, any industrial, scientific or commercial equipment) on gross basis. Having held that the assessee had a PE in India, the lower authorities were not required to give a finding on that aspect whether it is taxable as royalty on gross basis. Non tax ability under Article 7 will still mean that application of Article 13 is to be considered and adjudicated upon. However, since this aspect was not considered by lower authorities, the matter has been remitted back to the CIT(A) for limited adjudication on this aspect of the matter.
Our View:
This judgement has correctly brought out the important ingredients of a fixed place PE i.e. existence of physical location, right to use that place and carrying on business through that place. It is only then, a PE under the basic rule can be said to have come into existence. This important live- link of carrying on the business through a fixed place PE had been well brought out by Authority for Advance Ruling in Morgan Stanley (284 ITR 260), which has been confirmed by the Supreme Court (292 ITR 416).
This decision finely distinguishes between having a stock of goods for incidental activity as in the instant case and having stock of goods, stored in a warehouse for sale, which clearly results in a fixed place PE.
The Tribunal has further held that the onus is on the Revenue to show that the assessee has a PE.
Note
1. Rotable is an item, with a manufacturer’s serial number, that can be economically restored to a serviceable condition, and, in the normal course of operations rehabilitated to a fully serviceable condition over a period approximating the life of the light equipment to which it is rel
ITAT judgement to show that a mere place of storage of stock would not amount to having a PE, because There are three criterions embedded in this definition – (i) physical criterion i.e. existence of physical location, (ii) subjective criterion i.e. right to use that place and (iii) functionality criterion i.e. carrying out of business through that place. It is only when these conditions are satisfied, a PE under the basic rule can be said to have come into existence.