Consideration for assignment of supply agreement not taxable in the absence of Permanent Establishment in India

Facts

• The applicant, Laird Technologies India Pvt. Ltd. is engaged in the business of designing and manufacturing antenna and battery packs for mobile phone industry. The applicant is part of Laird PLC, UK group. Another group company viz. Laird Technologies Inc., USA (Laird-US) had negotiated a Product Purchase Agreement (PPA) with Nokia Corporation, Finland to supply the products globally including in India. The PPA was entered into between Laird-US and its affiliates (as one part) and Nokia Corporation, Finland and its affiliates (as other part).
• Laird-US entered into an assignment agreement with the applicant for irrevocably assigning all its beneficial rights, title, interest, obligations and duties related to supply of products to Nokia-India under the PPA for a period of 5 years. In pursuant of the above assignment agreement, the applicant agreed to pay a lump sum consideration of USD 5,300,000 to Laird-US.
• The applicant was of the view that since the assignment agreement is executed outside India and the capital asset being right in PPA was located and transferred outside India, there is no taxable income either on accrual or receipt basis in India. Accordingly the applicant is not required to withhold tax from such payment pursuant to the assignment agreement.

Contentions of the Revenue

• Laird-US and the applicant are affiliates; therefore the applicant is deemed to be a party to the PPA. Hence, question of assignment of rights and obligations under the PPA to its affiliate does not arise.
• The PPA casts host of obligation upon Laird-US without any consideration flowing to it and any legal right derived by it. In the absence of any legal right accruing to Laird-US under the PPA, there is no question of assignment of any rights in favour of the applicant.
• Under law, there can be assignment only of the rights and benefits in the contract but not of the burden and obligations. Assignment of obligations by Laird US under the PPA requires a consent of Nokia Corporation, which is absent in the present case. Therefore, such assignment of obligations without consent of Nokia Corporation could not be treated as transfer of capital asset.
• Under clause 5 of the PPA, Laird-US has an obligation to deliver the products to Nokia, India for which it has to avail of the services of a domestic Logistic Service Provider (LSP) for warehousing and delivering the products at the plant site of Nokia. The business network of LSP who would import goods on behalf of Laird-US and deliver them to Nokia at site constitutes the permanent establishment (PE) of Laird-US.
• The consideration payable to Laird-US under the agreement will increase or decrease with the change in volume of sales to Nokia-India. Laird-US continues to have legal commitment in respect of the business operations of the applicant in terms of guarantee of risks of deficiency in volume of sales. Laird-US is also required to make good the deficiency in relation to the gross margins that the applicant would have earned in supplying the products to Nokia India as per the volume indicated in the Agreement. Hence, the applicant is a dependent agent of Laird-US for its business of supplies of products to Nokia resulting in permanent establishment of Laird-US in India.

Contentions of the Applicant

• Affiliated company^? is defined in the PPA to include “any other entity controlled by or under control with, a Party”. Laird-US is neither a shareholder nor has any control over the management of the applicant company. Hence, the applicant is not Affiliate Company as defined in the PPA.
• The expression ^„cost of acquisition of capital asset^? under the Income-tax Act (ITA) specifically recognizes right to manufacture, produce or process any article or thing^? or ^„right to carry on any business^? as capital asset. The right conferred under PPA to supply the product represents capital asset. Any income from transfer of any part of such right is ^„capital gain and would not be taxable in India as capital asset being right in the PPA is situated outside India and transfer of such right has also taken place outside India.
• Clause 5 of the PPA was never invoked and accordingly no LSP was ever appointed or provided by Laird-US. Hence, Laird-US cannot be said to have fixed place PE in India.
• The agreement specifically provides that the applicant has to act in an independent status and has to supply products to Nokia India for a period of 5 years at its own risk and obligation on principal to principal basis. It has been carrying its business operations by itself without any direction or instructions from Laird-US. It supplies goods to Nokia-India not on behalf of Laird-US but on its own. In case of significant increase in volume of supply contemplated under PPA, the applicant is free to renegotiate the terms with Nokia-India. The applicant is also free to establish business relationships with other major electronics manufacturers in India. It has recruited its own sales personnel for the task. It is not depending on Laird-US economically nor is it acting according to instructions or subjected to any form of control by Laird USA from functional point of view. The applicant was not acting as agent much less as a depended agent of Laird-US in supplying the products to Nokia, India.

 Ruling of the Authority

• The fact that Laird Plc, UK is the ultimate holding Company of Laird US and the applicant company and both of them are a part of the organisational structure of Laird Plc. UK and known as Laird group companies in a broad sense, does not for the purpose of the agreement make the applicant an ^„affiliate^? of Laird-US in the absence of direct or indirect control of one party on the other.
• In the absence of an express or necessarily implied consent of Nokia Corporation (which was a party to the PPA), the assignment of burden and obligations cannot be accepted as legal transfer of capital asset. Therefore, the consideration cannot be deemed to be the capital gain.
• Irrespective of the validity of the assignment vis-a-vis Nokia Corp. i.e. the contractee, the assignment agreement is binding on Laird-US and the applicant. The consideration passed under the said agreement for parting with certain rights in favour of the applicant would still be income in the nature of business profits in the hands of the recipient.
• Once the necessary authorisation to manufacture and supply the products to Nokia India has been given, Laird-US cannot carry on the same business in India or interfere with the business carried on by the applicant. The provisions in the agreement relating to making good the deficiency in relation to the gross margins in case of decrease in volume of agreed sale does not militate against the relationship of principal to principal between Laird-US and the applicant. Therefore, Laird-US cannot be said to have any permanent establishment in India.
• The amount of consideration received by Laird-US from the applicant is in the nature of business profit that has accrued or arisen in India. However, as the recipient has no permanent establishment in India, the same is not liable to be taxed under the ITA having regard to the Double Taxation Avoidance Agreement between India and US.
• The income is not chargeable to tax in India therefore the applicant is not required to withhold tax on remittance of consideration.

Conclusion

The AAR upheld the contention that a transfer for the purpose of capital gain should be a legal transfer. The transfer of rights and obligations even if not binding on the third party are still binding on the parties to the agreement therefore consideration against the same could be treated as business profit. In absence of permanent establishment in India, consideration for assignment of supply agreement can not be taxable in India.

Source: Laird Technologies India Pvt. Ltd., AAR No. 73/2008 (Authority for Advance Ruling) dated 18 February 2010

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