Permanent Establishment (PE) is the fundamental criterion under the tax treaties for taxation of foreign company’s business income in India. A permanent establishment of a foreign company is typically regarded as a virtual extension or taxable presence of such foreign company in the host country, similar to that of an independent legal entity in such country. A PE of a foreign company is required to maintain books of accounts as per the normal accounting principles in the host country, besides undertaking tax compliances alike an independent legal entity.
Indian tax treaties follow the UN Model Tax Convention (MTC) and certain treaties typically include a “Service PE” clause, besides the general fixed place PE and dependent agent PE clauses. Fundamentally, a Service PE clause provides that if services are furnished through employees or other personnel of foreign company in a host country for a threshold period (say for a period or periods aggregating six months within any 12 month period as per the UN MTC), the foreign company shall constitute a service PE in the host country.
The ensuing paragraphs attempt to highlight a perspective only in relation to the concept of service PE in the context of the recent decision of the Hon’ble Income Tax Appellate Tribunal (ITAT), Bangalore in case of ABB FZE LLC (the assessee), a Dubai incorporated entity. The other aspects viz. validity of tax residency certificate, tax ability as royalty under the India UAE tax treaty, etc. which have been subject matter of analysis and decision by the Hon’ble ITAT are not subject matters of analysis, under this article.
Briefly stated, the facts of the ABB FZE’s case are, during AY 2010-11 and 2011-12, the assessee provided certain consultancy and management services under the regional headquarter service agreement to ABB Ltd. (assessee’s Indian counterpart), for consideration. To this end, employees of the assessee were present in India for a period of 25 days during the relevant financial year. The Indian Revenue authorities contended that the consideration received by ABB FZE LLC for providing the above-mentioned consultancy and management services is taxable in India as royalty under section 9(1)(vi) of the Income Tax Act 1961 (the Act), being consideration towards use of information concerning industrial, commercial or scientific experience. The assessee argued that the consideration received from ABB Ltd was in the nature of Fees for Technical Services (FTS). This consideration was not taxable in India in the absence of specific FTS clause under the India- UAE tax treaty. Moreover, since the assessee did not constitute any PE in India, such FTS could not be taxed as business income. The assessee relied upon the decision of the Hon’ble ITAT, Bangalore in its own case, based on similar facts for AY 2012-13. Additionally, the assessee contended that the consideration would also not taxable under residual Article 22 (‘other income’).
While the key grounds of the appeal by the assessee were whether the impugned consideration can be taxed as royalty and whether in the absence of any specific provision under the tax treaty (viz. FTS clause absent in the India UAE tax treaty), an amount can be taxed under the provisions of the domestic tax law (i.e. the Act), the Hon’ble appears to also have probed into and ruled on the aspect of existence of permanent establishment of the assessee. Some of the following viewpoints of the Hon’ble ITAT, with respect to PE of the assessee in India, are imperative to note.
- Article 5(1) of the India UAE tax treaty deals with fixed place PE and the conditions for constituting fixed place business of the assessee are not attracted in the given case;
- However, provision of services including consultancy services through employees of the assessee could lead to constitution of service PE under Article 5(2)(i) of the said tax treaty;
- In the context of provision of services, in the present technology era, where the services, information, consultancy, etc. can flow to the recipient thereof, through virtual modes like email, internet, video conference, etc., the physical presence of employees in India within the stipulated thresholds, to render such services should not be the sole criteria for determining existence of the Service PE of the assessee in India;
- As per the said India UAE tax treaty, it is not the threshold of stay of the employees for more than 9 months during any twelve month period as per Article 5(2) of treaty, but the fact that services or activities have been rendered/performed for a period of more than nine months within 12 months period, that is relevant in determining service PE of the assessee;
As may be apparent from the above, the Hon’ble ITAT’s viewpoints convey a new dimension in the interpretation of the relevant Service PE clause in tax treaties. Some of the key points to consider, could be whether, for the purpose of service PE clause in the UN MTC and relevant Indian tax treaties, provision of services in a host country (say India), may also include services rendered from home country of the foreign company (say UAE) and whether the time thresholds stipulated under concerned tax treaties qualify “provision / furnishing of services” or “physical presence” of foreign entity employees / personnel.
Assuming without admitting for a moment, that the relevant intent of the international tax law enshrined in the tax treaties, is that provision of services by a foreign entity through its employees / personnel in a host country (say India) could include provision of services from home country (UAE), virtually all income generating services by a foreign entity, rendered from outside India may lead to business income tax ability in India for such foreign entity through an implied service permanent establishment. Could this interpretation mean therefore, that the other pertinent income distributive rules under the tax treaty (viz. with respect to Royalty / FTS/ Other Income, etc.) lose relevance and thereby lead to unintended consequences?
Further, a logical interplay of the terms / phrases “furnishing”, “through employees or other personnel”, “in”/ “within” forming critical tenets of the service PE clause in tax treaties may signify services being furnished / rendered by a foreign company in the host country through its employees or other personnel in such host country. If employees or other personnel provide services (whether consultancy, technical, managerial or otherwise) through technological aids of communication, viz. emails, video conference, telephone, etc. technically the place of provision / furnishing of such services ought to be the place of origination of such emails / calls/ conferences and not destination thereof. It may be appropriate to contend that the terms “in” / “within” with respect to the host country qualifies the act of furnishing / rendition of services (economic activity) and not consumption thereof.
The outcome of this new dimension of interpretation by the Hon’ble ITAT will be important to watch out for in the near future, as it may tantamount to far reaching implications for global business operations in this technology weaved world.
(Sandeep Dasgupta is a Senior Manager with Deloitte Haskins & Sells LLP. The views are personal.)