AAR Ruling: The demarcated space made available in the warehouse by the logistics service provider constitutes fixed place of business [Sea gate Singapore International Headquarters Pvt. Ltd. (AAR No. 831 of 2009) (2010-TIOL-08-ARA-IT)].
Seagate Singapore International Headquarters Pvt. Ltd. (applicant) was engaged in the business of manufacture and sale of Hard Disk Drives (disks). It has been supplying disks to Original Equipment Manufacturers (OEMs) in India. In order to minimise the delays in the procurement of inputs from the applicant, the OEM proposed to put in place a Vendor Managed Inventory (VMI) model. Under the VMI model, the applicant would enter into agreements with ‘Independent Service Providers’ (ISPs) in India who would stock disks in India on behalf of the applicant and deliver the same to the OEM on a ‘Just-in Time’ basis. The typical steps involved in this arrangement were as follows:
- The OEM would raise a purchase order on the applicant pursuant to which the applicant would ship the goods to the ISPs in India;
- The ISPs would clear the goods from the customs port as the Importer on Record and would, thereafter store the same in a bonded warehouse. The ISPs would also furnish the bond with the customs authorities of India for clearing the goods without payment of customs duty. The ownership of the goods would remain with the applicant;
- Whenever the OEM places a ‘pull request’ for the goods on any ISP, it would immediately deliver the goods to the OEM and inform the applicant of such delivery having been made;
- After receiving a pull request from the OEM, such ISP would clear the goods from the bonded warehouse by following the required procedures and deliver the same at the OEM’s premises. The applicant would, at this point, raise its invoice for the goods delivered by ISP to the OEM;
- The OEM would, in turn, make the payment directly to the applicant outside India;
- The ISPs would operate from bonded warehouses (operated and controlled by them) and would raise their invoices on the applicant for services performed in India;
- The ISPs would also obtain registration with the Value Added Tax authorities in their names in the relevant State in India, pay applicable taxes and would file related returns in connection with delivery of goods to the OEM. The ISPs would be remunerated on an arm’s length basis by the applicant.
A similar arrangement is proposed to be put in place by entering into an agreement with YCH Logistics (India) Pvt. Ltd. (YCH), a private Company incorporated in India. The said company would stock goods in India on behalf of the applicant and deliveries will be effected to Dell India (Pvt.) Ltd. (Dell). The modus operandi of the proposed arrangement with YCH and Dell is broadly similar, that of with the ISPs and OEMs, as mentioned above. As per the agreement with YCH, YCH will act as a logistics service provider and it shall be responsible for warehousing the Sea gate products and to deliver the same to Dell in India.
Issues raised before the Authority for Advance Rulings (AAR):
(a) Whether the applicant would have a Permanent Establishment (PE) in India under Article 5(1) or 5(8) of the India- Singapore Double Taxation Avoidance Agreement (DTAA) in relation to the activity of delivering goods through a customs bonded warehouse owned and operated by an ISP in India.
(b) In case the answer to Question (a) is in the affirmative, but the service provider is remunerated on an arm’s length basis, would any further income be attributable to the PE of the applicant in India in terms of Article 7 of the DTAA?
(c) Whether the applicant would have a PE in India under Article 5(1) or 5(8) of the DTAA, in relation to the activity of delivering goods through a customs bonded warehouse owned and operated by YCH in India.
(d) In case the answer to Question (c) is in the affirmative, considering that YCH would be remunerated on an arm’s length basis, would any further income be attributable to the PE of the applicant in India in terms of article 7 of the DTAA.”
Contention of the Applicant:
- The applicant submitted that it did not have any presence in India in the form of an office or any other place of business and the applicant would not have employees based in India. Therefore, in the absence of a fixed place PE or agency PE within the meaning of Art.5 of DTAA, the business profits derived by it on account of supplies of goods to the customers in India through the media of ISPs or YCH are not liable to be taxed in India.
- The applicant contended that it has no premises or facilities or installations owned, leased or kept at its disposal in India nor does it have any other kind of physical presence in India. It only has its goods stored in India in a warehouse owned and operated by ISPs and the applicant has only a restricted right of entry into the warehouse for the purpose of inspecting the goods during business hours.
Contention of the Revenue:
- The applicant has a PE in India and that the demarcated space in the warehouse of the ISPs or YCH shall be treated as the fixed place PE. In the alternative it is submitted that an agency PE exists.
AAR Observation and Ruling:
- The AAR observed that the applicant does have a fixed place of business, which is the focal point of its business operations in India. The fact that the fixed place of business is owned or possessed by the logistics service provider does not detract from the position that the applicant has a distinct, earmarked and identified place which caters to its business. In one sense, it is the business place of warehouse/service provider and in another sense, it is also the fixed place of business of the applicant from where the sales activities are carried on.
- As per the agreement, YCH will have to provide warehouse space at a specified location. YCH is also required to provide the necessary systems to facilitate electronic data interchange so that the products can be pulled from the warehouse promptly and the necessary business information’s are exchanged. There are enough indications in the agreement that there should be earmarked space in the warehouse with racks and electronic devices.
- The AAR further observed that the agreement also speaks of inventory control apart from storage, handling, repacking etc. Moreover, the applicant’s agent or representative has a right to enter the warehouse for the purposes of physical inventory, inspection, audit, repackaging etc. Both the applicant and the warehouse/ service provider act in cohesion to ensure the product delivery to the customers promptly. By merely outsourcing the operations leading to supplies of products, it cannot be said that the applicant does not carry on any business in India from a fixed place.
- The question whether the person carrying on business operations on behalf of or pursuant to the instructions of the applicant is a dependent or independent agent is not very material in considering the applicability of Art.5.1. The business of the applicant at a fixed place is being carried on through the media of the warehouse provider who can also be characterised as service provider.
- In view of the above, the demarcated space in the warehouse of ISP constitutes the fixed place of business within the meaning of Art.5.1 of DTAA. Therefore, the AAR found it unnecessary to discuss whether the applicant has an agency PE within the meaning of Article 5.8 of the DTAA.
- For the purpose of computation of profits of the PE in relation to the sales activity in India, it should be treated as a separate and distinct enterprise wholly independent of the enterprise of which it is a PE. The amounts paid to ISP/ YCH and other expenses, if any, incurred should be deducted.
This AAR Ruling is in line with the UN Model Income and Capital Tax Convention which states that the presence of a stock of goods for prompt delivery facilitates sales of the product and thereby the earning of profit in the host country by the enterprise having the facility. Therefore, a ‘warehouse’ used for storage of goods in order to facilitate sales of the product would create a fixed place of business. This, however, contradicts with the OECD Model Convention that such activity does not give rise to a PE. Hence, the activities, like, “the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise” and “the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery”, fall within the excepted activities which do not give rise to a PE, under the OECD Model Convention. This is the fine distinction between the UN Model and OECD Model.
As regards the attribution of profits to PE is concerned, although the specific question was raised before the AAR, that if the logistics service provider is remunerated on an arm’s length basis, would any further income be attributable to the PE of the applicant in India in terms of article 7 of the DTAA, the same has not been answered clearly by the AAR. We believe that the said question is very critical for the purpose of attribution of profits to a fixed place FE, especially after the withdrawal of circular no. 23 dated 23 July 1969 and in the absence of any judicial precedents available on the extinguishment of tax liability, in case the arm’s length remuneration is paid to an entity which constitutes a fixed place PE for the foreign enterprise. Earlier, the decisions rendered in case of Morgan Stanley (292 ITR 416) and SET Satellite (307 ITR 205) by the Supreme Court and High Court were in the context of a Service PE and Agency PE, respectively, where it has been held that the tax liability of the non-resident entity is extinguished if an associated enterprise (that also constitutes a PE) is remunerated on an arm’s length basis, taking into account all the risk-taking functions of the enterprise.