In a recent ruling Mumbai Income Tax Appellate Tribunal (Tribunal) in the case of Airlines Rotables Ltd. UK (Taxpayer) [ITA No. 3254/Mum/06F ] on the issue of whether maintenance of stock of goods, belonging to the Taxpayer, by its Indian customer results in the Taxpayer having a permanent establishment (PE) in India, under the India UK Tax Treaty (UK Treaty) reaffirmed some general principles relating to PE, the Tribunal further ruled that the Taxpayer does not have a PE under the basic rule or the agency rule. The Tribunal remanded the matter to the first appellate authority to determine if any part of the consideration could be taxed as royalty for use of equipment by the customer.
The Taxpayer is a company incorporated in the UK. Its main business is providing spares and component support to aircraft operators.
The Taxpayer entered into an agreement with Jet Airways Ltd. (Customer), an Indian aircraft operator, for providing certain support services in respect of aircraft.
The agreement requires the Taxpayer to repair the component when it becomes operationally unserviceable and to provide replacement of the component during the interim period.
The consideration received by the Taxpayer is divided into two segments: (a) For repairing and overhauling of the components. (b) For use, or right to use, of the replacement components.
In order to ensure adequate availability of the components, the Taxpayer maintains stock of such replacement components at the operational bases of the Customer in India, as also in the UK at the Taxpayer’s main depot. The Customer holds the component stock as a bailee (delivery of goods without transfer of ownership). The component stock continues to remain the property of the Taxpayer at all times.
The issue in dispute is whether the maintenance of the component stock constitutes a PE of the Taxpayer in India under the UK Treaty. The Tax Authority concluded that there exists a PE in India and the first appellate authority concurred with the Tax Authority’s view and determined 10% of gross receipts of the Taxpayer as profits attributable to the PE.
Aggrieved by the first appellate authority’s order, the Taxpayer appealed to the Tribunal.
Tax Authority’s contentions
The Tax Authority relied on a statement obtained from stores staff of the Customer to conclude that the staff of the Customer were acting as agents of the Taxpayer in maintaining the component stock. This resulted in an agency PE coming into existence under Article 5(4) of the UK Treaty.
Also, since the Taxpayer’s stock was permanently kept at fixed places in India, with clear identification of each stock item, the Taxpayer has a fixed place of business in India.
Delivery of repaired component stock amounts to sales, which has to be understood in its widest meaning in relation to business transactions. Since income arises to the Taxpayer out of such delivery of goods and the repaired component, the benefit of exclusion in clauses (a) and (b) in Article 5(3) of the UK Treaty, in relation to use of facility for storage or display and in relation to the maintenance of stock solely for storage respectively, is not available to the Taxpayer.
Since the Taxpayer does not have a PE in India, its business profits are not taxable in India.
Without prejudice, even if there were a PE, the application of an ad hoc rate of 10% on its entire gross receipts for India was not appropriate. The finding that the entire profits from Indian sales were attributable to the PE in India was also inappropriate, in view of the fact that the repair operations were carried out entirely outside India.
PE under the basic rule
PE under the agency rule
Taxation as royalties
This ruling reaffirms some of the general principles for determining existence of PE under the basic rule as well as the agency rule.
With regard to the basic rule, this ruling confirms that mere existence of a physical location is insufficient to result in a PE if the foreign enterprise does not have some sort of a right to use the location for its business. This ruling clarifies that mere presence of goods belonging to the foreign enterprise at the physical location does not result in the physical location being at the disposal of the foreign enterprise.
On agency PE, this ruling clarifies that maintenance of stock of goods by a person in India should not result in a PE if the goods are maintained for subsequent use and not for onward delivery on behalf of the foreign enterprise.