PRELUDE
Delhi High Court in its recent judgment given on February 5, 2014, in the case of DIT v. E-funds Corporation, has clearly and comprehensively established the basic criterion for determination of a “Permanent Establishment” in India of a foreign enterprise. The Court has held that mere presence of a subsidiary of the foreign enterprise in India did not itself create a PE under the Indian-USA tax treaty as the foreign enterprise did not have a “fixed place of business in India” through which the business of enterprise was carried on, nor it had right to use for business any of the premises belonging to its Indian subsidiary at its disposal or control. Additionally, the judgment also throws light on aspects of an “agency PE” and “Service PE” and “Mutual Agreement Procedure” which are noteworthy.
OVERVIEW OF CONCEPT OF PERMANENT ESTABLISHMENT & MAP
Under the Income Tax Act, 1961 (“Act”), a non resident is liable to tax in India, if he has a business connection in India, as defined in section 9(1) of the Act. However, if India has entered into a double tax avoidance agreement (“DTAA”) with any country, a non resident of that country dealing with a resident of India may be liable to tax in India only if he has a permanent establishment (“PE”) in India. The provisions of the Act or of the DTAA, whichever is more beneficial to the non resident assessee will apply, except that the GAAR provisions override the benefits provided under the DTAA. A DTAA usually follows any one of the model conventions, namely, (i) the United Nations Model Convention (UNMC), or (ii) the OECD Model Convention (“OECD”) or (iii) the United State Model. OECD has prepared a commentary interpreting each of the Articles in its model convention. India has been admitted as an observer member of the OECD. Although the OECD commentary is not legally binding on the tax authorities, Courts usually give a due weight to the OECD commentary.
Fixed Place PE
Under a DTAA, usually the term “PE” is articulated in Article 5 of DTAA and means a fixed place of business through which a foreign enterprise wholly or partly carries on business in another country. DTAAs usually contain specific activities which are excluded from the purview of PE, which are not regarded as PEs even if any of those activities is carried on through a fixed place of business. (e.g. – use of facilities solely for storage or display of goods belonging to the foreign enterprise, maintenance of a fixed place of business solely for the purpose of advertising, scientific research, being activities solely of a preparatory or auxiliary character in the trade or business of enterprise etc).
Dependant agent PE (“DAPE”)
Under a DTAA, a DAPE is created of the foreign enterprise is created when the following conditions are satisfied: i. a person in the source country (i.e. India) is dependent on the non resident enterprise; and ii. acts on behalf of the said non resident enterprise; and iii. has the authority to conclude contracts on behalf of the non resident enterprise; and iv. habitually exercises such authority to conclude contracts on behalf of such non resident enterprise.
Service PE
A PE also usually includes the furnishing of services by the foreign enterprise in India through employees or “other personnel” for period exceeding certain threshold limits (such as 90 days within any 12 months period etc).
Mutual Agreement Procedure (“MAP”)
In the interpretation of DTAAs, disputes do arise. DTAAs, therefore, contain an article providing for a mechanism to settle such disputes. MAP is a treaty mechanism and can be taken recourse to irrespective of the remedies provided by the domestic law of the contracting states. The dispute is resolved by a ‘Competent Authority’ of the State of which he is a resident with a request for redressal of grievances. Thus, if an American Company operates through a branch in India and in the assessment of the branch, adjustments are made, which the non resident thinks are in violation of the treaty, then the Competent Authority to which the grievance is to be addressed is the US Competent Authority. In the process of executing a MAP, the competent tax authorities of both the countries interact with each other to arrive at an amicable solution, which suits the intention of the treaty. Thus, it is a remedy available to the resident of a country (parallel to the normal domestic remedies) to settle the cross border taxation disputes out of the Court.
FACTS OF THE CASE
With respect to fixed place PE
Group companies / corporations E-funds Corporation, USA and eFunds IT Solutions Group Inc, USA (“e funds Corporation” and “efunds IT Solutions Group Inc.” are herein collectively referred to as “efunds USA”), assessee tax payers and residents of USA entered into contracts with their clients for providing certain IT enabled services like ATM management service, decision support and risk management. The said contracts were either assigned or sub-contracted to e-Funds International India Private Limited (“efunds India”), subsidiary of e-funds USA for execution and e-funds India mainly performed back office operations in respect of some of the aforesaid services. The Assessing Officer (“AO”) held that the income of e-funds India was liable to tax in India as efunds India was carrying on the core activities of efunds USA and being a subsidiary of efunds USA, it was a fixed place permanent establishment.
With respect to DAPE
Based on the Function Performed, Assets used and Risks Assumed Analysis (FAR Analysis), the Assessing Officer held that as (i) eFunds India did not having requisite software and database needed for providing IT enabled services independently and that they were made available by the E-funds USA to eFunds India free of any charges and that (ii) eFunds India did not bear any significant risk as the ultimate responsibility lay with the e-funds USA, efunds India was an agent of efunds USA and accordingly efunds USA was liable to be taxed in India in respect of operations carried out by efunds India on its behalf.
With respect to Service PE
The AO contended that as efunds India hired employees for performing its operations, the same were considered to be “other personnel” of efunds USA.
With respect to MAP
In this case, MAP under Article 27 of the India USA DTAA was resorted to for the earlier years and the competent authorities of India and USA had entered into an agreement as to attribution of profits between efunds US and efunds IT US in case a PE was created. The AO contended that in view of the aforesaid arrangement, a PE was established.
The aforesaid views of AO were upheld by the Commissioner of Income Tax (Appeals) and the Tribunal on appeal. Aggrieved by the ruling, e-funds appealed filed an appeal before the High Court.
ANALYSIS AND COMMENTS
Although the principles relating to determination of PE have been explained with illustrations in OECD Commentary and have also been laid and dealt with in certain rulings of AAR and judgments of ITAT, the judgment happens to be the first one in which criterion for determination of a fixed place PE has been comprehensive exemplified. It is a welcome ruling particularly for foreign companies carrying out back office operations in India through subsidiaries.
The requirement of a “fixed place” and carrying on business of the foreign enterprise through that fixed place connotes the idea of certain degree of permanence attached to it and this very idea is inbuilt in the nomenclature of “permanent establishment”. Moreover, the activities must be considerable and regular although not endless or without any interruptions. Even if a place of business is owned by an enterprise but is placed at the disposal of a third party, it would not result in PE. Suffice is to say that mere existence of a subsidiary company does not by itself make the subsidiary company a PE in India, unless the criterion laid down in the judgment are satisfied.
Merely because an Indian company conducts its business with the help and guidance received in India from the related foreign enterprise did not mean that the foreign enterprise will always be deemed to have a PE in India in the form of that Indian company.
Further, even if the activities are carried on through a fixed place of business and contribute o the productivity of the enterprise, if the same fall within any of the specific exclusions as provided under the relevant DTAA, they are not regarded as PE, because the activities are remote from the actual realisation of profits by the foreign enterprise.
In relation to Service PE, the Court’s decision is in line with the Delhi bench of the Tribunal’s observation in the case of Lucent Technologies International Inc. v. D.I.T. 1 from which it can be concluded that the “other personnel” of the foreign enterprise should include only persons who work under direct instructions, supervision and control of the foreign enterprise.
However, the High Court’s interpretation in this regard that when the employees are defacto and dejured employed by Indian enterprise, they would not be considered to be other personnel of foreign enterprise providing services in India, may be vulnerable to misuse as the employees of the foreign enterprises may be seconded to its India to show employment under the Indian subsidiary where as the actual supervision and control over the said employees would be made by the foreign enterprise indirectly through the Indian subsidiary.
About Bulwark Solicitors
Bulwark Solicitors is a law firm pioneered by Solicitor Chirag Sancheti and Advocate Deep Shridharani. The firm has expertise in the areas of both Litigation and non-Litigation. Under the non-litigation Law practice, the firm practices in the areas of Corporate Law, Intellectual Property Law, Bankruptcy & Insolvency Law, Competition Law, Real Estate and Conveyancing and DTAA Advisory. Further, under Corporate Law area, we practice Company Law, Securities Law, Mergers and Amalgamations, Private Equity and Venture Capital Investment Transactions, Legal Due Diligence and Foreign Exchange Management Law.