Background
Permanent Establishment (“PE”) is typically defined in DTAAs to mean a fixed place of business through which the business of an enterprise is wholly or partly carried on in another country. Under a Double Tax Avoidance Agreement (“DTAA”), concept of PE is relevant for taxation of international transactions. A non resident dealing with resident in India will be liable to tax in India if he has a PE in India.
One of the important features in the definition of PE is regarding ‘agent’. A foreign enterprise may choose between performing business activity itself or having it through a domestic agent. Whether one carries on the business activity directly or through the dependant agent, the profit attributable to such business continues to be taxable in the source country. This is the unmistakable underlying principle behind the dependant agent PE clause in all DTAAs. Hence, in order to treat any person as a PE, it is of utmost importance that such person should first answer to the description of ‘dependent agent’ and then such dependant agent must perform either of the activities as mentioned in the concerned DTAA. A dependant agent constitutes a PE and independent agent does not constitute a PE.
Business profits of a foreign enterprise are always taxable in the state (country) of residence of the foreign enterprise, unless it carries on business in the state of source, i.e. the country in which the income arises through a PE. Once such a PE exists, the country of source gets the jurisdiction to tax the business profits, but only to such profits as is attributable to PE in that state.
However, in some treaties which are based on UN model, there exists special provisions, which enhance the scope of attribution of profits to cover the profits of the foreign enterprise made in the country of residence, even if such PE has not performed any activities for business transactions effected by the foreign enterprise in the source country. This is known as “Force of Attraction” (“FAR”) rule. Hence, in substance, the country of source gets extended powers to tax profits of the foreign enterprise, without involvement of a PE. The profits which are thus taxed are the profits which the PE might be expected to make if it were a distinct and separate enterprise engaged in same or similar activities under the same or similar conditions and dealing wholly independently with the foreign enterprise of which it is a PE.
The rationale is that when an enterprise sets up a PE in that another country, it brings itself within the fiscal jurisdiction of that other country to such a degree that such other country can properly tax all profits that the enterprise derived from that country whether through the PE or not. FAR finds place in the DTAA with USA, Canada, Cyprus, New Zealand, Italy, Indonesia, Denmark, Thailand, Poland, Romania etc. However, in any case, existence of PE is pre condition for FAR to get attracted.
Facts of the case & Issue
Varian India Private Limited v. ADIT
The taxpayer was the Indian branch of an American company Varian India Pvt. Ltd. (“VIPL”), which in turn was a wholly owned subsidiary of Varian Inc., USA. Varian Inc. was engaged in manufacturing and marketing of various kinds of scientific instruments. The tax payer carried out pre-sale activities such as liaison and post-sale support activities on behalf of various group companies belonging to the Varian group in different countries, viz. Italy and Australia and received commission for the same. The tax payer did not have any authority to negotiate or conclude contracts on behalf of the group companies of Varian USA. The tax payer did not bear any risks like market risk, product liability risk, research and development risk, credit risk, price risk, inventory risk or foreign currency risk were born by the selling entity.
The AO contended that the tax payer was a dependent agent PE under the DTAAs with USA and few other countries and due to the rule of FAR, the profits earned by not only the tax payer but also of the other group companies of the Varian group were taxable in India. CIT upheld the order of AO and an appeal was made to the Mumbai bench of ITAT. The issues before the ITAT were as follows:
(i) Whether the Indian branch of VIPL constituted PE of the group companies of Varian?
(ii) If the taxpayer was considered to constitute the PE, whether ‘force of attraction rule’ could apply?
ITO v. Pubmatic India Pvt. Ltd.
The Taxpayer, an Indian company (“I Co.”), and its parent company, a resident of the US (“US Co.”), are engaged in the business of providing services of internet advertising and marketing services. I Co. caters to Indian clients whereas the US Co. caters solely to clients outside India and generally in the US. In case of advertisements on foreign websites, the US Co. purchases the advertisement space from foreign website owners and sells them to I Co. at cost plus mark-up and I Co. in turn, sells to I Co.’s clients. I Co. made payments to US Co. towards purchase of online advertising space without deducting taxes.
The issue was whether I Co. constituted a dependant agent permanent establishment for US Co. as I Co. was habitually conducting business on behalf of the US Co. in India and the activities of the I Co. were devoted wholly or almost wholly on behalf of US Co?
Who is a dependant and independent agent under India – USA DTAA?
Article 5 (4) of India –USA DTAA (Relating to dependant agent)
“Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 5 applies – is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned State, if : (a) he has and habitually exercises in the first-mentioned State an authority to conclude on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph ; (b) he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise, and some additional activities conducted in the State on behalf of the enterprise have contributed to the sale of the goods or merchandise ; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise.”
Article 5 (5) of India –USA DTAA (Relating to independent agent)
“An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arms length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph.”
Article 7 (1) and 7 (2) of India –USA DTAA (Relating to attribution of profits)
“The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment ; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment.”
“ Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arms length with the enterprise of which it is a permanent establishment and other enterprises controlling, controlled by or subject to the same common control as that enterprise. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article.”
Judgment of the ITAT (Mumbai)
In the case of Varian India Private Limited v. ADIT
Dependent agent PE As the taxpayer did not have any authority to negotiate or conclude contract on behalf of group companies of Variant and the group companies directly sold the products to the Indian customers and also undertook all the associated risks, the taxpayer did not fulfil any of the conditions to satisfy the criteria to establish a dependent agent PE under the India- USA DTAA, India-Italy DTAA and IndiaAustralia DTAA.
ITAT observed that in order to establish that an agent would be considered as a PE exists, the following two conditions must be fulfilled: i. the activities must of the agent must be wholly or almost wholly carried out on behalf of the foreign enterprise; and ii. the transactions made between them are not on an arm’s length basis.
Applicability of ‘force of attraction rule’
As the foreign enterprise did not have a PE in India, question of applicability of ‘force of attraction rule’ did not arise.
In the case of ITO v. Pubmatic India Pvt. Ltd
ITAT held that I Co. was an independent party and did not constitute a dependant agent permanent establishment of US Co. The advertisement space from US Co. was purchased for I Co.’s customers and was not a transaction which was carried out on behalf of US Co. Further the same was sold at cost plus mark-up being an arm’s length price to I Co on a principal-to-principal basis. All risks and rewards of the business were borne by I Co. The advertisement space was in turn ‘sold’ by I Co. to customers at a different price and the same income has been offered as business income of I Co. The similarity of business activity does not, by itself, indicate that I Co is acting or doing business on behalf of US Co. Further, neither I Co. nor US Co. was providing services or goods to the clients of the other party or dealing with the clients of the other party. Accordingly, remittance was towards business income which was not taxable in absence of PE.
Our Analysis & Comments
The ruling reiterates the principles established in several precedents as follows for determining whether a PE has been constituted by an agency.
In the case of TVM Ltd, a Mauritian company had an Indian subsidiary through which it was carrying out some of its activities. Although it was its subsidiary, it did not have authority to conclude the contracts. Only the Mauritian company had that authority. The AAR ruled that the subsidiary would be treated as in independent agent and not a PE.
In the case of PE Amadeus Global Travel Distributions SA it was held by the ITAT that the dependant agent is not considered to be a PE unless he has an authority to conclude contracts on behalf of such enterprise. The authority to conclude contracts must be in respect of contracts relating to operations, which constitute a business proper of the enterprise.
In the case of eBay International AG, it was held by ITAT that simply by providing marketing services to the assessee or making collection from the customers and forwarding the same to the assessee, it could not be said that e-Bay India entered into contracts on behalf of the assessee.
In the case of Laird Techonlogies India (P.) Ltd, based on the facts of that case, the AAR ruled that as there was nothing to show that activities of Laird was devoted wholly or almost wholly o or on behalf of Laird USA, there was no agency PE.
To determine whether the agent is of an independent status or not, one must examine the following: i. Agent’s scope of authority and limitations imposed by the principal; ii. Correspondence between agent and the principal; iii. Risks borne by the agent vis-à-vis risks borne by the principal;
The reference to “mainly or wholly” does not mean that the agent should be the sole agent in India for the non resident but what was essential is that he should work mainly or wholly for the non resident. In the case of Reuters Limited Construction House7 , it was held by the ITAT that even though the agents act independently in the ordinary course of business, if they devote their activities wholly or mostly wholly on behalf of a foreign enterprise, they would be considered as a PE of a foreign enterprise irrespective of whether they conclude contracts binding on the principal or not.
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.