The Role of Permanent Establishment in Preventing Tax Evasion

[nikhil raghav]

The Role of Permanent Establishment in Preventing Tax Evasion

Introduction

Since the advent of globalization, companies across the globe began to broaden their operations. This included setting up subsidiaries, and branches, installation of plants and machinery, appointment of agents working on their behalf etc. Subsequently, companies were able to generate a significant number of profits. But it led to complications regarding the ability to tax the income generated by the corporate entities. The question arose which nation possesses the authority to impose taxes on the gains made by overseas entities with a formal existence in the nation? To answer this question the concept of permanent establishment was introduced. These regulations impact the capacity of a nation to charge tax on the gains of an entity based in another nation. They outline the notions and elements that must be taken into account for forming a Permanent Establishment, including tax systems to minimize dual taxation. Most nations recognize the idea of Permanent Establishment and have included it in both national & global tax agreements.

PE's origin can be traced back to the 19th century, when tax treaties were enacted in Prussia & Saxony which gave rise to the idea of PE which was legally established in 1909. The German dual tax legislation declared that a business entity would be required to make payment of taxes to the departments in the jurisdiction only if it had established a fixed location of business.

The Phrase “Permanent Establishment’ is a conception enshrined in International Taxation which provides that if a business entity has a presence in another nation other than the nation in which its business is situated then the entity is liable to make the payment of taxes in that nation also.

Types of PE

1. Fixed Place PE

2. Construction PE

3. Agency PE

4. Service PE

Fixed Place PE

Fixed Place Permanent Establishment has been expounded under Article 5 (1) of the OECD Model Convention. The term "permanent establishment" refers to a stationary business location where the enterprise conducts all or part of its business activities.

a) Place of management- It means where the supervision, control and management of the entity are located.

b) Branch- If a business entity from outside India has established a branch within the country, then it is often treated as a PE of the business entity that is a non-resident.

c) Office- It often refers to a permanent location, space, or structure from which the operations of business are conducted.

d) Factory- a building or set of buildings with facilities for manufacturing.

e) Workshop-It refers to a place where industrial procedures are conducted. In simple words it means any location where collectively physical labour is performed under the supervision of a manager, such as manufacturing,

f) Mining site, a quarry, gas well or any location where minerals are extracted - If a non-resident corporation is the owning any of the abovementioned places, then the non-resident corporation will create an existence of PE in India.

Judicial Verdicts on Fixed Place PE in India

1. R & B Falcon Offshore Ltd vs. ACIT [1]- In this case, the Delhi Tribunal referred to the OECD Commentary & held just the workplace address can’t be regarded as a PE until it is settled that operations apart from preparation and auxiliary operations are conducted out from that location to be considered a PE. The mention of the office address in the agreement did not provide enough evidence to indicate that any business operations were conducted, therefore it could not be assumed that the corporation had a fixed place PE.

2. Vishakhapatnam Port Trust Case [2]- The term "Permanent Establishment" implies that there is a significant & lasting presence of an overseas corporation in another nation that can be linked to a permanent location of enterprise in that nation. The nature it possesses should reflect and showcase the overseas company extending into the soil of another nation.

3. Renoir Consulting Ltd v. DDIT [3]- There existed a Fixed Place PE due to the foreign corporation's consistent involvement with individuals, which necessitated their ongoing existence in India for an indeterminate contractual term for the execution of the project.

4. Rolls Royce Plc., v. DIT [4]- In the case, taxpayer utilized specified support services from its subsidiary located in the UK, which maintained a workplace in India. The corporation’s staff made regular visits to the office situated in India. A fixed place Permanent Establishment was found to be present because the place of work situated in India was accessible to all the corporation employees.

5. Motorola Inc., v. DCIT [5]- The staff of the parent corporation were employed by both the parent corporation and the subsidiary. Therefore, it is likely that the parent company had the authority to access and utilize the office of the subsidiary. It was concluded that a fixed location PE exists.

6. Metal One Corporation v. DDIT [6]- Even though the corporation maintains a liaison Office in India, which constitutes a fixed location for company operations in India, there isn't any documented proof of any significant business operations being conducted from this location. It is determined that only preparatory or auxiliary work is being performed and not any core activity, hence there was no PE in India.

7. Formula 1 Case [7]- The tax treaty was interpreted by the Apex Court to include the international circuit as a fixed place of business. Income was generated in India from a motor car race physically held there, indicating that the company received money in India utilizing a circuit they fully controlled during the race. The Apex Court ruled that an overseas entity might be designated as a Permanent Establishment, even if its operations in India are limited to a 3-day race. The verdict states that if a foreign entity does activity in India for a brief time with complete authority and accessibility, then it qualifies as a PE in India.

8. Golf in Dubai Case [8]- The court determined that organizing a 1-week golf event in India does not amount to permanent establishment in India.

Construction PE

As stated in Article 5 (3) of the OECD Model Convention, "a construction site or installation project amounts to permanent establishment if it continues for a period beyond 12 months.

According to Article 5 (3) of the UNMC - A construction site, assembling, or installing of a project, or corresponding supervising operations lasting constantly in excess of months.

If the overseas company is engaged in the following activities, then it shall result in a Construction PE.

1. Operations of buildings or sites for construction- Setting up of roads, bridges, channels, etc. Pipeline construction, mining, operations;

2. Assembly or Installation- It consists of the setting up of novel equipment, plants, and machines, as well as the establishment of computer networks.

3 Supervisory services- When an overseas corporation has the capacity to monitor and regulate an Indian company's actions, it can establish a supervisory Permanent Establishment in India.

4. Duration Test ­- Indian bilateral tax treaties state a time limit for the aforementioned operations for establishing a Construction PE in India. The time typically is either 120 or 183 days. If an overseas corporation engages in construction operations but does not meet the specified criteria, then it won't amount to a Permanent Establishment. Duration Test for a Construction Permanent Establishment as stated in the OECD Commentary demonstrates it is obligatory for every construction project in India.

Dependent Agent PE

If an individual is performing business tasks for a foreign entity in India, it shall be recognized with the status of dependent representative of the entity. This will lead to the establishment of a permanent presence in India. But autonomous agents have no status as a Permanent Establishment. Examples of operations carried out by dependent agents are: -

a. Frequently uses its power to conclude agreements.

b. Controls inventory and Maintains orders.

The Agency Permanent Establishment in India requires an 'agency connection' between a foreign corporation that would operate as a principal & its delegate in India, who behaves as the representative and represents an overseas corporation in India.

1. Western Union Financial Services (WUFS). v. ADIT [9]- A parent company belonging to the United States was involved in the transferring of funds and assigned representatives in India to handle liaison & associated tasks. The representatives conducted operations from their office exhibiting their association with WUFS. It was noted that the corporation had a "business connection" in India. But it was determined that the PE does not exist in India as the taxpayer lacked the privilege of accessing and utilizing the agent's place.

2. Galileo Incorporation Case [10]- The company belonged to the United States. It utilized the services of a distributor in India to furnish airline reservation system services. This distributor was declared an agent of Galileo Incorporation.

3. Exclusive Motors Case [11]- The question in this case was whether the United Kingdom company had a Dependent Agent Permanent Establishment in India. The Court determined that an agreement was present between the Indian customers & taxpayer with no involvement of the United Kingdom Company. Therefore, the taxpayer did not form a Dependent Agent PE of the United Kingdom corporation. The following observations were made by the court.

• Invoices produced by the Taxpayer on customers along with those generated by the United Kingdom Company. on the Taxpayer shows that the Taxpayer pays a different amount for the extended warranty from the United Kingdom Company than it does for the customers.
• The Taxpayer's sales invoices to Indian customers for extended warranties are issued under its own name and do not include the United Kingdom Company’s name.
• The Taxpayer remits to the United Kingdom Company the consideration received from customers for the extended warranty after retaining a portion of it.

Service PE

Foreign companies can establish Service PEs in India if they render services in India by way of personnel or staff under their authority and superintendence for a duration the limit defined in the treaties. For comprehending the service permanent establishment, the following ways are important; -

a. Stewardship Activities-Stewardship payments are the expenses that an entity incurs when it engages in measures intended at monitoring and managing its interests in another associated corporation. Foreign companies do stewardship-related tasks to safeguard their interests. This was held in Morgan Stanley.

b. Secondment of employees to India-Globalization has led to businesses establishing offices overseas. corporations often depute their personnel to these nations to ensure that the company can expand its business across the globe.

Secondment is the process of deputing staff belonging to a foreign company to an Indian company which can be its subsidiary to fulfil their needs.

For a better apprehension of the notion of secondment of employees, the following pointers are to be kept in mind.

• During the secondment phase, employees are sent by a foreign corporation and they are not assigned any task. Further, no limitations are imposed on the seconded employees by their original company.
• Seconded personnel are exclusively instructed, managed, monitored and controlled by the Indian corporation & are permitted to undertake duties for them.
• The Indian corporation is accountable for the tasks carried out by the seconded personnel.
• The Indian corporation is also in charge of evaluating and paying the salary, allowances, bonuses, etc., for the seconded employees. If expenses are borne by a foreign corporation, the Indian company must compensate it.
• Seconded workers are subject to the same code of conduct as followed by the employees of the Indian company.

c. Fees for Technical Services- Certain bilateral tax treaties prohibit the emergence of service-based PE in India if the services offered by foreign corporations and the payment provided qualify as Fees for Inclusive Services, as described in the agreements.

The following are some notable judicial decisions regarding the notion of Service PE; -

1. DIT v. Morgan Stanley & Co.[12]-Morgan Stanley India supports the US company's primary administrative tasks in conducting equities, reconciling accounts, and delivering computer services like back-office operations, processing of information, & technical assistance centres. A service PE was acknowledged when services were provided through employees deployed to India. Simultaneously, it was found that only participating in stewardship operation/shareholders activities wouldn't count as a service PE since simply safeguarding one's interests from competition through guaranteeing excellence and secrecy didn't qualify as a service PE.

2. DDIT v. Tekmark Global Solutions LLC[13]- The taxpayer and a corporation from India agreed that the taxpayer would provide staff to the Indian corporation as needed. The contract stated that assigned staff would be overseen by the Indian entity, & the taxpayer wouldn't be held accountable for their conduct & work. The Indian entity would be responsible for arranging lodging, boarding, and related expenses for the deputed personnel, who would continue to be employed by the overseas corporation. The agreement allows the Indian corporation to repatriate appointed staff if deemed unsuitable, inefficient, or lacking ethical conduct to the non-resident company. Additionally, the agreement does not mention any services provided by the non-resident company other than supplying personnel, and there is no reference to the deputed personnel furnishing any services mentioned in the agreement. The Tribunal determined that the US corporation's selection & provision of staff in India didn't amount to technical services given by the taxpayer to the Indian corporation. The assigned individuals tend to be staff of the Indian corporation, The taxpayer has no authority regarding the conduct or tasks undertaken by the individuals who are assigned tasks by the Indian corporation. The Indian entity holds the ability to fire individuals assigned to the positions. The amount recovered by the taxpayer represents the real salary owed to the assigned individuals. Given these circumstances, the Bench concluded that if the rendered services are self-regulating and not under the taxpayer's authority, the assigned individuals cannot be viewed as establishing a (PE) in India. Therefore, the taxpayer does not own a PE in India.

3. Centrica India Offshore Private. Ltd., (Delhi High Court)[14] The court determined that the assignment of staff to an Indian corporation from the affiliated entities in United Kingdon & Canada established a Permanent Establishment in India since the overseas continued to employ the seconded/transferred/people.

4. The case of Samsung company.[15]- The court held that outsourcing support services to India does not amount to a fixed place permanent establishment. It highlighted that outsourcing work to India won't result in the emergence of fixed-place PE.

5. Adobe Systems Incorporated Vs. ADIT[16]-The court held that transferring business operations to an Indian subsidiary does not form a fixed location permanent establishment. The court noted the subsidiary's activities should not be considered as forming a fixed location PE.

6. Asstt. DIT v. E-Funds IT Solution Inc.[17]: No service PE is created since none of the United States Company's customers are based in India / receive assistance from India. Hence the criterion outlined in Article 5(2)(l) is not met. Even though United States Companies has seconded personnel to an Indian entity, Still, to create a PE employees have to provide services in India. The Court dismissed Revenue's contentions and held the contentions of the revenue are not valid since a service PE forms only if services are supplied to customers in India, whether resident or non-resident. All the customers that obtained services from United States Companies via seconded personnel or an Indian company were situated outside of India. Only ancillary operations that enabled these services were performed out of India.

Preparatory & Auxiliary Activities

The Tax treaties state several exempt activities that do not trigger the emergence of PE in India. The commentary of the OECD nowhere has pointed out the expression Preparatory & Auxiliary.

But it specifies the following crucial parameters for determining if an activity qualifies as preparatory or auxiliary in character.

1. Whether the affairs associated with the established place of the corporation a significant or major element of the company's overall activities?

2. Does the main function of the established business location match the overall objective of the entire company?

If the abovementioned parameters are satisfied then the activity won’t amount to preparatory or auxiliary. Listed below are some of the activities that do not represent a permanent establishment.

• Storage of Stock & Products
• Activities pertaining to acquisition
• Research and Development activities

Conclusion

The notion of permanent establishment is critical in international taxation because it assures companies pay equitably to the countries in which they function & operate whilst dealing with the intricate nature of a multinational corporate environment. Apprehension of Permanent Establishment tenets is vital for companies to efficiently manage their tax obligations and adhere to international tax legislation.

References

[1]R&B FALCON OFFSHORE LTD. VERSUS ADDITIONAL COMMISSIONER OF INCOME-TAX, RANGE-I, DEHRADUN - 2010 (9) TMI 741 - ITAT, DELHI

[2] COMMISSIONER OF INCOME-TAX, AP -I VERSUS VISAKHAPATNAM PORT TRUST - 1983 (6) TMI 31 - ANDHRA PRADESH HIGH COURT

[3] RENOIR CONSULTING LTD. C/O. HARIBHAKTI & CO. VERSUS DY. DIT (INTERNATIONAL-TAXATION) - 2014 (4) TMI 702 - ITAT MUMBAI

[4] ROLLS ROYCE PLC VERSUS DIRECTOR OF INCOME TAX - 2011 (8) TMI 313 - DELHI HIGH COURT

[5] MOTOROLA INC., ERKSSON RADIO SYSTEM AB AND OTHERS. VERSUS DEPUTY COMMISSIONER OF INCOME-TAX, NON-RESIDENT CIRCLE - 2005 (6) TMI 226 - ITAT DELHI-A

[6] METAL ONE CORPORATION VERSUS DEPUTY DIRECTOR OF INCOME-TAX, CIRCLE - 3(1), INTERNATIONAL TAXATION - 2012 (6) TMI 294 - ITAT DELHI

[7] FORMULA ONE WORLD CHAMPIONSHIP LTD. VERSUS COMMISSIONER OF INCOME TAX, INTERNATIONAL TAXATION – 3, DELHI & ANR. - 2017 (4) TMI 1109 - SUPREME COURT

[8] GOLF IN DUBAI, LLC., IN RE - 2008 (10) TMI 3 - AUTHORITY FOR ADVANCE RULINGS

[9] WESTERN UNION FINANCIAL SERVICES INC. VERSUS ASSISTANT DIRECTOR OF INCOME-TAX, CIRCLE 2 (1) , INTERNATIONAL TAXATION. - 2006 (3) TMI 220 - ITAT DELHI-E

[10] GALILEO INTERNATIONAL INCORPORATION. VERSUS DEPUTY COMMISSIONER OF INCOME-TAX, NON-RESIDENT CIRCLE, NEW DELHI. - 2007 (11) TMI 329 - ITAT DELHI-B

[11]  ACIT, CIRCLE 8 (2) , NEW DELHI VERSUS M/S. EXCLUSIVE MOTORS PVT. LTD. - 2022 (9) TMI 1251 - ITAT DELHI

[12] DIRECTOR OF INCOME TAX (INTERNATIONAL TAXATION) VERSUS MORGAN STANLEY AND COMPANY INC. - 2007 (7) TMI 201 - SUPREME COURT

[13]  DDIT VERSUS TEKMARK GLOBAL SOLUTIONS LLC - 2010 (2) TMI 807 - ITAT, MUMBAI

[14] M/S. CENTRICA INDIA OFFSHORE PVT. LTD. VERSUS COMMISSIONER OF INCOME TAX-I & OTHERS -2014 (5) TMI 154 - DELHI HIGH COURT

[15] DIRECTOR OF INCOME TAX-II (INTERNATIONAL TAXATION) NEW DELHI & ANR. VERSUS M/S SAMSUNG HEAVY INDUSTRIES CO. LTD. - 2020 (7) TMI 545 - SUPREME COURT

[16] ADOBE SYSTEMS INCORPORATED VERSUS ASSISTANT DIRECTOR OF INCOME TAX AND ANR - 2016 (5) TMI 728 - DELHI HIGH COURT

[17] ASSISTANT DIRECTOR OF INCOME TAX-I, NEW DELHI VERSUS M/S E-FUNDS IT SOLUTION INC. -2017 (10) TMI 1011 - SUPREME COURT