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Is there a PE? Recent Trends in Permanent Establishment (PE) Taxation in India India Tax Workshop 2014
11-13 September 2014
India Tax Workshop 2014
Contents
India Tax Workshop 2014
► Background
► Is there a PE?
► Digital Economy
► Employee Secondment
► PE for a Group
► Outsourcing
► Use of Hotel Rooms
► Concluding thoughts
Page 2
Background
Background
► PE concept — core mechanism for allocating taxing rights when an enterprise of one country derives
business profits from another country
► “Permanent establishment: postulate existence of a substantial element of an enduring or
permanent nature of a foreign enterprise in another country which can be attributed to a fixed placed
of business in that country. It should be such as that it would amount to a virtual projection of the
foreign enterprise of one country into the soil of another country”, as per Andhra Pradesh HC in
Vishakapatnam Port Trust (144 ITR 146)
► “Is there a PE?” — arguably the most contentious and frequently confronted issue for multinational
enterprises doing business in India
► Despite its long history, practical application of the PE concept raising a number of issues
► Globalisation of international trade, multifarious business models and the development of a digital
economy have exerted pressure on the PE concept
India Tax Workshop 2014 Page 4
OECD developments
► OECD Revised discussion draft on PE (published in Oct 2012)
► Potential broadening of the PE concept
► Interpretation of “at the disposal”
► PE through use of sub-contractors — an enterprise can carry on business activities in another
state, even where such activities are carried on entirely or partly through a subcontractor
► Proposals not reflected in the 2014 update of the OECD Model Tax Convention(OECD MC)
► BEPS Action Plan
► Action 1: proposes to identify the main difficulties in applying existing international tax rules to the
digital economy and to develop detailed options to address these difficulties — Target date: Sept
2014
► Action 7: proposes to develop changes to the definition of PE to prevent the artificial avoidance of
the PE status in relation to BEPS, including through the use of commissionaire arrangements and
under exceptions granted for preparatory and ancillary activities — Target date: Sept 2015
India Tax Workshop 2014 Page 5
Is there a PE?
Slide 6
► Digital economy
► Employee secondment
► PE for a group
► Outsourcing
► Use of Hotel Rooms
Digital Economy
Digital economy
► Digital technology has a significant impact on how businesses are carried on
► Use of multi-sided business models
► E- Commerce : sale and purchase of products (tangible or soft merchandise) electronically (virtual
store front); Application Stores as retail platforms
► E-helpdesk, call centres
► Online advertising
► Cloud computing
► Payment services – electronic fund transfer
► Online securities transactions, provision of financial/other services, etc.
► Subscription to and use of an internet service provider (ISP)
India Tax Workshop 2014 Page 8
Digital economy
Issues
► Characterization of income — business profits or royalty or FTS?
► Creation of PE — local independence and local execution
► Traditional PE Concept blurred?
► How can a “permanence” or “disposal” test be satisfied on digital platforms?
► Attribution of profits to source jurisdiction
► Transfer pricing (TP) — central management and central control
Digital Economy – Functions & Processes
HQ
Supplier Entrepreneur
Production R&D Services Distribution
Customer
Warehouse
Virtual
Store
E-Payment
Server
People functions Assets and risks Capital
“Central control” versus “local independence”
India Tax Workshop 2014 Page 9
Ireland
India
US
Right Florists Case (143 ITD 445)(Kol)(2013)
Payment for advertising
► Issue
► Payments made to Google Ireland (Google)
and Yahoo US (Yahoo) for displaying the
Taxpayer's advertisement when certain key
terms were used on such search engines.
► Do Google/Yahoo have a taxable presence in
India?
► Ruling of Tribunal
► Reliance placed on OECD MC to conclude that
a search engine, which has presence through
its website, cannot have a PE in India, unless
the web servers are located in India
Yahoo
Right Florist
India Tax Workshop 2014 Page 10
Online advertising
Is there a PE exposure where the online advertising space is sold in the source country through an
intermediary?
► Recent ruling by Mumbai ITAT - Pubmatic India [ITA No. 7044/Mum/2011] — The US website
owner sold online advertising space to an Indian subsidiary, which, in turn, sold it to Indian clients.
► Held; the Indian subsidiary was carrying on its own business of sale of online advertising space
in India and not on behalf of or as an agent of the US website owner.
► The Indian subsidiary bore the risks and rewards of the business and was answerable to its
Indian clients.
► The Indian subsidiary does not constitute PE for the US website owner.
India Tax Workshop 2014 Page 11
Employee
Secondment
Employee secondment
Typical arrangement Issues
► Legal versus economic
employer
► Recharge mechanism
► Fixed PE exposure
► Access to the premises
of an Indian company
► Control over an Indian
company
► Service PE exposure
► Attribution of profits
Affliliate
Secondment
of employees
Salary
payment to
Bank a/c of
employee
Reimbursement of cost
FE
Form-over-substance versus substance-over-form
India Tax Workshop 2014 Page 13
Centrica India Offshore Case [TS-237-HC-2014(DEL)]
► Centrica India, an Indian company (I Co) and
Group Cos were subsidiaries of a UK parent
► Group Cos outsourced back office support
functions to third party vendors in India. I Co
was required to act as the local interface for
vendors in India.
► Since I Co was newly incorporated, it needed
the knowledge of processes and practices of the
Group Cos. For this purpose, Group Cos
seconded some assignees to work with I Co
► Salary was disbursed overseas by Group Cos
and it was recovered monthly from I Co.
► Issue – tax treatment of the payments made by
I Co to Group Cos and whether Group Cos had
a PE in India?
Vendors
India
Outsource of
Back office
work Assignees
Local Interface,
Quality Check
Payment
Overseas
Ownership linkage
Group
Cos
I Co
UK Parent
India Tax Workshop 2014 Page 14
Centrica India Offshore Case
► Ruling of Delhi HC
► Assignees remained employees of Group Cos
► There is subsisting and independent employment relationship with Group Cos,
► Assignees retained “lien” on employment with Group Cos; they continued to participate in
retirement and social security plans and other benefits
► Group Cos were not conduits and employment with them is not fraudulent
► I Co merely had operational control over the assignees and had to bear the risks/ rewards of
their work, which is not sufficient
► I Co had no right to terminate their employment with Group Cos
► Right to remunerate assignees as well as to legal recourse lied with Group Cos and right to
terminate employment is not with I Co
► Payments by I Co amounted to Fees for Included Services (FIS) under the relevant tax treaty.
► Furthermore, the presence/ activities of assignees created service PE for Group Cos in India
based on the SC decision of Morgan Stanley.
India Tax Workshop 2014 Page 15
PE for a group
PE for a group
Group PE Topics
► Can group inter-
dependence result in PE?
► Central control versus
local independence
► Functions carried out by
an Indian affiliate for or on
behalf of FE?
► Whose business is carried
on?
► Premises of an Indian
affiliate “at the disposal of”
FE?
FE
Indian affiliate
Global Optimization
Expansion of
business
Sharing of
Resources
Re
mu
ne
ratio
n P
2P
Serv
ices
Allocation of functions, assets, risks Local independence and local execution
Slide 17 India Tax Workshop 2014
Booz & Co. Group ruling [TS-76-AAR-2014]
► In Booz & Co. Group, group entities provided as well as
availed of services from each other with the intention of
optimising the group’s global business network and expertise
► All projects won by the group entities were catered to by a
common pool of personnel.
► Certain group entities received payments from I Co for
provision of technical and professional personnel (personnel)
► Issue – Whether fee received by group entities qualified as
FTS or business profits;whether group entities had a PE in
India
► AAR held that group entities had a PE in India
► It is unclear which type of PE is constituted. AAR analysed various rulings and laid down broad
principles indicating that a PE may be created under fixed PE, service PE and agency PE .
India
Overseas
Technical and Professional personnel
I Co
Group entities Group entities Group entities
India Tax Workshop 2014 Page 18
PE for a group - issues and analysis
► Whether the premises of the group company are at disposal of FE
► Although no formal legal right is required on the place of business, mere factual use is not sufficient
(OECD commentary)
► OECD Revised Discussion Draft on Art. 5 - effective power to use the location
► Whose business is carried on?
► The mere fact that a foreign entity derives economic benefit on account of activities of another
entity does not mean that FE carries on its business “through” that location.
► Group companies to satisfy general PE rules under the tax treaty
► It can become a PE of the related companies under the circumstances where the same conclusion
is reached for unrelated companies (Delhi HC in eFunds Case and Rolls Royce, Mumbai Tribunal
in Varian India Case)
► When a business cannot be carried on in India by a group without the intervention of another entity
(e.g. of a subsidiary), the entity must be deemed to be the PE of the group in that particular country
(AAR in Aramex)
India Tax Workshop 2014 Page 19
Outsourcing
Outsourcing
Outsourcing Issues
► Whether premises/
activities of Indian affiliate
can be treated as fixed PE
or agency PE?
► Presence of FE’s
employees in India -
service PE exposure?
► Whether activities in India
can be treated as
preparatory/ auxiliary or
stewardship in nature
► Attribution of profits
Indian entity (usually WOS)
Outsourcing of business functions
Call Centre
Back Office Support
R&D, etc.
Assistance
Supervision
Training
Monitoring
Business synergies Risk mitigation Functions
Consideration of entire value chain
FE
India Tax Workshop 2014 Page 21
E-funds Corporation case TS-63-HC-2014 (DEL)
► US companies (US Cos) were engaged in the
business of electronic payment, ATM
Management, decision support and risk
management services
► An Indian affiliate (I Co) was subcontracted back
office and data entry support in respect of the core
business of US Cos
► US Co sent some employees to India for short
periods to ensure quality and confidentiality of
services by I Co
► Issue - whether US Co has a PE in India?
► For the past years, pursuant to MAP, certain
income allocation was agreed to on “without
prejudice” basis
I Co
US
India
Corp US Cos S
ub
co
ntr
act
Short term visits
by Employees of
US Cos
India Tax Workshop 2014 Page 22
E-funds Corporation case
► HC Ruling and significant observations
► A subsidiary is an independent legal entity, that is not a PE in India, unless the contrary is proved.
► Factors not relevant in determining a PE
► Close connection between US Cos and I Co
► Services provided by I Co to US Cos
► Dependency of I Co on US Cos for its earnings
► I Co was a risk mitigated entity and remunerated on cost + model
► Intangibles provided free of cost by the Taxpayer
► Taxpayer outsourcing activities to save cost
► Agreeing to taxation under an MAP Agreement signed in the past
► Even though I Co was carrying out core activities for US Cos, it would not constitute a fixed place
PE
► The term “through” postulates that the FE should have the power or liberty to control the
place and, hence, the right to determine the conditions according to its needs.
India Tax Workshop 2014 Page 23
E-funds Corporation case
► No Service PE in India
► Activities of US Cos’ employees in India to protect the interests of US Cos – “Stewardship
activities”
► Employees of I Co do not qualify as “other personnel” of US Cos. Employees de facto and de jure
employed with and working for I Co
► Any other interpretation of treating employees as other personnel of US Cos to result in
incongruities, for every subsidiary that engages an employee, would always become a PE of the
controlling foreign company.
► In sub-contract or outsource arrangements, rendering services to a third party on behalf of the principal
does not, by itself result in DAPE.
► No DAPE in the absence of authority to conclude contract, stock maintenance etc; also, I Co was
remunerated on an arm’s length basis.
India Tax Workshop 2014 Page 24
Outsourcing - issues and analysis
► Delhi ITAT decision in Convergys on the outsourcing of back office operations
► PE exists since the Indian affiliate was a projection of F Co’s business and carried on business
under the control and guidance of F Co’s employees without assuming any significant risk
► Spanish SC decision: Swiss Principal had PE on account of activities of Spain Co:
► Spain Co lacked independence because it operated exclusively for Swiss Co and bore no risk
► Spain Co manufactures resources exclusively at the disposal of SwissCo
► Spanish SC reiterates its view in another ruling issued on 18 June 2014
► OECD Commentary (Para 42)
► A company that merely purchases parts produced or services supplied by a company in a different
country would not have a PE simply for this purpose.
► OECD PE Discussion Draft:
► A location that is owned and used by a supplier or a contract manufacturer and is not, per se at the
disposal of the foreign enterprise
India Tax Workshop 2014 Page 25
Use of Hotel rooms
Use of Hotel Rooms
India
Service Contracts Issues
► Fixed PE exposure (for
treaties not having a
service PE clause)
► Different fixed places used
for the provision of
services . How is location
test/ duration test met?
What is the role of short
term visits?
► Disposal test – Employee
versus Employer’s right to
use
Employees
Overseas
Provision of Services
Services No specific office
Commercial activities of employee from hotel room – PE risk for
employer?
FE
Client
Preparation,
meetings
Use of Internet, fax,
telephone etc.
Video Conferencing
Use of Hotel Rooms, client premises
Duration
India Tax Workshop 2014 Page 27
Renoir Consulting case (ITA No. 4323& 4125/Mum/2011)
► F Co, a Mauritius company, was engaged for the
provision of management/ consultancy services to I
Co. The duration of the project was 50 weeks
► F Co deputed its employees to work on I Co’s
project in India
► No office space was available for employees. As
the project was primarily for the improvement of
sales, meetings with I Co were held at different
venues
► Employees stayed in a hotel for accommodation
► The issue was whether a fixed PE of F Co was
created in India (Mauritius DTAA does not have
service PE clause)
F Co
I Co
Employees
of F Co
India
Consultancy,
management
services
Mauritius
Hotel
India Tax Workshop 2014 Page 28
Renoir Consulting case
► Tribunal held that the hotel rooms/ I Co’s premises constituted a fixed PE in India
► PE indicates the degree of economic penetration that justifies a nation treating foreign person in
the same way as a domestic person
► Nature of work and its execution suggests that some place is at the disposal of F Co’s employees
during their stay in India
► Whether the hotel rooms could be legally or contractually used for business purposes was not
ascertained. Even if the use of hotel rooms for business prohibited, the PE could be constituted if
the rooms are factually used for business purpose.
India Tax Workshop 2014 Page 29
Hotel rooms as PE - issues and analysis
► Does the employer (F Co) have a “right to use” hotel rooms for its business activities?
► 2012 OECD Revised Discussion Draft on “home office” as PE
► Regular and continuous use of home for commercial activities
► PE risk where the employer does not provide a formal office and requires employee to work from
home
► Other negative factors – rental costs borne by the employer, cost of facilities (telephone, printer
etc.) borne by the employer
India Tax Workshop 2014 Page 30
Concluding Thoughts
Concluding thoughts
► PE and profit attribution to PE is one of the most complex issue in tax treaty law
► The absence of clarity and certainty can result in unrelieved double taxation and administrative burden
► Recent case laws point to a trend towards increasing the number of situations in which PE would be
found to arise
► Even if PE exists what may be taxed are profits attributable determined based on the application of
arm’s length principles
► Inter-play between PE and transfer pricing
► Possibility of obtaining certainty on PE profit attribution by way of APA
► Dynamic nature of the issue requires periodic PE (and related profit attribution) risk assessment
India Tax Workshop 2014 Page 32
Thank you
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