One of the most important and widely debated concept of Double Taxation Agreements is that of "Permanent Establishment"[hereinafter referred as PE]. Time and again courts have given interpretations and clarifications on its multi aspects. Recently the Delhi High Court in the case of DIT v. E Funds Corporation and DIT v. E Funds IT Solutions1 has held that Indian Subsidiary of a foreign company providing back office support operations does not constitute a PE in India. The High court has rightly observed that a wholly owned Indian company of a foreign company would not create a permanent establishment for the Assessee, despite of the MAP [Mutual Agreement Procedure] finding to the contrary. There was no authority with the Indian Subsidiary to take any decisions or conclude contracts, etc. on behalf of its Foreign Holding Company and hence such Indian subsidiary cannot be termed as agency PE of its Foreign Holding Company.
Facts of the case:
e-fund Corp Corporation, USA and e-Fund IT Solutions Group Inc., USA (hereinafter collectively referred as taxpayers) were residents of USA. The businesses of taxpayers included electronic payments, ATM management service, decision support and risk management and professional services, e-fund India performed certain back-office operations in respect of some these services, which included data entry operations etc. in respect of decision and risk management.
Whether the taxpayers had a permanent establishment in India under Articles 5(1), 5(2)(1) and 5(4) of the India- US DTAA? And Whether any income of e-funds International India Pvt. Ltd. Can be assessed in hands of taxpayers?
Observations of the Hon'ble High Court2:
1. The Court observed that business connection of taxpayers in India with e-fund was established, as e-Funds India was providing information and details to the taxpayers in USA for the purpose of entering into contracts with third parties and subsequently the said contracts were performed fully or partly by e-funds India as an assignee or sub-contractee . Analyzing and observing the said transactions and the manner in which contracts were executed and where the taxpayers had assumed and agreed to third party claims and risks; business connection was established. However, it was held that when provisions of tax treaty and provisions of the Act are applicable to the taxpayer, which one of the two is more beneficial or advantageous to the taxpayer should apply.
2. Hon'ble Court discussed at length whether a subsidiary per se would constitute a PE, after discussing and analyzing definition of PE as given under Article 5 of the India- US Double Taxation avoidance Agreement. A write up from Bulletin for International Taxation , February 2011 titled 'The subsidiary as a Permanent Establishment" was quoted by the Hon'ble Court, which states as follows:
"A PE is, however, not always easy to identify. This is particularly true where a PE is hidden behind a dependent operating company, i.e. if an operating company in addition to its own business also carries on another company's business as a PE of the latter. In this regard, the 2010 OECD Model Tax Convention (the –OECD Model ) states in Art. 5(7) that:
the fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other state (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other
This follows from the principle that, for the purpose of taxation, such a subsidiary constitutes an independent legal entity. Accordingly, both companies are subject to unlimited tax liability in the state in which they are resident or where their place of management is located.
However, by using the wording –not of itself , the provision clarifies that a parent company (parent) can have an (agent) PE in its subsidiary's state of residence if the general requirements for a PE set out in Art. 5(1) to (5) of the OECD Model are met. Accordingly, any space or premises belonging to the subsidiary that is at the disposal of the parent (the –right-to-use test ) and that constitutes a fixed place of business (the –location test and the –duration test ) through which the parent carries on its own business (the –business activity test ), gives rise to a PE of the parent under Art. 5(1), subject to Art. 5(3) and (4), of the OECD Model. In addition, under Art. 5(5) of the OECD Model, a subsidiary constitutes an agency PE of its parent if the subsidiary has the authority to conclude contracts in the name of its parent and habitually exercises this authority, unless these activities are limited to those referred to in Art. 5(4) or unless the subsidiary does not act in the ordinary course of its business as an independent agent within the meaning of Art. 5(6)........
3. Subsidiary as a Permanent Establishment: Hon'ble Court after analyzing the definition of PE as contained under Article 5 of the DTAA observed that a subsidiary per se does not constitute a PE. The Hon'ble court further observed that there was not sufficient material to prove that the taxpayers (i) had a fixed place of business of enterprize was wholly or partly carried on and (ii) had right to use any of the premises belonging to efund India. Therefore Article 5(1) of the tax treaty cannot be evoked to constitute a PE in India.
4. Factors such as e-fund provides various services to the taxpayers and was dependent on them for earning, e-fund was reimbursed the cost of the cell Centre operations with a certain margin of profit, or fund did not bear sufficient risk, direct or indirect costs, and corporate allocations in software development Centre or BPO, etc. are not relevant to determine and decide location of PE. Only due to the fact that the subsidiary company was performing the core activities as were required to be performed by the foreign taxpayer does not create a fixed place PE. All the requirements of Article 5 of the DTAA need to be satisfied to term a subsidiary as a PE of its foreign holding company and merely because an enterprize enters into contracts, assign or sub-contract works or render services to third party on behalf of the principal, by itself would not lead to a subsidiary becoming a PE.
5. Service PE under Article 5(2)(1) of the DTAA: In respect of e-Fund employees the Hon'ble High Court observed that the Employees of E-Fund India were their employees, i.e. employees of an Indian entity and not employees of the assesse. The employees of e-fund India did not become ― other personnel of the two assesse, once and if the said persons were defacto and dejure employed by the Indian entity/enterprise, i.e., e-Fund India. The words ―employees and ― other personnel have to be read along with the word ―through and furnishing of services by the foreign enterprise within India. Thus the employees and other personnel must be of the non-resident assesse to create a service PE. Any other interpretation or treating employees of the Indian entity, i.e., e-Fund India as ―other personnel of the foreign assesse would lead to incongruities and irrational result, for every subsidiary which engages an employee, would always become a PE of the controlling foreign company.
The High Court relied on the Supreme Court decision in the case of Morgan Stanley and held that merely because the non - resident taxpayer to protect their interest, for ensuring quality and confidentiality has sent its employees to provide stewardship services, will not make the Indian subsidiary or another entity, a PE of the non-resident company even if the employees of the non – resident taxpayer were taken on deputation.
6. Agency PE under Article 5(4) and (5) of DTAA: Paragraphs 4 and 5 of Article 5 relate to creation of agency PE in the second contracting country. Agency replaces fixed place with personal connection. Subsidiary by itself cannot be considered to be a dependent agent PE of the Principal. Transactions between a foreign enterprise and an independent agent, do not result in establishment of a Permanent establishment under 5 to Article 5 if the independent agent is acting in ordinary course of their business. The expression –ordinary course of their business has reference to activity of the agent tested by reference to normal customs in the case in issue. It has reference to normal practice in the line of business in question.
However as per paragraph 5 of Article 5, an agent is not considered to be an independent agent if his activities are wholly or mostly wholly on behalf of foreign enterprise and the transactions between the two are not made under arm's length conditions. The twin conditions have to be satisfied to deny an agent character of an independent agent. In case the transactions between an agent and the foreign principal are under arm's length conditions the second stipulation in paragraph 5 of Article 5 would not be satisfied, even if the said agent is devoted wholly or almost wholly to the foreign enterprise. The transactions between the taxpayers and e -Fund India were at arm's length and were taxed on arm's length principle and therefore, requirements of Article 5(5) are not satisfied. Consequently, there was no Agency PE of the taxpayer in India.
India is day by day becoming a preferred destination for investment by foreign companies, with increase in foreign investment, back office operations by foreign companies have increased considerable and are bound to increase in future also. Taxability of such foreign companies have back office operations in India time and again been debated over in courts of India, above ruling of Delhi High Court in such background has been welcomed and looked upon. The said Ruling of High Court has made it clear that mere presence of a subsidiary of a foreign entity does not make such subsidiary o PE of the foreign entity. For a subsidiary to be termed a PE, all the conditions mentioned in Article 5 of the DTAA are required to be satisfied. The underlying principle being that such subsidiary, if acting/ performing on just behalf of its Foreign Holding Company may constitute a PE of its foreign holding company, but a subsidiary cannot be per se tagged as PE just by virtue of its being a subsidiary of its Foreign Holding Company.
1. ITA 738/2011 and ITA No. 736/2011 & 737/2011
2. References taken from KPMG issue titled " Indian subsidiary of a Foreign company providing back office support operations does not constitute a PE in India dated 11th February, 2014