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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


► Background

► Is there a PE?

► Digital Economy

► Employee Secondment

► PE for a Group

► Outsourcing

► Use of Hotel Rooms

► Concluding thoughts

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


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


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)


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”


Ireland

India

US

Right Florists Case (143 ITD 445)(Kol)(2013)

Payment for advertising

Google

► 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


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.


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


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


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.


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


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)


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


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


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.


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.


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


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


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


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.


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


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


Thank you

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