When an establishment is not permanent
The Supreme Court order will guide determination of permanent establishment by multinational companies, say experts
The issue of permanent establishment (PE) for multinational companies (MNCs) has been a matter of intense debate for many years. The Supreme Court (SC) had settled some aspects of this issue in cases relating to Morgan Stanley and Formula One Championship earlier. Now, it has put to rest the issue in case of service-related sub-contracting of work to Indian subsidiaries by MNCs. Significance of PEs It is on the basis of PE the tax department can impose income tax on international transactions of these companies. The moot issue in the latest case was whether outsourcing of functions by MNCs to its Indian subsidiaries constitutes a fixed PE. The SC upheld the verdict of the Delhi High Court, reversing that of the Income Tax Appellate Authority (ITAT), Delhi. Genesis of the dispute The case related to taxation matters of two US-based companies — e-Fund Corporation and e-Fund IT Solutions Group Inc (e-Fund Inc). These companies had paid taxes on their global income in the US. Now, e-Fund Corp is a holding company with almost 100 per cent stake in IDLX Corporation, another company based in the US. IDLX Corporation holds almost 100 per cent stake in IDLX international BV, based in the Netherlands, which in turn owns 100 per cent stake in another Netherlands-based company IDLX Holding BV. IDLX Holding BV holds 100 per cent stake in e-Funds International India Private Limited. IDLX International BV is also a holding company with almost 100 per cent stake in e-Fund Inc.
The revenue department claimed that income of the e-Fund Corp and e-Fund Inc was attributable to India because the two assessees had a PE in India. This means their income should be taxed in India, irrespective of whether they had paid taxes in the US. To establish the two US-based firms had a PE in India, the department said the companies were outsourcing business to their 100 per cent subsidiary which resulted in creation of a PE. It also gave arguments such as: 40 per cent of employees of the entire group were in India; e-Funds Corp had call centres and software development centres only in India; and e-Funds Corp essentially did only marketing work and its contracts with clients were assigned, or sub- contracted, to e-Funds India.
The Supreme Court found this approach erroneous.
Earlier, the Delhi HC had also said the fact that e-Fund India provides various services to the assessee and was dependent for its earning upon the two assessees was not the relevant test to determine and decide the location of the PE. The SC upheld it.
For this, the Supreme Court relied on its judgment in a case related to Formula One. In that case it had held that fixed-place PE arises when there is a physical location which is at the disposal of the enterprise through which the business is carried on.
However, no part of the main business and revenue earning activity of the two US companies was carried on through a fixed business place in India and as such would not give rise to a fixed-place PE, the SC ruled. A trendsetter According to Dinesh Kanabar, chief executive officer, Dhruva Advisors, the focus in case of Formula One was on whether a limited presence for a temporary racing activity could create a PE. And although this judgment was farreaching, it was rendered in the context of a very specific fact pattern. “The e-Funds judgment, on the other hand, deals with a fact pattern that is fairly widespread in the Indian context where a foreign entity sub- contracts work to its group entities, subsidiaries in India. This judgment will provide significant clarity and certainty in such situations,” he said.
Experts say this order will provide significant certainty and clarity, specifically to the BPO and ITES sectors where it is common for overseas entities to market and enter into contracts with customers, which are thereafter sub-contracted to India. Interestingly, the judgment has wider ramifications for subsidiaries of MNCs as well.
Abhishek Goenka, leader, corporate and international tax, PwC, said this decision reinforces the internationally accepted principle that a subsidiary carrying on its own business activity does not, by itself, create a PE of the foreign parent in India.
For creation of a PE, the criterion is that the business of the foreign enterprise needs to be carried out through the fixed place of business in India which is at disposal of that enterprise. The judgment has another important takeaway. The two US-based companies had admitted under the Mutual Agreement Procedure (MAP) that income tax will be attributable “to the Indian PEs” based on a certain ratio for earlier assessment years.
The apex court ruled that such agreement ( MAP) cannot be considered as a precedent for subsequent years. Experts say the SC verdict is also important for establishment of a service PE. It held that this kind of PE is established when the services are rendered within India and to Indian customers, which was not the case in relation to the two US companies.
Amit Maheshwari, partner, Ashok Maheshwary & Associates, said the ruling could provide relief to a lot of cases where due to cross-border transactions, service PE could be constituted. The other important aspect of the judgment is that it reiterated the principle laid down in Morgan Stanley’s case that payment of an arms’ length consideration to the Indian entity would extinguish any potential tax liability that may arise even if a PE is established.
Arijit Chakravarty, senior principal, Advaita Legal, pointed out issues such as — whether the Indian entity provides various services to non-resident entities and is dependent for its earning on them, the Indian entity was reimbursed on a cost-plus basis — would not really be relevant for the existence of a PE.
This order will provide certainty and clarity, specifically to BPO and ITeS sectors where it is common for overseas entities to market and enter into contracts with customers, which are thereafter subcontracted to India