Delhi HC rules that outsourcing of services by a US company to its Indian affiliate does not constitute a PE

This Tax Alert summarizes a recent decision of the Delhi High court (HC) in the case of E Funds Corporation and its group entities on whether outsourcing of services to an Indian affiliate results in a Permanent Establishment (PE) in India for the Foreign Enterprise (FE) under the provisions of the India-US Double Taxation Avoidance Agreement (DTAA). The HC held that a subsidiary constitutes an independent legal entity for taxation purpose and, hence, the holding-subsidiary relationship or control exercised by a parent on its subsidiary, by itself, does not result in a PE of the FE in India unless the contrary is proved.

On facts, the outsourcing of activities to the Indian affiliate was found not to result in either a fixed place or agency PE of the FE in India. Deputation of employees of the FE to carry out stewardship activities to protect the interests of the FE does not result in a service PE of the FE in India. Similarly, employees of the subsidiary who work under the supervision and direction of the Indian affiliate also do not result in a service PE of the FE in India. On attribution of profits, the assets and activities of the PE (and not of the subsidiary) should be considered to determine if there is any need to attribute any further profits to the PE. In the present fact pattern, as no PE of the FE was found to exist, there were no profits that could be taxed in India and further no income of the subsidiary could be attributed or assessed in the hands of the FE.

Globalization has led many multi-national enterprises to outsource business process and information technology services to affiliates in India. The Indian affiliates are typically set up as captive service providers, contractually insulated from significant risks and entitled to a stable return for their services. Whether such arrangements could result in a PE for the FEs and the attribution of profits if a PE exists in such a scenario have been contentious issues in India. This decision provides guidance on the issues that are relevant as well as factors that are not relevant in making this determination.

The HC has ruled that the premises or facility of the Indian affiliate that provides services to its foreign group company under a sub-contract arrangement does not, by itself, result in a PE of the foreign enterprise. The ruling clarifies that even if the core activities of the FE are outsourced to an Indian affiliate under a sub-contract arrangement, with the Indian affiliate bearing limited risk, it should not create a PE for the FE if the FE does not have the right of use of the premises or facility from where the services are delivered. The ruling also confirms that visits by personnel of the FE for stewardship activities or secondment of personnel who work under the direction and control of the Indian affiliate should not result in a PE under the service PE rule.

It will be useful for multi-national enterprises that outsource functions to Indian affiliates to review the impact of this ruling on their existing outsourcing arrangements.