Monday, 31 March 2014

Changing contours of permanent establishment

In the context of taxation of business profits in India, the concept of permanent establishment (PE) has been of intense debate and interpretation. Over a period of time, the concept of PE has undergone significant evolution, due to several developments such as tax commentaries and judicial rulings. It would be interesting to look at and analyse the trend of some recent rulings.
E-commerce
Gone are the days when MNCs were required to invest in setting-up physical presence to further their



business ambitions. The explosion of e-commerce has brought businesses to the door step (or better said, finger tips!) of the consumers. Tax laws of countries across the world have relied on physical presence or nexus theory for taxing income of MNCs. Where the income has nexus with a physical presence, such income is taxable to the extent attributable to such presence. In the case of Right Florists Pvt Ltd, the Kolkata Tribunal had to decide whether payments made to search engines like Google for online advertising on their search engines were taxable in India, given the fact that web-servers were located outside India. The OECD commentary specifies that an internet website, which is a combination of software and electronic data, does not in itself constitute tangible property. It, therefore, does not have a location that can constitute a PE as there is no facility such as premises, machinery or equipment. However, India had expressed reservations to the commentary and stated that website may constitute PE in certain circumstances. Till date, these circumstances have not been specified, in light of which the Tribunal held that Google’s presence in India through its website cannot be said to constitute PE in India, unless the web-server is also situated in India. In the absence of a PE, such payments were not taxable in India.

Subsidiary company

In many cases, MNCs have set up subsidiary in India which undertakes transactions with other group companies. In a decision in the case of Pubmatic India Pvt Ltd, the Mumbai Tribunal held that where transactions are between related parties on principal to principal basis and at arm’s length, a PE cannot be said to be created merely because one entity is a subsidiary of the other. In this case, an Indian company purchased advertisement space for its clients from its US holding company which, in turn, would purchase space on foreign websites. Both transactions were undertaken at a cost-plus mark-up. It was observed that the transactions were on a principal-to-principal basis and, in absence of a PE, the US company was not taxable in India. On the other hand, in the case of Convergys Customer Management, the Delhi Tribunal held that the holding company had a PE in India as its employees frequently visited the Indian subsidiary premises to provide supervision, direction and control over the operations of the Indian subsidiary and such employees had a fixed place of business at their disposal.

Force of attraction rule
In the consultancy industry, it is possible to conduct services sitting outside India for Indian clients without the need to physically visit India. India has amended the local law retrospectively to provide that services need not be rendered in India to be taxable in India. However, the treaties do provide for some relief, except for those based on the UN Model Convention which states that when an enterprise sets up a PE in another country, it brings itself within the fiscal jurisdiction of another country to such a degree that another country can properly tax all profits that the enterprise derives from that country, whether the transaction is routed and performed through the PE or not. This is popularly known as the Force of Attraction rule. In a decision by the special bench of Mumbai Tribunal, which should come as a major relief, it was held in the context of legal services provided by Clifford Chance from abroad that such services were not covered under the ambit of the retrospective amendment, since these services were in the nature of business income. Further, the special bench resolved the contradictions in the earlier decisions in the context of the India-UK Treaty and held that Force of Attraction rule does not trigger in this case in view of differences in language under the treaty from
the UN Model Convention.

The above decisions last year point towards the pragmatic approach of taxmen while taxing evolving business transactions and structures. Indian judicial authorities have acted judiciously in applying taxing principles. As taxation statutes continue to evolve to keep pace with the evolving environment, MNCs need to ensure that their operations are structured appropriately to mitigate adverse tax consequences and litigation

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