Delhi Tribunal rules on Service PE trigger on account of deputation and principles for examining “effectively connected” with PE

This Tax Alert summarizes a recent ruling of the Delhi Income Tax Appellate Tribunal (Tribunal) in the case of JC Bamford Excavators Ltd. (Taxpayer) on the tax implications arising from grant of use of intellectual property rights (IPRs) and provision of services of personnel by the Taxpayer to a wholly-owned Indian subsidiary, under the India-UK Double Taxation Avoidance Agreement (DTAA), as well as the Indian Tax Laws (ITL).

The Tribunal held that consideration for grant of use of IPRs was taxable as royalty in India. It was held that activities of inspection and testing by employees of the Taxpayer were undertaken to ensure that quality of the licensed products adhered to the specifications/global standards, which was in the interest of the Taxpayer. Such activities would amount to stewardship activities and would not give rise to a permanent establishment (PE) in India. Furthermore, technical assistance was rendered to the Indian subsidiary by employees of the Taxpayer, which resulted in a Service PE and fee for such technical services was effectively connected with the Service PE. Accordingly, such fee was taxable as business profits under the DTAA.

Business arrangements with affiliates across jurisdictions, involving technical collaboration for use of IPRs and assignment of employees for assistance thereof, are not uncommon in multinational enterprises. However, such arrangements often raise peculiar tax issues under the applicable Double Taxation Avoidance Agreements, as well as the ITL. This ruling deals with the issues of royalty taxation as also Service PE emergence on deputation/assignment of personnel to an entity in India. It provides guidance on the factors which are relevant for determining whether services are rendered as employees of the foreign enterprise or whether the deputees have become employees of the Indian entity. On this aspect, apart from relying on principles laid down by the SC in the case of Morgan Stanley (supra), the Tribunal acknowledged the “substance over form” approach based on actual conduct and the arrangement. It is also noted that, where assignment of employees is incidental to a technology transfer agreement, it indicates that the foreign enterprise is rendering services through its employees. Furthermore, activities like quality control undertaken for ensuring global standards of the licensed products, for the benefit of the parent company, are regarded as stewardship activities not giving rise to a Service PE. This ruling also elucidates on the interpretation and application of the term “effectively connected” which has not been defined under the ITL and the Double Taxation Avoidance Agreements.