Delhi Tribunal rules on existence of PE and on profit attribution to the PE (Nortel Networks)

We are pleased to release a tax alert which summarizes a recent ruling of the Delhi Income Tax Appellate Tribunal (Tribunal) in the case of Nortel Networks India International Inc. (Taxpayer) on whether the Taxpayer had a permanent establishment (PE) in India under the provisions of the India-US Double Taxation Avoidance Agreement (DTAA) on account of a contract with an Indian customer for supply, installation and commissioning of equipment, and the extent of profits attributable to the PE, if any.

The  Taxpayer’s Indian affiliate, Nortel Networks India Pvt. Ltd. (Nortel India), had initially entered into a contract with an Indian customer for supply, installation and commissioning of telecommunication equipment. Nortel India, thereafter, assigned the contract to the Taxpayer. The Taxpayer executed the contract by purchasing equipment from Group companies and using Nortel India for installation and commissioning work. The Tribunal treated the entire contract as an indivisible one under which all activities done by other Group entities were treated as done on behalf of the Taxpayer. Based on the facts, the Tribunal held that, under the DTAA, the Taxpayer had a fixed place PE, as well as a dependent agent PE in India, , by virtue of the activities of Nortel India, as well as on account of the Group company’s liaison office (LO) in India. Furthermore, the Taxpayer’s profits were recast based on the Group’s global accounts, as well as gross profits margins and, thereafter, deducting some amount for general and marketing expenses. The Tribunal upheld attribution of 50% of such profits to the Taxpayer’s PE in India.

Existence of PE has emerged as a contentious international tax issue for multinational enterprises doing business in India. This ruling indicates the potential for a PE exposure while executing a turnkey contract involving equipment supply and provision of installation and commissioning services using related parties. Even though this ruling does not provide much insight into factors which the Tribunal considered as determinative for concluding on existence of PE, it highlights the need for multinational enterprises to review contractual arrangements for such projects to assess potential PE risk. The Tribunal also upheld the Tax Authority’s formulary approach to attribution of profits to the PE, even though judicial precedents in India have generally supported the use of arm’s length principles. This indicates the need for taxpayers to manage profit attribution risk in case a PE is inevitable by maintaining appropriate documentation to demonstrate the application of arm’s length principles for attributing profits, in case a PE is asserted by the Tax Authority.