India

Tax & Regulatory

For private circulation only

International Tax Alert

Volume: ITX/2/2014

9 February 2014

Indian entity or its employees providing back office operations did

not create PE for offshore entity

Synopsis

The Delhi High Court (Delhi HC) in its judgment dated 5 February 2014 analyzed the provisions of Article 5

dealing with Permanent Establishment (PE) and considering the facts of case held that neither the Indian

entity nor its employees who provided back office operations create a PE for the foreign entity in India. The

judgment has comprehensively explained situations that could create a PE for a foreign entity in India and

has also thrown some light on attribution of profits.

Facts

e-Fund Corporation, USA (e-Fund Corp.) and e-Fund IT Solutions Group Inc., USA (e-Fund Inc.)

(collectively referred to as taxpayer/s) were incorporated under the laws of the USA and were tax residents

of the USA.

e-Fund International India Private Ltd., India (e-Fund India) was a company incorporated in India and a

resident of India.

e-Fund Inc. and e-Fund India were wholly owned indirect subsidiaries of e-Fund Corp.

The taxpayers had four main business lines, namely (a) Electronic Payments; (b) ATM Management

Service; (c) Decision support and risk management; and (d) Professional Services. e-Fund India had

performed back office operations in respect of the first three. This included data entry operations etc. in

respect of ‘Decision Support and risk management’.

e-Fund India was remunerated for the services rendered to the taxpayers. The international transactions

between the taxpayers and e-Fund India and the income of e-Fund India were made the subject matter of

arm’s length pricing by the tax authorities.

The Mutual Agreement Procedure (MAP) under Article 27 of the India-US tax treaty was resorted to in the

case of e-Fund Corp. for the AY 2003- 04 and in the case of e-Fund Inc. for the AYs 2003-04 and 2004-05.

These AYs are not under consideration by the present HC decision.

As per the terms of the MAP, the Competent Authorities agreed on a basis for attributing income in relation

to Indian operations. The letter issued by the Competent Authorities stated that the said basis would not be

binding on subsequent years. The taxpayer intimated the tax authorities that they did not agree on

technical merits that they had a PE in India but had agreed to accept the mutual settlement.

Considering the facts of the case, on the main issue of PE, the Assessing Officer (AO) came to the

conclusion that the taxpayers had a PE in India, which was confirmed by the Commissioner of Income-tax

(Appeals) [CIT(A)] as well as by the Tribunal. On other issues, the Tribunal held that re-opening of

assessment was valid in law; MAP proceedings had an important bearing on the PE issue and had to be

given effect on priority wherever required. However, the Tribunal did not adopt the method adopted by the

AO or as agreed under MAP for attributing the profit to the Indian PE of the taxpayers.

Significant issues

Whether the taxpayers have a PE in India under Article 5(1) (fixed place PE), 5(2)(l) (service PE) and 5(4)

(agency PE) of the India-US tax treaty?

Whether the taxpayers have a business connection in India in terms of provisions of the Income Tax Act

(ITA)?

Whether any income of e-Fund India can be attributed and assessed in the hands of the taxpayers? If yes,

whether the Tribunal was correct in adopting a method for determining attribution of profits different than

as agreed under MAP for some of the AYs?

High Court Judgement

Permanent Establishment in India:

Fixed place PE

Neither in the assessment order nor in the appellate order including the order of the Tribunal, there is any

material and relevant discussion to hold that the taxpayers had a fixed place of business in India through

which business of enterprise was wholly or partly carried on. None of the authorities including the Tribunal

have held that the taxpayers had right to use any of the premises belonging to e-Fund India.

The ‘right to use test’ or ‘disposal test’ had not been applied nor was there any observation or finding to that

effect. In the absence of any such finding, it cannot be said that the taxpayers had a fixed place of business

in India as contemplated in Article 5(1) of the India-US tax treaty.

Paragraph 3 of Article 5 sets out a negative list or excludes activities performed through a fixed place in

India or USA by a foreign enterprise/assessee, from application of paragraphs 1 and 2 to Article 5. It does

not follow that if activities are not covered in the negative or exclusions set out in paragraph 3, a PE is

established or deemed to be established under paragraphs 1 or 2 of Article 5.

The submissions of the Revenue that the taxpayers were a joint venture or in partnership with e-Fund India

as the business of the assessee and the Indian subsidiary were interlinked and closely connected, were out

of the context.

The following factors were considered to be not relevant in determining a fixed place PE:

(a) Close association between e-Fund India and the taxpayers

(b) Various services being provided by e-Fund India to the taxpayers and its dependence upon them for

its earning

(c) e-Fund India not bearing sufficient risk

(d) Assignment or sub-contract of contracts to e-Fund India

(e) e-Fund India being reimbursed on a certain cost-plus basis

(f) Direct or indirect costs and corporate allocations in software development centre or BPO

(g) Intangible software being provided to e-Fund India free of cost

(h) Saving / reduction in cost by transferring business or back office operations to the Indian subsidiary

(i) The manner and mode of the payment of royalty or associated transactions

(j) e-Fund India carrying on core activities as performed by the taxpayers

The judgment contains an observation suggesting that certain other entities of e-funds group may have a PE

in India if it is found that they have a ‘place of management’ in India. This observation was made with specific

reference to the fact that employees of certain offshore entities reported to an employee in India. This, not

being the subject matter of the present appeal, was not discussed further.

Agency PE

Conditions of Articles 5(4) of the India-USA tax treaty were not satisfied as e-Fund India was not authorized

and did not habitually exercise authority to ‘conclude‘ contract or was maintaining stock or merchandise from

which it delivered goods or merchandise on behalf of the taxpayers or secured orders on behalf of the

taxpayers.

Conditions of Article 5(5) of the India-USA tax treaty were not satisfied as there was no allegation or

considered finding that the transactions were not in ordinary course of business and the assessment order

did not state or mention how and why the transactions between the taxpayers and e-Fund India were not at

arm’s length.

Further, the following factors were considered to be not relevant in determining Agency PE:

(a) 40% of the employees of the entire group were in India i.e. were employees of e-Fund India

(b) Provision of any software, intangible data etc. – irrespective of the same being provided free of cost or

otherwise

(c) Basis of reimbursement of certain expenses to e-Fund India

Service PE

The ‘employees’ and ‘other personnel’ must be of the non-resident assessee to create a service PE. Any other

interpretation or treating employees of the Indian entity, i.e. e-Fund India as other personnel of the foreign assessee

would lead to incongruities and irrational result, for every subsidiary which engages an employee, would always

become a PE of the controlling foreign company.

The nature and functions performed by the employees seconded by the foreign enterprise/assessee to the Indian

enterprise/subsidiary and who exercised control and supervised them, are critical factors in determining whether a

Service PE exists on not. When and if the said employees had provided stewardship function, no PE exists even if

the employees of the non-resident assessee were taken on deputation.

Employees of e-Fund India were not to be counted and treated as employees of the taxpayers as e-Fund India was

a separate entity and taxable assessee.

Based on facts, two employees deputed to e-Fund India did not create the Service PE as the entire salary cost was

borne by e-Fund India and they were working under control and supervision of e-Fund India.

Subsidiary PE

A holding or a subsidiary company by themselves would not become PE of each other.

In view of Article 5(6) of India-USA tax treaty, the taxpayers and Indian Subsidiary (e-Fund India) did not become PE

of each other in the respective countries just because they controlled or were being controlled by another company.

Business Connection in India

Business connection did exist, not because the taxpayers were associated enterprise or had a subsidiary in India,

but because the e-Funds India was providing information and details to the taxpayers in the USA for the purpose of

entering into contracts with third parties subsequently the said contracts were performed fully or partly by e-Funds

India as an assignee or sub-contractee.

Looking at the nature of the said transactions and the manner in which contracts were executed and where the

taxpayers had assumed and agreed to third party claims and risks, business connection was established.

What was attributable and taxable as business connection was not adjudicated and decided by the High Court. This

was because both the tax authorities and the taxpayer had proceeded that in terms of Section 90(2) of the Act,

provisions of the India-USA tax treaty were more beneficial to the taxpayer.

MAP

The MAP procedure and agreement, is no doubt relevant but cannot be determinative or the primary basis to decide

whether the assessee had PE in India. Whether or not PE exists is a matter of law and fact, and there has to be

determination of the said issue on merits.

Profit attribution

In the MAP proceedings once a formula was adopted, it should be consistently followed. But if the said formula was

irrational and inappropriate; it could be corrected in other and subsequent years.

Comments

The Delhi HC held that no income of the e-Funds India could be attributed and assessed in the hands of the

taxpayers as the taxpayers did not have a PE in India.

This is a landmark decision in the area of International Taxation. The Delhi HC in its judgment has referred to

OECD and UN commentaries as well as views expressed by eminent international authors while arriving at

the conclusion that the taxpayers in the instant case did not have a PE in India. This judgment provides the

much needed relief to the international business community who has set up back office operations in India.

Way Forward

Taxpayers should review their existing arrangement / contracts with Indian entities to assess whether or not

there exists a PE in India or not.

Where employees are seconded to India – ascertain under whose control and supervision are these

employees working and who is bearing the costs of such employees.

Assess whether ‘place of management’ of any of the offshore entities can be said to exist in India.

If a PE exists in India, ascertain a reasonable and logical basis for ascertaining the profits that are attributable

to the Indian PE.

Source:

E Funds Corporation – The Delhi HC judgement dated 5 February 2014

Do you know about Dbriefs ?

Dbriefs are live webcasts that gives valuable insights on important developments affecting your

business. To register, visit www.deloitte.com/ap/dbriefs

Contacts

Ahmedabad Heritage, 3rd Floor, Near Gujarat Vidyapith, Off Ashram Road, Ahmedabad – 380 014. Tel: + 91 (079) 2758 2542 Fax: + 91 (079) 2758 2551

Bangalore Deloitte Centre, Anchorage II, 100/2, Richmond Road, Bangalore 560 025. Tel: +91 (080) 6627 6000 Fax: +91 (080) 6627 6010

Chennai No.52, Venkatanarayana Road, 7th Floor, ASV N Ramana Tower, T-Nagar, Chennai 600 017. Tel: +91 (044) 6688 5000 Fax: +91 (044) 6688 5050

Coimbatore Shanmugha Manram 41, Race Course, Coimbatore Tamil Nadu - 641018 Tel: + 91 (0422) 439 2801 Fax: +91 (0422) 222 3615

Delhi/Gurgaon Building 10, Tower B, 7th Floor, DLF Cyber City, Gurgaon 122 002 Tel : +91 (0124) 679 2000 Fax : + 91 (0124) 679 2012

Hyderabad 1-8-384 and 385, 3rd Floor, Gowra Grand S.P.Road, Begumpet, Secunderabad – 500 003. Tel: +91 (040) 4031 2600 Fax:+91 (040) 4031 2714

Kolkata Bengal Intelligent Park Building Alpha, 1st floor, Block EP and GP Sector V, Salt Lake Electronics Complex, Kolkata - 700 091. Tel : + 91 (033) 6612 1000 Fax : + 91 (033) 6612 1001

Mumbai Indiabulls Finance Centre, Tower 3, 28th Floor, Elphinstone Mill Compound, Senapati Bapat Marg, Elphinstone (W), Mumbai – 400013 Tel: + 91 (022) 6185 4000 Fax: + 91 (022) 6185 4101

Pune 106, B-Wing, 7th Floor, ICC Trade Tower, Senapati Bapat Road, Pune – 411 016. Tel: + 91 (020) 6624 4600 Fax: +91 (020) 6624 4605

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its

network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about

for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms.

This material and the information contained herein prepared by Deloitte Touche Tohmatsu India Private Limited (DTTIPL) is

intended to provide general information on a particular subject or subjects and is not an exhaustive treatment of such

subject(s). This material contains information sourced from third party sites (external sites). DTTIPL is not responsible for

any loss whatsoever caused due to reliance placed on information sourced from such external sources. None of DTTIPL,

Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively, the “Deloitte Network”) is, by

means of this material, rendering professional advice or services. The information is not intended to be relied upon as the

sole basis for any decision which may affect you or your business. Before making any decision or taking any action that

might affect your personal finances or business, you should consult a qualified professional adviser.

No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person who relies on this

material

© 2014 Deloitte Touche Tohmatsu India Private Limited. Member of Deloitte Touche Tohmatsu Limited

Registered Office: 12, Dr. Annie Besant Road, Opp. Shiv Sagar Estate, Worli, Mumbai 400 018.

Home | Add Deloitte as safe sender