Supreme Court’s Verdict on PE of MNCs having their Business Operations in India

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  • Last Updated on 15 June, 2022
 
1. Introduction:
With the growing trend of globalization and the increasing presence of enterprises across the globe, the concept of Permanent Establishment (‘PE’) has gained significant magnitude, both in India and worldwide, due to its direct influence on the tax revenues earned by a Country. The issues regarding the constitution of PE and the attribution of the profits of PE have always been a matter of high litigation in India. The issues become even more complex when the foreign enterprise has a subsidiary in India.
 
After the landmark judgment of the Apex Court in the case of the Formula One World Championship Ltd. v. CIT (International Taxation) [2017] 394 ITR 80/248 Taxman 192/80 taxmann.com 347 (SC) in which the conditions for the constitution of PE were explained at length, the Apex Court has recently delivered another important ruling in the case of E-funds IT Solutions Inc., dealing with the issue of whether or not the various back office services that are outsourced by a foreign enterprise to its Indian subsidiary constitute the PE of the foreign enterprise.
 
The Apex Court held that a Fixed Place PE can be created only if all the tests for the constitution of a Fixed Place PE are satisfied, i.e., there is a ‘fixed place’ at the ‘disposal of the foreign enterprise’, with some ‘degree of permanence’, from which the ‘business is carried on’. Applying these principles, the Apex Court held that the support services that are performed by the Indian subsidiary do not create a Fixed Place PE of the foreign company in India under the India-US Double Taxation Avoidance Agreement (‘DTAA’).
 
The Apex Court negated the arguments of the Revenue that it would trigger a Service PE in India, on the basis that none of the customers of the foreign company received any services in India and further held that the Indian affiliate was not authorised to conclude contracts on behalf of the foreign company, and accordingly, it did, not create Agency PE in India.
 
The Apex Court also held that no further profits of the foreign company would be attributable even if there exists a PE in India, since the Indian affiliate was remunerated at arm’s length, relying upon the ruling of DIT (International Taxation) v. Morgan Stanley [2007] 292 ITR 416/162 Taxman 165 (SC)
 

2. Facts of the case – E-funds IT Solutions Inc.:

E-Funds Corporation and E-Funds IT Solutions Inc. (collectively known as ‘Taxpayers’) were incorporated and were tax residents of the United States of America (‘USA’). The Taxpayers were engaged in the following business operations outside India: – ATM management services, which covered the business of ATM deployment, management and branding services; – Electronic payment management comprising the provision of payment processing software and electronic payment processing services; – Decision support and risk management provided risk management-based data and products to financial institutions, retailers, etc.; and – Global outsourcing services and professional services, which involved Information technology and business process outsourcing services to support electronic payment businesses.  E-Funds International India Private Limited (‘E-funds India’)was an Indian company and wholly owned indirect subsidiary of E-Funds Corporation. E-funds India supported the Taxpayers as its back office and carried out Information Technology (‘IT’) and IT-enabled services in respect of the above overseas businesses of the Taxpayers. The Taxpayers had seconded two employees in India to oversee the work of E-funds India.  During the course of the tax audit proceedings, the Tax Officer concluded that the Taxpayers had established a business presence in India under the provisions of the Income-tax Act, 1961 (‘the Act’). Further, the Taxpayers also constituted a Fixed Place PE in India under Article  5 of the India-US DTAA. Accordingly, income attributable to the Taxpayers should be taxed in India. The Commissioner (Appeals) [First Appellate Authority]dismissed the appeal of the Taxpayers, holding that the Taxpayers constituted a Fixed Place PE, a Service PE, and an Agency PE in India.  The Tax Tribunal [Second Appellate Authority]upheld the order of the Commissioner (Appeals) on the constitution of a Fixed Place PE and a Service PE of the Taxpayers in India. However, it did not adjudicate the issue as to whether the Taxpayers constituted an Agency PE in India, or not as the same was not argued by the Revenue. Furthermore, the Tribunal adopted a different calculation formula in comparison with the formula adopted by the Commissioner (Appeals), and arrived at a nil figure of income attributable to the PE. The Taxpayers as well as the Revenue appealed to the High Court against the ruling of the Tribunal. The High Court passed a detailed order and held as the following: – E-funds India was providing information and details to the Taxpayers for the purpose of entering into contracts with third parties. Relying on the ratio of the earlier Apex Court’s decisions, in the cases of R.D. Aggarwal and Company [1965] 56 ITR 20 and Ishikawajma-Harima Heavy Industries Ltd. v. DIT [2007] 288 ITR 408/158 Taxman 259 (SC) a business connection of the Taxpayers existed in India. However, the Taxpayers were eligible to opt for the beneficial provisions of the India-US DTAA. – E-funds India did not constitute a PE of the Taxpayers in India under the India-US DTAA. The High Court dismissed the findings and appeals of the Tax Officer and concurred with the Tribunal on the calculation of the profits attributable to the PE, which resulted in nil taxation.  

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3. Arguments before the Apex Court

3.1 Contentions of the Revenue

3.1.1 Fixed Place PE:

40% of the employees of the Taxpayer’s group were in India, and the personnel employed in E-funds India were working under the de facto control and supervision of the Taxpayers.
 
The corporate offices of E-funds India were used to oversee the operations of E-funds India and the other overseas entities of the E-funds group.
 
The counsel relied upon certain statutory disclosures made by the Taxpayers in filings before the regulators in the USA(in Form 10K) to highlight that the Taxpayers had call centres and software development centres in India.
 
The master service agreement between the Taxpayers and E-funds India gave complete control to the Taxpayers over the personnel employed by E-funds India.
 
The Taxpayers were conducting marketing work only and all of the contracts were assigned or subcontracted to E-funds India, which carried out the functions using the proprietary database and software of the Taxpayers that was provided to E-funds India free of cost.
 
Applying the principles laid down by the Apex Court in the judgment of the Formula One World Championship (supra), the location of E-funds India was at the disposal of the Taxpayers with the degree of permanence required, namely, for the entire year.

3.1.2 Service PE: 

40% of the employees of the Taxpayers’ group were working in India under the de facto control and supervision of the Taxpayers.
 
The Taxpayers had call centres and software development centres in India.
 
The Taxpayers were conducting marketing work only and all of the contracts were assigned or subcontracted to E-funds India.
 
The corporate offices of E-funds India were used to oversee the operations of E-funds India and the other overseas entities of the E-funds group.
 
E-funds India’s assignment to work with the Taxpayers or customers located in the US was directed by the Taxpayers or by supervisors acting at the direction of the Taxpayers.
 
The Taxpayer was the sole judge of the performance and capability of each personnel of E-funds India’s, and could request for the removal of one or more of E-funds India’s personnel employees from a project.
 
E-funds Corporation has seconded two employees to India in the senior management of E-funds India, whose activities were beyond the scope of ‘stewardship activities’, as contended by the Taxpayers.
 
Relying upon para 42.31 of the OECD commentary, for services to be furnished within India does not mean that they must be furnished to customers in India. Therefore, the Taxpayers constituted a Service PE in India.
 

3.1.3 Agency PE: 

Since the Taxpayers failed to furnish information when requested, an adverse inference was drawn against them; once this inference was drawn, the burden shifted to the Taxpayers which they had failed to discharge constituting an Agency PE in India.
 

3.1.4 Other key contentions: 

During MAP proceedings for earlier years, under Article 27 of the India-US DTAA, the Taxpayers had admitted that they constituted a PE in India. Such an admission of a PE had to be applied for all of the subsequent years, since there was no change in the factual position.
 

3.2 Contentions of the Taxpayers:

 

 

3.2.1 Fixed Place PE:

The Taxpayers relied on the Apex Court’s ruling in the case of the Formula One World Championship (supra), to contend that they did not satisfy the ‘Disposal Test’ for constituting a Fixed Place PE in India, since there was no fixed place which was at the disposal of the Taxpayers in India.
 
The entire businesses of the Taxpayers was carried on outside India. All the assets and infrastructure through which the business was carried out was located outside India.
 
Besides, E-funds India paid an arm’s length price, as also confirmed by the Transfer Pricing Officer; and, hence, there would be no further attribution of profits to India, even if there was the emergence of a PE.
 

3.2.2 Service PE:

It was necessary that the services were to be rendered to customers in India. In the present case, the Taxpayers had no customers in India.
 
The entire personnel engaged in the Indian operations were employed only by the Indian company, and the fact that the Taxpayers controlled such employees was only for the purpose of protecting their own interests.
 
The activities of E-funds India were independent business activities on which taxes were levied under the Act.

 

3.2.3 Agency PE: 

The aspect of Agency PE was never argued before the Tribunal and no factual foundation for the same had been provided.  

3.2.4 Other key contentions: 

Article 5(6) of the India-US DTAA states that mere fact that a 100% subsidiary may be carrying on business in India does not by itself mean that the holding company would have a PE in India.1
 
The MAP resolution that was passed for the earlier assessment years was not binding for subsequent years, as it was without prejudice to the Taxpayers’ contention that they had no PE in India.

4. Ruling of the Apex Court :

4.1 Fixed Place PE: 

 

There was no specific finding in the tax audit order or the appellate orders that any place in India had been put at the disposal of the Taxpayers. Further, the reliance placed by the revenue on the filings made by the Taxpayers in the USA was also misplaced. The Apex Court concurred with the noting of the High Court that factors like economic dependence, the close association between parties, low risks with the Indian affiliate, and the use of the Taxpayers’ intangible property free of cost by the Indian affiliate in the process of rendering services, etc., were not relevant or criteria for determining the exposure of Fixed Place PE. The Apex Court examined in detail the factual reports on the various business segments of the Taxpayers and the related involvement of E-funds India. On this basis, the Apex Court accepted the contentions of the Taxpayers that no part of the main business or revenue-earning activity of the Taxpayers was carried on through a fixed business place in India, which would not give rise to a Fixed place PE in India.

4.2 Service PE:

 

For the constitution of a service PE it is necessary that the foreign enterprise must provide services “within India” through employees or other personnel. In the current case, none of the customers of the Taxpayers were located in India nor had they received any service in India. Infact, only the auxiliary operations of the overseas services were carried out in India by E-funds India. Hence, this test was not satisfied.

On the role of deputed employees, the Apex Court noted in particular the observations of the High Court that the employees were deputed towards the development of domestic work in India. The deputed employees were working under the control and supervision of E-funds India and their remuneration was borne by E-funds India only. Based on the above, the Apex Court accepted the contentions of the Taxpayers that they had not created a Service PE in India.

4.3 Agency PE:

 
 The Apex Court upheld the High Court’s ruling that E-funds India was neither authorized to exercise any authority to conclude contracts on behalf of the Taxpayers, nor was there any factual foundation laid to attract any of the conditions of the Agency PE clause under the India-US DTAA.
 

4.4 Other key observations:

 

The burden of proving the fact that a foreign enterprise has a PE in India and must therefore suffer tax from the business generated from such a PE initially falls on the Revenue. The Apex Court placed reliance on the principle laid down in the case of the Morgan Stanley (supra) ruling, which held that since the arm’s length principle had been satisfied in the present case, no further profit would be attributable, even if the Taxpayers constituted a PE in India. In relation to the resolution passed during the MAP proceedings for the earlier years, the Apex Court took note of the OECD Manual, which states that MAP resolutions cannot be considered precedents for either the taxpayer or the tax administrations regarding adjustments or issues relating to subsequent years, or for MAP discussions on the same issues for other taxpayers. Accordingly, the Apex Court accepted the ruling of the High Court that the MAP agreement between the parties cannot be considered as a precedent for subsequent years; based on previous MAP proceedings, it cannot, therefore, be concluded that E-funds India constituted a PE of the Taxpayers in India.

5. Comments:

The concept of PE has been defined extensively in various places, but the interpretation of the same continues to be complex and subjective. The distinct nature of each transaction makes the interpretation of the law and the judicial precedents worth noting. Although determination of the PE is a contentious issue, yet the arm’s length transaction restricts the scope of further attribution to the PE. The decision of the Apex Court in the case of Formula One (supra) was far-reaching in many ways, but it was nonetheless given in the context of specific facts. The judgment in the case of the E-Funds group deals with a fact pattern that is widespread in general. It shall serve as guidance for determining the taxable presence of multinationals which have outsourced their business operations to India. Hence, the principles applied in this judgment could have a far greater practical impact.

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