Permanent Establishment: Supreme Court clarifies taxability of Formula One in India (2017)

Introduction

Citation: (2017) INSC 406

Judges: A.K. Sikri, J., and Ashok Bhushan, J.

This case involves appeals by Formula One World Championship Limited (FOWC), Jaypee Sports International Limited (Jaypee), and the Union of India (Revenue). The core issue revolves around whether FOWC had a “Permanent Establishment” (PE) in India, making its income taxable under Indian tax laws. The High Court of Delhi had ruled that FOWC did have a PE in India, a decision that FOWC and Jaypee challenged.

Case Background

FOWC, a UK-based company, holds commercial rights to the Formula One World Championship. Jaypee, an Indian company, wanted to host the Formula One Grand Prix of India. They entered into a “Race Promotion Contract” (RPC) in 2011, where FOWC granted Jaypee the right to host the event for US$ 40 million.

FOWC and Jaypee approached the Authority for Advance Ruling (AAR) seeking clarification on two main issues:

• ✓ Whether the payment to FOWC was “royalty” under the Double Taxation Avoidance Agreement (DTAA) between the UK and India.
• ✓ Whether FOWC had a “Permanent Establishment” (PE) in India under the DTAA.

The AAR ruled that the payment was royalty and that FOWC did not have a PE in India. Both FOWC/Jaypee and the Revenue appealed this decision to the High Court. The High Court reversed the AAR’s decision, ruling that the payment was not royalty but that FOWC did have a PE in India.

Timeline

Course of Proceedings

The Authority for Advance Ruling (AAR) initially held that the payments to FOWC were royalty but that FOWC did not have a Permanent Establishment (PE) in India. Both FOWC/Jaypee and the Revenue challenged this ruling in the High Court of Delhi.

The High Court reversed the AAR’s findings on both issues. It concluded that the payments were not royalty but that FOWC did have a PE in India. The High Court also held that Jaypee was obligated to deduct tax at source under Section 195 of the Income Tax Act, 1961.

Legal Framework

The case hinges on the interpretation of the Double Taxation Avoidance Agreement (DTAA) between India and the United Kingdom, particularly Article 5, which defines “Permanent Establishment” (PE). According to Article 5(1), a PE is a “fixed place of business through which the business of an enterprise is wholly or partly carried on.”

Section 9 of the Indian Income Tax Act, 1961, also plays a crucial role. It specifies when income is deemed to accrue or arise in India. Specifically, Section 9(1)(i) states that income accruing through a business connection in India is taxable in India.

Explanation 2 to Section 9(1)(i) clarifies that a “business connection” includes business activities carried out through a person acting on behalf of a non-resident. This includes situations where the person has the authority to conclude contracts or habitually secures orders for the non-resident.

The DTAA between India and the UK also defines a PE in Article 5, which includes:

• ✓ A place of management
• ✓ A branch
• ✓ An office
• ✓ A factory
• ✓ A workshop

Article 5(4) of the DTAA states that a person acting on behalf of a non-resident is deemed to be a PE if they have and habitually exercise the authority to conclude contracts or habitually secure orders for the enterprise.

Arguments

FOWC’s Arguments:

• ✓ FOWC argued that it did not have a fixed place of business in India. It contended that the Buddh International Circuit was not “at the disposal” of FOWC.
• ✓ FOWC claimed that it was merely exploiting its commercial rights and not conducting business from the circuit. It stated that its main business was to exploit commercial rights, including intellectual property rights, and this was done outside India.
• ✓ FOWC submitted that Jaypee was responsible for organizing the races, and FOWC’s role was limited to granting permission to host the event.

Jaypee’s Arguments:

• ✓ Jaypee supported FOWC’s arguments, stating that FOWC did not have physical control over the circuit.
• ✓ Jaypee argued that the income accrued in the UK, where the agreement was signed, and not in India.
• ✓ Jaypee contended that the High Court should not have reviewed the AAR’s findings of fact under Article 226 of the Constitution.
• ✓ Jaypee also argued that no interest should be charged under Section 201 of the Income Tax Act, 1961, as it had approached the AAR in good faith.

Revenue’s Arguments:

• ✓ The Revenue argued that FOWC had a business connection in India through the Buddh International Circuit, which was a fixed place of business at its disposal.
• ✓ The Revenue contended that FOWC was carrying on business in India through the exploitation of commercial rights related to the Formula One event.
• ✓ The Revenue highlighted that FOWC and its affiliates had complete control over the event, including the circuit, paddock, and media rights.
• ✓ The Revenue argued that FOWC’s agreements with Jaypee and its affiliates were designed to avoid tax liability in India.

The Revenue relied on the various agreements to show that FOWC and its affiliates had taken total control of the event, and that the agreements were a subterfuge to avoid tax.

Arguments Table

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues:

1. Whether FOWC had control over the Buddh International Circuit, making it a fixed place of business.
2. Whether FOWC carried on business and commercial activity in India.
3. Whether FOWC carried on business through its agents under Article 5(4) or Article 5(5) of the DTAA.

Treatment of the Issue by the Court

The following table demonstrates how the Court decided the issues:

Authorities

The Supreme Court considered the following authorities:

Cases:

• ✓ Commissioner of Income Tax, A.P.-I v. Visakhapatnam Port Trust [ (1983) 144 ITR 146 ] – Andhra Pradesh High Court: Defined “permanent establishment” as a substantial element of an enduring nature of a foreign enterprise in another country.
• ✓ Transvaal Associated Hide & Skin Merchants (Pty) Ltd. (1967) 29 S.A.T.C. 97 (Court of Appeal, Botswana): Shed rented for thirteen years for storing and preparing hides constituted a PE.
• ✓ Georges Simenon (1965) 44 T.C. (US) 820 (US Tax Court): Writer’s study was held to constitute a PE.
• ✓ Joseph Fowler v. M.N.R. (1990) 90 D.T.C. 1834; (1990) 2 C.T.C. 2351 (Tax Court of Canada): Stand at trade fair occupied regularly was a PE.
• ✓ Antwerp Court of Appeal, decision of February 6, 2001: Temporary restaurant at a flower show was a PE.
• ✓ William Dudney v. R (1999) 99 DTC 147 (Tax Court of Canada): Taxpayer did not have a fixed base as he did not have the right to use premises as the base for his business.
• ✓ Hotel Manager Bundersfinanzhof, February 3, 1993: UK hotel management company had a PE in Germany as it had a right to use an office.
• ✓ Commissioner of Income Tax, Andhra Pradesh v. M/s. Toshoku Ltd., Guntur & Ors. (1980) Supp SCC 614 = 1981 AIR 148 – Supreme Court of India: Income accrues where the operations are carried out.
• ✓ Union of India & Anr. Vs. Azadi Bachao Andolan & Anr. 2004 (10) SCC 1 = 2003 (262) ITR 706 – Supreme Court of India: Transactions could not be treated as sham.
• ✓ GE India Technology Centre Private Limited v. Commissioner of Income Tax & Anr. (2010) 10 SCC 29 – Supreme Court of India: Discussed the obligation to deduct tax at source under Section 195 of the Act.
• ✓ Columbia Sportswear Company v. Director of Income Tax, Bangalore (2012) 11 SCC 224 – Supreme Court of India: Aggrieved person required to approach the High Court in the first instance from the rulings of AAR.
• ✓ Maganbhai Ishwarbhai Patel Etc. v. Union of India and Another 1970 (3) SCC 400 – Supreme Court of India: International treaties have to be given adequate and due respect.
• ✓ Sepet v. Secretary of State for the Home Department 2003 (3) AllER 304 – UK Judgment: Single autonomous meaning was required to be given to the treaties which are living instruments.
• ✓ Universal Furniture Ind. AB v. Government of Norway (Stavanger Court, Case No. 99-00421, dated 19-12-1999): Salesman’s house was a PE.
• ✓ Joseph Fowler v. Her Majesty the Queen 1990 (2) CTC 2351: Sales in camper trailer at fairs was a PE.

Legal Provisions:

• ✓ Section 4 of the Indian Income Tax Act, 1961: Charging section for income tax.
• ✓ Section 5 of the Indian Income Tax Act, 1961: Scope of total income of a resident.
• ✓ Section 6 of the Indian Income Tax Act, 1961: Defines “resident” and “not-ordinarily resident.”
• ✓ Section 9 of the Indian Income Tax Act, 1961: Income deemed to accrue or arise in India.
• ✓ Section 9(1)(i) of the Indian Income Tax Act, 1961: Income accruing through business connection in India is taxable.
• ✓ Section 92F of the Indian Income Tax Act, 1961: Definitions of certain terms, including “enterprise” and “permanent establishment.”
• ✓ Section 195 of the Indian Income Tax Act, 1961: Obligation to deduct tax at source.
• ✓ Section 201 of the Indian Income Tax Act, 1961: Liability to pay interest.
• ✓ Article 5 of the Double Taxation Avoidance Agreement (DTAA) between India and the UK: Defines “Permanent Establishment”.
• ✓ Article 5(1) of the DTAA: Definition of PE as a fixed place of business.
• ✓ Article 5(4) of the DTAA: A person acting on behalf of a non-resident is deemed to be a PE.

Commentaries:

• ✓ “A Manual on the OECD Model Tax Convention on Income and on Capital” by Philip Baker Q.C.
• ✓ “Double Taxation Conventions” by Klaus Vogel.
• ✓ OECD’s “Model Tax Convention on Income and on Capital”.

Authorities Table

Judgment

The Supreme Court upheld the High Court’s decision, ruling that FOWC did have a Permanent Establishment (PE) in India. The Court found that the Buddh International Circuit was a fixed place of business at the disposal of FOWC, through which FOWC carried on its business.

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• ✓ The Court relied on Commissioner of Income Tax, A.P.-I v. Visakhapatnam Port Trust to define “permanent establishment.”
• ✓ The Court cited Transvaal Associated Hide & Skin Merchants (Pty) Ltd., Georges Simenon, Joseph Fowler v. M.N.R., and Antwerp Court of Appeal, decision of February 6, 2001 as examples of what constitutes a fixed place of business.
• ✓ The Court referred to William Dudney v. R as an example of a case where no fixed base was found.
• ✓ The Court used Hotel Manager as an example of a company having a PE.
• ✓ The Court followed Commissioner of Income Tax, Andhra Pradesh v. M/s. Toshoku Ltd., Guntur & Ors. for the principle that income accrues where operations are carried out.
• ✓ The Court relied on Union of India & Anr. Vs. Azadi Bachao Andolan & Anr. for the principle that transactions could not be treated as sham.
• ✓ The Court relied on GE India Technology Centre Private Limited v. Commissioner of Income Tax & Anr. for the principle regarding tax deduction at source under Section 195.
• ✓ The Court cited Columbia Sportswear Company v. Director of Income Tax, Bangalore for the principle that aggrieved person required to approach the High Court in the first instance from the rulings of AAR.
• ✓ The Court cited Maganbhai Ishwarbhai Patel Etc. v. Union of India and Another for the principle that international treaties have to be given adequate and due respect.
• ✓ The Court cited Sepet v. Secretary of State for the Home Department for the principle that single autonomous meaning was required to be given to the treaties which are living instruments.
• ✓ The Court referred to Universal Furniture Ind. AB v. Government of Norway and Joseph Fowler v. Her Majesty the Queen as examples of a PE.

The Court emphasized the importance of examining the entire arrangement between FOWC and Jaypee and its affiliates. It found that FOWC had control over the circuit and was actively involved in the business of conducting the Formula One event in India.

The Court quoted from the judgment:

“The words ‘permanent establishment’ postulate the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another country which can be attributed to a fixed place of business in that country.”

“A place is a certain amount of space within the soil or on the soil…Rooms or technical equipment above the soil may qualify as a PE only if they are fixed on the soil.”

“The degree of control depends on the type of business activity that the taxpayer carries on. It is therefore not necessary that the taxpayer is able to exclude others from entering or using the POB.”

What Weighed in the Mind of the Court?

The Supreme Court’s decision was heavily influenced by the fact that FOWC, as the Commercial Rights Holder (CRH), had extensive control over the Formula One event in India. The Court noted that FOWC and its affiliates managed various aspects of the event, including the circuit, media rights, and sponsorship. The court emphasized that the various agreements between FOWC, Jaypee and other parties were to be seen together and not in isolation to determine the real nature of the transaction.

The Court also considered the fact that FOWC’s activities were not merely preparatory or auxiliary but were central to the business of the Formula One event. The Court also noted that the circuit was at the disposal of FOWC for the duration of the event and that FOWC had complete control over access to the circuit.

The Court also took into account that the agreements between FOWC and Jaypee were designed to avoid tax liability in India. The court viewed that the agreements were a subterfuge and that the real control was with FOWC.

The Court also noted that the income was generated from the conduct of the event in India, and therefore, the income was taxable in India.

The Court’s reasoning was also influenced by the commentaries on Double Taxation Conventions by Philip Baker and Klaus Vogel.

Logical Reasoning

Key Takeaways

• ✓ Foreign companies involved in events in India can be deemed to have a Permanent Establishment (PE) if they have control over the venue and actively conduct business there.
• ✓ The nature of the business activity, rather than the duration, is a crucial factor in determining the existence of a PE.
• ✓ Agreements designed to avoid tax liability may be scrutinized by tax authorities, and the real nature of the transaction will bescrutinized.
• ✓ The judgment emphasizes the importance of looking at the entire arrangement between parties to determine the existence of a PE.
• ✓ The Supreme Court’s decision clarifies the interpretation of the DTAA between India and the UK, particularly Article 5.
• ✓ The judgment serves as a precedent for similar cases involving foreign companies engaged in events in India.
• ✓ Foreign companies need to carefully structure their agreements to ensure they do not create a PE in India.

Impact

The Supreme Court’s ruling in the Formula One case has far-reaching implications for international taxation, particularly for foreign companies operating in India. The judgment has clarified that the definition of “Permanent Establishment” (PE) is broad and includes situations where a foreign company has control over a venue and actively conducts business there.

This decision has led to increased scrutiny of the agreements between foreign companies and Indian entities. Tax authorities are now more likely to examine the entire arrangement between parties to determine the existence of a PE and whether the agreements are designed to avoid tax liability.

The judgment has also impacted business practices. Foreign companies are now more cautious about how they structure their agreements and operations in India. They are more likely to seek tax advice to ensure that they do not inadvertently create a PE in India.

The Formula One case serves as a significant precedent for similar cases involving foreign companies engaged in events in India. It has also reinforced the importance of adhering to international tax treaties and domestic tax laws.

Conclusion

The Supreme Court’s judgment in the Formula One tax case is a landmark decision in international taxation law. It has clarified the definition of “Permanent Establishment” (PE) and has set a precedent for similar cases involving foreign companies operating in India.

The judgment emphasizes that the mere presence of a foreign company in India is not enough to create a PE. The company must have control over a fixed place of business and must actively conduct business through that place. The court also emphasized that the agreements between the parties should be seen in its entirety and not in isolation.

The Formula One case serves as a reminder that foreign companies must carefully structure their agreements and operations to ensure that they comply with international tax treaties and domestic tax laws. The judgment has also highlighted the need for tax authorities to scrutinize agreements to ensure that they are not designed to avoid tax liability.