Supreme Court clarifies Permanent Establishment (PE) norms in India-US DTAA: Assistant Director of Income Tax vs. E-Funds IT Solution Inc. (24 October 2017)

Date of the Judgment: 24 October 2017
Citation: (2017) INSC 966
Judges: R.F. Nariman, J. and Sanjay Kishan Kaul, J.
Can a foreign company be taxed in India simply because its subsidiary operates here? The Supreme Court of India, in a significant judgment, addressed this question, focusing on whether two US-based companies had a “Permanent Establishment” (PE) in India, which would make them liable for Indian taxes. This case delves into the complexities of international taxation and the interpretation of the India-US Double Taxation Avoidance Agreement (DTAA). The judgment was delivered by a two-judge bench comprising Justice R.F. Nariman and Justice Sanjay Kishan Kaul, with Justice Nariman authoring the opinion.

Case Background

The case involves two American companies, e-Funds Corporation, USA, and e-Funds IT Solutions Group Inc., USA, which were assessed for income tax in India for various assessment years (2000-01 to 2002-03 and 2004-05 to 2007-08). These companies had international transactions with their Indian subsidiary, e-Funds International India Private Limited (e-Fund India).

e-Fund India, a company incorporated and resident in India, was taxed on its income in India, including its global income. The international transactions between the US companies and e-Fund India were subjected to arms-length pricing adjudication by the Transfer Pricing Officer (TPO) and the Assessing Officer (AO).

The Revenue contended that the US companies had a Permanent Establishment (PE) in India and should be taxed in India, irrespective of whether they had paid taxes in the USA. The Revenue argued that the income attributable to the US companies, which was not included in the income taxed in the hands of e-Fund India, should be taxed in India.

Timeline

Course of Proceedings

The assessing authority determined that the US companies had a fixed place PE in Delhi and were liable to pay tax in India under Article 5 of the India-US DTAA. The Commissioner of Income Tax (Appeals) [CIT (Appeals)] upheld this decision, stating that the US companies had a fixed place PE, a service PE, and an agency PE.

The Income Tax Appellate Tribunal (ITAT) agreed with the CIT (Appeals) regarding the fixed place PE and service PE but did not address the agency PE. However, the ITAT calculated the income differently and arrived at a nil figure of income for all relevant assessment years.

The High Court allowed the appeals of the assessees, setting aside the findings of all the authorities and dismissing the cross-appeals of the Revenue.

Legal Framework

The judgment primarily revolves around the interpretation of the India-US Double Taxation Avoidance Agreement (DTAA) of 1990, specifically Article 5, which defines “Permanent Establishment” (PE).

Section 90 of the Income Tax Act, 1961, allows the Central Government to enter into agreements with foreign countries for the avoidance of double taxation.

Article 5 of the DTAA defines PE as a fixed place of business through which the business of an enterprise is wholly or partly carried on. It includes:

• a place of management
• a branch
• an office
• a factory
• a workshop
• a mine, an oil or gas well, a quarry
• a warehouse
• a farm, plantation
• a store or premises used as a sales outlet
• an installation or structure used for the exploration or exploitation of natural resources
• a building site or construction, installation or assembly project
• the furnishing of services within a Contracting State by an enterprise through employees or other personnel

Article 5(2)(l) of the DTAA specifies that a service PE is created when an enterprise furnishes services within a contracting state through employees or other personnel, provided the activities continue for more than 90 days or the services are performed for a related enterprise.

Article 5(4) states that a dependent agent PE exists when a person habitually exercises an authority to conclude contracts on behalf of the enterprise.

Article 7 states that the profits of an enterprise of a contracting State may be taxed in the other State only to the extent of so much of the business as is attributable to a permanent establishment in the other State.

Article 27 provides for a mutual agreement procedure (MAP) to resolve cases of taxation not in accordance with the convention.

Rule 44H of the Income Tax Rules, 1962, outlines the procedure for giving effect to decisions under the mutual agreement procedure.

Arguments

The Revenue, represented by the learned Attorney General, argued that the US companies had a fixed place PE in India because:

• Most of the employees of the e-Funds group were in India.
• e-Funds Corp had call centers and software development centers only in India.
• e-Funds Corp was essentially doing marketing work, and its contracts were assigned or sub-contracted to e-Funds India.
• The master services agreement gave complete control to the US entity over the personnel of the Indian entity.
• e-Funds India carried out its functions using the proprietary database and software of e-Funds Corp.
• The corporate office of e-Funds India housed an ‘International Division’ overseeing operations of e-Funds group entities overseas.

The Revenue also argued that a service PE existed because:

• Most of the employees were in India.
• e-Funds Corp was doing marketing work, and its contracts were assigned to e-Funds India.
• The personnel, though employees of e-Funds India, were de facto working under the control of e-Funds Corp.
• Two employees of e-Funds Corp were seconded to e-Funds India.

Further, the Revenue contended that a dependent agent PE was made out under Articles 5(4) and 5(5). They also argued that the assessees failed to furnish information, leading to an adverse inference.

The Revenue relied on admissions made under the mutual agreement procedure (MAP) for certain assessment years, stating that this admission would continue to bind the assessees.

The respondents, represented by Shri S. Ganesh, argued that:

• For a fixed place PE, the premises must be “at the disposal” of the assessees, meaning they must have the right to use the premises for their own business, which was not the case here.
• Both the US companies and the Indian company pay income tax, and the Transfer Pricing Officer (TPO) had held that the payments between the companies were at arm’s length pricing.
• Even if a fixed place PE is found, once the arm’s length price is paid, the US companies are not liable for Indian taxation.
• The mere fact that a 100% subsidiary is carrying on business in India does not mean that the holding company has a PE in India.
• The assessing officer did not find that a service PE existed.
• Under Article 5(2)(l), the foreign enterprise must provide services to customers in India, which was not the case.
• The personnel engaged in Indian operations were employed by the Indian company, and the US companies’ control was only to protect their own interests.
• The businesses of the assessees were carried on outside India, and the activities of e-Funds India were independent business activities.
• The agency PE was never argued before the assessing officer or the ITAT.
• The settlement procedure availed for certain assessment years was without prejudice to the assessees’ contention that they have no PE in India.
• The ground of adverse inference was not argued before the authorities below.

The respondents also relied on the OECD Commentary to support their arguments.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a separate section. However, the main issue before the court was:

• Whether the US-based companies, e-Funds Corporation and e-Funds IT Solutions Group Inc., had a Permanent Establishment (PE) in India under Article 5 of the India-US Double Taxation Avoidance Agreement (DTAA), making them liable for taxation in India.

The sub-issues that the court dealt with were:

• Whether a fixed place PE existed in India.
• Whether a service PE existed in India.
• Whether an agency PE existed in India.
• Whether the MAP settlement was binding for subsequent years.
• Whether an adverse inference could be drawn due to non-disclosure of documents.

Treatment of the Issue by the Court

Authorities

The Court considered the following authorities:

Judgment

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Lack of Control: The Court emphasized that for a fixed place PE to exist, the foreign enterprise must have control over the premises, which was not the case here. The Indian subsidiary operated independently.
• Absence of Direct Services: The Court noted that the US companies did not provide direct services to customers in India. The services provided by the Indian subsidiary were auxiliary and not the core business activity of the US companies.
• Arm’s Length Pricing: The Court acknowledged that the transactions between the US companies and the Indian subsidiary were at arm’s length pricing, which meant no further profits could be attributed to the US companies even if a PE existed.
• Independent Entity: The Court reiterated that the Indian subsidiary was an independent legal entity and not a mere extension of the US companies.
• MAP Settlement: The Court held that the MAP settlement was specific to the years under consideration and not binding for subsequent years.

The Court’s reasoning was that the mere presence of a subsidiary in India or the outsourcing of services to that subsidiary does not automatically create a Permanent Establishment for the foreign parent company. The key factors are control over the premises, the nature of services provided, and the presence of direct customers in India.

The Court considered and rejected the Revenue’s argument that the MAP settlement was binding for subsequent years, emphasizing that such agreements are case-specific and not precedents.

The Court also rejected the Revenue’s argument on adverse inference due to non-disclosure of documents, as it was not raised before the lower authorities.

“The assessing officer, CIT (Appeals) and the ITAT have essentially adopted a fundamentally erroneous approach in saying that they were contracting with a 100% subsidiary and were outsourcing business to such subsidiary, which resulted in the creation of a PE.”

“It is clear that the report speaks of the e-Funds group of companies worldwide as a whole… which show the assets of the group worldwide.”

“This outsourcing of work to India would not give rise to a fixed place PE and the High Court judgment is, therefore, correct on this count.”

Decision

The Supreme Court upheld the decision of the High Court, dismissing the appeals of the Revenue. The Court held that:

• The US companies did not have a fixed place PE in India.
• The US companies did not have a service PE in India.
• The US companies did not have an agency PE in India.
• The MAP settlement was not binding for subsequent years.
• No adverse inference could be drawn due to non-disclosure of documents.

The Supreme Court’s judgment clarified that the mere presence of a subsidiary in India or the outsourcing of services to that subsidiary does not automatically create a Permanent Establishment (PE) for the foreign parent company. The key factors are control over the premises, the nature of services provided, and the presence of direct customers in India.

The Court emphasized that the Indian subsidiary was an independent legal entity and not a mere extension of the US companies. Therefore, the activities of the Indian subsidiary could not be attributed to the US companies for the purpose of establishing a PE.

Implications

The Supreme Court’s judgment in Assistant Director of Income Tax vs. E-Funds IT Solution Inc. has significant implications for businesses, tax authorities, and the legal landscape:

• For Businesses:
  • Multinational corporations can structure their operations with greater clarity, knowing that outsourcing to a subsidiary in India does not automatically create a PE.
  • Businesses can rely on the arm’s length principle to ensure that transactions with their subsidiaries are fairly priced, minimizing the risk of being taxed in India.
  • This judgment provides a degree of certainty for businesses operating in India, especially those with subsidiaries providing services.
• For Tax Authorities:
  • The judgment sets a precedent that tax authorities must consider the “at the disposal” test for fixed place PEs and the nature of services provided for service PEs.
  • Tax authorities must focus on the actual control and business activities of the foreign enterprise rather than merely relying on the presence of a subsidiary in India.
  • The judgment clarifies that MAP settlements are case-specific and not binding for subsequent years.
• For the Legal Landscape:
  • The judgment reinforces the importance of the “at the disposal” test for fixed place PEs, which has been followed in subsequent cases.
  • It clarifies the distinction between stewardship activities and services rendered for service PEs.
  • The judgment provides valuable guidance for interpreting the India-US DTAA and similar tax treaties.

Overall, the judgment has provided clarity on the concept of Permanent Establishment under the India-US DTAA, ensuring that foreign companies are not unduly taxed in India merely due to the presence of a subsidiary. It highlights the importance of a substance-over-form approach in international taxation and the need to consider the actual business activities and control of the foreign enterprise.

Conclusion

The Supreme Court’s judgment in Assistant Director of Income Tax vs. E-Funds IT Solution Inc. is a landmark decision that has significantly clarified the concept of Permanent Establishment (PE) under the India-US Double Taxation Avoidance Agreement (DTAA). The Court’s emphasis on the “at the disposal” test for fixed place PEs, the nature of services provided for service PEs, and the independent status of subsidiaries has provided much-needed clarity for businesses and tax authorities alike.

The judgment underscores that the mere presence of a subsidiary in India or the outsourcing of services to that subsidiary does not automatically create a PE for the foreign parent company. The key factors are control over the premises, the nature of services provided, and the presence of direct customers in India.

This decision has far-reaching implications for international taxation and serves as a reminder that substance should prevail over form when determining tax liabilities. It is a significant victory for foreign companies operating in India and a crucial guide for tax authorities in their assessment practices.