PE & Attribution of ProfitsYogesh Thar
Bombay Chartered Accountant‟s Society December 13, 2014
PE – Definition in IT Act
Section 92F(iiia)
Circular 14 of 2001
DIT v. Morgan Stanley and Co. Inc (292 ITR 416)
Business Connection v. PE
Business Connection wider than PE
Business connection may exist without a PE(239 ITR 879– AAR) (237 ITR 230 – AAR)
Absence of Business connection may indicate absence of PE (Circular no. 5 of 2004 dated 28.09.2004)
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Yogesh Thar
Article 5(UN Model) Article 5(1)- Basic Rule
Fixed Place of Business
Business Carried on
Article 5(2)- Illustrative List
Article 5(3) -What PE also includes (Construction/Installation PE)
Article 5(4)- What PE excludes(Preparatory/Auxiliary activities)
Article 5(5)-
Agency PE
Article 5(7)-
Article 5(6)- Insurance Company – Special Rule
Article 5(8)- Rule of AE December 13, 2014
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Basic Rule for PEConditions to be satisfied for constituting a PE
There is an „enterprise‟
Carrying on a „business‟
There is a „place of business‟
The place of business is at the disposal of the enterprise
„Fixed‟ place of business
Business of the enterprise is carried on wholly or partly through this fixed
place of business
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Business
Not defined in UN Convention
Section 2(13) of Income tax Act – „including any trade, commerce or
manufacture or any adventure or concern in the nature of trade, commerce
or manufacture‟
An activity carried on continuously in an organized manner with a view to
earn profit
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„Place of Business‟ Test
Not defined
All tangible assets(eg:- premises, facilities, machinery or equipment or
installations) used for carrying on the business, whether or not they are
exclusively used for business purpose
Even one tangible asset sufficient
One must be able to point out the physical location through which business
is carried on
Degree of Permanence and Continuity
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Issues relating to „Place of Business‟ Test
Employee of a foreign company had residential flat in State S and its group company in State S allowed such employee to use its business premises on an occasional basis
Receipt of advertisement charges by an International newspaper(X) from its Indian Client(Y) for publishing Y‟s advertisements in X‟s newspaper
Foreign television channel companies having footprint over Indian Sub-continent
Whether Liaison office would constitute PE?
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“Power of Disposition” Test
Certain space should be available at disposal of foreign enterprise
Some Right or Domain or control to use the place is required
Ownership test – irrelevant
Evidence to indicate that whenever any employee of the foreign enterprise came to source state, he could straightaway walk into the business premises and occupy a space or a table
Motorola Inc [2005] 95 ITD 269 (Del) (SB)
Western Union Financial Services Inc [2006] 101 TTJ 56 (Del)
Premises of wholly owned subsidiary in India available to all the employees of the UK company in respect of its business operations in India - UK Co. had a place of business at its disposal and PE in India
Rolls Royce Plc [2009] 122 TTJ 359 (Del)
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„Fixed‟ Place of Business
Space Aspect -Location Test and Time Aspect – Permanence Test
Location Test
Specific Situs
Specific Place
Geographical Coherence
Commercial Coherence
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„Fixed‟ Place of Business
Permanence Test
Place of business to have certain degree of permanency
Permanent” does NOT mean eternal or everlasting
Reasonable period of existence
More than mere transitory /temporary
Virtual projection of the Foreign Enterprise itself into the territory of „S‟ in a substantial and enduring form (144 ITR 146)(AP)
Intention important
Conduct Important
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5(2) – Illustrative List
A Place of management
A Branch
An Office
A Workshop
A mine, an oil or gas well, quarry or any other place of extraction of natural
resources
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5(3) - Construction PE
PE “also” encompasses – thus expansion of scope
A building site, a construction, assembly or installation project
Supervisory activity in connection therewith
Such Site/ Project/Activity lasts more than 6 months.
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Issues
Covers contractors and sub-contractors
“Project” may be more than one site
A building site, a construction, assembly or installation project
Construction of roads, buildings, canals etc
Renovation of buildings
Mere maintenance not covered
Laying of pipelines
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Time Limit Applicability
Applies to each site/project
If different sites/project form a “coherent whole, commercially
or geographically” – one site/project
Principle of substance over form
Domestic anti avoidance rules applicable in case of abuse of
threshold time limit
How are “Months” counted
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Commencement and Cessation of PE
Commencement of PE
When preparatory work begins; or
When work begins physically
Cessation of PE
When activity is completed or permanently abandoned
End of business activity by foreign enterprise for good
Seasonal/temporary interruptions to be counted
Presence extended over 2 taxable years? [(257 ITR 1) (Del)]
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5(4) – Exclusions from PE
Use of facilities for storage or display of goods/merchandise
belonging to the enterprise
Maintenance of stock of goods/merchandise belonging to the
enterprise for purpose of storage/display
Maintenance of stock of goods/merchandise belonging to the
enterprise for purpose of processing by another enterprise
Maintenance of fixed place of business solely for the purpose
of purchasing goods or merchandise or of collecting
information for the enterprise
Maintenance of fixed place of business solely for carrying on
activity of preparatory or auxiliary character
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5(5) and 5(7) – Agency PE
Expansion of scope of PE – third party
When does agency PE exist?
A person acts on behalf of foreign enterprise in state „s‟ ;
He is not independent agent; and
Specified conditions for dependent agent are satisfied.
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Agency PE 18
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Specified conditions for dependent agent
Authority to conclude contracts; and
Such authority is habitually exercised
Activities are not merely preparatory or auxilary
or
No such authority; and
Habitually maintains stock; and
Regularly delivers goods on behalf of principal
Dependent Agent working from fixed place of foreign
enterprise – 5(1) or 5(5)
Yogesh Thar
Agency PE 19
December 13, 2014
Independent Agents
Broker or commission agent
Acts in ordinary course of business
Legally independent of foreign enterprise
Activities not exclusively or almost exclusively on behalf of
foreign enterprise
Arm‟s length dealing
Principal-Agent relation required – Contractor not Agency
PE
DHL Operations BV (142 Taxman 1)(Mumbai)
Galileo international Inc – Delhi High Court
Yogesh Thar
Agency PE 20
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Authority to conclude contracts
Authority to bind Foreign Enterprise in state „S‟
Authority to decide final terms of contract and conclude contracts
independently.
“In the name of foreign enterprise” – not to be taken literally - whether the
foreign enterprise is bound
De facto authority relevant
If agent signs contracts only after foreign enterprise‟s approval implies no
authority to conclude contracts
Mere authority to sub-agents not determinative
Contracts related to core business activities only relevant. Eg. Contract to
hire employees or acquire premises or lease not relevant.
Yogesh Thar
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Service PE
Furnishing of services within by non-resident in India – Not FTS
Through employees or other personnel
May result in creation of „Service PE‟ if the duration of such
services exceeds the specified period
Number of days to be calculated on basis of number of
man days
Stewardship services – No service PE
Yogesh Thar
5(8) – No PE by virtue of Relationship
Subsidiary/Holding Company would not form PE of each other
merely because it controls the other
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5(6) – Insurance
PE if agent through which premiums are collected and risk
insured is present in State S where risk is located
Does not apply to re-insurance
If insurance agent is independent, no PE exists
Yogesh Thar
Attribution of Profits
Residence Country – generally taxation of global profits
Right of source country to tax profits of foreign enterprise
operating in its jurisdiction – when PE exists i.e. Source Based
Taxation
Only those profits which are attributable to PE in the source
country
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December 13, 2014Yogesh Thar
Article 7 – Business Profits
Article 7(1)- Basic Rule
Article 7(2)- Scope and Attribution of Profits to PE
Article 7(3) –Expense Deduction
Article 7(4)- Apportionment basis of taxation of PE
Article 7(5)- Consistent method for taxation of PE
Article 7(6)-Exclusion of Other Articles
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Attribution of Profits
Business profits of Enterprise taxable only in State of Residence
unless it carries on business in the Other State through PE
If business is carried on through PE then the profits that may be
taxed in the Other State are
Only so much as is attributable to the PE
Sales in the other state of goods / merchandize of the same /
similar kind as sold through the PE
Other business activities carried on in the Source State of same /
similar kind as that of PE
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December 13, 2014Yogesh Thar
Force of Attraction Rule
Absent in OECD Model
If business is carried on through PE then the profits that may be
taxed in the Other State are
Only so much as is attributable to the PE
Sales in the other state of goods / merchandize of the same /
similar kind as sold through the PE
Other business activities carried on in the Source State of same /
similar kind as that of PE
The allocation of profits to PE presupposes arm‟s-length rule /
legislation in domestic law
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December 13, 2014Yogesh Thar
Force of Attraction Rule
FOA applies only to Business Profits and not to
dividend/interest/royalty – covered by other treaty provisions
“Same or Similar” excludes something which is distinct
(DDIT v. Scientific Atlanta)(33 SOT 220)(Mum)
“Similar” means relatable
Linklaters LLP v. ITO (132 TTJ 20)(Mum)
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Turnkey Contract
Foreign contractor constructs factory, machinery etc in State S
for local customer, make it ready for operations and handed
over to customer.
Involves the following
Offshore supply of goods
Onshore supply of goods
Offshore services
Onshore services in State S
Supply of designs
Where different severable parts of composite contract are
performed in different places, principle of apportionment
should be applied – Ishikawajima Harima Heavy Metals (158
Taxman 259)
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December 13, 2014Yogesh Thar
Article 7(2): Approach to determine profit
attributable to PE
It were a distinct and separate enterprise; and
Engaged in same or similar activities under same or similar conditions; and
Dealing wholly independently with the enterprise of which it is a PE
Only such portion of profits of a foreign enterprise is taxable in State S, which
has economic nexus with the PE
If due to FOA rule, profits other than those directly attributable to PE are
taxable in State S, such profits should be determined in the same way as if
they were directly attributable to the PE
Functionally Separate Entity Approach
Relevant Business Activity ApproachDecember 13, 2014
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Functionally Separate Entity Approach v. Relevant
Business Activity Approach
Functionally Separate Entity Approach – Profits of PE as if it were a
separate and independent entity, taking into account FAR Analysis
Relevant Business Entity Approach – Profits of PE are attributed on the
basis of apportionment of total profits of an enterprise to its various
parts
OECD Approach suggests Functionally Separate Entity Approach,
however Indian Judicial precedents have preferred Relevant Business
Activity Approach
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Approach for determining Profits of PE
Determiningthe profits
of a PE
Functional / factual analysis to
determine the Activities and
conditions of the PE
Step1: Hypothesising the PE as a distinct and separate
enterprise
Functions performed
Assets used
Risk assumed
Capital and funding
Recognition of dealings
Step 2: determining the profits of the PE
Comparability analysis
Applying transfer pricing methods to
attribute profits
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Computation of profits attributable to PE under the
Act
Attribution of income to the extent of operations / activities carried in trade
Nothing attributable if activities are preparatory or auxiliary in nature e.g. purchasing of goods
No specific mechanism provided for attribution of profits
Transfer pricing rules can be applied
Rule 10 of the Income-tax Rules can be applied
- Presumptive Method
- Proportionate Method
- Discretionary Method
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Article 7(4) - Provisions
Profits can be attributed to the PE by appointment of total profits of the
enterprise to its various parts, provided
It is customary in State S to determine the profits in such a manner
The method of apportionment is in accordance with Article 7
Rule 10 of Income tax Rules suggest similar basis
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Landmark Judgements
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DIT v. Morgan Stanley & Co– SC Ruling
Facts
Activities outsourced by MS Co. to Indian
group entity MSAS:
- Equity / fixed income research
- Account reconciliation;
- IT enabled services, etc
MS Co. staff visited India for monitoring/quality
control – providing stewardship services
MS Co. staff deputed to MSAS
- MSAS reimburses salary cost to MS Co.
- Employees deputed continue to be
employed with MS Co., which pays salary to
the deputees outside India
Morgan Stanley & Co.
MSAS
India
USA
ActivitiesOutsourced
Remunerated at arms length price
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DIT v. Morgan Stanley & Co
Article 5(1) not attracted in case of back office operations carried out by Indian Company – preparatory and auxiliary services
PE definition under Section 92F(iii) includes Service PE, Agency PE, Construction PE, etc
Employees deputed in India by Foreign Company for Stewardship activity do not constitute PE – this activity relates to protecting its own interest as customer and they are not engaged in day to day management / rendering services to Indian Company
Deputation arrangement where Foreign Company is responsible for work of the deputations and the employee continues on payroll or work or lien of the Foreign Company constitute its Service PE
Since remuneration to Indian Company is on arm arm‟s-length, no further income can be attributed to such PE of the Foreign Company
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Ishikawajima-Harima Heavy Industries Ltd. v. DIT 158
Taxman 259 (SC)
All income of turnkey projects not assessable in India merely due to PE
The fact that the contract signed in India is not material
If services have been rendered outside India and have nothing to do with the PEthen they cannot be attributable to the PE
Only part of income attributable to the operations carried out in India by PEtaxable
Offshore supply not taxable if property in goods passed outside India
In Jindal Thermal Power Co. Ltd. v DCIT (2009) 182 Taxman 252 (Kar), the Courthas held that criteria of rendering services in India as laid down by the SupremeCourt has not been done away by the Explanation
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Galileo International Inc – Delhi HC (180 Taxman 357)
Whether Computer Reservation Services (CRS) Companies have a PE in India
CRS allows real-time access to airline fares, schedules, and seating availability
and offers the facility of booking reservations and generating tickets
Delhi Tribunal in the case of Galileo Intl. v DCIT [2008] 19 SOT 257 [affirmed
by Delhi HC] and Delhi Tribunal in Amadeus Global Travel v DCIT [13 TTJ 767
(Delhi)] - fixed place PE - bookings originating in India are taxable as
business income of the PE in India; and
Proportion to be taxed in India - extent of income reasonably allocated to
the revenue generating activities performed in India.
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Yogesh Thar
DDIT v. Set Satellite(Singapore PTE Limited)
SET Satellite Pte Ltd, a foreign telecasting company, tax resident in
Singapore
Engaged in the business of broadcasting various television channels
and had a dependent agent in India
Agent remunerated on arm‟s length basis
If commission paid to SET Indi-dependent agent is at arm‟s length -
no further profits can be attributable to its activities in the hands of
SET Singapore‟s PE in India in terms of Circular 23 of 1969 r.w. Article
7(2)
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Judicial Precedents and Case
Studies on Attribution of Profits
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Judicial Precedents on Attribution of Profit
eFunds Corporation v . ADIT (42 SOT 165) (Del)
Profits to be attributed to be calculated as under
Step 1 - Determine Proportion of assets of IA to global assets
Step 2 - Aggregate “global profits of foreign entity
Step 3 - Determine Profits attributable to India by applying the “proportion”
in Step 1 to “global profits” in Step 2
Step 4 - Profits attributable to PE = Profits Determined in Step 3 (-) Profits of
Independent Agent
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Judicial Precedents on Attribution of Profit
Convergys Customer Management Group Inc v. Asst DIT(58 SOT 69) (Del)(URO)
Profits to be attributed should not be calculated on profit split method but as
follows
Step 1 – Compute the foreign entity‟s (CG) global operating profit
percentage (z %)
Step 2 – CG‟s operating income from Indian Operations( Rs y) = Foreign
entity‟s end-customer revenue from its contracts where services have been
procured from Indian subsidiary (CIS) (*) z %
Step 3 –
Profits attributable between both countries = Rs y – Profit of CIS before tax
Step 4 - Profits attributable to PE = Rs m * 15%
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Attribution of Profits to Fixed Place PE
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Outside India
In India
F Co.
BranchCustomers
PE sells products manufactured by F Co.
SalesLess: Expenses incurred
-Cost of products imported (on
arm‟s length basis)
-Employee Cost
-Rent of premises of branch
office
--General administrative
expenses of HO – Rs. 40,000 (10%
allocable to PE)
-Depreciation on branch assets
Total expenses
Profit attributable to PE
Rs. 2,00,000
Rs. 1,30,000
Rs. 16,000
Rs. 5,000
Rs. 4,000
Rs. 5,000
Rs. 1,60,000
Rs. 40,000
Profit & Loss A/c of Branch as a PE of F Co
Yogesh Thar
Attribution of Profits to Service PE
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Outside India
In India
F Co.
Customers Service PE
Re
nd
erin
g
leg
al/
ad
vis
ory
se
rvic
es.
Total man days spent on job
Offshore man days
Onshore man days
Project revenue
Revenue attributable to India (PE
only on account of onshore
activities)
Less: Expenses incurred
-Personnel cost
-Depreciation on Indian assets
-Royalty
Total cost
Profit taxable in India
1000 mandays
600 mandays
400 mandays
Rs.1,000,000
Rs. 400,000
Rs. 75,000
Rs. 75,000
Rs. 100,000
Rs. 250,000
Rs. 150,000
Profit & Loss A/c of Service PE
Onshore Activities
Offshore Activities.
Yogesh Thar
Attribution of Profits to Agency PE
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Outside India
In India
F Co.
Dependant
Agent
Customers
Supply of products to agent (remunerated by
way of commission)
Sales
Less: Cost of goods paid to F Co.
Less: Commission @ 20% of sales
(agent sufficiently remunerated)
Profit attributable to PE PE
Rs. 100,000
Rs. 80,000
Rs. 20,000
Rs. 20,000
NIL
Profit & Loss A/c of Agent
Sale to final customer
Offshore Activities.
Yogesh Thar
Thank You
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