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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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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

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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.

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December 13, 2014

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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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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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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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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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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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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