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12 June, 2017
With globalisation spreading economic activities across jurisdictions, enterprises nowadays have a presence in several jurisdictions. The taxability of activities undertaken by companies on foreign soil is closely linked to whether they are conducted through a permanent establishment (PE). This is a concept widely used in the context of international taxation wherein a particular business transaction leaves its footprint in multiple jurisdictions. Under the terms of various tax treaties, existence of a PE in the source State is a pre-requisite to hold a non-resident liable to pay taxes on business profits. The term PE is generally defined in the tax treaties as “a fixed place of business through which the business of a foreign enterprise is carried on wholly or in part”.
Under the various tax treaties executed with other countries, India imposes tax on any business income accruing or arising to a non-resident, whether directly or indirectly through or from any PE in India.
The Hon’ble Supreme Court of India (SC) has recently delivered a first-of-its-kind landmark judgment, laying down basic principles of a fixed place PE in the case of Formula One Championship Ltd. v. CIT (SC Civil Appeal No. 3849 of 2017). The case dealt with a motor racing championship, which was held in India over a brief period of three days – the question being whether the income earned from the event should be taxed in India. In its decision, the SC has ruled against the taxpayer and held that such brief activity could also result in the creation of a PE in India.
Supreme Court ruling in Formula One case
Facts
The taxpayer, Formula One World Championship Limited (FOWC), a UK tax resident, acquired commercial rights in the F1 Championships held all across the world for a period of 100 years. In India, FOWC entered into a race promotion contract with Jaypee Sports International Limited (Jaypee), which gave Jaypee the right to host, stage and promote the Formula One Grand Prix racing event in India for a payment to FOWC.
Both FOWC and Jaypee approached the Authority for Advanced Rulings (AAR) seeking an advance ruling on whether that payment to FOWC would be taxed under the (Indian) Income Tax Act, 1961 (IT Act). The AAR inter alia held that on the facts and circumstances of the case, FOWC did not constitute PE in India and payments made were in the nature of royalty. On appeal to Delhi High Court, the ruling of AAR was reversed which held that while the payment made to FOWC cannot be characterised as royalty, FOWC did constitute a PE in India. Being aggrieved by the order of the Delhi High Court, both parties approached the SC. The basic issue before the SC was whether FOWC constituted a PE under the India-UK Double Taxation Avoidance Agreements (DTAA) and, accordingly, whether the amounts received by FOWC from Jaypee were taxable in India.
Decision
The SC while referring to the definition of PE provided under Article 5 of the DTAA, held that under the facts and circumstances, FOWC constituted a fixed place PE in India for the following reasons:
(a) Presence of a foreign enterprise’s business in a source State: FOWC was the exclusive commercial rights holder in relation to F1 Championships and was exploiting such commercial rights in India, which resulted in the presence of its business in India. These rights, among others, included the right to host, stage and promote F1 Championship events, as well as exclusive media rights.
(b) Existence of a fixed place of business, which is at the disposal of the enterprise: Jaypee’s capacity to act was extremely restricted during the event and it was FOWC which played a dominant role in conducting the F1 Championship racing event in India. Accordingly, FOWC had the right to use and control over, the Buddh International Circuit.
The SC also observed that the time period was not as significant a consideration given the kind of business activity involved in the instant case – i.e. racing and the exploitation of all the rights FOWC had as commercial rights holder. However, the presence of FOWC was ‘fixed’ under Article 5(1) of the DTAA, as it had exclusive access to the event for the whole period of the event (including time preceding and succeeding the event).
Also, the five year contract with Jaypee indicated repetition. Accordingly, it was held that FOWC had control over the circuit which constituted its fixed place of business.
(c) The business of such enterprise wholly or partly is carried on through such fixed place: According to the SC, FOWC undertook its business, that of exploitation of its commercial rights, through conducting the F1 Championship racing event in India at the circuit from which income was generated in India.
In other words, the SC held that FOWC constituted a fixed place PE in India by virtue of its control over the circuit. Therefore, payments made by Jaypee to FOWC in relation to the racing event in India were held to be taxable in India as ‘business income’ of FOWC. The SC also held that withholding tax obligation of Jaypee with regard to the payments made to FOWC, shall be limited to such portion of income attributable to its PE in India and the Assessing Officer was directed to compute the same.
Conclusion
This is one of the very first decisions by the Indian SC in the context of PE especially when the operations of the foreign enterprise were carried out only for a short duration. In the instant case, the SC clarified that the duration for which the fixed place is available to the non-resident may not be the sole important criteria. It would have to be examined along with the nature of business activity and the extent of control exercised by the non-resident over such fixed place of business. So long as the premises are under the control and supervision of the non-resident and the business activities are carried out from the said premises, it may constitute a fixed place PE.
From a perusal of the recently pronounced decisions in cases such as GE Group, NetApp and this ruling, it appears that the authorities are looking at substance and totality of a commercial arrangement to decide whether a PE is constituted. Further, the detection techniques of Indian tax authorities have become more sophisticated (using self-appraisal reports, email correspondences, etc. as evidence) and the judiciary is also taking cognizance of the same.
PE determination is a fact-based exercise. In light of this decision, non-resident taxpayers are well advised to plan their business activities and the rights that they should seek not only from their Indian counterparts but also other affiliates.
It is also pertinent to note the last word on this issue has not been spoken as yet, since the issue of attribution of profits to the PE has been referred to the Assessing Officer. It is possible that even the attribution of profits might have to be ultimately decided by the SC as it may be difficult for the taxpayers and the tax authorities to find common ground.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
srpatnaik@cyrilshroff.com
