17 January, 2018
Multinational enterprises often outsource back-office support operations to their captive subsidiaries in India. Additionally, foreign parent companies second their employees to provide guidance to the Indian subsidiary in the provision of back-office functions. A contentious question has for some time arisen, however. Should such arrangements constitute a fixed place Permanent Establishment (PE), a service PE or a Dependant Agent PE (DAPE) for the foreign company in India?
In the 2007 case of Morgan Stanley[i], the Supreme Court (SC), while dealing with the issue of PE, held that back office functions performed by the Indian subsidiary were preparatory and auxiliary in nature and, therefore, did not constitute a fixed place PE. The SC also held that if the foreign company had deputed its employees to the Indian company to render stewardship services, then no service PE would be constituted in India.
In contrast, however, in the case of Centrica Offshore[ii] in 2014, the Delhi High Court (Del HC), held that if the terms of employment of the employees seconded to India continued to be controlled by the foreign company, it would be regarded as having constituted a service PE in India.
In the ensuing paragraphs, we discuss the recent decision of the SC in the instant case of e-Funds Corporation and its implications for resolving this long-standing issue.
Background of the Instant Case
e-Funds Corporation and e-Funds IT Solutions Group Inc. (the Taxpayers) were companies incorporated and resident in the USA. Further, e-Funds International India Private Limited (e-Funds India) is the wholly-owned Indian subsidiary of e-Funds Corporation. The Taxpayers were engaged in the business of electronic payments, ATM management services, decision support and risk management. E-funds India was the Taxpayers’ captive back office and carried out data entry operations in respect of the above businesses of the Taxpayers.
The Tax Authorities contended that the Taxpayers had a taxable presence in India as per the Income Tax Act by way of business connection as well as a PE as defined under Article 5 of the India-USA tax treaty.
When Del HC was called upon to adjudicate[iii], it decided that the Taxpayers did not constitute a fixed place PE for the foreign company in India since the premises of the Indian subsidiary were not ‘at the disposal’ of the foreign company.
The Del HC also held that visits by its employees for undertaking stewardship activities or secondment of employees to work under the control and direction of the Indian subsidiary should not lead to the establishment of a service PE.
Aggrieved by the order of the Del HC, the Indian tax authorities (Tax Authorities) appealed before the SC, which upheld the decision of the Del HC.
Fixed Place PE
The SC dismissed the factors considered by the Tax Authorities and the Income Tax Appellate Tribunal (ITAT) for contending that the Taxpayers had a PE in India, namely that the Taxpayers and their Indian subsidiary were closely connected, the Indian subsidiary provided services to, and was dependent on, the Taxpayers for its earnings and it did not bear sufficient risk etc., and held that the only factors relevant for the constitution of a fixed place PE are whether the Taxpayers had a fixed place of business in India through which it carried on its business in India. As per the recent SC ruling in the case of Formula One, a fixed place is defined as one that is ‘at the disposal’ of the non-resident, where the non-resident has the right to use and control over the said place at its sole discretion.
In the instant case, since the business premises of e-Funds India were not ‘at the disposal’ of the Taxpayers, it was held that they did not establish a fixed place PE in India.
Service PE
The SC observed that although the seconded employees were present in India, no services were rendered by them on behalf of the Taxpayers in India, as the seconded employees were under the control and supervision of e-Funds India.
As the preliminary condition of Article 5(2) (l) of the India-US tax treaty -rendering any services in India on behalf of the Taxpayers – was not satisfied, the SC held that no service PE was constituted.
Dependent Agency PE (DAPE)
The SC held that merely because the Indian entity was a subsidiary of the foreign entity, it cannot be considered to be a dependent agent of the parent as it would negate the overriding effect of Article 5(6) of the Treaty, which recognizes the principle of separate legal entity. A subsidiary may be construed as a DAPE only if it habitually exercises an authority to conclude contracts on behalf of the principal or habitually secures orders almost wholly or wholly for the principal.
The SC observed that although e-Funds India was engaged in providing inputs and information to the Taxpayers to enable them to enter into contracts with end customers which were subsequently sub-contracted to it, there was no evidence of e-Funds India participating in the negotiations or concluding contracts with end customers on behalf of the Taxpayers. Accordingly, it was held that it could not be regarded as a DAPE of the Taxpayers in India.
Profits attributable to the PE
The SC held that if the Indian entity is compensated by its non-resident affiliate on arm’s length for the services rendered by it, no further profits would be attributable in India. Further, the SC also clarified that any settlement under the Mutual Agreement Procedure during any tax period cannot be considered as a precedent for subsequent years.
Conclusion
This SC decision has brought in further clarity in the ever-contentious issues of formation of PE and profit attribution and should help taxpayers plan their business transactions. In the instant case, the SC clarified that even if back office services are outsourced to the Indian entity, which are carried out by the employees of the Indian entity along with employees seconded by the overseas parent, it would not amount to a fixed place PE of the foreign entity if the premises of the Indian entity are not ‘at the disposal’ of the foreign entity. It was also held that the foreign entity will not constitute a DAPE, if the seconded employees do not carry any business activities or negotiate and conclude contracts on behalf of the foreign entity. The SC also held that as no services were rendered in India and the control and supervision over the seconded employees was exercised by eFunds India, no service PE of eFunds US was constituted in India.
Lastly, reiterating the principle enunciated by the SC in the case of Morgan Stanley, the SC also upheld that once the services rendered and activities performed in India have been compensated on arm’s length basis, no further income can be attributed to the PE of the foreign entity in India.
* The author was assisted by Jyoti Anumolu, Associate
[i] DIT v. Morgan Stanley & Co., [2007] 162 Taxman 165 (SC).
[ii] Centrica Offshore India Pvt. Ltd. v. CIT, 346 ITR 336 (Delhi).
[iii] E-Funds IT Solution Inc. v. ADIT, 364 ITR 256 (Delhi).
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
srpatnaik@cyrilshroff.com
