The Supreme Court (SC) in a recent judgment in Assistant Director of Income tax v M/s E‑Funds IT Solutions Inc [2017] 86 Taxmann.com 240 (SC) held that rendition of support services by Indian group company to its parent company in the US would not lead to creation of permanent establishment (PE) of the parent company in India in terms of India-USA Double Taxation Avoidance Agreement (DTAA). Further, since the parent company's personnel by being present in India were not furnishing services to its customers in India, such deputed personnel would not create service PE of the parent company in terms of Article 5(2)(l) of the DTAA.
Background
E-Funds Corporation, USA (E-Funds Corp) and E-Funds IT Solutions Inc, USA (E-Funds Inc) (collectively called as the US Companies) are engaged in the business of ATM management services and electronic payment management. E-Funds International India Private Limited (E-Funds India), group company of the US Companies provide management and marketing support for business activities relating to electronic payments and ATM management services to the latter. The US Companies had also deputed two of its employees to E-Funds India to work as Senior Director Technical Services and Country Head-Business Development (Seconded Employees) to work under the control and supervision of E-Funds India. 25% of the salary component of the Seconded Employees was paid by E-Funds India and the rest by the US Companies which was ultimately reimbursed by E-Funds India. Furthermore, the US Companies and E-Funds India entered into a service agreement (Services Agreement) wherein the employees of E-Funds India were rendering certain marketing services to US Companies, under the supervision and direction of the US Companies. For these services, the US Companies remunerated E-Funds India on an arms' length basis.
During the assessment proceedings of the US Companies, the Indian tax authorities (Tax Authorities) concluded that E-Funds India constituted a PE of the US Companies in India under Article 5 of the DTAA and held that income attributable to such PE was taxable in India in terms of Article 7 of the DTAA. In relation to the Seconded Employees, the Tax Authorities concluded that the Seconded Employees were not merely providing stewardship activities. Also, under the Services Agreement, the employees of the E-Funds India US Companies who were providing services to the US Companies were treated as employees of E-Funds India, owing to the de facto control and management of those employees rejecting the argument of the US Companies that their indirect control on the employees of E-Funds India was for protecting its own interest. On appeal, the Income Tax Appellate Tribunal (Tribunal) held that though the Tax Authorities were correct in holding E-Funds India as a PE of the US Companies, it disagreed with the Tax Authorities on the mode of computation and attribution of profits to such PE in India.
Both parties appealed against the findings of the Tribunal before the Delhi High Court (High Court). The High Court had set aside the findings of the Tax Authorities and Tribunal and held that E-Funds India did not constitute a PE of the US Companies in India and thus no attribution of profits was required. Being aggrieved by the ruling of the High Court, the Tax Authorities filed an appeal before the SC.
SC Judgment
The SC affirmed the judgment of the High Court and held that the US Companies do not have any PE in India under the terms of the DTAA.
Fixed Place PE
The SC observed that Tax Authorities have failed to record existence of a fixed place of business in India, which is at the "disposal" of the US Companies through which they carry on their own business. The SC remarked that the Tax Authorities have rather adopted a fundamentally erroneous approach in alleging that the US Companies had a PE in India as they were contracting with a subsidiary. The SC agreed with the observations of the High Court that a mere assignment or sub-contracting to E-Funds India or provision of intangible software for free of cost are not factors determinative of applicability of Article 5(1) of the DTAA. The SC further referred to a report dated 13 March 2009 of Deloitte Haskins and Sells which was submitted by the US Companies before the Tax Authorities and observed that no part of the main business and revenue earning activity of the US Companies is being carried on through a fixed place of business in India which has been put at their disposal as E-Funds India only renders support services to the US Companies. The SC thus held that the outsourcing of work to India would not give rise to any fixed place PE in India for the US Companies under the DTAA.
Service PE
The SC noted that Article 5(2)(l) of the DTAA deals with the concept of service PE which essentially has two important limbs:
- furnishing of services within a contracting state by a foreign enterprise; and
- such services being provided through the employees or other personnel of the foreign enterprise for the specified time threshold.
The SC held that provision of services by the US Companies through its Seconded Employees to any customer in India, would create a service PE, whether or not the customer is resident in India. In the instant case, none of the customers of the US Companies had received any services in India. Only auxiliary operations that facilitated such services were carried out in India. This being the case, it was not necessary to refer to the other limb of Article 5(2)(l) i.e. whether employees of E Funds India could be treated as "other personnel" of the US Companies in India, for furnishing any services in India. Therefore, since the necessary condition for provision of services in India was not met, the SC held that the US Companies cannot be said to have a service PE in India.
Furthermore, the SC held that even if it is concluded that the US Companies did create a PE in India, as per the principles laid out in DIT v Morgan Stanley (2007) 7 SCC 1 if a foreign enterprise compensates a PE at arm's length price then in that case no further profits would be attributable to such PE.
Comment
This ruling delivered by the apex court of India has dealt with the finer and practical aspects which are pertinent to the outsourcing sector such as provision of back end and support services by an Indian group entity, deputation of employees by the offshore entities, quality monitoring by the offshore service recipient entities etc. Such inbound outsourcing business models have been subjected to scrutiny where the Indian captive unit is generally seen as an extension of the offshore parent entity basis aspects such as the extent of involvement of the latter by way of quality control, shared software and database and intra-group deputation of employees. The SC ruling lends much-needed clarity on how these business models should be evaluated from the perspective of PE determination. One hopes that this ruling will bring an end to the ongoing litigation in this sector. It should still be borne in mind that the structuring of outsourcing activities is undertaken within the contours as explained in the above ruling to avoid them falling into PE traps.
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