India: Supreme Court Holds Project Office Undertaking Non-core Activities In India Does Not Constitute Permanent Establishment

Background:

Once a turnkey project is awarded, a foreign company usually sets up Project Office (PO) in India to undertake project related activities. Sometimes, the only activity to be undertaken by the PO is to act as a communication link between the foreign company and the Indian customer. Therefore, the PO is not involved in any of the core activities. However, Revenue Authorities contend that such a PO constitutes a Permanent Establishment (PE) of a foreign company in India and thereby levy tax by attributing profits to the PE. Recently, the Supreme Court¹ had an occasion to examine whether the PO set up for non-core activities constitutes a Fixed Place PE in India. We, at BDO in India, have summarised the ruling of the Supreme Court and provided our comments on the impact of this landmark decision.

Facts of the case:

Taxpayer, a non-resident company incorporated in South Korea, was awarded a turnkey contract by Oil and Natural Gas Corporation (ONGC) for carrying out the work involving surveys, design, engineering, procurement, fabrication, installation and modification of existing facilities; and start-up and commissioning of entire facilities of an oil and gas rig (Project) at north-west of Mumbai. The taxpayer, after seeking approval from Reserve Bank of India (RBI), setup a PO in Mumbai which would act as 'communication channel' between the taxpayer and ONGC in respect of the Project. The taxpayer undertook entire activities (as required under the Project) from outside India and later the rig platforms were brought to Mumbai for installation at the Project site. In its Indian tax return, the taxpayer disclosed a loss of INR 2.35mn which had been incurred on account of the activities carried out in India.

However, the tax officer, after examining the terms of agreement of Project, concluded that the project was a single indivisible turnkey project whose work was wholly executed by the PO which constitute a PE in India and thus consequently profits (attributed at the rate of 25% of the revenue) arising from such project would be taxable in India. The Dispute Resolution Panel (DRP) as well as Mumbai Tax Tribunal affirmed the findings of the tax officer. Further, the Tribunal observed that the onus lies on the taxpayer to prove that the activities of PE are of preparatory and auxiliary in nature. Upon further appeal, the Hon'ble Uttarakhand High Court (HC) held that the question relating to whether the PO opened at Mumbai cannot be said to be a "Permanent Establishment" within the meaning of Article 5 of the Tax Treaty would be of no consequence. The HC then held that there was no finding or justification on record that 25% of the gross revenue of the taxpayer outside India was attributable to the business carried out by the PO.

Supreme Court ruling:

Revenue Authorities filed an appeal before the Apex Court (SC) against the HC order. SC relied on its earlier decisions². It observed that when it comes to 'fixed place' PE under the Tax Treaty, the condition precedent for applicability of Article 5(1) of the Tax Treaty and there by constituting PE is that there should be a place 'through which the business of an enterprise' is wholly or partly carried on. Further, the profits of the foreign enterprise are taxable in India only if the said enterprise carries on its core business (through a PE) in India. Further, SC perused the documents that were relied upon by Tribunal and made the following observations:

• Board Resolution shows that the PO was established to coordinate and execute 'delivery documents in connection with construction of offshore platform modification of existing facilities for ONGC'. Tribunal's finding that PO was involved in core activity of execution of the Project is perverse.
• Tribunal ignored facts submitted by the taxpayer which established that no expenditure was incurred by PO in India and that only 2 employees (having no technical qualification) were engaged to perform non-core activities.
• Tribunal's finding that the onus to establish that PO does not constitute a PE is on taxpayer, is against the SC decision in case of E-Funds IT Solution Inc³.

Basis the above observations, SC held that taxpayer's PO in Mumbai did not constitute a Fixed Place PE in India. SC also affirmed the stand taken by the taxpayer that on the facts of the case, PO in Mumbai would fall within exclusionary Article 5(4)(e) of Tax Treaty as PO is only an auxiliary office meant to act as a liaison office between taxpayer and ONGC.

BDO comments:

This is a welcome ruling. After analysing the facts of the case, SC has held that activities carried by PO in India are not forming part of core activities and therefore PO should not be regarded as constituting PE in India. This Ruling will help all foreign companies which set-up POs and are engaged merely in preparatory and auxiliary activities, subject to the provisions of the applicable Tax Treaty. However, it is imperative to note that India is signatory to Multilateral Instrument (MLI) and in light of the ratification, the tax treaty provisions are now required to be read in conjunction with MLI provisions, with effect 01 from April 2020. Hence, while applying the principles of SC's decision, taxpayers should also evaluate the impact of MLI.

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