The concept of Permanent Establishment (PE)

6 May 2013

Page 1

The concept of PE

Importance of Permanent Establishment

Business profits, under Article 7 of the treaty are taxable only if the non resident has a PE in India Concept of PE is used to determine the right of Source State to tax business profits of the foreign enterprise

Existence of PE also enables the Source State to tax capital gains, dividends, interest and royalties that are effectively connected/attributable to such PE

Page 2

The concept of PE

Article 5 of the Treaty Typical structure of a PE article

Article 5(1) Fixed Place PE
Article 5(7) Subsidiary company Article 5(2) Specific inclusions

Article 5(6) Independent Agent

Permanent Establishment [Article 5]

Article 5(3) Construct ion PE

Article 5(5)Dependent Agent PE

Article 5(4) Exclusions from PE

Page 3

The concept of PE

Article 5(1) - Basic Rule PE

Article 5(1) - Basic Rule PE

the term permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on

Place of business test

Location test

Permanen ce test Business activity test

Right to use test

A PE can be constituted under Basic Rule only if all of above conditions are satisfied

Page 5

The concept of PE

Basic Rule PE Place of business test

The term place of business covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. Which of these are a place of business?

Residential premises/ Hotel accommodation Office of 3 metres by 6 metres Stall or pitch in the market A computer server located in India

Internet website

Page 6

The concept of PE

Basic Rule PE Power of disposition test

Place should be at the disposal of the foreign enterprise for the purpose of its business activities
The foreign enterprise should have the ability to exercise some right or dominion or control The place may be owned, rented or leased;

Legal right to use need not be the sole determinant; factual use or exercise of such right will have a greater bearing
Even illegal occupation could constitute a PE Which of these constitute a PE?

Possession of mailing address without an office, telephone listing or bank account Foreign training agency imparting training to Indian Cos employees in Indian Cos office at the behest of Indian Co Salesman visiting customers office regularly to collect orders

Page 7

The concept of PE

Basic Rule PE Location test

Presence to be 'visible' in the other contracting state Usually linked to a geographical location Covers premises as well as tangible assets used for carrying on business

Movable places of business with a temporary fixed location meet the location test
Activities carried on within a defined geographical location could constitute a PE; (eg, a diving offshore vessel functioning within a defined area, dealer selling merchandise from, a mobile van)

Page 8

The concept of PE

Basic Rule PE Duration Test

No minimum threshold under Indian law

The fixed place of business must have a certain degree of permanence, ie should not be of purely temporary nature Availability of a fixed place of business for a reasonable period should result in compliance with this condition.

An isolated activity should not lead to establishment of a fixed base PE as the ingredients of regularity, continuity and repetitiveness are essentially missing
Where the activities are of a recurrent nature, each period during which the place is used needs to be considered in combination with the number of times during which that place is used (which may extend over a number of years)

A place of business may constitute a Fixed Place PE, even though it exists, in practice, only for a very short period of time, where the nature of the business is such that it will only be carried on for that short period of time
OECD Commentary PE normally have not been considered to exist in situations where a business had been carried on in a country through a place of business that was maintained for less than six months
The concept of PE

Page 9

Article 5(2) Specific inclusions

Article 5(2) Specific Inclusions

Specific Inclusions OECD MC

A place of management A branch An office A factory A workshop A mine, an oil & gas well, a quarry or any other place of extraction of natural resources Whether inclusions in 5(2) independent of 5(1) ? Warehouse in relation to person providing storage facilities for others Treaties with Singapore, USA, Mauritius, Netherlands etc A store or premises used as a sales outlet Treaties with USA, Netherlands, Germany etc

Additional inclusions - Indian Treaties

Page 11

The concept of PE

Article 5(4) Exclusions from PE

Article 5(4) Exclusions from PE

OECD: A PE will not include:

Use of facilities solely for storage, display or delivery of goods Maintenance of stock of goods solely for storage, display or delivery Maintenance of stock of goods solely for purpose of processing by another enterprise Maintenance of fixed place of business solely for purpose of purchasing goods, or collecting information Maintenance of fixed place of business solely for purpose of carrying on any activity of a preparatory or auxiliary character solely for combination of any of the above

Page 13

The concept of PE

Preparatory or auxiliary character

Analysis to be done on a case by case basis

The decisive criterion is whether the activity of the fixed place of business in itself is an essential part of the activity of the enterprise as a whole If the purpose of the fixed place of business is identical to the purpose of the general enterprise then it is not preparatory or ancillary

A fixed place of business which manages an enterprise cannot be preparatory or ancillary. This is true even if it only manages certain areas of operation

Page 14

The concept of PE

Article 5(3) Construction PE

Article 5(3) Construction PE

Article 5 (3) - Building and Construction PE

Building site or construction or installation project constitutes a PE only if it lasts more than twelve months Building site: not only construction of buildings but also construction of roads, bridges or canals etc, and renovation thereto Twelve month test applies to each individual site or project A building site should be regarded as a single unit, even if it is based on several contracts Site exists from date on which work begins, including any preparatory work It continues to exist until work is completed or permanently abandoned. Should not be regarded as ceasing to exist if work is temporarily discontinued Six month test applies to each individual site or project
The concept of PE

12 Month Period OECD Model

Duration

UN Model

Page 16

Type of Projects

Would include:

Construction of buildings Roads, bridges, canals Renovation (involving more than mere decorating) of buildings, roads, bridges, etc Laying of pipelines and excavating and dredging

Installation of new plant and equipment

Planning and supervision of the above (UN Model only supervision)

Page 17

The concept of PE

Article 5(5) & 5(6) - Agency PE

Why an Agency PE clause?

An enterprise considering performing business in a host jurisdiction may:

perform the activity by itself; perform the activity through a separate legal entity; or consider outsourcing that same activity to an agent (resident or not in the host jurisdiction).

The mere absence of an Agency clause in a tax treaty would represent the possibility of avoiding source taxation just by interposing an agent between the foreign enterprise and the local customer

Page 19

The concept of PE

Article 5(5) - Dependent Agent PE (DAPE)

Conditions to be satisfied (cumulative conditions)

Should be a Person Agent other than an agent of independent status as per Article 5(6) Acting on behalf of an enterprise Has an authority to conclude contracts in a Contracting State

Habitually exercising such authority in a Contracting State

In name of enterprise No auxiliary activities

Satisfaction of all the above conditions is necessary

Page 20

The concept of PE

Independent Agent Tests

Agent

Not subject to high degree of control

(like employer/ employee relationship) Not subject to detailed instructions and control in respect of conduct of business Conduct business according to own view, expertise and method Will the agent continue its business if principal terminates the service agreement Agent bears the risk of loss from its own activities

Is he legally & economically independent Yes

No

Is he acting ordinary course of his business?

No

Yes

No

Are activities wholly, or almost wholly, on behalf of principal?

Yes

Independent Agent

Dependent Agent

Page 21

The concept of PE

Independent Agent

A PE will NOT include:

Carrying on of business in the other contracting state through:

a broker,
general commission agent, or any other agent

of an INDEPENDENT status acting in the ordinary course of their business legal and economic independence

Page 22

The concept of PE

Exercise the authority to conclude contracts in the name

Person said to have authority to conclude contracts if, he/she:

Has sufficient authority to bind foreign enterprise and decide final terms Can act independently, without control from the principal Is authorized to negotiate all elements and details of a contract Agency PE would be constituted where approval of contract by foreign enterprise is a mere formality Agent is required to conclude contracts relating to operations which constitute business proper of the enterprise Participation / attendance in mere negotiations of contracts not sufficient to trigger DAPE No signature but negotiation of all elements and details of the contract in a way binding on the enterprise

OECD Position

Signature

Page 23

The concept of PE

Article 5 (6) - Agent of Independent Status

A person is regarded as an agent of independent status if he is legally and economically independent of the foreign principal Ordinarily an independent agent does not constitute a PE if he acts in the ordinary course of his business while acting for his principal Legal independence - Agent is not subject to significant control/ instruction by principal with respect to manner in which work is carried out Economic independence - Agent bears entrepreneurial risk associated with his business operations

Key terms

Ordinary course - As commonly understood by relevant industry

Page 24

The concept of PE

Article 5 (7) - Subsidiary Company

Enterprise under the same control need not be a PE

Subsidiary company will constitute PE if it satisfies any of the conditions for creating a PE Parent Company may constitute a PE under Article 5(1) or Article 5 (2) in a State where it has a place of business

Page 25

The concept of PE

Service PE

India- US tax treaty: The furnishing of services, other than included services as defined in Article 12 (Royalties and fees for included services), within a Contracting State by an enterprise through employees or other personnel, but only if (a) activities of that nature continue within that State for a period or periods aggregating more than 90 days within any twelve-month period; or (b) the services are performed within that State for a related enterprise (within the meaning of paragraph 1 of Article 9 (Associated enterprises) Service PE - Conditions

Furnishing of services (other than covered by FTS clause) Within a contracting state Through employees, or other personnel For a period or periods aggregating more than 90 days within 12 month Period of stay or number of days when services are furnished?

Page 26

The concept of PE

Service PE

Most treaties specify a period of 90 days to constitute a Service PE (UAE has a specified period of 9 months); Special clause for Associated Enterprises in some treaties where lower time threshold necessary to constitute Service PE eg USA (1 day), UK(30 days), Singapore (30 days); The concept specifically excludes services covered by Fees for Technical Services (FTS)/ Fees for Included Services (FIS) Article

Page 27

The concept of PE

OEDC MC and UN MC Difference in Approach towards PE

OECD MC 1. Under Construction PE, assembly and supervisory activities are not covered 1. UN MC Assembly and supervisory activities are specifically provided for.

2.
3. 4.

Threshold for construction PE is 12 months

Does not provide for Service PE clause Maintenance of stock for delivery does not create Agency PE

2.
3. 4.

Threshold for construction PE is 6 months

Provides for Service PE clause Maintenance of stock for delivery and regular delivery, even without authority to conclude contracts, triggers Agency PE Stock Agent

Page 28

The concept of PE

Indias approach towards PE

Combination of OECD and UN Model with emphasis on source based taxation consistent with the object and rationale of the UN MC Approach not uniform, differs form treaty to treaty

Service PE clause is found in treaties with USA, UK, Singapore etc but not in treaties with Mauritius, Germany, Netherlands etc Threshold for Service PE for services to related enterprises is 30 days for treaties with UK, Singapore etc; for USA even 1 day will trigger Service PE risk

Treaties with Australia, Germany, Singapore and UK contain securing orders clause and Associated Enterprise clause in their Agency PE definition, which is missing in Treaties with Netherlands, Mauritius etc.

Page 29

The concept of PE

Important principles

Carborandum Ltd vs CIT and Tekniskil Sendirian Berhard vs CIT

DECISION OF THE CASE
Deputation of employees by the Foreign Co to Indian Co not to constitute a PE in India BASIS

Indian Co to exercise full control over the activities of deputed employees Foreign Cos role limited to that of a recruitment agency

Foreign Cos role limited to making employees available to Indian Co does not tantamount to rendering of services by Foreign Co
Foreign Co not involved with details of the work of the employees

Page 31

The concept of PE

General Motors Overseas Corp vs CIT

DECISION OF THE CASE Deputation of employees by the Foreign Co to Indian Co to constitute a PE in India FACTS CONSIDERED

Foreign Cos principal business was to provide management and consultancy services to Indian Co and other global affiliates Employees were on the Foreign Co payroll

Costs paid to Foreign Co were not indicative of reimbursement of salary

Foreign Co assumed responsibility of deputed employees Foreign Co had full right on the inventions, ideas and improvements by the deputed employees

Page 32

The concept of PE

Morgan Stanley ruling

FACTS Captive BPO in India to provide IT support, account reconciliation, research, etc

No revenue generating functions undertaken / significant market risks borne by BPO MS to send staff to India for stewardship activities including :

Briefing MS on standards of service Conducting training sessions for MS staff and Monitoring overall outsourcing operations of MS

Staff of MS not involved in day-to-day management & continue as employees of MS MS to depute staff (on request), to work under BPOs control & supervision Salary of deputed staff to be borne by MS initially

Whether BPO constituted a PE of MS? If yes, taxability of global income

Page 33 The concept of PE

Morgan Stanley ruling

DECISION

No fixed place PE:

No fixed place of business with a degree of permanence Business of MS not carried on through BPO BPO is an agent of MS carries on activities in India on behalf of MS Legally & economically dependent on MS However, no Agency PE is constituted as:

No agency PE:

No authority to conclude contracts on behalf of MS;

No orders secured by it for and on behalf of MS; and

No stock / merchandise maintained on behalf of MS

Page 34

The concept of PE

Morgan Stanley ruling

Service PE constituted as:

Salary reimbursed by BPO for MS staff engaged in stewardship activities constitute almost 50 percent of salary costs of BPO

Performance appraisal carried out by BPO in consultation with MS

Although ultimate benefit of services of staff endures to MS, they were working for BPO Employees on deputation actively involved in key managerial activities of BPO

Page 35

The concept of PE

Case study

Case studies on PE
Facts

A US Co carrying on business of rendering money transfer services across international borders appoints agents in India for paying the monies to beneficiaries after making identity / credit checks. The agents premises had to display on a board that they are agents of US Co. US Co provides its software to the agents which affords access to the agents to US Cos mainframe computers in USA. Does US Co have a PE in India?

Issue

Page 37

The concept of PE

Case studies on PE
Facts

F co is a company incorporated in UK It was engaged in supplying aero engines and spare parts to India customers F co entered into support service agreement (includes organising events, conferences, business development, maintaining media relations, providing administrative support and co-ordinating technical support) with its wholly owned subsidiary in UK. This wholly owned subsidiary had offices in India (I co) F co reimbursed the entire cost relating to provision of services to I co and also paid service fees to I co Employees of F co frequently visited I co and occupied the premises of I co during such visits Whether F co has PE in India ?

Issues

Page 38

The concept of PE

Case studies on PE
Facts

X Ltd., a company incorporated in Singapore, has established a liaison office in India. LO undertakes following activities for a group company, Y Ltd. (also incorporated in Singapore)

collection of market information and intelligence; meeting potential clients and distributors of products; and promoting companys products.

Issue

Can LO be construed to be a PE of X Ltd. or Y Ltd. in India under IndiaSingapore treaty?

Page 39

The concept of PE

Case studies on PE
Facts

F co, a company incorporated in Singapore, engaged in business of promoting golf by organizing golf tournaments in different countries

F co, organized golf tournament in India and paid fees to I co for using the golf course
The golf tournament was organized by hiring independent third parties, i.e. contractors and suppliers Does F co constitute a PE in India

Issues

Page 40

The concept of PE

Case studies on PE
Facts

UK company carrying on business of publishing magazines Indian Co. acting as advertisement concessionaire for a UK company Indian Co. gets 15% commission on gross value of invoices raised by UK company on the Indian client Indian Co. authorized to collect advertisement charged from Indian clients, convert into foreign currency and remit to UK company.

Indian Co. earns around 80% of commission income from UK company and balance from the other clients
Whether Indian Co. constitutes PE of UK company in India under India-UK DTAA?

Issue

Page 41

The concept of PE

Case studies on PE
Facts

A US co is in the business of providing technical services It has a subsidiary in India rendering similar technical services It renders certain services directly to an Indian company from US Whether income would be taxable as per the provisions of Article 7

Issue

Page 42

The concept of PE

Thank You

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The concept of PE