TAXABILITY OF A PROJECT OFFICE OR BRANCH OFFICE OF A FOREIGN ENTERPRISE IN INDIA

In our last article
published in the August, 2020 issue of the BCAJ, we discussed various
aspects relating to taxability of a Liaison Office (LO) in India, including the
recent decision of the Supreme Court in the case of the U.A.E. Exchange Centre.

In addition to a Liaison
Office (LO), Project Offices (PO) and Branch Offices (BO) of foreign
enterprises have also been important modes of doing business in India for many
foreign entities.

Issues have arisen for
quite some time as to under what circumstances a PO / BO has to be considered
as a Permanent Establishment (PE) of a foreign enterprise in India and then be
subjected to tax here.

In this article, we
discuss various aspects relating to taxability of a PO / BO in India, including
the recent decision of the Supreme Court in the case of Samsung Heavy
Industries Ltd.

BACKGROUND

The determination of tax
liability of a foreign enterprise has been a contentious subject in the Indian
tax regime for a very long time. And whether a foreign enterprise has a PE in
India has been a highly debatable issue, though it is very fact-intensive. The
ITAT and the courts have been taking different views based on the facts of each
case.

A Project Office means a
place of business in India to represent the interests of the foreign company
executing a project in India but excludes a Liaison Office. A Site Office means a
sub-office of the Project Office established at the site of a project but does
not include a Liaison Office.

A foreign company may open
project office(s) in India provided it has secured from an Indian company a
contract to execute a project in India, and (i) the project is funded directly
by inward remittance from abroad; or (ii) the project is funded by a bilateral
or multilateral international financing agency; or (iii) the project has been
cleared by an appropriate authority; or (iv) a company or entity in India
awarding the contract has been granted term loan by a public financial
institution or a bank in India for the project.

A Branch Office in
relation to a company means any establishment described as such by the company.

As per Schedule I read
with Regulation 4(b) of the FEM (Establishment in India of a Branch Office or a
Liaison Office or a Project Office or any Other Place of Business) Regulations,
2016 [(FEMA 22(R)], a BO in India of a person resident outside India is
permitted to carry out the following activities:

(i)  Export / import of goods.

(ii) Rendering
professional or consultancy services.

(iii) Carrying out
research work in which the parent company is engaged.

(iv) Promoting technical
or financial collaborations between Indian companies and parent or overseas
group company.

(v) Representing the
parent company in India and acting as buying / selling agent in India.

(vi) Rendering services in
Information Technology and development of software in India.

(vii) Rendering technical
support to the products supplied by parent / group companies.

(viii) Representing a
foreign airline / shipping company.

Normally, a branch office
should be engaged in the same activity as the parent company. There is a
difference between the PO / BO and LO, both in terms of their models and, more
importantly, their permitted activities. As per the FEMA 22(R), an LO is
permitted to carry out very limited activities and can only act as a
communication channel between the source state and the Head Office; whereas a
PO / BO is permitted to carry out commercial activities, but only those
specified activities as per the RBI Regulations.

Thus, under FEMA 22(R) a PO
is allowed to play a larger role as compared to an LO in India. Further, the
scope of permitted activities of a BO provided in Schedule I of FEMA 22(R) is
much larger than the scope of permitted activities of an LO provided in
Schedule II of FEMA 22(R).

In National
Petroleum Construction Company vs. DIT (IT) [2016] 66 taxmann.com 16 (Delhi),
the Delhi High Court, after referring to the definitions of LO and PO in the
Foreign Exchange Management (Establishment in India of Branch or Office or
Other Place of Business) Regulations, 2000, held that ‘It is apparent from
the plain reading of the aforesaid definitions that whereas a liaison office
can act as a channel of communication between the principal place of business
and the entities in India and cannot undertake any commercial trading or
industrial activity, a project office can play a much wider role. Regulation (6)(ii)
of the aforesaid regulations mandates that a “project office” shall not
undertake or carry on any other activity other than the “activity relating
and incidental to execution of the project”. Thus, a project office can
undertake all activities that relate to the execution of the project and its
function is not limited only to act as a channel of communication.’

WHETHER A PO / BO CONSTITUTES A PE IN INDIA?

As mentioned above, as per
the prevailing FEMA regulations a PO / BO can carry out activities which may
not be limited to acting as a communication channel between the parent company
and Indian companies.

An issue that arises for
consideration is whether just because the scope of the permitted activities of
a PO / BO is much wider as compared to an LO under FEMA 22(R), would that be an
important consideration in determining the existence of a PE of a foreign
enterprise in India?

Due to the difference in
scope of activities to be carried out by an LO and a PO / BO, the assessing
officers many a times take a stand that the PO / BO is a PE of a foreign
enterprise as they are permitted to carry out commercial activities as compared
to an LO. This perception leads to the conclusion of a PO / BO being a PE in
India.

In order to decide whether
a PO / BO constitutes a PE in the source state, the actual activities carried
out by them in India need to be minutely analysed irrespective of the fact
whether such activities were carried out in violation of FEMA regulations and
RBI approval.

RELEVANT
PROVISIONS OF THE INCOME-TAX ACT, 1961 (the ITA) and the (DTAAs) relating to
PEs

Definition
under the ITA

Section 92F(iiia) defines
a PE as follows: ‘permanent establishment’, referred to in clause (iii),
includes a fixed place of business through which the business of the
enterprise is wholly or partly carried on.’

Section 94B defines a PE
as a ‘permanent establishment’ and includes a fixed place of business
through which the business of the enterprise is wholly or partly carried on.

Similarly, Explanation (b)
to section 9(1)(v), Explanation (c) to sections 44DA, 94A(6)(ii) and 286(9)(i)
defines a PE by referring to the definition given in section 92F(iiia).

It is important to note
that under the ITA a PE is defined in an inclusive manner. It has two limbs,
i.e. (a) it has to be a fixed place of business, and (b) through such fixed
place the business of the enterprise is wholly or partly carried on.

Definition of
Fixed Place PE and exceptions under the OECD Model Conventions

Since the publication of
the first ambulatory version of the OECD Model Convention in 1992, the Model
Convention was updated ten times. The last such update which was adopted in
2017 included a large number of changes resulting from the OECD / G20 Base
Erosion and Profit Shifting (BEPS) Project and, in particular, from the final
reports on Actions 2 (Neutralising the Effects of Hybrid Mismatch
Arrangements), 6 (Preventing the Granting of Treaty Benefits in
Inappropriate Circumstances), 7 (Preventing the Artificial Avoidance
of Permanent Establishment Status), and 14 (Making Dispute
Resolution Mechanisms More Effective), produced as part of that project.

Article 5(1) of the OECD
Model Convention 2017 update defines the term ‘permanent establishment’ as
follows:

‘1. For the purposes of
this Convention, the term ‘‘permanent establishment’’ means a fixed
place of business through which the business of an enterprise is wholly
or partly carried on.

Article 5(2) of the OECD
Model Convention 2017 provides that the term ‘permanent establishment’
includes, especially, (a) a place of management; (b) a branch; (c) an
office; (d) a factory; (e) a workshop; and (f) a mine, an oil or gas well,
a quarry or any other place of extraction of natural resources.

Thus, on a plain reading
of Articles 5(1) and 5(2), a branch or an office is normally considered as a PE
under a DTAA.

The updated Article 5(4)
provides that the term PE shall be deemed not to include:

(a) the use of facilities
solely for the purpose of storage, display or delivery of goods or
merchandise belonging to the enterprise;

(b) the maintenance of a
stock of goods or merchandise belonging to the enterprise solely for the
purpose of storage, display or delivery;

(c) the maintenance of a
stock of goods or merchandise belonging to the enterprise solely for the
purpose of processing by another enterprise;

(d) the maintenance of a
fixed place of business solely for the purpose of purchasing goods or
merchandise or of collecting information for the enterprise;

(e) the maintenance of a
fixed place of business solely for the purpose of carrying on, for the
enterprise, any other activity;

(f) the maintenance of a
fixed place of business solely for any combination of activities mentioned
in sub-paragraphs (a) to (e), provided that such activity or, in the
case of sub-paragraph (f), the overall activity of the fixed place of
business is of a preparatory or auxiliary character.

Paragraph 4.1 of Article 5
provides for exception to paragraph 4 as under:

‘4.1 Paragraph 4 shall not
apply to a fixed place of business that is used or maintained by an
enterprise if the same enterprise or a closely related enterprise
carries on business activities at the same place or at another place in
the same Contracting State, and

(A) that place or other
place constitutes a permanent establishment for the enterprise or the
closely related enterprise under the provisions of this Article, or

(B) the overall
activity resulting from the combination of the activities carried on by the
two enterprises at the same place, or by the same enterprise or closely related
enterprises at the two places, is not of a preparatory or auxiliary
character, provided that the business activities carried on by the two
enterprises at the same place, or by the same enterprise or closely related
enterprises at the two places, constitute complementary functions that are
part of a cohesive business operation.’

It is important to note
that the UN Model Convention 2017 contains a modified version of Article 5 to
prevent the avoidance of PE status which is on the same lines as Articles 5(4)
and 5(4.1) of the OECD MC mentioned above, except that in Articles 5(4)(a) and
5(4)(b) of the UN MC 2017, the word ‘delivery’ is missing. This is due to the
fact that the UN MC does not consider activity of ‘delivery’ of goods as of
preparatory or auxiliary character.

Determination
of existence of PE in cases of non-carrying on of ‘business’ or ‘core business’
of the assessee

On a proper reading and
analysis of Article 5(1), it would be observed that it contains two limbs and
to fall within the definition of a fixed place PE both the limbs have to be
satisfied. Therefore, in case of a PO / BO, normally the first limb is
satisfied, i.e., there is a ‘fixed place of business’ in India but if the second
limb ‘through which the business of an enterprise is wholly or partly
carried on’ is not satisfied, then a fixed place PE cannot be said to be in
existence.

The Tribunal and courts
have, based on the facts of each case, often held that if the actual activities
of a PO / BO did not tantamount to carrying on the business of an enterprise
wholly or partly, then a fixed place PE cannot be said to have come into
existence.

Recently, the Supreme
Court in the case of DIT vs. Samsung Heavy Industries Limited (SHIL)
[2020] 117 taxmann.com 870 (SC) after in-depth analysis of the facts
held that the Mumbai Project Office of SHIL cannot be said to be a fixed place
of business through which the ‘core business’ of the assessee was wholly or
partly carried on. Relying on a number of judicial precedents of the Supreme
Court in the cases of CIT vs. Hyundai Heavy Industries Co. Ltd., [2007] 7
SCC 422; DIT (IT) vs. Morgan Stanley & Co. Inc., [2007] 7 SCC 1;
Ishikawajima-Harima Heavy Industries Ltd. vs. DIT, [2007] 3 SCC 481;
and ADIT vs. E-Funds IT Solution Inc. [2018] 13 SCC 294, the
Court in paragraphs 23 and 28 held as follows:

‘23. A reading of the aforesaid judgments makes it clear that
when it comes to “fixed place” permanent establishments under double
taxation avoidance treaties, the condition precedent for applicability of
Article 5(1) of the double taxation treaty and the ascertainment of a
“permanent establishment” is that it should be an establishment
“through which the business of an enterprise” is wholly or partly
carried on. Further, the profits of the foreign enterprise are taxable only where the said enterprise carries on its core
business through a permanent establishment. What is equally clear is
that the maintenance of a fixed place of business which is of a preparatory or
auxiliary character in the trade or business of the enterprise would not be
considered to be a permanent establishment under Article 5. Also, it is
only so much of the profits of the enterprise that may be taxed in the other
State as is attributable to that permanent establishment.

28. Though it was pointed out to the ITAT that there were
only two persons working in the Mumbai office, neither of whom was qualified to
perform any core activity of the assessee, the ITAT chose to ignore the
same. This being the case, it is clear, therefore, that no permanent
establishment has been set up within the meaning of Article 5(1) of the DTAA, as
the Mumbai Project Office cannot be said to be a fixed place of business
through which the core business of the assessee was wholly or partly carried
on. Also, as correctly argued by Shri Ganesh, the Mumbai Project Office,
on the facts of the present case, would fall within Article 5(4)(e) of the
DTAA, inasmuch as the office is solely an auxiliary office, meant to act as a
liaison office between the assessee and ONGC. This being the case, it is
not necessary to go into any of the other questions that have been argued
before us.’

In the context of a fixed
place PE, in the SHIL case the Supreme Court mentioned and summarised the
aforesaid aspect in the decision in the case of Morgan Stanley & Co.
Inc. (Supra) as under:

‘17. Some of the judgments of this Court have dealt with
similar double taxation avoidance treaty provisions and therefore need to be
mentioned at this juncture. In Morgan Stanley & Co. Inc. (Supra),
the Double Taxation Avoidance Agreement (1990) between India and the United
States of America was construed. …..Tackling the question as to whether a
“fixed place” permanent establishment existed on the facts of that
case under Article 5 of the India-US treaty – which is similar to Article 5 of
the present DTAA – this Court held:

“10. In our view, the second requirement of Article 5(1) of DTAA is not
satisfied as regards back office functions. We have examined the
terms of the Agreement along with the advance ruling application made by MSCo
inviting AAR to give its ruling. It is clear from reading of the above
Agreement / application that MSAS in India would be engaged in supporting the
front office functions of MSCo in fixed income and equity research and in
providing IT-enabled services such as data processing support centre and
technical services, as also reconciliation of accounts. In order to
decide whether a PE stood constituted one has to undertake what is called as a
functional and factual analysis of each of the activities to be undertaken by
an establishment. It is from that point of view we are in agreement with the
ruling of AAR that in the present case Article 5(1) is not applicable as the
said MSAS would be performing in India only back office operations. Therefore
to the extent of the above back office functions the second part of Article
5(1) is not attracted.”

14. There is one more
aspect which needs to be discussed, namely, exclusion of PE under Article 5(3).
Under Article 5(3)(e) activities which are preparatory or auxiliary in
character which are carried out at a fixed place of business will not
constitute a PE. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is stated in
Article 5(1) or
under Article 5(2) the term PE shall not include maintenance of a fixed place
of business solely for advertisement, scientific research or for activities
which are preparatory or auxiliary in character. In the present case we are
of the view that the abovementioned back office functions proposed to be
performed by MSAS in India falls under Article 5(3)(e) of the DTAA. Therefore,
in our view in the present case MSAS would not constitute a fixed place PE
under Article 5(1) of the DTAA as regards its back office operations.’

The Supreme Court further
mentioned about the decision in the case of E-Funds IT Solution Inc. (Supra)
as follows:

‘22. Dealing with “support services” rendered by an Indian
Company to American Companies, it was held that the outsourcing of such
services to India would not amount to a fixed place permanent establishment
under Article 5 of the aforesaid treaty, as follows:

“22. This report
would show that no part of the main business
and revenue-earning activity of the two American companies is carried on
through a fixed business place in India which has been put at their
disposal. It is clear from the above that the Indian company only renders
support services which enable the assessees in turn to render services to their
clients abroad. This outsourcing of work to India would not give rise to a
fixed place PE and the High Court judgment is, therefore, correct on this
score.”’

In view of above
discussion, to constitute a fixed place PE it is particularly important to
determine what constitutes the ‘Business’, ‘Core Business’ or the ‘Main
business’, as referred to by the Supreme Court, of the assessee foreign
enterprise. This determination is going to be purely based on the facts and
hence an in-depth functional and factual analysis of the activities being
actually performed by the PO / BO would be required to be carried out in each
case.

The term ‘business’ is
defined in an inclusive manner in section 2(13) of the ITA as follows:
‘Business’ includes any trade, commerce, manufacture or any adventure or
concern in the nature of trade, commerce or manufacture.

Article 3(1)(h) of the
OECD MC provides that the term ‘business’ includes the performance of
professional services and of other activities of an independent character.

From
an overall analysis of the decisions, it appears that if the activities of the
PO / BO are purely in the nature of back office activities or support services
which enables the assessee foreign enterprise in turn to render services to
their clients abroad or performing mere coordination and executing delivery of
documents, etc., then the same would not be considered as the core or main
business of the assessee, and accordingly a PO / BO performing such activities
would not constitute a fixed place PE in India.

It is not quite clear as
to whether to constitute Core or Main business of the assessee foreign
enterprise there has to be revenue-earning activity in India, i.e., having
customers or clients in India to whom goods are sold or for whom services are
rendered, invoiced and revenue generated in India, is necessary for the same to
be constituting a fixed place PE in India and consequently be taxable in India.

RELIANCE OF RELEVANT DOCUMENTS

Since the determination of
a fixed place PE is predominantly an in-depth fact-based exercise, the ITAT and
the courts have to rely on various relevant documents.

It has been observed that
in the application to the Reserve Bank of India (RBI) for obtaining approval of
PO / BO, the relevant Board resolution of the foreign enterprise to open a PO /
BO, the approval given by the RBI, the accounts maintained by the PO / BO in
India, etc., are very relevant for arriving at the determination of the
existence of a PE in India.

The ITAT in SHIL vs.
ADIT IT [2011] 13 taxmann.com 14 (Delhi), largely relied upon (a)
SHIL’s application to RBI for opening the PO; (b) SHIL’s Board Resolution for
opening the PO; and (c) RBI’s approval for opening the PO. In respect of the
Board Resolution, the ITAT focused on its first paragraph alone and in
paragraph 71 of the order observed as follows:

‘71. There is a force in the contention of Learned DR that
the words “That the Company hereby open one project office in Mumbai,
India for co-ordination and execution of Vasai East Development Project for Oil
and Natural Gas Corporation Limited (ONGC), India” used by the assessee company
in its resolution of Board of Directors meeting dated 3-4-2006 makes it
amply clear that the project office was opened for coordination and execution
of the impugned project. In the absence of any restriction put by the assessee
in the application moved by it to the RBI, in the resolutions passed by the
assessee company for the opening of the project office at Mumbai and the
permission given by RBI, it cannot be said that Mumbai project office was not a
fixed place of business of the assessee in India to carry out wholly or partly
the impugned contract in India within the meaning of Article 5.1 of DTAA.
These documents make it clear that all the activities to be carried out in
respect of impugned contract will be routed through the project office only.’

All these gave a prima
facie impression that the PO was opened for coordination and execution of
the entire project and was thus involved in the core business activity of SHIL
in India.

However, the Supreme Court
delved deeper and looked at various other factors which the ITAT had ignored or
dismissed. In paragraphs 27 and 28, the Court, relying on the second paragraph
of the Board Resolution which clarified that the PO was established for
coordinating and executing delivery of certain documents, and not for the
entire project, the fact that the accounts of the PO showed no expenditure
incurred in relation to execution of the contract and that the only two people
employed in the PO were not qualified to carry out any core activity of SHIL,
concluded that no fixed place PE has been set up within the meaning of Article
5(1) read with Article 5(4)(e) of the India-Korea DTAA.

The
above indicates that the determination of the existence of a fixed place PE of
a foreign enterprise in India requires a deep factual and functional analysis
and the same cannot be determined on mere prima facie satisfaction.

Even in the case of Union
of India vs. U.A.E. Exchange Centre [2020] 116 taxmann.com 379 (SC)
dealing with the question relating to a Liaison Office being considered as a
fixed place PE in India, the Court relied on the approval letter given by the
RBI. In paragraph 9 of the judgment. the Supreme Court mentioned that ‘keeping
in mind the limited permission and the onerous stipulations specified by the
RBI, it could be safely concluded, as opined by the High Court, that the
activities in question of the liaison office(s) of the respondent in India are
circumscribed by the permission given by the RBI and are in the nature of
preparatory or auxiliary character. That finding reached by the High Court is
unexceptionable.’

In Hitachi High
Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.) the ITAT held that whether the assessee violated the
conditions of RBI or FEMA is not relevant in determining the LO as a PE under
the I.T. Act.

It appears
that there is an increasing reliance by the ITAT and courts, inter alia, on the application and related documents
and the approval of the RBI in considering whether an LO / PO / BO can
constitute a fixed place PE in India.

INITIAL ONUS REGARDING EXISTENCE OF A FIXED PLACE PE IN
INDIA

An important question
arises as to whether the onus is on the assessee or the tax authorities to
first show that a PO / BO is a fixed place PE in India.

The ITAT in the SHIL
case (Supra) held that the initial onus was on the assessee and not the
Revenue. However, the Supreme Court in the SHIL case reiterated the fact
that the initial onus lies on the Indian Revenue, and not the assessee, to
prove that there is a PE of the foreign enterprise in India before moving
further to determine the Indian tax liability of that enterprise. While
reversing the finding of the ITAT, the Supreme Court stated that ‘Equally
the finding that the onus is on the Assessee and not on the Tax Authorities to
first show that the project office at Mumbai is a permanent establishment is
again in the teeth of our judgment in E-Funds IT Solution Inc. (Supra).’

The Supreme Court in E-Funds
IT Solution Inc. (Supra) stated that the burden of proving the fact
that a foreign assessee has a PE in India and must, therefore, suffer tax from
the business generated from such PE, is initially on the Revenue. The
Court observed as follows:

‘16. The Income-tax Act,
in particular Section 90 thereof, does not speak of the concept of a PE. This
is a creation only of the DTAA. By virtue of Article 7(1) of the DTAA, the
business income of companies which are incorporated in the US will be taxable
only in the US, unless it is found that they were PEs in India, in which event
their business income, to the extent to which it is attributable to such PEs,
would be taxable in India. Article 5 of the DTAA set out hereinabove provides
for three distinct types of PEs with which we are concerned in the present
case: fixed place of business PE under Articles 5(1) and 5(2)(a) to 5(2)(k);
service PE under Article 5(2)(l) and agency PE under Article 5(4). Specific and
detailed criteria are set out in the aforesaid provisions in order to fulfil
the conditions of these PEs existing in India. The burden of proving the
fact that a foreign assessee has a PE in India and must, therefore, suffer tax
from the business generated from such PE is initially on the Revenue. With
these prefatory remarks, let us analyse whether the respondents can be brought
within any of the sub-clauses of Article 5.’

In view of above referred
two Supreme Court decisions, it can be said that the initial onus is on the
Revenue and not on the assessee.

PREPARATORY OR AUXILIARY ACTIVITIES TEST

As mentioned above,
Article 5(4) of the OECD MC provides exclusionary clauses in respect of a fixed
place PE provided the activities of a PE, or in case of a combination of
activities the overall activities, are of a preparatory or auxiliary
character. In this connection, the readers may refer to extracts of the
OECD Commentary in this regard discussed in paragraph 4 of the article
published in the BCAJ of August, 2020 in respect of Taxability of the
Liaison Office of a Foreign Enterprise in India.

Further, in the context of
activities of an ‘auxiliary’ character, in National Petroleum
Construction Company vs. DIT (IT) (Supra) the Delhi High Court in paragraph
28 explained as follows:

‘28. The Black’s Law Dictionary defines the word “auxiliary”
to mean as “aiding or supporting, subsidiary”. The word “auxiliary”
owes its origin to the Latin word “auxiliarius” (from auxilium meaning help).
The Oxford Dictionary defines the word auxiliary to mean “providing
supplementary or additional help and support”. In the context of Article
5(3)(e) of the DTAA, the expression would necessarily mean carrying on
activities, other than the main business functions, that aid and support the
Assessee. In the context of the contracts in question, where the main
business is fabrication and installation of platforms, acting as a
communication channel would clearly qualify as an activity of auxiliary
character – an activity which aids and supports the Assessee in carrying on its
main business.’

BEPS Report on Action 7 – Preventing
the Artificial Avoidance of Permanent Establishment Status

When the exceptions to the
definition of PE that are found in Article 5(4) of the OECD Model Tax
Convention were first introduced, the activities covered by these exceptions
were generally considered to be of a preparatory or auxiliary nature.

Since the introduction of
these exceptions, however, there have been dramatic changes in the way that
business is conducted. Many such challenges of a digitalised economy are
outlined in detail in the Report on Action 1, Addressing the Tax Challenges
of the Digital Economy. Depending on the circumstances, activities
previously considered to be merely preparatory or auxiliary in nature may nowadays
correspond to core business activities. In order to ensure that profits derived
from core activities performed in a country can be taxed in that country,
Article 5(4) is modified to ensure that each of the exceptions included therein
is restricted to activities that are otherwise of a ‘preparatory or auxiliary’
character.

BEPS concerns related to
Article 5(4) also arose from what is typically referred to as the
‘fragmentation of activities’. Given the ease with which multinational
enterprises may alter their structures to obtain tax advantages, it was
important to clarify that it is not possible to avoid PE status by fragmenting
a cohesive operating business into several small operations in order to argue
that each part is merely engaged in preparatory or auxiliary activities that
benefit from the exceptions of Article 5(4).

Article 13 of
Multilateral Instrument (MLI) – Artificial avoidance of Permanent Establishment
status through the Specific Activity Exemptions

MLI has become effective
in India from 1^st April, 2020 and it will affect many Indian DTAAs
post MLI because, wherever applicable, MLI will impact the covered tax
agreements. Article 13 of MLI deals with the artificial avoidance of PE through
specific activity exemptions, i.e., activities which are preparatory or
auxiliary in nature, and provides two options, i.e. ‘Option A’ and ‘Option B’.

India
has opted for ‘Option A’, which continues with the existing list of exempted
activities from (a) to (e) in Article 5(4), but has added one more sub-clause
(f) which states that the maintenance of a fixed place of business solely for
any combination of activities mentioned in sub-paragraphs (a) to (e) is covered
in the exempt activities, provided all the activities mentioned in sub-clauses
(a) to (e) or a combination of these activities must be preparatory or
auxiliary in nature. Therefore, as per modified Article 5(4), in order to be
exempt from fixed place PE, each activity on a standalone basis as well as a
combination of activities should qualify as preparatory or auxiliary activity
test.

INDIAN JUDICIAL PRECEDENTS

On the issue of whether a
PO / BO constitutes a fixed place PE in India, there are mixed judicial
precedents, primarily based on the facts of each case. In addition to various Supreme
Court cases mentioned and discussed above, there are many other judicial
precedents in this regard.

BO Cases

In a few cases, based on
the peculiar facts of each case, the Tribunals and courts have held that a BO
does not constitute a fixed place PE in India. In this regard, useful reference
can be made to the following case: Whirlpool India Holdings Ltd. vs. DDIT
IT [2011] 10 taxmann.com 31 (Delhi).

However, in the following
case it has been held that a BO constitutes a fixed place PE in India: Hitachi
High Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.).

In the case of Wellinx
Inc. vs. ADIT IT [2013] 35 taxmann.com 420 (Hyderabad-Trib.), where it
was contended by the assessee that the income of the BO is not taxable in
India, the ITAT held that services performed by a branch office are on account
of outsourcing of commercial activities by its head office, and income arising
out of such services rendered would be taxable under article 7(3) of the
India-USA DTAA.

PO Cases

Similarly, in the case of
POs, based on the factual matrix the following cases have been decided in
favour of assessees as well as the Revenue:

In favour of the
assessees:

Sumitomo
Corporation vs. DCIT [2014] 43 taxmann.com 2 (Delhi-Trib.);

National
Petroleum Construction Company vs. DIT (IT) [2016] 66 taxmann.com 16 (Delhi);

HITT Holland
Institute of Traffic Technology B.V. vs. DDIT (IT) [2017] 78 taxmann.com 101
(Kolkata-Trib.).

In favour of the Revenue:

Voith Paper
GmbH vs. DDIT [2020] 116 taxmann.com 127 (Delhi-Trib.);

Orpak Systems
Ltd. vs. ADIT (IT) [2017] 85 taxmann.com 235 (Mumbai-Trib.).

KEY POINTS OF JUDGMENT OF THE SUPREME COURT IN SHIL

The Supreme Court in this
case has clearly established that facts are important in deciding about the
existence of a fixed place PE in India, while principles of interpretations
more or less remain constant. It is imperative that one must minutely look into
the facts and actual activities to decide existence of a fixed place PE in case
of a PO / BO.

The key points of this
judgment can be summarised as under:

Even post-MLI, the Supreme
Court ruling in SHIL’s case should help in interpretation on a fixed place PE
issue.

CONCLUSION

The issue of existence of
a fixed place PE in case of a PO / BO has been a subject matter of debate
before the ITAT and courts for long. The ruling of the Supreme Court in SHIL’s case
endorses the settled principles on fixed place PE in the context of a PO of a
turnkey project. The Supreme Court reiterated that a fixed place PE emerges
only when ‘core business’ activities are carried on in India. The Court brings
forth more clarity on the existence of a fixed place PE or otherwise in case of
a PO / BO and should instil confidence in multinationals to do business in
India and bring much needed certainty in this regard.