PERMANENT ESTABLISHMENT & BUSINESS
PROFITS
INTERNATIONAL TAXATION
&
YOUNG MEMBERS EMPOWERMENT COMMITTEE
OF
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
July 17, 2014
Natwar Thakrar
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ARTICLE 5- PERMANENT ESTABLISHMENT
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STRUCTURE OF ARTICLE -5 (OECD) – QUICK OVERVIEW
Para 1
Basic Rule
Para 2
Specific Inclusions -Illustrative list of PEs
Para 3
Building site, Installation projects, Furnishing of Service, etc.
Para 4
Exclusions – Activities which do not constitute PE
Para 5
Dependent agents may be a PE
Para 6
Independent agents not a PE
Para 7
Associate Enterprises – Control of a subsidiary does not constitute a PE
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BASIC RULE PE
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ARTICLE 5(1)- BASIC RULE PE
“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.”
 There must be a fixed place of business (situs test);
 The fixed place of business must be located [in a] certain territorial area (locus
test);
 The use of the fixed place of business must last for a certain period of time
(tempus test);
 The taxpayer must have a certain right of use [over] the fixed place of business
(ius test);
 The activities performed through the fixed place of business must be of a
business character (business activity test)
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3
CONDITIONS MUST BE MET FOR A BASIC
RULE PE TO EXIST
locus, tempus and ius test
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CONDITION 1- A PLACE OF BUSINESS
Fixed place:
 Usually linked to a specific geographical spot (the “Locus Test”)
 Presence should be visible in the other contracting state
Any premises, facilities or installation or tangible asset used for carrying on
the business
 whether or not used exclusively for that purpose
Movable places of business with a temporary fixed location meet the locus
test
Activities carried out 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
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CONDITION 1- A PLACE OF BUSINESS
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
Legal right to use need not be the sole determinant; factual use or exercise
of such right will have a greater bearing
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MEANING OF PE – EXTRACRS FROM JUDICIAL PRECEDENTS
The concept as explained by Andhra Pradesh High Court in C.I.T. V/s.
Visakhapatnam Port Trust (144 ITR 146…..162):
“The words ‘permanent establishment’ postulates the existence of a
substantial element of an enduring or permanent nature of a foreign
enterprise in another country which can be attributed to a fixed
place of business in that country. It should be such as that it would
amount to a virtual projection of the foreign enterprise of one
country into the soil of another country”.
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PLACE OF BUSINESS – EXAMPLES
Fishing boat operated within the territorial waters
Streets in a city? E.g. milkman selling milk on streets
Circus or a carnival performing at different places in a city
Concert tours, music shows etc.
Restaurants and shops on-board ships in international traffic?
Home offices
Partner’s premises – a PE for the partnership?
Joint ventures/ AOP
Trusts
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MEANING OF PE – EXTRACTS FROM JUDICIAL PRECEDENTS
Extract from (Subsea Offshore Ltd. - 66 ITD 296… 303, 304)(Mum ITAT)

“…..it seems to be evident that permanent establishment denotes some place
of fixed nature with permanency, and it does not include in its ambit a moving
vessel which operates near a fixed place and which does not belong to the
assessee.”

Assessee’s vessel being in India only for 2 1/2 months cannot be said to be of
enduring continuity nor could it be said in this case that there was a virtual
projection of the assessee into the soil of India
Extract from (P. No. 24 of 1996 - 237 ITR 798… 805)(AAR)

“It seems to the authority that the expression “fixed place” envisages the
possibility of locating, identifying or pointing out to a definite place as the place
from which a business is carried on and does not import a requirement that the
place of business should be stationary and not moving”.
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CONDITION 2 – PLACE OF BUSINESS MUST BE FIXED
It may be owned, rented or leased.
 Even illegal occupation could constitute a PE.
It may also include machinery or equipment.
 Machinery or equipment constituting the place of business need not be actually
fixed to the soil on which it stands. It is enough if it remains on a particular site
Some examples Ships used as Museum, Restaurant etc. and located at a certain place
 Oil rigs firmly anchored to the sea bed and repeatedly used for a certain work or
for the same principle
 An automatic vending machine, gaming machine at a fixed place and operated
and maintain by enterprise or its dependent agent
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CONDITION 3 – BUSINESS ACTIVITY THROUGH FIXED PLACE
Business of the enterprise (wholly or party) must be carried through the
fixed place of business
No minimum threshold under Indian law
 An isolated activity cannot lead to establishment of a fixed base PE as the
ingredients of regularity, continuity and repetitiveness will be missing.
Activity need not be of productive character (OECD Commentary)
“Activity test” would be satisfied by having personnel (Employee or
dependent agent) at the fixed place of business.
“Activity test” would also be satisfied by having fully automatic equipment –
Say Fully Automatic pumping stations or Gaming or vending Machines.
Leasing tangible property or arranging finance through a fixed place of
business can constitute a PE
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SOME JUDICIAL PRECEDENCE
The residence of a country manager was held to be a fixed place of
business as the same was also an office address [Sutron Corporation, 268
ITR 156 (AAR)]
An office space of 3 X 6 metres was held to be fixed place of business
[Motorola Inc & Others, 95 ITD 269 (Del)]
The diving offshore vessel functioning within a defined area (defined
geographical location) was held to be a fixed place [P. No. 24 of 1996, 237
ITR 798(AAR)]
However, a moving vessel performing repairs of submarine pipelines in
India was held as Not constituting a PE. [Subsea Offshore Ltd.. 66 ITD 296
(Mum)]
Conducting of golf tournament in India for a week’s duration does not lead
to existence of a fixed base PE in India. [Golf in Dubai, LLC, 306 ITR 374
(AAR)]
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SOME JUDICIAL PRECEDENCE
The use of the premises by an agent for the purpose of the business of the
principal may lead to the interpretation that such premises are at the
disposal of the principal and therefore constitute a PE [Galileo International
Inc and Maruthi Info and Tech Centre v DCIT (114 TTJ 289)]
Similarly, in ACIT v DHL Operations BV (108 TTJ 152), the office of a local
courier company was considered to constitute a PE for the foreign company
engaged in providing courier services since the foreign company delivered
packages to the local courier company for onward delivery to the addressee
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COMMENCEMENT & CESSATION OF A PE
PE comes into existence, as soon as the foreign enterprise commences
business activities through a fixed place.
The time spent to establish the fixed place of business should be excluded.
A PE ceases to exist when the foreign enterprise disposes the fixed place of
business.
A PE ceases to exist when the business activities being carried out through
it cease or terminate.
Temporary closure or interruption of operations – No cessation of PE
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SPECIFIC PE
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ILLUSTRATIVE LIST
Article 5(2) provides for an illustrative list of facilities constituting a PE
The term PE includes especially:

A place of management

A branch

An office

A factory

A workshop; and

A mine, an oil or gas well or any other place of extraction of natural resources
OECD considers the satisfaction of conditions prescribed in paragraph 1 of
Article 5 as a prerequisite for examples in paragraph 2 to constitute a PE
[Para 12]
India does not agree with the above interpretation and holds that all the
examples provided under paragraph 2 of Article 5 could independently
constitute a PE [Para 28]
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ARTICLE 5(2) - SOME JUDICIAL PRECEDENT
In case of Micoperi SPA Milano (82 ITD 369), Mumbai Tribunal held that a
project office constitutes a PE since expenses are incurred on account of
telex, telephone, postage etc. out of rupee receipts by a project office.
However, Delhi Tribunal in BKI/HAM VOF (70 TTJ 480) held that a project
office does not carry on a business at all and is merely a support office
existing solely for the purpose of facilitating the performance of a contract;
hence it is not a PE.
Andhra Pradesh High Court, in case of Vishakhapatnam Port Trust (144 ITR
146), held that a representative office would not constitute a PE.
In case of Motorola Inc. (95 ITD 269) and Western Union Financial Services
Inc. (101 TTJ 56), it was held that a liaison office would not constitute a PE.
However, In UAE Exchange Centre LLC (268 ITR 9), depending upon the
facts of the case, AAR ruled that an Indian liaison office of a foreign
enterprise was a PE.
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EXCLUSIONS
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EXCLUSIONS
The following are excluded from the definition of PE:
 Use of facilities solely for storage or display of merchandise
 Maintenance of stock of goods solely for the purpose of processing by another
enterprise
 Maintenance of a fixed place of business solely for
 Advertising
 Supply of information
 Scientific research
 Other similar activities which have a preparatory or auxiliary character
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CONSTRUCTION OR
INSTALLATION PE
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ARTICLE 5(3) – CONSTRUCTION OR INSTALLATION PE
A building site or construction or installation project” includes:
 construction of roads, bridges or canals
 renovation (involving more than mere maintenance or redecoration) of buildings,
roads, bridges or canals
 Laying of pipelines
 excavating and dredging
 installation of new equipment in an existing building or outdoors
 onsite planning and supervision of the construction of a building
[OECD model treaty commentary, para 17]
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CONSTRUCTION PE – TEMPUS TEST
The permanence element of a PE is replaced by a test of minimum length
of time
The minimum period starts when the enterprise starts to perform business
in connection with the building or construction or installation project
A site exists from the date on which the contractor begins his work,
including any preparatory work, in the country where the construction is to
be established and it continues to exist until the work is completed or
permanently abandoned
Seasonal interruptions including interruptions due to bad weather and
temporary interruptions should be included in determining the life of a site
If a contractor subcontracts parts of a project, the period spent by a subcontractor working on the building site must also be considered as being
time spent on the building project
The sub-contractor himself has a PE at the site if his activities there last
more than 12 months
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SERVICE PE
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SCOPE
The term permanent establishment includes especially:
……..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:
•
Activities of that nature continue within that State for a period or periods
aggregating more than 90 days within any twelve-month period; or
•
The services are performed within that State for a related enterprise within the
meaning of paragraph 1 of Article 9 (Associated Enterprises)
The permanence element of a PE is replaced by a test of minimum length
of time in the case of Service PE as in case of Construction PE
It is important to evaluate the requirements of Article 12 before examining
the service PE clause
The number of days calculation is based on man days
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STEWARDSHIP
Stewardship services are rendered to protect the interest of the customer/
principal
Stewards are typically not involved in the day-to-day management or in
rendering the services undertaken by the service provider
Their function is essentially of quality control and ensuring confidentiality
Usually, the foreign enterprise does not receive fees from the recipient of
such services and the cost of the personnel performing these services are
also borne by the foreign enterprise
Given the above, stewardship activities do not lead to the constitution of a
service PE
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SECONDMENT
The typical features of a secondment are:

An employee of enterprise X in State X is seconded to enterprise Y in State Y;
he continues on the payroll of enterprise X

Employee resides and renders services in State Y; he reports to enterprise Y

The employee may continue to be paid by enterprise X who in turn is
reimbursed by enterprise Y
Critical parameters in determining the existence of a PE or otherwise

Commercial justification

Enterprise which exercises control over the employee

Existence or otherwise of a lien on employment with enterprise X for the
employee
The SC distinguished between legal employment and economic
employment in the case of Morgan Stanley
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DEPUTATION
The typical features of deputation are:

An employee of enterprise X in State X is deputed to enterprise Y in State Y; he
shifts to the payroll of enterprise Y

Employee resides and renders services in State Y; he reports to enterprise Y

Salary of the employee is paid by enterprise Y
It may be possible to demonstrate that the employee does not retain a lien
on his employment with enterprise X
Deputation may not be preferred since:

Employees are keen to retain a lien

Continuity of social security/ provident fund/ mortgage could be affected

Position of the employee within the organization could be affected

The period for which the services of the employee are required could be short
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AGENCY PE
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DEPENDENT AGENCY
“Notwithstanding the provisions of paragraphs 1 and 2, where a
person — other than an agent of an independent status to whom
paragraph 6 applies — is acting on behalf of an enterprise and has,
and habitually exercises, in a Contracting State an authority to
conclude contracts in the name of the enterprise, that enterprise
shall be deemed to have a permanent establishment in that State in
respect of any activities which that person undertakes for the
enterprise, unless the activities of such person are limited to those
mentioned in paragraph 4 which, if exercised through a fixed place
of business, would not make this fixed place of business a
permanent establishment under the provisions of that paragraph.”
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AGENCY UNDER TREATY
Replaces requirement of fixed place of business
Employees of the enterprise can be dependent agents if they meet the
requirements of paragraph 5 (habitually exercise authority to conclude
contracts etc.)
Only dependent agent constitutes a PE who
Acts on behalf of enterprise

Has authority to conclude contracts

Has no authority but habitually maintains stock of goods and regularly delivers
goods for the enterprise
PE in the State would be only in respect of activities which the agent
undertakes for the enterprise
Contracts must relate to the profit making activity of the enterprise - “the
business proper” of the enterprise
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DEPENDENT AGENCY
An agent will not constitute a PE of its principal if he is “ agent of an
independent status”, i.e.,
 Legally and economically, he is independent of the enterprise on whose behalf he
acts, and
 When acting on behalf of the enterprise, he acts in the ordinary course of his
business.
Under Indian contract law, agency can be created in the following ways:
 Actual express or implied authority
 Ratification
 Ostensible authority
 Necessity
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JUDICIAL PRECEDENT - ORDINARY COURSE OF THE BUSINESS
A newspaper company, collecting advertisements for other foreign
newspapers, acts in the “ordinary course” of its business when it enters into
solicitation agreement with foreign principals [Al Nisr Publishing, In re, 239
ITR 879 (AAR)]
The department of Posts accepts money orders for transfer of funds within
India, Engaging itself in the same type of business with international
ramifications, i.e., money transfer services across international borders, is
just an extension of its business and hence, is in the “ordinary course of its
business” [Western Union Financial Services Inc., 101 TTJ 56 (Del)]
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JUDICIAL PRECEDENT - ORDINARY COURSE OF THE BUSINESS
A local custodian providing custodial services to various FIIs is acting in
“ordinary course” of its business in providing such agency services since it
is not a special business done exclusively for a single FII.
 Fidelity Advisor Series - 271 ITR 1 (AAR)
 XYZ / ABC Equity Fund- 250 ITR 230 (AAR)
An entity, that produces television software (A) and which licenses its
software to a broadcasting entity (B), acts in the “ordinary course of its
business” when it solicits advertisements for B and is able to factually prove
that such solicitation is incidental to its (A’s) business of producing television
programmes (TVM Ltd., 237 ITR 230 (AAR)]
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ASSOCIATED ENTERPRISE
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ARTICLE 5(7)- ASSOCIATED ENTERPRISE
“The fact that a company which is a resident of a Contracting State controls
or is controlled by a company which is a resident of the other Contracting
State, or which carries on business in that other State (whether through a
permanent establishment or otherwise), shall not of itself constitute either
company a permanent establishment of the other.”
The article clarifies that a company is not deemed to have a PE in the other
state merely because it controls, or is controlled by, a company that is
resident of the other state.
Each company constitutes an independent legal entity.
Mere existence or possibilities of existence of close relationships is not
sufficient to constitute a PE [TVM Ltd., 237 ITR 230 (AAR)] [DDIT Vs.
Daimler Chrysler Ltd (2010-TII-99ITAT-MUM-INTL)]
Subsidiary was held to be PE in case of eFund Corporation Vs. ADIT
[2010-TII-165-ITAT-DEL-INTL]
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ARTICLE 5(7)- ASSOCIATED ENTERPRISE
Mere fact that the subsidiary company is managed by its parent or that the
parent exercise control over activities of its subsidiary and desires stringent
financial reporting, does not constitute the subsidiary a PE of the parent.
However, if the activities of the subsidiary on behalf of the parent are within
other provisions of Article 5 then the subsidiary may become a PE of the
parent [P - 8 of 1995 - 223 ITR 416 (AAR)]
A subsidiary would be regarded as PE of parent, if it has habitually
exercised in the other country, an authority to conclude contracts for sale of
goods on behalf of the parent.
DTAA with UAE has no such clause
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Types of PE
Fixed Place PE
An office is a
fixed place
Preparatory
and auxiliary
activities
No PE
Agency PE
Dependent
Agent
Income
generating
activities
PE
Independent
Agent
Installation PE
Service PE
Building site,
Construction,
Installation or
assembly
project
Service by
employee
or other
personnel
PE if lasts
greater
than 6/12
months
PE if
services
last
beyond
specifie
d time
No PE
PE (if certain
conditions are
satisfied)
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ARTICLE- 7: BUSINESS PROFITS
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STRUCTURE OF ARTICLE -7 (OECD) – QUICK OVERVIEW
Para 1
Charging Paragraph
Para 2
Framework for Profit Attribution
Para 3
Elimination of Double Taxation
Para 4
Limitation of Scope
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Article 7(1) – Charging paragraph
“The profits of an enterprise of a Contracting State shall be taxable
only in that State unless the enterprise carries on business in the other
Contracting State through a permanent establishment situated therein.
If the enterprise carries on business as aforesaid, the profits that are
attributable to the permanent establishment in accordance with the
provisions of paragraph 2 may be taxed in that other State.
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Article 7(1) – Exception to Basic Rule
Key Aspects
•
NR carries on a business in the host country
•
There is a Permanent Establishment (‘PE’) in the host country
•
The business is carried on through the PE; and
•
There is income attributable to the PE
All FOUR pre-conditions must be satisfied
Business should be carried on
- Preparatory activities do not trigger attribution
Only profits attributable to such PE is taxable in the source country
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Force of Attraction Rule – UN MC
“ The profits of an enterprise of a Contracting State shall be taxable only
in that State unless the enterprise carries on business in the other
Contracting State through a permanent establishment situated therein. If
the enterprise carries on business as aforesaid, the profits of the
enterprise may be taxed in the other State but only so much of them as
is attributable to
(a) that permanent establishment;
(b) sales in that other State of goods or merchandise of the same
or similar kind as those sold through that permanent
establishment; or
(c) other business activities carried on in that other State of the
same or similar kind as those effected through that permanent
establishment”
‘Force of attraction’ rule not present in OECD Model Convention
Does exist in the US Model Convention
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Force of Attraction Rule
Different kinds of Force of Attraction in context of DTAA’s entered by India
Type 1:
- Once activities are same / similar
- Without specific requirement of role by PE
Type 2:
- Business reasons for not routing the direct business of HO through PE
- Tax avoidance motive need to be established
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Force of Attraction…
Examples Type 1:
Article 7(1) of India USA DTAA
“The profits of an enterprise of a Contracting State shall be taxable only in that State
unless the enterprise carries on business in the other Contracting State through a
permanent establishment situated therein. If the enterprise carries on business as
aforesaid, the profits of the enterprise may be taxed in the other State but only so much
of them as is attributable to (a) that permanent establishment ; (b) sales in the other
State of goods or merchandise of the same or similar kind as those sold through that
permanent establishment ; or (c) other business activities carried on in the other State
of the same or similar kind as those effected through that permanent establishment.”
Some other countries having similar Force of Attraction rule are Cyprus, Denmark,
Indonesia, New Zealand, Italy.
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Force of Attraction…
Examples Type 2:
Article 7(1) of India JAPAN DTAA
“The profits of an enterprise of a Contracting State shall be taxable only in that
Contracting State unless the enterprise carries on business in the other Contracting
State through a permanent establishment situated therein. If the enterprise carries on
business as aforesaid, the profits of the enterprise may be taxed in that other
Contracting State but only so much of them as is directly or indirectly attributable to
that permanent establishment.
Some other countries having similar Force of Attraction rule are Malta, Vietnam,
Oman, Switzerland, Uzbekistan.
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Article 7(2)
For the purposes of this Article and Article [23A] [23B], the profits that are
attributable in each Contracting State to the permanent establishment referred to in
paragraph 1 are the profits it might be expected to make, in particular in its
dealings with other parts of the enterprise, if it were a separate and independent
enterprise engaged in the same or similar activities under the same or similar
conditions, taking into account the functions performed, assets used and
risks assumed by the enterprise through the permanent establishment and
through the permanent establishment and through the other parts of the
enterprise
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Article 7(2): Approaches to determine profit
Approaches to determine profit:
- relevant business activity; or
- functionally separate entity.
Recommended approach – OECD report suggest functionally separate
entity approach as preferable
Profit should be determined by applying the arm’s length principle –
OECD Transfer Pricing Guidelines could be applied
49
Article 7(2) – Approaches to determine profit
Profits attributable to PE are the profits it might be expected to make, in particular in
its dealing with other parts of the enterprise, if it were a:
 Separate and independent enterprise; Engaged in same or similar activities;
Under the same or similar conditions
 Taking into account the functions performed, assets used and risks assumed by
the enterprise through the PE and through other parts of the enterprise
– The above rule applies for purposes Article 23A / 23B [Methods for Elimination
of Double Taxation] as well
Deeming fiction (qua rest of the enterprise)
 Corresponding to the Arm’s-length Principle applicable under Article 9 for
adjusting profits between Associated Enterprises
No need to allocate overall profits to PE – but determine as a separate enterprise
 PE can have profits when overall enterprise as a whole never made profits; or
 No profits could be attributed to PE even where enterprise as a whole has made
profits
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Article 7(3) - Provisions
Where, in accordance with paragraph 2, a Contracting State adjusts the
profits that are attributable to a permanent establishment of an enterprise
of one of the Contracting States and taxes accordingly profits of the
enterprise that have been charged to tax in the other State, the other
State shall, to the extent necessary to eliminate double taxation on
theses profits, make an appropriate adjustment, the competent
authorities of the Contracting states shall if necessary consult each other
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Article 7(3) - Principles of computation of Income of PE
In determining profits of a PE
 Deduction shall be allowed for expenses (including executive & general
administrative)
 Incurred for the PE
 Incurred in or outside the source country
 In accordance with and subject to limitations of domestic law
No deduction – amount paid by PE to the HO or to any other offices of the
enterprise, except reimbursement of actual expenses
 For use of patents or other rights in the form of royalties, fees or other similar
payments
 For specific services performed or for management in the form of commission
 For money lent in the form of interest (exception for banking enterprises as
explained by CBDT Circular 740)
Similarly, income received by PE from HO for aforesaid purposes shall be
ignored
52
Article 7(3) - Principles of computation of Income of PE
Attribution of income to the extent of operations / activities carried in
trade
Nothing attributable if activities are preparatory or auxiliary in nature
e.g. purchasing of goods
No specific mechanism provided for attribution of profits
 Transfer pricing rules can be applied
 Rule 10 of the Income-tax Rules can be applied
Function / Asset / Risk analysis imperative to determine profit
attribution – Morgan Stanley
| 53
Computation of profits attributable to PE under the Act
Rule 10 – Method of Attribution under the Act:
Determination of actual profits if it can be ascertained
Methods prescribed in Rule 10 are not accurate methods
 These involve estimation and subjectivity
 Hukumchand Mills Ltd. v. CIT, 103 ITR 548 (SC)
Can be followed only when the AO is of the opinion that profits cannot be
definitely ascertained
 Rule is last in priority list and is to be applied in exceptional situations
Rule 10(i) - Presumptive Method
• Adhoc profits is estimated as attributable to the PE
| 54
Computation of profits attributable to PE under the Act
Rule 10(ii) - Proportionate Method
 Proportionate profits based on world income is attributed to the PE
 Difficult method as World income of the enterprise is to be computed
under the ITA before applying proportionate method
 In case of different businesses relevant business income be
considered
Rule 10(iii) - Discretionary Method
 Attribution in some other method
| 55
Computation of profits attributable to PE under the Act
Specific provisions for computing profits:
 All provisions applicable as is applicable to resident enterprise for e.g.
section 32, 40(a), 43B, etc,.
 Section 44C – Branch
 Section 44D and 44DA – Taxability of royalties and FTS
 Section 115JB – MAT provisions
| 56
Computation of profits attributable to PE under the Act
Presumptive basis of taxation
 Income is computed on presumptive basis
 Provisions of sections 28 to 44 not applied
 Applied in case of specific types businesses/assesses
 It is not in line with the principles laid down in Article 7(2)
Examples
 Shipping business (u/s 44B) - 7.5% of gross revenue
 Business of Exploration (u/s 44BB) - 10% of gross revenue
 Business of Aircraft (u/s 44BBA) - 5% of gross revenue
 Turnkey Power Projects (u/s 44BBB) - 10% of gross revenue
| 57
Example: Attribution of Profit – Fixed place PE
F Co.
US
India
Branch
PE sells garments
manufactured by F Co.
Customers in
India
Profit & Loss A/c of Branch as a PE of F Co. for India tax purpose:
Sales
Less: Expenses incurred
-Cost of garments imported (to be on arm’s length basis based on FAR)
-Personnel cost of branch employees
-Rent of branch office premises
-General administrative expenses of HO – Rs. 20,000 (10% allocable to PE)
-Depreciation on branch assets
-Royalty on intangible assets (assuming economic ownership rests with HO)
Total expenses
Profit attributable to PE
Rs. 1,00,000
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
70,000
3,000
5,000
2,000
2,000
3,000
85,000
15,000
| 58
Example: Attribution of Profit – Service PE
Rendering of legal
services
F Co.
Offshore Activities
US
India
Onshore Activities
Customers in
India
Total man days spent on job
Offshore man days
Onshore man days
Project revenue
Revenue attributable to India (PE only on account of onshore)
Less: Expenses incurred
-Personnel cost
-Depreciation on India assets (Assuming all assets acquired from India)
-Royalty for know-how
Total cost
Profit taxable in India
Service PE
1000 mandays
600 mandays
400 mandays
Rs.1,000,000
Rs. 400,000
Rs. 75,000
Rs. 75,000
Rs. 100,000
Rs. 250,000
Rs. 150,000
| 59
Example: Attribution of Profit – Agency PE …
Payment of commission
Supply of garments to
agent
F Co.
Dependent Agent
US
India
Sale of garments to final customer
Credit / Inventory risk by HO
Customers in
India
Sales
Less: Cost of goods paid to F Co. (Based on FAR / TNMM)
Less: Commission @ 20% of sales (agent sufficiently remunerated)
Profit attributable to PE
Rs. 100,000
Rs. 80,000
Rs. 20,000
Rs. 20,000
NIL
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Article 7(4) - Provisions
Where profits include items of income which are dealt with separately in
other Articles of this Convention, then the provisions of those Articles
shall not be affected by the provisions of this Article
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Deleted Paragraphs
Existing Article 7(4) on customary determination of profits of PE on apportionment
method deleted
 Apportionment method not warranted in view of new Article 7(2)
Existing Article 7(5) on no Attribution of profits to PE by reason of mere purchase of
goods / merchandize deleted
 Exemption under Article 5(4) [Preparatory / Auxiliary ] continues
 If activities constitute taxable pursuant to other functions then its exclusion or that
of corresponding expenses inconsistent with arm’s-length principle
Existing Article 7(6) according to which profits to be attributed by the same method
year by year deleted
 New approach does not allow following of fundamentally different approach
Existing Article 7(7) substantially retain in the form of new Article 7(4)
 Article 7 does not prejudice items of income dealt with separately in other Articles
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Thank
You
Natwar Thakrar
Mobile: 98210-21841
Email: natwarthakrar@gmail.com
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