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(6)
–
Independent
Agent
Article 5(2)
– Specific
inclusions
Permanent
Establishment
[Article 5]
Article 5(5)Dependent
Agent PE
Page 3
The concept of PE
Article
5(4) –
Exclusions
from PE
Article 5(3)
– Construct
ion PE
Article 5(1) - Basic Rule PE
Article 5(1) - Basic Rule PE
Place of
business
test
Location
test
Right to
use test
Permanen
ce test
Business
activity
test
Page 5
“the term ‘permanent establishment’
means a fixed place of business
through which the business of an
enterprise is wholly or partly carried
on”
A PE can be constituted
under “Basic Rule” only if
all of above conditions are
satisfied
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 Co’s employees in Indian Co’s
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
Page 9
The concept of PE
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) ?
Additional inclusions - Indian Treaties
►
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
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
12 Month Period – OECD Model
►
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
Duration
►
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
UN Model
►
Six month test applies to each individual site or project
Page 16
The concept of PE
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
►
Is he legally
& economically
independent
Yes
Is he acting ordinary
course of his business?
Agent bears the risk of loss from its own
activities
No
No
Yes
No
Are activities wholly,
or almost wholly, on
behalf of principal?
Independent Agent
Page 21
The concept of PE
Yes
Dependent Agent
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
OECD Position
►
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
Signature
►
No signature but negotiation of all elements and details of the contract in a
way binding on the enterprise
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
Key terms
►
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
►
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
UN MC
1.
Under Construction PE, assembly
and supervisory activities are not
covered
1.
Assembly and supervisory activities
are specifically provided for.
2.
Threshold for construction PE is
12 months
2.
Threshold for construction PE is 6
months
3.
Does not provide for “Service PE”
clause
3.
Provides for “Service PE” clause
4.
Maintenance of stock for delivery does
not create “Agency PE”
4.
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
India’s 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 Co’s role limited to that of a recruitment agency
►
Foreign Co’s 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 Co’s 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 BPO’s 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
No agency PE:
►
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:
Page 34
►
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
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 Co’s mainframe computers in USA.
Issue
►
Does US Co have a PE in India?
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
Issues
►
Whether F co has PE in India ?
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 company’s 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
Issues
►
Does F co constitute a PE in India
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
Issue
►
Whether Indian Co. constitutes PE of UK company in India under India-UK
DTAA?
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
Issue
►
Whether income would be taxable as per the provisions of Article 7
Page 42
The concept of PE
Thank You
Page 43
The concept of PE