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PE & PROFIT ATTRIBUTION
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Permanent establishment &
Profit attribution - Recent developments
April 23, 2010
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CA Darpan Mehta
Tax
PE & PROFIT ATTRIBUTION
Disclaimer
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This presentation provides general information existing at the time of its
preparation. The presentation is meant for general guidance and no
responsibility for loss arising to any person acting or refraining from acting as a
result of any material contained in this publication will be accepted by the
Presenter. It is recommended that professional advice be taken based on the
specific facts and circumstances. This presentation does not substitute the
need to refer to the original pronouncements
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Contents
Recent controversies on Permanent Establishment (‘PE’) and profit
attribution
 Seagate Singapore International
 BBC Worldwide Limited
 Aramco Overseas Company BV
Case Study: Attribution of profits to an Agency PE
Whether arms length remuneration to Agency PE extinguishes tax liability
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 Judicial Precedents
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Recent controversies on
Permanent Establishment
and Profit Attribution
Tax
PE & PROFIT ATTRIBUTION
Seagate – Background
1/3
Singapore
India
Facts of the case

•
•

Invoice
Seagate Singapore International
Headquarters Pvt Ltd (‘Seagate’):
Tax resident of Singapore
Manufactures and sells hard disk
drives to Original Equipment
Manufacturers (‘OEMs’) in India
•
To enter into arrangements with
Independent Service Providers
(‘ISPs’) who will stock the disks in
India and supply it to OEMs on a
Just-in-Time basis
ISPs
Bonded
Agreement Warehouse
with
ISPs
Fees
Proposed Venture:
Applicant
Disk
Delivery
OEMs
Purchase Order


Whether ISPs would constitute a PE?
• Proposal to put a Vendor Management Inventory model
If so, what would be the income
• Agreement with ISPs to stock and deliver on JIT basis
attributable to the PE, if it has been
remunerated on an arms length
• Operating system of ISPs to support electronic data
basis?
interchange, furnish receipt, sale advice and inventory
reports
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Questions before the AAR
Seagate – Contentions of the Revenue and Applicant 2/3
Revenue:


The warehouses of ISPs would constitute a ‘fixed place of business’ and thus would result
into a PE of Seagate.
Alternatively, can be constituted as agency PE
Seagate:



Applicant would not have any premises or facilities neither any installations owned, leased or
at its disposal in India
Goods would be stored in warehouses of ISPs in India wherein it would have a restricted
right of entry
No employees would be based in India
No other physical presence in India
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
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Seagate – Ruling of the AAR
3/3
Whether ISPs constitute a PE?

Demarcated space in the warehouse constitutes a fixed place PE in India
•

As per the agreement with ISPs
•
•
•

Fixed place meaning ‘distinct situs’ or an ‘earmarked place’ with racks and electronic services
ISPs to provide adequate warehouse space at a specified location
Applicant’s representative to have the right to enter the warehouse premises for the purposes of
physical inventory, inspection, audit, repackaging etc
Both applicant and ISP act in cohesion to ensure that goods are delivered promptly
Following facts are not conclusive
•
•
Ownership / Possession / Operation of ISP’s warehouse
Merely outsourcing the operations to ISP’s (and not applicant’s employees)
Income attribution to PE
For computing profits of the PE in relation to the sales activity:
•
•
Treat ISP as a separate and distinct enterprise wholly independent of Seagate
Amounts paid to the ISPs and other expenses, incurred should be deducted from attributable profits
For a PE under fixed rule: (i) place of business (ii) degree of permanent set up
(iii) place of business at the disposal of the foreign enterprise
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
BBC – Background
1/3
Facts of the case

BBC Worldwide Limited (‘BBC’):
•
•

BBC
(UK)
UK
Tax resident of UK
Sister concern of the BBC Group
which operates the BBC World
News Channel (‘the Channel’)
Appointment of
agent for sale of
airtime in India
Proposed Venture:
•
•
BBC appointed BBC Worldwide
(India) Private Limited (‘BWIPL’) (a
group company) as its authorized
agent
In consideration, BWIPL received a
commission of 15% of the
advertisement revenues received
by BBC from Indian advertisers
India
Revenue Commission
@ 15%
BBC
(India)
sale of
airtime in
India
Revenue
Advertisers
• Agreement entered between:
• BBC and BBC India under Airtime Sales Agreement
Questions before the Tribunal:

Any additional income which
remains to be taxed in India, in the
hands of BBC, despite of payment
at arms length basis?
•
solicit orders for sale of advertisement airtime on the Channel
•
collect payments from Indian advertisers
•
remit the payments received
• Remuneration:
• Commission of 15% of the gross advertisement revenues
received by BBC
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• Agent’s role:
BBC – Contentions of the Revenue and Applicant
2/3
Revenue:
•
Dependent Agent PE
•
•
Morgan Stanley - not applicable
•
•
•
Besides soliciting orders, BWIPL also engaged in activities of sales promotion, airtime and
sponsorship, identifying new clients and distributors
Functions, Assets and Risk analysis (‘FAR’) is not carried out
Wrongly equated the assessment of Indian agent with that of dependent agent PE
Presumptive rate of tax
•
Since no different sets of figures of receipts and expenditure - Circular 742 dated May 2, 1996 would
be applicable
•
•
•
•
•
Reference was drawn to transfer pricing order of the subsequent year wherein the tax
authority has accepted the Fair Transfer Price (‘FTP’) on a FAR Analysis
BWIPL been remunerated on the basis of a FTP
Commission received by BWIPL fully represented the value of the profits attributable to its
services - Circular 23 of 1969
BWIPL was remunerated on an arm’s length basis, no further income could be brought to tax
Reference to following circulars and judicial precedents:
•
•
•
SET Satellite (Singapore) Private Limited (Bom) (307 ITR 205)
Morgan Stanley and Company Inc (SC) (292 ITR 416)
DIT v Galileo International Inc (180 Taxman 357)
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BBC:
BBC - Ruling of the Delhi ITAT
3/3
Tribunal held:
 The case has direct applicability of:
•
•
Apex Court in the case of Morgan Stanley
Bombay High Court in the case of SET Satellite (Singapore)
• Rate of 15% is appropriate as also followed by SET Satellite (Singapore)
• BBC had filed its country-wise accounts for India with the tax authorities and difference arose
because of foreign exchange fluctuation
• Circular 742 would have been applicable only if:
BBC is a non-resident foreign telecasting company;
BBC does not have a branch office or PE in India and
BBC does not maintain country wise accounts of its operations
If the correct arm’s length price is applied and paid to the agent in India, nothing
further would be left to be taxed in the hands of the foreign enterprise
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•
•
•
Aramco – Background

Aramco Overseas Company BV (‘Aramco BV’):
•
•

Aramco BV to provide the following to Saudi
Aramco and group companies:




Tax resident of Netherlands
Subsidiary of Saudi Arabian Oil Company
(‘Saudi Aramco’)
Supply Chain Management services (SCM)
Technical, financial and administrative support
Aramco BV gets remunerated on cost plus 5%
mark up
Proposed venture of Aramco BV


Setup a liaison office in India (‘Aramco India’) to
provide similar services to its group companies
Undertake Procurement Support Services (‘PSS’)
for the purpose of export of goods required by
Saudi Aramco and group companies
Questions before the Tribunal:

Income arising on account of PSS to be
rendered by Aramco India, in connection with
exports to Saudi Aramco / group companies be
taxable in India?
Tax
Saudi
Aramco
Saudi
Arabia
Export of goods
• Agreement for SCM
• Cost + 5% mark up
Netherlands
Aramco
BV
Agreement to
render PSS
India
Aramco
India
• Agreement between Saudi Aramco and
Aramco BV
• Proposal to set up Indian office for assisting
with PSS
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Facts of the case:
1/3
Aramco – Contentions of the Revenue and Applicant 2/3
Revenue:


The fact that the actual export was done by Aramco India does not detract from the position
that the goods purchased by the applicant through the support of its regional office were
meant to be exported
Aramco India mainly facilitated the purchases made by the applicant

No direct link as a purchaser of goods nor as an agent of such purchaser
Aramco:
PSS activities in India:




Undertaken by Aramco India for its group companies
The activities are directed towards purchase of goods for the purpose of export
The income tax law exempts income arising from such activities even if purchaser is any
other non-resident
Aramco India was to be funded by reimbursements with no profit element thereon
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
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Aramco - Ruling of the Delhi ITAT
3/3
Ruling
If purchase operations are not undertaken on ones own account or as an agent
of group company, tax liability arises in India
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 Exemption from tax only if:
• Operations are confined to purchase of goods in India for the purpose of export
 No exemption if the service provider is neither –
• the purchaser of goods nor
• an agent of such purchaser
 Merely by facilitating purchases made by a non-resident does not provide exemption
 Applicant was unable to factually substantiate that it rendered the PSS as an agent
• Failed to file any documents or give authenticated evidence to support the contention
 Applicant’s income does not arise in India from purchase operations but from support
services rendered in connection with purchases by third parties
 The applicant’s income is based on mark-up allowed on the costs and not on the volume or
value of purchases
Key discussion points
Has the AAR expanded the scope of PE in Seagate ruling



The use of the word ‘occasional delivery’ with reference to the fixed place rule of Article 5(1)
Restricted rights, since the warehouse may not be at the disposal of Seagate
The conclusive facts


The specific demarcation of warehouse space for Disks
The restricted rights of entry & inspection of the premises
Single vs dual entity approach

Takeaway from Seagate ruling?
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 Any inferences from the Aramco ruling?
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Case study:
Attribution of profits to
an Agency PE
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Relevant facts
1/2
Facts of the case:
 X is a Singapore based manufacturer
Manufacturing goods
 X sells its products to customers in India through
its selling agent Y
X
Singapore
 Y undertakes the entire sales activity
 X has no presence in India
 As per the agency agreement between X and Y, Y
acts for the account and at the risk of X in
performing marketing, sales and distribution
activities in India
Agreement for
selling agent
Revenue
Y
 In return, X pays Y a commission, calculated as a
percentage of sales revenue
Sale of
goods
Key questions:
Customers
Revenue
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 What is the appropriate FAR for Y; Is this FAR
different from the FAR of the Agency PE that X
has in India
India
 Applying the principle that arms length
remuneration to Y extinguishes further tax liability
for X
Tax
Impact
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of Circular
ATTRIBUTION
No 7 of 2009
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FAR Analysis for the Sales function
Functions, Assets and Risks Analysis
2/2
Y
Agency PE of X
Product ordering
√
?
Marketing - sales force
√
?
Marketing / advertising strategy
√
?
Warehousing / inventory management
√
?
Delivery / shopping
√
?
Debt management and collections
√
?
After-sales support
√
?
Functions
Assets
Inventory
?
Property, plant and equipment (distribution)
Receivables
√
?
Inventory risk
?
Credit risk
?
Foreign exchange risk
?
Tax
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Risks
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Arms length remuneration
to Agency PE extinguishes
tax liability
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Whether arms length remuneration to Agency PE
extinguishes tax liability
1/2
Principles
Morgan Stanley and Co
Inc

Existence of ‘economic nexus’ as opposed to legal and
financial nexus important for income attribution
[Supreme Court]

PE to be considered as a distinct and independent
enterprise for profit attribution

No further attribution required if PE is compensated at
arms’ length

Compensation to PE – based on FAR analysis and
adequate transfer pricing documentation

Attribution based on FAR analysis

No further attribution required if dependant agent PE is
compensated at arms’ length


Reliance placed on Set Satellite and Morgan Stanley
No further attribution required if PE is compensated at
arms’ length
SET Satellite
(Singapore) Pte Ltd
[Bombay High Court]
BBC Worldwide Ltd
[Delhi Tribunal]
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Case Law
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Whether arms length remuneration to Agency PE
extinguishes tax liability
2/2
Case Law
Galileo International Inc
[Delhi Tribunal]
Principles






Seagate
[AAR]
Ownership of warehouse / outsourcing of sales activity not
a conclusive test to determine whether a PE is constituted
or not
Dual entity concept suggested for attribution of profits ?
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
Income attributable to Indian operations of non-resident –
determined on the basis of FAR analysis
No distinction between DAPE and DA
15% of income - deemed to be attributable to the PE, since
the PE was remunerated at a higher rate, no further
attribution made
No further attribution if DA is compensated at arms’ length
Consistent with SET Satellite
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