Proposed changes to oecd commentary art.5 - permanent establishment

PROPOSED CHANGES TO OECD COMMENTARY ART.5-PERMANENT ESTABLISHMENT

By Jay Shah (Consultant at Hedge-Square) 25/2/2013

Introduction

Relevance of OECD Commentary Change of Facts Independent Analysis At the disposal of Home Office as a PE Shops on Ships Time Requirement Presence of Foreign Personal as a PE

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Hedge-Square Consultancy Services

Introduction

Subcontractor as a PE Joint Venture Partnership Place of Management Additional Work at Construction Site Preparatory and Auxiliary Storage, Display and Delivery Negotiation of Contract – Conclusion of Contract Activity of Fund Manager

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CHANGE OF FACTS4


Change of Facts – Para 3.1

The basic conditions should be examined at each pointof time whenever the question of determination of a PEarises.

Examination of the conditions at one point of time maynot be relevant after a change in the way thebusiness activities are carried on.

For Example, facts may change after restructuring ofbusiness - Subsidiary previously was a supplier andsubsequently converted into contract manufacturer

Ericsson AB, 25 taxmann.com 466 (Delhi ITAT)

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ANALYSIS INDEPENDENT TO THE NATURE OF INCOME6


Analysis Independent to the Nature of Income – Para 3.2

The determination of whether or not an enterpriseof a Contracting State has a PE in the otherContracting State must be made independentlyfrom the determination of which provisions ofthe Convention apply to the profits derived bythat enterprise.

For instance, income from a farm or a rented officeis covered by Art.6 and in that case existence of aPE may not be relevant.

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Analysis Independent to the Nature of Income – Para 3.2

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However, it would remain relevant for the purposes of other provisions, such as paragraphs 4 and 5 of Article 11 (Interest), subparagraph 2 (c) of Article 15 (Income form employment) and paragraph 3 of Article 24 (Non-discrimination).

India’s position on Art.5 includes ‘farm’ in para 2 of Art.5


“AT THE DISPOSAL OF”9


Place of Business “at the Disposal of” – Para 4.2

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1• The effective power to use that location

2• The extent of the presence of the enterprise at

that location

3• The activities that it performs there

The following factors are relevant for a location to be considered at the disposal of an enterprise:


Place of Business “at the Disposal of” – Para 4.2 – Examples of “at the Disposal of”

Enterprise has an exclusive legal right to use a particularlocation which is used only for carrying on that enterprise’sown business activities (e.g. where it has legal possession ofthat location), that location is clearly at the disposal of theenterprise.

Where an enterprise is allowed to use a specific location thatbelongs to another enterprise or that is used by a number ofenterprises and performs its business activities at thatlocation on a continuous basis during an extended period oftime.

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Place of Business “at the Disposal of” – Para 4.2 – Examples of “Not at the Disposal of”

Where the enterprise’s presence at a location is so intermittent or incidentalthat the location cannot be considered a place of business of the enterprise(e.g. where employees of an enterprise have access to the premises ofassociated enterprises which they often visit but without working in thesepremises for an extended period of time).

Where an enterprise does not have a right to be present at a location and,in fact, does not use that location itself, that location is clearly not at thedisposal of the enterprise; thus, for instance, it cannot be considered that aplant that is owned and used exclusively by a supplier or contract-manufacturer is at the disposal of an enterprise that will receive the goodsproduced at that plant merely because all these goods will be used in thebusiness of that enterprise

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Place of Business “at the Disposal of” – Para 4.2 – Examples of “Not at the Disposal of”

It is also important to remember that even if aplace is a place of business through which theactivities of an enterprise are partly carried on,that place will be deemed not to be a permanentestablishment if the only business activities carriedon at that place are those listed in all fall within thescope of paragraph 4.

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Place of Business “at the Disposal of” –Para 4.2 – Recent Judgments Delmas, France, 17 taxmann.com 91 (Mum ITAT) – place of agent cannot

be treated as a place at disposal of Principal and thus, no PE u/a.5(1)

Airlines Rotables Ltd, 44 SOT 368 (Mum ITAT) - storage space providedfor use other than the main business cannot be treated as place ofbusiness

Seagate Singapore International Headquarters, 322 ITR 650 (AAR) –warehouse treated as a fixed place of business at disposal and thus, PE.

Sutron Corporation, , 268 ITR 156 (AAR) – Individual treated as a placeof business and thus, PE

Daimler Chrysler, 133 TTJ 766 (Mum ITAT) – No place of managementand no right to use premises of the subsidiary and thus, no PE. Sale onprincipal to principal basis

Golf in Dubai, 174 Taxman480 (AAR )– No PE

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HOME OFFICE AS A PE15


Home Office as a PE – Para 4.8

Even if part of the business is carried on at Individual’s HomeOffice, that should not lead to automatic conclusion that thelocation (home office) is at disposal of enterprise

Facts and Circumstances of each case

Many a time the activities will be so intermittent or incidental

A home office is used on a regular and continuous basis forcarrying on business activities for an enterprise and theenterprise has required the individual to use that location tocarry on the enterprise’s business (e.g. by not providing anoffice to an employee in circumstances where the nature of theemployment clearly requires an office), the home office may beconsidered to be at the disposal of the enterprise.

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Home Office as a PE – Para 4.8

Example of PE: A non-resident consultant who is present for anextended period in a given State where she carries on most of thebusiness activities of her own consulting enterprise from an office setup in her home in that State

Since the vast majority of employees reside in a State where theiremployer has at its disposal one or more places of business to whichthese employees report, the question of whether or not a homeoffice constitutes a location at the disposal of an enterprise willrarely be a practical issue.

The activities carried on at a home office will often be merelyauxiliary or preparatory

Sutron Corporation, 268 ITR 156 (AAR) – Representative Individual’shome or office can be treated as place of business

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SHOPS ON SHIPS18


Shops on Ships Operated in International Traffic – Para 5.5 A ship or boat that navigates in international waters or within

one or more States is not fixed and does not, therefore,constitute a fixed place of business (unless the operation ofthe ship or boat is restricted to a particular area that hascommercial and geographic coherence).

Business activities carried on aboard such a ship or boat, suchas a shop or restaurant, must be treated the same way forthe purposes of determining whether or not para 1 of Art.5applies.

Deemed PE under Art.5(5) if the contracts are concluded whensuch shops are operated within a State.

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TIME REQUIREMENT FOR THE EXISTENCE OF A PE20


Time Requirement for the Existence of a PE – Para 6 No consistencies so far as time requirements are

concerned. However, the experience has shown thata place is not treated as a PE if it exists for lessthan six months. – Para 6

Two Exceptions:

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Recurring Nature- period of time with number of times

Short duration because of its nature and activitiesperformed exclusively in the State S


Time Requirement for the Existence of a PE – Para 6 eFunds Corporation, 134 TTJ 1 (Delhi ITAT) - No time

period test is prescribed for permanence as thepermanence of the establishment has to bedetermined in the context of the nature of thebusiness being carried on.

Fugro Engineers BV, 26 SOT 78 (Delhi) – Time spenton three projects in India - 13 days, 14 days and 37days for providing geo-technical investigationservices at various oil drilling locations constitutedfixed place of business.

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Time Requirement for the Existence of a PE – Para 6 The phrase used in the article is ‘carried on’ as against other

possible phrase ‘carried out’ or ‘carried’. The use of thepreposition ‘on’ in conjunction with ‘carried’ suggests that thebusiness should not be one of the activities, but a regular andcontinued exercise even if it be an intermittent one and of a shortduration every time. In other words, the expression ‘carry onbusiness’ signifies a course of conduct involving theperformance of a succession of acts, and not just effectingone solitary event. As such, ventures like travel circuses, musicaltroupes, stalls in exhibition and game shows, etc., will have afixed place PE in a State only if they carry on their activitieson a regular basis [Golf In Dubai,174 Taxman480 (AAR)].

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PRESENCE OF FOREIGN ENTERPRISE’S PERSONNEL24


Presence of Foreign Enterprise’s Personnel – para 10 Where individuals who are formally employed by an enterprise will

actually be carrying on the business of another enterprise andwhere, therefore, the first enterprise should not be considered to becarrying on its own business at the location where these individualswill perform that work. This is generally the case with a multinationalgroup. In such cases, administrative reasons (e.g., the need topreserve seniority or pension rights) often prevent a change in theemployment contract.

Generally, presence of F Co.’s employee in India can give rise to twotypes of PE: Fixed Place PE Service PE

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Presence of Foreign Enterprise’s Personnel – para 10 Centrica India Offshore (P.) Ltd., 19 taxmann.com 214 (AAR) – Service

PE in India – on payroll of F co.

Morgan Stanley and Co Inc., 292 ITR 416 (SC) – can have service PEin India – On payroll of F co.

Lucent Technologies International Inc., 120 TTJ 929 (Delhi ITAT) –Service PE in India

Motorola Inc, 95 ITD 269 (Delhi SB) – Fixed place of business andthus, PE

Tekmark Global Solution LLC, 38 SOT 7 (Mum ITAT) – No PE in India -On payroll of F co. – employee was working for business of I co.

Stock Engineer & Contractors B.V. – No Service PE as the person hasworked under the supervision and control of I co.

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SUBCONTRACTOR AS A PE27


Sub-Contractor as a PE – Para 10

A foreign enterprise may also carry on its business through asub-contractor, who may work alone or together withemployees of the foreign enterprise. In that case, a PE willexist for the enterprise only if the other conditions of Article 5are met. In other words, the sub-contractor should perform thework of the enterprise at a fixed place of business that is at thedisposal of the enterprise. Whether or not a fixed place ofbusiness where a subcontractor performs work of an enterpriseis at the disposal of that enterprise will be determined on thebasis of the guidance given in para 4.2 of the Commentary.

More relevant when the subcontractor is working without thepresence of the foreign enterprises personnel

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The site should be considered to be at the disposal of the generalcontractor during the time spent on that site by any subcontractorwhere circumstances indicate that, during that time, the generalcontractor clearly has the construction site at its disposal byreason of factors such as the fact that he has legal possession ofthe site, controls access to and use of the site and has overallresponsibility for what happens at that location during that period.The subcontractor himself has a permanent establishment at the siteif his activities there last more than twelve months.

Pintsch Bamag, 318 ITR 190 (AAR) – Main Contractor did not haveconstruction PE since entire work was performed by sub-contractor –Considered OECD but not applied as no building site by F Co.

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Laird Technologies India (P.) Ltd., In re, 323 ITR 598 (AAR) –Group F Co. assigned the entire work to I Co. – Payment for theassignment is not taxable in India.

Hyosung Corporation, 181 taxman 270 (AAR) – Indian workwas performed by L&T – F Co. was responsible for theperformance of overall contract – no PE

eFunds Corporation, 134 TTJ 1 (Delhi ITAT) – sub-contracted theIT work to the Indian Subsidiary -treated as a place of businessin Indian and thus, PE

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JOINT VENTURE31


Joint Venture – Para 10.3

Generally, the definition of an ‘Enterprise of a Contracting State’given in Article 3 refers to any form of enterprise carried on by aresident of a Contracting State, whether this enterprise is legally setup as a company, partnership, sole proprietorship or any other legalform.

Different enterprises may collaborate on the same project and thequestion of whether their collaboration constitutes a separateenterprise (e.g., in the form of a partnership) is a question thatdepends on the facts and the domestic law of each State. If twoenterprises carried on by different persons decide to form acompany in which these persons are shareholders, the companyconstitutes a legal person that will carry on what becomes aseparate enterprise and thus, covered by the definition of the‘Enterprise of a Contracting State’.

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However, if different enterprises simply agree that (a) each will carry out on a separate part of the same project, (b) these enterprises will not jointly carry on business activities, (c) will not share the profits thereof but (d) they will only share the overall revenue or output from the

project or the remuneration for the activities that will be carriedon for that project,

it would be difficult to consider that a separate enterprise has been setup. Although such an arrangement would be referred to as a “jointventure” in many countries, the meaning of “joint venture” dependson the domestic laws and it is therefore possible that, in somecountries, the term “joint venture” would refer to a distinct enterprise.

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Van Oord ACZ BV, 248 ITR 399 (AAR) -(Breakwater construction at Chennai) – not an AOP

Hyundai Rotem Co. ,323 ITR 277 (AAR) - (Delhi Metro rail works) – not an AOP

Hyosung Corporation, 314 ITR (AAR) - (Power transmission in AP) – not an AOP

Geoconsult ZT GmbH, 304 ITR 283 (AAR) -(Project consultancy services for road projects) –an AOP

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Alstom Transport SA, (AAR No.958 of 2010) - Bangalore Metro RailCorporation Limited awarded a contract for installation and commissioningof signalling / train control and communication systems. It was held that thecomposite contract was for installation and commissioning project cannot besplit into parts for the purpose of taxation and hence, the consortium towhom the contract was awarded was liable to be taxed as an AOP. TheAAR relied on Vodafone Judgment that the Revenue/ Court should ‘look at’the transaction as a whole.

Linde AG, 19 taxmann.com 238 (AAR) - ONGC entered into a contract withthe Consortium for supply of a plant on a lump sum turnkey basis. It washeld that the composite contract was awarded to the Consortium and thus itwas to be taxed as an AOP. Mere internal division of responsibility orseparate payment cannot undo the AOP. The AAR relied on VodafoneJudgment that the Revenue/ Court should ‘look at’ the transaction as awhole.

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PARTNERSHIP36


Partnership – Para 10.4

If an enterprise is a fiscally transparent partnership, theenterprise is carried on by each partner. If such a partnershiphas a PE in a Contracting State, each partner’s share of theprofits attributable to the PE will therefore attract theprovisions of Article 7.

If partners are from two or more different foreign countries,then the Tax Treaty between India and each of the respectiveforeign countries will have to be looked at to determine thetax incidence of each partner.

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Partnership – Para 10.4

In the case of Linklaters LLP, 132 TTJ 20 (Mum ITAT), the firmwas entitled to the Indo-UK treaty benefits. ITAT held that eventhough the profits of the firm were not taxable as a separateunit, the profits were taxable in the hands of the 'individualpartners. However, ITAT did not approve of the OECDprinciples determining tax residency for partnership firms

Schellenberg Wittmer, 24 taxmann.com 299 (AAR) - Firm, notbeing taxable entity in Switzerland, not a ‘person,’ and hence,not entitled to Indo-Swiss DTAA benefit; Partners not being‘recipients’ of income also not entitled to benefit; Reliance onOECD Commentary rejected owing to India's reservations

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PLACE OF MANAGEMENT39


Place of Management – Para -12

Relationship between Art.5(1) & Art.5(2):

The terms listed, “a place of management”, “a branch”, “anoffice”, etc. must be interpreted in such a way that such placesof business constitute permanent establishments only if theymeet the requirements of paragraph 1 and are not places ofbusiness to which paragraph 4 applies. – Para 4 – nonobstante

Few Indian Judicial pronouncements support this view where asfew Judicial pronouncements have held otherwise

Place of Management in case of Multinational Group

Daimler Chrysler, 133 TTJ 766 (Mum ITAT) – No place ofmanagement

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ADDITIONAL WORK ON A CONSTRUCTION SITE41


Additional Work on A Construction Site – Para 19.1 The period during which the facilities are tested

would normally be included, that the hand-over ofthe building to the client would usually represent theend of that period

Work undertaken subsequently pursuant to aguarantee would not be taken into account.

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PREPARATORY OR AUXILIARY43


Preparatory or Auxiliary Nature –Para 21 & 23 Whether the subpara (a) to (d) of para 4 is subject to the additional

condition that the activities should be of a preparatory or auxiliary in nature? – NO

It is clarified that where the only activities carried on at a fixed place of business are activities to which one of subparagraphs a) to d) apply the place is deemed not to constitute a permanent establishment.

Since subparagraph e) deals with other unspecified activities,however, the requirement that the activity must have a preparatoryor auxiliary character has been laid down explicitly in the case ofthe exception mentioned in that subparagraph, which actuallyamounts to a general restriction of the scope of the definitioncontained in paragraph 1

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Preparatory or Auxiliary Nature –Para 21 & 23 Example given in para 23 are explanatory in

nature and should not be taken as a general rule.For example – activity of research anddevelopment. Pioneer Oversea, 37 SOT 404 (Delhi ITAT) – conducting

a research activities were held as an integral part of thebusiness

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Preparatory or Auxiliary Nature –Para 42.7 E-Commerce No PE if the electronic commerce operations carried on through

computer equipment at a given location in a country arerestricted to the preparatory or auxiliary activities covered byparagraph 4. - needs to be examined on a case-by-case basis

Examples of activities which would generally be regarded as covered by paragraph 4 include: ….

advertising of goods or services Galileo International Inc, 19 SOT 257 (Del)

Yahoo India Pvt. Ltd., 46 SOT 105 (‘Mum ITAT’)

Pinstorm Technologies Pvt. Ltd., (ITA No.4332/Mum/2009)

Google Ireland – approaches AAR

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Preparatory or Auxiliary Nature –42.9 E-Commerce What constitutes core functions for a particular enterprise clearly depends on the

nature of the business carried on by that enterprise.

If these activities are merely preparatory or auxiliary to the business of sellingproducts on the Internet or are otherwise covered by paragraph 4 (for example, thelocation is used to operate a server that hosts a web site which, as is often the case,is used exclusively for advertising, displaying a catalogue of products or providinginformation to potential customers), paragraph 4 will apply and the location will notconstitute a permanent establishment. If, however, the typical functions related to asale are performed at that location (for example, the conclusion of the contract withthe customer, the processing of the payment and the delivery of the products areperformed automatically through the equipment located there), these activitiescannot be considered to be covered by paragraph 4

AREVA T&D, 18 taxmann.com 171 (AAR) – PE – existence of computer server

Amadeus Global, 11 taxmann.com 153 (Delhi ITAT)] - PE

eBay International AG, 25 taxmann.com 500 (Mumbai ITAT) – No PE

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STORAGE , DISPLAY & DELIVERY AND SALE OF GOODS48


Storage , Display & Delivery And Sale Of Goods – Para 22 & 27 Does the exception in subpara 4(a) apply to goods

or marchandise to be sold from abroad? Subparagraphs a) and b) apply regardless of whether the

storage or delivery takes place before or after a contractfor the sale of the goods or merchandise has beenconcluded provided that the goods or merchandise belongto the enterprise whilst they are at the relevant location (e.g.the subparagraphs would remain applicable if contracts forthe sale of some of the goods that are stored at a locationhave already been concluded but the property title to thesegoods only passes to the customer after their delivery)

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Storage , Display & Delivery And Sale Of Goods – Para 22 & 27 An enterprise cannot fragment a cohesive operating business

into several small operations in order to argue that each ismerely engaged in a preparatory or auxiliary activity.

A similar issue arises where an enterprise that maintains in aContracting State one or more fixed places of business towhich sub-paragraphs (a) to (e) apply is also deemed,through the application of paragraph 5, to have a PE in thesame State. In that case, if the activities that resulted in thatdeemed PE are not separated organisationally from thesefixed places of business, it could not be argued that theenterprise is solely engaged in a preparatory or auxiliaryactivity at these places.

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Storage , Display & Delivery And Sale Of Goods – Para 22 & 27 It is clarified that the term ‘ goods and merchandise’ used in

sub-paragraph would cover tangible products that includedata, such as CDs and DVDs.

Does a development of property constitute a PE? –right to taxwith Source state – capital gain or business income - it isclarified that subpara 4(a) would not be applicable toimmovable property

What if the facility is used for the activities of storage, displayor delivery of goods? – it should be read as storage, displayand delivery as many a time facility used for delivery wouldalso be used for a storage - Seagate Singapore , 322 ITR 650(AAR)

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NEGOTIATION OF IMPORT CONTRACTS52


Negotiation of Import Contract -Preparatory or Auxiliary Nature - Para 24.2

Enterprise that sells goods worldwide establishes office in one stateand the employees working at that office take an active part in thenegotiation of important part of contract for sale of goods - thetype, quality or quantity of products

Does not matter whether they have authority to conclude thecontracts

The activities constitute the essential part of the business of theenterprise Jebon Corporation India, 206 Taxman 7 (KAR) Columbia Sportswear Co., 337 ITR 407 (AAR) Amadeus Global, 11 taxmann.com 153 (Delhi ITAT) – decisive

criterion is whether the activities are the essential part of thebusiness of the enterprise

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AGENCY PE54


To Conclude Contracts in the Name of the Enterprise – Para 32.1 Whether it only includes when the principal is legally

bound or is it sufficient that the principal iseconomically bound? the paragraph applies equally to an agent who concludes

contracts which are binding on the enterprise even if thosecontracts are not actually in the name of the enterprise. Forexample, in some countries an enterprise would be bound, incertain cases, by a contract concluded with a third party by aperson acting on behalf of the enterprise even if the persondid not formally disclose that it was acting for the enterpriseand the name of the enterprise was not referred to in thecontract.

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To Conclude Contracts – para 33

The types of contracts referred to in paragraph 5 are notrestricted, however, to contracts for the sale of goods: theparagraph would cover, for example, a situation where aperson has and habitually exercises an authority to concludeleasing contracts or contracts for services.

The authority to conclude contracts must, however, covercontracts relating to operations which constitute the businessproper of the enterprise.

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ACTIVITIES OF FUND MANAGERS57


Activities of Fund Managers in India

Whether the Fund Carried on Business?

Which enterprise’s business was carried on through the activities of the local advisory company ?

How did the transparent status of the fund affect the application of the concepts of “enterprise” and “permanent establishment ?

Whether the local advisory company or fund manager could claim to be an independent agent for the purposes of Article 5(6)? Morgan Stanley & Co., 142 Taxman 630 (AAR)

Fidelity Advisory Series, 271 ITR 1 (AAR)

XYZ / ABC Equity Fund Mauritius, 116 Taxman 719 (AAR)

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HEDGE-SQUARE Beyond Consultancy59

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Proposed changes to oecd commentary art.5 - permanent establishment

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