The concept of PEPage 1 The concept of Permanent Establishment (PE) 6 May 2013.

The concept of PE

The concept of Permanent Establishment (‘PE’)

6 May 2013

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

The concept of PE

Article 5 of the Treaty – Typical structure of a PE article

Permanent Establishment

[Article 5]

Article 5(1) – Fixed Place PE

Article 5(2) – Specific

inclusions

Article 5(3) – Construct ion PE

Article 5(4) – Exclusions

from PE

Article 5(5)- Dependent Agent

PE

Article 5(6) – Independent

Agent

Article 5(7) – Subsidiary

company

Article 5(1) - Basic Rule PE

The concept of PE

Article 5(1) - Basic Rule PE

Location test

Right to use test

Business activity

test

Permanence test

Place of business

test

A PE can be constituted under “Basic Rule” only if all of above conditions are satisfied

“the term ‘permanent establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on”

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

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

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)

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

Article 5(2) – Specific inclusions

The concept of PE

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

Article 5(4) – Exclusions from PE

The concept of 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

The concept of PE

► 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

Preparatory or auxiliary character

Article 5(3) – Construction PE

The concept of 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

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)

Article 5(5) & 5(6) - Agency PE

The concept of 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

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

The concept of PE

Independent Agent – Tests

Yes

Agent

Are activities wholly, or almost wholly, on behalf of principal?

No

Yes

Yes

Independent Agent

No

Dependent Agent

Is he acting ordinary course of his business?

Is he legally & economically

independent

► 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► Agent bears the risk of loss from its own

activities

No

The concept of PE

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

The concept of PE

Exercise the authority to conclude contracts in the namePerson 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

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

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

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?

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

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

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.

Important principles

The concept of PE

Carborandum Ltd vs CIT and Tekniskil Sendirian Berhard vs CIT

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

DECISION OF THE CASE

Deputation of employees by the Foreign Co to Indian Co not to constitute a PE in India

The concept of PE

General Motors Overseas Corp vs CIT

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

DECISION OF THE CASE

Deputation of employees by the Foreign Co to Indian Co to constitute a PE in India

The concept of PE

Morgan Stanley ruling

► 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

FACTS

The concept of PE


► 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:

► 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

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DECISION

The concept of PE


| 35

► 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

Case study

The concept of PE

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?

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 ?

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 India-

Singapore treaty?

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 suppliersIssues► Does F co constitute a PE in India

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 clientsIssue► Whether Indian Co. constitutes PE of UK company in India under India-UK

DTAA?

The concept of 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 USIssue ► Whether income would be taxable as per the provisions of Article 7

Case studies on PE

The concept of PE

Thank You

The concept of PEPage 1 The concept of Permanent Establishment (PE) 6 May 2013.

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