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PE & PROFIT ATTRIBUTIONPE & PROFIT ATTRIBUTION | 1Tax
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Permanent establishment &
Profit attribution - Recent developments
April 23, 2010
CA Darpan Mehta
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Disclaimer
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
Judicial Precedents
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Recent controversies on Permanent Establishment and Profit Attribution
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Facts of the case Seagate Singapore International
Headquarters Pvt Ltd (‘Seagate’):• Tax resident of Singapore• Manufactures and sells hard disk
drives to Original Equipment Manufacturers (‘OEMs’) in India
Proposed Venture:• 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
Questions before the AAR Whether ISPs would constitute a
PE? If so, what would be the income
attributable to the PE, if it has been remunerated on an arms length basis?
Seagate – Background 1/3
Applicant
OEMsISPs
Bonded Warehouse
Invoice
Purchase Order
Disk Delivery
Fees
Agreement with
ISPs
Singapore India
• Proposal to put a Vendor Management Inventory model
• Agreement with ISPs to stock and deliver on JIT basis
• Operating system of ISPs to support electronic data interchange, furnish receipt, sale advice and inventory reports
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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
Seagate – Contentions of the Revenue and Applicant 2/3
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Whether ISPs constitute a PE? Demarcated space in the warehouse constitutes a fixed place PE in India
• Fixed place meaning ‘distinct situs’ or an ‘earmarked place’ with racks and electronic services
As per the agreement with ISPs • 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
Seagate – Ruling of the AAR 3/3
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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Facts of the case BBC Worldwide Limited (‘BBC’):
• Tax resident of UK• Sister concern of the BBC Group
which operates the BBC World News Channel (‘the Channel’)
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
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?
BBC(UK)
BBC(India)
Appointment of agent for sale of airtime in India
Commission @ 15%
• Agreement entered between:
• BBC and BBC India under Airtime Sales Agreement
• Agent’s role:
• 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
BBC – Background 1/3
UK
IndiaAdvertisers
sale of airtime in
India
Revenue
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Revenue:• Dependent Agent PE
• Besides soliciting orders, BWIPL also engaged in activities of sales promotion, airtime and sponsorship, identifying new clients and distributors
• Morgan Stanley - not applicable • 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
BBC:• 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)
BBC – Contentions of the Revenue and Applicant 2/3
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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
BBC - Ruling of the Delhi ITAT 3/3
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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Facts of the case: Aramco Overseas Company BV (‘Aramco
BV’):• Tax resident of Netherlands• Subsidiary of Saudi Arabian Oil Company
(‘Saudi Aramco’)
Aramco BV to provide the following to Saudi Aramco and group companies:
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?
Saudi Aramco
Aramco BV
Aramco – Background 1/3SaudiArabia
India
Aramco India
Netherlands
Agreement to render PSS
• Agreement between Saudi Aramco and Aramco BV
• Proposal to set up Indian office for assisting with PSS
Export of goods
• Agreement for SCM• Cost + 5% mark up
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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
Aramco – Contentions of the Revenue and Applicant 2/3
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Ruling 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
Aramco - Ruling of the Delhi ITAT 3/3
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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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?
Any inferences from the Aramco ruling?
Key discussion points
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Case study:Attribution of profits to an Agency PE
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PE & PROFIT ATTRIBUTIONImpact of Circular No 7 of 2009 | 17
Relevant facts 1/2
Facts of the case:
X is a Singapore based manufacturer
X sells its products to customers in India through its selling agent Y
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
In return, X pays Y a commission, calculated as a percentage of sales revenue
Key questions:
What is the appropriate FAR for Y; Is this FAR different from the FAR of the Agency PE that X has in India
Applying the principle that arms length remuneration to Y extinguishes further tax liability for X
X
Y
Singapore
India
Customers
Agreement for selling agent
Manufacturing goods
Sale of goods
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FAR Analysis for the Sales function 2/2
Functions, Assets and Risks Analysis Y Agency PE of X
Functions
Product ordering √ ?
Marketing - sales force √ ?
Marketing / advertising strategy √ ?
Warehousing / inventory management √ ?
Delivery / shopping √ ?
Debt management and collections √ ?
After-sales support √ ?
Assets
Inventory ?
Property, plant and equipment (distribution) √
Receivables ?
Risks
Inventory risk ?
Credit risk ?
Foreign exchange risk ?
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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
Case Law Principles
Morgan Stanley and Co Inc
[Supreme Court]
Existence of ‘economic nexus’ as opposed to legal and financial nexus important for income attribution
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
SET Satellite (Singapore) Pte Ltd
[Bombay High Court]
Attribution based on FAR analysis
No further attribution required if dependant agent PE is compensated at arms’ length
BBC Worldwide Ltd
[Delhi Tribunal]
Reliance placed on Set Satellite and Morgan Stanley No further attribution required if PE is compensated at
arms’ length
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Whether arms length remuneration to Agency PE extinguishes tax liability 2/2
Case Law Principles
Galileo International Inc
[Delhi Tribunal]
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
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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