A foreign enterprise could be deemed as having a taxable presence in India if it has a place of business at its disposal in India. The domestic law read with bilateral tax treaties prescribes tests and forms of presence which could be deemed as a taxable presence i.e. a permanent establishment (PE). Once a PE is constituted, income arising to the foreign enterprise which is attributable to its PE is taxable in India.
Existence of a PE and attribution of income thereto are issues of a factual-cum-legal nature and the analysis could be complex and even subjective. Foreign enterprises doing business in India often come under the scanner of the Indian tax authorities to test whether they have a PE in India and if they do, how much income is attributable to the PE for the purposes of taxation in India. In recent times, some large multinational groups such as Formula One, General Electric, Nokia, Daikin have come under the scanner due to the nature of their activities in India. This article discusses the nuances emerging from a recent ruling of the Indian tax tribunal in the case of Hitachi treating its liaison office as its PE in India for six years.
Hitachi Technologies Singapore Pte Limited (Hitachi), a wholly owned subsidiary of Hitachi High-Technologies Corporation, Japan, was engaged in trading operations across ASEAN countries. Hitachi had set up a liaison / representative office in India in the year 1988. In 2007, Hitachi closed its liaison office and opened a branch office.
Under the Indian exchange control laws, a liaison office is not permitted to engage in any income generating activity while a branch office can. Thus, if a liaison office merely carries on liaison, advertising and general market research activities, it should not be treated as a PE. However, a branch office is deemed as a PE unless the scope of its activities suggests otherwise.
Hitachi’s liaison office was engaged in marketing, marketing research, sales promotion and communication and logistical support services.
In April 2008, the tax authorities conducted a survey at the premises of Hitachi’s branch and collected certain information, based on which they treated Hitachi’s liaison office as its PE in India for the years 2001-2002 to 2006-2007. The key sources of information were – statements of employees recorded during the survey proceedings and email communication within the group.
The tax authorities heavily cross-examined the employees of the branch, raising questions such as:
- Nature of activities conducted by the liaison office and the branch respectively, and whether there was any difference in the two as earlier conducted by the liaison office and now conducted by the branch;
- Number of employees and nature of activities undertaken by each employee;
- Reason for conversion of liaison office to a branch office; and
- Details regarding salary expenses incurred by Hitachi in relation to employees working in India.
The tax authorities also accessed 93 pages of email communications from the laptop of one of the key employees and heavily relied on email exchanges between the representatives of Hitachi and its tax consultants, wherein the litigation risk exposure and the strategy to deal with this very tax issue was discussed. In such emails, the representative of Hitachi has stated that the liaison office was in fact actively involved in “commercial activities”.
Hitachi’s key contention was that its office was only acting as a communication channel between the customers and Hitachi and providing logistical support. It therefore contended that the activities of its office were “preparatory and auxiliary” in nature and would fall under the exclusion provided under Para 7(e) of Article 5 of the India-Singapore tax treaty, as per which a PE shall not arise where a place of business is maintained “solely for the purpose of advertising, for the supply of information, for scientific research, or for similar activities which’ have a preparatory’ or auxiliary character, for the enterprise.”
Based on the information unearthed in the course of the survey operation, the tax authorities observed that the key personnel of Hitachi were working in the office and were carrying out advertisement, sales promotion and marketing activities. The office was involved in ascertaining customer requirements, price negotiations, following up on deliveries and chasing the customers for payments.
The tribunal upheld the view of the tax authorities that since Hitachi was engaged in trading operations, the nature of activities undertaken by its office could not be considered as “preparatory and auxiliary” in nature. Such activities are core business activities of Hitachi and therefore, constituted its PE in India.
As regards attribution of income to the PE, the tribunal appreciated that the basis adopted by the tax authorities (considering sales commission charged by an independent agent as a comparable) was not appropriate, given that the office was performing routine and limited functions with negligible risk profile (as compared to an independent agent) and therefore, directed the tax authorities to recompute attributable income, using the Transactional Net Margin Method.
PE analysis is a mixed question of facts and law. This ruling once again highlights the extent to which tax authorities examine facts; they do not limit their review only to the intra-group contractual arrangements but go far beyond it to understand the factual matrix. External and internal email communication and how the representatives on the ground understand the business operations of the offshore group entities emerge to be the key sources of information in such cases. The deciding factor for determining whether the activities are merely “preparatory or auxiliary” in nature or are core functions, is the criticality of such activities vis-à-vis the overall business of the foreign enterprise.
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