By Daksha Baxi (Head of International Taxation, Cyril Amarchand Mangaldas) and Jyoti Anumolu (Associate, Cyril Amarchand Mangaldas)
India’s Income Tax Appellate Tribunal (ITAT) at New Delhi last month delivered a significant decision in the case of Nokia Networks OY (taxpayer) on the issue of whether it’s Indian subsidiary, Nokia India Private Limited (NIPL) (which was assigned installation contracts by the taxpayer or entered into independent installation contracts with customers) constituted a permanent establishment (PE) for the taxpayer.
Nokia’s Indian subsidiary not a PE: majority decision
The majority of the ITAT members ruled in favor of the taxpayer holding that its Indian subsidiary would not constitute a PE in India. The majority members of the ITAT rejected the Revenue’s stand that the Indian subsidiary is a “virtual projection” of the assesse. They clarified that the concept of “virtual projection” flows from fixed place itself or with any other parameters of establishment of PE under Article 5 of the India-Finland tax treaty and cannot exist in vacuum, dehors of any other parameters of PE. They concluded that in the absence of a service PE provision in the then existing India-Finland tax treaty, the presence of the employees of the taxpayer company performing certain functions in India did not result in the taxpayer having a PE in India.
Dissenting opinion
However, the dissent of the third member of the ITAT, Pramod Kumar, provides an interesting angle to the issue. Kumar argued that when a subsidiary company’s survival for carrying on its business activities is entirely connected with, and dependent on, the business of its parent, then the subsidiary is merely an “alter ego”, or “virtual projection”, of its parent. Consequently, it must be treated as a PE of the non-resident parent.
Kumar categorized PEs into two types: “associated/direct” PEs and “unassociated/indirect” PEs. In his view, a subsidiary would fall into the latter category and concluded that the fixed place of business and the place being at the disposal of the parent are not relevant for such PEs. If the subsidiary performed actions in furtherance of the business interests of the foreign enterprise, it would constitute a PE. He justified his argument by placing reliance on the commentaries in this regard of leading international tax scholars.
Kumar also disagreed that NIPL was compensated adequately for the marketing activities that it carried out in India for the taxpayer for sales in India and attributed 35 percent of 10.8 percent of the global profits of the taxpayer from sales in India to the Indian PE on the grounds that all the crucial marketing and support functions have been rendered by the Indian PE. He justified his conclusion by placing reliance on the Rolls Royce decision.
Impact of the decision
The dissenting judgement goes beyond the settled principles of international tax law that a subsidiary is a separate legal entity and that merely because it is a subsidiary it would not constitute a PE. Similarly, the dissenting judgment has treated the taxpayer and its subsidiary as a single entity and has attributed 35 percent of the global profits to the PE on the basis of global formulary approach.
The dissent would give tax authorities ammunition to contend that Indian subsidiaries of foreign companies would constitute a PE. If upheld by the higher authorities, this would have wide ramifications. Companies will have to revisit their business models and the substance of conduct of business. It seems that increasingly the actual conduct of business as well as documentation will need attention for the purposes of achieving tax certainty, especially in cross-border situations.
The views are personal and should not be taken to be legal advice.
Daksha Baxi is Head of International Taxation at Cyril Amarchand Mangaldas (www.cyrilshroff.com). Daksha has been recognized as a leading tax professional in India by International Tax Review Leading Women in Tax, Legal 500, Chambers & Partners, Asia Leading Lawyers, and Whos’s Who Legal. She has over 30 years of experience in International Taxation. She has advised clients on all aspects of taxation, including structuring of cross border mergers and acquisitions, restructuring and reorganisations as well as spin off of businesses to unlock valuation, availing tax treaty benefits to contesting invocation of anti-avoidance rules and characterisation of income. Jyoti Anumolu is an Associate at Cyril Amarchand Mangaldas (www.cyrilshroff.com). Jyoti specialises in international taxation, mergers and acquisitions, inbound and outbound structuring.