Maintenance of stock by customer does not constitute a PE.

In a recent ruling Mumbai Income Tax Appellate Tribunal (Tribunal) in the case of Airlines Rotables Ltd., UK (Taxpayer) [ITA No. 3254/Mum/06F ] on the issue of whether maintenance of stock of goods, belonging to the Taxpayer, by its Indian customer results in the Taxpayer having a permanent establishment (PE) in India, under the India UK Tax Treaty (UK Treaty) reaffirmed some general principles relating to PE, the Tribunal further ruled that the Taxpayer does not have a PE under the basic rule or the agency rule. The Tribunal remanded the matter to the first appellate authority to determine if any part of the consideration could be taxed as royalty for use of equipment by the customer.

Facts

The Taxpayer is a company incorporated in the UK. Its main business is providing spares and component support to aircraft operators.

The Taxpayer entered into an agreement with Jet Airways Ltd. (Customer), an Indian aircraft operator, for providing certain support services in respect of aircraft.

The agreement requires the Taxpayer to repair the component when it becomes operationally unserviceable and to provide replacement of the component during the interim period.

The consideration received by the Taxpayer is divided into two segments: (a) For repairing and overhauling of the components. (b) For use, or right to use, of the replacement components.

In order to ensure adequate availability of the components, the Taxpayer maintains stock of such replacement components at the operational bases of the Customer in India, as also in the UK at the Taxpayer’s main depot. The Customer holds the component stock as a bailee (delivery of goods without transfer of ownership). The component stock continues to remain the property of the Taxpayer at all times.

The issue in dispute is whether the maintenance of the component stock constitutes a PE of the Taxpayer in India under the UK Treaty. The Tax Authority concluded that there exists a PE in India and the first appellate authority concurred with the Tax Authority’s view and determined 10% of gross receipts of the Taxpayer as profits attributable to the PE.

Aggrieved by the first appellate authority’s order, the Taxpayer appealed to the Tribunal.

Tax Authority’s contentions

The Tax Authority relied on a statement obtained from stores staff of the Customer to conclude that the staff of the Customer were acting as agents of the Taxpayer in maintaining the component stock. This resulted in an agency PE coming into existence under Article 5(4) of the UK Treaty.

Also, since the Taxpayer’s stock was permanently kept at fixed places in India, with clear identification of each stock item, the Taxpayer has a fixed place of business in India.

Delivery of repaired component stock amounts to sales, which has to be understood in its widest meaning in relation to business transactions. Since income arises to the Taxpayer out of such delivery of goods and the repaired component, the benefit of exclusion in clauses (a) and (b) in Article 5(3) of the UK Treaty, in relation to use of facility for storage or display and in relation to the maintenance of stock solely for storage respectively, is not available to the Taxpayer.

Taxpayer’s contentions

Since the Taxpayer does not have a PE in India, its business profits are not taxable in India.

Without prejudice, even if there were a PE, the application of an ad hoc rate of 10% on its entire gross receipts for India was not appropriate. The finding that the entire profits from Indian sales were attributable to the PE in India was also inappropriate, in view of the fact that the repair operations were carried out entirely outside India.

Tribunal ruling

PE under the basic rule

• As per the basic rule in Article 5(1) of the UK Treaty, a PE is said to exist when an enterprise of one country has a fixed place of business in the other country through which the business is wholly or partly carried out. Thus, the following three criteria are embedded in this definition:

•

o Physical criterion i.e., existence of a physical location.

o Subjective criterion i.e., right to use that place.

o Functionality criterion i.e., carrying out of business through that place.

• It is, thus, necessary that for a PE to exist not only should there be a physical location through which the business of the foreign enterprise is carried out, but also should such a place be at the disposal of the foreign enterprise. In other words, the foreign enterprise should have some sort of right to use the said physical location for its own business.

• In the present case, there is no doubt the consignment stock of the Taxpayer is stored at a specified physical location. However, this storage was under the control of the Customer and the Taxpayer did not have any place at its disposal.

• When the physical location at which the consignment stock is kept does not result in virtual projection of the Taxpayer into India, it cannot be said that the location constitutes a PE of the Taxpayer.

PE under the agency rule

• Under Article 5(4)(b) of the UK Treaty, a foreign enterprise can have a PE if a person, other than an agent of independent status, maintains stock of goods from which he regularly delivers on behalf of the foreign enterprise.

• A dependant agent PE (DAPE) can come into existence only when the business of the Taxpayer is carried out through the DAPE. In the present case, no business is carried out through the agent, even if the Customer is regarded as an agent. Maintaining the consignment stock by the Customer is the end result of the Taxpayer’s business and not an intermediate step to get the business.

• There is no material to establish or indicate that the Customer constitutes a DAPE of the Taxpayer. Even if one assumes that the Customer can be treated as an agent of the Taxpayer, the Customer, at best, will be an agent of independent status. Further, the Customer maintains the consignment stock for standby use and not for delivery, on behalf of the Taxpayer.

• The Taxpayer, therefore, does not have a PE in India and, accordingly, there is no question of quantification of income attributable to the PE under the UK Treaty.

Taxation as royalties

• Where the payment is not taxable as business profits under Article 7 of the UK Treaty because a PE is not constituted, taxability is required to be examined under Article 13 of the UK Treaty that provides for taxation of ‘equipment royalty’ i.e., whether the consideration is for use, or right to use, of the components.

• Thus, non-taxability under Article 7 will still mean that application of Article 13 is to be considered and adjudicated upon. Since this aspect had not been heard by any lower authorities, it was remanded to the first appellate authority to adjudicate only on this limited aspect.

Comments

This ruling reaffirms some of the general principles for determining existence of PE under the basic rule as well as the agency rule.

With regard to the basic rule, this ruling confirms that mere existence of a physical location is insufficient to result in a PE if the foreign enterprise does not have some sort of a right to use the location for its business. This ruling clarifies that mere presence of goods belonging to the foreign enterprise at the physical location does not result in the physical location being at the disposal of the foreign enterprise.

On agency PE, this ruling clarifies that maintenance of stock of goods by a person in India should not result in a PE if the goods are maintained for subsequent use and not for onward delivery on behalf of the foreign enterprise.

Fees for Technical Services, even if rendered outside India, are taxable.

Mumbai Tribunal Ruling: Fees for Technical Services, even if rendered outside India, are taxable consequent to retrospective amendment in Section 9 by the Finance Act, 2010 (Ashapura Minichem Limited v. ADIT)(ITA No. 2508/M/2008)

Facts:

Ashapura Minichem Limited (AML/Assessee), an Indian company entered into an agreement on 5 April 2007 with China Aluminum International Engineering Corp. Ltd. (CAIECL), a company based in China. AML, was in the process of building an alumina refinery in Gujarat and in this regard it was to pay a sum of USD one million in consideration of bauxite testing services availed from and for preparation of test reports by CAIECL. These services were rendered by CAIECL in its laboratories in China. These test reports of bauxite samples were to cover complete chemical composition of bauxite, physical phase constitution of bauxite, abradability test of bauxite, pre-desilication of bauxite, digestion performance test and red mud settling performance test.

AML approached Tax Department by filing an application under section 195 of the Income tax Act (Act) at the time of remittance of this sum to CAIECL for obtaining a nil withholding tax certificate. The Assessing Officer (AO) passed an order directing AML to deduct tax at source on the ground that these services rendered by CAICEL were in the nature of ‘fees for technical services’ as per Article 12 of India-China Double Tax Avoidance Agreement (‘tax treaty’).

On appeal, the Commissioner of Income tax [CIT (A)] upheld the order of the AO. Therefore, AML preferred an appeal before the Income tax Appellate Tribunal (Tribunal).

Contention of the Assessee:

In order attract taxability under section 9(1 )(vii) (fees for technical services), not only that the services should be utilized in India, but should also be rendered in India.

The testing services were rendered in China and not in India; and therefore, these services would not be considered as fees for technical services as defined in section 9(1 )(vii) of the Act. In this connection, reliance was placed on Ishikawajima Harima Heavy industries Ltd. v. DIT (288 ITR 408) (SC) and Clifford Chance v DCIT (318 ITR 297)(Bom).

Even in terms of Article 12 of the India-China tax treaty, taxability of fees for technical services can only arise when not only the services are used in India but also rendered in India.

Unlike the provisions in most other tax treaties, the taxability of fees for technical services in the India-China tax treaty has an additional requirement of ‘place of performance’ in the source country, to be satisfied before it can be taxed as fees for technical services in the source country.

In order to highlight that India-China tax treaty is unique in its wordings and its scope as far as taxability of fees for technical services is concerned, an attention was invited to the provisions of India-China tax treaty, China-Pakistan tax treaty, India-Israel tax treaty, India-South Africa tax treaty and India-Germany tax treaty.

In view of the above, it was contended that if at all this amount is liable to tax in India, it is by way of business profits only; and in the absence of any Permanent Establishment of CAIECL in India, such business profits would not be liable to tax in India.

Contention of the Revenue:

If the royalties and fees for technical services can only be taxed in India only when not only the services are utilised in India; but also rendered in India, the source rule will cease to have any meaning.

The judgement of the Supreme Court in the case of Ishikawajima (supra) and Bombay High Court in the case of Clifford Chance (supra) are contrary to the legislative intent and the doubts, if any, have been set at rest by the retrospective amendment in Explanation to section 9(1)(vii), as introduced in Finance Act, 2010. Once the amendments are carried out in the Act, these judicial precedents will no longer constitute good law.

As regards the applicability of Article 12 of India-China tax treaty is concerned, it was contended that the deeming provision of Article 12(6) [royalties or fees for technical services shall be deemed to arise in a Contracting State where the payer is a resident of a Contracting State] is quite clear and categorical, and therefore, it was urged to give it a sensible and reasonable meaning which makes the provision workable rather than making the provision redundant.

The services rendered by CAIECL are liable to tax under domestic tax law as well as tax treaty.

Tribunal’s observation and Ruling:

As per the retrospective amendment in section 9(1) by the Finance Act, 2010, utilisation of services in India is enough to attract its taxability in India. To that extent, recent amendment in the statute has virtually negated the judicial precedents supporting the proposition that rendition of services in India is a sine qua non for its taxability in India.

The impugned receipt of fees of technical services from AML is to be deemed to accrue or arise in India under section 9(1 )(vii) of the Act.

As per Article 12(4) of India-China tax treaty, technical services provided by a resident of China to a resident of India are liable to tax in India. Even under deeming provisions contained in Article 12(6), the said fees are liable to tax in India.

The argument that in using the words “in the Contracting State“, Article 12(4) incorporates the “place of performance test” and negates the “source rule” and that services rendered offshore are not taxable is not acceptable for two reasons. Firstly, because the expression “provision for services” is wider than the term “provision for rendering of services” and covers services rendered in the one State but used in the other State. Secondly, because the interpretation will render Article 12(6) redundant. A literal interpretation to a tax treaty which renders a treaty provision unworkable should be avoided. In this regard, the Tribunal has reiterated the Principles of treaty interpretation.

In view of the above, AML was liable to deduct tax at source under section 195 of the Act at the time of remittance of fees to CAIECL.

Comments :

The Legislature, in wanting to nullify the effect of the Supreme Court judgement in the case of Ishikawajima (supra), had attempted to amend the Act in 2007 by the Finance Act, 2007 by adding an explanation to section 9(2) of the Act, with retrospective effect from 1 June 1976. However, subsequently the Karnataka High Court in the case of Jindal Thermal Power Company Ltd. v. DIT (182 Taxman 252) held that the explanation, i.e. the 2007 amendment (supra), in its present form, does not do away with the requirement of rendering services in India, for such fees for technical services to be taxable under section 9 of the Act. In order to remove any doubt about the legislative intent of the aforesaid source rule, the amendment has been carried out again in section 9 by the Finance Act, 2010. This judgement has brought out this aspect by holding that as per the retrospective amendment in section 9(1) by the Finance Act, 2010, utilisation of services in India is enough to attract its taxability in India. However, it would be interesting to see how the Courts will interpret the law even after the amendment to section 9, as regards the taxability of payments for fees for technical services, irrespective of territorial nexus of such fees to the state of India.

Although this judgement is in line with the retrospective amendment in section 9 to the extent of taxability of fees for technical services in the hands of a non-resident, we believe that as far as payer’s obligation to withhold tax under section 195 is concerned, he may not be hit by the retrospective amendment in section 9 in the absence of any such extension of retrospective effect either in section 195 or section 201 of the Act. This is on the basis that the payer has withheld tax in a bonafide manner applying the law prevalent at the time of remittance. Further, the withholding tax is in the nature of vicarious liability and therefore, the payer should not be considered as ‘an assessee in default’ on account of any retrospective amendment carried out subsequently in the charging section of the Statute. In this connection, reliance can placed on the decision rendered by Nagpur bench of Tribunal in the case of Canara Bank v ITO (ITA Nos.366 to 370/Nag/2007) and Hyderabad Tribunal in the case of State Bank of India v DCIT (20 10- TIOL-23 1 -ITAT-HYD). Thus, expecting the tax payer to act on foresight of a retrospective amendment would be hit by the doctrine of impossibility of performance

Source : http://www.taxguru.in/income-tax-case-laws