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.
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