India: Delhi High Court rules on constitution of permanent establishment in outsourcing arrangements

Rajendra Nayak		Aastha Jain

E Funds Corporation and E Funds IT Solutions Inc., residents of USA (US Co), were engaged in the business of electronic payments, ATM management, decision support and risk management. E Fund India, an Indian company (I Co) and an indirect wholly owned subsidiary of US Co, provided back-office support and data entry operations to US Co. The Delhi High Court adjudicated on whether a permanent establishment (PE) was created in India for US Co under India-USA tax treaty.

The court observed that a subsidiary is an independent legal entity and its mere existence does not make it a PE of parent company. Factors like US Co and I Co were closely connected, I Co was dependent on US Co for earning income, intangibles were provided by US Co free of cost, US Co were deriving economic benefit by sub-contracting work/ services to I Co are not relevant for deciding on whether US Co had a PE in India. A subsidiary can become a PE of the holding company under the same circumstances where the conclusion is reached for unrelated companies. It was held that US Co had no "right to use" the premises of I Co. Even if the core activities of US Co were outsourced to I Co under sub-contract arrangement, with I Co bearing limited risk, it would not constitute a fixed place PE of US Co.

US Co had sent certain personnel to work with I Co to ensure confidentiality and quality of services provided by I Co. Such functions performed to protect the interest of US Co were stewardship services and no service PE arises from such services. Further, employees of I Co may not be considered as employees or other personnel for US Co. Any other interpretation would lead to irrational results that every subsidiary which engages an employee would always become a PE of the controlling foreign parent company. Further, since employees of I Co were not rendering any services on behalf of US Co, service PE was not constituted in India.

It was held that rendering of services to a third party by I Co on behalf of US Co would not, by itself, lead to I Co becoming a dependent agent PE. I Co did not satisfy the conditions of dependent agent PE under the tax treaty. As no PE of US Co was found to exist, no profits could be taxed in India and no income of I Co could be attributed to or taxed in the hands of US Co.

Globalisation has led many multinational enterprises to outsource business process and information technology services to affiliates in India. This decision provides guidance on issues as well as factors relevant for making a determination of PE in India in such business arrangements.

Rajendra Nayak (rajendra.nayak@in.ey.com) and Aastha Jain (aastha.jain@in.ey.com)
EY
Tel: +91 80 6727 5275
Website: www.ey.com/india

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