The service PE clause is a grey area of treaty interpretation and this ruling goes against the decision handed down in eFunds.
Facts of the case
JC Bamford Excavators, a foreign non-resident taxpayer, granted the right to use intellectual property rights (IPR) to its wholly owned subsidiary in India and also sent eight employees on deputation to the subsidiary to provide technical assistance for effective use of the intellectual property, as well as to assist in managing overall operations of the subsidiary.
Other employees also occasionally visited the premises of the Indian subsidiary to engage in the testing and inspecting of licensed products manufactured by the subsidiary.
The transactions under consideration were the:
Assignees (Tribunal term for the deputation of eight employees);
Royalty income received upon grant of IPR to the Indian subsidiary; and
Provision of occasional visitors (Tribunal term for employees occasionally visiting the Indian subsidiary to test and inspect the products/services of the subsidiary company).
The authorities claimed the deputation of eight employees constituted a service PE of the taxpayer and that the other transactions relating to the royalty payment (including payment for testing and inspection) were “effectively connected” to the service PE and therefore were taxable as business income under article 7 of the India-UK treaty.
The taxpayer’s stance was that no service PE existed in India and therefore all receipts were taxable under article 13 covering royalties and fees for technical services (FTS).
On appeal, the first appellate authority upheld the stance of the taxpayer, prompting the revenue authority to appeal to the Income Tax Appellate Tribunal.
Employees of the taxpayer
The Tribunal ruled that the assignees were employees of the taxpayer and not of the Indian subsidiary company, even after secondment. Despite the Indian subsidiary controlling and directing the assignees, no employment contract or agreement was entered into. The assignees also retained employment with the taxpayer so that after three years of secondment they would return to the taxpayer company, holding a position of at least the same rank as the role they left behind on secondment. There was no evidence indicating the assignees terminated their employment with the taxpayer and were re-employed by the Indian subsidiary. The activities of the assignees continued for a period of more than 90 days (treaty requirement for service PE to be triggered).
The Tribunal held that the assignees constituted a service PE of the taxpayer, providing technical assistance services to the Indian subsidiary.
In a recent case involving eFunds Corporation, the Delhi High Court stated that where employees are seconded by a foreign company to its Indian subsidiary, such employees do not constitute a service PE of the foreign holding company if the employees are under de facto and de jure control of the Indian subsidiary.
“In this case, however, though the employees were under the direction and control of the Indian subsidiary, there was no evidence that the seconded employees had entered into employment agreement with the Indian subsidiary. Hence the test of de facto and de jure control was not fully satisfied,” said Sagar Wagh, a tax and transfer pricing specialist based in Mumbai. “Further, as the employees provided technical assistance services on behalf of the holding company and retained lien over their employment with the holding company, the Tribunal has rightly held that the assignees constituted a service PE of the foreign holding company in India.”
“The key takeaway from this ruling is that, to mitigate service PE risk, multinationals need to meticulously draft their inter-company legal agreements while deputing their employees to subsidiaries on secondment basis,” said Wagh. “Also, the actual conduct of business should reflect the terms and conditions of such legal agreements.”
Effectively connected
The Tribunal also ruled on the effective connection question.
“The Tribunal ruling in respect of the term ‘effectively connected’ to PE in the royalty and FTS treaty article is technically perfect and deserves appreciation,” said Wagh. “The Tribunal has rightly held that effective connection should exist between PE on one hand and right, property or contract on the other. Hence, when the PE plays no part in the granting of IPR, such IPR cannot be effectively connected to the PE and consequently the royalty income cannot be taxed in the hands of the PE.”
Similarly, if the question arose in relation to the interest article, interest income cannot be said to be effectively connected to the PE if the PE plays no role in the granting of debt.
