Is Ware House Agent A PE??

DIVAKAR VIJAYASARATHY & ASSOCIATES Is Ware House Agent A PE??. Divakar Vijayasarathy 10

Does Demarcated Space in a Warehouse constitute a PE?? The term permanent establishment has been the subject of matter of intense litigation. Increasing complexities in business environment, innovative operational styles and humungous growth in cross border transactions have led to significant evolution and interpretation of the term Permanent Establishment or PE. PE has fundamentally been understood to be a fixed place of business through which business of an enterprise is wholly or partly carried on. The concept PE is extremely crucial since Article 7, on taxation of Business Profits, states that the profits of an enterprise of one of the Contracting States shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. In other words, business income of a non resident entity shall be taxable in India, if and only if, such non resident has a PE in India. According to Sec 5(2) of the Income Tax Act, income of a non resident is taxable in India if such income: - Is received or is deemed to be received in India in such year by or on behalf of such person or - Accrues or arises or is deemed to accrue or arise to him in India during such year According to Sec 9(1)(i), business income accruing or arising through a business connection in India is regarded as income accruing or arising in India. Explanation 2 to Sec 9(1)(i) defines business connection to include a person in India who: - has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident, unless his activities are limited to the purchase of goods or merchandise for the non-resident; or - has no such authority, but habitually maintains in India a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the non-resident; or

- habitually secures orders in India, mainly or wholly for the non-resident or for that non-resident and other non-residents controlling, controlled by, or subject to the same common control, as that non-resident: Provided that such business connection shall not include any business activity carried out through a broker, general commission agent or any other agent having an independent status, if such broker, general commission agent or any other agent having an independent status is acting in the ordinary course of his business : In this article the concept of PE has been critically analyzed based on a recent judicial pronouncement by Authority for Advance Rulings in the case of M/s Seagate Singapore International Headquarters Pvt Ltd. The ruling seems significant in the light of the interpretation of the term PE based on the exception of independent agents. The brief facts of the case are as follows: - The assessee is a non resident company, engaged in the business of manufacture and sale of Hard Disk drives in India. - The assessee has entered into agreements with domestic manufacturers for supply of hard disks in India - In order to minimize the lead time in supplying, the assessee decided to have an independent vendor in India to manage the inventory movement. - The brief scope of activity of the vendor is as follows: o The vendor would operate from bonded warehouses o He shall be responsible for safekeeping of the goods in custody o He shall deliver the goods to customers of the assessee based on specific communication from the assessee o The vendor shall bear the risk of loss of goods in custody o He shall register with local VAT authorities for the payment of applicable statutory taxes on behalf of the assessee o No employee of the assessee shall be deputed to the office of the vendor.

o The warehouse of the vendor shall adhere to the security requirements prescribed by the assessee. o The vendor shall provide adequate opportunity for inspection and audit of the warehouse by the assessee. - The vendor shall be compensated at Arm s Length Basis for the services rendered in India based on the risk undertaken, assets employed and functions performed. According to Article 5 of the Indo Singapore DTAA: Para 1: For the purposes of this Agreement, the term permanent establishment means a fixed place of business through which the business of the enterprise is wholly or partly carried on Para 8: Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 9 applies is acting in a Contracting State on behalf of an enterprise of the other Contracting State that enterprise shall be deemed to have a permanent establishment in the first-mentioned State, if - (a) he has and habitually exercises in that State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise; (b) he has no such authority, but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control, as that enterprise. Para 9: An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status provided that such persons are acting in the ordinary course of their

business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise itself or on behalf of that enterprise and other enterprises controlling, controlled by, or subject to the same common control, as that enterprise, he will not be considered an agent of an independent status within the meaning of this paragraph. The assessee claimed that, based on the exception provisions provided in para 8 and 9 of Article 5 and the fact that the delivery operations in India are being managed by an independent agent, there exists no PE in India and hence no income shall be taxable in India. In this aspect, it is also pertinent to note the rules for interpretation enunciated in para 2(b) of Explanatory notes to Model Conventions for Article 5: when examining whether or not a PE exists, it is expedient to begin by viewing the case against the background of the first four paragraphs. If there is a fixed place of business in the sense of these rules, there is no longer any need to revert to para 5 and 6. If, on the other hand, application of para 3 or 4 reveals that no PE exists, say because the time for which the building site or construction or assembly project lasted, fell short of the minimum required or because of one of the exceptions envisaged by para 4, a dependant agency relationship within the sense of para 5 can likewise not lead to a PE. It is only when the first and second para reveal the non existence of a PE on account of the absence of a fixed place of business that para 5 and 6 should be reverted to for an examination of the case under the agency aspect. The AAR in its wisdom has held that: - The applicant has a fixed place of business which is the focal point of its business operations in India - The fact that the fixed place of business is owned or possessed by the logistics service provider does not detract from the position that the applicant has a distinct, earmarked and identified place which caters to its business. - Both the applicant and the warehouse provider act in cohesion to ensure the product delivery to the customer promptly. - By merely outsourcing the operations leading to supply of products, it cannot be said that the applicant does not carry on any business in India from a fixed place.

- Where article 5.1 applies, the question of carrying on business through an independent or dependant agent does not arise at all. - The business of the applicant at a fixed place is being carried on through the media of the warehouse provider who can also be characterized as service provider. - Therefore demarcated space in the warehouse of an independent service provider constitutes a fixed place of business within the meaning of Article 5.1 of DTAA. Hence income attributable to the portion of activities carried out by the PE shall be liable for taxation in India. With due respects to the Honourable Bench the decision requires reconsideration on the following grounds: - The fact that the operation is carried through an independent agent who is remunerated at Arm s Length Price clearly indicates that income for services rendered / activities performed in India are already subject to tax in India. - The issue of dependant agent, dependant agent PE and attribution of profits has been elaborately addressed by the Honorable Supreme Court in the case of Morgan Stanley & Co. Inc vs DIT Mumbai (292 ITR 416). Accordingly it has been held that if the transaction between the assessee and the associated enterprise (which also constitutes a PE) is made at arm s length basis taking into consideration functions performed, assets employed and risks assumed, no further income shall be attributable to the PE for taxation in India. Also, in the case of SET Satellite (Singapore) PTE Ltd vs DDIT Mumbai (307 ITR 205), where the assessee had a dependant selling agent in India for selling ad slots, the Honorable High Court held that if service charges are paid to the dependant agent at arm s length by the non resident principal and the same is taxed in India, it extinguishes the tax liability of the non resident company in India. One aspect common to both the above rulings is that both have relied on circular 23/1969 dated 23-07-1969 which has since been withdrawn vide circular no 7/2009 dated 22-10-2009. Even though the circular has been withdrawn, the principles enunciated are still valid however they may not have a binding impact on the

revenue. These principles have been held valid by the honorable Supreme Court of India and hence shall continue to remain valid irrespective of the validity of the circular. - Interpretation of the present ruling suggests that, the exception provided in para 9 of Article 5, which is similar to the exclusion of independent agent in the term business connection, would be practically irrelevant for all non service based businesses since almost all the agents of goods would require a fixed place for storage and operation. The ruling would thus bring within its ambit almost any transaction carried out through an agent who has a place of operation in India for storage and delivery which does not seem to be intention of the legislature. - According to Sec 90(2), the assessee has a choice to be governed by the treaty or the Income Tax Act whichever is more beneficial to the assessee. As per Income Tax Act, income of a non resident is taxable in India if such income accrues or arises in India in accordance with Sec 9. Accordingly explanation to Sec 9 on business connection has clearly stated that business connection shall not include any business activity carried out through a broker, general commission agent or any other agent having an independent status, if such broker, general commission agent or any other agent having an independent status is acting in the ordinary course of his business. Therefore, no business connection shall arise in the course of the transaction and hence no income shall be liable to taxable by virtue of Sec 5(2) read with Sec 9(1)(i). Hence, in a situation as the present case, it is more beneficial for the assessee to adopt the domestic law (Income Tax Act 1961) provisions vis a vis the treaty provisions. - This ruling throws open another series of debate on taxation of independent agent dependant businesses based on the concept of PE. India is regarded as one of the strongest and fastest growing economies of the world. The whole world wants to invest in India and capitalize on the enormous opportunities and market potential. However the investing fraternity would crave for a stable taxation regime to have their plans fructified. Indian tax judgments are viewed

very seriously in the international tax arena. In the recent past, Indian decisions have found references in foreign judgments signifying the level of respect Indian judiciary commands globally. - With due respects to the Honorary Bench, it is hereby humbly submitted that the decision requires reconsideration and a higher judicial authority may have an option to reconsider the decision. This decision, has in all probability, caused a serious concern in the minds of foreign suppliers with domestic independent store keepers. CA. Divakar Vijayasarathy