Limited (Canada) Nortel NetworksInc (Luxemburg) SA India International Inc. (Taxpayer) International Finance &Holding Key Summary: Delhi HC ruled that offshore supply of equipments neither lead to attribution of income to India under the Income Tax Act nor it lead to creationof a permanent establishment in India. I. Brief facts of case 99.82% Singapore Pte. Mauritius Ltd. India Apart from the above, Nortel Canada also has a Liaison Office in India (Nortel LO). Series of steps depicting involvement of various Nortel Group entities in securing & execution of contracts: The Hon ble High Court of Delhi (Delhi HC) recently pronounced its ruling in case of India International Inc (taxpayer) [IT Appeal No. 666/ 2014]. Relevant group structure of Nortel Group is as follows: <<this space is intentionally left blank>> Nortel India negotiated and entered into three contracts with Reliance Infocom Limited (Reliance), namely, Optical Equipment Contract (Equipment Contract), Optical Services Contract (Services Contract) and the Software Contract (Software Contract) on 8th June 2002. On the same date, Nortel India entered into an agreement assigning all rights and obligations to sell, supply and deliver equipment under the Equipment Contract to the taxpayer (Assignment Contract). Reliance and Nortel Canada were also parties to the Assignment Contract and Nortel Canada guaranteed the For discussion purposes only Page 1
performance of the Equipment Contract by the taxpayer (Assignee). In terms of the Assignment Contract, Reliance placed purchase orders directly on the taxpayer and also made all payments for the equipment supplied directly to the taxpayer. The equipments supplied to Reliance were manufactured by Nortel Canada and another Nortel group entity in Ireland (Nortel Ireland). The same was invoiced by the taxpayer directly to Reliance and consideration for the same was also received directly by the taxpayer. The taxpayer contended that its income was not chargeable to tax in India. However, the tax officer held that Nortel India and Nortel LO are the PE of the taxpayer in India and accordingly, made upward adjustment to the income of taxpayer by attributing income on estimated basis for India activities / operations. Taxpayer s arguments/ contentions Contract for supply of equipment was a separate contract and was performed by the taxpayer independently. Since Reliance insisted on having an Indian company as a single point of contact and, therefore, the contract was initially entered into between Nortel India and Reliance and, subsequently, assigned to the taxpayer. Reliance is a party to the assignment contract and such assignment was also contemplated under the Equipment Contract. Purchase orders were placed directly by Reliance on the taxpayer and the payments for the supply were also made directly by Reliance to the taxpayer. Pricing terms 1 as provided in the contract were referred according to which the taxpayer was liable to deliver the equipment to the carrier at the port of shipment. The Equipment Contract only obliged the taxpayer to deliver the equipment overseas and no part of the taxpayer's activities were to be performed in India. The decision of the Supreme Court in the case of DIT (International Taxation), Mumbai v. Morgan Stanley and Co. Inc.: (2007) 292 ITR 416 (SC) and Director of Income Tax and Ors. etc v. M/s. E. Funds IT Solution and Ors. etc: (2014) 364 ITR 256 (Delhi) referred in support of contention that a subsidiary of a foreign company could not be construed as its PE. No expatriate employee of the taxpayer had visited India in connection with the Equipment Contract since the equipment was manufactured and supplied from overseas and there was no requirement to depute personnel to India. Nortel India had negotiated the contract on its behalf and, therefore, its activities prior to assignment of contract could not be considered as the taxpayer's activities. Nortel India had undertaken the responsibility and secured the contracts which included the Services Contract that was to be executed by Nortel India. In the circumstances, the conclusion that Nortel India had acted on behalf of the taxpayer was erroneous. In terms of the services agreement, Nortel India was to carry out all activities relating to installation, erection and commissioning. Since installation was not a part of scope of the works contracted to the taxpayer, there 1 FCA relevant international airport basis INCOTERM 2000, including costs of exportation procedures from the country/ies of export and insurance from the Vendor's (i.e. Nortel India) warehouse up to Substantial Completion For discussion purposes only Page 2
was no question of the taxpayer having any installation PE in India. In view of above, taxpayer contended that it is not liable to tax in India. Tax authorities arguments/ contentions Considering the following, the tax officer held that taxpayer was a paper company incorporated only with a motive to evade income tax liability on the income arising out of the supply contract in India and, therefore, Nortel Canada and the taxpayer were to be considered as a single entity. The contracts entered into with Reliance the Equipment Contact, Software Contract and Services Contract are essentially a part of the singular turnkey contract. Taxpayer was assigned the contract for supply of hardware to Reliance days after its incorporation. This is the only business that taxpayer had done during the relevant period under consideration. Taxpayer did not have any financial or technical capability of its own. The equipment supplied was manufactured by Nortel Canada/ Nortel Ireland. Nortel Canada / Nortel Ireland shipped directly from respective jurisdiction. Taxpayer had supplied the equipment at approximately half its purchase price, thus, incurring huge trading loss in the transaction. Further, the tax officer concluded that the taxpayer has various types of PE in India including fixed place PE, installation PE, service PE, etc. Keeping in view the facts of the case, 50% of the profits of the taxpayer's estimated incomeshould be attributed to the PE in India. II. Appellate Authority Observations The first level appellate authority [Commissioner of Income Tax (Appeals)] and second level appellate authority [Income Tax Appellate Tribunal] upheld the order of tax officer. However, the appellate authorities allowed deduction of certain expenses which was not allowed by the tax officer and the same had resulted in lower adjustment by a certain amount. III. Issue for consideration before Hon ble Delhi HC IV. Whether under the present case, the taxpayer can be said to have a PE in India and whether 50% of taxpayer s estimated income can be attributed to India and liable to tax in India. Key Observations Key Observations of Hon ble Delhi HC In relation to above, key observations/ views/ decision of the Hon ble Delhi HC (in summary) are as follows: Views on lifting of corporate veil Since Reliance insisted to execute contract with an Indian entity, therefore, Nortel India executed the contracts. Based on this finding, it cannot be said that Nortel India had acted for itself and not on behalf of any other group entity. The Delhi HC lift the corporate veil considering the exceptional circumstances of this case (as provided in below bullet For discussion purposes only Page 3
points) and viewed that taxpayer is a mere shadow company. Further, it held that the Equipment Contract was in essence performed by Nortel Canada (instead of taxpayer) due to the following reasons as observed by Hon ble Delhi HC: Taxpayer was incorporated a day prior to execution of the agreements and when the award of contract from Reliance was a certainty. The equipment supplied to Reliance was manufactured by Nortel Canada and Nortel Ireland and shipped directly to Reliance. Performance guarantee of the Equipment Contract was provided by Views on business connection and attribution of income under Income Tax Act No portion of income can be attributed to operations in India due to the following: Consideration was received by the taxpayer for the equipment manufactured and delivered overseas. No material on record to hold that Nortel India habitually exercises any authority on behalf of the taxpayer or Nortel Canada to conclude contracts on their behalf. Also, it cannot be said that Nortel India maintained any stocks of goods or merchandise in India from which goods were regularly delivered on behalf of the taxpayer or Thus, no part of taxpayer s income could be brought to tax under the Act 2. Even if it is accepted that the equipment supplied overseas continued to be in possession of Nortel India till the final 2 By virtue of Explanation 2 read with Explanation 3 to Section 9(1)(i) of the Act acceptance by Reliance, the same would not imply that the taxpayer s income from supply of equipment could be taxed under the Act. The Delhi HC relied on the various clauses of the contracts entered between parties in this case, based on which it is held that taxpayer is not liable to tax in India even under other contracts (other than equipment contract). The activities pertaining to installation and commissioning were performed by Nortel India on its own behalf rather not on behalf of the taxpayer or Therefore, it can be said that the taxpayer / Nortel Canada did not perform any installation or commissioning activity in India. Taxpayer only assumed the obligation to sell, supply and deliver equipment in terms of the Equipment Contract and was paid in terms of the pricing mechanism as agreed to under the Equipment Contract. For other supplies/ services Nortel India was responsible for which Nortel India had been paid separately. Views on creation / presence of Permanent Establishment 3 in India No Fixed Place PE of taxpayer in India based on following: Nortel LO did not act on behalf of the taxpayer or Nortel Canada in negotiating and concluding agreements. Thus, the offices of Nortel LO cannot be considered as a fixed place of business of the taxpayer. In so far as Nortel India is concerned, the offices of Nortel India were not at the disposal of the taxpayer or Nortel Canada and thus, the offices of Nortel 3 In this case, since Hon ble Delhi HC was of view that taxpayer was a paper company, therefore, while analysing the provisions of Double Taxation Avoidance Agreement (DTAA), the relevant Articles of both India-US DTAA and India-Canada DTAA are referred for the purpose of determining whether taxpayer can be said to have a PE in India. For discussion purposes only Page 4
India also did not constitute a fixed place business PE of the taxpayer or No Sales Outlet of taxpayer in India based on following: The facts on record only indicate that Nortel India negotiated contracts with Reliance. Even assuming that the contracts form a part of the single turnkey contract, which includes supply of equipment, the same cannot lead to the conclusion that Nortel India acted as a sales outlet. No Installation PE of taxpayer in India based on following: Services Contract clearly indicates that the tasks of installation, commissioning and testing were contracted to Nortel India and Nortel India performed such tasks on its own behalf and not on behalf of the taxpayer or Also, Nortel India received the agreed consideration for performance of the Services Contract directly by Reliance. No Service PE of taxpayer in India based on following: contracts had been concluded by Nortel India in India on behalf ofother group entities. In absence of any such evidence, taxpayer cannot be said to be a dependent agent PE in India. Views on Taxability of revenue earned by Nortel India from installation, commissioning and testing activities The income from installation, commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the taxpayer. For taxation in the hands of Nortel India, Delhi HC referred that Arms Length Price (ALP) of the transaction related to secondment of employees, should be determined in accordance with TP provisions. Based on the above, Delhi HC held that the taxpayer does not have a PE in India. Further, taxpayer's income from supply of equipment was not chargeable to tax in India and accordingly, attribution of income from supply of equipment cannot be made for taxability in India. No material to hold that Nortel India performed services on behalf of the taxpayer. For detailed discussion/ observations of the Hon bledelhi HC, refer the ruling in the case of India International Inc. No Dependent Agent PE of taxpayer in India based on following: No material on record which would indicate that Nortel India habitually exercises authority to conclude contracts for the taxpayer or Nortel Canada. Note: The above discussion is subject to detailed disclaimer policy as mentioned on website. Refer www.fealtyadvisors.com -------------------------------------------------------------------------- For more updates, visit our blogs at: In order to conclude that Nortel India constitutes a Dependent Agent PE, it would be necessary for the AO to notice at least a few instances where For discussion purposes only Page 5