Delhi High Court
Director Of Income Tax-Ii vs Western Union Financial Services Inc. on 18 December, 2024
Author: Yashwant Varma
Bench: Yashwant Varma
* IN THE HIGH COURT OF DELHI AT NEW DELHI
% Judgment reserved on: 19 September 2024
Judgment pronounced on: 18 December 2024
+ ITA 1288/2006
DIRECTOR OF INCOME TAX INTN'L .....Appellant
Through: Mr. Aseem Chawla, SSC with
Ms. Pratishtha, JSC.
versus
WESTERN UNION FINANCIAL SERVICES
INC. .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 724/2016
PR.COMMISSIONER OF INCOME TAX .....Appellant
Through: Mr. Aseem Chawla, SSC with
Ms. Pratishtha, JSC.
versus
WESTERN UNION FINANCIAL SERVICES .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 192/2019
COMMISSIONER OF INCOME TAX (INTERNATIONAL
TAXATION)- 3 .....Appellant
Through: Mr. Ruchir Bhatia, SSC with Mr.
Anant Mann, Adv.
versus
WESTERN UNION FINANCIAL
SERVICES INC. .....Respondent
Signature Not Verified
Digitally Signed
ITA 1288/2006 & Connected Matters Page 1 of 72
By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 126/2016
DIRECTOR OF INCOME TAX-II .....Appellant
Through: Mr. Ruchir Bhatia, SSC with Mr.
Anant Mann, Adv.
versus
WESTERN UNION FINANCIAL
SERVICES INC. .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 141/2016
DIRECTOR OF INCOME TAX -II .....Appellant
Through: Mr. Ruchir Bhatia, SSC with Mr.
Anant Mann, Adv.
versus
WESTERN UNION FINANCIAL
SERVICES INC .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 235/2019
THE COMMISSIONER OF INCOME TAX-
INTERNATIONAL TAXATION - 3 .....Appellant
Through: Mr. Aseem Chawla, SSC with
Ms. Pratishtha, JSC.
Signature Not Verified
Digitally Signed
ITA 1288/2006 & Connected Matters Page 2 of 72
By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
versus
WESTERN UNION FINANCIAL
SERVICES INC. .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 237/2019
THE COMMISSIONER OF INCOME TAX-
INTERNATIONAL TAXATION - 3 .....Appellant
Through: Mr. Aseem Chawla, SSC with
Ms. Pratishtha, JSC.
versus
WESTERN UNION FINANCIAL
SERVICES INC. .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 110/2024
THE COMMISSIONER OF INCOME TAX -
INTERNATIONAL TAXATION -3 .....Appellant
Through: Mr. Ruchir Bhatia, SSC with Mr.
Anant Mann, Adv.
versus
WESTERN UNION FINANCIAL
SERVICES INC .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 111/2024
THE COMMISSIONER OF INCOME TAX -
Signature Not Verified
Digitally Signed
ITA 1288/2006 & Connected Matters Page 3 of 72
By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
INTERNATIONAL TAXATION -3 .....Appellant
Through: Mr. Ruchir Bhatia, SSC with Mr.
Anant Mann, Adv.
versus
WESTERN UNION FINANCIAL
SERVICES INC .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
+ ITA 597/2019
THE COMMISSIONER OF INCOME TAX -
INTERNATIONAL TAXATION -3 .....Appellant
Through: Mr. Ruchir Bhatia, SSC with Mr.
Anant Mann, Adv.
versus
WESTERN UNION FINANCIAL
SERVICES INC .....Respondent
Through: Mr. Ajay Vohra, Sr. Adv. with
Mr. Gaurav Jain and Mr.
Shubham Gupta, Ms. Shalini,
Advocates.
CORAM:
HON'BLE MR. JUSTICE YASHWANT VARMA
HON'BLE MR. JUSTICE RAVINDER DUDEJA
JUDGMENT
YASHWANT VARMA, J.
1. These batch of appeals emanate from judgments handed down by
the Income Tax Appellate Tribunal1 negating the stand of the
appellant and principally holding that the respondent-assessee did not
1
Tribunal
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
have a Permanent Establishment2 in India in the relevant Assessment
Years3 as contemplated under Article 5 of the Double Taxation
Avoidance Agreement4 between India and the United States of
America5. The appeals themselves pertain to AYs 2001-02 [ITA
1288/2006], 2002-03 [ITA 126/2016], 2003-04 [ITA 141/2016] 2004-05
[ITA 724/2016], 2006-07 [ITA 597/2019], 2007-08 [ITA 237/2019],
2008-09 [ITA 235/2019], 2011-12 [ITA 192/2019], 2013-14 [ITA
111/2024] and 2015-16 [ITA 110/2024].
2. The Tribunal had rendered its principal decision on 10 March
2006 while dealing with the appeal pertaining to AY 2001-02 and which
decision has been followed in the subsequent years. We had in terms of
our order dated 20 July 2009 admitted ITA 1288/2006 on the following
question of law:-
―Whether on facts, income earned from customers outside India is
liable to tax in India under AADT with USA‖The remainder of the appeals subsequently came to be tagged with ITA
1288/2006 and were admitted on similar questions of law.
3. From the material placed before us as well as the submissions
addressed by learned counsels appearing for respective sides, the
following would appear to be the uncontested facts and which we for
the sake of convenience glean from the material placed on the record by
way of ITA 1288/2006.
4. The respondent-assessee is stated to be a non-resident company
registered in USA and has been engaged in the business of rendering
2
PE
3
AYs
4
DTAA
5
USA
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
Money Transfer Services6 since 1890. The essential business model
adopted by it has been recorded by the Tribunal to be as follows. A
person residing in USA desirous of transferring money to an individual
or an entity in India, approaches a branch or an outlet of the assessee
and transfers the money in USDs, together with the charges prescribed
by the respondent-assessee. Upon receipt of that money, the
respondent-assessee generates a unique number which is referred to as
the Money Transfer Control Number7. It is this MTCN which is
communicated by the remitter to the person or entity situate in India.
5. The beneficiary of that remittance residing in India then
approaches the representative/agent of the respondent-assessee along
with the MTCN details. Upon verification of the MTCN with the aid of
a software owned by the respondent-assessee, the MTCN, once
matched, leads to the transaction being honoured. This is, of course,
subject to the Indian agent of the respondent-assessee satisfying itself
with respect to the identity of the recipient.
6. It has further come to be noted by the Tribunal that for the
purposes of the aforesaid business, the respondent-assessee had entered
into agreements appointing agents in India and which included the
Department of Posts, Commercial Banks, Non-Banking Financial
Companies8 and Tour Operators. In terms of the agency agreements
which came to be executed between the respondent-assessee and the
Indian agents, the agreement was initially to run for a period of five
years and was extendable thereafter. In the shape of remuneration, the
Department of Posts was entitled to charge 30% of the remittance made
6
MTS
7
MTCN
8
NBFCs
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
and in the case of all others, the remuneration was fixed at 25%. The
aforesaid payment, which was in the nature of a commission, was
described as the ―base compensation‖ in the agency agreements.
7. For the purposes of facilitating its business and undertaking
promotional activities, the respondent-assessee is also stated to have
applied to the Reserve Bank of India9 for grant of requisite
permissions as contemplated under Section 29(1)(a) of the Foreign
Exchange Regulation Act, 197310. Basis the permission granted, it
also established an office in India and posted a representative therein.
This office was described to be the Liaison Office11, manned by one
manager and supporting staff.
8. As per the disclosures made, the respondent-assessee had made a
declaration before the RBI that the said LO would not represent any
party other than Western Union Financial Services. The annexure to
that application enumerated the following activities/services which
would be undertaken by the LO:-
―The Liaison office shall undertake the following liaison
activities/services:
(a) Distribute brochures and literature describing the activities of
Western Union Financial Services, Inc. (“Western Union”).
(b) Maintain liaison contact with government authorities and
officials of the government, its agencies and other organizations
and associations.
(c) Maintain and develop the relationship of mutual understanding
and co-operation between Western Union and India.
(d) Address seminars on Western Union’s activities.
(e) Put interested parties in direct contact with Wester Union’s
principal offices.
9
RBI
10
1973 Act
11
LO
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
(f) Explore legal, commercial and regulatory feasibility of setting
up subsidiaries, affiliates, partnerships, joint ventures, licensing
arrangements, etc.
(g) Keep in touch with the economic developments.
(h) Gather commercial and marketing data and information,
including its assessment of the requirements of the private sector
and of the government.
(i) Gather, receive and transmit message/information from
customers and other interested parties to Western Union’s
offices.
(j) Assist personnel from Western Union during their visits to India,
making travel arrangements and arranging appointments with
customers and other concerned parties, agencies, government
officials, etc.
(k) Investigate business opportunities in the Western Union range of
activities and develop business contacts.
The Liaison Office will not:
(a) Undertake any commercial, trading or industrial activity in
India.
(b) Sign any commercial agreement (except those directly
incidental to the conduct of operations of the liaison office such
as office leases, employment of local personnel, car rental, etc.)
(c) Have any power of attorney to participate in any commercial,
trading or industrial activity and/or negotiate any related
contracts;
(d) Have any authority to bind Western Union companies in any
manner in connection with commercial, trading or industrial
matters;
Be allowed or entitled to receive any monies on account of
commissions, fee or remuneration or otherwise in regard to any
commercial, trading or industrial activity‖
9. The aforesaid application came to be approved by the RBI with it
being noted that the said permission would be for a period of three
years ―for the purpose of undertaking liaison activities viz., to act as a
communication channel between Head Office and parties in India‖.
Apart from the aforesaid and as the Tribunal records in para 5 of its
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
judgment, the following additional conditions came to be imposed by
the RBI:-
―(i) Except the liaison work, the office in India will not undertake
any other activity of a trading, commercial or industrial
nature nor shall it enter into any business contracts in its own
name without our prior permission.
(ii) No commission/fees will be charged or any other
remuneration received/income earned by the office in India
for the liaison activities/services rendered by it or otherwise
in India.
(iii) The entire expenses of the office in India will be met
exclusively out the funds received from abroad through
normal banking channels.
(iv) The office in India shall not borrow or lend any money
from/to any person in India without our prior permission.
(v) The office in India shall not acquire, hold (otherwise than by
way of lease for a period not exceeding five years) transfer or
dispose off any immovable property in India without
obtaining prior permission of the Reserve Bank of India
under Section 31 of the Foreign Exchange Regulation Act,
1973.
(vi) The office in India will furnish to our Mumbai Regional
office (on a yearly basis):
(a) a certificate from the auditors to the effect that during
the year no income was earned by/or accrued to the
office in India;
(b) details of remittances received from abroad duly
supported by Foreign Inward Remittance Certificate;
(c) certified copy of the audited final accounts of the office
in India; and
(d) annual report of the work done by the office in India,
stating therein the details of actual export or import, if
any, effected during the period m respect of which the
office had rendered liaison services.
(e) The number of staff engaged/appointed and duties
assigned to each staff.
(vii) The liaison office will not render any consultancy or any
other services directly/indirectly with or without any
consideration.
Signature Not Verified
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
(viii) The liaison office will not have signing/commitment powers
except than those which are required for normal functioning
of liaisoning office on behalf of the Head Office.‖
10. It has further come on record that the respondent-assessee in
terms of the conditions imposed by the RBI had also submitted activity
reports pertaining to its LO periodically. One such report which has
been noticed in para 6 of the order of the Tribunal is extracted
hereinbelow:-
―Activity Report of the Liaison Office
Report for the period: 1 January 2000 to December 2000
The liaison office acted as a communication link between the agents
and the Head Office of Western Union International.
The Liaison office trained and installed one new Agent – Bank of
Madura Ltd. After they received final approval from the Reserve
Bank of India.
The Liaison office visited the Head Office locations of the Agents
and offered training and refresher courses in the areas of Western
Union Operations, Customer Service Standard, Security Standard,
accounting and reconciliation procedures, telecommunications and
systems configuration, merchandising standards and Reserve Bank
of India guideline.
The Liaison office communicated procedures to all Agents to ensure
a smooth roll over Y2K.
The Liaison office organized local production of posters and
merchandising material for the Agents to display at their locations.
The Liaison office facilitated the visit of the Director Operations of
Western Union International to visit with Agents and review their
quality operational standards.
The Liaison Office provided the latest Western Union Agent
Management Software – VOYAGER to the Agents and trained the
staff on the usage and versatility.
List of Employees:
Harsh Lambah
Business Development Manager
Shekhar Nair
Regional operations Manager‖Signature Not Verified
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ITA 1288/2006 & Connected Matters Page 10 of 72
By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
11. For AY 2001-02, the respondent-assessee is stated to have paid a
total commission of INR 12,16,94,036/- to its agents situate in India
being equivalent to USD 2,663,472/-. On 13 January 2003, the Income
Tax Department is stated to have issued a notice to the respondent-
assessee calling upon it to file its Income Tax Returns. The respondent-
assessee initially questioned the assumption of jurisdiction, as would be
evident from its letter of 03 October 2003. However, notwithstanding
that objection being raised, it ultimately furnished a return of income on
08 December 2003 declaring its income as ‗nil’.
12. The Assessing Officer12, however, assessed the total income to
be INR 4,90,22,316/-, as a consequence of which notices under Section
143(2) came to be issued on 04 March 2004. The AO, while framing
the order of assessment essentially came to hold as under. It firstly
opined that the income of the respondent-assessee had accrued and
arisen in India and would consequently be exigible to tax. It further
held that the respondent-assessee would be liable to tax under the
provisions of the DTAA.
13. Tested on the anvil of the activities that occurred in India, the AO
came to conclude that not only did the respondent have a fixed place of
business and which constituted a ―Fixed Place‖ Permanent
Establishment13, the activities undertaken by the LO were sufficient to
treat it as a Dependent Agent being present in India and thus the test of
existence of a Dependent Agent Permanent Establishment14 were
also met.
12
AO
13
PE
14
DAPE
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
14. Apart from what was construed by the AO and is noticed above,
it was further observed and held that the software installed in the office
of the Indian agents and the facility of connectivity so provided would
also lend credence to the premises of those agents being viewed as a
PE. The AO further observed that the test of business connection in
India also stood satisfied. This, according to the AO, was in light of the
Indian agents carrying out activities which constituted an integral part
of the business of the assessee and the revenue so generated.
15. Aggrieved by the aforesaid, the respondent-assessee is stated to
have moved the Commissioner of Income Tax (Appeal)15. The
CIT(A), while taking note of the activities undertaken by the LO, held
that the training activity undertaken by that establishment of employees
of the agents such as regulation of service and security standards,
accounting and reconciliation procedures as well as the providing of the
software ‗Voyager’, would be indicative of the LO not being a mere
passive communication channel but one which had been actively
involved in the business activity of the appellant. The CIT(A) further
held that the said establishment would thus satisfy the tests of ‗place of
management’ as well as the existence of a substantial element of an
enduring or permanent nature of the foreign enterprise in India. Basis
the above, it came to affirm the view which had been taken by AO
insofar as Fixed Place PE was concerned. The CIT(A) also concurred
with the AO of the installation of the software ‗Voyager’ in the fixed
premises of the agents as being one more element which would be
liable to be viewed as being of significance for the purposes of
acknowledging the existence of a Fixed Place PE.
15
CIT(A)
Signature Not Verified
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
16. Before proceeding further, it would be relevant to note that
undisputedly the LO which had been established in India operated only
up to 31 July 2005 whereafter it was closed and the subsidiary, Western
Union Services India Private Limited, came to be incorporated.
17. When the matter travelled to the Tribunal, it firstly held that the
business connection test, as enumerated in Explanation 2 to Section
9(1) stood satisfied. However, it held against the appellants insofar as
the question of Fixed Place PE was concerned. It further proceeded to
hold that the LO would not satisfy the tests enumerated in Article 5 of
the DTAA and the activities undertaken by it would be liable to be
viewed as being merely ―preparatory‖ or ―auxiliary‖ in character.
18. From the record we find that a decision of the Authority for
Advance Rulings16 in UAE Exchange Centre LLC, In re.17 was also
cited. The applicant in that case also was engaged in money transfer
business and had adopted a similar model of remitting money to India
through its LOs. The LOs were stated to have engaged in downloading
of data pertaining to the beneficiaries in India, printing of cheques and
dispatching the same to the beneficiaries. It was on the basis of these
facts that the AAR had proceeded to hold that the LOs constituted a PE
in India.
19. However and was noticed by the Tribunal, the AAR had
observed that the role of the LO must involve performing the contract
of remittance of amounts at least in part before it could be said to be a
PE of the foreign enterprise. The Tribunal while contrasting the facts of
the AAR ruling to the present case, noted that the LO performed no part
16
AAR
17
(2004) 268 ITR 9 (AAR)
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
of the contract of remittance of monies to India because of which it
could not be considered to be a PE of the respondent-assessee in India.
20. It is pertinent to note that the decision of the AAR thereafter
came to be overturned by the Delhi High Court in UAE Exchange
Centre Ltd. v. Union of India and Another18 and which decision was
affirmed by the Supreme Court in Union of India and Another v.
U.A.E. Exchange Centre19.
21. Insofar as the issue of software constituting a PE is concerned,
the Tribunal held that it merely accorded access to the agents to
communicate with the mainframe computers and servers situate outside
India. According to the Tribunal, the software was the property of the
respondent-assessee and mere use thereof would not lead to a PE
coming into existence. It also negated the conclusions which were
rendered by the AO as well as the CIT(A) insofar as the question of
DAPE was concerned. It is aggrieved by the aforesaid decision of the
Tribunal that these appeals have come to be preferred before this Court
22. Leading submissions on behalf of the appellants, Mr. Chawla,
learned counsel submitted that bearing in mind the nature of activities
which the LO had undertaken and which extended to training of agents
in India as well as interacting with local agents, conducting refresher
courses in accounting, reconciliation, aiding them in successfully
transitioning Y2K and the provision of the ‗Voyager’ software, when
cumulatively considered, would lead one to the irresistible conclusion
that a Fixed Place PE came into existence.
18
2009 SCC OnLine Del 337
19
(2020) 9 SCC 329
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
23. It was Mr. Chawla’s submission that it would be wholly incorrect
to view the activities undertaken and functions discharged by the LO as
being preparatory or auxiliary. It was submitted by learned counsel that
the LO was engaged in the core activities of the respondent and would
thus be liable to be viewed as a projection of the foreign enterprise
itself.
24. Mr. Chawla further argued that the installation of software in the
premises of the Indian agents would satisfy the provisions made in
Article 5(2) of the India-USA DTAA and which speaks of letting or
leasing of intangible property. Mr. Chawla argued that the software
plays a central role in the completion of transactions and thus the
placement of that dedicated software would result in the establishments
of the Indian agents being liable to be viewed as a Fixed Placed PE. It
was then argued that the Indian agents were in turn entitled to appoint
sub-agents to carry on the business of the respondent and this too would
be a factor which would render the conclusions of the Tribunal
unsustainable.
25. Refuting those submissions, Mr. Vohra, learned senior counsel
appearing for the respondents, firstly urged us to dismiss the appeals
outrightly since according to learned senior counsel, the determination
of whether a PE exists or not is essentially a question of fact. According
to Mr. Vohra, the Tribunal being the final fact finding authority having
come to the conclusion that no PE existed, the same would clearly not
give rise to any substantial question of law.
26. Mr. Vohra then cited for our consideration the decision of the
Supreme Court in Formula One World Championship Limited v.
Commissioner of Income Tax, International Taxation-3, Delhi and
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
Another20 and which, according to learned senior counsel, had
identified the principal elements for a Fixed Place PE being assumed to
have come into existence to be: (a) an identified fixed place, (b) that
fixed place being made available and placed at the disposal of the
foreign enterprise and (c) business of that foreign enterprise being
carried on through such fixed place. Mr. Vohra in order to buttress his
submissions adverted to the following paragraphs from the Formula
One decision of the Supreme Court:-
―33. The principal test, in order to ascertain as to whether an
establishment has a fixed place of business or not, is that such
physically located premises have to be ―at the disposal‖ of the
enterprise. For this purpose, it is not necessary that the premises are
put at the disposal of the enterprise. However, merely giving access
to such a place to the enterprise for the purposes of the project would
not suffice. The place would be treated as ―at the disposal‖ of the
enterprise when the enterprise has right to use the said place and has
control thereupon.
xxxx xxxx xxxx
39. OECD commentary on Model Tax Convention mentions that a
general definition of the term ―PE‖ brings out its essential
characteristics i.e. a distinct ―situs‖, a ―fixed place of business‖. This
definition, therefore, contains the following conditions:
(i) the existence of a ―place of business‖ i.e. a facility such as
premises or, in certain instances, machinery or equipment.
(ii) this place of business must be ―fixed‖ i.e. it must be
established at a distinct place with a certain degree of permanence;
(iii) the carrying on of the business of the enterprise through
this fixed place of business. This means usually that persons who, in
one way or another, are dependent on the enterprise (personnel)
conduct the business of the enterprise in the State in which the fixed
place is situated.
xxxx xxxx xxxx
74. As per Article 5 of the DTAA, the PE has to be a fixed place of
business ―through‖ which businesses of an enterprise is wholly or
partly carried on. Some examples of fixed place are given in Article
5(2), by way of an inclusion. Article 5(3), on the other hand,
excludes certain places which would not be treated as PE i.e. What is20
(2017) 15 SCC 602
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By:KAMLESH KUMAR
Signing Date:18.12.2024
17:35:40
mentioned in clauses (a) to (f) as the ―negative list‖. A combined
reading of sub-articles (1), (2) and (3) of Article 5 would clearly
show that not only certain forms of establishment are excluded as
mentioned in Article 5(3), which would not be PEs. Otherwise, sub-
article (2) uses the word ―include‖ which means that not only the
places specified therein are to be treated as PEs, the list of such PEs
is not exhaustive. In order to bring any other establishment which is
not specially mentioned, the requirements laid down in sub-article
(1) are to be satisfied. Twin conditions which need to be satisfied
are: (a) existence of a fixed place of business; and (b) through that
place business of an enterprise is wholly or partly carried out.‖
27. Learned senior counsel then took us through the decision
rendered by this Court in Director of Income Tax v. E-Funds IT
Solution21 and which had underscored the requirement of the core
business of the foreign enterprise being carried out through an
identified fixed place in order to constitute a Fixed Place PE. Our
attention was drawn to the following paragraphs of that decision:-
―53. Reference to core of auxiliary or preliminary activity is relevant
when we apply para 3 of Article 5 or when sub-clause (a) to para 4
to Article 5 is under consideration. The fact that the subsidiary
company was carrying on core activities as performed by the foreign
assessee does not create a fixed place PE. Paragraph 3 of Article 5
lists negative activities which when performed from a fixed placed
in the other contracting State would not create a PE. The activities
specified in Article 5, para 3 would not create a PE, even when the
conditions specified in paras (1) and (2) of Article 5 are satisfied.
Paragraph 3 is not a positive provision but a negative list. The said
paragraph does not create a PE but has a negative connotation and
activities specified when carried on do not create a PE.
xxxx xxxx xxxx
59. 10K report referred to in the orders was filed by the assessee
with the S.E.C. USA. The details submitted in this document not
only pertain to the two assessee incorporated and paying tax in USA
but the entire group companies including e-Fund India. The assets,
revenues, income earned, employees of e-Fund India, etc. have to be
disclosed and elucidated in the said report. The report, no doubt, is
relevant and material but has to be examined with due care and
caution to determine and decide whether the two assessees have PE
in India. The fact that business has been transferred or sub-
21
2014 SCC OnLine Del 555
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contracted or assigned to e-Fund India is not relevant and material,
unless we are determining applicability of para 3 to para 5 and the
question is whether the Indian company is performing core or
auxiliary and preliminary activities. The fact, the report refers to and
give details of or number of employees of e-Fund India which are
part of the e-Fund group is not relevant. Neither income earned by e-
Fund India nor activities in India by the Indian subsidiary by itself,
relevant in determining whether or not PE exists under paras 1, 2, 4
and 5 of Article 5. Thus and therefore, the fact that 40% of the
employees of the entire group were in India i.e. were employees of
e-Fund India, will not make the said company agency subsidiary PE
or fixed place PE of the assessee. Neither provision of any software,
intangible data etc. whether free of cost or otherwise, make e-Fund
India an agency or fixed place PE of the two foreign assessees.
Whether or not and on what basis e-Fund India was reimbursed
expenses of xerox, courier charges etc. will not make e-Fund India
as PE of the assessee under Articles 5(1), 5(4) or 5(5). Conditions
and stipulates under Articles 5(1), 5(4) or 5(5) will create a PE and
not the said facts as highlighted in the impugned orders. Therefore,
we will now examine the facts found and refer to Articles 5 (4) and
5(5) of DTAA.‖
28. Mr. Vohra also laid emphasis on the fact that the legal position as
enunciated by this Court ultimately came to be affirmed by the
Supreme Court in Assistant Director of Income Tax-I, New Delhi v.
E-Funds IT Solution Inc.22 and where the law was explained in the
following terms:-
―16. The Income Tax Act, in particular Section 90 thereof, does not
speak of the concept of a PE. This is a creation only of the DTAA.
By virtue of Article 7(1) of the DTAA, the business income of
companies which are incorporated in the US will be taxable only in
the US, unless it is found that they were PEs in India, in which event
their business income, to the extent to which it is attributable to such
PEs, would be taxable in India. Article 5 of the DTAA set out
hereinabove provides for three distinct types of PEs with which we
are concerned in the present case: fixed place of business PE under
Articles 5(1) and 5(2)(a) to 5(2)(k); service PE under Article 5(2)(l)
and agency PE under Article 5(4). Specific and detailed criteria are
set out in the aforesaid provisions in order to fulfil the conditions of
these PEs existing in India. The burden of proving the fact that a22
(2018) 13 SCC 294
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foreign assessee has a PE in India and must, therefore, suffer tax
from the business generated from such PE is initially on the
Revenue. With these prefatory remarks, let us analyse whether the
respondents are brought within any of the sub-clauses of Article 5.
17. Since the Revenue originally relied on fixed place of business
PE, this will be tackled first. Under Article 5(1), a PE means a fixed
place of business through which the business of an enterprise is
wholly or partly carried on. What is a ―fixed place of business‖ is no
longer res integra. In Formula One, this Court, after setting out
Article 5 of the DTAA, held as follows: (SCC pp. 625-29, paras 33-
39)
―33. The principal test, in order to ascertain as to whether an
establishment has a fixed place of business or not, is that
such physically located premises have to be “at the
disposal” of the enterprise. For this purpose, it is not
necessary that the premises are owned or even rented by the
enterprise. It will be sufficient if the premises are put at the
disposal of the enterprise. However, merely giving access to
such a place to the enterprise for the purposes of the project
would not suffice. The place would be treated as “at the
disposal” of the enterprise when the enterprise has the right
to use the said place and has control thereupon.
* * *
35. According to Philip Baker, the aforesaid illustrations
confirm that the fixed place of business need not be owned
or leased by the foreign enterprise, provided that it is at the
disposal of the enterprise in the sense of having some right
to use the premises for the purposes of its business and not
solely for the purposes of the project undertaken on behalf
of the owner of the premises.
36. Interpreting the OECD Article 5 pertaining to PE, Klaus
Vogel has remarked that insofar as the term “business” is
concerned, it is broad, vague and of little relevance for the
PE definition. According to him, the crucial element is the
term “place”. Importance of the term “place” is explained
by him in the following manner:
‗In conjunction with the attribute ―fixed‖, the
requirement of a place reflects the strong link between
the land and the taxing powers of the State. This
territorial link serves as the basis not only for the
distributive rules which are tied to the existence of PE
but also for a considerable number of other distributive
rules and, above all, for the assignment of a person to
either contracting State on the basis of residence (Article
1, read in conjunction with Article 4 OECD and UN
MC).’
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37. We would also like to extract below the definition to the
expression “place” by Vogel, which is as under:
‗A place is a certain amount of space within the soil
or on the soil. This understanding of place as a three-
dimensional zone rather than a single point on the earth
can be derived from the French version (installation fixe)
as well as the term ―establishment‖. As a rule, this zone
is based on a certain area in, on, or above the surface of
the earth. Rooms or technical equipment above the soil
may qualify as a PE only if they are fixed on the soil.
This requirement, however, stems from the term ―fixed‖
rather than the term ―place‖, given that a place (or space)
does not necessarily consist of a piece of land. On the
contrary, the term ―establishment‖ makes clear that it is
not the soil as such which is the PE but that the PE is
constituted by a tangible facility as distinct from the soil.
This is particularly evident from the French version of
Article 5(1) OECD MC which uses the term
―installation‖ instead of ―place‖.’
The term “place” is used to define the term
“establishment”. Therefore, “place” includes all
tangible assets used for carrying on the business, but one
such tangible asset can be sufficient. The
characterization of such assets under private law as real
property rather than personal property (in common law
countries) or immovable rather than movable property
(in civil law countries) is not authoritative. It is rather the
context (including, above all, the terms “fixed”/―fixe‖*),
as well as the object and purpose of Article 5 OECD and
UN MC itself, in the light of which the term “place”
needs to be interpreted. This approach, which follows
from the general rules on treaty interpretation, gives a
certain leeway for including movable property in the
understanding of “place” and, therefore, we assume a
PE once such property has been “fixed” to the soil.
For example, a workbench in a caravan, restaurants
on permanently anchored river boats, steady oil rigs, or a
transformer or generator on board a former railway
wagon qualify as places (and may also be “fixed”).
In contrast, purely intangible property cannot qualify
in any case. In particular, rights such as participations in
a corporation, claims, bundles of claims (like bank
accounts), any other type of intangible property (patents,
software, trademarks, etc.) or intangible economic assets
(a regular clientele or the goodwill of an enterprise) do
not in themselves constitute a PE. They can only form
part of PE constituted otherwise. Likewise, an internet
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website (being a combination of software and other
electronic data) does not constitute tangible property
and, therefore, does not constitute a PE.
Neither does the mere incorporation of a company in
a contracting State in itself constitute a PE of the
company in that State. Where a company has its seat,
according to its bye-laws and/or registration, in State A
while the POEM is situated in State B, this company will
usually be liable to tax on the basis of its worldwide
income in both contracting States under their respective
domestic tax law. Under the A-B treaty, however, the
company will be regarded as a resident of State B only
[Article 4(3) OECD and UN MC]. In the absence of both
actual facilities and a dependent agent in State A, income
of this company will be taxed only in State B under the
1st sentence of Article 7(1) OECD and UN MC.
There is no minimum size of the place of work. If the
qualifying business activities consist (in full or in part)
of human activities by the taxpayer, his employees or
representatives, the mere space needed for the physical
presence of these individuals will be sufficient if it were
available. Article 5(5) OECD MC and Article 5(5)(a)
UN MC and the notion of agent PEs were superfluous!
This can be illustrated by the example of a salesman who
regularly visits a major customer to take orders and
conduct negotiations in the purchasing Director’s office.
The OECD MC Comm. has convincingly denied the
existence of a PE, based on the implicit understanding
that the relevant geographical unit is not just the chair
where the salesman sits, but the entire office of the
customer, and the office is not at the disposal of the
enterprise for which the salesman is working.’
38. Taking cue from the word ‗through’ in the Article,
Vogel has also emphasised that the place of business
qualifies only if the place is ―at the disposal‖ of the
enterprise. According to him, the enterprise will not be able
to use the place of business as an instrument for carrying on
its business unless it controls the place of business to a
considerable extent. He hastens to add that there are no
absolute standards for the modalities and intensity of
control. Rather, the standards depend on the type of
business activity at issue. According to him, ―disposal‖ is
the power (or a certain fraction thereof) to use the place of
business directly. Some of the instances given by Vogel in
this behalf, of relative standards of control, are as under:
‘The degree of control depends on the type of
business activity that the taxpayer carries on. It is
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therefore not necessary that the taxpayer is able to
exclude others from entering or using the POB.
The painter example in the OECD MC Comm. (No.
4.5 OECD MC Comm. on Article 5) (however
questionable it might be with regard to the functional
integration test) suggests that the type and extent of
control need not exceed the level of what is required for
the specific type of activity which is determined by the
concrete business.
By contrast, in the case of a self-employed engineer
who had free access to his customer’s premises to
perform the services required by his contract, the
Canadian Federal Court of Appeal ruled that the engineer
had no control because he had access only during the
customer’s regular office hours and was not entitled to
carry on businesses of his own on the premises.
Similarly, a Special Bench of Delhi’s Income Tax
Appellate Tribunal denied the existence of a PE in the
case of Ericsson. The Tribunal held that it was not
sufficient that Ericsson’s employees had access to the
premises of Indian mobile phone providers to deliver the
hardware, software and know-how required for operating
a network. By contrast, in the case of a competing
enterprise, the Bench did assume an Indian PE because
the employees of that enterprise (unlike Ericsson’s) had
exercised other businesses of their employer.
The OECD view can hardly be reconciled with the
two court cases. All three examples do indeed shed some
light onto the method how the relative standards for the
control threshold should be designed. While the OECD
MC Comm. suggests that it is sufficient to require not
more than the type and extent of control necessary for
the specific business activity which the taxpayer wants to
exercise in the source State, the Canadian and Indian
decisions advocate for stricter standards for the control
threshold.
The OECD MC shows a paramount tendency (though
no strict rule) that PEs should be treated like subsidiaries
[cf. Article 24(3) OECD and UN MC], and that facilities
of a subsidiary would rarely been unusable outside the
office hours of one of its customers (i.e. a third person),
the view of the two courts is still more convincing.
Along these lines, a POB will usually exist only
where the taxpayer is free to use the POB:
- at any time of his own choice; Signature Not Verified Digitally Signed ITA 1288/2006 & Connected Matters Page 22 of 72 By:KAMLESH KUMAR Signing Date:18.12.2024 17:35:40 - for work relating to more than one customer; and - for his internal administrative and bureaucratic work.
In all, the taxpayer will usually be regarded as
controlling the POB only where he can employ it at his
discretion. This does not imply that the standards of the
control test should not be flexible and adaptive.
Generally, the less invasive the activities are, and the
more they allow a parallel use of the same POB by other
persons, the lower are the requirements under the control
test. There are, however, a number of traditional PEs
which by their nature require an exclusive use of the
POB by only one taxpayer and/or his personnel. A small
workshop [cf. Article 5(2)(e) OECD and UN MC] of 10
or 12 sq m can hardly be used by more than one person.
The same holds true for a room where the taxpayer runs
a noisy machine.’
39. OECD Commentary on Model Tax Convention
mentions that a general definition of the term ―PE‖ brings
out its essential characteristics i.e. a distinct ―situs‖, a ―fixed
place of business‖. This definition, therefore, contains the
following conditions:
(i) the existence of a ―place of business‖ i.e. a facility
such as premises or, in certain instances, machinery or
equipment;
(ii) this place of business must be “fixed” i.e. it must be
established at a distinct place with a certain degree of
permanence;
(iii) the carrying on of the business of the enterprise
through this fixed place of business. This means usually that
persons who, in one way or another, are dependent on the
enterprise (personnel) conduct the business of the enterprise
in the State in which the fixed place is situated.”
(emphasis supplied)‖
18. Thus, it is clear that there must exist a fixed place of business in
India, which is at the disposal of the US companies, through which
they carry on their own business. There is, in fact, no specific
finding in the assessment order or the appellate orders that applying
the aforesaid tests, any fixed place of business has been put at the
disposal of these companies. The assessing officer, CIT (Appeals)
and the ITAT have essentially adopted a fundamentally erroneous
approach in saying that they were contracting with a 100%
subsidiary and were outsourcing business to such subsidiary, which
resulted in the creation of a PE. The High Court has dealt with this
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aspect in some detail in which it held: (E Funds case, SCC OnLine
Del para 49)
xxxx xxxx xxxx
22. This report would show that no part of the main business and
revenue earning activity of the two American companies is carried
on through a fixed business place in India which has been put at
their disposal. It is clear from the above that the Indian company
only renders support services which enable the assessees in turn to
render services to their clients abroad. This outsourcing of work to
India would not give rise to a fixed place PE and the High Court
judgment is, therefore, correct on this score.‖
29. According to Mr. Vohra, the issues which are sought to be
canvassed no longer survive and nor do they merit any exposition by
this Court in light of the decision of the Supreme Court in UAE
Exchange. Mr. Vohra submitted that the facts as they obtained in UAE
Exchange are identical to those which form the subject matter of these
appeals and thus following the principles culled out by the Supreme
Court, the arguments advanced by the appellants are wholly unmerited.
30. Mr. Vohra then submitted that the assumption of the LO carrying
on business activities in India is factually flawed and had come to be
rendered by the AO as well as the CIT(A) in ignorance of Article
5(3)(e) of the India-USA DTAA and the fundamental functions and
attributes which must be found to vest in an agent before a DAPE could
be said to have come into being.
31. Elaborating on that aspect, Mr. Vohra also vehemently assailed
the view expressed by the AO as well as the CIT(A) insofar as the
question of DAPE was concerned. It was submitted that the Department
of Posts, NBFCs were all independent third parties having substantial
business and revenue of their own and were thus clearly not dependent
upon the revenue that came to be generated while discharging certain
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functions under the agency agreements. It was submitted that the
conclusions to the contrary as drawn by the AO as well as the CIT(A)
would in any case not sustain in light of the decision of this Court in E-
Funds.
32. Mr. Vohra also highlighted the fact that the Indian agents were
remunerated at arm’s length and were, in that sense, independent. This
according to learned senior counsel more so since undisputedly they
stood conferred with no authority to conclude contracts on behalf of the
principal in India.
33. Mr. Vohra submitted that all contracts for MTS were entered into
by the respondent-assessee outside India with the remitters too being
situate outside the country. The submissions, which were addressed in
the backdrop of the ‗Voyager’ software, were countered by Mr. Vohra
who referred for our consideration the following passage from the
Organization for Economic Cooperation and Development23 Model
Commentary, 200524.
―42.2 Whilst a location where automated equipment is operated by
an enterprise may constitute a permanent establishment in the
country where it is situated (see below), a distinction needs to be
made between computer equipment, which may be set up at a
location so as to constitute a permanent establishment under certain
circumstances, and the data and software which is used by, or stored
on, that equipment. For instance, an Internet web site, which is a
combination of software and electronic data, does not in itself
constitute tangible property. It therefore does not have a location that
can constitute a ―place of business‖ as there is no “facility such as
premises or, in certain instances, machinery or equipment” (see
paragraph 2 above) as far as the software and data constituting that
web site is concerned. On the other hand, the server on which the
web site is stored and through which it is accessible is a piece of
equipment having a physical location and such location may thus
23
OECD
24
OECD Model 2005
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constitute a “fixed place of business” of the enterprise that operates
that server.‖
34. Mr. Vohra argued that the software was merely a tool employed
to facilitate the verification of details and its role being confined to
enabling the Indian agents to undertake that exercise and communicate
with the mainframe computers and servers of the respondents situate
outside India. Learned senior counsel thus submitted that it would be
wholly incorrect for the installation of that software to be viewed as
giving rise to the creation of a Fixed Place PE. It is these rival
submissions which arise for consideration
35. Although, the Tribunal has come to hold against the respondent-
assessee insofar as the issue of business connection is concerned, we do
not find any legal imperative to engage with that question since the
same is undisputedly concerned with Section 9 of the Act and thus
relating to income which could be said to be deemed to have accrued or
arisen in India. We thus propose to confine and focus our discussion in
evaluating the correctness of the view expressed by the Tribunal
primarily on the anvil of the DTAA.
36. Having chronicled the submissions which were addressed by
respective sides before us, we proceed further and firstly take up for
consideration Article 5 of the DTAA and which defines the concept of a
PE. Article 5 of the India-USA DTAA reads as follows:-
―ARTICLE 5
PERMANENT ESTABLISHMENT
1. For the purposes of this Convention, the term “permanent
establishment” means a fixed place of business through which the
business of an enterprise is wholly or partly carried on.
2. The term “permanent establishment” includes especially:
(a) a place of management
(b) a branch
(c) an office
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(d) a factory
(e) a workshop
(f) a mine, an oil or gas well, a quarry, or any other place of
extraction of natural resources;
(g) a warehouse, in relation to a person providing storage
facilities for others;
(h) a farm, plantation or other place where agriculture, forestry,
plantation or related activities are carried on;
(i) a store or premises used as a sales outlet;
(j) an installation or structure used for the exploration or
exploitation of natural resources, but only if so used for a
period of more than 120 days in any twelve-month period;
(k) a building site or construction, installation or assembly
project or supervisory activities in connection therewith,
where such site, project or activities (together with other such
sites, projects or activities, if any) continue for a period of
more than 120 days in any twelve-month period;
(l) The furnishing of services, other than included services as
defined in Article 12 (Royalties and Fees for Included
Services), within a Contracting State by an enterprise through
employees or other personnel, but only if:
(i) activities of that nature continue within that State for a
period or periods aggregating more than 90 days
within any twelve-month period; or
(ii) the services are performed within that State for a
related enterprise [within the meaning of paragraph 1
of Article 9 (Associated Enterprises)].
3. Notwithstanding the preceding provisions of this Article, the term
“permanent establishment” shall be deemed not to include any one
or more of the following:
(a) the use of facilities solely for the purpose of storage, display,
or occasional delivery of goods or merchandise belonging to
the enterprise;
(b) the maintenance of a stock of goods or merchandise
belonging to the enterprise solely for the purpose of storage,
display, or occasional delivery;
(c) the maintenance of a stock of goods or merchandise
belonging to the enterprise solely for the purpose of
processing by another enterprise;
(d) the maintenance of a fixed place of business solely for the
purpose of purchasing goods or merchandise, or of collecting
information, for the enterprise;
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(e) the maintenance of a fixed place of business solely for the
purpose of advertising, for the supply of information, for
scientific research or for other activities which have a
preparatory or auxiliary character, for the enterprise.
4. Notwithstanding the provisions of paragraphs 1 and 2, where a
person–other than an agent of an independent status to whom
paragraph 5 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 the first-mentioned State an
authority to conclude on behalf of the enterprise, unless his
activities are limited to those mentioned in paragraph 3
which, if exercised through a fixed place of business, would
not make that fixed place of business a permanent
establishment under the provisions of that paragraph;
(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, and some additional activities conducted in the
State on behalf of the enterprise have contributed to the sale
of the goods or merchandise; or
(c) he habitually secures orders in the first-mentioned State,
wholly or almost wholly for the enterprise.
5. 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 and the
transactions between the agent and the enterprise are not made under
arm’s length conditions, he shall not be considered an agent of
independent status within the meaning of this paragraph.
6. The fact that a company which is a resident of a Contracting State
controls or is controlled by a company which is a resident of the
other Contracting State, or which carries on business in that other
State (whether through a permanent establishment or otherwise),
shall not of itself constitute either company a permanent
establishment of the other.‖
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37. As per Article 5(1), a PE would mean a fixed place through
which the enterprise carries on its business wholly or in part. Article
5(2) then proceeds to specify several categories of establishments
which would fall within the ambit of the expression ‗Permanent
Establishment’. This, as our Court correctly explained in E-Funds, is a
provision with a positive connotation as opposed to the negative list
enumerated in Article 5(3) and which excludes a fixed places of
business if it satisfies the conditions prescribed therein. The argument
of ―preparatory‖ and ―auxiliary‖ proceeds in light of the aforesaid
distinction.
38. In these proceedings, the appellants had contended that it was the
LO of the respondent-assessee which constituted a PE in India. That
submission was addressed in the backdrop of the various functions
which were discharged by that LO upto 2005. The Tribunal has taken
due note of the nature of permission which was accorded by RBI
relating to the functioning of the LO and which enabled it to engage in
activities such as distribution of brochures and literature, educating and
informing parties with respect to the nature of activities of Western
Union Financial Services, liaising with governmental authorities and
officials, addressing seminars on its activities, putting interested parties
in contact with Western Union Financial Services and exploring legal,
commercial and regulatory feasibility of setting up subsidiaries and
affiliates.
39. The permission granted by RBI proscribed the LO from
undertaking any commercial trading or industrial activity in India,
signing any commercial agreements, participating in any commercial
trading or industrial activity or for that matter negotiating any related
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contracts. From the activity report which was submitted by that LO to
the RBI, we note that it had asserted that it had merely acted as a
communication link between the agents and Western Union Financial
Services. It had also made due disclosure of the initiatives undertaken
by it and which included training agents, administering training and
refresher courses as well as providing the updated versions of the
‗Voyager’ software to agents and training their staff with respect to its
usage. The respondent-assessee had in the aforesaid light argued that
the activities undertaken by the LO would clearly fall within the
category of activities which could at best be described as ‗preparatory’
or ‗auxiliary’ and thus falling within the ambit of Article 5(3) of the
DTAA.
40. It is pertinent to note that Article 5(3) sets out the exclusions
from the term ‗Permanent Establishment’ and thus excludes a fixed
place of business from where ‗preparatory’ or ‗auxiliary’ activities may
be undertaken. Although Mr. Chawla had sought to lay stress on the
phrase ―or for other activities‖ as it appears in Article 5(3)(e), we find
no merit in that contention since the said expression would have to be
read in conjunction with the phrase ―which have a preparatory or
auxiliary character‖ to which it is prefaced. The scope of the words
―preparatory‖ and ―auxiliary‖ had directly arisen for the consideration
of this Court in UAE Exchange. The said decision was concerned with
the assertion of the Income Tax Department of an office of the assessee,
UAE Exchange Centre, situate in India constituting a PE. Similar to the
fact which obtain in these appeals, UAE Exchange was also concerned
with the movement of monies handed over to it by various remitters
residing outside India. The funds were deposited with that entity by
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remitters in the United Arab Emirates25 and thereafter transmitted to
beneficiaries in India either through normal banking channels or with
the involvement of the LOs. The LOs of UAE Exchange Centre were
enabled to download requisite information particulars by using
computers installed in India and which were in turn connected to
servers in the UAE. It was the LOs which after due verification were
drawing cheques on banks in India and transmitting them to the
concerned beneficiaries. The AAR had held against the assessee by
observing that those LOs would constitute a PE.
41. Our Court in UAE Exchange while examining the challenge had
held that the AAR had clearly erred in taking that position and ignoring
that the services rendered by LOs clearly fell within the scope of Article
5(3). This becomes apparent from a reading of para 32 of that decision
and which is extracted hereinbelow:-
―32. In our opinion, this view is clearly erroneous. We are living in
an era where the world is described euphemistically as ―flat‖ or even
a global village. Organisations and companies operate
transnationally. There is an eagerness to bring to tax by States
income, by employing deeming fictions so that incomes which
ordinarily do not accrue or arise within the taxing State are brought
within the State’s tax net. It is in this context that the expression
―permanent establishment‖ appearing in the DTAA has to be
viewed. In the case of the DTAA under consideration in the present
case under article 5 read with article 7, profits of an enterprise are
liable to tax in India if an enterprise were to carry on business
through a permanent establishment, meaning thereby fixed place of
business through which business of an enterprise is wholly or partly
carried on. Under article 5(2)(c), amongst others, permanent
establishment includes an office. However, article 5(3) which opens
with a non obstante clause, is illustrative of instances where under
the DTAA various activities have been deemed as ones which would
not fall within the ambit of the expression ―permanent
establishment‖. One such exclusionary clause is found in article
5(3)(e) which is : maintenance of fixed place of business solely for
the purpose of carrying on, for the enterprise, any other activity of a25
UAE
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preparatory or auxiliary character. The plain meaning of the word
―auxiliary‖ is found in the Black’s Law Dictionary 7th Edition at
page 130 which reads as ―aiding or supporting, subsidiary‖. The only
activity of the liaison offices in India is simply to download
information which is contained in the main servers located in the
UAE based on which cheques are drawn on banks in India
whereupon the said cheques are couriered or despatched to the
beneficiaries in India, keeping in mind the instructions of the NRI
remitter. Can such an activity be anything but auxiliary in character.
Plainly to our minds, the instant activity is in ―aid‖ or ―support‖ of
the main activity. The error into which, according to us, the
Authority has fallen is in reading article 5(3)(e) as a clause which
permits making a value judgment as to whether the transaction
would or would not have been complete till the role played by
liaison offices in India was fulfilled as represented by the petitioner
to their NRI remitter. According to us, what has been lost sight of is
that by invoking the clause with regard to permanent establishment,
we would, by a deeming fiction tax an income which otherwise
neither arose nor accrued in India–when looked at from this point
of view, the exclusionary clause contained in article 5(3) and in this
case in particular, sub-clause (e) have to be given a wider and liberal
play. Once an activity is construed as being subsidiary or in aid or
support of the main activity it would, according to us, fall within the
exclusionary clause. To say that a particular activity was necessary
for completion of the contract is, in a sense saying the obvious as
every other activity which an enterprise undertakes in earning profits
is with the ultimate view of giving effect to the obligations
undertaken by an enterprise vis-a-vis its customer. If looked at from
that point of view, then, no activity could be construed as
preparatory or of an ―auxiliary‖ character. On this aspect of the
matter, the Supreme Court in the case of DIT (International
Taxation) v. Morgan Stanley and Co. Inc. [2007] 292 ITR 416 ;
[2007] 7 SCC 1 amongst other issues was called upon to decide as to
whether back office operations carried on by Morgan Stanley
Company for one of its Morgan Stanley Advantages Services Pvt.
Ltd. would qualify as having a permanent establishment in India.
The Supreme Court, while holding that back office operations fall
within the exclusionary clause article 5(3)(e) of the Indo-US DTAA,
which is, identical to the DTAA under consideration in the present
case, came to the conclusion that back office operations came within
the purview of article 5(3)(e). It is laid down by the Supreme Court
in the case of Morgan Stanley [2007] 292 ITR 416 ; [2007] 7 SCC 1
that in ascertaining what would constitute a ―permanent
establishment‖ within the meaning of article 5(1) of the Indo-US
DTAA, one had to undertake what is called a functional and factual
analysis of each of the activities undertaken by an establishment. In
that case, the Supreme Court came to the conclusion that the entity
located in India which was engaged in only supporting the front
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office functions of Morgan Stanley and Co., a non-resident, in fixed
income and equity research and information technology enabled
services such as data processing support centre, technical services
and reconciliation of accounts being back office operators would not
fall within article 5(1) of the Indo-US DTAA.‖
42. Our Court found that the LOs were merely aiding and supporting
the entity, UAE Exchange Centre. Thus, and viewed in that light, the
said offices could not possibly be held to constitute a PE. It also bore in
consideration that every aspect of the principal transaction had been
concluded in the UAE and the remittances as well as the commission
was deposited and earned in that territory. It pertinently observed that
the functions performed by the LOs were merely supportive of the
transaction which had occurred in the UAE. It thus observed that the
LOs did not contribute to the earning of profits by the assessee.
43. The aforesaid judgment rendered by this Court came to be
appealed by the Union before the Supreme Court and which, while
affirming the judgment handed down by this Court had observed as
follows:-
―31. While answering the question as to whether the activity in
question can be termed as other than that ―of preparatory or auxiliary
character‖, we need to keep in mind the limited permission given by
RBI to the respondent under Section 29(1)(a) of the 1973 Act, on 24-
9-1996. From Para 2 of the stated permission, it is evident that RBI
had agreed for establishing a liaison office of the respondent at
Cochin, initially for a period of three years to enable the respondent
to:
(i) respond quickly and economically to enquiries from
correspondent banks with regard to suspected fraudulent
drafts;
(ii) undertake reconciliation of bank accounts held in India;
(iii) act as a communication centre receiving computer (via
modem) advices of mail transfer T.T. stop payments
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respondent’s several branches in UAE and transmitting to its
Indian correspondent banks;
(iv) printing Indian Rupee drafts with facsimile signature
from the Head Office and counter-signature by the authorised
signatory of the office at Cochin; and
(v) following up with the Indian correspondent banks.
These are the limited activities which the respondent has been
permitted to carry on within India. This permission does not
allow the respondent assessee to enter into a contract with
anyone in India, but only to provide service of delivery of
cheques/drafts drawn on the banks in India.
32. Notably, the permitted activities are required to be carried out by
the respondent subject to conditions specified in Clause 3 of the
permission, which includes not to render any consultancy or any
other service, directly or indirectly, with or without any
consideration and further that the liaison office in India shall not
borrow or lend any money from or to any person in India without
prior permission of RBI. The conditions make it amply clear that the
office in India will not undertake any other activity of trading,
commercial or industrial, nor shall it enter into any business
contracts in its own name without prior permission of RBI. The
liaison office of the respondent in India cannot even charge
commission/fee or receive any remuneration or income in respect of
the activities undertaken by the liaison office in India.
33. From the onerous stipulations specified by RBI, it could be
safely concluded, as opined by the High Court, that the activities in
question of the liaison office(s) of the respondent in India are
circumscribed by the permission given by RBI and are in the nature
of preparatory or auxiliary character. That finding reached by the
High Court is unexceptionable.
34. The High Court had justly adverted to the exposition of this
Court in CIT v. Morgan Stanley & Co. Inc. [CIT v. Morgan Stanley
& Co. Inc., (2007) 7 SCC 1] , which dealt with the case of an
assessee having set up office in India to support the main office
functions in fixed income and equity research and in providing IT
enabled services such as back office operations, data processing and
support centres to the entity in the United States. This Court, in paras
10 to 14, observed thus: (SCC pp. 13-14)
―10. In our view, the second requirement of Article 5(1) of
DTAA is not satisfied as regards back office functions. We
have examined the terms of the agreement along with the
advance ruling application made by MSCo inviting AAR to
give its ruling. It is clear from reading of the above
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agreement/application that MSAS in India would be engaged
in supporting the front office functions of MSCo in fixed
income and equity research and in providing IT enabled
services such as data processing support centre and technical
services as also reconciliation of accounts. In order to decide
whether a PE stood constituted, one has to undertake what is
called as a functional and factual analysis of each of the
activities to be undertaken by an establishment. It is from that
point of view, we are in agreement with the ruling of AAR
that in the present case Article 5(1) is not applicable as the
said MSAS would be performing in India only back office
operations. Therefore, to the extent of the above back office
functions the second part of Article 5(1) is not attracted.
11. Lastly, as rightly held by AAR there is no agency PE as
the PE in India had no authority to enter into or conclude the
contracts. The contracts would be entered into in the United
States. They would be concluded in US. The implementation
of those contracts only to the extent of back office functions
would be carried out in India, and therefore, MSAS would
not constitute an agency PE as contended on behalf of the
Department.
12. In DTAA, the term PE [Ed.: The matter between two
asterisks has been emphasised in original.] means [Ed.: The
matter between two asterisks has been emphasised in
original.] a fixed place of business through which the
business of an MNE is wholly or partly carried out. The
definition of the word PE in Section 92-F(iii) is inclusive,
however, it is not under Article 5(1) of the Treaty. It is for
this reason that Article 5(2) of DTAA herein refers to places
included as PE of the MNE. One such place is mentioned in
Article 5(2)(l) which deals with furnishing of services.
13. The concept of PE was introduced in the 1961 Act as part
of the statutory provisions of transfer pricing by the Finance
Act of 2001. In Section 92-F(iii) the word ―enterprise‖ is
defined to mean
‗92-F. (iii) … a person (including a permanent establishment
of such person) who is, or has been, or is proposed to be,
engaged in any activity, relating to the production, …’
Under CBDT Circular No. 14 of 2001 it has been clarified
that the term PE has not been defined in the Act but its
meaning may be understood with reference to DTAA entered
into by India. Thus, the intention was to rely on the concept
and definition of PE in DTAA. However, vide the Finance
Act, 2002 the definition of PE was inserted in the Income
Tax Act, 1961 (for short ―the IT Act‖) vide Section 92-F(iii-
a) which states that the PE shall [Ed.: The matter between
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two asterisks has been emphasised in original.] include [Ed.:
The matter between two asterisks has been emphasised in
original.] a fixed place of business through which the
business of MNE is wholly or partly carried on. This is where
the difference lies between the definition of the word PE in
the inclusive sense under the IT Act as against the definition
of the word PE in the exhaustive sense under DTAA. This
analysis is important because it indicates the intention of
Parliament in adopting an inclusive definition of PE so as to
cover service PE, agency PE, software PE, construction PE,
etc.
14. There is one more aspect which needs to be discussed,
namely, exclusion of PE under Article 5(3). Under Article
5(3)(e) activities which are preparatory or auxiliary in
character which are carried out at a fixed place of business
will not constitute a PE. Article 5(3) commences with a non
obstante clause. It states that notwithstanding what is stated
in Article 5(1) or under Article 5(2) the term PE shall not
include maintenance of a fixed place of business solely for
advertisement, scientific research or for activities which are
preparatory or auxiliary in character. In the present case, we
are of the view that the abovementioned back office functions
proposed to be performed by MSAS in India falls under
Article 5(3)(e) of DTAA. Therefore, in our view in the
present case MSAS would not constitute a fixed place PE
under Article 5(1) of DTAA [Ed.: The matter between two
asterisks has been emphasised in original.] as regards its
back office operations [Ed.: The matter between two
asterisks has been emphasised in original.].‖
(emphasis supplied)
35. The learned counsel for the appellant, however, attempted to
distinguish this judgment in Morgan Stanley & Co. Inc. [CIT v.
Morgan Stanley & Co. Inc., (2007) 7 SCC 1] on the argument that
this case dealt with the issue of service PE. According to him, the
Court must examine the full transactions of the respondent to
determine whether the work done by the respondent assessee was
one of a backup office work or auxiliary work. Insofar as the nature
of activities carried on by the respondent through the liaison office in
India, as permitted by RBI, we have upheld the conclusion of the
High Court that the same were in the nature of ―preparatory or
auxiliary character‖ and, therefore, covered by Article 5(3)(e). As a
result, the fixed place used by the respondent as liaison office in
India, would not qualify the definition of PE in terms of Articles 5(1)
and 5(2) of the DTAA on account of non obstante and deeming
clause in Article 5(3) of the DTAA.
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36. Having said thus, it must follow that the respondent was not
carrying on any business activity in India as such, but only
dispensing with the remittances by downloading information from
the main server of the respondent in UAE and printing
cheques/drafts drawn on the banks in India as per the instructions
given by the NRI remitters in UAE. The transaction(s) had
completed with the remitters in UAE, and no charges towards
fee/commission could be collected by the liaison office in India in
that regard. To put it differently, no income as specified in Section
2(24) of the 1961 Act is earned by the liaison office in India and
more so because, the liaison office is not a PE in terms of Article 5
of DTAA (as it is only carrying on activity of a preparatory or
auxiliary character). The concomitant is — no tax can be levied or
collected from the liaison office of the respondent in India in respect
of the primary business activities consummated by the respondent in
UAE. The activities carried on by the liaison office of the respondent
in India as permitted by RBI, clearly demonstrate that the respondent
must steer away from engaging in any primary business activity and
in establishing business connection as such. It can carry on activities
of preparatory or auxiliary nature only. In that case, the deeming
provisions in Sections 5 and 9 of the 1961 Act can have no bearing
whatsoever.
37. Our attention was invited to the dictum in CIT v. E-Funds IT
Solution Inc. [CIT v. E-Funds IT Solution Inc., (2018) 13 SCC 294]
Para 2 of the said decision would clearly indicate the background in
which the issue was answered by this Court. The same reads thus:
(SCC pp. 301-302)
―2. The assessing authority decided that the assessees had a
permanent establishment (hereinafter referred to as ―PE‖) as
they had a fixed place where they carried on their own
business in Delhi, and that, consequently, Article 5 of the
India US Double Taxation Avoidance Agreement of 1990
(hereinafter referred to as ―DTAA‖) was attracted.
Consequently, the assessees were liable to pay tax in respect
of what they earned from the aforesaid fixed place PE in
India. The CIT (Appeals) dismissed the appeals of the
assessees holding that Article 5 was attracted, not only
because there was a fixed place where the assessees carried
on their business, but also because they were ―service PEs‖
and ―agency PEs‖ under Article 5. In an appeal to ITAT,
ITAT held that the CIT (Appeals) was right in holding that a
―fixed place PE‖ and ―service PE‖ had been made out under
Article 5, but said nothing about the ―agency PE‖ as that was
not argued by the Revenue before ITAT. However, ITAT, on
a calculation formula different from that of the CIT
(Appeals), arrived at a nil figure of income for all the relevant
assessment years. The appeal of the assessees to the High
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Court proved successful and the High Court, by an elaborate
judgment [CIT v. E-Funds IT Solution, (2014) 9 HCC (Del)
70 : (2014) 364 ITR 256] , has set aside the findings of all the
authorities referred to above, and further dismissed the cross-
appeals of the Revenue. Consequently, the Revenue is before
us in these appeals.‖
38. The Court in E-Funds IT Solution Inc. [CIT v. E-Funds IT
Solution Inc., (2018) 13 SCC 294], after analysing the decisions and
the report concerned produced before it, observed in para 22 as
follows: (SCC p. 320)
―22. This report would show that no part of the main business
and revenue earning activity of the two American companies
is carried on through a fixed business place in India which
has been put at their disposal. It is clear from the above that
the Indian company only renders support services which
enable the assessees in turn to render services to their clients
abroad. This outsourcing of work to India would not give rise
to a fixed place PE and the High Court judgment [CIT v. E-
Funds IT Solution, (2014) 9 HCC (Del) 70 : (2014) 364 ITR
256] is, therefore, correct on this score.‖
(emphasis supplied)
39. We may usefully refer to paras 24 and 26 of the reported
decision in E-Funds IT Solution Inc. [CIT v. E-Funds IT Solution
Inc., (2018) 13 SCC 294] , which read thus: (SCC pp. 322-23)
―24. It has already been seen that none of the customers of
the assessees are located in India or have received any
services in India. This being the case, it is clear that the very
first ingredient contained in Article 5(2)(l) is not satisfied.
However, the learned Attorney General, relying upon Para
42.31 of the OECD Commentary, has argued that services
have to be furnished within India, which does not mean that
they have to be furnished to customers in India. Para 42.31 of
the OECD Commentary reads as under:
‗42.31. … Whether or not the relevant services are furnished
to a resident of a State does not matter; what matters is that
the services are performed in the State through an individual
present in that State.’
***
26. We entirely agree with the approach of the High Court in
this regard. Para 42.31 of the OECD Commentary does not
mean that services need not be rendered by the foreign
assessees in India. If any customer is rendered a service in
India, whether resident in India or outside India, a “service
PE” would be established in India. As has been noticed by us
hereinabove, no customer, resident or otherwise, receives any
service in India from the assessees. All its customers receive
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services only in locations outside India. Only auxiliary
operations that facilitate such services are carried out in
India. This being so, it is not necessary to advert to the other
ground, namely, that ―other personnel‖ would cover
personnel employed by the Indian company as well, and that
the US companies through such personnel are furnishing
services in India. This being the case, it is clear that as the
very first part of Article 5(2)(l) is not attracted, the question
of going to any other part of the said Article does not arise. It
is perhaps for this reason that the assessing officer did not
give any finding on this score.‖
(emphasis supplied)
40. As aforesaid, we agree with the finding recorded by the High
Court about the nature and character of stated activities carried on by
the liaison offices of the respondent and in our view, the High Court
justly reckoned the same as being of preparatory or auxiliary
character, falling under Article 5(3)(e).‖
44. The question of a Fixed Place PE as well as DAPE had also
arisen for our consideration in Progress Rail Locomotive Inc. v.
Deputy Commissioner of Income-tax (International Taxation) and
Others26.
45. While dealing with the concept of a PE, we had taken note of
some illuminating passages which appear in Klaus Vogel’s work on
Double Taxation Conventions. We deem it apposite to extract the
following paragraphs from Progress Rail:-
―67. Mr. Datar had with his characteristic erudition and clarity not
only sketched out the well-recognised principles governing the
question of a permanent establishment, he had also placed for our
consideration various academic texts and treatises to enable us to
obtain a broader perspective on the concept of a permanent
establishment. We, however, deem it apposite to additionally notice
some of the principles which stand enunciated in Klaus Vogel’s
seminal work on Double Taxation Conventions [Klaus Vogel on
Double Taxation Conventions, Edited by Ekkehart Reimer and
Alexander Rust, Wolters Kluwer, 5th edition, 2022.]. While
explaining the ―control‖ test which would be determinative for the
purposes of acknowledging the existence of a place of business26
2024 SCC OnLine Del 4065
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under the sufficient command of an entity situate in one of the
contracting States, the learned author observes as under:
―110. For all types of business activities, control can be based
on legal titles or factual circumstances. Legal control might
be derived from ownership or any other right, including
equitable rights under common law if the respective right
conveys factual mastery of a place of business to the taxpayer
enterprise. Such rights are perfect where the taxpayer
enterprise is the legal proprietor of the place of business.
Likewise, the position of the taxpayer as a tenant, a lessee
(leaseholder, even in cases of short-term lease) or even a co-
tenant will usually qualify as a controlling interest under
article 5(1) of Organization for Economic Co-operation and
Development and UN MC (No. 44 OECD MC Comm. on
article 5).
111. But even in the absence of a legal right to use that place,
the control test can be met if the taxpayer enterprise has
sufficient command of the place of business as a matter of
fact (No. 11 et seq. OECD MC Comm. on article 5). Thus,
for instance, a permanent establishment could exist where an
enterprise illegally occupied a certain location where it
carried on its business (as mentioned explicitly in No. 11 et
seq. OECD MC Comm. on article 5). Likewise, a company
may create a permanent establishment on the premises of an
associated company if this associated company grants
accommodation to, or tolerates the lasting presence of
employees of the first-mentioned company (see infra m. No.
430 et seq.).‖
68. Klaus Vogel, while seeking to amplify the importance of the
expression ―through‖ when used in the context of the business of the
holding company being carried on by the subsidiary, makes the
following pertinent observations:
―134. Article 5(1) OECD MC (since 1977; see supra m. No.
45) requires that the business of an enterprise (for these
terms, see supra m. No. 27 et seq.) is carried on through the
fixed place of business. The preposition ‗through’ specifies
the functional relation between the place of business and the
activities of the taxpayer. This relation can be described best
by the notion of a functional integration of the place of
business in the enterprise of the taxpayer. Such functional
integration contains several aspects which need to be
carefully distinguished from one another. Their common
denominator, however, is the type and degree of proximity of
the place of business to, or even identification with, the
taxpayer’s paramount economic activity.
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135. The first function of the term ‗through’ is to make it
clear that the taxpayer has to control the permanent
establishment (see supra m. No. 106 et seq. for details).
136. Secondly, functional integration presupposes that the
taxpayer ‗wholly or partly carrie(s) on’ his business (article
5(1) OECD MC; the OECD MC Comm. uses the verb
‗carried out’ synonymously (No. 35 OECD MC Comm. on
article 5)). However, like ‗business’ and ‗enterprise’ (cf.
supra m. No. 27 et seq.), these words do not function as a
substantive filter either. While early draft Model Conventions
contained the condition that the fixed POR should have a
productive character, this requirement was never adopted by
the OECD Model (see No. 35 OECD MC Comm. on article
5). None of the current MCs provide a specific productivity
test. It follows that place of business may constitute a
permanent establishment even if they perform activities
which mainly or exclusively expenditures to show for.
137. Likewise, the ‗carrying-on’ requirement does not imply
an activity in the sense of an active and visible work. It
includes even stand-by services and omissions. This gains
significant relevance where the omission is profitable (e.g., in
the case of a place of business earning money in the source
State simply by fulfilling, for whichever period of time, a
non-competition agreement relating to the territory of that
State).
138. However, a diffuse passivity which equals a (temporal
or lasting) suspension of the activities which the place of
business has been designed for may indicate that the place of
business is not ‗permanent’. For details, see supra m. No. 87
et seq.
139. Thirdly, the phrase ‗through which’ indicates that the
taxpayer makes use of the place of business in that he
employs it an instrument (equalling or resembling an
operating asset) for his entrepreneurial activities. This third
aspect of the functional integration is by far the most disputed
one.
140. Historically, the instrumental character of the place of
business for the carrying-on of the enterprise could not be
taken for granted. Between 1963 and 1977, the
OEEC/Organization for Economic Co-operation and
Development did not employ this term. Rather, it was
sufficient that the taxpayer carried on his business ‗in’ the
place of business (see supra m. No. 45). Based on the old
Model, some older DTCs use the words ‗in which’ still today.
While some authors have denied any divergence in substance,
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the 1977 amendment is a strong reason to assume a semantic
shift indeed.
141. In a different context (viz., in article 5(4.1) of the
Organization for Economic Co-operation and Development
and UN MC, (as amended in 2017), the Organization for
Economic Co-operation and Development and UN have
returned, in one specific regard, to this old line by stating that
an enterprise should carry on business ‗at the same place’.
However, the simultaneous use of this language on the one
hand and the terms ‗used or maintained by an enterprise’ on
the other, in one and the same sentence in the initial phrase of
article 5(4.1) of Organization for Economic Co-operation and
Development and UN MC, proves how careful and attentive
the 2017 Models have been drafted. This dualism is another
good reason to stipulate a different meaning of ‗through’, as
opposed to ‗in’ or ‗at’. For all of these reasons, we do see a
substantial difference between both terms.
142. It follows that on the one hand, the activities mentioned
in article 5(1) of the Organization for Economic Co-operation
and Development and UN MC need no longer be carried on
‗in’ or ‗at’ the place of business. In this respect, the 1977
change of article 5(1) of OECD MC has enlarged the scope of
the permanent establishment definition. Especially if one
thinks of an activity as a human behaviour, one can now
(unlike before 1977) easily subsume unmanned facilities
under the permanent establishment definition (see supra m.
No. 45 and see, e.g., No. 127 OECD MC Comm. on article
5).
143. On the other hand, the requirement of an instrumental
character of the place of business has become irrefutable.
Even stronger than the English amendment (‗through which’
instead of ‗in which’), the corresponding modification of the
French text (‗par l’intermediaire de laquelle’ instead of ‗ou’)
has stressed the functional integration of the place of business
in the business.
144. The OECD MC Comm. has weakened the meaning of
‗through’ since 2003. The Commentary holds the view that
the requirement of a functional integration is met as soon as
the taxpayer exercises the business in a fixed place of
business which is at his disposal (No. 20 OECD MC Comm.
on article 5 (added on January 28, 2003)). This is the reason
for the characterisation of the famous painter example (i.e.,
the fictitious case of a painter who, for two years, spends
three days a week in the large office building of its main
client) as a service permanent establishment. In substance,
the view of the OECD MC Comm. limits the meaning of
‗through’ to the first two instead of all three semantic aspects
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required by article 5(1) OECD MC (supra m. No. 135 et seq.
and 139 et seq.).‖
69. Proceeding further to deal with the concepts of ―preparatory‖ and
―auxiliary‖ services and which are intended to remove a place of
business which may otherwise fall within the meaning of a
permanent establishment and which phraseology is mirrored in
article 5(3)(e) of the India-USA Double Taxation Avoidance
Agreement, Klaus Vogel’s work has the following instructive
passages:
―59. (Determination of the activity’s character) It is often
difficult to distinguish between activities which have a
preparatory or auxiliary character and those which have not.
The decisive criterion is whether or not the activity of the
fixed place of business in itself forms an essential and
significant part of the activity of the enterprise as a whole.
Each individual case will have to be examined on its own
merits. In any case, a fixed place of business whose general
purpose is one which is identical to the general purpose of the
whole enterprise, does not exercise a preparatory or auxiliary
activity.
60. (Preparatory character) As a general rule, an activity that
has a preparatory character is one that is carried on in
contemplation of the carrying on of what constitutes the
essential and significant part of the activity of the enterprise
as a whole. Since a preparatory activity precedes another
activity, it will often be carried on during a relatively short
period, the duration of that period being determined by the
nature of the core activities of the enterprise. This, however,
will not always be the case as it is possible to carry on an
activity at a given place for a substantial period of time in
preparation for activities that take place somewhere else.
Where, for example, a construction enterprise trains its
employees at one place before these employees are sent to
work at remote work sites located in other countries, the
training that takes place at the first location constitutes a
preparatory activity for that enterprise. An activity that has an
auxiliary character, on the other hand, generally corresponds
to an activity that is carried on to support, without being part
of, the essential and significant part of the activity of the
enterprise as a whole. It is unlikely that an activity that
requires a significant proportion of the assets or employees of
the enterprise could be considered as having an auxiliary
character….
69. (Collect information) The second part of sub-paragraph
(d) relates to a fixed place of business that is used solely to
collect information for the enterprise. An enterprise will
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frequently need to collect information before deciding
whether and how to carry on its core business activities in a
State. If the enterprise does so without maintaining a fixed
place of business in that State, sub-paragraph (d) will
obviously be irrelevant. If, however, a fixed place of business
is maintained solely for that purpose, sub-paragraph (d) will
be relevant and it will be necessary to determine whether the
collection of information goes beyond the preparatory or
auxiliary threshold. Where, for example, an investment fund
sets up an office in a State solely to collect information on
possible investment opportunities in that State, the collecting
of information through that office will be a preparatory
activity. The same conclusion would be reached in the case of
an insurance enterprise that sets up an office solely for the
collection of information, such as statistics, on risks in a
particular market and in the case of a newspaper bureau set
up in a State solely to collect information on possible news
stories without engaging in any advertising activities : in both
cases, the collecting of information will be a preparatory
activity.‖
70. Speaking in greater detail on the aspect of ―preparatory‖ and
―auxiliary” functions, the author observes:
―303. Already before the 2017 Update to the OECD MC, all
of the activities listed in article 5(4)(a) to (f) of OECD and
UN MC had to be preparatory or auxiliary (infra m. No. 304
et seq.). This followed from the use of the word ‗other’ in
article 5(4)(e) of UN MC. This word relates not only to the
subsequent word ‗activity’ (otherwise, one should have
expected an if-clause or a ‗provided that’- clause after
‗activity’, like in article 5(4)(f) of UN MC) but to the entire
phrase ‗activity of a preparatory or auxiliary character’. The
2017 update to the OECD MC has made this entirely clear by
adding the words ‗provided that such activity or, in the case
of sub-paragraph (f), the overall activity of the fixed place of
business, is of a preparatory or auxiliary character’ as a joint
supplement to sub-paragraphs (a)-(f). By contrast, other
requirements in article 5(4)(e) of UN MC have no paramount
relevance but apply within the ambit of this sub-paragraph
only (infra m. No. 315 et seq.).
304. The preparatory or auxiliary character of the activities
listed in article 5(4) of OECD MC can be based on an
absolute standard or based on a relative standard. For
example, consider a comparison of two enterprises : (1) an
integrated enterprise which covers many steps in the creation
of value (e.g., all steps from agricultural production through
the processing of raw materials, further refinement up to
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marketing, sale and delivery of the goods to final consumers)
and (2) a specialised enterprise which focuses on one of these
steps only (e.g., on the delivery of goods). Suppose that each
enterprise maintains a place of business in a foreign State just
for the sake of the delivery of goods. The same activity (the
delivery of goods) is ancillary and subordinate for enterprise
(1) while it constitutes the core business of enterprise (2).
305. The amount of value added by either enterprise is the
same, and so is the potential tax revenue in the source State.
An absolute standard suggests equal treatment of cases (1)
and (2).
306. However, the ordinary meaning of both ‗preparatory’
and ‗auxiliary’ requires the identification of a point of
reference. One may say that the absolute standards are based
on an analysis of the function of the core activity in relation
to the entire chain of economic value added. It is more
convincing, however, to apply relative standards in the sense
that the value added is considered on a micro rather than a
macro level, that is, that the core activity should be compared
to the entirety of all activities exercised by the enterprise.
This relative view would deny a permanent establishment in
case (1), and assume a permanent establishment in case (2).
This view is shared by No. 60 of OECD MC Comm. on
article 5 as well as by most authors.
307. It seems to your author, however, that the strict and
exclusive application of relative standards would not do
justice to cases where an enterprise of type (1) above (supra
m. No. 283) is so large that place of businesses which, from
an absolute perspective, are respectable entities with valuable
assets, a considerable number of employees and full-fledged
bureaucratic and administrative facilities of their own, just
seem to be small, preparatory or auxiliary from the
perspective of the company’s headquarters. If they are still the
biggest employer in a given municipality, it is hardly justified
from the viewpoint of fiscal equivalence to exempt such
place of businesses under article 5(4) of OECD and UN MC.
308. It follows that a combined approach is most appropriate.
While relative standards apply at the outset (supra m. No.
304), absolute standards require a second filter:
The activities of a place of business qualify as being ‗of a
preparatory or auxiliary character’, as compared to the overall
activities of the enterprise if they have not more than a
marginal relevance within the enterprise’s overall business
plan. It should be noted that it is not the share in actual profits
or losses on which the comparison should be based. Rather,
the characterisation of an activity as preparatory and/or
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auxiliary depends on the type, sector and intensity of the
activity, as compared to the core business of the enterprise as
a whole.
If the activities of a place of business qualify as preparatory
and/or auxiliary under these relative standards, they still do
not fall under article 5(4) of OECD MC if the place of
business (and the activities exercised through it) alone, when
looked at separately from the rest of the enterprise, exceeds a
certain size and degree of professional entrepreneurship….
313. A further group of examples covers rooms and facilities
which an employer makes available in order to accommodate
his employees or help them to recreate or spend their idle
time. This includes hotels, bedrooms, lounges or restrooms
maintained outside the ordinary premises which the employer
uses for the purpose of his core business. Similarly, locker
rooms and coaches’ rooms occupied by a baseball team while
playing in venues outside the headquarters of the team do not
constitute permanent establishments of the baseball clubs. In
contrast, sales activities of a manufacturing company are not
of an auxiliary character. If they occur in a fixed place of
business, they create a permanent establishment even if the
sales contracts are subject to approval by the head office or
another permanent establishment.‖
46. We had in Progress Rail noticed some of the seminal decisions
which had been rendered by various Courts while seeking to define the
concept of a Fixed Place PE. The discussion on Fixed Place PE as
appearing in Progress Rail is extracted below:-
―85. That leads us to examine the correctness of the opinion as
formed with respect to the Noida factory and the Varanasi office
constituting a fixed place permanent establishment. Decades before
global commerce attained the degree of complexity which attaches to
it today, the Andhra Pradesh High Court in CIT v. Visakhapatnam
Port Trust [(1983) 144 ITR 146 (AP); 1983 SCC OnLine AP 287;
(1984) 38 CTR 1 (AP); (1983) 15 Taxman 72 (AP).] , and which
decision constitutes the locus classicus on the subject, explained the
concept of a ―permanent establishment‖ as postulating a substantial
element of presence of a foreign enterprise in another country. The
presence, as Jagannadha Rao, J. explained, had to additionally meet
the test of an enduring and permanent nature. It was this seminal
decision which propounded the concept of ―virtual projection‖.
86. The principles pertaining to fixed place permanent establishment
were more lucidly explained by the Supreme Court in Formula One
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World Championship Ltd. [Formula One World Championship Ltd.
v. CIT (International Taxation), (2017) 394 ITR 80 (SC); (2017) 15
SCC 602; (2017) 295 CTR 12 (SC); (2017) 248 Taxman 192 (SC).]
in the following terms (page 100 of 394 ITR):
―Emphasising that as a creature of international tax law, the
concept of permanent establishment has a particularly strong
claim to a uniform international meaning, Philip Baker
discerns two types of permanent establishments contemplated
under article 5 of Organization for Economic Co-operation
and Development Model. First, an establishment which is
part of the same enterprise under common ownership and
control–an office, branch, etc., to which he gives his own
description as an ‗associated permanent establishment’. The
second type is an agent, though legally separate from the
enterprise, nevertheless who is dependent on the enterprise to
the point of forming a permanent establishment. Such
permanent establishment is given the nomenclature of
‗unassociated permanent establishment’ by Baker. He,
however, pointed out that there is a possibility of a third type
of permanent establishment, i.e., a construction or installation
site may be regarded as permanent establishment under
certain circumstances. In the first type of permanent
establishment, i.e., associated permanent establishments,
primary requirement is that there must be a fixed place of
business through which the business of an enterprise is
wholly or partly carried on. It entails two requirements which
need to be fulfilled : (a) there must be a business of an
enterprise of a contracting State (FOWC in the instant case);
and (b) permanent establishment must be a fixed place of
business, i.e., a place which is at the disposal of the
enterprise. It is universally accepted that for ascertaining
whether there is a fixed place or not, permanent
establishment must have three characteristics : stability,
productivity and dependence. Further, fixed place of business
connotes existence of a physical location which is at the
disposal of the enterprise through which the business is
carried on…
The principal test, in order to ascertain as to whether an
establishment has a fixed place of business or not, is that such
physically located premises have to be ‗at the disposal’ of the
enterprise. For this purpose, it is not necessary that the
premises are owned or even rented by the enterprise. It will
be sufficient if the premises are put at the disposal of the
enterprise. However, merely giving access to such a place to
the enterprise for the purposes of the project would not
suffice. The place would be treated as ‗at the disposal’ of the
enterprise when the enterprise has right to use the said place
and has control thereupon….
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Taking cue from the word ‗through’ in the article, Vogel has
also emphasised that the place of business qualifies only if
the place is ‗at the disposal’ of the enterprise. According to
him, the enterprise will not be able to use the place of
business as an instrument for carrying on its business unless
it controls the place of business to a considerable extent. He
hastens to add that there are no absolute standards for the
modalities and intensity of control. Rather, the standards
depend on the type of business activity at issue. According to
him, ‗disposal’ is the power (or a certain fraction thereof) to
use the place of business directly….
Organization for Economic Co-operation and Development
commentary on Model Tax Convention mentions that a
general definition of the term ‗permanent establishment’
brings out its essential characteristics, i.e., a distinct ‘situs’, a
‗fixed place of business’. This definition, therefore, contains
the following conditions : (i) the existence of a ‗place of
business’, i.e., a facility such as premises or, in certain
instances, machinery or equipment; (ii) this place of business
must be ‗fixed’, i.e., it must be established at a distinct place
with a certain degree of permanence; (iii) the carrying on of
the business of the enterprise through this fixed place of
business. This means usually that persons who, in one way or
another, are dependent on the enterprise (personnel) conduct
the business of the enterprise in the State in which the fixed
place is situated.
The term ‗place of business’ is explained as covering any
premises, facilities or installations used for carrying on the
business of the enterprise whether or not they are used
exclusively for that purpose. It is clarified that a place of
business may also exist where no premises are available or
required for carrying on the business of the enterprise and it
simply has a certain amount of space at its disposal. Further,
it is immaterial whether the premises, facilities or
installations are owned or rented by or are otherwise at the
disposal of the enterprise. A certain amount of space at the
disposal of the enterprise which is used for business activities
is sufficient to constitute a place of business. No formal legal
right to use that place is required. Thus, where an enterprise
illegally occupies a certain location where it carries on its
business, that would also constitute a permanent
establishment. Some of the examples where premises are
treated at the disposal of the enterprise and, therefore,
constitute permanent establishment are : a place of business
may thus be constituted by a pitch in a market place, or by a
certain permanently used area in a customs depot (e.g. for the
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be situated in the business facilities of another enterprise.
This may be the case for instance where the foreign
enterprise has at its constant disposal certain premises or a
part thereof owned by the other enterprise. At the same time,
it is also clarified that the mere presence of an enterprise at a
particular location does not necessarily mean that the location
is at the disposal of that enterprise….
As per article 5 of the Double Taxation Avoidance
Agreement, the permanent establishment has to be a fixed
place of business ‗through’ which business of an enterprise is
wholly or partly carried on. Some examples of fixed place are
given in article 5(2), by way of an inclusion. Article 5(3), on
the other hand, excludes certain places which would not be
treated as permanent establishment, i.e., what is mentioned in
clauses (a) to (f) as the ‗negative list’. A combined reading of
sub-articles (1), (2) and (3) of article 5 would clearly show
that only certain forms of establishment are excluded as
mentioned in article 5(3), which would not be permanent
establishments. Otherwise, sub-article (2) uses the word
‗include’ which means that not only the places specified
therein are to be treated as permanent establishments, the list
of such permanent establishments is not exhaustive. In order
to bring any other establishment which is not specifically
mentioned, the requirements laid down in sub-article (1) are
to be satisfied. Twin conditions which need to be satisfied are
: (a) existence of a fixed place of business; and (b) through
that place business of an enterprise is wholly or partly carried
out….
We are of the opinion that the test laid down by the Andhra
Pradesh High Court in CIT v. Visakhapatnam Port Trust
[(1983) 144 ITR 146 (AP); 1983 SCC OnLine AP 287;
(1984) 38 CTR 1 (AP); (1983) 15 Taxman 72 (AP).] fully
stands satisfied. Not only the Buddh International Circuit is a
fixed place where the commercial/economic activity of
conducting F-1 Championship was carried out, one could
clearly discern that it was a virtual projection of the foreign
enterprise, namely, Formula-1 (i.e., FOWC) on the soil of
this country. It is already noted above that as per Philip Baker
(A Manual on the Organization for Economic Co-operation
and Development Model Tax Convention on Income and on
Capital), a permanent establishment must have three
characteristics : stability, productivity and dependence. All
characteristics are present in this case. Fixed place of
business in the form of physical location, i.e., Buddh
International Circuit, was at the disposal of FOWC through
which it conducted business. Aesthetics of law and taxation
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has taken place in India and the non-resident FOWC is liable
to pay tax in India on the income it has earned on this soil.‖
87. As per the Manual on the Organization for Economic Co-
operation and Development Model Tax Convention, and the
precedents rendered on the subject, there are two basic conditions
which are spelt out and which must be fulfilled for acknowledging a
permanent establishment being existent and constituting a fixed
place of business. They are:
(a) a place which stands placed at the ―disposal‖ of an
enterprise; and
(b) The establishment answering the characteristics of
stability, productivity and dependence.
xxxx xxxx xxxx
89. The principles governing fixed place permanent establishment
were again spelt out and enunciated by the Supreme Court in
Morgan Stanley and Co. Inc. [DIT (International Taxation) v.
Morgan Stanley and Co. Inc., (2007) 292 ITR 416 (SC); (2007) 7
SCC 1.] and Samsung Heavy Industries Co. Ltd. [DIT (International
Taxation) v. Samsung Heavy Industries Co. Ltd., (2020) 426 ITR 1
(SC); (2020) 7 SCC 347.] In Morgan Stanley and Co. Inc. [DIT
(International Taxation) v. Morgan Stanley and Co. Inc., (2007) 292
ITR 416 (SC); (2007) 7 SCC 1.] , and where the following pertinent
observations came to be rendered (page 421 of 292 ITR):
―With globalisation, many economic activities spread over to
several tax jurisdictions. This is where the concept of
permanent establishment becomes important under article
5(1). There exists a permanent establishment if there is a
fixed place through which the business of an enterprise,
which is multinational enterprise (MNE), is wholly or partly
carried on. In the present case MSCo is a multinational entity.
As stated above it has out sourced some of its activities to
MSAS in India. A general definition of permanent
establishment in the first part of article 5(1) postulates the
existence of a fixed place of business whereas the second part
of article 5(1) postulates that the business of MNE is carried
out in India through such fixed place. One of the questions
which we are called upon to decide is whether the activities
to be undertaken by MSAS consist of back office operations
of MSCo and if so whether such operations would fall within
the ambit of the expression ‗the place through which the
business of an enterprise is wholly or partly carried out’ in
article 5(1)….
In our view, the second requirement of article 5(1) of the
Double Taxation Avoidance Agreement is not satisfied as
regards back office functions. We have examined the terms
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of the Agreement along with the advance ruling application
made by MSCo inviting the AAR to give its ruling. It is clear
from a reading of the above Agreement/ application that
MSAS in India would be engaged in supporting the front
office functions of MSCo in fixed income and equity research
and in providing Information Technology enabled services
such as data processing support centre and technical services
as also reconciliation of accounts. In order to decide whether
a permanent establishment stood constituted one has to
undertake what is called as a functional and factual analysis
of each of the activities to be undertaken by an establishment.
It is from that point of view, we are in agreement with the
ruling of AAR that in the present case article 5(1) is not
applicable as the said MSAS would be performing in India
only back office operations. Therefore to the extent of the
above back office functions the second part of article 5(1) is
not attracted.‖
xxxx xxxx xxxx
91. When we test the stand taken by the respondents, bearing in
mind the aforesaid precepts as culled out from the various judgments
noticed hereinabove, we find ourselves unable to sustain even the
prima facie formation of opinion by the first respondent in this
respect. It is pertinent to note that the impugned notices and the
reasons set out for initiating action under section 147/148 nowhere
allude to a particular space or a part of the premises situated in Noida
or Varanasi having been placed under the exclusive or significant
―control‖ or ―disposal‖ of the petitioner. The first respondent fails to
rest its prima facie opinion with respect to fixed place permanent
establishment on any part of the Noida or Varanasi premises which
may have been set apart or exclusively placed in and under the
―control‖ of the petitioner for use of its business activities and which
may have tended to indicate that the space was made available for
the use of the petitioner and from where it was conducting its
business activities. It would have had to be shown that the ―control‖
of that space answered the test of considerable extent. We recall
Vogel describing this particular genre of a permanent establishment
as being akin to an ―instrument (equalling or resembling an
operating asset) for his entrepreneurial activity‖. The concept of
―virtual projection‖ is concerned with a functional integration
between the two units and which would mean an establishment
which has been virtually used for all purposes to carry out the
paramount business activity of the petitioner. None of these factors
are either alluded to or appear to have been borne in consideration
before arriving at the conclusion that the Indian establishment
constituted a fixed place permanent establishment.
xxxx xxxx xxxx
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94. We also take note of the judgment in Formula One World
Championship Ltd. [Formula One World Championship Ltd. v. CIT
(International Taxation), (2017) 394 ITR 80 (SC); (2017) 15 SCC
602; (2017) 295 CTR 12 (SC); (2017) 248 Taxman 192 (SC).] and
where it was significantly observed that a permanent establishment
must qualify and meet the tests of stability, productivity and
dependence. Of equal significance were the observations which
explained the phrases ―at the disposal of‖ and ―through‖. Tested on
the aforesaid precepts also, the impugned notices and the reasons set
out for initiating action under section 147/148 woefully fail to rest on
any evidence which could have possibly compelled us in
acknowledging that a fixed place permanent establishment had come
into being.‖
47. Proceeding to examine the scope of the expressions
―preparatory‖ and ―auxiliary‖, we had in Progress Rail held:-
―96. We then proceed to test the correctness of the prima facie
conclusions arrived at by the first respondent on the anvil of article
5(3) of the India-USA Double Taxation Avoidance Agreement
((1991) 187 ITR (Stat) 102). As was noticed hereinabove, article
5(3) excludes permanent establishments which may otherwise fall
within the ambit of article 5(1) or article 5(2), if it were found that
the said permanent establishment were engaged in the discharge of
functions enumerated therein. While and undisputedly sub-clauses
(a), (b) and (c) of article 5(3) are not even invoked, even if we were
to examine the correctness of the view taken by the first respondent
based on sub-clauses (d) and (e), we find ourselves unable to sustain
the impugned notices and the reasons set out for initiating action
under section 147/148, basis which the impugned notices were
issued.
97. In terms of article 5(3)(d), if a permanent establishment were to
be engaged solely for the purposes of purchase of goods or
merchandise, or for that matter for ―collecting information‖ for a
foreign enterprise, the same would stand excluded from the ambit of
sub-clauses (1) and (2) of article 5. The first respondent appears to
have been heavily influenced by the Indian subsidiary – PRIPL
routing communications between the petitioner and DLW and other
arms of the Indian Railways. The first respondent also alludes to
certain supportive functions such as gathering of information and
other allied activities allegedly undertaken by PRIPL for and on
behalf of the petitioner. It becomes pertinent to note that be it
collecting information or for that matter studying market trends or
future business prospects, the same would clearly fall not only
within the ken of sub-clause (d), but also partly within the scope of
sub-clause (e) of article 5(3). This, since both sub-clauses (d) and (e)
are concerned with collection or supply of information. We also bear
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in consideration the Supreme Court in Morgan Stanley and Co. Inc.
[DIT (International Taxation) v. Morgan Stanley and Co. Inc.,
(2007) 292 ITR 416 (SC); (2007) 7 SCC 1.] having held that market
research or analysis, data processing support or for that matter,
account reconciliation are essentially back office functions and
support services and which would not be sufficient to acknowledge a
fixed place permanent establishment existing.
98. That takes us then to further test the stand as struck by the
respondents and to examine the correctness of their conclusion that
the activities undertaken by the Indian subsidiary could not be said
to be of a ―preparatory‖ or ―auxiliary‖ character. The decision of the
Supreme Court in Morgan Stanley and Co. Inc. [DIT (International
Taxation) v. Morgan Stanley and Co. Inc., (2007) 292 ITR 416
(SC); (2007) 7 SCC 1.] , while explaining the meaning to be
ascribed to support services and activities of a ―preparatory‖ or an
―auxiliary‖ nature enunciates the legal position in the following
terms (page 425 of 292 ITR):
―In our view, the second requirement of article 5(1) of the
Double Taxation Avoidance Agreement is not satisfied as
regards back office functions. We have examined the terms
of the Agreement along with the advance ruling application
made by MSCo inviting AAR to give its ruling. It is clear
from a reading of the above Agreement/application that
MSAS in India would be engaged in supporting the front
office functions of MSCo in fixed income and equity research
and in providing Information Technology enabled services
such as data processing support centre and technical services
as also reconciliation of accounts. In order to decide whether
a permanent establishment stood constituted one has to
undertake what is called as a functional and factual analysis
of each of the activities to be undertaken by an establishment.
It is from that point of view, we are in agreement with the
ruling of AAR that in the present case article 5(1) is not
applicable as the said MSAS would be performing in India
only back office operations. Therefore to the extent of the
above back office functions the second part of article 5(1) is
not attracted….
There is one more aspect which needs to be discussed,
namely, exclusion of permanent establishment under article
5(3). Under article 5(3)(e) activities which are preparatory or
auxiliary in character which are carried out at a fixed place of
business will not constitute a permanent establishment.
Article 5(3) commences with a non obstante clause. It states
that notwithstanding what is stated in article 5(1) or under
article 5(2) the term permanent establishment shall not
include maintenance of a fixed place of business solely for
advertisement, scientific research or for activities which are
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preparatory or auxiliary in character. In the present case we
are of the view that the abovementioned back office functions
proposed to be performed by MSAS in India falls under
article 5(3)(e) of the Double Taxation Avoidance Agreement.
Therefore, in our view in the present case MSAS would not
constitute a fixed place permanent establishment under article
5(1) of the Double Taxation Avoidance Agreement as regards
its back office operations.‖
xxxx xxxx xxxx
101. The aspect of whether an Indian establishment was performing
functions of a ―preparatory‖ or an ―auxiliary‖ character was
considered by this court in National Petroleum Construction Co. v.
DIT (International Taxation) [(2016) 383 ITR 648 (Delhi); 2016
SCC OnLine Del 571.] , and where it was pertinently observed (page
672 of 383 ITR):
―The language of sub-paragraph (e) of paragraph (3) of
article 5 of the Double Taxation Avoidance Agreement is
similar to the language of sub-paragraph (e) of paragraph (4)
of article 5 of the Model Conventions framed by
Organization for Economic Co-operation and Development,
United Nations as well as the United States of America. The
rationale for excluding a fixed place of business maintained
solely for the purposes of carrying on activity of a
preparatory or auxiliary character has been explained by
Professor Dr. Klaus Vogel. In his commentary on ‗Double
Taxation Conventions, Third Edition’, he states that ‗It is
recognised that such a place of business may well contribute
to the productivity of the enterprise, but the services it
performs are so remote from the actual realisation of profits
that it is difficult to allocate any profit to the fixed place of
business in question. Examples are fixed places of business
solely for the purpose of advertising or for the supply of
information or for scientific research or for the servicing of a
patent or a know-how contract, if such activities have a
preparatory or auxiliary character’….
The Black’s Law Dictionary defines the word ‗auxiliary’ to
mean as ‗aiding or supporting, subsidiary’. The word
‗auxiliary’ owes its origin to the Latin word ‗auxiliarius’
(from auxilium meaning ‗help’). The Oxford Dictionary
defines the word ‗auxiliary’ to mean ‗providing
supplementary or additional help and support’. In the context
of article 5(3)(e) of the Double Taxation Avoidance
Agreement, the expression would necessarily mean carrying
on activities, other than the main business functions, that aid
and support the assessee. In the context of the contracts in
question, where the main business is fabrication and
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installation of platforms, acting as a communication channel
would clearly qualify as an activity of auxiliary character – an
activity which aids and supports the assessee in carrying on
its main business.
In view of the above, the activity of the assessee’s project
office in Mumbai would clearly fall within the exclusionary
clause of article 5(3)(e) of the Double Taxation Avoidance
Agreement and, therefore, cannot be construed as the
assessee’s permanent establishment in India.‖
102. When tested on the aforesaid principles, it becomes apparent
that the activities undertaken by the Indian subsidiary clearly do not
appear to travel beyond being ―preparatory‖ or ―auxiliary‖. It is
pertinent to note that both entities do not appear to have been
established with a commonality of general purpose. The expression
―preparatory‖ has been understood to mean work which is
undertaken in contemplation of the essential and significant part of
the principal activity of an entity. The principal or for that matter the
essential activity of the petitioner is the manufacture and production
of goods needed by railroad companies. The principal activity is
concerned with the core business activity of the petitioner. That has
clearly not been shown to have been undertaken at the Noida
premises. Of equal significance are the observations appearing in
National Petroleum, and where the court had held that while
activities undertaken by an entity which is asserted to be a
―permanent establishment‖ may contribute to the productivity of the
foreign enterprise, but if those functions be remote from the actual
realisation of profits, the tests of a permanent establishment would
not be satisfied.‖
48. Having noticed the precedents which have explained the meaning
liable to be ascribed to the words ―preparatory‖ and ―auxiliary‖, the
first aspect which merits evaluation is whether the LO could have
fulfilled the description of a Fixed Place PE. From the host of activities
and functions which that office of the respondent was discharging and
undertaking, it is manifest it was only engaged in activities relating to
liaising with governmental authorities, training of personnel and
undertaking various other peripheral functions in aid of the business of
Western Union Financial Services. The gamut of activities which it
undertook cannot thus be described to be the undertaking of an essentialSignature Not Verified
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or significant part of the principal business activity of Western Union
Financial Services.
49. For the purposes of being acknowledged as a PE, the said office
would have had to qualify the provisions of sub-paras 1 and 2 of Article
5. It would thus have to be held to be a ‗fixed place’ through which the
business of the enterprise was being wholly or partly carried out. In
order to constitute a Fixed Place PE, it would have to satisfy the tests of
virtual projection, a takeover of the premises as well as the precepts of
control and disposal and the undertaking of core business activity of the
enterprise.
50. Of equal importance are the provisions comprised in Article 5(3)
and which excludes places of business related to an enterprise in the
other contracting state and which undertakes ―other activities‖ which
are liable to be countenanced as being preparatory or auxiliary. It is thus
Article 5(3)(e) which clearly appears to be applicable when viewed in
juxtaposition with the activities which the LO performed and the
functions that it discharged. This becomes evident from the discussion
which follows.
51. We note that the position commended for our acceptance by the
appellants would have been sustainable, provided the activities and
functions performed by that LO met the aforenoted tests. However, we
find ourselves unable to sustain those submissions bearing in mind the
peripheral character of the actual activities which were undertaken by
that office.
52. For the purposes of the LO qualifying the requirements of a PE,
it would have been incumbent upon the appellants to establish that its
activities breached the preparatory or auxiliary threshold or boundary
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which Article 5(3) erects. Regard must be had to the fact that Article
5(3) constitutes a list of negative stipulations and which removes a
fixed places of business from the ambit of a PE. Thus, even if an
establishment were to meet the test of a fixed place, it would stand
exorcised from the main provision of that covenant if it were found that
its activities were confined to preparatory and auxiliary work for the
enterprise.
53. As was noticed in the previous parts of this decision, the
transaction pertaining to the transfer of funds was consummated in the
USA itself and it was the Indian agents of Western Union Financial
Services which undertook and discharged the essential functions
required for the completion of those transactions. The LO was not even
remotely involved in the conclusion of those transactions.
54. Regard must also be had to the fact that the RBI permission
proscribed that LO from undertaking any trading, commercial or like
activities. It was also forbidden from entering into any business
contracts in its own name. The activity reports which have been taken
note of by the Tribunal do not demonstrate that it had either
contravened any of those proscriptions or undertaken activity in
violation of the restrictions which applied. The appellants have
woefully failed to establish and prove that the LO was, in fact,
undertaking trading activity or pursuing commercial interests as an arm
or an adjunct of Western Union Financial Services.
55. Since the activities undertaken were far removed from the core
business of the Western Union Financial Services enterprise, it is the
tests of ―preparatory‖ and ―auxiliary‖ as embodied in Article 5(3)(e)
which stand met and satisfied. This we hold since it is by now well
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settled that activities such as market research, promotional activities,
training or deployment of software would clearly not breach the
threshold of auxiliary functions as are envisaged under the DTAA.
56. That then takes us to the argument based on the criterion of
DAPE being met under the DTAA. The said contention would have to
be evaluated on the basis of Article 5(4) and which speaks of entities
who may be connected with the enterprise in the other Contracting
State and not being an agent of independent status. It is only once such
entities are found to be acting in the Contracting State on behalf of that
enterprise that Article 5(4) would be attracted. For the purposes of
being viewed as DAPE, it would have been incumbent upon the
appellants to have established that the LO was acting on behalf of
Western Union Financial Services and that its functions fell within the
four corners of clauses (a), (b) and (c) of Article 5(4). For the purposes
of being held to be a dependant agent, it was incumbent for the
appellants to establish that such an entity habitually exercised an
authority to conclude contracts. It could have also been proved by the
appellants that the LO habitually secured orders for Western Union
Financial Services. However, none of these conditions are met in the
facts of the present case. In the absence of these conditions being found
to exist, it would be wholly incorrect in law for the LO to be classified
as a DAPE.
57. Regard must be had to the fact that Article 5(4) introduces a legal
fiction in cases where it be found that the enterprise has an agent which
is acting on its behalf in the other Contracting State. The first limb of
Article 5(4), when met, gets coupled to the legal fiction embodied in
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establishment‖. However, of crucial significance is the use of the word
‗if’, which precedes clauses (a), (b) and (c) and thus being indicative of
the clear intent of the contracting parties of recognizing the existence of
a DAPE only if one of those were also met. The appellants have not
relied on any evidence or material which may have even remotely
established the criterion of either clauses (a), (b) or (c) being satisfied
by the LO.
58. That only leaves us to evaluate the correctness of the submissions
of Mr. Chawla that the installation of the software in the premises of the
Indian agents should be acknowledged as being sufficient to recognize
a Fixed Place PE coming into existence. We find ourselves unable to
countenance this contention in light of paras 1 and 2 of Article 5
essentially envisaging places and premises of business. Neither para 1
nor para 2 appear to ostensibly contemplate an intangible property as
constituting a Fixed Place PE. We are, in the facts of the present case,
not concerned with automated equipment or a piece of hardware. The
submission of the appellants rests solely on the installation of a
software and its residence in the systems maintained by the Indian
agents.
59. A software is clearly not a place of management, a branch, office,
factory or a workshop. In fact, a plain reading of paras 1 and 2 of
Article 5 leaves us in no doubt that the said covenant is concerned with
tangible premises and establishments in which business activities may
be undertaken. An intangible property, which software is, clearly lacks
the physical attributes which underlie and constitute an integral part of
the concept of PE as embodied in paras 1 and 2 of Article 5.
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60. At this juncture, we deem it apposite to notice some of the salient
principles emanating from Klaus Vogel’s work on Double Taxation
Conventions27. The Klaus Vogel Commentary, albeit in the context of
electronic commerce, renders the following illuminating observations
with respect to whether software and computer equipment could
constitute a PE:-
―122. [E-commerce operations as PE] There has been some
discussion as to whether the mere use in electronic commerce
operations of computer equipment in a country could constitute a
permanent establishment. That question raises a number of issues in
relation to the provisions of the Article.
123. [Distinction] Whilst a location where automated equipment is
operated by an enterprise may constitute a permanent establishment
in the country where it is situated (see below), a distinction needs to
be made between computer equipment, which may be set up at a
location so as to constitute a permanent establishment under certain
circumstances, and the data and software which is used by, or stored
on, that equipment. For instance, an Internet web site, which is a
combination of software and electronic data, does not in itself
constitute tangible property. It therefore does not have a location that
can constitute a ‘place of business’ as there is no ‘facility such as
premises or, in certain instances, machinery or equipment’ (see
paragraph 6 above) as far as the software and data constituting that
web site is concerned. On the other hand, the server on which the
web site is stored and through which it is accessible is a piece of
equipment having a physical location and such location may thus
constitute a ‘fixed place of business’ of the enterprise that operates
that server.
124. [Internet Service Providers (ISPs)] The distinction between a
web site and the server on which the web site is stored and used is
important since the enterprise that operates the server may be
different from the enterprise that carries on business through the web
site. For example, it is common for the web site through which an
enterprise carries on its business to be hosted on the server of an
Internet Service Provider (ISP). Although the fees paid to the ISP
under such arrangements may be based on the amount of disk space
used to store the software and data required by the web site, these
contracts typically do not result in the server and its location being at
the disposal of the enterprise (see paragraph 10 to 19 above), even if
the enterprise has been able to determine that its web site should be27
Klaus Vogel on Double Taxation Conventions, Edited by Ekkehart Reimer and Alexander Rust,
Wolters Kluwer, 5th edition, Vol. 1, 2022
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hosted on a particular server at a particular location. In such a case,
the enterprise does not even have a physical presence at that location
since the web site is not tangible. In these cases, the enterprise
cannot be considered to have acquired a place of business by virtue
of that hosting arrangement. However, if the enterprise carrying on
business through a web site has the server at its own disposal, for
example it owns (or leases) and operates the server on which the
web site is stored and used, the place where that server is located
could constitute a permanent establishment of the enterprise if the
other requirements of the Article are met.
125. [Requirement of fixation] Computer equipment at a given
location may only constitute a permanent establishment if it meets
the requirement of being fixed. In the case of a server, what is
relevant is not the possibility of the server being moved, but whether
it is in fact moved. In order to constitute a fixed place of business, a
server will need to be located at a certain place for a sufficient
period of time so as to become fixed within the meaning of
paragraph 1.
126. [Facilities at disposal] Another issue is whether the business of
an enterprise may be said be wholly or partly carried on at a location
where the enterprise such as equipment such as a server at its
disposal. The question of whether the business of an enterprise is
wholly or partly carried on through such equipment needs to be
examined on a case-by-case basis, having regard to whether it can be
said that, because of such equipment, the enterprise has facilities at
its disposal where business functions of the enterprise are performed.
127. [Presence of personnel] Where an enterprise operates
computer equipment at a particular location, a permanent
establishment may exist even though no personnel of that enterprise
is required at that location for the operation of the equipment. The
presence of personnel is not necessary to consider that an enterprise
wholly or partly carries on its business at a location when no
personnel are in fact required to carry on business activities at that
location. This conclusion applies to electronic commerce to the same
extent that it applies with respect to other activities in which
equipment operates automatically, e.g. automatic pumping
equipment used in the exploitation of natural resources.
128. [Preparatory or auxiliary activities] Another issue relates to
the fact that no permanent establishment may be considered to exist
where the electronic commerce operations carried on through
computer equipment at a given location in a country are restricted to
the preparatory or auxiliary activities covered by paragraph 4. The
question of whether particular activities performed at such a location
fall within paragraph 4 needs to be examined on a case-by-case basis
having regard to the various functions performed by the enterprise
through that equipment. Examples of activities which would
generally be regarded as preparatory or auxiliary include:
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– providing a communications link – much like a telephone line –
between suppliers and customers;
– advertising of goods or services;
– relaying information through a mirror server for security and
efficiency purposes;
– gathering market data for the enterprise;
– supplying information.
129. [Essential and significant functions] Where, however, such
functions form in themselves an essential and significant part of the
business activity of the enterprise as a whole, or where other core
functions of the enterprise are carried on through the computer
equipment, these would go beyond the activities covered by
paragraph 4 and if the equipment constituted a fixed place of
business of the enterprise (as discussed in paragraphs 123 to 127
above), there would be a permanent establishment.
130. [Constitution of core functions] What constitutes core
functions for a particular enterprise clearly depends on the nature of
the business carried on by that enterprise. For instance, some ISPs
are in the business of operating their own servers for the purpose of
hosting web sites or other applications for other enterprises. For
these ISPs, the operation of their servers in order to provide services
to customers is an essential part of their commercial activity and
cannot be considered preparatory or auxiliary. A different example is
that of an enterprise (sometimes referred to as an ‘e-tailer’) that
carries on the business of selling products through the Internet, In
that case, the enterprise is not in the business of operating servers
and the mere fact that it may do so at a given location is not enough
to conclude that activities performed at that location are more than
preparatory and auxiliary. What needs to be done in such a case is to
examine the nature of the activities performed at that location in
light of the business carried on by the enterprise. If these activities
are merely preparatory or auxiliary to the business of selling
products on the Internet (for example, the location is used to operate
a server that hosts a web site which, as is often the case, is used
exclusively for advertising, displaying a catalogue of products of
providing information to potential customers, paragraph 4 will apply
and the location will not constitute a permanent establishment. If,
however, the typical functions related to a sale are performed at that
location (for example, the conclusion of the contract with the
customer, the processing of the payment and the delivery of the
products are performed automatically through the equipment located
there), these activities cannot be considered to be merely preparatory
or auxiliary.
131. [ISPs as PE] A last issue is whether paragraph 5 may apply to
deem an ISP to constitute a permanent establishment. As already
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noted, it is common for ISPs to provide the service of hosting the
web sites of other enterprises on their own servers. The issue may
then arise as to whether paragraph 5 may apply to deem such ISPs to
constitute permanent establishments of the enterprises that carry on
electronic commerce through web sites operated through the servers
owned and operated by these ISPs. Whilst this could be the case in
very unusual circumstances, paragraph 5 will generally not be
applicable because the ISPs will not constitute an agent of the
enterprises to which the web sites belong, because they will not
conclude contracts or play the principal role leading to the
conclusion of contracts in the name of these enterprises, or for the
transfer of property belonging to these enterprises or the provision of
services by these enterprises, or because they will act in the ordinary
course of a business as independent agent, as evidenced by the fact
that they host the web sites of many different enterprises. It is also
clear that since the web site through which an enterprise carries on
its business is not itself a ‘person’ as defined in Article 3, paragraph 5
cannot apply to deem a permanent establishment to exist by virtue of
the web site being an agent of the enterprise for purposes
of that paragraph.‖
61. As is manifest from a reading of the aforenoted passages, the
Vogel Commentary commends a view that while software itself may
not constitute tangible property and therefore a location that can
constitute a ‗fixed place of business’, the computer equipment within
which such software is stored can meet that threshold, with or without
the presence of personnel. However, this is subject to the computer
equipment itself meeting the requirement of being ‗fixed’ and of the
equipment and place being at the disposal of the enterprise and of the
activities themselves not being of a ‗preparatory’ or ‗auxiliary’ nature.
62. The Vogel Commentary, while examining the concept of a ‗place’
under Article 5 takes the categorical position that purely intangible
property, such as software, cannot constitute a PE:-
―A place is a certain amount of space (no. 11 OECD MC Comm. on
Article 5) within the 20 soil or on the soil. This understanding of
place as a three-dimensional zone rather than a single point on the
earth can be derived from the French version (‘installation fixe’) as
well as the term ‘establishment’. As a rule, this zone is based on a
certain area in, on, or above the surface of the earth. Rooms or
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technical equipment above the soil may qualify as a PE only if they
are fixed on the soil (for details, see infra m.no. 50 et seq.). This
requirement, however, stems from the term ‘fixed’ rather than the
term ‘place’, given that a place (or space) does not necessarily consist
of a piece of land. On the contrary, the term ‘establishment’ makes
clear that it is not the soil as such which is the PE but that the PE is
constituted by a tangible facility as distinct from the soil. This is
particularly evident from the French version of Article 5(1) OECD
MC which uses the term ‘installation’ instead of ‘place’.
The term ‘place’ is used to define the term ‘establishment’. ”
Therefore, ‘place’ includes all tangible assets used for carrying on
the business (for this connection, see infra m.no. 45 et seq.), but one
such tangible asset can be sufficient. ‘ The characterization of such
assets under private law as real property rather than personal
property (in common law countries) or immovable rather than
movable property (in civil law countries) is not authoritative. It is
rather the context (including, above all, the terms ‘fixed’/’fixe’; see
infra no. 50 et seq.), as well as the object and purpose of Article 5
OECD and UN MC itself (supra m.no. 2 et seq.), in the light of
which the term ‘place’ needs to be interpreted. This approach, which
follows from the general rules on treaty interpretation (supra
Introduction m.no. 87 et seq.), gives a certain leeway for including
movable property in the understanding of ‘place’ and, therefore, to
assume a PE once such property has been ‘fixed’ (infra m.no. 50 et
seq.) to the soil.
For example, a work bench in a caravan, restaurants on permanently
anchored river boats, steady oil rigs, or a transformator or generator
on board a former railway wagon qualify as places (and may also be
‘fixed’; see infra m.no. 50 et seg.).
In contrast, purely intangible property cannot qualify in any case.
In particular, rights such as participations in a corporation, claims,
bundles of claims (like bank accounts), any other type of intangible
property (patents, software, trademarks etc.) or intangible economic
assets a regular clientele or the goodwill of an enterprise) do not in
themselves constitute a PE. They can only form part of a PE
constituted otherwise (see Article 7 at m.no 60 et seq.). Likewise, an
internet website (being a combination of software and other
electronic data) does not constitute tangible property and, therefore,
does not constitute a PE (no. 123 OECD MC Comm. on Article
5)……‖
63. One cannot also lose sight of the fact that the software only
constituted a medium of communication and which enabled the Indian
agents to talk and communicate with the servers of Western Union
housed in USA. The ‗Voyager’ software merely enabled the Indian
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agents to verify details and correlate data relevant to the remittance.
There was no installation of hardware in the premises of those agents or
for that matter a placement of their premises or a part thereof at the
disposal of Western Union. We are thus unconvinced that the
deployment of the software is entitled to be viewed as having resulted
in the creation of a PE. This issue in any case stands answered against
the appellants by our Court in E-Funds.
64. We then propose to evaluate some of the decisions which were
cited for our consideration by Mr. Chawla. Mr. Chawla had heavily
relied upon the judgment of our Court in Rolls Royce PLC v. Director
of Income-tax, International Taxation (and vice versa)28 in order to
buttress his submission that the LO constituted a Fixed Place PE. In
Rolls Royce PLC, our Court on facts had clearly found that the Indian
subsidiary was habitually engaged in securing orders in India for the
appellants therein. It was found that as a matter of practice, no customer
of Rolls Royce PLC in India could directly address orders to that
appellant in the United Kingdom. Such orders, the Court noted, were
routed only through the Indian subsidiary. It was in the aforesaid
conspectus of facts that the Court had come to hold against the
appellants. This becomes evident from a reading of paragraphs 16 and
17 of the report and which are reproduced hereinbelow:-
―16. After holding that the assessee had business connection in
India, the Tribunal adverted to the question as to whether there was
any PE in India within the meaning of article 5 of the Indo-UK
DTAA. The Tribunal extracted the provisions of article 5 and stated
the legal position that emerged therefrom. Thereafter, it referred to
various documents in para 22 and narrated its effect in detail. Our
purpose would be served by extracting para 23 of the impugned
order which reads as under:-
28
2011 SCC OnLine Del 3659
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―23. It is also seen that the appellant has a dependent
agent in India in the form of RRIL. The fact that RRIL is
totally dependent upon the appellant is not denied.
However, the contention of the appellant is that even though
RRIL is a dependent agent and such agency is to be deemed
as PE, so long such dependent agent has no authority to
negotiate and enter into contracts, under Article 5(4), there
is no PE in India. It is to be noted that Article 5(4) has three
clauses, namely, a, b & c. Thus, even if one has to hold that
the dependent agent has no authority to negotiate and enter
into contracts for and on behalf of appellant, still as per
clause (c) of sub-Article (4), it is found that RRIL habitually
secures orders in India for the appellant. It is a set practice
that no customers in India are directly to send orders to the
appellant in UK. Such orders are required to be routed only
through RRIL. This fact is evident from the letter of Mr.
L.M. Morgan to Mr. Prateek Dabral and Ms. Usha. In the
said letter, it is made clear that even request for
quotation/extension could not be communicated directly to
the appellant but are to be routed through the office of
RRIL. This is applicable even to the orders. The fact is not
denied that the orders are firstly received by RRIL from the
customers in India and only then communicated to the
appellant. Thus, as per Para 4(c) of Article 5, the dependent
agent habitually secures orders wholly for the enterprise
itself and hence, is deemed to be a permanent establishment
of the appellant. The contention of appellant that the role of
RRIL is merely of a post office is, therefore, unacceptable
in view of the facts of the case as evidenced by various
documents and correspondence found during the course of
survey. It can, therefore be summarized that in the light of
the facts as well as documents mentioned above, RRIL’s
presence n India is a permanent establishment of appellant
because:
(a) It is a fixed place of business at the disposal of the Rolls
Royce Pic and its group companies in India through which
their business are carried on.
(b) The activity of this fixed place is not a preparatory or
auxiliary, but is a core activity of marketing, negotiating,
selling of the product. This is a virtual extension/projection
of its customer facing business unit, who has the
responsibility to sell the products belonging to the group.
(c) RRIL acts almost like a sales office of RR Pic and its
group companies.
(d) RRIL and its employees work wholly and exclusively
for the Rolls Royce Pic and the Group.
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(e) RRIL and its employees are soliciting and receiving
orders wholly and exclusively on behalf of the Rolls Royce
Group.
(f) Employees of Rolls Royce Group are also present in
various locations in India and they report to the Director of
RRIL in India.
(g) The personnel functioning from the premises of RRIL
are in fact employees of Rolls Royce Pic. This has been
admitted by the MD Mr. Tim Jones, GM, and can be
discerned from statement of Mr. Ajit Thosar and documents
like terms of employment of GMS.
Thus, the appellant can be said to have a PE in India
within the meaning of Article 5(1), 5(2) and 5(4) of the Indo
UK DTAA. Since we have found that the appellant has a
business connection in India as well as PE in India, the
income arising from its operation in India are chargeable to
tax in India.‖
17. We are thus convinced that there is a detailed discussion after
taking into consideration all the relevant aspects while holding that
RRIL constituted PE of the assessee in India. While undertaking
critical analysis of the material on record, the Tribunal kept in mind
the objections filed by the assessee as well as the documents on
which it wanted to rely upon. Those objections were duly met and
answered.‖
65. Jebon Corporation v. Commissioner of Income-tax and
another29, a judgment rendered by the Karnataka High Court was again
concerned with a LO of a South Korean enterprise which had come to
be established at Bangalore. On facts, that High Court in Jebon
Corporation had found as follows:-
―19. It is on the basis of the aforesaid material, the Tribunal held that
the activities carried on by the liaison office are not confined only to
the liaison work. They are actually carrying on the commercial
activities of procuring purchase orders, identifying the buyers,
negotiating with the buyers, agreeing to the price, thereafter,
requesting them to place a purchase order and then the said purchase
order is forwarded to the head office and then the material is
dispatched to the customers and they follow up regarding the
payments from the customers and also offer after-sales support.
Therefore, it is clear that merely because the buyers place orders
directly with the head office and make payment directly to the head29
2011 SCC OnLine Kar 4420
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office and it is the head office which directly sends goods to the
buyers, would not be sufficient to hold that the work done by the
liaison office is only liaison and it does not constitute a permanent
establishment as defined in article 5 of the Double Taxation
Avoidance Agreement. In fact, the Assessing Officer has clearly set
out what was discovered during the investigation and the same has
been properly appreciated by the Tribunal and it came to the
conclusion that though the liaison office was set up in Bangalore
with the permission of the Reserve Bank of India and in spite of the
conditions being stipulated in the said permission preventing the
liaison office from carrying on commercial activities, they have been
carrying on commercial activities.
20. It was further contended that the Reserve Bank of India has not
taken any action and, therefore, such interference is not justified.
Once the material on record clearly establishes that the liaison office
is undertaking an activity of trading and, therefore, entering into
business contracts, fixing price for sale of goods and merely because
the officials of the liaison office are not signing any written contract
would not absolve them from liability. Now, that the investigation
has revealed the facts, we are sure that the same will be forwarded to
the Reserve Bank of India for appropriate action in the matter in
accordance with law. But merely because no action is initiated by
the Reserve Bank of India till today would not render the findings
recorded by the authorities under the Income-tax Act as
erroneous or illegal.‖
66. As is apparent from the aforesaid passages, the said decision is
clearly distinguishable and has no application to the facts which obtain
in these appeals. Contrary to what the Karnataka High Court found in
Jebon Corporation, there is no material which may have even remotely
tended to indicate that the LO was engaged in commercial or trading
activities.
67. Columbia Sportswear Co. v. Director of Income Tax
(International Taxation)30 was yet another decision which came to be
cited by Mr. Chawla for our consideration. This too was a matter which
pertained to a LO established by Columbia Sportswear in India. The
activities which were being undertaken by that office in India and as
30
AAR No. 862 of 2009 dated 08 August 2011
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were identified by the AAR and which is also noticed in the judgment
of this Court would become evident from a reading of paras 12 and 32
of the report and which are extracted hereinbelow:-
―12. The question, therefore, is whether the activities undertaken by
the liaison office on behalf of the applicant are activities limited to
or confined to the purchase of goods in India by the applicant. We
have referred in detail to the various activities undertaken by the
liaison office on behalf of the applicant. We have also noticed that it
has about 35 employees divided into 5 teams dealing with material
management, merchandising, production management, quality
control and administration support constituting teams from finance,
human resources and information systems. In addition to assisting
the applicant in the actual purchase of the goods direct from the
manufacturers in India, various activities are carried on by the
liaison office which relate to ensuring the choosing of quality
material, occasionally testing them for quality, conveying of
requisite design, picking out of competitive sellers, the ensuring of
quality, the ensuring of adherence to the policy of the applicant in
the matter of procurement and employment, in the matter of
compliance with environmental and other local regulations by the
manufacturers – suppliers and in ensuring that the payments made by
the applicant reach the suppliers. The applicant is obviously in the
business of designing, manufacturing and selling branded products,
brands over which it has exclusive rights. In the matter of
manufacturing of products as per design, quality and in
implementing policy, the liaison office is actually doing the work of
the applicant. The activities of the liaison office are not confined to
India. It also facilitates the doing of business by the applicant with
entities in Egypt and Bangladesh. A person in the business of
designing manufacturing and selling cannot be taken to earn a profit
only by a sale of goods. The goods as designed and styled by the
applicant cannot be sold without it being got manufactured and
procured in the manner designed and contemplated by the applicant.
It will be unrealistic to take the view that all the activities other than
the actual sale of the goods are not integral part of the business of
the applicant and have no role in the profit being made by the
applicant by the sale of its branded products. It is difficult to accept
the argument that what is done in India by the liaison office of the
applicant is only to expend money and all its income accrues outside
India by the sale of the products. The position we have adopted is
clearly supported by the decision of the Supreme Court in Anglo-
French Textile Co. Ltd. v. CIT [1953] 23 ITR 101 affirming the
decision of the Madras High Court in Anglo-French Textile Co. Ltd.
v. CIT [1950] 18 ITR 888. The Supreme Court answered the
question, “can any profit arise out of mere purchase of raw-
material,” thus ‘In our judgment, the contention of the Learned
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Counsel for the applicant, – and on which the whole argument is
founded – that it is the act of sale alone from which the profits accrue
or arise can no longer be sustained and has to be repelled in view of
the decision of this Court in CIT v. Ahmedbhai Umarbhai & Co.
[1950] 18 ITR 472. …
It was held by this court that the profits of that part of the
business, viz., the manufacture of the oil in the Mill in Raichur,
accrued or arose in Raichur even though the manufactured oil
was sold in Bombay and the price was received there, and,
accordingly that part of the profits derived from sales in
Bombay which was attributable to the manufacture of the oil
in Raichur was exempt from excess profits tax under the
proviso to section 5 of the Act.’ Their Lordships quoted the
following observations of Lord Davy in In re: Commissioners
of Taxation v. Kirk 1900 AC 588. ‘It appears to their Lordships
that there are four processes in the earning or production of
this income: (1) The extraction of the ore from oil soil; (2) the
conversion of the crude ore into a merchantable product,
which is a manufacturing process; (3) the sale of the
merchantable product; (4) The receipt of the moneys arising
from the sale. All these processes are necessary stages which
terminate in money, and the result is the money resulting less
the expenses attendant on all the stages. The first process
seems to their Lordships clearly within sub-section (3), and the
second or manufacturing process, if not within the meaning of,
‗trade’ in sub-section (1) is certainly included in the words
‗any other source whatever’ in sub-section (4).
So far as relates to these two processes, therefore, their
Lordships think that the income was earned and arising and
accruing in New South-Wales’
xxxx xxxx xxxx
32. It is true that in terms of the permission taken from the Reserve
Bank of India, the liaison office can undertake purely liaison
activities, viz., to inspect the quality, to ensure shipments and to act
as a communication channel between Head office and parties in
India and will not take up any other activity of a trading, commercial
or industrial nature. The liaison office, on the applicant’s own
showing is also engaged in identifying suppliers, recommending
them for acceptance, getting competitive quotations from suppliers,
recommending their acceptance and so on. In addition, it is also
doing the work of the applicant in Egypt and Bangladesh. Whether
all these activities will also come within the permission granted by
the Reserve Bank of India, need not be considered here. Suffice it is
to say that one has to test the effect of the activities admittedly
undertaken by the liaison office in the context of Article 5 of DTAA
to adjudge whether it would be a permanent establishment within
that Article. On the basis of our reasoning as above, we are satisfied
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that the liaison office in question would qualify to be a permanent
establishment in terms of Article 5 of the DTAA.‖Here too on facts, it was found that the LO was discharging functions
and duties indelibly connected with the principal business of Columbia
Sportswear. Although various other decisions were also included in the
compilation by Mr. Chawla, none of the others appear to be of
sufficient significance so as to warrant a discussion.
68. On an overall conspectus of the various decisions handed down
by this Court as well as the Supreme Court insofar as Fixed Place PE
and DAPE are concerned as well as the language of Article 5, we have
no hesitation in holding that the LO failed to meet the threshold
requirements so as to constitute a PE.
69. In summation, we come to the firm conclusion that the LO did
not meet the criteria established in sub-paras 1 and 2 of Article 5, so as
to constitute a ‗fixed place’ of business or meet the tests of virtual
projection, a takeover of the premises as well as the precepts of control
and disposal in order to be a Fixed Place PE. The activities undertaken
by the LO even otherwise were clearly auxiliary in character and would
thus clearly fall within Article 5(3)(e) of the DTAA. The LO also did
not meet the requirements of a DAPE as per of clauses (a), (b) and (c)
of para 4 of Article 5. Furthermore, the software utilised for the purpose
of connecting the Indian agents to the mainframe, being intangible
property, would invariably be excluded from the threshold of PE. The
argument of the premises of the Indian agents constituting a PE is
clearly misconceived since these were independent third parties having
their own business portfolio. Their premises, in any case, would not
satisfy the test of virtual projection.
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70. Accordingly and for all the aforesaid reasons, we find ourselves
unable to sustain the arguments of the appellants and who had
commended us to upset the conclusions rendered by the Tribunal. In
our considered opinion, the Tribunal rightly came to the conclusion that
the LO of the respondent-assessee did not constitute a PE in India, there
was no DAPE and that the software did not result in the creation of a
permanent establishment.
71. We thus answer the questions as posed in the negative and
against the Revenue. The instant batch of appeals shall consequently
stand dismissed.
YASHWANT VARMA, J.
RAVINDER DUDEJA, J.
DECEMBER 18, 2024/RW/DR
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