DIT vs. E Funds IT Solutions Group Inc. [2014] 42 taxmann.com 50 (Delhi)

Indian subsidiary of a foreign company providing back office support operations does not constitute a PE in India if the conditions mentioned in Articles 5(1), 5(4) and 5(5) are not satisfied – Employees of e-Fund India did not become other personnel of the assessee’s, once and if the said persons were de facto and de jure employed by the Indian entity/enterprise – MAP cannot be determinative or primary basis to decide whether the assessee had PE in India

DIT vs. E Funds IT Solutions Group Inc. [2014] 42 taxmann.com 50 (Delhi)

Facts

1.     The assessees, E Funds Corporation (“e-funds Corp”) and E Funds IT Solutions Group Inc. (“e-funds Inc”), are companies incorporated and resident in USA. E Funds International India Private Ltd. (“e-funds India”), a company incorporated and resident of India. E-funds Corp was the ultimate holding of e-funds India and also e-funds Inc.

2.     The assessee’s had four main business lines, namely electronic payments, ATM management service, decision support & risk management and professional services. E-funds India had performed back office operations in respect of the first three. This included data entry operations etc. in respect of decision support and risk management.

3.     The pertinent issue involved in the case was whether e-funds India would be deemed as PE of assessee in India and how much income could be attributed and taxed in the hands of the assessee in India.

Judgment

Business connection

1.     The Hon’ble High Court held that there was a business connection of the taxpayers in India, because the e-funds India was providing information and details to the taxpayers in USA for the purpose of entering into contracts with third parties and subsequently the said contracts were performed fully or partly by e-funds India as an assignee or sub-contractee.

Mutual Agreement procedure

2.     The Hon’ble High Court observed that Mutual Agreement Procedure (MAP) procedure as envisaged under Article 27 of the tax treaty was resorted to for the earlier years. As per the communication by US treasury department, they did not agree that taxpayers had a PE in India but they had agreed to mutual agreement to divide income to avoid double taxation. The tax department contended that taxpayer has a PE as India and USA had resorted to MAP as envisaged under Article 27 of the tax treaty.

3.     It held that the MAP procedure and agreement is relevant but cannot be the primary basis to decide whether the taxpayer had PE in India. Whether or not PE exists is a matter of law and fact, and there has to be determination of the said issue on merits.

Fixed Place and Subsidiary PE

4.     The Hon’ble High Court held that a perusal of Article 5(6) indicates that even carrying on business in the other country by either the “controlled company” or the “controlling company”, would not make them, i.e. the two companies, a PE of each other. However, a subsidiary can become a PE of the holding/controlling company or the related company, if it satisfies the postulates and requirements of other paragraphs of Article 5, notwithstanding and negating the protection provided under paragraph 6 of Article 5, which recognises legal independence of the two entities for tax purposes.

5.     The Hon’ble High Court observed that none of the authorities including the tribunal held that the two assessees had right to use any of the premises belonging to e-fund India. It was not adverted to or stated that premises of e-fund India were at the disposal, legally or otherwise, of the two assessees. In the absence of any such finding Article 5(1) cannot be invoked and applied. Also, even if the foreign entities have saved and reduced their expenditure by transferring business or back office operations to the Indian subsidiary, it would not by itself create a fixed place or location PE.

6.     It also held that 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 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.

7.     It further held that following factors relied upon by the lower authorities were not relevant to determine and decide PE under Articles 5(1), 5(4), or 5(5):

•      Close association between e-fund India and the assessee’s

•      E-fund India provides various services to the taxpayers and was dependent on them for its earning

•      E-Fund India did not bear sufficient risk

•      E-Fund India was reimbursed the cost of the call centre operations plus 16 per cent basis or that the basis of margin fixation was not known

•      Direct or indirect costs, and corporate allocations in software development centre or BPO

•      Assignment or sub-contract to e-fund
India

•      Whether or not any provisions for intangible software was made or had been supplied free of cost

•      Details of or number of employees of e-fund India which are part of the e-fund group

Agency PE

8.     The Hon’ble High Court observed that subsidiary by itself cannot be considered to be a dependent agent PE of the Principal. However, a subsidiary may become dependent or an independent PE agent provided the tests as specified Articles 5(4) and (5) are satisfied.

9.     The Hon’ble High Court held that conditions of Article 5(4) were not satisfied in the present case. It observed that it was not the case of the Revenue that e-fund India was authorised and habitually exercised authority to conclude contract or was maintaining stock or merchandise from which it delivered goods or merchandise on behalf of the assessee or secured orders on behalf of the assessee. The fact that e-fund India had provided necessary inputs to e-fund Corp or e-Fund Inc. to enable them to enter into contracts which were assigned to e-fund India will not make e-fund India a PE of the assessee.

10.   As per Article 5(5), an agent is not considered to be an independent agent if his activities are wholly or mostly wholly on behalf of foreign enterprise and the transactions between the two are not made under arm‘s length conditions. The twin conditions have to be satisfied to deny an agent, the character of an independent agent. It held that the transactions between the taxpayers and e-fund India were at arm‘s length and were taxed on arm‘s length principle and therefore, requirements of Article 5(5) were not satisfied.

Service PE

11.   The Hon’ble High Court held that the employees of e-fund India were their employees, i.e. employees of an Indian entity and not employees of the taxpayers. The employees of e-fund India did not become other personnel of the assessee’s, once and if the said persons were de facto and de jure employed by the Indian entity/enterprise. The words ‘employees and other personnel’ under the Article 5 of the tax treaty have to be read along with the words ‘through’ and ‘furnishing of services’ by the foreign enterprise within
India. Thus, the employees and other
personnel must be of non-resident to create a Service PE.

12.   It further observed that assessment order also does not record any other relevant finding for creation of service PE under Article 5(2)(l), other than payment received by e-fund India for providing management and support service by the President and Sales Team to overseas group entities. Such a fact was relevant with reference to Article 5(2)(a) but the said provision was not invoked by the lower authorities. It held that extent and timing of applicability of the ‘Place of Management’ principle in such cases, require findings of facts at the first instance and cannot be made matters to be decided for the first time in an appeal before the High Court under section 260A of the Act.

13.   The Hon’ble High Court relied on the Supreme Court decision in the case of DIT vs. Morgan Stanley and Co. Inc. [2007] 292 ITR 416 (SC) and held that merely because the non-resident taxpayer to protect their interest, for ensuring quality and confidentiality has sent its employees to provide stewardship services, will not make the Indian subsidiary or another entity, a PE of the non-resident company even if the employees of the non-resident taxpayer were taken on deputation.