INSIGHT: Business Activities Constitute PE Under the India–Singapore Tax Treaty

Hitachi High Technologies Singapore Pte Ltd (taxpayer or Hitachi Singapore) is a step-down subsidiary incorporated in Singapore of Hitachi, an entity incorporated under the laws of Japan. The taxpayer is engaged in trading operations across Asia and involved in sourcing and trading of various products and equipment.

Hitachi Singapore established a liaison office (LO or representative office) in India to render preparatory and auxiliary services such as market research and liaison activities. Independent of the LO, the taxpayer also established a branch office in India. The Revenue Authorities (Revenue) carried out a tax investigation at the branch office premises in India and initiated reassessment proceedings on the activities of the LO alleging that it was:

• not merely undertaking preparatory and auxiliary activities; and
• engaged in executing/negotiating contracts for the taxpayer in India.

This resulted in the LO having a permanent establishment (PE) of the taxpayer in India under Article 5 of the India–Singapore tax treaty (tax treaty). The Revenue issued a draft assessment order revising the income of the taxpayer as a PE in India, applying the global profit margin method to the sales made in India, attributing 50% of profits to the Indian PE.

Hitachi Singapore filed objections before the Dispute Resolution Panel (DRP) against the draft assessment order, though the DRP upheld the view of the Revenue. Aggrieved by the DRP order, the taxpayer filed an appeal before the Income-tax Appellate Tribunal of Delhi (Tribunal).

The Tribunal set aside the Revenue/DRP order and restored the matter back to the DRP with a direction to pass a speaking order. Under re-adjudication proceedings, the DRP framed its order under the Tribunal’s directions though the final order was passed by the Revenue under the initial proceedings. The taxpayer, aggrieved by the DRP order, filed another appeal before the Tribunal, taking into account the following:

• on re-adjudicating directions of the Tribunal, the DRP exceeded directions;
• in framing the final order, Revenue put the taxpayer in a more adverse position than it was before filing the appeal;
• there was no PE of the taxpayer constituted in India; and
• in absence of a PE of the taxpayer in India, no profit is attributable for tax purposes.

Tribunal Ruling

Dispute Resolution Panel

The Tribunal stated that the case was disposed of by the DRP without a speaking order and lacked non-adjudication of the application to consider additional evidence and objections. Also, in the re-adjudication proceedings, the DRP disposed of the objections reasoned by a speaking order following the directions of the First Tribunal order. The DRP simply followed directions of the First Tribunal order in the re-adjudication proceedings to assist the Revenue.

The Tribunal is not open to giving an adverse finding to the taxpayer which does not arise from questions raised in the appeal nor is it open to dealing on any grounds that work adversely in the interest of the taxpayer for an order that makes the taxpayer’s position worse than it was under the DRP order.

The Tribunal stated that though powers of the Tribunal to dispose of an appeal are wide, in the absence of a cross appeal or cross objection by the Revenue, the Tribunal cannot enhance the scope of an appeal by relying on the Supreme Court case of Vijaya Stores.

The Tribunal concluded that since the taxpayer did not file any appeal against the total assessed income of all the assessment years under consideration, the entire proceedings should be restricted to adjudication of the assessed income of all the years subject to the lower threshold appealed.

PE in India

It was stated that the taxpayer had a representative office duly registered in India and approved by the Reserve Bank of India (RBI) under Foreign Exchange Control Regulations. The letter granting permission for the LO in India by the RBI read that the LO:

• will not undertake any other activity of trading, commercial or industrial nature nor shall enter into any business contracts in its own name without prior permission;
• will not charge commission/fee or any other remuneration received/income earned for liaison activities/services rendered by representatives or otherwise in India;
• expenses will be met exclusively out of funds received from abroad and not funded from borrowing/lending activities from/to any person in India without prior permission; and
• will not acquire, hold, transfer or dispose of any immovable property in India without obtaining prior permission.

However, new facts emerged following the investigation, prompting the Revenue to reopen the case for five years. The facts also revealed enhanced activities by the LO in India of advertisement and marketing, sales promotion, market research and administration that occupy a significant amount of time, attention and labor by at least six employees. This established a co-relation between the taxpayer’s business, its trading activities in India and the core business activities of the LO in India.

Article 5(7) of the tax treaty exempts preparatory or auxiliary activities to determine existence of a PE. The exclusions prescribed under preparatory or auxiliary category in paragraph 7 of Article 5 of the tax treaty is ejusdem generis (general) to other terms, similar activities which are preparatory or auxiliary in character shall be read as business solely used for the purpose of advertising, the supply of information, scientific research or similar activities.

Conversely, under the PE clause of the India–USA or India–Canada tax treaties “other activities” is referred to as “besides advertisement, supply of information and scientific research” clearly distinguishing that the India–Singapore tax treaty is restrictive in nature than the exclusionary article of the India–USA or India–Canada tax treaties.

Effectively, under the India–Singapore tax treaty, unless the fixed place of business (LO in this case) under Article 5(1) of the tax treaty, is used only for the purpose of advertisement, for supply of information, for scientific research or for similar activities which are preparatory or auxiliary in character, it cannot be excluded from the PE definition.

The business activities of the LO, read with relevant context and response at the time of the investigation, confirmed that the employees were engaged in marketing, sales promotion and market research activities which were sine qua non for the taxpayer’s business in India.

Further, the representative office was actively involved in ascertaining customer requirements, price negotiation, obtaining of purchase orders and the follow-up on delivery of material and payments. Hence, none of these activities are preparatory or auxiliary in nature under Article 5(7)(e) of the tax treaty.

The Tribunal observed that the LO was directly participating in core trading activities of the taxpayer except for preparing invoices and receiving payments. Thus, it opined that the LO constitutes a PE of the taxpayer in India, in light of the business activities carried out in India through the LO.

Profit Attribution

Article 7(2) of the tax treaty requires that a PE of a nonresident entity is treated as a distinct and a separate entity engaged in the same or similar activities under such conditions as wholly independent from the entity of which it is a PE.

Thus, the PE, though a distinct and a separate entity, is treated as an associated enterprise under Article 9 of the tax treaty, obligating international transactions between them to be on an arm’s length basis.

The Tribunal observed that the DRP found the work profile of the taxpayer’s PE similar to an independent agent (agent) used by the taxpayer as comparable undertaking the same activities in India. The DRP, on comparing activities of the agent with the LO, directed the Revenue to use the profit margin of the agent as an internal comparable. However, the Tribunal agreed that since the LO performs routine and limited functions in a risk-free environment the intensity of functions compared with attribution made by the Revenue using the comparable was abnormal.

The Tribunal, taking into consideration the business profile of the agent, rejected the comparable and suggested allocation of profits to be undertaken applying the transactional net margin method (TNMM). Accordingly, the Tribunal directed the taxpayer to supply the necessary details and asked the Revenue to re-compute profits attributable to tax of the LO (PE) by applying the TNMM method.

Planning Points

The ruling attributes an interesting proposition of the connectivity between the main business and the relationship of carrying out other ancillary activities affiliated to or solely in conjunction with the main business. The Tribunal elaborately explained and distinguished the cases of E-Funds IT Solution and UAE National Petroleum Construction Company relied on by the taxpayer thus rejecting the exemption claimed under Article 5(7) of the tax treaty.

Interestingly, the OECD BEPS Action Plan 7 deals with “preventing the artificial avoidance of PE status” and recommends to expand the PE scope under the multilateral instrument (MLI) restricting a foreign company and its group to access the treaty in inappropriate circumstances.

Though the MLI will be effective from April 1, 2020 for withholding tax purposes proposed in The Finance Bill, 2020, it would be worthwhile to note that the synthesized version of the India–Singapore text of the MLI does not adopt the avoidance of PE option for the specific activity related exemption clause under Article 5 of the tax treaty.

Shailendra Sharma is a Chartered Accountant associated with a multinational financial services firm, India.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.