General Electric (“GE”), a leading group dealing in sophisticated equipment such as gas turbine parts and sub-assemblies, trades in products offshore on a principal-to-principal basis for its customers across the globe, including India. GE sources its products, services and intellectual talent from India for its global businesses where strategy decisions are effected outside India.
General Electric International Operations Company Inc., an affiliate of GE Energy Parts Inc. (“GEP” or “taxpayer”), tax resident of the U.S., registered a liaison office (“LO”) for a communication network without undertaking business activities in India. GEP executed a global service agreement with its affiliate GE India Industrial P Ltd (“GEIIPL”), an Indian company, for limited market inputs and interface support activities at cost-plus consideration.
The LO, under its scope, collected information about potential Indian customers to be shared with its affiliate businesses for creating product awareness and did not file tax returns in India for several years. Consequently, Indian revenue authorities performed a permanent establishment (“PE”) survey at the LO and observed that foreign employees in India undertook marketing activities/sale functions of the group.
During the PE survey, the taxpayer and affiliate explained that foreign employees deputed to GE companies initially worked as their own employees on their payroll until transferred to other entities. Even though transactions were on an arm’s length basis, the revenue authorities regarded the LO as a fixed place PE of GE in India. Revenue also argued that the LO in India, with foreign employees alongside Indian employees of its group, constituted a dependent agency PE (“DAPE”) in India.
The Indian Income-tax Appellate Tribunal (“Tribunal”) ruled against the taxpayer, subsequent to which the taxpayer appealed against such order before the High Court.
Fixed Place PE
A PE is formed under Article 5(1) of the India–U.S. tax treaty (“tax treaty”) when a foreign enterprise has a fixed place at its disposal to carry on its business through such place in India.
On perusal of the applicable tax treaty and the Organization for Economic Co-operation and Development ("OECD") Model Tax Convention (“Model”), the High Court observed that the term “place of business” means any premises, facilities or installations used to carry on business activity of the enterprise.
The space at its disposal does not merely mean a legal right to use that place, but includes persistent use to satisfy the disposal test. The High Court opined that GE’s activities in India are wholly or partly carried on through its fixed place of business. The term “through which” is construed widely where business is carried out, at a specific location being at the disposal of the foreign enterprise, to qualify for the threshold of “through which.”
The High Court concluded that GE’s foreign enterprises has a fixed place PE in India under Article 5(1) of the tax treaty applying the rationale under the Supreme Court ruling of Formula One World Championship Ltd.
The taxpayer contested that merely because expatriates and employees work at the premises it cannot be concluded that sales are made from that place.
However, the High Court analyzed that GE was situated in leased premises in India that was at its disposal through specific chambers/rooms and secretarial staff allotted for their work thereby ensuring continuity of space. The High Court also distinguished between sales made from the Indian office and from the presence of GE India employees at its premises.
The High Court, accepting the Tribunal’s findings that the core sales activity was performed from the LO building in absence of any additional evidence presented by GE to use LO premises for other activities, assumed that the additional activities were undertaken through the LO premises. The High Court concluded that discharge of vital responsibilities to conclude commercial terms, etc. established that GE carried on its activities in India through its fixed place.
Preparatory and Auxiliary Activities
Article 5(3)(e) of the tax treaty expressly excludes preparatory or auxiliary activities from the provisions of fixed place PE. The High Court reviewed the taxpayer’s argument of its activities to be covered under Article 5(3) exclusion from applicability of Article 5(1), in case of premises used for other activities and absence of authority to conclude/negotiate contracts is a primary test to regard the auxiliary or preparatory activities.
The High Court referred the Tribunal’s findings on the process adopted by GE group entities for business development, sales and marketing which involved a complex matrix of technical specifications like pre-qualification, bid/no bid and proposal development, commercial terms, financial terms and other policies obligating GE to position several employees and officials in the office. The High Court observed that the process was comprehensive, expecting experienced consultations with clients, technical and financial experts at its headquarters.
On review of the communication trail with its clients the High Court apprehended the key roles of GE employees engaged in the negotiating process. The High Court evaluated that the taxpayer’s employees were not merely liaising with clients at its headquarters office but alo undertaking the core activity of GE by discussing contractual terms and consideration payable, warranty and other commercial conditions.
The High Court referred to numerous rulings disregarding preparatory or auxiliary activities, like National Petroleum Construction Company, the Indian Supreme Court decision of E-Funds IT Solution Inc., Morgan Stanley & Co. Inc., UAE Exchange Centre LLC and Karnataka High Court decision of Jebon Corporation India.
The High Court acknowledged that the LO was not actively engaged in the final decision-making process and had to await final approval from the headquarters. However, applying the analogy of the referred cases, the High Court concluded that the LO in substance was not merely established for mute data collection and information dissemination to qualify exclusion under Article 5(3)(e) of the tax treaty.
Dependent Agency PE
The taxpayer relied on commentary to the OECD and UN Model under paragraphs 33 and 24 of Article 5, respectively, clarifying that mere participation in negotiation cannot lead to either a fixed place PE or DAPE. The commentary or few settled cases manifested that authority to negotiate should be treated distinctly from authority to conclude contracts. Thus, unless the agent is authorized to conclude all elements or at least critical elements of the contract, it cannot be construed as the authority to bind its principal.
GE proposed that activities of an agent is devoted wholly, or almost wholly, to one enterprise including that highly qualified expatriates and employees of an Indian entity though participating in the negotiation process to conclude contracts never really had authority, whether expressed or implied, to finalize any of their desired position or bind GE in the contract. Hence, GE insisted that in the absence of an authority to conclude contracts by such employees, there was no exposure of DAPE.
The High Court expressed that India reserved its position with reference to the paragraphs in the commentary. Contrary to the taxpayer’s argument, the High Court relied on the Philip Morris position where participation of representatives or employees of a resident company engaged in conclusion of a contract between a foreign and a resident entity may fall within the concept of an authority to conclude contracts in the name of the foreign enterprise.
Additionally, the High Court observed that the position under paragraph 32.1 is contrary to the DAPE commentary relied on by GE. The High Court also stated that the taxpayer cannot quote selective parts of the commentary but must consider its entire intent.
The High Court disregarded the taxpayer’s claim to exempt DAPE on the premise that:
- GE did not organize business principles on which the tax treaty is envisioned;
- ingenuity and innovation of the group was to aggregate and maximize profits in the most efficient manner, whilst minimizing cost;
- the intricate nature of the activities was carefully designed, where technical officials with varied degree of authority were involved with local managerial and technical employees in:
- contract negotiation in core or “key” areas;
- modification of technical specifications and the negotiations for it, to comply with local needs and regulatory requirements; and
- price negotiation complexities, etc.
Based on the above rationale it was concluded that the taxpayer carried out business through a PE in India. Also, the activities intersected and overlapped with the principal content of DAPE, demonstrating that the affiliate’s work was solely for a foreign enterprise in their core activities.
Consequent to the constitution of PE, the High Court upheld the Tribunal’s analysis for profit attribution by estimating income at 10 percent of the sales made in India and 26 percent of such profit to the marketing activity carried out by the PE in India.
The reliance on Formula One World Championship Ltd to distinguish its activities from the E-Funds IT Solutions case, based on the facts and operations of its business activities in the LO office could transgress the settled position on PE.
Further, the concept of remuneration satisfying arm’s length price not to impact profit attribution in case of PE was settled by the Morgan Stanley case. The ruling may disrupt such a settled position adopted by numerous courts. Though it is worth evaluating observations from select rulings on similar facts ruled in favor of the taxpayer like Tesco International Sourcing Ltd, Kawasaki Heavy Industries Ltd, Nokia Networks OY.
The concept of DAPE is undergoing significant change where the meaning of business connection under Indian domestic laws expands to include DAPE, in cases of participants habitually playing a principal role resulting in conclusion of contracts. In addition to the DAPE expansion under Indian domestic tax laws, the OECD BEPS guidelines on DAPE include activities routinely concluded without material modification by the enterprise.
Interestingly, absent the force of attraction clause under Article 7 of the India–U.S. tax treaty, an argument of business activities by the LO independent of its legal entity may be worth analyzing.
The High Court has laid down guiding principles for the determination of PE based on the facts of each case. In doing so, it has distinguished commentaries under the Model commentary and other international commentaries like Philip Morris for purposive interpretation and PE determination under the India–U.S. tax treaty. The ruling could interrupt the established principle on PE where multinational enterprises operate under a dual model of the LO and legal entity obligating them a revisit of the arrangement taking into consideration the present dynamics.
Shailendra Sharma is a chartered accountant in the multinational financial services sector, India.