INSIGHT: The Fault Lines in MasterCard—For Everything “PE” there is MasterCard

In 2017, the Supreme Court of India got the opportunity in the case of Formula One World Championship (Formula One) Ltd v. Commissioner of Income Tax (International Taxation and Another [2017] 394 ITR 80 (SC) and Assistant Director of Income Tax v. E-Funds (E-Funds) IT Solution Inc [2017] 399 ITR 34 (SC) to deal with some of the most crucial and complex aspects of PE and have laid down two precedents in the Indian PE jurisprudence.

However, very recently, the Authority for Advanced Ruling (“AAR”), which is primarily a pre-trial tax determination body for a nonresident or certain categories of resident to obtain binding rulings on question of law or fact arising out of any transaction and/or proposed transactions which are relevant for the determination of his/its tax liability, pronounced its ruling on an application filed by MasterCard Asia Pacific Pty Ltd Singapore [2018] 94 taxmann.com 195 (AAR—New Delhi) (“applicant”) .

The AAR ruled that the applicant has a fixed place PE, service PE and dependent agent PE in India under Article 5 of the India–Singapore Double Taxation Avoidance Agreement in respect of the services with regard to use of a global network and infrastructure to process card payment transactions for customers in India.

Structure of MasterCard Operations in India and Worldwide

The applicant is a Singapore-based MasterCard group company, which is the regional headquarter for the Asia Pacific, Middle East and Africa (“APMEA”) region. It carries out the MasterCard group’s principal business of transaction processing and payment related services. The applicant is a wholly-owned indirect subsidiary of MasterCard’s wholly owned direct Delaware incorporated subsidiary, MasterCard International Incorporated (“MCI”).

The services are provided by the applicant to APMEA Customers pursuant to Master License Agreements (“MLA”), which the applicant signs with each and every customer in the APMEA region (including those based in India, pursuant to the proposed business operating mechanism to be adopted in India). Consequent to the terms of an MLA, the applicant charges its customers transaction processing fees relating to authorization, clearing and settlement of transactions. The applicant also receives assessment fees for building and maintaining a processing network that serves the needs of customers globally, for setting up and maintaining a set of rules that govern the authorization, clearing and settlement process for every payment transaction, so as to maintain the integrity and reputation of its network and also for guaranteeing settlement between the member banks/customers for payment transactions processed by MasterCard. Additionally, it receives miscellaneous revenue for the provision of services which are ancillary to the transaction processing activities, e.g. warning bulletin fees for listing invalid or fraudulent accounts either electronically or in paper form, cardholder service fees, program management services (e.g. foreign exchange margin, commissions, load fees), account and transaction enhancement services, holograms and publication.

The transaction processing activity consists of electronic processing of payments between banks of merchants (acquirer or acquirer bank) and banks of cardholders (issuer or issuer bank) through the use of MasterCard Worldwide Network (“the Network”). The MasterCard Interface Processor (“MIP”) that connects to MasterCard’s Network and processing centers, is located at the customer location. The Network facilitates authorization, clearing and settlement of payment transactions between customers on a proprietary, global payment system (which comprises both hardware and software). The network links issuers and acquirers around the globe for transaction processing services and through them permits MasterCard cardholders to use their cards at millions of merchants worldwide.

The applicant has a subsidiary in India, namely MasterCard India Services Private Limited (Indian subsidiary), in which it owns 99 percent of the shareholding. The remaining 1 percent is held by the applicant’s immediate holding company, MasterCard Singapore Holding Pte Ltd (“MSHPL”). The India subsidiary owns and maintains the MIPs placed at the customers’ locations in India. The figure below represents the mode of a typical transaction:

Constitution of a Fixed Place of Business—Different Scenarios

Whether MIPs Constitute a Fixed Place of Business?

With respect to fixed place PE, AAR cites the three tests:

• A fixed place;
• At the disposal of the applicant; and
• Whether significant work is being done through the fixed place and does not fall within the exemption of preparatory or auxiliary in nature.

In relation to the first two tests the AAR heavily relied on the decision of the Supreme Court in the case of Formula One (above).

In relation to the question as to whether the MIPs were carrying out any significant activity(s) in India so as to form a permanent establishment the AAR observed the following:

• That there are three stages of transaction processing which is the business of the applicant which are: (a) authorization; (b) clearance and (c) settlement.
• The AAR goes on to verify in minute detail as to whether the authorization activity is being carried out in India.
• The AAR relies mainly on the transfer pricing (“TP”) Audit Report of MISPL to arrive at the real nature of activities performed by the MIPs as opposed to what was submitted by the applicant during the course of hearing. By analyzing in detail, the authorization transaction, the AAR came to a finding that the role of MIP is a significant one.
• The AAR further observed that the maintenance of MIPs is being carried out by Associated Enterprises (“AEs”) of the applicant and are subsequently being charged back to back through MISPL to the applicant itself. Further, it also observes that all the conditions of repair and cost of maintenance are being determined by the applicant or by its AEs on behalf of the applicant. Thus, for all practical purposes the control and consequently the MIPs were always at the disposal of the applicant.
• The AAR distinguishes the case of the applicant from its own case fought before the Australian Taxation Office on the ground that the Australia–Singapore DTAA provided for the requirement of “substantial equipment” which was not present in the India–Singapore DTAA.

MasterCard Network

The AAR placed heavy reliance on the TP Report to come to a finding that MIP was itself a part of the MasterCard network. The AAR goes on to state that MasterCard Network consist of MIPs, transmission towers, leased lines, fiber optic cables, nodes, internet and application software being MasterConnect and MasterCard File Express.

The AAR finds that the application software is owned by the applicant and applies the decision of Delhi Income Tax Appellate Tribunal (ITAT) in Amadeus Global v. DCIT (2008) 113 TTJ 767 and Galileo International v. DCIT (2008) 114 TTJ 289 to state that MasterCard Network is creating a PE in India. However, very interestingly, in a rather sweeping statement states that since MasterCard Network is being managed and maintained by MCT LLC (a U.S. company, not being the applicant), the MasterCard Network stand the test of being at the disposal of the applicant. This seems to be without any logic and a self-contradictory observation. It also holds that the MasterCard Network provides significant contribution towards clearance and settlement process in India.

Premises of Bank of India is a Fixed Place

The AAR in this proposition holds that settlement activities carried out by the employees of Bank of India is a principal-agent relationship and by necessary implication, the place in which employees are carrying out the functions of the settlement is at the disposal of the applicant and hence constitutes a fixed place PE.

The relationship of agency between the Bank of India and the applicant was established by the fact that there was a dedicated team of the bank which would carry out the instructions of the applicant. The applicant would send instructions everyday to the said depicted team and all the risks were on account of the applicant. However, the AAR fails to get into a fact-finding exercise as to whether the place in which the dedicated team of the Bank is working is at the disposal of such team. This would be as per paragraph 4.3 of the OECD Commentary on Article 5 Concerning the Definition of Permanent Establishment.

MISPL is a Fixed Place PE

The AAR details the Function Asset Risk (“FAR”) analysis submitted by the applicant pre- and post-restructuring and also states that in the FAR analysis of MISPL only support services are being shown to be rendered while transaction processing services are being actually rendered by the applicant through the facility, personnel and premises of MISPL. The AAR also notes that since the MIPs which are claimed to be owned by MISPL, the transaction processing activity which is carried out by the MIPs and goes unreflected in the FAR of MISPL could create a PE of the applicant as it would mean that transaction processing services are being carried out by the applicant through the facilities of MISPL. This finding of the AAR is directly in contravention to its own finding in paragraph 26.3 of this decision where it has come to a finding that the MIPs continue to be owned by the AEs of the applicant and it turn the AEs have given the MIPs under license to the applicant.

Service PE through the Employees of the Applicant

AAR notes that clients of the applicant are in India, thus, relying on SC ruling in E-Funds (above), AAR holds that the first test for creating service PE is satisfied since service is provided to Indian customers. Further, AAR observes that the threshold of 90 days of the DTAA is also satisfied.

The applicant’s placed reliance on the judgment of Morgan Stanley ruling to plead that stewardship activities cannot create service PE. AAR highlighted that it is not a case where visiting employees are checking the service provided by MISPL to see if it meets the requisite standards and/or requirement. AAR observed that they were meeting clients in India to whom they were rendering service and are talking about the possibility of improving and adding services. This was not stewardship activity and was part of the main functions that were to be performed by any organization for rendering service to its clients.

MISPL is a Dependent Agent PE

Despite there being no evidence in support of this contention by the Revenue to indicate that MISPL habitually concludes contracts on behalf of the applicant, the AAR held that just by the fact that MISPL approaches the bank on behalf of the applicant to secure orders, it became a dependent agent PE. It observed as under:

“orders or agreements are routed through MISPL though the finalization of the contract is by the Applicant in Singapore…. Though the proposals and counter proposals would be vetted by the Applicant in Singapore, it would ultimately get accepted by the customer banks in India when MISPL brings that proposal or counter proposal to it.”

However, this is also antithetical to the findings given by the AAR in relation to service PE being created on account of employees of the applicant visiting India.

Looking Ahead

This article purely focuses on what the AAR has held to constitute PE in India. The findings of the AAR seem to be an extension of the Formula One (supra) decision of the Apex Court. In relation to the fact-finding, there appears to be several contradictions in the submissions of the applicant which also has consequently led to contradictions in the decision of the AAR. Some of the issues that would need further clarity are as follows:

• Whether an agency would automatically lead to a fixed place PE in India?
• Whether functions of the subsidiary not reflected in the FAR analysis would automatically mean that the services are being rendered by the applicant and necessarily through its subsidiary and thereby creating a fixed place PE in India?
• Whether even if a sister concern maintaining any property would also mean that it is at the disposal of the applicant?

If the aforementioned issued are not adequately addressed by any appropriate forum, then it would seriously jeopardize carrying out business in India as that would be tantamount to significantly lowering the thresholds to constitute a PE in India.

Planning Points

Needless to say, the decision rendered by the AAR has far-reaching ramifications insofar as identification and establishing PE in India is concerned. The fact that the PE jurisprudence in India is evolving is also not in doubt. However, multinational corporations like MasterCard in this case must necessarily understand that PE laws are continuously changing to meet market realities of a more globalized economy.

First and foremost:

• If there is any business activity outside the ambit of a contracting state, the activity must be reviewed in light of domestic legislation of both contracting states, the OECD’s Multilateral Conventions, the Double Taxation Avoidance Agreement (if any). This will involve researching the ramifications of triggering a PE, including whether or not the organization should involve the primary requirement to establish a legal entity and, if so required, the optimization of the type of such entity based on the nature of the activities planned to be carried out, the duration of the activities and other relevant factors.
• In this case, the AAR has heavily relied on the TP documentation and FAR analysis to conclude the various PEs were existing for MasterCard. The AAR considered substantial realities over the overall form and characterization of the transaction. It has sent out a rather stern message that the TP documentation must reflect the accurate picture of functions to be performed and the risks to be undertaken by the entity in India. Although it was argued before the AAR that what was being provided was merely “support services,” the AAR relied on what the FAR documentation provided.
• Therefore, one must structure their global operations in a manner which is in sync with what they provide in its FAR analysis or any other document submitted before relevant tax authorities.
• Preparation of functional profiles and any variance therein both pre- and post-restructuring or in any normal scenario must be supported by adequate documentation.
• Classification of each and every functionality/risk must be done with caution and must be checked on the touchstone of established principles governing PE regulations and norms.

Asim Choudhury is a Principal Associate and Rohan Poddar is an Associate with the tax team at Khaitan & Co, India.