Supply of Telecoms Equipment Income Creates PE Under India–China Tax Treaty

The Delhi Bench of the Income-tax Appellate Tribunal (Tribunal) in the case of Huawei Technologies Co. Ltd. (taxpayer) regarded income arising from supply of telecommunications network equipment, its installation and commissioning, as income from supply of equipment with a primary objective to commission customized hardware and software for the telecommunications service provider, subject to tax in India owing to active participation in the negotiation of the deal with Indian clients on behalf of the taxpayer, where the installation/commissioning is executed by the Indian entity.

The Tribunal considered the frequent visits by the taxpayer’s employees to monitor progress of the project from the bidding to final implementation phase, and activities like the signing of bid documents executed by the Indian entities from its office premises, continued risk taking of the equipment supplied in India treated as an extension of the taxpayer’s supplying business in India, to conclude that supervision activity is in connection with installation to constitute a permanent establishment (PE) in India under Article 5 of the India–China tax treaty (tax treaty).

Facts

The taxpayer is a Chinese entity engaged in the business of offshore supply of products such as telecommunications network equipment, access network equipment, mobile network equipment and data communications equipment, utilized in fixed and mobile networks and terminal products of mobile phone handsets to global customers, including India. The taxpayer also had a subsidiary in India but the supplies were made on a principal-to-principal basis of such equipment where the title was transferred to Indian customers outside India.

The taxpayer also rendered services to its Indian subsidiary under the technical service agreement (agreement) for the provision of integration, installation and commissioning services of the telecommunications equipment supplied outside India. The taxpayer offered technical service income accrued and rendered to the Indian entity on gross basis and paid taxes under the provisions of fees for technical services under Article 12 of the tax treaty, claiming tax exemption for the income earned from the sale of telecommunications network equipment.

The revenue authorities (revenue), based on an investigation and the statements of senior employees, analysis of survey documents, agreements and submissions of the taxpayer, alleged that the taxpayer carried out business in India through its frequently traveling and working employees from the Indian premises of its subsidiary, thus creating a business connection in India under Indian domestic laws, and thus constituted a fixed place PE under Article 5(1) of the tax treaty.

Additionally, the revenue noted that the taxpayer’s employees also made numerous visits to India for the installation project, exceeding 183 days, to render installation-related activities and technical services in India, thereby constituting an installation PE under Article 5(2)(j) and service PE under Article 5(2)(k) of the tax treaty, respectively, in India. The revenue also observed that the process of collective bidding undertaken by the taxpayer and its Indian subsidiary created a dependent agency PE under Article 5(4) of the tax treaty.

Tribunal Decision

Fixed Place PE

The Tribunal evaluated the interconnected transaction between the taxpayer and its Indian subsidiary towards the sale of telecommunications equipment for installation and commission ultimately accomplished by the Indian subsidiary in India. Effectively, ongoing activities of the taxpayer until the telecommunications network equipment is installed and commissioned in India directly contributes towards the earning of the taxpayer’s income from its cohesive business activities even though the sale transaction was concluded offshore.

The Tribunal, relying on multiple cases, explained the concept of dominant test of equipment that plays a vital role in sales and commissioning by implying the analogy in this case that the primary purpose of the taxpayer was not to sell telecommunications equipment but to undertake commissioning activities after suitably modifying the hardware and software as per the requirements of the telecommunications service provider.

The Tribunal specifically relied on the cases of L&T Ltd, Andhra Pradesh, High Court and Usha Beltron Ltd, Supreme Court to confirm that the taxpayer continued to undertake the risk of rejection of the supply made to the Indian customer resulting in the extension of the taxpayer’s business towards supply of equipment in India. The Tribunal, also relying on the case of Ericsson A.B. , observed that the taxpayer’s position may have been distinct if the Indian customer had the right to reject the equipment due to the failure of an acceptance test carried out in India.

The Tribunal noted that the letter from the telecommunications customer confirms the responsibility of installation and commissioning, along with supply of equipment, was with the taxpayer, but through the collective bidding process by engaging employees of the Indian subsidiary and the taxpayer involved in active participation of the bidding. The resources of the Indian subsidiary were also engaged in dealing with the negotiation process on behalf of the taxpayer, evidenced from the purchase order from an employee of the Indian subsidiary affirming that such employees were representing the taxpayer for the finalization of the contract/purchase order.

The Tribunal, relying on the case of Formula One World Championship Limited, observed that, overall, control lies with the taxpayer capable of delivering the critical business functions. The Indian subsidiary of the taxpayer had no ability to undertake technical work of installation/commissioning of telecommunications network equipment without any assistance from the taxpayer. Hence, considering the Supreme Court rationale, the position is clear that control and disposal are associated and the disposal of fixed place is determined by the degree of control exercised by the foreign entity, i.e. the taxpayer.

Accordingly, the Tribunal, analyzing the broad-based activities, confirmed that the taxpayer had control over the entire project including installation and commissioning even after the sale of equipment, resulting in a fixed place PE of the taxpayer in India under Article 5(1) of the tax treaty.

Installation PE

The Tribunal realized that the taxpayer’s Indian subsidiary was not technically capable of completing the installation and commissioning, as it requested support from the offshore resources of the taxpayer to supervise the installation site in India. It was also evident that the Indian subsidiary’s employees were extensively involved in the negotiation process with Indian customers and permitted the taxpayer’s representative to use the premises of the Indian subsidiary.

The Tribunal, relying on the customer’s letter, confirmed that the taxpayer was collectively responsible for not only the supply of equipment but also the installation/commissioning, a primary reason to consider the Indian subsidiary as not independent. It was reasonably proved that the activity of installation was performed by the taxpayer’s employees and equipment technology experts were present on site in India to supervise the installation and commissioning of the project, thus making the installation process an integral part of the supply of equipment transaction.

The Tribunal could not conclude that the Indian subsidiary was independent to complete the installation and commissioning of the equipment sold by the taxpayer for its Indian customer, leading the Tribunal to confirm that the activity of supervision in connection with the installation process constituted an “installation PE” under Article 5(2)(j) of the tax treaty.

Service PE and Dependent Agency PE

The Tribunal established that the Indian subsidiary was actively involved in deal negotiations on behalf of the taxpayer. The joint bidding also reflects that the activity, including signing of bid documents, was executed from the office premises of the Indian subsidiary, participating in the deal negotiation process with the Indian clients on behalf of the taxpayer. It was also proved that the Indian subsidiary was economically dependent on the taxpayer for installation work of telecommunications equipment supplied by the taxpayer.

The Tribunal, based on the documents of the survey proceedings, recognized that the Indian and Chinese employees were collectively responsible for the bid submission to the Indian customers, where the taxpayer’s employees were seconded to the Indian subsidiary premises for development of the taxpayer’s business in India, including monitoring of the project at various stages, beginning from the bidding stage to the final phase of implementation.

The Tribunal concluded that the Indian entity was established with the sole intent to support the taxpayer’s business in India. Further, as the Indian subsidiary was not supplying the equipment, involved in bidding process, including supplies made through a third party vendor, but merely executed installations/commission of the equipment, made the taxpayer’s offshore supply of equipment business in India as fully dependent to the activities of its Indian subsidiary.

In such case, it cannot be treated as a simplistic supply of standard product, but was a sale of a specified product as per the customer’s choice. Hence the Tribunal concluded that the Indian subsidiary not only constituted a dependent agent PE under Article 5(4) but also a service PE of the taxpayer under Article 5 (2)(k) of the tax treaty.

Key Takeaways

The tax liability of a foreign entity exploring supply of goods bundled with other installation and commissioning of technical equipment has been the subject matter of controversy under international tax. There are a plethora of cases that deal with the subject of supply of goods with installation, commissioning and service in favor and against the taxability of income arising to the nonresident in India from such activities, by virtue of taxable presence and applying the income attribution principle.

The Tribunal conclusion discredits the jurisdictional High Court cases of Ericsson A. B. which concluded that the income from supply of telecommunications equipment cannot be regarded as taxable in India since the title of the property in goods was passed outside India, followed by LG Cable Ltd., which held that income from offshore supply of equipment cannot be taxed in India simply because it is interlinked with the performance of the onshore contract, and reinforced the principles laid down in the Supreme Court case of Formula One World Championship Ltd. It is worth referring to the landmark cases of Ishikawajima-Harima Heavy Industries and Hyosung Corp. where the nonresident did not constitute a fixed place of business in India through which its business was wholly or partly carried out under Article 5(1) of the applicable tax treaty.

Importantly, the ruling becomes vital since India and China have signed a protocol to the tax treaty in 2019 to adopt and give effect to similar changes of the multilateral instrument (MLI), especially where the protocol amends the preamble of the tax treaty to replace that its intention is to eliminate double taxation without creating opportunities for non/reduced taxation, including through treaty shopping arrangements.

The protocol to the tax treaty also takes into consideration the recommendations of the Organization for Economic Co-operation and Development (OECD) BEPS Action Plan 7 to widen the scope of PE towards installation or assembly projects or supervisory activities lasting more than 183 days and project aggregation to the time period of the enterprise in case of defragmented contracts for PE determination.

Accordingly, the tax treaty benefit claimed by the nonresident considering the MLI and protocol that prescribes anti-abuse provisions of the MLI will obligate the taxpayer with an added level of due diligence and robust documentation, in light of the widened scope and concept of PE as prescribed by the MLI. Further, the creation of PE of a foreign enterprise in India would also require a detailed analysis and working on the newly codified attribution rules for determination of the tax liability based on the OECD and the United Nation Model Tax Convention.

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

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