By Jitendra Jain, Executive Director, Transfer Pricing, PricewaterhouseCoopers Private Limited
John Allen Paulos, Professor of Mathematics at Temple University in Philadelphia, Pennsylvania, said, “Uncertainty is the only certainty there is.”
This is certainly true of the concept of permanent establishment in international tax.
While permanent establishment is a contentious area, rulings from tribunals and courts have helped shape the jurisprudence.
The July 22 ruling of the Supreme Court of India in the case of Samsung Heavy Industries Co. Ltd. concerning the preparatory or auxiliary activities exception to permanent establishment, otherwise known as the specific activity exemption, is a case in point.
Facts of the case
In 2006, the Oil and Natural Gas Corporation, a state-owned enterprise of the government of India, awarded a turnkey contract to a consortium comprising of Samsung Heavy Industries, a company incorporated in South Korea, and an Indian company.
The scope of the contract was to carry out work, inter alia, of surveys, design, engineering, procurement, fabrication, installation and modification at existing facilities, and start-up and commissioning of the entire facilities covered under the Vasai East Development Project.
Samsung Heavy Industries set up a project office in Mumbai to act as a communication channel with the Oil and Natural Gas Corporation for the project. Pre-engineering, survey, engineering, procurement, and fabrication activities took place abroad.
Samsung Heavy Industries’ India income tax return declared a loss in relation to its activities carried out in India.
Tax office’s findings
The Indian tax officer issued a show cause notice, alleging that Samsung Heavy Industries’ offshore supply and services should be taxed in India as they were attributable to a permanent establishment in India.
The tax officer alleged that the project office was involved in the core activity of execution of the project and therefore was a permanent establishment of Samsung Heavy Industries in India within the meaning of Article 5.1 of the India-Korea tax treaty.
Samsung Heavy Industries argued that the offshore supply and services were not attributable to the permanent establishment in India. It argued that the project office was acting as a mere communication channel and therefore was used merely for preparatory and auxiliary activities.
Samsung Heavy Industries argued that the offshore supply and services were not attributable to the permanent establishment in India. It argued that the project office was acting as a mere communication channel and therefore was used merely for preparatory and auxiliary activities.
The tax officer alleged that the project in question was a single, indivisible “turnkey” project which could not be split up and, therefore, the entire profit from the project should be taxable in India.
The tax officer attributed 25% of the revenues allegedly earned outside India as the profit attributable to the permanent establishment in India.
It alleged that the work was wholly executed by the permanent establishment in India and it would be absurd to suggest that permanent establishment in India was not associated with the designing or fabrication of materials.
The order of the tax officer was upheld by India’s Dispute Resolution Panel, the first appellate authority.
Tax Tribunal ruling
Samsung Heavy Industries then filed an appeal before India’s Income Tax Appellate Tribunal.
The tribunal relied on an application that was submitted by Samsung to the Reserve Bank of India for the registration of the project office.
The application referred to a board resolution of the company for opening the project office in India, which stated that “the company hereby open one project office in Mumbai, India for coordination and execution of Vasai East Development Project”.
The tribunal held that it was clear from the board resolution that the project office was opened for coordination and execution of the project. It then held that the project office was a fixed place of business of Samsung Heavy Industries in India.
Samsung Heavy Industries argued that even if there was a permanent establishment, the activities of the permanent establishment met the test of preparatory or auxiliary activities in Article 5.4.
The tribunal rejected this argument, stating that the onus of proving that the activities were preparatory or auxiliary was on Samsung Heavy Industries and that it brought no material on record to prove this fact.
Samsung Heavy Industries produced the accounts of the project office to demonstrate that there was no expenditure related to the execution of the project. Samsung Heavy Industries also argued that only two people worked in the project office, neither of whom was qualified to perform any core activity of Samsung Heavy Industries.
The tax tribunal rejected these arguments, stating that the accounts were in the hands of Samsung Heavy Industries and that the mere mode of maintaining the accounts alone cannot determine the character of a permanent establishment.
The tax tribunal, however, remanded the matter back to the tax officer to reconsider the deemed profit of 25% attributed by the tax officer to the permanent establishment. The tribunal found that there was insufficient information to ascertain the extent of business activities carried on by Samsung Heavy Industries through the project office.
High Court ruling
Samsung Heavy Industries filed an appeal with the Uttarakhand High Court, which allowed the appeal only on the question of whether the tax officer used an arbitrary profit rate of 25% without examining whether it was attributed to the activities of the permanent establishment.
The High Court set aside the ruling of the tribunal.
According to the High Court, neither the tax officer nor the tribunal made any effort to bring on record any evidence to justify this figure.
Supreme Court ruling
The Indian tax department then filed an appeal in the Supreme Court.
The tax department again argued that the project office was connected with Samsung Heavy Industries’ core business.
However, Samsung reiterated that the Mumbai project office consisted of only two employees, neither of whom had any technical qualifications to execute the project. Further, the project office accounts demonstrated that it had not incurred any expenditure for execution of the project.
The Supreme Court relied on the board resolution enclosed with the application to the Reserve Bank of India for the registration of the project office, which stated that the project office was established for coordinating and executing “delivery of documents in connection with construction of offshore platform modification of existing facilities for [the Oil and Natural Gas Corporation] above”.
The Supreme Court stated that the findings of the tribunal were perverse to the extent of its conclusion that the project office was involved in the core activity of execution of the project and that merely maintaining accounts cannot determine the character of permanent establishment.
The Supreme Court thus concluded that the activities performed by the project office were of auxiliary nature as the project office acted as a communication channel between Samsung Heavy Industries and the Oil and Natural Gas Corporation.
In deriving the above conclusions, the Supreme Court relied on its rulings in Morgan Stanley & Co. Inc. and E-Funds IT Solutions, Inc., where, depending on the specific facts of the case, certain back office and support functions were held not to give rise to a fixed place permanent establishment.
Takeaways
This is the second ruling this year by the Supreme Court on the ‘preparatory or auxiliary’ activities test in the context of a permanent establishment, the first one being the ruling in the UAE Exchange Center case.
Both these rulings demonstrate that the test of ‘preparatory or auxiliary’ activities is very factual.
In this case, the Supreme Court relied on the Reserve Bank of India registration and the accounts of the project office to determine the scope of the activities of the project office.
Even in the UAE Exchange Center case, the Supreme Court relied on permission granted by the Reserve Bank of India (among others) in concluding that the activities of UAE Exchange Center’s liaison office in India were ‘preparatory or auxiliary.’
The reliance by the Supreme Court on the Reserve Bank of India permission is a significant development in jurisprudence relating to the interpretation of permanent establishment.
Both of the above rulings demonstrate that assessees having a project office or liaison office should perform activities within the realm of the permission of the Reserve Bank of India.
The rulings also highlight the importance of a taxpayer’s ability to demonstrate, through appropriate documentation, that activities performed by it are indeed preparatory or auxiliary.
Lastly, the Supreme Court, relying on its ruling in E-Funds IT Solution Inc., also reiterated that the onus of proving that a taxpayer has a permanent establishment in India is on the tax authorities and not the taxpayer.
– The views expressed in this article are the author’s own and do not represent the views of the organisation.
Jitendra Jain
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facts: 1. registration document for the scope
2. booking accounts of no expense
3. 2 employees without qualification for technology.
here one thing important that might go wrong is the fact that the two employees might have done the core work here apart from their liaison communication and correspondence. In the course of daily communication, the veteran employees even without technical qualification or certificates may have done some core business research and judgement on the basis of fact collection and data capture for the core business, they could even come to some conclusions which might have been driven in by offshore employess and offshore offices, especially on onsite examination and immediate treatment. If that is the case, this might be considered as a fixed place, and constitute a PE. 25% of course will be the onus of the tax authority, and not that convincing.