Foreign companies while doing business in India often create a Permanent Establishment (PE). Establishment of such PEs is more frequent when foreign companies are involved in providing services. It is an internationally-accepted principle that if a non -resident carries on its business through a PE, then the profit which is attributable to the business activities being carried on by that PE is liable to be taxed in that country.
The controversy, however, lies in the attribution of profits because the tax department is always eager to attribute as much profits as possible to the operations of the PE.
It is contended by the tax department that the foreign company, which has a PE in India is taxable on a part of its global profits, which is attributable to such PE in India. In addition to such taxable entity, there is a second taxable unit also like an agent or an associated enterprise itself, which in fact has constituted the PE of the foreign company in India. For example, in the case of SET Satellite the department was of the view that SET India, dependent agent of foreign company, is separate tax unit, and PE of foreign company, which is also SET India is nevertheless a separate tax unit. While the former is clearly established tax entity, the latter is a hypothetical establishment (see 106 ITD 175).
In the above case, the Tribunal drew a fine distinction between “dependent agent enterprise” i.e. SET India and the PE of the foreign company. Accordingly, the Tribunal held that on one hand SET India would pay tax on the profits earned by it, which includes the amount received by it from the foreign company. On the other hand, the foreign company will pay a further tax on its profits, which are attributable to the activities of its PE in India i.e. SET India again.
Thus, tax in India will be paid in the following manner; by SET India on its profits, which include amount received by it for its services to the foreign company, and by foreign company on its foreign profits attributable to activities of PE in India. Accordingly, two tax returns will be filed; one by SET India and other by the foreign company.
The Tribunal upheld the above stand because in their opinion otherwise a situation will arise where taxability of Indian Company will allow to extinguish tax liability of the foreign company.
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In case of Morgan Stanley also (see 292 ITR 416), the Honourable Supreme Court was seized with similar issue and it was observed that: “Therefore, there is a difference between the taxability of the P.E. in respect of its income earned by it in India which is in accordance with the Income-Tax Act, 1961 and which has nothing to do with the taxability of the MNE, which is also taxable in India under Article 7, in respect of the profits attributable to its P.E.”
However, the Honourable Supreme Court has finally concluded that where the PE in India has been remunerated at arm’s length price, nothing further would be left to attribute to the PE.
The effect of the Honourable Supreme Court decision (supra) is that where the transaction between the foreign company and the PE in India is at arm’s length, and the Indian tax entity has paid its taxes, there will be nothing left to be taxed in the hands of foreign company. This situation will prevail despite the fact that in principle there are two separate taxable entities.
In view of the decision of the Apex Court in Morgan Stanley case, the Bombay High Court in the case of SET Satellite has reversed the decision of Bombay Tribunal (See 307 ITR 205).
Before concluding, it may be stated that the government has filed a review petition for Morgan Stanley’s case. Therefore, the controversy is still far from over.
The author is partner in SS Kothari Mehta & Co.