Foreign firms out of tax net in India, their PEs not

When a foreign company establishes a permanent establishment (PE) in India, the question is whether the company will be liable to be taxed in India, besides its PE.

In this matter, some confusion has been created by a recent judgment of the Bombay Tribunal in the case of Set Satellite (106 ITD 175). The tribunal held that the foreign company and its PE are two distinct taxable units.

The former is a hypothetical establishment, the taxability of which is on the basis of the revenues of the activities of the foreign company attributable to the PE. The second taxable unit is the PE itself, but taxability is only in respect of the income of the PE.

However, in a recent case of Hyundai Heavy Industries Co Ltd (291 ITR 482), the Supreme Court has clarified that "under the Act, the taxable unit is a foreign company and not its branch or PE in India. A non-resident assessee may have several incomes accruing or arising to it in India or outside India but so far as taxability under Section 5(2) is concerned, it is restricted to incomes which accrue or arise or are deemed to accrue or arise in India. The scope of this deeming fiction is mentioned in Section 9 of the Act.

Therefore, as far as the income accruing or arising in India, income which accrues or arises to a foreign enterprise in India can be only such portion of income accruing or arising to such foreign enterprise as is attributable to its business carried out in India."

It is, therefore, important to know that under the Act, while the taxable subject is the foreign enterprise, it is taxable only in respect of the income including business profits, which accrues or arises to that foreign enterprise in India.

In the case of Hyundai (supra), the issue for consideration was that in a turnkey project, when the foreign company had supplied the equipment from abroad, but had also installed and commissioned the same in India through its PE, whether foreign company's income from off-shore supplies will also be taxed in India in addition to the income of the PE in India. In other words, whether foreign company and PE would be taxed as two separate and distinct taxable entities or not.

The Supreme Court held that the foreign company and its PE cannot be taxed as two separate entities. Further, "in terms of paragraph 1 of article 7, the profits to be taxed in the source country were not the real profits but hypothetical profits which the PE would have earned if it was a wholly independent enterprise.

Therefore, even if we assume that the supplies were necessary for the purposes of installation (activity of the PE in India) and even if we assume that the supplies were an integral part, still no part of profits on such supplies can be attributed to the independent PE unless it is established by the department that the supplies were not at arm's length price."

In view of the above, it is now absolutely clear and certain that even in turnkey projects, offshore supplies will remain outside the tax net in India unless the foreign supplier has a PE in India and offshore supplies are attributed to that PE.

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