Permanent establishment significant for foreign COs companies

The Double Taxation Avoidance Agreements (DTAAs) signed between India and other countries determine the tax liability of a foreign enterprise in India. As a matter of fact the provision of DTAA’s which India has signed with other countries, e.g. tax treaty with South Africa will supersede the domestic tax law of India and Africa.

Provisions of Indian Income Tax Act can of course be applied, but only if and when they are more beneficial to the assessee compared to the provisions of the treaty. This is an internationally accepted legal position, which has also been confirmed in a large number of court decisions in India (see Azadi Bachao Andolan 263 ITR 706).

 

In the context of DTAAs, “PE” is an important issue. Its significance lies in that “business profits” of a foreign enterprise can be taxed in India only if it has a PE in India and the profits are attributable to the PE. Even the amount for “royalty” or “fee for technical services” received by foreign enterprises will be taxed as business profits if they are attributable to a PE in India.

Creation of PE depends upon the facts and circumstances of each case. There is no general law on this point except whatever is provided in the relevant DTAA. Various judgments have been given by different courts in order to decide whether under the specified facts of a particular case, a Permanent Establishment is created or not.

The significance of existence of a PE in India has assumed further importance because of some recent judgments. For example, on the issue whether MAT is applicable to a foreign company or not, the AAR had earlier taken a view that MAT is applicable to a foreign company (see 234 ITR 335). However, in a very recent judgment delivered on 23rd July 2010, the Authority took a view that MAT may not be applicable to a foreign company if it has no presence or PE in India. In the earlier judgment where the Authority had held that MAT is applicable to a foreign company, the foreign company did not have a PE in India. Thus, it appears that if a foreign company has a PE in India then MAT will be payable on its book profits, but if the foreign company does not have a PE in India, then the provisions of MAT may not apply.

In another recent case of SET Satellite Singapore Pte. Ltd. vs Addl. DIT (Intl. Taxation)(see Taxman issue 2 Vol. 192) the Mumbai Tribunal has held that the income by way of royalty will also be taxed as business profits instead of the concessional rate of tax of 10 per cent on the gross amount if the foreign company has a Permanent Establishment in India. However, the Hon’ble Tribunal also held that the existence of Permanent Establishment should relate to the liability to pay the royalty. In other words, the royalty should be attributable to the Permanent Establishment.

Keeping in view the law in relation to Permanent Establishments and some recent judicial pronouncements, the foreign enterprises are advised as under:

 

They should try to arrange their affairs in India in a manner that their activities do not create a Permanent establishment in India. This may be done by reference to the provisions of the relevant DTAA relating to PE. 
 

If however creation of Permanent Establishment is unavoidable, then proper records and documents should be maintained for Indian PE so that only that income is taxed in India which accrues or arises through the said PE. 
 

That business income of a foreign company which is not connected with the Indian PE is not taxable in India. Such income cannot be taxed only by virtue of the fact that the foreign company has a PE in India. Such income should however neither relate to the PE nor should be received or paid by the PE.

The author is a Sr. Partner in S.S. Kothari Mehta & Co.

E-mail: hp.agrawal@sskmin.com