Indian Project Office of Foreign Company Not Engaged In Core Business Activities Not a Permanent Establishment (PE): Supreme Court India

By Mr. Shahid Khan, Senior Partner, and Department Head, Taxation Practice, Kochhar & Co.

NEW DELHI: Double Tax Avoidance Agreements (Tax Treaties) signed by India with various countries provide that business income of an enterprise, which is tax resident of a foreign country would be taxable in India only if it has or is deemed to have a Permanent Establishment (PE) in India.

The term PE is defined in Article 5 of the respective Tax Treaties. Although there are minor variations in the definition of PE in the Tax Treaties signed by India with different countries, Article 5(1) of the Tax Treaties is common and defines the term PE to mean a ‘fixed place of business through which the business of an enterprise is wholly or partly carried on’.

This general definition is thereafter supplemented by providing in Article 5(2) that if the foreign enterprise has a place of management or a branch, or an office, or a factory, or a workshop, or a mine or quarry, etc., or a construction or installation project, in India then also it will be deemed to have a PE in India.

The other sub-clauses of Article 5 provide certain exceptions under which PE will not be deemed to arise.

However, one of the exceptions is that where the Indian establishment of the foreign enterprise is engaged only in activities of a preparatory and auxiliary character it will not be construed as a PE.

The in-the-Court proceedings:

Recently the Indian Supreme Court in the case of Director of Income Tax versus Samsung Heavy Industries Co. Ltd. held that the condition precedent for applicability of Article 5(1) of the Tax Treaties for ascertaining the existence of a PE in India is that the Indian establishment of the foreign enterprise should be one through which the business of the enterprise is wholly or partly carried on. The Court went on to hold that a fixed place of business which is only of a preparatory or auxiliary character would not constitute a PE. The Court next held that where the Project Office of a foreign enterprise was only engaged in activities that were of a preparatory and auxiliary character and were not the core business activities of the enterprise, the Project Office cannot be construed to be a PE of the foreign enterprise in India.

The facts of the above case were that a consortium including the taxpayer Samsung Heavy Industries Co. Ltd. and an Indian company was awarded a “turnkey” contract by the Oil and Natural Gas Corporation (ONGC). The work inter-alia included survey, design, engineering, procurement, fabrication, installation and modification at the existing facilities, and start-up and commissioning the ‘Vasai East Development Project’ of ONGC.

In this connection, the taxpayer company Samsung Heavy Industries set up a Project Office in Mumbai, which it claimed was to act as ‘a communication channel” between it and ONGC in respect of the Project. The pre-engineering, survey, engineering, procurement, and fabrication, etc. were done by the taxpayer outside India, after which these platforms were brought out to be installed at the Vasai East Development Project. On examining the Resolution of the Board of Directors of the company for setting up the Project Office and the application that it filed before the Reserve Bank of India (RBI), the tax authorities noted that the Project office was opened for coordination and execution of the ONGC project and that in the absence of any restriction in these documents it cannot be said that Project Office was not a fixed place of business of the taxpayer in India to carry out wholly or partly the contract with ONGC.

Therefore, the tax authorities held that the taxpayer has a PE in India. Based on this they estimated 25% of the profit of the project as attributable to the PE and liable to tax in India. The finding regarding the existence of PE was upheld in appeals up to High Court though the estimate of profit attributable to the PE was remanded back for fresh determination.

The SC ruling:

The Supreme Court referring to its earlier judgment in the case of Director of Income Tax versus E-Funds IT Solution Inc noted that the initial burden of proving the fact that a foreign enterprise has a PE in India is on the Tax department.

Referring to the resolution of the Board of Directors of the taxpayer and its application before RBI the Court noted that the Project Office was established to coordinate and execute delivery documents in connection with the construction of the offshore platform modification of the existing facilities for ONGC. It also noted that there were only two persons working in the Project Office neither of whom was qualified to perform any core activity of the taxpayer. It, therefore, held that the Project Office cannot be said to be a fixed place of business through which the core business of the taxpayer was wholly or partly carried on in India. The Court went on to hold that the Project Office of the taxpayer would fall within Article 5(4)(e) of the India-Korea Tax Treaty as it is solely carrying out activities of an auxiliary nature.

Similarly, in the case of Union of India versus U.A.E. Exchange Centre the Supreme Court, relying on the permission granted to the taxpayer by RBI for setting up the liaison office, held that as the liaison office was engaged only in fund remittance services which were of an auxiliary nature it did not constitute PE of the UAE company in India.

About the Author:

Mr. Shahid Khan, the Senior Partner and Department Head, Taxation Practice, Kochhar & Co., is a former officer of the Indian Revenue Service (IRS) and a highly respected former member of the Central Board of Direct Taxes (CBDT) – the highest policy and decision-making body of the (Indian) Income Tax Department (IT Department) of the Government of India. Mr. Khan owns a rich and unparalleled experience of over 40 years.