SKP Tax Alert
10 July 2017
 Bengaluru Tribunal taxes regional support provided by a UAE company to its Indian group company as royalty and also makes certain adversarial game changing observations regarding Permanent Establishment rules
 
In a recent decision[1] (pertaining to Financial Year (FY) 2009-10 and FY 2010-11[2]), the Bengaluru Tribunal was dealing with the issues arising from the Double Taxation Avoidance Agreement (DTAA) between India and the United Arab Emirates. In order to appreciate the issues involved, the relevant provisions of the DTAA are broadly outlined below:
 
Eligibility to claim relief under the DTAA
As per Article 4(1)(b) of the DTAA, a company is a tax resident of the United Arab Emirates (UAE) if it is incorporated in the UAE and is managed as well as controlled wholly in the UAE.
 
As per Article 29 of the DTAA, if one of the main purposes of creation of any entity is to obtain benefits of the DTAA, then such entity shall not be entitled to the benefits of the DTAA. This Article shall also cover the case of any legal entity not having bona fide business activities.
 
Permanent Establishment (PE) provisions under the DTAA
As per Article 5(1) of the DTAA, the term PE means a fixed place of business through which the business of an enterprise is wholly or partly carried on (Fixed Place PE).
 
As per Article 5(2)(i) of the DTAA, the term PE also includes the furnishing of services by UAE entity, through employees or other personnel, in India if such services continue for the same project or connected project for the aggregate periods of more than 9 months within any 12 month period (Service PE).
 
Royalty definition under the DTAA
As per Article 12(3) of the DTAA, the term ‘royalties’ has been defined to include payment received as a consideration for information concerning Industrial, Commercial or Scientific (ICS) experience.
 
Facts
  • The taxpayer, a company incorporated in the UAE, claimed to be engaged in the business of providing regional service activities for the benefit of ABB Group legal entities in India, Middle East and Africa (IMEA).  
  • Pursuant to Regional Headquarter Service Agreement (Agreement), which was effective from 1 January 2010, the taxpayer received a certain amount from ABB Ltd (Ico), a company incorporated in India. Three employees of the taxpayer visited India for 25 days till March 2010.  
  • The taxpayer claimed the amount received from Ico as non-taxable in India since there are no Fees for Technical Services (FTS) Article in the DTAA. Furthermore, such amount is not taxable in India under Other Income Article of the DTAA since the taxpayer does not have a PE in India.  
  • The Assessing Officer (AO) took a view that the amount received from Ico is taxable as FTS under the provisions of the Income Tax Act, 1961 (Act) in the absence of FTS Article in the DTAA. Alternatively, such amount is taxable as royalty under the Act as well as the DTAA.  
  • Upon the filing of objections by the taxpayer, the Dispute Resolution Panel (DRP)[3] confirmed the action of the AO. The DRP also held that taxpayer has a PE in India.    
  • Being aggrieved, the taxpayer filed an appeal before the Bengaluru Tribunal. 
Key observations, views and conclusions of the Bengaluru Tribunal
 
Issue 1: Whether the taxpayer is eligible to claim the DTAA benefit or relief? 
  • In order to claim any benefit or relief under the DTAA:
    • Tax Residency Certificate (TRC), in support of taxpayer’s tax residence in UAE, should be obtained from the UAE tax authorities;  
    • Taxpayer is required to prove that it is managed and controlled wholly in the UAE; and 
    • Income of the taxpayer should be assessable under the Act as well as tax law of the UAE.
  • The TRC obtained by the taxpayer would not help the FYs under dispute since it is valid for a period of one year with effect from 1 April 2012.  
  • Furthermore, the taxpayer has not placed any evidence to show that it was wholly managed as well as controlled in the UAE and it is a tax entity in UAE.  
  • The taxpayer has also not filed any document to show that income arising to it was taxable in UAE.  
  • Accordingly, the taxpayer is not entitled to any benefits of the DTAA.
Issue 2: Whether the taxpayer has a Service PE in India? 
  • The services can be rendered without physical presence of the employees of the taxpayer since services can be provided with various virtual modes (like email, internet, video conference, remote access, etc.) in the present age of technology.  
  • Service PE (Article 5(2)(i)) is an independent clause and it does not require to fulfil the requirement of Fixed Place PE (Article 5(1)).  
  • There is no requirement of stay of employees for more than nine months, but there is a requirement that the services should be rendered for a period of nine months.  
  • Once the activity of the taxpayer commenced only in January 2010, it is not expected to complete nine months before March 2010. The completion of 9 months activities was only conceived in a period of 12 months. However, it is undisputed that taxpayer continues to render services from January 2010 and thereafter, also in subsequent FY. 
  • Thus, the Service PE is only dependent upon the continuation of activity for the same project or connected project for periods aggregating to more than 9 months within any 12 month period.  
  • Accordingly, the taxpayer is having a Service PE in India. 
Issue 3: Whether the amount received by the taxpayer from Ico is taxable as royalty in India?
 
After gauging activities of the taxpayer from various clauses of the Agreement and distinguishing certain judgments relied on by the taxpayer, the Tribunal held that: 
  • The information provided to Ico were acquired by the taxpayer from its expertise, experience and knowledge based on its association with ABB Group Zurich. This information remains unrevealed to the public and also cannot be acquired by Ico on its own effort.  
  • The taxpayer has merely provided access to the specialised knowledge, skill and expertise. After giving such access to Ico, the taxpayer has not done anything more for rendering the services.  
  • It was not possible for the taxpayer to render services merely with the help of three employees sent to India only for 25 days since the nature, scope and ambit of clauses or activities in the Agreement are very wide.  
  • The taxpayer has also not provided any evidence of actual rendering of services.  
  • Therefore, instead of taxpayer providing services through its employees, the taxpayer had merely granted access to Ico of various secret, confidential and Intellectual Property Rights (IPRs) protected information and other information acquired by the taxpayer from its past experience.  
  • If the services were actually rendered by the taxpayer, then it is essential that the taxpayer would have sent some of its employees to actually execute the services at various branch offices of Ico.  
  • The taxpayer rendered activities in the form of sharing or permitting the use of special knowledge, expertise and experience of the taxpayer, which it has acquired from its parent company, and was shared by it with Ico.  
  • As evident from the Secrecy Clause of the Agreement, the dominant character of the Agreement was for sharing secret, confidential and IPRs protected information.  
  • The visits of the employees of the taxpayer to Ico was only for the purposes of providing access for using the information concerning ICS experience belonging to the taxpayer and to assist Ico in commercially exploiting it.  
  • Thus, the information provided by the taxpayer to Ico were in the nature of know-how contract and squarely falls within the realm of ‘royalty’ as defined under the DTAA.
 

[1] ABB FZ - LLC vs DCIT in IT(TP)A No. 1103/Bang/2013 and 304/Bang/2015 dated 21 June 2017
[2] Assessment Years 2010-11 and 2011-12
[3] DRP is a collegium of three Principal Commissioners or Commissioners of Income Tax
 
SKP's comments

Although the Bengaluru Tribunal dismissed the appeal of the taxpayer after taking a view that it is not entitled to any benefits of the DTAA, the Tribunal decided to adjudicate other grounds relating to Service PE and royalty taxation. Furthermore, even Tribunal’s view that the taxpayer has a Service PE in India also seems to have become academic since Tribunal ultimately took a view that income earned by the taxpayer is in the nature of royalty for providing information concerning ICS experience.

However, it is still worth pondering all the three issues before the Bengaluru Tribunal since they shake certain basic principles of international taxation.
 
As regards, Issue 1 of eligibility to claim the DTAA benefit or relief before the Bengaluru Tribunal, the possible questions that may crop up are: 
  • Whether the TRC was a relevant document for disputed FYs 2009-10 and 2010-11 before the Bengaluru Tribunal when the requirement to obtain the TRC was inserted in the Act only from FY 2012-13?  
  • Once any UAE company passes the tests of Article 29 of the DTAA dealing with Limitation of Benefits (LoB) and General Anti-Avoidance Rules (GAAR) provided in the Act, is it necessary for such UAE company to establish that it is wholly managed and controlled in UAE? Whether valid TRC issued by UAE tax authorities certifying UAE company as a tax resident of UAE under the DTAA for the relevant period should not be considered as conclusive evidence in this regard? If the UAE company is required to establish that it is wholly managed and controlled in UAE despite such valid TRC, would it not amount to lifting the corporate veil by the Indian tax authorities? Whether such lifting of corporate veil is permissible beyond the scope of Article 29 of the DTAA and GAAR provisions of the Act?  
  • Is it also necessary for the UAE Company to show that it is taxable in UAE post-substitution of Article 4 of the DTAA, dealing with the tax residence of such company, by CBDT[4] Notification dated 28 November 2007? Post such substitution, is it not true that the entire controversy of ‘liable to tax’ and ‘actual payment of tax’ has been done away with?
As regards Bengaluru Tribunal’s view on Issue 2 that the taxpayer has a Service PE in India, it appears to us that the DTAA provision dealing with Service PE has not been interpreted correctly. It is a fundamental principle of international taxation that a Foreign Enterprise (FE) shall constitute a PE in the source state (India in the instant case) only if FE has an economic presence in India for conducting its business activities. Such economic presence could be either the physical presence (through an office in India, visit of employees, personnel of FE to India, etc.) or through a Dependent Agent in India.

Based on the judicial precedents in India, Article 5(1) (Fixed Place PE) and Article 5(2) of the DTAA need to be read harmoniously. Accordingly, the physical presence of employees or other personnel of the taxpayer in India beyond the threshold period provided in the DTAA should be considered as a necessary condition for constitution of Service PE in India.
 
However, the Bengaluru Tribunal seems to be taking a view that Service PE is constituted in India if the overall activity of the taxpayer exceeds the threshold period provided in the DTAA and for this purpose, the actual visit of employees or other personnel of the taxpayer in India is not a relevant criteria. Although this view of the Bengaluru Tribunal does not seem to gel with the fundamental principles of international taxation, the possibility of lower-level tax authorities taking such a view and hence, the possibility of litigation cannot be ruled out at this stage.
 
As regards Bangalore Tribunal’s view on Issue 3 that the amount received by the taxpayer is taxable as royalty income, there appears to be a dichotomy in the Tribunal’s order. On one hand, while dealing with Service PE issue, the Tribunal is taking a view that the physical presence of employees in India is not necessary for rendering services in the present age of technology. On the other hand, while dealing with the royalty issue, the Tribunal is taking a view that the taxpayer has not rendered any services since only three employees of the taxpayer visited India, only for 25 days.
 
Having said that, it has become necessary nowadays to take conscious and proactive tax position in relation to cross-border arrangements (especially intra-group arrangements) for any activities or services after assessing the substance of the transaction and determine whether it is a transaction of providing know-how or it is a transaction of rendering services. The principles laid down in the international taxation commentaries and judicial precedents pronounced in India should be duly considered in this regard. Furthermore, it goes without saying that the underlying documentary evidence shall play a vital role in deciding the nature of activities actually performed at the ground level.
 
[4] Central Board of Direct Taxes - Apex Direct Tax administrative body in India 
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