SKP Tax Alert
17 January 2019
GE Energy Parts Inc[1] - Common office premise of LO, India subsidiary and expatriates, constitute fixed place PE; subsidiary’s authority to negotiate critical contractual terms constitute DAPE 
 
Brief background:
  • GE Energy Parts Inc (GEP) is a tax resident of the USA. It is engaged in the business of manufacturing and offshore sale of highly sophisticated equipment, such as gas turbine parts and sub-assemblies. GE Group supplies its products to worldwide customers (including Indian customers) on principal-to-principal basis whereby title to goods passes from outside India.
  • The Hon’ble High Court (HC) has a consolidated batch of appeals for 20+ overseas GE Group entities by taking GEP as the primary case. GEP and the other Group entities is collectively referred herewith as (GE Group or the taxpayer).
  • GE group has a Liaison Office (LO) in India, and, it also has a legal entity in India, GE India Industrial P Ltd (GE India), which is said to provide limited marketing support services to GE Group entities.
  • The tax authorities conducted survey at LO and observed that certain expatriates and employees of GE India together carried out marketing activities in India and were involved in negotiation of prices. Furthermore, these expatriates operated from the premises of LO in India.
  • The activities of GE Group in the context of the above-mentioned case are summarized below:
  1. Whether LO constituted Fixed place PE for GE Group entities?
    Core business activity/preparatory or auxiliary activity
  • The taxpayer contended –
    • Work in India is only limited to providing market inputs and interface.
    • To create awareness of the business products.
    • All strategy decisions reside with the taxpayer outside India. 
  • The sales function is a small part of the overall business activity that comprises of R&D, design, fabrication and manufacture, all of which happened outside India. Therefore, mere participation in negotiation by employees, which was a small part of the sales function, cannot be said to be the core business activity of the taxpayer.
  • The taxpayer pleaded that the test of preparatory and auxiliary character of an activity is to be judged from the viewpoint of its role in the overall business.
  • Relying on Article 5(3) (e) of India-US DTAA (the treaty), the taxpayer argued that preparatory or auxiliary activities as a whole do not constitute fixed place PE even though there is a presence of the fixed place. In other words, both ‘disposal test’ and ‘business function test’ must be cumulatively satisfied.
  • On the other hand, the Tax authorities, on the basis of the survey documents, self-appraisals, manager assessment, etc., alleged that overseas GE Group entities were selling its products in India and the core activities in regard to the sale, namely pre-sale, during sale and post-sale were being carried out in India.
  • Therefore, according to the tax authorities, marketing and sales activities carried out by the expatriates, was a core business activity and integral part of the business and hence, activities of LO cannot be said be preparatory or auxiliary in nature.

    Disposal test
  • Based on the observations during the survey operations, the tax authorities alleged that AIFACS building (see above diagram) is a ‘fixed place,’ from which business of overseas GE Group entities was partly carried out in India.  
  • Furthermore, specific chambers/rooms and secretarial staff were allotted to GE staff, which was used for their work indicating continuity of the space available.
  • With regard to the above observations, the taxpayer argued that merely because the expatriates/employees were found in the AIFACS building, it cannot be assumed that the sales were also made from the said premises.

    Participation in negotiation of contractual terms
  • The taxpayer argued that participation or even negotiation of a few terms of the contract by expatriates and Indian employees does not result in a PE, since, all terms of the contract aren’t negotiated and finalized by such expatriates and employees.
  • On this point, the tax authorities alleged that few expatriates were designated as ‘County heads’ and highly qualified and they were heading the operations of overseas GE Group entities in India. These expatriates were involved and they participated in the negotiation of contracts leading to ‘business connection’ in India.  

    The Judgement of HC:
    Core business activity/preparatory or auxiliary activity
  • HC upheld the findings of the ITAT that entering into a contract with stakeholders involved a complex matrix of technical specifications, commercial terms, financial terms and other policies of GE.
  • HC observed that the work of high-ranking employees could be categorized into two-
    • Information gathering and analysis, which helped in developing business and commercial opportunities;
    • Intensive negotiations with respect to the change of technical parameters that were to be made to suit the customers.
  • Based on this HC concluded that the taxpayer’s employees were not merely liaising with the client and the headquarter.
  • Relying on Delhi HC decision, in case of National Petroleum Construction Company[2], the HC held that it is not simply that an activity is necessary for the completion of a contract– it must be the case that the activities must, per se, be responsible for the realization of profits.  

    Disposal test
  • AIFACS building, which was also leased by overseas GE Group entity was at the constant disposal of overseas GE Group entity as evidenced by specific chambers/rooms and secretarial staff allotted to GE Group staff for their work.
  • Having space at disposal does not require a legal right to use that place – mere continuous usage is sufficient if it indicates being at disposal. Based on this, GE Group had a place of business in India.
  • Once the business is carried out at a particular location at the disposal of an enterprise, it is sufficient to say that it meets the ‘through which’ threshold.
  • HC also noted ITAT’s remark that since the taxpayer has not contested that AIFACS premises were indeed used for activities of some form, it is reasonable to assume sales activities occurred only through the said premises.
  • HC held that the discharge of vital responsibilities relating to the finalization of commercial terms, or at least a prominent involvement in the contract finalization process, clearly revealed that the overseas GE Group entities carried on business in India through its fixed place of business through the premises.

    Participation in negotiation of contractual terms
  • HC rejected the taxpayer’s contention that the business activities in India must include the authority to conclude contracts, else, the activities will assume the character of auxiliary or preparatory in nature.
  1. Whether GE India constituted DAPE for GE Group entities?
  • The taxpayer argued that the expatriates and employees do not have the authority, expressed or implied, to conclude contracts.
  • Relying on OECD Commentary (para 33 on Article 5), the taxpayer argued that the mere participation in a negotiation does not lead to either a fixed place PE or DAPE.
  • Furthermore, UN Commentary on Model Tax Convention (para 44 on Article 5) and settled jurisprudence under Indian Contract Law specifically recognized that the authority to negotiate is different from any authority to conclude contracts, and without authority to conclude all elements of contracts, it cannot be said to have authority to bind the principal.
  • Relying on Varian India[3], the taxpayer argued that it is necessary that the activities of an agent must be devoted wholly or almost wholly to one enterprise and considering that services of LO/expatriates from India were not limited to one specific GE Group entity but to multiple GE Group entities, Article 5(5) conditions are not met and hence, no DAPE exists.
  • In addition to the support services provided by GE India, it also has 12 different business divisions and hence, cannot be said to be dependent, whether economical or legal.
  • GE India was remunerated by GE overseas Group entities at arm’s length for its provision of sales support services, and the same has been accepted by transfer pricing officers in past years. Thus, relying on rulings of E-Funds IT Solutions Inc.[4] and Honda Motor Company Ltd. v. Commissioner of Income Tax[5], the taxpayer argued that once the agent is remunerated at arm’s length, no further attribution can be made.

    The Judgement of the HC:
  • HC agreed with the ITAT’s conclusion that if activities of the agent in concluding contracts are not auxiliary in nature, and, at the same time it does not require concluding every single element of the contract, GE India’s activities constitute DAPE in India.
  • HC noted that the para 32 of OECD commentary states that lack of active involvement by an enterprise in transactions may be indicative of a grant of authority to an agent. Accordingly, para 32.1 of Commentary is contrary to para 33 of Commentary (relied upon the taxpayer). Therefore, the HC opined that a taxpayer could not selectively quote on certain parts of the commentary, instead must read the spirit of the entire commentary.
  • HC held the taxpayer has designed its activities in such a manner that it has employed technical officials with varying degree of authority. These technical officials work along with local managerial and technical employees –
    • In contract negotiation, often into core or ‘key’ areas
    • In modification of technical specifications
    • In negotiations of terms, to fulfil local needs and even local regulatory requirements
    • In the complexities of price negotiation, etc.
  • Furthermore, the taxpayer is performing all the above-referred activities solely for its group companies, in their core activities. HC opined that an agent of a foreign company is an agent of dependent status even if there is more than one company in the related group.
  • Based on the above, HC upheld ITAT’s view that the taxpayer carries out business through PE in India and GE India constituted DAPE in India for all overseas GE Group entities.
  1. Attribution of profits in India
  • HC had upheld ITAT’s view on attributing 10% of the value of supplies made to clients in India as profit arising from such supplies and attributing 26% of such profits to taxpayer’s PE in India considering that GE Group’s activities of making sales are India is roughly one-fourth of the total marketing efforts. 
 
[1] ITA No 621/ 2017; ITA No 627/ 2017, ITA No 628/ 2017, ITA 629/ 2017, ITA No 671/ 2017, ITA No 674/ 2017 C.M. Appl 29470/ 2017, ITA No 675/ 2017, CM Appl 29471/ ITA No 677/ 2017
[2] (IT) (2016) 383 ITR 648 (Del)
[3] ADIT 2013 (142) ITD 692 (Mum)
[4] 2014 (364) ITR 256
[5] 2018 (6) SCC 70
SKP Comments
Historically, the activities of LO, in general, are always subject to deep scrutiny by the Indian tax authorities from PE perspective. Similarly, the deputation of expats to India and constitution of PE also has been a highly litigated matter in India.
 
This decision once again brings to light the importance of documentation, roles and functions carried out by the Indian entity/LO. This clearly shows that transfer pricing documentation should appropriately capture the FAR (functions, assets and risks) performed by the Indian entity and transfer pricing should not be merely a compliance activity. Also, it is important to analyze on a periodic basis the functions performed by the liaison office and whether there is any need to change the business model in India.

This decision would have a far-reaching impact on the MNC’s operation in India as it gives an insight as to how minutely the Indian Revenue Authorities are examining the documentation and these kinds of structures. MNC’s operating in India, especially, with LO or through expatriates/long-term deputation shall relook at the functions performed in India by the LO/subsidiary/expatriates in light of the findings of Hon’ble High Court in this judgment. Also, with the introduction of BEPS related measures, now all the activities performed by the LO would require meeting the preparatory and axillary test in order to mitigate PE risk. Furthermore, it is also advisable that the MNC plans the deputation structure from a tax perspective at the initial stage to avoid litigation on activities of these deputations in future from tax perspective. 
SKP
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