Tax Alert | Delivering clarity - 15 March 2021 - Deloitte
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Tax Alert | Delivering clarity
15 March 2021
Existence of PE based on activities of subsidiary, taxability of offshore supplies
The Authority for Advance Ruling rendered its decision that based on the facts of the case, the
business transaction and related activities with subsidiary did not result in constitution of a
permanent establishment of the taxpayer in India under the India-Japan tax treaty. Further, the
offshore supplies were not taxable in India as their title passed outside India.
Background:
• The taxpayer1, a corporation established under the laws of Japan, is engaged in the business of
manufacturing automobiles, ranging from small general-purpose engines to scooters, motorbikes,
passenger cars, aircrafts, specialty sports cars, etc.
• The taxpayer had entered into various agreements with its Indian subsidiary (I Co). Amongst others,
it included an agreement for supply of parts / components for manufacture of specified car models
in India on cost & insurance basis (C&I), wherein the title and risk in goods transferred at the port of
delivery. Further, I Co also imported cars (as a completely built-up unit) from the taxpayer on
principal-to-principal basis. Certain capital goods were also sold to I Co on C&I basis.
• The taxpayer sought an advance ruling from the Authority for Advance Ruling (AAR) on the following
questions in relation to the above supplies:
─ Whether the taxpayer had a permanent establishment ('PE') in India by reason of its business
transaction and related activities with I Co, under the provisions of India-Japan tax treaty (‘tax
treaty’)?
─ Whether the amount received / receivable by the taxpayer from I Co as a consideration for
offshore supply of raw materials / components / capital goods and cars was liable to tax in India
under the provisions of the Income tax Act, 1961 (‘ITA’) and the tax treaty?
─ If answer to first two questions is negative, whether I Co would be liable to withhold taxes under
section 195 of the ITA on payments made to the taxpayer towards the offshore supplies?
• The taxpayer, amongst others, contended before the AAR that it did not have a PE in India on the
following basis:
─ I Co was not acting as an agent on behalf of the taxpayer, to perform its business operation in
India and was an independent entity, undertaking its own risks and enjoying rewards. It secured
and concluded the contract for sale of cars in its own name and under its sole risk and
responsibility, and not on behalf of the taxpayer.
1 Honda Motor Co. Ltd., In re [2021] 124 taxmann.com 225 (AAR - New Delhi)
©2021 Deloitte Touche Tohmatsu India LLP─ The transaction with I Co was on principal-to-principal basis at arm's length price which was
accepted / adjusted by transfer pricing authority in the past years.
─ The exercise of control / supervision of the taxpayer was limited in its capacity only as a
shareholder and it was not involved in day-to-day operations / decision making of I Co.
─ The taxpayer did not have any premises at its disposal in India and the technicians / experts,
visiting India as per specific request of I Co rendered technical training / services without getting
any designated place in the office / factory premises of I Co.
─ The taxpayer's employees during their deputation period to I Co, worked under the control and
supervision of I Co. Therefore, they could not be held to be carrying out any business activity of
the taxpayer in India.
• To controvert the above, the Revenue contended that the taxpayer had a PE in India on the
following basis:
─ The survey operations in I Co’s premises (a separate proceeding) had brought on record material
to show that I Co did not function as an independent corporate entity and that taxpayer’s
business functions were carried out in India through their employees. I Co served as a fixed place
of business through which taxpayer’s business was being carried out.
─ I Co was headed by an employee of the taxpayer (who was also a Director of the taxpayer) and
all its major departments were headed by taxpayer’s employees .
I Co had no say either in the mode and manner of the selection or the placement of the
expatriate employees of the taxpayer, for their assignments in India. These employees had lien
over their employment with the taxpayer and they were assigned the jobs in India for a specific
period by either the head office or the regional offices of the group. Further, they reported to
the regional headquarters or the head office.
Such employees were not in India as mere deputationists working for the I Co, but they were
representing the taxpayer in India and doing functions on its behalf. They were not only
controlling and supervising the operations of the I Co, but they were also carrying out the
following business functions of the taxpayer:
o Conducting market surveys to explore business opportunities in India;
o Supervision, maintenance, development and promotion of brand in India;
o Negotiating and concluding the price at which cars and spare parts were to be exported to I
Co and the import of the same by the I Co;
o Looking after every aspect of foreign operations of the taxpayer in India; and
o Undertaking post sale functions in respect of cars on behalf of taxpayer.
Accordingly, the expatriate employees seconded by the taxpayer constituted a fixed place PE
under Article 5(1) of the tax treaty.
• The taxpayer rebutted the contentions of the Revenue for consideration by the AAR.
©2021 Deloitte Touche Tohmatsu India LLPCertain relevant provisions in brief:
• As per Article 5(1) of the India-Japan tax treaty (relating to PE) the term 'permanent establishment'
means a fixed place of business through which the business of an enterprise is wholly or partly
carried on.
Decision of the AAR:
Constitution of PE
• The AAR noted that the general definition of the term PE in Article 5(1) of the India-Japan tax treaty
postulates two conditions to be fulfilled, namely:
i. the existence of a fixed place of business, and
ii. the business of an enterprise is wholly or partly carried out in India through such fixed place.
Accordingly, it observed that the question to be answered was whether the expatriate employees of I
Co (seconded by the taxpayer) constituted the existence of fixed place of business? If, whether activities
undertaken by I Co through its expatriate employees would also fall within the ambit of the expression
"the place through which the business of an enterprise is wholly or partly carried out" in Article 5(1) of
the tax treaty?
Existence of a fixed place of business:
• Based on perusal of the statements recorded during the survey proceedings, the AAR observed that
the appointment and transfer of the expatriate employees (with the I Co) was regulated by the
taxpayer or its regional headquarters.
Accordingly, the AAR held that the taxpayer had a fixed place of business in India and the first
requirement for constitution of a PE was fulfilled in the form of office space of the employees.
However, it further observed that the fixed place of business would result into PE only if it was used
for carrying on the business of the taxpayer either wholly or partly.
Business wholly or partly carried in India through fixed place:
• The AAR dismissed the Revenue’s contentions that I Co was carrying on business on behalf of the
taxpayer in India on the following basis:
─ No evidence was brought on record (by the Revenue) that the expatriate employees were
performing functions on behalf of the taxpayer. A mere reporting to the regional headquarters
or the head office did not establish that the expatriate employees were doing functions on
behalf of the taxpayer.
─ The market surveys were conducted by I Co in order to launch the models in the Indian market
and such market surveys were not conducted on behalf of the taxpayer.
─ As regards brand building exercise, 95% of I Co’s sales came from its own manufacturing and
therefore, maintenance, development and promotion of the brand was more in the interest of I
Co than the taxpayer. The promotion of taxpayer’s brand in the Indian market was done for the
©2021 Deloitte Touche Tohmatsu India LLPpurpose of supplementing the business opportunities in India. Thus, it could not be said that by
promoting the brand in India, I Co had carried on taxpayer’s business activity.
─ With respect to negotiating and concluding the price at which the car and spare parts were to be
exported to I Co, the taxpayer had submitted evidences that cost comparison amongst foreign
supplier entities was done by I Co and the parts were imported from the entity offering the least
cost on competitive basis. Further, I Co could not become an extension of the taxpayer merely
on the ground that the employees placed the order and negotiated the price.
─ All the imports of cars and spares were made by I Co and therefore, the warranty claims were in
favour of the I Co. The warranty claims in respect of defective parts were settled by I Co and
then, reimbursed by the taxpayer. The fact that certain claims made by I Co were not reimbursed
by the taxpayer could not lead to a conclusion that I Co carried on business on behalf of the
taxpayer.
Similarly, for post-sale functions, since the cars were first imported by I Co and then sold to the
customers, it could not be said that such functions were done on behalf of the taxpayer.
─ The AAR distinguished Revenue’s reliance on an earlier decision2 on facts. The AAR in that case
had lifted the corporate veil as the parent took decisions on behalf of its subsidiary for
conducting the business, which was absent in the case under consideration.
─ As regards the Revenue’s contention that management activities were being carried out in India,
the AAR observed that activities of the employees related to the specificity of the products,
market surveys, promotion of brands, market strategies, etc. which were within the ambit of I
Co’s business and not of the taxpayer.
By sharing periodic reports, the employees were only discharging the duties of the I Co towards
the taxpayer.
Accordingly, the AAR held that no business of the taxpayer was conducted through the employees,
working with the I Co. As the condition precedent for carrying on of the business was not fulfilled, it
could not be held that the taxpayer had a PE under Article 5(1) of the tax treaty, even if it had a fixed
place of business in the form of employees.
Offshore supply of raw material / components / capital goods
• The AAR noted the following on perusal of the Memorandum on Supply of Parts entered into
between the taxpayer and I Co:
─ The parts were sold at prices on Free on Board of shipment in Japan, in case of delivery by sea or
on Free Carrier (FCA) place of delivery in Japan in case of delivery by air; plus, cost of insurance
for transportation from the port of shipment/delivery to India.
2 AB, Mauritius (AAR no. 1128 of 2011)
©2021 Deloitte Touche Tohmatsu India LLP─ The title to the parts supplied by the taxpayer were transferred outside the territory of India
upon loading of the parts on to the mode of transport, to be used to convey the same from the
country of origin and upon endorsement of dispatch document in favour of the purchaser.
Further, the payment of the price of the parts delivered was made via telegraphic transfer in
Japanese Yen (JPY) to the bank account of the taxpayer.
Thus, the AAR observed that the facts clearly established that the supply of parts was made outside
India and the transfer of title to the parts also took place while the goods were outside the territory
of India.
• The AAR relied on an earlier decision3 wherein it was held that offshore supply will not be taxable in
India if the property and risk in the equipment passed outside India.
• In view of the above, the AAR held that since the sale was completed outside India and the payment
was made in foreign currency outside India, the consideration received towards offshore supply was
not chargeable to tax in India.
Withholding tax obligation
• Considering that the receipt was not chargeable to tax India, the AAR held that there was no
requirement of withholding tax under section 195 of the ITA.
Conclusion of the AAR
Based on the above and on the facts of the case, the AAR answered the questions raised by the taxpayer
as under:
• The taxpayer would not be considered to have a PE in India by reason of its business transaction and
related activities with I Co under the provisions of the tax treaty.
• The amounts received / receivable by the taxpayer from I Co as a consideration for offshore supply of
raw material / components / capital goods would not be liable to tax in India under the provisions of
the ITA and the tax treaty.
• I Co was not liable to deduct tax at source under section 195 of the ITA on the offshore supply of
parts to the taxpayer.
Comment:
This ruling affirms the principle that in order to constitute a fixed place PE under Article 5(1) of the
India-Japan tax treaty; in addition to a fixed place of business in India, the non-resident taxpayer should
also carryout business activity through such a fixed place.
It is pertinent to note that the tax treaty does not have a service PE clause.
3 Ishikawajima-Harima Heavy Industries Ltd. vs DIT [2007] 158 Taxman 259/288 ITR 408 (SC)
©2021 Deloitte Touche Tohmatsu India LLPTaxpayers’ may want to evaluate the impact of this ruling to the facts of their specific case. It may be important to
note that an advance ruling is binding only on the applicant and the tax authorities in respect of the relevant
transaction. It only has a persuasive value in the case of other taxpayers.
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