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December 14, 2007
Indian Revenue Authorities getting more aggressive on
attribution of profits: Rolls Royce held to have a PE in India
In a recent decision in the case of Rolls Royce Plc.[1]
(“RRPLC”), the Delhi Bench of the Income Tax
Appellate Tribunal (ITAT), has held that RRPLC
has a business connection as well as a permanent establishment (“PE”)
in India on account of the marketing activities and support
services carried on by its subsidiary in India and has
attributed 35% of its profits to the Indian PE constituted in
India.
Facts of the Case
RRPLC, is incorporated in the UK, and is in
the business of supplying aero-engines and spare parts to a
number of Indian customers mainly to Hindustan Aeronautics
Limited, Indian Navy and Indian Air Force. RRPLC has a wholly
owned subsidiary, M/s Rolls Royce India Ltd. (“RRIL”) incorporated in the UK
but having an office in
India.
RRIL was engaged in the
business of marketing and liaising with the customers and
providing administrative and technical support in
India.
Decision
The ITAT held that a business connection clearly
existed under the Income Tax Act, 1961 since RRIL facilitated
the business and the earning of profits of the taxpayer and
there was a real and intimate connection in their dealings.
Further, the ITAT noted that:
-
RRIL is a fixed place of business at the disposal of RRPLC and
its group companies in India through which their business is
carried on;
-
The activity of this fixed place is not a preparatory or
auxiliary but is a core activity of marketing, negotiating and
selling of the product;
-
RRIL acts almost like a sales office of RRPLC and its group
companies;
-
RRIL and its employees work wholly and exclusively for RRPLC and
the group;
-
RRIL and its employees are soliciting and receiving orders
wholly and exclusively on behalf of the Rolls Royce group;
-
The personnel working from the premises of RRIL are in fact
employees of RRPLC.
All the above factors led the ITAT to conclude that RRPLC had a
PE in India within the meaning of Articles 5(1), 5(2) and 5(4)
of the Indo-UK Tax Treaty.
With respect to attribution of profits, the ITAT rejected the
plea that since RRIL was remunerated on an arm’s length basis,
no further profits could be attributed to the PE in India.
Instead, the ITAT held that Article 7(3) of the India UK Treaty
provides for direct as well as indirect income attribution to
the PE involved in negotiating, concluding or fulfilling
contracts, and hence observed the following:
-
the total profits of the enterprise have to be apportioned
on the basis of various factors affecting accrual of income
-
a functional and factual analysis of the activities of the
PE has to be undertaken
-
the economically significant activities and responsibilities
undertaken through the PE have to be identified
-
due consideration is to be given to the activities and
responsibilities undertaken through the PE in the
enterprise’s overall operations
-
the attributable income has to be determined by due
application of the arm’s length principle by reference to
the functions performed, assets used and risk assumed by the
enterprise through the PE and through the rest of the
enterprise.
Based on the above, the ITAT held that since the taxpayer
undertook all manufacturing and research and development
activity outside India and the PE was only engaged in marketing
activities, the attribution of profits was reduced from 75% (as
held by the Assessing Officer) to 35% of the global profits of
the taxpayer with respect to sales made in India.
Observations
The above decision comes in stark contrast to the recent
decision of the Supreme Court in the case of Morgan Stanley[2]
wherein the apex Court had held that in the event that the
Indian entity was remunerated on arm’s length basis, no further
profits could be attributed to the PE constituted in India.
Further, the Supreme Court in the Morgan Stanley ruling had also
held that even the office of an Indian subsidiary could not be
held to be a PE of the foreign entity in India. While Supreme
Court judgments are considered to be law of the land, this
decision has been completely ignored by the ITAT while
delivering its judgment.
It may be noted that this ruling follows the Mumbai ITAT
decision in the case of SET Satellite (Singapore) Pte Ltd.[3]
where the ITAT had upheld the dual entity approach while
analyzing the attribution of profits in India on account of an
agency PE being formed in India. It may also be interesting to
note that following the Vodafone tax controversy, the revenue
authorities have reopened about 400 cases of private equity
transactions including transactions where shares of an offshore
entity holding shares of the Indian entity have been transferred
outside India. This continuing aggressiveness of tax authorities
in India could result in new challenges for multinationals
investing into India, or doing business in India.:
________________________
1 - ITA Nos. 1496 to 1501/DEL
of 2007, 26 October 2007
2 - Civil Appeal No. 2914 of 2007 (Arising out
of S.L.P. (C) No. 12907 of 2006) and Civil Appeal No. 2915 of
2007 (Arising out of S.L.P. (C) No. 16163 of 2006) decided on:
09.07.2007.
3 - ITA No. 535/Mum/04,
Assessment year 1999-2000
Source:
Rolls Royce PLC vs DDIT
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