Permanent establishment costly despite shutdown

By Sumes Dewan, KR Chawla & Co

Foreign companies operating in India should carefully structure their operations with an eye on the tax collector. Shutting down a permanent establishement (PE) does not necessarily allow companies to avoid taxes in India if their proceeds are linked to a PE, even one that has already been shut down.

Sumes Dewan Partner KR Chawla & Co
Sumes Dewan
K.R. Chawla & Co

A non-resident or foreign company is treated as having a PE or business connection in India under Article 5 of the Double Taxation Avoidance Agreements (DTAA) or under Section 9 of the Income-tax Act, 1961, if it carries on business in India through a branch or sales office, or through an agent (other than an independent agent).

To qualify as a PE, the branch or agent should habitually exercise authority to conclude contracts, deliver goods or merchandise or regularly secure orders in India on behalf of the non-resident principal.

In these cases, the profits of the non-resident or foreign company attributable to the business activities carried out in India become taxable under the Income-tax Act, 1961.

Fixed location

A PE is a fixed place of business through which the business of an enterprise is carried out in whole or in part.

The actual operations of an enterprise have to be carefully examined in order to establish whether it does, in fact, have permanent establishment in India because the business profits can be taxed in India only if the foreign enterprise has a PE.

The definition of PE covers a wide spectrum of locations and places of business including a management or other type of office, a branch, a factory, a workshop, a mine, oil or gas well, quarry or other place of extraction of natural resources.

Important distinction

The permanent establishment concept is important because it distinguishes between enterprises that trade with a country and those that trade within it.

This is an important distinction.

Enterprises trading within a country are subject to taxation on the income and assets derived from its physical presence through a PE.

This insures that business activities will not be taxed by a state unless there is a significant economic relationship between the permanent establishment and the state.

Timing matters

The next very controversial issue that arises is whether income of a PE would be taxable in the financial year when it is received even if, by then, it is no longer a permanent establishment.

In the recent case of Van Gord Dredging v DDTT (reported in 105 ITD 97), the Mumbai Bench of Income-tax Appellate Tribunal considered the interesting circumstance of a foreign company that once had a permanent establishment in India but received the business profits attributable to it only after it had closed it down.

Facts of the case

The brief facts are that the business liable for the taxes is a resident of Netherlands.

During 2001-02, the assessee executed contracts in India.

For this purpose it had maintained project and site offices in India, established with the approval of the Reserve Bank of India.

In this case, the PE was admittedly in existence in India during the earlier assessment years 1995-96 and 1996-97 and the income received by the assessee-company during the assessment year 2001-02 was attributable to the PE.

However, the PE of the assessee for the project that received the profits in 2001-02 had been shut down before the income was received.

Relevant laws

A reading of the relevant Articles 5 and 7 of the DTAA between India and the Netherlands shows that there are only two basic conditions for taxing an amount received by the assessee in India.

The first condition is that the assessee should have a permanent establishment in the country. The second is that the income should be attributable to the said PE.

In the case, the court held that since the assessee had a PE in India and also income of more than US$7.5 million which was attributable to the PE in India, and since there is no condition that PE should be in existence in India in the year of receipt of proceeds by the enterprise in question, the total received by the company was liable to tax.

The court held that “the project has rightly been taxed by the Assessing Officer as income of the assessee-company for the assessment year 2001-02”.

Sumes Dewan is a partner at KR Chawla & Co Advocates & Legal Consultants. The firm is headquartered in New Delhi and has offices in Chennai and Bangalore as well as a representative office in Singapore.

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