Introduction
The concept of Permanent Establishment (PE) is a fundamental idea, which is intrinsic to double taxation agreements. The very existence of a PE, only determines the right of a contracting state to tax the profits of an enterprise of the other contracting state. There are three major types of PE which usually exist in double tax treaties:
Fixed PE
Agency PE
Service PE
This article looks at the Service PE concept in the UN Model Convention (MC), OECD MC and Indian tax treaties.
UN Approach
The concept of Service PE exists in Article 5 of UN MC. UN MC, which favors source based taxation, though does not specifically use the expression Service PE, but its Article 5(3) (b), which deals with the concept of Service PE reads as under;
The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than six months within any twelve month period
Developing and emerging economies, which are predominantly capital importing nations, generally try and negotiate Service PE clause in bilateral treaties, so as to tax profits of foreign enterprises operating within their territories, even in circumstances where no Fixed or Agency PE exists.
Indian Tax Treaties
Indias tax treaties are a combination of both OECD and UN MC. India does not follow a uniform definition of PE in its treaties, but is understandably more inclined towards UN approach, with emphasis on source taxation. In fact in certain treaties, for example, the one with United Kingdom, the definition of service PE is even wider than the one in UN MC. There is also a Service PE clause incorporated in the India-US Double Taxation Avoidance Agreement, even though no such concept exists in the US MC.
In recent years, most of the global businesses have entered India to profit from the growing market by way of joint ventures, liaison offices, representatives, branches, agents and also incorporation. This has resulted in spate of tax litigation, especially around the concept of permanent establishment, with the revenue taking a tough stance (fairly or unfairly) to protect and increase its tax coffers.
Indian Service PE
Service PE is attracted by the foreign enterprise in India, if the employees of the foreign enterprise furnish or perform services in India, other than the services covered under royalties or fee for technical services, for a specified period of time. Furnishing of services, and the time factor, are the most important check for attraction of Service PE.
There have been some landmark judgments on the Service PE concept in recent years. Two of those rulings are discussed below.
DIT Vs Morgan Stanley & Co
In this case, the Supreme Court of India had to determine, whether the deputation of employees by Morgan Stanley (MS), to its Indian affiliate Morgan Stanley Advantage Services Private Limited (MSAS), constituted a Service PE. Admittedly MS used to depute its employees to Indian Affiliate for a period exceeding one year. Supreme Court held, that though the US Company had no fixed PE in the country, but deputation of its employees for a period exceeding 90 days, as provided in the India-US Treaty, would attract Service PE in India, and thus MSAS would deem to be the Service PE of MS in India. The court held MSAS, the Indian Affiliate as the Service PE, and not the employees of MS.
Linklaters LLP Vs ITO
A recent ruling by the Mumbai Income Tax Appellate Tribunal has held Linklaters, a UK based global law firm, of having a Service PE in India. The Tribunal had to interpret the India-UK Article 5 dealing with PE, to arrive at the above conclusion. As per the Service PE clause in the treaty, a Service PE is deemed to exist, if there was any furnishing of services including managerial services through the employees or other personnel in the host country for a period exceeding 90 days in case of unassociated enterprise or 30 days in case of associated enterprise, within any twelve-month period.
Admittedly, several partners of the law firm visited India frequently for work, thus satisfying the above criteria. The Tribunal ruled, that the non-resident firm had a Service PE in India in light of above circumstances. The Tribunal also observed, that in order to constitute Service PE, permanence test need not be satisfied.
OECD Approach
Historically OECD has always expressed its preference for residence taxation and given justification for not including Service PE, but it now recognizes the growing role of developing nations, which is reflected in its commentary on Article 5. Though the 2008 update to the OECD Model did not change the definition of PE, but it did add in the commentary an alternative provision for states wishing to include it in their double tax conventions.
The Linklaters judgment is contrary to the OECD principle that a Service PE should not exist if the services are rendered outside the source country. In Linklaters, the services, which were rendered in UK, but utilized in India, were held to be taxable in India. The Tribunal also deviated from the OECD approach on partnership taxation and territorial nexus in the above ruling.
OECD has also stipulated, that Service PE should only exist in case of services provided to third parties only, but in the Indian treaties, Service PE is also deemed to exist even in case of services to associated enterprise.
Conclusion
It is crucial for multinational enterprises to carefully plan the movement of its employees and personnels across territories, so as to avoid giving rise to Service PE, especially in jurisdictions which have incorporated Service PE clauses in their double tax treaties. It is not necessary that deputation of employees would always give rise to Service PE unless there is furnishing of services through those employees.
With the labour becoming so mobile, it is likely that more nations would prefer having Service PE clause in their treaties. But on the contrary, it is possible, that with a few developing nations, especially emerging economies, becoming net exporter of capital rather than net importer, the service PE clause might not seem as attractive to them in future, as it seems now.