Tax All rights reserved PE & PROFIT ATTRIBUTION | 1 Tax

All rights reserved PE & PROFIT ATTRIBUTION Permanent establishment & Profit attribution - Recent developments April 23, 2010 CA Darpan Mehta

Tax All rights reserved PE & PROFIT ATTRIBUTION | 3 Disclaimer This presentation provides general information existing at the time of its preparation. The presentation is meant for general guidance and no responsibility for loss arising to any person acting or refraining from acting as a result of any material contained in this publication will be accepted by the Presenter. It is recommended that professional advice be taken based on the specific facts and circumstances. This presentation does not substitute the need to refer to the original pronouncements

Tax All rights reserved PE & PROFIT ATTRIBUTION | 4 Contents Recent controversies on Permanent Establishment (‘PE’) and profit attribution  Seagate Singapore International  BBC Worldwide Limited  Aramco Overseas Company BV Case Study: Attribution of profits to an Agency PE Whether arms length remuneration to Agency PE extinguishes tax liability  Judicial Precedents

Tax All rights reserved PE & PROFIT ATTRIBUTION Recent controversies on Permanent Establishment and Profit Attribution

Tax All rights reserved PE & PROFIT ATTRIBUTION Facts of the case  Seagate Singapore International Headquarters Pvt Ltd (‘Seagate’): Tax resident of Singapore Manufactures and sells hard disk drives to Original Equipment Manufacturers (‘OEMs’) in India  Proposed Venture: To enter into arrangements with Independent Service Providers (‘ISPs’) who will stock the disks in India and supply it to OEMs on a Just-in-Time basis Questions before the AAR  Whether ISPs would constitute a PE?  If so, what would be the income attributable to the PE, if it has been remunerated on an arms length basis? Seagate – Background 1/3 Applicant OEMs ISPs Bonded Warehouse Invoice Purchase Order Disk Delivery Fees Agreement with ISPs SingaporeIndia Proposal to put a Vendor Management Inventory model Agreement with ISPs to stock and deliver on JIT basis Operating system of ISPs to support electronic data interchange, furnish receipt, sale advice and inventory reports

Tax All rights reserved PE & PROFIT ATTRIBUTION Revenue:  The warehouses of ISPs would constitute a ‘fixed place of business’ and thus would result into a PE of Seagate.  Alternatively, can be constituted as agency PE Seagate:  Applicant would not have any premises or facilities neither any installations owned, leased or at its disposal in India  Goods would be stored in warehouses of ISPs in India wherein it would have a restricted right of entry  No employees would be based in India  No other physical presence in India Seagate – Contentions of the Revenue and Applicant 2/3

Tax All rights reserved PE & PROFIT ATTRIBUTION Whether ISPs constitute a PE?  Demarcated space in the warehouse constitutes a fixed place PE in India Fixed place meaning ‘distinct situs’ or an ‘earmarked place’ with racks and electronic services  As per the agreement with ISPs ISPs to provide adequate warehouse space at a specified location Applicant’s representative to have the right to enter the warehouse premises for the purposes of physical inventory, inspection, audit, repackaging etc Both applicant and ISP act in cohesion to ensure that goods are delivered promptly  Following facts are not conclusive Ownership / Possession / Operation of ISP’s warehouse Merely outsourcing the operations to ISP’s (and not applicant’s employees) Income attribution to PE  For computing profits of the PE in relation to the sales activity: Treat ISP as a separate and distinct enterprise wholly independent of Seagate Amounts paid to the ISPs and other expenses, incurred should be deducted from attributable profits Seagate – Ruling of the AAR 3/3 For a PE under fixed rule: (i) place of business (ii) degree of permanent set up (iii) place of business at the disposal of the foreign enterprise

Tax All rights reserved PE & PROFIT ATTRIBUTION Facts of the case  BBC Worldwide Limited (‘BBC’): Tax resident of UK Sister concern of the BBC Group which operates the BBC World News Channel (‘the Channel’)  Proposed Venture : BBC appointed BBC Worldwide (India) Private Limited (‘BWIPL’) (a group company) as its authorized agent In consideration, BWIPL received a commission of 15% of the advertisement revenues received by BBC from Indian advertisers Questions before the Tribunal:  Any additional income which remains to be taxed in India, in the hands of BBC, despite of payment at arms length basis? BBC (UK) BBC (India) Appointment of agent for sale of airtime in India 15% Agreement entered between: BBC and BBC India under Airtime Sales Agreement Agent’s role: solicit orders for sale of advertisement airtime on the Channel collect payments from Indian advertisers remit the payments received Remuneration: Commission of 15% of the gross advertisement revenues received by BBC BBC – Background 1/3 UK India Advertisers sale of airtime in India Revenue

Tax All rights reserved PE & PROFIT ATTRIBUTION Revenue: Dependent Agent PE Besides soliciting orders, BWIPL also engaged in activities of sales promotion, airtime and sponsorship, identifying new clients and distributors Morgan Stanley - not applicable Functions, Assets and Risk analysis (‘FAR’) is not carried out Wrongly equated the assessment of Indian agent with that of dependent agent PE Presumptive rate of tax Since no different sets of figures of receipts and expenditure - Circular 742 dated May 2, 1996 would be applicable BBC: Reference was drawn to transfer pricing order of the subsequent year wherein the tax authority has accepted the Fair Transfer Price (‘FTP’) on a FAR Analysis BWIPL been remunerated on the basis of a FTP Commission received by BWIPL fully represented the value of the profits attributable to its services - Circular 23 of 1969 BWIPL was remunerated on an arm’s length basis, no further income could be brought to tax Reference to following circulars and judicial precedents: SET Satellite (Singapore) Private Limited (Bom) (307 ITR 205) Morgan Stanley and Company Inc (SC) (292 ITR 416) DIT v Galileo International Inc (180 Taxman 357) BBC – Contentions of the Revenue and Applicant 2/3

Tax All rights reserved PE & PROFIT ATTRIBUTION Tribunal held:  The case has direct applicability of: Apex Court in the case of Morgan Stanley Bombay High Court in the case of SET Satellite (Singapore) Rate of 15% is appropriate as also followed by SET Satellite (Singapore) BBC had filed its country-wise accounts for India with the tax authorities and difference arose because of foreign exchange fluctuation Circular 742 would have been applicable only if: BBC is a non-resident foreign telecasting company; BBC does not have a branch office or PE in India and BBC does not maintain country wise accounts of its operations BBC - Ruling of the Delhi ITAT 3/3 If the correct arm’s length price is applied and paid to the agent in India, nothing further would be left to be taxed in the hands of the foreign enterprise

Tax All rights reserved PE & PROFIT ATTRIBUTION Facts of the case:  Aramco Overseas Company BV (‘Aramco BV’): Tax resident of Netherlands Subsidiary of Saudi Arabian Oil Company (‘Saudi Aramco’)  Aramco BV to provide the following to Saudi Aramco and group companies:  Supply Chain Management services (SCM)  Technical, financial and administrative support  Aramco BV gets remunerated on cost plus 5% mark up  Proposed venture of Aramco BV  Setup a liaison office in India (‘Aramco India’) to provide similar services to its group companies  Undertake Procurement Support Services (‘PSS’) for the purpose of export of goods required by Saudi Aramco and group companies Questions before the Tribunal:  Income arising on account of PSS to be rendered by Aramco India, in connection with exports to Saudi Aramco / group companies be taxable in India? Saudi Aramco BV Aramco – Background 1/3 Saudi Arabia India Aramco India Netherlands Agreement to render PSS Agreement between Saudi Aramco and Aramco BV Proposal to set up Indian office for assisting with PSS Export of goods Agreement for SCM Cost + 5% mark up

Tax All rights reserved PE & PROFIT ATTRIBUTION Revenue:  The fact that the actual export was done by Aramco India does not detract from the position that the goods purchased by the applicant through the support of its regional office were meant to be exported  Aramco India mainly facilitated the purchases made by the applicant  No direct link as a purchaser of goods nor as an agent of such purchaser Aramco:  PSS activities in India:  Undertaken by Aramco India for its group companies  The activities are directed towards purchase of goods for the purpose of export  The income tax law exempts income arising from such activities even if purchaser is any other non-resident  Aramco India was to be funded by reimbursements with no profit element thereon Aramco – Contentions of the Revenue and Applicant 2/3

Tax All rights reserved PE & PROFIT ATTRIBUTION Ruling  Exemption from tax only if: Operations are confined to purchase of goods in India for the purpose of export  No exemption if the service provider is neither – the purchaser of goods nor an agent of such purchaser  Merely by facilitating purchases made by a non-resident does not provide exemption  Applicant was unable to factually substantiate that it rendered the PSS as an agent Failed to file any documents or give authenticated evidence to support the contention  Applicant’s income does not arise in India from purchase operations but from support services rendered in connection with purchases by third parties  The applicant’s income is based on mark-up allowed on the costs and not on the volume or value of purchases Aramco - Ruling of the Delhi ITAT 3/3 If purchase operations are not undertaken on ones own account or as an agent of group company, tax liability arises in India

Tax All rights reserved PE & PROFIT ATTRIBUTION Has the AAR expanded the scope of PE in Seagate ruling  The use of the word ‘occasional delivery’ with reference to the fixed place rule of Article 5(1)  Restricted rights, since the warehouse may not be at the disposal of Seagate  The conclusive facts  The specific demarcation of warehouse space for Disks  The restricted rights of entry & inspection of the premises Single vs dual entity approach  Takeaway from Seagate ruling?  Any inferences from the Aramco ruling? Key discussion points

Tax All rights reserved PE & PROFIT ATTRIBUTION Case study: Attribution of profits to an Agency PE

Tax All rights reserved PE & PROFIT ATTRIBUTIONImpact of Circular No 7 of 2009 | 17 Relevant facts 1/2 Facts of the case:  X is a Singapore based manufacturer  X sells its products to customers in India through its selling agent Y  Y undertakes the entire sales activity  X has no presence in India  As per the agency agreement between X and Y, Y acts for the account and at the risk of X in performing marketing, sales and distribution activities in India  In return, X pays Y a commission, calculated as a percentage of sales revenue Key questions:  What is the appropriate FAR for Y; Is this FAR different from the FAR of the Agency PE that X has in India  Applying the principle that arms length remuneration to Y extinguishes further tax liability for X X Y Singapore India Customers Agreement for selling agent Manufacturing goods Sale of goods Revenue

Tax All rights reserved FAR Analysis for the Sales function 2/2 Functions, Assets and Risks AnalysisYAgency PE of X Functions Product ordering√? Marketing - sales force√? Marketing / advertising strategy√? Warehousing / inventory management√? Delivery / shopping√? Debt management and collections√? After-sales support√? Assets Inventory ? Property, plant and equipment (distribution)√ Receivables ? Risks Inventory risk ? Credit risk ? Foreign exchange risk ?

Tax All rights reserved PE & PROFIT ATTRIBUTION Arms length remuneration to Agency PE extinguishes tax liability

Tax All rights reserved PE & PROFIT ATTRIBUTION | 20 Whether arms length remuneration to Agency PE extinguishes tax liability 1/2 Case LawPrinciples Morgan Stanley and Co Inc [Supreme Court]  Existence of ‘economic nexus’ as opposed to legal and financial nexus important for income attribution  PE to be considered as a distinct and independent enterprise for profit attribution  No further attribution required if PE is compensated at arms’ length  Compensation to PE – based on FAR analysis and adequate transfer pricing documentation SET Satellite (Singapore) Pte Ltd [Bombay High Court]  Attribution based on FAR analysis  No further attribution required if dependant agent PE is compensated at arms’ length BBC Worldwide Ltd [Delhi Tribunal]  Reliance placed on Set Satellite and Morgan Stanley  No further attribution required if PE is compensated at arms’ length

Tax All rights reserved PE & PROFIT ATTRIBUTION | 21 Whether arms length remuneration to Agency PE extinguishes tax liability 2/2 Case LawPrinciples Galileo International Inc [Delhi Tribunal]  Income attributable to Indian operations of non-resident – determined on the basis of FAR analysis  No distinction between DAPE and DA  15% of income - deemed to be attributable to the PE, since the PE was remunerated at a higher rate, no further attribution made  No further attribution if DA is compensated at arms’ length  Consistent with SET Satellite Seagate [AAR]  Ownership of warehouse / outsourcing of sales activity not a conclusive test to determine whether a PE is constituted or not  Dual entity concept suggested for attribution of profits ?

Tax All rights reserved PE & PROFIT ATTRIBUTION | 22 Tax