Brief facts of the case
- Nokia Networks OY (‘assessee’), a finish company was engaged in the manufacturing of GSM equipments to be used in fixed and mobile phone networks and trading of telecommunication of hardware and software.
- The assessee sold its products to Indian customers outside India on principal to principal basis under an independent buyer-seller agreement. It established a Liaison office (‘LO’) in India to support the assessee in carrying out the installation and other related activities.
- Subsequently, the assessee had set up a wholly owned subsidiary, Nokia India Private Limited (‘NIPL’) and all the contracts for installation were either assigned or separately entered by the NIPL with the customers.
- Further, NIPL entered into two more contracts, one being a technical support agreement with the Indian telecom operators and other being a marketing support agreement with the assessee.
- During the course of the assessment proceedings, the assessing officer held that the LO and NIPL constituted permanent establishment (‘PE’) of the assessee in India. Also, it held that the assessee supported NIPL in carrying out installation activities and therefore, there is constitution of installation PE. 70% of the equipment revenue was attributed to the sale of hardware whereas remaining 30% was attributed to supply of software and taxed as royalty.
- The issue came up for consideration before the special bench of Income Tax Appellate Tribunal, Delhi (‘ITAT’). It held NIPL as the PE of the assessee in India since the assessee virtually projected itself in India through NIPL and common personnel. It further noted that NIPL undertook certain activities on behalf of the assessee such as network planning, negotiation in connection with sale of equipment and signing and supply and installation contract.
It further held that the LO does not constitute PE of the assessee in India and no part of income from the offshore sales taken place outside India should be taxed in India.
- Aggrieved, both the assessee and IT department filed an appeal before the Delhi High Court which ruled in favour of the assessee with respect to the grounds related to off shore supply and constitution of LO as PE. Also, it remitted the issue of constitution of NIPL as PE or business connection to ITAT for deciding the matter afresh based on proper appreciations of facts on record.
- It contended that NIPL did not provide any business connection while undertaking the sale transaction as it was not involved by any means in selling the goods outside India. The contract entered before the constitution of NIPL were concluded in the capacity of the country manager of LO.
- With respect to the issue constitution of PE, it contended that examination should be done from the point of view of DAPE only as constitution of fixed place PE should require the satisfaction of disposal test which was missing in the case of the assessee.
- Also, it contested that the basic condition specified in article 5(5) of the tax treaty, which is subject to the activities being in the nature of preparatory or auxiliary, for the constitution of DAPE could not be satisfied as the assessee was not involved in negotiating or signing contracts on behalf of the assessee.
- No business of the assessee was carried out through the expatriates rendering technical support. All expatriates were working as the employees of NIPL under its complete control and supervision.
- The assessee was carrying out negotiations, network planning and marketing of its business through the fixed place in the form of NIPL.
- It argued that the employees of the assessee were seconded to NIPL which indicated that the assessee’s presence in all the activities of NIPL. Also that the employees working for the assessee and NIPL were same which constituted service PE, fixed place PE and DAPE of the assessee in India. It further contended that these seconded employees constituted installation PE in India.
- Provisions of the facilities like telephone, fax, vehicles by NIPL to the employees of the assessee further evidenced the constitution of fixed place PE basis the existence of a place at the disposal of the assessee.
- Also, there was a contention that NIPL was dependent on the assessee as its ownership could not be diluted.
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The majority members of the ITAT ruled in favor of the assessee holding that no PE of the assessee gets constituted in India. While holding the same, it made the following observations:
- The special bench has examined the concept of fixed place PE in light of Article 5 of India-Finland DTAA and propositions laid down by SC in Formula One ruling and E-Funds and international lax commentaries.
- According to the Supreme Court the ‘disposal test’ is paramount which needs to be seen while analyzing fixed place PE under Article 5(1). Key sequitur and proposition which is culled out from the SC judgment is as under.
- Firstly, the fixed place should be where the commercial and economic activity of the enterprise is carried out;
- Secondly, such a fix place acts as a virtual projection of the foreign enterprise;
- Thirdly, PE must have three characteristics, stability, productivity and dependence; and
- Lastly, fixed place of the business must be at the disposal of the foreign enterprise through which it conducts business.
- ITAT special bench examined various kinds of contracts/ activities undertaken by assessee and the facts and material on record, specifically with reference to the following activities which have been identified by HC while remanding the matter back to the Tribunal.
- Signing of contracts;
- Network planning;
- Negotiation of off-shore contract in India.
Whether NIPL is a fixed place PE of Nokia Networks OY?
ITAT rules that providing telephone or fax or conveyance services can never be equated with fixed place. ITAT states that Revenue could not bring any further material support or evidence that any physical place was made available which can be said to be at the disposal of the assessee for carrying out its off-shore supply contract in India. Hence, ITAT holds that the test laid down by SC does not get satisfied in this case as nothing has been brought on record by Revenue that any physical space was made available which can be said to be at the disposal of assessee for assessee’s own business of supply and sale of equipment.
Whether NIPL constitutes dependent agency PE?
ITAT observes that there is no material fact on record that NIPL has negotiated or concluded any contract of supply of equipment on behalf of the assessee which binds the assessee. Further, ITAT observes that the title of the goods supplied is directly passed on to the customers in India and NIPL neither undertakes any negotiation process nor assist in delivery of goods. Further, ITAT observes that the NIPL neither has any authority to conclude contracts for supply nor any of the orders has been booked by NIPL which can be said to be binding upon the assessee.
Whether NIPL is the ‘virtual projection’ of assessee?
ITAT rejects Revenue’s stand that the Indian subsidiary is a virtual projection of the assessee as employees of assessee company were practically performing all kinds of work, and therefore, it has to be treated as a PE of assessee. ITAT clarifies that “The concept of ‘virtual projection’ flows from the fixed place itself or with any other parameters of establishment of PE under Article 5. This concept alone is not relevant but has to be seen in relation to fixed place or any other concept of PE.
Whether Nokia Networks Oy had any kind of a business connection in India in the form of NIPL?
At the outset, ITAT clarifies that “Though this issue has become slightly academic in view of our above finding, because even if it is held that assessee had a business connection in India, then also under the treaty provisions, if there is no PE in terms of Article 5, then no income can be attributed to India under Article 7….but, for the sake of completeness, we shall discuss in brief, whether the assessee was having any kind of business connection in India or not”. ITAT re-iterates that in the present case, the goods were manufactured outside India and even the sale has taken place outside India and once this fact is established even in those cases where there is a one composite contract supply has to be segregated from installation and only then would question of apportionment arise having regard to expressed language of Section 9(1)(i) of the Act, which makes the income taxable in India to the extent it arises in India.
However, dissenting from majority view, ITAT Member Shri Pramod Kumar gave a separate ruling on the issue of constitution of PE/ existence of a business connection, and held as under:
- The assessee and NIPL were carrying out business activities in tandem and NIPL’s work cannot be seen on standalone basis. Thus, taking note of interdependence and interconnection between assessee and NIPL, he upholds existence of business connection.
- He holds that the fixed place of business and the disposal tests are not relevant for unassociated or indirect Pes
- He also rejects assessee’s reliance on Formula One ruling to contend that since the conditions precedent for existence of a fixed place PE, i.e. right to disposal, stability and productivity, are not satisfied, there cannot be a PE even if there is a virtual projection of the foreign enterprise by the NIPL.
- He thus holds that 35% of 10.8 % of global profit on sales can be allocated to marketing functions carried out in India. He then rounds off the attribution to 3.75% of sales.
This is a landmark ruling, though ruled in favor of the assessee, has left the door for future litigation on this matter open.
Owing to the varying ruling on the concept of Fixed place PE and Dependent Agent PE, the litigation on this matter has increased substantially. The tax department invariably alleges a PE of foreign entity, irrespective of the period of existence, extent of existence, extent of activity undertaken and the right to disposal available to the foreign entity.
The dissenting judge’s ruling in this case has opened a Pandora box, especially owing to the fact that the well settled position on disposal test have been challenged. Also, mere interdependence and interconnection between the foreign entity and its Indian subsidiary, has been taken as a base for constitution of business connection, which may lead to frivolous litigation on this matter