This was laid down by a three-judge bench of the Delhi High Court in a ruling which would impact several MNCs using liaison office, subsidiary, or a fixed place like a hotel room — arrangements which are considered as ‘permanent establishment’ or PEs in tax parlance — to meet customers, negotiate prices, and market products and services.
The ruling, pronounced on September 19, was in response to a petition by the UAE-based Hyatt International Southwest Asia which had a fixed place or PE in India at the premises of Hyatt Regency hotel in Delhi.
“The fact that a PE is conceived to be an independent taxable entity cannot possibly be doubted or questioned,” said the ruling, adding that the source state (i.e, India in this case) cannot be deprived of its right to tax a PE and this is not dependent upon the overall and global financials of an entity.
“This important judgement is in consonance with the language and core principle of Article 7 of Tax treaties dealing with taxation of permanent establishments. The key principle of article 7(1) is that profits of a foreign enterprise having a PE in the source country would be taxable in that country (source country) to the extent of ‘profits’ attributable’ to the PE. Hence, whether at an ‘entity level’ the foreign enterprises concerned have profits or losses, should not really matter. This detailed judgement also deals with various other important principles and ingredients concerning PE taxation under tax treaties,” said Sanjay Sanghvi, partner at the law firm Khaitan & Co.The profits attributable to such PEs are the earnings generated from India but booked in the global accounts of the parent, and not in the books of the Indian arms or outfits of the MNCs.
In a situation where the MNC is reporting losses in the global consolidated accounts, the earnings ‘attributable to India’ would have to be arrived at on the basis of principles of profit attribution and transfer pricing given in the Income Tax rules which require comparison of profit margins reported by peers in the business.The key aspect of the recent ruling is that an MNC would be liable to pay tax on such income in India notwithstanding the losses that the enterprise as a whole may have suffered in other jurisdictions.
Upholding the view that a PE (of an MNC) is “distinct and separate enterprise”, the court turned down Hyatt’s contention that if a foreign enterprise was making losses, the question of attributing any profit to its PE in India would not arise and consequently that enterprise would have no tax liability in India.
“This is an important and detailed ruling that relies on multiple commentaries such as OECD and UN Model conventions and other key Supreme Court decisions which could restrict chances of a reversal at the apex court. The changed position might now impact many already disposed cases as well as existing situations. A detailed Indian attribution study would be required irrespective of the global position for taxability in India. This may open a new Pandora’s box of complex litigations considering the subjectivities involved,” said Rahul Garg, managing partner, Asire Consulting, which advises on tax, assurance and regulatory matters.