In case of sale of goods, sometimes the title in goods is transferred outside India but the risk of rejection of goods is not transferred. In such instances, whether it could be said that the sale has concluded in India. If yes, the profits arising from such sale could be taxed in India if the seller has PE / business connection in India.
Recently, the Delhi Tax Tribunal1 had an occasion to examine PE exposure of a Chinese company selling advanced telecommunication equipment to its Indian customers. It also examined whether the taxpayer continued to undertake the risk of rejection of the supply in India and therefore, there is extension of business of the taxpayer in India in respect of the supply of equipment to India. We, at BDO in India, have summarised the ruling of the Tax Tribunal and provided our comments on the impact of this decision.
Facts of the case
Taxpayer, a Chinese company, is primarily engaged in the business of supplying (on off-shore basis) non-terminal products i.e. advanced telecommunication network equipment namely core and access network equipment, mobile network equipment and data communications equipment etc. for use in fixed and mobile phone network and terminal products (i.e. mobile phone handsets) to various customers (including customers in India). The said supplies were made on principal to principal basis and property in equipment was transferred to Indian customers outside India.
The Taxpayer also provided services to its Indian subsidiary – ICO - under the terms of Technical Service Agreement (TSA). ICO is involved in the provision of integration, installation and commissioning services in relation to telecom network equipment supplied from outside India. While the Taxpayer offered receipts from provision of technical services to ICO on gross basis and paid taxes in accordance with Article 12 of the India-China DTAA, it did not offered the revenue on account of sale of telecom network equipment and terminal equipment/mobile handsets. The international transactions relating to provision of services to ICO were studied and analysed by the Transfer Pricing Officer (TPO) and no adjustments were recommended by him. In a survey conducted under section 133A of the Income Tax Act, 1961 (IT Act) at the office premises of ICO, several incriminating documents were found, and statements of various senior executives were also recorded.
The Taxpayer was asked as to why revenue from supply and installation of equipment should not be taxed in India. The Taxpayer raised following contention for non-taxability of the revenue from supply and installation of equipment:
- It being a tax resident of China, income derived from supply of telecommunication equipment to Indian customers qualifies as business profits and accordingly taxability of such income is governed by Article 7 of India-China DTAA.
- As per Article 7, business profits earned by Chinese tax resident are taxable in India only if it carries on business in India through a PE in India.
- Supply contracts with Indian customers were negotiated through electronic means or through short visits of its personnel at the customer locations in India and all contracts were accepted and concluded outside India. Therefore, there is no fixed place PE in India.
- ICO does not qualify as taxpayer’s dependent agent PE since ICO provided market support services and other preliminary and auxiliary services.
- Market support services under TSA are preparatory and auxiliary in nature in terms of Article 5 of India-China DTAA. Therefore, there is no Service PE in India and also no installation PE in India.
However, the Tax Officer relying on Apex Court’s decision in the case of R D Agarwal and Co2 and Bombay High Court decision in the case of Blue Star Engineering Co3, came to a conclusion that taxpayer has business connection in India. Thereby, the Tax Officer passed the draft assessment order which was partially confirmed by Dispute Resolution Panel (DRP) under section 144C of the IT Act holding that taxpayer has a PE in India in the form of ICO. Being aggrieved, the taxpayer filed an appeal before the Tax Tribunal.
Rejecting taxpayer’s contention, the Tax Tribunal made following observation:
Extension of risk of rejection to India could lead to sale concluding in India
- Risk of loss of goods shall pass from seller to owner upon acceptance of the goods.
- It would be pertinent to understand that if the buyer had the right to reject the equipment on failure of acceptance test, then how the transactions can be considered as completed outside India.
- Tribunal referred to Delhi High Court decision in the case of Ericsson A.B4 wherein it was held that acceptance test is not material event for passing of the title and risk in the equipment supplied. However, the position may be different if the buyer had the right to reject the equipment on failure of acceptance test carried out in India.
- Hence, Tribunal took a view that taxpayer continued to undertake the risk of rejection of the supply in India and therefore, there is extension of business of the taxpayer in India in respect of the supply of equipment to India.
Fixed Place PE
- As held by the Hon'ble Supreme Court5, the control and disposal go hand in hand. Thus, the disposal of fixed place is determined by the degree of control exercised by the foreign entity.
- Frequent visits of the expats from the taxpayer exert the control to carry out various business activities of the taxpayer.
- Evidence on record shows that the Indian resources were involved in deal negotiations on behalf of the taxpayer.
- Purchase orders from Indian customers refer to email offer of ICO employee.
- Joint bidding shows the business activity including signing of bid documents from the office premises of ICO and there is no denial that ICO is participating in negotiations of deal with Indian clients on behalf of the taxpayer.
- Hence, ICO premises constitutes Fixed Place PE of the taxpayer in India.
- There can be no denial that installation and other managed services were carried on by ICO under supervision of the taxpayer.
- The moot point is that ICO is not equipped to install equipment supplied by the taxpayer and therefore the act of installation has been performed only with the supervision of taxpayer’s resources which means supply of equipment and its installation are integral.
- Therefore, the activity in connection with installation constitutes installation PE.
Service PE and Dependent Agent PE
- On perusal of statements recorded of key personnel at the time of survey, Tax Tribunal observed that ICO resources were involved in negotiations with customers in India.
- Taxpayer’s representatives were allowed to use HI office premises.
- Another statement given by an executive director states that the employees of taxpayer visited India for negotiations, presentations, signing of contracts, etc and during their visit operated from hotel or office of ICO or premises of the client. Employees of taxpayer have rendered services in India other than in the nature of technical services and that such services have continued in India for more than 183 days thereby creating service PE.
- Facts on record clearly establish that ICO is economically dependent on taxpayer as it has handled the work of installation of telecom equipment.
- Further, the business of ICO is wholly and exclusively for equipment supplied by taxpayer. In fact, ICO came into existence with an intent to aid the business of taxpayer in India.
- Facts on record clearly show that ICO is not capable of supplying the equipment what it is bidding for.
- Products to be supplied must cater to the specific requirement of customer’s business of ICO is totally dependent on taxpayer. In fact, the business of taxpayer in India is also totally dependent on ICO. Even where supplies have been made through the taxpayer or Sterlite, the installations / commission have been done by ICO.
- ICO is not capable of supplying the equipment and since the technology know how and capability is owned by the taxpayer, ICO could not have bid on its own, which means that ICO is economically dependent on HC.
Attribution of profit
Tribunal directed the attribution of profits to PE in India should be as per the findings of the co-ordinate bench ruling in the taxpayer’s own case of prior years.
While the Tax Tribunal has dealt with constitution of PE in India of Chinese Company, it has made an important observation pertaining to sale of goods. In most of the cases, the taxpayers contended, and judiciary have held that where the title in goods have transferred outside India, the same shall not be taxable in India. However, in this decision, Tax Tribunal have given weightage to risk of rejection to conclude that the sale has concluded in India. In light of this observation, the Foreign Companies supplying goods to Indian Customers on offshore basis should revisit their agreements with Indian Customers along with its (Foreign Companies) activities conducted in India which are related to such offshore supply contract and evaluate the impact of this decision based on its factual matrix in order to distinguish its case and avert adverse tax implications.
1Huawei Technologies Co Ltd vs ADIT (International Taxation) [ITA No. 1500/DEL/2014, 6921/DEL/2014, 937/DEL/2016, 6376/DEL/2016, 6377/DEL/2016, 6799/DEL/2017, 5506/DEL/2018, 8263/DEL/2019]
2CIT vs R.D Agarwal and Co 56 ITR 20
3Blue Star Engineering Co vs CIT 73 ITR 283
4Delhi High Court-Ericsson A.B ITA No.504/2007
5Formula One World Championship Ltd 80 Taxmann 347