Service through video conferencing: Whether amounts to Permanent Establishment in India?

The outbreak of coronavirus has opened up innovative ways of carrying out business activities and business interaction across the world. Prohibition on travel, lockdown and social distancing has limited the reach of business not only in domestic market but in foreign market.

The outbreak of coronavirus has opened up innovative ways of carrying out business activities and business interaction across the world. Prohibition on travel, lockdown and social distancing has limited the reach of business not only in domestic market but in foreign market. This has resulted in adoption of video conferencing as one of the pertinent tool for interaction and providing service wherein government, professionals, foreign companies, domestic companies, etc. are using video conferencing software to connect on regular basis. Adoption of different method of providing service is the need of hour and has changed regular working style impacting the cross border transactions such as-
 
  • Foreign companies/ professionals/ engineers/ technicians, etc. which were earlier providing services physically by traveling to source country are now providing the same through video conferencing from their home country.
 
  • Non-resident employees are working from their home country to perform activities via video conferencing in respect of cross boarder contacts which they were physically performing from source country earlier.
 
Therefore it becomes imperative for entities and professionals especially the foreign companies and foreign professionals to analyse tax implication by evaluating the status of permanent establishment in source country considering the fact that now the services are provided from their home country via video conferencing.
 
In this article we will deliberate upon status of permanent establishment in India of such foreign companies/ professionals who are providing services to companies/ entities in India via video conferencing from their home country.
 
What is Permanent Establishment and why it is important to evaluate its status in India?
 
permanent establishment (PE) is a place of business which generally gives rise to income and value added tax liability in a particular jurisdiction. For instance if a foreign company becomes PE in India, it has to comply with various provisions such as higher rate of tax i.e. 40% instead of 10% in case when not a PE, filing of income tax returns in India, tax audits compliances, GST implications and all other relevant compliances as domestic company in India. Thus it is important to evaluate whether foreign company/ professional is exposed to the status of PE in India even if service provided virtually via video conferencing from home country.

Permanent Establishment in India can be “Fixed Place PE” or “Service PE”. If a foreign company have a fixed place of business in India (such as a place which is continuously available for the disposal of foreign enterprise), in such case it is fixed place PE in India. However, if there is no fixed place in India but the foreign company/ non resident professional provides service in India through employees/ other personnel and delivers services for longer than the prescribed threshold period (say 180 days normally), in such case it becomes service PE.

Generally, a foreign company/ non resident professional is exposed to the status of Service PE by way of physical presence of employees of the non-resident in the source country for more than threshold period (say 180 days normally).

However, Indian tax authorities have been taken a contrary view in 2017 wherein TRIBUNAL passed the judgment challenging the general practise of physical presence in India as a requirement of service PE considering the technological and digital advancement across the world. In other words, services performed offshore by a foreign company/ non-resident for a period longer than the tax treaty threshold period will also amount to service PE.

Ruling in the case of ABB FZ LLC (ITAT Bangalore)

The Bangalore Income Tax Appellate Tribunal (ITAT) in the case of ABB FZ–LLC held that Service PE do not require fixed place PE as well.

In the present age of technology where services, information, consultancy, management etc., can be provided via various virtual modes, the taxpayer’s argument of a fixed place of business cannot be sustained as such services can now easily be rendered without necessitating the physical presence of taxpayer employees. Thus, the court held that for the constitution of a Service PE (under India’s UAE tax treaty), it is not dependent on whether the employees stayed in India for the threshold period. However, it will depend upon the fact that services have been rendered over a period of more than nine months within any 12 months period.

Further, the court held that the Article 5(2) is independent clause and the condition of having fixed place PE under Article 5(1) is not attracted for PE under Article 5(2) of the tax treaty.

The controversial ruling by ITAT Bangalore has exposed numerous cross broader transactions wherein the non-resident professionals/ foreign company who renders service beyond threshold period to India clients offshore from their home country will become service PE. Such interpretation will drastically impact the multi national enterprises involved in cross border transactions with India. Thus, it becomes imperative to deliberate upon other judicial pronouncements passed in India interpreting service PE in India.

Ruling in the case of Electrical Material Center Co. Limited v. Deputy Director of Income Tax  (ITAT Bangalore)

The Bangalore ITAT in the case of Electrical Material Centre Ltd. Vs. Deputy Director of Income Tax held that taxpayer has no PE in India since the engineers were present in India for only 90 days, it was less than the number of days prescribed under the Tax Treaty for a service PE to be formed in India; the Taxpayer could not have been construed to have a PE in India. The ITAT Bangalore passed the judgment deliberating on below points:-

  • ITAT Bangalore placed reliance on ITAT Mumbai decision in the matter of Clifford Chance v. DCIT (2002) wherein it was held that multiple counting of the common days is to be avoided so that the days when two or more partners were present in India, together, are to be counted only once. Multiple counting would lead to absurd results. For example, if 20 partners were present in India together for 20 days in one fiscal year, multiple counting would result in 400 days. There cannot be more than 365 days in a year”.

  • ITAT Bangalore rejected the argument of the revenue department which was relying on the Bangalore ITAT case of ABB FZ-LLC v. DCIT by distinguishing with the facts of both the cases. In the present case, engineers provided personalized services in India and there is no evidence of online services being rendered by taxpayers and accordingly ruled out the ruling passed in the case of ABB.

Thus, the Tribunal has followed the decision in Clifford Chance and rejected the applicability of ABB case. The proposition in the case of ABB may be used by the tax authorities especially at lower levels to create service PE for offshore service providers.
 
What steps should foreign company/ non-resident professions take in such scenario?

Till the time there is clarity from Supreme Court, it is opined constantly that foreign companies/ non resident professionals entering into cross-border transactions with clients in India to maintain detailed documentation setting out the intention of the parties clearly specifying the nature and method of provision of service in order to mitigate Service PE exposure.

In case of existing agreements/ contracts, it is suggested to amend the same in view of current pandemic situation wherein service will be rendered virtually only.