In the last decade or so, globalisation has become a strategic element in business economy. With the rise of globalisation, businesses are now spread to the length and breadth of the world expanding their business and at times inadvertently creating a presence in a foreign soil. Such presence may be termed as ‘Permanent Establishment’ (‘PE’).
Taxation is based on source of income or / and residence of taxpayer. These are recognized by the model tax treaties of Organisation for Economic Co-operation and Development (‘OECD’) and United Nations (‘UN’). The tax treaties aim at determining the country that has prior taxing rights. Thus, the PE concept is crucial to determine the right mix of source and residence based taxation.
Recently, the Supreme Court (‘SC’) has laid down a detailed analysis and interpretation on the concept of PE in the case of Formula One World Championship. The SC held that the race circuit at the disposal of FOWC for a period of four weeks is sufficient time to regard it as a ‘Fixed Place’ where Formula One was carrying on its business.
Federation Internationale de I’ Automobile (‘FIA’)
- Non-profit organisation
- The principal body for establishing the rules and regulations for all major international four-wheel motorsport events.
- Regulates the FIA Formula One World Championship
Formula One World Championship (‘FOWC’)
- A company incorporated in UK
- The Commercial Rights Holder (‘CRH’) of F1
- The exclusive nominating body at whose instance the event promoter is permitted participation
FIA Formula One World Championship (‘F1’)
- Premier form of motor racing run every year since its inception in 1950
- Held across the world on specially designed and built F-1 circuits across 26 different locales.
- Teams participate in about 19 to 21 F1 racing events in a year, set by the FIA.
- Participating teams
- About 12 to 15 teams typically compete in these Championship in any one annual racing season.
- As per the rules, they would neither participate nor promote in any other similar motor racing event.
Commercial Right Holder (‘CRH’)
- FOWC has entered with FIA and FOAM
- FOAM licensed all commercial rights in F1 to FOWC for 100 years
Race Promotion Contract (‘RPC’)
- Grant of a right to host, stage and promote F1
- Jaypee entered with FOWC
- Consideration of US$ 40 Million
Artwork License Agreement (‘ALA’)
- FOWC entered with Jaypee to use certain marks and intellectual property of FOWC
- Consideration of US$ 1 Million
- Constructors enter with FOWC and FIA
- Terms & Conditions for F1
FOWC and Jaypee approached AAR with three uncertainties:
- Whether consideration received / receivable by FOWC under the RPC was in the nature of royalty in terms of Article 13 of DTAA between India and UK?
- Whether FOWC was having any PE in India in terms of Article 5 of DTAA between India and UK?
- Whether any part of consideration received / receivable by FOWC from Jaypee was subject to tax at source u/s 195 of the Income-tax Act, 1961 (‘the Act’)?
AAR held that consideration from Jaypee to RPC comprised not only of hosting rights but also permission to use marks and intellectual property of FOWC. Thus, by reading RPC and ALA together the consideration received by FOWC amounted to Royalty.
However, the Delhi High Court (‘HC’) reversed the judgement by holding as follows:
- The function of the ALA was to provide limited and restricted usage of the marks and is only for obtaining exclusive distribution rights.
- ALA was neither a license nor any form of right to use the trademark and hence does not amount to royalty.
- Following the judgement of DIT v. Ericsson A.B. [2012 – Del HC – 343 ITR 470], the HC held that payments that were lumpsum and not connected to revenue earned cannot not constitute royalty.
- Tax department has accepted the judgement of HC in this issue and hence it had attained finality.
Story so far:
AAR held that taxpayer has no fixed place of business in India and is not carrying out any business activity in India. Therefore, AR held that FOWC does not have a PE in India.
However, HC held that the circuit itself would constitute fixed place of business and that FOWC carried on business in India.
Aggrieved by the HC’s order, FOWC and Jaypee has approached SC.
Back to basics:
Before we go into specifics, lets first understand the basics of PE in detail.
PE has been defined in Article 5 of OECD Model Tax Convention and can be summarised as follows:
- A fixed place of business through which the business of an enterprise is wholly or partially carried on;
- Specific list of places that would constitute a PE: a place of management, a branch, an office, a factory, a workshop, and a place of extraction of natural resources;
- Specific rule for building / construction / installation sites;
- Specific list of activities that would not result in a PE: maintenance of fixed place of business only for preparatory or auxiliary activities;
- Dependent agent constitutes a PE;
- Independent agent in the form of broker, general commission agent or any other agent of an independent status acting in the ordinary course of their business do not constitute PE; and
- Subsidiary by itself will not necessarily give rise to PE.
Article 5 of OECD Model is more or less reproduced in the term ‘Business Connection’ under ‘Explanation 2’ to Sec. 9 of the Act. ‘Business Connection’ shall include any business activity carried out through a person who, on behalf of a non-resident, has the authority to conclude contracts, secures order or maintains stock but does not include independent agents in the form of broker, general commission or any other agent.
From the above, it could be summarised that to constitute a PE the following basic criteria must be met:
- Place of Business:
There must be a place of business i.e. a facility such as premises or, in certain instances, machinery or equipment.
The mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is therefore required. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise.
Such place of business must be fixed in nature & must possess certain degree of permanency.
- Carrying on the business:
To constitute a PE, such fixed place of business must be used for carrying on the business of the enterprise. Such business need not be continuous but must be carried out on regular basis.
However, maintenance of fixed place of business only for preparatory or auxiliary activities would not constitute PE.
SC upheld the HC’s ruling on the following grounds:
- FOWC had full and exclusive access to the circuit. Not just that, it could also dictate who was authorised to enter the areas reserved for it. Further, it was evident that Jaypee’s access was extremely restricted.
- The arrangement clearly demonstrates that the entire event is taken over and controlled by FOWC and its affiliates.
- The access period of up to six weeks during the F1 is a fixed place of business as contemplated under Article 5(1) of India – UK DTAA. Further, the event is repetitive in nature for a period of five years and extendable to another five years.
- FOWC and its affiliates are responsible for access track, advertisement, media rights, public / viewers witnessing the race etc. Thus, as part of its business, FOWC undertook the commercial activity in India.
- Ownership or organising other events in this circuit is immaterial as the issue in contention is only about F1.
- The fixed place of business (i.e. circuit) carrying on commercial activity (i.e. F1) was a virtual projection of a foreign enterprise (i.e. FOWC) on soil of another country (i.e. India). Thus, the principle laid down in CIT v Visakhapatnam Port Trust [1983 – 144 ITR 146] is fully satisfied.
- All characteristics of PE (i.e. stability, productivity and dependence) are present in this case.
The SC had the following issues to deal in front of them:
- Disposal Test – The circuit was at FOWC’s disposal
- Permanency Test – Considering the nature of business, a three-day event would possess a degree of permanency and be treated as a fixed place.
- Business Test – On examining the multiple agreements as one and with the wholesome approach the SC has established the commercial essence behind the agreements
The SC has come up with a detailed analysis relying on OECD Model Tax Convention, OECD Commentaries and global judicial rulings. By this, SC has stressed upon the importance of international regulation / principle to frame a legal opinion on interpretation of tax laws.
A structure with multiple agreements with multiple entities to conduct a racing event in India is now done and dusted.
With importance on international laws / commentaries and considering GAAR is also in place, its high time that multinational enterprises create arrangements that will withstand commercial substance and PE test.
Note: This article was published in CASC Bulletin - June 2017