Volume 7, Issue 4

4 July 2014
www.skpgroup.com

Tax Alert
No supervisory PE in absence of construction or building sites: India-Germany DTAA

Background

Recently, the Income Tax Appellate Tribunal of Hyderabad (ITAT) came up with a ruling in case of GFA Anlagenbau Gmbh (GFA) (M/s GFA Anlagenbau Gmbh vs DCIT (Int. Tax) – TS-383-ITAT-2014 (HYD)) that elaborates on whether supervisory activities provided by a German entity in relation to projects in India constitute a Permanent Establishment (PE) of such entity in India. 

Facts

  • GFA, a company incorporated in Germany, is engaged in rendering the activity of supervision, erection and commissioning of plant and machinery for steel and allied plants in India.
  • During the year under consideration, GFA rendered services to various Indian business houses. In order to carry out such supervisory and technical services, foreign technicians were deputed on the work sites of these clients.
  • In one of the projects, the stay of these technicians in India exceeded 182 days and they duly filed their income tax returns in India.
  • Income earned from such projects was offered to tax as Fees for Technical Services (FTS) by GFA and taxes at the rate of 10% were deducted according to the India-Germany Double Taxation Avoidance Agreements (DTAA). This position had been accepted in earlier years.
  • Based on the stay of the technicians in India, the Assessing Officer (AO) held that GFA has a PE in India and further held that income earned from all the projects should be taxed under Article 7 read with Article 5 of the India-Germany DTAA as business profits at the rate of 40%.
  • Aggrieved by the above, GFA raised objections before the Dispute Resolution Panel (DRP). However, the DRP upheld the AO’s order partially i.e. by holding that only 50% of the income should be taxed in India and 50% should be considered, on an ad hoc basis, to be expenditure incurred in relation to the execution of contracts.
  • Aggrieved by the DRP’s order, GFA preferred an appeal before the ITAT. 

Key Issues Before the ITAT

  • Do supervisory services rendered constitute a PE of GFA in India in light of Article 5 of the India-Germany tax treaty?

GFA’s Contention

  • GFA contended that the fixed place of business should be owned or leased by the company and should not be the place provided by the contractee where the supervisors attend to work. Provision of mere accommodation to the technicians cannot be considered as fixed place of business (relying on the decision in the case of Vishakhapatnam Port Trust [144 ITR 146] (AP High Court)).
  • Reference was also drawn to section 92F(iiia) of the Income Tax Act, 1961 (ITA) wherein it is mentioned that a PE includes a fixed place of business through which the business of the enterprise is wholly or partly carried on.
  • There was only one project where the stay exceeded the threshold of six months.
  • Without prejudice to the above contentions, it was also argued that fees earned through a PE can only be considered under Article 7. Hence, the other projects should not be should not be clubbed together and income from such projects should not be brought to tax under Article 7.
  • The learned counsel of GFA also submitted the decision of Motorola Inc vs DCIT 96 TTJ (Del) and mentioned that the issue is squarely covered by the said judgement.

Revenue’s Contention

  • One of the contracts undertaken by GFA continued for a period of more than six months and thus it had a PE in India as per Article 5(2)(i) of the India- Germany DTAA.
  • GFA’s activities in India were in the nature of technical supervision for the execution of the projects and it was earning its income by providing technical services from its PE located in India though being in the nature of FTS under Article 12 of the DTAA.
  • As per Article 12(5), the earnings of FTS by GFA can be said to be effectively connected with GFA’s PE in India.
  • Accordingly, it was held that provisions of Article 7(3) will be applicable and the FTS income should be taxed under Article 5 read with Article 7.

ITAT’s Ruling

  • Relying on the judicial precedents and section 92F(iiia), it has been noted that the prime condition for constituting a fixed place PE is when it amounts to virtual projection of the foreign entity in India by existence of substantial element of enduring or permanent nature.
  • In the present case, GFA’s technicians were at the sites of Indian business houses as a part of the contractual terms to render services to respective customers, and GFA does not own or operate such sites independently. Hence, such sites cannot be said to be available at their disposal for carrying on GFA’s business in India. Thereby, no fixed place PE of GFA in India can be held to be constituted irrespective of the fact that the technicians’ stay exceeded the threshold limit.
  • Reliance was placed on the decisions of the ITAT in the cases of Motorola Inc (95 ITD 269) and Airlines Rotables (131 TTJ 385) to conclude that GFA does not have a fixed place PE in India.
  • In case of CIT vs Visakhapatnam Port Trust (1983) 144 ITR 146 (AP), it was held that mere supervisory services cannot constitute a Supervisory PE. However, the language of the DTAA is revised now. Hence, the view adopted in the said judgment cannot be applied in GFA’s case.
  • Supervisory activities constitute a PE only if they are in connection with any building site, or construction or assembly project (reference made to the book of Klaus Vogel (Third edition), page 306, M.N. 74).  In the present case, GFA merely provides such services and does not have any building or construction site or a fixed place at its disposal.
  • It is further observed by the ITAT that it is incorrect to aggregate all contracts of the foreign company in India and consider it as one. Unless otherwise linked with each other, contracts should be individually assessed with respect to the duration test.
  • Reliance was also placed on the Andhra Pradesh High Court’s decision in the case of Clouth Gummiwerke Akrineqesellschaft (238 ITR 861) to conclude that the supervisory activities are in nature of FTS as per section 9(1)(vii) of the ITA. 
  • Based on the above, it has been held that income earned by GFA is rightly considered under the ambit of Indian income tax laws and article 12 of the tax treaty and should be taxed as FTS and not as business profits.

Apart from the above, the AO also reopened the assessment for earlier years on the ground that the income should have been taxed at the rate of 40% instead of 10%. The DRP had upheld the AO’s view and the said issue was also raised before the ITAT.

On this issue, the ITAT held that the entire income was offered to tax in the return of income by GFA and hence “no income has escaped assessment”. The section governing the reopening of the assessment is applicable when the income has escaped assessment i.e. when the income has been understated or has claimed excessive loss/deduction.  In the present case, the entire income was offered to tax and a mere change in the applicable tax rate does not lead to understating the income. Accordingly, the reopening of the assessment was held to be not valid.

SKP's Comments

This is a welcome ruling and will provide great relief to foreign enterprises rendering mere supervisory services in India. The crux of the decision is that there has to be a link between services rendered and the building or construction site/projects. However, it would be pertinent to note that the clause of Service PE is absent in the India­-Germany DTAA. If the Service PE clause was available in the tax treaty, this issue may have had a different outcome.