Delhi High Court prematurely applies BEPS standards to rule that GE Overseas entities had a PE in India
Recently, while upholding an order of the Delhi Income Tax Appellate Tribunal (“ITAT”), the Delhi High Court (“Court”) held that the General Electric (“GE”) overseas group of companies (“GE Overseas / Taxpayer”) constituted a fixed place permanent establishment (“PE”) and a dependent agent PE (“DAPE”) in India for the assessment year (“AY”) 2001-02.
The GE group is a diversified technology, media and financial services company spread across the globe. GE Energy Parts Inc. (“GEP”), a tax resident of the US is engaged in the business of manufacture and offshore sales of highly sophisticated industrial equipments. GEP sells its products offshore on a principal to principal basis, including to customers in India, where the title to goods sold to Indian customers is transferred outside India. General Electric International Operations Company Inc. (“GEIOC”), part of the GE group and a tax resident of the US, set up a liaison office (“LO”) in India in 1991 with the RBI’s permission to act only as a communication channel and not to carry on any business activity. Further, GE India Industrial Pvt. Ltd. (“GEIIPL / GE India”), also part of the GE group, is an Indian company which provides marketing support services to GE Overseas including to GEP under a Global Service Agreement (“GSA”) with GEIOC, for which it is remunerated on a cost-plus basis. For the year under consideration, GE India was assessed by the Transfer Pricing Officer who held that the transactions of GE India with its associated enterprises were at arm’s length. As per the GSA, GE India is restricted from entering into contracts on behalf of or acting as agents of GE Overseas. Further, in the year under consideration, GEIOC had about 50 employees, of which most were designated as Head India Operations and deputed to India.
The GE Overseas entities had not filed tax returns in India for the year under consideration. In 2007, Indian tax authorities conducted a survey under section 133A of the (Indian) Income Tax Act, 1961 (“ITA”) at the premises of the LO (“Survey”). Further, in accordance with section 131, the tax authorities also summoned GE Overseas to furnish information, which was duly furnished. The Survey and review of furnished information revealed that GE’s presence in India (which existed since 1902) was significant with over 12,000 employees and over 1 billion dollars in exports to support the global business operations of GE. Further, GE had pioneered the idea of sourcing software from India and had become one of the largest customers of the Indian Information Technology industry. Based on these observations, the assessing officer (“AO”) initiated re-assessment proceedings and passed an order dated December 31, 2008 holding that the GE Group had a fixed place PE and a DAPE in India. Further, the AO deemed 10% of the value of the sales made to Indian customers as profits arising from them and attributed 35% of the said profits to the PE in India. Upon appeal, the first appellate authority – the Commissioner of Income Tax (Appeals) (“CIT(A)”) upheld the order of the AO.
In second appeal, the ITAT, based on its analysis of the facts, held that GEIOC’s employees who were deputed to India and GE India’s employees (“GE Professionals”) used the premises of the LO for carrying on core business activities (not being preparatory and auxiliary) of GE Overseas in India and hence constituted a fixed place PE. Further, it also held that the activities conducted by GE India, through the GE Professionals were core in nature, which demonstrated its authority to conclude contracts on behalf of GE Overseas in India. Accordingly, it was concluded that GE India constituted a DAPE of GE Overseas. Further, the ITAT concurred with the AO on estimating the profits to be 10% of the value of the sales made to Indian clients. However, it reduced the attribution of the profits to Indian PE from 35% (accorded by the AO) to 26%, effectively concluding that 2.6% of the value of the sales should be profits attributed to India.
In further appeal before the Court, the following three questions of law were posed: (i) whether the GE Group had a fixed place PE in India, (ii) whether the GE Group separately had a DAPE in India, and (iii) whether the ITAT was justified in attributing as high as 26% of the estimated profits (10% of the value of sales) to the PE in India. The submissions put forth by the parties were as follows:
On the question whether GE Overseas constituted a fixed place PE in India, the Court observed:
On the question whether GE Overseas constituted a DAPE in India, the Court observed:
‘a person who is authorized to negotiate all elements and details of a contract in a binding way on the enterprise can be said to have exercised this authority and the mere fact, however, that a person has attended or even participated in negotiations…will not be sufficient, by itself, to conclude that a person has exercised in that State an authority to conclude contracts.’ [Emphasis Supplied.]
The Revenue, on the other hand relied on Paragraph 32.1 of the OECD Commentary, introduced in 2008 as India’s reservation to the language of the Commentary on ‘authority to conclude contracts’, which reads as:
‘a person has attended or participated in negotiations in a State between an enterprise and a client, can in certain circumstances, be sufficient, by itself to conclude that the person has exercised an authority to conclude contracts in the name of the enterprise; and that a person who is authorized to negotiate the essential elements of a contract and not all the elements, can be said to exercise the authority to conclude contracts.’ [Emphasis Supplied]
On the apparent contradiction between Paragraphs 33 and 32.1, the ITAT’s opinion was that the latter, which was introduced in 2008 cannot have a retroactive application on treaties entered into prior to 2008 (including the India – US tax treaty). Further, it noted that the OECD Commentary is not binding and can only serve as a guidance as it does not form part of the treaties under the doctrine of incorporation.
The Court however, taking a very aggressive stand, held that since the OECD Commentary appears to be contradictory regarding the interpretation of the phrase ‘authority to conclude contracts’, it cannot be relied upon wholly. The Court instead noted that enterprises these days do not necessarily organize businesses in a way which may be envisioned by tax treaties. The tax treaty regimes are based on known patterns of business and cannot cater to all situations which today’s innovative and complex enterprises may present. In this context, the Court instead of going by the letter of the law (definition and interpretation of DAPE), relied on the overall facts (indicating GE India and GE Professionals’ involvement in the core business activities) and adopted a substance over form approach to rule that GE Overseas had a DAPE in India.
The Court also relied on Ministry of Finance (Tax Office) v. Phillip Morris (GmBH), Corte Suprema di Cassazione8 which held that even in the absence of a formal authority to conclude contracts, mere participation of representatives or employees in the phase of conclusion of contracts may in some instances constitute the authority to conclude contracts. Further, the court also relied on Rolls Royce Plc v. Director of Income Tax9 where although the dependent agent in India did not have the authority to conclude contracts, it was held to be a DAPE on the basis of the overall facts.
On the question of attribution, the Court observed:
Following through on the above observations, the Court did not dissect the question on attribution and upheld the attribution by the ITAT, specifically based on the fact that the question was already extensively discussed and concluded on at three levels, i.e. the AO, CIT(A) and the ITAT. The Court noted that the absence of statutory or formal framework render the task on attribution dependent on some extent of guess work and the endeavor will only be to approximate the correct figure. The Court specifically relied on Hukum Chand v. UOI10 where it was held ‘there cannot in the very nature of things be great precision and exactness in matters. As long as the attribution fixed by the Tribunal is based upon the relevant material, it should not be disturbed’ to not interfere with the attribution fixed by the ITAT in the present case.
In the landscape of India’s tax judgments on PE, this can be viewed as a conservative one. This judgment is a reminder that judicial authorities are moving from a formal rule-based approach to a substance-based approach. Glaring evidence of this lies in the present case, where the Court completely ignored some crucial clauses in the GSA (the contract on the basis of which GE India was conducting its activities in India) such as ‘GSA forbids GE India from entering into any contract on behalf of the GE Group companies’ etc. to determine the question on ‘authority to conclude contracts’. In order to record its intention of doing business in a particular manner, enterprises tend to ensure robust documentation. However, with the current trend that courts are adopting, it seems that what is recorded in documents may be of little consequence and that courts will in all cases, pierce the form to analyse the substance of transactions, structures etc.
Further, with respect to the determination of DAPE, the Court’s approach to disregard the treaty definition due to inherent contradictions in the OECD Commentary (owing to India’s reservation) seems to be an act of judicial overreach. In doing so, the Court has also ignored the observation of the Kolkata ITAT in ITO v. Right Florists (P.) Ltd.11 where the Tribunal had categorically denounced India’s reservations to the OECD Commentary playing a role in judicial analysis.
Action 7 of the Base Erosion and Profit Shifting (“BEPS”) Action Plans, has proposed to amend one of the tests of DAPE, i.e. ‘authority to conclude contracts’ to ‘playing a principal role leading to conclusion of contracts’. In line with this proposal, India, through Finance Act, 2018, has also amended its definition of ‘business connection’ with prospective effect from April 1, 2019. The approach adopted by the Court in the determination of DAPE seems to be in line with the amended standard proposed under BEPS. However, the said BEPS proposal is keeping in mind the current global business scenario and has a specific objective, i.e. to prevent the widespread base erosion and profit shifting in today’s world and hence should be made applicable only prospectively. Further, the proposed changes have not yet been incorporated in most tax treaties. In this context, having adopted the BEPS proposed standard for determination of DAPE, that too retrospectively for AY 2001-2002, is premature and harsh. Businesses can only arrange themselves based on the currently existing laws. The possibility of them being scrutinized in the future based on newer standards being applied retrospectively, as done in the present case, instills a sense of uncertainty in them and hampers the ecosystem of doing business in India.
With respect to the applicability of Independent Agent Exception, the Court held that an entity can be considered as ‘devoted wholly or almost wholly’ even if it is devoted to several related enterprises part of the same group. In doing so, it went against the ratio laid down in by the Mumbai Tribunal in Varian India (P) Ltd. v. ADIT12 that an entity can be considered as ‘devoted wholly or almost wholly’ only if it is devoted to any one foreign enterprise. The Court distinguished Varian on the basis of the fact that unlike in the case of GE, the concerned Indian entity had entered into separate contracts with every related entity of the concerned foreign group. Based on this distinction, going forward, it may be feasible for Indian entities working on behalf of a multinational group to enter into separate contracts with each entity in the group to possibly avail the ‘Independent Agent Exception’.
Lastly, owing to the element of subjectivity involved in this case, the Court’s decision to not dissect the question on attribution could be viewed as questionable. Given the considerations on the question of attribution, i.e. it (attribution) was based on subjective parameters relying on other provisions and similar judgments, the workings by the AO were reworked by the ITAT etc.; there was a need for the Court to have dissected this question to ensure that the attribution was undertaken properly. The Court’s refusal to address the question, observing that attribution by its nature involves an amount of guess-work, raises concerns about judicial propriety, and makes one wonder how a Taxpayer is expected to have any assurance on legal principles around attribution of profits to a PE if admittedly it is undertaken by the courts of India through guess-work and approximation.
1 2009 (313) ITR 94 (Del.)
2 CIT 2017 (394) ITR 80 (SC).
3 2016 (383) ITR 648
4 For the argument on the position under Indian Contract Law, the taxpayer relied upon the Black’s law dictionary, 10 Edition (Pgs 350, 1199, 1200); Major Law Lexicon P.R. Aiyar, 4th Edition 2010, (Pgs 1361 (Vol2), 4530 (Vol4); and Devkubai N. Mankar v. Rajesh Builders AIR 1997 Bom 142.
5 2013 (142) ITD 692 (Mum).
6 2014 (364) ITR 256
7 2018 (6) 6 SCC 70
8 No. 7682/02 of May 25, 2002.
9 2011 (339) ITR 147 Del.
10 1976 (103) ITR 548.
11  25 ITR(T) 639 (Kolkata - Trib.)
12  142 ITD 692 (Mumbai-Trib)