© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
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Indian subsidiary of a foreign telecom company constitutes a PE under India-US tax treaty. Attributed 50 per cent of profit to the PE in India

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Recently, the Delhi Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Nortel Networks India International Inc. (the taxpayer) held that since the hardware supplied by the taxpayer is installed by an Indian subsidiary and the contracts were pre-negotiated by it, Indian subsidiary constitutes fixed place of the business and dependent agent Permanent Establishment (PE) of the taxpayer in India under the India-USA tax treaty.

Further the Tribunal held that since the accounts of the taxpayer have no sanctity and the same were not audited, resorting to Rule 10 of the Income-tax Rules, 1961 would be justified. Accordingly, an attribution of 50 per cent of the profits to the activities of PE in India would be a reasonable attribution in the taxpayer’s case.

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Indian subsidiary of a foreign telecom company constitutes a PE under India-US tax treaty. Attributed 50 per cent of profit to the PE in India

  1. 1. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG FLASH NEWS KPMG IN INDIA Indian subsidiary of a foreign telecom company constitutes a PE under India-US tax treaty. Attributed 50 per cent of profit to the PE in India 16 June 2014 B Background Recently, the Delhi Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Nortel Networks India International Inc. 1 (the taxpayer) held that since the hardware supplied by the taxpayer is installed by an Indian subsidiary and the contracts were pre-negotiated by it, Indian subsidiary constitutes fixed place of the business and dependent agent Permanent Establishment (PE) of the taxpayer in India under the India-USA tax treaty (tax treaty). Further the Tribunal held that since the accounts of the taxpayer have no sanctity and the same were not audited, resorting to Rule 10 of the Income-tax Rules, 1961 (the Rules) would be justified. Accordingly, an attribution of 50 per cent of the profits to the activities of PE in India would be a reasonable attribution in the taxpayer’s case. _______________ 1 Nortel Networks India International Inc. v. DDIT (ITA Nos. 1119,1120 & 1121 of 2010) – Taxsutra.com Facts of the case  The taxpayer was a company incorporated in USA. It is a group concern of Nortel group, which was a leading supplier of hardware and software products for GSM cellular radio telephones system. The Indian subsidiary of the Nortel group, Nortel Networks India Pvt. Ltd., entered into a contract with Reliance Infocom for supply of hardware equipment. Immediately after the signing this contract, it was assigned by the Indian subsidiary to the taxpayer without any consideration.  In terms of the said contract, the taxpayer has supplied telecommunication hardware to Reliance Infocom. The equipments supplied by the taxpayer was purchased from a group company i.e. Nortel Canada. Nortel Canada was not engaged in providing any services and undertook only liaison activities in India.  The taxpayer did not file its return of income for the relevant year and, it did not file any audited accounts. The profit and loss account of the taxpayer was unaudited and certified by the tax manager. In the said profit and loss account, the taxpayer has booked huge gross losses.
  2. 2. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.  The Assessing Officer (AO) held that the taxpayer does not have any manufacturing or trading infrastructure. It does not have any financial or technological capability of its own. The taxpayer was only a paper company incorporated for the sole purpose of evading taxes in India. Nortel India was a fixed place of business and dependent agent Permanent Establishment (PE) of the taxpayer as well as it was business connection of the taxpayer in India. The AO observed that the taxpayer and Nortel Canada cannot be held as two separate entities.  The Commissioner of Income-tax Appeals [CIT(A)] upheld the order of the AO. Tribunal’s ruling Permanent Establishment  The contract entered between the Nortel group and the Reliance Infocom was a turnkey contract, indivisible contract for supply, installation, testing, commissioning etc. Nortel India had undertaken the responsibility for negotiating and securing the contracts. The contract for installation and commissioning was also undertaken by Nortel India.  The above arrangements indicate that the taxpayer was getting its work executed through Nortel India. The taxpayer was merely a shadow company of Nortel group and for all practical purposes, all the facilities and services available to the Nortel group of companies are equally available to the taxpayer.  Since the hardware supplied by the taxpayer was installed by Nortel India and the contracts were pre- negotiated by the same, it was constituted a fixed place of the business and dependent agent PE of the taxpayer in India.  The Liaison Office (LO) of Nortel Canada was rendering all kinds of services to all the group companies including the taxpayer. The LO pertaining to Canadian company constituted fixed place PE of the taxpayer in India.  The taxpayer through Nortel India and LO approached the customer, negotiated the contract, bagged the contract, supplied equipment, installed the same, undertook acceptance test after which the system was accepted. The equipment remains in the virtual possession of Nortel group till the equipment is set up and acceptance test is done.  Employees of group companies did visit in India in connection with project in India. Thus, this indicates the employees of the group companies did carry out business of the taxpayer through the premises of LO or the premises of the subsidiary. Thus, the entire business enterprise activities of the taxpayer were managed by the subsidiary in India and the requisite supply is made from abroad.  The contract does not only need loading of the equipments in the ship, but includes number of activities which are carried out in the Indian territory and the compensation/remuneration for that was also included in the consideration. The compensation which has been represented to a sale consideration for the equipment represents the payment for works contract where entire installation and customisation has been carried out in India.  The subsidiary has not only acted as a service provider for the taxpayer, but at the same time acted as a sale outlet co-operating with after sale service and also providing any assistance or service requested by the taxpayer.  The assignment agreement between Indian subsidiary, the taxpayer, the parent company i.e. Nortel Network Canada, and Reliance Infocom, indicates that the contract initially signed by the Indian company which in turn assigned to the taxpayer and all the risk and responsibility in this regard are assumed by the parent company.  Accordingly, the activities of the taxpayer in India constitute PE under Article 5 of the India-USA tax treaty (tax treaty). The activities carried out by the PE are the core activities of the taxpayer resulting in generation of income to the taxpayer and they cannot be considered to be preparatory and auxiliary and therefore, the contention of the taxpayer that it do not have PE in India was rejected. Profit attribution  The accounts of the taxpayer furnished in the assessment proceedings have no sanctity and the same were not audited. The gross trading loss incurred from transaction within the group cannot be explained except for the reasons, that it has been designed as such to avoid taxation in India.  The Tribunal observed that for all purposes, the accounts of the Nortel Group, would give a true and correct picture of the profit of the taxpayer. Hence, AO’s reference to the global accounts of the Nortel and gross profit margin percentage as 42.6 per cent was accepted. Further, the AO has only allowed 5 per cent of the turnover as deduction pertaining to other selling general and marketing expenses.  The lower authorities were justified in resorting to Rule 10 of the Rules. However, when profits are computed under Rule 10 of the Rules after applying the profit rate, the expenses pertaining to the PE have to be allowed as deduction.
  3. 3. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.  Income of the PE has to be computed based on the facts of each case. In the present case, an attribution of 50 per cent of the profits to the activities of PE in India would be a reasonable attribution in the taxpayer’s case.  Various rates of profit attribution applied in various cases 2 , relied on by the taxpayer, cannot be accepted to the facts of the present case, since the facts of those respective cases are different.  The Tribunal observed that the CIT(A) has directed the AO to allow expenses relatable to PE. Further, it was directed to allow selling general and marketing expenses and R&D expenses. Thereafter, 50 per cent of the resultant figure has been attributed to PE. The Tribunal uphold the CIT(A)’s order. Our comments Determination of PE and profit attribution has been a matter of debate before the Courts/Tribunal over a period of time. Based on peculiar facts of the present case the Delhi Tribunal has held that since the hardware supplied by the taxpayer was installed by an Indian subsidiary and the contracts for supplying the hardware were pre-negotiated by it, Indian subsidiary constituted PE in India. The Tribunal applied the Rule 10 and attributed of 50 per cent of the profits to the activities of PE in India. It is pertinent to note that the Delhi Tribunal in the case of Convergys Customer Management Group Inc. 3 has prescribed a methodical approach for profit attribution by applying the percentage of global income to the end- customer revenue from India operations. Further the Tribunal attributed 15 per cent of profit to the activities of PE in India. The Tribunal had relied on the Supreme Court’s decision in the case of Hukum Chand Mills Ltd 4 to arrive at the profits attributable to the PE. Further the Delhi Tribunal in the case of Huawei Technologies Co. Ltd 5 dealt with the taxability of income from supply of telecommunications and network equipment along with software embedded in it. The Tribunal held that the taxpayer had a PE in India under India-China tax treaty and attributed 20 percent of profit as business income. However, the Delhi Tribunal in this decision applied higher percentage while arriving at profit attributed to PE in India. ______________ 2 ZTE Corporation and Huawei Technologies Co. Ltd. v. ADIT [2014] 44 taxmann.com 296 (Del) 3 Convergys Customer Management v. ADIT [2013] 58 SOT 69 (Del) (URO) 4 Hukum Chand Mills Ltd. v. CIT [1976] 103 ITR 548 (SC) 5 Huawei Technologies Co. Ltd. v. ADIT [2014] 44 taxmann.com 296 (Del)
  4. 4. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity“ are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. www.kpmg.com/in Ahmedabad Commerce House V, 9th Floor, 902 & 903,Near Vodafone House,Corporate Road, Prahlad Nagar, Ahmedabad – 380 051 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Chandigarh SCO 22-23 (Ist Floor) Sector 8C, Madhya Marg Chandigarh 160 009 Tel: +91 172 393 5777/781 Fax: +91 172 393 5780 Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai 600 034 Tel: +91 44 3914 5000 Fax: +91 44 3914 5999 Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana 122 002 Tel: +91 124 307 4000 Fax: +91 124 254 9101 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Kochi Syama Business Center 3rd Floor, NH By Pass Road, Vytilla, Kochi – 682019 Tel: +91 484 302 7000 Fax: +91 484 302 7001 Kolkata Unit No. 603 – 604, 6th Floor, Tower – 1, Godrej Waterside, Sector – V, Salt Lake, Kolkata 700 091 Tel: +91 33 44034000 Fax: +91 33 44034199 Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai 400 011 Tel: +91 22 3989 6000 Fax: +91 22 3983 6000 Pune 703, Godrej Castlemaine Bund Garden Pune 411 001 Tel: +91 20 3050 4000 Fax: +91 20 3050 4010

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