The income tax department has moved the apex court seeking setting aside of a Delhi High Court judgment that held that Indian subsidiaries providing back-end services to foreign parent companies cannot be considered their permanent establishments (PE) in India if they conduct business at arm’s length. If the SC accepts the plea, it could adversely impact foreign companies that conduct back-office operations in India or get contract manufacturing done here.
Contract manufacturers not classified as PEs —such as subsidiaries of foreign parents — are liable to pay income tax at 30% plus surcharges and cesses, while PEs are taxed at 40% plus surcharges.
Foreign companies entering India have the option to set up shop either as a subsidiary or as a liaison office, branch office or project office. Liaison and branch offices are prone to get characterised by the tax department as PEs with the consequence of a higher tax rate.
The HC’s February 5 decision had prevented authorities from taxing a part of the parent company’s income by attributing it to the Indian subsidiary.
The HC held that e-Fund India, which was providing back-office operations to US-based parent and US-based subsidiary — e-Fund Corp and e-Fund IT Solutions Inc — wouldn’t be deemed as PE of the US parent in terms of Articles 5(1), (2) and (4) of DTAA as it had no fixed place of business in India through which its business was wholly or partly conducted. HC further held the parent company had no right to use any premises belonging to the Indian subsidiary and a mere indirect control didn’t amount to a PE, after rejecting the revenue department’s plea that staff of foreign enterprises involved in domestic operations amounted to service PE of foreign enterprises.
Challenging the order, the revenue department said income of the two assesses was attributable to India because the two firms had PE in India, therefore, both should be taxed here irrespective of whether e-Fund Inc paid taxes in the US.
The department said: activities of the Indian company and e-Fund Inc were linked and inter-related: the non-resident assessee earned huge profits from business activities carried in India; that majority of employees of the assessee operated from India; that the assessee had significant assets located in India…; that the assessee did not operate on arm’s length basis; in respect of certain contracts, the Indian company was retaining the entire amount billed by it directly on customers, yet on the other hand the foreign parent had retained all profits and only miniscule amount was given to Indian company in similar other contracts, thus there was no basis for sharing of revenue.”