Service through video conferencing: Whether amounts to Permanent Establishment in India?

The outbreak of coronavirus has opened innovative ways of carrying out business activities and business interactions across the world. Prohibition on travel, lockdown, and social distancing has limited the reach of business not only in the domestic market but also in the foreign market. This has resulted in the adoption of video conferencing as one of the pertinent tools for interaction and providing service wherein government, professionals, foreign companies, domestic companies, etc. are using video conferencing software to connect on regular basis. Adoption of a different method of providing service is the need of the hour and has changed regular working style impacting the cross-border transactions such as-

• Foreign companies/ professionals/ engineers/ technicians, etc. which were earlier providing services physically by traveling to source country are now providing the same through video conferencing from their home country.

• Non-resident employees are working from their home country to perform activities via video conferencing in respect of cross-border contacts which they were physically performing from the source country earlier.

Therefore, it becomes imperative for entities and professionals especially foreign companies and foreign professionals analyze tax implications by evaluating the status of a permanent establishment in the source country since now the services are provided from their home country via video conferencing.

In this article, we will deliberate upon the status of a permanent establishment of such foreign companies/professionals in India who i providing services to companies/ entities in India via video conferencing from their home country.

What is a Permanent Establishment and Why is It Important to Evaluate its Status in India?

A permanent establishment (PE) is a place of business that generally gives rise to income and value-added tax liability in a particular jurisdiction. For instance, if a foreign company becomes PE in India, it has to comply with various provisions such as a higher rate of tax i.e., 40% instead of 10% in the case when not a PE, filing of income tax returns in India, tax audits compliances, GST implications, and all other relevant compliances as a domestic company in India. Thus, it is important to evaluate whether a foreign company/professional is exposed to the status of PE in India even if service is provided virtually via video conferencing from the home country.

Permanent Establishment in India can be “Fixed Place PE” or “Service PE”. If a foreign company has a fixed place of business in India (such as a place that is continuously available for the disposal of the foreign enterprise), in such case, it is fixed place PE in India. However, if there is no fixed place in India but the foreign company/non-resident professional provides service in India through employees/ other personnel and delivers services for longer than the prescribed threshold period (say 180 days normally), in such case it becomes service PE.

Generally, a foreign company/ non-resident professional is exposed to the status of Service PE by way of the physical presence of employees of the non-resident in the source country for more than the threshold period (say 180 days normally).

However, Indian tax authorities have been taken a contrary view in 2017 wherein a tribunal passed the judgment challenging the general practice of physical presence in India as a requirement of service PE considering the technological and digital advancement across the world. In other words, services performed offshore by a foreign company/non-resident for a period longer than the tax treaty threshold period will also amount to service PE.

Ruling in the Case of ABB FZ LLC (ITAT Bangalore)

The Bangalore Income Tax Appellate Tribunal (ITAT) in the case of ABB FZ–LLC held that Service PE does not require fixed place PE as well.

In the present age of technology where services, information, consultancy, management, etc., can be provided via various virtual modes, the taxpayer’s argument of a fixed place of business cannot be sustained as such services can now easily be rendered without necessitating the physical presence of taxpayer employees. Thus, the court held that the constitution of a Service PE (under India’s UAE tax treaty) is not dependent on whether the employees stayed in India for the threshold period. However, it will depend upon the fact that services have been rendered for more than nine months within 12-month period.

Further, the court held that Article 5(2) is an independent clause and the condition of having fixed place PE under Article 5(1) is not attracted for PE under Article 5(2) of the tax treaty.

The controversial ruling by ITAT Bangalore has exposed numerous cross-border transactions wherein the non-resident professionals/foreign company who renders service beyond threshold period to Indian clients offshore from their home country will become Service PE. Such interpretation will drastically impact the multinational enterprises involved in cross-border transactions with India. Thus, it becomes imperative to deliberate upon other judicial pronouncements passed in India interpreting Service PE in India.

Ruling in the case of Electrical Material Center Co. Limited v. Deputy Director of Income Tax (ITAT Bangalore)

The Bangalore ITAT in the case of Electrical Material Centre Ltd. Vs. Deputy Director of Income Tax held that taxpayer has no PE in India since the engineers were present in India for only 90 days, it was less than the number of days prescribed under the Tax Treaty for a service PE to be formed in India; the Taxpayer could not have been construed to have a PE in India. The ITAT Bangalore passed the judgment deliberating on the below points: -

• ITAT Bangalore placed reliance on ITAT Mumbai decision in the matter of Clifford Chance v. DCIT (2002) wherein it was held that multiple counting of the common days is to be avoided so that the days when two or more partners were present in India, together, are to be counted only once. Multiple counting would lead to absurd results. For example, if 20 partners were present in India together for 20 days in one fiscal year, multiple counting would result in 400 days. There cannot be more than 365 days in a year”.
• ITAT Bangalore rejected the argument of the revenue department which was relying on the Bangalore ITAT case of ABB FZ-LLC v. DCIT by distinguishing with the facts of both the cases. In the present case, engineers provided personalized services in India and there is no evidence of online services being rendered by taxpayers and accordingly ruled out the ruling passed in the case of ABB.

Thus, the tribunal has followed the decision in Clifford Chance and rejected the applicability of the ABB case. The proposition in the case of ABB may be used by the tax authorities especially at lower levels to create service PE for offshore service providers.

What steps should foreign company/non-resident professionals take in such a scenario?

Till the time there is clarity from Supreme Court, it is opined constantly that foreign companies/non-resident professionals entering cross-border transactions with clients in India to maintain detailed documentation setting out the intention of the parties specifying the nature and method of provision of service to mitigate Service PE exposure.

In the case of existing agreements/ contracts, it is suggested to amend the same given the current pandemic situation wherein service will be rendered virtually only.