Increased presence of cross-border economic activities have led to increase in tax challenges around the world. India is no exception. Normally, India applies the ‘resident rule’ for tax purposes. Which simply means that if an individual or corporation is a resident or is incorporated in India, its income is taxable in India. Additionally, the ‘source rule’ is also applicable. Which is mainly applicable in case of non-residents and foreign entities whose income arises or accrues in India, in that case as well India will have the right to tax the corporation. However this source rule applies to foreign corporate entities for taxation purposes under heads of income such as Royalties, Fees for Technical Services etc.
For taxation of business profits of foreign corporations arising in India, we have to look at a related concept of source rule, which is the concept of permanent establishment. A corporate entity is normally only subjected to their domestic tax laws where it is established and carries out their business. However, even a source country becomes eligible to tax the said corporate entity on their business profits which arises in the source country, if it can be proved that the company has an extended established period of presence or a physical nexus to carry out business activities in that country. Permanent Establishment is a concept essentially developed to mitigate instances of double taxation for corporate entities between the resident state and the source country. Article 5 of the several Double Tax Agreements (DTAA) that India has signed with several countries defines what permanent Establishment is. There are different types of PE which can be established namely, fixed place PE, Construction PE, Service PE, Agency PE or subsidiary PE. Permanent Establishment is synonymous to ‘business connection’ concept under the Income Tax Act of India.
Speed thrills but also kills. Formula One has made it possible for people to thrill of speed, from a distance. Formula One is an international racing sport of the highest class. The matches are called Grand prix and grand indeed they are, both in terms of popularity- especially in recent times and the money involved. One of the basic requirements of a motorcar race is of course, the racing track. India’s very own world class racetrack, the Buddh International Circuit situated in Noida, on the outskirts of Delhi even hosted the Indian edition of Formula One events from 2011 to 2013. This article is about the (in)famous case of Formula One World Championship Limited v. CIT[1], one of the reasons why F1 might not be hosted in India again in the near future[2] and the Supreme Court’s explanation of what constitutes permanent Establishment, more specifically, fixed place PE.
Facts:
Federation Internationale de I’Automobile (FIA) a non-profit organization, was the regulating body of FIA Formula One World Championship. Formula One World Championship Limited (FOWC) is UK incorporated company. Formula One Asset Management Limited (FOAM) was handed over its exclusive commercial rights and FOAM in turn licensed those commercial rights to FOWC for a period of 100 years. FOWC contracted with Jaypee Sports International Limited in India for a race promotion, wherein Jaypee was to pay a consideration of $40 million to FOWC in exchange of getting the right to hold Formula One Grand prix racing in India.
In lieu of this agreement, Jaypee constructed the Buddh International Circuit. Media and broadcasting agreements were further made by Jaypee with various other corporation. Owing to all these agreements, Jaypee and FOWC applied to Authority for Advance Ruling (AAR) seeking clarification whether FOWC had established PE in India. The AAR replied stating that payment made to FOWC was in the nature of royalty and FOWC also had no PE in India. The decision of the AAR was appealed in the Delhi High Court by the Revenue authorities wherein the court reversed the decision of AAR and held that FOWC did in fact have PE in India and the consideration payed by Jaypee to FOWC was liable to be taxed in India as business income and not as royalty. Again, not accepting the Delhi HC decision, there was a further appeal in the Supreme Court.
Issues:
So, the main issue before the Supreme Court was whether FOWC had PE in India
Arguments from FOWC–
It was contended that in order to establish permanent Establishment, it had to be proved that FOWC had an office and FOWC should have conducted business from such office in India. In fact, the organization responsibility was given to Jaypee by way of their contractual agreement and therefore, all rights of constructing the race track, hosting, staging and promoting etc. were a work of Jaypee Limited and not FOWC. It was also argued that the racing event only lasted three days in totality and there is no extended stay of FOWC in India. Therefore, FOWC had no control over the working of the event and permanent Establishment cannot be established.
Arguments of the Revenue department–
The revenue department argued that on an examination of the various agreements, it could be ascertained that FOWC actually retained control over the racing event held in India and Jaypee merely acted on behalf of FOWC. Pointing out that the media and title sponsor rights were transferred to the company Beta prema 2 and All Sports was transferred paddock rights by Jaypee vide contract which is an affiliate of FOWC. So, business was carried out from the paddock of the circuit. In fact, FOWC had actually been working in India since the time of the construction of the racing track.
What constitutes under different types of PE
Before going into what was held, following is a discussion about the tests which need to be satisfied to constitute that PE.
- For establishing fixed place PE, the taxpayer has to have a physical place of business in the source country. It must be fixed and it might also be a residence, if business activities are carried out from such residence. Further the place of business must be used for a continuous extended period of time where mere passing by does not come under the scope of fixed place PE. The office space used by such foreign entity must be at its constant disposal and used to carry out business activity.
- Construction PE and service PE is usually to determine taxation in instances of construction of installation projects for more than the minimum threshold time prescribed under the DTAA.
- Dependent Agency PE arises when the business of the foreign entity in question is carried out by an Indian resident in India. The work of the India agent must work on behalf of and be dependent on the foreign enterprise, which may or may not include having the ability to conclude contracts on behalf of the foreign enterprise or the agents habitually exercises such authority. In order to satisfy the Dependent Agency PE, all of these above conditions have to be satisfied.
- To constitute subsidiary PE, the foreign enterprise’s business must be carried out through the subsidiary company. There mere existence of a subsidiary company does not by itself give rise to the establishment of PE of the foreign company.
Holding of the court:
The court held that FOWC did satisfy the condition of permanent Establishment in India. Firstly, FOWC did have business presence in India as it was the exclusive commercial rights holder of Formula One racing championships which was held in India. It also accepted the argument that FOWC was the actual holder of hosting, staging and promoting rights of the event as well as the media rights. Secondly, the court also said that FOWC satisfied the condition of having a fixed place of business from where business was carried out in India by FOWC. Buddh International Circuit was at the disposal of FOWC and as is, Jaypee had extremely restricted role in conducting the racing event, highlighting the five year renewal condition for renewal of contract with Jaypee. The argument that FOWC operated in India only for the three days that the race was held did not stand well in court because the SC observed that it was not a significant issue. Instead, it explained that FOWC’s presence in India counted from the time period even before the event was actually held.
Thoughts and conclusion:
The SC’s decisions highlights the fact that ascertainment of time period is not as important or be the sole criteria to decide whether it constitutes fixed PE but the nature of the business must be examined to understand the control that the foreign entity exercised to conduct business in India. In the present case, SC after examining the different contracts, arrived at the conclusion that the end result was that FOWC was actually the one in control of the business activities. The court’s analysis in this regard did not provide adequate reasoning as to how FOWC was the one actually in control. Johnathan Schwarz questioned why there was no explain given regarding any finding which would prove that profits ended up in FOWC’s favour instead of its affiliates, since that is what the SC seemed to content. Additionally, he also put forth that if SC really wanted to tax the business profits which generated out of F1 races, then there should have been an examination of permanent establishment of the affiliate companies to ascertain where the business profits were taxable in India[3]. I also do not agree with the observation that the racing track constituted a fixed location from where FOWC conducted business. More elaboration should have been made on the point of duration from which FOWC’s presence is India is being considered, rather than terming it as a not so important aspect. Since the SC considered that FOWC’s involvement was present majorly in all the activities of the racing event, then the construction of the racetrack by Jaypee could have been construed as indirectly being done by FOWC itself and therefore a possible application of construction PE might have been considered. An additional issue which would then crop up is whether FOWC’s time spent in India would count from the construction days or only the duration during which the racing event was held. Which is more important to consider: time duration or the nature of business conducted?
I believe that the court was right in making effort to ascertain the true nature and substance of commercial activities as determination of PE is largely decided on a case by case basis where the burden of proof is on the taxpayer. However having said so, there is room for further clarifications to be made and it is no way a complete guide to determination of fixed PE. Taxation of foreign entities has always been fraught with controversy and media attention. Courts have to be careful to find the right balance between thinking about public policy and a tool to welcome more foreign investments in India.
[1] Formula One World Championship Ltd v. Commissioner of Income-Tax, International Taxation Delhi [2017] 291 CTR 24 (Delhi)
[2] ‘What Killed F1 In India?’ (Deccan Chronicle 19 November 2018) https://www.deccanchronicle.com/sports/in-other-news/191118/what-killed-f1-in-india-2.html
[3] Jonathan Schwarz, ‘F1’s Indian permanent establishment: car crash or racing to the future?’ (Kulwertaxblog 21 May 2017) http://kluwertaxblog.com/2017/05/21/f1s-indian-permanent-establishment-car-crash-racing-future/
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