In a decision which would have significant ramifications for foreign companies in general, and Computer Reservation Service (CRS) majors in particular, the Delhi Income-tax Appellate Tribunal, in a recent ruling of Galileo International Inc., has held that payment of arm’s length remuneration to the Indian agent would absolve a company from any further liability to pay tax in India. This decision is in line with the principles laid down by the Supreme Court in the Morgan Stanley case and would surely comfort foreign companies, especially those engaged in e-commerce.
CRS companies specialize in providing electronic global distribution/ticketing services to airlines, hotels, cab operators, etc., by connecting them to travel agents. The issue before the tribunal was related to the taxability of Galileo in India. While rendering this decision, the tribunal made several observations which could impact the taxability of foreign companies operating in India. Also, the tribunal’s conclusions on profit attribution would be of particular importance.
The concept of permanent establishment is one of the most important in international tax treaty law. Virtually all modern tax treaties use it as the key tool to establish taxing jurisdiction over a foreigner’s business activities in the host country. It could be constituted either by having a fixed place of business, or a sustained presence of employees, or even an agent in the other country. So, the focus of this article is to explain the impact of the said ruling and analyse the principles it lays down to constitute permanent establishment in India and attribute profits to it.
The broad facts are as follows: Galileo is a US-based CRS company. CRS firms receive, process, store and disseminate data about flight schedules, seat/room availability, fares, etc. Galileo entered into agreements with various airlines to provide these services. To market and distribute CRS in India, it appointed a distributor in India, who in turn entered into subscription agreements with travel agents across the country. Further, to facilitate CRS operations, computers were installed at the premises of the subscribers.
Galileo was remunerated outside India by the airlines, while it paid fees to its Indian distributor for providing marketing and communication services, at the rate of 33.3% of the booking income from the country. It is against this backdrop that the issue of Galileo’s taxability in India arose.
In most countries, including India, the legislation has not kept pace with the rules of doing trade in the borderless world of e-commerce.
For instance, even the US treasury department has no specific guidance on e-commerce trade, except for a report it issued in 1996, which discussed the emerging trade challenges posed by the Internet economy.
Against this backdrop, the tribunal analysed whether the computers installed at the premises of the travel agents would constitute Galileo’s permanent establishment in India. The tribunal observed that Galileo had installed the computers as well as the connectivity, and exercised complete control over them. Further, the computers so connected and configured were a part of the CRS system.
In the context of whether any income accrues in India, an additional dimension raised by Galileo was that the travel agent, while punching seat requests, only makes an offer, and that the booking is concluded when the airline server accepts the offer outside India. Hence, the contract is made outside India, and no income arises in India. However, this was negated by the tribunal, which stated that booking does initiate in India, and hence some part of income would arise in India.
Accordingly, the tribunal held that the computers/connectivity present in India, which were a part and parcel of the CRS system would constitute a fixed-place permanent establishment in India.
Now, coming to the issue of agency permanent establishment, the ruling has laid down an important proposition for determining whether an agent is dependent or independent.
Ordinarily, when the activities of the agent are devoted almost entirely for the overseas principal, it would be considered a dependent agent of that principal. In the present case, the Indian distributor had a full-fledged travel agency business.
The tribunal held that since it provided CRS services only to Galileo, hence the distributor would be a dependent agent of Galileo.
This proposition is clearly debatable, and would be tested judicially in the times to come. What could also spark off another debate is whether an arm’s length transaction could trigger the dependent agency clause in the context of the India-US tax treaty. In contrast to most treaties which India has signed, the India-US treaty has an additional condition for determining whether an agent is dependent or not, that is, the transactions between the agent and the principal is not made under arm’s length conditions. In this case, the tribunal has itself held that the fees paid to the distributor were at arm’s length. Given this, the justification for holding the distributor as a dependent agent in India is questionable.
Having held the distributor to be a dependent agent in India, the tribunal further noted that it had the authority to conclude contracts which would bind Galileo. Further, the said contracts were not ancillary contracts but constituted business proper of Galileo, and this authority was habitually exercised. Accordingly, Galileo was held to have a dependent agency permanent establishment in India.
Attribution of profits
On the attribution issue, the tribunal observed that while the activities in India were minuscule, income would not have been generated, without the presence in India. Accordingly, 15% of the revenue from Indian bookings was held as attributable to its Indian presence. However, since remuneration paid to the agent (at 33.3%) was more than the income attributable of 15% (thereby implying the same to be at arm’s length), no further income was taxable in India.
With the Delhi tribunal following the apex court on the attribution issue, it seems that there is finally some judicial consensus on this aspect, and the IT/e-commerce industry would definitely heave a sigh of relief.
On a broader note, the issue of permanent establishment in India is a vexed one, especially in the context of e-commerce and the traditional international tax laws are insufficient to confront the emerging challenges posed by the e-commerce economy. In fact, the high-powered committee on e-commerce constituted by the Central Board of Direct Taxes (CBDT) in 1999 had suggested that an attempt be made to find an alternative to the concept of permanent establishment.
As such, in the interests of clarity and of mitigating disputes, CBDT needs to proactively address these issues. There is already a mechanism in the form of an Emerging Issues Task Force (constituted by the Union government), which has unfortunately not thrown much light on vexed issues such as these. At this juncture, suffice to say, the last word on the issue has not been said as yet.
Ketan Dalal is executive director of PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org