International Tax Updates

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Direct Tax – International Tax Updates

Physical presence of employees necessary for Service Permanent Establishment (PE) constitution under India-Singapore DTAA, rules out Virtual Presence / Virtual PE constitution

In the instant case, the taxpayer is a company incorporated in Singapore and was engaged in rendering legal advisory services to the clients in India. The services were provided virtually from outside India using digital means. Some of the employees also visited India for rendition of services in India.

The tax officer alleged that the employees have virtual presence / virtual service PE in India as the services were rendered from outside India using digital means and through the physical presence of employees in India exceeded the prescribed threshold for service PE of 90 days in a financial year under the India-Singapore DTAA. Further, while counting the period of days in India, the tax officer considered the following:

1. the period for which the employees were on vacation
2. common days spent by two employees in India as separate days, resulting in double counting and
3. days when business development work was carried out and no services were rendered.

The order of the lower tax authorities was appealed by the taxpayer before the Delhi Income Tax Appellate Tribunal (‘ITAT’), wherein it was held that only when the services are rendered by the employees within India with their physical presence, a Service PE can be constituted. In doing so, ITAT also placed reliance on the Supreme Court (SC) ruling in case of E-funds IT Solutions Inc. that services must be furnished “within India”.

The tax officer preferred an appeal against the order of the Delhi ITAT before the Delhi High Court (‘HC’). Detailed arguments were made by the tax officer which inter-alia included placing reliance on the judicial precedents of SC judgement in Hyatt International Southwest Asia Ltd. , Madras HC in Verizon Communications Singapore Pte. Ltd. v. ITO , and Bangalore Tribunal in the case of ABB FZ-LLC v. DCIT .

The tax officer also relied upon the OECD Interim Report, 2018 regarding establishment of a virtual service PE, wherein a minority view was expressed by some countries that the requirement of physical presence is not relevant for the constitution of service PE as services can be rendered from remote locations as well.

The HC upheld the order of the ITAT and ruled in favour of the taxpayer. In doing so, it made the following remarks/observations:

• Article 5(6)(a) of the India-Singapore DTAA contemplates rendition of services in India and in the absence of personnel physically performing services in India, there can be no furnishing of services “within” India.
• There is no such concept of Virtual Service PE in India-Singapore DTAA. Further, the concept of Significant Economic Presence (SEP) introduced under the domestic tax laws cannot be read under the DTAA.
• OECD Interim Report, 2018 itself states that in the absence of any amendments to the DTAA, these virtual PE measures run the risk of being challenged by taxpayers before Courts, which suggest the need for amendment in tax treaties before applicability of these provisions.
• The rulings of Hyatt and Verizon do not deal with the issue in hand. The SC in Hyatt ruled on continuity of business operations and not the aggregate time of stay of employees. Further, Madras HC in Verizon specifically mentioned that PE issue is neither raised nor argued before the Court.
• With respect to Bangalore Tribunal ruling in ABB FZ, the HC held that the ruling discusses the requirement of fixed place of business for a Service PE under Article 5(2) of India-UAE DTAA. However, the provision of Article 5(6) of India-Singapore is clearly worded and there is no such issue in interpretation.
• With respect to the computation of the threshold for Service PE, it was held that:
  • Vacation days will not be included as no services were rendered on such days
  • Common days will be considered as one while computing the Service PE threshold
  • Business development days will not be considered as what is relevant is the actual rendition of services and not mere stay of employees in India

In view of the above, the Delhi High Court held that the rendition of services virtually from outside does not result in constitution of Service PE in India. While the ruling favors the taxpayer, it is relevant to take note of the remark of the HC wherein it acknowledged that the Revenue may potentially be justified in raising concerns regarding taxability of foreign entities in the increasingly open global virtual economy, and the diminishing requirement of physical presence of non-resident employees to furnish services. Thus, the looming risk of taxation of the emerging business model remains susceptible to review by tax authorities.

Bombay High Court (Goa Bench) rules that tax rate as per DTAA prevails, even where domestic company liable to dividend distribution tax (‘DDT’)

Recognition of ‘Dividend’ as an income and ‘Dividend tax’ to be paid on the same has been in existence since the inception of the ITA. Historically, dividends were taxed in the hands of the shareholders (recipients of dividends) who were supposed to discharge the tax on dividend income. The rate of DDT prescribed under the ITA has generally been on the higher side, as compared to the tax rate prescribed in the relevant Double Taxation Avoidance Agreements (DTAA) entered by India with its tax treaty partner nations. In the context of cross-border payment of dividends i.e. by an Indian Company to its non-resident shareholders, such non-resident shareholders are able to claim lower tax rate as per applicable treaty provisions. However, the issue had arisen in respect of DDT regime, when domestic companies used to discharge the tax liability and non-resident shareholders were not liable to tax in respect of such dividend income. The question raised was, whether the dividend income should be subject to higher DDT rate as per the ITA, or at the lower beneficial tax rates available in the DTAAs subject to fulfilment of specified conditions. Bombay HC has recently ruled in favor of taxpayer in respect of this question. Further details on this judgement can be found on our website Tax rate as per treaty prevails, even where domestic company liable to dividend distribution tax | RÖDL

Mumbai Tax Tribunal (‘ITAT’) holds use of technology doesn’t make service technical in nature, not ‘FTS’ under India-Belgium DTAA

In the present case, Solvay S.A., a Belgium-based chemical manufacturer, entered into a Functional Services Agreement with its Indian affiliates to provide centralized business support services. These services included IT support, procurement, HR, finance, legal compliance, and communication functions. For the Assessment Year (‘AY’) 2022–23, the company received INR 109,72,75,428 for these services. The Indian tax authorities classified this amount as Fees for Technical Services (FTS) under section 9(1)(vii) of the ITA and Article 12 of the India–Belgium DTAA, asserting that the services involved technical or managerial expertise.

The Assessing Officer initially treated the receipts as royalty, while the Dispute Resolution Panel (DRP) recharacterized them as FTS. Mumbai ITAT, after examining the Functional Services Agreement and the actual nature of services rendered, held that the services were routine, standardized, and centralized support functions aimed at ensuring group-wide uniformity and efficiency. Further, the Tribunal clarified that managerial services require control, direction, or administration of the recipient’s business, which was absent in the present case. Merely providing group policies, standard procedures, or centralized facilities does not amount to managing the affairs of the Indian entities. Relying on the OECD e-commerce report, the ITAT emphasized that services relating to ‘how a business is run’ may be managerial, whereas services involved in ‘carrying on the business’ are not. The Tribunal also noted that in earlier years, similar receipts were never treated as royalty or FTS, thereby reinforcing the assesses claim on the principle of consistency.

Further, in relation to technical and consultancy services, the Tribunal held that the mere use of sophisticated technology or IT systems does not render a service technical. Technical services arise only when specialised skills or technical knowledge are required at the time of rendering the service to the recipient. In Solvay’s case, the services were limited to providing access to standardized infrastructure and facilities, with technology being only a means of delivery and not the service itself. Further, consultancy services necessarily involve advisory or recommendatory inputs requiring human intervention and specialised expertise, which were clearly absent.

Based on above, the Tribunal ruled that the receipts cannot be taxed as FTS under the DTAA or domestic law. The appeal was partly allowed in favor of the Assessee. This decision provides significant clarity for multinational corporations, confirming that business support services without specialized expertise or managerial involvement do not fall under FTS provisions, reducing the risk of unwarranted tax exposure in similar cases.

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