[Taxation Law] Market Research, Promotional Activities, Training Or Deployment Of Software Are 'Auxiliary Functions' Under DTAA: Delhi HC

Double Taxation Avoidance Agreement (DTAA) was signed between India and the US to prevent International Double Taxation and encourage international trade.

Determination of core or auxiliary activity is a relevant factor to ascertain whether a unit of a foreign entity constitutes 'Permanent establishment' in India, exigible to tax. Entities performing auxiliary functions are excluded under Article 5 of DTAA.

In the case at hand, Revenue argued that Liaison Office (LO) of Western Union Financial Services Inc. (a non-resident company registered in the USA) in India, constitutes PE. It further contended that the activities undertaken by the LO were sufficient to treat it as a Dependent Agent being present in India and thus the test of existence of a Dependent Agent Permanent Establishment was also met.

ITAT had held that the LO would not satisfy the tests enumerated in Article 5 of the DTAA and the activities undertaken by it would be liable to be viewed as being merely 'preparatory' or 'auxiliary' in character.

Aggrieved, the Revenue approached the High Court.

In its 72-page judgment, a division bench of Justices Yashwant Varma and Ravinder Dudeja noted that the LO was only engaged in activities relating to liaising with governmental authorities, training of personnel and undertaking other peripheral functions in aid of the business of Western Union Financial Services.

“The gamut of activities which it undertook cannot thus be described to be the undertaking of an essential or significant part of the principal business activity of Western Union Financial Services,” it said.

It heavily relied on Morgan Stanley and Co. Inc. [DIT (International Taxation) v. Morgan Stanley and Co. Inc., (2007) where the Supreme Court held that market research or analysis, data processing support or for that matter, account reconciliation are essentially back office functions and support services and which would not be sufficient to acknowledge a fixed place permanent establishment existing.

The Court then enunciated that for the purposes of being acknowledged as a PE, LO would have to qualify the provisions of Article 5.

“It would thus have to be held to be a 'fixed place' through which the business of the enterprise was being wholly or partly carried out. In order to constitute a Fixed Place PE, it would have to satisfy the tests of virtual projection, a takeover of the premises as well as the precepts of control and disposal and the undertaking of core business activity of the enterprise,” it said.

The Court added, “Of equal importance are the provisions comprised in Article 5(3) and which excludes places of business related to an enterprise in the other contracting state and which undertakes 'other activities' which are liable to be countenanced as being preparatory or auxiliary. It is thus Article 5(3)(e) which clearly appears to be applicable when viewed in juxtaposition with the activities which the LO performed and the functions that it discharged. This becomes evident from the discussion which follows.”

The Court pointed out that Article 5(3) constitutes a list of negative stipulations, which removes a fixed place of business from the ambit of a PE. “Thus, even if an establishment were to meet the test of a fixed place, it would stand exorcised from the main provision of that covenant if it were found that its activities were confined to preparatory and auxiliary work for the enterprise,” it said.

The High Court then proceeded to observe that the core function, i.e. transaction pertaining to the transfer of funds was consummated in the USA itself and it was the Indian agents of Western Union Financial Services which undertook and discharged the essential functions required for the completion of those transactions.

“The LO was not even remotely involved in the conclusion of those transactions. Since the activities undertaken were far removed from the core business of the Western Union Financial Services enterprise, it is the tests of 'preparatory' and 'auxiliary' as embodied in Article 5(3)(e) which stand met and satisfied,” it held and dismissed Revenue's appeal.

Case title: Director Of Income Tax Intn'l v. Western Union Financial Services Inc. (and batch)

Case no.: ITA 1288/2006