Are you creating a Dependent PE taxable in India by appointing a sales agent in India?
A foreign entity in Japan is appointing an sales agent in India to market and sell their products. They are not setting up an Indian entity, not hiring an employee in India but only appointing a full time agent in India. Can such a person be construed as a permanent establishment (PE) for the Japanese entity in India? The answer is YES !
In this article we have discussed provisions applicable to such agents including:
- The likelihood of the agreement resulting in PE issues for foreign entity.
- Indian agent’s dependence/independence status given its financial situation.
In case a Dependent permanent establishment is created in India for a foreign entity, the Indian revenue authorities would generally attribute to the PE, approximately 10-35 percent of total profits of the foreign entity in home country from sale of products to the Indian companies. Such profits would then be taxed in India at approximately 40 percent plus applicable surcharge & cess (tax rates applicable to foreign entities).
As per Section 92F (iiia) of Domestic Tax Act (DTA), “Permanent establishment” includes a fixed place of business through which the business of the enterprise is wholly or partly carried on.
The concept of Permanent Establishment (PE) is generally defined in Article 5 of tax treaties. Further, as defined by India – Japan DTAA, the term ‘permanent establishment’ includes especially:
(a) a place of management ;
(b) a branch ;
(c) an office ;
(d) a factory ;
(e) a workshop ;
(f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources ;
(g) a warehouse in relation to a person providing storage facilities for others;
(h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on ;
(i) a store or other sales outlet ; and
(j) an installation or structure used for the exploration of natural resources, but only if so used for a period of more than six months.
As per clause 7 of Article 5 of the DTAA:
“Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 8 applies – is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned Contracting State, if
(a) he has and habitually exercises in that Contracting State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 6 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph; or
(b) he has no such authority, but habitually maintains in the first-mentioned Contracting State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise; or
(c) he habitually secures orders in the first-mentioned Contracting State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control as that enterprise.
In this article we are concentrating on Dependent PE or a PE where an individual agent can be construed as a PE of a foreign entity in India.
An agent or an entity working for a foreign enterprise does not necessarily create “dependent agency” permanent establishment. One of the essential pre-requisites in such situations is that the agent must have the authority and he habitually must be exercising authority to conclude contracts on behalf of the foreign enterprise.
If he has no such authority but maintains stock of goods from which he delivers regularly on behalf of foreign enterprise or he habitually secures orders for the foreign enterprise and its group entities; he may also be considered to be a dependent agent. Therefore, undertaking activities like concluding contracts, holding stock of goods from which deliveries are made or securing orders wholly or almost wholly can lead to a dependent agency.
Further the authority need not be explicit – it could be even implied. In certain situations, such an authority could be inferred, even if the agent concludes contracts that are not in the name of the foreign enterprise, but are still binding on the foreign enterprise. It is also essential that the authority relates to core business operations, and not internal operations, which constitute the business proper of the foreign enterprise.
The agreements signed between Indian agents and foreign entities should be strengthened to ensure that the Indian agent does not hold any stock of goods in India from which deliveries can be made. His role should be only in making introductions/ providing leads to prospective buyers and undertaking only administrative work in India. Contract negotiations and terms should be decided between the foreign entity and Indian buyer directly. Also in certain cases, efforts from Indian agent that lead to ultimate signing of contract, may construe PE in India. Further the title/ risk in goods should directly be passed on from foreign entity to buyer in India. Indian buyers should also be able to directly approach foreign entity and not indirectly through Indian Agent.
Further with similar facts the honorable Delhi High Court in
Rolls Royce Plc. vs. ADIT. held the following:
1. Where the Indian company (agent) was prohibited from selling competitive products and was engaged exclusively to sell products of the foreign company in India, it was held that the same is restrictive and tantamounts to controlling the Indian agent and effecting his independence. If the foreign company has business reasons to impose such restrictions it will need to prove the independence of activities undertaken by the Indian agent.
2. In the said case, the Indian agent while undertaking its obligations was under extensive control of the foreign company. It was required to take detailed instructions, advice from employees of foreign company on various aspects. On the basis of such obligations it was held that Indian agent was dependent on the foreign company.
3. True test of the dependence was whether activities of Indian agent were devoted wholly or almost wholly for the foreign company.
Therefore, keeping the above in mind, we will need to ensure that the Indian agent should never be absolutely barred from selling products of other foreign companies. It would in fact be better if other products are sold by such entity as an independent agent. Further the provisions with regards to selling products of competition should not be too restrictive.
The Indian agent should not be under control and instruction of the company in Japan or its employees. Further it would be ideal, if the Indian agent does not wholly or almost wholly secure orders for single foreign entity. Clauses should be included in the agreement where foreign entity can directly secure orders from India.
Further clause 8 of the said Article deals with Independent agent, adds the following:
“An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that Contracting State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.”
Therefore, an enterprise shall not be deemed to have a permanent establishment in a contracting state merely because it carries on business in that contracting state through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.
Please note that in case of certain treaties entered into with India (for example India Singapore DTAA and India USA DTAA), there is a specific clause which provides “However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise itself or……., he will not be considered an agent of an independent status within the meaning of this paragraph”.
If we undertake a detailed reading of the India Japan DTAA such clause has not been incorporated in clause 8 which deals with independent agent but has been included in clause 7 (dependent agent) of the said article. India has further specifically expressed to the OECD in its reservations to interpretations that it reserves the right to make it clear that an agent whose activities are conducted wholly or almost wholly on behalf of a single enterprise will not be considered an agent of an independent status.
Therefore, only if the agent has revenue from other sources and devotes time to other activities it would be considered independent. There are high chances of the Indian revenue department contesting the independent nature in a case where revenue of Indian agent would be entirely or mostly received from the same foreign entity or activities undertaken are mostly for the foreign entity.
Discussing a specific case, the primary concern of a Japanese company in a particular case was that the Indian company (to be appointed as agent) has been recording losses for the last few years and hence if the agreement results in the Indian company recording profits then would it be treated that the Indian company is deriving whole or almost the whole of its income from the Japanese company i.e., the Indian company is wholly or almost wholly dependent on the Japanese entity for its business and will cease to have any business if the agency agreement is terminated.
For existence of a dependent agency permanent establishment, the agent must be legally or economically dependent on the principal (the foreign enterprise). Otherwise, ‘independent agent’ provisions of the Article 5 paragraph 8 may negate the existence of a dependent agency permanent establishment.
Generally, an agent is regarded as legally dependent on the principal if the agent’s activities are subject to detailed instructions or comprehensive control by the principal. Further, an agent is generally regarded as economically dependent on the principal if he derives almost entire revenue from the principal or if he services only one principal.
In the case of
Rolls Royce Singapore (P.) Ltd. vs. ADIT
the Income tax Appellate Tribunal (ITAT) held “the agreement between a Singapore company (principal) and the Indian agent imposed certain restrictions on the Indian agent. Particularly, the Indian agent was required to act exclusively for the Singapore company, and it was prohibited from assisting any other company or person that competed with the Singapore company. In the ITAT’s view, that was an unusual restriction and, therefore, the Indian agent could not be regarded as having independent status. Also, in the ITAT’s view, the said restriction indicated that the Indian agent did not act in ordinary course of business of an independent agent.”
In the situation, where the Indian Agent is not required to act ONLY for a foreign entity and can pursue other activities excluding the ones mentioned in “Non-Competition” clause, he may not be considered legally dependent on the foreign entity.
Further, an agent is not considered independent of an enterprise (the principal) if his activities are devoted wholly or almost wholly on behalf of that enterprise. If an agent works exclusively for or earns revenue from a single principal, then that would generally indicate that the agent is economically dependent on the principal.
The Authority on Advance Ruling (AAR) in the case of Speciality Magazines (P.) Ltd. clarified the meaning of the expression “wholly or almost wholly”. The AAR opined that for Speciality Magazines to be considered as devoting its activities ‘wholly or almost wholly’ on behalf of the UK magazine, at least 90% of Speciality Magazines’ revenue had to come from the UK Magazine. Accordingly, the AAR held that Speciality Magazines was an independent agent.
In the current case if the Indian agent is deriving whole or almost whole of its business and profits from the Japanese business it may be considered a case of economic dependence resulting in Permanent Establishment for the Japanese entity in India. In order to ensure such a Permanent Establishment is not formed it should be ensured that the Indian agent is not solely dependent on one foreign business for its revenue. For an agent to be independent, it should be ensured that he is not solely dependent on single entity for its revenues and profits.
If a foreign entity sells products worth 1000 USD and earns a 20% margin; Indian tax authorities may attribute part of profits (10-35% to Indian agent’s efforts) and tax USD 20-70 in India. The tax on the above transaction (USD 1000) would be approximately USD 8-22. Therefore it would always be advisable to review the agreements signed between Indian agent and foreign entity. Also ensuring independent nature of the agent would be very important.
Further in certain cases, foreign companies obtain Advance ruling from the Authority of Advance Ruling (AAR) to ascertain the position tax authorities will take for their specific transaction.