Home

Internal

Deutsch|English

Insights "Quantitative Advisory – Your caring partner for complex valuation challenges" » |

Worldwide

International Tax Updates

published on 30 October 2024 I reading time approx. 4.50 minutes

1. Indian High Court affirms ‘Independent Entity’ approach for profit attribution of a permanent establishment (‘PE’)

In a recent decision, the Delhi High Court upheld the proposition that profits of a PE of a foreign company shall be taxable independently irrespective of whether the foreign company, incurs a profit or loss at a global level. The Delhi High Court opined that activities of a PE shall be independently assessed and determined in light of the language of Article 7 of tax treaties, which lays emphasis on functions, activities performed and risks undertaken.

Interestingly, there have been divergent decisions of the High Court in the past on this issue. A Full Bench was therefore constituted as a consequence of the Court doubting the correctness of views expressed in an earlier decision where the High Court held that profit attribution to a PE was warranted only if the enterprise as a whole had earned profits. With this decision, remarkably a Full bench decision, this controversy seems to have been put to rest.

In the context of the Organization for Economic Cooperation and Development (‘OECD’) guidance, India does not follow the Authorized OECD Approach (‘AOA’) for the attribution of profits to a PE. AOA presents the idea of treating a PE as if it were an independent and functionally separate entity engaged in the same or similar activities under the same or similar conditions. However, in general, the exercise to attribute profits to PE based on Functions, Assets and Risk analysis, has been upheld by Courts. In absence of said analysis, Revenue authorities generally apply an ad-hoc method to attribute profits to a PE constituted in India.

2. Tax treaty eligibility for a Limited Liability Company incorporated in US upheld considering that the entity is liable to tax

In the instant case, the taxpayer, a limited liability company (‘LLC’) incorporated in United States (‘US’), earned an income from rendering of Fees for Technical Services (‘FTS’) from its group entities in India. The taxpayer offered such income to tax in India at a rate of 15% under Article 12 of India-US DTAA, which is beneficial vis-à-vis the tax rate of 25 per cent under the Indian Income-tax Act, 1961 (ITL).

During the course of reassessment proceedings, the tax officer held that the taxpayer is a fiscally transparent entity in US and such Corporation does not qualify as Resident under Article 4 of the India-US DTAA as they are not liable to tax in US. Accordingly, the tax officer denied the beneficial tax rate of 15 per cent to the taxpayer, considered on the FTS income,.

The Dispute Resolution Panel (‘DRP’) upheld the order of the tax officer and held that LLC is not subject to tax in their own hands and accordingly, not liable to tax in India. In doing so, a reference was made to OECD Model Convention on Article 4, wherein it is stated that where a particular country disregards a partnership for tax purposes and treats it as fiscally transparent, taxing the partners on their share of the partnership income, the partnership itself is not 'liable to tax’, and may not, therefore, be considered a resident.

Aggrieved by the DRP’s order, the taxpayer preferred an appeal before the ITAT. The taxpayer inter-alia submitted before the ITAT, that what is relevant for determining the residency under Article 4 of the India-US DTAA is the legal situation that entity is liable to taxation and not the fiscal fact of actual payment of tax. In doing so, it relied on various commentaries on international taxation and jurisprudence to substantiate its claim before the tax authorities.

The ITAT, while adjudicating on the issue, made following observations:

Publication 3402 states that LLC is a business entity recognized by the US under State law. A LLC may be classified as a partnership, corporation or a disregarded entity for federal income tax purposes.
While a single member LLC is considered as a disregarded entity (i.e. income / loss of LLC is reported in owner’s tax return), however, it is considered as a separate entity for the employment tax and certain excise taxes.
Form 6166 read with Instruction for Form 8802 provides that a fiscally transparent entity organized in US and that does not have US partners, beneficiaries, or owners, then such entity is not entitled to residency certification.
The tax residency certificate of the taxpayer reads that LLC is a branch, division, or business unit of a U.S. corporation that is a resident of the USA for purposes of U.S. taxation.
A single member LLC can make an election to be treated as a corporation for US federal income tax purposes. This ability of the LLC to elect its tax classification supports the legal situation or aspect of the LLC being liable to tax.
The owner of the LLC pays tax on its share of the taxable income attributed from the LLC, which is like US consolidated group rules where all affiliated US corporations file a single US federal income tax return.

In view of the above, the ITAT held that LLC is organized as a body corporate as it enjoys a separate existence from its Member and therefore, qualifies as a ‘person’. By virtue of incorporation, the taxpayer is a resident under Article 4 of the India-US DTAA. Further, the taxpayer is liable to tax by virtue of US Income-tax Law, as an LLC is given an option to either be taxed as a corporation or as a disregarded entity or partnership, wherein the income of the LLC is clubbed in the hands of its owner who merely discharges the tax that is assessable in the case of the LLC.

The issue of treaty eligibility to fiscally transparent entities has been a long-debated issue. The Indian Courts have observed that if the beneficiary is liable to tax in such jurisdiction in respect of the pass-through income, the treaty benefit should be allowed to the transparent entity. However, this is the first time that the Indian Courts have upheld the treaty eligibility in case of LLC incorporated in US.

The primary contention of the tax officer was whether the LLC is ‘liable to tax’ in US. While the taxpayer has relied on various judicial precedents as to what constitute ‘liable to tax’ and accordingly, substantiate how a LLC is ‘liable to tax’ in US, it is worth noting that Indian Government has vide Finance Act, 2021 has introduced the definition of ‘liable to tax’ under section 2(29A) of the ITA which states – “in relation to a person and with reference to a country, there is an income-tax liability on such person under the law of that country for the time being in force and shall include a person who has subsequently been exempted from such liability under the law of that country”. Section 90 of the ITA specifically provides that any term which is not defined under the treaty, unless the context otherwise requires, will derive its meaning from the ITA. The ITAT, while adjudicating on the issue, has not made any reference to such definition under the ITA, probably because such definition was not applicable for the year under consideration. Hence, it would be interesting to watch how the judiciary interprets the definition of ‘liable to tax’ under the ITA while determining the tax treaty eligibility for fiscally transparent entities.

From The Newsletter

Newsletter India

Contact

Contact Person Picture

Martin Wörlein

Partner, Head of India practice

+49 911 9193 3010

Send inquiry

How We Can Help

Rödl & Partner in India