There has been considerable controversy over the correct interpretation of the permanent establishment provisions found in Double Taxation Avoidance Agreements [“DTAA”] to which India is party. While recognising that this is a fact-sensitive inquiry, there are distinct signposts in the jurisprudence of the courts on this issue, both in India and elsewhere. In an important decision given last week in Samsung Heavy Industries v ADIT, the ITAT (Delhi) has considered some of the controversial issues in this area, particularly the extent of involvement before an “office” is regarded as a fixed place PE, and the relationship between the installation and fixed place PE provisions.
The assessee, Samsung Heavy Industries [“Samsung”], and Larsen & Toubro [“L&T”] entered into an agreement [“the Agreement”] with ONGC in February 2006, under which Samsung was to perform a number of functions in relation to ONGC’s Vasai East Development Project near Mumbai. The Agreement set out in detail the scope of each consortium partner’s work, and Samsung, among other things, was to engage in survey, design, engineering, procurement, fabrication, transportation and installation. The Recital to the Agreement noted that this was a turnkey project, and clause 184.108.40.206 required Samsung to provide ONGC with an organisation chart and a curriculum vitae of every project member involved, within twenty one days of the commencement of work. Clause 3 provided for a firm contract price (nearly US$450 million), and clause 3.2 stipulated that “provisional progressive payments” would be made by ONGC to Samsung, but that no payment would be due until Samsung furnished a Performance Bank Guarantee and obtained the permission of the Reserve Bank of India [“RBI”] to establish a Project Office in India. Samsung accordingly sought and obtained RBI permission, and opened a Project Office in Mumbai in May 2006. Two events then occurred that were to assume considerable importance in the disposition of the case. First, Samsung offered for assessment a certain sum arising to the Project Office and claimed a larger sum as a loss – a decision the Department tried to use as an admission that the Project Office is a PE under the DTAA. Secondly, a Samsung Board Resolution in April 2006 indicated that a Project Office was to be opened for the “coordination and execution” of the Vasai East Development Project.
Samsung’s case was three-fold: first, that there was no fixed place PE under art 5(1) of the Treaty although there was a “fixed place”, because business was not carried on wholly or partly through that place; secondly, that the functions of the PE were auxiliary or preparatory in nature for the purpose of art 5(4); and finally, that in any event art 5(3) is a special provision that is intended to deal with an installation project and that such a PE cannot have come into existence because the fabrication activity was sub-contracted to a Malaysian firm.
The Tribunal gave three reasons to reject these contentions. First, it held that Samsung had in fact entered into a composite, not divisible, contract – in other words, the parties had not agreed that Samsung would fabricate the platform and install it as two distinct sets of obligations, but simply that Samsung would perform the functions listed above for the consideration specified in Clause 3. The Tribunal also relied on the fact that the payment schedule took the form of a Provisional Progressive Payment, indicating that ONGC was not paying for the completion of distinct stages or components of an agreement. As a result, the Tribunal held that the decision of the Supreme Court in Hyundai Heavy Industries did not assist Samsung. According to the Tribunal, that case had turned on the fact that there was a divisible contract of fabrication and installation and this, said the Tribunal, was the basis of the Supreme Court’s observation that no installation PE could have come into existence before the platform fabricated outside India was transported to India. According to the Tribunal, another crucial difference between Hyundai and Samsung is that the assessee in Hyundai merely had a liaison office, whereas Samsung not only had a Project Office but was required to have one as a precondition for executing its role under the Agreement.
Secondly, the Tribunal found that the extent to which the Project Office was involved in the execution of the Agreement made it a PE. Samsung had suggested that the mere existence of an office is not sufficient, and that its business was not wholly or partly carried on through the Project Office because it was merely a communication interface between ONGC and Samsung. The reasons the Tribunal gives to reject this contention are, with respect, not entirely persuasive. For one, it relied on the fact that it was a condition precedent of the Agreement that a Project Office had to be established, except that this does not, in and of itself, demonstrate that the function of the Project Office was such as to attract art 5(1). Similarly, it may be that it accorded more weight than was due (¶71) to the Board Resolution of 3 April 2006 and to the expression used therein that the Project Office was to be established for the “coordination and execution” of the Agreement.
The final limb of Samsung’s case that art 5(3) is a special provision and overrides art 5(1) was rejected because art 5(3) is not a restriction on the scope of art 5(1). There is some support for the Tribunal’s view on this issue in the language of the DTAA – art 5(1) provides that PE “means a fixed place of business through which the business of an enterprise is wholly or partly carried on”, and art 5(3) provides that the term PE “likewise encompasses” a building site, installation project etc. The Tribunal made the following observations:
Article 5.3 used the words “likewise encompasses” and these items are, a building site; a construction; assembly or installation project or supervisor activity in connection therewith but only in a case where such site/project or activity continue for a period of more than nine months. So, it has further enhanced the term “permanent establishment” to these entities. Therefore, it will be wrong to say that Article 5.3 is an exclusionary clause, restricting the scope of Article 5.1 or Article 5.2 [emphasis mine].
In short, there is some uncertainty today over the extent to which a fixed place may be involved in the execution of an agreement without inviting the conclusion that there is a fixed place PE. It may also be important to ascertain whether the juridical basis of “severing” an agreement is the intention of the parties (as Gannon Dunkerley suggests, in another context) or specific to the particular legislation.