The Verdict in Reuters’ Case on ‘Dependent PE’ Is Not Correct

The decision of the tribunal (ITAT) in the case of Reuters Limited Construction House involving the issue of dependent PE under Indo-UK treaty – requires reconsideration.

Though the above decision is not yet reported, the relevant facts and the ratio laid down therein have been clearly stated by the Tribunal in its order u/s 254(2) of I T Act 1961 (the Act) which is reported as 48 SOT 246 (Mum).

The assessee, a resident of UK, was engaged in the business of providing news and financial information products. It did some business in India through its Indian subsidiary, Reuters India Ltd (RIL). It provided Reuters products to its Indian subsidiary under certain agreements. The fee charged by the assessee under such agreements was taxed by the AO. The CIT(A) held that the same could not be taxed in India since it had no permanent establishment (PE) in India in terms of Article 5(4) r/w 5(5) of Indo UK Treaty. Two findings were given by him—(i) that RIL did not fulfill the conditions specified in Article 5(4) and therefore it cannot be considered as dependent agent of the assessee so as to constitute a PE of the assessee in India and(ii) though under Article 5(5), RIL can be said to be independent agent of the assessee in India yet considering the OECD commentary and the fact that Indian subsidiary was a separate legal entity which was managed by the parent company, it would not be sufficient to conclude that RIL was an independent agent of the assessee unless it had the power to habitually exercise the authority to conclude the contract in the name of parent company. According to him, para 4 and 5 of Article 5 were not separate clauses. In other words, Article 5(4) would govern Article 5(5). Therefore, in the absence of such authority, it was held that RIL could not be considered as PE of assessee in India. The appeal of assessee was, therefore, allowed by him.

On appeal, it was contended by the revenue before the tribunal that there was a contradiction between the above findings of the CIT(A). The tribunal agreed with the contention of the revenue and observed that issue requires fresh examination by the AO.

Aggrieved by the order of the tribunal, the assessee filed a misc. application u/s 254(2) of the Act contending that conclusion of the CIT(A) was correct and the tribunal erroneously assumed that there was a contradiction in the findings of the CIT(A). The tribunal has held that the correctness of the legal opinion expressed by the tribunal cannot be challenged in the proceedings u/s 254(2) of the Act. Thus the application filed by the assessee has been dismissed.

In the above order, the tribunal has not expressed any opinion on the scope of paras 4-5 of Article 5 of Indo UK treaty. The original order is not yet reported. However, the ratio laid down by the Tribunal in its original order u/s 254(1) has been noted and mentioned in the above order u/s 254(2) in para 17 as under:

“The tribunal’s conclusions are based on its opinion that if the conditions mentioned in Article 5(5) of the DTAA are satisfied then that would be sufficient to constitute RIPL as an independent agent of the assessee in India and conditions mentioned in Article 5(4) need not be satisfied. In other words, even though the agent acts independently in the ordinary course of business, if they devote their activities wholly or mostly wholly on behalf of the foreign enterprise, they would be considered independent (should be ‘as dependent’) agents and would be PE of the foreign enterprise irrespective of whether they conclude contracts binding on their principal or not.”

It is the above finding which is the ratio of the decision in main appeal which is the subject matter of discussion in this Article. With all due respect to the hon’ble members constituting the bench in the main appeal, in my humble opinion, the later part of the above finding requires reconsideration for the reasons given hereafter.

There is no dispute that as per Article 7 of Indo UK Treaty, the business profits of a foreign enterprise would be taxable in India if such enterprise carries on business through a PE in India. The PE has been defined in Article v in India. Thus, interpretation of paras 4 & 5 of the Article 5 assumes importance for determining the issue whether the RIL, in the case before the tribunal, constituted a PE in India. Hence, it would be appropriate to reproduce the same here:

Article 5

4. A person acting in a Contracting State for or on behalf of an enterprise of the other Contracting State–other than an agent of an independent status to whom paragraph 5 of this article applies–shall be deemed to be a permanent establishment of that enterprise in the first-mentioned State if :

(a) he has, and habitually exercises in that State, an authority to negotiate and enter into contracts for or on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise ; or

(b) he habitually maintains in the first-mentioned Contracting State a stock of goods or merchandise from which he regularly delivers goods or merchandise for or on behalf of the enterprise ; or

(c) he habitually secures orders in the first-mentioned 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.

5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status, where such persons are acting in the ordinary course of their business. However, if the activities of such an agent are carried out wholly or almost wholly for the enterprise (or for the enterprise and other enterprises which are controlled by it or have a controlling interest in it or are subject to same common control) he shall not be considered to be an agent of an independent status for the purposes of this paragraph.

A bare reading of the above provisions reveals that para 4 excludes an independent agent from the purview of PE. It only takes within its ambit the agent other than the agent of independent status to whom paragraph 5 of this article applies subject to fulfillment of the conditions specified in para 4. That means that even the agent other than an independent agent would not constitute PE if the conditions specified in para 4 are not satisfied. The agent falling within the scope of para 4 is described in the judicial forum as dependent agent or dependent agency PE.

The scope of independent agent has been defined in para 5 of the article. The point to be noted is that para 5 nowhere says that an agent other than an agent of independent status would constitute PE while para 4 specifically says that an agent fulfilling the conditions specified therein would be deemed to constitute a PE. On the other hand, para 5 simply says to the effect that an agent of independent status shall not constitute a PE. The provisions of both the paras are deeming provisions and therefore, are required to be construed strictly. In my humble opinion, para 5 only provides that(i) an agent of independent status would not constitute a PE and (ii) if activities of an agent are carried out wholly or almost wholly for the foreign enterprise then such an agent would not be considered as an independent agent. At the cost of repetition, it is submitted that it nowhere provides that an agent other than an agent of independent status would constitute PE of the foreign enterprise. Thus, the only inference which can be drawn is where activities of an agent of independent status are carried out wholly or almost wholly for the foreign enterprise then such an agent would not be considered as an agent of independent status. Thus, such an agent would fall outside the ambit of Article 5(5) and consequently it is to be treated as an agent other than an independent agent for the purpose of Article 5(4). Such an agent would constitute Agency PE only if either of the conditions specified in article 5(4) is satisfied. If none of the conditions is satisfied then such an agent would not be considered as PE of foreign enterprise. That clearly means that an agent other than an agent of independent status by itself cannot be considered as PE of the foreign enterprise. The tribunal, in Reuter’s case, seems to have proceeded on the assumption that an agent other than an independent agent would automatically become dependent agent so as to constitute PE of foreign enterprise. If such a view is accepted than provisions of Article 5(4) would become otiose to the extent it specifies the conditions for constituting the PE. Such an interpretation, in my humble opinion, is not permissible in law.

In order to buttress my view, I would refer to two decisions of Authority for Advance Ruling (AAR). The first decision is in the case Morgan Stanley & Co. International Ltd 284 ITR 260. In that case, the applicant was a non-resident company incorporated in the United States of America (USA) under the General Corporate Law of the State of Delaware and it was a tax resident of USA. It was a leading investment Bank having a number of group companies in various parts of the world. The applicant, inter alia, provided financial advisory services, corporate lending and securities underwriting. The diverse activities of the applicant were undertaken by various divisions. One of the group companies was a Morgan Stanley Advantage Services Private Limited (“MSAS”) which was incorporated in India and was set up by the Morgan Stanley Group to support the Group Member’s front office and infrastructure unit functions in their global operations for providing support services. MSAS was a wholly owned subsidiary of Morgan Stanley International Holdings Inc., (U.S.) in which 80% shares are held by Morgan Stanley U.S. and 20% shares are held by Morgan Stanley International Corporated US which was a wholly owned subsidiary of Morgan Stanley, US. MSAS rendered support services such as IT support, account reconciliation, research etc. Under an agreement dated 1.12.2003, the applicant had out-sourced support services specified in Schedule-II thereto as amended from time to time. MSAS did not undertake the important revenue generating functions of the applicant nor did it bear any significant market risk with respect to its transactions with the applicant. The client’s interaction was done entirely by the employees/personnel of the applicant.

On the above mentioned facts, the applicant sought advance rulings of the Authority on various issues which inter alia included the following questions:-

1. Whether on the facts and in the circumstances of the case, Morgan Stanley & Co. incorporated (“the Applicant”) would be regarded as having a Permanent Establishment (“PE”) in India under the provisions of Article 5 of the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to taxes on Income and Capital Gains entered into between the Government of the Republic of India and the Government of the United States of America (hereinafter referred to as the “Treaty”), and specifically:-

(a) —-

(b) Whether MSAS would be regarded as constituting an agency PE of the Applicant under Article 5(4) of the Treaty?

At this stage, It is to be noted that AAR accepted the contention of the revenue that activities of MSAS were almost wholly devoted to foreign enterprise(applicant).

After hearing both the parties, the Authority commented upon the scope of paragraphs 4 & 5 of Article 5 as under:

“An agent of an independent status to whom para 5 applies, is excluded from para 4. Para 4 commences with a non obstante clause and says that notwithstanding the definition of the expression P.E. outlined in paras 1 and 2, a person, other than an agent of independent status to whom para 5 applies, acting in a contracting state on behalf of an enterprise of the other contracting state shall be deemed to have a permanent establishment in the first mentioned state, if any one of clauses (a), (b) and (c) thereof applies. Clause (a) deals with a person who has and habitually exercises authority to conclude contracts on behalf of the enterprise in the first mentioned state unless (i) the activities are limited to those mentioned in para 3 (excluded activities) and (ii) if they are exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that para. Clause (b) deals with a person who acts without authority. Clause (c) says that the person habitually secures orders in the first mentioned state wholly or almost wholly for the enterprise. It is seen that para 5 contains an exclusionary clause which says that an enterprise of a contracting State shall not be deemed to have a permanent establishment in the other contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status provided that such agents are acting in the ordinary course of business. Nonetheless when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm’s length conditions, he shall not be considered as an agent of an independent status within the meaning of those paragraphs.”

At this stage, it would be most appropriate to refer to another unreported decision of AAR In re (AAR/611/2003) which has been usefully referred to by the AAR in the aforesaid decision. In this case, the AAR considered the scope of dependent agent under Article 5 of Indo UK DTAA itself and held as under:

“(i) that paragraph 5 of article 5 of the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion between India and the U.K. provides that an enterprise of the Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status provided such person is acting in the ordinary course of business. However, this is subject to an exception, namely, where activities of such an agent are wholly or almost wholly devoted for the enterprise or controlling enterprise. In such a situation such an agent shall not be considered an agent of independent status. Paragraph 4 of article 5 of the Agreement is couched in very wide language to take in its fold a person other than an agent covered by paragraph 5, which includes a dependent agent. But merely because an agent does not satisfy the test embodied in paragraph 5, he does not per se become a dependent agent so as to be called a deemed permanent establishment under paragraph 4. To bring a person within the meaning of permanent establishment under paragraph 4, the following conditions have to be satisfied: (i) the person must be acting in a Contracting State for and on behalf of an enterprise of the other Contracting State; (ii) such person must be other than an agent of an independent status to whom paragraph 5 of article 5 applies; (iii) in addition the activities of such person should fall under one of the three clauses, clauses (a) to (c), of paragraph 4. On the mere ground of an agent not being an independent agent falling under paragraph 5 he cannot be brought within the meaning of deemed permanent establishment under paragraph 4 as a dependent agent, unless (a) he has an habitually exercises authority to conclude contracts on behalf of the enterprise and the activities are not limited to the purchase of goods or merchandise for the enterprise; or (b) though he acts without authority, he habitually maintains a stock of goods or merchandise from which he regularly delivers them on behalf of the enterprise; or (c) he habitually secures orders for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same control, as that enterprise”.

Thereafter the AAR, in the Morgan’s case, proceeded to answer the question as under:-

“So far as question 1(b) is concerned, we have already referred to the scope of para 4 of article 5 of the treaty. To constitute MSAS a PE of the applicant/Morgan group, it has to be shown that (1) MSAS is acting in India on behalf of the applicant/Morgan Group of US; (2) MSAS is a person other than an agent of independent status to whom para 5 applies; (3) MSAS (a) has and habitually exercises an authority to conclude contracts on behalf of the applicant; (b) has no such authority but habitually maintains a stock of goods or merchandise from which it regularly delivers goods on behalf of the applicant; or (c) habitually secures orders in India wholly or almost wholly for the applicant/Morgan Group.”

“In the light of the above principles, we have to examine whether the service agreement creates any agency PE between the applicant/Morgan group and MSAS for the purpose of para 4 of article 5 of the treaty. We would point out that for the purpose of para 4 it is not necessary that MSAS should be an agent of the applicant/Morgan group. It is enough if it satisfies the above mentioned three requirements which are cumulative. So far as requirement (1) is concerned, we have held above that MSAS is acting in India on behalf of the applicant/Morgan group. Regarding requirement (2), according to the applicant MSAS is not agent and according to the Commissioner, it is not an agent of independent status thus admittedly this requirement is also satisfied. Having carefully gone through the facts and contentions of the parties both oral and written we cannot but hold that there is no material to record a finding that any of the three requisites of requirements (3) is also satisfied. It follows that paragraph 4 of article 5 will not be attracted for the purpose of sub-question (b) of question no.1 and therefore MSAS can not be held the agency PE of the applicant/Morgan group.”

The above observations in both the cases clearly fortify the view that an agent other than an agent of independent status by itself would not constitute a PE. Such an agent would constitute a PE only if either of the conditions specified in Article 5(4) of Indo UK treaty is satisfied.

Thus, in my humble opinion, the decision of the ITAT in Reuter’s case requires reconsideration.