The Delhi Income Tax Appellate Tribunal (ITAT) ruled on 14 March 2024 that the physical presence of employees or other personnel in India is essential to create a service permanent establishment (PE). The ITAT also held, in the context of the India-Singapore double tax agreement (DTA), that in the absence of virtual service PE provisions in a relevant DTA, services provided remotely do not give rise to a virtual service PE in India.
Historically, a service PE of a nonresident entity can be created in India if the foreign entity provides services in India using its own employees or through other personnel who are physically present in India for a specific period of time (typically 90 days) in a fiscal year (FY) and render the services. However, with the rise of highly digitised business models, the physical presence requirement is being challenged. The OECD in its interim 2018 report on the “Tax Challenges arising from digitalisation” highlighted the concept of a virtual service PE, which does not require the physical presence of a nonresident entity. Countries such as Israel and Kuwait have adopted rules under which a nonresident will have a service PE if it provides services, including consulting services, through employees or other personnel who are offshore and not physically present in the source country.
The taxpayer elected to be subject to the India-Singapore DTA and filed its tax return for FY 2020-21 declaring no income and claiming a tax credit for taxes deducted at source. Under the service PE provision in the DTA, a nonresident will be deemed to have a PE in India if it supplies services within India through its employees or other personnel provided the activities continue within India for a period or periods aggregating at least 90 days. The Indian assessing tax officer determined that the taxpayer created both a service PE in India based on the physical presence of its employees and a virtual service PE. The officer took the position that the duration of the provision of services both within and outside India should be included in determining whether the 90-day threshold was met. The taxpayer appealed and the case was eventually brought before the ITAT.
As explained above, the employees were physically present in India for 120 days in 2019-20. However, it is necessary to exclude the 36 vacation days, the 35 business development days and the five common days from the total number of days for which the services were rendered in India, which means the employees were present for only 44 days, well below the 90-day threshold in the DTA. As a result, there cannot be a service PE.
In reaching its conclusions, the ITAT made several observations:
Historically, a service PE of a nonresident entity can be created in India if the foreign entity provides services in India using its own employees or through other personnel who are physically present in India for a specific period of time (typically 90 days) in a fiscal year (FY) and render the services. However, with the rise of highly digitised business models, the physical presence requirement is being challenged. The OECD in its interim 2018 report on the “Tax Challenges arising from digitalisation” highlighted the concept of a virtual service PE, which does not require the physical presence of a nonresident entity. Countries such as Israel and Kuwait have adopted rules under which a nonresident will have a service PE if it provides services, including consulting services, through employees or other personnel who are offshore and not physically present in the source country.
Facts of the case
The taxpayer, a resident of Singapore, provided legal advisory services to international clients, including clients in India. For FY 2019-20 and 2020-21, the taxpayer entered into legal advisory contracts with Indian clients. In FY 2019-20, the advisory services were partly rendered from outside India but three of the taxpayer’s employees travelled to India for a total period of 120 days, which included vacation (36 days), business development activities (35 days), the provision of services to Indian clients and five common days (i.e., days on which more than one employee was present in India). In FY 2020-21, services were rendered remotely from outside India and no employees visited India.The taxpayer elected to be subject to the India-Singapore DTA and filed its tax return for FY 2020-21 declaring no income and claiming a tax credit for taxes deducted at source. Under the service PE provision in the DTA, a nonresident will be deemed to have a PE in India if it supplies services within India through its employees or other personnel provided the activities continue within India for a period or periods aggregating at least 90 days. The Indian assessing tax officer determined that the taxpayer created both a service PE in India based on the physical presence of its employees and a virtual service PE. The officer took the position that the duration of the provision of services both within and outside India should be included in determining whether the 90-day threshold was met. The taxpayer appealed and the case was eventually brought before the ITAT.
ITAT decision
The Delhi ITAT held in favour of the taxpayer that it did not have a virtual service PE in India because the India-Singapore DTA does not contain such a provision, so only the service PE provision in the DTA—which requires the physical rendering of services in India—should be applied.As explained above, the employees were physically present in India for 120 days in 2019-20. However, it is necessary to exclude the 36 vacation days, the 35 business development days and the five common days from the total number of days for which the services were rendered in India, which means the employees were present for only 44 days, well below the 90-day threshold in the DTA. As a result, there cannot be a service PE.
In reaching its conclusions, the ITAT made several observations:
- It reiterated the requirements that must be met to create a service PE under article 5(6)(a) of the DTA, i.e., employees or other personnel of the taxpayer must be physically present in India; the services must be provided in India through the taxpayer’s employees or other personnel; and the services must be provided for a period exceeding 90 days in the aggregate.
- It referenced India’s Supreme Court decision in the 2017 E-Funds IT Solutions Inc. case, in which the court held that services must be provided “within India” to give rise to a service PE.
- In determining the 90-day threshold, only the days in which the taxpayer actively rendered services should be taken into account. Therefore, days that were not used for rendering services, i.e., vacation days and days where employees were engaged in business development, should be excluded. The number of days spent by a foreign enterprise in India should be measured based on the number of days spent by the enterprise in India through employees or other personnel and not based on the man days by aggregating common days spent by more than one individual. Accordingly, common days should be counted as one day.
- The OECD interim report 2018, which the Indian tax authorities relied on to dispense with the physical presence requirement to create a service PE, has not been officially endorsed by India in the Singapore DTA.
Comments
The ITAT decision clarifies and brings certainty to the concept of a service PE and also touches on other issues, such as the Indian tax authorities’ rejection of a virtual service PE based on the OECD interim report. Further, the decision clarifies that vacation days, business development visits and common days are to be excluded in computing the number of days that services are provided.
The decision also highlights the need to maintain accurate supporting documentation. In this case, the taxpayer provided the ITAT with timesheets of the employees traveling to India, which clearly showed the various activities they undertook and assisted in determining the number of days for which services were rendered by the employees. Robust documentation played a pivotal role in the case.
It is relevant to note that the concept of a virtual PE is a prominent issue as businesses increasingly are providing services remotely. The ITAT decision is likely to be tested in higher courts, so affected taxpayers should monitor future developments, obtain professional advice as needed and maintain contemporaneous documentation.
Dharmesh Bhambha
Mihir Gandhi
BDO in India