A ruling by the Chennai bench of the income tax tribunal in Redington (India) Ltd.’s case can prove to be problematic for companies selling equipment to units based in special economic zones and software technology parks.
At the heart of it is the tax arbitrage that exists when companies import equipment for their SEZ units versus non-SEZ units.
When a company buys personal computers, PC building blocks, networking, software and enterprise solutions products, etc., for their SEZ unit from an overseas entity, there’s no import duty. But when the same company buys these products for units outside of the SEZs, they have to pay import duty.
Enter Redington India and its kind, who as per the tax department fulfill purchase requests by SEZ units via their offshore subsidiary. But the actual business gets conducted by the Indian entity. This, the department argued in Redington’s case, constituted permanent establishment, meaning a fixed place of business through which the business of the enterprise is wholly or partly carried.
As per the income tax law, if it’s established that a foreign firm has a PE in India, profits linked to its activities in India can be taxed as business income. The foreign entity also has to carry out other compliances like maintain books of accounts, apply for PAN, register for indirect tax purposes, etc.
Of late, we have observed that the tax authorities have been increasingly wanting to understand the ‘substance’ of a transaction and are not just driven by its ‘form’, Rahul Charkha, partner at ELP, said.
This ruling of the Income Tax Appellate Tribunal, which validates the factual findings of the tax authorities, would certainly lead to higher scrutiny of transactions of entities following similar business models, he said.
This is a very prevalent business model and the decision could have wide ramifications, Ajay Rotti, partner at Dhruva Advisors, told BQ Prime.
The tax department’s case was that Redington India’s Singapore subsidiary had a PE, and was liable to pay tax in India because:
A group of employees called the ‘Dollar Team’ of Redington India was working and looked after the business activities of the Singapore entity.
The customers of the Indian and Singapore entity are the same, and as and when they required import duty benefit, the purchase in USD was routed through the Singapore subsidiary.
Employee interviews revealed that the ‘Dollar Team’ negotiated with Indian customers for their import requirements to avail duty benefit and also fix terms and conditions of sales.
Except shipment of goods from Singapore entity, all other activities are carried out from the Indian office.
Redington Singapore argued against the department’s conclusion saying that Redington India’s ‘Dollar Team’ only provides back-office support to it. And that the department has selectively relied on employee statements to arrive at the PE conclusion.
The tribunal rejected the company’s arguments. It pointed to the tax department’s investigation and noted that the ‘Dollar Team’ of Redington India exclusively worked for the Singapore entity—right from identifying the customers, negotiating the price, follow-up of outstanding receivables, etc.
Redington India supplies various products to companies like Cognizant Technology Solutions, Sify Technologies Ltd., Zoho Corp., etc., and such business is carried out in the name of Redington Singapore, the tribunal highlighted.
The facts show that Redington Singapore has a PE and its income is liable to be taxed in India, the ITAT held.
Rotti pointed to an argument that’s not put forth before the tribunal. That Redington Singapore would have remunerated Redington India at arms length for the services. This would’ve extinguished any additional attribution to the PE in respect of the very same transactions, he explained.
If this argument is made and backed by facts, then the Supreme Court’s ruling in Morgan Stanley’s case will work in favour of companies. The apex court had categorically held that if the Indian PE is remunerated at arm’s length, then no further attribution of profits is required, Charkha said.