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June 13, 2024

PE Watch | Latest developments and trends, June 2024

PE case law

Indian Court examines subsidiary's role in determining the existence of a PE

On 28 May 2024, the High Court of Delhi issued a decision that analyzed whether a nonresident had a Permanent Establishment (PE) in India under the United States (US)-India tax treaty. In this case, the nonresident is a US-based company engaged in providing solutions and technologies to rail customers across the globe. The nonresident has a wholly owned subsidiary in India that provides back-office and technical support services to the nonresident on a cost-plus basis.

The assessing officer believed there was a PE in India based on the substantial involvement of the subsidiary in core business activities such as managing purchase orders, logistics and coordination with customers in India. Employee statements indicated their participation in tender processes and post-agreement services, as well as marketing, engineering support and customs brokerage. Key officers in the subsidiary reported to the nonresident's US executives, reflecting control and supervision by the parent company. The officer concluded that the nonresident had a fixed place of business, a Service PE, and a dependent agent PE in India.

However, the High Court found that the subsidiary did not result in a fixed-place PE in India under the India-US treaty because: (i) the subsidiary's involvement in tenders and technical support was restricted to assisting the nonresident and hence qualified as preparatory or auxiliary rather than core business operations; (ii) the subsidiary's employees reported to the nonresident's personnel solely to ensure compliance with global best practices; (iii) there was no evidence that any part of the Indian subsidiary premises was under the control of or at the disposal of the nonresident; and (iv) collaboration between the nonresident's employees and Indian subsidiary does not indicate or prove that Indian subsidiary premises were at the "disposal" of the nonresident.

Further, the High Court noted that absent any evidence that the Indian subsidiary acted as a habitual authority to conclude contracts or securing orders wholly or almost wholly for the nonresident, the Indian subsidiary cannot be considered as constituting a dependent-agency PE for the nonresident in India.

Furthermore, the High Court held that a Service PE would be triggered if the employees of nonresident rendered services in India. Because the nonresident's employees did not render any services to the subsidiary, the Court held that the nonresident does not have a Service PE in India. The High Court also clarified that interactions between the nonresident's employees and the subsidiary on subjects of mutual concern or interest does not amount to rendering a service.

Consequently, the High Court held that the reassessment notices were unwarranted. The nonresident was not liable for tax in India on this basis, as the subsidiary's activities did not establish a PE under the terms of the US-India tax treaty.

Indian Court rules on taxation of interest paid by Indian PE to overseas head office

On 13 May 2024, the Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) issued a ruling that provides clarity on the taxation of interest paid by an Indian PE to its overseas head office under the India-France tax treaty.

This case involves a bank resident in France (head office) with PEs in India. The Indian PEs had paid interest to the French head office and claimed a deduction for the interest payments. However, the head office did not recognize the interest as taxable income in India.

The Indian tax authorities challenged this position, contending that the interest payments should be subject to tax in India under the interest article of the India-France tax treaty. Their argument was that the debt on which interest was paid was not connected to the PE but rather to the head office, rendering the business profits article inapplicable.

The nonresident countered this view, arguing that the interest article did not apply because the payment was made to itself, and the article requires two separate parties for interest payments to be covered.

Ruling in favor of the taxpayer, the ITAT observed that the principle of the "separate legal entity" applies for the computation of profits as per Article 7 but cannot be extended to other articles of the tax treaty. Further, where interest income is attributable to the PE of the recipient in India, the taxability of interest income would be governed by Article 7, the ITAT reasoned. Under Article 7, although the interest expenditure attributable to the PE is deductible from the income attributable to the PE in India, interest that the head office received that was not attributable to the PE is not taxable in India. Hence, the ITAT held that the interest article of the tax treaty is not applicable on interest paid to itself.

Additionally, the ITAT invoked the principle that tax treaties prevail over domestic law to the extent they are more beneficial to the taxpayer. Accordingly, it held that interest paid by the Indian PE to its French head office, though taxable under domestic law, is not taxable in India under the India-France tax treaty.

Kenya determines the existence of a PE for fund management activities

In a recent decision, the Kenya Tax Appeals Tribunal (KTAT) has ruled in favor of the Kenya Revenue Authority (KRA) regarding the existence of a PE in Kenya. The case revolves around the determination of whether a foreign private equity fund had a PE in Kenya, which would subject it to corporate income tax on gains derived from the sale of shares by the private equity fund.

The KRA contended that the fund created a PE in Kenya because its investment and disposal decisions were made by employees of a Kenyan entity (the Appellant) acting as the fund's manager. The KRA argued that the Appellant's employees, as directors of the fund, exercised control over the fund's transactions while operating from the Appellant's offices in Kenya. The Appellant refuted the KRA's claims, asserting that none of its employees were directors of the fund and that it merely performed routine functions as a fund manager, without discretionary control over the fund's investments.

The KTAT sided with the KRA, ruling that the Appellant was indeed carrying out the Fund's business activities from its premises in Kenya, creating a PE for the fund. The KTAT also determined that the income from the share sale qualified as business income subject to corporate income tax, rather than capital gains.

See EY Global Tax Alert, Kenya Tax Appeals Tribunal rules certain fund management activities can trigger a PE, dated 31 May 2024.

PE domestic law

Kenya proposes to introduce Significant Economic Presence rules

On 13 May 2024, Kenya published the Finance Bill for 2024, which proposes a wide array of tax and administrative measures affecting different tax laws. Among other items, the Bill proposes replacing the Digital Services Tax (DST) with the Significant Economic Presence (SEP) tax.

The Significant Economic Presence (SEP) concept extends traditional tax nexus rules to include a taxable presence based on significant digital engagement with a country's economy. It establishes corporate tax liability based on the level of economic engagement within a jurisdiction, even without a physical presence.

The SEP tax applies to nonresident persons earning income from services provided through a digital marketplace. However, it excludes nonresident persons offering services through a PE and income earned by nonresident persons from specific telecommunication services and other listed services.

Under this proposal, the taxable profit is deemed to be 20% of the gross turnover and is subject to income tax at a rate of 30%. The tax is payable by the 20th day of the month following the provision of the service.

The Bill grants the Cabinet Secretary of the National Treasury the authority to make regulations aiding the implementation of the SEP tax. If enacted, these rules would come into effect on 1 January 2025.

See EY Global Tax Alert, Kenya proposes tax changes under the Finance Bill, 2024, dated 21 May 2024.

Other PE developments

New Zealand issues ruling on the existence of a PE

On 29 May 2024, the New Zealand Inland Revenue issued a technical decision summary (TDS 24/11) addressing whether a nonresident company had a PE in New Zealand due to services provided by its New Zealand subsidiary.

The key facts were that the nonresident company established a wholly owned New Zealand subsidiary to undertake work in New Zealand. Some employees of the nonresident company took a leave of absence, temporarily moved to New Zealand and were directly employed by the New Zealand subsidiary on fixed-term contracts. The New Zealand subsidiary charged the nonresident company fees on a cost-plus basis, with the terms of the contract, including the service fee, being on an arm's-length basis.

The technical decision concluded that the nonresident company did not have a PE in New Zealand under the relevant double tax treaty. Critical factors were that the New Zealand subsidiary's premises were not at the disposal of the nonresident company, the New Zealand subsidiary could not conclude contracts binding on the nonresident company, and the subsidiary relationship alone did not create a PE.

Colombia issues ruling on Significant Economic Presence rules

On 30 April 2024, the Colombian Tax Authority (DIAN) issued Ruling No. 100208192-305, aimed at resolving several concerns in relation to the Significant Economic Presence (SEP) rules. Under these rules, nonresidents who sell goods or provide certain digital services to customers in Colombia may create an SEP, subjecting them to Colombian income tax. This can be either a 10% withholding tax or a 3% annual income tax based on gross income earned in Colombia.

DIAN has confirmed that payments to nonresidents with SEP are exempt from the deductibility limitations under the Colombia Tax Code, provided these nonresidents file an income tax return in Colombia and request nonapplication of withholding tax. Colombian taxpayers, however, must ensure withholding tax is applied unless it is clear that the nonresident is an SEP income tax filer or that the nonresident confirmed that does not have a SEP in Colombia.

Furthermore, DIAN clarified that digital services subject to SEP taxation are restricted to those explicitly listed in Colombian tax law. Services not included in this list are governed by general tax regulations. For foreign housing service providers using digital platforms to offer accommodation in Colombia, income generated is considered Colombian-source income and subject to general tax laws, while platform commissions may fall under SEP rules.

Regarding the taxation of goods, DIAN noted that SEP rules apply regardless of the sales channel, including direct importation processes that meet SEP criteria. Additionally, for sales in foreign currency, the applicable exchange rate at the time of initial recognition in the financial statements must be used, with adjustments for exchange differences made according to Colombian tax law.

See EY Global Tax Alert, Colombian Tax Authority issues new ruling on Significant Economic Presence, dated 22 May 2024.

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For additional information concerning this Alert, please contact:

Ernst & Young Belastingadviseurs LLP (Netherlands)

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Ernst & Young LLP (United States)

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor

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