Article 5(3) of UN model provides for existence of construction PE as under;-
A building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months
Herein after a building site, a construction, assembly or installation project or supervisory activities is being referred to as construction project. Further UN model convention is use, where required.
In this article attempt is made to dwell upon ambiguous issues surrounding around Construction PE. These aspects have been grouped as under:-
1. Association with Construction Project- Whether every association of Foreign resident (R) with Construction project in Source state, will render that association as PE of foreign Resident i.e whether in the following case, R will be deemed to have construction PE in source state:-
a. Where R makes available its employees to construction Project operated by S
i. To be worked under the control and supervision of R.
ii. To be worked under the control and supervision of S.
b. Where R makes available its equipment to be used in construction project operated by S
i. Equipment to be operated by R
ii. Equipment to be operated by S.
2. Delegation of Work- Foreign Resident (R) was awarded the work of construction activities for construction project in source state, which it delegated to Third Person as under:-
a. Entire activities are delegated to Third person on Principal to Principal basis with the consent of Project Owner i.e all construction activities will be carried out by Third person, but foreign resident will continue to be responsible to project owner.
b. Only part of the activities of project, (say labour work) was delegated to Third person, who has to perform under control and Supervision of R.
Whether in above cases, R will be deemed to have Construction PE in source state?
Holding –Subsidiary Relationship – A holding company, being resident of foreign state, was awarded a contract to supply equipment and it installation work was awarded to Subsidiary company.
Whether in the instant case, Holding company will be deemed to have construction PE on account of construction/assembly activities being conducted in source state by its subsidiary?
Before deliberating on above-stated contentious issues, it is worthwhile to analyse the position of Article 5(3) vis-à-vis Article 5(1) i.e whether Article 5(3) stand on footing independent of Article 5(1)or else.
a. Article 5(1) commences with words “Permanent Establishment means…”, thereby implying that said article give exhaustive definition of term Permanent establishment, laying down certain test for evaluating the existence of PE.
b. These test are as under:-
i. Place of business test
ii. Permanence test & Location test
iii. Disposal Test
iv. Business activity test
Article 5(2) starts with words “Permanent Establishment includes…”, thereby implying that said article gives inclusive definition, stating therein certain places (Branch , office, place of management, which are considered as PE.
Article 5(3) initialled with words Permanent Establishment encompass…”, implying that this article too gives an inclusive definition of term PE.
1. The definition clause generally defines the term in either exhaustive manner or inclusive manner. But if the term is defined to cover both exhaustive and inclusive sense, it implies that inclusive definition needs to take its colour from principles enunciated in exhaustive definition. It would be Incongruity, if inclusive definition is given independent meaning de-hors the essentials ingredients of exhaustive definition.
2. OCED commentary
With respect to Article 5(2), Para 41 of OCED commentary provides as under:-
This paragraph contains a list, by no means exhaustive, of examples, each of which can be regarded, prima facie, as constituting a permanent establishment. As these examples are to seen against the background of general definition of given in paragraph 1, it is assumed that the contracting states interpret the terms listed, a place of management , a branch, an office etc., in such a way such places of business constitute permanent establishment only if they meet the requirement of paragraph 1
Thus based on afore-said analysis, a conclusion can be drawn that construction project before enjoining upon itself the label of PE, has to satisfy all the evaluation test of Article 5(1), except permanence test, for which duration of 6 months is substituted. In other words article 5(3) has to be read co-jointly with Article 5(1). Similar conclusion was drawn in Cal Dive Marine Construction (Mauritius) Ltd. - 315 ITR 334 by Authority for Advance Ruling.
Evaluation of Construction PE on critical aspects enumerated above
Assessment of existence of construction PE on association/activity with construction project is being evaluated on consideration of following aspects:-
a. Satisfaction of PE test stated in Article 5(1), except duration test
b. OCED commentary
c. Legal Precedents
Association with Construction project
Evaluation of Article 5(1) Tests
Suppose Resident of Foreign state (R) makes available its personnel/equipments on construction project (owned and operated by Resident of Source State (S)) in following 4 scenarios:-
a. Employees work under the control and supervision of S (Non-Control employee)
b. Employees work under the control and supervision of R (Control Employee)
c. Equipment is being operated by S, without involvement of R (Non-control equipment)
d. Equipment is being operated by R (Control equipment)
1. Place of business, Disposal Test and Business Activity test, cumulatively, provide that Foreign resident should have a place of business in source state, from where he can pursue his entrepreneurial activity in his own right.
2. The place in source state, where the output of foreign enterprise is being used/utilised would not by itself render that place as PE, unless foreign enterprise is actively carrying on business activities in source state. This spirit is also enshrine in Section 9 of Income Tax Act as under:-
i. Section 9 deemed income through or any Business connection in India as income accruing or arising in India.
ii. Further Explanation 1 to section 9(1) provides in case of business of which all operations are not carried out in India, the income deemed to accrue or arise in India, shall be only such part of income as is reasonably attributable to the operations carried out in India.
3. Had the afore-said test being not interpreted this way, then every consumption of product of foreign enterprise in source state would render such consumption point as PE of foreign enterprise, which is neither intended in domestic law nor is the same mandated in DTAA.
4. Thus based on afore-said, raison d'être for satisfaction of test in afore-said scenarios are summarise as under:-
Satisfaction of Place of business, Disposal Test and Business Activity test
Tests are not satisfied -No Business Activity in the Source state-
Tests are satisfied -Business Activity in his own right in source state, as R is actively supervising the employee/Operating the equipment, to execute the Construction Project.
OECD commentary on Article 5(1)
Relevant excerpts from Para 8 of said commentary are as under:-
If an enterprise of state lets or lease facilities, ICS equipment, buildings or intangible property to an enterprise of other state without maintaining for such letting or leasing activity a fixed place of business in other state, the leased facility, ICS equipment, building or intangible property, as such, will not constitute a permanent establishment of lessor provided contract is limited to mere leasing of ICS equipment
Tekniskil (Sendirian) Berhard v CIT (1996) 222 ITR 551 (AAR)
ARR has held that a lessor of personnel, who furnishes staff for operation and management of barge used for installation activities does not carry on installation activities when such staff is working under the control and direction of the lessee and lessor is merely responsible for staff welfare and hence no creation of PE of lessor.
Based on consideration of satisfaction of Article 5(1) tests, OECD Commentary & legal Precedent, following conclusion can be drawn:-
a. Employees work under the control and supervision of S – No construction PE
b. Employees work under the control and supervision of R – Existence of Construction PE
c. Equipment is being operated by S, without involvement of R –No Construction PE
d. Equipment is being operated by R (Control equipment) - Existence of Construction PE.
a. In certain DTAA, the provision of technical personnel & Leasing of commercial or industrial equipment by foreign enterprise to source state enterprise is covered under Fees for Technical Services (FTS) and Royalty respectively. Thus in above cases, where is no PE, income from leasing of personnel /equipments may be taxable as FTS /Royalty in source state.
b. However explanation 2 to section 9(1)(vii) provides that Fees for Technical services does not include consideration for for any construction, assembly or like project undertaken by recipient. In Pintsch Bamag 318 ITR 190 (AAR) (2009), Authority held that the component of technical or consultancy services incidental to the execution of project cannot be segregated and brought within the scope of FTS.
Delegation of Work
Foreign Resident was awarded the work of construction activities for construction project in source state, which it delegated to Third Person as under:-
a. Entire activities are delegated to Third person on Principle to Principle basis with the consent of Project Owner i.e all construction activities will be carried out by Third person, but Foreign resident will continue to be responsible to project owner.(Delegation without Supervision)
b. Only part of the activities of project, (say labour work) was delegated to Third person, who has to perform under control and Supervision of R. (Delegation with Supervision)
PE valuation Test & OCED Commentary
1. Among different PE’s evaluation test, one of them is Business Activity test in source state, which require conduct of business in source state.
2. As per para 10 of OCED Commentary on Article 5(1) , with respect to fixed place of business, foreign enterprise may carry on business in source state, either through its own employees or dependent agent.
3. At this point, it is essential to mentione that Article 5(5) dealing with Agency PE will not come into picture on account of following reasons:-
a. Agency relationship will create agency PE of foreign enterprise in source state, when said enterprise has no fixed place of business in source state and business of enterprise is conducted through agent.
b. If foreign enterprise has fixed place of business in source state, then active conduct of business thereat by dependent agent will create Fixed PE under Article 5(1)
4. The main question for consideration is what meaning could be attributable to word “Dependent” with regard to conduct of business by agent at fixed place of business of foreign enterprise in source state. Mine understanding is being captured as below:-
a. Merely pecuniary dependency of agent/sub-contractor on Principle/contrcator is not contemplated.
b. Operational dependence /independence are the things which matter most, concept akin to satisfaction of Disposal test either by principle/agent
i. Disposal test mandate the authority to carry on business at fixed place of business in source state in its own right without inference by anybody
ii. Agent/sub-contractor having entire operational independence, without supervision/involvement by principle/contractor, seems to satisfy disposal test on its part. Thus failure on the part of principle/contractor to satisfy disposal test, a conclusion can be drawn that principle is not carrying on business in source state.
iii. Performance by agent/sub-contractor, with dependency on principle/contractor for supervision and other guidance, seems to satisfy disposal test by principle/contractor and hence carrying on business in source state on the part of principle/contractor.
a. Delegation without Supervision – Existence of Construction PE seems doubtful, as business activity test is not met by contractor. In such case, however if sub-contractor is resident of foreign state and satisfying other requirements of Article 5(3), mainly duration of 6 months, the sub-contractor will be deemed to have construction PE.
b. Delegation with supervision – Existence of Construction of PE, as business activity test is met by contractor.
c. Legal Precedent
Pintsch Bamag 318 ITR 190 (AAR) (2009)
a. Applicant was awarded a awarded a contract for various activities in connection with construction of “Ship Channel” by TPT
b. Applicant sub-contracted most of its work to sub-contractor, with the consent of TPT with express stipulation that sub-contracting does not exonerate the main contractor (the applicant) from liabilities under the Contract.
c. Authority held that in the instant case, the sub-contractor does not constitute PE of Applicant, which can only in the case when sub-contractor constitute dependent agent. In rendering this decision, Authority also drew support from decision of the Andhra Pradesh High Court in CIT vs. Vishakapatnam Port Trust 144 ITR 146
Holding- Subsidiary Relationship
a. As per Article 5(8), a holding (Company resident of foreign state) subsidiary (Company resident of source state) relationship will not per se makes subsidiary a permanent establishment of source state.
b. However if subsidiary’s execution of construction/assembly project is actively monitored/supervised/guided by holding company (on the basis of afore-said analysis), then subsidiary company may constitute construction PE of Holding company.
In India’s future economic growth, Infrastructure development occupies a prime place, which in turn is partly dependent upon the support of global players. In such situation, enhance clarity on the concept of Construction PE is essential requirement to prevent tax litigation.
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