Income Tax

Nokia Networks OY v. Joint Commissioner of Income Tax: Case Analysis

On 5^th June 2018, the Special Bench of the Income Tax Appellate Tribunal Delhi, in the case titled Nokia Networks OY Vs. Joint Commissioner of Income Tax dealt with the issues of Permanent Establishment (PE), Profit Attribution and Business Connection wherein the majority, i.e. 2 members, held that the assessee’s Indian subsidiary doesn’t constitute a fixed place PE as per the India – Finland Tax treaty as the place of business isn’t at the disposal of the assessee.

The activities of the assessee in India were solely with regard to the network planning, signing and negotiation of the contracts before the offshore supply of equipment and sales of goods. Further, the assesse doesn’t have any agency PE in India under the tax treaty since the Indian subsidiary company hadn’t negotiated or concluded any contract with regard to the supply of equipment on behalf of the assessee. Along with this, it was held that the assesse didn’t have any business connection under the IT Act 1961 due to the title of the goods being transferred outside India and the receipt of the payment being outside India.

On the other hand, the 3rd  member of the special bench held that there was the existence of a business connection in India through its Indian subsidiary, which was operating as per the assessee’s business interests in India. The Indian subsidiary was a proxy/ virtual projection of the foreign parent company, and therefore, the subsidiary constituted a fixed place PE under the tax treaty. Therefore 35% of the global profits of sales can be attributed to the PE in India. The present article shall discuss the aspects coved in the case in detail.

Facts of the Case

• Nokia Networks OY [assessee] is incorporated under the laws of Finland and involved in the manufacturing of advanced telecommunication systems and equipment (GSM Equipment) being used in fixed and mobile phone networks, as well as the trading of telecommunication hardware and software.
• The assessee had established a liaison office [LO] in India in 1994, which conducted only advertising activity. The assessee used to sell equipment which was manufactured in Finland, to Indian telecom operators, on a principal-to-principal basis in accordance with independent buyer-seller arrangements and also entered into certain contracts for installation.
• After the incorporation of the subsidiary, Nokia India Pvt. Ltd. [NIPL], in 1995, the NIPL was assigned the existing installation contracts, and thereafter, all installation activities were carried out by NIPL as per separate agreements with Indian telecom operators.
• The assessee failed to file the return of income For AY 1997-98 in India. Subsequently, it was filed by the assessee as a response to the notice issued u/s 142(1) of the Income-tax Act, 1961 [the Act]^[1]. In the income tax return, it didn’t offer any income taxable in India based on the non-existence of a Permanent Establishment [PE] in India under the India-Finland tax treaty. It also claimed that there wasn’t any business connection in India as goods were sold to Indian customers on a principle-to-principle basis.
• In the assessment order passed, both the LO and NIPL were held to constitute a PE of the assessee in India. ‘Installation PE’ was also constituted based on the fact that the assessee had supported NIPL in discharging its obligation under the installation contracts.
•  The Assessing Officer [AO] attributed 70% of the total revenue to the sale of hardware and the remaining 30% towards the supply of software, and the same was taxed as royalty. Out of the 70% of the revenue attributed to the sale of hardware, the AO ascertained 40% as the income from the supply of hardware and attributed 30% of such profits to the PE.
• The notional interest from vendor financing and delayed payment were also taxed by the AO as per the specific clause in the offshore supply contract.

Accordingly, additions regarding the following incomes were made by the AO:

• Profit on the sale of hardware;
• Profit from licensing of software, and
• Interest Income.
• The matter was referred to the Tribunal, wherein a Special Bench was constituted along with other appeals of Motorola Inc. and Ericsson radio systems. However, the assessee, as well as the Revenue, were aggrieved by the order passed by the Tribunal, and therefore, an appeal was preferred by both parties before the High Court.
• The High Court pronounced the judgment favouring the assessee, holding that LO didn’t constitute a PE in India, nor did it have any business connection in India. The High Court also held that the income from the supply of software couldn’t be treated as royalty, whereas the other issues were remanded back by the High Court to the Special Bench of the Tribunal for fresh consideration due to factual inaccuracies in the order of the lower authorities.
• The Special Bench, while carrying out the analysis of the scope of adjudication of grounds remanded back by the High Court, identified that with regard to this issue, four contracts had been referred to by the lower authorities. Out of these contracts, the Special Bench observed the scope of dispute to be with reference to the supply of equipment contract between the assessee and Indian customers.

Issues of the Case

• Whether the subsidiary of the assessee (NIPL) would constitute a PE  or business connection of the assessee in India.
• If the answer to the above question is affirmative, can there be any attribution of profits on account of network planning, signing, and negotiation of offshore supply contracts in India, and if yes, what is the extent and basis thereof?
• Whether notional interest on delayed consideration for the supply of equipment and licensing of software is taxable in the hands of the assessee as interest from vendor financing?

Ruling of the Tribunal

The Tribunal has answered all questions sent to it by the High Court in favour of the assessee. The ruling of the tribunal in the  case is discussed below –

Fixed Place PE

The Tribunal observed there was an absence of any categorical and specific findings by the lower authorities on the existence of any fixed place PE qua the Indian subsidiary, i.e. NIPL.

The Tribunal further observed that, as held by the Supreme Court in the Formula One ruling, the ‘disposal test’ is paramount while analysing fixed place PE under Article 5(1).

 In the present case, the fixed place PE does not get established at all by making reference to providing telephone, fax and car facility to employees of the assessee visiting India

The High Court has accepted that after the incorporation of NIPL, the assessee hasn’t conducted any other activity other than offshore supply, and therefore any activity performed by NIPL under the independent contract can’t be reckoned for constituting a PE.

Further, the assessee hasn’t performed any activity under the independent contract of NIPL and its customers from which there has been the receipt or accrual of any income in India or through an asset in India. NIPL entered into an installation contract directly with the customer (although a guarantee was given by the assessee), the income from which was offered to tax in its hands.

The Tribunal has held that even otherwise, the activities conducted by the assessee’s employee travelling to India, i.e., negotiation, network planning and signing of contracts, are in the nature of preparatory and auxiliary in nature and thus, there couldn’t be any fixed place PE as there is a specific exclusion for such activities under the tax treaty.

With regard to Revenue’s contention on virtual projection, the Tribunal has observed that the concept of virtual projection flows from a fixed place; and that such concept isn’t alone relevant but has to be seen with regard to the fixed place or any other concept of PE.

 Virtual projection doesn’t imply that even without a fixed place, virtual projection itself will lead to an inference of a PE. In the present case, as there is the absence of any establishment of a fixed place, the virtual projection itself cannot be held to be a factor in the creation of PE.

On the contention of the Revenue that the employees of the assessee were seconded to NIPL and thus constituted a PE, it was held that these facts might be relevant while analyzing service PE; however, there is no concept of service PE in the tax treaty. Agency PE

The Tribunal observed that the qualified character of agency PE is authorization to act on behalf of somebody so as to conclude the contracts.

In the present case, there was the absence of any material on record regarding NIPL negotiating or concluding any contract of supply of equipment on behalf of the assessee, which binds the assessee.

Further, the marketing support agreement is an independent agreement between the assessee and NIPL, for which NIPL is remunerated at arm’s length; and activities of this agreement do not even remotely relate to the supply of equipment. Thus, the question of NIPL exercising any authority for concluding contracts on behalf of the assessee does not arise.

On the Revenue’s contention that the assessee has given a guarantee to Indian customers regarding the execution of the installation contracts by NIPL, it is observed that such a guarantee doesn’t have any significance for the assertion of agency PE; because such contention may be relevant in a situation of composite contract which isn’t there in the present case.

Subsidiary PE

The Tribunal further held that a subsidiary could not be reckoned for constituting PE merely due to being controlled by the assessee.

 Business Connection

Once the question regarding the PE is answered, the Tribunal observed that the issue of business connection under the Act has become academic.

In the context of LO, the High Court had held that there was an absence of any material or evidence based on which it can be said that LO is a business connection of the assessee in India, and it doesn’t constitute the PE of the assessee in India. Similarly, with regard to the supply of offshore equipment, which has been done outside India, the High Court has decided that such activity can’t be considered to be taxable in India. The Tribunal accordingly held that these principles will mutatis mutandis be applicable to NIPL as well, as there isn’t any material change in the facts.

Notional interest income

With regard to the interest income, the Tribunal has held that no income can be said to accrue to the assessee due to delayed payments as neither there existed any corresponding liability on any of the debtors nor the assessee had claimed any entitlement on such interest.

 Dissenting member view

The dissenting member of the Special Bench has rejected the assessee’s plea against the existence of a business connection and the existence of PE. The member is of the opinion that when a subsidiary company is merely an alter ego, or virtual projection of its parent company, in the sense that there isn’t any significant activity of its own or on behalf of persons other than the non-resident parent company, it must be treated as a PE of the parent company in India.

As NIPL is treated as a PE, the member has also answered the question regarding the attribution of profits against the assessee. However, marginal relief is granted by reducing the quantum of profits attributable to the PE.

Conclusion

The Tribunal has ruled in favour of the assessee by holding that it has neither a PE in India nor any business connection in India, and consequential to the same, the question of attribution does not arise.

The above judgement would support the assessee to clarify the issue of PE or business connection in India as it has followed the principles laid down by the Apex Court on this issue in the right perspective.

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