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A foreign company can arrange to sell its products in another jurisdiction (say in this case “India”), where there is a ready market for its products. Various models are adopted  o sell their products in foreign jurisdictions such as, (1) direct sale which is generally implemented through a marketing and sourcing agent, (2) commissionaire arrangement and 3) distributor arrangement. Broadly, the difference between these arrangements is that in case of direct sale and commissionaire arrangement, the title to goods continues to be with the foreign company till the goods are sold to the customer, whereacooperative societys under a distribution arrangement, the goods are sold to the distributor on a principal to principal basis and the distributor further sells  goods to the ultimate customers.

Arrangements involving direct sale and commissionaire arrangement prima facie raises a tax questions as to creation of a permanent establishment (“PE”) of the foreign company in India mainly on the premise that contracts are concluded by the agent in India on behalf of the foreign company but, in terms of strict reading of law (Double Taxation Avoidance Agreement), such arrangements do not ordinarily constitute PE. A distribution arrangement is a principal to principal arrangement, wherein goods are purchased by the distributor and sold to the ultimate customer; so in such an arrangement PE implications should not ordinarily arise, since the distributor cannot be termed to be acting on behalf of the foreign company and he effectively holds and transfer title.

There are various flavours to them but, effectively two types of distribution model are prominent: a) Normal distribution model and b) Low risk distributor (“LRD”). In a normal distribution model, all the risks associated with the product are borne by the distributor. Whereas in the LRD model, the distributor sells the goods in its own name; however, most of risks are borne by the principal, and only limited risks are borne by the LRD. Further, LRD is remunerated on a standard margin and such margin again is determined based on an arm’s length basis. Distribution arrangement, whether as normal distribution model or LRD usually does not create a PE risk for the principal foreign entity; however, factual analysis is required to be undertaken in each case to definitely conclude and rule out such an exposure.

The issue of taxation of revenues arising in a case of distribution model was before the Income-tax Appellate Tribunal (“Tribunal”), Mumbai Bench in the case of Reuters Limited (“assessee”) [ITA No 7895/Mum/2011]. The assessee provided its products (worldwide news and financial information products) to its Indian subsidiary and in turn the Indian subsidiary distributed the products to the Indian subscribers independently and in its own name. The revenues arising from such distribution arrangement became the subject matter of dispute, as the assessing officer held that the revenues resulting from the distribution agreement is chargeable to tax in India either under Article 5(2)(k) [dealing with Service PE] or Article 5(5) [dealing with Dependant Agent PE] of the Double Taxation Avoidance Agreement between India and UK (“Tax Treaty”).

The first issue which the Hon’ble Tribunal examined was whether the Indian subsidiary constitutes a dependent agent PE of the assessee (Reuters Limited) or, not. The following aspects are statutorily required to be examined as to whether a person can constitute a dependent agent PE of the foreign enterprise in India:

Whether such an agent has an independent status (legally and economically independent) or not;
If such agent has an independent status, such agent will not be regarded as an agency PE in India for the foreign enterprise, even if requirements of Article 5(5) of the Tax Treaty are fulfilled; the requirements under Article 5(5) are as follows:
Habitually exercises an authority to conclude contracts on behalf of the enterprise;
Habitually maintains stock of goods or merchandize from which he regularly deliver goods or merchandize on behalf of the enterprise; or
Habitually secures orders solely or almost wholly for the enterprise.
If the agent is not of an independent status, i.e. it is a dependent agent and any of the tests prescribed above in Article 5(5) are fulfilled then the foreign enterprise creates an Agency PE in India. In other words, if the agent is dependent, but does not fulfill any of the tests prescribed in Article 5(5) (refer to serial number (i) to (iii) above), then such an agent cannot be regarded as a PE of the foreign enterprise in India.

The Hon’ble Tribunal after examining the various clauses of the distribution agreement of Reuters India concluded as follows:
The Indian subsidiary does not habitually exercise authority to negotiate and to conclude contracts on behalf of the assessee which binds the assessee;
The Indian subsidiary has an independent contract with subscribers, and does all the activities to protect its interest.
The Indian subsidiary earned substantial portion of its income from its own dealings i.e. independently with third party customers.


One important fact which the Hon’ble Tribunal noted was that there was no income by way of “commission” which the Indian subsidiary earned and thus, concluded that nothing is flowing from the distribution agreement for the Indian subsidiary to act as an agent of the assessee. Another facet was that even the activities of the Indian subsidiary were not devoted wholly or almost wholly on behalf of the assessee and revenues generated from its independent transactions were far in excess from the transactions with the assessee. Thus, it was concluded the Indian subsidiary was not a dependent agent of the assessee.
The second issue the Hon’ble Tribunal examined was whether the assessee created a Service PE in terms of Article 5(2)(k) of the Tax Treaty. On this issue, the Hon’ble Tribunal observed that since no services were rendered to the Indian subsidiary by the employee of the assessee which had lead to earning of the distribution fee in the hands of the assessee, the employee did not constitute a Service PE of the assessee in India. Based on the above, the Hon’ble Tribunal held that neither under Article 5(2)(k) nor under Article 5(4) read with 5(5) of the Tax Treaty, the assessee has a PE in India and, therefore the distribution fee is not taxable in India.

Even though distribution arrangements in general do not appear to constitute a PE, the Income-tax department has often raised these issues. This ruling of the Hon’ble Tribunal in Reuters case, has laid down certain important aspects which can guide the assessees with respect to the issue of creation of a PE in case of distribution activities.

The following takeaways may be gleaned from the judgement:

Firstly, it is important to evaluate the distribution agreement as a whole to conclude whether a dependent agent PE is created or not. Secondly, the flow of money also plays role to determine who is rendering services to whom. Thirdly, the commercial activities of the agent are subject to instructions or comprehensive control by the foreign enterprise and whether the agent bears the entrepreneur risk or not. Lastly, in relation to Service PE, an important condition being rendition of services by the employees of the foreign enterprise to the Indian enterprise i.e. if no services are rendered, Service PE cannot be constituted.

All the above aspects appear to be of generic nature; but, these play an important role when examining creation of a PE, and are useful to counter the contention (by the income-tax department) of creation of a PE in India, in relation to distribution arrangements.

Looking forward, one important facet which the distribution arrangement should take into account is the upcoming OECD’s Base Erosion & Profit Shifting Project, which proposes to extend the definition of PE to include commissionaire arrangements and similar arrangements. These arrangements will need a revisit to analyze PE risk.

DISCLAIMER: This article has been authored by Ranjeet Mahtani, who is an Associate Partner and Vidushi Maheshwari, who is an Associate Manager at Economic Laws Practice (ELP), Advocates & Solicitors. The information provided in the article is intended for informational purposes only and does not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.





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