"Website"-whether constitutes a permanent establishment in the source country

Introduction

Internet has brought revolution in the world since last few decades. Development of internet and its use by the people in India had been gaining strength since the beginning of last decade of the twentieth century but it really started growing by leaps and bounds by the turn of the 21st Century. Mass increase in use of internet has led to change in the rules of the game as to how business is being run. E-Commerce has become the buzzword. Though the ecommerce bubble burst in the beginning of the 21st Century but that might be mainly due to the reason that people just started using internet and penetration was still low. But last 10 years has seen the tremendous increase in the ecommerce activities and huge revival and success of commercial activities through internet. Introduction of smart phones in last couple of years has again revolutionized the use of internet.

However, if seen from the perspective of taxation, online business activities carries with it a plethora of complications in managing the jurisdictional issues. Some examples of online commercial activities or e commerce activities :-

1. Sale of traditional products like books, garments , equipments etc.
2. Sale of digitized products like software and music.
3. Sale of services.
4. Sale or licensing of online products like games or other commercial software etc.
5. Providing online advertisement opportunities.

Many Multi Nationals engage themselves in variety of business transactions through websites developed by them. Their websites have presence across the globe or some companies are running country specific websites from server located in a single country. To take one such example of a business process , a company selling some products may list its product on its website having global presence. The buyers , say from India, come to the website and register themselves on the website. When they want to purchase a particular product, they click on it and make payment through credit card online. The said product is then delivered to the buyer . If the said product is some software , then same is delivered online. Now in this simple example there might be different types of business processes involved varying from case to case, as follows:-

1. The product being delivered is from country other than where buyer is located i.e stock is being kept in country other than the country where the same has been sold.
2. The stock is being kept in the country where the same has been sold.
3. The website owning company has tie ups with the sellers in the country from where it receives the orders and same is got delivered from them without any stock being kept by the website company itself.
4. The sellers from different countries list their product on some other company's website and buyers come and purchase the product they want from the website.
5. There might be different situations like website company having its physical presence in the other country or they might have subsidiary companies to handle limited activities like marketing or certain preparatory or auxiliary activities.
6. Likewise there might be number of other business models but the main point here is that server is located in a single country ,say US, from where global website of company or country specific websites of similar nature are being hosted and there might be ,or might be not, the physical presence of the website company in the said country of operation . Further even if they have some physical presence in shape of subsidiary or fully controlled group companies , it is only for limited purpose of marketing or does not go beyond certain preparatory or auxiliary activities that enjoy exempt status under the tax treaty.

Apart from traditional business of sale and purchase of goods on e-commerce platform , there are many new revenue streams that are being targeted by the companies world over like revenue generated from the advertisements on the websites or income earned by search engine websites like Google and Yahoo through promotion of sites by 'Key Words'. Payments from source country to these companies also raise question about their taxability in the source country.

Basics of Taxability

Income derived from online business transactions generated by non residents is taxable under the same domestic rules applicable to income derived from other type of activities. However as per Section 9(1) of the Income Tax Act and Article 5 read with Article 7 of tax treaties , a non resident would be taxable in source country only if it has some relationship or minimum presence , in the source state. Even Section 5(2)(b) of Income Tax Act fastens the tax liability in the hands of non-resident only if the income accrues or arises in India or deemed to accrue or arise in India.

A common rule ,as per tax treaties , is that a non resident taxpayer must have a fixed place of business (Permanent Establishment) in the country. Now, to apply this rule, the source state also need to decide whether an electronic presence is sufficient to constitute a fixed place of business under various circumstances or not. Hence to tax an entity engaged in e-commerce ,it has to be decided in the first place as to whether activities of said entity constitute a PE for DTAA purposes or not. Then the next step is to determine as to whether such activities are within the scope of preparatory or exempted activities that enjoy exemption status.

Issues Involved and Judicial Precedence

The concept of PE is material and it has to be seen whether a non resident entity operating website can be said to have a PE within its primary meaning in India. Two recent cases laws on this issue have been discussed as under.

1. Case of eBay International AG vs ADIT¹

   In the case of eBay International AG vs ADIT1 the Mumbai Tribunal has held that the revenue earned by the assessee from India specific websites is taxable as per the provisions of Article 7 of the DTA only if it has a PE in India as per Article 5 of the DTA. Since the assessee did not have any PE in India as such no amount was taxable in India.

   1. Facts of the Case

      In this case the assessee , tax resident of Switzerland, operated India specific websites providing an online platform for facilitating the purchase and sale of goods and services to users based in India. The assessee entered into Marketing Support Agreement with two group companies incorporated and registered in India viz eBay India and eBay Motors in connection with Indian specific sites. The assessee claimed that revenue earned by it from operations of websites in India was not taxable in India as it did not have any PE in India as per Article 5 of the DTA.

   2. Issues Raised

      The department was of view that revenue earned by ebay from India would be taxable as Business Profits as the assessee has dependent agent PE ,as per Article 5(5) and 5(6) of DTA, in India in form of eBay India and EBay Motors, two group companies. That both the group companies were providing the services only to the assessee for facilitating operations of India specific websites. That the Indian companies had no independent existence and the assessee exercised full and direct control over the group companies.

      The revenue further took assistance of Article 5(2)(a) of the DTAA to contend that Indian group companies can also be treated as PEs of the assessee in India as its 'Place of management'. That all the costs incurred by eBay India were reimbursed by the assessee with 8% mark-up. Since, the assessee was required to reimburse the entire amount of expenses to eBay India, this, in effect meant that the premises for which rent was paid by eBay India etc., belonged to the assessee and all other expenses, though apparently incurred by eBay India, were, in reality, incurred by the assessee. In the light of the above , it was contended that eBay India and eBay Motors also constitute permanent establishment of the assessee in terms of Article-5(2).

   3. Held

      The Mumbai Tribunal held that there is no dispute about the fact that eBay India and eBay Motors are providing their exclusive services to the assessee. It has been fairly admitted that these two entities have no other source of income except that from the assessee in lieu of the provision of service as set out in the agreements. In view of the fact that eBay India and eBay Motors are exclusively assisting the assessee in carrying on business in India, they definitely become dependent agents of the assessee. The next question, however, is whether or not these dependent agents constitute permanent establishments of the assessee as per Clause (i),(ii) or (iii) of Article 5 (5), on which the Tribunal observed as under:-

      1. That clause (ii) of Article 5(5) refers to the dependent agent habitually maintaining a stock of goods or merchandize for or on behalf of the enterprise. This clause has no application in this case because there is no requirement on the part of eBay India or eBay Motors to maintain any stock of goods or merchandize on behalf of the sellers.
      2. Clause (iii) applies where the dependent agent manufactures or processes the goods or merchandize in that State for the enterprise. Obviously, this clause is also not applicable because Indian group companies are not required to manufacture or process the goods or merchandise on behalf of the assessee.
      3. That as per Clause (i), it is to be seen whether the Indian group companies do or habitually exercise 'an authority to negotiate and enter into contracts for or on behalf of the assessee.' By performing the activities as narrated in the agreement, it is seen that Indian Companies have at no stage negotiated or entered into contract for or on behalf of the assessee. Simply by providing marketing services to the assessee or making collection from the customers and forwarding the same to the assessee, it cannot be said that eBay India or eBay Motors entered into contracts on behalf of the assessee. That there is no mention in the assessment order or the contentions of DR that any contract was entered into by Indian companies, during the discharge of their functions or otherwise, for or on behalf of the assessee. Thus the test laid down as per clause (i) of Article 5 (5) also fails in the present case.
      4. Further as regards reliance placed by revenue on Article 5(2)(a) , it was held that Indian Companies were neither taking any managerial decision and nor had any role to play in maintenance or operations of websites. They had no role to play in online business agreements and were required to perform only marketing support services for assessee.Hence , it cannot be said that they form 'place of management' of the assessee's overall business.
      5. Held: Though eBay India and eBay Motors are dependent agents of the assessee, but do not constitute 'Dependent agent PEs' of the assessee in terms of Article 5 of the DTA
2. Case of ITO vs Rights Florists (P) Ltd.2

   The concept of PE in relation to websites has again been discussed in a recent ruling of Kolkata Tribunal in the case of ITO vs Rights Florists (P) Ltd. as under :-

   1. Concept of PE evolved because in traditional commerce physical presence was required in the source country if any significant level of business was to be carried on, but, with the development of internet, correlation between the size of business and extent of physical presence in the source country has virtually vanished. The traditional concept of PE , which was conceived at a point of time when internet and ecommerce was not even on radar, does not really fit into the modern day world in which virtual presence through internet, in certain respects , is as effective as physical presence for carrying on business.
   2. In order to study the tax impact of ecommerce, CBDT had appointed a High Powered Committee . The Committee also observed that applying the existing principles and rules to ecommerce does not ensure certainty of tax burden and maintenance of the equilibrium in the sharing of tax revenues between the countries of residence and source. "The Committee, therefore, supports the view that the concept of PE should be abandoned and a serious attempt should be made within OECD or the UN to find an alternative to the concept of PE." Clearly , conventional PE test fails in this virtual world even when a reasonable level of commercial activity is crossed by foreign enterprise. The traditional tests for determination of PE fail in virtual world of ecommerce.
   3. The Commentary on OECD Model Convention observes on this issue that there has been some discussion as to whether the mere use in electronic commerce operations of computer equipment in a country could constitute a PE. That question raises a number of issues in relation to the provisions of the article. It further observes as under:-
      1. Website, per se, which is combination of software and electronic data, does not itself constitute a tangible property. It, therefore, does not have a location that can constitute "place of business" as there is no " facility such as premises or, in certain instances, machinery or equipment" as far as software and data constituting that website is concerned."
      2. The server on which the website is hosted and through which it is accessed is a piece of equipment having a physical location and such location may constitute a "fixed place of business" of the enterprise that operates that server.
      3. However , if the enterprise uses the services of an Internet Service Provider (ISP) for hosting website, then location of such server may not constitute PE for such enterprise, if the ISP is an independent contractor and acting in its independent course of business. In such an event even if the enterprise is able to dictate that its website may be hosted on a particular server at a particular location, it will not be in possession or control of that server and therefore, such server will not result into PE.
      4. However, if the enterprise carrying on business through a website has the server at its own disposal , e.g. it owns or leases and operates the server on which website is stored and used, the place where the server is located could constitute the PE of the enterprise.
   4. Though India has expressed its reservations on the OECD Model Commentary and has taken a stand that website may constitute a PE in certain circumstances but High Powered Committee report has clearly laid down the need for present concept of PE to be abandoned and new alternative to be introduced if virtual transactions have to be brought to tax net in source country.
   5. Held:- Hence it has been held by the Kolkata Tribunal in this case that receipts in shape of online advertisement charges by non resident search engine websites, Google and Yahoo, from India cannot be brought to tax in India in absence of any PE of said website in India.

   In view of aforesaid analysis, it can be concluded that mere presence of website per se does not constitute PE but location of server may be a criteria for determination of PE. This conclusion as per the case of Right Florists (P) Ltd. is in relation to Fixed place PE.

   However even if a web site were treated as an office or fixed place of business, it would not form a PE in all cases. The exception for a fixed pace of business engaged merely in preparatory or auxiliary functions would be applicable to virtual office also.

   Further whether PE exists in the form of dependent agent or otherwise can been seen in light of discussions made in the case of eBay International AG.

Conclusion and Effect of Non-Constitution of Website as PE in the Source Country

While some countries argue that a website could constitute PE in the source country but OECD argues otherwise. In these type of cases OECD,which mostly favours residence base of taxation, has always contended that web site cannot constitute a PE as there is no physical presence in source state. According to OECD Commentary , a PE requires a "physical presence" in a country and a website is "intangible".However the developing countries have always registered their disagreement. The UN Model Treaty, which favours source based taxation, doesnot clearly deals with these issues relating to e-commerce.

Where companies located abroad, like in the case of ebay, are operating country specific websites and generating revenue clearly attributable to the source country ,law should be made clear as to whether such websites would themselves be treated as PE in the source country. Moreso when companies like eBay India are working to provide all the support services. Otherwise,as we have seen in the case of ebay, companies registered abroad and operating website relating to Source country would move on without being taxed in the Source state on pretext that website is not PE and companies providing support services are also not PE or dependent agent PE.

From a policy perspective, a website should be treated as a PE if it is used to perform the functions of a traditional office.Non taxation of ecommerce in source state is also providing opportunities to the taxpayers to avoid all the taxes by shifting their ecommerce income to a tax heaven. There are many offshore jurisdictions which are currently providing tax free or low tax regime for ecommerce. Some companies may avoid tax by earning profits in subsidiary companies in offshore centers and not remitting them to parent company.

Hence it is imperative that clear law should be laid down for taxability of ecommerce transactions so that neither the source country have to forgo their share of legitimate taxes nor the non-resident companies have to bear the heat of double taxation.

Reference to Judgements

1. (2012) 25 taxmann.com 500 (Mumbai Tribunal)
2. (2013) 32 taxmann.com 99 (Kolkata Tribunal)

CA.Arun Gupta
Partner M/s G D Singla & Co., Chartered Accountants
Ex-Chairman Ludhiana Branch of NIRC of ICAI
9814104273
arunaru@yahoo.com
www.cagds.in