The concept of Permanent Establishment (‘PE’) holds critical importance in international tax law. It determines whether a contracting state (country where business activity occurs) has the right to tax the profits earned by an enterprise from another contracting state (country of residence). Article 5 of most Tax treaties between India and other countries acts as the cornerstone for defining PE, stipulating the conditions under which an Indian tax liability on business profits might arise for the foreign enterprise.
Article 5(1) explains the meaning of PE. It states that the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. In simple words, the three basic ingredients which need to be cumulatively considered to establish PE in India are:
Carrying of business
Place of business which is at the disposal
Permanence of such place of business
A fixed place of business in the contracting state essentially ensures substantial economic presence, justifying taxation by the host country. In the recently passed judgment in the case of Hyatt International Southwest Asia Ltd v. Additional Director of Income tax, the Delhi High Court held that the assessee had a fixed place permanent establishment in India under Article 5(1) of the India-UAE Double Taxation Avoidance Agreement. The Assessee entered into two Strategic Oversight Services Agreements (‘SOSA’) with Asian Hotels (North) Limited (Hyatt Regency) in Delhi and a hotel in Mumbai. Another agreement named Hotel Operation Service Agreement (‘HOSA’) was entered into between Asian Hotels (North) Limited and Hyatt India an affiliate of assessee wherein Hyatt India would provide day-to-day management assistance and technical assistance for operation of the Hotel. In short, SOSA provided overarching strategic services for management of the Hotel and HOSA provided day to day management of the Hotel which was essentially to implement the strategic policies set by Hyatt International. The Indian tax authorities assessed Hyatt International on income received from SOSA by alleging that it had a PE in India, making it liable to be taxed under Indian laws.
The Delhi High Court ruled that assessee had a PE in India and the factors that governed this decision are:
1. Hyatt International exercised extensive control over all Hotel activities, had unfettered access to the Hotel premises, and framed comprehensive strategic plans, policies, processes, procedures, guidelines and operating parameters. Thus, it satisfies the principal test of Hotel premises being ‘at the disposal’ of the assessee and being in the form of a fixed place for carrying on its business.
2. Hyatt International’s personnel were readily available in India without concurrence of Hyatt Regency, thus exceeding the level of mere managerial assistance.
3. Hyatt International established and implemented other policies and agreements for operation of Hotel in accordance with its Operating Standards.
The service fee received by Hyatt International was held not to be in the nature of royalty, but rather compensation for the specific services provided under SOSA. Although there was no standalone branch office in India, but the agreements and Hyatt’s control and activities within the Hotel constituted a fixed place of business at the disposal of the assessee. With regard to Assessee suffering losses at the entity level and hence should not have actual Indian tax liability, the High Court held that the profits attributable to the PE in India are required to be determined on the footing that the PE is an independent taxable entity and it referred this issue to a larger bench on the aspect of profit attribution.
In taking this view, the Delhi High Court has relied on the decision of the Hon’ble Supreme Court in the case of Formula One World Championship Ltd. vs Commissioner of Income Tax, International Taxation-3, Delhi & Anr. [(2017) 15 SCC 602] wherein it was held that assessee had a fixed place PE in India in terms of Article 5(1) of India - UK DTAA. The Court held that the entire event was taken over and controlled by the assessee, the fixed place of business in form of physical location was at the disposal of assessee, the taxable event i.e., conducting Formula One Championship racing event had taken place in India, and the assessee had full access to the fixed place through its personnel. The Court emphasised on the exclusive nature of access exercised by assessee and also the period for which it was accessed. It held that the race track was a distinct place. The case of Director of Income Tax v. Sheraton International Inc., (2009) 313 ITR 267 (Delhi) (also related to hotel industry) would not be applicable as it dealt with the issue of royalty taxation and the PE aspect was not raised before the High Court.
This ruling of Delhi High Court has placed emphasis on SOSA and has overlooked that day-to-day management was in the hands of Hyatt India under HOSA. It termed assessee’s control to be persuasive in nature in this regard and hence, has relied more in terms of SOSA. The Court has been swayed more by the policies and processes outlined in SOSA and presence of assessee’s employees in India rather than focusing on the activities undertaken by Hyatt Regency. Further, the Court is of the view that providing guidance, accessing premises, exercising control, and sharing of Standard Operating Procedure (in this case Hyatt Operating Standards) of an International hotel renowned for its brand and grandeur with its hotel chains operating in India to exhibit the same opulence and magnificence will constitute de facto control over the fixed place and carrying on business in India. It is a common feature in the hotel industry that famed and luxurious international hotels would maintain brand consistency across its hotels and ensure that they are operated as an upscale hotel commensurate with the standards of its international hotel chains, and for this, it would have to exercise some control over and provide managerial assistance to chain hotels with which it has entered into agreements.
It will be reasonable to assume that the matter would travel to the Supreme Court for the final adjudication. It will be very interesting to see how the finality is achieved in this matter where the debate boils down to finding a balance between recognizing legitimate international brand influence and upholding brand consistency with the taxation principles.
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