The Supreme Court of India lays down the law on fixed-place permanent establishments, holding that races conducted annually, if only for a brief period each year, constituted the permanent establishment of Formula One.
Summary
With the emergence of a connected, global economy, it is commonplace to have the presence of foreign business activities on the soil of any country. Whether these activities are taxable in that country is a question closely linked to the concept of ‘permanent establishment’ (PE) – a creation of international tax and treaty law. India’s Supreme Court has recently laid down a treatise on PE, in the case of Formula One World Championship (Formula One). The court has gone into some detail to explain the basic principles of a ‘fixed-place PE’ in a fact-matrix, which involved the conducting of a motor racing championship in India for a brief period of three days. In its judgment, the court has ruled against the taxpayer – Formula One – and held that such brief activity would also result in a PE in India.
The court concluded that the ‘race circuit’ itself would be regarded as a ‘fixed place’ where Formula One was carrying on its business.
The period of four weeks during which the race circuit was at the disposal of the race organisers would be sufficient time to comply with the test of permanence, given that the event was to recur annually for five years. The court held that the race circuit was at the disposal of Formula One and that it exercised control over it. For concluding so, various contracts entered into between the Indian party, Jaypee Sports International Ltd. and Formula One (including its affiliates), had to be collectively examined.
The Law
The taxation of cross-border businesses is governed by international tax law, which is based on tax treaties entered between various countries – a suitable example here would be the treaty between India and the United Kingdom, Formula One being a resident of the UK. Per the treaty, a UK resident is taxable in India if it has a PE in India. PE is defined as a fixed place of business through which business of the enterprise is wholly or partly carried on. The relevant phrases in this definition are ‘fixed place’ and ‘business’.
Now, the term ‘fixed place’ refers to an identifiable geographical place which is permanent in nature – a ‘permanence test’ – and is at the disposal of the enterprise – a ‘disposal test’. Permanence means that the place should be available with the business for a considerable period. One-off instances of having a place to itself, for brief periods, do not satisfy the permanence test. Further, disposal test requires that the non-resident should have the right to use the place, and should exercise control over it. If these attributes are absent, the place would fail the disposal test.
‘Business’, on the other hand, signifies that it should be the business of the non-resident that is carried on through the PE – a ‘business activity test’. If the business being carried on is that of someone else, even though there is a fixed place at the disposal of the non-resident, there would be no PE constituted as the setup would fail the business test.
The Facts
Jaypee entered into a Race Promotion Contract (RPC) in September 2011 with Formula One, for conducting races over a five-year period starting from 2011. The races were to be conducted annually over a span of three days each year. The venue of the races was the Buddh International Circuit, which was constructed and operated by Jaypee. The term of the RPC was five years, extendable by another five years. For two years, a consideration of $40 million was paid by Jaypee to Formula One.
Around the same time, Jaypee also entered into agreements with affiliates of Formula One for a lump sum consideration, related to various rights in the event like media and title sponsorship rights, right to generate television fees, paddock rights, besides others.
Regarding the consideration paid in pursuance to the RPC, both Jaypee and Formula One filed applications before the Authority for Advanced Rulings (AAR) seeking, inter alia, a ruling on whether Formula One had a PE in India under the India-UK Double Taxation Avoidance Agreement treaty. While the AAR ruled in favour of the applicants, holding that there would be no PE constituted, the Delhi High Court reversed the ruling. Aggrieved by the judgment, Formula One moved the Supreme Court.
The Judgment
The Supreme Court held that the race circuit where the races were conducted is a ‘fixed place’. It upheld the High Court’s finding that Formula One had full access to, right to use, and control over, the race circuit. The ‘disposal test’ was thus satisfied.
Regarding the ‘permanence test’, it was held that though the event happened for just 3 days, the control over the venue vested with Formula One and its affiliates for a period of several weeks before and after the race – two weeks prior to the race and one week succeeding it. This period of a few weeks would generally not satisfy the ‘permanence test’, but in the instant facts, the test was satisfied. The court reasoned that,
- the entire revenue generating activities were concluded within the short period, and
- the event was to be repeated annually.
On permanence, the court also relied upon the judgment of the Tax Court of Canada in the Joseph Fowler case, wherein it was held that a stand at a trade fair, occupied regularly for 3 weeks each year, through which the enterprise obtained contracts for a significant part of its annual sales, would constitute a PE.
The court found the ‘business activity test’ also to be satisfied in the given facts. It held that the races being conducted were economic or business activities.
Though Jaypee was supposed to carry on the various activities, they were factually, under the compulsion of Formula One, divided among its many affiliates.
A combined reading of all the agreements entered into by Jaypee with Formula One and its affiliates demonstrates that the entire event in India was taken over and controlled by Formula One and not by Jaypee. Thus, the business test – that the business of the non-resident should be carried on from the fixed place – was found satisfied.
With a fixed place at its disposal, which was permanent in nature, and through which Formula One was carrying on its business activities, a PE was certainly constituted.
Analysis
The Formula One case is certainly a treatise in itself by the Supreme Court on fixed-place PE. The observations of the court, more particularly on ‘permanence test’, ‘business activity test’ and ‘disposal test’, would assist in resolving many disputes on the subject pending before various judicial forums.
The most relevant fact that resulted in the Supreme Court holding the petition in favour of the Department of Revenue was that almost the whole of the economic or business activities necessary for conducting the event in India was managed by Formula One and its affiliates.
In all other cases, where the Indian event organisers themselves manage and conduct such international events, PE would not be constituted. Whether such a decision would deter international events from being organised in India is a matter more related to commercial structures behind such events, rather than law.
Even where business activities are bifurcated and spread amongst many affiliates, the Supreme Court has held that such activities would be aggregated and examined to judge upon the disposal test. This observation of the court is the first of its kind on this subject internationally.
The court has heavily relied on commentaries (Klaus Vogel, Philip Baker) and the OECD model convention. Such reliance establishes that model conventions and commentaries have a significant persuasive value when it comes to forming a legal opinion on interpretation of tax law. Interestingly, the court has earlier, in the Azadi Bachao Aandolan case, relied upon commentaries including the ones named above, to deliver a landmark judgment. The Formula One case certainly lays down that commentaries and model convention are to be taken as significant aids to construction.
(Amar Gahlot is a tax consultant at Lakshmikumaran & Sridharan Attorneys and a former officer of the Indian Revenue Service.)
(The article was originally published on BloombergQuint)
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