E-commerce: new ruling will affect taxability of foreign firms [India]

The issue of permanent establishment in India remains a vexed one.

In a decision which would have significant ramifications for foreign companies in general, and Computer Reservation Service (CRS) majors in particular, the Delhi Income-tax Appellate Tribunal, in a recent ruling of Galileo International Inc., has held that payment of arm’s length remuneration to the Indian agent would absolve a company from any further liability to pay tax in India. This decision is in line with the principles laid down by the Supreme Court in the Morgan Stanley case and would surely comfort foreign companies, especially those engaged in e-commerce.
CRS companies specialize in providing electronic global distribution/ticketing services to airlines, hotels, cab operators, etc., by connecting them to travel agents. The issue before the tribunal was related to the taxability of Galileo in India. While rendering this decision, the tribunal made several observations which could impact the taxability of foreign companies operating in India. Also, the tribunal’s conclusions on profit attribution would be of particular importance.
The backdrop
The concept of permanent establishment is one of the most important in international tax treaty law. Virtually all modern tax treaties use it as the key tool to establish taxing jurisdiction over a foreigner’s business activities in the host country. It could be constituted either by having a fixed place of business, or a sustained presence of employees, or even an agent in the other country. So, the focus of this article is to explain the impact of the said ruling and analyse the principles it lays down to constitute permanent establishment in India and attribute profits to it.
The broad facts are as follows: Galileo is a US-based CRS company. CRS firms receive, process, store and disseminate data about flight schedules, seat/room availability, fares, etc. Galileo entered into agreements with various airlines to provide these services. To market and distribute CRS in India, it appointed a distributor in India, who in turn entered into subscription agreements with travel agents across the country. Further, to facilitate CRS operations, computers were installed at the premises of the subscribers.
Galileo was remunerated outside India by the airlines, while it paid fees to its Indian distributor for providing marketing and communication services, at the rate of 33.3% of the booking income from the country. It is against this backdrop that the issue of Galileo’s taxability in India arose.
In most countries, including India, the legislation has not kept pace with the rules of doing trade in the borderless world of e-commerce.
For instance, even the US treasury department has no specific guidance on e-commerce trade, except for a report it issued in 1996, which discussed the emerging trade challenges posed by the Internet economy.