Ascertaining what constitutes a Permanent Establishment: An analysis of DIT

vs. M/S Samsung Heavy Industries Co. Ltd.

Harshda Bakshi & Ashray Behura

Introduction
International trade and commerce inherently involve growing cross-border transactions
between companies incorporated in different countries.1 A pressing issue that arises with respect to
these transactions is the tax liability supposedly incurred on such transacting parties. As a means to
avoid double-taxation (double-taxation as foreign income in resident country as well as taxation on non-
resident income in the source country), the countries execute agreements for the same known as
Double Tax Avoidance Agreements.2 India is no exception and has executed agreements of this nature
with numerous countries.3 Such agreements lay down the terms which govern the taxability of the
income earned by a foreign body corporate in India and the determination of the same largely depends
on the fact whether the body corporate is operating in India via a permanent establishment (hereinafter,
“PE”) or not. Through this written piece, the author aims to analyse the decision of the Hon’ble Supreme
Court of India in the case of Director of Income Tax-II v. M/S Samsung Heavy Industries Co. Ltd.4 which
primarily involves interpretation as to whether a “project office” (hereinafter, “PO”), which had been
established by a company incorporated in South Korea, would fall within the definition of PE as defined
under the ‘Agreement for avoidance of double taxation of income and the prevention of fiscal evasion’
(hereinafter, “DTAA”) executed between India and the Republic of Korea.

Attending facts of the case in question

Article 7.1 of the DTAA states that the profits earned by a contracting party of the Korean State
shall be taxable only in Korea unless such party carries on business in India also, by way of establishing
a PE in India. In the latter case, the profits earned by the party would be taxable in India as well but
only to such extent as could be attributed to the PE in India. 5 Furthermore, Article 5.1 of the DTAA goes
on to define a PE as ‘a fixed place of business through which the business of an enterprise is wholly or
partly carried on’.6 Functioning as an exception to Article 5.1, Article 5.4 further clarifies that the
maintenance of a fixed place of business solely for the purpose of carrying on any activity of a
preparatory or auxiliary character shall not be deemed to be a PE. 7

In the present case, the Oil and Natural Gas Company (hereinafter, “ONGC”) entered into a
contract with a consortium of Larsen & Toubro Limited and Samsung Heavy Industries Co. Ltd.
(hereinafter, “SHI”/ “Assessee”) for the development of a certain turnkey Project (hereinafter, “Project”).
SHI, being a company incorporated in South Korea, established its PO in Mumbai. According to the first
paragraph of the board minutes of the Meeting of SHI that took place on 3rd of April, 2006, the PO was
established for the purpose of coordination and execution of the Project. However, the second
paragraph of the same additionally clarified that the PO was instituted for coordinating and executing
delivery of documents in relation to the Project.

Dispute
The dispute in the present case arose when the Assessment Officer (hereinafter, “AO”) brought to
tax 25% of the revenue earned by the Assessee from offshore activities. As per the AO, the turnkey


Harshda Bakshi is a 5th year student of B.A. LL.B. (Hons.) at Dr. Ram Manohar Lohiya National Law University, Lucknow.
Ashray Behura is a lawyer at the Office of the Additional Solicitor General of India.
1
DR. JASON CHUAH, LAW OF INTERNATIONAL TRADE: CROSS-BORDER COMMERCIAL TRANSACTIONS 18 (Sweet & Maxwell, 5th ed.
2013).
2
D.P. MITTAL, INDIAN DOUBLE TAXATION AGREEMENTS & TAX LAWS 214 (Taxmann, 2014).
3
S.RAJARATNAM & B.V.VENKATARAMAIAH, TREATISE ON DOUBLE TAXATION AVOIDANCE AGREEMENTS 120 (9th Ed. 2018).
4
Director of Income Tax-II (International Taxation) New Delhi v. Samsung Heavy Industries Co. Ltd., (2020) S.C.C. Online S.C.
590.
5
INCOME TAX DEPARTMENT, Agreement For Avoidance Of Double Taxation Of Income And The Prevention Of Fiscal Evasion
With- Korea, GOVERNMENT OF INDIA, https://www.incometaxindia.gov.in/Pages/international-taxation/dtaa.aspx (last accessed on
12th September, 2020).
6
Id.
7
Supra note 2.

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project was one single indivisible project and thus any profits accruing from the same would be deemed
to be earned within India through the PE set up in India.8 The objections raised by the Assessee to the
order of the AO were rejected by the Dispute Resolution Panel which reaffirmed the AO’s ruling on the
inseparable nature of the project and further went on to categorise the PO as a PE depending on the
nature of activities that were being undertaken by it.9

• Ruling by ITAT
The ITAT referred to the application submitted by the Assessee to the Reserve Bank of India
(hereinafter, “RBI”) for the opening of the PO and the first paragraph of the Board Resolution contained
therein and upon a reading of the same observed that neither the Board of Directors of the Assessee
nor the RBI had placed any restriction on the business which was to be carried by the PO which makes
it a PE in the eyes of law as it could carry on any business activity for the execution of the Project.

The ITAT further observed that the burden of proving that the activities being carried out by the PO
were merely auxiliary in nature was upon the Assessee and the same could not be discharged by solely
relying on the fact that the accounts maintained by the Assessee in India did not show any expenditure
relating to the execution of the contract.10

• Ruling by the Uttarakhand High Court

The High Court struck down the AO’s finding as well as the decision of the Appellate Tribunal insofar
as it related to the imposition of 25% tax liability on the offshore activities carried out by the Assessee
as neither of the authorities could bring sufficient evidence in support of the attribution of the offshore
income of the Assessee to the office established in India.

• Decision of the Supreme Court

While deliberating on the issue whether the office of the Assessee in India was a PO or a PE, the
Supreme Court relied on its own judgement in the case of DIT v. Morgan Stanley & Co.11 wherein
deciding on a similar issue arising out of a DTAA between India and the USA, the SC held that ‘in order
to decide whether a PE stood constituted one has to undertake a functional and factual analysis of each
of the activities undertaken by an establishment”. It ruled that the back-office functions that were being
undertaken were in the form of auxiliary activities and resultantly out of the scope of the definition of
PE’. The SC also referred to its own decision in Asst. DIT, New Delhi v. E-Funds IT Solution Inc.12
wherein it was recognised that the burden of proving that a PE existed in India was on the Department
of Revenue.

Relying on the judgements as cited above, the SC held that in order for a place to be categorised
as a PE it was quintessential that the business of the enterprise was being carried out through it, wholly
or in part. Accordingly, a place established to carry out functions of preparatory or auxiliary nature would
not be considered to be PE within the meaning of Article 5 of DTAA. In addition to the above, the Hon’ble
Court also reiterated the principle that the initial burden to prove the existence of PE was upon the
Revenue and not the Assessee. As for the present case, after a factual analysis of the Board Resolution
of the Assessee, the application made to the RBI, the accounts maintained by the PO and the
qualification of the people working at the PO, the Hon’ble Court was of the view that the office
established by the Assessee was not a PE as it was not involved in any core activity in relation to the
project and was meant to act merely as a liaison office (hereinafter, “LO”). In view of same, it found the
decision of the ITAT to be “perverse” as it has only placed its reliance on a partial reading of the Board
Resolution and it had refused to acknowledge the accounts maintained by the Assessee and the fact
that neither of the two people working in the PO was qualified to carry any core activity in relation to the
Project. Although, upon finding that the Assessee’s office was not a PE, the Court itself did not go into
the question of profit attribution, it still referred to the rulings of the SC in the cases of CIT v. Hyundai

8
Supra note 1, at ¶ 5.
9
Supra note 1, at ¶ 6.
10
Supra note 1, at ¶ 9.
11
DIT (International Taxation) v. Morgan Stanley & Co. Inc., (2007) 7 S.C.C. 1.
12
Asst. Director of Income Tax, New Delhi v. E-Funds IT Solution Inc., (2018) 13 S.C.C. 294.

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Heavy Industries Co. Ltd.13 and Ishikawajma-Harima Heavy Industries Ltd. v. DIT, Mumbai14 which
clarified that only such offshore profits could be taxed in India with respect to which the PE was involved.

Conclusion
It is now the undeniable position that in order to construe the nature of an establishment,
attention needs to be paid on whether the activities carried out are in the nature of core activities or
merely ‘preparatory and auxiliary activities’. This decision of the SC is of immense significance as it also
further highlights the importance of a deep factual inquiry that is required to be made in such cases. It
clarifies that the ascertainment of the nature of an establishment is as much a question of fact as it is
of law. It becomes amply clear that a mere prima facie and superficial analysis of the facts is not
sufficient. The ITAT had erred by only carrying out a prima facie factual investigation as it had only
restricted itself to the first para of the Board Resolution and the application made to the RBI while
choosing to ignore the more essential aspects that would have provided a better understanding of the
nature of activities carried out by the PO viz. the accounts maintained by the Assessee and the
qualifications of the people employed at the office. The judgement becomes especially significant
because the findings on facts of ITAT, which has been held to be the final fact-finding authority15, have
been found to be ‘perverse’ by the SC.

This judgement also sheds light on the relevance of the nomenclature of the permission
granted. An LO has been defined as a place of business which is set up to act merely as a channel of
communication between the Head Office and entities in India and is itself not involved in any commercial
activity.16 Further, a PO is defined as a place of business set up to represent the interests of the foreign
company executing a project in India and excludes an LO.17 Thus, it is abundantly clear that an LO and
a PO are not similar in their functioning and the scope of activities that can be performed by a PO are
much wider than those that can be performed by a LO.18 In the present case, as per the RBI approval
letter dated 24th May, 2006, the Assessee was granted the approval for setting up a PO, however, as
discussed above, the SC was of the view that the office was a LO, based on the auxiliary nature of the
activities being executed by it. If the office was established by the Assessee with the sole objective to
act as a “communication channel” 19 then it only makes sense that the Assessee should have had
applied for establishment of an LO instead of a PO but this fact was not taken into consideration by the
Hon’ble Court while deciding the nature of the office. This judgement thus very clearly indicates that
while ascertaining the nature of an office, attention is to be paid only to the nature of activities being
performed and not the activities that could have been performed by virtue of the permission granted.

In addition to the above, the judgement reiterates the principle that the initial burden of proving
an establishment to be a PE lies upon the Revenue and not the Assessee. Lastly, this judgement also
highlights the significance of proper documents which must be necessarily maintained by a company
as the entire evaluation as to whether the office established by it is a PO or PE is primarily based on
the factual matrix surrounding it. The judgement is bound to serve as guidance for various Multi-National
Companies which seek to carry business activities in India.

13
CIT v. Hyundai Heavy Industries Co. Ltd., (2007) 7 S.C.C. 422.
14
Ishikawajma-Harima Heavy Industries Ltd. v. Director of Income Tax, (2007) 3 S.C.C. 481.
15
Ganapathy & Co. v. CIT, (2016) 11 S.C.C. 274.
16
Foreign Exchange Management (Establishment in India of Branch or Office or other Place of Business) Regulations, 2000,
Regulation 2(e).
17
Foreign Exchange Management (Establishment in India of Branch or Office or other Place of Business) Regulations, 2000,
Regulation 2(f).
18
National Petroleum Construction Co. v. CIT, (2016) 1 H.C.C. (Del) 525.
19
Supra note 1, at ¶ 3.

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