New Delhi: In a significant ruling, the Bangalore Tax Tribunal held that no portion of Nike Inc's income derived from Indian operations could be attributed to its representative office in India, as the Indian office did not engage in any income generating activities.
Rejecting appeals filed by the Revenue department, the Tribunal on facts held that the activities of Nike's Indian representative offices were restricted to purchase of goods for exports and that would not constitute a permanent establishment under Article 5 of India-US tax treaty.
Lately, the Indian Revenue has upped its surveillance on activities of MNC representative offices, in general. The Revenue alleges that representative office activities result in revenue generation.
Hence, a portion of revenues earned by head quarters is liable to tax under the domestic ‘business connection' principles or is held to have a ‘permanent establishment' (PE) in India and hence a portion of such profits is attributable to Indian operations.
Historically, India has had archaic profit attribution rules with sweeping powers to the tax inspector for attributing income to Indian operations.
Facts of the case
Nike, a renowned brand in sports apparels having its head quarters in United States acted as a procurement agent for its overseas subsidiaries and affiliates.
Nike's products are sold through its subsidiaries as well as third party distributors. The HQ undertakes activities such as designing, marketing and distribution of range of products.
However, it does not undertake manufacturing and instead engages contract manufacturers. Nike Inc had arrangements with Indian manufacturers to undertake contract manufacturing in India. Nike US received commission from its affiliates on such procurement.
With a view to supervise quality of its products, Nike established a representative office (RO), after seeking approval from Reserve Bank of India.
The RO employed specialized personnel (eg, merchandiser, product analyst, quality engineer, apparel product integrity manager, fabric controller etc) for providing information to local manufacturers about quality of products, reasonability of price etc. The RO opines on reasonableness of quality and product price. The product price, quality, quantity and other related decisions were made by the US office
Nike contended that activities of the Indian RO were restricted to purchase of goods for exports and hence not taxable based on an administrative guidance issued by the department of Revenue supported by plain reading of the legislation.
The Revenue however, held that activities of the RO were not confined to mere purchase of goods, it rather represented ‘core business activities' of the Company and also constituted substantial activity.
Further, the Revenue contented that activities of RO were not ‘preparatory or auxiliary' to the business activity, and that the RO constituted a (PE) under the provisions of India - USA tax treaty. To add to Nike's agony, the Revenue took a view that applying the Income tax rules on attribution, 5 per cent of export value was reasonable income attributable to operations in India.
Ruling
The Tribunal allowing Nike's appeal held that the activities of the RO in India were restricted to mere purchase of goods for the purpose of export. The contention of the Revenue that exclusion of activities of purchase of goods for export was applicable only to ‘actual buyer' and not the agent was rebuffed by the Tribunal.
The Tribunal held that emphasis is on the purchase of goods in India for the purpose of export by non-resident. Therefore, purchase by principal directly or through an agent is of no relevance. The Tribunal observed that the RO has not communicated with local manufacturers in any way other than ensuring that manufacture of products is in accordance with the quality standards set out by the US office.
The Tribunal held that recruitment of specialized personnel was necessitated by the very nature of RO's activities of providing quality assurance service. Training manufacturers' personnel was part and parcel of supervisory activities of the RO.
Nike Principles will assist other RO's
The Tribunal's ruling brings a clear distinction between an income generating activity and activities of ‘preparatory and auxiliary' character by holding that there should be a ‘real and proximate' connection between activities and the business objective of the tax payer.
Even if certain activities contribute to the overall productivity of the enterprise, yet it could be remote from actual realization of profits and hence it is not be possible to allocate income to such activities.
The Tribunal decision would be welcomed by RO's of several MNC arms who are otherwise locked in litigation with the Indian Revenue. Ofcourse, the facts of each case will govern the outcome of those appeals. Having said that, the legal principles for RO activities seems to be established. One just hopes that the Revenue will not appeal further to the high court. |
