Tribunal orders Rolls Royce to pay 35% of profits as tax.
The taxman is rapidly catching up with foreign companies operating in India through agents.
After Star, Morgan Stanley and Sony, it was the turn of UK-based Rolls Royce to be asked to pay taxes on a part of profits earned from Indian operations.
In a ruling a few days ago, the Income Tax Appellate Tribunal has held that Rolls Royce, which conducts marketing activities and provides support services from a distinct location in the country, has a permanent establishment in India as well as a business connection and would, accordingly, have to pay taxes.
The tribunal, however, lowered the proportion of India-derived profits on which Rolls Royce would have to pay tax from 75 per cent demanded by the income tax authorities to 35 per cent.
The ruling by the tribunal, however, may force multinational companies operating in India to review the scope of their operations and inter-company relationships to make an assessment of a potential permanent establishment risk, said a senior tax consultant.
Rolls Royce Plc supplies aero-engines and spare parts to Indian customers like the Indian Navy and Air Force. It has an Indian subsidiary, Rolls Royce India Limited (RRIL), which provides support services on a cost-plus basis to its UK parent.
The support services cover organising events, conferences, media relations, business development and administrative and technical support services. The subsidiary maintained a permanent office in India for these activities and employees from the UK companies visiting India used the premises.
The income tax authorities held that Rolls Royce Plc has a business connection in India under the Income Tax Act, 1961, as well a permanent establishment under the Double Taxation Avoidance Agreement between India and the UK.
Since the company did not maintain separate accounts, the authorities held that Rolls Royce Plc had to pay tax on 75 per cent of its global profits attributable to Indian sales.
Rolls Royce appealed before the tribunal, which, however, upheld that the company had both a permanent establishment and a business connection in India.
The tribunal held that under article 5(1) of the Indo-UK double tax treaty, a permanent establishment is defined as one in which there is a fixed place of business through which the business of the foreign enterprise is wholly or partly carried on.
The tribunal said the company had a business connection because the Indian company was processing correspondence and quotations before forwarding them to the UK company.
The tribunal, however, allocated 35 per cent of the profit from Indian operations to marketing activities and said this amount is taxable in India.
The remaining part of profit was attributed to manufacturing and research and development done outside the country and hence not taxable.
At the peak rate of 42 per cent income tax for foreign companies plus education cess and surcharges, the tax incidence on Rolls Royce in India works out to around 15 per cent.
Rolls Royce India declined to comment. The ruling, however, has attracted criticism from tax consultants.
Merely because the Indian entity is reimbursed on a cost-plus basis, the premises in India cannot be stated to be a fixed place of business for the foreign entity, said Gaurav Taneja, partner, Ernst & Young.
Instead of using the ad hoc methodology to determine profit attributable to India entity, the transfer pricing methodology should have been used to determine the attribution, Taneja added.