A recent ruling by the Authority for Advance Ruling on Income Tax (AAR) in the case of FRS Hotel Group (Lux) S.a.r,l, [(2018) 94 taxmann.com 23 (AAR- New Delhi)] on the issue of operation and management contract for the hotels has brought a question mark on such contract. In the hotel industry, the involvement of foreign players for operation and management of hotel properties is a common phenomenon. The far-reaching implications of such contracts were never envisaged until this ruling came out.
Accordingly, in this article we have endeavoured to discuss the key points of the judgement while discussing the applicable provisions.
The AAR Ruling
The Applicant in this case being a company within the FRHI Group, was incorporated in Luxembourg, and was engaged in providing services in connection with hotel management including all services that were necessary for hotel operations. The Applicant, in the instant case, entered into an agreement called Centralized Services Agreement (in short ‘CSA’) with an Indian hotel owner, under which the Applicant had agreed to provide Indian hotel owner a number of services in relation to hotel through different agreements. These services were global reservation services, centralized services, corporate design & construction services and purchasing services.
The Applicant had approached the AAR in respect of only one category of services being the Global Reservation Services (GRS) to determine whether the payments for the same was chargeable to tax in India as Fees for Technical Services (FTS) or royalty under the domestic tax provision read with relevant Double Taxation Avoidance Agreement (DTAA). The revenue contended before the AAR, that all streams of income including income from GRS was taxable under the Act as business income since there was a business connection and also the source of income was for the operation of the hotel in India. The revenue further contended, that the Indian hotel constituted the Permanent Establishment (PE) of the Applicant in India and profits attributable to such PE were taxable as business profits as per Article 5 of Indian-Luxembourg DTAA.
The AAR based its ruling on the tests for fixed place PE, as laid by the Apex Court in the case of Formula One World Championship Ltd. These tests were a) existence of a fixed place b) fixed place being at the disposal of the non-resident c) non-resident carrying on its business (wholly or partly) through such fixed place. For satisfying these tests, the AAR placed the reliance on the terms of not only the GRS agreement but also other agreements which were not even placed before the AAR by the Applicant initially. The AAR observed that right from the inception, i.e. the construction of the hotel, the Applicant was given the control and authority over the Indian hotel under different agreements. The AAR further observed that pursuant to construction, some of the core aspects of operations and management of the hotel rested with the Applicant along with no right of interference by the hotel owner. Not only this, the final decision-making power with respect to operations of the hotel were also with the Applicant and the Indian hotel owner was bound to take advice and be under the supervision of the Applicant. AAR also observed that the Indian Hotel owner was also barred from contacting directly any of the hotel staff appointed by the Applicant.
Based on the above findings, the AAR was of the view that since the Applicant had in substance taken over all the important functions in relation to operation and management of the Indian hotel under various agreements, the fixed place being the Indian hotel was rightly at the disposal of the Applicant through which its business was carried on. It was held by the AAR that the Indian hotel constituted fixed place PE of the Applicant in India and the income received under different agreements by the Applicant were taxable in India as business profits.
In short, where the person enters into multiple agreements for a particular project (including agreements which are ancillary in nature), all the agreements are to be read together as a whole because reading of the agreements in isolation may lead to absurd and incongruent results. Where from the reading of the agreements, it was clear that the foreign service provider was entrusted with exclusive authority over the operations and management of the hotel in India, then the risk of constituting PE cannot be avoided.
Article 5(1) deals with fixed place of business through which the business is carried on and is similarly worded both in OECD model and UN model convention. The phrase used in Article 5(1) “through which the business of the enterprise” is a matter which requires due consideration. The Authority, referred to the ruling of Formula One for the purposes of determining the scope of this phrase. In Formula One judgement, the Apex Court referred to the provisions of the Act which provides that the word ‘through which’ include ‘by means of’, ‘in consequence of’ or ‘by reason of’. The Apex Court further relied on the interpretation of the phrase as given in Klaus Vogel’s commentary, to emphasize that the place of business qualifies as PE only if the place is ‘at the disposal’ of the enterprise. The word disposal is further equated with the control that an enterprise needs to have, before a place could be used as an instrument for carrying on business.
The words ‘through which’ have also been discussed under OECD commentary as words of wide meaning applicable in any situation where the business activities are carried on. It further states such business must be carried on at a particular location which is at the disposal of that enterprise. Further, particular location does not restrict the movement of activity between that location merely but refers to a single place of business and such single place of business may have multiple locations in it.
Article 5 (1) also uses the word ‘fixed’. The word fixed is also discussed in OECD commentary by associating it with a certain degree of permanency. However, it also takes care of the exception of a very short period where the nature of business is the reason for such short period of time.Lastly, for the purposes of Article 5(1) the term ‘carried on’ has to be taken in the context where the business is undertaken by the employees or the dependent agents. The non-existence of the power to conclude contract with the dependent agents shall not be impediment for the purposes of Article 5(1).In case of multiple contracts, even if the assessee had certain agreement(s) for preparatory or auxiliary services along with other commercial contracts, such preparatory agreement would not have given any beneficial conclusion for the assessee. It is only where the services are restricted to preparatory or auxiliary alone, that the benefit of Article 5(4) can be claimed.
Reading all the discussions above in a holistic manner, one can say that Article 5(1) is an inclusive provision of wide amplitude. In the above discussed ruling where an assessee entered into multiple contracts for a common purpose of hotel operations and management, the conclusion of AAR can have far reaching consequences where such contracts are actually required to be entered individually due to certain commercial purposes. Further, where such contracts are entered by way of a single contract also, no beneficial conclusions can be achieved.It is also to be noted that the tax planning of split contracts has been addressed by India by entering into MLI (Article 14), but where such splitting of contracts is not for the purposes of splitting the number of days of residence and is on account of certain commercial and legal reasons, then one may take the argument of genuine commercial reasons as a reason for such multiple contracts.
[The authors are Associate and Joint Partner, respectively, in Direct Tax Team of Lakshmikumaran & Sridharan at New Delhi]