Delhi High Court denies tax plea against Western Union, relies on India-US tax treaty

The Delhi High Court rejected a plea by the income tax deparment against American multinational Western Union Financial Services, citing provisions of the India-US double taxation avoidance agreement (DTAA).

The court on 18 December held that Western Union did not have a so-called permanent establishment (PE) in India and, therefore, could not be taxed under the Income Tax Act, 1961 for transactions between 2001 and 2016.

The high court bench ruled that the mere provision of software by a foreign company to its Indian agents did not constitute a PE to attract tax liability. 

“The software utilized for connecting the Indian agents to the mainframe, being intangible property, would invariably be excluded from the threshold of PE. The argument of the premises of the Indian agents constituting a PE is clearly misconceived since these were independent third parties with their own business portfolios. Their premises, in any case, would not satisfy the test of virtual projection,” the judgment stated.

Under the Income Tax Act, 1961, a foreign entity is taxable in India if it has a permanent establishment, which refers to a fixed place of business such as a branch, office, or dependent agent through which its business is wholly or partly conducted in India.

Section 5 of the India-US tax treaty specifies that a foreign enterprise does not have a permanent establishment in the other country merely by conducting business through an independent agent, like a broker or commission agent, as long as the agent operates in the ordinary course of business.

However, if the agent works exclusively or almost exclusively for the enterprise and the transactions are not at arm’s length, the enterprise may be deemed to have a permanent establishment.

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Tribunal too favoured Western Union

The India-US DTAA, signed on 12 September 1989 and effective from 18 December 1990, aims to prevent double taxation and allocate taxing rights between the two nations.

India’s tax department had challenged a decision by the Income Tax Appellate Tribunal rejecting its claims against Western Union. 

The tribunal had issued several orders for different assessment years and consistently ruled in favour of Western Union. The order that was challenged, which was passed on 20 July 2009, had raised the question of law: “Is income earned from customers outside India subject to tax in India under the DTAA with the USA?”

The tribunal had held that the US company’s provision of software to agents did not meet the criteria for a permanent establishment and that its income earned from customers outside India was not taxable under Indian law.

Western Union, a non-resident company registered in the United States, has provided money transfer services since 1890. The company’s operational model allows customers in the US to transfer money to recipients in India via agents, including banks and financial institutions.

India’s Income Tax Department argued that Western Union’s activities in the country, including having a liaison office and agency agreements with local entities, constituted a permanent establishment. 

It insisted that the use of Western Union’s software by agents in India indicated a fixed place of business, making the company liable for taxation.

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Solely for communication purposes

Western Union contended that its liaison office in India, approved by the Reserve Bank of India (RBI), was solely for communication purposes and did not engage in any commercial activities. 

The company provided evidence of compliance with RBI regulations, which explicitly prohibit such offices from conducting trading or commercial functions.

The Delhi High Court rejected the Income Tax Department’s claims stating that the liaison office was not authorized to conduct business or generate income.

It clarified that the software provided to agents was a communication tool and did not establish a fixed place of business or a permanent establishment. Additionally, training and support provided to agents were deemed auxiliary activities, not amounting to carrying on the company’s core business in India.

DTAAs are bilateral treaties aimed at avoiding double taxation, encouraging cross-border investments and benefiting non-resident Indians. India has signed such agreements with nearly 100 countries.

Recently, Switzerland suspended the most-favoured-nation clause in its double taxation avoidance agreement with India citing a Supreme Court ruling in the Nestle case from 2023.

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