India: SC Upholds Delhi HC Verdict - Racing Circuit Is PE Of Formula One

On 24 April 2017, the Apex Court upheld the decision of the Delhi High Court in the case of Formula One World Championship Limited v CIT, treating the Buddh International Circuit as a permanent establishment (PE) of Formula One World Championship Limited (FOWC) in terms of Article 5 of the India-UK Tax Treaty.¹ Given that the conflicting decisions of the Authority for Advance Rulings (AAR) and the Delhi High Court in this case were both premised on compelling legal reasoning, it was expected that the case would be preferred in appeal before the Supreme Court (SC), as highlighted in our Ergo Newsflash dated 30 December 2016.

Background

Federation Internationale de I'Automobile (FIA), the international motor sports events regulating authority, originally owned all commercial rights in the FIA Formula One World Championship (F1 Championship). In 2001, these were transferred to FOWC's parent company, i.e. SLEC Holding Company, for a consideration and then to Formula One Asset Management Limited (FOAM). By way of a new Concorde Agreement of 2009 between FIA, FOAM and FOWC, FOAM licensed all commercial rights in the F1 Championship with effect from 1 January 2011 to FOWC, a tax resident of the United Kingdom, for a 100-year term.

Various F1 race teams, known as "constructors" also signed the Concorde Agreement with FOWC and the FIA, undertaking to participate in every F1 event included in the official annual F1 racing calendar.

FOWC entered into a Race Promotion Contract dated 13 September 2011 with Jaypee (2011 RPC) granting it the right to host, stage and promote the Formula One Grand Prix of India for a consideration of USD 40 million. An Artworks License Agreement (ALA) contemplated in the 2011 RPC was also entered into between FOWC and Jaypee on the same day permitting the use of certain marks and intellectual property belonging to FOWC.

Certain conditions precedent to the 2011 RPC required Jaypee to enter into independent contractual arrangements with FOWC's affiliates, namely, Beta Prema 2 Ltd (Beta Prema), Allsports Management SA (Allsports), and FOAM.

Procedural History

FOWC and Jaypee both approached the AAR to seek an advance ruling on (i) Whether the consideration receivable by FOWC from Jaypee in terms of the 2011 RPC was royalty as defined in Article 13 of the India-UK Tax Treaty; and (ii) Whether FOWC was justified in its position that it did not have a PE in India in terms of Article 5 of the India-UK Tax Treaty.

The AAR held the consideration payable by Jaypee to FOWC to be "royalty" in terms of the India-UK Tax Treaty, and found that FOWC did not have a PE in India. Interestingly enough, the Delhi High Court reversed the findings of the AAR on both the issues.

Having preferred an appeal against the decision of the Delhi High Court before the Supreme Court, FOWC and Jaypee both claimed that no tax was payable in India on the consideration under the 2011 RPC as it was neither "royalty", nor did FOWC have a PE in India. The Indian revenue authorities did not challenge the findings of the Delhi High Court on the issue of the consideration under the 2011 RPC not constituting royalty, which was therefore considered final. The primary bone of contention before the Apex Court was whether FOWC had a PE in India.

Arguments Advanced by Jaypee and FOWC

• In order to constitute a PE, two conditions were necessary to be satisfied – (i) there should have been a particular fixed place which was at the disposal of FOWC; and (ii) from the said fixed place, FOWC should have been conducting its business activity. It was argued that both the conditions were absent in the present case.
• It was FIA which had control over the manner in which the F1 Championship was to be conducted. Further, it was Jaypee which was responsible for conducting the races and had complete control of the event. All obligations for conduct of the F1 Championship were to be discharged by Jaypee as the organiser.
• The entire expenditure for construction of the track had been borne by Jaypee, for which it had hired its own engineers, architects etc. The circuit was owned by Jaypee and control thereof vested with Jaypee alone. The track was utilized by Jaypee not only for the F1 Championship but for organizing several other events as well on a regular basis, all year round. Right from construction of the track to conclusion of the events, all acts and obligations were to be performed by Jaypee, with no role of FOWC.
• According to the 2011 RPC, FOWC as the commercial rights holder of the F1 Championship had simply granted Jaypee permission to host the event since it was FOWC which had the exclusive right to propose the F1 Championship calendar. FOWC's role was primarily that of advising, assisting and consulting with the Jaypee (Promoter) in relation to the event. Jaypee was required to construct the circuit in a form and manner as approved by both FOWC and FIA only in order to ensure that the track met all requirements of the FIA regulations. Other than that, all rights to stage, host and promote the event vested exclusively with Jaypee. Thus, the circuit was not under the physical control or at the disposal of FOWC.
• The business of FOWC was not to organize F1 races, and therefore the question of its PE in India in the form of the race circuit did not arise.
• The entire F1 Championship event in India was a temporary model for three days in a year only. Even if it was accepted that the FOWC had control over the circuit for those three days, possession of the site for three days in a year could not be termed as PE.

Arguments Advanced by Revenue

• Counsel for the revenue demonstrated that under various agreements executed between different stakeholders from time to time, the entire flow of commercial rights in relation to the Formula One Grand Prix of India was ultimately exploited by FOWC and its group companies. It was argued that FOWC and its subsidiaries had taken total control over the event.
• Rights granted to Jaypee as Promoter were transferred back to FOWC's affiliates inasmuch as Beta Prema acquired circuit rights (media and title sponsorship), Allsports was given paddock rights, and FOAM was granted rights to provide various services. FOWC's business was carried out and physically managed from the circuit, paddock etc.
• FOWC and its affiliates were a single conglomerate – the entire bouquet of commercial rights of different nature, viz the CRH bouquet was with the group companies, which was under the control of the same management, which in turn exploited all these rights. The group companies had pooled all the profits, and sharing thereof was in the ratio of 50:50 between them and the F1 racing teams.

SC Verdict

• The SC relied on various illustrative examples of fixed place PE as elucidated in the commentaries on Double Taxation Conventions by Philip Baker Q C, Klaus Vogel and the Organization for Economic Co-operation and Development (OECD). The SC also placed reliance on the interpretation of fixed place PE in various judicial decisions in India as well as in other jurisdictions.
• The Buddh International Circuit was a fixed place, from where the Indian Grand Prix was conducted including all other activities in relation thereto as set out in various agreements and this undoubtedly constituted an economic and business activity of FOWC.
• To answer the question of whether the circuit was put at the disposal of FOWC, the Court examined the manner in which commercial rights held by FOWC and its affiliates were exploited. To this end, the Court opined that the various agreements executed between FIA, FOWC, Jaypee and FOWC's affiliates could not be looked at in isolation from one another. A conjoint reading thereof was necessary to bring out the real transaction between the parties and to capture the real essence of FOWC's role and to determine who had real and dominant control over the event.
• On a perusal of various agreements, the Court observed that by virtue of the Concorde Agreement of 2009, FOWC was authorized to exploit the commercial rights in relation to the "F1 Business" directly or indirectly only through its affiliates, where "F1 Business" was defined to mean exploitation of various rights, including media rights, hospitality rights, title sponsorship etc. Under the 2011 RPC, the right to host, stage and promote the Formula One Grand Prix of India was given by FOWC to Jaypee for a consideration of USD 40 million. On the same day, another agreement was signed between Jaypee and three affiliates of FOWC, whereby Jaypee gave back (i) Circuit rights, mainly media and title sponsorship, to Beta Prema; (ii) Paddock rights to Allsports; and (iii) Rights to services such as generation of television feed, licensing and supervision of other parties at the event, travel, transport and data support to FOAM.
• The aforementioned rights were critical to hosting the Grand Prix in India. The success of the event depended not only on the track and participation by teams, but was also guaranteed by services aimed at ensuring maximum public viewership such as paddock seating, media advertising, television broadcasting etc, all of which were outsourced to affiliates of FOWC. Revenues generated therefrom solely accrued to FOWC's associates. Such an arrangement clearly demonstrated that the entire event had been taken over and controlled by FOWC and its affiliates.
• Relying on the commentaries of international tax experts such as Dr Phillip Baker, the Court observed that for ascertaining whether there was a fixed place or not, a PE must have three characteristics – (i) stability; (ii) productivity; and (iii) dependence. Further, a fixed place of business necessarily connotes existence of a physical location which is at the disposal of the enterprise through which its business is carried on.
• It is not necessary that the premises are owned or even rented by the enterprise. It will be sufficient if the premises are put at the disposal of the enterprise. However, merely giving access to such a place to the enterprise for the purposes of the project would not suffice. The place would be treated as 'at the disposal' of the enterprise when the enterprise has the right to use the said place and has control thereupon. In terms of the various provisions of the agreements between Jaypee and FOWC and its affiliates, the Court opined that FOWC did have the place – the Buddh Circuit and related premises – at its disposal and under its control throughout the duration of the race and for a fortnight prior thereto and a week thereafter.
• The SC rejected the argument that the duration for which the circuit and the associated infrastructure at the disposal of FOWC was too short. The fact was that the race was to be held for only three days in a year, i.e. the business was to be conducted only for three days. Since for all the three days the entire control was with FOWC, this duration was sufficient to constitute fixed place PE. Concurring with the views of the Delhi High Court, the SC held that notwithstanding that the event was held for limited days in a year, FOWC had unbridled access through its personnel to the circuit for the entire duration of the event, and for two weeks prior thereto and a week thereafter.
• The Court also opined that the mere construction of the track by Jaypee at its expense was of no consequence. Ownership of the track or use thereof for hosting other events was also immaterial. The argument that FOWC's role came to an end with granting permission to host the event was categorically rejected by the Court. It was held that conduct of the F1 Championship and control over the track during that period unequivocally reflected omnipresence of FOWC and its affiliates. FOWC's stamp over the event was loud and clear.
• The Court observed that even the physical control of the circuit was with FOWC and its affiliates from the inception, i.e. right from inclusion of the event in the F1 calendar till the conclusion of the event. The Buddh International Circuit was under the control and at the disposal of FOWC through which it conducted its business as the commercial rights holder of the F1 Championship.
• In conclusion, the Court held that the PE test as laid down by the Andhra Pradesh High Court in the case of CIT v Visakhapatnam Port Trust² stood fully satisfied. The Buddh International Circuit was a fixed place where the commercial / economic activity of conducting the F1 Championship was carried out, and was a virtual projection of the foreign enterprise, i.e. FOWC on Indian soil. The circuit bore all three characteristics of a PE, i.e. stability, productivity and dependence.

Khaitan Comment

This is an important ruling laying down the law in relation to fixed place of business PE. It is noteworthy that the Court has referred to many major commentaries on the interpretation of a "fixed place of business". There were two critical tests in this case: (i) whether the circuit, which was the place of business (the business being that of holding and conducting the race) was at the disposal of the foreign enterprise and (ii) if it was, then whether just three days of such control and disposal in the hands of the foreign enterprise were sufficient to constitute a PE. It is important to note that for deciding the first point against the foreign enterprise, the Court examined all the agreements in totality and analyzed each and every right which was given to the foreign enterprise, each of which was necessary to conduct the business. In order to determine the second point against the foreign enterprise, the Court referred to various international cases where the principle emerged that the duration of the place at the disposal of the foreign enterprise needed to be considered from the nature of the business and not in absolute terms. Thus, it is very interesting to note that the Court has taken cognizance of how these concepts are dealt with internationally.

It is important also to note that this transaction and arrangements under the various agreements were under a pre-GAAR era. Under GAAR examination, the various agreements would also have had to stand the commercial substance test in order for the structure not to be disregarded and collapsed. This ruling will have a great deal of impact and relevance as far as arrangements of such nature are concerned. Each business would need to apply these principles in order to counter the PE test, apart from employing strategies to mitigate against any potential GAAR risk.

Footnotes

1. [2017] 80 taxmann.com 347 (SC)

2.[1983] 144 ITR 146

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