Rethinking Permanent Establishment in DTAAs: The Hyatt Conundrum

The author is Raghunandan N, a Third Year Student from National Law University, Jodhpur.

Abstract:

The Supreme Court recently confirmed the Delhi High Court’s judgment which held that Hyatt had a permanent establishment under Article 5 of the Indo-UAE DTAA, thereby denying them benefits under the Indo-UAE DTAA. Relying on the two tests laid down in the Formula One World Championship Ltd v. Commissioner of Income Tax, the court held that Hyatt held substantive control over AHL’s operations. This article argues that the Court overlooked factual differences and misapplied the Permanent Establishment test. Further, it explores how such decisions disregard the treaty interpretation principles and blurs the line between tax avoidance and evasion, which undermines investor protections under DTAAs.

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1. Introduction

   
   

In a recent judgment, the Supreme Court while dismissing the appeal against the Delhi High Court’s judgment, held that Hyatt’s presence through the two Strategic Oversight Services Agreements (SOSA) with Asian Hotels Limited (AHL) India amounted to a Permanent Establishment (PE) in India. This was treated as a “fixed place” under Article 5 of the Indo-UAE Double Taxation Avoidance Agreement (DTAA), making the company liable for taxation. 

Hyatt argued that it is a Dubai-based company offering hotel consultancy and advisory services from Dubai to hotels in the Hyatt Group, including some located in India. It claimed that the agreements did not require it to station or send any employee to India. Therefore, under the Indo-UAE DTAA, it argued that its income should not be taxed in India, since there is no provision enabling taxation for Fees for Technical Services (FTS). 

On the contrary, the state argued that the agreement with AHL, an Indian company, pertained to more than mere oversight services. It further contended that the premises were at the appellant’s full and unconditional disposal, and that the business was carried on through the employees stationed at the hotel, thereby meeting the threshold for a fixed place of business PE under Article 5. The State relied on the language of the provision which requires a fixed place of business through which the business of an enterprise is wholly or partly carried on. It further claimed that the appellants were involved in the appointment and training of staff which demonstrated substantive control over the company.

1. Supreme Court’s reasoning

   
   

Relying on Formula One World Championship Ltd (FOWC) v. Commissioner of Income Tax (Formula One) and Assistant Director of Income Tax-1, New Delhi vs. M/s. E-Funds IT Solutions Inc (E-Funds), the Supreme Court ruled in favour of the State. It reiterated the two essential requirements for the existence of a fixed place of business PE. First, there must be a specific, fixed, and identifiable physical location in India, and second, such location must be at the disposal of the foreign enterprise for use in carrying out its own business activities. The Supreme Court interpreted the AHL’s physical presence as Hyatt’s PE, holding that Hyatt had substantive control over the operation and was not merely offering consultancy. 

The Court relied on certain clauses in the SOSA which required Hyatt to oversee operational decisions, staff training, marketing, and quality standards. It also took note of temporary visits made by Hyatt’s employees, and the fact that a portion of revenue was linked to the gross turnover of AHL. These factors made the Court conclude that Hyatt was not simply advising AHL but was functionally involved in its commercial activities, thereby satisfying the “at its disposal” requirement.

2. Analysis

   
   

This reasoning raises several concerns about how tax treaties are interpreted, particularly in light of investors’ legitimate expectations under such agreements. It also blurs the line between tax avoidance and tax evasion. The finding that Hyatt had a PE in India rests on the idea that the hotel premises were at Hyatt’s disposal and that its role went beyond policy oversight.  This closely mirrors the logic of the Substance Over Form Doctrine (SOFD), though the Court never explicitly referred to it. The Court adopted the two-prong disposal test laid down in Formula One case law and supplemented its reasoning with Assistant Director of Income Tax case, but did so without considering the factual context in which those tests were originally developed. 

1. Misapplication of judicial precedents 

   
   

The reliance on the Formula One case was flawed. Both the Supreme Court and the High Court only focused on the two tests laid down, and attempted to match them to the present. However, those tests were fact-specific. In that case, Formula One World Championship Limited and Jaypee Sports International Limited had entered into a Race Promotion Contract (RPC) to organise the India Grand Prix at the Buddh International Circuit. Formula One dictated all the terms, and Jaypee had to fulfil all such obligations. For instance, the rules with respect to the race, the race cars, the plans of installing paddocks, and the travel arrangements had to be arranged in accordance with the rules of the Federation Internationale de I’ Automobile (FIA). This showed that they had complete control over the race track during the course of the racing event. The FOWC maintained constant employee presence at the track. The race circuit was a fixed place of business under their control. In other words, they did not hold just substantive control, but full control. These facts differ from Hyatt, where control was not omnipresent and the company merely limited its presence to consulting services to ensure that the business runs effectively and efficiently.

Similarly, in E-Funds, the PE finding was justified because 40% of the workforce was permanently stationed in India and core operations like call centres and software development centres were conducted from India. Hyatt’s employees, by contrast, made only temporary visits. No employee was permanently stationed at AHL.

Judicial tests should not be extracted and applied independently, but must be viewed in light of the context and rationale in which they were created.

2. Defining Permanent Establishment under the DTAA

   
   

Article 5 of the Indo-UAE DTAA follows the Organisation for Economic Cooperation and Development’s (OECD) Model of Double Taxation Convention, which defines it as a virtual projection of a foreign enterprise into another country’s territory, involving substantive control and actual use of a fixed place of business. The establishment in that other country should be at the full disposal of the parent company. According to Philip Baker, a renowned author on tax conventions, merely giving access to such a place of business in a different country for the purposes of a business would not suffice, it will only be treated as “at the disposal” when the enterprise has the right to use the premises and has full control over the same.

In a Canadian case of William Dudney v. R, the US-based taxpayer was contracted to supply training employees of a Canadian company in their premises. Here, he was allowed to enter such premises only during officers, and the Tax Court of Canada confirmed that he had no fixed base declared that it was not a permanent establishment, making him avoid double taxation. Furthermore, the Tax Court of Baden-Wurttemberg held that mere supervision of the employees in the host country company does not account for permanent establishment as long as it is temporary. Therefore, the commentaries and the jurisprudence confirm that PE only exists where the taxpayer is free to use the PE at any time of his own choice. In the present case, the requirements under Article 5 were not met because Hyatt did not have AHL at its disposal and it did not have fixed presence in India. 

3. The Inconsistent use of SOFD and its impact on investor rights

   
   

SOFD allows tax authorities to examine the underlying substance by circumventing the legal form of a transaction or a business activity. It essentially seeks to penalise the real owners of a company. The Supreme Court functionally applied the same principle here, it pierced through the form and looked at the functional features of Hyatt such as the appointment of staff and the occasional visits by Hyatt employees, making them liable for taxation. The presence of influence was mistaken for the presence of fixed place of business PE. Article 5 of the Indo-UAE DTAA requires the foreign company to carry on business through a fixed place of business, and occasional visits by the employees does not satisfy this requirement. 

Further, a treaty must be interpreted in good faith in light of its object and purpose under Article 31 of the Vienna Convention on Law of Treaties. The Indo-UAE DTAA was entered to avoid double taxation on investors. Moreover, Article 5(3)(d) and 5(3)(e) of the DTAA stipulates that the term “permanent establishment” shall not be deemed to include maintenance of a fixed place of business for the purpose of collecting information, or for carrying out preparatory or auxiliary activities required for achieving the main place of business. The court did not attempt to provide protection to investors using these clauses of the provision but heavily relied on the tests laid down in Formula 1 case. 

3. The misunderstanding of Tax Evasion and Tax Avoidance

   
   

The terms tax-avoidance and tax-evasion sound similar, but have different meanings. Lord Tomlin, while reinstating the form over substance doctrine, enunciated the difference between tax avoidance and tax evasion.  He noted that, “every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers maybe of his ingenuity, he cannot be compelled to pay an increased tax” (Emphasis on ‘compelled’).

This principle came to be known as the Westminster principle which suggested that tax planning with an objective of legally obviating tax liability is a legitimate right of the tax payers and anything otherwise is illegal tax evasion. Tax avoidance doctrines do not lack an objective aim per se, but lacks consistent interpretation, which results in the abuse of investor rights. Thus, the two terms have to be carefully examined so as to not deprive the investors of their rights in host countries.

4. Conclusion

   
   

The object and purpose of Double Tax Avoidance Agreement is to promote cross border investment by preventing double taxation. When a foreign investor puts capital into a host country, it is only fair for the investor to have some oversight on the business running in that other country. In the present case, the concept of substantive control was stretched to include the temporary visits by employees of Hyatt to oversee the operations of the business under Article 5 of the Indo-UAE DTAA. This would open a pandora’s box leading to double taxation of multiple companies that are currently availing the benefits of a double taxation treaty. 

In a tax treaty, the host state compromises some tax sovereignty in exchange for investment and economic growth. A foreign investor is a guest investing in an alien country wherein it is vulnerable and susceptible to unfair treatment by the entities of the host state. A treaty has to be interpreted in good faith in light of its object and purpose according to VCLT, and it should limit its construction to the scope of the treaty. Widening the meaning of PE to include routine oversight disregards the object of a DTAA. Foreign investment may reduce astronomically owing to such wide interpretation of treaties, and would create uncertainty for multinational enterprises operating in good faith under the protections of tax treaties. Therefore, terms such as PE should be pragmatically interpreted keeping in mind the rights of the investors, and the object of a DTAA. This ensures that tax treaties remain reliable instruments of cross-border investment rather than tools for expansive tax claims.