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GALILEO International, a computer reservation service (CRS) company specialising in electronic booking of air tickets, has been exempted from paying tax, thanks to Income Tax Appellate Tribunal (ITAT) Delhi bench’s order. The order says the company is not liable to pay tax since it has made an arm’s length payment to its agent in India Interglobe. This decision will have a bearing on the Indian operations of CRS majors such as Abacus, Amadeus and Saber.

The ITAT’s ruling is in tune with the principles laid down by the Supreme Court in the case of Morgan Stanley. In that case, the apex court had said the commission paid to an agent extinguishes the liability to pay taxes in India. The ITAT made several observations that will have a bearing on the taxability of foreign companies operating in India. Firstly, it said Galileo has a permanent establishment in India through the computers installed in the country. Secondly, the distributor who markets and distributes Galileo’s network in India, is a permanent agent even though the distributor has a full-fledged travel business in the country.

Both observations have sparked off a debate among tax professionals as what constitutes a permanent establishment has a bearing on the taxability of a foreign company in India. The ITAT also held that the profits attributable to Galileo’s Indian operation are 15% of its revenue, but the payment Galileo had made to the Indian distributor exceeded this amount and hence no tax is payable in India. The ITAT used the functions performed, assets used and risk undertaken (FAR) analysis in this case to determine the profits attributable to the Indian operations. This decision is the first of its kind to apply FAR analysis in a services business for arriving at the amount attributable to the Indian operations.

The revenue flow of CRS companies is as follows: CRS companies get a certain payment (about $2 to $3) when bookings are made by travel agents in India. Part of the income is paid to the distributors. For example, for a booking on the Mumbai-London sector, the CRS company would get $3 from the airline. Of this, $1 would be passed on to the Indian distributor by the CRS company.

The Indian distributor is assigned the job of liaisoning with travel agents and providing them with computers, modems and other equipment and services. The Indian distributor, however, pays income tax in India on the income derived from the CRS companies.

But ITAT’s conclusion that the Indian distributor for all practical purposes is an agency permanent establishment — because on CRS activities it deals only with Galileo USA — has opened up a debate among senior tax professionals on what constitutes an agency permanent establishment.

In the case of Western Union, the Delhi tribunal observed that merely because the agents were not acting as agents for any other company carrying on money transfer business, it could not be said that their activities were devoted wholly for a single entity.

Another point discussed among tax professionals is the ITAT's conclusion that Galileo's Indian distributor has a permanent establishment through computers installed in India. T P Ostwal, senior chartered accountant, said, “The decision though does not levy any tax on the appellant is based on wrong interpretation of treaties.”

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