2025 (6) TMI 1630 - AT - Income Tax

Receipts earned by the foreign assessee from Indian customers for provision of software-based information security solutions -Income deemed to accrue or arise in India - income attributable to the alleged PE in India - assertion of Revenue - HELD THAT - The burden to prove that assessee has a PE in India lies initially on the Revenue as held in E-Funds IT Solution Inc. 2017 (10) TMI 1011 - SUPREME COURT As discussed above there was no discussion of ld.Tax authorites on basis of any material available in the form of two agreements we have discussed to show that any element of agency was there in the respective rights and obligations of two parties. Evidence such as email record travel itinerary etc. would not have mattered much. Reliance placed on the judgment of Daikin Industries Ltd 2018 (6) TMI 210 - ITAT DELHI is differentiated by ld.Sr. Counel submitting in the said case the Indian entity involved was finalizing products sold by it in the capacity of a distributor as well by the non-resident entity therein which is not the case herein. In any case the above principles have been distinguished by this Tribunal in in the case of Siemens Mobile Communications SPA vs. DCIT 2019 (10) TMI 512 - ITAT DELHI Secondly the reliance placed on the judgment of Rolls Royce Singapore (P.) Ltd. vs. ADIT 2011 (8) TMI 769 - DELHI HIGH COURT is also misplaced inasmuch as in that case the Tribunal had given a factual finding that there existed DAPE and the Hon ble High Court after concluding that the Tribunal had arrived on wrong conclusion remanded the matter back to reconsider the issue. In the present case it has been sufficiently demonstrated above that Zscaler India does not constitute DAPE of the Appellant and is only providing marketing support services to the Appellant.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal include:

(a) Whether the Indian subsidiary, Zscaler Softech India Pvt. Ltd., constitutes a Dependent Agent Permanent Establishment (DAPE) of the foreign assessee company under Article 5(4) of the India-USA Double Taxation Avoidance Agreement (DTAA) for AYs 2021-22 and 2022-23;

(b) Whether the receipts earned by the foreign assessee from Indian customers for provision of software-based information security solutions are taxable as business income attributable to the alleged PE in India;

(c) Whether the assessee is entitled to exemption under section 10(50) of the Income Tax Act on account of payment of Equalisation Levy;

(d) Whether the assessee was duly provided opportunity of being heard before the AO held Zscaler India as DAPE, in compliance with principles of natural justice;

(e) Whether the remuneration paid to Zscaler India is at arm's length and whether any further income could be attributed to the foreign company beyond such remuneration;

(f) Whether the AO's attribution of entire receipts from India to the alleged PE is justified;

(g) Whether the AO's adoption of 25% profit margin for attribution is appropriate given the assessee's global losses;

(h) Whether the assessee is entitled to credit for Equalisation Levy paid;

(i) Whether interest and penalty proceedings initiated under sections 234A, 234B, and 270A of the Act are justified.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a): Whether Zscaler India constitutes a Dependent Agent Permanent Establishment (DAPE) under Article 5(4) of India-USA DTAA

Legal Framework and Precedents: Article 5(4) of the India-USA DTAA defines DAPE based on the existence of a principal-agent relationship where the agent has authority to conclude contracts on behalf of the foreign enterprise, maintains stock of goods, or habitually secures orders. The Supreme Court's decision in Bharti Cellular Ltd. vs. ACIT clarifies that agency exists where the agent acts on behalf of the principal in dealings with third parties, representing the principal rather than himself.

Court's Interpretation and Reasoning: The Tribunal examined the contractual relationships between the foreign company and its Indian subsidiary through the Reseller Agreement and Service Agreement. It was found that:

• There is no explicit principal-agent relationship; the parties transact on a principal-to-principal basis.
• Zscaler India does not have authority to conclude contracts on behalf of the foreign company; the ultimate decision to accept or reject clients rests with the foreign company.
• Zscaler India does not maintain stock of goods or merchandise for the foreign company.
• Zscaler India's role is limited to providing IT support, marketing support, product demos, and customer lead identification, which amounts to marketing support services rather than agency functions.

The Tribunal relied on the recent High Court and Supreme Court decisions, including Progress Rail Locomotive Inc. vs. DCIT and Western Union Financial Services Inc. vs. DIT, which emphasize that for DAPE to exist, the agent must habitually exercise authority to conclude contracts or maintain stock or secure orders almost wholly for the foreign enterprise. Such conditions were not met here.

Key Evidence and Findings: The agreements explicitly restrict Zscaler India from concluding contracts or binding the foreign company. The reseller/channel partners, not Zscaler India, enter into contracts with Indian customers. Financial records showed no evidence of stock maintenance by Zscaler India. The foreign company's end users enter into subscription agreements directly with the foreign company.

Application of Law to Facts: Since the preconditions under Article 5(4) were not satisfied, the Tribunal concluded that Zscaler India does not constitute a DAPE of the foreign company.

Treatment of Competing Arguments: The Revenue argued that Zscaler India is economically dependent and acts wholly for the foreign enterprise, thus constituting DAPE. The Tribunal rejected this, noting absence of contractual authority and actual conduct. The Revenue's reliance on lack of direct evidence such as emails or travel records was considered insufficient to establish agency. The Tribunal distinguished precedents cited by the Revenue on facts.

Conclusion: The Tribunal held that Zscaler India is not a DAPE under Article 5(4) of the India-USA DTAA.

Issue (b): Taxability of receipts from Indian customers as business income attributable to PE

Legal Framework and Precedents: Under Article 7 of the DTAA, business profits are taxable in the source country only if attributable to a PE therein. The Supreme Court's ruling in Engineering Analysis Centre of Excellence (EACoE) clarified that revenues from provision of software-based solutions do not constitute royalty.

Court's Interpretation and Reasoning: Since the Tribunal found no PE in India, the receipts from Indian customers are not taxable in India as business profits. The assessee's claim of exemption under DTAA stands upheld.

Key Evidence and Findings: The assessee's receipts were from subscription-based software services, directly contracted with end users outside India. No income was routed through Zscaler India beyond arm's length remuneration for support services.

Application of Law to Facts: Absence of PE negates taxability of business profits in India. The receipts are not royalty as per settled law.

Treatment of Competing Arguments: The Revenue's attribution of entire receipts to the alleged PE was rejected due to lack of PE. The Revenue's attempt to characterize the Indian subsidiary as DAPE was also dismissed.

Conclusion: Receipts are not taxable in India as business income attributable to PE.

Issue (c): Exemption under section 10(50) of the Income Tax Act on account of Equalisation Levy

Legal Framework: Section 10(50) exempts income on which equalisation levy has been paid. However, Section 165A of the Act excludes e-commerce operators having PE in India from the levy.

Court's Interpretation and Reasoning: Since the Tribunal rejected existence of PE, the assessee's payment of Equalisation Levy was not an afterthought to avoid tax on business income. However, the Revenue contended that where PE exists, equalisation levy is not applicable.

Key Evidence and Findings: The assessee paid equalisation levy before the scrutiny proceedings but after the notice under section 142(1). The Tribunal noted that the assessee's receipts fall under business income with no PE; hence, the equalisation levy does not apply.

Application of Law to Facts: Since no PE exists, the assessee's payments of equalisation levy do not disqualify it from exemption under section 10(50).

Treatment of Competing Arguments: The Revenue's contention that the levy was paid to avoid higher tax was rejected as speculative. The Tribunal did not sustain the AO's denial of exemption under section 10(50).

Conclusion: The assessee is entitled to exemption under section 10(50) for equalisation levy paid.

Issue (d): Whether principles of natural justice were violated by AO not issuing show cause notice before holding Zscaler India as DAPE

Court's Interpretation and Reasoning: The Tribunal found no merit in the contention that the AO failed to provide opportunity of hearing before holding Zscaler India as DAPE. The issue was considered during assessment and DRP proceedings with ample opportunity to the assessee to present its case.

Conclusion: No violation of natural justice occurred.

Issue (e): Whether remuneration paid to Zscaler India is at arm's length and whether further income can be attributed to the foreign company

Legal Framework and Precedents: The Supreme Court in DIT (International Taxation) v. Morgan Stanley & Co. held that where the Indian entity is remunerated at arm's length for services rendered, no further income can be attributed to the foreign company.

Court's Interpretation and Reasoning: The Tribunal found that Zscaler India was remunerated at arm's length price for IT and marketing support services. No evidence suggested diversion of income beyond such remuneration.

Conclusion: No additional income is attributable to the foreign company beyond arm's length remuneration paid to Zscaler India.

Issue (f): Whether AO's attribution of entire receipts from India to alleged PE is justified

Court's Interpretation and Reasoning: Since the Tribunal held no PE exists, attribution of entire receipts to a PE is not sustainable. The receipts belong to the foreign company and are not taxable in India.

Conclusion: AO's attribution is rejected.

Issue (g): Whether AO's adoption of 25% profit margin for attribution is appropriate given assessee's global losses

Court's Interpretation and Reasoning: The Tribunal noted that the AO's arbitrary adoption of 25% profit margin without considering the assessee's global losses is erroneous.

Conclusion: Profit attribution methodology is flawed and not upheld.

Issue (h): Whether assessee is entitled to credit for Equalisation Levy paid

Court's Interpretation and Reasoning: The Tribunal observed that the AO failed to allow credit for equalisation levy despite directions by the Dispute Resolution Panel. Given the levy was paid, credit is warranted.

Conclusion: Assessee is entitled to credit for equalisation levy paid.

Issue (i): Whether interest and penalty proceedings under sections 234A, 234B, and 270A are justified

Court's Interpretation and Reasoning: These grounds were general or consequential and not separately adjudicated by the Tribunal, given the primary issues were decided in favour of the assessee.

Conclusion: No separate determination made; consequential relief implied.

3. SIGNIFICANT HOLDINGS

"Agency in terms of Section 182 exists when the principal employs another person, who is not his employee, to act or represent him in dealings with a third person. An agent renders services to the principal. The agent does what has been entrusted to him by the principal to do. It is the principal he represents before third parties, and not himself. As the transaction by the agent is on behalf of the principal whom the agent represents, the contract is between the principal and the third party."

"It is pertinent to recall that in order to fall within the scope of Article 5(4), it was imperative for the respondents to have found that the Indian subsidiary not only stood conferred with the 'authority to conclude contracts' but also that it was in fact 'habitually' engaged in acting in discharge of that authority. The issue of a habitual or recurrent exercise of authority does not arise at all since we have already found that an 'authority to conclude contracts' never stood conferred."

"Clause (c) of Article 5(4) would have been attracted if the respondents had, even on a prima facie examination, found that the Indian subsidiary was concerned primarily with securing orders for the petitioner. This, in light of the said clause using the expression 'wholly or almost wholly for the enterprise'. Clause (c) not only alludes to aspects of an enterprise being exclusively concerned with working for the fulfilment of the business interests of another, it would also have to be additionally proven that it does so 'habitually'."

"Section 165A clearly states that E-Commerce operator who has a PE in India does not come under the purview of Equalisation levy."

"Where compensation received by the Indian entity is established for valuable services, then without there being direct evidence by way of an agreement that the contract is one of agency, on the basis of contract orders received by appellant, there can be no justification to hold the Indian entity to be agent."

Core principles established include:

• Strict interpretation of the definition of DAPE under Article 5(4) of DTAA requires clear evidence of authority to conclude contracts, maintenance of stock, or habitual securing of orders.
• Marketing support services, IT support, and lead generation do not constitute agency or PE.
• Receipts from software-based information security solutions, in absence of PE, are not taxable as business income in India.
• Equalisation Levy is not applicable where PE exists; conversely, payment of Equalisation Levy entitles exemption under section 10(50).
• Arm's length remuneration to Indian subsidiary negates further attribution of income to foreign company.
• Burden of proving existence of PE lies on Revenue.

Final determinations:

• Zscaler Softech India Pvt. Ltd. does not constitute a Dependent Agent Permanent Establishment of the foreign assessee under India-USA DTAA.
• The receipts from Indian customers are not taxable in India as business income attributable to PE.
• The assessee is entitled to exemption under section 10(50) for Equalisation Levy paid.
• The AO's assessment attributing income to PE and denying exemption is set aside.
• Other consequential grounds, including interest and penalty, are not sustained.