TMI Blog2008 (6) TMI 288X X X X Extracts X X X X X X X X Extracts X X X X ..... Of course, in the light of our finding that no revenues earned by the assessee company could be said to be attributable to the PE, even if one was to come to the conclusion that a PE existed, no taxability could arise under art. 7. The assessee has offered the royalties and fees for technical services for taxability in India under art. 12, and, to that extent, admitted tax liability exists. The overzealous approach of the AO has been rightly rejected by the CIT(A). We approve and confirm the stand of the CIT(A), and decline to interfere in the matter. Taxability @ 20 per cent in terms of s. 44D r/w s. 115A in case PE is found to be in existence - we had taken note of the proposition advanced by the Revenue authorities that once art. 12(5) is invoked, all the receipts as 'royalties and fees for technical services' are taxable in India on gross basis under s. 44D, though, as per the provisions of s. 115A, at a lower rate of 20 per cent. The proposition is well settled that nobody can make profit out of self or trade deal with self or earn from self. It is so held it a series of cases, including Sir Kikabhai Premchand vs. CIT [ 1953 (10) TMI 5 - SUPREME COURT] , Betts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d tax liability to that extent, and there is no dispute so far as taxability under art. 12(2) is concerned. In the result, the appeal lied by the AO is dismissed. - Pramod Kumar Accountant Member And Mukul Shrawat Judicial Member For the Appellant : Ajit Srivastava For the Respondent : R. Murlidhar ORDER PRAMOD KUMAR, ACCOUNTANT MEMBER : - Issues requiting our adjudication This is an appeal filed by the Revenue against the order dt. 22nd Dec., 2006 passed by the CIT(A). The tax assessment year involved is 2003-04. This appeal seeks our adjudication on two main issues, besides, of course, the associated peripheral issues and the principles on the basis of which these main issues are to be decided, which are as follows: (i) first, whether or not the taxpayer foreign company had a permanent establishment (PE, in short) in India; and (ii) second, if we are to hold that the taxpayer had a PE In India, whether or not the entire business receipts of the taxpayer sourced from India, are to be taxed in India on gross basis @ 20 per cent in terms of the provisions of s. 115A r/w s. 44D of the Indian IT Act, 1961. 2. Learned Departmental Repres ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... including managerial consultancy. in relation to outside activities of the assessee are connected with the PE Of the assessee, and such activities are controlled and managed by the employees of the subsidiary company. 6. That the learned CIT(A) further erred in law and on facts in ignoring the findings of the AO that the income of the assessee be charged as per art. 7 of the DTAA, under s. 44D r/w s. 115A, of the IT Act. Facts of the case and findings of the AO: 5. The assessee is a German company engaged in the business of designing, manufacturing and marketing passive electronic components. It has subsidiaries across the world including two subsidiaries in India, namely-Epcos India (P) Ltd. at Nasik and Epcos Ferrites (P) Ltd. at Kolkatta. In the relevant financial year, the assessee has disclosed following receipts from the two subsidiaries: Royalty fees received INR 1,83,97,713 Product marketing services fees received INR 4,02,74,364 Receipts on account of information and technology support services INR 3,96,37,980 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sions and each division has its central marketing team, which works for all the manufacturing companies within that division. It was also pointed out that the central marketing team renders valuable services for the benefit of various manufacturing companies in that division all over the world, and a fees is charged by the Epcos AG for those services. These services include (i) market analysis (ii) technology change, growth and price forecast (ii) deciding global marketing strategy on various parameters (iii) co-ordination with sales organizations and factories to implement agreed marketing strategies (iv) follow up with sales organizations (v) handle customer relations centrally (vi) explore new areas of markets, applications and customers, (vii) development and printing of product brochures, etc. (viii) advertising (ix) sales staff training (x) planning and organizing of fairs, exhibitions and seminars etc., and (xi) other allied activities. As regards the receipts for information and technology support costs, it was submitted by the assessee that these receipts shares of central common information technology costs, borne by the subsidiaries in India. The services rendered by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t substantiating the claim that the assessee had actually rendered the services to the Indian subsidiaries. On a perusal of these details including correspondence and e-mails, the AO was of the view that the services, for which the payment is made by the subsidiaries companies to the assessee company, were actually rendered by the employees of the subsidiaries company though under guidance of the assessee company. When the assessee was confronted with this observation, the assessee's comments were as follows: With reference to the above-mentioned letter and subsequent oral and written submissions made by us, you had raised a query as to whether the persons in Epcos India (P) Ltd. (EIPL) and Epcos Ferrites (P) Ltd. (EFPL) acting upon the guidance, instructions or advice of our product marketing/central IT team are our (Epcos AG) employees. In response to this, we hereby confirm that, based on guidance of our product marketing team, activities relating to our decision to sale, production, dispatch, cost computation and other relevant activities for effecting sales are carried out by employees of EIPL and EFPL. Also, based on guidance and support of our central IT team, loc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 20 per cent under s. 44D r/w s. 115A of the Act. The AO took note of art. 12(5) which provides that in case the 'royalties and fees for technical services', under the description of the said term under art. 12(3), are earned through a PE, the same will be taxed under art. 7 and not under art. 12. Under art. 7, on the other hand, the admissibility of deduction has to be on the basis of domestic law which, under s. 44D, denies any deduction of expenditure from earnings in the nature of fees for technical services as per description given in Expln. 2 to s. 9(1)(vii). Since the amounts in question meet that description, no deduction for expenses is to be allowed and the earnings, even under art. 7, are to be taxed on gross basis. However, as per the provisions of s. 115A, the said earnings are taxable at a concessional rate of 20 per cent. On the basis of this reasoning, the AO concluded that the correct rate of taxation of these receipts is 20 per cent on gross basis under the domestic law, and not 10 percent, as claimed by the assessee under art. 12 of the Indo-German tax treaty. Aggrieved by the stand so taken by the AO, the assessee carried the matter in appeal before the C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income earned by the foreign company, under the provisions of the Indian IT Act (hereinafter referred to as the 'domestic tax legislation' or 'the Act') and, when this income is found to be taxable in terms of the domestic tax legislation, we should hold its taxability as such, unless, of course, the income is exempt from taxation in India under the provisions of the tax treaty. He then submits that the income in question is squarely covered by the provisions of s. 44D r/w s. 115A which requires that income by way of fees for technical services and royalties is to be taxed @ 20 per cent on gross basis; and that the treaty does not provide for any exemption from taxation of this income in India. On the contrary, according to the learned Departmental Representative, treaty provides that the taxation of such an income under art. 7 is to be 'according to the domestic law of the Contracting State in which the PE is situated'. Learned Departmental Representative further submits that the assessee company admittedly has a subsidiary company in India through which the business of the assessee is carried on, and therefore, income of the assessee is to be taxed as per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n more than one jurisdiction, or in which the source of income and residence of the person earning such an income are in two different tax jurisdictions), first thing to be ascertained is the rights of the taxing jurisdictions over taxability-full or partial-of that income. As the Special Bench of this Tribunal, in the case of Motorola Inc. (supra) appropriately observes, a tax treaty certainly does not constitute an exemption system. Strictly speaking, a tax treaty may not even constitute alternative taxation regime, for the elemental reason that no tax treaty or DTAA, whatever one calls it, can ever impose taxes. A view is thus indeed possible that there cannot be an alternate taxation regime which does not impose taxes. Yet, a tax treaty can be said to be an alternate taxation regime in the sense that it allocates taxing rights of the competing tax jurisdictions. As far as the related tax jurisdictions are concerned, a tax treaty, first and foremost, allocates the rights of taxation of the tax jurisdictions over a tax object. In a cross-border tax situation, there is always a conflict between source rule and residence rule. This conflict develops when a person resident in one of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntry yield taxability to residence country over a tax subject in respect of a limited tax object in the source country. Therefore, broadly speaking, a tax treaty is primarily a detailed instrument assigning the taxing rights between two, or more, competing tax jurisdictions over a tax subject. Unless a tax jurisdiction has a right to tax an income, it is irrelevant whether or not, under the domestic tax legislation of that tax jurisdiction, the income in question is taxable. This was also the conclusion arrived at by this Tribunal in the cases of Kotak Mahindra Primus Ltd. vs. Dy Director of IT (2006) 105 TTJ (Mumbai) 578 : (2007) 11 SOT 578 (Mumbai) and McKinley Co., Inc. (Phillippines) Ors. vs. Asstt. Director of IT (2006) 99 TTJ (Mumbai) 857 : (2006) 99 ITD 549 (Mumbai). 17. In our considered view, therefore, a tax treaty is an alternative taxation regime in the sense that it is an allocation of taxing rights between two, or more, competing tax jurisdictions over a tax object. The provisions of treaty override, as envisaged in s. 90 of the Indian IT Act, also support this inherent scheme of the tax treaties as the provisions of the Indian IT Act are applicable only to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lding their such an emphatic preference on this issue. We did not find any conceptual support or other material whatsoever for 'domestic law first' approach, though, in all fairness, there is literature to support the proposition that this debate as to whether one should see the treaty first or domestic law first is a non-starter. Whichever path we follow, we reach the same destination anyway: whether or not a cross-border income is taxable in the source country in the light of the domestic tax laws read with the applicable tax treaty, it would not make difference, in the ultimate analysis, whether one examines the case on the touchstone of the scheme of the treaty first and domestic law later, or vice versa. Late Prof Klaus Vogel, in his oft referred book 'Klaus Vogel on Double Taxation Conventions', has observed that, only very little legal background, is required to recognize that logically, both the methods or procedure are equivalent . Giving an illustration, he further explains, that the treaty acts like a stencil that is placed over the pattern of domestic law and covers over certain parts and adds that whether the stencil or the pattern is examined first ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r tax jurisdiction does not have right to tax that income. We are not inclined to approve this shift in onus, nor do we see any rationale in such a paradigm shift which will be inevitable corollary to acceptance of the approach canvassed by the Revenue authorities. 20. The only way in which a tax treaty is to be viewed as an exemption regime is like this. When an income is taxable under the domestic law in the source country, and even when source country has a tax treaty with the residence country the income could be exempt from source taxation only in the event that residence country has a right to tax the same. This can only proceed on the assumption that the taxability in residence country is to the exclusion of taxation in source country (and vice versa), but such a simplistic approach cannot coexist with credit method of avoiding double taxation, which is an integral part of Indian tax treaties. Such an approach also presupposes that the only method of avoiding double taxation is 'exemption method'-something which is perhaps not quite appropriate to say so far as Indian tax treaties are concerned. One must also remember that under this approach, i.e., treating a tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... since worldwide income of an Indian resident is to be taxed in India anyway. 22. In other words, the provisions of the Act cannot be imposed on a taxpayer against his will, though the taxpayer has an option to, when it so suits him, to be governed by the provisions of the Act. There is also no dispute that the case of the assessee is governed by the Indo-German tax treaty. We have to, therefore, examine the case of the assessee on the touchstone of the principles envisaged in the Indo-German tax treaty. It is only when the assessee is held to be taxable in India, in terms of the provisions of the applicable tax treaty, that we are required to take a look at the taxability under the domestic tax legislation in India. Relevant provisions in the India-German tax treaty: 23. We consider it appropriate to first reproduce arts. 5, 7 and 12 of the India-German Double Taxation Avoidance Agreement (hereinafter referred to as 'Indo-German tax treaty'), dealing with the 'PE', 'business profits' and 'royalties and fees for technical services' respectively, as follows: Article 5-Permanent establishment 1. For the purposes of this agreement, the t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -is acting in a Contracting State on behalf of an enterprise of the other Contracting State that enterprise shall be deemed to have a PE in the first-mentioned State, if this person,- (a) has and habitually exercises in that State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise; (b) has no such authority, but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise; or (c) habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control, as that enterprise. 6. An enterprise shall not be deemed to have a PE in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business and in their commercial and financial relations to the enterprise n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urposes of the preceding paras, the profits to be attributed to the PE shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 7. Where profits include items of income which are dealt with separately in other articles of this agreement, then the provisions of those articles shall not be affected by the provisions of this article. Article 12-Royalties and fees for technical services 1. Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner of the royalties, or fees for technical services, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties or the fees for technical services. 3. The term royalties as used in this article means payments of any kind received as, a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, incl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... axable according to the laws of each Contracting State, due regard being had to the other provisions of this agreement. The scheme of taxability on account of existence of a PE: 24. The scheme of taxability of business profits of enterprise of one of the Contracting States, as sourced from other Contracting States and as evident from the above treaty provisions, appears to be as follows. When an enterprise of one of the Contracting States (i.e. residence country of such an enterprise) does business in the other Contracting State (i.e. source country for the business profits) and earns business profits from this venture, as a general rule these business profits are only taxed in the residence country, unless the enterprise has a minimum level of presence, termed as having 'PE' in tax treaty parlance, in the source country of business profits, which constitutes threshold for the purpose of taxation in the other country. In such a situation, the taxing rights of the business profits remain with the residence country and no part of such taxing rights are exercisable also by the source country. In other words, when we are dealing with a German enterprise earning business ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fectively connected with such PE or fixed base . Both these conditions in our considered view, must be cumulatively satisfied. In other words when 'royalties and fees for technical services' are rendered by an enterprise engaged in doing business in the source country or in practicing as a professional through a fixed base in the source country, and when rights, contracts, property in respect of which such royalties or fees for technical services are paid is effectively connected with such PE or fixed base, the taxability will be on net basis, as is the inherent scheme of art. 7 dealing with business profits and art. 14 dealing with professional income, but on the regular rate of taxability in the source country as against a concessional rate of 10 per cent prescribed in the treaty itself. 28. On the face of it, the scheme of art. 15(5), which moves taxability of royalties and fees for technical services from art. 12(2) to art. 7 in specified circumstances, reflects a paradigm shift in taxability under the Indo-German tax treaty. The existence of a PE, or for that purpose an existence of 'a fixed base', brings in paradigm shift to the extent that (a) instead of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cal services are paid, its taxability of 'royalties and fees from technical services' shifts from art. 12(2) to art. 7(2). The impact of this change is that as against taxability on gross basis @ 10 per cent. the taxability goes upto 20 per cent though on gross basis again. It is this line of argument that the Revenue authorities are canvassing before us. 32. The case of the Revenue authorities, therefore, hinges on whether or not the foreign enterprise has a 'PE', and we have to examine that aspect next. It is only if the foreign enterprise is held to have a 'PE', the next thing to be ascertained is whether the rights, properties or contracts in which such royalties or fees for technical services are paid is effectively connected with such a PE. And finally, it is to be seen as to what is the quantum of business profits attributable to such a PE and, of course, the impact of s. 44D r/w s. 115A of the Act. The nature of services rendered by the taxpayer: 33. It is important to first understand the nature of arrangements between the Epcos AG, and its Indian subsidiaries, which, according to the Revenue authorities, have lead to the existence of its P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s are concerned. the taxpayer company has provided these services only to EFPL, Kolkata. and these services are in the nature of identifying customers, consultation, working out time schedules, negotiating price terms, fixing delivery schedules, negotiating credit terms, assuring payments, taxing care of currency and exchange rates, supply of technical information, attending to customer complaints and organization of rework, if necessary. It is in consideration for these services that the taxpayer is, in terms of the separate agreements, compensated as follows: Epcos India shall pay to Epcos AG a sum of covering costs incurred by Epcos AG in the performance of services described in Annex. 1 plus a profit mark up of 1 per cent for third party services passed on by Epcos AG and 3 per cent for services provided by Epcos AG itself. Epcos AG shall invoice Epcos India accordingly at the end of each quarter and payment shall fall due by 15th day of the first month of the following quarter. The costs incurred by Epcos AG shall be documented by time sheets, listing of administration costs, third party invoices etc. On request, Epcos AG shall make these documents available to Epcos In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PE of the taxpayer company. Did the assessee company have a PE in India? 36. There are several fallacies in the line of reasoning adopted by the AO. The taxpayer before us has received payments for support services and not the functions of the subsidiaries. It is not the case that the taxpayer company was supposed to handle entire marketing function or entire information technology function and a part of this work was delegated by the taxpayer company to the employees of the subsidiary. The payment which is made to the taxpayer company is only for the services rendered by the taxpayer company-either directly or through the intervention of a third party. This payment has two elements-one reimbursement of costs, plus, two, a mark up thereon for the indirect overheads. Admittedly, there is no reimbursement of costs incurred on any of the employees in India and as such there cannot be any payment for, or in connection with. the services rendered by any India based employee. It cannot, therefore, be, said that any income is earned by way of any employee in India. The business of the taxpayer, so far as impugned receipts are concerned, is rendering services to Indian subsidiaries, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... done by the employees of Indian subsidiaries is not at all germane to the issue of foreign company's PE. 37. The concept of PE, as evident from the earlier discussions, is a result of compromise between residence rule and source rule of taxation, and it constitutes 'home' of a foreign enterprise abroad. The core of PE in the source country consists of (a) fixed place of business of foreign enterprise-its location, as also its permanence; and (b) the business activity of the foreign enterprise. The expression 'PE' in art. 5(1) of the Indo-German tax treaty, as indeed in UN and OECD Model Conventions, is basically defined as a fixed place of business through which the business of the enterprise is wholly or partly carried on . The expression 'enterprise' in this definition obviously refers to the enterprise of the other Contracting State, because the expression 'PE' has no relevance when business of enterprise of one of the Contracting States is carried on in that very Contracting State. In such a situation, the residence country and the source country are the same and there is no conflict in residence rule and source rule, and, therefore, ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... branches' but then there is no rationale basis for such an aggressive proposition. Undoubtedly, business is being carried out in Indian subsidiaries but the crucial question whose business is it. The expression 'carrying on of the business' can only refer to the conduct of the business of the foreign enterprise in the source jurisdiction, because the question of triggering tax liability by the virtue of a PE is relevant only for a foreign enterprise; the domestic enterprise is taxable anyway by the virtue of residence rule. What is being done by the Indian subsidiaries under the guidance and supervision of Epcos AG is business of the Indian subsidiaries, and that aspect of the matter, by no stretch of logic, is relevant for deciding whether or not the Epcos AG has a PE in India. Merely because an Indian company conducts its business, with the help and guidance it has received from a foreign company, in India, it does not follow that the foreign company so giving help and guidance will be deemed to have a PE in the form of that domestic company. Is it necessary that the PE can only be said to exist, under the basic rule, when core business activity is carried out by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adiction in the OECD approach inasmuch as on one hand PE provides threshold limits for triggering taxation in the source country, on the other hand the existence of the PE is decided de hors the activity in the absence of which taxability of profits in the source country cannot be triggered at all. On the face of it, when a PE is not engaged in a critical activity having some contribution to overall profits of the enterprise or a revenue generating activity, the exercise to ascertain whether or not a PE is in existence is a meaningless ritual and an empty formality. Viewed in this perspective, and bearing in mind the fact that by no stretch of logic it could be held that any significant or critical business activity by the Epcos AG was carried out in India, even if there is a PE in India, that will be wholly academic and will not lead to any taxability of income. Not only the work done in India, if at all, did not constitute significant or critical business activity, the assessee company did not earn any revenues as a result of the activities so carried out by the employees of Indian subsidiaries, and, therefore, no part of the revenues actually generated by the assessee company co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd issue i.e. on taxability @ 20 per cent in terms of s. 44D r/w s. 115A in case PE is found to be in existence: 42. While dealing with the interplay between existence of a PE and taxability as 'royalties and fees for technical services', we had taken note of the proposition advanced by the Revenue authorities that once art. 12(5) is invoked, all the receipts as 'royalties and fees for technical services' are taxable in India on gross basis under s. 44D, though, as per the provisions of s. 115A, at a lower rate of 20 per cent. 43. This proposition proceeds on the fallacy that once the first conditions under art. 12(5) are satisfied, i.e. once the assessee company has a PE in India, the 'royalties and fees for technical services' are to be necessarily taxed in India under art. 7. That is clearly erroneous, because, as noted above, twin conditions of existence of the PE as also the effective nexus between the PE and the subject 'royalties' and 'fees for technical services' are to be satisfied. We are of the view that on account of existence of a PE in India, only such profits of the assessee company can be brought to tax in India as are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hould this profit attribution exercise done, the guidance is available from art. 7(2). 45. Under art. 7(2), these profits are to be so attributed as PE might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a PE . The PE is to be considered as hypothetically independent but let us not forget that the services are rendered by the PE, i.e. Indian subsidiaries, and the services are also availed by same Indian subsidiaries. The fundamental question that would arise in such a cases whether someone can make profit out of dealings with oneself. The answer poses no difficulty. The proposition is well settled that nobody can make profit out of self or trade deal with self or earn from self. It is so held it a series of cases, including Sir Kikabhai Premchand vs. CIT (1953) 24 ITR 506 (SC), Betts Hartley Huett Co. Ltd. vs. CIT (1979) 116 ITR 425 (Cal) and ABN Amro Bank NV us. Asstt. Director of IT (2005) 98 TI'J (Kol)(SB) 295 : (2005) 97 ITD 89 (Kol)(SB). It is thus clear that an income of the Indian subsidiaries, on acc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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