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TMI Blog2008 (6) TMI 288X X X X Extracts X X X X X X X X Extracts X X X X ..... an IT Act, 1961. 2. Learned Departmental Representative argues that what we need to do is to examine the taxability under s. 115A r/w s. 44D first, and, then, examine whether or not the income so taxable, if any, is exempt under the treaty provisions. He submits that notwithstanding the grounds of appeal before us, which mayor may not be happily worded, we have powers, as also a corresponding duty to exercise these powers when so considered appropriate, to decide the appeal on any of the grounds as long as both the parties have been heard on that ground. We are thus urged to take a look at the dispute before us in this light. We will deal with this aspect of the matter a little later, but suffice to say that we are satisfied that, in order to properly dispose of this appeal, only the above two and other related issues, and in that order, require our adjudication. 3. While the first issue is required to be adjudicated in the light of the provisions of the India-Germany DTAA, dt. 19th June, 1995 as the taxpayer foreign company (assessee, in short) is a resident of Germany, the second issue requires adjudication mainly in the light of the provisions of the domestic tax law, i.e., In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 31,80,116 6. A reference was made to the TPO, for ascertainment of ALP of the above international transactions. The TPO accepted the transaction values as disclosed by the assessee as an ALP, without making any adjustments. 7. In the course of the assessment proceedings, the AO noted that the assessee has accepted a tax liability @ 10 per cent, on the basis of the provisions of art. 12 of the Indo-German tax treaty but none of the receipts, save and except on account of royalty fees, is of such a nature as can be covered by art. 12. The AO was of the view that 'income from product marketing fees' amounts to a commercial activity as the same cannot be termed as a royalty or fees for technical services. As for the receipts for information and technology support, the AO required the assessee to furnish complete details about the nature of information and technology support and added that, in any event, such receipts are not specifically included in art. 12 of the Indo-German tax treaty. Similar was the AO's stand so far as the receipts for sales support fees were concerned. The AO also requisitioned details of and computation methodology for the sales support fees as wel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ystem etc. It was also pointed out that sales support services were rendered to only one of the subsidiaries in India, i.e., Epcos Ferrites Ltd. and that these services were in the nature of services for identifying the customers, consultations, working out time schedules, negotiating price terms, fixing delivery schedule, negotiating credit terms, assuring payments, taking care of currency and exchange rates, supply of technical information, attending to customer complaints and organization of rework, if necessary. The assessee further submitted that since the assessee company does not have a PE in India, these receipts could only be taxed under art. 12 of the Indo-German tax treaty, and in case the AO is of the opinion that these receipts are not covered by art. 12, these receipts are not taxable at all. The assessee also submitted that as far as ECB loan interest was concerned, it was indeed not covered under art. 12 of the Indo-German treaty but then that this fact does not make any difference to the tax liability, because, under art. 11 of the treaty, interest income is to be taxed @ 10 per cent anyway. The assessee thus urged the AO to accept the taxability of all these recei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... There is no employer-employee relationship between these persons and us." 10. Taking note of the above reaction and particularly of the underlined portion (italicized in print) therein, the AO pointed out to the assessee that services of EIPL and EFPL employees have been availed to earn the receipts on account of product marketing, sales support and information technology services as also of the royalty. The AO was also of the view that the assessee has a PE in India, in the form of its subsidiaries i.e. EIPL and EFPL, since the assessee was conducting its business in India through its subsidiaries and more specifically through employees of the subsidiaries. The submissions of the assessee did not find any favour with the AO. The AO concluded that "it is observed, on the basis of various letters and e-mails received, that each and every activity is done under the active supervision of Epcos AG in India". The AO further observed that the term 'PE' connotes a fixed place of business through which the business of all enterprise is wholly or partly carried on and that it includes especially 'a place of management, a branch, an office or a factory'. He noted that in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted aspect of "business of the Indian subsidiaries" and, therefore, "the AO wrongly concluded that each and every activity of Indian subsidiaries is done under the active supervision of Epcos AG in India". The CIT(A) also noted that the assessee company has no employees in India and, therefore, the AO's claim that the assessee has a place of management in India, is not correct. The CIT(A) further held that in view of art. 5(7), merely because the assessee has a subsidiary company, it cannot be concluded that the assessee has a PE in India. The Advance Rulings, relied upon by the AO. were held to be inapplicable on the facts of this case. The CIT(A) also observed that the AO has not properly understood the activities of the assessee company and has 'created a paradoxical situation'. On one hand. it is stated that the assessee is rendering services in India through its PE in the form of subsidiaries as per art. 5(2)(a) and (b) and. on the other hand, the very same services are consumed by its subsidiaries in India. It is illogical to imagine that the subsidiaries are both providing and utilizing the services. 12. The CIT(A) thus concluded that in terms of the provisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under the India-Germany DTAA. and by virtue of art. 7 r/w art. 5, the income is taxable in India under the 'domestic law'. 16. Even as we are alive to the fact that the approach suggested by the learned Departmental Representative will not lead to any different results than the one arrived at by any other approach to the issue, we are not inclined to accept the suggestion of the learned Departmental Representative. There is indeed a school of thought which suggests that what needs to be examined first is the taxability under the domestic law i.e., the Indian IT Act and only when the taxability under the domestic law is held to be in existence, one has to see the applicable treaty, if any, to examine whether or not the assessee gets any relief from the provisions of such a tax. This approach, however, was not approved in the landmark Special Bench decision in the case of Motorola Inc. vs. Dy. CIT (2005) 96 TTJ (Del)(SB) 1, wherein the Tribunal had observed that "DTAA is only an alternate tax regime and not an exemption regime" and, therefore, "the burden is first on the Revenue to show that the assessee has a taxable income under the DTAA, and then the burden is on the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e unit, thus invariably belongs to the residence jurisdiction or, in the case of the USA. citizenship jurisdiction, as the US laws provides for taxation of all citizens-irrespective of their residential status. The source rule, however, lays down that an income earned in a tax jurisdiction, irrespective of the residential status of the person earning the said income, is liable to be taxed in the tax jurisdiction where the income is earned. Therefore, a tax object, i.e. the income which is to be taxed, as a rule attracts taxability in the source jurisdiction. A tax treaty resolves this conflict by laying down the principles on the basis of a tax jurisdiction, other than the residence jurisdiction, gets rights to tax the residents of the other Contracting States and the manner in which a person gets the credit in his residence jurisdiction for the taxes so paid outside the residence jurisdiction. When an income is to be so taxed in the source country, the tax treaties further provide for the manner in which the income is to be taxed as such. Therefore, it provides for the basis and mechanism of taxability outside the residence jurisdiction. By the virtue of residuary clauses in most ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mine taxability under the domestic law in such a case, No tax treaty can impose a tax but a tax treaty does something far more fundamental-in case of competing tax jurisdiction claims, which are inevitable corollaries of inherently contradictory source and residence rules a tax treaty decides which tax jurisdiction can levy tax on a tax object, and to what extent it can do so. To examine taxability of a cross-border income in a source tax jurisdiction, without first establishing the right to tax that income by the source tax jurisdiction, is like putting the cart before the horse. Therefore, before proceeding to consider taxability of a nonresident, covered by the provisions of a tax treaty, in terms of the provisions of the domestic tax laws of the source jurisdiction, it is useful to first check whether source jurisdiction has a right to tax that income at all. We would, therefore, prefer to follow the approach of first examining whether or not the source country has right to tax, a particular cross-border income, and, in case the right is so established, to examine whether or not the domestic tax, laws of the source country provide for taxation of such an income, and if so, to w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rked that this "issue can be theorized and philosophized upon. but the inevitable conclusion is that one must consider both domestic law and the treaty" and he concludes that "in practice it does not matter". While we recognize the school of thought canvassed by the learned representatives. we are. for the reasons' we have set out in the preceding paras-including the reasons of deference for the Larger Bench of this Tribunal and conceptual foundation elaborated in these paras, of the considered view that in the case of the cross-border tax situation between treaty partner States, logically first thing for a source tax jurisdiction is to establish the right to tax under the applicable tax treaty, and only if such a source tax jurisdiction indeed has right to tax, the next thing is to examine is the taxability under the domestic laws of that State. 19. There is one more aspect of the matter. A view could indeed be taken that the difference, if at all, in these two approaches is that in the approach suggested by the learned Departmental Representative, the onus shifts on the assessee to demonstrate that the income in question is exempt under the applicable tax treaty. Law is trit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion is also a fact of life, and tax sparings, which find place in several Indian tax treaties, are also a reality in international taxation. One could possibly argue that a treaty can also work as an exemption regime when viewed as a mere allocation of taxing rights, but, in such a situation, it would indeed be somewhat illogical to examine the taxability under the domestic law first and then examine whether or not the source jurisdiction has right to tax at all. There is thus a reasonable conceptual basis for first ascertaining source country's right to tax, and then application of domestic tax law, if needed, to ascertain existence and quantum of tax under the domestic tax laws of source country. Treaty override: 21. The practice of treaty override, which has legal sanction in India by the virtue of s. 90 of the Indian IT Act, also recognizes this scheme of things by specifically providing that the provisions of the Indian IT Act will have limited application on a non-resident taxpayer, who is covered by the scope of a tax treaty entered into by India, only to the extent these, are more beneficial to such a taxpayer. In other words, when a non-resident taxpayer can demonstr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of natural resources, including an installation or structure used for the exploration or exploitation; (g) a warehouse or sales outlet; (h) a farm, plantation or other place where agricultural, forestry, plantation or related activities are carried on; and (i) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities continue for a period exceeding six months. 3. An enterprise shall be deemed to have a PE in a Contracting State and to carry on business through that PE if it provides services or facilities in connection with, or supplies plant and machinery on hire used for or to be used in the prospecting for or extraction or exploitation of mineral oils in that State. 4. Notwithstanding the preceding provisions of this article, the term "PE" shall be deemed not to include,- (a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; (c) the maintenance of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , shall not of itself constitute either company a PE of the other. Article 7-Business profits 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a PE situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that PE. 2. Subject to the provisions of para 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a PE situated therein, there shall in each Contracting State be attributed to that PE the profits which it 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. 3. In the determination of the profits of a PE, there shall be allowed as deductions, expenses which are incurred for the purposes of the business of the PE including executive and general administrative expenses so incurred, whether in the State in which th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... services" as used in this article means payments of any amount in consideration for the including the provision of services by technical or other personnel but does not include payments for services mentioned in art. 15 of this agreement. 5. The provisions of paras 1 and 2 shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State, in which the royalties or fees for technical services arise, through a PE situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such PE or fixed base. In such case, the provisions of art. 1 or art. 14, as the case may be, shall apply. 6. Royalties and fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a land or a political sub-division, a local authority or a resident of that State, Where, however, the person paying the royalties or fees for technical services, whether he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... so far as relatable to 'business profits' under art. 7 is concerned, is confined only to such business profits as can be held to be "attributable to that PE" in India. 25. The first step towards examining taxability of business profits in the source country thus is to ascertain whether or not the foreign enterprise has a 'PE', and if the foreign enterprise is held to have a 'PE', the next thing to be ascertained is the quantum of business profits attributable to such a PE. Interplay between taxability of 'business profits' and taxability of 'royalties and fees for technical services': 26. Under art. 12 of the Indo-German tax treaty, any payments on account of 'royalties and fees for technical services' arising in one Contracting State and paid to the resident of the other Contracting State are, in addition to primarily taxability in the residence State, attract a limited taxation, @ 10 per cent in the source jurisdiction as well. Therefore, as long as the payments are in the nature of 'royalties and fees for technical services', the recipient of such payments has a limited tax liability @ 10 per cent on gross basis under a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , apparently even under the domestic law all these receipts as 'royalties and fees for technical services' were taxable on gross basis in India, though, as per the provisions of s. 115A, at a lower rate of 20 per cent. 30. To decide whether this legal proposition is correct or not, we will have to analyze things in some detail. Let us understand that proposition, and its conceptual basis, first. Under art. 7(3), which deals with the ascertainment of business profits attributable to the PE, it is provided that "there shall be allowed as deductions, expenses which are incurred for the purposes of the business of the PE .......according to the domestic law of the Contracting State in which the PE is situated.". It could therefore follow that the restrictions on allowance of deductions, in computation of business income as placed under the Indian IT Act, will also apply while computing the income attributable to the PE. One of these restrictions, as provided in s. 44D of the Act, as it stood at the material point of time, is that "notwithstanding anything to the contrary contained in ss. 28 to 44C, in case of an assessee being a foreign company, no deduction in respect of any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... EFPL) and copies of these agreements were placed before us at pp. 166 to 179 of the paper book. Epcos AG maintains centralized information technology infrastructure at its German office and it provides the services of creating and maintaining the WAN (wide area network) for the whole group. The services of outside parties are engaged for maintaining this WAN. This centralized information technology unit of the taxpayer company also procures and furnishes to its subsidiaries, licences for programmes such as MS Office, Oracle for servers and other softwares, develops and maintains central SAP system which is also used by the Indian subsidiaries, and implements a common e-mail service which is used by Indian subsidiaries. Similarly, so far as product marketing services are concerned, these services are also provided by Epcos AG's centralized marketing unit in Germany. As we have noted earlier, Epcos Group is organized by product divisions and each division has its central marketing team, which works for all the manufacturing companies within that division. These centralized services are the benefit of various manufacturing companies in that division all over the world. and a fees ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts are directly allocated to such a subsidiary, but whenever costs are not directly allocable, these costs are allocated on some rational basis. Such cost sharing arrangements are quite common in the cases where support activities of the group companies are centralized. In view of the fact that the TPO has accepted the payments to the taxpayer company as an arms length payment for services so rendered, and in the absence of any allegation to the contrary in the assessment order, there is no dispute about the fact that the amounts paid by the EIPL and EFPL to Epcos AG constitute arms length consideration for services so rendered by the taxpayer company, and that these arrangements are not sham arrangements. The AO's case for existence of a PE: 35. The case of the AO, as evident from his observations at p. 25 of the assessment order, is that since the taxpayer has accepted that "based on guidance of our product marketing team, activities relating to decisions of sale, production, dispatch, cost computation and other relevant activities for effecting the sale are carried out by the EIPL and EFPL" and that "based on guidance and support of our central IT team. local activities su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oreign company which is taxpayer before us. We must, at this stage, understand distinction between business of the foreign company and that of its Indian subsidiaries. While the business of the foreign company, for our purposes, is rendering certain types of services to its Indian subsidiaries, the business of the Indian company is to manufacture and sell its products. What is done by the employees of the Indian subsidiaries is running business of the Indian subsidiaries which includes marketing of its products-with or without guidance of the foreign parent company, and ensuring a smooth functioning of business by ensuring an effective information technology support service. Just because employees of Indian subsidiaries are also engaged in marketing activities and information technology support activities, it would not mean that these employees are doing business of the foreign principal unless the work so done by these employees entitles the foreign parent company for rewards of the work so done. It is also to be remembered that merely because the foreign parent company is engaged in rendering certain centralized services, it does not mean that all the services are to be rendered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tax treaties, but there are negative and positive lists of what the expression 'PE' does not include and what the expression 'PE' does include, and these lists can also help us draw inferences on this aspect as well. The expression 'fixed place of business' presupposes that there is a place of business, i.e., a facility such as premises or, in certain instances, even machinery or equipment, and that such a place of business is a 'fixed' place, i.e. a distinct place with certain degree of permanence. While in terms of the provisions of art. 5(7), existence of a subsidiary or parent company in the source jurisdiction by itself does not constitute a PE; there is no bar on the parent or subsidiary being PE of each other. The true test, in our considered view, is whether or not business of the foreign enterprise is carried out by the PE. Therefore, when business of enterprises of one of the Contracting States is carried out by its subsidiaries in the other Contracting States, such a subsidiary can indeed be its PE. In principle, therefore, there cannot be any bar on a subsidiary being a PE of the parent company. However, whether or not is it to be treated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... carried out by the PE may not be a productive character, though the commentary does recognize that it could perhaps be argued that in the general definition, some mention should also be made of the other characteristic of the PE, namely that the establishment must have a productive character-i.e. contribute to the profits of the enterprise. However, in the present definition, this course has not been taken. Late Prof Vogel also concurred with this school of thought and observed that "... the PE need not be a branch in the nature of facility engaged in activities of the same type as those of the head office organization, nor need the place of business directly contribute to enterprise's profits" and "all that its business must do is to serve the enterprise's overall purpose, but it must be an activity". The question, however, is that the activity must be of the business of the taxpayer company, and not of the independent subsidiaries of such a taxpayer company. On the facts of the case before us, no part of the work of Epcos AG was carried out in India. The e-mails and letters were sent from outside India, and at best Indian subsidiaries acted upon the advices so given in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) existence of the PE through which business is carried out; and of (b) existence of effective connection between such a PE and the rights, properties and contracts in respect of which 'royalties' and 'fees for technical services' are paid. That would mean that only such 'royalties' and fees for technical services' are excluded from the scope of art. 12(1) and (2) as are attributable to the PE through which business is carried on by the enterprise. In other words, the taxability under art. 12 shifts to taxability under art. 7 only in respect of 'royalties' and 'fees for technical services' which are attributable to the PE in question. In case an assessee receives 'royalties' and 'fees for technical services' but these receipts do not have an effective nexus with the PE, and are not, therefore. attributable to the PE, the exclusion clause under art. 15(5), as also taxability under art. 7(1) and (2), is not triggered. Conclusion on the first issue i.e. on existence of PE: 41.1 In the light of these discussions, in our considered view, the assessee company did not have any PE in India, much less a PE to which subject 'r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vices are paid, with PE, and, on the other hand, the scheme of taxability under art. 7, which is complementary to this approach, is also such that the taxability under art. 7 is attracted only in respect of such 'royalties' and 'fees for technical servicer' as are so attributable to the PE. Unless an amount is such that it is taxable under art. 7, even if it is in the nature of 'royalties' or 'fees for technical services', the exclusion clause under art. 12(5) will not come into play. At the same time, unless an amount representing 'royalties' or 'fees for technical services' is such that it triggers exclusion clause under art. 12(5), it would not be taxable under art. 7. 44. Art. 7(1) restricts the scope of taxability of business profits of an enterprise in the source country to only such profits as are attributable to the PE. Therefore, to bring any income to taxability under art. 7 in the source country, the first thing to be satisfied under art. 7(1) is that the income being sought to be taxed is only such as is attributable to the PE. In other words, unless the Revenue authorities can demonstrate that the 'royalties and fees ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f allowing deductions therefrom. That aspect of the matter is entirely infructuous. The limitation under s. 44D is, therefore, not relevant in the present case. The same is the position with regard to the lower rate prescribed under s. 115A of the Act. There is no warrant for application of s. 44D and s. 115A unless there is a positive income from 'royalties and fees for technical services' which can be brought to tax under art. 7. Conclusion on the second issue i.e., taxability @ 20 per cent in terns s. 44D r/w s. 115A in case PE is found to be in existence: 47. In our considered view, in terms of the indo German tax treaty provisions, it will have to be demonstrated that such royalties and fees for technical services have a live economic nexus with the PE and only then exclusion clause under art. 12(5) as also taxability under arts. 7(1) and 7(2), will come into play. It is only after these royalties and fees for technical services are so included in the business profits attributable to the PE that the provisions of ss. 44D and 115A can be invoked. Therefore, even if we are to hold that the taxpayer had a PE in India, unless there is a categorical finding that entire re ..... X X X X Extracts X X X X X X X X Extracts X X X X
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