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TMI Blog2010 (7) TMI 535X X X X Extracts X X X X X X X X Extracts X X X X ..... s, however, no dispute that the assessee does not have any branch office or any other similar form of presence in India. During the relevant previous year, the assessee firm rendered services to certain clients whose operations extended to India, and these services were in connection with projects in India. The services so rendered were rendered from outside India as also from within India. The services were rendered from outside India by assessee's London office, but at times partners and staff members of the assessee firm also visited India to render these professional services. The assessee had worked for following projects for which partly work was done in India and partly work was done outside India: Sl. No. Name of the Client Name of the Project / Matter 1. Denro Ispat Chandrapur coal project 2. CESC Balagrah power project 3. Enron Power Indian power project 4. Hinduja National Power Vizag 5. Dresdner Kleinwortbenson Bajaj GDR issue 6. Barclays Capital Finolex Cables GDR 7. S.S. Warburg Securities Ltd. India cements Limited 8. HSBC Investment Bank PLC Sriram Enterprises GDR 9. Lazard Brothers & Co. Ltd. Usha Beltron GDR issue 10. Chase M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nvisaged in Article 5(2)(k) of the Indo UK tax treaty as the assessee is an international professional enterprises rendering services directly to its clients. It was also contended by the assessee that the professional services rendered by the assessee can at best be covered by Article 15 but, in any event, Article 15 extended to only individuals and not to the partnership firms or other forms of business organizations. It was submitted that the assessee cannot be taxed under Article 7 as the assessee did not have a PE in India under the provisions of Article 5(2)(k) read with Article 5(1), and the assessee can not be taxed under Article 15 as the said Article only applies to the services rendered by individuals whereas the assessee is a partnership firm. It was contended that since the provisions of the applicable tax treaty were beneficial to the assessee, these treaty provisions will override the provisions of the Indian Income Tax Act, 1961, and the income of the assessee cannot be brought to tax under the provisions of the Indian Income Tax Act either 4. None of these submissions, however, impressed the Assessing Officer. The Assessing Officer was of the view that in case one ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble under Article 15 as 'independent personal services' and he relied upon the decision of this Tribunal in the case of Clifford Chance Vs DCIT (82 ITD 106) in support of the same. 5. Having held that the income of the assessee from projects in India is taxable in India, the Assessing Officer turned to quantification of the income so liable to be taxed in India. It was noted that without prejudice to assessee's contentions regarding non taxability of its income in India, the assessee had enclosed an income and expenditure account in which income has been computed as follows: In UK GBP Income 6,91,190 Less : Direct expenditure 1,88,206 Overheads (5% of income) 34,565 Profits 4,68,419 6. It was also noted that the above computation was based on the position stated at Note 10 of the statement accompanying the income tax return and the position stated in the tax audit report attached to the return of income. A perusal of these documents revealed that the assessee had prepared a profit and loss account with reference to the fees charged to the clients as could reasonably be attributed to the work performed in India. According to the assessee, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th the Explanations thereto, makes it clear that the statutory test for determining the place of accrual of income is not the place where these services are rendered but where those services are utilized". Therefore, irrespective of the place where services are rendered, income should be deemed to accrue or arise in India. The Assessing Officer, having noted that the assessee has taken into account charges only for services rendered in India, thus held that whether the services rendered from India, or from outside India, the entire income in connection with projects in India is required to be taxed in India. He thus took into account the overall amounts invoiced by the assessee in respect of services rendered for Indian projects. It was also noted by the Assessing Officer that amounts invoiced to the clients were in the nature of invoices for professional fees as well as invoices/ requisitions for reimbursements of expenditure. While Assessing Officer noted assessee's claim that the reimbursements of expenses are in respect of actual expenditure incurred by the assessee, on behalf of clients, and have no element of mark up or income, he treated 50% of such reimbursements of expend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ected the adjustments done by the assessee in respect of revenues for work done by the PE and adoption of hypothetical market rates for such services in India, and held that only actual billing amount is to be taken into account. While holding so, the CIT(A), inter alia, made following significant observations: On the question of existence of PE "........... The contention of the learned A.R. cannot be accepted for the following reasons. * *Para 2 of Article 5 of the DTAA provides the circumstances under which permanent establishment arises in a Contracting State. Para 2 provides for specific instances over and above the general provisions contained in para 1 of Article 4 e.g. duration of construction contract, furnishing of services other than technical services, etc. It is a well accepted principle that specific provisions prevail over the general provisions. Therefore, if the conditions provided in para 2 of Article 5 are satisfied, it will amount to a permanent establishment irrespective of the fact whether the general provisions of Article 5(1) cover such a situation or not. * *The term furnishing of services as referred in Article 5(2)(k) also includes rendering of serv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ered outside India. I have also perused the invoices raised by the appellant. From the details, it can be observed that more than 90% of the invoices are raised by the appellant on foreign enterprises. Further, in many cases, the appellant has rendered services in relation to ADR/GDR or Bound issues outside India. Therefore, it will be incorrect to assume that the services rendered by the appellant are utilized in India. In any event, I agree with the learned A.R. that the income earned by the appellant were not in the nature of fees for technical services as defined in section 9(1)(vii) and therefore the AAR Ruling in the case of S.R.K. Consulting Engineers (supra) will not apply to the facts of the appellant. 6.10 Even in the case of Clifford Chance (82 ITD 106) the Hon'ble Mumbai Bench of ITAT has held that the income relating to services rendered outside India is not taxable in India. At para 64 of the order, the Hon'ble ITAT has observed as under:-6.4 The question in the present case is very simple. If assessee proves that it rendered services outside India, its income to that extent can be excluded while computing its total income for determining tax payable in India. But th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India under Article 5(2)(k) of the Tax Treaty between India and the U.K. The Learned Commissioner (Appeals) ought to have appreciated that appellant had no permanent establishment in India. 3. Without prejudice to the above, the Learned Commissioner (Appeals) erred in not directing the Assessing Officer to accept the computation provided by the appellant in the Income and Expenditure Account as being the income attributable to the permanent establishment. The Learned Commissioner (Appeals) ought to have directed the Assessing Officer to adopt the gross income at 6,91,190 pounds deduction for direct expenditure at 1,88,206 pounds, deduction for overheads 34,565 pounds and net profit 4,68,419 pounds. 4. Without prejudice to the above, the Learned Commissioner (Appeals) erred in not directing the Assessing Officer to compute the total income at the number of hours charged at appropriate rates for an Indian lawyer viz 100 pounds per hour for a partner and 75 pounds per hour for an assistant. 5. The Learned Commissioner (Appeals) erred in upholding the action of the Assessing Officer in considering reimbursement of expenditure of 8,02,486.13 pounds, 65,327 US dollars ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t even under the domestic law, the income of the assessee firm is taxable only to the extent the work has been carried out in India. It is submitted that in view of Hon'ble Bombay High Court's judgment in the case of Clifford Chance vs DCIT (318 ITR 237) only such services as are rendered in India can be subjected to tax in India. Therefore, according to the learned counsel, even under domestic law, we cannot bring to tax services rendered to Indian projects from outside India. When learned senior counsel's attention was drawn to the amendments in Section 9 as proposed by the Finance Bill 2010, and impact of these amendments, when carried out, on Clifford Chance judgment of Hon'ble Bombay High Court, it was submitted that these amendments, even if carried out, will at best require reconsideration of Clifford Chance decision by Hon'ble Bombay High Court, whenever these issues come up before Their Lordships again, but, under no circumstances, it can be said that Clifford Chance will not be good law even after the amendments are brought in force. It was submitted that these amendments pertain to the taxability of fees for technical services, and, as such, do not directly cover the iss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e claim of the assessee was that only such portion of the fees received, in connection with these projects is taxable in India as is attributable to services performed in India, the Assessing Officer opined that the total fees received for the India Project, whether the work was done in India or outside India, was taxable in India. When this dispute finally travelled before the Hon'ble Bombay High Court, it was, inter alia, contended by the assessee that "the place of utilization of service is not relevant but place of performance of the service is what would be determinative (of taxability)........" and reliance was placed on Hon'ble Supreme Court's judgment in the case of Ishikawajima Harima Heavy Industries Ltd. vs. DIT (288 ITR 408). Their Lordships noted that the taxability is to be determined under section 9(1)(vii) of the Act, and observed as follows: "The apex court had occasion to consider the above question in the case of Ishikawajima Harima [2007] 288 ITR 408 (SC), wherein, while interpreting the provisions of section 9(1)(vii)(c) of the Act, the Supreme Court held as under (page 444) : "Section 9(1)(vii)(c) of the Act states that 'a person who is a non-resident, where ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urview of section 9(1)(vii) of the Act, a non-resident would not, as services of a non-resident to a resident utilized in India may not have much relevant in determining whether the income of the non-resident accrues or arises in India. It must have a direct link between the services rendered in India. When such a link is established, the same may again be subjected to any relief under the DTAA. A distinction may also be made between rendition of services and utilization thereof. With the above understanding of law laid down by the apex court, if one turns to the facts of the case in hand and examines them on the touchstone, section 9(1)(vii)(c) which clearly states...where the fees are payable in respect of services utilized in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India". It is thus, evident that section 9(1)(vii)(c), read in its plain, envisages the fulfillment of two conditions : services, which are source of income sought to be taxed in India must be (i) utilized in India, and (ii) rendered in India. In the present case, both these conditions have not been satisfied simultaneously. 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, both these conditions have not been satisfied simultaneously". It is on this basis that Their Lordships came to the conclusion that "In the above view of the matter, contentions raised by the assessee/ appellant are to be accepted". The conclusions arrived at by Their Lordships were thus entirely based on their reading of the scope of Section 9(1) of the Income Tax Act, but in view of the retrospective amendment in Explanation to Section 9(1), the scope of this provision does no longer permit the interpretation adopted by Their Lordships. The very conceptual foundation of Hon'ble Bombay High Court's decision in the case of Clifford Chance (supra) ceases to hold good in law. When the legal provisions considered in the judicial precedent, vis‐à‐vis the legal provisions prevalent when that precedent is sought to be applied, are not in pari materia, the judicial precedent cannot have precedence value. 17. A school of thought does exist to the effect that the concept of territorial nexus, for the purpose of determining the tax liability, is relevant only for a territorial tax system in which taxability in a tax jurisdiction is confined to the income earned within ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax systems. This school of thought is now specifically supported by the retrospective amendment to section 9. 18. It is, therefore, free from any doubt that Hon'ble Bombay High Court's judgment in the case of Clifford Chance is no longer good law, as there have been amendments in law in consonance with the school of thought discussed above and these amendment unambiguously negate the principle of territorial nexus which is the understructure of line of reasoning adopted by the Hon'ble Courts above. It is no longer necessary that, in order to invite taxability under section 9(1)(vii) of the Act, the services must be rendered in the Indian tax jurisdiction 19. In view of the above discussions, we are of the considered view that the entire fees for professional services earned by the assessee, in connection with the projects in India and which is thus sourced from India, is taxable in India under the domestic law. We reject the contentions advanced by the learned counsel. 20. Having held so, however, we may add that under the scheme of the Indian Income Tax Act, where the Government of India has entered into an agreement, with the Government of any country outside India for grantin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l, expanding the scope of appeal before us - something beyond the scope of our powers. Our attention was invited to Hon'ble Bombay High Court's judgment in the case of Pokhraj Hirachand Vs CIT (49 ITR 293). It is submitted that all that we are to decide at this stage is the issues raised by the appellants, and we cannot travel beyond that to unsettle the settled matters. Without prejudice to these objections on jurisdiction, learned counsel for the assessee also addressed us on merits on assessee's eligibility for treaty benefits. 23. Learned counsel submits that the assessable unit is the partnership firm itself, though the manner of computation of tax liability is such that the tax payable by the partners is taken into account. Our attention is drawn to the UK Inland Revenue's assessment order of the assessee shows assessment order drawn up in the name of the firm, though the tax is computed with reference to the tax liability of the partners. The expression 'liable to tax', according to the learned counsel, must include the person who is under an obligation to file the income tax return, in whose hands the income is determined and from whom taxes are recovered. The assessee ful ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applicable legal provisions in the relevant tax jurisdictions, and, as such, this decision cannot have any bearing on the question as to whether or not a partnership firm in UK is entitled to the treaty benefits under India UK tax treaty. 27. Learned counsel further submitted that when words of a tax treaty are less than unambiguous, even if that be so, the Courts and Tribunals have to interpret these words so as to advance the objectives and purposes of the tax treaty rather than so as to frustrate the undisputed objectives and purposes of the tax treaty. According to the learned counsel, this peculiar problem regarding eligibility of tax treaty benefits arises, if at all it can be deemed to arise, because of asymmetrical tax treatment to partnership firm in the treaty partner tax jurisdictions, and, the treaty should be so interpreted as to resolve this unintended incongruity. We are thus urged to so interpret the tax treaty as to ensure meaningful interpretation to the provisions of tax treaty. 28.Learned Departmental Representative submits that the point of dispute before us is taxability of income from a definite source, and the authorities below have given their reas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... merits, and reject the technical objection raised by the assessee. 29. Learned Departmental Representative invites our attention tothe definition of 'resident of a contracting state', as set out in Article 4(1), which states that resident of a Contracting State means "any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature". It is pointed out that as evident from Article 1(1) of the India UK tax treaty, the treaty can only apply to a person who is resident of one or both the contracting states. Therefore, in view of the provisions of Article 4(1) read with Article (1) and on the facts of this case, unless the assessee can be said to resident of UK, the assessee cannotr claim treaty benefits, and unless the assessee is liable to tax in UK, assessee cannot fulfill the requirement of being a resident in UK. He further submits that it is not in dispute that in the United Kingdom, a partnership firm is not taxable unit so far as income of the partnership firm is concerned, and the expression 'liable to tax' cannot include a person who is not a taxable unit. Only such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... issue was entirely academic at that stage since, even under the provisions of the treaty, entire income of the assessee relatable to project in India was held to be taxable. It is also not the case that the Assessing Officer decided the issue of admissibility of treaty benefits in favour of the assessee and that decision is now being put to scrutiny again. The Assessing Officer's action of not considering it expedient to look into the taxability of an income from all other possible angles cannot foreclose the examination of the taxability from different perspective. What is subject matter of dispute is not a facet of law but an income which is sought to be taxed. As long as the income, which is impugned in appeal, is same as assessed by the Assessing Officer, there cannot be any bar on considering any aspect of the legal position in this regard. Elaborating upon this aspect of the matter, a Special Bench of the Tribunal in the case of Tata Telecommunications Ltd Vs DCIT (121 ITD SB 384 ), has, inter alia, observed as follows : ................It was bounden duty of the Tribunal to consider and decide the above issue and to examine that each of the condition specified by the sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eme Court. In the present case also, the condition regarding providing eligible telecommunication services was not discussed by the Assessing Officer and the Commissioner (Appeals) and yet this issue was taken up by the Departmental Representative before us. The same was the situation in Hukumchand Mill's case (supra) wherein, as noted by the Hon'ble Supreme Court in paragraph 4 of their judgment, "it was urged before the Tribunal by the department that although the ITO had not considered the provisions of paragraph 2 of Section 2 of Taxation Laws Order, the said provisions were applicable in the present case and certain amounts of depreciation, which are allowed under the Industrial Tax Rules, which had the force of law in Indore State, were required to be deducted in arriving at written down value of the assets of the assessee". This plea was accepted by the Tribunal and the Hon'ble Supreme Court confirmed the action of the Tribunal in doing so. In this view of the matter, not only that admitting the plea regarding the assessee not rendering eligible telecommunication services does not suffer from any mistake apparent on record, but it does not suffer from any mistake at all. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ay not have been specifically raised by either of the parties. The only limitation to this power perhaps is that it should not expand the scope of the appeal in terms of the income sought to be taxed or disallowance sought to be made, and that both the parties should have adequate opportunity of being heard on this issue in terms of the provisions of Rule 11 of the Appellate Tribunal Rules, 1963. As far as this aspect of the matter is concerned, we may usefully refer to the following observations and analysis of the legal position as made by a coordinate bench of this Tribunal, in the case of Morgan Stanley Asset Management Inc Vs DCIT (39 DTR 240) with which we are in respectful agreement : "............ When the assessee had itself repeatedly filed the returns in the capacity of AOP, how it can be argued that the Tribunal should close its eyes and ignore its mistake, which is manifest on the face of it. The Tribunal being a final fact finding authority cannot ignore such patent deficiencies. Moreover, the only question before us is to examine the validity or otherwise of the return. When we have to adjudicate upon this issue, all the aspects concerning it are open for inspection ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld by the Hon'ble apex Court that : "The Tribunal rejected the claim of the assessee, but on that account the Tribunal was not bound to disallow the claim of the assessee for allowance of that amount spent if it was a permissible allowance on another ground. The Tribunal, on investigation of the true nature of the alterations made by the introduction of the Casablanca conversion system, came to the conclusion that it did not amount to installation of new machinery or plant, but it amounted in substance to current repairs to the existing machinery. The subject-matter of the appeal in the present case was the right of the assessee to claim allowance for Rs. 93,215. Whether the allowance was admissible under one head or the other of sub-s. (2) of s. 10, the subject- matter for the appeal remained the same and the Tribunal having held that the expenditure incurred fell within the terms of s. 10(2)(v), though not under s. 10(2)(vib), it had jurisdiction to admit that expenditure as a permissible in the computation of the taxable income of the assessee." Similar view has been expressed by several other High Courts holding that the power of the Tribunal extends to examining the subject-ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this aspect itself nor restore the matter to the AO for proper adjudication from this angle, we want to make it clear that there is no such bar on the Tribunal in restoring the matter to the file of AO even though it may result in enhancement. Hon'ble Supreme Court in CIT vs. Assam Travels Shipping Service 199 ITR 1 has held as under: "The AAC as well as the Tribunal clearly held that the computation of penalty made by the ITO was not in accordance with law and that the correct computation of penalty was also made while taking that view. The conclusion clearly reached was that the computation of penalty had to be made in accordance with s. 271(1)(a) r/w sub-s. (2) of s. 271. The correct figure arrived on that basis on the facts of this case was also indicated. On that conclusion, the only question arising out of the Tribunal's order was whether the Tribunal had no other alternative except to dismiss the Department's appeal and thereby affirm the order of the AAC cancelling even the lesser penalty imposed by the ITO overlooking s. 271(2). The expression 'as it thinks fit' is wide enough to include the power of remand to the authority competent to make the requisite order in accord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iterion of a similar nature. 35. We find that in terms of Article 1 (1), the India UK tax treaty "shall apply to persons who are residents of one or both of the Contracting States". As to what are the connotations of expression "resident of a contracting state", Article 4(1) of the treaty provides that, for the purposes of the said tax treaty, term 'resident of a Contracting State' " means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature." It is thus necessary that the resident can only be 'person' and that person should be 'liable to taxation by reasons of his domicile, place of management or any other criterion of similar nature'. It is also important to bear in mind the fact that in terms of provisions of Article 3(2), "a partnership which is treated as a taxable unit under the Income‐tax Act, 1961, of India shall be treated as a person" for the purposes of this treaty. To the extent that a partnership is required to be treated as a person, thus, the position is free from any doubt or ambiguity. 36. The controversy, however, revolves around secon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... entity is treated as opaque, and taxed as such, in one jurisdiction, and as fiscally transparent, and disregarded as such, in the other jurisdiction. While in the first jurisdiction, the entity will be taxed in its own right, and the second jurisdiction, i.e. where it is disregarded and treated as transparent, the taxability will be in the hands of the owners. That results in a situation that while there is no juridical double taxation of an income, there is undoubtedly economic double taxation of an income. Take, for example, a situation in which a partnership firm is treated as an opaque entity in the source jurisdiction and taxed as such in respect of profits of the partnership in the source jurisdiction, but the same firm is treated as a fiscally transparent entity in the residence jurisdiction and the taxability of income, in the residence jurisdiction, arises only in the hands of the partners of the partnership firm. 40. This incongruity arises because of the fact that mechanism of relieving a taxpayer of double taxation in respect of cross border income typically takes care of international juridical double taxation i.e. the same income getting taxed twice - in the source j ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hanges to OECD Model Commentary, also show that it is well within the scope and intention of tax treaties to aim at resolving economic double taxation caused by asymmetrical tax treatment and entity classification. It does not, therefore, seem to be beyond the fundamental objectives of a tax treaty to relive the economic double taxation of an income a situation in which such economic double taxation arises due to asymmetrical tax treatment of a business entity. 43. Coming back to the fundamental issue that we need to deal with, i.e. whether or not the partnership firm before us is entitled to the benefits of the India UK tax treaty, we have noted that the controversy is confined to whether or not the assessee can be said to be 'liable to taxation (in UK) by reasons of his domicile, residence, place of management or any other criterion of similar nature' so as to qualify as a resident of UK, and, in turn, be eligible for benefits of the tax treaty. While the issue of treaty benefits eligibility of partnership firms has not come up for specific adjudication before the Indian judicial authorities, the judicial authorities, in several cases, have proceeded on the basis that the partne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... entity under the Indian Income Tax Act, under Article 3(2), is specifically covered by the definition of 'person'. This judicial precedent from South Africa is thus of little use to us. 46.In the case of TD Securities (USA) LLC Vs Her Majesty the Queen [2010 TCC 186; IBFD tax treaty case law database reference Canada‐ 2008‐2314(IT)G], Tax Court of Canada had an occasion to deal with the question of treaty entitlements to transparent entities. 47. Although the taxable entity in this case was not a partnership firm, the taxable entity was a fiscally transparent entity under the US laws and the income of the said entity was entirely taxable, in its residence country i.e. USA, in the hands of its ultimate owner member i.e. TD Holdings (II) Inc., and yet it was held to be eligible, in Canada, for treaty benefits of Canada US tax treaty. 48. Interestingly, in this case, the stand of the revenue authorities was the same, as before us, as evident from the observation of the court to the effect that "It is the respondent's position that the meaning of the phrase resident of a Contracting State set out in the US Treaty is clear and unambiguous and that the evidence ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... follows: .........The US Code provides that the income of TD LLC is fully and comprehensively taxed to its member, Holdings II. This income is consolidated in the TD USA tax return and tax thereon is charged back by TD USA to TD LLC............In such a case, it seems clear that the income of TD LLC should enjoy the benefits of the US Treaty. The evidence is overwhelming that the object and purpose of the US Treaty read in the context of all of the evidence and authorities would not be achieved and would be frustrated if the Canadian sourced income of TD LLC that is fully taxed in the US under the US Code does not enjoy the benefits of the US Treaty including Article X(6). 50. While deciding the above question Hon'ble Justice Patrick Boyle, delivering a very elaborate judgment of the court dealing with several facets of this question - though mainly in the context of aspects relating to Canada US tax treaty, Canadian and US tax policies and peculiarities of Delaware single member corporations, also set out the principles on the basis of which the above question is to be answered. Justice Boyle observed, inter alia, as follows: [50] The Vienna Convention on the Law of Treaties p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Supreme Court of Canada in Crown Forest confirm that "literalism has no role to play in the interpretation of treaties": Coblentz v. The Queen, 96 DTC 6531 (FCA). [55] In Crown Forest the Supreme Court of Canada also held that, in ascertaining the purposes of a treaty article, a court may refer to extrinsic materials which form part of the legal context, including model conventions and official commentaries thereon, without the need to first find an ambiguity before turning to such materials. [56] The Preamble to the US Treaty sets out its purposes of reducing or eliminating double taxation of income earned by a resident of one country from sources in the other country, and of preventing tax avoidance or evasion. In Crown Forest the Supreme Court of Canada held that the purposes of the US Treaty also included the promotion of international trade between the two countries and the mitigation of administrative complexities arising from having to comply with two uncoordinated taxation systems. [57] In Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, 2005 DTC 5523, the Supreme Court of Canada emphasized that "[t]he provisions of the Income Tax Act must be interpreted in order to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxation of a person in all these situation does not necessarily indicate a fiscal domicile in that jurisdiction. In our considered view, in its contextual sense, expression 'liable to tax by reasons of his domicile, residence, place of management or any other criterion of similar nature' refers to a situation in which a person is liable to tax in a tax jurisdiction by the virtue of a locality related attachment which leads to residence type taxation. While elaborating upon the scope of this expression, a coordinate bench of this Tribunal, in the case of DCIT Vs General Electric Co plc (2001) 71 TTJ 973 had observed as follows: ...........Art. 4(1)* ....clearly provides that "for the purpose of this Convention, the term 'resident of one of the states' means any person who, under the laws of that state, is liable to taxation therein by reasons of his domicile, residence, place of management or any other criterion of a similar nature". The requirements for fiscal domicile cannot be satisfied by mere liability to tax in that country, but as clearly provided by art. 4(1) ......, such a liability to taxation has to be on account of domicile, residence, place of management or any other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y taxes on its income in more than one tax jurisdiction. Take, for example, a company, incorporated and fiscally domiciled in X tax jurisdiction, which has income generating activities in A,B,C and D tax jurisdictions. It has a royalty income sourced from 'A' tax jurisdiction, so it is liable to tax in 'A' jurisdiction in respect of royalty income sourced from there. It has a liaison office in 'B' tax jurisdiction, and it is liable to pay municipal trade tax in respect thereof in B tax jurisdiction. The same organization has permanent establishments in C and D tax jurisdictions, and, therefore, it is liable to pay taxes in respect of the profits of the PE in C and D tax jurisdictions. As a fiscal resident of X tax jurisdiction, however, it is also liable to pay tax on all its incomes, whether sourced from A,B,C,D or X itself or from any other tax jurisdiction, in X tax jurisdiction. In this example, while the related business organization is liable to tax in A,B,C,D and X jurisdictions, it is taxable by the reason of 'domicile, residence, place of management or such other criterion of similar nature' only in X jurisdiction. It is in this sense that being liable to tax in a contract ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y entitlement, confirm this approach. This amendment specifically addresses how the Canada US tax treaty applies to fiscally transparent treaties such as partnerships and LLCs. Of course, the Canadian Tax Court has expressed, in no uncertain words, the view that even without the aforesaid amendment, a fiscally transparent entity is eligible for treaty benefits in the country of domicile as long as its profits get taxed in that country, and the amendment only grants, or rather restricts, application of an existing benefit. That is what was also held in TD Securities case (supra), but, for the present purposes, what is even more important that some tax jurisdictions, on their own, are consciously interpreting the 'liable to taxation' in such a pragmatic manner as to extend treaty benefits to fiscally transparent entities. 58. We are alive to the fact that the Canadian Tax Court decision, in the case of TD Securities (USA) LLC (supra), related only to the period prior to the said amendment as the protocol amendment was not taken as retroactive. The amendment was done by adding two paragraphs in Article IV of the Canada US tax treaty, and one of the arguments of the revenue authoritie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as fiscally transparent under the laws of that State. 59. A plain reading of the judgment of Canadian Tax Court in the case of TD Securities (supra) does show that the above amendment in the treaty position was more of a restriction on the treaty entitlements benefits to a fiscally transparent entity rather than the sole basis for the treaty entitlement benefit. 60. It would, therefore, seem logical that it is the event of taxability in the residence state, rather than the mode of taxability there, which should be a decisive factor for determining whether the person should be treated as eligible for treaty benefits of the contracting state in which he claims to be resident, but then while interpreting a tax treaty, is it really open to us to address ourselves to the rationale and objective of a tax treaty and disregard the plain words of the treaty? Does the context in which this expression is used in the tax treaty require a rather legalistic or somewhat liberal view of this expression? Are we to read the words used in a tax treaty in a mechanical manner or we are to give effect to the same in the light of the underlying, but clearly discernible, scheme of tax treaty? 61. Elab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd in the light of its objects and purpose. Literal meanings of these terms are not really conclusive factors in the context of interpretating a tax treaty which ought to be interpretated in good faith and ut res magis valeat quam pereat, i.e., to make it workable rather than redundan Hon'ble Supreme Court in the case of Union of India & Anr. v. Azadi Bachao Andolan & Am. 263 ITR 706, had an occasion to deal with the principles governing the interpretation of tax treaties. In this regard, Hon'ble Supreme Court held that the principles adopted in the interpretation of treaties are not the same as those adopted in the interpretation of statutory legislation. Their Lordships quoted, with approval, following passage from the Judgment of the Federal Court of Canada in the case of IV. Gladden v. Her Majesty the Queen 85 DTC 5188, at p. 5190, wherein the emphasis is on the 'true intentions' rather than 'literal meaning of the words employed' : "Contrary to an ordinary taxing statute, a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of the parties. A literal or legalistic interpretation must be avoided when the basic object ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of interpretation of a statutory enactment is not a mechanical task. It is more than a mere reading of mathematical formulae because few words possess the precision of mathematical symbols. It is an attempt to discover the intent of the legislature from the language used by it and it must always be remembered that language is at best an imperfect instrument for the expression of human thought and, as pointed out by Lord Denning, it would be idle to expect every statutory provision to be 'drafted with divine prescience and perfect clarity'. We can do no better than repeat the famous words of Judge learned Hand when he said : '... it is true that the words used, even in their literal sense, are the primary and ordinarily the most reliable source of interpreting the meaning of any writing : be it a statute, a contract or anything else. But it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary; but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning.' We must not adopt a strictly literal interpretation of ....... but w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated insofar as particular items under consideration are concerned. Words are to be understood with reference to the subject-matter, i.e., verba accopoenda sunt secundum subjectum materiam. * It is inevitable that interpreter of a tax treaty is likely to be required to cope with disorganised composition instead of precision drafting. Therefore, the words employed in the treaty are to be given a general meaning - general to lawyers and general to layman alike. * When a tax treaty does not define a term employed in it, and the context of the treaty so requires, it can be given a meaning different from domestic law meaning thereof. The meaning of the undefined terms in a tax treaty should be determined by reference to all of the relevant information and all on the relevant context. There cannot, however, be any residual presumption in favour of a domestic law meaning of a treaty term. (Emphasis supplied by us) 71. Viewed in the light of the detailed analysis above, in our considered view, it is the fact of taxability of entire income of the person in the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that is necessary for this purpose is that the person should be liable to tax in the contracting State by reason of domicile, residence, place of management, place of incorporation for any other criterion of similar nature which essentially refers to the fiscal domicile of such a person. In other words, if fiscal domicile of a person is that person is actually liable to pay tax in that country, he is to be treated as resident of that contracting State. The expression 'liable to tax" is not to read in isolation but in conjunction with the words immediately following it i.e. 'by reason of domicile, residence, place of management place of incorporation or any other criterion of similar nature'. That would mean that merely a person living in a Contracting State should not be sufficient, that person should also have fiscal domicile in that country. These texts of fiscal domicile which are given by way of examples following the expression 'liable to tax by reason of i.e. domicile, residence, place of management, place of incorporation etc. are no more than examples of locality related attachments which attract, residence type taxation, that 'person' is to be treated as resident and this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eek law was established. 75. A view is thus indeed possible that, given the context in which the expression 'liable to taxation by reasons of his domicile, residence, place of management or any other criterion of similar nature' is employed i.e. in the context of ascertaining fiscal domicile - as evident from the title of Article as 'Fiscal domicile', it is sufficient that under the assignment or distributive rules of the treaty, the residence state has a right to tax income of the partnership firm - irrespective of the fact the position whether or not such a right is actually exercised by the residence state. The undisputed objective of Article 4 is to ascertain fiscal domicile of a person, and the heading of Article 4, as we have reproduced earlier in this order, is "Fiscal domicile". It is a well known Latin legal maxim that "A rubro ad nigrum" which means, literally, from red to the black. In olden times, the title of a statute as well as headings of a provision in the statute, were written in red while its body text was written in black. This Latin maxim implies that in the process of interpreting a statute, one must start from the title and interpret the text of the provisio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e to the fact that this line of reasoning is diametrically opposed to the stand taken by the OECD in the matter, but, having carefully considered the stand of the OECD on this issue, we are not persuaded by the OECD stand on the matter, nor the Indian judicial precedents support that position. As a matter of fact, even the Government of India's approach to the tax treaties does not entirely approve that school of thought either. 76. While on this issue, it is useful to take note of the fact that vide notification No. 282 of 2007, dated 28th November 2007 (213 CTR Statues 64), One of the amendments made by the protocol to the India UAE tax treaty is the change in definition of resident in Article 4(1)(b) which now provides that for the purpose of the Indo UAE tax treaty, resident of a Contracting State, in the case of the UAE, means "an individual who is present in the UAE for a period or periods aggregating totalling in aggregate at least 183 days in the calendar year concerned, and a company, which is incorporated in UAE and which is managed and controlled wholly in UAE". This amendment in the definition of resident of UAE thus accepts the broad proposition that the taxability in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therefore, the treatment accorded to the said provision, in the same report, cannot be accepted either. Any other view of the matter will lead to absurd consequences rather than avoiding the absurd consequences. 79. In view of the above discussions, as also bearing in mind the entirety of the case, we hold that the assessee was indeed eligible to the benefits of India UK tax treaty, as long as entire profits of the partnership firm are taxed in UK - whether in the hands of the partnership firm though the taxable income is determined in relation to the personal characteristics of the partners, or in the hands of the partners directly. To that extent, objection taken by the learned Departmental Representative, on the question of admissibility of India UK tax treaty benefits, is held as maintainable but rejected on merits. On existence of assessee's permanent establishment in India under Article 5(2)(k) 80. The next issue that we have to decide is whether or not the assessee had a permanent establishment in India. 81. The case of the assessee is that the assessee did not have any permanent establishment in India. The attach against the findings of the authorities below rests on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ich, inter alia, observes that, Article 5(2) "contains a list, by no means exhaustive, of examples, each of which can be regarded, prima facie, constituting a permanent establishment" and that "[a]s these examples are to be seen against the background of general definition given in paragraph 1, it is assumed that the contracting states interpret the items listed, 'a place of management', 'a branch', 'an office' etc in such a way that such places constitute permanent establishment only if they meet the requirement of paragraph 1". We are thus urged to interpret Article 5(2) of India UK tax treaty in the light of the above analysis contained in Prof Klaus Vogel's book and OECD Commentary. 83. Learned senior counsel further contends that, in any event, the activities of assessee do not involve furnishing of services as envisaged in Article 5(2)(k) of the Indo UK tax treaty as the assessee is an international professional enterprises rendering services directly to its clients. We are taken through dictionary meanings of expressions 'furnishing' and 'rendering' and efforts are made to demonstrate that these expressions cannot be used interchangeably, since these expressions have signif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d. Once the duration test is satisfied, according to the learned Commissioner, permanence test visualized in Article 5(1) does not come into play at all. We are thus urged to hold that Section 5(2)(k) is to be decided on standalone basis, and that as long as conditions set out in Article 5(2)(k) are satisfied and, irrespective of fulfilment or non fulfilment of conditions under Article 5(1), permanent establishment comes into existence. As regards the connotations of expressions 'furnishing' and 'rendering', it is submitted that distinction sought to be made out is without any material difference. The difference between 'furnishing of services' and 'rendering of services', even if any, does not have any effect on the question as to whether there is any permanent establishment. We are thus urged to confirm the findings of the authorities below and decline to interfere in the matter. 85. In rejoinder, learned counsel for the assessee reiterates his submissions on the same line. He submits that Article 5(2)(k) is more of an elaboration on the scope of and restriction on the applicability of Article 5(1), rather than an extension of Article 5(2)(k). He submits that Article 5(2)(k) wil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f services including managerial services, other than those taxable under Article 13 (Royalties and fees for technical services), within Contracting State by an enterprise through employees or other personnel, but only if: (i) activities of that nature continue within that State for a period or periods aggregating more than 90 days within any twelve-month period; or (ii) services are performed within that State for an enterprise within the meaning of paragraph (1) of Article 10 (Associated enterprises) and continue for a period or periods aggregating more than 30 days within any twelve- month period. Provided that for the purposes of this paragraph an enterprise shall be deemed to have a permanent establishment in a Contracting State and to carry on business through that permanent establishment if it provides services or facilities in connection with, or supplies plant and machinery on hire used or to be used in, the prospecting for, or extraction or production of, mineral oils in that State. (3) The term "permanent establishment" shall not be deemed to include: (a) the use of facilities solely for the purpose of storage or display of goods or merchandise belonging to the enter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r, general commission agent or any other agent of an independent status, where such persons are acting in the ordinary course of their business. However, if the activities of such an agent are carried out wholly or almost wholly for the enterprise (or for the enterprise and other enterprises which are controlled by it or have a controlling interest in it or are subject to the same common control) he shall not be considered to be an agent of an independent status for the purposes of this paragraph. (6) The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other. (7)For the purposes of this Article the term "control", in relation to a company means the ability to exercise control over the company's affairs by means of the direct or indirect holding of the greater part of the issued share capital or voting power in the company. 88. Article 5(1) of the India UK tax treaty refers to the require ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... traction of natural resources. 3. The term "permanent establishment" also encompasses: (a) A building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months; (b) The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than six months within any twelve-month period. OECD Model Convention Article 5 - PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop, and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nstitute permanent establishment only if they meet the requirement of paragraph 1". Even by the OECD Model Convention Commentaries, however, this theory is not extended to the items in second category i.e. (j) and (k). So far as paragraph 3 of the OECD Model Conventions dealing with these items are concerned, OCED Model Convention Commentary states as follows: " This paragraph provides expressly that a building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months. Any of those items which does not meet this condition does not of itself constitute a permanent establishment, even if there is within it an installation, for instance an office or a workshop within the meaning of paragraph 2, associated with the construction activity. Where, however, such an office or workshop is used for a number of construction projects and the activities performed therein go beyond those mentioned in paragraph, it will be considered a permanent establishment if the conditions of the Article are otherwise met even if one of the projects involved.......lasts for more than 12 months" (Emphasis supplied by us) 91. It is thus clear t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns in Article 5(3) in all most standard model conventions. For this reason, we also reject learned counsel's reliance on the OECD Model Convention Commentary and Prof Klaus Vogel's analysis. His reliance on these commentaries are misplaced as the provisions these commentaries have dealt with are not in pari materia with the tax treaty provisions that we are in seisin of. 95. We may also add that similar argument, materially similar to the argument raised by the assessee before us and in respect of materially similar treaty provision, also came up for consideration before Hon'ble Authority for Advance Ruling in the case of XYZ In Re (242 ITR 208). Rejecting this plea, Hon'ble Justice Ranganathan, Chairman - AAR, observed as follows: 23. The learned counsel also submitted that the definition of PE is only what is formulated in Article 5(1) and that Article 5(2) is only illustrative of the cases that fulfill the requirement of paragraph 1 of Article 5. In other words, XYZ cannot be said to have a PE even if the requirements of sub clause (1) are satisfied, unless it has a fixed place of business in India. He relies on paragraph 11 of the Commentary on OECD Model Convention which rea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of services including managerial services within Contracting State by an enterprise through employees or other personnel, where such activities are rendered for more than 90 days for any enterprises, or for more than 30 days for an associated enterprise, within any twelve month period. The only exclusion clause envisaged from the services so furnished is when the consideration for such services is taxable in the source jurisdiction under Article 13. In order to invoke this provision, all that is needed is that (a) a resident of other contracting state furnishes services ‐ for more than 90 days, within any twelve month period, for any enterprises [excluding an associated enterprises within the meanings of that expression under Article 10(1)], or ‐ for more than 30 days, within any twelve month period, for an associated enterprises within the meanings of that expression under Article 10(1); (b) consideration for services so furnished are not taxable in the source jurisdiction under Article 13 of the India UK tax treaty. 98. There is no dispute about the fact that the assessee has fulfilled the 90 days duration test, envisaged in Article 5(2)(k) analyzed above, and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot interpret a tax treaty, or for that purpose even a tax legislation, with dictionary in one hand and tax treaty in another. As Justice Hand has observed in the context of interpreting tax law, which is even more relevant in the context of interpreting a tax treaty, "it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning". And object and purpose of Article 5(2)(k) is unambiguously set out in UN Model Convention Commentary which, dealing with Article 5(3)(b), which is in pari materia with Article 5(2)(k) of India UK tax treaty, states that, "[i]t is believed that management and consultancy services should be covered because the provision of such services in developing countries by corporations of industrialized countries often involves very large sums of money". This objective, by no stretch of logic, supports the interpretation canvassed by the learned counsel. 103. Learned counsel has also contended that the rendition of professional services cannot be covered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nded that Article 15 applies only to individuals. As to the situations in which Article 5 will apply in respect of the professional services and the situations in which Article 15 of the India UK tax treaty, which is in pari materia Article 14 of the UN Model Convention, will apply, we find guidance from the following observations made in the UN Model Convention Commentary: The Group discussed the relationship between article 14 and subparagraph 3(b) of article 5. It was generally agreed that remuneration paid directly to an individual for his performance of activity in an independent capacity was subject to the provisions of article 14.Payments to an enterprise in respect of the furnishing by that enterprise of the activities of employees or other personnel are subject to articles 5 and 7. The remuneration paid by the enterprise to the individual who performed the activities is subject either to article 14 (if he is an independent contractor engaged by the enterprise to perform the activities) or article 15 (if he is an employee of the enterprise). If the parties believe that further clarification of the relationship between article 14 and articles 5 and 7 is needed, they may mak ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... work carried out by the PE, as the prevalent market prices of similar services as were rendered by the PE were lower than the rates charged by the GE to its clients. It is thus contended that for the purpose of computing income of the PE, the value of services rendered by the PE is to taken at the market value of such services in India and not the price at which GE has billed the clients. On this basis, he contends that as against the actual billing by the GE to the clients, the revenues of the PE should be taken at the rate of UK Pounds 100 per hour for the partners. And UK Pounds 75 for assistants, which at best is the market price of such services rendered in India. According to the learned counsel, when profits attributable to PE in India are to computed, one has to take into account the revenue that the PE in India would have earned, for rendering these services, at the prevalent market rates in India. 109. Learned Commissioner (Departmental Representative) does not share that perception, and submits that learned counsel's interpretation of Article 7(2) is stretching the fiction of hypothetical independence to absurd lengths. He submits that all that Article 7(2) requires is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x treaty. He also points out that there is no other way, except by carrying out the adjustments that the assessee has claimed, in which clear words of Article 7 (2) can be given effect. One cannot proceed in a manner, contends the learned counsel, so as to ignore the words "profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arm's length". It is submitted that not carrying out the adjustments in respect of market price will have the effect of these words being ignored for all practical purposes. 111. We have heard the rival submissions, perused the material on record and duly considered the factual matrix of the case as also the applicable legal position. In order to adjudicate on the above controversy, what we really need to decide is the manner and extent to which theory of hypothetical independence enshrined in Article 7(2) is to be applied in computation of the profits attributable to PEs. 112. We may first reproduce Article 7 of the India UK tax treaty, which deals with and lays down mechanism of computing profits of the permanent estab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the above analysis. In our considered view, the fiction of hypothetical independence indeed provides mechanism for taking into account intra organization transactions whether these are GE‐PE transactions or PE‐PE transactions, and it also extends, in whatever limited way, to ensuring that the transaction value between permanent establishments and the general enterprises, to which it belongs, as also with the inter se transactions between permanent establishments of the same general enterprises are reflected at arms length price. 115. In computation of PE profits, recognition of GE PE transactions, as also recognition of transactions between PEs inter se ( of PEs belonging to a common general enterprises), at arms length price, has dual role to perform. In the first place, the very recognition of these transactions ensures that intra GE transactions are duly taken into account so as to separately ascertain profits subject to tax in each tax jurisdiction. Secondly, inclusion of arms length principle in the recognition of these transactions ensures that the allocation of profits in a cross border economic activity is not distorted by way of manipulation of transaction va ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se, tax authorities also decide that, in any case, deduction can not be allowed in respect of centralized coordination, sales and marketing, because these payments are only payments by self to self, the profit in C jurisdiction end up being only the difference between sales price and cost of raw diamonds. The profits so arrived at will clearly be more than overall profits of the enterprise. The proposition that intra organization transactions cannot be taken into account has been subject matter of litigation in India as well. One could possibly argue that, in view of Hon'ble Calcutta High Court judgment in the case of Betts Hartley Huett & Co Ltd Vs CIT (116 ITR 425) , transactions between head office and branch office (GE and PE, in treaty terms) are to be ignored for the purposes of computing PE profits. Applying this principle, in the given example, while overall profit on sale of each unit of diamond will be Rs 4,00,000 but it will end up paying profits on sale of diamond at the rate of Rs 10,00,000 per unit in the C tax jurisdiction in which sales outlet is situated. The jurisdictional profits of the PE will thus end up being much more than overall profits of the GE itself - o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gth Principle to Intra Company Dealings : Back to Origins ( 2005 ITPJ 7; published by IBFD, Amsterdam), the genesis of arm's length as an international agreed principle goes back to 1933, when the Fiscal Affairs Committee of the League of Nations approved a "Draft Convention on the Allocation of Business Profits Between States for the Purposes of Taxation". The 1933 Draft Convention is based on the principle that permanent establishments ('PEs') must be treated in the same manner as independent enterprises operating under the same or similar conditions. According to this report, the above principle leads to the corollary that the taxable income of a PE must be determined on the basis of its separate accounts. That is how arms length principle saw the light in the field of intra‐company dealings, which was later extended to transactions between associated enterprises, which are separate legal entities. 121. Whether it was in respect to the GE‐ PE transactions, or inter se transactions with PEs belonging to the same GE, the underlying thrust of the adjustments envisaged under Article 7(2) is that any distortions in assigned transaction values, which are obviously determi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Article 7(2), has no role to play in adjusting actual revenues with independent entities. As is clearly set out in that treaty provision itself, it refers for transactions at arm's length only "with the enterprise of which it is permanent establishment" and the scope of enterprise in this context would include the entire general enterprise, including its other permanent establishments (i.e. GE and other PEs belonging to the same GE). The very concept of adjustment for arms length price relates only to associated enterprise, as, on a conceptual note, an arms length price adjustments, in computation of PE profits, only seek to nullify the impact of PE's proximity and interrelationship with other associated enterprises, including its GE and its PEs belonging to its GE. There is no support whatsoever for the proposition that this arms length principle must also be extended to independent entities. The words of Article 7(2) are clear and unambiguous. 126. Learned counsel's argument seem to suggest that the transactions with the clients should be seen in two compartments - first, transactions of the clients with the GE, i.e. when client assigns the professional work to the GE; and - se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e is a school of thought, which is recognized by Prof Vogel and which has also found favour with several European judicial authorities‐ as mentioned by Prof Vogel in his book 'Klaus Vogel on Double Taxation Conventions', that the connotations of hypothetical independence are confined to, what he terms as, 'restricted independence'. Of course, even in this scenario tax authorities can adjust the transaction values when they find that the same are in consonance with the arms length prices, and, as such, distort the PE profit computation, but the substitution of real transaction value by an ideal transaction value in the perfect market conditions, so as to reflect profitability in ideal conditions, can not be permissible. Lets not forget that the end purpose of entire exercise of PE profit computation is a fair allocation of taxability of an income in related tax jurisdictions, and not computation of possible profits of the PE in perfect market conditions. Viewed in this perspective, in any event, the fiction of hypothetical independence would not permit the transactions between various limbs of GE to be taken as artificial prices. The adjustment contemplated in Article 7(2) are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of transaction values on the basis of market prices will inherently involve, and the allocation of profits over GE and PEs have to be on an equitable and rationale basis. Be that as it may, it is not really necessary to go any deeper into this aspect of the matter, in view of our categorical finding to the effect that the transactions in questions in respect of which revenues are sought to be modified on the basis of arms length principle, on the facts of this case, are transactions with the independent enterprises, whereas arms length principle is relevant only for intra organization transactions or transactions with associated enterprises. Accordingly, the assessee has wrongly invoked the independence fiction under Article 7(2) to revalue the figures of revenues generated by the permanent establishment. 130. In view of the above discussions, in our considered view, the very plea of the assessee proceeds on fallacy that arms length price adjustment can be made in respect of the transactions with the clients of the assessee. The revenues earned by the assessee are to be taken at actual figures and no adjustments are permissible in the same. We reject this plea of the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ularly on the facts of the case, cannot be treated as income in the hands of the assessee. Learned Departmental Representative, on the other hand, relies upon the orders of the authorities below and submits that the onus is on the assessee to produce all the evidences of expenditure and that this onus is clearly not discharged by the assessee. 133. Having heard the rival submissions and having perused the material on record, we are inclined to uphold the grievance of the assessee. The reimbursements received by the assessee are in respect of specific and actual expenses incurred by the assessee and donot involve any mark up, there is reasonable control mechanism in place to ensure that these claims are not inflated, and the assessee has furnished sufficient evidence to demonstrate the incurring of expenses. There is thus no good reason to make any addition to income in respect of these reimbursements of expenses. The action of the CIT(A), as learned counsel rightly contends, on pure surmises and conjectures. In view of the above discussions, we direct the Assessing Officer delete the disallowance of expenses as sustained by the CIT(A) and hold that no part of reimbursements of exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngineers (supra) will not apply to the facts of the appellant" and that " as per Explanation (a) to Section 9(1)(i), even if there is a business connection in India, only income related to operations carried out in India is taxable in India"; ‐ second, that "in the case of Clifford Chance (82 ITD 106) the Hon'ble Mumbai Bench of ITAT has held that the income relating to services rendered outside India is not taxable in India"; and - third, that "as per Article 7, only that portion of income, which is attributable to the permanent establishment in India, can be taxed in India". 141. Having heard the rival contentions, and having carefully considered factual matrix of the case as also the applicable legal position, we find that none of these three reasons are sustainable in law. 142. As far as fist reason, or rather set of reasons, adopted by the CIT(A),these reasons no longer hold good in law in view of legal position as a result of retrospective legal amendment in the scheme of Section 9. Even prior to the retrospective amendment, the same interpretation about the legal position was approved by the Hon'ble Authority for Advance Ruling. As was noted by Hon'ble Authority for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the work performed in the PE itself but he has not taken note of the position that it is only in respect of the profits directly attributable to work done in the PE but it is in respect of profits "directly" or even "indirectly" attributable to the permanent establishment. The import of "directly or indirectly attributable to PE" has been clearly ignored. The inclusion of 'profits indirectly attributable to the PE' clearly incorporates a force of attraction principle in the India UK tax treaty, but the CIT(A) has simply not taken note of that aspect of the matter. In the impugned order, the CIT(A) has, inter alia, observed that, "I also agree with the learned A.R's arguments that as per Article 7, only that portion of income, which is attributable to the permanent establishment in India, can be taxed in India", and that, "..........only that portion of income relating to rendering of such services in India can be attributed to the services PE of the appellant in India". This approach of the CIT(A) is clearly incompatible the force of attraction rule embedded in Article 7(2) of India UK tax treaty. In this view of the matter, We cannot, and do not, approve the action of the CIT(A) i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... especially with respect to transactions conducted directly by the home office within the country, but similar in nature to those conducted by the permanent establishment. However, after discussion, it was proposed that the "force of attraction" rule, should be limited so that it would apply to sales of goods or merchandise and other business activities in the following manner: if an enterprise has a permanent establishment in the other Contracting State for the purpose of selling goods or merchandise, sales of the same or a similar kind may be taxed in that State even if they are not conducted through the permanent establishment; a similar rule will apply if the permanent establishment is used for other business activities and the same or similar activities are performed without any connection with the permanent establishment. (Emphasis supplied by us) 148. In our considered view, therefore, the connotations of "profits indirectly attributable to permanent establishment" do indeed extend to incorporation of the force of attraction rule being embedded in Article 7(1). The way it needs to be implemented, on the facts of the present case, is like this. In addition to taxability of i ..... X X X X Extracts X X X X X X X X Extracts X X X X
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