TMI Blog2013 (11) TMI 195X X X X Extracts X X X X X X X X Extracts X X X X ..... to perform either of the activities as mentioned in Articles-5(4) and 5(5), otherwise, it cannot be held that agent constitutes a P.E. of the foreign enterprise - VGCs were exercising comprehensive control over the branch of Varian India and that also bears entrepreneur risk in terms of collection of debtors and bad debt and sales return, etc. - in the case of indent sales, the sales made to the Indian customers are in pursuance of orders introduced and liaised by the assessee for which the assessee receives commission income from the VGCs - These indent sale orders produced by the assessee were not binding on the VGCs. They may accept or reject the orders completely at their own discretion and the assessee had no authority to negotiate or conclude contract on behalf of the VGCs - Further, the goods were delivered by the VGCs directly to the customers and all the risk associated with the sale of products lies with the VGCs and not with the assessee - Thus, the entrepreneur risk was not undertaken by the assessee - This also, inter-alia, means that the VGCs does not have any comprehensive control over the assessee = A lot of emphasis had been given by the Commissioner (Appeals) a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r's commission 9,81,966 - - - Addition on account of attribution of profits to Permanent Establishment (PE) 63,25,580 36,23,371 40,09,360 8,76,559 36,06,267 2. Brief facts of the case are that the assessee is an Indian Branch of Varian India Pvt. Ltd. (for short "VIPL"), which is incorporated in U.S.A. VIPL in turn is held by Varian Inc., U.S.A. and is thus 100% subsidiary of Varian U.S.A. VIPL has only an Indian Branch which is primarily engaged in the distribution of Varian products manufactured by Varian Group of companies (for short "VGCs") all over the world. These products mainly relate to analytical instruments, laboratory equipments and other scientific instruments and electronic items. In the assessment year 2002-03, the assessee had shown sales of Rs. 52,05,468, in the relevant previous year and has shown other income of Rs. 6,10,74,335, which mainly includes commission income received from various Varian Group of Companies. 3. The Assessing Officer, during the course of the assessment proceedings for the assessment year 2002-03 on a perusal of Profit Loss Account, noted that the assessee ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as been reproduced at Page-5 of the appellate order. The Commissioner (Appeals) upheld the action of the Assessing Officer and rejected the assessee's contentions on the ground that the expenditure pertaining to the earlier years cannot be deducted in the relevant financial year and accrual of dealers' commission is dependent on the execution of sales and the assessee cannot withhold the commission without any mutually agreed terms between the dealer and the assessee company. Accrual of dealers' commission is different from the modalities of the payments and it accrues immediately on the completion of the sale. Further, if the assessee's plea is accepted for allowing the expenditure in this year, it would result in cash system of accounting with no certainty regarding the amount of commission payable in a particular year. 6. Before us, the learned Counsel submitted that the assessee has been following the system of debiting the dealers commission based on dealers invoices which is raised after various formalities have been completed like installation, follow-up for final payment, release of bank guarantee, etc. This system of accounting has been accepted in the earlier years. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d expenditure associated with it has to be matched and shown in the same year. The assessee cannot be allowed to follow mixed system of account i.e., accrual of sales in one year i.e., at the time of raising the sale bills and expenses to be allowed in different year when various other formalities relating to the sales have been fulfilled. Thus, the findings of the Commissioner (Appeals), as given in Para-3.3, which for better appreciation of facts, are reproduced below :- 3.3 "I have carefully gone through the order of the Assessing Officer and also the submissions as made by the Authorized Representative of the appellant company. I am inclined to agree with the views of the Assessing Officer that expenses pertaining to earlier years are not deductible in the Financial Year relevant to the Assessment Year 2002-03. The accrual of the dealers commission is dependent on the execution of the sales order by the dealer. The appellant company can withhold the dealer commission in case mutually agreed terms between the dealer and the appellant company are not complied with by the dealer. Accrual of dealer commission is different from the modalities of its payments. The dealers comm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uments. The VIPL has entered into distribution and representation agreement (for short "D.R. Agreements") with all the five companies of Varian Group for supply and sale of analytical lab instruments to the Indian customers directly. The assessee carries out two types of sale of Varian products in India - one is direct sale and other is indent sale. Insofar as direct sale is concerned, the assessee directly imports spare parts from Varian Group of Companies (for short "VGCs") and sell them to Indian customers directly on its own account on principal-to-principal basis. These spare parts are made available on discounted price by the various Associates Enterprises (for short "A.Es"), i.e., Varian Group of Companies which is sold by the assessee on its own account. In the activities relating to indent sale, the Varian group of companies sell analytical lab instruments to the Indian customers directly and the assessee carries out pre-sale activities like liaisoning and other incidental post-sale support activities for which it is entitled for commission. In the D.R. Agreement entered with the five companies wherein the Assessee has been referred to as independent contractor, is collect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of commission rate specified in Schedule A, however, Contractor's service obligations under section 4 will remain the same and not be otherwise affected Where Contractor obtains only sales orders and does not purchase Products. Contractor's entire consideration in those transactions will be a commission as set forth in Schedule A. If sales of Products are made by through or with the assistance of persons other than Contractor to customers within territory, at Supplier's sole discretion, commission may be allocated by Supplier on a fair and reasonable basis. 4. Obligations The provisions of this section below shall apply only to the extent permitted at any particular time by the laws and regulations or effect in the country in which this Agreement is made or to be performed. If any such restriction or obligation is or becomes prohibited under such laws or regulations, it shall be automatically void and separated from the remainder of this Agreement, or Varian at its option may terminate this Agreement immediately, in whole or in part, by written notice. A. Contractor shall: actively and diligently promote the sale of the Products in the Territory and co-operate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, whether related or not, in the execution of its responsibilities Contractor may participate with other Varian Contractors, where appropriate, in the joint sharing of costs where such costs provide a proportionate benefit to Contractor. 5. Sale and Payment A. Sale of Products from Supplier to Contractor shall be at prices established by Supplier from time to time in price lists or quotation(s), less the applicable discounts) set forth in Schedule A. Supplier shall have the right to change the schedule of discounts (or rate of commission in Schedule A) with 15 days notice to Contractor. Discounts and or commissions for products not manufactured by Varian shall be separately agreed to on a case by case basis. Prices are net to Supplier, Contractor may be charged extra for all export packing, handling, insurance, transportation, taxes, fees, duties and any other items not specifically included in Supplier's price lists and/or quotations, unless otherwise agreed to in writing on a case by case basis. Sales shall be made only pursuant to Contractor's written purchase orders. No order shall be final and binding until accepted in writing by Supplier. B. Unless other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... customer and shall cooperate with Varian in the defense or handling of such claim. D. Contractor further warrants that it will not at any time do or cause to be done, by any act or omission, directly or indirectly, that would in any way impair Varian's right title or interest in intangibles." 11. In pursuance of the D.R. Agreement with these five A.Es (i.e., VGCs) in relation to the indent sale, the assessee has earned following commission:- (i) Varian Australia Rs. 47,16,563 (ii) Varian USA Rs. 34,12,975 (iii) Varian Italy Rs. 58,07,471 (iv) Varian Chrompak International Netherlands Rs. 3,49,91,934 (v) Varian AG - Switzerland Rs. 53,70,674 Rs. 5,42,99,617 12. The Assessing Officer required the assessee to furnish the working of the profit attributable to the P.E. which he meant the Assessee in respect of sales made in the territory of Indian on behalf of the VGCs in view of Article-7 of DTAA between India and U.S.A. and similar agreements with other countries. In response, the assessee submitted that with regard to the indent sale, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions of section 9(1)(i) also, the assessee had shown the income which has been reasonably attributed to the operations carried out in India. Reliance was also placed on CBDT Circular No.23 of 1969. 14. The Assessing Officer analysed the assessee's contentions which has been referred to in Pages-9 to 21 of the assessment order. Finally, the assessee's Explanation was rejected by the Assessing Officer mainly on the following reasons:- "9.20 The claim of the assessee that if payment to the agent is made at arm's length, then the non resident is not liable to tax (hypothesis) is not acceptable for the following reasons :- (a) The payment to the agent and profit of the assessee from business operations in India are two separate things which cannot be compared. (b) The hypothesis is applicable only in the case of independent agents where no assets I capital of NR are used in India, no risk is assumed by the NR in India and no other activity is carried out by the NR in India. (c) The draft discussion paper of OECD also suggest apportionment basis for determination of profits attributable to PE which is similar to the provisions in Rule 10 of the IT Rules. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income of the branch and not of the agent. In view of the above discussion, it is held that the assessee branch is the PE in respect of the business done out of the supplies made by Varian Group of USA, Australia and Italy." 16. Further, in the absence of actual profit attributable to the P.E., vis-a-vis three VGCs, he applied the provisions of Rule-10 of the Income-tax Rules, 1962, to estimate the profit attributable to the P.E. in view of "Force of Attraction Rule" applicable under the DTAA of U.S.A, Australia and Italy and estimated 10% of the operating profit from the business done in respect of these three companies. Accordingly, the addition of Rs. 63,25,580 was made. 17. Before the Commissioner (Appeals), apart from reiterating the contentions raised before the Assessing Officer, the assessee spelt out the activities and functions which were carried out by the assessee in the case of indent sale, on which commission was earned from various VGCs which were, inter-alia, spelt out as under:- (a) The appellant company is not a party to any legal contract with the customer; (b) The appellant company does not take title or own or have risk of loss as to the produ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... out these activities, the assessee is compensated quite well in the form of commission income, which have been held to be as arm's length by the TPO. Regarding applicability of 10% of the operating profit on estimate basis of the profits of three VGCs, attributable to India, it was submitted that the Assessing Officer has made an assumption of that the Varian global accounts are comparable to the operating profit account of a distributor company which is wholly erroneous because the profits of VGC also include research and development operations and various other factors. Without prejudice, on the basis of comparative analysis of the comparable companies engaged in distribution activities of the products similar to the assessee, it was submitted that the profitable percentage is only 1.99% which should be taken into consideration for estimating the profit. 19. The Commissioner (Appeals) rejecting the entire contentions of the assessee held that first of all, "Force of Attraction Rule" does apply in assessee's case and all the essential conditions given in Article-7(1) are applicable i.e., the assessee is a dependent agent and P.E. of Varian Inc. U.S.A., Varian Australia and Vari ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... titled for commission as per the D.R. Agreement, wherein it carries out pre-sale activities like liaisoning, marketing and promotion of products sold by VGCs and other incidental and ancillary post-sales support service services. Under these activities, the assessee is not responsible for maintaining books of account either for booking of sales or for the corresponding purchase as it is not a part of any legal contract with the customers. The assessee neither takes any title or own any risk of loss of the products. It neither raises invoice to the customers nor received any funds as the dealing as per the agreement is only between the VGCs and the customer. Insofar as the activity relating to the direct sales are concerned, the assessee directly imports spare parts from VGCs and sell them to Indian customers directly on its own account. These spare parts are brought on discounted price from VGCs sold them to Indian customers on principal-to-principal basis and not as an agent of any of the VGCs. For the purpose of its operation of indent sales, the assessee has four offices located in Delhi, Mumbai, Kolkata and Chennai which are mainly involved in liaisoning activity, providing mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessing Officer as well as the Commissioner (Appeals), specifically with regard to their conclusion on dependent agency P.E., as given in Article-5(4) vis-a-vis assessee's facts. He furnished a statement showing the rate of commission received from various VGCs in support of the contentions that none of the clauses or conditions mentioned in Article 5(5) stand fulfil in assessee's case and, therefore, the assessee cannot be said to be P.E. of various VGCs in India. He also referred to the judgment of the Hon'ble Supreme Court in Morgan Stanley Co. (supra), in support of the contention that there cannot be an agency P.E. in India if the P.E. has no authority to enter into or conclude contracts on behalf of foreign enterprise. Regarding application of "Force of Attraction Rule", as given in Article-7(1) of Indo-U.S. DTAA and similar provisions in Australia and Italy DTAA, he submitted that none of the prerequisite conditions spelt out in Article-7(1) stand fulfilled as the assessee does not constitute P.E. in India of the VGCs and secondly, the product sold by the assessee and the VGCs are different. Further, he submitted that assessee's case is also supported by the provisions of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ficer and the Commissioner (Appeals) are in accordance with the DTAA. Once the assessee is a dependent P.E., the "Force of Attraction Rule" as given in Article 7(1) gets clearly applicable and the global profits of the three VGCs insofar as their operations in India are concerned, becomes taxable in India in the hands of the assessee. 24. Regarding TPO's order to whom reference was made for determining the ALP for international transactions, she submitted that prior to 1st June, 2007, the Assessing Officer was not bound by the TPO's order and, therefore, any finding by the TPO regarding the adjustment of the price or profit, does not bind the Assessing Officer. On the issue of "Force of Attraction Rule", she relied heavily on a co-ordinate bench decision of the Tribunal in Linklaters LLP v. ITO (International Taxation) [2010] 40 SOT 51 (Mum.) Further, she submitted that even if the assessee is to be treated as agent acting Independently in the ordinary course of business and if its entire activities are devoted wholly or mostly on behalf of the foreign enterprise, then they should be considered as dependent agent and would constitute P.E. of the foreign enterprise, irrespective o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofits attributable to India is to be taxed in the hands of the Assessee. Now, the main issues before us are that, firstly, whether the assessee company i.e., VIPL through its Indian branch (VIB) constitute a P.E. for Varian Inc., U.S.A., Varian Australia and Varian Italy. The second issue is, whether "Force of Attraction Rule" would be applicable in case the assessee is held to be the P.E. and; lastly, whether the rate of 10% of the profitability as applied by the Assessing Officer under Rule-10 can be said to be reasonable attribution of the profit. 26. On the first issue, the Commissioner (Appeals) has confirmed the action of the Assessing Officer after holding that the assessee is dependent agent of three VGCs in view of the activities and functions performed by the assessee for them in India. He has further held that the assessee is not only a P.E. under Article 5(4), but also under Article 5(5) of Indo-U.S. DTAA and similar articles contained in Indo-Australia and Indo-Italy DTAA. 27. To decide this issue as to whether the activities of the assessee falls within the parameters and definition given in Articles 5(4) and 5(5) of Indo U.S. DTAA and other DTAAs, it is necessary ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... romotion of the products, maintaining sales and service organization, providing customer support, product inquiries assist in delivery, schedules, administrative support, functions such as order processing, customer credit review and host of other services. Besides this, the assessee is also engaged in direct sales wherein it directly imports spare parts from VGCs and sells them to Indian customers directly on its own account. The VGCs do not sell spare parts to the Indian customers at all except to the assessee. The assessee buys the spare parts at a discounted price and in turn it sold to the customers independently. The dealing of spare parts between the assessee and VGCs are on principal-to-principal basis. It is for these activities, the assessee has to maintain its own inventories and stock of goods and is solely responsible for sale and purchase. For carrying out indent sale activities, the assessee receives commission income at the rate specified in the respective D.R. Agreements and with regard to the direct sale, the assessee only receives the spare parts on discounted price which is sold in India at the profit which is shown in its hands. The commission income as well as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hrough the assessee are not binding on the VGCs as they may accept or reject the orders completely at their own discretion. From the D.R. agreement, it is seen that the assessee has no authority and also cannot negotiate or conclude contracts on behalf of the VGCs. It only provides marketing support liaisoning activity for pre-sale and incidental and ancillary post-sale activities; (ii) The second condition that the agent has no such authorities but habitually maintains Stock of Goods and merchandise from which he regularly deliver goods on behalf of foreign enterprises and some activities conducted on their behalf which contributes to the sale of the goods and merchandise also does not fulfil, as the assessee has no authority on behalf of the VGCs and does not maintain any cost of analytical instruments supplied by the VGCs to the customer in India. The title of the goods supplied by the VGCs is directly passed on to the customers and the assessee neither undertakes any risk or title of the product at any point of time. The assessee mainly facilitates the process of sale. The assessee keeps stock of spare parts which it sells in India on its own account and this transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... portant factor which needs to be seen is that whether the assessee assumes any kind of risk on behalf of the VGCs. From plain reading of D.R. Agreements and the material placed on record, it is seen that none of the risks like market risk, product liability risk, R D risk, credit risk, price risk, inventory risk or foreign currency risk is undertaken by the assessee. All these risk factors are borne by VGCs. Thus, from the above, we find that the assessee is not a dependent agent in terms of the conditions laid down in Article 5(4). 32. Now, whether the assessee can be said to be a P.E. within the parameter of Article 5(5), which reads as under:- "5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Officer has referred the matter to the TPO to determine the arm's length compensation with regard to international transactions. The TPO found that the assessee's transactions have been at arm's length price which acknowledges the fact that the assessee has been compensated by the VGCs at ALP. Even the Assessing Officer has also not adversely held that compensation in the form of commission is not at arm's length. The second condition also does not fulfil. Thus, under Article 5(5) also, the assessee cannot be held to be agent for constituting a P.E. in India for the various VGCs. 34. The Commissioner (Appeals) and the Assessing Officer have observed that the assessee which is a branch of VIPL, and which in turn is a 100% subsidiary of Varian Inc. U.S.A., therefore, the assessee constitute P.E. in India through its subsidiary. Merely because the assessee is a subsidiary of Varian Inc. U.S.A., VIPL or its branch, i.e., VIB, would not constitute P.E. of Varian Inc. U.S.A. This is clear from Para-6 of Article-5, which is reproduced below:- "6. The fact that a company which is a resident of a Contracting State controls or is controlled by company which is a resident of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tracts on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise; (b) he has no such authority, but habitually maintains in the first-mentioned State a Stock of Goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise; (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprise controlling, controlled by, or subject to the same common control, as that enterprise; or (d) in so acting, he manufactures or processes in that State for the enterprise goods or merchandise belonging to the enterprise." Under these agreements (DTAA) also except for clause (d) all other clauses are by and large similar to Article 5(4) of Indo U.S. DTAA. The additional clause (d) provides that if a dependent agent manufactures or process enterprise's goods or merchandise belonging to enterprise in that states, then such an agent is deemed as P.E. In the present case, admittedly, the Assessee does not manufacture or process any other products developed or manufactured by VGCs. Thus, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ticle 7(1)(b) and (c) of India Italy DTAA will apply in case of assessee so as to tax the profits of foreign enterprise, i.e., VGCs in the hands of the assessee in India. The basic condition for application of "Force of Attraction Rule" is that, it has to be established that the foreign enterprise has a P.E. in India and then only it can be said to be brought within the fiscal jurisdiction of another country to such a degree that such another country can tax the profits which the enterprise derived from that country. To fall within the realm of "Force of Attraction Rule" two basic requirements which would satisfy is that (i) the foreign enterprise has a P.E. in the other State for the purpose of selling goods and merchandise and (ii) the direct sale by the foreign enterprise is the same or similar kind of goods or merchandise as sold by the P.E. in India. In this case, we have already held that the assessee do not constitute a P.E. of various VGCs, therefore, "Force of Attraction Rule", will not be applicable in this case. Thus, this issue becomes purely academic in this case. 39. In assessee's case, there is another important fact that the assessee is showing the entire income a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtificial division between profits earned in India and profits earned outside India." 40. In view of the aforesaid findings, we hold that - Firstly, the assessee, i.e., Varian Indian Branch of VIPL is not a dependent agent of VGCs and, therefore, it does not constitute a P.E. for various VGCs in India; and Secondly, once the assessee is not a P.E. of VGCs, then "Force of Attraction Rule" will not apply in terms of Article 7(1) of various DTAA. Accordingly, the attribution of 10% profit margin on the basis of global accounts of VGCs, as applied by the Assessing Officer, also has no legs to stand in view of the above conclusion and, therefore, the addition made by the Assessing Officer on this score and as confirmed by the Commissioner (Appeals), thus, stands deleted. 41. Before parting with this order, we would like to discuss the judgment of Delhi High Court in Rolls Royce PLC (supra), as heavily relied upon by the learned Departmental Representative, wherein, in this case, the British Company supplied certain parts and equipment to Indian customers and RRIL was assessee's 100% subsidiary set-up in India through which it carried out marketing and selling of good ..... X X X X Extracts X X X X X X X X Extracts X X X X
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