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TMI Blog2014 (2) TMI 442X X X X Extracts X X X X X X X X Extracts X X X X ..... Taxation has been referred to as the "Revenue". The cross-appeals arise out of two common orders passed by the Income Tax Appellate Tribunal (tribunal, for short). The first order dated 30th September, 2010 relates to all assessment years, except assessment years 2006-07 and 2007-08, which are subject matter of the second order of the tribunal dated 15th March, 2011. 2. The assessee are primarily aggrieved by the finding of the tribunal that they have Permanent Establishment (PE, for short) in India. They are also aggrieved with the initiation of the assessment proceedings under Section 147 read with Section 148 of the Income Tax Act, 1961 (Act, for short), whereas the Revenue is aggrieved by the finding of the tribunal relating to computation or attribution of the income earned by the assessee through the PE in India. 3. By order dated 27th September, 2011, the following substantial common questions of law were framed in the appeals Nos. 912/2011, 913/2011, 914/2011, 915/2011, 916/2011, 917/2011, 918/2011, 919/2011 and 920/2011 relating to assessment years 2000-01, 2001-02, 2002-03, 2004-05 and 2005-06 filed by the assessee:- 1. Whether, on the facts and circumstances of the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the IT Act is correct?‖ 5. The substantial questions of law framed on the appeals being ITA Nos. 735/2011, 736/2011, 737/2011, 738/2011, 739/2011, 740/2011, 802/2011, 845/2011 and 1002/2011 filed by the Revenue vide order dated 27th September, 2011 read as under:- "1. Whether on the facts and circumstances of the case, the Income Tax Appellate Tribunal has erred in law I not appreciating that the method adopted by the AO for attributing the profit to the PE of the assessee is based on the lines of MAP proceedings based on A.Y. 2003- 04? 2. Whether on the facts and circumstances of the case, the order of the ITAT is not perverse?‖ 5A. In ITA Nos. 1217/2011, 1218/2011, 1219/2011 and 1221/2011 for Assessment Years 2006-07 and 2007-08 filed by the Revenue, the following substantial questions of law were framed vide order dated 21st November, 2011:- "(1) Whether the Income Tax Appellate Tribunal has correctly rejected the computation of profit attributed to the Permanent Establishment on the lines of the MAP proceedings?‖ (2) Whether the formula prescribed by Income Tax Appellate Tribunal for computation of profit attributable to a Permanent Establishment is corr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be taxed in India, irrespective of whether the said assessees had paid taxes in USA. Income earned and taxed in the hands of e-Fund India was different from the income attributable to the two assesses. Thus the balance or differential amount, i.e., income attributable to the two assesses, which was not included in income earned and taxed in the hands of e-Fund India, should be taxed in India. 8. As a principle what is stated and submitted by the Revenue cannot be contested and in fact not contested by the assessees as it is a principle applicable to international taxation. A foreign or a nonresident company can be taxed in the country where it has a subsidiary, which is also a PE on the income attributable to the said PE, even if the subsidiary (in the present case of e-Fund India) is being taxed in the said country. The principle being that subsidiary being an independent and a distinct entity is taxed for its income, whereas the foreign entity, i.e., holding company is taxed for the income earned by the said independent entity attributable to the PE in the country where subsidiary is situated. The income of the subsidiary is not taxed in the hands of the non-resident principal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the holding company or the controlling company possibly may not be a PE of a subsidiary (the later question is not subject matter of the present decision and we express no opinion on the said question though it may be a relevant aspect, which the tax adjudicators, policy makers and the legal draftsmen in India and abroad may have to deal with). Indeed if this principle is not applicable it could be argued that the Indian subsidiary, i.e., eFund India"s income could be taxed in the country from where it is controlled or managed. A subsidiary can become a PE of the holding/controlling company or the related company, if it satisfies the postulates and requirements of other paragraphs of Article 5, notwithstanding and negating the protection provided under paragraph 6 of Article 5, which recognizes legal independence of the two entities for tax purposes. This legal principle that the holding or contracting company and the subsidiary or the controlled company are two separate and independent tax entities and must be so treated permeates and pervades but will give way to the exceptions carved out and stated in the DTAA. The legal principle is simple, a subsidiary being a resident of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bsidiary. Thus, from a de lege ferenda point of view, PE taxation of the parent company is justified in cases where residence state taxation of the subsidiary does not adequately attribute taxing jurisdiction to the source state. The commentaries to the OECD model treaty do not de lege lata give conclusive reasons for the conventional wisdom with regard to this question.‖ A part of the above observations are in the nature of justification of right of taxation in source State and relate to the domain of PE principle and inter-state neutrality as a theory. Issue of source State in the present factual matrix has been touched below. 14. The aforesaid principle is no longer res integra and has been lucidly elucidated by the Supreme Court in DIT versus Morgan Stanley and Co. Inc., (2007) 292 ITR 416 (SC) in the following words:- "32. The object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. Under Article 7(2) not all profits of MSCO would be taxable in India but only those which have economic nexus with PE in India. A foreign enterprise is liable to be taxed in India on so much of its business profit as is attributable to the PE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idiary may be considered a dependent agent of its parent by application of the same tests which are applied to unrelated companies.‖ 16. It has been observed below, that subsidiary can constitute PE, other than dependent agent PE. A write up in Bulletin for International Taxation, February 2011 titled "The Subsidiary as a Permanent Establishment‖ has summarized the true and correct legal position in the following words;- "A PE is, however, not always easy to identify. This is particularly true where a PE is hidden behind a dependent operating company, i.e. if an operating company in addition to its own business also carries on another company"s business as a PE of the latter. In this regard, the 2010 OECD Model Tax Convention (the "OECD Model‖) states in Art. 5(7) that: [t]he 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 (emphasis added) This follows from the princip ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a sales outlet; (j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve month period; (k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects- or activities, if any) continue for a period of more than 120 days in any twelve month period; (l) the furnishing of services other than included services as defined in Article 12 (Royalties and Fees for Included 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 within any twelve-month period; or (ii) the services are performed within that State for a related enterprise (within the meaning of paragraph 1 of Article 9 (Associated Enterprise). 3. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include any one or more of the following: (a) the use of facilities so ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. Article7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices. 4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. 5. For the purposes of this Convention, the (sic) to be attributed to the permanent establishment as provided in paragraph 1 (a) of this Article shall include only the profits derived from the assets and activities of the permanent establishment and shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 6. Where profits include items of income which are dealt with separately in other Articles of the Convention, then the provisions of those Articles shall not be affected by the provisions of this Article. 7. For the purposes of the Convention, the term "business profits" means income derived fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... DTAA. Location or fixed place PE under Article 5(1) and (2) of DTAA. 19. Paragraph 1 of Article 5 refers to what can be described as fixed place PE. Tiiu Albin commentary, Problems with PE; problems in determining permanent establishment on the basis of Article 5(1) has stated that the said Article encapsulates three requirements, namely, (i) the existence of place of business at the disposal of the enterprise; (ii) the place of business must be of a "fixed nature‖ (geographical and temporal permanence); and (iii) the enterprise being carried on is required to be "carried on through the place of business‖. 20. The word "permanent‖ in the expression PE is of significance and imperial importance. It refers to some degree of permanency and not a mere transitory nature of the business in the other State. Further, the enterprise must have a fixed place of business. The expression "fixed place of business‖ refers not only to physical location in the form of immovable property or premises but in certain instances can mean machinery and equipment. The word "fixed‖ refers to a distinct place with some or certain degree of permanence. The relevant and import ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he term "permanent establishment‖, emphasizing its essential nature as a "fixed place of business‖ with a specific "situs‖. According to paragraph 2 of the OECD Commentary (the 2005 version of which is cited below), this definition contains the following conditions: - the existence of a "place of business‖, i.e., a facility such as premises or, in certain instances, machinery or equipment; - this place of business must be "fixed‖, i.e., it must be established at a distinct place with a certain degree of permanence; - the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated.‖ The OECD Commentary goes on to observe:- "3. It could perhaps be argued that in the general definition some mention should also be made of the other characteristic of a permanent establishment to which some importance has sometimes been attached in the past, namely that the establishment must have a productive character-i.e., contribute to the profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rs and meets the purchasing director in his office to do so. In that case, the customer"s premises are not at the disposal of the enterprise for which the salesman is working and therefore do not constitute a fixed place of business through which the business of that enterprise is carried on (depending on the circumstances, however, paragraph 5 could apply to deem a permanent establishment to exist). 4.3 A second example is that of an employee of a company who, for a long period of time, is allowed to use an office in the headquarters of another company (e.g. a newly acquired subsidiary) in order to ensure that the latter company complies with its obligations under contracts concluded with the former company. In that case, the employee is carrying on activities related to the business of the former company and the office that is at his disposal at the headquarters of the other company will constitute a permanent establishment of his employer, provided that the office is at his disposal for a sufficiently long period of time so as to constitute a "fixed place of business‖ (see paragraphs 6 to 6.3) and that the activities that are performed there go beyond the activities refer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ular location within which the activities are moved may be identified as constituting a coherent whole commercially and geographically with respect to that business.‖ 22. The UN Commentary observes that place of business to constitute PE, the enterprise using it must carry on its business wholly or partly "through‖ it, though the activity need not be productive in character and need not be permanent in the sense that there is no disruption, but the operations must be carried out on regular basis. Branch, offices and factory mentioned in paragraph 2 are examples of fixed place of business. In paragraph 4.6 of the OECD Commentary, the words "through which‖ have been interpreted to have a wide meaning but postulate that the particular location should be at the disposal of the enterprise for that purpose and only then the business is carried through the location where the activity takes place. The word "through‖ has been interpreted and read in a manner that the foreign enterprise should have the right to use the location in the second State. The said right may or may not be formalized through legal documentation, but right to use should be established and show ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not only include places which are legally at the disposal of an enterprise but also places where the non-resident assessee can as a matter of right claim is right to use. The said right to use can be inferred from the conduct etc‖. 25. There is some controversy whether the examples given in paragraph 2 to Article 5 are per se and ex facie permanent establishments or the requirements of paragraph 1 should also be satisfied. This controversy is in respect of building and construction sites etc. We need not give an affirmative opinion on the said question in relation building/construction sites etc. Overwhelming international commentaries, write ups and decisions support the position that for applying the location test, requirements of paragraph 1 to Article 5 must be independently satisfied. Therefore, to create a location PE, requirements of paragraph 1 to Article 5 should be satisfied. To some extent, the controversy and contention to the contrary is academic in view of the negative list given in paragraph 3, which is fairly comprehensive and the restrictive; and postulates of paragraph 1 to Article 7 and other paragraphs to Article 7. Even otherwise, a mine, oil or gas fuel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y which engages an employee, would always become a PE of the controlling foreign company. The said submission of the Revenue is misconceived and has to be rejected. This would be contrary to the overriding mandate of Article 5 paragraph 6. Decision in the case of Morgan Stanley (supra) as suggested and submitted by the Revenue does not hold or propound to the contrary. In the said case, the Supreme Court has held as under:- "13. However, the question which arises for determination in the present case is the nature of activities performed by stewards and deputationists deployed by MSCO to work in India as employees of MSAS. Under Article 5(a)(1) furnishing of services through the fixed place in India can constitute a P.E. The AAR In the impugned ruling has held that the stewards and deputationists are proposed to be sent by the MSCO from U.S. According to the AAR there is a flow of service from the MSCO to the MSAS when the former deputes its own employees to work in India in MSAS. Therefore, according to the AAR the service Agreement between MSCO and MSAS dated 14.4.3005 would fall under Article 5(2)(1) and consequently the transfer pricing regulation would apply for evaluating th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tional enterprise renders services through its employees in India provided the services are rendered for a specified period. In this case, it extends to two years on the request of MSAS. It is important to note that where the activities of the multinational enterprise entails it being responsible for the work of deputationists and the employees continue to be on the payroll of "the multinational enterprise or they continue to have their lien on their jobs with the multinational enterprise, a service PE can emerge. Applying the above tests to the facts of this case we find that on request/requisition from MSAS the applicant deputes its staff. The request comes from MSAS depending upon its requirement. Generally, occasions do arise when MSAS needs the expertise of the staff of MSCO. In such circumstances, generally, MSAS makes a request to MSCO. A deputationist under such circumstances is expected to be experienced in banking and finance. On completion of his tenure he is repatriated to his parent job. He retains his lien when he comes to India. He lends his experience to MSAS in India as an employee of MSCO as he retains his lien and in that sense there is a service PE (MSAS) under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , etc., would be carried out in consultation with the applicant. Clause (4) of the agreement expressly stipulates that MSAS shall comply with all performance standards as specified by the Morgan group and that it shall comply with all reasonable directions or instructions of the group. Operation manual would be prepared and updated in conformity with the policy, procedures and practices of the Morgan group. Clause 7 enjoins upon MSAS to submit reports or other information concerning the services that the group may require. It further enjoins MSAS to attend all meetings convened for reviewing the services at the appointed time, place and agenda fixed by the group. By virtue of clause 8, MSAS is required to maintain a complete record which would be subject to audit and investi-gation by the applicant. The persons authorized by the Morgan group are provided unrestricted access to the business premises of the MSAS for audit and investigation. While clause 19 of the agreement disables MSAS from disclosing the information contained in the software products to any party except the Morgan group which has the liberty to share the infor-mation with any member of the Morgan group. All this wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tivities and primary or core activities. Therefore, first and foremost, Article 5(1)/(2) should be applicable but then if the activities fall within parameters of paragraph 3, PE is not created for imposing tax in the second state. It does not follow that if activities are not covered in the negative or exclusions set out in paragraph 3, a PE is established or deemed to be established under paragraphs 1 or 2 of Article 5. This principle is relevant. As noticed below, the tribunal has erred and has referred and applied paragraph 3 of Article 5 as if all activities performed and undertaken by the Indian subsidiary and their employees would still create a PE in India of the assessees, because the activities of e-funds India were not preparatory or auxiliary in character. This is not the correct legal position. Agency PE under Article 5(4) and (5) of DTAA. 31. Paragraphs 4 and 5 of Article 5 relate to creation of agency PE in the second contracting country. Agency replaces fixed place with personal connection. Arvid K. Skaar in his work "Permanent Establishment" has opined that primacy of "location test" of the basic rule is consistent with the conceptual structure of the PE clause it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat an agent who was wholly or almost wholly engaged by one principal shall be considered to be a dependent agent. This initial position stated in UN commentary has, however, not been accept in subsequent commentaries. The essential criteria being arms length relationship though engagement with one or a group might serve as an indicator of absence of independence of an agent. 34. Subsidiary by itself cannot be considered to be a dependent agent PE of the Principal, otherwise it would negate the overriding effect of paragraph 6 to Article 5, a provision which precedes and seeks to give recognition to separate legal entity principle associated with juristic incorporated enterprises. However, a subsidiary may become dependent or an independent PE agent provided the tests as specified in paragraphs 4 and 5 are satisfied. A dependent agent is deemed to be PE of the principal establishment under paragraph 4, if one of the three conditions specified in sub-clause (a) to (c) are satisfied. Under sub-clause (a), a dependent agent should have authority and should habitually exercise the said authority to conclude contracts on behalf of the foreign enterprise. What is meant by the term "auth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 99) 237 ITR 230, Authority of Advance Ruling has interpreted the two expression "has" and "habitually exercises" in the case of dependent agent. It has been observed that the expression "has" may have reference to the legal existence of such authority on terms of the contract between the Principal and the Agent, the expression "habitually exercises" has certainly reference to systematic course of conduct on the part of the agent. Reference to OECD Commentary and Klaus Vogel was made and it has been observed :- ".....Para. 4 uses two expressions : "has‖ and "habitually exercises‖ an authority to conclude contracts on behalf of the enterprise in question. While the expression "has‖ may have reference to the legal exist- ence of such authority on the terms of the contract between the principal and agent, the expression "habitually exercises‖ has certainly reference to a systematic course of conduct on the part of the agent. If, despite the specific provision of the soliciting agreement, it is found, as a matter of fact, that TVI is habitually concluding contracts on behalf of TVM without any protest or dissent, perhaps it could be presumed either that the rele ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt Authorities of both the countries after examined the facts of the case and issues involved have arrived at a resolution in terms of Section 90 of Income Tax Act, 1961 read with Article 27 of Indo -USA Double Taxation Avoidance Agreement and Rule 44 I-I of Income Tax Rules, 1962. The Competent Authorities of USA and India have reached an agreement as follows with respect to the Tax assessment on M/s e Funds Corporation and e Funds IT Solution Group Inc: Income will be attributed to the Indian PEs based on the ratio of certain developed and acquired tangible and intangible assets in India and outside India. Out of the total assets for the AY 2003-04 , 10.48% of the assets were located in India and accordingly 10.48% of the Income would be attributable to India. The percentage attributable to India for the AY ending 2005 was arrived of 11.11% These percentages will be applied to the base of consolidated gross income as reduced by the income of subsidiary e Funds India Pvt. Ltd. Already reported in India. Thereafter the total income so attributed will be apportioned between e Funds and IT solutions in the ratio of 85% (to e Funds) and 15% (to IT Solutions) for the AY 2003-04 and 87 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or income in the hands of one assessee or one person in the two different countries. Double taxation can be avoided by either granting exemption or giving tax credit paid in the third country. As per the MAP procedure, there was decrease in the American taxable income and the tax paid on income in India was credited under the American laws. FACTS AND APPLICATION OF AFORESAID PRINCIPLES TO THE FACTS 43. Tribunal in the impugned order has held that the assessee had fixed place PE under Article 5(1) and also service PE under Article 5(2)(l) of the DTAA. The assessment order on the said aspect is rather ambiguous and unclear. In paragraph 7 of the assessment order, it is observed that the assessee had permanent establishment in India in various forms without elucidating any specific paragraph of Article 5 which was invoked and held to be applicable. However, in paragraph 8 reference is made to the assessment order for assessment year 2003- 04 in the case of e-Fund Corp and it was observed that assessee had fixed place PE as well as dependent agent PE i.e. PE under Article 5(1) and Article 5(4) of the DTAA. 44. Commissioner of Income Tax (Appeals) has held that the assessees had PE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in India. All the servers processing the transactions were not installed in India and were located wholly outside India. Electronic Payments That ATM machines installed by other companies not belonging to the appellants outside India were also managed i.e. the transactions for these ATM machines were routed through servers installed by the appellant. These servers contained database of various cardholders for the purpose of verification and, revenues were shared from the ATM machine installers. Here also no activity was carried on by the appellants in India and, therefore no income accrued in India. Decision Support and Risk Management That appellants further provide decision support and, risk management services providing risk management based data and other products to financial institutions, retailers and other businesses that assist in detecting fraud and assessing the risk of opening a new account or accepting a check. These products and services are based on or enhanced by appellant's proprietary databases such as Debit Bureau(r), ChexSystems (SM) and SCAN(SM) and other sources. Neither the customers to whom such services are provided are situated in India nor the service ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appropriate test to determine location PE. The fixed place of business PE test is different. Therefore, the fact that e-Fund India provides various services to the assessee and was dependent for its earning upon the two assessees is not the relevant test to determine and decide location PE. The allegation that e-Fund India did not bear sufficient risk is irrelevant when deciding whether location PE exists. The fact that e- Fund India was reimbursed the cost of the call centre operations plus 16% basis or the basis of margin fixation was not known, is not relevant for determining location or fixed place PE. Similarly what were the direct or indirect costs and corporate allocations in software development centre or BPO does not help or determine location PE. Assignment or sub-contract to e-Fund India is not a factor or rule which is to be applied to determine applicability of Article 5(1). Further whether or not any provisions for intangible software was made or had been supplied free of cost is not the relevant criteria/test. e-Fund India was/is a separate entity and was/is entitled to provide services to the assessees who were/are independent separate taxpayer. Indian entity i.e. s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cterization of the subsidiary as a permanent establishment. In such cases, the subsidiary continues to be a separately taxable entity. his its parent company's permanent establishment only to the extent that it satisfies the agency requirement set out in Art. 5(5). and (6) MC. Paragraph 41 MC Comm.Art. 5 makes express mention of this only in regard to the independent agent within the meaning of Art. 5(5). Like any other unrelated company, however, a subsidiary, if an independent agent, can very well also constitute a permanent establishment of its parent company under, the conditions laid down in Art. 5(6). A subsidiary may, for instance, act as an agent of its parent nd conclude such contracts for the latter on the b as is of a corresponding authority as go beyond the limits of the ordinary course of its business. The independence of the subsidiary under company law also remains authoritative for tax purposes if it subcontracts. entirely or partially to associated enterprises or it acquires the means required for the contract's execution from associated enterprises. The latter is particularly true ,fir the hiring out of employees as temporary workers. If the parent company makes p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... so render services to a third party on behalf of the principal. This by itself would not lead to a subsidiary becoming a PE unless requirements of paragraphs 1, 2, 4 or 5 are satisfied. The observations of the Klaus Vogel in fact support the assessee as it postulates that partnership PE would be created only when the principal of the foreign enterprise retains the economic risk of contract and other general conditions i.e. Articles 5(1), 5(2), 5(4) and 5(5) of the DTAA are fulfilled. Tax authorities have to be cautious and aware of consequences when they apply joint venture or partnership principle in a case like the present one as it could be argued that substantial or significant part of the income of the joint venture entity should be taxed in the source State. 53. This is also the view and opinion of Arvind K. Skaar, wherein he has referred to the principle of altered ego companies and decision of American courts in National Carbide Corporation vs. Commissioner 336 US 422; Moline Properties Inc. vs. Commissioner 319 US 436 and Bollinger vs. Commissioner 108 S.Ct. 1173 and has referred to six point as the National Carbide criteria. These are: "(1) The corporation must operate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... auxiliary and preliminary activities. The fact, the report refers to and give details of or number of employees of e-Fund India which are part of the e-Fund group is not relevant. Neither income earned by eFund India nor activities in India by the Indian subsidiary by itself, relevant in determining whether or not PE exists under paragraphs 1, 2, 4 and 5 of Article 5. Thus and therefore, the fact that 40% of the employees of the entire group were in India i.e. were employees of e-Fund India, will not make the said company agency subsidiary PE or fixed place PE of the assessee. Neither provision of any software, intangible data etc. whether free of cost or otherwise, make e-Fund India an agency or fixed place PE of the two foreign assessees. Whether or not and on what basis e-Fund India was reimbursed expenses of xerox, courier charges etc. will not make e-Fund India as PE of the assessee under Articles 5(1), 5(4) or 5(5). Conditions and stipulates under Articles 5(1), 5(4) or 5(5) will create a PE and not the said facts as highlighted in the impugned orders. Therefore, we will now examine the facts found and refer to Articles 5(4) and 5(5) of DTAA. 57. Conditions of Articles 5(4) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yees of e-Fund India are not to be counted and treated as employees of the assessees; e-Fund India being a separate entity and taxable assessee. The tribunal and the authorities have erred in treating employees of e-Fund India as employees of the assessees for determining whether service PE under Article 5(2)(l) was created. There are no other factual findings recorded by the tribunal in respect of service PE under Article 5(2)(l). The assessment order also does not record any other relevant finding for creation of service PE under Article 5(2)(l), other than payment received by e-Fund India for providing management and support service by the President and Sales Team to overseas group entities. Payment by e-Fund Corp on the said account were received for the year ending 31st March, 2002, but stopped thereafter. This no doubt is a relevant aspect with reference to Article 5(2)(a) but the said provision has not been invoked in the assessment order and in the appellate orders including order of the tribunal. We do not have details with regard to the exact nature and character of the management services provided to the overseas group entities. 60. Before the Commissioner (Appeals), th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , if we treat the President and employees whose salary was reimbursed as "other personnel‖ who had performed services within that State for a related enterprise as defined in paragraph 1 of Article 9. Thus, at best service PE for the year ending 31st March, 2002 would have been created under Article 5(2)(l) but again there has not been thorough and detailed discussion on the nature and type of services rendered and determination on question of salary and whether the President and employees of Regional Office could be treated as "employees or other personnel" of the assessee. 62. The appellants had pleaded before the authorities and the tribunal that prior to assessment year 2005-06 not even a single employee of the assessee ever visited India even for a short period and in 2005-06, two employees of e-Fund were transferred to e-Fund India and that the entire expenditure for these two employees were borne by e-Fund India. No employees were present in India after 2005-06. Presence of employees in India is relevant under Article 5(2)(l) but the said employees should furnish services within the contracting State. These services should not be mere stewardship services. The Assessi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee, though he has recorded comments in respect of replies to other issues raised by him (see paragraph 7 of the assessment order). The aforesaid factual assertion made by the assessee, therefore, was not negated or questioned by the Assessing Officer. 64. Commissioner (Appeals) has referred to technical explanation to DTAA issued by the US Department of Treasury. The said explanation refers to the definition of term "PE" including service PE and states as under:- "Subparagraph (1) provides the rule for determining the conditions under which the activity of furnishing services, through employees or other personnel, constitutes a PE. These rules apply only to the provision of services which are not considered to be "included services", as the term is defined in article 12 (Royalties and Fees for included Services). Under the subparagraph, the furnishing of services gives rise to a PE if either the activity continues for an aggregate of more than 90 days in a twelve month period, or the services are performed fir a person related to the enterprise providing the services. In the latter case, no time threshold test must be met for a PE to exist. The determination of whether ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... several factors like, business environment, quality of business operations etc. including transfer of back office operations or other operations to a more efficient and cost effective locations. The said finding can be given after minute and meticulous examination of the data, reasons and not by a straight forward and simplistic inference. Further existence of PE does not depend upon transfer of assignment or sub-contracting work/services to India, with an intent and purpose to save costs and to increase profitability of the assessee resident abroad. This is not the stipulation or requirement in Article 5. 68. The contention of the Revenue is that if rights in the software had been transferred to e-Fund India, compensation was required to be paid by e-Fund India and this would have required deduction of tax at source. The argument is farfetched. We are not dealing with assessment or failure of e fund India to deduct tax at source. The argument cannot be accepted as it would interfere with the working or business model adopted by the assessee and e-Fund India. The said working model is not a sham or a camouflage having no business character. 69. Similarly, the contention and findi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... performed and utilized, though certain operations took place in India. The beneficiaries of the services and the payment of the services were sourced in USA. Casual examination of India"s balance for payments in US Dollars available on Reserve Bank of India"s website from the year 2000-01 to 2010-11, would indicate that India has substantial inflow under the head "invisible‖ i.e. payments for services and products which do not result in transfer of physical objects. A significant portion of India"s services, which contributes almost 55% to the Indian Gross Domestic Product, are for outbound and cross borders services. A greater and in-depth study is required to understand the full tax or revenue implication as far as India is concerned including study of proposed amendments to the OECD Model Treaty. Section 9(1)(i) of the Act 72. No arguments have been addressed before us on the aspect of legal connection which justifies taxation of a non-resident under Section 9(1)(i) of the Act on income which is deemed to be accrue or arise in India. The tribunal in the impugned order has held that the assessees had business connection in India for the points noted in paragraph 18.3. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nment has entered into DTAA and the said agreement applies, the provisions of that Act will apply to the extent they are more beneficial to the assessee. In other words, when DTAA and provisions of the Act apply to an assessee, then the Article of DTAA or the provision of the Act will apply depending upon, which one of the two is more beneficial or advantageous to the assessee. Challenge to the initiation of proceedings under Section 147/148 of the Act. 74. Challenge to the initiation of proceedings under Sections 147/148 of the Act by the two assessees is devoid of merits. In the present case, the assessee had not filed returns of income and were not subjected to regular assessment under Section 143(3). Challenge on the ground of change of opinion etc. is not available. The only ground on which proceedings can be challenged is that the reasons recorded do not disclose any rational or relevant nexus with the formation of belief that income of the two assessees had escaped assessment. At the stage of issue of notice only a tentative or prima facie view, justifies initiation of proceedings under Section 147/148 of the Act, though the reasons or grounds recorded must not be based on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessment order drawing authority from Article 7(2) of the DTAA and Rule 10 of the Income Tax Rules, holds that profit of the two assessees attributable to Indian PE should be computed on reasonable basis. The Assessing Officer took into account the assets of the two assessees located outside India and located in India, i.e., the assets of e-Fund India. In proportion to the assets located in and outside India, income from operations was attributed to the Indian PE. However, in computing the income from operations, the net profit of e- Fund India was reduced from the total income and then 2.51% of the net profit was attributed to India, 2.51% being the percentage of assets in India. The aforesaid income was divided in the ratio of 15% and 85% towards as income of Indian PE of e-Fund Inc. and e-Fund Corp. In view of the said computation, the total income of the two assessees determined for the relevant assessment years is as under:- For e-Funds Corporation & e-funds IT Solutions Group Inc. 77. Commissioner (Appeals) did not interfere with the aforesaid computation except that for the purpose of attribution, he held that the value of assets should be taken at actual cost and not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble. Besides income generating capacity of the assets would diminish with the lapse of time and depreciation, as provided in the respective statutes, should be given due regard. In such circumstances, it was desirable and expedient to base attribution on depreciated cost of assets for purpose of apportionment as it would be fairer, practical and hassle free method. As a result of the direction given by the tribunal, income of the two assessees has been computed as under:- For e-funds Corporation & e-funds IT Solutions Group Inc. Thus, no tax is payable by the two assessees in any year because e- Fund India had declared and stands taxed on a higher income. 80. Learned counsel for the Revenue has raised three contentions. Firstly, the method adopted by the Assessing Officer was in terms of the method adopted and accepted in the MAP proceedings and, therefore, the most reasonable method. Order of the tribunal does not set out or give reasons why the method adopted in the MAP proceedings was unreasonable and inappropriate. Secondly, as per Article 7, method once adopted should be followed from year to year and can be only altered under paragraph 5 of Article 7 for good and sufficien ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of attribution when the Indian company, i.e., e-Fund India itself was assessed and subjected to tax on "arms length" basis. The Supreme Court has observed that in such cases when transfer pricing analysis includes and takes into account risk taking functions of the PE enterprise, nothing further would be attributable to the foreign or non-resident enterprise. However, if the transfer pricing order or computation does not adequately reflect the functions performed and risk assumed by the Indian enterprise, there is need to attribute profits for those functions or risks which have not been considered. Data placed by the taxpayer, which is examined and considered in transfer pricing analysis is, therefore, of importance and has to be examined in each case. 84. Apportionment criteria or method is beset with difficulties and complications. Recent OECD attempt for application of people functions tests etc. has been subject matter of unfavourable comments. The criteria or apportionment principles can be grouped as:- (i) Receipt of enterprise based on turnover or commission. (ii) Expenses i.e. based upon wages paid. (iii) The capital structure i.e. based upon apportionment of total ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be fair, rational and logical. Assets and net income criteria applied must collate and refer to the assets which have contributed to the earning of the net income. The tribunal, therefore, rightly interfered and corrected the error, which was apparent. In the MAP proceedings a formula was adopted and should be consistently followed but if the said formula was irrational and inappropriate, it could be corrected in other and subsequent years. The approach of the tribunal, therefore, cannot be faulted. 87. On the question whether depreciated/written down value or the original cost of assets should be taken as the basis, the tribunal has accepted the written down value of the assets adopted by the Assessing Officer. Revenue has not specifically questioned the said finding and had contested original cost basis adopted by Commissioner (Appeals). Moreover, the tribunal has given valid and cogent reasons for the same, though in a given case, adjustments may have to be made when there is material to show that written down value may lead to irrational or illogical results due to difference in rate of depreciation or 100% depreciation was/is allowed under applicable tax laws of one of the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Officer was justified in reopening the assessment under Section 147/148 of the Income-Tax Act?‖ Notices under Section 147/148 are valid and as per law. "Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that Appellant has a business connection in India under Section 9(1) [or 9(1)(i)] of the Act ?‖ The assessees have business connection in India, but the tribunal has given a wide and broad meaning to the term "business connection‖ and what is attributable and taxable as "business connection‖ has not been adjudicated and decided. This is because both the Assessing Officer and the assessees have proceeded that in terms of Section 90(2) of the Act, provisions of the DTAA were more beneficial to the assessee. Question No. 2 is accordingly answered. "Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that the Appellant has a permanent establishment in India under Articles 5(1), 5(2) (1) and 5(4) of the India-US DTAA?‖ The assessees did not have "permanent establishment‖ in India under Articles 5(1), 5(2)(l) and 5(4) of the DTAA. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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