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2016 (5) TMI 728 - DELHI HIGH COURT

2016 (5) TMI 728 - DELHI HIGH COURT - TMI - Reopening of assessment - existence of PE in India - Indo-US DTAA - Held that:- AO's view that Adobe India constituted the Assessee's PE in terms of paragraph 1 of Article 5 of the Indo-US DTAA is palpably erroneous and not sustainable on the basis of the facts as recorded by him.

We also find that there is no material to hold that the Assessee's employees constitute a Service PE in terms of Article 5(2)(l) of the Indo-US DTAA. The Assessee .....

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e Assessee. The said terms of the agreement do not in any manner indicate that the Assessee has been providing services in India. Clause 5.5 of the agreement referred to by the AO indicates that the Assessee is authorized to audit the Indian subsidiary (Adobe India), so as to ensure that Adobe India adheres to the standards required by the Assessee.

AO's view that Adobe India constitutes the Assessee's PE under Article 5(5) of the Indo-US DTAA is also wholly unsustainable. Article 5(5 .....

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Assessee. Further, there is no allegation that any of the other conditions specified under clauses (a), (b) or (c) of paragraph 4 of Article 5 of the Indo-US DTAA are applicable to Adobe India. One of the necessary conditions for holding that an agent constitutes a PE of an enterprise is that the agent must have an authority to conclude contracts or should have been found to be habitually entering into or concluding contracts on behalf of the enterprise. In the present case, there is no allegati .....

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r the AO to assume that Adobe India constitutes the Assessee's PE under Article 5(5) of the Indo-US DTAA. - Decided in favour of assessee - W.P.(C) 2384/2013 & CM 4515/2013, WITH W.P.(C) 2385/2013 & CM 4517/2013, W.P.(C) 2390/2013 & CM 4523/2013 - Dated:- 16-5-2016 - S. MURALIDHAR & VIBHU BAKHRU JJ. For the Appellant: Mr R.P. Bhat, Senior Advocate with Mr Prakash Kumar, Mr Vishal Kalra and Mr Vivek Bansal, Advocates. For the Respondent: Mr Dileep Shivpuri, Senior Standi .....

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ctively. The Assessee further impugns three separate orders dated 8th March, 2013 (hereafter impugned orders ) passed by the Assessing Officer (hereafter the AO ) rejecting the objections raised by the Assessee against the assumption of jurisdiction under Section 148 of the Act. 2. Briefly stated, the controversy in these petitions involves the question whether Adobe Systems India Private Limited (an Indian subsidiary of the Assessee and hereafter referred to as "Adob .....

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e could be attributed to Adobe India even if it was assumed to be the Assessee's PE in India. On the other hand, it is the Revenue's case that the activities carried out by the Adobe India are the core business activities of the Assessee; Adobe India is the Assessee's PE in India; the cost plus basis on which Adobe India is remunerated by the Assessee does not capture the fair share of Assessee's income attributable to its PE; and that a part of the Assessee's income, compute .....

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nder the laws of Delaware in USA. The Assessee provides software solutions for network publishing which includes web, print, video, wireless and broadband applications. The Assessee has a wholly owned subsidiary in India, namely, Adobe India. It is stated by the Assessee that Adobe India provides software related Research and Development (R&D) services to the Assessee and the Assessee does not have any business operations in India. The R&D services rendered by Adobe India, are paid for b .....

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xes (TDS) on such interest, the Assessee was not obliged to file its return of income under the Act by virtue of Section 115A(5) of the Act. 5. Adobe India is assessed to tax in India in respect of its income. As stated earlier, Adobe India is mainly engaged in the business of providing software related R&D services to the Assessee. It is stated by the Assessee that R&D activities carried out by Adobe India are on assignment basis and does not entail end to end software devel .....

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not subject matter of any further proceedings. It is stated that in Adobe India's assessment for AY 2006-07, the TPO/AO did not accept the Transfer Pricing Study submitted by the Assessee therein as he did not accept the set of comparables used by the Adobe India to determine the ALP. However, Adobe India succeeded in its appeal before the Income Tax Appellate Tribunal and this Court is informed that the Revenue has assailed the Tribunal's order in this Court which as yet is .....

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rs. 6. The AO issued the impugned notices under Section 148 of the Act on 30th March, 2011. In response to the aforesaid notice for AY 2004-05, the Assessee sent a letter dated 9th May, 2011 stating that it did not conduct any business activity in India and had not earned any taxable income except the interest on advances received from Adobe India, tax on which was duly withheld and deposited by Adobe India. The Assessee also referred to Section 115A (5) of the Act to contend that by .....

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on 9th August, 2011 and to the show cause notices for AYs 2005-06 and 2006- 07 on 24th August, 2011, by reiterating its earlier stand that it had earned only interest income from Adobe India in respect of which tax was withheld by Adobe India in terms of Article 11 of the DTAA between USA and India. 7. Reasons recorded for initiation of reassessment proceedings were furnished by the AO under cover of a letter on 17th October, 2011. After the receipt of aforesaid reasons, Assessee req .....

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013, without prejudice to its rights and contentions, filed the returns of income for AYs 2004-05, 2005-06 and 2006-07. 10. Thereafter, on 22nd February, 2013, the Assessee filed additional objections after inspecting the records. By an order dated 8th March, 2013, the AO disposed of the objections filed by the Assessee for the relevant AYs. 11. In the aforesaid backdrop, the limited controversy to be addressed is whether the AO had any reason to believe that the Assessee&# .....

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or the Assessee for which Adobe India has been compensated on a 'cost plus profit basis'; (b) the ownership of the software developed by Adobe India is the sole property of the Assessee and Adobe India does not retain any intellectual property rights in respect of the software developed by it; (c) the Assessee makes substantial profits by selling the software developed in India abroad for which no taxes have been paid by the Assessee in India; (d) Adobe .....

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siness activities and, consequently, Adobe India constituted the Assessee's PE under Article 5(1) of the Indo-US Double Taxation Avoidance Agreement (DTAA). He also observed that in terms of the agreement between Adobe India and the Assessee, the Assessee was obliged to provide assistance, specifications and supervision and was further entitled to audit the facilities of Adobe India for maintenance of the requisite standards. This, according to the AO, indicated that the Assessee had a Servi .....

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ee and Adobe India involved transfer of intangibles and multiple interrelated transactions which could not be evaluated separately for the purposes of determining ALP by any one transaction. The AO also recorded that development and customisation of software was a highly technical job and the same could not be restricted to computation on cost plus basis. In his view, cost plus basis was not a suitable method for intangibles like software services and the Profit Split Method was applicable in te .....

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r the provisions of Section 147 r.w.s. 148 of the Income-tax Act, 1961. The total value of the transactions is ₹ 1094766837/-. These are R&D expenses of the assessee's Co. As per global B/S of the assessee company the total R&D expenses are $365328000 and profit is $728434000 applying the same ratio the profit attributable to India R&D which is ₹ 1094766837 come to ₹ 2080056990 which is more than ₹ 1 lakh. Although the figures are for calendar y .....

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p> 16. It is apparent from the plain reading of the reasons recorded by the AO that his belief that the income of the Assessee had escaped assessment stems from his understanding that the activities pertaining to R&D services rendered by Adobe India were conducted by the Assessee. He has, therefore, concluded that the Assessee must surrender a part of his income, which is attributable to those activities in India, to tax under the Act. It is not disputed that Adobe India has been assessed to .....

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t any income arising from international transactions shall be computed having regard to the ALP. The purpose of enacting the transfer pricing regulations is to ensure that income from transactions between the related parties are not shifted out of India so as to escape or mitigate the incidence of tax payable under the Act. Thus, the transfer pricing regulations are to be read as providing the framework, to tax the real income of an assessee derived from international transactions with a related .....

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ext of Chapter X of the Act in the following words:- 77. As a concept and principle Chapter X does not artificially broaden, expand or deviate from the concept of "real income". Real income", as held by the Supreme Court in Poona Electricity Supply Company Limited versus CIT, : [1965] 57 ITR 521 (SC), means profits arrived at on commercial principles, subject to the provisions of the Act. Profits and gains should be true and correct profits and gains, neither under nor .....

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cepted in AYs 2004-05 and 2005-06. The method of determining the ALP for the said transaction, that is, TNMM, has been accepted for AYs 2004-05, 2005-06, 2006-07; although for AY 2007-08, the TPO has sought to use the PSM, the same was not upheld by the DRP. Thus, undisputedly, the real income of Adobe India, which is related to the activities carried out by Adobe India has been brought to tax in its hands. And even if there is any dispute relating to the same, it is liabl .....

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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 .....

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ises controlling, controlled by or subject to the same common control as that enterprise. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article. .....

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the State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of .....

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its 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 estab .....

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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 from any trade or business including income from the furnishing of services other than included services as defined in Article 12 (Royalties and Fees for Included Services) and including income from the rental of tangible personal property other th .....

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e sold through the PE or other business activities which are similar to those effected through the PE, can also be taxed in the state where the PE is situated. 22. Further, paragraph 2 of Article 7 of the Indo-US DTAA also stipulates that profits attributable to a PE would be such profits which a PE might be expected to make if it were a distinct and an independent enterprise engaged in the same or similar activities and dealing wholly at arm's length with the enterprise of which .....

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( that is, at ALP). Therefore, even if Adobe India is considered to be the Assessee's PE, the entire income which could be brought in the net of tax in the hands of the Assessee has already been so taxed in the hands of Adobe India. There is no material that would even remotely suggest that the Assessee has undertaken any activity in India other than services which have already been subjected to ALP scrutiny/adjustment in the hands of Adobe India. Thus, in our view, even if the AO is correct .....

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ct 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 in India. The quantum of taxable income is to be determined in accordance with the provisions of I.T. Act. All provisions of I.T. Act are applicable, includ .....

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equates an arm's length analysis (ALA) with attribution of profits. It holds that once a transfer pricing analysis is undertaken; there is no further need to attribute profits to a PE. The impugned ruling is correct in principle insofar as an associated enterprise, that also constitutes a PE, has been remunerated on an arm's length basis taking into account all the risk-taking functions of the enterprise. In such cases nothing further would be left to be attributed to the PE. The situati .....

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ctional and factual analysis to be undertaken in each case. Lastly, it may be added that taxing corporate on the basis of the concept of Economic Nexus is an important feature of Attributable Profits (profits attributable to the PE)." 25. We may also mention that according to the AO, the profits attributable to the activities carried out by Adobe India are to be ascertained by PSM as, according to him, the Cost Plus method used by Adobe India for determining the ALP does not fair .....

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ed notices and the proceedings initiated by the AO are liable to be set aside. 27. In view of our above conclusion, it is not necessary for us to examine whether the Assessee had a PE in India in terms of Article 5(1), 5(2)(l) or Article 5(5) of the Indo-US DTAA. However for the sake of completeness, we consider it appropriate to also examine the question whether the AO's opinion that the Assessee has a PE in India is informed by reason. 28. A subsidiary company is an i .....

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ct 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." 29. The aforesaid principle is also stated in Klaus Vogel on Double Taxation Conventions, Third Edition in the following words:-

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ablishment of the parent company." 30. Having stated the above, we must also clarify that the fact that a subsidiary company is a separate tax entity does not mean that it could never constitute a PE of its holding company. In certain circumstances, where the specified parameters defining PE - in the present case Article 5 of the Indo-US DTAA - are met, a subsidiary would constitute a PE of its holding company. However, in determining whether the requisite parameters are met, it .....

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gh its PE and that of the subsidiary as its own activity resulting in income from the same activities being taxed twice over; once in the hands of the subsidiary and again in the hands of the holding company. In cases where a subsidiary acts as an agent of its holding company, the income from the activities conducted by the subsidiary for and on behalf of its principal would be assessed in the hands of the principal - that is, the holding company - and not in the hands of the subsidiary. The sub .....

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:- 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 ; f) a mine, an oil .....

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re 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 .....

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nent establishment" shall be deemed not to include any one or more of the following: a) the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise ; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or occasional delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise .....

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anding the provisions of paragraphs 1 and 2, where a person-other than an agent of an independent status to whom paragraph 5 applies - is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned State, if: a) he has and habitually exercises in the first-mentioned State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited .....

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buted to the sale of the goods or merchandise ; or c) he habitually secures orders in the firstmentioned State, wholly or almost wholly for the enterprise. 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 ordin .....

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racting 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." 32. Para (1) of Article 5 defines a PE to mean a fixed place of business through which the business of an enterprise is wholly or partly carried on. The term 'fixed place of business' includes premises, facilities, offices which are used by an enterprise f .....

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decision, a Division Bench of this Court in Director of Income Tax v. E-Funds IT Solution: [2014] 364 ITR 256 (Delhi) reiterated the above-stated attributes; after quoting from various authors, this Court held that "The term 'through' postulates that the taxpayer should have the power or liberty to control the place and, hence, the right to determine the conditions according to its needs". In the present case, there is no allegation that the Assessee has any Branch Office or an .....

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of business. Thus, clearly the right to use test or the disposal test is not satisfied for holding that the Assessee has a PE in India in terms of Article 5(1) of the Indo-US DTAA. 33. In E-Funds IT Solution (supra), this Court had expressly negated that an assignment or a sub-contract of any work to a subsidiary in India could be a factor for determining the applicability of Article 5(1) of the Indo-US DTAA. The Court had further expressly held that : "Even .....

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3 of Article 5 or when sub-clause (a) to paragraph 4 to Article 5 is under consideration. The fact that the subsidiary company was carrying on core activities as performed by the foreign assessee does not create a fixed place permanent establishment." 34. Thus, the AO's view that Adobe India constituted the Assessee's PE in terms of paragraph 1 of Article 5 of the Indo-US DTAA is palpably erroneous and not sustainable on the basis of the facts as recorded by him.

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d that the agreement between the Assessee and Adobe India entails that the Assessee would provide specifications, assistance and supervision for the R&D services procured by the Assessee. The said terms of the agreement do not in any manner indicate that the Assessee has been providing services in India. Clause 5.5 of the agreement referred to by the AO indicates that the Assessee is authorized to audit the Indian subsidiary (Adobe India), so as to ensure that Adobe India adheres to the stan .....

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5(2)(l) of the Indo-US DTAA. This has also been authoritatively held by Supreme Court in Morgan Stanley (supra). 36. It is also noteworthy that the AO while computing the income that is alleged to have escaped assessment has also not alluded or attributed any income to the services alleged to have been rendered by the Assessee to Adobe India. In terms of Article 7(1) of the Indo-US DTAA, only such income as is attributable to the PE can be taxed in the State where the PE is located.

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gent of an enterprise would constitute its PE. In the present case, there is no material to form a view that Adobe India acts as an agent for and on behalf of the Assessee. Further, there is no allegation that any of the other conditions specified under clauses (a), (b) or (c) of paragraph 4 of Article 5 of the Indo-US DTAA are applicable to Adobe India. One of the necessary conditions for holding that an agent constitutes a PE of an enterprise is that the agent must have an authority to conclud .....

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