TMI Blog2021 (5) TMI 857X X X X Extracts X X X X X X X X Extracts X X X X ..... f the assessee. Once basic taxability under the DAPE itself comes to an end, all other issues raised in the appeal are rendered academic and infructuous - ITA No.: 7280/Mum/2018 - - - Dated:- 3-5-2021 - Pramod Kumar, Vice President, And Vikas Awasthy Judicial Member For the Appellant : Ketan Ved For the Respondent : S. S. Iyangar ORDER PER PRAMOD KUMAR, VP: 1. By way of this appeal, the assessee appellant has challenged correctness of the order dated 18th October 2018, passed by the Assessing Officer under section 143(3) r.w.s. 144C (13) of the Income Tax Act 1961, for the assessment year 2014-15. 2. Grievances raised by the appellant are as follows:- 1. On the facts and in the circumstances of the case and in law, the Assessing Officer erred in treating the sale of Novell Software Products of ₹ 9,04,66,939 as 'Royalties' on substantive basis both under the Income-tax Act, 1961 ( the Act ) as well as the Double Taxation Avoidance Agreement entered into between India and USA ('India-USA DTAA'). In accordance with India-USA DTAA, the receipts from sale of Novell Software Products being in the nature of business income and in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted through NSDIPL and taxing it as business income applying the arbitrarily profit ratio as stated at Ground No.3 above. 6. Without Prejudice to the Ground No.l Ground No.2, Ground No. 3, Ground No. 4 and Ground No.5, on the facts and in the circumstances of the case and in law, the Learned Assessing officer erred in taxing the revenues from the sale of Novell Software Products twice- once on gross basis as royalty and secondly by attributing the entire sales revenues to the alleged DAPE by applying the gross profit ratio of 55 percent and erred in determining the taxable income at ₹ 14,02,34,700. In essence, this has resulted into double taxation of the revenues from the sale of Novell Software Products applying the substantive approach and protective approach. 7. Without Prejudice to the Ground No. 1, Ground No.2, Ground No. 3, Ground No. 4, Ground No. 5 and Ground No. 6, on the facts and in the circumstances of the case and in law, the Learned Assessing officer erred in levying interest of ₹ 4,39,122 under Section 234A of the Income Tax Act, 1961 despite the Return of Income filed on the due date. 8. Without Prejudice to the Ground No.l1 Ground ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ence of permanent establishment under Article 5(1) and 5(2), as we have reproduced earlier, there is not even a whisper of a mention about any fixed place of business. All this analysis points out is that The assessee could not have earned any income from India but for its Indian agent, ZTL/EI Zee and that The employees of ZTL/EI Zee are employees of Zee group as a whole and they perform functions as required by ATL also , but then the agent and the principal being from the same busines group would not obliterate their separate legal existence. It is only elementary that there cannot be a permanent establishment under the basic rule, i.e., 5(1), unless there is a fixed place of business. It is by now well settled in law that in order to constitute a fixed place permanent establishment under Article 5(1), there has to a fixed place of business from which business of the foreign enterprise is carried out, and such a place of business should be at the disposal of foreign enterprise. As observed by a coordinate bench of this Tribunal, relying upon the landmark Special Bench decision in the case of Motorola Inc v. DCIT [2005] 95 ITD SB 269 (Del) and in the case of Airlines Rotables L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agency permanent establishment', and it's in this light that we have to take note of the analysis of legal position. There can be simple situations in which a foreign enterprise operates through an agent, acting as a franchise, and such a franchise can virtually project business of the foreign enterprise on the soil of another country. Clearly, therefore, just because there is virtual projection of business, as the case is made out by the Assessing Officer, it is to be inferred that that there is a permanent establishment under the basic rule, i.e., Article 5(1) an 5(2), and negate the existence of a dependent agency permanent establishment, as would at best emerge out of the facts marshalled out by the Assessing Officer. As we are examining this aspect of the matter, it may also be useful to refer to the following extracts, defining permanent establishment, from the India Mauritius Double Taxation Avoidance Agreement [1984] 146 ITR (St.) 214]:- 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 the enterprise is wholly or partly carried on. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if: (i) he has and habitually exercises in that first-mentioned State, an authority to conclude contracts in the name of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise; or (ii) he habitually maintains in that first-mentioned State a stock of goods or merchandise belonging to the enterprise from which he regularly fulfils orders on behalf of 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, where such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted exclusively or almost exclusively on behalf of that enterprise, he will not be considered an agent of an independent status within the meaning of this paragraph. 6. The fact that a company, which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ne of us, (i.e. the Vice President), had upheld the two taxpayer approach , in computation of DAPE profits, and observed as follows: 11. The particular difficulty in the case of a dependent agent permanent establishment is that DAPE itself is hypothetical because there is no establishment - permanent or transient- of the GE in the PE state. The hypothetical PE, therefore, must be visualized on the basis of presence of the GE as projected through the PE, which in turn depends on functions performed, assets used and risks assumed by the GE in respect of the business carried on through the PE. The DAPE and DA has to be, therefore, be treated as two distinct taxable units. The former is a hypothetical establishment, taxability of which is on the basis of revenues of the activities of the GE attributable to the PE, in turn based on the FAR analysis of the DAPE, minus the payments attributable in respect of such activities. In simple words, whatever are the revenues generated on account of functional analysis of the DAPE are to be taken into account as hypothetical income of the said DAPE, and deduction is to be provided in respect of all the expenses incurred by the GE to earn suc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ther assume that the reasonable handling costs of Sing Co. for souring the merchandise is 60 per cent on cost. In a particular year, Sing Co. sells goods worth $ 3 million in India. Let us further assume that expenses incurred by Ind. Co., to earn the agency remuneration, is $ 8,99,000. The profits taxable in India, in such a case and based on the treaty provisions before us, should be as follows : A. Commission earned by Ind. Co. $9,00,000 Less : Deductible expenses of Ind. Co $ 8,99,000 Taxable in the hands of the Ind. Co. $ 1,000 B. Profits attributable to Sing Co.'s DAPE in India Sales consideration 30,00,000 Less : Commission paid to Ind. Co. 9,00,000(-) : Cost of purchases 10,00,000(-) : Sing Co.'s handling charges 6,00,000(-) Profit of the DAPE or, in other words, 25,00,000 profits Attribute to India op ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tly with the enterprise of which it is permanent establishment , the taxable profits of the foreign enterprise cannot extend beyond the profit earned by the dependent commission agent. The line of reasoning adopted by the learned counsel is that PE is nothing but the dependent agent, and, the taxability of PE can only, therefore, be in respect of the earnings of the agent. Learned counsel has, with his inimitable oration, erudition and legal skills, woven a complex web of arguments to support this legal proposition. However, as it sometimes happens, the quality of arguments in support of a legal proposition is inversely proportional, proportional if it is, to the merits of the proposition sought to be advanced. This is one such occasion. Let us set out the reasons why we think so, and, in the process, deal with various arguments of the learned counsel one by one. 13. At the outset, we must reiterate that a dependent agent (DA) and a dependent agent permanent establishment (DAPE), in our humble understanding, are two distinct things. As we have stated earlier, it is as a result of existence of a dependent agent that the foreign enterprise is 'deemed to have' a permanent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6] 103 TTJ (Mum.) 8911 which was authored by one of us. This decision, however, did not deal with the peculiarities of a dependent agent permanent establishment. This decision dealt with the taxability of the installation PE, and, the principles dealing with computation of profits of installation PE, in our considered view, do not have any bearing on the computation of profits of the dependent agency PE. We are, therefore, not persuaded by this reasoning either. 12. Late Prof Klaus Vogel, one of the very eminent international tax scholars of our times, had favoured the path adopted by the coordinate bench. In his last in Tax Treaty Monitor (Bulletin for International Taxation, November 2007, page 475), referring to the above coordinate bench decision, he had this to say: One can understand that many have problems imagining how profits should arise to a permanent establishment which, as the Tribunal itself repeatedly stated, does not exist in reality and is a non-entity wholly hypothetical and fictional . Such sceptics should consider, however, that the parent enterprise as a rule will aim to realize receipts from the contracts concluded by the dependent agent which, in addit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mic opinion on the approach to the DAPE profit attribution and that is a highly contentious issue on the first principles. When the matter travelled before Hon'ble High Court, however, these views of the coordinate bench did not find favour with Their Lordships. Rejecting the theory about separate profit attribution for the dependent agency permanent establishment vis- -vis the dependent agent, Their Lordships have, in the judgment reported as Set Satellite Pte Ltd. v. CIT [2009] 307 ITR 205 (Bom), observed as follows: 10. From a reading of Article 7(1) of the DTAA it is clear that 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. The profits of the enterprise may be taxed in the other State but only so much of them as is directly or indirectly attributable to that permanent establishment. In para 2 while determining the profits attributable to the permanent establishment the expression used is estimated on a reasonable basis . The DTAA does not refer to arm's length payment. The principles contained in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt in the affirmative on all three counts. It is in these circumstances that it was held that the advertisement revenue received by the Appellant may be from the customers in India is not liable for tax in India. That CBDT Circulars are binding needs no repetition. If authorities need be cited. We may now refer to the judgment of the Supreme Court in UCO Bank v. CIT [1999] 237 ITR 889. In that judgment the issue was whether Circular of 9-10-1984 was inconsistent or whether there was contradiction in the circular and Section 145 of the Income-tax Act. The Supreme Court observed that :- ... In fact, the circular clarifies the way in which these amounts are to be treated under the accounting practice followed by the lender. The circular, therefore, cannot be treated as contrary to section 145 of the Income-tax Act or illegal in any form. It is meant for a uniform administration of law by all the income-tax authorities in a specific situation and, therefore, validly issued under section 119 of the Income-tax Act. As such, the circular would be binding on the department. (p. 901) See also CIT v. Hero Cycles (P.) Ltd. [1997] 228 ITR 463 (SC). It would thus be clear that the C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of the group companies of Morgan Stanley, Morgan Stanley Advantages Services Pvt. Ltd. (for short MSAS ). An agreement was entered into for providing certain support services to MSCo. MSCo. outsourced some of its activities to MSAS. MSAS was set up to support the main office functions in equity and fixed income research, account reconciliation and providing IT enabled services such as back office operations, data processing and support centre to MSCo. On 5-5-2005 MSCo. filed its advance ruling application . The basic question related to the transaction between the MSCo. and MSAS. The advance ruling was sought on two counts (i) whether the applicant was having PE in India under Article 5(1) of the DTAA on account of the services rendered by MSAS under the services agreement dated 14-4-2005 and if so (ii) the amount of income attributable to such PE. It was ruled that MSAS should be regarded as constituting a service PE under Article 5(2)(1). On the second question the AAR ruled that the transactional net margin method (TNMM) was the most appropriate method for the determination of the Arm's Length Price (ALP) in respect of the service agreement dated 14-4-2005 and it meets th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ese civil appeals. After discussing the various issues the Court in its conclusion held as under :- As regards attribution of further profits to the PE of MSCo. where the transaction between the two are held to be at arm's length, we hold that the ruling is correct in principle provided that an associated enterprise (that also constitutes a PE) is remunerated on arm's length basis taking into account all the risk-taking functions of the multinational enterprise. In such a case nothing further would be left to attribute to the PE. The situation would be different if the transfer of pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise. In such a case, there would be need to attribute profits to the PE for those functions/risks that have not been considered. The entire exercise ultimately is to ascertain whether the service charges payable or paid to the service provider (MSAS in this case) fully represent the value of the profit attributable to his service. In this connection, the Department has also to examine whether the PE has obtained services from the multinational enterprise at lower than the arm's ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... somewhat incongruous from an academic point of view inasmuch as what was considered to be a threshold limit for source taxation ceases to have any relevance for source taxation, and as, on a conceptual note, PE, whether a fixed base PE, DAPE or any other type of PE, provides for threshold limits to trigger taxation in the source state, but then if as a result of a DAPE, no additional profits, other than agent's remuneration in the source country - which is taxable in the source state anyway dehors the existence of PE, become taxable in the source state, the very approach to the DAPE profit attribution may seem incompatible with the underlying scheme of taxation of cross border business profits under the tax treaties. These aspects, however, cannot come in the way of the binding force of judicial precedents from Hon'ble Courts above. The SLP against this decision is said to pending before Hon'ble Supreme Court, but that does not, in any way, dilute the binding nature of this binding judicial precedent. In all fairness to the learned Departmental Representative, however, we may take refer to observations in another coordinate bench decision in the case of Delmas France v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gth remuneration, and nothing further can, therefore, be taxed in the hands of the assessee. 15. It has not been the case of the revenue authorities at any stage that the remuneration paid to the Indian agent is not an arm's length remuneration for the services rendered by the agents concerned, yet a prayer is now made that the matter should be sent back to the assessment stage for detailed findings in this regard. In a written note filed by the learned Departmental Representative, it has been submitted that, it is humbly submitted that in the case of DIT v. Morgan Stanley (292 ITR 416 (SC) The Hon'ble Apex Court in para 32 of its order (page 124 of PB II) has carved out an exception. It has held that 'The situation would be different if transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise. In such a situation, there would be a need to attribute profits to the PE for those functions/risks that have not been considered. Therefore, in each case, the data placed by the taxpayer has to be examined as to whether the transfer pricing analysis placed by the taxpayer is exhaustive of attribution of profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t in a working state from the content provider , that all risks for up linking and finally relaying the signals in India is borne by the transponder company and not the assessee , and, therefore, concluded that in view of the above discussions, it can be seen that major part of the risk in terms of market risk and technology risks are borne by the ZTL/El Zee and that almost 85% to 90% revenues from advertisement and subscription of the assessee comes through Indian viewership which is undoubtedly linked with the PE i.e., ZTL/El Zee . This is not the Indian viewership which is relevant in this context. What was relevant was the role played by the agent in India and whether the remuneration paid by the assessee company, for the services of the agent, was a fair and arm's length remuneration vis- -vis the functions performed, assets employed and risks assumed by the Indian agent. No issues are raised on the inadequacy of agent's remuneration by the Assessing Officer, and now a fresh inning is sought to find these inadequacies and improve the case of the revenue. That is impermissible. In his analysis, while the Assessing Officer has proceeded on sweeping generalizations ab ..... X X X X Extracts X X X X X X X X Extracts X X X X
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