TMI Blog2022 (5) TMI 1513X X X X Extracts X X X X X X X X Extracts X X X X ..... phold the plea of the assessee to this extent. - Decided in favour of assessee. - ITA No.863/Mum/2021 - - - Dated:- 30-5-2022 - Pramod Kumar (Vice President), and Sandeep Singh Karhail (Judicial Member) For the Applicant : Ninad Patade For the Respondent : K.C. Selvamani ORDER Per Pramod Kumar, VP: 1. By way of this appeal, the assessee-appellant has challenged the correctness of the order dated 26.02.2021, passed by the learned CIT (DRP-2), Mumbai in the matter of assessment under section 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961, for the assessment year 2017-18 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 INR 10,62,80,020 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 the absence of Permanent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or sale of such Novell Software products in relation to which the income is sought to be taxed in India. 7. Without Prejudice to the Ground No.1 to Ground 6, on the facts and in the circumstances of the case and in law, the Learned Assessing Officer erred in attributing the revenues of IN 28,36,961 from sale of Novell Software products made by appellant directly to third parties to the alleged DAPE without appreciating the fact that such sales made to third parties were not effected through NSDIPL and taxing it as business income applying the arbitrarily profit ratio as stated at Ground No. 6 above. 8. Without Prejudice to the Ground No. 1 to Ground No. 7, on the facts and in the circumstances of the case and in law, the Learned Assessing officer erred in levying interest under section 234A of the Act of INR 3,344 even though Company has filed the return of income within due date as per section 139(1) of the Act. 9. The levy of interest under section 234B of the Act is consequential in nature. 3. The issues raised in this appeal, as learned representatives fairly agree, are covered in favour of the assessee, by a decision of coordinate bench dated 31st August ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny 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 Ltd. v. JDIT [1911] 44 SOT 368 (Mum), The physical test, i.e., place of business test, requires that there should be a physical location at which the business is carried out. However, mere existence of a physical location is not enough. This ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 2. The term permanent establishment shall include (a) a place of management ; (b) a branch ; (c) an office ; (d) a factory ; (e) a workshop ; (f) a warehouse, in relation to a person providing storage facilities for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bitually 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 that other Contracting State (whether through a permanent establishment or otherwise) shall not, of itself, constitute either company a permanent establishment of the other. 11. The case of the Revenue is thus clearly confined to the existence of D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 such revenues, including, of course, the remuneration paid to the DA. The second taxable unit in this transaction is the DA itself, but this taxability is in respect of the remuneration of the DA. The provisions of the tax treaty are silent on this issue, and right ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uneration, 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 operations of the Sing Co. $ 5,00,000 As far as 'A' in the above example is concerned, it does not have anything to do with the income of the foreign company. This taxability is in the hands of the domestic dependent agent and is on net basis after taking into account the expenses incurred by the agent for earning of remuneration whether or not the same relates to the business of the foreign company or not. As regards 'B' above, it represents the earnings of the foreign company attributable to the dependent agent permanent establishment, on account of it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 establishment in the country in which dependent agent is situated. 14. Under Article 7 of the treaty, the taxability is of the foreign company. What is taxable under Article 7 is profit earned by the foreign enterprise, as it Article 7(i) provides 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 . Agency remuneration paid by the foreign enterprise is not an income of the foreign enterprise but an expenditure of the foreign enterprise. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 addition to compensating the agent's fee, include a surplus profit, for otherwise the parent would lack any commercial reason for employing the agent. This surplus is not- or only secondarily- attributable to activities in the parent's residence country. Rather, it is a profit that the parent obtains through employing the agent in the country in which the profits arise. Fairness ( inter-nations equity ) requires that the surplus profit be taxed in that state. If the drafters of a treaty or model treaty want to provide this, they must notionally attribute it to a contact in that state. This does not mean that they mu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 matter of income from international transaction on an arm's length price are contained in section 92 of the Income-tax Act. The principles have been clarified by the Finance Act, 2001 as also Finance Act, 2002. From the order of the CIT, which has been accepted it is clear that the Appellant herein has paid to its PE on arm's length principle. It recorded a finding of fact that the Appellant had paid service fees at the rate of 15 per cent of gross ad revenue to its agent, SET India, for procuring advertisements during the period April 1998 to October, 1998. The fact that 15 per cent service fee is an arm's ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Circular No. 23 would be binding on the Assessing Officer and had to be considered while assessing the tax liability of an assessee. The Tribunal in its judgment has not considered the effect of the finding recorded by the CIT (Appeals) based on the Circular and which circular was relevant for the purpose of deciding the controversy in issue. This circular read with Article 7(1) of the DTAA would result in holding that the income from advertisement if neither directly nor indirectly attributable to that of the permanent establishment, would not be taxable in India. The Tribunal in fact in para 10 has recorded a finding t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s (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 the test of arm's length as prescribed under section 92C of the 1961 Act and no further income was attributable in the hands of MSAS in India. The said ruling of AAR on the question of income attributable to the PE was the subject-matter of challenge by the Department. Insofar as the issue of PE is concerned the Supreme Court was pleased to hold that it agreed with the Ruling of the AAR that stewardship activities would fall under Article 5(2)(1). Dealing with the question of deputation, the Court held that on the facts that there is a service PE under Article 5(2)(1) and as such held that the Department was right in its c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 length cost. In our opinion considering the judgment, if the correct arm's length price is applied and paid then nothing further would be left to be taxed in the hands of the Foreign Enterprise. 13. Considering the above principle as may be discerned from the judgment in DIT (International Taxation) 292 ITR 416 (supra) it would be clear that (1) Considering the CBDT Circular No. 742 it would be fair and reasonable that the taxable income is computed at 10 per cent of the gross profits. In the instant case insofar as marketing services are concerned by the arm's length principle what has been paid is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith 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. ADIT [2012] 17 taxmann.com 91 (Mum), to the effect, Similarly, before accepting DAPE profit neutrality theory, we will still have to deal with learned Departmental Representative's plea that as per the law laid down by Hon'ble Supreme Court in the case of DIT v. Morgan Stanley Co Inc. [2007] 162 Taxman 165 (SC), the arm's length remuneration paid to the PE must take into account 'all the risks of the foreign enterprise as assumed by the PE', but then in an agency PE situation, unlike a service PE situation which was the case before the Hon'ble Supreme Court, a DAPE assumes the entrepreneurship risk in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 and that would depend on the corporates on the basis of the concept of Economic Nexus is an important feature of Attributable Profits (profits attributable to the PE)'. Taking into considering the above and applying to the facts of the case, it is humbly submitted that all the international transactions entered into by assessee have not been examined by the authorities below . There is no material whatsoever before us to show, or even indicate, that the remuneration paid to the agents is not arm's length remuneration. In any case, the agent has been paid a remuneration at the rate of ten percent of the related revenues w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 about the risks assumed by the PE but there is no specific FAR analysis which could support that the agent's remuneration not being an arm's length remuneration, and the Assessing Officer has proceeded on the basis that all the business risks of the assessee (i.e. the foreign company) are borne by the PE as PE is the content provider and responsible for up linking activity. That's too sweeping a generalization to meet any judicial approval, and, on the same set of findings, the coordinate benches have disapproved the stand of the Assessing Officer. Under these circumstances, we see no reasons to remit the matter to the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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