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International Taxation

Case Law Update

Tarunkumar Singhal Sunil Lala
Chartered Accountant  Advocate


 

 

  1. SUPREME COURT

  1. Non-resident – Providing financial advisory services – Setting up Indian company to support main office functions – Non-resident company sending deputationist and stewards to Indian company – Indian company would be service PE – Only on account of deputationist deployed and not on account of stewardship activities.

    No further need to attribute profit to PE – PE is remunerated at arm’s length taking into all risk taking functions of the multinational enterprise – in case service PE – Transactional Net Margin Method – Appropriate method.

DIT (International Taxation) vs. Morgan Stanley and Co. Inc. – [2007] 292 ITR 416 (SC) : 210 CTR 419 : 162 Taxman 165

Indian company performing back office functions for US company does not constitute PE of US company within the meaning of Art. 5(1) of DTAA between India and US, nor does it constitute agency PE; US company sending its employees on deputation to Indian company for a period of two years on the request of Indian company to render their expert services, Indian company constitutes service PE of US company within the meaning of Art. 5(2)(1).

Once the transfer pricing analysis is undertaken, there is no further need to attribute profits to PE which is an associated enterprise, and has been remunerated on an arm’s length basis taking into account all the risk-taking functions of the multinational enterprise; situation would be different if transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise.

Facts

  1.  Morgan Stanley and Co. (a foreign company of the USA) was an investment bank engaged in the business of providing financial advisory services, corporate lending and securities underwriting. Morgan Stanley Advantages Services P. Ltd. (‘MSAS’), an Indian company, was set up to support the main office functions of the USA company in equity and fixed income research, account reconciliation and providing IT enabled services such as back office operation, data processing and support centre.
     

  2. The Indian company entered into an agreement with the foreign company, whereby the foreign company outsourced some of its activities to the Indian company. The USA company sought rulings from the Authority for Advance Rulings on: (i) whether it had a Permanent Establishment (‘PE’) in India under Article 5(1) of the India-USA Tax Treaty on account of the services rendered by the Indian company under that agreement, and, if so, (ii) the amount of profits attributable to such PE.
     

  3. The Authority ruled, inter alia, that : (i) the applicant (USA company) could not be regarded as having a fixed place of business PE under Article 5(1) of the Tax Treaty, (ii) the Indian company could not be regarded as an agency PE under Article 5(4); (iii) that the applicant would be regarded as having a PE if it were to send some of its employees to India as stewards or deputationists in the employment of the Indian company; and (iv) that so long as MSAS was remunerated for its services at arm’s length no further income could be attributed in the hands of the PE of the applicant. Both the applicant, the USA company, and the Department preferred cross appeals to the Supreme Court.

Judgment

The Supreme Court held that:

  1. It was clear from the agreement with the Indian company that the Indian company would be engaged in supporting the front office functions of the USA company in fixed income and equity research and providing IT enabled services such as data processing support centre and technical services as also reconciliation of accounts. The Authority was correct in ruling that Article 5(1) of the India-USA Tax Treaty (‘Tax Treaty’) was not applicable as the Indian company would be performing only back office operations in India.
     

  2. There was no agency PE in India as the Indian company had no authority to enter into or conclude contracts. The contracts would be entered into in the USA and would be concluded there. The implementation of those contracts only to the extent of back office functions would be carried out in India. The back office operations proposed to be performed by the Indian company in India would fall under Article 5(3)(a) of the said Tax Treaty and would not, therefore, constitute a fixed place PE under Article 5(1) as the second requirement of Article 5(1) was not satisfied. To this extent also the Authority was correct in its ruling.
     

  3. That the object of the stewardship activities, which involved briefing of the staff of the Indian company, was to ensure that the output met the requirements of the foreign company and protected its interests. By these activities the foreign company was merely protecting its own interests in the competitive world by ensuring the quality and confidentiality of the services of the Indian company. The Authority was not, therefore, correct in ruling that these activities would fall under Article 5(2)(1) of the Tax Treaty.
     

  4. That where the activities of a multi-national enterprise entailed its being responsible for the work of the deputationists and the employees continued in the payroll of the multi-national enterprise or to have their lien on their jobs with the multinational enterprise a service PE emerged. The employee deputed was expected to be experienced in banking and finance and lent his experience to the Indian company as an employee of the foreign company and he retained his lien and in that sense there was (deemed) service PE under Article 5(2)(1) of the Tax Treaty. And the Authority was correct in so ruling.
     

  5. That the transactional net margin method (TNMM) was the appropriate method of quantifying the profits of the foreign company in the case of a service PE (as in this case) because under the TNMM the total operating profit arising from the transaction was apportioned on the basis of sales, costs, assets, etc.
     

  6. That the Authority was correct in principle in its ruling as regards there being no need for attribution of further profits to the PE of the foreign company where the transaction between the two was held to be at arm’s length, but this was only provided that the associate enterprise (that constituted a PE) was remunerated at arm’s length basis taking into account all the risk-taking functions of the multi-national enterprise. The situation would, however, be different if the transfer pricing analysis did 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 had not been considered. The entire exercise ultimately was to ascertain whether the service charges payable or paid to the service provider (the Indian company, in this case) fully represented the value of the profit attributable to its service. In this connection the Department had also to examine whether the PE had obtained services from the multi-national enterprise at lower than the arm’s length cost. Economic nexus was an important aspect of the principle of attribution of profits.
     

  7. There is a difference between the taxability of the PE in respect of its income earned by it in India which is in accordance with the Income-tax Act, 1961 (the Act), and the taxability of the multinational enterprise through its PE in India under Article 7 of the Double Taxation Agreement. In the case of the multi-national enterprise the taxable unit is the foreign company.
     

  8. Section 92F(iiia) of the Act, provides that PE would include a fixed place where the business of the multinational enterprise is wholly or partly carried on. This is where the difference lies between the definition of "PE" in the inclusive sense under the Act as against the definition of "PE" in the exhaustive sense under the Double Taxation Agreement.

Case referred to

Morgan Stanley and Co. Inc., In Re [2006] 284 ITR 260 (AAR)

  1. Tribunal Decisions

  1. TDS u/s 195 from Reimbursement of Expenses – Obligation only with reference to income element embedded in the remittance – No income element in reimbursement of expenses – No liability to deduct TDS u/s 195(1)

 

ACIT vs. Modicon Network (P.) Ltd. [2007] 14 SOT 204 (Delhi)

Facts

  1. The assessee-company was created as a joint venture vehicle of three companies, viz., ‘M’ (a company incorporated in India), ‘HK’ (a company incorporated in Hong Kong), and ‘MI’ (a company incorporated in the USA) which formed a consortium for the purpose of bidding for operation GSM-based cellular services in India.
     

  2. The respective consortium members undertook to bear their own pre-bid expenses till such time the bid was successful. The understanding was that as soon as the joint venture vehicle was created, the respective members of the consortium would become entitled to get their share of the pre-bid expenses reimbursed out of the capital of the assessee-company.
     

  3. Since the HK company lacked the expertise to draw up the pre-bid documents, it had engaged the services of another consultancy firm. The consultancy firm, therefore, rendered services to the assessee-company. The HK company, therefore paid certain amount to the consultancy agency and raised an invoice for the amount on the assessee-company, under the terms of the consortium arrangement, to get reimbursed.
     

  4. The assessee-company was permitted by the RBI to make a remittance to the HK company. The assessee, thereafter, made an application under section 195(1) to the A.O. seeking permission to remit the amount without deduction of income-tax and also submitted before the A.O that since the amount was being remitted only towards reimbursement of pre-bid expenses, there was no income element embedded therein and that the remittance could not also be considered as fees for technical services (‘FTS’) because no technical services of any kind were rendered by the HK company.
     

  5. The A.O. refused to accept the claim of the assessee on the grounds that the provisions of section 9(1)(vii), read with Explanation 2 thereto, defining the expression ‘fees for technical services’ were applicable to the instant case and that the assessee-company was getting the technical services through the HK company which was acting as its agent in Hong Kong and had made the payment on behalf of the assessee-company. He, therefore, held that the payments made by the assessee to the HK company towards professional and consultancy fees to the consultancy agency would be treated as income and tax would be charged @ 30% as per section 115A.
     

  6. On appeal, the Commissioner (Appeals) upheld the action of the Assessing Officer. He, however, held that the assessee was liable to deduct tax u/s 195(1) only on the income embedded in the remittance and that the Assessing Officer was not right in directing the assessee to deduct tax at 30% on the entire amount remitted. He estimated the income element embedded in the remittance at 20% of the same and directed tax to be deducted at 30% on 20% of the amount remitted.

Decisions

On revenue’s appeal ; the Tribunal held in favour of the assessee as under:

  1. Under section 195(1), any person responsible for paying to a non-resident any interest or any other sum chargeable under the provisions of the Act (except salaries) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof, whichever is earlier, deduct income-tax thereon at the rates in force. Under sub-section (2), the person paying the amount, if he considers that the whole of the amount would not be income chargeable to tax in the hands of the recipient, may make an application to the Assessing Officer to determine the appropriate proportion of such sum so chargeable and upon such determination, the tax shall be deducted only on the chargeable proportion of the amount. Therefore, the obligation to deduct tax is only with reference to the income element embedded in the remittance.
     

  2. The main question that arose for consideration in the instant case was as to whether the amount remitted by the assessee to the HK company contained any income element so as to fasten liability upon the assessee to deduct tax thereon at the appropriate rate. The Assessing Officer had taken the view that the amount represented FTS in terms of Explanation 2 below section 9(1)(vii) and, therefore, the assessee was liable to deduct the tax. A look at the above Explanation shows that it contains a definition of FTS and says that FTS means any consideration for the rendering of any managerial, technical or consultancy services including the provision of services of technical or other personnel, but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head ‘Salaries’. The content of the Explanation unmistakably is that the payment must be made as quid pro quo for such services rendered as have been enumerated therein. It postulates that the remitter of the amount has received the benefit of the technical services and that the technical services have been rendered by the recipient of the amount. In the instant case, the HK company had not rendered any services, let alone technical services, to the assessee-company for which the amount was remitted. The services were rendered by a consultancy firm engaged by the HK company. The HK company paid the consultancy agency and sought reimbursement of the same from the assessee-company in terms of the consortium arrangement. Thus, the amount remitted by the assessee-company was only by way of reimbursement of the expenses incurred by the HK company and not by way of consideration for rendering any services which were technical services. There was no evidence on record to show that the HK company and the agency firm engaged by it were connected in any manner or that the entire transaction was a pre-planned or premeditated arrangement devised in order to avoid the provisions of tax deduction at source. Therefore, it could not be said that the remittance was, in truth and reality, consideration for technical services disguised as reimbursement of the expenses.
     

  3. In the very nature of things, reimbursement of expenses cannot be considered as having an income element embedded therein so as to attract section 195(1). If under a bona fide arrangement, there is a provision for reimbursement of expenses to the parties, which they incur in furtherance of a common objective, such reimbursement cannot be considered as bearing the character of income. In the instant case, there was no dispute about the genuineness or bona fide of the terms of arrangement between the partners of the consortium. Since the HK company lacked the expertise to draw up the pre-bid documents, it had to engage the services of another consultancy firm. It paid the consultancy firm and raised an invoice for the amount on the assessee-company, under the terms of the consortium arrangement, to get reimbursed. The argument of the department was that the nature of the remittance as FTS did not change merely because the HK company had to engage another agency to prepare the pre-bid documents. The argument could not be accepted having regard to the objective of the consortium and the agreement between the partners of the consortium to the effect that the pre-bid expenses incurred by them would be reimbursed by the joint venture vehicle. The reimbursement per se cannot bear the character of income. Thus, the preliminary question, namely, whether the amount remitted would in its entirety or partly be considered as income of the HK company had to be resolved in favour of the view that it being a mere reimbursement, it could not be so considered.
     

  4. The evidence brought on record by the assessee showed that what it wanted to remit abroad to the HK company was only by way of reimbursement without any element of profit or income embedded therein. No material had been brought on record to show that the expenses included an income element.

Since there was no income element in the remittance made by the assessee to the HK company, the orders of the lower authorities were to be set aside.

Cases referred to

  1. Transmission Corpn. of AP Ltd. vs. CIT [1999] 239 ITR 587/105 Taxman 742 (SC)
     

  2. CIT vs. Industrial Engg. Projects (P.) Ltd. [1993] 202 ITR 1014 (Delhi),
     

  3. Hyderabad Industries Ltd. vs. ITO [1991] 188 ITR 749/59 Taxman 202 (Kar.),
     

  4. CIT vs. Neyveli Lignite Corpn. Ltd. [2000] 243 ITR 459/109 Taxman 369 (Mad.)
     

  5. DECTA, In re [1999] 237 ITR 190/103 Taxman 525 (AAR)
     

  6. Rolls Royce India Ltd. vs. ITO [1988] 25 ITD 136 (Delhi)(TM),
     

  7. CIT vs. S.G. Pgnatale [1980] 124 ITR 391/4 Taxman 79 (Guj.) and
     

  8. SEDCO Forex International Drilling Inc. vs. Dy. CIT [2000] 72 ITD 415 (Delhi)

  1. Presumptive taxation u/s 44BB – Only that part of receipt of mobilization charges, which was attributable to activities carried out in India, was liable to be included in receipts for purpose of computing presumptive income u/s 44BB – Whether amounts reimbursed to assessee could not be included in amounts referred to in section 44BB

R & B Falcon Drilling Co. vs. ACIT [2007] 14 SOT 281 (Delhi)

Facts

  1. The assessee, a non-resident, had received certain amount from an Indian company ‘C’ engaged in exploration of petroleum, on account of mobilization charges. The major part of mobilization charges pertained to mobilization of the drilling rig from Bombay High to Sharjah. The assessee claimed that the whole mobilization charges were not taxable in India, as a major part of mobilization work was done outside Indian territorial waters and, therefore, only that part of the charges, which pertained to the work done in Indian territorial waters, should be taxed in India.
     

  2. The assessee further contended that the instant case was covered by the Third Member decision of the Delhi Tribunal rendered in the case of Saipem SPA vs. Dy. CIT [2004] 88 ITD 213. However, the A.O. disallowed the assessee’s claim and relying on the decision of the Delhi Bench of the Tribunal rendered in the case of Sedco Forex International Drilling Inc. vs. Dy. CIT [2000] 72 ITD 415 considered whole of the mobilization charges for the purpose of computing presumptive income under section 44B.
     

  3. The Assessing Officer also included the amounts paid to the assessee being reimbursement of expenses such as, meals, accommodation charges and consumables on cost, etc., in the receipts for finding out presumptive income under section 44BB. On appeal, the Commissioner (Appeals) upheld the impugned order.

Decision

On Second Appea, the Tribunal held in favour of the assessee as under:

  1. Section 44BB contains special provision for computing of profits and gains in connection with the business of exploration, etc., of mineral oils and provides that such profits in the case of non-resident person shall be a sum equal to ten per cent of the aggregate of the amounts specified in sub-section (2). Clause (a) of sub-section (2) of section 44BB provides that the amount paid or payable, whether in or out of India, on account of the provision of services and facilities in connection with, or supply of plant and machinery on hire used or to be used, in the prospecting for, or extraction or production of mineral oil in India is includible in the receipt mentioned in section 44BB. Thus, the said clause takes into its ambit the amount paid or payable in or out of India on provision of services, etc., for supply of plant and machinery for extraction or production of mineral oil in India. Clause (b) of sub-section (2) of section 44BB includes in its ambit the amount received or to be received in India for provision of services, etc., in connection with exploration of mineral oil outside India.
     

  2. In the instant case, the services were rendered by the assessee for production for mineral oils in India and, therefore, the facts lead to the prima facie conclusion that mobilization charges, whether paid in India or outside India, were includible in the receipts for the purpose of computing presumptive income under section 44BB. Further, following the decision of the Tribunal in the case of Saipem SPA, which was squarely applicable to the instant case, it was to be held that only that part of the receipt of the mobilization charges, which was attributable to the activities carried out in India, was liable to be included in the receipts for the purpose of computing presumptive income under section 44BB.
     

  3. Further, following the decisions of the Tribunal rendered in the cases of Saipem SPA and Sedco Forex International Drilling Inc., it was to be held that the amounts reimbursed to the assessee could not be included in the amounts referred to in section 44BB. [Para 6.2]

Cases referred

  1. Saipem SPA vs. Dy. CIT [2004] 88 ITD 213 (Delhi) (TM),
     

  2. Sedco Forex International Drilling Inc. vs. Dy. CIT [2000] 72 ITD 415 (Delhi)
     

  3. Dual Offshore Ltd. vs. Asstt. CIT [IT Appeal No. 2215 of 1997, dated 18-3-2002],
     

  4. Dy. CIT vs. Ensco Maritime Ltd. [IT Appeal No. 3869 (Delhi) of 2002, dated 15-2-2006],
     

  5. Dy. CIT vs. Dual Offshore Ltd. [IT Appeal No. 1400 (Delhi) of 2003, date
     

  6. d 8-3-2006],
     

  7. Asstt. CIT vs. Transocean Offshore Deep Water Drilling Inc. [IT Appeal No. 3906 (Delhi) of 2005, dated 11-10-2006] and
     

  8. Asstt. CIT vs. Atwood Oceanics Pacific Ltd. [IT Appeal No. 4755 (Delhi) of 2005, dated 12-10-2006]

  1. Non-resident company – Liability to Interest u/ss. 234A and 234B – Entire income liable to TDS u/s 195 – Held that the assessee liable to interest u/s 234A but not u/s 234B.

Jt. DIT vs. Booz Allen & Hamilton Inc. 2007] 13 SOT 10 (Mum.)

Facts

The assessee-company was the representative assessee of a NRI company ‘B’ u/s 163. The company ‘B’ had received various payments, on which tax was deductible at source as per the provisions of section 195. The assessee filed the return of income of company ‘B’ belatedly declaring nil income, on the ground that the payments received by the NRI company ‘B’ from other NRI companies could not be brought to the charge of tax under the provisions of the Act. The A.O. rejected the claim and assessed the payments received by the company ‘B’ in the hands of the assessee. The Assessing Officer also levied interest under sections 234A and 234B upon the assessee.

On appeal, the Commissioner (Appeals) confirmed the quantum of the assessed income, but deleted the interest charged under both the sections, holding that it was a case of a non-resident assessee, where any sum chargeable to tax was liable to deduction of tax at source under section 195.

Decision

On revenue’s appeal : the Tribunal held as under:

  1. Interest under section 234A is chargeable where the return of income is not furnished before the due date. Such interest is chargeable on the amount of the tax on the total income, as determined under section 143(1), or on regular assessment, as reduced by the advance tax paid and any tax deducted or collected at source. Thus, such interest is leviable when return of income is filed late by the assessee and the calculation of interest is based upon the tax, after allowing credit for the advance tax and tax, which is deducted at source. Section 234A refers to ‘tax deducted’ and not ‘tax deductible’. On the other hand, the liability for levy of interest under section 234B arises in a case, where an assessee, who is liable to pay advance tax, has failed to pay such tax or where there is shortfall in payment of advance tax. The defaults, for which interest is chargeable under sections 234A and 234B, are separate and distinct. Before interest under section 234B is charged, it must be established that the assessee is liable to pay advance tax under section 208. There is no such requirement for levy of interest under section 234A. Hence, irrespective of the fact as to whether advance tax has been paid or not, interest under section 234A will be chargeable, if there is a delay in filing return of income.
     

  2. In the instant case, the return had been delayed and the tax had not been paid before the due date for filing the return of income. The assessee had contended that on the entire income tax was deductible at source and further, the return of income was filed declaring nil income. These contentions were not relevant for the purpose of charging of interest under section 234A. The liability for payment of advance tax is determined, after taking into account the tax deductible at source. However, the return of income for the relevant assessment year is required to be filed in the subsequent financial year and before filing the return of income, the assessee is well aware as to whether any tax at source has been deducted or not. The assessee is liable to levy of interest under section 234A on the assessed tax, as reduced by the advance tax actually paid and the tax actually deducted at source. In the instant case, the liability for levy of interest under section 234A had arisen on account of the additions made by the Assessing Officer and, therefore, even though interest under section 234A is mandatorily leviable, yet such interest has to be consequential to the quantum of tax determined as payable. Since the assessee’s quantum appeal was pending before the Tribunal, the Assessing Officer was to be directed to recalculate the interest chargeable under section 234A on correct tax, after giving effect to the Tribunal’s order in the quantum appeal.
     

  3. In terms of decision of the Special Bench of the Delhi Tribunal, in the case of Motorola Inc. vs. Dy. CIT [2005] 95 ITD 269, which was squarely applicable to the instant case, on the issue of levy of interest under section 234B, the interest under section 234B was not leviable upon the assessee, as the entire income was subjected to tax deductible at source. The liability for payment of advance tax arises under section 208 and the advance tax payable has to be computed under section 209. Section 209(1)(d) clearly stipulates that income-tax shall be reduced by the amount of income-tax, which would be deductible or collectible at source during the relevant financial year. Hence, the Assessing Officer was to be directed to delete the interest levied under section 234B.

Cases referred

  1. Asia Satellite Telecommunication Co. Ltd. vs. Dy. CIT [2003] 85 ITD 478 (Delhi),
     

  2. Motorola Inc. vs. Dy. CIT [2005] 95 ITD 269 (Delhi)(SB),
     

  3. CIT vs. Borhat Tea Co. Ltd. [1992] 193 ITR 134/[1993] 66 Taxman 11 (Cal.),
     

  4. Fisons PLC vs. Dy. CIT [2004] 91 ITD 450 (Mum.),
     

  5. SEDCO Forex International Drilling Inc. vs. Dy. CIT [2000] 72 ITD 415 (Delhi),
     

  6. M.M. Ratnam vs. ITO [1997] 62 ITD 21 (Mum.)(TM),
     

  7. Dr. Prannoy Roy vs. CIT [2002] 254 ITR 755/121 Taxman 314 (Delhi) and
     

  8. Milan Enterprise vs. Asstt. CIT [2005] 95 ITD 18 (Mum.)

 

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