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International Taxation

Case Law Update

  1. Tribunal decisions

  1. [2007] 106 ITD 175 (Mum.) Deputy

Director of Income-tax, International Taxation, Range 2(1), Mumbai vs. Set Satellite (Singapore) (Pte.) Ltd. [Assessment Year 1999-2000]

Section 9 of the Income-tax Act, 1961, read with articles 5 and 7 of India Singapore Double Taxation Avoidance Agreement – Income – Deemed to accrue or arise in India – Assessment year 1999-2000 – Dependent agent and dependent agent permanent establishment cannot be one and same thing, but on the contrary, it is by virtue of an enterprise having a dependent agent, that enterprise is deemed to have a permanent establishment. As per article 7 of India–Singapore Tax Treaty, what is to be taxed, is income of foreign enterprise attributable to permanent establishment in the host country; agency remuneration paid by foreign enterprise to its dependent agent is not its income but an expenditure and, therefore, it cannot be said that by payment of tax liability by dependent agent, tax liability of foreign enterprise is also discharged. Therefore, in addition of taxability of dependent agent in respect of remuneration earned by him, which is in accordance with domestic law and which has nothing to do with taxability of foreign enterprise of which he is dependent agent, foreign enterprise is also taxable in India, in terms of provisions of article 7 in respect of profits attributable to dependent agent permanent establishment.

Facts

  1. The assessee was a foreign company having a Dependent Agent (DA) in India. It had remunerated the agent on an arm's length basis for the services rendered by the agent. As regards its tax liability in India, the assessee submitted that having remunerated the agent on an arm's length basis and the agent having offered said payment for taxation, no further profits of the assessee could be taxed in India other than the profits so earned by the DA.

  2. The A.O. rejected the contention of the assessee.

  3. The Commissioner (Appeals), however, reversed the order and allowed the assessee’s claim. It was further held that the advertisement revenue earned by the assessee was not taxable in India, on the ground that the assessee had paid an arm's length remuneration to the DA for the services rendered by the latter.

Decision

On appeal; the Tribunal held in favour of the revenue as follows:

  1. When an enterprise acts in the other Contracting State through a ‘dependent agent’ who satisfies at least one of the tests set out in article 5(8), such an enterprise is deemed to have a PE in the other Contracting State. This deemed PE is wholly hypothetical and fictional, because in strict sense of the word, there is no PE at all.

  2. It is, however, important to note that what is defined as a permanent agent is not the dependent agent per se, but on the contrary, it is by virtue of an enterprise having a DA that the enterprise is deemed to have a PE. A DA cannot, strictly speaking, be termed as PE because neither the DA belongs to the PE, nor can one have something as a result of having the same thing; i.e., if a DA is itself a PE, one cannot have a PE as a result of having a DA. In such a case, the Treaty could have simply stated that a DA or agency shall be deemed to be PE of the enterprise; there was no need to say, as has actually been said, that an enterprise shall be deemed to have a PE by virtue of having a DA and meeting one of tests set out in the relevant sub-article. DA and the DAPE, therefore, cannot be one and the same thing.

  3. The rationale for DAPE is simple. A foreign enterprise may choose between performing business activity itself, and having it done through a domestic agent. In case, foreign enterprise prefers to perform the business activity through a domestic agent, it does not need to depend on the right to use a fixed place of business. The business activity is carried out through an agent, and a DA at that. However, taxation would infringe neutrality in the event the tax position of a foreign enterprise is to depend on whether the business activity is carried out by the foreign enterprise directly or whether the foreign enterprise conducts business activity through an agent — who, being a DA, is integrated into principal’s business to a large extent. In case the tax position is to vary based only on whether or not the business activities are carried out directly or through an agent, it would be a bit too easy to circumvent the PE taxation, if no PE taxation is to be applied to the DAPE. Whether one carries on the business directly or through the DA, the profit attributable to such business continues to be taxable in the source country. This is the unmistakable underlying principle behind the DAPE clause in the Treaties.

  4. The profit computations of the PE have to proceed on the basis that the PE is wholly independent of its General Enterprise (GE) which, from a purely accounting and commercial point of view, generally means nothing more than the hypothesis that intra organization transactions are to be taken into account at arm's length price. It is important to bear in mind the fact that in the case of intra organization transactions within an enterprise, there are several ways of accounting for the same, e.g., at cost, at transfer price, at arm's length price or simply at fair market price. Article 7(2), thus, provides that the arm's length price is the criterion for computation of these hypothetical profits. Such profits cannot be determined otherwise than hypothetically and, therefore, no more than approximately, if at all, because in practice, there is no such thing as unrelated enterprise available for comparison and satisfying completely all the conditions. The two-step process in so computing the profits, therefore, involves identifying the PE, proceedings to compute hypothetical profits of the PE by taking into account PE-GE transactions at an arm's length price.

  5. The particular difficulty in the case of a DAPE 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 the DA have to be, therefore, 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 rightly so, because the taxability of the DA is quite distinct from the taxability of the enterprise of the Contracting State which is in respect of PE of such an enterprise. It is not the DA who constitutes PE of the GE, but it is by virtue of a DA that the GE is deemed to have a PE, a DAPE though, in the other Contracting State. In addition of the taxability of DA in respect of remuneration earned by him, which is in accordance with the domestic law and which has nothing to do with the taxability of the foreign enterprise of which he is DA, the foreign enterprise is also taxable in India, in terms of the provisions of article 7 of the Tax Treaty, in respect of the profits attributable to the DAPE. A DAPE is distinct from the DA.

  6. While computing the profits of this DAPE, a deduction is to be allowed for the remuneration paid to the DA as that is cost of operation of the DAPE and as it has been incurred for generating the revenues attributable to such hypothetical PE. What is to be taxed under article 7, is income of the foreign enterprise attributable to the PE in the host country. The income attributable to the PE in the host country is the income attributable to foreign company’s operations in the host country, which, in turn implies the income attributable to the activities carried on by the foreign enterprise in the host country. However, it is open to the foreign enterprise to claim appropriate adjustment for the foreign enterprise’s overheads and even a reasonable charge, on account of activities of the foreign enterprise carried on outside the host country, by treating the foreign enterprise as a fictionally separate entity.

  7. Agency remuneration paid by the foreign enterprise is not an income of the foreign enterprise, but an expenditure of the foreign enterprise. The taxability of any profit under article 7 has to be in the hands of the foreign company and not the host country of which DA is resident. Therefore, it is patently erroneous to suggest that by payment of tax liability by the DA, tax liability of the foreign-principal is discharged. So far as article 7 is concerned, it deals with the taxability of the foreign company.

  8. As a matter of fact, in case the plea of the assessee was to be accepted, the whole concept of agency PE would be rendered meaningless. The profits earned by the DA, or even independent agent, are any way to be taxed in the host country of which the dependent agent is resident. The existence of the PE would, therefore, be rendered meaningless by the interpretation sought to be canvassed by the assessee. It is well-settled that no law or treaty can be interpreted in such a manner so as to make a clause meaningless. The interpretation is required to be made ut res magis valeat quam pereat, i.e., making it effective rather than making it redundant.

  9. Therefore, the tax liability of a foreign enterprise, in respect of its DAPE, is not extinguished by making an arm's length payment to the DA. There was no dispute in the instant case to the extent that the assessee-company had a DA in India; and that the profits of the DAPE were, therefore, taxable in India. The relief given by the Commissioner (Appeals) by holding that the taxability of arm's length remuneration to the DA extinguished the tax liability of DAPE as well, was unjustified and the same was to be vacated.

Cases referred to

  1. Dy. CIT vs. Roxon Oy [2006] 10 SOT 454 (Mum.)

  2. Morgan Stanley & Co., USA, In re [2006] 284 ITR 260 (AAR-New Delhi)

  3. Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706 (SC)

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

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

  6. Fisons PLC vs. Dy. CIT [2004] 91 ITD 450 (Mum.) & Motorola Inc. vs. Dy. CIT [2005] 95 ITD 269 (Delhi) (SB)

Author’s Note

  1. The Supreme Court in the case of DIT (International Taxation vs. Morgan Stanley & Co. Inc [2007] 292 ITR 416 (SC) rendered subsequent to the Tribunal’s Order, has taken in view in favour of the assessee. The Department has filed a Review Petition which is pending before the Supreme Court.

  2. The Tribunal upheld order of the Commissioner (Appeals) holding that the assessee-company being a non-resident and the entire income being subject to tax deduction at source under section 195, no liability under sections 234B and 234C would arise.

  1. Taxability of business profits – Permanent Establishment not in existence in the year of receipt of Income – Whether taxable in India under Indo-Netherlands Tax Treaty – Held Yes – Whether claim for set off of Unabsorbed Depreciation and Current Depreciation to be allowed — Held: No if the same has been set off against the Income of the H.O. – Claim for arbitration expenses allowed

[2007] 105 ITD 97 (Mum.) Vanoord Dredging & Marine Contractors bv vs. DDIT (International Taxation) (10), Mumbai [Assessment Year 2001-02]

As per various articles in Double Taxation Avidance Agreement between India and Netherlands, there is no condition, for taxability of income received by assessee in India, that in year of receipt of that income, there should be a Permanent Establishment (PE) in India or assessee-company should have a separate PE for each of its projects in year of receipt of income Held, yes – Assessee, tax resident of Netherlands, was an international dredging contractor – During relevant assessment year, it executed contracts in India for which, it established project/site offices in India – In return of income for relevant assessment year, it did not include certain income received in relevant assessment year in relation to NMPT project, which was completed by it in financial year 1995-96, contending that in absence of PE in relation to said project in relevant assessment year, said amount was not taxable as per various clauses of Indo-Netherlands Tax Treaty – Assessing Officer, however, made addition of said amount treating same as income from assessee’s discontinued business under section 176(3A) – Commissioner (Appeals) affirmed said order – Whether income received from NMPT being attributable to PE in India and there being no condition in Treaty that PE should be in existence in India in year of receipt of amount by enterprise, amount received by assessee from NMPT had rightly been taxed as assessee’s income for assessment year under consideration — Held, yes — Whether however, such income was not to be taxed on gross basis and allowable deductions in relation thereto were to be allowed, if had not been allowed in earlier assessment year — Held, yes

Facts

  1. The assessee, tax resident of the Netherlands, was an international dredging contractor. During the relevant assessment year, it executed contracts in India and for that purpose, it had maintained project/site offices in India established with the approval of the RBI.

  2. In its return of income for relevant assessment year, the assessee did not include amount received pursuant to an arbitration award in relation to NMPT project, which was completed earlier in financial year 1995-96 contending that in the absence of Permanent Establishment (PE) in relation to NMPT project in the assessment year under consideration, said amount was not taxable as per the various clauses of the Indo-Netherlands Tax Treaty.

  3. The A.O., however, made the addition of said amount treating the same as income from assessee’s discontinued business u/s 176(3A).

  4. On appeal, the Commissioner (Appeals) affirmed the taxing of said amount under section 176(3A) on gross basis and did not allow to set off unabsorbed depreciation and current depreciation against assessed income of the relevant assessment year on ground that the assessee could claim loss of Indian project against income of its head office as per the provisions of the DTAA. The Commissioner (Appeals) also disallowed deduction of arbitration proceedings related expenses and upheld the levy of interest under section 234D. The Commissioner (Appeals), however, deleted interest levied under section 234B and set-aside the disallowance of payment made as lease rent.

Decision

On cross appeals; the Tribunal held as under:

  1. A reading of the articles 5 and 7 of the DTAA between India and Netherlands shows that there are only two conditions for taxing an amount received by the assessee in India and these are that there should be a PE of the assessee in India, and that the income should be attributable to the PE. In the instant case, the PE was admittedly in existence in India in the earlier assessment years 1995-96 and 1996-97 and the income received by the assessee-company during the relevant assessment year was attributable to the PE in India of the assessee-company.

  2. As per various articles of the DTAA between India and Netherlands, there is no condition therein for taxability of the income received by the assessee-company in India that in the year of receipt of that income, there shall be a PE in India. In fact, in instant case, the assessee-company was carrying on its business of dredging contract at various other sites in India during the relevant assessment year and it could not be said that the assessee was having no PE in India during the relevant assessment year.

  3. There is also no condition that for taxability of the amount, the assessee-company shall have a separate PE for each of its projects in the year of receipt of income by the assessee.

  4. The argument of the assessee was that the source of income received by the assessee-company was the order of the Court for which there was no PE in India. Although the assessee had received the said amount in consequence of the order of the Court, yet the fact remained that the amount related to the business of the assessee of dredging operations for which the assessee-company was having a PE in India.

  5. If the plea of the assessee, that to tax its income, the PE should be in existence during the relevant assessment year, was accepted, then it could lead to anomaly since the assessee would be entitled to deduction of all expenses and income received in the subsequent years would not be taxable due to non-existence of the PE. The Commissioner (Appeals) had mentioned in its order that by assessee’s own admission in the statement of fact that the assessee had made claim at NMPT for additional work performed and for that, the assessee-company had claimed all expenditure and at the time of offering the income, which was received on account of those expenditure, the assessee had taken the argument that the same was not taxable in view of provision of article 7 of Treaty, which was not correct.

  6. The language of article 7(1) of DTAA between India and Netherlands is unambiguous and clearly lays down that if an enterprise carries on business in the other State through a PE situated therein, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that PE. In this article, there is no mention of any condition of there being a PE in that other State to be in existence in the year of receipt of income by the enterprise.

  7. On facts, since the assessee was having a PE in India and also the income received from NMPT being attributable to the PE in India and there being no condition that PE should be in existence in India in the year of receipt of the amount by the enterprise, the arbitration award received by the assessee-company from NMPT project had rightly been taxed by the Assessing Officer as income of the assessee-company for the assessment year 2001-02. In view of the finding that the assessee was having PE in India and the income was attributable to PE in India and, accordingly taxable in the hands of the assessee for the relevant assessment year 2001-02, the issue of applicability of provision of section 176(3A) was not relevant. Accordingly, the issue was to be decided in favour of the revenue.

  8. The language of section 176(3A) lays down that the amount received will be taxed as income in the like manner as if such sum were received before such discontinuation of business. Accordingly, it could not be said that as per the wording of section 176(3A), such income could be taxed in the hands of the assessee on a gross basis. The Assessing Officer was to be directed to tax the receipt of arbitration award not on gross basis and to allow the allowable deductions thereon, if had not been allowed already in the earlier assessment years.

  9. As far as the disallowance of unabsorbed depreciation and current depreciation was concerned, the Assessing Officer was to be directed to verify whether the assessee had claimed the loss of Indian branch against the income of the head office as per the provision of the Netherlands and if those losses had been claimed and set off against the whole income in Netherlands, then the same should not be allowed to be set-off against the Indian income of the relevant assessment year or any other year and if the assessee-company had not claimed those losses in Netherlands, the set-off of losses should be u/s 72.

  10. There was no justification for not allowing the genuine expenses incurred by the assessee in relation to the arbitration award amount received by it. While deciding the earlier ground of appeal, it was held that the assessee was having a PE and the amount received by the assessee was attributable to the PE in India and accordingly, the allowable expenses in relation to that amount had to be allowed as allowable deduction to the assessee. Accordingly, the Assessing Officer was directed to examine and allow the genuine and allowable expenses incurred by the assessee in relation to the arbitration award amount received by the assessee. The provision of section 234D was not in the statute book during the relevant period and was inserted by the Finance Act, 2003 with effect from 1-6-2003. In the instant case, the processing under section 143(1)(a) was made on 25-2-2003, wherein the order was passed granting refund to the assessee and on which date, the provision of section 234D had not come on the statute. As per those facts of the case, the interest under section 234D was not chargeable to the assessee.

  11. All payments made to a non-resident are subject to tax deduction at source u/s 195 and, accordingly, it could not be said that the assessee-company was liable to payment of advance tax. Merely because the assessee had requested the A.O. for issue of certificate for tax deduction at a lower rate of tax, it would not make the assessee liable for payment of interest under section 234B. There was no mistake in the order of the Commissioner (Appeals) in holding that since all payments made to non-residents are subject to tax deduction at source under section 195, the assessee was not liable for advance tax and, therefore, the interest under section 234B was not leviable on the assessee. Accordingly, no interference in the order of the Commissioner (Appeals) was called for on that issue.

Cases referred

Numerous case laws were referred to and relied upon by both the parties.

[Editorial Note: There were few other issues relating to buy of Interest u/s 234D and disallowance of lease charges u/s 40A(2)(b), which are not discussed here.]

  1. TDS u/s 195 from Interest paid by an Indian Bank to a Foreign Bank in terms of letter of credit – Held that assessee not liable to deduct TDS u/s 195

2007] 13 SOT 489 (Hyd.) Tecumseh Products (I) LTD. vs. DCIT [Assessment Years 1996-97 and 1997-98]

  1. Assessee opened a letter of credit and Andhra Bank issued letter of credit guaranteeing payment on behalf of assessee — Since assessee could not pay money to foreign supplier within time-limit, foreign supplier approached foreign bank, which in terms of letter of credit negotiated with Andhra Bank and demanded interest money arising on account of late payment. Andhra Bank, accordingly, paid interest to foreign bank. The A.O. held that assessee was liable to deduct tax at source u/s 195 on amount of interest paid by Andhra Bank to non-resident bank –Held that since immediate responsibility for making payment of interest was that of Andhra Bank and not of assessee, assessee could not be made responsible for deduction of tax at source on payment of interest made to foreign bank.

Facts

  1. The assessee-company had entered into an import transaction with a foreign supplier. For import of materials, the assessee had opened a letter of credit and the Andhra Bank had issued the letter of credit guaranteeing payment on behalf of the assessee.

  2. Since the assessee could not pay the money to the foreign supplier within the time-limit, the foreign supplier approached the foreign bank [non-resident bank]. Thereafter, the foreign bank in terms of the letter of credit negotiated with the Andhra Bank and demanded interest arising on account of late payment by the assessee. The Andhra Bank, accordingly, paid interest to the foreign bank on account of late payment.

  3. The Assessing Officer held that the assessee was liable to deduct tax at source under section 195 on the amount of interest paid by the Andhra Bank to the non-resident bank. On appeal, the Commissioner (Appeals) confirmed the action of the Assessing Officer.

Decision

On Second Appeal, the Tribunal held as follows:

Section 195 provides for deduction of tax by any person responsible for paying to a non-resident, any interest or any amount chargeable under the provisions of the Act. Therefore, the person responsible to pay the interest has to deduct the tax under section 195. In the instant case, the question for consideration was as to who was responsible for making payment of interest to the non-resident bank. Admittedly, the interest was paid by Andhra Bank and not by the assessee. The case of the department was that since the bank had paid interest on behalf of the assessee as an agent, the assessee was responsible for making deduction of tax before payment. It was not in dispute that in terms of letter of credit, non-resident bank negotiated with the Andhra Bank for payment of interest on late payment. When the supplier presented the letter of credit and negotiated the same through non-resident bank in terms of letter of credit, Andhra Bank was bound to pay interest in case of any late payment. The Andhra Bank might recover the payment from the assessee, but the immediate responsibility was that of Andhra Bank and not the assessee. The Legislature has used the words “any person responsible for paying”. In instant case, the responsibility was of Andhra Bank and not of the assessee. The payment might have been made on behalf of the assessee but that did not take away the responsibility of Andhra Bank from paying interest to the foreign bank. Therefore, it might not be proper to say that the assessee failed to deduct tax while paying interest to the foreign banker. In other words even though the liability to pay interest was on the assessee, the responsibility for making the payment of interest was entrusted to Andhra Bank, because Andhra Bank had granted a letter of credit undertaking to discharge the assessee’s liability. Therefore, the responsibility for making payment of interest was only on Andhra Bank and not on the assessee; and if at all any tax was to be deducted, it had to be done by Andhra Bank and not the assessee. Hence, the impugned order was to be set aside.

 

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