2010 (7) TMI 535 - AT - Income Tax

Taxpayer income from Indian projects taxable; PE exists under Article 5(2)(k); UK partnership granted treaty benefits; arm's-length revaluations rejected

Linklaters LLP Versus ITO (Int’l Taxation)

ITAT, MUMBAI held that the assessee's income from Indian projects is taxable in India: a permanent establishment exists under Article 5(2)(k) and related ... Correctness of order passed by Commissioner (Appeals), in the matter of assessment under section 143(3) r.w.s. 250 - Existence of Permanent Establishment (PE) in India under Article 5(2)(k) of the India-UK Tax Treaty - scope of “force of attraction” principle embedded in Article 7 (1) of the India‐UK tax treaty - Whether or not a partnership firm based in United Kingdom is entitled to the benefits of the India UK tax treaty - HELD THAT:- The income of the assessee from projects in India is taxable in India, the Assessing Officer turned to quantification of the income so liable to be taxed in India - in a situation when assessee is in appeal, Tribunal cannot give a finding adverse to the appellant so as to place him in a position worse than what it was before the appeal - the partnership firm is eligible for treaty benefits in the source country even as it is not taxable in its own right in the residence country - The remedy to unintended consequence of a treaty provision in the said report has been rejected, and, therefore, the treatment accorded to the said provision, in the same report, cannot be accepted either. We have discussed the issue of taxability under the domestic law, which includes detailed analysis of the provisions of Section 9(1), in paragraphs 14 to 19 of this order. In this analysis, we have held that, under the provisions of the Indian Income Tax Act, the entire income from professional services sourced from India, whether in respect of the services rendered in India or outside India, is taxable in India. In this view of the matter the reasoning adopted by the CIT(A), so far as it related to the provisions of the Indian Income Tax Act, does not hold good in law, and it cannot be sustained by us. Whether with the associated enterprise or by routing transactions notionally through the GE, PE will never reflect actual profits attributable to PE - The GE PE profit computation approach will then be, as what can be termed as, octopus approach in which GE is seen as mouth of octopus, whereas all PEs are viewed as sort of arms of that feed the mouth i.e. center or the GE. In this fiction of octopus theory, the enterprise is seen as consisting of a productive center where the bulk of activities and brainpower are situated and a series of tentacles thus provide sustenance to the center. Even when it is a GE PE transaction, the residual profit cannot always be allocated straight away to the general enterprise, as a simplistic revaluation of transaction values on the basis of market prices will inherently involve, and the allocation of profits over GE and PEs have to be on an equitable and rationale basis. Be that as it may, it is not really necessary to go any deeper into this aspect of the matter, in view of our categorical finding to the effect that the transactions in questions in respect of which revenues are sought to be modified on the basis of arms length principle, on the facts of this case, are transactions with the independent enterprises, whereas arms length principle is relevant only for intra organization transactions or transactions with associated enterprises. Accordingly, the assessee has wrongly invoked the independence fiction under Article 7(2) to revalue the figures of revenues generated by the permanent establishment. In our considered view, the very plea of the assessee proceeds on fallacy that arms length price adjustment can be made in respect of the transactions with the clients of the assessee. The revenues earned by the assessee are to be taken at actual figures and no adjustments are permissible in the same. We reject this plea of the assessee as well. The action of the authorities below is confirmed on this count as well. Whether or not the assessee had a permanent establishment in India - Article 5(2) of India UK tax treaty is a mixture of what is usually contained in Article 5(2) and Article 5(3) in all major model conventions i.e. UN Model Convention, OECD Model Convention an UN Model Convention - the present case, is like this. In addition to taxability of income in respect of services rendered by the PE in India, any income in respect of the services rendered to an Indian project, which is similar to the services rendered by the permanent establishment, is also to be taxed in India in the hands of the assessee – irrespective of the fact whether such services are rendered through the permanent establishment, or directly by the general enterprise - The twin conditions to be thus satisfied for taxability of related profits are (i) the services should be similar or relatable to the services rendered by the PE in India; and (ii) the services should be ‘directly or indirectly attributable to the Indian PE’ i.e. rendered to a project or client in India - the appeals filed by the assessee as also by the Assessing Officer are partly allowed in the terms indicated above Issues Involved:1. Existence of Permanent Establishment (PE) in India under Article 5(2)(k) of the India-UK Tax Treaty.2. Adjustments claimed by the assessee in earnings of the PE based on prevailing market prices.3. Taxability of reimbursement of expenditure.4. Quashing of penalty proceedings.5. Levy of interest under section 234B of the Income Tax Act.6. Application of the 'force of attraction' principle in computation of profits attributable to the PE.Detailed Analysis:1. Existence of Permanent Establishment (PE) in India under Article 5(2)(k) of the India-UK Tax Treaty:The Tribunal held that Article 5(2)(k) of the India-UK tax treaty, which includes the furnishing of services within a Contracting State for more than 90 days within any twelve-month period, is a standalone provision and does not need to be read in conjunction with Article 5(1). The Tribunal rejected the assessee's argument that Article 5(2) is merely illustrative of Article 5(1) and confirmed that the assessee had a PE in India under Article 5(2)(k). The Tribunal also dismissed the contention that 'furnishing' and 'rendering' of services are distinct, holding that these terms can be used interchangeably in the context of the treaty.2. Adjustments claimed by the assessee in earnings of the PE based on prevailing market prices:The Tribunal rejected the assessee's plea to adjust the revenues of the PE based on hypothetical market rates for similar services in India. The Tribunal emphasized that Article 7(2) of the India-UK tax treaty, which requires the profits to be those which the PE might be expected to make if it were a distinct and separate enterprise, does not extend to revaluing actual transactions with independent clients. The Tribunal held that the revenues must be taken at actual figures without any adjustments for market rates.3. Taxability of reimbursement of expenditure:The Tribunal found that the reimbursements received by the assessee were in respect of specific and actual expenses incurred without any markup. Given the reasonable control mechanisms in place and the sufficient evidence provided by the assessee, the Tribunal directed the deletion of the disallowance of expenses sustained by the CIT(A). The Tribunal held that no part of the reimbursements of expenses should be treated as income of the assessee.4. Quashing of penalty proceedings:The Tribunal dismissed the ground of appeal seeking the quashing of penalty proceedings as it was not pressed by the assessee.5. Levy of interest under section 234B of the Income Tax Act:The Tribunal upheld the CIT(A)'s decision that interest under section 234B was not chargeable, as all sums chargeable to tax in the hands of the assessee were liable to deduction of tax at source under section 195 of the Act. The Tribunal followed the jurisdictional High Court's decision in DIT Vs NGC Network LLC (313 ITR 187).6. Application of the 'force of attraction' principle in computation of profits attributable to the PE:The Tribunal held that the CIT(A) erred in limiting the taxability of the assessee to only the portion of income related to services performed in India. The Tribunal emphasized that Article 7(1) of the India-UK tax treaty incorporates a 'force of attraction' principle, which extends the taxability to profits indirectly attributable to the PE. The Tribunal restored the order of the Assessing Officer, holding that the entire profits relating to services rendered by the assessee, whether in India or outside India, in respect of Indian projects, are taxable in India.Summary of Outcome:- The assessee's appeal was partly allowed.- The Assessing Officer's appeal was partly allowed.- The Tribunal upheld the existence of a PE in India under Article 5(2)(k).- Adjustments to earnings of the PE based on market prices were rejected.- Disallowance of reimbursement of expenses was deleted.- Penalty proceedings were dismissed as infructuous.- Levy of interest under section 234B was not chargeable.- The 'force of attraction' principle was applied, extending the taxability to profits indirectly attributable to the PE.