2010 (7) TMI 1226 - AT - Income Tax

Tribunal Partly Allows Appeals, Deletes Expense Disallowance, Affirms Permanent Establishment, Upholds Tax Deduction Exemption.

Assessee's appeal was partly allowed by the tribunal, which ordered the deletion of the disallowance of expenses while affirming the existence of a ... - Issues Involved:1. Existence of Permanent Establishment (PE) under Article 5(2)(k) of the India-UK tax treaty.2. Adjustments in earnings of the PE based on prevailing market prices under Article 7(2).3. Taxability of reimbursement of expenditure.4. Levy of interest under section 234B of the Income Tax Act.5. Application of the 'force of attraction' principle in computing profits attributable to the PE.Detailed Analysis:1. Existence of Permanent Establishment (PE) under Article 5(2)(k) of the India-UK tax treaty:The tribunal examined whether the assessee had a PE in India under Article 5(2)(k). The assessee argued that Article 5(2)(k) should be read in conjunction with Article 5(1), meaning that the basic conditions of Article 5(1) must be satisfied for a PE to exist. The tribunal rejected this argument, stating that Article 5(2)(k) is a standalone provision and does not require the conditions of Article 5(1) to be met. The tribunal also dismissed the contention that professional services can only be 'rendered' and not 'furnished,' thus falling outside the scope of Article 5(2)(k). The tribunal found that the assessee had a PE in India as the services were rendered for more than 90 days within a twelve-month period.2. Adjustments in earnings of the PE based on prevailing market prices under Article 7(2):The assessee argued that the profits attributable to the PE should be computed based on the prevailing market rates for similar services in India, rather than the actual billing amounts. The tribunal rejected this argument, stating that Article 7(2) does not permit substitution of actual transaction values with hypothetical market rates. The tribunal emphasized that the purpose of Article 7(2) is to ensure that intra-organization transactions are recognized and valued at arm's length prices, but it does not extend to transactions with independent entities.3. Taxability of reimbursement of expenditure:The Assessing Officer had treated 50% of the reimbursements of expenses as income, while the CIT(A) reduced this to 15%. The tribunal found that the reimbursements were for specific and actual expenses incurred by the assessee and did not involve any mark-up. The tribunal noted that the assessee had provided sufficient evidence to support these claims and that the CIT(A)'s partial disallowance was based on surmises and conjectures. The tribunal directed the Assessing Officer to delete the disallowance and held that no part of the reimbursements should be treated as income.4. Levy of interest under section 234B of the Income Tax Act:The CIT(A) had held that interest under section 234B was not chargeable as all sums chargeable to tax were subject to deduction of tax at source under section 195. The tribunal upheld this decision, citing the Special Bench decision in Motorola Inc Vs DCIT and the jurisdictional High Court's approval in DIT Vs NGC Network LLC.5. Application of the 'force of attraction' principle in computing profits attributable to the PE:The CIT(A) had held that only the income related to services performed in India was taxable, not appreciating the 'force of attraction' principle in Article 7(1). The tribunal disagreed, stating that Article 7(1) includes profits 'directly or indirectly attributable to the PE,' thereby incorporating the 'force of attraction' rule. This rule extends taxability to all profits from services rendered to Indian projects, whether performed in India or outside. The tribunal restored the Assessing Officer's order, which taxed the entire income from Indian projects.Outcome:- Assessee's Appeal: Partly allowed. The tribunal directed the deletion of the disallowance of expenses but upheld the existence of a PE and the method of computing profits without adjustments for market rates.- Assessing Officer's Appeal: Partly allowed. The tribunal upheld the application of the 'force of attraction' principle and restored the Assessing Officer's order on this issue. The tribunal also upheld the CIT(A)'s decision on the non-levy of interest under section 234B.