2016 (5) TMI 728 - HC - Income Tax

Adobe India not a PE under Indo-US Tax Agreement: Court rules in favor of Assessee

The court held that Adobe India did not constitute a Permanent Establishment (PE) of Adobe Systems Incorporated under the Indo-US Double Taxation ... Reason to believe income escaped assessment - transfer pricing / arm's length price - permanent establishment - attribution of profits to permanent establishment - profit split method versus cost plus methodReason to believe income escaped assessment - transfer pricing / arm's length price - Whether the Assessing Officer had any reason to believe that the appellant's income for the AYs in question had escaped assessment so as to justify issuance of notices under Section 148. - HELD THAT: - The Court held that the AO's belief was founded on the premise that activities carried out by the Indian subsidiary were in substance those of the foreign parent and therefore a part of the parent's income remained untaxed. Chapter X and the transfer pricing regime require that international transactions be measured at arm's length to tax the real income; they do not permit imputing hypothetical income where the subsidiary's real income from those activities has already been brought to tax. Adobe India had been assessed on the relevant R&D activities at arm's length (TNMM/cost-plus accepted for AYs 2004-05 and 2005-06 and subject-matter for separate proceedings for other years). Consequently the AO had no material to form a reason to believe that any part of the appellant's income had escaped assessment, and the reassessment notices and consequent proceedings were liable to be set aside. [Paras 16, 17, 19, 23, 26]Impugned notices and proceedings under Section 148 set aside for the AYs 2004-05, 2005-06 and 2006-07 as there was no reason to believe income had escaped assessment.Permanent establishment - attribution of profits to permanent establishment - profit split method versus cost plus method - Whether the AO's conclusion that the appellant had a Permanent Establishment in India (under Article 5(1), Article 5(2)(l) or Article 5(5) of the Indo US DTAA) was supported by reason. - HELD THAT: - The Court observed that a subsidiary is an independent taxable entity (Article 5(6)) and that the mere fact of a subsidiary carrying out core activities or being managed by the parent does not, by itself, establish a PE of the parent. The 'right to use' or 'at the disposal of' test for a fixed place of business under Article 5(1) was not satisfied on the material before the AO. There was no material that the appellant's employees performed services in India to attract Article 5(2)(l), nor was there evidence that Adobe India acted as a dependent agent authorised to conclude contracts on behalf of the appellant under Article 5(4)/(5). Further, the correctness of the method for determining ALP (PSM v. cost plus) is a matter for proceedings in relation to Adobe India and cannot, merely because the AO prefers PSM, furnish a reason to attribute additional profits to the foreign parent. On these bases the AO's conclusions as to PE were unsustainable. [Paras 34, 35, 36, 37, 38]AO's view that the appellant had a PE in India under the cited Articles of the DTAA was unsupported by reason and unsustainable on the recorded material.Final Conclusion: The reassessment notices dated 30 March 2011 and the orders rejecting objections (8 March 2013) are set aside for AYs 2004-05, 2005-06 and 2006-07; the AO had no reason to believe that the appellant's income had escaped assessment, and the AO's conclusions regarding a Permanent Establishment were unsupported by the material. Issues Involved:1. Whether Adobe Systems India Private Limited (Adobe India) constitutes a Permanent Establishment (PE) of Adobe Systems Incorporated (the Assessee) in India.2. Whether any part of the Assessee's income can be attributed to Adobe India and subjected to tax in India.3. Whether the Assessing Officer (AO) had any reason to believe that the Assessee's income had escaped assessment, justifying the issuance of notices under Section 148 of the Income Tax Act, 1961.Issue-wise Detailed Analysis:1. Permanent Establishment (PE) Status of Adobe India:- The AO concluded that Adobe India constituted the Assessee's PE under Article 5(1) of the Indo-US Double Taxation Avoidance Agreement (DTAA) due to Adobe India's involvement in the Assessee's core business activities.- The AO also considered Adobe India as a Service PE under Article 5(2)(l) and a dependent agent PE under Article 5(5) of the Indo-US DTAA.- The court noted that a subsidiary company is an independent tax entity and is separately taxed. The mere control by a holding company does not render the subsidiary a PE of the holding company (Article 5(6) of the Indo-US DTAA).- The court clarified that a subsidiary's activities, taxed at arm's length pricing, cannot be the sole basis for imputing the subsidiary to be a PE of the holding company.2. Attribution of Income to Adobe India:- The Assessee argued that since Adobe India’s income was assessed at Arm’s Length Prices (ALP), no part of the Assessee’s income could be attributed to Adobe India even if it was assumed to be the Assessee’s PE.- The court emphasized that transfer pricing regulations ensure that income from transactions between related parties is not shifted out of India. The transfer pricing scrutiny/adjustments capture the entire income from the said activities in the net of tax.- The court held that even if Adobe India is considered the Assessee’s PE, the entire income which could be taxed in the hands of the Assessee has already been taxed in the hands of Adobe India. There was no material suggesting that the Assessee undertook any other activity in India.3. Reason to Believe Income Escaped Assessment:- The AO issued notices under Section 148 based on the belief that the Assessee’s income had escaped assessment due to Adobe India’s activities.- The court found that the AO’s belief stemmed from the assumption that the R&D services rendered by Adobe India were conducted by the Assessee. The AO concluded that the Assessee must surrender a part of its income attributable to those activities in India.- The court noted that Adobe India was assessed to tax on the same activities priced on an ALP basis. Therefore, activities of a subsidiary company could not provide a reason to believe that any income relating thereto had escaped assessment in the hands of the foreign holding company.- The court referred to Article 7 of the Indo-US DTAA, which stipulates that only profits attributable to a PE can be taxed in the state where the PE is located. Since Adobe India’s income was already taxed, there was no reason to believe that any part of the Assessee’s income had escaped assessment.Conclusion:- The court set aside the impugned notices and proceedings initiated by the AO, concluding that the AO did not have any reason to believe that the Assessee’s income had escaped assessment.- The court also found that the AO’s opinion that the Assessee had a PE in India was not informed by reason and was unsustainable based on the facts recorded.- The petitions were allowed, and the pending applications were disposed of, with parties bearing their own costs.