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 ... Reopening of assessment - existence of PE in India - Indo-US DTAA - Held that:- AO's view that Adobe India constituted the Assessee's PE in terms of paragraph 1 of Article 5 of the Indo-US DTAA is palpably erroneous and not sustainable on the basis of the facts as recorded by him. We also find that there is no material to hold that the Assessee's employees constitute a Service PE in terms of Article 5(2)(l) of the Indo-US DTAA. The Assessee has denied that any of its employees has rendered any service in India. There is no material available with the AO that would contradict the same. The AO has concluded that the Assessee has a PE in India in terms of Article 5(2)(l) of the Indo-US DTAA, only on the basis that the Assessee has a right to audit Adobe India and that the agreement between the Assessee and Adobe India entails that the Assessee would provide specifications, assistance and supervision for the R&D services procured by the Assessee. The said terms of the agreement do not in any manner indicate that the Assessee has been providing services in India. Clause 5.5 of the agreement referred to by the AO indicates that the Assessee is authorized to audit the Indian subsidiary (Adobe India), so as to ensure that Adobe India adheres to the standards required by the Assessee. AO's view that Adobe India constitutes the Assessee's PE under Article 5(5) of the Indo-US DTAA is also wholly unsustainable. Article 5(5) of the Indo-US DTAA provides for an exclusion to Article 5(4) of the Indo-US DTAA. In terms of Article 5(4), where a person acts in a contracting state on behalf of an enterprise of the other contracting state, the enterprise shall be deemed to have a Permanent Establishment in the first mentioned state. In other words, a dependent agent of an enterprise would constitute its PE. In the present case, there is no material to form a view that Adobe India acts as an agent for and on behalf of the Assessee. Further, there is no allegation that any of the other conditions specified under clauses (a), (b) or (c) of paragraph 4 of Article 5 of the Indo-US DTAA are applicable to Adobe India. One of the necessary conditions for holding that an agent constitutes a PE of an enterprise is that the agent must have an authority to conclude contracts or should have been found to be habitually entering into or concluding contracts on behalf of the enterprise. In the present case, there is no allegation that Adobe India is authorised to conclude contracts on behalf of the Assessee or has been habitually doing so. In the present case, apart from the AO stating so, there is no reason to assume that Adobe India is an agent of the Assessee; there is neither any agreement which states so nor any material which indicates that Adobe India acts as such. More importantly, it is not disputed that Adobe India is assessed on its income determined at ALP and, therefore, there is no occasion for the AO to assume that Adobe India constitutes the Assessee's PE under Article 5(5) of the Indo-US DTAA. - Decided in favour of assessee 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.