Indian PE profit attribution, software supply receipts and section 234B interest treated under non-resident tax principles.

Profits attributable to a non-resident's Indian permanent establishment were to be determined on a reasonable basis reflecting the actual Indian functions performed, not by a fixed mechanical percentage; because no separate Indian books were maintained and significant marketing, negotiation, pricing, installation support and post-sale activities were carried out in India, Rule 10 applied and 35% of net global profits from India-related transactions was attributed to the PE. Receipts for software supplied as an integral part of telecom equipment were not royalty, since no copyright was transferred and the payment related to a copyrighted article, so the receipts were taxable as business income. Interest under section 234B was not leviable because tax was deductible at source by the payer under section 195.

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Issues: (i) Whether the income attributable to the assessee's Indian permanent establishment was to be computed at 2.5% of sales or on a higher attribution basis; (ii) Whether receipts from supply of software embedded in telecom equipment were taxable as royalty; (iii) Whether interest under section 234B was leviable on the non-resident assessee.

Issue (i): Whether the income attributable to the assessee's Indian permanent establishment was to be computed at 2.5% of sales or on a higher attribution basis.

Analysis: The Tribunal held that attribution had to be made on the basis of the actual level of operations carried out in India and not by applying a mechanical percentage. Since the assessee had not maintained separate books for Indian operations, Rule 10 of the Income-tax Rules, 1962 had to be applied. The record showed that substantial activities connected with marketing, contract negotiation, pricing, bidding, installation support, post-sale support and other revenue-generating functions were carried out in India, and that the transfer pricing study did not capture all such functions. On that basis, the Tribunal rejected the assessee's challenge to further attribution but also found the Assessing Officer's method of taxing software receipts separately and the adopted percentage on global profits to be unsatisfactory.

Conclusion: The Tribunal held that 35% of the net global profits from India-related transactions was to be attributed to the permanent establishment in India.

Issue (ii): Whether receipts from supply of software embedded in telecom equipment were taxable as royalty.

Analysis: The Tribunal followed the jurisdictional High Court decisions holding that where software is supplied as an integral part of telecom equipment and no copyright is transferred, the receipt is for a copyrighted article and not for use of copyright. The contractual terms and the composite nature of supply did not justify treating the consideration as royalty under the domestic provision or the treaty. The retrospective amendment arguments did not alter the treaty position for the years in question on the facts of this case.

Conclusion: The Tribunal held that the software receipts were not taxable as royalty and were to be assessed as business income.

Issue (iii): Whether interest under section 234B was leviable on the non-resident assessee.

Analysis: The Tribunal followed the later jurisdictional High Court ruling that, for the relevant period, the primary obligation to deduct tax on payments to a non-resident lay on the payer under section 195, and failure of the payer attracted consequences under section 201. In such circumstances, where tax was deductible at source, no advance tax liability could be fastened on the non-resident so as to levy interest under section 234B.

Conclusion: The Tribunal held that interest under section 234B was not leviable.

Final Conclusion: The assessee succeeded on the software-royalty and interest issues, while the Tribunal sustained substantial attribution of profits to the Indian permanent establishment, resulting in a partial allowance of the assessee's appeals and dismissal of the revenue's appeals.

Ratio Decidendi: For a non-resident with an Indian permanent establishment, profits must be attributed on a reasonable basis reflecting all Indian functions not already compensated in transfer pricing analysis; consideration for software supplied as an inseparable part of equipment is not royalty absent transfer of copyright; and no interest under section 234B is chargeable where tax was deductible at source by the payer under section 195 during the relevant period.

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