2025 (10) TMI 905 - AT - Income Tax

Dependent agent PE left open; arm's-length distributor transactions upheld, distribution receipts not royalty, refund interest taxed at 15%

ITAT MUMBAI - AT left open whether a dependent agent PE existed in India, finding lower authorities failed to examine agreements and party conduct ... TP Adjustment - existence of Dependent Agent Permanent Establishment (“DAPE”) of the assessee in India and the taxability of distribution income as business income - HELD THAT:- As in order to arrive at such a conclusion, it is necessary not only to examine the terms and clauses of the agreement entered into by the Indian entity with the third parties but also to take into consideration the conduct of the parties. Thus, we are of the considered view that for deciding the issue, the mere terms of the agreement may not be the sole criterion. In the present case, even though the lower authorities held that Warner Bros. India was the DAPE of the assessee in India, they failed to examine whether the contract entered into by Warner Bros. India with a third party in India was on behalf of the assessee and also failed to examine the conduct of the parties for entering into such an agreement. Therefore, a thorough examination of the aforesaid aspects is relevant to determine whether Warner Bros. India was the DAPE of the assessee in India in the year under consideration. Hence, in the facts and circumstances noted above, due to a lack of proper enquiry by the lower authorities, this issue cannot be conclusively decided, and accordingly, we are leaving our findings on the same open. We are of the considered view that once the transaction between Warner Bros. India and the assessee has been found to be at arms’ length by the TPO in the preceding years as well as in the subsequent assessment years, the fact that there was no reference to the TPO for determination of the arms’ length price of this transaction in the year under consideration cannot go against the assessee and it can be safely assumed that, even in the year under consideration, such a transaction is at arms’ length and by not referring the same to the TPO under section 92CA of the Act, the transaction has been accepted as such by the Revenue. Therefore, without going into the question whether the assessee has a DAPE in India in the form of Warner Bros. India in this year, once the transaction between the Warner Bros. India and the assessee has been at arms’ length price, respectfully following the decision of the Hon’ble Supreme Court in Morgan Stanley and Co. [2007 (7) TMI 201 - SUPREME COURT] we are of the considered view that there is no further need to attribute profits. Taxability of distribution revenue as royalty - We are of the considered view that the revenue received by the assessee from Warner Bros. India cannot be taxed as royalty in India. As a result, Grounds raised in assessee’s appeal are allowed. Rate of tax on interest earned on income tax refund - Revenue could not show us any reason to deviate from the aforesaid decision rendered in the assessee’s own case, and no change in facts and law was alleged in the relevant assessment year. Thus, respectfully following the orders passed in Bechtel International Inc [2012 (4) TMI 206 - ITAT MUMBAI] we direct the AO to tax the interest income on income tax refund @15%. As a result, Ground raised in assessee’s appeal are allowed. 1. ISSUES PRESENTED AND CONSIDERED 1. Whether the foreign enterprise's Indian distributor constitutes a Dependent Agent Permanent Establishment (DAPE) in India under Article 5(4) of the India-USA DTAA where the distributor (a) habitually exercises authority to conclude contracts, (b) habitually secures orders wholly or almost wholly for the enterprise, or (c) habitually maintains stock for delivery on behalf of the enterprise. 2. If a DAPE is found (or assumed), whether further attribution of profits to that DAPE is permissible where the transactions between the enterprise and the agent are at arm's length under Article 5(5) of the India-USA DTAA and domestic transfer-pricing provisions. 3. Whether payments received by the non-resident for distribution of cinematographic films in India constitute 'royalty' taxable under section 9(1)(vi) of the Income Tax Act or under the DTAA, or are excluded as payments for sale, distribution and exhibition of films. 4. The correct rate of tax on interest on income-tax refund: whether it is taxable at the treaty rate (15%) under Article 11(2)(b) of the DTAA or at domestic rates if attributable/effectively connected to a PE in India. 5. Ancillary issues: levy of interest under sections 234A/234B and initiation of penalty under section 270A (whether adjudicable given findings on primary issues). 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Existence of DAPE under Article 5(4) of the India-USA DTAA Legal framework: Article 5(4) deems an enterprise to have a PE where a person acting in the source state on behalf of the enterprise (not being an agent of independent status) (a) has and habitually exercises authority to conclude contracts on behalf of the enterprise, (b) habitually maintains stock of goods for regular delivery on behalf of the enterprise with contributing activities, or (c) habitually secures orders wholly or almost wholly for the enterprise. Precedent treatment: Prior coordinate Tribunal decisions in the taxpayer's earlier years and a jurisdictional High Court decision on analogous facts were relied on by the assessee to show non-existence of DAPE where the local entity acted on principal-to-principal basis and contracted in its own name; Revenue relied on prior assessments treating distributor as DAPE. Interpretation and reasoning: The Court emphasized substance over form: mere contractual authority in the distributor is not sufficient - the authority must be exercised 'on behalf of' or 'for' the foreign enterprise. Determination requires examination of (i) terms of contracts between the distributor and third parties, and (ii) conduct of the parties (e.g., whether distributor contracted in its own name, bore entrepreneurial risk, or acted as principal). The lower authorities failed to examine the distributor's contracts with third parties and the parties' conduct; thus, the record was insufficient for a conclusive finding on DAPE. Ratio vs. Obiter: Ratio - a finding of DAPE under Article 5(4) requires proof that contracts were concluded on behalf of or for the foreign enterprise and cannot be based solely on the distributor's authority in the agreement. Obiter - factual specifics of prior years (multiple principals dealt with by distributor) were observed but the Court left factual determination open due to inadequate inquiry. Conclusion: The existence of DAPE was left open. Because lower authorities did not examine third-party distributor contracts and conduct, the Tribunal cannot conclusively uphold the DAPE finding on the record before it. Issue 2 - Attribution of profits to DAPE where transactions are at arm's length (Article 5(5) and domestic law) Legal framework: Article 5(5) excludes independent agents acting in the ordinary course of business from creating a PE; however, where an agent's activities are devoted wholly or almost wholly to one enterprise and transactions between agent and enterprise are not at arm's length, the agent is not independent. Domestic transfer-pricing regime (sections 92/92CA/92E) governs determination of arm's-length remuneration. Precedent treatment: The Supreme Court decision holding that where PE remuneration is at arm's length, no further attribution is warranted was relied upon by the assessee. Interpretation and reasoning: The Tribunal found that the international transaction between the assessee and the distributor had been declared in Form 3CEB and had been found at arm's length by the Transfer Pricing Officer in preceding and subsequent assessment years. The arrangement and remuneration model were consistent over years. The AO did not refer the year under consideration to the TPO; the Tribunal held that absence of reference and prior/subsequent TPO findings that the transaction was arm's length supported an inference that the transaction for the year was also at arm's length and was accepted by Revenue. Following the Supreme Court precedent, once the agent-transaction is at arm's length, further attribution of profits to a PE is not warranted. Ratio vs. Obiter: Ratio - where international transactions between enterprise and local agent have been tested and found arm's length (and no contrary finding exists for the year in question), no additional attribution to an assumed PE should be made. Obiter - reliance on continuity of years as determinative may be fact-sensitive. Conclusion: Even assuming a DAPE existed, no further profits were attributable because the payment model was at arm's length; the addition of profits attributed to DAPE was deleted and related grounds allowed. Issue 3 - Characterisation of distribution receipts as 'royalty' under section 9(1)(vi) / DTAA Legal framework: Section 9(1)(vi) and Explanation 2(v) exclude payments relating to sale, distribution and exhibition of cinematographic films from the definition of 'royalty'. The DTAA's definition of royalty (Article 12) also excludes certain payments related to copyrights/artistic works vis-à-vis broadcasting/film use. Precedent treatment: Coordinate Bench earlier held in the taxpayer's own case that distribution receipts are excluded from 'royalty' under Explanation 2(v) and the DTAA; that decision considered both statute and the agreement facts. Interpretation and reasoning: The Tribunal found no change in facts or law that would warrant deviation from the coordinate Bench decision; the specific statutory exclusion applies directly to payments for distribution/exhibition of cinematographic films, and the DTAA similarly excludes such payments. Revenue advanced no compelling reason to depart from the earlier finding. Ratio vs. Obiter: Ratio - distribution receipts under the distribution agreement were not taxable as royalty under domestic law or the DTAA because of the specific exclusion for sale, distribution and exhibition of cinematographic films. Conclusion: Payments received for distribution of films are not 'royalty'; grounds challenging royalty characterization were allowed. Issue 4 - Rate of tax on interest on income-tax refund (treaty vs domestic treatment) Legal framework: Article 11 of the India-USA DTAA governs taxation of interest, with a specified treaty rate (15% for certain interest). Whether interest is taxable at treaty rate depends on whether it is attributable/effectively connected to a PE; US-model conventions' terminology ('attributable') was analyzed vis-à-vis 'effectively connected'. Precedent treatment: Coordinate Tribunal and Special Bench precedent held that where interest on tax refund is not effectively connected/attributable to a PE, it is taxable only under the DTAA at the treaty rate; commentary equates 'attributable' to 'effectively connected'. Interpretation and reasoning: Following earlier coordinate Bench decisions and authoritative reasoning equating 'attributable' to 'effectively connected', the Tribunal held that interest on income-tax refund should be taxed under the DTAA at 15% where it is not attributable to a PE. Revenue had not shown a basis to depart from these precedents. Ratio vs. Obiter: Ratio - interest on tax refund was taxable at 15% under the DTAA where not effectively connected/attributable to a PE; AO's taxation at domestic rates was set aside in the circumstances. Conclusion: Interest on income-tax refund taxed at treaty rate (15%); related grounds allowed. Issue 5 - Interest under sections 234A/234B and penalty under section 270A Legal framework and reasoning: Interest under sections 234A/234B are consequential to tax liability; penalty proceedings under section 270A are premature where primary tax issues are being adjudicated. Ratio vs. Obiter: Ratio - consequences and penalties depend on final taxability; penalty initiation dismissed as premature. Conclusion: Interest issues require no separate adjudication (consequential); penalty initiation under section 270A dismissed as premature.