2026 (1) TMI 984 - AT - Income Tax

Permanent establishment and managerial service characterisation in cross-border distributor arrangements; PE denied, managerial services taxed

Analysis addresses whether a foreign enterprise had an Agency permanent establishment in India through its local distributor and whether payments ... Treating the Indian AE as PE of the assessee - attributing 35% of Offshore sales to Indian AE as income - Income deemed to accrue or arise in India - reimbursement of expenses by Indian AE treated as FTS - stress of the Revenue is that the Indian AE falls under the clause 5(c) of Article 5 whereas the assessee contends that principal-agent relationship is not established. HELD THAT:- AO has read the Sales Agreement selectively without considering various other sections in the Agreement where it is apparent that KDID purchases the Products of the assessee for resale to customers within Indian Territory and to otherwise act as a distributor for the assessee. Section 2.03 provides that KDID is an independent contractor and does not have the right to assume or create any obligation of any kind, express or implied, on behalf of the assessee, except as expressly provided for in this Agreement. Further nothing in the Agreement shall be deemed to establish or otherwise create a relationship of principal and agent between KDID and the assessee. Section 2.04 provides that neither party shall possess, nor shall either party hold itself to third persons as possessing, any power or authority to bind the other party in anyway. This shows that KDID has obtained the rights of distribution of the products for itself. Subsequently it had entered into contracts with third party customers in its own name in which the Assessee is not a party which illustrates that no arrangement exists between the Assessee and KDID's customers. With respect to warranty, we find that while the assessee provides warranty related to manufacturing defects on the products supplied to KDID, it is KDID that bears various risks such as entrepreneurial, inventory and distribution risks. The risk of non-performance of its sales staff is borne by KDID. The sales agreement at Section 4.01 provides that KDID would assume all market, credit (i.e., bad debt), and inventory risks for Products which are merchantable (i.e., suitable for sale).' Agreement at section 6.01 and elsewhere provides that KDID shall buy and resell the Products for its own account within the Territory. The purchase by KDID is on FOB basis in its own name which reinforces the argument of the assessee that the transaction between the assessee and the KDID is on principal to principal basis and KDID does not act as an agent of the assessee. In view of the above, we are of the considered view that the relationship between the assessee and that of KDID is as in principal to principal basis. Assertion of the assessee that KDID is a separate legal entity and is not subject to significant control by the assessee is nowhere controverted. There is no evidence brought out by the AO that KDID is not economically independent as well as we have seen that KDID bears the entrepreneurial risk of its activities and is acting in ordinary course of business. Application of provisions of DTAA is concerned, we find that the Article 5(5) of the India-Hong Kong DTAA, provides that a foreign enterprise may have an 'Agency PE' in India if such foreign enterprise performs any of the below mentioned activities through its dependent agent in India. Under this Article the AO has to establish that KDID habitually exercises in India an authority to conclude contracts for or on behalf of the foreign enterprise; or habitually maintains in India a stock of goods or merchandise from which it regularly delivers goods or merchandise on behalf of the enterprise; or habitually secures orders in India, wholly or almost wholly for the enterprise itself or for other enterprises controlling, controlled by, or subject to the same common control, as that enterprise. We find that none of the conditions of Article 5(5) are met in the case of the assessee. We find that the AO has not provided any evidence/materials to show that KDID habitually binds the assessee or secures order or maintains stock for the assessee. In view of the same, we are of the considered view that no Agency PE exist for the assessee in the form of KDID. Since we have held that the assessee does not have a PE in India in the shape of KDID, consequently the question of attributing 35% of the Offshore sales to Indian AE, as income of the assessee, does not arise. The ground 2 is allowed. Fees for technical services - Managerial services - Article 13 of India-Hong Kong DTAA - Assessee has rendered a service to KDID in making all such arrangements which KDID, otherwise on its own, could not have availed. In particular, the section 5.01 of the Sales Agreement specifically provides that assessee would provide to KDID sales and technical information. The assessee has provided to KDID various standard automated facilities from the third parties and therefore we are of the considered view that arrangement being made by the assessee for KDID qualifies as rendering of ‘managerial’ service to KDID. We find that though the terms 'managerial', 'technical' and 'consultancy' have not been specifically defined in the Act or the DTAA, various courts have interpreted the meaning of the said term ‘Managerial’ as controlling, directing or administering the business. The expression 'managerial services' means managing the affairs by laying down certain policies, standards and procedures and then evaluating the actual performance in light of the procedures so laid down. Services which the assessee provides to KDID are towards adoption and carrying out policies of an organization. Our view is strengthened by the fact that the Hong Kong DTTA do not postulate the concept of “make available” as essential ingredient to consider a service as FTS. We find that the assessee is instrumental in providing services of various software to KDID which is used for understanding assessee’s products (copiers/ printers) strengths and weaknesses, competitor's machines as well as environmental factors. The software arranged for KDID enables it to track various tasks in relation to its business functions. The software enables the KDID to support, manage and register customer information and manage key financial and human resources. The payment made by KDID also includes cost of travelling traveling of KDID employees to attend business conferences organized by the assessee which is a service provided by the assessee. Assessee arranges the services of web server and e-mail domain as well as cloud solutions to KDID to improve the overall business of KDID and its own. All such activities which the assessee provides to KDID would fall within the ambit of “managerial services” under Article 13 of India-Hong Kong DTAA. Following the decision of Volvo information Technology AB [2024 (5) TMI 442 - ITAT DELHI] and that of H.J. Heinz Company [2019 (8) TMI 1264 - ITAT DELHI] we therefore uphold the action of the AO in treating the amount paid by KDID towards the above expenses as FTS as it falls under “payments of any kind as consideration for managerial, technical or consultancy services”. The ground 3 is dismissed. Issues: (i) Whether the Indian associated enterprise (KDID) constitutes a Dependent Agent Permanent Establishment (Agency PE) of the non-resident assessee under Article 5(5) of the IndiaHong Kong DTAA and, if so, whether 35% of offshore sales can be attributed to such PE; (ii) Whether reimbursements received by the assessee from the Indian associated enterprise constitute Fees for Technical Services (FTS) under Explanation 2 to section 9(1)(vii) of the Income-tax Act, 1961 and Article 13 of the IndiaHong Kong DTAA.Issue (i): Whether KDID is an Agency PE of the assessee under Article 5(5) of the IndiaHong Kong DTAA and whether 35% of offshore sales can be attributed to such PE.Analysis: The Tribunal examined the Sales Agreement and relevant factual matrix to assess the presence of conditions in Article 5(5) authority to conclude contracts on behalf of the enterprise, habitually maintaining stock from which deliveries are made on behalf of the enterprise, or habitually securing orders wholly or almost wholly for the enterprise. The Agreement contains express clauses (Sections 2.032.05, 4.01, 6.01) stating KDID is an independent distributor, purchases and resells for its own account (FOB), bears entrepreneurial, inventory and credit risks, and lacks authority to bind the seller. The AO did not produce cogent material to rebut legal and economic independence or to show KDID habitually binds the assessee, maintains stock on behalf of the assessee, or secures orders almost wholly for the assessee. OECD Commentary paragraph 6 guidance on legal and economic independence and acting in the ordinary course of business was applied to the facts.Conclusion: Issue (i) decided in favour of the assessee. No Agency PE of the assessee exists in India through KDID; attribution of 35% of offshore sales to an Indian PE does not arise.Issue (ii): Whether reimbursements by KDID to the assessee constitute FTS under Explanation 2 to section 9(1)(vii) of the Act and Article 13 of the IndiaHong Kong DTAA.Analysis: The Tribunal analysed the nature of services and facilities for which costs were reimbursed (software, cloud solutions, email hosting, training, travel for conferences, sales and technical information). Section 5.01 of the Sales Agreement contemplates provision of sales and technical information by the assessee. The Tribunal found the assessee arranged and provided standard automated facilities and managerial-type services which enable KDID to manage and administer its business functions. Considering definitions in the Act and DTAA and relevant precedents, these arrangements were held to amount to consideration for managerial/technical/consultancy services rather than mere neutral cost-sharing; the IndiaHong Kong DTAA does not require a separate 'make available' test for FTS.Conclusion: Issue (ii) decided against the assessee. The reimbursements constitute FTS and are taxable under Explanation 2 to section 9(1)(vii) of the Act and Article 13 of the DTAA.Final Conclusion: The appeals are partly allowed: the Tribunal rules that no Agency PE exists (relief to the assessee on attribution of offshore sales) but upholds the assessment treating reimbursements as FTS (against the assessee) such that the departmental addition on that account is sustained.Ratio Decidendi: Where a distributor purchases and resells goods in its own name on FOB terms, bears entrepreneurial, inventory and credit risks and is contractually an independent contractor, it does not constitute an Agency PE under Article 5(5); conversely, reimbursements for arrangements by a non-resident that provide managerial, technical or consultancy facilities to a resident may qualify as FTS under Explanation 2 to section 9(1)(vii) of the Income-tax Act, 1961 and Article 13 of the DTAA.