TaxTMI 
TaxTMI 
2008 (6) TMI 288
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.... terms of the provisions of s. 115A r/w s. 44D of the Indian IT Act, 1961. 2. Learned Departmental Representative argues that what we need to do is to examine the taxability under s. 115A r/w s. 44D first, and, then, examine whether or not the income so taxable, if any, is exempt under the treaty provisions. He submits that notwithstanding the grounds of appeal before us, which mayor may not be happily worded, we have powers, as also a corresponding duty to exercise these powers when so considered appropriate, to decide the appeal on any of the grounds as long as both the parties have been heard on that ground. We are thus urged to take a look at the dispute before us in this light. We will deal with this aspect of the matter a little later, but suffice to say that we are satisfied that, in order to properly dispose of this appeal, only the above two and other related issues, and in that order, require our adjudication. 3. While the first issue is required to be adjudicated in the light of the provisions of the India-Germany DTAA, dt. 19th June, 1995 as the taxpayer foreign company (assessee, in short) is a resident of Germany, the second issue requires adjudication mainly in....
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.... 3,96,37,980 Receipt of interest on ECB loans INR 8,50,398 Receipts sales support fees INR 2,40,19,661 Total INR 12,31,80,116 6. A reference was made to the TPO, for ascertainment of ALP of the above international transactions. The TPO accepted the transaction values as disclosed by the assessee as an ALP, without making any adjustments. 7. In the course of the assessment proceedings, the AO noted that the assessee has accepted a tax liability @ 10 per cent, on the basis of the provisions of art. 12 of the Indo-German tax treaty but none of the receipts, save and except on account of royalty fees, is of such a nature as can be covered by art. 12. The AO was of the view that 'income from product marketing fees' amounts to a commercial activity as the same cannot be termed as a royalty or fees for technical services. As for the receipts for information and technology support, the AO required the assessee to furnish complete details about the nature of information and technology support and added that, in any event, such receipts are not specifically included in art. 12 of the Indo-German tax treaty. Similar was the AO's stand so far as ....
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....hardware like routers, switches etc., licences for MS Office and other software such as Oracle for servers, development and maintenance of central SAP system etc. It was also pointed out that sales support services were rendered to only one of the subsidiaries in India, i.e., Epcos Ferrites Ltd. and that these services were in the nature of services for identifying the customers, consultations, working out time schedules, negotiating price terms, fixing delivery schedule, negotiating credit terms, assuring payments, taking care of currency and exchange rates, supply of technical information, attending to customer complaints and organization of rework, if necessary. The assessee further submitted that since the assessee company does not have a PE in India, these receipts could only be taxed under art. 12 of the Indo-German tax treaty, and in case the AO is of the opinion that these receipts are not covered by art. 12, these receipts are not taxable at all. The assessee also submitted that as far as ECB loan interest was concerned, it was indeed not covered under art. 12 of the Indo-German treaty but then that this fact does not make any difference to the tax liability, because, unde....
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.... and EFPL. We also confirm that these employees are not our (Epcos AG) rolls. Also. the remuneration to these employees is paid and borne by EIPL and EFPL respectively. There is no employer-employee relationship between these persons and us." 10. Taking note of the above reaction and particularly of the underlined portion (italicized in print) therein, the AO pointed out to the assessee that services of EIPL and EFPL employees have been availed to earn the receipts on account of product marketing, sales support and information technology services as also of the royalty. The AO was also of the view that the assessee has a PE in India, in the form of its subsidiaries i.e. EIPL and EFPL, since the assessee was conducting its business in India through its subsidiaries and more specifically through employees of the subsidiaries. The submissions of the assessee did not find any favour with the AO. The AO concluded that "it is observed, on the basis of various letters and e-mails received, that each and every activity is done under the active supervision of Epcos AG in India". The AO further observed that the term 'PE' connotes a fixed place of business through which the busine....
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.... and correspondence exchanged by the assessee with its subsidiaries in India, the CIT(A) concluded that these are routine mails and correspondence which deal with a very limited aspect of "business of the Indian subsidiaries" and, therefore, "the AO wrongly concluded that each and every activity of Indian subsidiaries is done under the active supervision of Epcos AG in India". The CIT(A) also noted that the assessee company has no employees in India and, therefore, the AO's claim that the assessee has a place of management in India, is not correct. The CIT(A) further held that in view of art. 5(7), merely because the assessee has a subsidiary company, it cannot be concluded that the assessee has a PE in India. The Advance Rulings, relied upon by the AO. were held to be inapplicable on the facts of this case. The CIT(A) also observed that the AO has not properly understood the activities of the assessee company and has 'created a paradoxical situation'. On one hand. it is stated that the assessee is rendering services in India through its PE in the form of subsidiaries as per art. 5(2)(a) and (b) and. on the other hand, the very same services are consumed by its subsidia....
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....s clearly taxable in India, the onus is on the assessee to show that it is exempt under the India-Germany DTAA. Without prejudice, learned Departmental Representative submits that even under the India-Germany DTAA. and by virtue of art. 7 r/w art. 5, the income is taxable in India under the 'domestic law'. 16. Even as we are alive to the fact that the approach suggested by the learned Departmental Representative will not lead to any different results than the one arrived at by any other approach to the issue, we are not inclined to accept the suggestion of the learned Departmental Representative. There is indeed a school of thought which suggests that what needs to be examined first is the taxability under the domestic law i.e., the Indian IT Act and only when the taxability under the domestic law is held to be in existence, one has to see the applicable treaty, if any, to examine whether or not the assessee gets any relief from the provisions of such a tax. This approach, however, was not approved in the landmark Special Bench decision in the case of Motorola Inc. vs. Dy. CIT (2005) 96 TTJ (Del)(SB) 1, wherein the Tribunal had observed that "DTAA is only an alternate ta....
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....espective of the geographical location of a place where a person earns income, the income is taxable in the tax jurisdiction in which a person is resident. A tax subject, i.e. the taxable unit, thus invariably belongs to the residence jurisdiction or, in the case of the USA. citizenship jurisdiction, as the US laws provides for taxation of all citizens-irrespective of their residential status. The source rule, however, lays down that an income earned in a tax jurisdiction, irrespective of the residential status of the person earning the said income, is liable to be taxed in the tax jurisdiction where the income is earned. Therefore, a tax object, i.e. the income which is to be taxed, as a rule attracts taxability in the source jurisdiction. A tax treaty resolves this conflict by laying down the principles on the basis of a tax jurisdiction, other than the residence jurisdiction, gets rights to tax the residents of the other Contracting States and the manner in which a person gets the credit in his residence jurisdiction for the taxes so paid outside the residence jurisdiction. When an income is to be so taxed in the source country, the tax treaties further provide for the manner in....
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....hich India has no right to tax a particular income in the hands of this non-resident covered by a tax treaty, provisions of the Indian IT Act do not come into play at all. One need not examine taxability under the domestic law in such a case, No tax treaty can impose a tax but a tax treaty does something far more fundamental-in case of competing tax jurisdiction claims, which are inevitable corollaries of inherently contradictory source and residence rules a tax treaty decides which tax jurisdiction can levy tax on a tax object, and to what extent it can do so. To examine taxability of a cross-border income in a source tax jurisdiction, without first establishing the right to tax that income by the source tax jurisdiction, is like putting the cart before the horse. Therefore, before proceeding to consider taxability of a nonresident, covered by the provisions of a tax treaty, in terms of the provisions of the domestic tax laws of the source jurisdiction, it is useful to first check whether source jurisdiction has a right to tax that income at all. We would, therefore, prefer to follow the approach of first examining whether or not the source country has right to tax, a particular c....
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.... taken by another eminent international tax expert. Ned Sheldon, is also on these lines. In his well-known work 'Interpretation and Application of Tax Treaties'. Ned Sheldon has remarked that this "issue can be theorized and philosophized upon. but the inevitable conclusion is that one must consider both domestic law and the treaty" and he concludes that "in practice it does not matter". While we recognize the school of thought canvassed by the learned representatives. we are. for the reasons' we have set out in the preceding paras-including the reasons of deference for the Larger Bench of this Tribunal and conceptual foundation elaborated in these paras, of the considered view that in the case of the cross-border tax situation between treaty partner States, logically first thing for a source tax jurisdiction is to establish the right to tax under the applicable tax treaty, and only if such a source tax jurisdiction indeed has right to tax, the next thing is to examine is the taxability under the domestic laws of that State. 19. There is one more aspect of the matter. A view could indeed be taken that the difference, if at all, in these two approaches is that in the ....
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....ing State, it has to be necessarily taxed in the source Contracting State; that is the only way in which exemption regime works. However, we cannot be oblivious to the fact that double non-taxation is also a fact of life, and tax sparings, which find place in several Indian tax treaties, are also a reality in international taxation. One could possibly argue that a treaty can also work as an exemption regime when viewed as a mere allocation of taxing rights, but, in such a situation, it would indeed be somewhat illogical to examine the taxability under the domestic law first and then examine whether or not the source jurisdiction has right to tax at all. There is thus a reasonable conceptual basis for first ascertaining source country's right to tax, and then application of domestic tax law, if needed, to ascertain existence and quantum of tax under the domestic tax laws of source country. Treaty override: 21. The practice of treaty override, which has legal sanction in India by the virtue of s. 90 of the Indian IT Act, also recognizes this scheme of things by specifically providing that the provisions of the Indian IT Act will have limited application on a non-resident ta....
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....on. 2. The term "PE" includes especially,- (a) a place of management, (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources, including an installation or structure used for the exploration or exploitation; (g) a warehouse or sales outlet; (h) a farm, plantation or other place where agricultural, forestry, plantation or related activities are carried on; and (i) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities continue for a period exceeding six months. 3. An enterprise shall be deemed to have a PE in a Contracting State and to carry on business through that PE if it provides services or facilities in connection with, or supplies plant and machinery on hire used for or to be used in the prospecting for or extraction or exploitation of mineral oils in that State. 4. Notwithstanding the preceding provisions of this article, the term "PE" shall be deemed not to include,- ....
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....tions to the enterprise no conditions are agreed or imposed which differ from those usually agreed between independent persons. 7. The fact that a company which is a resident of a Contracting Slate controls or is controlled by a company which is a resident of the other Contracting State or which carries on business in that other State (whether through a PE or otherwise), shall not of itself constitute either company a PE of the other. Article 7-Business profits 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a PE situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that PE. 2. Subject to the provisions of para 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a PE situated therein, there shall in each Contracting State be attributed to that PE the profits which it might be expected to make, if it were a distinct and separate enterprise engaged in ....
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....ation for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematograph films or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. 4. The term "fees for technical services" as used in this article means payments of any amount in consideration for the including the provision of services by technical or other personnel but does not include payments for services mentioned in art. 15 of this agreement. 5. The provisions of paras 1 and 2 shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State, in which the royalties or fees for technical services arise, through a PE situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or ....
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....ghts are exercisable also by the source country. In other words, when we are dealing with a German enterprise earning business profits sourced from India, unless that German enterprise has such a significant business presence in India, as can be termed as its having a PE, and the business is carried out through such PE, its business profits are not taxable in India under art. 7. Further, even when the German company, as in this case, has a PE in India, the tax liability of the German company, so far as relatable to 'business profits' under art. 7 is concerned, is confined only to such business profits as can be held to be "attributable to that PE" in India. 25. The first step towards examining taxability of business profits in the source country thus is to ascertain whether or not the foreign enterprise has a 'PE', and if the foreign enterprise is held to have a 'PE', the next thing to be ascertained is the quantum of business profits attributable to such a PE. Interplay between taxability of 'business profits' and taxability of 'royalties and fees for technical services': 26. Under art. 12 of the Indo-German tax treaty, any payments....
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.... a PE, or for that purpose an existence of 'a fixed base', brings in paradigm shift to the extent that (a) instead of taxability on gross basis in the source country, the taxability is ascertained on net basis; and (b) instead of a lower rate of 10 per cent. which is charged under art. 12(2), the tax is at the rate prescribed under the domestic legislation but on net income. 29. However, in terms of the provisions of s. 44D of the Indian IT Act, as it was in force at the relevant point of time, apparently even under the domestic law all these receipts as 'royalties and fees for technical services' were taxable on gross basis in India, though, as per the provisions of s. 115A, at a lower rate of 20 per cent. 30. To decide whether this legal proposition is correct or not, we will have to analyze things in some detail. Let us understand that proposition, and its conceptual basis, first. Under art. 7(3), which deals with the ascertainment of business profits attributable to the PE, it is provided that "there shall be allowed as deductions, expenses which are incurred for the purposes of the business of the PE .......according to the domestic law of the Contracting....
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....een the Epcos AG, and its Indian subsidiaries, which, according to the Revenue authorities, have lead to the existence of its PE in India. We find that the Epcos AG has rendered certain services to its Indian subsidiaries in respect-(a) product marketing and sales support services; and (b) information and technology support services. The terms and conditions on which these services are rendered are set out in separate agreements entered into by the taxpayer company with both its Indian subsidiaries (i.e., EIPL and EFPL) and copies of these agreements were placed before us at pp. 166 to 179 of the paper book. Epcos AG maintains centralized information technology infrastructure at its German office and it provides the services of creating and maintaining the WAN (wide area network) for the whole group. The services of outside parties are engaged for maintaining this WAN. This centralized information technology unit of the taxpayer company also procures and furnishes to its subsidiaries, licences for programmes such as MS Office, Oracle for servers and other softwares, develops and maintains central SAP system which is also used by the Indian subsidiaries, and implements a common e-ma....
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....me sheets, listing of administration costs, third party invoices etc. On request, Epcos AG shall make these documents available to Epcos India." 34. The common thread in all these services are that these are support services and the arrangement primarily seeks allocation of such costs which are incurred centrally and which benefit all the group companies, including group companies in India. As contended by the taxpayer, wherever costs incurred by the taxpayer company can be identified directly to a specific subsidiary, the costs are directly allocated to such a subsidiary, but whenever costs are not directly allocable, these costs are allocated on some rational basis. Such cost sharing arrangements are quite common in the cases where support activities of the group companies are centralized. In view of the fact that the TPO has accepted the payments to the taxpayer company as an arms length payment for services so rendered, and in the absence of any allegation to the contrary in the assessment order, there is no dispute about the fact that the amounts paid by the EIPL and EFPL to Epcos AG constitute arms length consideration for services so rendered by the taxpayer company, and ....
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....y employee in India. The business of the taxpayer, so far as impugned receipts are concerned, is rendering services to Indian subsidiaries, in consideration of which the taxpayer gets costs reimbursements plus a mark up. No part of this business is carried out in India inasmuch as there are no billing raised in connection with any services rendered in India. No doubt, some employees of the Indian subsidiaries work under guidance of the taxpayer company, but the work so done is for the business of the Indian subsidiaries and not for the foreign company which is taxpayer before us. We must, at this stage, understand distinction between business of the foreign company and that of its Indian subsidiaries. While the business of the foreign company, for our purposes, is rendering certain types of services to its Indian subsidiaries, the business of the Indian company is to manufacture and sell its products. What is done by the employees of the Indian subsidiaries is running business of the Indian subsidiaries which includes marketing of its products-with or without guidance of the foreign parent company, and ensuring a smooth functioning of business by ensuring an effective information t....
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.... the residence country and the source country are the same and there is no conflict in residence rule and source rule, and, therefore, there is no need to resolve the same through the tax treaty provisions. What follows from these discussions is (i) that there should be a fixed place of business in the source jurisdiction, and (ii) that the business of the foreign enterprise should be carried on through such a fixed place of business in the source jurisdiction. 38. The expression 'fixed place of business' is not defined under the tax treaties, but there are negative and positive lists of what the expression 'PE' does not include and what the expression 'PE' does include, and these lists can also help us draw inferences on this aspect as well. The expression 'fixed place of business' presupposes that there is a place of business, i.e., a facility such as premises or, in certain instances, even machinery or equipment, and that such a place of business is a 'fixed' place, i.e. a distinct place with certain degree of permanence. While in terms of the provisions of art. 5(7), existence of a subsidiary or parent company in the source jurisdictio....
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....ic company. Is it necessary that the PE can only be said to exist, under the basic rule, when core business activity is carried out by the PE? 39. We quite agree with the stand of the Revenue authorities to the extent that as long as an economic activity is carried out in the fixed plate of business available to foreign enterprise, whether such an activity is a core activity or a peripheral activity, it has to be concluded that the foreign enterprise has a PE in the source jurisdiction. Model Convention Commentary states that the activity carried out by the PE may not be a productive character, though the commentary does recognize that it could perhaps be argued that in the general definition, some mention should also be made of the other characteristic of the PE, namely that the establishment must have a productive character-i.e. contribute to the profits of the enterprise. However, in the present definition, this course has not been taken. Late Prof Vogel also concurred with this school of thought and observed that "... the PE need not be a branch in the nature of facility engaged in activities of the same type as those of the head office organization, nor need the place of....
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.... carried out by the employees of Indian subsidiaries, and, therefore, no part of the revenues actually generated by the assessee company could be said to be attributable to the PE. The question of existence of PE of the assessee company, in these circumstances, has no impact of taxability of the assessee company. 41. The requirements of exclusion clause under art. 15(5) also highlight this aspect of profit attribution. While we were examining interplay between art. 12 and art. 7, we had noticed that this exclusion clause has twin requirements of (a) existence of the PE through which business is carried out; and of (b) existence of effective connection between such a PE and the rights, properties and contracts in respect of which 'royalties' and 'fees for technical services' are paid. That would mean that only such 'royalties' and fees for technical services' are excluded from the scope of art. 12(1) and (2) as are attributable to the PE through which business is carried on by the enterprise. In other words, the taxability under art. 12 shifts to taxability under art. 7 only in respect of 'royalties' and 'fees for technical services' wh....
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....f the view that on account of existence of a PE in India, only such profits of the assessee company can be brought to tax in India as are "attributable to that PE". It is a typical chicken and egg situation of circular logic. On one hand, the wording of art. 12(5) is such that this exclusion clause is triggered only when 'royalties and fees for technical services' have a live economic nexus, reflected by effective connection with 'rights', 'properties' and 'contracts', in respect of which such royalties and fees for technical services are paid, with PE, and, on the other hand, the scheme of taxability under art. 7, which is complementary to this approach, is also such that the taxability under art. 7 is attracted only in respect of such 'royalties' and 'fees for technical servicer' as are so attributable to the PE. Unless an amount is such that it is taxable under art. 7, even if it is in the nature of 'royalties' or 'fees for technical services', the exclusion clause under art. 12(5) will not come into play. At the same time, unless an amount representing 'royalties' or 'fees for technical services' is....
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....tor of IT (2005) 98 TI'J (Kol)(SB) 295 : (2005) 97 ITD 89 (Kol)(SB). It is thus clear that an income of the Indian subsidiaries, on account of having rendered services to themselves, cannot be taxed. There cannot be any income in the hands of this PE, even if that be so, which can be brought to tax. 46. The limitation on deductions in accordance with the domestic law, as laid down by art. 7(3), can come to play when there is an income attributable to the PE in the first place. When there are no receipts which can be attributed to the PE, there is no question of allowing deductions therefrom. That aspect of the matter is entirely infructuous. The limitation under s. 44D is, therefore, not relevant in the present case. The same is the position with regard to the lower rate prescribed under s. 115A of the Act. There is no warrant for application of s. 44D and s. 115A unless there is a positive income from 'royalties and fees for technical services' which can be brought to tax under art. 7. Conclusion on the second issue i.e., taxability @ 20 per cent in terns s. 44D r/w s. 115A in case PE is found to be in existence: 47. In our considered view, in terms of the ind....