TaxTMI 
TaxTMI 
2007 (4) TMI 616
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.... appeal set out in the memorandum of appeal : 1. On the facts and in the circumstances of the case and in law, the Commissioner of Income-tax (Appeals) erred in holding that since the agent, i.e., SET India P. Ltd. has a good profitability record, it can be said that the assessee has remunerated the agent on an arm' s length basis, and based on the provisions of article 7(2), the OECD Commentary on the subject, and the other contentions made, no further profits should be taxed in India, in respect of advertisement revenues from its own channel ignoring the facts ; (i) that the assessee has dependent agency permanent establishment in India in the form of SET India P. Ltd. ; and (ii) that the assessee' s income is assessable as business income within the meaning of article 7 of the India-Singapore DTAA. 2. On the facts and in the circumstances of the case and in law, the Commissioner of Income-tax (Appeals) erred in holding that advertisement revenue pertaining to AXN channel are not taxable in India on the ground that the assessee has paid an arm' s length price for services rendered by its agent, i.e., SET India P. Ltd., and based on ....
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....ested in us under the proviso to rule 11, learned senior counsel stated such a reframing of the grounds of appeal, which goes beyond the controversy actually raised by the Assessing Officer, is contrary to the scheme of the Act. We are, however, not persuaded by the objections of learned counsel. These objections proceed on the fallacious assumption that firstly, we do not think that by reframing the ground before us, there is any enlargement of the subject-matter of appeal. The reframing of ground has been considered desirable not with a view to enlarge the scope of the appeal, but only with a view to provide clarity to the real controversy. Secondly, rule 11 of the Appellate Tribunal Rules 1963 specifically provides that "the Tribunal, in deciding the appeal, shall not be confined to the grounds set forth in the memorandum of appeal . . ."as long as "the party who may be affected thereby has had a sufficient opportunity of being heard on that ground". This rule is in conformity of the powers of the Tribunal laid down under section 254(1) of the Act. This sub-section provides that the "Tribunal may, after giving both the parties an opportunity of being heard, pass such orders ther....
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....irst briefly set out the scheme of the tax treaty which requires our interpretation. India and Singapore have entered into a tax treaty for avoidance of double taxation, titled as India Singapore Double Taxation Avoidance Agreement [see [1994] 209 ITR (St.) 1]. Since the dispute before us essentially concerns the correct interpretation of this tax treaty, it is essential to set out some of the relevant provisions of the treaty, and to appreciate the connotations and scope of certain technical expressions used therein. We consider it appropriate to first of all take up the provisions of article 5 and article 7 of the tax treaty. These articles are set out below for ready reference (page 4) : "Article 5. Permanent establishment.- 1. For the purposes of this Agreement, the term ' permanent establishment' means a fixed place of business through which the business of the enterprise is wholly or partly carried on. 2. The term ' permanent establishment' 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 we....
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....med not to include : (a) the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise ; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or occasional delivery ; (c) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise ; (d) The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise ; (e) the maintenance of a fixed place of business solely for the purpose of advertising for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the enterprise. However, the provisions of sub-paragraphs (a) to (e) shall not be applicable where the enterprise maintains any other fixed place of business in the other Contracting State through which the business of the enterprise is wholly or partly carried on. 8. Notwithstanding the prov....
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....aid, the profits of the enterprise may be taxed in the other State but only so much of them as is directly or indirectly attributable to that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall, in each Contracting State, be attributed to that permanent establishment the profits which it might be expected to make if it were a dis tinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. 3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the permanent establ....
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....t includes a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry or any other place of extraction of natural resources, a warehouse in relation to a person providing storage facilities for others, a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on, a premises used as a sales outlet or for soliciting and receiving orders, an installation or structure used for the exploration or exploitation of natural resources. The common thread in all these things is that an enterprise can carry on business through these establishments. Generally, therefore, enterprise of a contracting state is said to have a permanent establishment in the other contracting state when such an enterprise has a fixed place of business in that other contracting state through which business of the enterprise is wholly or partly carried on. However, in the modern age where a business is not always carried on, particularly outside national frontiers of an enterprise, through a fixed place of business of its own as is the lowest common denominator in all the situations visualized in article 5(2), there is a deemi....
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....gent permanent establishment, therefore, cannot be one and the same thing. Though at the cost of repetition, we consider it necessary to reproduce the provisions of article 5(8) which deal with this provision (page 6 of 209 ITR (St.)) : "8. Notwithstanding the provisions of paragraphs 1 and 2, where a person-other than an agent of an independent status to whom paragraph 9 applies-is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned State, if,- (a) he has and habitually exercises in that State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise ; (b) he has no such authority, but habitually maintains in the first mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise ; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, contro....
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....n the fiscal jurisdiction of that other country to such a degree that such other country can properly tax all profits that the enterprise derives from that country- whether through the permanent establishment or not. Therefore, under the force of attraction rule, mere existence of permanent establishment in other country, leads all profits, which can be said to be derived from that other country, being treated as taxable of that other country. That was the classical force of attraction rule but what is in vogue today is a much improvised and subdued form which restricts application of this rule to few specified areas. Even this subdued and improvised form of force of attraction rule, however, does not find much favour in the contemporary tax treaties, and particularly in OECD Model Convention on which the present tax treaty, in material respects, is based. The expression confining taxability of profits to "only so much of them as is directly or indirectly attributable to that permanent establishment" only confirm this paradigm feature. The first step to be taken for computation of profits liable to be taxed in the source country, therefore, is computing profits directly or indirect....
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....visualised on the basis of presence of the general enterprise as projected through the permanent establishment, which in turn depends on functions performed, assets used and risks assumed by the general enterprise in respect of the business carried on through the permanent establishment. The dependent agent permanent establishment and dependent agent has to be, therefore, be treated as two distinct taxable units. The former is a hypothetical establishment, taxability of which is on the basis of revenues of the activities of the general enterprise attributable to the permanent establishment, in turn based on the FAR analysis of the dependent agent permanent establishment, minus the payments attributable in respect of such activities, in simple words, whatever are the revenues generated on account of functional analysis of the dependent agent permanent establishment are to be taken into account as hypothetical income of the said dependent agent permanent establishment, and deduction is to be provided in respect of all the expenses incurred by the general enterprise to earn such revenues, including, of course, the remuneration paid to the dependent agent. The second taxable unit in th....
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....the electronic equipment from China, shipped directly to India and sells it in India after a mark up of 200 per cent. We further assume that the reasonable handling costs of Sing. Co. for sourcing the merchandise is 60 per cent. on cost. In a particular year. Sing Co. sells goods worth $ 3 million in India. Let us further assume that expenses incurred by Ind. Co. to earn the agency remuneration, are $ 8,99,000. The profits taxable in India, in such a case and based on the treaty provisions before us, should be as follows : A. Commission earned by Ind. Co. $9,00,000 Less : Deductible expenses of Ind. Co $8,99,000 Taxable in the hands of the Ind. Co $1,000 B. Profits attributable to Sing. Co.'s DAPE in India Sales consideration 30,00,000 Less : Commission paid to Ind. Co. Cost of purchases Sing. Co.'s handling charges 9,00,000 (-) 10,00,000 (-) 6,00,000 (-) 25,00,000 Profit of the DAPE or, in other words, profits attributable to India operations of the Sing. Co. $5,00,000 13. As far ....
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.... enterprise of which it is permanent establishment", the taxable profits of the foreign enterprise cannot extend beyond the profit earned by dependent commission agent. The sine of reasoning adopted by learned counsel is that permanent establishment is nothing but the dependent agent, and, the taxability of permanent establishment can only, therefore, be in respect of the earnings of the agent. Learned counsel has, with his inimitable oration, erudition and legal skills, woven a complex web of arguments to support this legal proposition. However, as it sometimes happens, the quality of arguments in support of a legal proposition is inversely proportional, proportional if it is, to the merits of the proposition sought to be advanced. This is one such occasion. Let us set out the reasons why we think so, and, in the process, deal with various arguments of learned counsel one by one. 15. At the outset, we must reiterate that a dependent agent (DA) and a dependent agent permanent establishment (DAPE), in our humble understanding, are two distinct things. As we have stated earlier, it is as a result of existence of a dependent agent that the foreign enterprise is "deemed to have" a p....
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....J 891; [2007] 291 ITR (AT) 275, which was authored by one of us. This decision, however, did not deal with the peculiarities of a dependent agent permanent establishment. This decision dealt with the taxability of the installation permanent establishment, and, the principles dealing with computation of profits of installation permanent establishment, in our considered view, do not have any bearing on the computation of profits of the dependent agency permanent establishment. We are, therefore, not persuaded by this reasoning either. 20. A reference is then made to the ruling given by the hon'ble Authority for Advance Rulings in the case of Morgan Stanley and Co. Inc. In re [2006] 284 ITR 260. We have perused the ruling, but, with respect, we are not persuaded. It is also well-settled in law that these rulings have binding value only on the assessee and on the Commissioner with reference to that particular transaction. In this regard, we deem it necessary to produce the following extracts from the judgment of the hon'ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706, at page 742 wherein their Lordships of the hon'ble Supreme Co....
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....e Board Circulars as well. 24. We have noticed that there are no specific guidelines on the issue of computation of profits for dependent agent permanent establishment from the tax authorities or in the applicable tax treaty. However, dealing with these treaty provisions, there is some guidance available from the tax rulings abroad and other literature from multilateral bodies like OECD (Organization of Economic Co-operation and Development, Paris) as also prominent organisations like IFA (International Fiscal Association, Amsterdam). We will briefly deal with these. 25. This issue, however, has been discussed in one of the recent Australian Tax Office guidelines titled "Attributing Profits to a Dependent Agent Permanent Establishment"(Product ID 14314-09.2005 ; www.ato.gov.au). These guidelines, inter alia, provide as follows : "The two-step process Taxation Ruling TR 2001/11 states our view that Australia' s permanent establishment attribution rules use a two-step process to apply an arm' s length separate enterprise principle in attributing profits to a permanent establishment : Step 1 : Undertake a functional analysis, which attributes t....
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....e ATO are on the right lines and these views meet our approval. 27. We would like to next deal with the views expressed by the OECD in this regard, in a recent report published by the OECD (www.oecd.org), on attribution of profits to the permanent establishment, it has been inter alia observed that in cases where a permanent establishment arises from the activities of a dependent agent, the host country will have taxing rights over two different legal entities-the dependent agent enterprise (which is a resident of the permanent establishment jurisdiction) and the dependent agent permanent establishment (which is a permanent establishment of a non-resident enterprise). This also supports the conclusions drawn by us earlier in this order. We may, in this regard, quote some of the relevant extracts from this report : "D-3 Dependent agent permanent establishments 275. As indicated in sections B-6 and D-5 in Part I, this report does not examine the issue of whether a permanent establishment exists under article 5(5) of the OECD Model Tax Convention (a so-called ' dependent agent PE' ) but discusses the consequences of finding that a dependent agent permanent....
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.... on behalf of the non-resident enterprise meet the permanent establishment threshold as defined under article 5. Further, the quantum of that profit is limited to the business profits attributable to global trading operations performed through the permanent establishment in the host country. 278. Where a dependent agent permanent establishment is found to exist under article 5(5), the question arises as to how to attribute profits to the permanent establishment. The answer is to follow the same principles as used for other types of permanent establishments for to do otherwise would be inconsistent with article 7 and the arm' s length principle. Under the first step of the authorised OECD approach a functional and factual analysis determines the functions undertaken by the dependent agent enterprise both on its own account and on behalf of the non-resident enterprise. On the one hand, the dependent agent enterprise will be rewarded for the ser vices it provides to the non-resident enterprise (taking into account its assets and its risks) usually by means of a fee from the non-resi dent enterprise. On the other hand, the dependent agent permanent establishment will have ....
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.... the authorised OECD approach, these risks, and therefore the capital needed to support them, will be attributed to the dependent agent permanent establishment to the extent that they arise from functions performed by the dependent agent in the host country on behalf of the non-resident enterprise. In short, when attributing profits to the dependent agent permanent establishment, there are likely to be profits (or losses) over and above the arm' s length reward paid to the dependent agent enterprise. This principle can be illustrated by the following commonly occurring situation where the trades of a broker dealer in the host country are booked in the accounts of a non-resi dent enterprise. The analysis applied to the functions performed by the dependent agent for attributing the assets and risks to the dependent agent permanent establishment is the same analysis applicable to determining the assumption of risk within a single enterprise as discussed in section D-1(i)(b). 280. The following illustration is intended to better explain the approach taken under the authorised OECD approach. It is recognised that in practice most situations will be significantly more comple....
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.... service provided by the dependent agent enterprise to the non resident enterprise. This is because the market credit risk associated with the financial assets created by the dependent agent enterprise do not belong to the dependent agent enterprise, but to the legal owner of the assets-the non-resident enterprise. An arm' s length fee paid by the non-resident enterprise would not therefore under article 9 as discussed in section C take account of the assumption of these risks nor the return on the capital needed to support those risks. The risks are assumed by the non-resident enterprise and so the reward for capital properly belongs to that non-resident enterprise. 283. The question is whether any of the reward for the assumption of the market and credit risk by the non-resident enterprise should be attributed to its dependent agent permanent establishment. On the facts of the present example the answer would be yes, since the key entrepreneurial risk-taking functions are undertaken, not by the non resident enterprise itself but by the dependent agent enterprise on behalf of the non-resident enterprise. The reward for the assumption of the market and credit risk, i.e....
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....t establishments. How ever, nothing in the authorised OECD approach would prevent coun tries from using administratively convenient ways of recognizing the existence of a dependent agent permanent establishment and collecting the appropriate amount of tax relating to the non-resident enterprise resulting from the activity of a dependent agent. For example, where a dependent agent permanent establishment is found to exist under article 5(5), a number of countries actually collect tax only from the dependent agent enterprise even though the amount of tax is calculated by reference to the activities of both the dependent agent enterprise and the dependent agent permanent establishment. In practice what this means is taxing the dependent agent enterprise not only on the profits attributable to the people functions it performs on behalf of the non-resident enterprise (and its own assets and risks assumed), but also on the reward for the free capital which is properly attributable to the permanent establishment of the non-resident enterprise. Such administrative matters related to the taxation of dependent agent permanent establishments are for the domestic rules of the host country and ....
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....nd the permanent establishment concept which is to allow, within certain limits, the taxation of the non-resident enterprise (including their assets and risks) in respect of their activities in the source jurisdiction. The single taxpayer approach simply does not consider that if the risks (and rewards) legally belong to a permanent establishment of a non-resi dent enterprise created by the activity of its dependent agent in the host country."(paragraph 273 at page 268 of the report) 29. We are in considered agreement with the views so expressed in the OECD report on attribution of profits to the permanent establishment. In our considered opinion, these views correctly state the interpretation of the existing article 7 in the OECD Model Convention which is materially the same as in the India Singapore tax treaty that we are concerned with. 30. We may now briefly deal with a report on the proceedings of the International Fiscal Associations 2006 Congress at Amsterdam. This report is by Professor Phillip Baker, QC, of Gray' s Inn Tax Chambers and Dr. Richard Collier, of Price Waterhouse Coopers. Learned counsel has invited our attention to the following observations in the ....
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....tablishment situation, and is general in scope. The objections of learned counsel, on the basis of IFA report, do not therefore merit acceptance. 33. There are, however, some direct references to the dependent agency permanent establishment profit attribution, in the IFA Congress Report 2006. We may refer to the following observations made in the said report at pages 69-70 : "As explained in part I, DDI (2004) has proposed that the correct interpretation of the MTC (Model Tax Convention) is that a profit may be attributed to the DAPE (dependent agent permanent establishment) over and above the arm' s length reward to the agent enterprise . . . Branch reporters were asked to speculate as to what they thought the DDI (2004) contentions that there might be a profit attributed to the DAPE over and above the arm' s length agency fees would be accepted in their jurisdiction. Not all the branch reporters responded to this question. A few indicated that the issue was highly controversial in their jurisdiction. Of the branch reporters who responded to the issue, five indicated that it was thought that there might be a profit attached to the DAPE. The Au....
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.... What one can say is that this is not a rousing show of support for the DDI (2004) contentions with regard to the DAPE or, put another way, that the adoption of WP6 approach to the DAPE issue seems unlikely to achieve the broad consensus regarding the interpretation and practical application of article 7 that it seeks." 34. The above observations clearly show that there is a widely held school of thought, even amongst the tax advisors who tend to take liberal interpretations in favour of the taxpayers and who easily outnumber and outweigh neutral members in bodies like IFA, that there has to be profit attributed to the dependent agent permanent establishment over and above the arm' s length fees paid to the dependent agent. Having given our careful consideration to the matter, we also subscribe to this school of thought. 35. As a matter of fact, in case the plea of the assessee is to be accepted, the whole concept of agency permanent establishment will be rendered meaningless. The profits earned by the dependent agent, or even independent agent, are anyway to be taxed in the host country of which the dependent agent is resident. The existence of the permanent establishme....
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....ents, accrues in India ; (iii) the assessee has a permanent establishment in India in the form of SET India P. Ltd., and, therefore, advertisement revenue from AXN channel is taxable in India as business income. 39. The learned Commissioner of Income-tax (Appeals) has not given any independent findings for the impugned finding. He has merely followed his stand as he had taken the first ground of appeal before us, and has held that as dependent agent has been paid an arm' s length consideration for the services rendered, no further profits can be attributed to the DAPEE. As we have reversed the action of the Commissioner of Income-tax (Appeals) on the first ground of appeal, and as a corollary thereto, we vacate the relief given by the Commissioner of Income-tax (Appeals) which is impugned in this appeal by way of the second ground of appeal as well. The Assessing Officer succeeds on this ground of appeal as well. 40. Ground No. 2 is also allowed. 41. In the ground of appeal No. 3, the Assessing Officer has raised the following grievance : 3. On the facts and in the circumstances of the case and in law, the Commissioner of Income-tax (Appeals) erred in....
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....appellant, under article 7 of the India Singapore tax treaty, when the remuneration paid to the Indian agent was paid on the arm' s length basis. 47. As far as this grievance of the assessee is concerned, it is raised in the backdrop of the Commissioner of Income-tax (Appeals)' s observation that even though the assessee did not have any tax liability in India, since the assessee has accepted the tax liability on his own at the time of filing the return of income, the assessee could not be given any relief from taxation and the Commissioner of Income-tax (Appeals) had "no reasons to interfere with the income offered to tax by the appellant". 48. However, while adjudicating upon the grievance of the Assessing Officer against the Commissioner of Income-tax (Appeals)' s findings about non taxability of the assessee, we have already reversed the action of the Commissioner of Income-tax (Appeals) so far as decision on merits is concerned. The grievance of the assessee, against not giving relief from taxation even after holding that the assessee has no tax liability, thus becomes infructuous and academic. It does not call for any adjudication by us. We, therefore, decli....