TaxTMI 
TaxTMI 
2016 (5) TMI 728
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....see against the assumption of jurisdiction under Section 148 of the Act. 2. Briefly stated, the controversy in these petitions involves the question whether Adobe Systems India Private Limited (an Indian subsidiary of the Assessee and hereafter referred to as "Adobe India") could be considered as its Permanent Establishment (PE). And if so, whether any part of the Assessee's income, could be attributed to such PE in respect of the activities carried out by Adobe India, income from which had been subjected to transfer pricing scrutiny/adjustment. 2.1 The Assessee disputes that it has a PE in India. It further contends that since the income of Adobe India has been assessed at Arm's Length Prices (ALP), no part of Assessee's income could be attributed to Adobe India even if it was assumed to be the Assessee's PE in India. On the other hand, it is the Revenue's case that the activities carried out by the Adobe India are the core business activities of the Assessee; Adobe India is the Assessee's PE in India; the cost plus basis on which Adobe India is remunerated by the Assessee does not capture the fair share of Assessee's income attributable to its PE; an....
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..... The assessment orders for AYs 2004-05 and 2005-06 have become final and are not subject matter of any further proceedings. It is stated that in Adobe India's assessment for AY 2006-07, the TPO/AO did not accept the Transfer Pricing Study submitted by the Assessee therein as he did not accept the set of comparables used by the Adobe India to determine the ALP. However, Adobe India succeeded in its appeal before the Income Tax Appellate Tribunal and this Court is informed that the Revenue has assailed the Tribunal's order in this Court which as yet is pending. The Assessee further informs that for AY 2007-08, the Transfer Pricing Study furnished by Adobe India was not accepted by the TPO, who sought to apply Profit Split Method (PSM) for determining the ALP instead of Transactional Net Marginal Method (TNMM) used in the preceding years. Adobe India successfully challenged the TPO's order for AY 2007-08 before the Dispute Resolution Panel (DRP) and the DRP has held that ALP be determined by applying TNMM as in the preceding years. 6. The AO issued the impugned notices under Section 148 of the Act on 30th March, 2011. In response to the aforesaid notice for AY 2004-05....
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....would be necessary to refer to the reasons recorded by the AO for forming the belief that the Assessee's income for the relevant AYs had escaped assessment. Reasons to believe that income had escaped assessment. 12. In the reasons recorded by the AO for issuance of the impugned notices, the AO had recorded that: (a) Adobe India develops software for the Assessee for which Adobe India has been compensated on a 'cost plus profit basis'; (b) the ownership of the software developed by Adobe India is the sole property of the Assessee and Adobe India does not retain any intellectual property rights in respect of the software developed by it; (c) the Assessee makes substantial profits by selling the software developed in India abroad for which no taxes have been paid by the Assessee in India; (d) Adobe India has been working wholly and exclusively for the Assessee and does not develop software for any other concern; and (e) the Assessee's transaction with Adobe India are not isolated transactions "but a continuous business connection as Adobe India is connected to the Assessee through a network of lease lines and other technological means". 13. On the basis of ....
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....utable to India R&D which is Rs. 1094766837 come to Rs. 2080056990 which is more than Rs. 1 lakh. Although the figures are for calendar year but same has been taken on pro-rata basis. From the above paras, it is clear that the income of the assessee escaping assessment is Rs. 2080056990/- which is more than Rs. 1 lacs and therefore I have reason to believe that income of the assessee has escape assessment as per section 151 r.w.s. 148 of the Income-tax Act, 1961." The taxable profits for AYs 2004-05 and 2005-06 were also computed in a similar manner. Reasoning and Conclusion 16. It is apparent from the plain reading of the reasons recorded by the AO that his belief that the income of the Assessee had escaped assessment stems from his understanding that the activities pertaining to R&D services rendered by Adobe India were conducted by the Assessee. He has, therefore, concluded that the Assessee must surrender a part of his income, which is attributable to those activities in India, to tax under the Act. It is not disputed that Adobe India has been assessed to tax on the very same activities priced on Arm's Length basis. In the circumstances, the first and foremost qu....
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....he ALP for the said transaction, that is, TNMM, has been accepted for AYs 2004-05, 2005-06, 2006-07; although for AY 2007-08, the TPO has sought to use the PSM, the same was not upheld by the DRP. Thus, undisputedly, the real income of Adobe India, which is related to the activities carried out by Adobe India has been brought to tax in its hands. And even if there is any dispute relating to the same, it is liable to be resolved in proceedings relating to Adobe India. 20. We may now refer to the provisions of Article 7 of the Indo-US DTAA which read as under:- "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 permanent establishment 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 (a) that permanent establishment ; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment ; or (c) other business activities carried on in....
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.... no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than toward reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices. 4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. 5. For the purposes of this Convention, the profits to be attributed to the permanent establishment as provided in paragraph 1(a) of this Article shall include only the profits derived from the assets and activities of the permanent establishment and shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 6. Where profits include items of income wh....
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....hands of Adobe India. Thus, in our view, even if the AO is correct in its assumption that Adobe India constituted the Assessee's PE in terms of Article 5(1), 5(2)(l) or 5(5) of the Indo-US DTAA, the facts in this case do not provide the AO any reason to believe that any part of the Assessee's income had escaped assessment under the Act. 24. In the case of DIT (International Taxation) v. Morgan Stanley & Company Inc.: (2007) 292 ITR 416 (SC), the Supreme Court had explained the above in the following manner:- "32. The object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. Under Article 7(2) not all profits of MSCO would be taxable in India but only those which have economic nexus with PE in India. A foreign enterprise is liable to be taxed in India on so much of its business profit as is attributable to the PE in India. The quantum of taxable income is to be determined in accordance with the provisions of I.T. Act. All provisions of I.T. Act are applicable, including provisions relating to depreciation, investment losses, deductible expenses, carry forward and set-off losses etc. However, deviations are made by DTAA in case....
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....clusion, it is not necessary for us to examine whether the Assessee had a PE in India in terms of Article 5(1), 5(2)(l) or Article 5(5) of the Indo-US DTAA. However for the sake of completeness, we consider it appropriate to also examine the question whether the AO's opinion that the Assessee has a PE in India is informed by reason. 28. A subsidiary company is an independent tax entity and is separately taxed for its income in the country of its domicile. In the present case, Adobe India is a separate assessee and is liable to pay tax on its income. The fact that a holding company in another contracting state exercises certain control and management over a subsidiary would not render the subsidiary as a PE of the holding company. This is expressly spelt out in paragraph 6 of Article 5 of the Indo-US DTAA, which reads as under:- "(6) The fact that a company which is a resident of a Contracting State 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 permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other....
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....ld that the Assessee has a PE in India in terms of Article 5(1), 5(2)(l) or Article 5(5) of the Indo-US DTAA. Article 5 of the Indo-US DTAA which defines Permanent Establishment reads as under:- "ARTICLE 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an 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 well, a quarry, or any other place of extraction of natural resources ; g) a warehouse, in relation to a person providing storage facilities for others ; h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on; i) a store or premises used as a sales outlet; j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve-month period ; k) a building site or construction, installation or assembly project or supervisory activities in conn....
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....ovisions of that paragraph; 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, and some additional activities conducted in the State on behalf of the enterprise have contributed to the sale of the goods or merchandise ; or c) he habitually secures orders in the firstmentioned State, wholly or almost wholly for the enterprise. 5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. 6. The fact that a company which is a resident of a Contr....
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....termining the applicability of Article 5(1) of the Indo-US DTAA. The Court had further expressly held that : "Even if the foreign entities have saved and reduced their expenditure by transferring business or back office operations to the Indian subsidiary, it would not by itself create a fixed place or location permanent establishment. The manner and mode of the payment of royalty or associated transactions is not a test which can be applied to determine, whether fixed place permanent establishment exists. Reference to core of auxiliary or preliminary activity is relevant when we apply paragraph 3 of Article 5 or when sub-clause (a) to paragraph 4 to Article 5 is under consideration. The fact that the subsidiary company was carrying on core activities as performed by the foreign assessee does not create a fixed place permanent establishment." 34. Thus, the AO's view that Adobe India constituted the Assessee's PE in terms of paragraph 1 of Article 5 of the Indo-US DTAA is palpably erroneous and not sustainable on the basis of the facts as recorded by him. 35. We also find that there is no material to hold that the Assessee's employees constitute a Service PE i....