TaxTMI 
TaxTMI 
2024 (9) TMI 1202
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....lishment [PE] would be warranted only if the enterprise as a whole, and the PE constituting merely a component thereof, had earned profits. 2. The appellants appear to have argued that in case the enterprise at an entity level had suffered a loss in the relevant Assessment Year [AY], no profit or income attribution would be warranted insofar as the PE is concerned. When these batch of appeals were initially considered by the Court on 16 January 2023, the following order came to be passed:- "1. One of the questions arising in the present petitions is whether any taxable income can be attributed to the Permanent Establishment (hereafter "PE") in India if the overseas entity has incurred a loss in the relevant assessment years. 2. Mr. S. Ganesh, learned Senior Counsel appearing for the appellant, submits that Article 7 of the Double Taxation Avoidance Agreement (hereafter "DTAA") entered into between the Government of United Arab Emirates and the Republic of India applies only in cases where the assessee earns profit. 3. If it is accepted that Article 7 of the DTAA doesn't apply; the questions that would next follow are whether DTAA applies in the context....
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.... if the establishment in India is generating profits, but the other entities of the assessee overseas are incurring a loss, the profits generated by the establishment, if otherwise chargeable under the Income Tax Act, would be required to be assessed and taxed. 10. In this view, we are inclined to observe that the aforesaid issue be referred to a larger Bench. 11. Mr. S. Ganesh submits that there are other questions which arise in the present appeal and if those are decided in favour of the assessee, the aforesaid issue may not be relevant. 12. He states that at the threshold, it is the assessee's case that it has no Permanent Establishment in India and if this issue is held in favour of the assessee/ appellant, it may not be relevant to address the issue as noted above. 13. Learned counsel for the respondent states that he is not prepared to argue on the questions as framed earlier and requests for an adjournment. 14. At his request, list on 13.02.2023. 15. The hearing fixed on 31.01.2023 stands cancelled." 3. The aspect of profit attribution to a PE again arose for consideration as would be evident from a reading of the ord....
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....etworks OY; ITA 503 of 2022, decided on 02.12.2022. 5. Mr. Ganesh, learned Senior Counsel appearing for the appellant states that, at this stage, the appellant does not wish to press the fourth question as stated above because the appellant's appeals can be decided on the basis of the first three questions. 6. He, however, reserves the right for pressing the said question at an appropriate stage if the need so arises. 7. In view of the above, this Court considers it apposite to examine the first three questions as set out above in the first instance. 8. Learned Counsel for the parties agree that if the decision in any of the three questions is in favour of the appellant, it would not be necessary for this court to consider the fourth question and the same will be taken as given up finally. 9. Arguments have been partly heard on the first three questions. 10. List for further proceedings on 20.04.2023". 4. It is on the aforesaid basis that the Court appears to have proceeded to consider the challenge which stood raised and the issue of applicability of Article 7 of the Double Taxation Avoidance Agreement [DTAA] between India a....
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....s Nokia Solutions and Networks OY. However, we have some reservations regarding the said view. 34. The profits attributable to the Assessee's PE in India are required to be determined on the footing that the PE is an independent taxable entity. It is, thus, possible that an Assessee makes a net loss at an entity level on account of losses suffered in other jurisdictions, which is partly offset by profits arising from India. In these circumstances, if it is held that the Assessee has a PE in India, prima facie the Assessee would be liable to pay tax on the income attributable to its PE in India notwithstanding the losses suffered in other jurisdictions. This aspect was not deliberated in the case of Commissioner of Income Tax (International Taxation)-2 v. Nokia Solutions and Networks OY. 35. This Court was of the view that the fourth question as raised by the Assessee ought to be referred to a larger Bench. This was recorded by this Court in an order dated 14.03.2023. However, the learned senior counsel appearing for the Assessee had requested this Court to consider the other questions and had asserted that the Assessee would not press the fourth question, if the A....
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....ment in India. However, without any prejudice to that basic contention, the assessee submitted that even assuming without conceding that the assessee has a permanent establishment in India, no profit or income can at all be attributed to the permanent establishment as the net profit of the assessee is loss and there are no taxable attributable profits available. The Assessing Officer has incorrectly determined the profits taking into gross profit into consideration and if the net profit is taken into consideration rightly, then the issue as to whether the assessee has a permanent establishment in India would end up as an academic issue. The attribution of profits (net profit) stands covered in favour of the appellant by the judgment of the Special Bench in the case of Nokia Corporation for the assessment year 1997-98 and 1998-99 (involving same business as carried out by the appellant) as mentioned in the paper book Volume C-page 936, at 949-950 (para 287). The Special Bench held that the appellant-company's world-wide net profit margins as per its audited accounts are to be applied for determining the quantum of the income to be attributed to the permanent establishme....
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....hod of attribution of profits to the permanent establishment on the basis of the net profit rate of the foreign enterprise has been applied by the Revenue in the cases of three other assessees who were in the same field of business as the appellant, viz., ZTE, Huawei and Nortel. Each of these assessees was engaged in the supply of telecom equipment to Indian telecom operators. The Income-tax Appellate Tribunal order passed in the case of Notel specifically records that in the cases of each of these two assessees, the Revenue had adopted the net profit rate of the foreign enterprise for determining the amount of profit income which was attributable to each enterprise's respective permanent establishment. Hence, applying the said Special Bench judgment to the facts of the present case, as the appellant has global net loss as per its audited accounts, no profit or income can be attributed to the assessee in India. To mention Special Bench ruling is in line with the provisions of article 7 (1) of the India Finland Double Taxation Avoidance Agreement (DTAA), which is set out at page 719, at 723 of Volume B of the compilation. For the sake of convenience, article 7 (1) is re....
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....on from the gross profit figures taken by the Assessing Officer, then again the resultant figure would be losses. Consequently, even if the method of attribution adopted by the Assessing Officer is considered to be correct, in any event, there would be no profit/income attributable to the permanent establishment. The computation is as under : xxxx xxxx xxxx 29. Consequently, even if the appellant has a permanent establishment in India, no profit or income can in law at all be attributed to permanent establishment which would be taxable in India. Hence, we hold that, the adjudication on issue of permanent establishment would be academic in nature. 12. Having regard to the following finding of fact returned by the Tribunal, we are of the view that the proposed questions of law, i. e., A and B would not arise for consideration. 13. We may also note, that a plain reading of the article 7 of the Double Taxation Avoidance Agreement entered into between India and Finland also persuades us to take the same view as that which is taken by the Tribunal. 13.1 A plain reading of the article 7 (1) would show, that the issue of taxability would arise q....
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....ent of the products were undertaken outside India, he has ultimately held that the profits attributable to operations in India should be taken at 5% of the sales to the Indian parties. For the assessment year 1998-99, he has taken 7.9% of the sale value considering the fact the net profit on Indian sales was 16.1% as against 10.8% in the preceding year. 424. The Department in its appeals has taken the ground that the CIT(Appeals) was not justified in reducing the income from 40% of the value of the hardware to 5% of the sales to Indian parties. Actually, for the assessment year 1998-99, the ground should be that the CIT(Appeals) was not justified in reducing the income to 7.9%. It appears to be a mistake in drafting the ground No. 1. On the other hand the assessee in its appeals has taken up several contentions including the contention that no income can be attributed to the PE at all primarily because whatever expenses that are incurred by it are compensated by the assessee on cost plus basis, that if the expenditure incurred by the PE is taken into account then there will be no income left to be assessed, that there are several activities which do not lead to the existen....
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....lve more effort on the part of the PE and the signing of the contracts is only the fructification of those efforts. Obviously, therefore, the income attributable to the negotiations part should be more and in addition to the income attributable to the signing of the contracts. Some income has to be attributed to the net work planning also. Taking all these into consideration, we consider it fair and reasonable to attributable 0% of the net profit in respect of the Indian sales as the income attributable to the PE. The following steps are involved in computing the income attributable to the PE. 427. First the global sales and the global net profit have to be ascertained. From the accounts presented before us as well as before the Income-tax authorities, the global net profit rate has been ascertained at 10.8% and 6.1% by the CIT (Appeals) to which no objection has been taken either side. This percentage has to be applied to the Indian sales and by Indian sales, we means the total contract price for the equipment as a whole and not the bifurcated price which the Assessing officer has referred to in the assessment order. This will also be consistent with our view that the sof....
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....lity could arise only if profits had accrued to the assessee and that too only to the extent attributable to its PE in India. 15. Appearing for the assessee, Mr. S. Ganesh, learned senior counsel, at the outset contended that once the Revenue had accepted the formulation of the legal position by the Special Bench of the Tribunal in Motorola Inc. and had restricted its challenge only to the prescription of a profit percentage, it would not be permissible for them to re-agitate those questions. 16. Apart from the above, Mr. Ganesh commended for our acceptance the view expressed by the Court in Nokia Solutions when it had observed that the question of taxability would arise only if profits had accrued to the assessee at a global level. According to learned senior counsel, a plain and textual reading of Article 7 of the DTAA would also lead us to the same conclusion. 17. According to Mr. Ganesh, on a reading of Article 7 of the DTAA, it would be apparent that the profits of an enterprise based in UAE would ordinarily be taxable only in that State and not in India. It was his submission that if the enterprise based in the UAE were making a loss, the question of taxability eithe....
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....ly to the extent they can be attributed to its permanent establishment in India. 14. Given this position, we are not inclined to entertain the appeal." 19. It was thus sought to be contended by Mr. Kumar that this Court ultimately declined to entertain the appeal of the Revenue in light of the findings of fact which had come to be rendered by the Tribunal. According to learned counsel, the decision of this Court in Nokia Solutions, and the correctness of which has been doubted by the Bench while referring the matter for our consideration, came to be rendered primarily influenced by the fact that the Revenue had failed to question the method of attribution and the net profit rate as was adopted by the Special Bench. According to learned counsel, the same must consequently be read as confined to the peculiar facts which obtained and that the said decision cannot possibly be read as an authority for the proposition of a global profit being an aspect of import insofar as attribution under Article 7 is concerned. 20. Proceeding then to the DTAA itself, it was Mr. Kumar's contention that the Convention clearly contemplates an exercise of attribution being undertaken under ....
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....establishment situated in the first State, it is paragraph 2 that determines the meaning of the phrase "profits attributable to a permanent establishment". In other words, the directive of paragraph 2 may result in profits being attributed to a permanent establishment even though the enterprise as a whole has never made profits; conversely, that directive may result in no profits being attributed to a permanent establishment even though the enterprise as a whole has made profits. 12. Clearly, however, the Contracting State of the enterprise has an interest in the directive of paragraph 2 being correctly applied by the State where the permanent establishment is located. Since that directive applies to both Contracting States, the State of the enterprise must, in accordance with Article 23, eliminate double taxation on the profits properly attributable to the permanent establishment. In other words, if the State where the permanent establishment is located attempts to tax profits that are not attributable to the permanent establishment under Article 7, this may result in double taxation of profits that should properly be taxed only in the State of the enterprise." 24. Hav....
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....ity for the proposition which is canvassed for our consideration by the appellants in these proceedings. The Tribunal in Nokia Solutions had ultimately held that "....as the Appellant has global net loss as per audited accounts, no profit or income can be attributed to the PE." The Tribunal too appears to have completely misconstrued Motorola Inc. as purporting to enunciate a binding legal principle of global loss being pertinent for the purposes of considering whether income is allocable to the PE. We thus find ourselves to read or construe the decision of the Special Bench as lending credence to the contentions which were canvassed at the behest of the appellants in these proceedings. The aspect of a failure on the part of the Revenue to question or assail the observations entered by the Special Bench, consequently, pale into insignificance. 29. However, and this we do propose to clarify. The observations that appear hereinabove are rendered solely in the context of our endevour to enunciate the correct legal position which would obtain and are not intended to shroud the ultimate judgment which the Court rendered and would continue to bind parties. 30. Having put the prelim....
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....e 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 carrying on, for the enterprise, any other activity of a preparatory or auxiliary character. 4. Notwithstanding the provisions of paragraphs (1) and (3), where a person - other than an agent of independent status to whom paragraph (5) applies - is acting on behalf of an enterprise and has, and habitually exercises in a Contracting State an authority to conclude contracts on behalf of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to the purchase of goods or merchandise 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 tha....
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....hat the result shall be in accordance with the principles contained in this Article. 5. No profits shall be attributed to a permanent establishment by reason of the mere purchase by the permanent establishment of goods or merchandise for the enterprise. 6. For the purposes of preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. (7) Where profits include items of income which are dealt with separately in other Articles of this Agreement, then the provisions of those Articles shall not be affected by the provisions of this Article." 33. It becomes pertinent to note that Article 5 while defining the expression "PE" brings within its ambit a varied nature of establishments and which need not necessarily be those which have a separate legal persona. As we view Article 5, it becomes apparent that the nature of establishments which are included within the meaning of the phrase "PE" range from a place of management to a mine or a building site and thus not being confined to a juridical entity as is ordinarily understood i....
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....urce State under the 'force of attraction' notion are not attributable to a permanent establishment and therefore not effectively connected with it. The US Technical Explanation gives the example of dividends derived by a dealer in shares or securities from shares or securities that the dealer held for sale to customers. However, in respect of debt claims, rights and property, the UN Model Convention allows a limited force of attraction under article 7 (1) (c) : Business activities in the source State of the same or similar kind as those effected through the permanent establishment may also be taxed in the source State. Consequently, interest received from debt claims and royalties received from rights and property effectively connected with such business activities may also be taxed unrestrictedly in the source State (No. 20 of UN Model Convention 2011 Comm. on article 11; No. 17 of UN Model Convention 2011 Comm. on article 12). For example, the proviso applies whenever both the permanent establishment's business activities and the head office's business activities carried out in the permanent establishment State consist of managing or trading shares, granting loans or lic....
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.... from what is actually relevant for answering the question of what assets must be allocated to a permanent establishment : The significant people's functions. The author believes that this is an activity test and has nothing to do with an ownership test, and therefore is of the opinion that the relevant test is, or should be, whether the shares, debt claims, rights or property, as the case may be, are managed and their exploitation is directed and controlled by people active in or from a permanent establishment. If so, the asset concerned is effectively connected with that permanent establishment and the income received from it (i.e., dividend, interest respectively royalty must be attributed to that permanent establishment (see supra m. No. 124)). Whether the economic strength of a permanent establishment is enhanced is, as such, not a relevant criterion. Assets cannot create economic activity by themselves." 35. The separate treatment which is liable to be accorded to the functioning of a PE is an aspect which also emerges from the following observations rendered by the Supreme Court in DIT (International Taxation), Mumbai vs. Morgan Stanley & Co. Inc. (2007) 7 SCC 1:- ....
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....ncome which serve as a (primary or secondary) basis for the taxpayer in a State other than his or her State of residence). To a large extent, a PE does not only resemble the concept of residence in appearance but may also trigger similar, though not identical legal consequences. Since the early 1920s, the PE threshold has been commonly used in DTCs to determine whether a particular kind of income shall or shall not be taxed in the country from which it originates. Wherever distributive rules use the PE concept (infra m.no. 4 et seq.). they reconcile requirements of international justice (prerogative of source-based taxation) and practical prudence (prerogative of residence-based taxation). In connection with those rules, Article 5 OECD and UN MC serves to simplify and facilitate taxation of cross-border activities. At the same time, it is in line with trends to encourage liberalization of international trade. Thus, the PE principle was adopted to accomplish three main objectives: - assigning tax revenue to the source State - maintaining practicability by establishing a minimum threshold (i.e., by preventing pure and unconditional source-based taxation whe....
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....irement does not imply an activity in the sense of an active and visible work. It includes even stand-by services and omissions. This gains significant relevance where the omission is profitable (e.g., in the case of a POB earning money in the source State simply by fulfilling, for whichever period of time, a non-competition agreement relating to the territory of that State). 138 However, a diffuse passivity which equals a (temporal or lasting) suspension of the activities which the POB has been designed for may indicate that the POB is not 'permanent'. For details, see supra m.no.87 et seq. 139 Thirdly, the phrase 'through which' indicates that the taxpayer makes use of the POB in that he employs it as an instrument (equalling or resembling an operating asset) for his entrepreneurial activities. This third aspect of the functional integration is by far the most disputed one. 140 Historically, the instrumental character of the POB for the carrying-on of the enterprise could not be taken for granted. Between 1963 and 1977, the OBEC/OECD MC did not employ this term. Rather, it was sufficient that the taxpayer carried on his business 'in' the POB (se....
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....vice PE. In substance, the view of the OECD MC Comm. limits the meaning of 'through' to the first two instead of all three semantic aspects required by Article 5 (1) OECD MC (supra m.no. 135 et seq. and 139 et seq.). 145 This abridging interpretation of Article 5 (1) OECD and UN MC is not convincing, though. It sets the term 'through' as a synonym of; in' or 'at'. It is certainly not harmful, under Article 5 (1) OECD and UN MC, if the taxpayer carries on his business also 'in' the POB. However, it is not sufficient. Given that the terms 'in' or 'at' have been used in a considerable number of bilateral DCs and, above all, that the OECD Model has intentionally replaced the word 'in' by 'through' in 1977 (supra m.no.45), the deviation in the text of the OECD MC is to be regarded as meaningful. The ordinary meaning of 'through' and 'par l'intermédiaire de' is different from, and goes beyond, the ordinary meaning of 'in' or 'at' (cf. Article 31(1) VCLT). Before the background of the 1963 OECD MC, it is least among OECD Member States that 'through' has been given a special meaning as opposed to 'in' (cf. Article ....
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....the permanent establishment situated in State S of an enterprise of State R acquires property from an associated enterprise of State T. If the price provided for in the contract between the two associated enterprises exceeds what would have been agreed to between independent enterprises, paragraph 2 of Article 7 of the treaty between State R and State S will authorise State S to adjust the profits attributable to the permanent establishment to reflect what a separate and independent enterprise would have paid for that property. In such a case, State R will also be able to adjust the profits of the enterprise of State R under paragraph 1 of Article 9 of the treaty between State R and State T, which will trigger the application of the corresponding adjustment mechanism of paragraph 2 of Article 9 of that treaty." 39. The OECD Commentary then proceeds to summarize the scope and extent of paragraph 1 as under: "Paragraph 1 10. Paragraph 1 incorporates the rules for the allocation of taxing rights on the business profits of enterprises of each Contracting State. First, it states that unless an enterprise of a Contracting State has a permanent establishment situated ....
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....traction approach that only applies to business profits derived from activities similar to those carried on by a permanent establishment, the general force of attraction approach described above has now been rejected in international tax treaty practice. The principle that is now generally accepted in double taxation conventions is based on the view that in taxing the profits that a foreign enterprise derives from a particular country, the tax authorities of that country should look at the separate sources of profit that the enterprise derives from their country and should apply to each the permanent establishment test, subject to the possible application of other Articles of the Convention. This solution allows simpler and more efficient tax administration and compliance, and is more closely adapted to the way in which business is commonly carried on. The organisation of modern business is highly complex. There are a considerable number of companies each of which is engaged in a wide diversity of activities and is carrying on business extensively in many countries. A company may set up a permanent establishment in another country through which it carries on manufacturing activitie....
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....d Developing Countries 2021 [UN Model Convention 2021] while explaining the concept of a PE makes the following pertinent observations: - "7. It could perhaps be argued that in the general definition some mention should also be made of the other characteristic of a permanent establishment to which some importance has sometimes been attached in the past, namely that the establishment must have a productive character, i.e. contribute to the profits of the enterprise. In the present definition this course has not been taken. Within the framework of a well-run business organisation it is surely axiomatic to assume that each part contributes to the productivity of the whole. It does not, of course, follow in every case that because in the wider context of the whole organisation a particular establishment has a "productive character" it is consequently a permanent establishment to which profits can properly be attributed for the purpose of tax in a particular territory (see Commentary on paragraph 4)." 41. The concept of a PE is more lucidly explained in the commentary as follows: - "41. Also, a permanent establishment may exist if the business of the enterprise is c....
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....herefore possible that, in some countries, the term "joint venture" would refer to a distinct enterprise. 43. In the case of an enterprise that takes the form of a fiscally transparent partnership, the enterprise is carried on by each partner and, as regards the partners' respective shares of the profits, is therefore an enterprise of each Contracting State of which a partner is a resident. If such a partnership has a permanent establishment in a Contracting State, each partner's share of the profits attributable to the permanent establishment will therefore constitute, for the purposes of Article 7, profits derived by an enterprise of the Contracting State of which that partner is a resident (see also paragraph 56 [of the Commentary on Article 5 of the 2017 OECD Model Tax Convention] below). 44. A permanent establishment begins to exist as soon as the enterprise commences to carry on its business through a fixed place of business. This is the case once the enterprise prepares, at the place of business, the activity for which the place of business is to serve permanently. The period of time during which the fixed place of business itself is being set up by the ent....
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....d to exist in one of the Contracting State, it is viewed as a unit which contributes to the economic life of that State and thus be liable to tax. It is these basic precepts which convince us to debunk the theory of taxation in the source State being dependent upon a global profit or taxation being subject to income or profit having been earned at an entity level. 44. The identity which attaches to a PE for the purposes of ascertainment of a taxing liability cannot possibly be doubted bearing in mind the succinct observations of the Supreme Court in Morgan Stanley and where their Lordships without a degree of equivocation acknowledged the distinction that is liable to be drawn between a PE with respect to income earned in the Contracting State where it is domiciled or deemed to exist and the global enterprise of which it may be a part. Vogel explains the PE concept as constituting the threshold and the "essential demarcation line" in the source State which sanctions the imposition of a tax in a fiscal jurisdiction other than the State of residence. This would clearly appeal to logical since the right of taxation which inheres in the source State is connected to the "economic lif....
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....titute a group of economists to study the issue of double taxation. That group is stated to have identified the fundamental factors worthy of consideration to be (a) the origin of wealth or income, (b) the situs of income, (c) enforcement of rights connected with the above and (d) domicile of the person vested with the power to use or dispose of that income or wealth. It was the factor pertaining to "origin" of income which led to the enunciation of the source rule bearing in mind the need to identify the primary source of creation of income and the residence of its owner. It is these fundamental precepts which led to the formulation of measures to determine the economic presence of an entity in a given State and the functional integration of such an entity in the economic activity undertaken in that State. 48. Vogel while speaking on taxing rights of nations makes the following pertinent observations [Vol. I, Fifth Edition, page 551 to 552]:- "Paragraph 1 10. [Taxing rights on business profits] Paragraph I incorporates the rules for the allocation of taxing rights on the business profits of enterprises of each Contracting State. First, it states that unless an....
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....nent establishment. Whilst some bilateral tax conventions include a limited anti-avoidance rule based on a restricted force of attraction approach that only applies to business profits derived from activities similar to those carried on by a permanent establishment, the general force of attraction approach described above has now been rejected in international tax treaty practice. The principle that is now generally accepted in double taxation conventions is based on the view that in taxing the profits that a foreign enterprise derives from a particular country, the tax authorities of that country should look at the separate sources of profit that the enterprise derives from their country and should apply to each the permanent establishment test, subject to the possible application of other Articles of the Convention. This solution allows simpler and more efficient tax administration and compliance, and is more closely adapted to the way in which business is commonly carried on. The organisation of modern business is highly complex. There are a considerable number of companies each of which is engaged in a wide diversity of activities and is carrying on business extensively in many....
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.... said to have been levied on such profits (see also paragraph 81 of the Commentary on Article 1. Paragraph 2 15. [Determination of attributable profits] Paragraph 2 provides the basic rule for the determination of the profits that are attributable to a permanent establishment. According to the paragraph, these profits are the profits that the permanent establishment might be expected to make if it were a separate and independent enterprise engaged in the same or similar activities under the same and similar conditions, taking into account the functions performed, assets used and risks assumed through the permanent establishment and through other parts of the enterprise. In addition, the paragraph clarifies that the rule applies with respect to the dealings between the permanent establishment and the other parts of the enterprise. 16. [Fiction of independence: arm's length principle] The basic approach incorporated in the paragraph for the purposes of determining what are the profits that are attributable to the permanent establishment is therefore to require the determination of the profits under the fiction that the permanent establishment is a separ....
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....n that Report. The Report therefore provides a detailed guide as to how the profits attributable to a permanent establishment should be determined under the provisions of paragraph 2. 20. [Two-step determination] As explained in the Report, the attribution of profits to a permanent establishment under paragraph 2 will follow from the calculation of the profits (or losses) from all its activities, including transactions with independent enterprises, transactions with associated enterprises (with direct application of the OECD Transfer Pricing Guidelines) and dealings with other parts of the enterprise. This analysis involves two steps which are described below. The order of the listing of items within each of these two steps is not meant to be prescriptive, as the various items may be interrelated (e.g. risk is initially attributed to a permanent establishment as it performs the significant people functions relevant to the assumption of that risk but the recognition and characterisation of a subsequent dealing between the permanent establishment and another part of the enterprise that manages the risk may lead to a transfer of the risk and supporting capital to the other pa....
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.... income that arises out of the said transaction would be required to be proportioned to each of the territories or not. 40. Income arising out of operation in more than one jurisdiction would have territorial nexus with each of the jurisdiction on actual basis. If that be so, it may not be correct to contend that the entire income "accrues or arises" in each of the jurisdiction. The Authority has proceeded on the basis that supplies in question had taken place offshore. It, however, has rendered its opinion on the premise that offshore supplies or offshore services were intimately connected with the turnkey project. xxx xxx xxx 82. In Klaus Vogel on Double Taxation Conventions, it is stated: "(g) No force of attraction principle.-The second sentence of Article 7 (1) allows the State of the permanent establishment to tax business profits, 'but only so much of them as is attributable to that permanent establishment'. The MC has thus decided against adopting the so-called 'force of attraction of the permanent establishment' i.e. against the principle that, where there is a permanent establishment, the State of the permanent establishment should be a....
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.... income of a non-resident under DTAA. There, however, may be a case where there can be overlapping of income; but we are not concerned with such a situation. The entire transaction having been completed on the high seas, the profits on sale did not arise in India, as has been contended by the appellant. Thus, having been excluded from the scope of taxation under the Act, the application of the Double Taxation Treaty would not arise. The Double Taxation Treaty, however, was taken recourse to by the appellant only by way of an alternate submission on income from services and not in relation to the tax of offshore supply of goods. xxx xxx xxx 92. Global income of a resident although is subjected to tax, global income of a non-resident may not be. The answer to the question would depend upon the nature of the contract and the provisions of DTAA. 93. What is relevant is receipt or accrual of income, as would be evident from a plain reading of Section 5 (2) of the Act. The legal fiction created although in a given case may be held to be of wide import, but it is trite that the terms of a contract are required to be construed having regard to the international c....
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....Act as the transaction/activity did not have any business connection. The conclusion of the High Court in this regard is absolutely defensible in view of the principles stated in CIT v. R.D. Aggarwal and Co. [(1965) 56 ITR 20 (SC); 1964 SCC OnLine SC 214.] , CIT v. T.I. and M. Sales Ltd. [(1987) 166 ITR 93 (SC); (1987) 3 SCC 132; 1987 SCC (Tax) 240.] and Barendra Prasad Ray v. ITO [(1981) 129 ITR 295 (SC); (1981) 2 SCC 693; 1981 SCC (Tax) 149.]. That being the position, the singular question that remains to be answered is whether the payment or receipt paid by the appellant to NRC as success fee would be deemed to be taxable in India under section 9 (1) (vii) of the Act ? As the factual matrix would show, the appellant has not invoked Double Taxation Avoidance Agreement between India and Switzerland. That being not there, we are only concerned whether the 'success fee' as termed by the assessee is 'fee for technical service' as enjoined under section 9 (1) (vii) of the Act. The said provision reads as follows: xxx xxx xxx 25. The principal provision is clause (b) of section 9 (1) (vii) of the Act. The said provision carves out an exception. The exception carve....
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....or juridical person. The "source State taxation" rule confers primacy to right to tax to a particular income or transaction to the State/nation where the source of the said income is located. The second rule, as is understood, is transaction specific. To elaborate, the source State seeks to tax the transaction or capital within its territory even when the income benefits belongs to a non-resident person, that is, a person resident in another country. The aforesaid principle sometimes is given a different name, that is, the territorial principle. It is apt to state here that the residence based taxation is perceived as benefiting the developed or capital exporting countries whereas the source based taxation protects and is regarded as more beneficial to capital importing countries, that is, developing nations. Here comes the principle of nexus, for the nexus of the right to tax is in the source rule. It is founded on the right of a country to tax the income earned from a source located in the said State, irrespective of the country of the residence of the recipient. It is well settled that the source based taxation is accepted and applied in international taxation law. 28. ....
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....they benefit, or belong to, non-resident persons (principle of source; the term 'territoriality principle' is avoided here because a variety of different meanings have been attributed to it)." As a consequence, tax claims of different States necessarily overlap. 3 Secondly, double taxation may also arise when a person is deemed a resident simultaneously by two (or more) States or because source rules overlap (i.e., because two (or more) States treat the same economic transaction or item of capital as having occurred or being situated in their territory). Thirdly, double taxation may arise because certain States tax the worldwide income of their citizens even when they are residents of another State (in particular the US and Eritrea; Bulgaria, Mexico, Myanmar, the Philippines and Vietnam gave up their earlier citizenship-based taxation). 4 By contrast, the term 'economic double taxation' is used to describe the situation that arises when the same economic transaction, item of income or capital is taxed in two or more States during the same period, but in the hands of different taxpayers (so-called 'lack of subject identity'). Economic double taxation will o....
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....scribing that if the enterprise were carrying on business through a PE situate in the other Contracting State, its profits would become liable to be taxed in the other State, restricted however, to the extent that those profits are attributable to that PE. 53. On a plain reading of Article 7 (1), it becomes apparent that while the profits of an enterprise of a Contracting State are ordained to be taxed only in that State, if that enterprise were to carry on business in the other Contracting State through a PE, the profits earned from activities undertaken by such an establishment would become subject to tax in the other State coupled with the rider of the same being confined to the extent to which those profits are attributable to such an establishment. 54. As we read Article 7, it becomes evident that Paragraph (1) clearly envisages the profits of a PE being liable to be independently taxed notwithstanding that PE being a constituent of a larger enterprise which may be domiciled in the other Contracting State. The exemption from taxation which stands accorded to an enterprise of a contracting State would cease to be applicable by virtue of the use of the word "unless" which ....
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....enterprise ultimately come to be taxed. 59. The view that we have taken above also finds support from the OECD Commentary on Article 7 and relevant parts whereof have been extracted in paragraph 39 of this judgment. As the Commentary succinctly explains, the taxation right of the source State is dependent upon the existence of a PE. That since such an establishment participates in economic activity within the territory of the source State. It is in the aforesaid context that the Commentary refers to it as constituting a "separate source of profit". Of equal significance are the observations in the Commentary and which bids us to bear in consideration the possibility of profits being attributed to the PE even though the entity as a whole had never earned the same. 60. Proceeding further to explain the ambit of Paragraph 2 of Article 7, the OECD Commentary observes: - "Paragraph 2 15. Paragraph 2 provides the basic rule for the determination of the profits that are attributable to a permanent establishment. According to the paragraph, these profits are the profits that the permanent establishment might be expected to make if it were a separate and independent ....
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....f profits that should properly be taxed only in the State of the enterprise." 61. Global income, as a fundamental precept, has always been invoked in respect of residents of a Contracting State. Most Nations have ultimately reverted to the source rule for purposes of taxation. We are thus called upon to deal with a regimen which concerns itself with the source from which income accrues or arises. This precept also stands mirrored in Section 5 of the Income Tax Act, 1961 [Act] and which jettisons the principle of territoriality only in respect of income earned by a resident. Thus, taxation based on worldwide income stands confined to natural residents. However, no Nation avowes or waives its right to tax capital or transactions which are anchored to its own territory. It is this basic precept of source which continues to bind. 62. The distinction which needs to be borne in mind with regard to the income of a non-resident as opposed to an entity domiciled and stationed in one of the Contracting States stands duly acknowledged in Section 5 of our Act and which subjects the global income of a resident alone to taxation. For non-residents, it is the principles of income accruing o....
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....n that the argument of global income or profit being relevant or determinative is totally unmerited and misconceived. The submission is clearly contrary to the weight of authority which has been noticed hereinabove. 65. Regard must also be had to the fact that Article 7 does not expand its gaze or reach to the overall operations or profitability of a transnational enterprise. It is concerned solely with the profits or income attributable to the PE. The taxability of income earned by a PE existing in a Contracting State is not even remotely linked or coupled to the overall operations of the enterprise of which it may be a part. The argument of world-wide income is thus rendered wholly untenable. 66. On an overall consideration of the above, we come to the firm conclusion that the submission of global income being determinative of the question which stood referred, is wholly unsustainable. The activities of a PE are liable to be independently evaluated and ascertained in light of the plain language in which Article 7 stands couched. The fact that a PE is conceived to be an independent taxable entity cannot possibly be doubted or questioned. The wealth of authority referred to h....