TaxTMI 
TaxTMI 
2024 (9) TMI 1202
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....he 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 where there is a loss, and whether recourse to DTAA is necessary....
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.... 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 order dated 14 March 2023 and which is extracted hereinbelow: - "1. On 05.07.2021, this Court had framed the following questions for consideration in ITA 216/2020: "(i) Has the T....
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.... 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 and the United Arab Emirates, in case losses had been suffered at an entity level was reserved for further consideration. The appeals were ultimately decided in terms of a final judgment rendered on 22 December 2023. The Court had identified the four principal questions which merited determination as being the fol....
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.... 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 Assessee's appeals are disposed of in its favour on the basis of the other questions as framed. The learned counsel for the parties had also agreed that if the appellant succeeded before this Court in respect of the first three questions, the Assessee would finally give-up the fourth question without any recourse. 36. In view of the above, this Court is confining further....
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....he 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 establishment. The effect being if the appellant-company is in net loss as per its audited accounts or the calendar years 2009 and 2010, which relate to the present assessment year 2010-11, there would be no profit or income attributable to the permanent establishment. There are losses in both years as per the audited accounts. Paper book-Volume A of compilation page 164, at 169 and page 180 at 185. The relevant portion of the sa....
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....ecifically 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 reproduced hereunder: 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 enterprises 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 permanent establishment.' Article 7 (1) thus provi....
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....nt 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 qua the respondent-assessee only if profits accrue to the respondent-assessee, and that too only 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." 10. It becomes pertinent to note that the Tribunal while considering the appeal preferred by Nokia Solutions had noticed the decision of the Special Bench in the assessee's own case and which formed part of a batch of connected appeals including the one preferred by Motorola Inc. in the follo....
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....ally, 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 existence of the PE and, therefore, they cannot contribute to the revenues of the PE, that no income can be attributed to the supervision because the supervision is only an incident of the sale and does not constitute an operation by itself, that the India specific accounts were wrongly rejected by the CIT (Appeals) and that at any rate the adoption of 5% and 7.9% of the sales to Indian parties is arbitrary and excessive. 425. We have carefully considered the argument raised by the Department as well as the assessee. In the present case it cannot be disputed that....
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..... 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 software and the hardware constitute one integrated equipment. The resultant figure would be the net profit arising in respect of the Indian sales. Out of this figure of net profit 20% shall be attributed to the PE to cover the three activities mentioned above. The A.O. is directed to compute the income of the PE as directed above." 11. As is evident from the aforesaid extracts of that decision, the reference to global sales and global net profit was made in the backdrop of the parties having failed to produce adequate material which may have independently established the profit margin of the PE in In....
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....ns 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 either in UAE or in India would not arise at all. According to learned senior counsel, only if an enterprise were making a profit, could a PE through which it carries on business be subjected to tax and that too restricted to so much of the profit as is attributable to that PE. Consequently, according to Mr. Ganesh, for a foreign enterprise to be taxed in India, the following three conditions precedent would have to be conjunctively satisfied: - A) The foreign enterprise must be making a profit; B) The foreign enterprise has a PE in India; and C) At least a part of the profit made by that enterprise is attributa....
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.... 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 Article 7 in light of the PE being treated as a separate and distinct enterprise in itself. According to Mr. Kumar, Article 7 mandates the attribution of profits to a PE acknowledging it to be a distinct and separate enterprise and thus such an exercise being undertaken independently. 21. According to learned counsel, the determination of business profit as per Article 7 is mandated to be undertaken on the basis that the PE is a separate enterprise and is operating independently of the enterprise of which it may be a PE. According to learned counsel, a reading of the provisions of the DTAA would lead one to the irresistible conclusion that the only relevant considerat....
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.... 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. Having noticed the submissions which were addressed by respective parties, it would be appropriate to deal with the submission of Mr. Ganesh who had argued that once the Revenue had accepted the decision of the Special Bench in Motorola Inc. it would not be permissible for it to take a contrary stand or contend that the profit or loss of an enterprise at a global level would be irrelevant. 25. We find ourselves unable to sustain that submission for the following reasons. Firstly, and at the outset, it must be borne in mind that this Full Bench is called upon to consider a question of law which stands referred for its consideration. It is clearly not concerned with whether the Revenue could ha....
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....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 preliminary submissions to rest, and before we commence our discussion on the principal question that stands posited, it would be appropriate to notice the salient provisions of the DTAA Article 3(1)(g) defines the expressions "enterprise of a contracting state and enterprise of the other contracting State" as follows: - "ARTICLE 3 GENERAL DEFINITIONS 1. In this Agreement, unless the context otherwise requires: xxx xxx xxx (g) the terms "enterprise of a Contracting State" and "enterprise of the other Contracting State" mean respectively, an enterprise carried on by a resident of a Contracting State and an enterprise carried only a resident of the other Contracting State ; 31. A PE is defined by Arti....
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....h 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 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, he will not be considered an agent of independent status within the meaning of this paragraph." 32. The subject of business profits and its taxability is regulated by Article 7 which reads 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 ....
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....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 in law. 34. The fact that a PE for the purposes of taxation is viewed as a separate and distinct centre, was one which was noticed by us, albeit briefly, in International Management Group (UK) Limited vs. Commissioner of Income Tax-2 2024 SCC OnLine Del 4558 as would be evident from the following extracts of that decision: - "107. We also bear in mind the submission of Mr. Vohra who had laid stress upon the memorandum of understanding and the services agreement being an indivisible contract and constituting a singular source of the income in question. Undisputedly, the income was earned by and was liable to be remitted to IMG. The service permanent establishment was undoubtedly not a separate legal entity which could have been possibly called upon to satisfy the test of economic ownership as suggested. While Conventions do accord an independent identity upon a permanent establishment, they do so for the purposes of t....
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....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 licensing. However, it does not apply if the head office's or the permanent establishment's activities consist only of disposing of capital by buying shares or depositing funds into bank accounts. Such activities are not the business activities referred to in article 7 (1) (c) of the UN Model Convention. The risk that the permanent establishment proviso may be abused through the transfer of shares, debt claims, rights or property to a permanent establishment set up solely to benefit from privileged tax regimes in the permanent establishment State may be remote (No. 32 of OECD Model Convention 2014 Comm. on article 10; No. 25 of OECD Model Convention 2014 Comm. on article 12; No. 21 of OECD Model Convention 2014 Comm. on article 12). First of all, a permanent establishment can only be identified if a business is carried on therein. Secondly, the condition that the shares, debt claims, rights or property must be effectively conne....
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....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:- "19. Under Article 7, the taxability is of MNE. What is to be taxed under Article 7 is income of MNE attributable to the PE in India. The income attributable to the said PE is the income attributable to foreign company's operations in India, which in turn implies the income attributable to the activities carried on by MNE through its PE in India. Therefore, there is a difference between the taxability of PE in respect of its income earned by it in India which is in accordance with the Income Tax Act, 1961 and which has nothing to do with the taxability of MNE, which is also taxable in India under Article 7, in respect of the profits attributable to its PE. Under Article 7, the taxability is of MNE. What is taxable under Article 7 is profits earned by MNE. Under the said IT Act, the taxable unit is the foreign company, though the quantum of income taxable is income attributable to PE of the said foreign company in India." xxx xxx xxx 34. Articl....
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.... - assigning tax revenue to the source State - maintaining practicability by establishing a minimum threshold (i.e., by preventing pure and unconditional source-based taxation where the contact of the taxpayer to the source State is only occasional or peripheral (ef. no. 132 et seq. OECD MC Comm. on Article 5)); and - placing the PE on equal footing with a local (i.e., resident) entrepreneur for the purposes of various articles, thus providing neutrality between the different forms of a secondary establishment available to foreign investors." 37. The working of an enterprise in a Contracting State through the agency of a PE, the "functional integration" between the two and the import of the word "through" as it appears in Article 5 was lucidly explained in Vogel as under [Vol. I, Fifth Edition, page 414 to 416.]:- "7. 'Through': Functional Integration 134 Article 5 (1) OECD MC (since 1977; see supra m. no. 45) requires that the business of an enterprise (for these terms, see supra m. no.27 et seq.) is carried on through the fixed POB. The preposition 'through' specifies the functional relation between the POB and the activities of the taxpayer. This relation can be described....
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....OBEC/OECD MC did not employ this term. Rather, it was sufficient that the taxpayer carried on his business 'in' the POB (see supra m.no.45). Based on the old Model, some older DCs use the words 'in which' still today. While some authors have denied any divergence in substance , the 1977 amendment is a strong reason to assume a semantic shift indeed. 141 In a different context (viz., in Article 5(4.1) of the OECD and UN MC, as amended in 2017), the OECD and UN have returned, in one specific regard, to this old line by stating that an enterprise should carry on business 'at the same place'. However, the simultaneous use of this language on the one hand and the terms 'used or maintained by an enterprise' on the other, in one and the same sentence in the initial phrase of Article 5(4.1) OECD and UN MC, proves how careful and attentive the 2017 Models have been drafted. This dualism is another good reason to stipulate a different meaning of 'through', as opposed to 'in' or 'at'. For all of these reasons, we do see a substantial difference between both terms. 142 It follows that on the one hand, the activities mentioned in Article 5 (1) OECD and UN MC need no longer b....
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.... States that 'through' has been given a special meaning as opposed to 'in' (cf. Article 31(4) VCLT). A reconsideration might be reasonable and recommendable from a policy viewpoint. It can only be realized, however, by a modification of the text of Article 5 (1) OECD and the UN MC itself. 146 Given that the POB may be a complex and heterogeneous object, the issue arises whether every single element or component part needs to be used. This is not required. It is sufficient that the POB as a whole is functionally integrated, in the aforementioned sense, into the business of the taxpayer. It should be noted, however, that a too narrow use might trigger the application of Article 5(4) OECD and UN MC even if the POB as a whole would not have fallen under Article S (4) OECD and UN MC by virtue of its outward appearance." 38. The imperatives of viewing the PE as a separate and independent centre for the purposes of fiscal treatment and taxation is necessitated for reasons of attribution and recognition of income generated by it independently. This becomes apparent from a reading of paragraph 24 of the Organisation for Economic Co-operation and Development [OECD Commentary on Model Tax ....
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....ontracting State has a permanent establishment situated in the other State, the business profits of that enterprise may not be taxed by that other State. Second, it provides that if such an enterprise carries on business in the other State through a permanent establishment situated therein, the profits that are attributable to the permanent establishment, as determined in accordance with paragraph 2, may be taxed by that other State. As explained below, however, paragraph 4 restricts the application of these rules by providing that Article 7 does not affect the application of other Articles of the Convention that provide special rules for certain categories of profits (e.g. those derived from the operation of ships and aircraft in international traffic) or for certain categories of income that may also constitute business profits (e.g. income derived by an enterprise in respect of personal activities of an entertainer or sportsperson). 11. The first principle underlying paragraph 1, i.e. that the profits of an enterprise of one Contracting State shall not be taxed in the other State unless the enterprise carries on business in that other State through a permanent establishment si....
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....hich it carries on manufacturing activities whilst a different part of the same company sells different goods in that other country through independent agents. That company may have perfectly valid commercial reasons for doing so: these may be based, for example, on the historical pattern of its business or on commercial convenience. If the country in which the permanent establishment is situated wished to go so far as to try to determine, and tax, the profit element of each of the transactions carried on through independent agents, with a view to aggregating that profit with the profits of the permanent establishment, that approach would interfere seriously with ordinary commercial activities and would be contrary to the aims of the Convention. 13. As indicated in the second sentence of paragraph 1, the profits that are attributable to the permanent establishment are determined in accordance with the provisions of paragraph 2, which provides the meaning of the phrase "profits that are attributable to the permanent establishment" found in paragraph 1. Since paragraph 1 grants taxing rights to the State in which the permanent establishment is situated only with respect to the prof....
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....prise is carried on mainly through automatic equipment, the activities of the personnel being restricted to setting up, operating, controlling and maintaining such equipment. Whether or not gaming and vending machines and the like set up by an enterprise of a State in the other State constitute a permanent establishment thus depends on whether or not the enterprise carries on a business activity besides the initial setting up of the machines. A permanent establishment does not exist if the enterprise merely sets up the machines and then leases the machines to other enterprises. A permanent establishment may exist, however, if the enterprise which sets up the machines also operates and maintains them for its own account. This also applies if the machines are operated and maintained by an agent dependent on the enterprise. 42. It follows from the definition of "enterprise of a Contracting State" in Article 3 that this term, as used in Article 7, and the term "enterprise" used in Article 5, refer to any form of enterprise carried on by a resident of a Contracting State, whether this enterprise is legally set up as a company, partnership, sole proprietorship or other legal form. Diff....
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....uld not be counted, provided that this activity differs substantially from the activity for which the place of business is to serve permanently. The permanent establishment ceases to exist with the disposal of the fixed place of business or with the cessation of any activity through it, that is when all acts and measures connected with the former activities of the permanent establishment are terminated (winding up current business transactions, maintenance and repair of facilities). A temporary interruption of operations, however, cannot be regarded as a closure. If the fixed place of business is leased to another enterprise, it will normally only serve the activities of that enterprise instead of the lessor's; in general, the lessor's permanent establishment ceases to exist, except where he continues carrying on a business activity of his own through the fixed place of business". 42. The concept of a PE is based upon the undertaking of economic activity in a particular State irrespective of the residence of an enterprise and the same being understood to be in the nature of a conglomerate or an entity which may have many arms or independent functional units situate in various fisc....
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....ational enterprise which is moored and berthed by virtue of the existence of a PE which may be found to exist. Regard must also be had to the fact that right of the source State to tax does not extend to profits which are not allocable to the PE. All of the above, thus clearly leads us to hold that the existence and identity of the PE is separate and distinct and subject to tax to the extent of activities that it may undertake in a State distinct from that of its principal. 45. It would also be pertinent to note that a cross-border entity may structure its operations in a manner where it operates in more than one taxing jurisdiction. If it be open for such an entity to assert that its global profits and income are not liable to be taxed on the basis of the source principle, it would be wholly impermissible for it to contend that the income which accrues or arises in the Contracting State is also exempt from tax. In any case, the usage of the phrase "...so much of them as is attributable to the permanent establishment." is a clear indicator of the DTAA warranting the PE being liable to be viewed as an independent center of revenue. 46. The identifiable parts of Article 7 not only ....
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....a permanent establishment situated in the other State, the business profits of that enterprise may not be taxed by that other State. Second, it provides that if such an enterprise carries on business in the other State through a permanent establishment situated therein, the profits that are attributable to the permanent establishment, as determined in accordance with paragraph 2, may be taxed by that other State. As explained below, however, paragraph 4 restricts the application of these rules by providing that Article 7 does not affect the application of other Articles of the Convention that provide special rules for certain categories of profits (e.g. those derived from the operation of ships and aircraft in international traffic) or for certain categories of income that may also constitute business profits (e.g. income derived by an enterprise in respect of personal activities of an entertainer or sportsman). 11. [Requirement of a PE] The first principle underlying paragraph 1, i.e., that the profits of an enterprise of one Contracting State shall not be taxed in the other State unless the enterprise carries on business in that other State through a permanent establishment sit....
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....hment in another country through which it carries on manufacturing activities whilst a different part of the same company sells different goods in that other country through independent agents. That company may have perfectly valid commercial reasons for doing so: these may be based, for example, on the historical pattern of its business or on commercial convenience. If the country in which the permanent establishment is situated wished to go so far as to try to determine, and tax, the profit element of each of the transactions carried on through independent agents, with a view to aggregating that profit with that the profits of the permanent establishment, that approach would interfere seriously with ordinary commercial activities and would be contrary to the aims of the Convention. 13. [Reference to paragraph 2] As indicated in the second sentence of paragraph 1, the profits that are attributable to the permanent establishment are determined in accordance with the provisions of paragraph 2, which provides the meaning of the phrase 'profits that are attributable to the permanent establishment' found in paragraph 1. Since paragraph 1 grants taxing rights to the State in w....
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....e of which it is a part as well as from any other person. The second part of that fiction corresponds to the arm's length principle which is also applicable, under the provisions of Article 9, for the purpose of adjusting the profits of associated enterprises (see paragraph 1 of the Commentary on Article 9). 17. [Separability of PE profits] Paragraph 2 does not seek to allocate the overall profits of the whole enterprise to the permanent establishment and its other parts but, instead requires that the profits attributable to a permanent establishment be determined as if it a separate enterprise. Profits may therefore be attributed to a permanent establishment even though the enterprise as a whole has never made profits. Conversely, paragraph 2 may rest in no profits being attributed to a permanent establishment even though the enterprise as whole has made profits. 18. [Double taxation difficulties] Clearly, however, where an enterprise of a Contracting State has a permanent establishment in the other Contracting State, the first State has an interest in the directive of paragraph 2 being correctly applied by the State where the permanent establishment is located. Since that....
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....taken which will lead to: - the attribution to the permanent establishment, as appropriate, of the rights and obligations arising out of transactions between the enterprise of which the permanent establishment is a part and separate enterprises; - the identification of significant people functions relevant to the attribution of economic ownership of assets, and the attribution of economic ownership of assets to the permanent establishment; - the identification of significant people functions relevant to the assumption of risks, and the attribution of risks to the permanent establishment; - the identification of other functions of the permanent establishment; - the recognition and determination of the nature of those dealings between the permanent establishment and other parts of the same enterprise that can appropriately be recognised, having passed the threshold test referred to in paragraph 26; and - the attribution of capital based on the assets and risks attributed to the permanent establishment." 49. Of equal significance are the following observations as appearing in the judgment of the Supreme Court in Ishikawajma-Harima Heavy Industries Ltd. vs. Director of Inc....
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....prevailing in the USA, such a 'force of attraction' was, for instance, incorporated in Germany's 1954 DTC with USA [second sentence of Article III (I)]. In contrast, the second sentence of Article 7 (1) MC allows the State of the permanent establishment to tax only those profits which are economically attributable to the permanent establishment i.e. those which result from the permanent establishment's activities, which arise economically from the business carried on by the permanent establishment (cf. also para 5, MC Comm. Article 7, supra m 10). As regards the profits made by the enterprise in the State of the permanent establishment, a distinction must always be made between those profits which result from the permanent establishment's activities and those made, without any interposition of the permanent establishment, by the head office or any other part of the enterprise (also for mere assembly permanent establishment: BFH 37 RIW 258 (1991). It is only when there is a connection with the permanent establishment that the State of the permanent establishment is entitled to impose tax. Conversely, losses incurred in connection with direct transactions may not be set o....
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....e. An endeavour should, thus, be made to construe the taxability of a non-resident in respect of income derived by it. Having regard to the internationally accepted principle and DTAA, it may not be possible to give an extended meaning to the words "income deemed to accrue or arise in India" as expressed in Section 9 of the Act. Section 9 incorporated various heads of income on which tax is sought to be levied by the Republic of India. Whatever is payable by a resident to a non-resident by way of fees for technical services, thus, would not always come within the purview of Section 9 (1) (vii) of the Act. It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax. Whereas a resident would come within the purview of Section 9 (1) (vii) of the Act, a non-resident would not, as services of a non-resident to a resident utilised in India may not have much relevance in determining whether the income of the non-resident accrues or arises in India. It must have a direct live link between the services rendered in India, when such a link is established, the same may again be subjected to any relief under DTAA. A distinction may also be made between re....
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....the purpose of making or earning any income from a source outside India. On a studied scrutiny of the said clause, it becomes clear that it lays down the principle what is basically known as the 'source rule', that is, income of the recipient to be charged or chargeable in the country where the source of payment is located, to clarify, where the payer is located. The clause further mandates and requires that the services should be utilised in India. 26. Having stated about the 'source rule', it is necessary to appropriately appreciate how the concept has developed. At the time of formation of 'League of Nations' at the end of 1920, it comprised of only 27 countries dominated by the European States and the United States of America. The United Nations that was formed after the Second World War, initially had 51 members. Presently, it has 193 members. With the efflux of time, there has been birth of nation States which enjoy political independence and that has led to cross-border and international trade. The State trade eventually has culminated in formulation of principles pertaining to international taxation jurisdiction. It needs no special emphasis to state that the said....
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....as a country where the income or wealth is physically or economically produced. (See League of Nations, Report on Double Taxation by Bruins, Einaudi, Saligman and Sir Josiah Stan (1923)). Appreciated on the aforesaid principle, it would apply where business activity is wholly or partly performed is a source State, as a logical corollary, the State concept would also justifiably include the country where the commercial need for the product originated, that is, for example, where the consultancy is utilised. 29. From the aforesaid, it is quite vivid that the concept of income source is multifaceted and has the potentiality to take different forms (See Klans Vogel, World-wide v. Source Taxation of Income-Review and Revision of Arguments (1988)). The said rule has been justified by Arvid A. Skaar in Permanent Establishment; Erosion of Tax Treaty Principle on the ground that profits of business enterprise are mainly the yield of an activity, for capital is profitable to the extent that it is actively utilised in a profitable manner. To this extent, neither the activity of business enterprise nor the capital made, depends on residence." 51. Vogel while explaining the circumstances in ....
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....ay also arise if, for example, alimony paid by a husband to his wife is considered income and taxed in her hands while not being allowed to be deducted as an expense by the husband in his residence State or if one State taxes a legal entity at its place of residence whereas another State disregards the legal entity and taxes its income or capital by attributing it to a resident shareholder. Furthermore, economic double taxation can result from conflicting rules regarding the inclusion or deduction of positive and negative elements of income and capital as, for example, in cases of transfer pricing. Occasionally, the term 'economic double taxation' is also used to describe the taxation of a corporation's income that is taxed initially at the corporate level and subsequently at the shareholder level (the so-called 'classical system of corporate taxation'). 5 The concept of 'double taxation', its prerequisites and its limitations, have been subject to much academic controversy. Application of tax treaties, however, is merely a matter of interpretation of the respective treaty. What conceptually is-and what is not-'double taxation' is therefore of no importance for the treaty's appli....
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....le 7 (1) thus in clear and unequivocal terms constructs a dichotomy between the profits that may be earned by an enterprise on a global scale and those which are attributable to a PE situate in the Contracting State. This becomes further evident from a reading of Paragraph (2) of Article 7 and which stipulates that where an enterprise carries on business through a PE in the other Contracting State, profits would be liable to be attributed to that PE as if it were a distinct and separate enterprise engaged in similar activities and independent of the enterprise of which it may be a part. 56. This aspect is further amplified when we bear in consideration Article 7 (2) employing the phrase "dealing wholly independently with the enterprise of which it is a permanent establishment". Article 7 (2) thus clearly bids us to view the PE as a distinct and separate entity engaged in undertaking business activity in its own right in a Contracting State. It would consequently and on a fundamental plane be incorrect to fuse the incomes generated by an enterprise as a whole with the income that may be earned by a PE in one of the Contracting States. 57. It would also be incorrect to interpret Ar....
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....r parts of the enterprise. 16. 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 separate enterprise and that such an enterprise is independent from the rest of the enterprise of which it is a part as well as from any other person. The second part of that fiction corresponds to the arm's length principle which is also applicable, under the provisions of Article 9, for the purpose of adjusting the profits of associated enterprises (see paragraph 1 of the Commentary on Article 9). 17. Paragraph 2 does not seek to allocate the overall profits of the whole enterprise to the permanent establishment and its other parts but, instead, requires that the profits attributable to a permanent establishment be determined as if it were a separate enterprise. Profits may therefore be attributed to a permanent establishment even though the enterprise as a whole has never made profits. Conversely, paragraph 2 may result in no profits being attributed to a permanent establishment ev....
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.... subjected to tax in the source State. As is pertinently noted in the OECD and UN Commentaries, it would be wholly incorrect to found taxation on the basis of the overall activities or profitability of an enterprise. The source State is ultimately concerned with the income or profit which arises or accrues within its territorial boundaries and the activities undertaken therein. As those commentaries pertinently observe, the profits attributable to a PE are not liable to be ignored on the basis of the performance of the entity as a whole. This position also finds resonance in the decisions of the Supreme Court in Morgan Stanley and Ishikawajama and relevant parts whereof have been extracted above. 64. If the submission of the appellants were to be accepted, the Revenue would be recognised to have the power to tax even in a situation where although the entity be profitable, the PE may have incurred a loss. If the aforesaid logic were to be applied, in a converse situation, the Contracting State would be countenanced to have the right to tax only if the assessee at a global level were found to have earned profit. That is clearly not the import of Article 7 of the DTAA. While protecti....