TaxTMI 
TaxTMI 
2025 (1) TMI 1274
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....2. The following question has been referred for consideration of the Special Bench: "Whether or not the transactions between an enterprise and its foreign permanent establishment can be considered international transactions for the purpose of section 92B, and accordingly can be subjected to the 'arm's length price' adjustment?" 3. Brief facts of the case are as follows: 4. The assessee is a Project Office ("PO") in India of TBEA Shenyang Transformer Group Company Ltd., ("TBEA"), a company which is incorporated in China and is a tax resident of China. Thus, PO of TBEA constitutes Permanent Establishment in India. Power Grid Corporation of India Ltd., ("PGCIL") awarded a contract to TBEA to build sub-stations in India, comprising of off-shore supply, on-shore supply, and on-shore Services, governed by separate agreements. Under the offshore supply agreement, the TBEA supplied equipment directly to PGCIL from outside India, invoiced and collected payments outside India. Under the onshore services agreement TBEA was to provide certain onshore services in the nature of inland transportation and civil work services to PGCIL within India. In order to provide these services,....
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..... Further, it is also necessary to discuss the so called conflict of orders of ITAT, which has led to the constitution of this Special Bench. 7. Purpose of TP Provisions 7.1 Section 92 of the Act provides that any income arising from an international transaction shall be computed having regard to the arm's length price. Section 92A of the Act defines who is Associated Enterprise. Section 92B(1) of the Act defines the international transaction and section 92B(2) of the Act defines the deemed international transaction. Section 92C of the Act, dealing with computation of ALP, provides through sub-section (1), that the ALP shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe. Five specific methods have been set out, namely, (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method. Thereafter, another method is given in clause (f), namely, such other method as....
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....7.3 The above view is also echoed by the Hon'ble Supreme Court in the case of DIT (International taxation) Vs. Morgan Stanley & Co, reported in (2007) 292 ITR 416 (SC) wherein the Supreme Court observed that the object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. 7.4 The transfer pricing provisions need to be interpreted keeping in mind the above objective of fair and equitable tax allocation. In the instant case, the PO has undertaken onshore services on behalf of HO and incurred substantial losses in executing such services. The crux of the matter is whether unrelated party would have taken up the obligation of rendering onshore services, which at the threshold itself result in loss. 8. Now let us discuss the conflict of decision of the ITAT which led to the constitution of this Special Bench. Conflict in Decisions 8.1 In the reference order to Special Bench under section 255(3) of the Act, it has been stated that there is conflict in the decisions in the case of Aithent Technologies Pvt Ltd vs DCIT reported in [(2015) 155 ITD 266 (Del)] and Fujifilm Corporation India reported in (2018) 193 TTJ 716 (Del) and hence n....
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....oviding services is an 'enterprise' as a permanent establishment of the general enterprise, all the transactions between the branch office and the general enterprise be subjected to the transfer pricing provisions. However, this prima facie impression loses its substance when the general enterprise is an Indian entity and the branch office is located outside India." 8.5 The reason for this differentiation for Indian entity and foreign branch was explained by ITAT in the following words: "Thus it is apparent that a resident assessee is liable to tax for its world income, which not only comprises of Indian income but also the income which 'accrues or arises to him outside India during such year'. The final accounts of foreign branch office, including all the items of income, expenses, assets and liabilities are merged with the accounts of head office and the accumulated income so determined is liable to tax in India. When the sale made by the Indian Head office is considered as purchase of the foreign branch office and the figures of head office and branch office are consolidated, any under or over invoicing becomes tax neutral. Even if for a moment, we ac....
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....that the Indian tax kitty is not deprived of the rightful amount of tax due to it. Thus, the definition of 'enterprise' as per section 92F(iii) as also including its permanent establishment for the transfer pricing provisions is confined only in respect of a foreign general enterprise having a branch office in India and not vice versa. 8.7 Thus, clear differentiation was made between foreign branch of Indian enterprise and Indian branch of foreign enterprise. This differentiation was made on the fact that in case of foreign branch of Indian enterprise, in the hands of Indian enterprise, the global income is taxable by virtue of section 5(1), which includes the income of foreign branch. However, in case of Indian branch of foreign enterprise, only income of Indian branch is taxable in India by virtue of section 5(2). In such cases, there is a potential to manipulate the profits of Indian branch qua transactions between Head Office and Branch. 8.8 Now, we come to the decision in the case of Fujifilm Corporation, Japan (supra). In this case, the Fujifilm Corporation. was a Japanese enterprise and it had branch Office in India. Vide Additional Ground, the assessee contend....
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....oach between a foreign branch of Indian enterprise and Indian branch of foreign enterprise should be maintained. Section 92B(1), defines 'international transactions' to mean a transaction between two or more associated enterprises, either or both of whom are non- residents, in the nature of... ... .... As per section 92B(1), to qualify as international transaction, atleast one party should be non- resident. The residential status of the branch is that of its head office. In case of Indian enterprise and its foreign PE, both are residents in India. Thus, the condition that at least one party should be non-resident does not get fulfilled in the case of Indian enterprise and its foreign branch. 8.12 However, in the case of foreign enterprise and its Indian branch, both parties are non-residents. Thus, the condition of section 92B(1) of the Act that atleast one party should be non- resident gets satisfied in the case of foreign enterprise and its Indian branch. 9. Now let us come to the contentions raised by AR and DR with reference to the reframed question. Whether PE a Separate Enterprise 9.1 The assessee has contended that Chapter X is not applicable in absence o....
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.... provisions to apply the international transaction should be between AE's. Both under the Act and the Rules, the applicability of transfer pricing and computation of ALP is dependent on qualifying as an "enterprise". Enterprise is defined in clause (iii) of section 92F of the Act as follows: (iii) "enterprise" means a person (including a permanent establishment of such person) who is, or has been, or is proposed to be, engaged in any activity, relating to the production, storage, supply, distribution, acquisition or control of articles or goods, or know-how, patents. copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights, or the provision of services of any kind, or in carrying out any work in pursuance of a contract, or in investment, or providing loan or in the business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any other body corp....
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....ty, learned AR has lost sight of Article 7(2) of India-China Tax Treaty. The same is extracted below: "2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment." 10.4 In the context of a PE in India of a foreign enterprise, Article 7(2) provides that profits, which the PE might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities shall be attributed to India. So, PE has to be treated as a distinct and separate enterprise. So even if profit attribution has to be done as per treaty, PE has to be treated as a distinct and separate enterprise from the HO. Therefore, even under the tax treaty, the PE is a separate enterprise. 10.5 Since, PE is....
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....or not such arrangement, understanding or action to intended to be enforceable by legal proceeding. 11.5 Thus, transaction includes arrangement, understanding or action in concert. The arrangement or understanding between two enterprises may also give rise to income or loss and it may be subject matter of transfer pricing. In the instant case, the arrangement between the HO and the PE is giving rise to loss in the hands of PE and thus such an arrangement is subject matter of transfer pricing. The PE has undertaken obligation of rendering onshore services to which the HO had agreed. The funds of PE are controlled and managed by HO. If the income or loss in the hands of PE was not due to arrangement with HO, then such a case would not be covered. However, that is not the case here. 11.6 In this context, useful reference can be made to the decision of the Tribunal in the case of Toyota Kirloskar Motors (P.) Ltd. V ALIT [2012] 28 taxmann.com293 (Bangalore). In this case, the assessee contended that no TP addition can be made as there is no amendment to the definition of the term 'income' to include amounts computed under Chapter X of the Act. Rejecting the above contentio....
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....er u/s 92B(1) or 92B(2) of the Act. Such international transaction should give rise to income which is within the taxing ambit of charging provisions of the Act. 11.8 As held above, in our view, PO and HO are separate enterprise. Further as per Article 7(2) of the India-China DTA A and para 15, 16 & 17 of the commentary on Article 7 on Model tax convention published by OECD in 2010 also states that permanent establishment is to be treated as a functionally separate entity. PO and HO have transaction between them which has an impact on 'income'. Both are non-residents and thus satisfy the basic test of section 92B of the Act. Whether they qualify as AEs within the meaning of section 92A is discussed below. 12. Associated Enterprise 12.1 The AR submitted that the Learned TPO has erred in concluding that PO and HO are 'associated enterprise' merely by evaluating section 92A(1) of the Act. It is submitted that in order to constitute 'associated enterprises', requirement of both, sections 92A(1) and 92A(2) of the Act have to be fulfilled. For this purpose, the AR relied on the Memorandum explaining the provisions of Finance Bill 2002. The AR has further ....
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....al, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise. (2) For the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during the previous year,- ............ 13.2 For dealing with this issue, it is necessary to appreciate the scheme of section 92A of the Act. The section 92A(1) of the Act sets out the basic rule for treating the enterprises as associated enterprises. The illustrations in which basic rule finds application are set out in section 92A(2) of the Act. 13.3 The basic rule of Section 92A(1) of the Act provides that in order to be treated one enterprise as associated enterprise, in relation to another enterprise, it has to participate, directly or indirectly, or through one or more intermediaries, 'in the management or control or capital of the other enterprise' or when 'one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, ....
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....in section 92A(2) of the Act are not satisfied, even if an enterprise has a de facto participation capital, management or control over the other enterprises, the two enterprises cannot be said to be associated enterprises. Once condition of any clauses in section 92A(2) of the Act are satisfied, the AE relationship is triggered. Nothing more is required. 13.7 In the cases of these kinds, the test of holding voting power through shares would not be satisfied as the PE has no independent share capital of its own. So also, the condition of appointment of the Executive director or a majority of the Board of directors may not be satisfied as PE would not have directors of its own. The DR has contended that PE has advanced its entire funds to HO. The quantitative test of clauses (c) and(d) of section 92A(2) of the Act are to be applied in the hands of recipient and not in the hands of lender. What may be satisfied in these kinds of cases is for example clause (g) providing that AE relationship would trigger if manufacture of goods or business carried out by one enterprise using the technology of the other enterprise or any other business or commercial rights of similar nature. Similar....
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.... associated enterprise under section 92A of the Act, may be deemed to be transaction between associated enterprises for the purposes of section 92B(1) of the Act, if the conditions contained in section 92B(2) of the Act are attracted. Section 92B(2) of the Act provides: "A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (I), be deemed to be an international transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise where the enterprise or the associated enterprise or both of them are nonresidents irrespective of whether such other person is a non- resident or not." 14.4 The primary condition for attracting transfer pricing provisions is that there should be an international transaction between two or more associated enterprises. Section 92B(2) of the Act outlines the circumstances under which a transaction between two persons would be ....
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....on Bench may analyse the applicability of section 92B(2) of the Act in accordance with law. 15. DTAA v Act 15.1 The Learned AR has submitted that as per the provisions of section 90 of the Act, the provisions of the DTAA (to the extent it is beneficial to the assessee) override the provisions of the Act. It is further submitted that as per Article 9 of India-China DTAA, the profits derived by the one enterprise would be subject to transfer pricing and determination of ALP, only where one of the two Enterprises is a resident of the other contracting state (India). It is submitted that neither the HO nor the PE can be termed as resident and thus transactions between them shall not be subject to transfer pricing considering provisions of Article 9 of DTAA. 16. We have heard the rival contention. It is first important to understand what is the purpose of Article 9 of the DTAA. This can be better understood from the following commentary of OECD on Article 9. Para 2 and Para 4 of OECD Model Tax Convention reads as follows: "2. This paragraph provides that the taxation authorities of a Contracting State may, for the purpose of calculating tax liabilities of associated en....
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...., as limited to the text of paragraph 1- which usually only confirms broadly similar rules existing in domestic laws-indicates that the intention was to have economic double taxation covered by the Convention. As a result, most member countries consider that economic double taxation resulting from adjustments made to profits by reason of transfer pricing is not in accordance with-at least- -the spirit of the Convention and falls within the scope of the mutual agreement procedure set up under Article 25. 18. As can be seen from above discussion, the purpose of Article 9 is limited to only confirm that broadly similar rules exist in domestic law. Article 9(1) does not, in itself fulfil any necessary function, as it only formulates rules that may already exist in domestic laws. Article 9(1) does not bar an adjustment of profits under the domestic law even under conditions that differ from those of Article 9(1) but the intention is to have economic double taxation covered by the convention. Assuming that argument of the learned AR that DTAA provisions in Article 9 override the Act is correct, then one needs to attribute profits to the PE as per provisions of Article 7 of the Treaty.....