2014 (7) TMI 678 - AT - Income Tax

Transfer pricing adjustments - Supply of hardware to Indian customers Permanent establishment - Whether the assessee constitutes a Permanent Establishment in India Held that - The decision in assessee s own case for the earlier year has been followed that the employees of group companies did visit in India in connection with Project in India - the employees of the group companies did carry out business of the assessee through the premise of LO or the premise of the subsidiary - the entire business enterprise activities of the assessee is managed by the subsidiary in India and the requisite supply is made from abroad - The contract does not only need loading of the equipments in the ship, but includes number of activities which are carried out in the Indian territory and the compensation / remuneration for that is also included in consideration the order of the CIT(A) is upheld that activities of the assessee in India constitute PE of the Assessee in terms of Article 5 of the Indo US DTAA - The activities carried out by the PE are the core activities of the assessee resulting in generation of income to the assessee and they cannot be considered to be preparatory and auxiliary - the contention of the assessee that it do not have PE in India is rejected. Attribution of profits - How much of the profits arising to the assessee from supply of telecom hardware to Indian customers is attributable to the PE in India Held that - The decision in assessee s own case for the earlier year has been followed that CIT(A) has held that AO was justified in resorting to Rule 10 - when profits are computed under Rule 10 after applying the profit rate, the expenses pertaining to the PE have to be allowed as deduction - CIT(A) has held that income of the PE has to be computed on the facts of each case CIT(A) has held that he was of the view that an attribution of 50% of the profits to the activities of PE in India would be a reasonable attribution. Hardware supply contract was a part of the turnkey contract which involved supply, installation, testing and commissioning etc. - Activities of M/s Nortel India and that of LO of Nortel Canada and services of expatriate workers have also been taken as part of the execution of the work by the PE - CIT(A) has directed the AO to also allow expenses relatable to PE - the gross profit computed by reference to the rate applicable to the global accounts of the assessee, further substantial deduction has been allowed for selling general and marketing expenses and also R&D expenses - 50% of the resultant figure has been attributed to PE - CIT(A) is justified in attributing 50% of the profit to the PE i.e. assessee - assessee constitutes Permanent Establishment in India in terms of Article 5 of the DTAC- attribution of 50% of profits is justified. Research & Development expenses Held that - The decision in assessee s own case for the earlier year has been followed that CIT(A) has held that AO has not verified the allowability of the expenditure CIT(A) that the same will be done if directed by him - the CIT(A) has himself examined the nature of the expenses and examined the allowability of these expenses as to whether the same were incurred wholly or exclusively for the purpose of business - CIT(A) has not even mentioned about the quantum of R&D expenses thus, the matter is to be remitted back to the AO Decided in favour of Assessee.

Issues Involved:
1. Taxation of revenues from supply of hardware to Indian customers.
2. Attribution of profits to the alleged Permanent Establishment (PE) in India.
3. Allowability of Research and Development (R&D) expenses.
4. Initiation of penalty proceedings under section 271(1)(c) of the IT Act.

Issue-wise Detailed Analysis:

1. Taxation of Revenues from Supply of Hardware to Indian Customers:
The assessee, a company incorporated in the USA and part of the Nortel Group, supplied hardware to Reliance Infocom and VSNL during the financial year relevant to the assessment year 2008-09. The assessee claimed that the income from these supplies was not taxable in India as the transactions were conducted on a principal-to-principal basis, with payments received outside India, and no PE was constituted in India. The AO, referring to earlier assessment orders, held that the assessee had a PE in India and attributed 80% of the profits from hardware supply to the PE, making them taxable in India.

2. Attribution of Profits to the Alleged Permanent Establishment (PE) in India:
The AO attributed 80% of the revenue from hardware supply to the PE in India, based on the assessment of earlier years. The DRP confirmed this attribution. The Tribunal referred to its earlier decisions for assessment years 2003-04, 2004-05, and 2005-06, where it was held that the assessee constituted a PE in India. The Tribunal agreed with the findings that the Indian subsidiary of Nortel Group, Nortel Networks India Pvt. Ltd., negotiated and secured contracts, and the LO of Nortel Canada provided services, indicating that the PE was involved in core activities generating income for the assessee. The Tribunal upheld the attribution of 50% of the profits to the PE, as determined in earlier assessments.

3. Allowability of Research and Development (R&D) Expenses:
The AO disallowed the R&D expenses claimed by the assessee, stating that the assessee failed to provide evidence linking the expenses to the hardware supplied to Indian customers. The AO also considered the R&D expenses as capital in nature. The Tribunal, referring to its earlier decision, remitted the issue to the AO for fresh consideration, directing the AO to examine the allowability of R&D expenses after giving the assessee an opportunity to present evidence.

4. Initiation of Penalty Proceedings under Section 271(1)(c) of the IT Act:
The AO initiated penalty proceedings under section 271(1)(c) of the IT Act against the assessee. However, the Tribunal did not provide a detailed analysis or conclusion on this issue in the judgment, focusing primarily on the attribution of profits and the allowability of R&D expenses.

Conclusion:
The Tribunal upheld the findings that the assessee constituted a PE in India and justified the attribution of 50% of the profits to the PE. The issue of allowability of R&D expenses was remitted to the AO for fresh consideration. The appeal was partly allowed for statistical purposes, and the order was pronounced in the open court on 13/6/2014.

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