2007 (10) TMI 317 - AT - Income Tax

Summary

Issues Involved:
1. Whether the liaison offices (LOs) in India constitute a Permanent Establishment (PE) of the assessee under Article 5 of the Double Taxation Avoidance Agreement (DTAA) between India and Japan.
2. Whether the income attributed to the PE in India was correctly assessed under Article 7 of the DTAA and Section 9(1)(i) of the Income Tax Act, 1961.
3. Whether the activities of the LOs were of a preparatory or auxiliary nature as per the DTAA and the approval granted by the Reserve Bank of India (RBI).
4. The applicability of res judicata principles in income tax proceedings.

Detailed Analysis:

1. Constitution of Permanent Establishment (PE):
The primary issue was whether the LOs of the assessee in India constituted a PE under Article 5 of the DTAA between India and Japan. The assessee argued that the LOs were engaged solely in collecting and sending information to Japan, as permitted by the RBI, and did not engage in any business activities. The AO and CIT(A) concluded that the LOs did constitute a PE because their activities contributed to the global operations of the assessee and were not merely preparatory or auxiliary. They cited the OECD Model Convention Commentary, which states that a fixed place of business whose general purpose is identical to the enterprise's general purpose does not exercise a preparatory and auxiliary activity.

2. Attribution of Income to the PE:
The AO attributed income to the PE based on the operating profit ratio derived from the assessee's global operations, as seen on the company's website. The AO calculated the profit attributable to the Indian PE as Rs. 15,48,848, which was 1% of the operating expenses incurred in India. The CIT(A) upheld this method, noting that the assessee did not challenge the calculation method.

3. Nature of Activities of the LOs:
The assessee contended that the activities of the LOs were preparatory or auxiliary, as they were limited to collecting and sending information. The RBI's approval explicitly restricted the LOs from engaging in any trading, commercial, or industrial activities. The assessee provided auditor's certificates confirming compliance with RBI conditions. The AO and CIT(A) argued that the significant expenditure on the LOs and their organizational structure indicated that their activities were substantial and contributed to the global profit, thus constituting a PE.

4. Applicability of Res Judicata:
The assessee argued that for the past 45 years, the Department had accepted that the LOs did not constitute a PE, and there was no new material to justify a different stance. The Department countered that the principle of res judicata does not apply to income tax proceedings, allowing them to reassess the nature of the LOs' activities.

Tribunal's Findings:

Constitution of PE:
The Tribunal found that the activities of the LOs were indeed preparatory or auxiliary in nature. The RBI's approval and the consistent compliance with its conditions indicated that the LOs were not engaged in any business activities. The Tribunal noted that the AO and CIT(A) did not provide evidence of the LOs engaging in activities beyond collecting and sending information.

Attribution of Income:
The Tribunal disagreed with the AO's method of attributing income based on the global operating profit ratio. It held that since the LOs were engaged in preparatory or auxiliary activities, no income could be attributed to them under Article 7 of the DTAA.

Nature of Activities:
The Tribunal emphasized that the LOs' activities were limited to collecting and sending information, as evidenced by the RBI's approval and the auditor's certificates. It concluded that these activities fell within the exclusionary clause of Article 5(6)(e) of the DTAA, which excludes preparatory or auxiliary activities from constituting a PE.

Res Judicata:
The Tribunal acknowledged that while res judicata principles do not strictly apply to income tax proceedings, the consistent acceptance of the LOs' status by the Department over the years should not be disregarded without new evidence. It cited relevant case law to support this position.

Conclusion:
The Tribunal concluded that the LOs did not constitute a PE under the DTAA, and no income could be attributed to them. It set aside the orders of the lower authorities and allowed the assessee's appeal. The Tribunal's decision was based on the preparatory and auxiliary nature of the LOs' activities, compliance with RBI conditions, and the lack of new evidence to justify a different stance by the Department.