2025 (1) TMI 1274 - AT - Income Tax

Applicability of transfer pricing provisions to the transactions between an enterprise and its Permanent Establishment ( PE ) - 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? - HELD THAT - The ultimate aim of Chapter -X of the Act is to determine the arm s length price of the transaction. The methods prescribed are only the means of achieving the object of the ALP determination. The purpose of transfer pricing provisions is to achieve reasonable fair and equitable profits and tax in India. The above view is also echoed by the Hon ble Supreme Court in Morgan Stanley Co 2007 (7) TMI 201 - SUPREME COURT wherein observed that the object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. 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. Whether unrelated party would have taken up the obligation of rendering onshore services which at the threshold itself result in loss? - 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. 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. Whether PE a Separate Enterprise? - 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. Since PE is a separate enterprise from the HO for the purpose of transfer pricing provisions the decisions relied by the learned AR to contend that one cannot generate income by dealing with self are not applicable in given context. The transfer pricing provisions are applicable to transactions between two enterprises and not between two persons. Thus decisions in the case of Sir Kikabhai Premchand 1953 (10) TMI 5 - SUPREME COURT Betts Huett Co Ltd 1978 (4) TMI 58 - CALCUTTA HIGH COURT Sumitomo Mitsui Banking Corporation 2012 (4) TMI 80 - ITAT MUMBAI are not applicable in the context of transfer pricing. Income arising from International Transactions - AR has contended that there is no income arising out of international transactions in the current case as there is only fund movement between HO and PE and actual transactions are between PE and third parties - Section 92 of the Act brings income arising from international transaction within the ambit of transfer pricing provisions. The international transaction is between the associated enterprises. So as a first step one needs to evaluate whether there are two enterprises and such enterprises qualify as associated enterprises u/s 92A of the Act. Such AE s should have entered into international transactions satisfying the test of either 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. 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. Associated Enterprise - AR submitted that the TPO has erred in concluding that PO and HO are associated enterprise merely by evaluating section 92A(1) - Transaction between an enterprise and an unrelated person should have been influenced by the associated enterprise of the first party having an arrangement or agreement with the unrelated party. The associated enterprise and the unrelated person can be said to have exercised influence over the transaction in question if the terms of such transaction would have been different but for such influence. Therefore where the associated enterprise and the unrelated person have not been able to influence the specific transaction between an enterprise and the unrelated person section 92B(2) of the Act does not have any application. The influence to attract section 92B(2) of the Act can take two forms. Firstly it can be in the form of a prior agreement in relation to the transaction in question (between the associated enterprise and the unrelated person). Secondly the terms of the transaction have to be in substance determined by the associate enterprise and the unrelated party. It is possible that these two forms may be satisfied in a fit case. DTAA v Act - PE of a foreign enterprise in India the Article 7(2) provides that profits that will be attributed to PE shall be profits which the PE 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 PE. Article 7(2) of the India China DTAA leads to the conclusion that determination of profits under the hypothesis of the PE being a distinct and separate enterprise dealing wholly independently with the enterprise of which it is a PE is nothing but adherence with the arm s length principles. The underlying philosophy of TP provisions and Article 7(2) is same wherein both try to analyse as to how third parties would have dealt with each other under uncontrolled conditions. Thus contention of the learned AR that there is conflict between Article 9 of the DTAA and domestic TP provisions is rejected. We are of the view that the transaction between foreign enterprise and its PE in India can be considered as an international transaction and be subject to ALP adjustment. The matter may be placed before the Division Bench to give effect to the direction of this Order

Summary

ISSUES PRESENTED and CONSIDERED

The core legal question considered by the Special Bench was whether transactions between a foreign enterprise and its Indian permanent establishment (PE) can be considered international transactions under section 92B of the Income Tax Act, 1961, and thus be subjected to arm's length price (ALP) adjustments.

ISSUE-WISE DETAILED ANALYSIS

Relevant Legal Framework and Precedents

The legal framework involves sections 92, 92A, 92B, 92C, and 92F of the Income Tax Act, which govern transfer pricing provisions. Section 92B defines international transactions, while section 92F(iii) defines an enterprise to include a permanent establishment. The interpretation of these provisions was essential to determine if transactions between a foreign head office and its Indian PE qualify as international transactions.

Precedents considered included conflicting decisions from ITAT in the cases of Aithent Technologies and Fujifilm Corporation, which addressed whether transactions between a head office and its branch or PE constitute international transactions.

Court's Interpretation and Reasoning

The Tribunal interpreted the transfer pricing provisions to apply to transactions between a foreign enterprise and its Indian PE. It emphasized that the definition of an "enterprise" under section 92F(iii) includes a PE, thereby treating the PE and the head office as separate entities for transfer pricing purposes. The Tribunal also considered the OECD Model Tax Convention and relevant commentary to support the application of ALP to such transactions.

Key Evidence and Findings

The Tribunal noted that the PO in India was incurring losses due to transactions with its foreign head office, which were not at arm's length. The head office controlled the funds and determined the terms of transactions with third parties, influencing the PO's financial outcomes.

Application of Law to Facts

The Tribunal applied the transfer pricing provisions by treating the PO and head office as separate enterprises. It concluded that transactions between them were not revenue-neutral and could affect taxable income in India, thus necessitating ALP adjustments.

Treatment of Competing Arguments

The Tribunal addressed arguments from the assessee that intra-company transactions should not trigger transfer pricing provisions. It rejected this view, emphasizing that the PE is treated as a separate enterprise under both domestic law and the India-China tax treaty, which requires profits to be attributed as if the PE were independent.

Conclusions

The Tribunal concluded that transactions between a foreign enterprise and its Indian PE are international transactions subject to ALP adjustments, aligning with the objective of preventing profit shifting and ensuring fair taxation in India.

SIGNIFICANT HOLDINGS

The Tribunal held that:

"The transaction between foreign enterprise and its PE in India can be considered as an international transaction and be subject to ALP adjustment."

Core principles established include the treatment of a PE as a separate enterprise for transfer pricing purposes and the application of ALP to transactions between a foreign head office and its Indian PE.

The Tribunal affirmed the applicability of transfer pricing provisions to such transactions, emphasizing that they are not revenue-neutral and can affect taxable income in India. The decision supports the objective of transfer pricing regulations to prevent profit shifting and ensure equitable taxation.