2025 (4) TMI 1472 - AT - Income Tax

Loss of PE against the FTS income earned by the assessee - whether the two steam of income to be treated as one income for the taxation purpose? - as submitted that PE also belongs to the same entity therefore the assessee should be allowed to claim the set of inter head adjustment - HELD THAT - We observed that the assessee has PE in India and during the current year the PE has no offshore supply and it has attributed expenses for running the same in India therefore it has declared loss attributing to its PE in India. Assessee is a foreign company taxable in India to extent of the income earned or sourced by it in India. We noticed that the assessee has two sources or stream of income one is from the services to its clients through its PE and another is by providing services to its clients directly. We noticed that the first stream falls under the Art.7 and the other under Art.12 of the DTAA. However both stream of income falls under the head business as far as the assessee is concerned. It is only classification and inter play between the two articles of the DTAA. There is no dispute as far as the classification of income is concerned. The AO has accepted that the loss claimed by the assessee is attributable to the PE and the FTS earned by the assessee is from the other services provided directly. In the given case no doubt the assessee has declared loss in the PE and at the same time the income earned by it falls under FTS as far as assessee is concerned it has earned the above income or loss sourced thru India. Therefore the provisions of section 71 are applicable. Just because the income is chargeable to tax under special provisions and also TDS is collected it does not change the determination of income under the Act. The Provisions of section 44DA and 115A are applicable or not and how it will impact the income declared by the assessee has to be analysed. As per the provisions of section 44DA the income of Royalty or FTS earned by the assessee through its PE is concerned the same is chargeable to tax under this provisions and it is chargeable to tax on gross basis. In the given case the assessee has earned the FTS directly without the assistance of its PE. Therefore the above section has no application. Coming to the provisions of section 115A the provisions starts with the words Where the total income of connotes the meaning that first we have to determine the total income and if the above total income includes the FTS as per the provisions of section 115A(1)(b) then the relevant FTS has to be excluded from the above income and then chargeable to tax at the specified rate (as per section 115A(1)(b)(B) of the Act). We observe that as per the provisions of section 115A(3) of the Act no deduction in respect of any expenditure or allowance shall be allowed to the assessee under the sections 28 to 44C and 57 of the Act in computing the income referred in section 115A(1) of the Act. If there is any loss in the PE the same can be set off against the Gross income of FTS. Provisions of section 115A(3) does not allow any expenditure or allowance the set off of loss is to be allowed or not? - It is clear that the legislature specifies the restrictions specifically in the statute. Therefore the provisions of sec.115A is silent hence the assessee is eligible to set off of the loss of its PE against the income earned through other sources in India under the provisions of section 71 of the Act. As noticed a reported decision of the coordinate bench in the case of Foramer S.A 1994 (11) TMI 177 - ITAT DELHI-B has considered the issue of allowability of depreciation when the rate of depreciation and allowability of the same are not prescribed under the Treaty the assessee may choose to apply the relevant provisions contained in the provisions of the Act applicable in the contracting state and also it was held that the a foreign national governed by avoidance of double taxation treaty is entitled to ask for application of provision of the Income Tax Act to the extent they are more beneficial to that assessee. Similarly in this case the issue involved is the issue of allowability of Set off of intra head of income the similar provisions are not present in the relevant treaty in case of absence of relevant provisions of set off the assessee has liberty to follow the provisions of Income Tax Act which is beneficial to it. In the absence of any provision of set off in the treaty the relevant findings of the coordinate bench applicable to the present case mutatis mutandis. Decided in favour of assessee.

Summary

The core legal questions considered in this appeal revolve around the tax treatment of losses incurred by a Permanent Establishment (PE) of a foreign company in India and the set-off of such losses against income earned as Fees for Technical Services (FTS) by the Head Office (HO). Specifically, the issues include:

1. Whether the Dispute Resolution Panel (DRP) directions and the final assessment order are valid and within jurisdiction.

2. Whether the losses incurred under the head 'Profit and Gains from Business or Profession' (PGBP) by the PE can be set off against income earned under the head 'Income from Other Sources', particularly FTS income, under the provisions of the Income Tax Act, 1961 (the Act).

3. The interpretation and applicability of the Double Taxation Avoidance Agreement (DTAA) between India and Korea, especially Article 7 and Article 12, concerning the attribution of income and losses between the PE and HO.

4. The applicability and impact of sections 44DA and 115A of the Act, which govern the taxation of income earned by non-residents, including FTS income.

5. The treatment of inter-head adjustments under sections 70 and 71 of the Act, and whether losses can be set off against income taxed at special rates under the DTAA.

6. The relevance and binding nature of precedents including ITAT and High Court decisions on similar issues.

7. The correctness of penalty proceedings initiated under section 270A of the Act.

Issue-wise Detailed Analysis:

Validity and Jurisdiction of DRP Directions and Assessment Order:

The assessee challenged the legality and jurisdiction of the DRP directions dated 25.07.2023 and the final assessment order dated 24.08.2023, claiming they were not in conformity with law and barred by limitation. However, the primary focus of the appeal was on the substantive tax issue rather than procedural defects. The Tribunal did not dwell extensively on these procedural grounds, implicitly affirming the validity of the DRP directions and assessment order as the appeal proceeded to consider the substantive issues.

Set-off of PE Losses Against FTS Income:

The assessee, a Korean company with a PE in India engaged in power business, declared a loss of Rs. 4.81 crores under PGBP attributable to the PE and income from FTS and interest under 'Income from Other Sources'. The assessee claimed set-off of PE losses against FTS income under section 71 of the Act, relying on the principle of inter-head adjustment and relevant case laws such as ITAT Bangalore in IBM India Pvt. Ltd. and Hitachi Zosen Corporation, which allowed such set-offs.

The Assessing Officer (AO) and DRP disallowed this set-off, relying on the Delhi ITAT decision in Iveco Spa, Italy and the Uttarakhand High Court decision in Samsung Heavy Industries Co. Ltd., holding that the PE and HO are separate entities for tax purposes and that income from royalty and FTS cannot be attributed to the PE without connection. Hence, losses of the PE cannot be set off against HO income.

The Tribunal examined the legal framework under the Act, particularly sections 70 and 71, which provide for inter-head and intra-head set-off of losses to arrive at the total income. The Tribunal emphasized that income tax is charged on total income aggregating all heads and not separately on each head of income. Therefore, losses under one head can be set off against income under another head to determine net taxable income.

The Tribunal further noted that the PE and HO are not independent persons under domestic law; the PE is part of the same entity as the HO. The Tribunal relied on the Special Bench decision in Sumitomo Mitsui Banking Corporation, which held that under domestic law, the PE and HO are not separately assessed entities, and only the total income of the overseas entity is taxable in India to the extent sourced or earned in India.

Accordingly, the Tribunal held that the PE losses can be set off against FTS income earned by the HO, as both streams constitute income of the same taxable entity.

Interpretation of DTAA Provisions and Attribution of Income:

The Revenue argued that under Article 7 and Article 12 of the India-Korea DTAA, income from FTS is not attributable to the PE unless there is a direct connection, and hence losses of the PE cannot be set off against such income. The Tribunal acknowledged that the two streams of income fall under different articles of the DTAA but emphasized that the classification under DTAA does not change the domestic law principle of aggregation of income for tax computation.

The Tribunal referred to the "no force of attraction" principle under Article 12(5) of the DTAA and the OECD Model Convention, which restricts taxing income only where it is economically attributable to the PE. However, since the FTS income was earned directly by the HO without assistance from the PE, it was not attributable to the PE. Nevertheless, this distinction does not preclude aggregation of income for computation of total income under domestic law.

Applicability of Sections 44DA and 115A of the Act:

Section 44DA applies to income of royalty or FTS earned through a PE and taxes such income on a net basis, allowing no expenditure deductions. Section 115A prescribes special rates for taxation of FTS income earned by non-residents on a gross basis, disallowing deductions or set-offs in computing such income.

The Tribunal observed that in the present case, the FTS income was earned directly by the HO, not through the PE, thus section 44DA did not apply. Regarding section 115A, the Tribunal noted that it applies after determination of total income and is concerned with the rate of tax, not the computation of total income itself.

Therefore, the provisions of sections 44DA and 115A do not restrict the set-off of PE losses against FTS income under sections 70 and 71. The Tribunal distinguished these provisions from sections 115BBDA and 115BBH, where the legislature explicitly bars set-off of losses and deductions, highlighting that section 115A is silent on set-off, implying no such bar.

Application of Sections 70 and 71 of the Act:

Sections 70 and 71 provide for set-off of losses against income from other heads to compute total income. The Tribunal reiterated the fundamental principle that income tax is levied on total income, not on separate heads independently. Consequently, loss under PGBP (business income) can be set off against income from other sources, including FTS income, to arrive at net taxable income.

Consideration of Precedents:

The Tribunal relied on several precedents, including:

• Sumitomo Mitsui Banking Corporation (Mumbai Special Bench) - PE and HO are not separate taxable entities under domestic law.
• Prudential Assurance Co. Ltd. (ITAT Mumbai) - Allowed set-off of loss from one head against income from other sources under section 71.
• Channel V Music Networks Ltd. (ITAT Mumbai) - Allowed set-off of business loss against royalty income taxed at a special rate under section 115A.
• Iveco Spa (Delhi ITAT) - Distinguished on facts as it involved attribution of income to PE, which was not established in the present case.
• Foramer S.A. (Delhi ITAT) - Held that where treaty provisions are silent or do not specify, the provisions of the Income Tax Act apply to the extent beneficial to the assessee.

The Tribunal also referred to CBDT Circular No. 333/1982 and judicial pronouncements emphasizing that treaty provisions prevail only where specific and that domestic law provisions apply in their absence or when more beneficial.

Treatment of Competing Arguments:

The Revenue's argument that PE and HO are separate entities for tax purposes and that income streams cannot be clubbed was rejected on the basis that domestic law treats the PE as part of the same entity and assesses the total income accordingly. The Revenue's reliance on special provisions for FTS income was held to be inapplicable to restrict set-off of losses, as these provisions relate to tax rates and disallowance of expenses but do not explicitly bar set-off of losses.

The Tribunal found the assessee's reliance on inter-head adjustment provisions and relevant case law more persuasive and consistent with the statutory scheme and principles of taxation.

Penalty Proceedings under Section 270A:

The assessee raised a ground challenging the initiation of penalty proceedings under section 270A. However, the Tribunal's order does not record any specific discussion or ruling on this issue, indicating that it was either not pressed or not found necessary to be adjudicated in the present order.

Conclusions:

The Tribunal concluded that the set-off of losses incurred by the PE under PGBP against the FTS income earned by the HO is permissible under the provisions of sections 70 and 71 of the Income Tax Act. The distinction between PE and HO for attribution of income under the DTAA does not preclude aggregation of income for tax computation under domestic law. The provisions of sections 44DA and 115A do not bar such set-off, as they pertain to taxation rates and disallowance of expenses, not to the computation of total income. The Tribunal emphasized that where the treaty is silent on set-off provisions, the assessee is entitled to follow the Income Tax Act provisions to the extent beneficial. Accordingly, the appeal was allowed.

Significant Holdings:

"As per the provisions of section 70 and 71, the total income has to be determined based on the provisions of section 14 of the Act... income tax is charged on net income and not separately on each head of income... If there is loss sustained in any year under one head of income, it should be set off against income under another head of income in that year, in order to arrive at the actual total income of the assessee."

"Under the domestic law, the PE in India and the GE abroad of which said PE is part, are not independent persons... There is thus only one person assessable to tax i.e. GE and PE is not an independent person who is assessed to tax separately in India."

"The provisions of section 115A is silent on set off of loss, hence, the assessee is eligible to set off of the loss of its PE against the income earned through other sources in India under the provisions of section 71 of the Act."

"Where the double taxation avoidance agreements have been entered into by the Central Government under Section 90 of the Income Tax Act, the provisions of this Act shall apply to the extent they are more beneficial to that assessee."

"In the absence of any provision of set off in the treaty, the assessee has liberty to follow the provisions of Income Tax Act, which is beneficial to it."

Final determination: The set-off of business loss of the PE against FTS income earned by the HO is allowed under sections 70 and 71 of the Income Tax Act. The appeal is allowed accordingly.