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2024 (9) TMI 1202 - HC - Income TaxProfit attribution to a Permanent Establishment PE in India - accrual of income in India - applicability of Article 7 of the DTAA between India and the United Arab Emirates, in case losses had been suffered at an entity level was reserved for further consideration - Determination of whether service charges received under various SOSA Agreements are taxable as royalty - HELD THAT - The distinction which needs to be borne in mind with regard to the income of a non-resident as opposed to an entity domiciled and stationed in one of the Contracting States stands duly acknowledged in Section 5 of our Act and which subjects the global income of a resident alone to taxation. For non-residents, it is the principles of income accruing or arising which are decreed to govern. It is these broadly accepted and well recognised principles which imbue the DTAA also. As was noticed hereinabove, the profits of an enterprise do not become subject to taxation unless it be found that it functions in the other Contracting State through a PE. Article 7 further postulates that it is only such income which is attributable to the PE which would be subjected to tax in the source State. As is pertinently noted in the OECD and UN Commentaries, it would be wholly incorrect to found taxation on the basis of the overall activities or profitability of an enterprise. The source State is ultimately concerned with the income or profit which arises or accrues within its territorial boundaries and the activities undertaken therein. As those commentaries pertinently observe, the profits attributable to a PE are not liable to be ignored on the basis of the performance of the entity as a whole. This position also finds resonance in the decisions of the Supreme Court in Morgan Stanley and Ishikawajama 2007 (7) TMI 201 - SUPREME COURT and relevant parts whereof have been extracted above. While protecting the right of an enterprise to be subject to tax in the State where it be resident, Article 7 places a negative stipulation in respect of cases where a PE is found to exist coupled with an attribution exercise being undertaken in respect of the domestic enterprise. The contention of the respondents essentially requires us to confer a judicial imprimatur upon the principle that the domiciled entity, namely a PE, would be liable to be taxed only if the global enterprise were profitable. This even though the income of that entity, by virtue of Article 7, stands restricted to the extent of income being attributable to the PE. In fact, Article 7 itself restricts the taxability of the enterprise to the extent of income or profit attributable to the PE. We are thus of the firm opinion that the argument of global income or profit being relevant or determinative is totally unmerited and misconceived. The submission is clearly contrary to the weight of authority which has been noticed hereinabove. Regard must also be had to the fact that Article 7 does not expand its gaze or reach to the overall operations or profitability of a transnational enterprise. It is concerned solely with the profits or income attributable to the PE. The taxability of income earned by a PE existing in a Contracting State is not even remotely linked or coupled to the overall operations of the enterprise of which it may be a part. The argument of world-wide income is thus rendered wholly untenable. We come to the firm conclusion that the submission of global income being determinative of the question which stood referred, is wholly unsustainable. The activities of a PE are liable to be independently evaluated and ascertained in light of the plain language in which Article 7 stands couched. The fact that a PE is conceived to be an independent taxable entity cannot possibly be doubted or questioned. The wealth of authority referred to hereinabove clearly negates the contention to the contrary and which was commended for our consideration by the appellants. Bearing in mind the well-established rule of source which applies and informs the underlying theory of taxation, we find ourselves unable to countenance the submission of the source State being deprived of its right to tax a PE or that right being dependent upon the overall and global financials of an entity. The Division Bench in these appeals rightly doubted the correctness of taxation being dependent upon profits or income being earned at the entity level . The decision of the Special Bench in Motorola Inc. 2005 (6) TMI 226 - ITAT DELHI-A has clearly been misconstrued and it, in any case, cannot be viewed to be an authority for the proposition which was canvassed on behalf of the appellants. Article 7 cannot possibly be viewed as restricting the right of the source State to allocate or attribute income to the PE based on the global income or loss that may have been earned or incurred by a cross border entity. We would thus answer the Reference by holding that the tentative view expressed by the Division Bench in these set of appeals as well as the doubt expressed with respect to the findings rendered in Nokia Solutions 2022 (12) TMI 700 - DELHI HIGH COURT was well founded and correct. The Reference stands answered in terms of our conclusions set forth above. The papers of these appeals may now be placed before the appropriate Roster Bench for disposal in light of our conclusions recorded hereinabove.
Issues Involved:
1. Attribution of taxable income to a Permanent Establishment (PE) in India when the overseas entity incurs a loss. 2. Applicability of Article 7 of the Double Taxation Avoidance Agreement (DTAA) between India and the United Arab Emirates in case of losses at an entity level. 3. Determination of whether service charges received under various SOSA Agreements are taxable as royalty. 4. Existence of a Permanent Establishment in India under the DTAA. 5. Perversity of Tribunal's findings regarding the Strategic Oversight Services Agreement (SOSA). Detailed Analysis: 1. Attribution of Taxable Income to a PE in India When the Overseas Entity Incurs a Loss: The primary issue was whether any taxable income could be attributed to a PE in India if the overseas entity incurs a loss in the relevant assessment years. The appellants argued that if the enterprise at an entity level suffered a loss, no profit or income attribution would be warranted for the PE. The respondents contended that positive income attributable to the PE would be taxable notwithstanding the overall loss of the enterprise. The Court observed that the profits attributable to the PE in India are required to be determined on the footing that the PE is an independent taxable entity. This means that even if the enterprise incurs a global loss, the profits generated by the PE in India would still be taxable. The Court noted that this aspect was not deliberated in the case of Commissioner of Income Tax (International Taxation)-2 v. Nokia Solutions and Networks OY. 2. Applicability of Article 7 of the DTAA in Case of Losses at an Entity Level: The Court examined whether Article 7 of the DTAA applies if the enterprise incurs a loss. The appellants argued that Article 7 of the DTAA applies only when the enterprise earns a profit. The Court disagreed, stating that Article 7 (1) of the DTAA concerns the attribution of profits of the assessee and is not restricted to cases where the enterprise makes a profit. The Court held that even if the enterprise incurs a global loss, the profits attributable to the PE in India would still be taxable. The Court emphasized that the PE should be treated as a separate and independent entity for tax purposes. 3. Determination of Whether Service Charges Received Under Various SOSA Agreements Are Taxable as Royalty: The Court considered whether the service charges received by the appellant under various SOSA Agreements were taxable as royalty. The Tribunal had held that these charges were taxable as royalty under Article 12. However, the Court found that the Tribunal's findings on this matter were unsustainable. The Court held that the service charges could not be considered royalty and thus were not taxable under Article 12. 4. Existence of a Permanent Establishment in India Under the DTAA: The Court examined whether the appellant had a PE in India within the meaning of the DTAA. The Tribunal had found that the appellant had a PE in India. The Court upheld this finding, agreeing that the appellant had a PE in India under the DTAA's provisions. 5. Perversity of Tribunal's Findings Regarding the SOSA: The Court considered whether the Tribunal's findings in paragraphs 56, 57, and 59 regarding the SOSA were perverse and contrary to the terms of the agreement. The Court found that the Tribunal had misdirected itself both in law and on facts in holding that the service charges received under the SOSA Agreements were taxable as royalty. The Court held that the Tribunal's findings were unsustainable and required reconsideration. Conclusion: The Court concluded that the profits attributable to a PE in India are taxable even if the enterprise incurs a global loss. Article 7 of the DTAA applies irrespective of whether the enterprise earns a profit or incurs a loss. The service charges received under the SOSA Agreements are not taxable as royalty. The appellant has a PE in India under the DTAA, and the Tribunal's findings regarding the SOSA were perverse and unsustainable. The Court answered the reference by holding that the tentative view expressed by the Division Bench was correct and well-founded.
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