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TMI Blog2007 (4) TMI 616X X X X Extracts X X X X X X X X Extracts X X X X ..... rendered meaningless by the interpretation sought to be canvassed by the assessee. It is well-settled that no law or treaty can be interpreted in such a manner so as to make a clause meaningless. The interpretation is required to be made ut res magis valeat quampereat, i.e, making it effective rather than making it redundant. We are of the considered view that the tax liability of a foreign enterprise, in respect of its dependent agency permanent establishment, is not extinguished by making an arm s length payment to the dependent agent. There is no dispute in the present case to the extent that the assessee-company has a dependent agent in India, and that the profits of the dependent agent permanent establishment are, therefore, taxable in India. Since the assessee has not produced any details of computation of profits of such DAPE, and had instead accepted the tax liability on presumptive basis at 10 per cent. under CBDT Circular at the time of filing of income-tax return, we are of the considered view that the Assessing Officer had rightly taxed the income on that basis. The relief given by the Commissioner by holding that the taxability of the arm s length remuneration to the d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... : (i) though the purchase and sale of airtime is effected in Singa pore, the receipt in respect of broadcasting advertisement is in the territory of India ; (ii) the income in respect of, or in connection with the relay of, advertisements, accrues in India ; (iii) the assessee has a permanent establishment in India in the form of SET India P. Ltd., and, therefore, advertisement revenue from AXN channel is taxable in India as business income. 3. On the facts and in the circumstances of the case and in law, the Commissioner of Income-tax (Appeals) erred in holding that the assessee being a non resident and the entire income being subject to tax deduction at source under section 195 of the Income-tax Act, 1961, no liability under sections 234B and 234C will arise, ignoring the fact : (i) that since the tax deducted at source was not adequate to meet the entire tax liability, it was an obligation on the part of the assessee to make the deficit good by making the payment towards the advance tax ; (ii) that since the assessee failed to pay the advance tax, the Assessing Officer was right in charging interest under sections 234B and 234C of the Income-tax Act, 1961. 4. In the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contrary to the scheme of the Act, he did not set out, even after taking note of the suggested reframed grounds of appeal, any specific propositions in respect of the same, or elaborate any further on this issue. In view of the foregoing discussions, and bearing in all the related facts, we deem it fit and proper to overrule the objection of learned senior counsel, and proceed with reframing the grounds of appeal to bring out the true controversy requiring our adjudication. 5. The first ground of appeal, having regard to the facts and pleadings on record, rival submissions before us, suggestions of the parties on the reframing the ground of appeal, as well as our understanding of the core issue requiring our adjudication, is reframed as follows : "On the facts and circumstances of the case, the learned Commissioner of Income-tax (Appeals) erred in holding that since the assesses has remunerated agent on ' arm' s length price' (ALP), no further profits of the assessee could be taxed in India other than the profits so earned by the ' dependent agent' (DA)". 6. The outcome of this ground of appeal, as the learned representatives agree, will solely depend on th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liciting and receiving orders ; (j) an installation or structure used for the exploration or exploitation of natural resources but only if so used for a period of more than 120 days in any fiscal year. 3. A building site or construction, installation or assembly project constitutes a permanent establishment only if it continues for a period of more than 183 days in any fiscal year. 4. An enterprise shall be deemed to have a permanent establishment in a Contracting State and to carry on business through that permanent establishment if it carries on supervisory activities in that Contracting State for a period of more than 183 days in any fiscal year in connection with a building site or construction, installation or assembly project which is being undertaken in that Contracting State. 5. Notwithstanding the provisions of paragraphs 3 and 4, an enterprise shall be deemed to have a permanent establishment in a Contracting State and to carry on business through that permanent establishment if it provides services or facilities in that Contracting State for a period of more than 183 days in any fiscal year in connection with the exploration, exploitation or extraction of mineral ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vities are limited to the purchase of goods or merchandise for the enterprise ; (b) he has no such authority, but habitually maintains in the first mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise ; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control, as that enterprise. 9. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise, itself or on behalf of that enterprise and other enterprises controlling, con trolled by, or subject to the same common control, as that enterprise, he will not be considered an agent of an independent st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n paragraph 2 shall preclude that Contracting State from determining the profits to be taxed by such an apportionment as may be customary ; the method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this article. 5. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. 6. For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 7. Where profits include items of income which are dealt with separately in other articles of this agreement, then the provisions of those articles shall not be affected by the provisions of this article. 8. For the purpose of paragraph 1, the term ' directly or indirectly attributable to the permanent establishment' includes profits arising from transactions in which the permanent establishment has been involved and such profits shall be regarded as attributable to the permanent establishment to the e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... one of the conditions set out in article 5(8)(a), 5(8)(b) or 5(8)(c), "the enterprise shall be deemed to have permanent establishment" in the other Contracting State. In simple terms, therefore, when an enterprise acts in the other Contracting State through a "dependent agent" who satisfies at least one of the tests set out in article 5(8), such an enterprise is deemed to have a permanent establishment in the other contracting state. This deemed permanent establishment, for the sake of convenience, we shall refer as "dependent agent permanent establishment" (DAPE, in short). It is wholly hypothetical and fictional, because, in the strict sense of the word, there is no permanent establishment at all. How can one have a permanent or even non permanent establishment, when there is no establishment at all. It is, however, important to note that what is defined as a permanent agent is not the dependent agent per se, but, on the contrary, it is by the virtue of an enterprise having a dependent agent that the enterprise is "deemed to have a permanent establishment". A dependent agent cannot, strictly speaking, be termed as permanent establishment because neither the dependent agent belong ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rality in the event the tax position of a foreign enterprise is to depend on whether the business activity is carried out by the foreign agent directly or whether the foreign enterprise conducts business activity through an agent--who, being a dependent agent, is integrated into principal' s business to a large extent. In case the tax position is to vary based only on whether or not the business activities are carried out directly or through an agent, it would be a bit too easy to circumvent the permanent establishment taxation if no permanent establishment taxation is to be applied to the dependent agent permanent establishment. Whether one carries on the business directly or through the dependent agent, the profit attributable to such business continue to be taxable in the source country. This is the unmistakable underlying principle behind the dependent agent permanent establishment clause in the treaties. This next issue is then how do you compute the profits of this fictional or hypothetical permanent establishment. 11. Article 7(1) provides that when an enterprise has a permanent establishment in the other contracting state, profits of the enterprise shall be taxed in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independent with the enterprise of which it is permanent establishment". In other words, the profit computations of the permanent establishment have to proceed on the basis that the permanent establishment is wholly independent of its general enterprise which from a purely accounting and commercial point of view, generally means nothing more than the hypothesis that intra organisation transactions are to be taken into account at the arms length price. It is important to bear in mind the fact that in the case of intra organisation transactions within an enterprise there are several ways of accounting for the same, e.g., at cost, at transfer price, at the arm' s length price or simply at fair market price. Article 7(2) provides that the arm' s length price is the criterion for computation of these hypothetical profits. Such profits cannot be determined otherwise than hypothetically and, therefore, no more than approximately, if at all, because in practice there is no such thing as unrelated enterprise available for comparison and satisfying completely all the conditions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gent that the general enterprise is deemed to have a permanent establishment, a dependent agent permanent establishment though, in the other contracting state. We are of the considered view that in addition of the taxability of the dependent agent in respect of remuneration earned by him, which is in accordance with the domestic law and which has nothing to do with the taxability of the foreign enterprise of which he is dependent agent, the foreign enterprise is also taxable in India, in terms of the provisions of article 7 of the tax treaty, in respect of the profits attributable to the dependent agent permanent establishment. As we have elaborated earlier in this order, a dependent agent permanent establishment is distinct from the dependent agent. While computing the profits of this dependent agent permanent establishment, a deduction is to be allowed for the remuneration paid to the dependent agent as that is cost of operation of the dependent agent permanent establishment and as it has been incurred for generating the revenues attributable to such hypothetical permanent establishment. Let us take a very simple example to understand the mechanism of this approach. Let us assume ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce country. If, in this example, we are to assume that the income of the permanent establishment is only the remuneration earned by the agent on net basis, we will end up in a situation that while profits of Sing company attributable to India operations will be $ 5,00,000, the taxability of the profits will be confined to only $ 1,000. What is to be taxed under article 7 is income of the foreign enterprise attributable to the permanent establishment in the host country. The income attributable to the permanent establishment in the host country is the income attributable to the foreign company' s operations in the host country, which, in turn, implies the income attributable to the activities carried on the foreign enterprise in the host country. That income, as shown in "B" above, is the income arrived at by taking into account revenues generated by the permanent establishment and deducting therefrom the expenditure incurred by the foreign enterprise to earn those revenues. However, it is open to the foreign enterprise to claim appropriate adjustment for the foreign enterprise' s overheads and even a reasonable charge, on account of activities of the foreign enterprise car ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ependent agent is resident. Therefore, it is patently erroneous to suggest that by payment of tax liability by the dependent agent, tax liability of the foreign principal is discharged. So far as article 7 is concerned, it deals with the taxability of the foreign company. 17. Under the scheme of the Act, the taxable unit is the foreign company, though the quantum of income taxable is such income as may be held to be attributable to the permanent establishment of the foreign company in India. The tax liability of the foreign company and not the Indian dependent agent. However, in case we are to uphold the stand of learned counsel, we will end up in a situation that taxability of Indian company is to be allowed to extinguish tax liability of the foreign principal. 18. Learned counsel has relied upon the commentaries of various authors including Phillip Baker, Prof. Roy Rohtagi and Prof. David R. Davies. it is contended that according to these distinguished authors, payment of the arm' s length remuneration by a foreign company to its agent extinguishes tax liability of the foreign principal. With respect, and for the reasons we have set out above, we are of the considered view ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it would be of no help to us. Having perused the order of the Advance Rulings Authority, we are not persuaded."[emphasis supplied] 21. The ruling does not have any binding force on us. Learned counsel submits that he wishes to adopt it as his arguments but then the very line of reasoning which has been approved by the Authority for Advance Rulings in this case, has already been declined our approval for the detailed reasons set out above. We are not persuaded to disturb our conclusions. 22. Learned counsel then refers to the judgment of the hon' ble Supreme Court' s judgment in the case of Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706 in support of the proposition that the purpose of the tax treaties is to allocate taxing jurisdiction between the contracting states. We cannot, and do not, dispute this proposition. However, we do not think that this proposition can be of use to advance the case of the assessee which is that the taxability the permanent establishment profits in the host country, in the case of the dependent agent permanent establishment, is confined to taxability of remuneration received by the dependent agent at the arm' s length price. 23 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rough its agency activities. The FAR of the dependent agent permanent establishment, are the FAR of ForCo, not SubCo, in respect of the agency activity. The dependent agent permanent establishment is attributed profit of ForCo, not SubCo, arising from the agency activity. Thus the profit attributable to ForCo' s dependent agent permanent establishment is not merely an arm' s length profit for the agent entity, SubCo. Rather, it is an arm' s length profit for the FAR of ForCo in respect of the agency activity performed by SubCo on behalf of ForCo. The taxable profit of the dependent agent permanent establishment is calculated by taking some part of ForCo' s income from the activity performed by the agent and deducting the expenses (includ ing the service fee paid to SubCo) ForCo incurs in deriving that income. Accordingly, while an arm' s length service fee paid by ForCo to SubCo may be an arm' s length reward for the agent' s FAR, it does not follow that it also constitutes the arm' s length reward for the dependent agent permanent establishment' s FAR." 26. The views so expressed by the Australian Tax Office also support the conclusion ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t agent permanent establishments is contained in section D-5 of Part I and this section applies that guidance to the specific and commonly occurring factual situation of global trading. 276. In cases where a permanent establishment arises from the activities of a dependent agent, the host country will have taxing rights over two different legal entities--the dependent agent enterprise (which is a resident of the permanent establishment jurisdiction) and the dependent agent permanent establishment (which is a permanent establishment of a non-resident enterprise). In respect of transactions between the associated enterprises (the dependent agent enterprise and the non-resident enterprise), article 9 will be the relevant article in determining whether the transactions between the associated enterprises, for example a volume based commission, were conducted on an arm' s length basis. 277. In respect of the dependent agent permanent establishment, the issue to be addressed is one of determining the profits of the non resident enterprise which are attributable to its dependent agent permanent establishment in the host country (i.e., as a result of activities carried out by the de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In calculating the profits attributable to the dependent agent permanent establishment it would be necessary to determine and deduct an arm' s length reward to the dependent agent enterprise for the services it provides to the non-resident enterprise (taking into account its assets and its risks). Issues arise as to whether there would remain any profits to be attributed to the dependent agent permanent establishment after an arm' s length reward has been given to the dependent agent enterprise. In accordance with the principles out lined above, the answer is that it depends on the precise facts and circumstances as revealed by the functional and factual analysis. The reward should provide the appropriate remuneration for the functions performed (taking into account the assets used and risks assumed) by the dependent agent enterprise in its own right. However, a functional analysis of a transaction may show that the ability to assume the risks arising from the transaction is not found in the dependent agent enterprise, for example because it has insufficient capital to upport the risks assumed. Rather the ability to assume the risks is generally found in the non-resident e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the highly simplified example, however, is to illustrate the principle that the host country' s taxing rights are not necessarily exhausted by ensuring an arm' s length compensation to the dependent agent enterprise under article 9 (the following example is one where the dependent agent is an associated enterprise). 281. Assume that a special purpose enterprise in country A, with no employees, has a broker-dealer subsidiary in country B. For regulatory and other reasons the equity derivatives business of country B is not booked in the broker-dealer subsidiary, but in the non resident (special purpose) enterprise. Assume further that all the functions (key entrepreneurial risk taking and support) in connection with the derivatives business is conducted in the host country by the broker-dealer subsidiary and its employees, who are authorised to conclude contracts in the name of the enterprise in country A. Assume, finally that the circumstances are such that the broker-dealer is a dependent agent enterprise and that a dependent agent permanent establishment is found to exist under article 5(5). There are two steps to the transfer pricing analysis. 282. Firstly, it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re. This analysis also gives a sensible policy outcome in that it produces the same outcome as performing the same functions in country B through a branch of country A. It is worth emphasising that the above analysis is only applicable if a dependent agent permanent establishment is found to exist under article 5(5). 285. An alternative approach, the ' single taxpayer approach', has been suggested by some business commentators, but this was rejected as an authorised OECD approach in section D-5 of Part I. 286. The danger of overlooking the assets used and risks assumed in the performance of the functions in the permanent establishment jurisdiction is minimised if the existence of the dependent agent permanent establishment is formally recognised so that it is clear that the host country has taxing rights over two different legal entities--the dependent agent permanent establishment and the dependent agent enterprise--and an attribution of profit based on a functional analysis is made to the dependent agent permanent establishment on the basis described in this section. This should also ensure that any other tax consequences arising from different rules for permanent est ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e best way to provide administrators and taxpayers with maximum certainty as to profits should be attributed to permanent establishment is to redraft article 7 in such a way that will remove the potential for different interpretation based on previous practices and existing commentary". It is thus contended that the present provisions do not support the interpretation given in the above report. We are thus urged to ignore this report. We are unable to see merits in this contention either. Just because a particular interpretation can be better supported by more specific provisions does not mean that the provision which exist do not support that interpretation. We have arrived at our independent conclusions but these are the same conclusions as arrived at in this report. We adopt the reasoning taken by this report as well. We particularly agree with the following observations made in the OECD report : "Whilst superficially attractive ' single taxpayer' approach (as canvassed by the assessee before us) infact contains a number of fundamental flaws. Firstly, this approach would not result in fair division of taxing rights between host and home jurisdictions as it ignores asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nly discussing what the law exists and not what the law should be. We are, therefore, urged to ignore the contents of the OECD report. 32. We are unable to find much substance in this objection of learned counsel. While we do recognise the significant contribution made by the IFA to the international tax literature and its pivotal position as a body dedicated to the study of inter alia, issues pertaining to the cross border taxation issues, we do not see any support to the assessee' s cause by the IFA report. We do attach due importance to the views and guidance of the IFA, but there is nothing to directly support the assessee' s case. As far as the observations at page 80, on which learned counsel has relied, immediately after the said observations, the report sets out two example to illustrate the point so made and none of those illustrations pertains to the dependent agent permanent establishment profit attribution. These observations, therefore, cannot be construed to mean that the changes are necessarily required to be made so far as profit attribution for dependent agent permanent establishment is concerned. Unless such is the proposition, there is no reason for us t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on arm' s length principle, no additional profit adjustment would be considered necessary by tax administration. The German report considers the difference between employed agent and agent enterprises and concludes that no scope remains for DAPE' s own profits except in the case of employee agents. The Italian report states that, to the extent that the costs effectively incurred by the HO for the agent is in line with the market rates, there will be no taxable income attributable to the permanent establishment. The Mexican report states that there should be no further profit--over and above the arm' s length reward--which should be attributed to the permanent establishment. The report quotes Mexican IFA branch in support of this view. The Dutch report quotes a 1957 Hoge Raad case in support of the view that taxable profit of the DAPE would be zero. Finally, the New Zealand report states that, in New Zealand, the risk of further profit being attributed to the DAPE will be low if the functional profile of the dependent agent and DAPE will be the same. The dependent agent should be receiving remuneration that is appro priate given the functions it undertakes and risk it as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [1996] 219 ITR (St.) 49 ) at the time of filing of income-tax return, we are of the considered view that the Assessing Officer had rightly taxed the income of Rs. 13,58,43,976 on that basis. The relief given by the Commissioner by holding that the taxability of the arm' s length remuneration to the dependent agent extinguishes the tax liability of dependent agent permanent establishment as well, is unjustified and we vacate the same. 37. Ground No. 1 is thus allowed. 38. In the second ground of appeal, the grievance raised by the Assessing Officer is as follows : On the facts and in the circumstances of the case and in saw, the Commissioner of Income-tax (Appeals) erred in holding that advertise ment revenue pertaining to AXN channel are not taxable in India on the ground that the assessee has paid an arm' s length price for services rendered by its agent, i.e., SET India P. Ltd., and based on the provisions of section 9(1)(i) the Act, article 7(1) of the DTAA, and the ratio of circular No. 23 dated July 23, 1969, no income in respect thereof is taxable in India, ignoring the fact that : (i) though the purchase and sale of airtime is effected in Singapore, the receipt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Deputy CIT [2005] 95 ITD 269 (Delhi). The learned Departmental representative, however, relied upon the stand of the Assessing Officer. 43. We see no reasons to take any other view of the matter than the view so taken by the co-ordinate benches in the cases of Sedco Forex International Drilling Inc. v. Deputy CIT [2000] 72 ITD 415 (Delhi), Asia Satellite Telecommunications Co. Ltd. v. Deputy CIT [2003] 85 ITD 478 (Delhi) and Fisons Plc. v. Deputy CIT [2004] 91 ITD 450; [2005] 272 ITR (AT) 59 and the Special bench in Motorola Inc case [2005] 95 ITD 269 (Delhi). Respectfully following the same, we uphold the relief given by the Commissioner of Income-tax (Appeals) and decline to interfere in the matter. 44. The appeal filed by the Assessing Officer is thus partly allowed in the terms indicated above. 45. We now take up the appeal filed by the assessee. 46. In the first ground of appeal, the assessee has raised the following grievance : The learned Commissioner of Income-tax (Appeals) erred in holding that as the appellant has offered the advertisement revenue (including those relating to the AXN channel) to tax in the revised return of income, no relief from taxation could be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stical purposes. 53. In ground No. 3, the assessee has raised the following grievance : The learned Commissioner (Appeals) erred in not appreciating that the information was placed on record indicated that the commission paid to SET India P. Ltd. fully represented the value of profit attributable to the services rendered by it and, therefore, having regard to Circular No. 23 dated July 23, 1969, the advertisement revenue earned by the appellant was not taxable in India. 54. The aforesaid issue, learned representatives agree, pertains to the assessee' s contention that the assessee did not have any tax liability in India even under the provisions of the Indian Income-tax Act. That aspect of the matter has not been examined by the Commissioner of Income-tax (Appeals) in the impugned order. 55. We, therefore, deem it fit and proper to remit this issue also to the file of the Commissioner of Income-tax (Appeals). The Commissioner of Incometax (Appeals) shall decide the matter afresh after giving due and fair opportunity of hearing to the assessee, in accordance with the law and by way of a speaking order. The matter thus stands restored to the file of the Commissioner of Incom ..... X X X X Extracts X X X X X X X X Extracts X X X X
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