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TMI Blog2011 (8) TMI 769X X X X Extracts X X X X X X X X Extracts X X X X ..... me from those other companies and whether the company stipulated in Article 5(9) namely ANR was wholly or almost wholly working on behalf of the assessee will have to be determined afresh by the Assessing Officer. Whether in the facts and circumstances of the case, the ITAT grossly erred in concluding that ANR has not been compensated at arm's length price, without adequate basis to arrive at such a conclusion? - held that: - the assessee could dictate the terms of the payment by altering the same and reducing it to the US$ 40,000 per annum from 5% of invoice value when assessee found that on the basis of 5% total commission payable could be much higher. This clearly leads to the inference that the assessee was in a position to dictate the terms and in the absence of any Transfer Pricing Analysis by the Transfer Pricing Officer in the instant case, it cannot be said that such commission could fit the description of "reasonable profits" within the meaning of Article 7(2) of DTAA. - it also needs to be highlighted that no plausible or justifiable reason is coming forthwith for changing the commission from 5% of the invoice value to US$40,000 per annum. - Decided in favor of revenue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sment years 2001-02, 2002-03 and 2003-04 on 31st December, 2003 voluntarily with the Assistant Director of Income-tax, Circle 2(1), International Taxation, New Delhi. Likewise, for the assessment year 2004-05, the Singapore Company filed return on 14th September, 2004. 6. For all these years in the voluntary Income-tax Return filed by the Singapore Company, it had disclosed Fees for Technical Services (hereinafter referred to as the FTS) income. The returns were processed by issuing notice under section 143(2) of the Income-tax Act (hereinafter referred to as 'the Act') and ultimately different assessment orders were passed making various additions. Summary of the returns filed and income assessed by the Assessing Officer for these years is as under: Assessment Year Income declared by the Company Income assessed by the Assessing Officer 2001-02 Rs. 26,07,430 Addition of Rs. 2,36,15,935 as business income. FTS income assessed at Rs. 96,85,586 2002-03 FTS income of Rs. 92,35,097 @ 20% under section 115A holding the income at Rs. 33,46, 61,049. 2003-04 FTS income of Rs. 11,100,491 Addition towards bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he company is taxed in India as business income. The Assessing Officer while making additions on this account in respect of these assessment years had returned the following findings: (i) The appellant has a business connection/PE in India. (ii) The supplies and services are intricately and inextricably linked with each other. (iii) The AO taxed business profits from supplies by attributing 100% of the profit (and 75% of the profits in AY 2004-05) to the Business connection/PE by applying profit earned by M/s. Rolls Royce Plc., an entity incorporated in the UK. However, he accepted the position taken by the appellant that service fees shall be subject to tax at the rate of 20% plus surcharge and cess even though he alleged that services and supplies are inter-related and they are effectively connected with the business connection/PE. It would also been seen that the Assessing Officer did not accept the income from FTS as declared by the assessee and made additions thereto. The reason, according to the Assessing Officer, was that the Singapore Company was liable to pay tax from its income from services and supplies on accrual basis. 9. The Singapore Company filed sep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... notices under section 148 of the Act were issued. The CIT(A) held that reopening of the assessment by invoking the provisions of section 147 of the Act was valid which is upheld by the ITAT also. Again, this is not the subject-matter of the present appeals. 12. The bone of contention in the appeals filed by the Singapore Company are the findings returned by the ITAT on the questions as to whether the Singapore Company had no business connection or Permanent Establishment in India insofar as its business activity of supplying the goods or spare parts to Indian customers is concerned. As already indicated in brief above, the Assessing Officer had held that the assessee is having PE in India and, therefore, the income earned by it from supplying the goods or spare parts to Indian customers was taxable in India. This view has been upheld by the CIT(A) as well as the ITAT. We may now proceed to give some details for forming such a view. 13. As pointed out above, though in the Income-tax return filed by the Singapore Company it had shown income from maintenance services as Fee for Technical Services (FTS) and paid tax @ 20% thereupon as per the provisions of the Income-tax Act, it ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the equipments are inextricably linked to each other as the service engineers would certainly required spares parts to be replaced or overhauled. 16. The AO further stated that the assessee company has placed one Mr. Venketaramana as Exclusive Regional Sales Manager in India and, thus, income of the assessee from supply of spares accrue or arise in India from the activities of its Sales manager as well. 17. The CIT(A) agreed with the AO's view. In the light of various points raised by the AO the CIT(A) held that the assessee company has a PE in India on following counts: (i) That the assessee has a source of income in India; (ii) That the assessee has established a complete set up of facility for providing services to the customers, during the whole year; and those services and facilities were provided in respect of the original equipment supplied by some other who are related/associated concern of the assessee for a period of more than 30 days. (iii) That office of the ANR was used for receiving and soliciting orders; (iv) M/s ANR is a dependent agent permanent establishment of assessee. 18. In other words, the CIT(A) took a view that the Singapore compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... service and supplying spare parts are inter-connected and related. Similarly, findings of the Assessing Officer that Singapore Company shall be deemed to have Permanent Establishment in India to carry on the business through PE as it has been providing service facility in India for a period of 183 days in a fiscal year to ONGC and GAIL in connection with their activity of exploration, exploitation or extraction of material oil in India has been upset and turned down by the Tribunal holding that no material has been brought on record to prove and establish the same. 21. In fact, the only reason given by the Assessing Officer, accepted by the CIT(A) and affirmed by the ITAT for holding that the Singapore Company has PE in India is premised on the relationship between the Singapore Company with ANR, which makes the ANR as the PE of Singapore Company within the meaning of Articles 5(1) and 5(2) of DTAA between India and the Singapore, is that the said ANR is a dependent agent of the Singapore Company within the meaning of Article 5(8) read with Articles 8 and 9 of DTAA. 22. We would like to point out here that the Assessing Officer as well as the CIT(A) had inter alia, held that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct in India. ANR was chosen since it has the infrastructure in India to provide such services. (3) ANR was to provide services in relation to promoting and supporting the sale of 'projects' in India. The expression 'products' has been deleted in the Schedule A to the agreement which has two sections. Section 1 is with regard to new unit products used by oil and gas industries and section 2 is with regard to the customers service products under oil and gas industry. (4) Clause 8.2 of the Agreement imposed certain limitations and restrictions upon ANR with stipulation that it shall Act exclusively for the assessee in relation to the promotion of its product and shall not directly or indirectly assist any other person, the firm or company competing with the assessee or shall not advice or represent or be concerned with or interested in the business of any such person, firm or any company in India. 24. Thus, ANR was prohibited from promoting identical products of any such person, firm or company competing with the firm of assessee. These unusual restrictions imposed upon the ANR would suggest that ANR never intended to work as an independent agent in its ordinary course of bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Assessing Officer. 28. Even the commission of US$ 40,000 per annum paid by the Singapore Company to ANR was not at arm's length payable to the agent had not termed with reference to the value of foreign products sold in the relevant year. Prior to 1-1-2002, commission was being paid @ 5% of invoice value, which had now been changed to lump sum amount of US$ 40,000 payable annually. This sort fixation of remuneration is usually not done between two independent parties in any uncontrolled transaction. The remuneration payable, therefore, seems to be in the nature of transaction controlled by the Singapore Company and cannot be considered to be made on arm's length. More so, when Singapore Company had not furnished any instance of transaction entered into between the two independent parties in uncontrolled manner in support of its contention that remuneration of lump sum amount of US$ 40,000 was determined at arm's length. 29. On the basis of the aforesaid findings the ITAT has summarised the activities of ANR in connection with the Singapore Company as under: "(i) That ANR is maintaining premises in India to carry out its obligation as an agent of the assessee company. ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rticle 5 does not apply inasmuch as there is no material or evidence brought on record to show and establish that the ANR habitually exercised an authority to conclude contracts on behalf of the assessee company in India or ANR habitually maintained in India a stock of goods or merchandise from which it regularly delivers goods or merchandise on behalf of the assessee company. However, having regard to the fact that ANR has been rendering services to negotiate and secured orders in India since long it can be said that ANR associates habitually secured orders in India wholly or almost wholly for the assessee company. This would be established from the very fact that prior to 1-1-2002, the assessee used to get commission at the rate of 5% of invoice value and that commission was deducted by ONGC from invoice value payable to assessee company and then paid to ANR. In other words, a role played by ANR in securing orders from ONGC on a consideration of % of invoice value was even recognized by the assessee's customer, namely, ONGC. The payment of 5% of commission of sale value is substantial amount having regard to the over all net profit of about 12 to 14% earned by the assessee from s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mission of US$ 40,000 per annum is not at arm's length and fixing 10% of the profits on sales of the spare parts made in India by the Singapore Company is to be carried out by ANR in India and chargeable to tax in India. 34. These appeals were admitted on as many as seven substantial questions of law reproduced below: "a. Whether in the facts and circumstances of the case, the ITAT grossly erred in holding that the appellant has a business connection in India? b. Whether in the facts and circumstances of the case, the ITAT grossly erred in holding that the Appellant has a Permanent Establishment in India as per Article 5 of the DTAA between India and Singapore? c. Whether in the facts and circumstances of the case, the ITAT grossly erred in holding that the appellant partly carried on a business in India through the premises of ANR under Article 5 (1) of the DTAA between India and Singapore? d. Whether in the facts and circumstances of the case, the ITAT grossly erred in holding that the appellant should be regarded as having a permanent establishment by way of premises used as a sales outlet or for soliciting and receiving orders in India under Article 5(2)( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ussion is needed. However, if these questions are decided against the assessee then the last question would be as to whether 10% of the profits of sales on spare parts made in India held as exigible to tax by the ITAT is wrong. We may again point out here that the Assessing Officer had attributed 25% of profits on sales of spare parts to the activities carried out by the ANR as chargeable to tax which was reduced to 10% by the CIT(A). The Revenue has also filed appeals challenging this part of the order of the Tribunal as Revenue claims that order of the Assessing Officer fixing 25% profits on sales on spare parts was proper and valid. Therefore, while discussing the question of law No. 'g', appeals of the Revenue shall also be taken into consideration. Question of Law-'e' "Whether in the facts and circumstances of the case, the ITAT grossly erred in holding that ANR should be regarded as a Dependent Agent Permanent Establishment of the Appellant under the Article 5(8) of the DTAA between India and Singapore on the premise that ANR habitually secures orders wholly and mainly on behalf of the appellant? 39. This question becomes relevant having regard to the provisions of Arti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of an independent status and, therefore, paragraph 8 of this Article have no application. Additionally, it was also argued that ANR had not undertaken any of the activities specified in said paras 8(a) to (c) of Article 5 and for this reason also, this para have no application. It was further argued that the activities of ANR as an agent were not devoted wholly or almost wholly on behalf of the assessee and thus conditions stipulated in para 9 of Article 5 are not fulfilled and on this reckoning also ANR would not be considered as an agent of independent status within the meaning of said para. 41. We have already taken note of the reasons which are given by the Tribunal in support of its findings that provisions of paras 8 9 of Article 5 stand attracted in the instant case. 42. His submission was that the Tribunal had given two reasons for drawing the conclusion which were totally immaterial having regarding to the provisions of Article 5(9). In this behalf, he referred to the following discussion in the Tribunal's order containing these reasons: (1) The Tribunal had held that ANR was prohibited from taking competitive products. In the agreement, certain limitation and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, he will not be considered an agent of an independent status within the meaning of para (9) of Article 5 of DTAA. (2) The Tribunal also held that the assessee exercised extensive control over ANR as for various actions, the ANR was supposed to take instructions and advise from the representatives of the assessee. The discussion of the Tribunal in this behalf is reproduced as under: "It is pertinent to note that clause 5 of the agreement dated 1-1-2002 between the assessee and ANR provides that ANR shall report to, take instructions and advice from, and make the services available to the assessee through Mr. Sudhir Mayor for the products identified in section 1 of Schedule A and Mr. Dave Klug for the products identified in section 2 of Schedule A, or their nominees. Mr. Robert Turner will handle liaison on all administrative aspects of this agreement on behalf of company. The assessee may change the person or persons nominated under this clause at any time by notice in writing to ANR. Further clause 8.2 of the said agreement provides that ANR shall act exclusively for the assessee in relation to the promotion of its products and shall not directly or indirectly assist any o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scussing as to whether the activities of ANR was devoted wholly or almost wholly on behalf of the assessee and further as to whether the assessee was exercising extensive control over the ANR. These very criteria are laid down in Article 5(9) for the purposes of determining as to whether such an agent of independent status or not. 45. It would, however, be a different question as to whether the reasons given by the Tribunal are sufficient to hold that the criteria stipulated in Article 5(9) treating ANR as dependent agent are satisfied. Coming to this aspect, the argument of Mr. Ganesh was that merely because ANR was prohibited from taking a competitive products would not mean that it was an agent of independent status. What was to be seen was that the 'activities' of ANR are devoted wholly or almost wholly on behalf of the assessee. According to Mr. Ganesh, ANR had many other activities and was doing business for many other parties. Agency of the assessee held by ANR was only one of those many activities. This contention of the assessee is not accepted by the Tribunal as according to the Tribunal the assessee had not stated as to the extent of services rendered by ANR to other c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cer. The Assessing Officer shall decide the question of applicability of Article 5(9) as to whether the ANR was providing services to companies other than the assessee as well and had substantial income from those other companies and whether the company stipulated in Article 5(9) namely ANR was wholly or almost wholly working on behalf of the assessee will have to be determined afresh by the Assessing Officer. 47. The assessee is permitted to file the evidence in the form of Income-tax Return or otherwise on this issue. We may, however, make it clear that onus would be on the assessee to show that ANR had been rendering services and earning commission from other companies on the basis of which it cannot be said that the ANR devoted wholly or almost wholly on behalf of the assessee. These matters are thus remanded back to the Assessing Officer for fresh adjudication. Question of Law - 'f' Whether in the facts and circumstances of the case, the ITAT grossly erred in concluding that ANR has not been compensated at arm's length price, without adequate basis to arrive at such a conclusion? 48. The submission of the assessee in this behalf is that even if the ANR is to be treated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an independent enterprise under similar circumstances might be expected to derive on its own. Article 7(2) of the U.N. Model Convention advocates the arm's length approach for attribution of profits to a PE. 32. The object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. Under Article 7(2) not all profits of MSCO would be taxable in India but only those which have economic nexus with PE in India. A foreign enterprise is liable to be taxed in India on so much of its business profit as is attributable to the PE in India. The quantum of taxable income is to be determined in accordance with the provisions of IT. Act. All provisions of IT Act are applicable, including provisions relating to depreciation, investment losses, deductible expenses, carry-forward and set-off of losses etc. However, deviations are made by DTAA in cases of royalty, interest etc. Such deviations are also made under the IT Act (for example: Sections 44BB, 44BBA etc.). Under the impugned ruling delivered by the AAR, remuneration to MSAS was justified by a transfer pricing analysis and, therefore, no further income could be attributed to the PE (MSAS). In other wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... matter of income from international transaction on an arms length price are contained in section 92 of the Income-tax Act. The principles have been clarified by the Finance Act, 2001 as also Finance Act, 2002. From the order of the CIT which has been accepted it is clear that the Appellant herein has paid to its PE on arms length principle." 50. There is no quarrel if it is a fair price paid by the assessee to ANR for the activities of the assessee in India through its PE namely ANR and the said price i.e. US$ 40,000 per annum has already been taxed in India at the hands of ANR, then no question of taxing the assessee again would arise. However, on the facts of this case, we are of the opinion that Mr. Sabharwal, learned counsel for the Revenue rightly argued that the judgment of Supreme Court in Morgan Stanley Co. and Bombay High Court in Set Satellite (Singapore) Pte Ltd.'s (supra) would not apply to the facts of this case. In Morgan Stanley, the Supreme Court accepted the payment as reasonable and fulfilling the ALP criteria only because the remuneration paid to the agent in India was justified by a Transfer Pricing Analysis. This Transfer Pricing Analysis (TPA) is to be und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e not been taken into account, there would be a need to attribute profits to the PE for those functions/risks of the dependent agent that have not been considered. In the absence of such an exercise and any material on record on these aspects, we are of the opinion that the assessee has not been able to establish that the remuneration paid to ANR was equal to arm's length remuneration. We are of the opinion that the Assessing Officer in his order has rightly pointed out that the Supreme Court has referred to the "functions performed only the risk assumed by the enterprise" as distinguished from the functions performed and the risk assumed by the agent (who may constitute a dependent agent PE). The Assessing Officer has also quoted Rule 10B(2) of the Income-tax Act which provides that uncontrolled transaction shall be judged with reference to following: (a) (b) the functions performed, taking into account assets employed or to be Employed and the risk assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transaction which lay down explicitly or implicitly how the responsibility, ri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the case of Ingersoll Rand Company v. ITO [1983] 4 ITD 654. The ITAT while agreeing with the aforesaid view of CIT (A) additionally referred to the judgment of the Supreme Court in Annamali Timber Trust Co. v. CIT [1961] 41 ITR 781 wherein it is held that there was justification only of apportionment of 10% of assessee's share of profit of the trading operations carried out in India when except entering into contract in taxable territory all other operations were carried out outside taxable territory. The CIT(A), however, held the view that attribution of income at the rate of 10% will not represent adequate attribution to all activities including services being performed in India by ANR. Thus, while restricting the attribution to 10% in respect of supplies, insofar as assessment years 2002-03, 2003-04 and 2004-05 are concerned, the CIT(A) maintained the attribution of income @ 25% of the profits. 56. We agree with the following conclusion of the ITAT: "The order of the CIT(A) in applying the rate of 10% of the profit attributable to PE in India is, thus, upheld, which would be applied for all the assessment years under consideration. In other words, the CIT(A)'s order in ..... 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