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TMI Blog2021 (2) TMI 95X X X X Extracts X X X X X X X X Extracts X X X X ..... nd in the circumstances of the case and in law, the learned CIT(A) erred in holding that Zee Telefilms Limited (ZTL) does not constitute a Permanent Establishment (PE) of the assessee in India. 2. On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in holding that, in the absence of a permanent establishment (PE), income of the assessee is not taxable as per article 7 of the DTAA. 3. The common grounds of cross objections, in CO Nos 124 and 125/Mum/2008, are as follows: Without prejudice to our contentions as respondent of the appeal, even if it is assumed, without accepting, that the respondent is held to have permanent establishment (PE) through its agent, Zee Telefilms Limited, we contend that no income can be attributed to such PE as agent is remunerated on arm's length basis having regard to the functions and risks performed by the agent, and no income of the assessee is taxable in India. 4. In the remaining two cross-objections, i.e. CO No 63 and 64/Mum/2008, the issue raised in the cross objection remained the same, but with the benefit of Hon'ble Bombay High Court's judgment in the case of Set Satellite Pte Ltd Vs CIT [(2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... revenues through its Indian affiliates Zee Telefilms Limited and El Zee, but its claim was that since it does not have any permanent establishment in India, no part of its income was taxable in India. The Assessing Officer did not accept the claim. He was of the view that its Indian agent constitutes virtual projection of the foreign company, and, therefore, it has a permanent establishment in India, in the light of Hon'ble Andhra Pradesh High Court's judgment in the case of CIT Vs Vishakhapatnam Port Trust (144 ITR 146). Referring to this judgment, and analyzing the facts of the case of the assessee, in the assessment order for the assessment year 2002-03, for example, the Assessing Officer concluded as follows: 5.2.3 Now keeping the above in view point, one has to look into the factual aspects of the case, particularly the following: * The assessee could not have earned any income from India but for its Indian agent, ZTL/EI Zee. * The 'brand name' used by the assessee is same as that of its agent in India, that is, ZEE. Thus, for persons desirous of doing business with the assessee in India, there is no difference between ZTL/EI Zee and Asia Today Ltd. it i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a PE. Thus, the profits attributable to the PE shall be the profits it would have made, if it were an independent enterprise. Since the assessee is making an arm's length payment to ZTL/EI Zee, ZTL/EI Zee would have made the same profits dealing with an independent enterprise. Since the said profits are already taxed in the hands of ZTL/EI Zee, no further profits can be attributed to the activities performed by it. Further, the assessee has laid Emphasis on CBDT Circular No. 5 dated September 28, 2004 which states that profits attributable to a PE have to be computed having regard to the arm's length principle. For the detailed reasons given in following paragraphs, I do not find merit in the claim of the assessee that if payment to ZTL/EI Zee is made at arm's length, then it extinguishes the tax liability of the assessee in India. 8. It was in this backdrop that the taxability of the assessee, in respect of advertisement revenue and subscription revenues earned through its agents in India, was confirmed. However, when he carried the matter in appeal before the learned CIT(A), he held that the assessee does not have any permanent establishment in India. Therefore, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a fixed place of business from which business of the foreign enterprise is carried out, and such a place of business should be at the disposal of foreign enterprise. As observed by a coordinate bench of this Tribunal, relying upon the landmark Special Bench decision in the case of Motorola Inc Vs DCIT [(2005) 95 ITD SB 269 (Del)] and in the case of Airlines Rotables Ltd Vs JDIT [(1911) 44 SOT 368 (Mum)], "The physical test, i.e., place of business test, requires that there should be a physical location at which the business is carried out. However, mere existence of a physical location is not enough. This location should also be at the disposal of the foreign enterprise and it must be used for the business of foreign enterprise as well. A place of business should be at the disposal of the foreign enterprise for the purpose of its own business activities. This place has to be owned, rented or otherwise at the disposal of the assessee, and a mere occasional factual use of place does not suffice". Even a case is not made out for the satisfaction of this condition by the Assessing Officer, and, as such, there is no case for the existence of a permanent establishment under Article 5(1) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g extracts, defining permanent establishment, from the India Mauritius Double Taxation Avoidance Agreement [(1984) 146 ITR (St.) 214]:- ARTICLE 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of the enterprise is wholly or partly carried on. 2. The term "permanent establishment" shall include- (a) a place of management ; (b) a branch ; (c) an office ; (d) a factory ; (e) a workshop ; (f) a warehouse, in relation to a person providing storage facilities for others ; (g) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources ; (h) a firm, plantation or other place where agricultural, forestry, plantation or related activities are carried on ; (i) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or supervisory activity continues for a period of more than nine months. (j) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsidered an agent of an independent status within the meaning of this paragraph. 6. The fact that a company, which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other Contracting State (whether through a permanent establishment or otherwise) shall not, of itself, constitute either company a permanent establishment of the other. 11. The case of the Revenue is thus clearly confined to the existence of DAPE on the facts of this case. The question thus arises as to what are the tax implications of the existence of a dependent agent permanent establishment (DAPE) under Article 5(4). The DAPE is, after all, a type of permanent establishment, and the very concept of permanent establishment is a compromise between source rule and residence rule inasmuch as it provides justification to trigger source jurisdiction taxation over business activities of a foreign enterprise. Unless there is a PE in the source jurisdiction, there cannot be taxation of business profits of the foreign enterprise in the source jurisdiction, and when there is a PE in the source jurisdiction, only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In simple words, whatever are the revenues generated on account of functional analysis of the DAPE are to be taken into account as hypothetical income of the said DAPE, and deduction is to be provided in respect of all the expenses incurred by the GE to earn such revenues, including, of course, the remuneration paid to the DA. The second taxable unit in this transaction is the DA itself, but this taxability is in respect of the remuneration of the DA. The provisions of the tax treaty are silent on this issue, and rightly so, because the taxability of the DA is quite distinct of the taxability of the enterprise of the contracting state which is in respect of PE of such an enterprise. At the cost of repetition, it is not the DA who constitutes PE of the GE, but it is by the virtue of a DA that the GE is deemed to have a PE, a DAPE though, in the other contracting state. We are of the considered view that in addition of the taxability of the DA 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as 'A' in the above example is concerned, it does not have anything to do with the income of the foreign company. This taxability is in the hands of the domestic dependent agent and is on net basis after taking into account the expenses incurred by the agent for earning of remuneration whether or not the same relates to the business of the foreign company or not. As regards 'B' above, it represents the earnings of the foreign company attributable to the dependent agent permanent establishment, on account of its having a dependent agent in source country. This income is taxable in the hands of the foreign company in the source country and the tax credit in respect of such taxability will be available to the foreign company in residence country. If, in this example, we are to assume that the income of the PE is only the remuneration earned by the agent on net basis, we will end up in a situation that while profits of Sing Co. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7 of the treaty, the taxability is of the foreign company. What is taxable under Article 7 is profit earned by the foreign enterprise, as it Article 7(i) provides that "The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein". Agency remuneration paid by the foreign enterprise is not an income of the foreign enterprise but an expenditure of the foreign enterprise. The taxability of any profit under Article 7 has to be in the hands of the foreign company and not the host company of which dependent agent is resident. Therefore, in 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. 15. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ason for employing the agent. This surplus is not- or only secondarily- attributable to activities in the parent's residence country. Rather, it is a profit that the parent obtains through employing the agent in the country in which the profits arise. Fairness ("inter-nations equity") requires that the surplus profit be taxed in that state. If the drafters of a treaty or model treaty want to provide this, they must notionally attribute it to a contact in that state. This does not mean that they must attribute it to a person or an object in the real world. In the world of law, a legal concept, a figure of thought, will do. The agency permanent establishment is such a figure of thought which makes it technically possible to connect the surplus profit to the agent's state. Thus, it is not only possible, but it is the rule that a profit exceeding the agent's compensation will be submitted to the agent's state". Philip Baker, another eminent international tax expert whose work in referred to, with approval and respect, in many of the judicial precedents from Hon'ble Courts above, did not agree with this approach. In his editorial comments in the International Tax La ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 arm's length principle. It recorded a finding of fact that the Appellant had paid service fees at the rate of 15 per cent of gross ad revenue to its agent, SET India, for procuring advertisements during the period April 1998 to October, 1998. The fact that 15 per cent service fee is an arm's length remuneration is supported by Circular No. 742 which recognizes that the Indian agents of foreign telecasting companies generally retain 15 per cent of the ad revenues as service charges. Effective November 1998, a revised arrangement was entered into between the parties whereby the aforesaid amount was reduced to 12.5 per cent of net ad revenue (i.e., gross ad revenues less agency commission). Simultaneously, the Appellant also entered into an arrangement entitling SET India to enter into agreements, collect and retain all subscription revenues. Considering all these aspects and the fact that the agent has a good profitability record, it held that the Appellant has remunerated th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al in its judgment has not considered the effect of the finding recorded by the CIT (Appeals) based on the Circular and which circular was relevant for the purpose of deciding the controversy in issue. This circular read with Article 7(1) of the DTAA would result in holding that the income from advertisement if neither directly nor indirectly attributable to that of the permanent establishment, would not be taxable in India. The Tribunal in fact in para 10 has recorded a finding that Article 7(2) provides that the arm's length price is the criterion for computation of these hypothetical profits. In our opinion the entire rational or reasoning given by the Tribunal has to be set aside. In matters of tax what has to be considered and more so in international transactions if there be a treaty, the provisions of the treaty and if the provisions of the treaty are more advantageous to an assessee, then the construction will have to be given which is advantageous to the assessee. At this stage we may note that on behalf of the assessee learned Counsel has produced an order passed by the Additional CIT (Transfer Pricing-II), Mumbai in the matter of determination of arm's length pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid ruling of AAR on the question of income attributable to the PE was the subject-matter of challenge by the Department. Insofar as the issue of PE is concerned the Supreme Court was pleased to hold that it agreed with the Ruling of the AAR that stewardship activities would fall under Article 5(2)(1). Dealing with the question of deputation, the Court held that on the facts that there is a service PE under Article 5(2)(1) and as such held that the Department was right in its contention that there exists a PE in India. Considering Article 7 of that treaty the Court observed that what is to be taxed under Article 7 is income of the MNE attributable to the PE in India and what is taxable under Article 7 is profits earned by the MNE. Under the Income-tax Act the taxable unit is the foreign company, though the quantum of income taxable is income attributable to the PE of the said foreign company in India. The Court observed that the important question which arises for determination is whether the AAR is right in its ruling when it says that once the transfer pricing analysis is undertaken there is no further need to attribute profits to a PE. The Court further noted that the computatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in the hands of the Foreign Enterprise. 13. Considering the above principle as may be discerned from the judgment in DIT (International Taxation) 292 ITR 416 (supra) it would be clear that- (1) Considering the CBDT Circular No. 742 it would be fair and reasonable that the taxable income is computed at 10 per cent of the gross profits. In the instant case insofar as marketing services are concerned by the arm's length principle what has been paid is more than 10 per cent as can be seen from the order of CIT(A). This was not disputed by the revenue in its Appeal before the ITAT. (2) The only contention advanced and which found favour with the Tribunal was that the advertisement revenue received by the assessee was also income liable to tax in India. The CIT(A) relied upon Circular No. 23 of 1969. That Circular read with Article 7(1) would result in holding that advertisement revenue received by the appellant are not taxable in India as long as the treaty and the Circular stands. 14. In the light of the above Appeal filed by the Appellant herein is allowed and the order of the ITAT is set aside. Merely because tax on income was paid for some assessment years would not s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 's plea that as per the law laid down by Hon'ble Supreme Court in the case of DIT v. Morgan Stanley & Co Inc. [2007] 162 Taxman 165 (SC), the arm's length remuneration paid to the PE must take into account 'all the risks of the foreign enterprise as assumed by the PE', but then in an agency PE situation, unlike a service PE situation which was the case before the Hon'ble Supreme Court, a DAPE assumes the entrepreneurship risk in respect of which agent can never be compensated because even as DAPE inherently assumes the entrepreneurship risk, an agent cannot assume that entrepreneurship risk. To this extent, there may clearly be a subtle line of demarcation between the dependent agent and the dependent agency permanent establishment. The tax neutrality theory, on account of existence of DAPE, may not indeed be wholly unqualified- at least on a conceptual note". However, these issues are wholly academic before this forum because Hon'ble jurisdictional High Court has taken a specific call on the issue to the effect that the Morgan Stanley decision of Hon'ble Supreme Court covers the DAPE situations as well. In a series of decisions of the coordinate ben ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the above and applying to the facts of the case, it is humbly submitted that all the international transactions entered into by assessee have not been examined by the authorities below". There is no material whatsoever before us to show, or even indicate, that the remuneration paid to the agents is not arm's length remuneration. In any case, the agent has been paid a remuneration at the rate of ten percent of the related revenues which is accepted as an arm's length price, in similar circumstances, in a large number of cases- including assessee's own cases for the assessment years, other than the assessment years in which this aspect of the matter is requested to be sent back for specific adjudication. Learned Departmental Representative himself submits that so far reliance of the assessment on the coordinate bench decisions for the assessment years 2006-07 to 2012-13 are concerned, "in the other cases relied upon by the assessee, the transfer pricing adjudication was made while in the present case, no such adjudication was made, and hence the decisions are not applicable as distinguishable on facts". We have also noted that the matter has come up for specific consideration of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that all the business risks of the assessee (i.e. the foreign company) are borne by the PE as PE is the content provider and responsible for up linking activity. That's too sweeping a generalization to meet any judicial approval, and, on the same set of findings, the coordinate benches have disapproved the stand of the Assessing Officer. Under these circumstances, we see no reasons to remit the matter to the file of the Assessing Officer for a fresh round of ALP ascertainment proceedings, as prayed by the learned Departmental Representative. The plea of the assessee, as raised in the cross-objections, therefore, merits acceptance. Whether there is a DAPE or not, there are no additional profits to be brought to tax as a result of the existence of the DAPE, and, therefore, the question about the existence of a DAPE on the facts of this case is wholly academic. 16. Once we hold, as we have held above, that in the light of the present legal position, existence of dependent agency permanent establishment in wholly tax-neutral, unless it is shown that the agent has not been paid an arm's length remuneration, and when it is not the case of the Assessing Officer, as we have noted earl ..... X X X X Extracts X X X X X X X X Extracts X X X X
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