9911796707
TMI Blog2010 (7) TMI 1226X X X X Extracts X X X X X X X X Extracts X X X X ..... Paris, Singapore, Tokyo, Moscow, and Sao Paulo. There is, however, no dispute that the assessee does not have any branch office or any other similar form of presence in India. During the relevant previous year, the assessee firm rendered services to certain clients whose operations extended to India, and these services were in connection with projects in India. The services so rendered were rendered from outside India as also from within India. The services were rendered from outside India by assessee's London office, but at times partners and staff members of the assessee firm also visited India to render these professional services. The assessee had worked for following projects for which partly work was done in India and partly work was done outside India: Sl.No. Name of the Client Name of the Project / Matter 1. Denro Ispat Chandrapur coal project 2. CESC Balagrah power project 3. Enron Power Indian power project 4. Hinduja National Power Vizag 5. Dresdner Kleinwortbenson Bajaj GDR issue 6. Barclays Capital Finolex Cables GDR 7. S.S. Warburg Securities Ltd. India cements Limited 8. HSBC Investment Bank PLC Sriram Enterprises GDR 9. Lazard Brothers ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee do not involve furnishing of services as envisaged in Article 5(2)(k) of the Indo UK tax treaty as the assessee is an international professional enterprises rendering services directly to its clients. It was also contended by the assessee that the professional services rendered by the assessee can at best be covered by Article 15 but, in any event, Article 15 extended to only individuals and not to the partnership firms or other forms of business organizations. It was submitted that the assessee cannot be taxed under Article 7 as the assessee did not have a PE in India under the provisions of Article 5(2)(k) read with Article 5(1), and the assessee cannot be taxed under Article 15 as the said Article only applies to the services rendered by individuals whereas the assessee is a partnership firm. It was contended that since the provisions of the applicable tax treaty were beneficial to the assessee, these treaty provisions will override the provisions of the Indian Income Tax Act, 1961, and the income of the assessee cannot be brought to tax under the provisions of the Indian Income Tax Act either 4. None of these submissions, however, impressed the Assessing Officer. The Ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the income earned by the assessee is also taxable under Article 15 as 'independent personal services' and he relied upon the decision of this Tribunal in the case of Clifford Chance Vs DCIT (82 ITD 106) in support of the same. 5. Having held that the income of the assessee from projects in India is taxable in India, the Assessing Officer turned to quantification of the income so liable to be taxed in India. It was noted that without prejudice to assessee's contentions regarding non taxability of its income in India, the assessee had enclosed an income and expenditure account in which income has been computed as follows: In UK £ Income 6,91,190 Less : Direct expenditure 1,88,206 Overheads (5% of income) 34,565 __________ Profits ___4,68,419_______ 6. It was also noted that the above computation was based on the position stated at Note 10 of the statement accompanying the income tax return and the position stated in the tax audit report attached to the return of income. A perusal of these documents revealed that the assessee had prepared a profit and loss account with reference to the fees charged to the clients as could reasonably be attributed to the wor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at, " A careful reading of Section 9, together with the Explanations thereto, makes it clear that the statutory test for determining the place of accrual of income is not the place where these services are rendered but where those services are utilized". Therefore, irrespective of the place where services are rendered, income should be deemed to accrue or arise in India. The Assessing Officer, having noted that the assessee has taken into account charges only for services rendered in India, thus held that whether the services rendered from India, or from outside India, the entire income in connection with projects in India is required to be taxed in India. He thus took into account the overall amounts invoiced by the assessee in respect of services rendered for Indian projects. It was also noted by the Assessing Officer that amounts invoiced to the clients were in the nature of invoices for professional fees as well as invoices/ requisitions for reimbursements of expenditure. While Assessing Officer noted assessee's claim that the reimbursements of expenses are in respect of actual expenditure incurred by the assessee, on behalf of clients, and have no element of mark up or income, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... illing amount is to be taken into account. While holding so, the CIT(A), inter alia, made following significant observations: On the question of existence of PE "……….. The contention of the learned A.R. cannot be accepted for the following reasons. • Para 2 of Article 5 of the DTAA provides the circumstances under which permanent establishment arises in a Contracting State. Para 2 provides for specific instances over and above the general provisions contained in para 1 of Article 4 e.g. duration of construction contract, furnishing of services other than technical services, etc. It is a well accepted principle that specific provisions prevail over the general provisions. Therefore, if the conditions provided in para 2 of Article 5 are satisfied, it will amount to a permanent establishment irrespective of the fact whether the general provisions of Article 5(1) cover such a situation or not. • The term furnishing of services as referred in Article 5(2)(k) also includes rendering of services. In commercial parlance, there is no difference between furnishing of services and rendering of services. The services excluded from the purview of Articl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it can be observed that more than 90% of the invoices are raised by the appellant on foreign enterprises. Further, in many cases, the appellant has rendered services in relation to ADR/GDR or Bound issues outside India. Therefore, it will be incorrect to assume that the services rendered by the appellant are utilized in India. In any event, I agree with the learned A.R. that the income earned by the appellant were not in the nature of fees for technical services as defined in section 9(1)(vii) and therefore the AAR Ruling in the case of S.R.K. Consulting Engineers (supra) will not apply to the facts of the appellant. 6.10 Even in the case of Clifford Chance (82 ITD 106) the Hon'ble Mumbai Bench of ITAT has held that the income relating to services rendered outside India is not taxable in India. At para 64 of the order, the Hon'ble ITAT has observed as under: 6.4 The question in the present case is very simple. If assessee proves that it rendered services outside India, its income to that extent can be excluded while computing its total income for determining tax payable in India. But this was not done. In the absence of any document and proof issue cannot be decided in f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... U.K. The Learned Commissioner (Appeals) ought to have appreciated that appellant had no permanent establishment in India. 3. Without prejudice to the above, the Learned Commissioner (Appeals) erred in not directing the Assessing Officer to accept the computation provided by the appellant in the Income and Expenditure Account as being the income attributable to the permanent establishment. The Learned Commissioner (Appeals) ought to have directed the Assessing Officer to adopt the gross income at 6,91,190 pounds deduction for direct expenditure at 1,88,206 pounds, deduction for overheads 34,565 pounds and net profit 4,68,419 pounds. 4. Without prejudice to the above, the Learned Commissioner (Appeals) erred in not directing the Assessing Officer to compute the total income at the number of hours charged at appropriate rates for an Indian lawyer viz 100 pounds per hour for a partner and 75 pounds per hour for an assistant. 5. The Learned Commissioner (Appeals) erred in upholding the action of the Assessing Officer in considering reimbursement of expenditure of 8,02,486.13 pounds, 65,327 US dollars and HKD 488 as part of income of the appellant and as liable to tax in India. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nly to the extent the work has been carried out in India. It is submitted that in view of Hon'ble Bombay High Court's judgment in the case of Clifford Chance vs DCIT (318 ITR 237) only such services as are rendered in India can be subjected to tax in India. Therefore, according to the learned counsel, even under domestic law, we cannot bring to tax services rendered to Indian projects from outside India. When learned senior counsel's attention was drawn to the amendments in Section 9 as proposed by the Finance Bill 2010, and impact of these amendments, when carried out, on Clifford Chance judgment of Hon'ble Bombay High Court, it was submitted that these amendments, even if carried out, will at best require reconsideration of Clifford Chance decision by Hon'ble Bombay High Court, whenever these issues come up before Their Lordships again, but, under no circumstances, it can be said that Clifford Chance will not be good law even after the amendments are brought in force. It was submitted that these amendments pertain to the taxability of fees for technical services, and, as such, do not directly cover the issue in appeal before us. Beyond these submissions, learned counsel did not m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... connection with these projects is taxable in India as is attributable to services performed in India, the Assessing Officer opined that the total fees received for the India Project, whether the work was done in India or outside India, was taxable in India. When this dispute finally travelled before the Hon'ble Bombay High Court, it was, inter alia, contended by the assessee that "the place of utilization of service is not relevant but place of performance of the service is what would be determinative (of taxability)…….." and reliance was placed on Hon'ble Supreme Court's judgment in the case of Ishikawajima Harima Heavy Industries Ltd. vs. DIT (288 ITR 408). Their Lordships noted that the taxability is to be determined under section 9(1)(vii) of the Act, and observed as follows: "The apex court had occasion to consider the above question in the case of Ishikawajima Harima [2007] 288 ITR 408 (SC), wherein, while interpreting the provisions of section 9(1)(vii)(c) of the Act, the Supreme Court held as under (page 444) : "Section 9(1)(vii)(c) of the Act states that 'a person who is a nonresident, where the fees are payable in respect of services utilized in a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ident would not, as services of a nonresident to a resident utilized in India may not have much relevant in determining whether the income of the nonresident accrues or arises in India. It must have a direct link between the services rendered in India. When such a link is established, the same may again be subjected to any relief under the DTAA. A distinction may also be made between rendition of services and utilization thereof. With the above understanding of law laid down by the apex court, if one turns to the facts of the case in hand and examines them on the touchstone, section 9(1)(vii)(c) which clearly states…where the fees are payable in respect of services utilized in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India". It is thus, evident that section 9(1)(vii)(c), read in its plain, envisages the fulfillment of two conditions : services, which are source of income sought to be taxed in India must be (i) utilized in India, and (ii) rendered in India. In the present case, both these conditions have not been satisfied simultaneously. 15. It is thus unambiguous that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een satisfied simultaneously". It is on this basis that Their Lordships came to the conclusion that "In the above view of the matter, contentions raised by the assessee/ appellant are to be accepted". The conclusions arrived at by Their Lordships were thus entirely based on their reading of the scope of Section 9(1) of the Income Tax Act, but in view of the retrospective amendment in Explanation to Section 9(1), the scope of this provision does no longer permit the interpretation adopted by Their Lordships. The very conceptual foundation of Hon'ble Bombay High Court's decision in the case of Clifford Chance (supra) ceases to hold good in law. When the legal provisions considered in the judicial precedent, vis‐à‐vis the legal provisions prevalent when that precedent is sought to be applied, are not in pari materia, the judicial precedent cannot have precedence value. 17. A school of thought does exist to the effect that the concept of territorial nexus, for the purpose of determining the tax liability, is relevant only for a territorial tax system in which taxability in a tax jurisdiction is confined to the income earned within its borders. Under this system, any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is now specifically supported by the retrospective amendment to section 9. 18. It is, therefore, free from any doubt that Hon'ble Bombay High Court's judgment in the case of Clifford Chance is no longer good law, as there have been amendments in law in consonance with the school of thought discussed above and these amendment unambiguously negate the principle of territorial nexus which is the understructure of line of reasoning adopted by the Hon'ble Courts above. It is no longer necessary that, in order to invite taxability under section 9(1)(vii) of the Act, the services must be rendered in the Indian tax jurisdiction 19. In view of the above discussions, we are of the considered view that the entire fees for professional services earned by the assessee, in connection with the projects in India and which is thus sourced from India, is taxable in India under the domestic law. We reject the contentions advanced by the learned counsel. 20. Having held so, however, we may add that under the scheme of the Indian Income Tax Act, where the Government of India has entered into an agreement, with the Government of any country outside India for granting of relief, or as the case may be, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e us - something beyond the scope of our powers. Our attention was invited to Hon'ble Bombay High Court's judgment in the case of Pokhraj Hirachand Vs CIT (49 ITR 293). It is submitted that all that we are to decide at this stage is the issues raised by the appellants, and we cannot travel beyond that to unsettle the settled matters. Without prejudice to these objections on jurisdiction, learned counsel for the assessee also addressed us on merits on assessee's eligibility for treaty benefits. 23. Learned counsel submits that the assessable unit is the partnership firm itself, though the manner of computation of tax liability is such that the tax payable by the partners is taken into account. Our attention is drawn to the UK Inland Revenue's assessment order of the assessee shows assessment order drawn up in the name of the firm, though the tax is computed with reference to the tax liability of the partners. The expression 'liable to tax', according to the learned counsel, must include the person who is under an obligation to file the income tax return, in whose hands the income is determined and from whom taxes are recovered. The assessee fulfils all these tests, on the facts of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vant tax jurisdictions, and, as such, this decision cannot have any bearing on the question as to whether or not a partnership firm in UK is entitled to the treaty benefits under India UK tax treaty. 27. Learned counsel further submitted that when words of a tax treaty are less than unambiguous, even if that be so, the Courts and Tribunals have to interpret these words so as to advance the objectives and purposes of the tax treaty rather than so as to frustrate the undisputed objectives and purposes of the tax treaty. According to the learned counsel, this peculiar problem regarding eligibility of tax treaty benefits arises, if at all it can be deemed to arise, because of asymmetrical tax treatment to partnership firm in the treaty partner tax jurisdictions, and, the treaty should be so interpreted as to resolve this unintended incongruity. We are thus urged to so interpret the tax treaty as to ensure meaningful interpretation to the provisions of tax treaty. 28. Learned Departmental Representative submits that the point of dispute before us is taxability of income from a definite source, and the authorities below have given their reasons of taxability, or non taxability, of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... raised by the assessee. 29. Learned Departmental Representative invites our attention to the definition of 'resident of a contracting state', as set out in Article 4(1), which states that resident of a Contracting State means "any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature". It is pointed out that as evident from Article 1(1) of the India UK tax treaty, the treaty can only apply to a person who is resident of one or both the contracting states. Therefore, in view of the provisions of Article 4(1) read with Article (1) and on the facts of this case, unless the assessee can be said to resident of UK, the assessee cannot claim treaty benefits, and unless the assessee is liable to tax in UK, assessee cannot fulfill the requirement of being a resident in UK. He further submits that it is not in dispute that in the United Kingdom, a partnership firm is not taxable unit so far as income of the partnership firm is concerned, and the expression 'liable to tax' cannot include a person who is not a taxable unit. Only such a person whose income is taxed can be cover ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce, even under the provisions of the treaty, entire income of the assessee relatable to project in India was held to be taxable. It is also not the case that the Assessing Officer decided the issue of admissibility of treaty benefits in favour of the assessee and that decision is now being put to scrutiny again. The Assessing Officer's action of not considering it expedient to look into the taxability of an income from all other possible angles cannot foreclose the examination of the taxability from different perspective. What is subject matter of dispute is not a facet of law but an income which is sought to be taxed. As long as the income, which is impugned in appeal, is same as assessed by the Assessing Officer, there cannot be any bar on considering any aspect of the legal position in this regard. Elaborating upon this aspect of the matter, a Special Bench of the Tribunal in the case of Tata Telecommunications Ltd Vs DCIT (121 ITD SB 384 ), has, inter alia, observed as follows: ………….…It was bounden duty of the Tribunal to consider and decide the above issue and to examine that each of the condition specified by the section is satisfied&hell ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly similar to the above case before the Hon'ble Supreme Court. In the present case also, the condition regarding providing eligible telecommunication services was not discussed by the Assessing Officer and the Commissioner (Appeals) and yet this issue was taken up by the Departmental Representative before us. The same was the situation in Hukumchand Mill's case (supra) wherein, as noted by the Hon'ble Supreme Court in paragraph 4 of their judgment, "it was urged before the Tribunal by the department that although the ITO had not considered the provisions of paragraph 2 of Section 2 of Taxation Laws Order, the said provisions were applicable in the present case and certain amounts of depreciation, which are allowed under the Industrial Tax Rules, which had the force of law in Indore State, were required to be deducted in arriving at written down value of the assets of the assessee". This plea was accepted by the Tribunal and the Hon'ble Supreme Court confirmed the action of the Tribunal in doing so. In this view of the matter, not only that admitting the plea regarding the assessee not rendering eligible telecommunication services does not suffer from any mistake apparent on record ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... related to the issue in appeal, even though the same may not have been specifically raised by either of the parties. The only limitation to this power perhaps is that it should not expand the scope of the appeal in terms of the income sought to be taxed or disallowance sought to be made, and that both the parties should have adequate opportunity of being heard on this issue in terms of the provisions of Rule 11 of the Appellate Tribunal Rules, 1963. As far as this aspect of the matter is concerned, we may usefully refer to the following observations and analysis of the legal position as made by a coordinate bench of this Tribunal, in the case of Morgan Stanley Asset Management Inc Vs DCIT (39 DTR 240) with which we are in respectful agreement : "………… When the assessee had itself repeatedly filed the returns in the capacity of AOP, how it can be argued that the Tribunal should close its eyes and ignore its mistake, which is manifest on the face of it. The Tribunal being a final fact finding authority cannot ignore such patent deficiencies. Moreover, the only question before us is to examine the validity or otherwise of the return. When we have to adjudi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tem was of the nature of plant and machinery did not find favour with the Tribunal. It was held by the Hon'ble apex Court that : "The Tribunal rejected the claim of the assessee, but on that account the Tribunal was not bound to disallow the claim of the assessee for allowance of that amount spent if it was a permissible allowance on another ground. The Tribunal, on investigation of the true nature of the alterations made by the introduction of the Casablanca conversion system, came to the conclusion that it did not amount to installation of new machinery or plant, but it amounted in substance to current repairs to the existing machinery. The subjectmatter of the appeal in the present case was the right of the assessee to claim allowance for Rs. 93,215. Whether the allowance was admissible under one head or the other of subs. (2) of s. 10, the subject matter for the appeal remained the same and the Tribunal having held that the expenditure incurred fell within the terms of s. 10(2)(v), though not under s. 10(2)(vib), it had jurisdiction to admit that expenditure as a permissible in the computation of the taxable income of the assessee." Similar view has been expressed by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll when the issue has been raised by the learned Authorised Representative that the Tribunal can neither examine this aspect itself nor restore the matter to the AO for proper adjudication from this angle, we want to make it clear that there is no such bar on the Tribunal in restoring the matter to the file of AO even though it may result in enhancement. Hon'ble Supreme Court in CIT vs. Assam Travels Shipping Service 199 ITR 1 has held as under: "The AAC as well as the Tribunal clearly held that the computation of penalty made by the ITO was not in accordance with law and that the correct computation of penalty was also made while taking that view. The conclusion clearly reached was that the computation of penalty had to be made in accordance with s. 271(1)(a) r/w subs. (2) of s. 271. The correct figure arrived on that basis on the facts of this case was also indicated. On that conclusion, the only question arising out of the Tribunal's order was whether the Tribunal had no other alternative except to dismiss the Department's appeal and thereby affirm the order of the AAC cancelling even the lesser penalty imposed by the ITO overlooking s. 271(2). The expression 'as it thin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature. 35. We find that in terms of Article 1 (1), the India UK tax treaty "shall apply to persons who are residents of one or both of the Contracting States". As to what are the connotations of expression "resident of a contracting state", Article 4(1) of the treaty provides that, for the purposes of the said tax treaty, term 'resident of a Contracting State' " means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature." It is thus necessary that the resident can only be 'person' and that person should be 'liable to taxation by reasons of his domicile, place of management or any other criterion of similar nature'. It is also important to bear in mind the fact that in terms of provisions of Article 3(2), "a partnership which is treated as a taxable unit under the Income‐tax Act, 1961, of India shall be treated as a person" for the purposes of this treaty. To the extent tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f taxation, or the manner in which the taxpayers falling under that classification are taxed, need not be homogenous in the treaty partner countries. Let us consider a situation in which an entity is treated as opaque, and taxed as such, in one jurisdiction, and as fiscally transparent, and disregarded as such, in the other jurisdiction. While in the first jurisdiction, the entity will be taxed in its own right, and the second jurisdiction, i.e. where it is disregarded and treated as transparent, the taxability will be in the hands of the owners. That results in a situation that while there is no juridical double taxation of an income, there is undoubtedly economic double taxation of an income. Take, for example, a situation in which a partnership firm is treated as an opaque entity in the source jurisdiction and taxed as such in respect of profits of the partnership in the source jurisdiction, but the same firm is treated as a fiscally transparent entity in the residence jurisdiction and the taxability of income, in the residence jurisdiction, arises only in the hands of the partners of the partnership firm. 40. This incongruity arises because of the fact that mechanism of relie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ated as a tolerable evil. OECD efforts to resolve this problem, which are demonstrated by publication of its report 'The Application of OECD Model Convention to Partnerships' and subsequent changes to OECD Model Commentary, also show that it is well within the scope and intention of tax treaties to aim at resolving economic double taxation caused by asymmetrical tax treatment and entity classification. It does not, therefore, seem to be beyond the fundamental objectives of a tax treaty to relive the economic double taxation of an income a situation in which such economic double taxation arises due to asymmetrical tax treatment of a business entity. 43. Coming back to the fundamental issue that we need to deal with, i.e. whether or not the partnership firm before us is entitled to the benefits of the India UK tax treaty, we have noted that the controversy is confined to whether or not the assessee can be said to be 'liable to taxation (in UK) by reasons of his domicile, residence, place of management or any other criterion of similar nature' so as to qualify as a resident of UK, and, in turn, be eligible for benefits of the tax treaty. While the issue of treaty benefits eligibility ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... African and the Kingdom of Lesotho". That situation is materially different vis‐à‐vis the situation that we are in seisin of in which a partnership firm regarded as a tax entity under the Indian Income Tax Act, under Article 3(2), is specifically covered by the definition of 'person'. This judicial precedent from South Africa is thus of little use to us. 46. In the case of TD Securities (USA) LLC Vs Her Majesty the Queen [2010 TCC 186; IBFD tax treaty case law database reference Canada‐ 2008‐2314(IT)G], Tax Court of Canada had an occasion to deal with the question of treaty entitlements to transparent entities. 47. Although the taxable entity in this case was not a partnership firm, the taxable entity was a fiscally transparent entity under the US laws and the income of the said entity was entirely taxable, in its residence country i.e. USA, in the hands of its ultimate owner member i.e. TD Holdings (II) Inc., and yet it was held to be eligible, in Canada, for treaty benefits of Canada US tax treaty. 48. Interestingly, in this case, the stand of the revenue authorities was the same, as before us, as evident from the observation of the court to th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... son' to be 'liable to taxation by reasons of his domicile, residence, place of management or any other criterion of similar nature'. On this issue, the Court, inter alia, concluded as follows: ………The US Code provides that the income of TD LLC is fully and comprehensively taxed to its member, Holdings II. This income is consolidated in the TD USA tax return and tax thereon is charged back by TD USA to TD LLC…………In such a case, it seems clear that the income of TD LLC should enjoy the benefits of the US Treaty. The evidence is overwhelming that the object and purpose of the US Treaty read in the context of all of the evidence and authorities would not be achieved and would be frustrated if the Canadian sourced income of TD LLC that is fully taxed in the US under the US Code does not enjoy the benefits of the US Treaty including Article X(6). 50. While deciding the above question Hon'ble Justice Patrick Boyle, delivering a very elaborate judgment of the court dealing with several facets of this question - though mainly in the context of aspects relating to Canada US tax treaty, Canadian and US tax policies and peculiarities of Delaw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated insofar as the particular item under consideration is concerned. [54] Both the Vienna Convention and the Supreme Court of Canada in Crown Forest confirm that "literalism has no role to play in the interpretation of treaties": Coblentz v. The Queen, 96 DTC 6531 (FCA). [55] In Crown Forest the Supreme Court of Canada also held that, in ascertaining the purposes of a treaty article, a court may refer to extrinsic materials which form part of the legal context, including model conventions and official commentaries thereon, without the need to first find an ambiguity before turning to such materials. [56] The Preamble to the US Treaty sets out its purposes of reducing or eliminating double taxation of income earned by a resident of one country from sources in the other country, and of preventing tax avoidance or evasion. In Crown Forest the Supreme Court of Canada held that the purposes of the US Treaty also included the promotion of international trade between the two countries and the mitigation of administrative complexities arising from having to comply ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ve tax in respect of an offshore business, or simply a tax because of a physical presence, such as by of a liaison office, in a tax jurisdiction, or because of a locality related attachment which leads to residence based taxation. The taxation of a person in all these situation does not necessarily indicate a fiscal domicile in that jurisdiction. In our considered view, in its contextual sense, expression 'liable to tax by reasons of his domicile, residence, place of management or any other criterion of similar nature' refers to a situation in which a person is liable to tax in a tax jurisdiction by the virtue of a locality related attachment which leads to residence type taxation. While elaborating upon the scope of this expression, a coordinate bench of this Tribunal, in the case of DCIT Vs General Electric Co plc (2001) 71 TTJ 973 had observed as follows: ………..Art. 4(1)* ….clearly provides that "for the purpose of this Convention, the term 'resident of one of the states' means any person who, under the laws of that state, is liable to taxation therein by reasons of his domicile, residence, place of management or any other criterion of a similar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is that these factors consist of some locality related attachment of the person which leads to residence type, i.e. full fledged and not in respect of a limited source, taxation of that person. 54. Let us take a hypothetical example to illustrate application of this principle. There are occasions when a business entity has to pay taxes on its income in more than one tax jurisdiction. Take, for example, a company, incorporated and fiscally domiciled in X tax jurisdiction, which has income generating activities in A,B,C and D tax jurisdictions. It has a royalty income sourced from 'A' tax jurisdiction, so it is liable to tax in 'A' jurisdiction in respect of royalty income sourced from there. It has a liaison office in 'B' tax jurisdiction, and it is liable to pay municipal trade tax in respect thereof in B tax jurisdiction. The same organization has permanent establishments in C and D tax jurisdictions, and, therefore, it is liable to pay taxes in respect of the profits of the PE in C and D tax jurisdictions. As a fiscal resident of X tax jurisdiction, however, it is also liable to pay tax on all its incomes, whether sourced from A,B,C,D or X itself or from any other tax jurisdic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r not. That is the clearly the underlying principle based on which residence definition is modeled. 57. The treaty developments around the globe, for example by way of 2007 amendments in US Canada tax treaty by way of fifth protocol to that treaty, which specifically provides that even a transparent tax entity will qualify for treaty entitlement, confirm this approach. This amendment specifically addresses how the Canada US tax treaty applies to fiscally transparent treaties such as partnerships and LLCs. Of course, the Canadian Tax Court has expressed, in no uncertain words, the view that even without the aforesaid amendment, a fiscally transparent entity is eligible for treaty benefits in the country of domicile as long as its profits get taxed in that country, and the amendment only grants, or rather restricts, application of an existing benefit. That is what was also held in TD Securities case (supra), but, for the present purposes, what is even more important that some tax jurisdictions, on their own, are consciously interpreting the 'liable to taxation' in such a pragmatic manner as to extend treaty benefits to fiscally transparent entities. 58. We are alive to the fact tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... received the amount from an entity that is a resident of that other State, but by reason of the entity being treated as fiscally transparent under the laws of the first mentioned State, the treatment of the amount under the taxation law of that State is not the same as its treatment would be if that entity were not treated as fiscally transparent under the laws of that State. 59. A plain reading of the judgment of Canadian Tax Court in the case of TD Securities (supra) does show that the above amendment in the treaty position was more of a restriction on the treaty entitlements benefits to a fiscally transparent entity rather than the sole basis for the treaty entitlement benefit. 60. It would, therefore, seem logical that it is the event of taxability in the residence state, rather than the mode of taxability there, which should be a decisive factor for determining whether the person should be treated as eligible for treaty benefits of the contracting state in which he claims to be resident, but then while interpreting a tax treaty, is it really open to us to address ourselves to the rationale and objective of a tax treaty and disregard the plain words of the treaty? Does the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of any agreement." 64. We are in considered agreement with this school of thought which lays down the proposition that, strictly speaking the principles of literal interpretation do not apply to the interpretation of tax treaties. To find the meaning of words employed in the tax treaties, we have to primarily look at the ordinary meanings given to those words in that context and in the light of its objects and purpose. Literal meanings of these terms are not really conclusive factors in the context of interpretating a tax treaty which ought to be interpretated in good faith and ut res magis valeat quam pereat, i.e., to make it workable rather than redundan 65. Hon'ble Supreme Court in the case of Union of India & Anr. v. Azadi Bachao Andolan & Am. 263 ITR 706, had an occasion to deal with the principles governing the interpretation of tax treaties. In this regard, Hon'ble Supreme Court held that the principles adopted in the interpretation of treaties are not the same as those adopted in the interpretation of statutory legislation. Their Lordships quoted, with approval, following passage from the Judgment of the Federal Court of Canada in the case of IV. Gladden v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tatutes, have held that the task of interpretation is not a mechanical task and, quoted with approval Justice Hand's observation that "it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning". Their Lordships observed as follows : "............... The task of interpretation of a statutory enactment is not a mechanical task. It is more than a mere reading of mathematical formulae because few words possess the precision of mathematical symbols. It is an attempt to discover the intent of the legislature from the language used by it and it must always be remembered that language is at best an imperfect instrument for the expression of human thought and, as pointed out by Lord Denning, it would be idle to expect every statutory provision to be 'drafted with divine prescience and perfect clarity'. We can do no better than repeat the famous words of Judge learned Hand when he said : '... it is true that the words used, even in their li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sentially implies that the provisions of the treaty are required to be construed in harmony with each other. • The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need not examined in precise grammatical sense or in literal sense. Even departure from plain meaning of the language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty ut res magis valeat quam pereat i.e., in such a manner as to make it workable rather than redundant. • A literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated insofar as particular items under consideration are concerned. Words are to be understood with reference to the subjectmatter, i.e., verba accopoenda sunt secundum subjectum materiam. • It is inevitable that interpreter of a tax treaty is likely to be required to cope with disorganised composition instead of precision drafting. Therefore, the words employed in the treaty are to be given a general meaning general to lawyers and general to layman alike. • When a tax treaty does not define a term employed in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ao Andolan's case (supra), Federal Court of Canada was observed that''' the nonresident can benefit from the exemption (under the treaty) regardless of whether or not he is taxable on that capital gain in his own country, If Canada or the US were to abolish the capital gains tax completely, while the other country did not, a resident of the country which has abolished the capital gains would still be exempt form capital gains in that country". It is thus clear that taxability in one country is not sine qua non for availing relief under the treaty from taxability in the other courts. All that is necessary for this purpose is that the person should be liable to tax in the contracting State by reason of domicile, residence, place of management, place of incorporation for any other criterion of similar nature which essentially refers to the fiscal domicile of such a person. In other words, if fiscal domicile of a person is that person is actually liable to pay tax in that country, he is to be treated as resident of that contracting State. The expression 'liable to tax" is not to read in isolation but in conjunction with the words immediately following ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Greek bureaucracy the company had not yet been assessed to the Greek corporate income tax. These facts were not contested by the Dutch authorities. But in 2004 they assessed the taxpayers for the Dutch corporate income tax retrospective for the year 1995. The tax inspector argued that, for applying Art 4(1) of the NetherlandsGreece tax liability is not sufficient rather a factual subjective indebtedness" ("een feitelike subjective onderworpnheld") is required. The Court, however, refuted this argument it pointed out that the tax treaty did not postulate factual taxation: instead a legal obligation to pay tax on worldwide income was called for, which under Greek law was established. 75. A view is thus indeed possible that, given the context in which the expression 'liable to taxation by reasons of his domicile, residence, place of management or any other criterion of similar nature' is employed i.e. in the context of ascertaining fiscal domicile - as evident from the title of Article as 'Fiscal domicile', it is sufficient that under the assignment or distributive rules of the treaty, the residence state has a right to tax income of the partnership firm - i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ding, as long as de facto entire income of the enterprise or the person is subjected to tax in that tax jurisdiction, whether directly or indirectly, the taxability test must be held to have been satisfied. Of course, the other possible approach to such a situation is that as long as the tax jurisdiction has the right to tax the entire income of the person resident there, whether or not such a right is exercised, the test of fiscal domicile should be satisfied. Viewed thus, all that matters is whether that tax jurisdiction has a right to tax or not; the actual levy of tax by the tax jurisdiction cannot govern whether a person has fiscal domicile in that jurisdiction or not. Having said that, we are alive to the fact that this line of reasoning is diametrically opposed to the stand taken by the OECD in the matter, but, having carefully considered the stand of the OECD on this issue, we are not persuaded by the OECD stand on the matter, nor the Indian judicial precedents support that position. As a matter of fact, even the Government of India's approach to the tax treaties does not entirely approve that school of thought either. 76. While on this issue, it is useful to take note of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s are entitled to the benefits of the tax conventions entered into by their State of residence. They believe that this result is only possible, to a certain extent, if provisions to that effect are included in the convention entered into with the State where the partnership is situated. 78. In this situation, i.e. when the Government of India has rejected the stand taken in the OECD partnership report and the changes made in the OECD Model Convention Commentary as a result of the same, it cannot be open to hold that in the light of the OECD report, the partnership firm must be declined treaty entitlement benefits. The remedy to unintended consequence of a treaty provision in the said report has been rejected, and, therefore, the treatment accorded to the said provision, in the same report, cannot be accepted either. Any other view of the matter will lead to absurd consequences rather than avoiding the absurd consequences. 79. In view of the above discussions, as also bearing in mind the entirety of the case, we hold that the assessee was indeed eligible to the benefits of India UK tax treaty, as long as entire profits of the partnership firm are taxed in UK - whether in the hand ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or infrastructure, no continuity and no stability so as to result in a permanent establishment. Learned senior counsel has also filed extracts from Prof Klaus Vogel's oft quoted treatise 'Klaus Vogel on Double Taxation Conventions', and referred to his observations at page 295 to the effect that "[article 5(2) gives substance to the general permanent establishment concept', that '[w]hat must be particularly examined in each case is whether the place of business satisfies the permanence criterion' and that '[t]he opening sentence of Article 5(2) shows that the list that follows is one of the examples and not exhaustive ('specially')'. Our attention is then invited to paragraph 12 of OECD Model Convention Commentary which, inter alia, observes that, Article 5(2) "contains a list, by no means exhaustive, of examples, each of which can be regarded, prima facie, constituting a permanent establishment" and that "[a]s these examples are to be seen against the background of general definition given in paragraph 1, it is assumed that the contracting states interpret the items listed, 'a place of management', 'a branch', 'an office' etc in such a way that such places constitute permanent est ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anent establishment under Article 5(2) (k) can come into existence only when conditions of Article 5(1) are also to be satisfied, Article 5(2)(k) will be rendered redundant. Under Article 5(2)(k), if services to an associated enterprise are rendered even for 30 days, it will result in existence of the deemed PE. However, Article 5(1) can come into play only when the assessee has a fixed place of business but once assessee has a fixed place of business, it is wholly irrelevant whether or not services are rendered for one day or for all the three hundred and sixty five days. It is thus submitted that in the case of Article 5(2)(k), permanence test of the PE has been substituted by the duration test for services rendered. Once the duration test is satisfied, according to the learned Commissioner, permanence test visualized in Article 5(1) does not come into play at all. We are thus urged to hold that Section 5(2)(k) is to be decided on standalone basis, and that as long as conditions set out in Article 5(2)(k) are satisfied and, irrespective of fulfilment or non fulfilment of conditions under Article 5(1), permanent establishment comes into existence. As regards the connotations of ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hers; (h) a mine, an oil or gas well, quarry or other place of extraction of natural resources; (i) an installation or structure used for the exploration or exploitation of natural resources; (j) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or supervisory activity continues for a period of more than six months, or where such project or supervisory activity, being incidental to the sale of machinery or equipment, continues for a period not exceeding six months and the charges payable for the project or supervisory activity exceed 10 per cent of the sale price of the machinery and equipment; (k) the furnishing of services including managerial services, other than those taxable under Article 13 (Royalties and fees for technical services), within Contracting State by an enterprise through employees or other personnel, but only if: (i) activities of that nature continue within that State for a period or periods aggregating more than 90 days within any twelvemonth period; or (ii) services are performed within that State for an enterprise within the meaning of paragraph ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise; or (b) he habitually maintains in the firstmentioned Contracting State a stock of goods or merchandise from which he regularly delivers goods or merchandise for or on behalf of the enterprise; or (c) he habitually secures orders in the firstmentioned 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. (5) 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, where such persons are acting in the ordinary course of their business. However, if the activities of such an agent are carried out wholly or almost wholly for the enterprise (or for the enterprise and other enterprises which are controlled by it or have a controlling interest in it or are subject to the same common control) he shall not be con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... S Model Conventions. The very fact that these two categories have been segregated in these model conventions also shows that these two categories belong to different genus. To appreciate this point, it may be useful to take a look at the relevant clauses of OECD, UN and US Model Conventions, which are reproduced below: UN Model Convention 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 an enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially: (a) A place of management; (b) A branch; (c) An office; (d) A factory; (e) A workshop; (f) A mine, an oil or gas well, a quarry or any other place of extraction of natural resources. 3. The term "permanent establishment" also encompasses: (a) A building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months; (b) The furnishing of services, including consultancy services, by an enterprise through employees or other p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed. What applies to clause (a) to (i) of this Article does not necessarily also apply to article (j) and (k) of this Article 5. As regards the first category of permanent establishments, i.e. under clause (a) to (i), OECD Model Convention Commentary, which is also adopted by the UN Model Convention Commentary, does state that the second paragraph of model conventions, " it contains a list, by no means exhaustive, of examples, each of which can be regarded, prima facie, constituting a permanent establishment", and that "as these examples are to be seen against the background of general definition given in paragraph 1, it is assumed that the contracting states interpret the items listed, 'a place of management', 'a branch', 'an office' etc in such a way that such places constitute permanent establishment only if they meet the requirement of paragraph 1". Even by the OECD Model Convention Commentaries, however, this theory is not extended to the items in second category i.e. (j) and (k). So far as paragraph 3 of the OECD Model Conventions dealing with these items are concerned, OCED Model Convention Commentary states as follows: " This paragraph provides expressly that a building si ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion extends beyond the scope of permanent establishment under the basic rule. For this reason also, we are unable to accept learned counsel's suggestion that Article 5(2) of India UK tax treaty should only be read as a bunch of illustration of permanent establishments under the basis rule set out in Article 5(1). 94. Learned senior counsel is perhaps quite right to the extent that Article 5(2), as in most standard model conventions, is no more than an illustration or examples of application of permanent establishment under basic rule i.e. under Article 5(1). However, so far as the provisions of India UK tax treaty are concerned, for the detailed reasons set out above, these arguments do not hold good in respect of clause (j) and (k) of Article 5(2), which are on the lines of provisions in Article 5(3) in all most standard model conventions. For this reason, we also reject learned counsel's reliance on the OECD Model Convention Commentary and Prof Klaus Vogel's analysis. His reliance on these commentaries are misplaced as the provisions these commentaries have dealt with are not in pari materia with the tax treaty provisions that we are in seisin of. 95. We may also add that simil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Hon'ble Authority of Advance Ruling that the OECD Commentary is in respect of the provisions which are not in pari materia with the respective tax treaty provisions [the provisions of Article 5(2) of OECD Model Convention, in respect of which commentary was written and as we have seen earlier in this order, are materially distinct from the tax treaty provisions of Article 5(2) which came up for consideration before the AAR and before us], Hon'ble Authority for Advance Ruling reached the same conclusions. On the basis of the line of reasoning adopted by the AAR also, we reject the contention of the assessee. 97. Let us once again take a look at Article 5(2)(k) and further analyze its scope and purpose. It provides that the term 'permanent establishment' shall include specially the furnishing of services including managerial services within Contracting State by an enterprise through employees or other personnel, where such activities are rendered for more than 90 days for any enterprises, or for more than 30 days for an associated enterprise, within any twelve month period. The only exclusion clause envisaged from the services so furnished is when the consideration for such servic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wledge or principles" (www.webster‐dictionary.org /definition/ furnish). The expression 'rendering' and 'furnishing' are somewhat interchangeable in normal course of business, and it will be too pedantic and hyper technical an approach to narrow down the meaning of the expression 'furnishing' to exclude rendering of professional services. A treaty, as we have see in detailed analysis of principles of interpretation of tax treaties earlier in this order, is to be interpreted in good faith on the basis of general expectations of the parties and in accordance with the ordinary meaning given to the treaty in the context and in the light of its objects and purpose. The interpretation canvassed by the learned counsel does not fit into this approach to treaty interpretation. 102. In any event, one cannot interpret a tax treaty, or for that purpose even a tax legislation, with dictionary in one hand and tax treaty in another. As Justice Hand has observed in the context of interpreting tax law, which is even more relevant in the context of interpreting a tax treaty, "it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the diction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s now dealt with under Article 7 as business profits.] Model Tax Convention on Income and on Capital - condensed version 15 July 2005 (OECD Committee on Fiscal Affairs; Indian reprint at page 204) 104. The above analysis shows that professional services are not beyond the scope of Article 5, existence of which is sine qua non for any taxability under Article 7. We agree with this analysis. In this view of the matter, we reject the contention that professional services cannot be covered by the provisions of Article 5(2)(k). 105. Learned counsel has also contended that the professional services can only be taxed under the head Article 15 and in case chargeability under Article 15 fails, that is end of the road. It cannot be open to revenue authorities to tax income from professional services under Article 7. It is contended that Article 15 applies only to individuals. As to the situations in which Article 5 will apply in respect of the professional services and the situations in which Article 15 of the India UK tax treaty, which is in pari materia Article 14 of the UN Model Convention, will apply, we find guidance from the following observations made in the UN Model Conventi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on profit attribution to PEs. He takes us through the text of Article 7(2) of India UK tax treaty and emphasizes that the profits of the PE are deemed to the he profits which "that permanent establishment might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment". It is thus pointed out that the profits attributable to PE are not the actual profits of the PE but hypothetical profits which the PE was expected to make if the PE was wholly independent of the general enterprise of which it is PE. According to the learned counsel, this exercise of computing hypothetical profits also warrants adjustments in the bills raised by the GE, in respect of the work carried out by the PE, as the prevalent market prices of similar services as were rendered by the PE were lower than the rates charged by the GE to its clients. It is thus contended that for the purpose of computing income of the PE, the value of services rendered by the PE is to taken at the market value of such services in India and not the price at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndia, it will clearly present a highly distorted, and somewhat absurd, figure of income. We are urged to avoid this patent absurdity of results, and hold that the actual billing figures are taken in computation of income of the assessee's PE in India. 110. In rejoinder, learned counsel for the assessee once again invited our attention to the wordings of Section 7(2) and reiterated his submissions. It was submitted that there will not be absurdity of results, and, on the contrary, such adjustments carried out to the revenue figures will lead to true hypothetical profits being brought to tax, as indeed visualized by the scheme of things envisaged in Article 7(2) of the India UK tax treaty. Learned counsel urges us to respect and give a sensible meaning to the scheme of taxability of PE profits under Article 7(2) of the India UK tax treaty. He also points out that there is no other way, except by carrying out the adjustments that the assessee has claimed, in which clear words of Article 7 (2) can be given effect. One cannot proceed in a manner , contends the learned counsel, so as to ignore the words "profits which it might be expected to make if it were a distinct and independent en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment". Explaining the import of this provision, OECD Model Convention Commentary states as follows: This paragraph contains the central directive on which the allocation of profits to the permanent establishment is based. The paragraph incorporates the view, which is generally contained in bilateral conventions, that the profits to be attributed to a permanent establishment are those which the permanent establishment would have made if, instead of dealing with the head office, it had been dealing with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market…………………The arm's length principle also extends to the allocation of profits which the permanent establishment may derive from transactions with other permanent establishments of the enterprise…… 114. We are in considered agreement with the above analysis. In our considered view, the fiction of hypothetical independence indeed provides mechanism for taking into account intra organization transactions whether these are GE‐PE transactions or PE‐PE transactions, and it also extends, in whatever limited way, to ensuri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... illed by PE in B jurisdiction is Rs 0.5 million, and its other costs in connection with coordination and sales and marketing billed from X jurisdiction work out to Rs 0.1 million per unit. In case the average sale price per unit of diamond is Rs 2 million, in this situation, the overall profits of enterprises will be Rs 4,00,000 per unit. To this extent, there cannot be any disputes. However, so as taxation in C jurisdiction is concerned, it will depend on whether or not the intra organization transactions are recognized for tax purposes, and, if so, at what price. In case, C jurisdiction holds that the payment of processing charges that the C PE has made to another PE, i.e. in B jurisdiction, cannot be allowed as a deduction, as it is a payment from one arm of the business to another arm of the same business ( i.e. from self to self), the taxable profits in C will go up by that extent. In case, tax authorities also decide that, in any case, deduction cannot be allowed in respect of centralized coordination, sales and marketing, because these payments are only payments by self to self, the profit in C jurisdiction end up being only the difference between sales price and cost of raw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ration that we can taken a little earlier, let us assume that instead of billing the PE in C tax jurisdiction for processing of diamond @ Rs 0.5 million per unit, which is fair market value of this processing in B jurisdiction, the PE in B jurisdiction raises bills of processing charges @ Rs 0.9 million per unit, entire profits of C jurisdiction will shift from C jurisdiction to B jurisdiction. In this case, while sum of taxable profits in different tax jurisdictions will not exceed overall profits of the enterprise, the allocation of such profits will be distorted. It is in this way, that the adjustments for arms length price under the scheme of Article 7(2) seeks to prevent such distortions in allocation of taxable profits in various tax jurisdictions involved in a business activity involving several tax jurisdiction. 120. As noted by Raffaele Russo, in his article 'Application of Arms length Principle to Intra Company Dealings : Back to Origins (2005 ITPJ 7; published by IBFD, Amsterdam), the genesis of arm's length as an international agreed principle goes back to 1933, when the Fiscal Affairs Committee of the League of Nations approved a "Draft Convention on the Allocation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d Ralph C Jones. In their studies, Carroll and Jones unanimously concluded that permanent establishment of international enterprises should, as far as possible, be treated independent units and, consequently, goods supplied by the a permanent establishment to its head office and vice versa should be taken to have been charged at the market prices. 124. It is thus clear that the fiction of hypothetical independence is confined to a permanent establishment's transactions with its general enterprises, i.e. enterprises of which it is permanent establishment, other permanent establishments belonging to the same GE and other specified associated enterprises. In our considered view, this fictional independence under Article 7(2) does not travel beyond the transactions with entities other than the GE, and the PEs belonging to the same GE. 125. The fiction of hypothetical independence, as set out in Article 7(2), has no role to play in adjusting actual revenues with independent entities. As is clearly set out in that treaty provision itself, it refers for transactions at arm's length only "with the enterprise of which it is permanent establishment" and the scope of enterprise in this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een entered into with the GE because these dealings involve a role for such GE as well. 128. Even with respect to the transactions covered by the fiction of Article 7(2), which, we must emphasize are only intra organization or intra associated enterprises transactions, the issue does arises as to what degree this fictional independence can be stretched. It could possibly be argued that the intra organization transactions should be valued at the prevailing market price in ideal conditions, while it is also a recognized approach to the issue that the fiction of hypothetical independence merely permits taking into account the intra organization transactions, at the normal transaction value, which was otherwise impermissible under the law of contracts. Prof Klaus Vogel describes the former approach as of 'absolute hypothetical independence' and the latter approach as of 'restricted independence'. There is a school of thought, which is recognized by Prof Vogel and which has also found favour with several European judicial authorities‐ as mentioned by Prof Vogel in his book 'Klaus Vogel on Double Taxation Conventions', that the connotations of hypothetical independence are confin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e eight. There are several good reasons for adopting this linear approach to allocation of residual profits because, if nothing else, in today's interdependent world, PEs are to be seen as an integral and essential part of the businesses as a whole, and, not as mere colonies or support systems of the GE. On a balancing note, however, as long as FAR (function, assets and risk) analysis is possible in each of the tax jurisdiction involved, neither there is a need to resort to rather colonial octopus approach, nor is there any need of banking upon a somewhat over simplistic linear approach. In such a situation, profit allocation can be on a more rational and justified basis of FAR analysis of establishment or activity in each tax jurisdiction. Therefore, even when it is a GE PE transaction, the residual profit cannot always be allocated straight away to the general enterprise, as a simplistic revaluation of transaction values on the basis of market prices will inherently involve, and the allocation of profits over GE and PEs have to be on an equitable and rationale basis. Be that as it may, it is not really necessary to go any deeper into this aspect of the matter, in view of our cate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tisfied by the part relief given by the CIT(A) and is in second appeal before us. 132. Learned counsel has taken us through meticulous documentation in respect of reimbursements of expenses, and also produced before us samples of supporting evidences in respect of each claim of reimbursement of expenses. He has also extensively referred to the prevailing regulation in the United Kingdom which ensure strict control over possible inflation of such reimbursement claims, as also to the internal control mechanism in respect of these claims. He submits that all requisitions of the authorities below, in respect of supporting evidences for such claims, have been duly complied with, and the CIT(A) has confirmed the partial disallowance only on surmises and conjectures. He urges us to delete the disallowance confirmed by the CIT(A) and hold that the reimbursements of expenses received by the assessee, particularly on the facts of the case, cannot be treated as income in the hands of the assessee. Learned Departmental Representative, on the other hand, relies upon the orders of the authorities below and submits that the onus is on the assessee to produce all the evidences of expenditure and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A) and decline to interfere on the matter on this count as well. Ground No. 1 of the Assessing Officer is thus rejected. Application of force of attraction principle in computation of profits attributable to the PE. 139. The only other grievance raised in Assessing Officer's appeal is that the CIT(A) erred in holding the assessee was taxable in respect of only that portion of income that was related to services performed in India, and did not appreciate the scope of "force of attraction" principle embedded in Article 7 (1) of the India‐UK tax treaty. 140. As we have seen earlier in this order, the impugned relief given by the CIT(A) was for three reasons reasons - first, the twin factors that the "income earned by the appellant were not in the nature of fees for technical services as defined in section 9(1)(vii) and therefore the AAR Ruling in the case of Steffen, Roberstson & Kirsten Consulting Engineers (supra) will not apply to the facts of the appellant" and that " as per Explanation (a) to Section 9(1)(i), even if there is a business connection in India, only income related to operations carried out in India is taxable in India"; ‐ second, that "in the case of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ord Chance Vs DCIT (supra), and, for the detailed reasons set out earlier in this order in paragraphs 14 to 19 and in view of the legal position as it stands now, Hon'ble Bombay High Court's judgment in Clifford Chance case (supra) does not hold good in law 144. As far as learned CIT(A)'s reliance on Article 7(1) of the India UK tax treaty is concerned, in support of the proposition that only such profits as attributable to the operations carried out in the PE are taxable in India, this is simply contrary to the plain provisions of the India UK tax treaty. Article 7, as we have seen earlier in this order, provides that if the enterprise carries on business through a PE, the profits of the enterprise may be taxed in the other State but only so much of them as is "directly or indirectly attributable to that permanent establishment". 145. Learned CIT(A) has apparently taken note of the profits in respect of the work performed in the PE itself but he has not taken note of the position that it is only in respect of the profits directly attributable to work done in the PE but it is in respect of profits "directly" or even "indirectly" attributable to the permanent establishment. The i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from the UN Model Convention Commentary in this regard. On this issue, the UN Model Convention Commentary states, inter alia, as follows ………………Some members from developed countries pointed out that the "force of attraction" rule had been found unsatisfactory and abandoned in recent tax treaties concluded by them because of the undesirability of taxing income from an activity that was totally unrelated to the establishment and that was in itself not extensive enough to constitute a permanent establishment. They also stressed the uncertainty that such an approach would create for taxpayers. Members from developing countries pointed out that the proposed "force of attraction" approach did remove some administrative problems in that it made it unnecessary to determine whether particular activities were or were not related to the permanent establishment or the income involved attributable to it. That was the case especially with respect to transactions conducted directly by the home office within the country, but similar in nature to those conducted by the permanent establishment. However, after discussion, it was proposed that the "force of ..... X X X X Extracts X X X X X X X X Extracts X X X X
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