INTERWOVEN INC. INDIA BRANCH,MUMBAI vs. ADIT (IT) 3(1), MUMBAI

But, during the course assessment proceedings, the AO did not accept the return of income filed by the assessee and recomputed the income by treating the branch office as PE of the assessee. It was held by the AO that gross revenue from sale of software directly in India

Being aggrieved, the assessee filed appeal before CIT(A) and made detailed submissions to challenge the assessment order on various fronts. The Ld. CIT(A) allowed part relief by accepting some of the grounds and rejecting the remaining. The Ld. CIT(A) upheld the action of the AO in treating the branch office as PE and also confirmed the action of AO in holding that if fee for software maintenance of Rs.52,92,089 received by the assessee during the year constituted fee for included services (FIS) in terms of Article 12 of DTAA and also confirmed the addition of Rs.1,14,00,547 which was offered by the assessee also in its return as FIS in terms of Article 12 of DTAA. Further, Ld. CIT(A) did not accept assessee’s submission that there was no necessity for further attribution of income to the Indian branch office since the Indian branch office had already been compensated at arm’s length price. However, Ld. CIT(A) accepted the claim of the assessee and held that sale of shrink wrap software did not involve receipt of consideration which could be said to be ‘royalty’. As a result of order of Ld. CIT(A), both the parties filed appeal before the Tribunal to challenge the respective part of the order of Ld.CIT(A) against which they were aggrieved.

During the course of hearing before us, the foremost ground taken by the Ld. Counsel of the assessee was with regard to the action of the

We have gone through the orders passed by the lower authorities as well as submissions made by both the sides before us. Since the issue of determination of PE goes to the root of the matter and all the issues are dependent upon it, we find it appropriate to deal with this issue first. It is noted that perusal of the order of AO reveals that from pages 32 to 40, the AO discussed at length the provisions of Article 5, few judgments, extracts from commentary on international taxation and ample law for deciding the issue of PE, but whether on facts in the case before us the Indian branch office constituted a PE of the assessee company, has not been discussed at all and nothing could be made out from the perusal of the assessment order as to how the Indian branch office constituted PE of the assessee company. Perusal of order of Ld. CIT(A) reveals that he has substantially reproduced or reiterated academic observations of the AO and though he has given few observations briefly on factual aspects, but these observations lack precision. Relevant part of observations of Ld. CIT(A) are reproduced hereunder for ready reference:

During the course of hearing before us, it was submitted by the Ld. Counsel that brief observations given on facts by the Ld. CIT(A) are either based upon mis- appreciation of facts or presumptions and in some cases, these are contradictory to the real facts and thus various submissions made by the assessee in detail before the Ld.CIT(A) have not been met by him before upholding the action of the AO. Ld. Counsel of the assessee explained before us the entire role and function of the Indian branch office. It was submitted that the Indian branch office was engaged in the provision of sales and marketing support services to Interwoven Inc., US, the Head Office (HQ), being:

It was also submitted that as part of the services, the BO was to only support the solicitation efforts of the HO. The BO was not to have any authority to conclude contracts in the name of the HO. All orders received by the BO were forwarded to HO immediately upon receipt by the BO. All such orders were subject to acceptance or rejection by the HO for any reason whatsoever at HO’s sole discretion. The BO was also not permitted to make any representations or warranties without prior written approval of the HO. The BO could also be required to maintain a stock only for demonstration purposes. The HO would directly ship products to customers, with support from the BO where required. It was reiterated that all contracts relating to software licenses and services were concluded by the HO directly with the customers and none of the sales were routed / concluded through / by the BO. The consideration for the software and services were received outside India and none of those receipts were reflected in the bank account of the BO.

Further, during the FY 2005-06 relevant to the A.Y. 2006- 07, the BO had three employees. With a view to demonstrate the limited activity profile of the BO, appointment letters 8 & 8755/Mum/2011 issued to the employees of the BO were also filed by Ld Counsel before us. The BO derived cost-plus 10% remuneration for the marketing support services. The arm’s length nature of the said remuneration was established through a transfer pricing benchmarking study undertaken by the BO.

The Ld. Counsel heavily relied upon the recent judgment of the Mumbai Bench of the Tribunal in the case of Variant India Pvt. Ltd vs ADIT (33 Taxman.com 249 dated 27- 02-2013) wherein various yardsticks were proposed for deciding the issue as to under what circumstances a branch office would constitute a PE in India of a foreign enterprise. In the said decision, the facts were that VIPL was a company incorporated in the US and it had a branch office (called as VIPL-BO) in India. VIPL-BO was engaged as indenting agent of foreign products. Following features were noted by the bench in the said case:- i. VIPL BO is not a party to any legal contract with the customer; ii. VIPL BO does not take title or own or have risk of loss to the product, at any point of time; iii. VIPL BO does not invoice the customer; iv. VIPL BO does not receive funds from customers (the payments are being made by the Indian customers directly to Varian Group of Companies); v. VIPL BO does not remit funds to the Varian Group of Companies on behalf of the customers; vi. The title of goods passes directly from the Varian Group of Companies to the customer; vii. All other functions like unloading of shipment,

After analyzing the aforesaid features of the activities and functioning of branch office of VIPL it was held by the bench that the aforesaid activity profile shall not constitute the Indian branch office as dependent agent PE in India. It was also observed that the orders relating to Indian sale were only introduced and co-ordinated by the branch office and were not secured by it, and these orders were not binding on the principal companies, only these were accepted by them. The branch office had no authority to accept orders on behalf of any of the foreign group companies. During the course of hearing, it was strongly contended by the Ld. Counsel that the facts involved in the case before us are identical. With a view to draw parity between the facts of the said case and the facts of the case before us, the following factual analysis was made before us by the Ld. Counsel:- 15. It was submitted that the Indian branch office of the assessee company was engaged in marketing, promoting and assisting and delivery of products of the assessee company in India and extending its sales and marketing programmes and components in India. Following features in the activity profile of the assessee company and its branch office were brought to our notice:- “i. BO is not a party to any legal contract with the customer; the Head Officer enters into such 10 & 8755/Mum/2011 contracts; ii. BO does not take title or own or have risk of loss as to the software products, at any point of time; iii. HO, and not BO, invoices the customer; iv. BO does not receive funds from customers (the payments are being made by the Indian customers directly to the bank account of Interwoven, US); v. BO does not remit funds to the HO on behalf of the customers; vi. The right to use the license in the software passes directly from the HO to the customers; vii. Credit terms in relation to the issue of the shrink wrap license are at the discretion of the HO and the BO is not involved in this function. viii. HO provides the software license directly to the customer.

In addition to the above, the Ld. Counsel of the assessee took us through few pages of the paper book to support his arguments and also relied upon various judgments for supporting his stand that Indian branch office did not constitute assessee’s PE in India. It was also brought to our notice that the branch suspended its operations from 01-01-2007.

It was submitted that in view of the aforesaid facts, the well settled legal principles were not correctly applied. It was submitted that as per Article 5(1) of the US DTAA, where the activity test is not satisfied, irrespective of the nature of the establishment, a fixed place cannot constitute a PE. Article 5(1) defines a PE to mean a fixed place of business

Further, our attention was drawn upon paragraph 2 to the Commentary on Article 5 of the OECD Model Tax Convention to argue that even where a fixed place of business satisfies the activity test, but if the activities of the BO are of a preparatory or auxiliary character, then it would not constitute PE. In this regard, reliance was placed on the judgment of Hon’ble Delhi High Court in U.A.E. Exchange Centre Ltd. v. Union of India (313 ITR 94). Similar principles were applied by the Supreme Court in the case of DIT v. Morgan Stanley (292 ITR 416), by the Authority for Advance Rulings in KT Corporation (181 Taxman 94) and by the Mumbai ITAT in Dy. DIT v. Staubli A.G. India Branch Office (40 SOT 14).

It was submitted that the assessee does not have a PE in India under the Agency PE of the assessee in India since mere provision of marketing services or making fee collection from customers and forwarding would not result in concluding contracts or securing orders nor assistance in sale of products in India without any authority to negotiate terms

It was emphasized that the BO was engaged in pre-sales marketing support services, and these activities cannot be regarded as concluding contracts or securing orders for or on behalf of the HO. Reliance was placed on principles emerging from the judgments of M/s eBay International AG v. Asst. DIT (25 taxrnann.com 500); Lubrizol Corporation USA v. Asst. DIT (33 taxmann.com 424); and DDIT v. Daimler Chrysler A.G. (133 TTJ 766).

It was further submitted that the Ld. CIT(A) wrongly inferred the activities as were mentioned in the agreement. He submitted before us a brief analysis showing contradictions / mistakes as were done in the conclusion by the Ld.CIT(A) as against the factual position, which are reproduced as under:-

Per contra, the Ld. CIT-DR strongly supported the order of CIT(A) as well as AO. But he was neither able to accept these analysis nor was he in a position to point out anything wrong in the factual analysis submitted by the Ld. Counsel. It was fairly accepted by him that lower authorities have not actually appreciated this aspect in detailed manner.

We have gone through the entire spectrum of the facts made available before us. It is noted by us that there are 14 & 8755/Mum/2011 apparent contradictions in the facts narrated by the Ld. Counsel before us and as has been noted by Ld. CIT(A) to arrive at the conclusions drawn by him. On the one hand, the Ld. CIT(A) is saying that while branch office will maintain stock, but the assessee states that the branch office was required to maintain stock of goods only for demonstration purposes and was not permitted to make any commitments on behalf of head office. Similarly, there are various other contradictions which have been tabulated in earlier part of our order. In addition to that various features as have been brought out before us, the activity profile of the branch office has not been examined by either of the lower authorities. As has been observed by us in earlier part of our order that the AO has not done any factual analysis at all and the Ld. CIT(A) has done a brief factual analysis but that was full of mistakes or lacks clarity and precision. Under these circumstances, it is difficult at this stage to apply the correct legal principles on the real facts. Therefore, we find it appropriate to send this issue back to the file of the AO who shall take into account all the facts and circumstances of the case and pleadings and documentary evidences as has been made before us and that may be made by the assessee before the AO in support of its claim. The AO shall give adequate opportunity of hearing to the assessee for furnishing all detailed submissions and requisite documentary evidences and these shall be taken into account before deciding this issue afresh. The AO shall accordingly

Grounds 3 to 5: These grounds are dependent upon the first ground, i.e. determination of PE. The assessee shall be at its liberty to furnish submissions and requisite evidences depending upon the outcome of the first ground and shall be decided accordingly by the AO. These grounds are also sent back to the file of the AO to be decided after giving adequate opportunity of hearing to the assessee. These grounds may be treated as allowed for statistical purposes.

In Revenue’s appeal in the only ground taken by the Revenue is with regard to the action of the Ld.CIT(A) in holding that sale of shrink wrap software did not involve receipt of consideration which could be said to be ‘royalty’. The Revenue has contended that Ld. CIT(A) has erred in taking this decision as the Indian branch office acted as PE in India of the assessee company. Thus, this ground is dependent upon the outcome of the issue of determination of PE. The issue of PE has been restored to the file of AO for deciding it afresh. Since the issue in Revenue’s appeal is dependent upon the issue of PE which has been restored to the file of AO, this ground is also restored to the file of the 16 & 8755/Mum/2011 AO. The AO shall first decide the issue of PE which has a bearing on the ground raised by the Revenue in its appeal and then decide the issues under appeal. The AO shall also take into consideration various judgments as may be relied upon by the assessee.

Now we shall take assessee’s appeal in for A.Y. 2008-09. It is noted that all the grounds raised in this appeal are identical to the grounds raised in A.Y. 2006-07. Since the grounds for A.Y. 2006-07 have been sent back to the file of the AO, we find it appropriate to send the grounds raised in this appeal also to the file of the AO with similar directions. All the grounds raised in this appeal shall be decided by the AO after providing adequate opportunity of hearing to the assessee. The grounds raised in this appeal, are therefore, treated as allowed, for statistical purposes.