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Income Tax Appellate Tribunal, H BENCH NEW DELHI
Before: SHRI I.C.SUDHIR & SHRI PRASHANT MAHARISHI
PER PRASHANT MAHARISHI, A. M. 1. These cross appeals are filed against the order of the learned Commissioner of Income-tax (Appeals)-XXIX, Delhi dated 28.03.2013 for the Assessment Year 2004-05. 2. The brief facts of the case is that the assessee company is incorporated in United Kingdom and is a non-resident engaged in outsourcing sales for its clients in finance, utility and public sector. The main service provided by the appellant is customer management outsourcing business, service outsourcing and transfer of technology. Vertex Customer Service India Pvt. Ltd is an Indian entity in the group which is also carrying on outsourced work from the assessee. This outsource work is in relation to contracts of the assesse with PowerGen Retial Ltd. and Last Minute Networks Ltd. The total revenue earned by Vertex India to the assessee was Pound 4735037. Over the above this sum of pound 60528/- was retained by the assessee as cost incurred by the assessee in United Kingdom and recovered from the customers. The balance amount is remitted to Vertex India. The assessee allowed Vertex India right to use certain equipment located outside India and claimed reimbursement of expenses incurred by the assessee on behalf of the Vertex India. 3. The assessee filed its return of income on 29.10.2004 and offered the sum received from Vertex India for right to use equipment outside India as royalty in accordance with Article 13.3 (b) of Indo UK DTAA. Regarding the reimbursement it was claimed that same is non- taxable as it was on cost to cost basis. The ld AO held that the assessee has PE in India and according to DTAA and business connection according to India Income Tax Act and hence computed the profit of Rs.30626180/- attributable to such PE. Regarding reimbursement of Rs.52452014/- as it has effect of reducing the service fee payable to the Indian Company was also considered as business profits of PE in India. Further royalty was also taxed as business profit of the PE in India. The assessee being aggrieved with this carried the order before the ld CIT(A) who in turn held as under:- i. Appellant has fixed place PE in India in terms of article 5(1) of the INDO UK DTAA. ii. Appellant does not have a service PE in terms of article 5(2)(k) of Indo UK DTAA iii. Vertex India did not constitute dependent agent PE in India as per DTAA. iv. Appellant does not have a sales outlet under Article 5(2)(f) of DTAA. v. Assessee has a business connection within the meaning of section 9(1)(i) of the Income Tax Act.
Page 24 of 24 vi. No further profits cannot be attributed to the appellant PE in India and hence profits attributable to such PE are NIL. vii. Royalty income already declared by the appellant in its return of income cannot be taxed as business income. Regarding reimbursement of expenses on account of 3rd party cost of viii. Rs.27940955/- is not chargeable to tax in India as it is directly relatable to Vertex India demonstrated by submission of documentary evidence. ix. A sum of Rs.24511059/- being cost that has been allotted to Vertex India is taken up said with certainity with this amount was on cost to cost basis or not and hence same is chargeable to tax in India as business profits of PE and has royalty not as business profits. x. It was also held that interest u/s 234B of the Act cannot be charged.
4. Against the above finding revenue is in appeal raising three effective grounds:- 1) On the facts and in the circumstances of the case, the Ld. CIT(A) has erred in holding that though the assessee is having a P.E, in India but is not having any Service PE and dependant Agent PE in the form of M/s Vertex India thereby ignoring the findings of the A.O in the case that there is continuous relationship between the assessee and M/s Vertex Customers is concluded in India, 2) On the facts and in the circumstances of the case, the Ld, CIT(A) has erred in holding that no further profits can be attributed after the transfer and pricing analysis as it had already covered analysis of functions, assets and risks in the hands of the assessee's PE. 3) On the facts and in the circumstances of the case, the Ltd. CIT(A) has erred in not appreciating of the facts that attribution of profit is about determining income element of the assessee out of taxable transaction between the assessee (nonresident) and Indian Parties as well as Associated Enterprises in India.
5. The assesse is also in appeal raising three effective grounds:-
1. 1. That on the facts and circumstance of the case and in law, the Commissioner of Income Tax (Appeals) - XXIX, New Delhi ['Ld. CIT(A)'] erred in upholding the order of the assessing officer ('Ld. AO') that the Appellant has a business connection in India under section 9(1) (i) of the Act.
2. That on the facts and circumstance of the case and in law, the CIT(A) erred in upholding the order of Id. AO that the Appellant has a fixed Permanent Page 24 of 24 Establishment ('PE') in India under Article 5(1) of the Double Taxation Avoidance Agreement between India and United Kingdom ('DTAA' or 'treaty‟).
3. That on the facts and circumstance of the case and in law, the CIT(A) erred in holding that the payments in respect of access circuits, networks, bandwidth, call charges etc aggregating to Rs.2,45,11,059 (GBP306,076) is taxable as Royalty under Article 13-3(b) of the India UK DTAA. 3.1 Without prejudice to the above, that on facts and circumstances of the case and in law, the CIT(A) erred in holding that the reimbursement of expenses aggregating to Rs. 2,45,11,059 (GBP 306,076) was taxable in India despite there was no income element.
6. Before us the LD AR of the appellant submitted as under :- a) It was submitted that vide service agreement dated 7 C holdings Limited UK and Seven C Customers Services India Private Limited , India where the subject matter of contract is mentioned. Indian Company was providing the services as per this agreement. 7C holdings Limited and vertex India entered in to a framework Agreement on 1-6-2012 and on 2/12/2002 the Framework agreement was novated by 7 C holdings Limited to vertex. 7 C holdings Limited were acquired by vertex UK and therefore there is novation of agreement. Vertex Customers Services India was formerly 7 C Customer Services India private limited. Vertex India Limited is a joint venture between vertex UK and GE capital Equity. Therefore there is an agreement in place of the work to be carried out in India. Hence allegation that the work was performed without there being an agreement is incorrect. He submitted that at page no 24 and 25 of the paper book which are the agreement with Power gen Limited with 7 C customer services Limited India. He also drawn the attention at page no 36 of the paper book of the agreement where in the contracts of power gen were with 7 C customer services India limited and for sub contracting only the prior written consent of the of Powergen is required so it was not mandatory that work should be performed by Indian Subsidiary only he also explained that services to be provided are classified at page no 42 of the paper book C customers Services India Limited to powergen and now being provided by vertex India. He also took us to page no 106-107 , 164 and 166 of the paper book to demonstrate that there was an agreement in place, and the Indian entity is independent entity and therefore cannot be a permanent Establishment of the assessee. He also referred to the clause of Novataion at page no 195 of the agreement. Therefore it was submitted that there Page 24 of 24 is no Service PE and there in Dependent Agent PE of the assessee in India. On fixed PE he relied on the decision of Honorable supreme court of India in case of Morgan Stanley and honourable Delhi high court in case of E Funds. He referred to various para of these judgments extensively. He submitted that CIT (A) has wrongly decided that assessee has a fixed place PE in India. b) On profit attribution he submitted that when the transaction is at arm‟s length no further profit can be attributed to the PE. He also submitted that for AY 2006-07 the TPO in his order has accepted the transaction and has not given any adverse comments and therefore there cannot be any profit attribution. c) On ground no 3 of the appeal regarding he relied on the decision of 14 SOT 20 ( Del) and submitted that there is no element in reimbursement of expenses and hence it cannot be charged to tax. d) Regarding reimbursements he submitted that it is actual cost which has been reimbursed based on cost recovery charges mechanism and company has not added mark up to these and therefore this just like a pass through cost and therefore there is no income in that. Regarding call charges it was submitted that there are the call charges incurred by the assessee o for powergen and last minute which have been incurred by the assessee and same are recharged to vertex India on actual basis. He also referred to a declaration furnished to the CIT for this. Therefore it was submitted that it is not Royalty as per article 13.3 (b) of Indo UK DTAA.
7. LD DR submitted that AO has rightly taxed the income of the assessee holding that assessee has Fixed place PE , services PE and DAPE and therefore income is attributed correctly. He vehemently supported the orders of AO and CIT (A) . Regarding business connection he submitted that Para no 8 of CIT (A) and the decision of Honorable Jurisdictional high court in case of UAE exchange center has been relied and therefore there is a business connection in India of the assessee.
8. In rejoinder LD AR submitted that regarding service PE LD AO himself has accepted in Remand report. Regarding DAPE he submitted that power and control test is not satisfied therefore there is no DAPE. Regarding attribution he argued that CIT (A) has correctly held that when the transaction with AE are at arms‟ length there cannot be further attribution of profit. He submitted that in next year AO has accepted the working of the assessee and for this he submitted that for AY 2006-01017 the issue of assessee has been accepted by the TPO and consequently assessment has been framed at Nil Income. Therefore AO has accepted the contention of assessee in subsequent years.
Page 24 of 24 9. We have carefully perused the relevant rival contentions and also the decisions of Honorable courts placed before us. Brief facts have already been enunciated. Now following questions arise in this appeal for our determination which takes care of all the grounds of both the appeals. a) Whether assesse has a business connection in India? b) Whether assesse has a Fixed PE In India? c) Whether assesse has a service PE In India/ d) Whether assesse has a dependent agent PE is India? e) Whether any further profit can be attributed to PE after transaction is determined at Arms‟ length. f) Whether the Reimbursement of Rs Rs.2,45,11,059 (GBP 306,076) is Royalty as per Indo UK DTAA and is chargeable to tax despite there being no income element.
Whether assessee has „ Business Connection “ in India? As per section 9(1)(i) of the Income tax Act any income earned, whether directly or indirectly, through or from any business connection in India, would be deemed to accrue or arise in India and hence would be taxable in India. However the term "Business Connection has not been defined in the Income tax Act.Thus rightly so, the Bombay High Court in Blue Star Engg. Co. (Bom) (P) Ltd v CIT [1969] 73 ITR 283 (Bom) following the principle laid down by honorable Supreme court in CIT v R D Aggarwal & Co. [1965] 56 ITR 20, 24 (SC) has stated that since the term Business Connection admits of no precise definition, the solution of the question must depend upon the particular facts of each case. Further, various honorable High Courts in Bangalore Woollen Cotton & Silk Mills Co. Ltd V CIT [1950] 18 ITR 423 (Mad); CIT v Evans Medical Supplies Ltd. [1959] 36 ITR 418 (Bom) and Jethabhai Javeribhai v CIT [1951] 20 ITR 331 (Nag) have also held that there is no definition of the words „business Connection‟ and the legislature has deliberately chosen words of wide import. Further, there is no determinative form, in which a business connection exists. As has been held by the honorable Supreme Court in a landmark case of CIT v R D Aggarwal & Co [1965] 56 ITR 20 that "a business connection may take several forms:- it may include carrying on a part of the main business or activity incidental to the main business of the non-resident through an agent, or it may merely be a relation between the business of the non-resident and the activity in India, which facilitates or assists the carrying on of that business. Honorable Bombay High Court in CIT v National Mutual Life Association of Australia [1933] I ITR 350 held that all that is necessary for a Business Connection to exist is that there should be: (i) a business in India; Page 24 of 24 (ii) a connection between non-resident person or company and that 'business'; and (iii) Non-resident person or company has earned an income through such connection. There are various factors, which need to be looked in to while determining whether a business connection exists in a particular situation, or not. The landmark judgment of the Honorable Andhra Pradesh High Court In G V K Industries Ltd v ITO [1997] 228 ITR 564 compiles the ratios of various other judgments and lays down the following principles of Business connection :- i. Whether there is a Business connection between an Indian person and a non- resident is a mixed question of fact and law which has to be determined on the facts and circumstances of each case; ii. The expression 'Business connection is too wide to admit of any precise definition; however it has some well known attributes; iii. The essence of 'Business connection ' is the existence of close, real, intimate relationship and commonness of interest between the non-resident and the Indian person; iv. Where there is control or management or finances or substantial holding of equity shares or sharing of profits by the non-resident of the Indian person, the requirement of principle (iii) is fulfilled; v. To constitute 'Business Connection ' there must be continuity of activity or operation of the non- resident with the Indian party and a stray or isolated transaction is not enough to establish a Business Connection. On reading of various decisions it requires to test the Business connection Principle with respect to Continuity, real and intimate connection, Attribution of income and Common Control and professional connection. The connection of the assesse with the Indian entity is continuous in order to have a business connection; there must be a real and intimate connection between the activity carried on by the non-resident outside India and the activity carried out in India. Further, such activity must be one, which contributes to the earnings of profits by the non-resident in his business. It is also a settled principle that to conform with the requirements of the expression "Business Connection" it is necessary that a common thread of mutual interest must run through the fabric of the trading activity carried on outside and inside India and the same can be described as real and intimate connection. The commonness of interest may be by way of management control or financial control or by way of sharing of profits. It may come into existence in some other manner but there must Page 24 of 24 be something more than mere transaction of purchase and sale between „principal to principal‟ in orders to bring the transaction within the purview of business connection. Further Where the Indian entity and the non-resident entity are both held by the same person, or have common control, then the non-resident would be regarded as having a business connection in India. In this case assessee company secures orders on behalf of the Indian company and outsources the job to Indian company. There is a continuous relationship between the assessee company and its affiliates and subsidiary company in India. The contract entered by the assessee company and its affiliates outside India are carried out in India. The responsibility of the assessee company vis a vis its customer is concluded in India. The responsibility of the assessee company cannot be segregated and will not complete unless the Indian company provides services to the customers. Based on these facts Ld CIT (A) has held that appellant has continuous revenue generating business activities with Vertex India and there is real and intimate relationship between activities of non-resident outside India and those inside India. In view of this we are of the view that the assesse has a business connection in India u/s 9 (1) (i) of the Act.On this score we confirm the order of CIT (A).
Whether the assesse has a Fixed Place PE In India? Regarding Fixed place Permanent establishment of the assessee CIT (A) has dealt with this issue as under:- “8.2 Fixed Place PE - 8.2.1 The appellant's main contention is that it has no physical presence in India and therefore there cannot be fixed place PE under Article 5(1) of DTAA. However, the Ld. AO has held that Vertex India is at the disposal of appellant and his reasoning is summarized here: The contracts between Vertex India and the Appellant were entered retrospectively; One of the contracts entered between the Appellant and its customer Powergen in UK in May 2001 specifically mentioned that the services will be provided from India; whereas the actual sub-contracting agreement between Appellant and the Indian Company (Vertex India) was entered in June 2002, which is subsequent to the contract entered with Powergen. 8.2.2 The provisions contained in Article 5(1) of Indo-UK treaty are reproduced as below; Page 24 of 24 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.
The requirement of above mentioned article is that there should be a fixed place of business through which business is carried on wholly or partly. It is a settled proposition that the fixed place may not belong to the non-resident appellant. It will be suffice if the fixed place is at disposal of the non-resident for carrying out its business wholly or partly through it. In present case, the appellant had entered into service contract with Powergen and Lastminute, its overseas customers. As per clause 20.2 of contract dated 10.05.2002 with Powergen, the appellant could sub-contract whole or part of the services only to its subsidiary in India. Accordingly, these contracts were sub-contracted to a subsidiary namely Vertex India. It is important to note that Vertex India started providing services in accordance with contract of the appellant with its overseas customers much before when services were sub-contracted to it retrospectively. It can be inferred that appellant and its overseas customers were in agreement that services shall be provided to overseas customers from subsidiary company based in India. Now, Vertex India is not doing anything else other than providing services to overseas customers of the appellant. The appellant is practically not doing anything with reference to its contracts with its overseas customers except that according to clause 20.2(ii) of the agreement dated 10.05.2002, it shall be responsible for acts, omissions, defaults or negligence of its sub-contractor. It means that the appellant assumes all the major risks whereas Vertex India is virtually a risk free enterprise. Therefore, in substance, the subsidiary Vertex India is operating as if it were a branch of the nonresident appellant. Vertex India is virtual projection of the appellant in India inspite of its having an independent legal status. In view of the above, it can be said that the premises of Vertex India were at the disposal of VCM. The business of the appellant is being carried on almost wholly through fixed place in India represented by Vertex India. In view of these facts, I am in agreement with the findings of the Ld. AO that the appellant has a fixed place PE in India within meaning of Article 5(1) of relevant DTAA.”
Page 24 of 24 We have carefully considered this issue of Fixed Place PE of the assessee in India. For establishing the Fixed Place PE test the following conditions should be satisfied cumulatively:- a) There is a place of business ( Place of Business Test) b) Such Place of business is at the disposal of the assessee. ( Disposal Test) c) Such place of business is fixed ( permanence Test) d) The business of the entity is carried on wholly or partly through such fixed place of business. ( Activity Test)
In the case of the assessee place of business test is satisfied as vertex India is the place of business. Whether that premises is at the disposal of the assessee or not. This is an important parameter to bear in mind is to constitute a PE that the fixed place of business must be at the disposal of the enterprise. It is not necessary that the premises need to be owned or even rented by the enterprise. All that is required is that the premises should be at the disposal of the enterprise. In this case it is not established that premises are made available to a foreign enterprise for the purposes of carrying out particular work on behalf of the owner of the premises; in that situation, the space provided is not at the disposal of the enterprise since it has no right to occupy the premises but is merely given access for the purposes of the work and hence disposal test is not satisfied in this case. Further nature of services provided by the assessee is BPO services and back office operations. Honorable supreme court in case of DIT V Morgan Stanley & co Inc. 292 ITR 416 (SC) in case of whether back office services constitute permanent Establishment or not under article 5(1) of The DTAA has held as under “Existence of P.E. in India
6. With globalization, many economic activities spread over to several tax jurisdiction. This is where the concept of P.E. becomes important under article 5(1). There exists a P.E. if there is a fixed place through which the business of an enterprise, which is a multi-national enterprise (MNE), is wholly or partly carried on. In the present case MSCo is a multi-national entity. As stated above it has outsourced some of its activities to MSAS in India. A general definition of the P.E. in the first part of article 5(1) postulates the existence of a fixed place of business whereas the second part of article 5(1) postulates that the business of the MNE is carried out in India through such fixed place. One of the questions which we are called upon to decide is whether the activities to be undertaken by MSAS consist of Page 24 of 24 back office operations of the MSCo and if so whether such operations would fall within the ambit of the expression " the place through which the business of an enterprise is wholly or partly carried out" in article 5(1).
We quote herein below articles 5 and 7 of the DTAA* :
" 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 ; (g) a warehouse, in relation to a person providing storage facilities for others ; (h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on ; (i) a store or premises used as a sales outlet ; (j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve month period ; (k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more than 120 days in any twelve month period ; (l) the furnishing of services, other than included services as defined in article 12 (royalties and fees for included 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 twelve month period ; or (ii) the services are performed within that State for a related enterprise (within the meaning of paragraph 1 of article 9 (associated enterprise)).
Notwithstanding the preceding provisions of this article, the term ' permanent establishment' shall be deemed not to include any one or more of the following :
(a) the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise ; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or occasional delivery ; (c) the maintenance of a stock of goods, or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise ; (d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise ; Page No : 0423 (e) the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for other activities which have preparatory or auxiliary character, for the enterprise.
Notwithstanding the provisions of paragraphs 1 and 2, where a person—other than an agent of an independent status to whom paragraph 5 applies—is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first- mentioned State if :
(a) he has and habitually exercises in that first-mentioned State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph ; (b) he has no such authority but habitually maintains in the first mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise, and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise ; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the 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, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost Page 24 of 24 wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm' s length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph.
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 State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other . . .
Article 7 Business profits
The profits of an enterprise of a Contracting State shall be tax able only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment ; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment ; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment.
Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arm' s length with the enterprise of which it is a permanent establishment and other enterprises controlling, controlled by or subject to the same common control as that enterprise, in any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in this article.
Page 24 of 24 3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of banking enterprises, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than toward reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices.
4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.
5. For the purposes of this Convention, the profits to be attributed to the permanent establishment as provided in paragraph 1(a) of this article shall include only the profits derived from the assets and activities of the permanent establishment and shall be determined by the same method year by year unless there is good and sufficient reason to the contrary.
6. Where profits include items of income which are dealt with separately in other articles of the Convention, then the provisions of those articles shall not be affected by the provisions of this article.
Page 24 of 24 7. For the purposes of the Convention, the term ' business profits' means income derived from any trade or business including income from the furnishing of services other than included services as defined in article 12 (royalties and fees for included services) and including income from the rental of tangible personal property other than property described in paragraph 3 (b) of article 12 (royalties and fees for included services)."
In our view, the second requirement of article 5(1) of the DTAA is not satisfied as regards back office functions. We have examined the terms of the agreement along with the advance ruling application made by MSCo inviting the AAR to give its ruling. It is clear from a reading of the above agreement/application that MSAS in India would be engaged in supporting the front office functions of MSCo in fixed income and equity research and in providing IT enabled services such as data processing support centre and technical services as also reconciliation of accounts. In order to decide whether a P.E. stood constituted one has to undertake what is called a functional and factual analysis of each of the activities to be undertaken by an establishment. It is from that point of view, we are in agreement with the ruling of the AAR that in the present case article 5(1) is not applicable as the said MSAS would be performing in India only back office operations. Therefore to the extent of the above back office functions the second part of article 5(1) is not attracted.”
Hence in view of the above and relying on the decision of Honourable supreme court in case of DIT V Morgan Stanely inc CO (Supra) we do not have any difficulty in holding that there is no Fixed Place PE in India of the assessee. To this extent we reverse the order of CIT (A).
Whether assesse has a service PE in India? Ld CIT (A) has given its finding holding that the assessee does not have a service PE In India as under “8.3 Service PE The Ld. AO has held that the expatriate employees of the Appellant were providing services other than fees for technical services in India and therefore, the Appellant was held to be Service PE in India in terms of Article 5(2)(k) of the India-UK DTAA. However, the Ld. AO has not furnished any material on record to prove the same. On the contrary, the Appellant has submitted that no employees of the Appellant visited India and therefore, the Service PE clause does not apply. In the remand report sought from the Ld. AO, he has Page 24 of 24 himself admitted that if the Appellant has not sent any employees to India then, it cannot be said to constitute a Service PEin India. In view of the above, I am of the view that the Appellant does not have a Service PE "under Article 5(2) (k) of the DTAA.”
When in the remand report revenue has accepted that in absence of the employees of the assesse visited India for the work then there cannot be service PE In India. In the remand proceedings also no evidences were produced to this effect by ld. AO. Further in appeal before us only issue of continuous relationship is taken up. We are afraid that cannot be a ground of holding that there is a „service PE‟ of the assesse company. In view of this we confirm the finding of CIT (A) on this issue.
Whether assesse has a dependent agent PE (DAPE) in India? Ld. CIT (A) has dealt with this issue as under :- “8.4 Dependent Agent PE 8.4.1 Regarding the constitution of dependent agent of PE (DAPE) of the Appellant in India, I am unable to agree with in the findings of the AO in this regard. In this case, none of three conditions in paragraph 4 of article 5 of India-UK DTAA is satisfied. Paragraph 4 and paragraph 5 of Article 5 of the treaty are reproduced below:
"4. A person acting in a Contracting State for or on behalf of an enterprise of the other contracting State - other than an agent of an independent status to whom paragraph (5) of this Article applies, shall be deemed to be a permanent establishment of that enterprise in the first mentioned State if:
(a) he has, and habitually exercises in that Stale, an authority to negotiate and enter into contracts for or 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 first-mentioned 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 first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and the enterprises controlling, controlled by, or subject to the same common control, as that enterprise.
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 Page 24 of 24 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 same common control) he shall not be considered to be an agent of an independent status for the purposes of this paragraph.”
8.4.2 Paragraph 5 of Article 5 of the treaty is not to be read alone but in conjunction with paragraph 4. Paragraph 5 is in the nature of proviso to paragraph 4. In other words, if the conditions provided in paragraph 4 are not met, then paragraph 5 is of no relevance even if the conditions provided in paragraph 5 are satisfied. The moment an enterprise is out of scope paragraph 4, it cannot constitute a DAPE. The AAR in the case of TVM Ltd. (237 ITR 230) has held that merely because the agent is not independent would not automatically create an agency PE. The agent should be able to exercise the authority to conclude contracts.
8.4.3 The AO has held that the Appellant constitutes a dependent agent PE as per Article 5(4)(a) and 5(4)(c) of the DTAA. In this regard, he has alleged that the Indian and UK employees co-ordinate with each other for business development as well as marketing. They also secure orders for its parent company either in India or abroad. The AO has also stated in his order that they negotiate with customers and secures contract for Vertex and its affiliates. Though the AO has made all these allegations, no material has been brought on record in this regard. All these allegations were denied by the Appellant in his detailed submission; whereas the AO in his remand report has simply contended that the Appellant is not an agent of independent status. Therefore, in view of the business model of the Appellant and in the absence of material to suggest that the conditions mentioned in Article 5(4) are satisfied, I am of the view that Vertex India did not constitute a dependent agent PE of the Appellant in India.
We have carefully considered the issue of DAPE in case of the assessee. Paragraphs 4 and 5 of Article 5 of DTAA relate to creation of agency PE in the second contracting country. Agency replaces fixed place with personal connection. Transactions between a foreign enterprise and an independent agent do not result in establishment of a Permanent establishment under Article 5 if the independent agent is acting in ordinary course of their business. The expression „ordinary course of their businesses has reference to activity of the agent tested by reference to normal customs in the case in issue. It has reference to normal Page 24 of 24 practice in the line of business in question. However as per paragraph 5 of Article 5, an agent is not considered to be an independent agent if his activities are wholly or mostly wholly on behalf of foreign enterprise and the transactions between the two are not made under arm's length conditions. The twin conditions have to be satisfied to deny an agent character of an independent agent. In case the transactions between an agent and the foreign principal are under arm's length conditions the second stipulation in paragraph 5 of Article 5 would not be satisfied, even if the said agent is devoted wholly or almost wholly to the foreign enterprise. Further in absence of any evidence brought on record to establish DAPE in the case of the assessee we confirm the finding of CIT (A) holding that assessee does not have Dependent Agent permanent Establishment in India.
Whether any further profit can be attributed to PE after transaction is determined at Arms‟ length. Though we have already held that there is no permanent establishments of the assessee in India and therefore the business income is not chargeable to tax in India. Despite the above we concur with the views of Ld CIT (A) who has decided this issue as under :- “11.1 After having held that the appellant has PE in India, the AO has computed profit attributable to PE by resorting to Rule 10. During appellate proceeding, the appellant filed a copy of TP study in respect of alleged PE in support of its contention that such PE has already been compensated at arm's length price and therefore nothing more should be attributed to it. Since this TP study report was new evidence, it was sent to AO for his remand report u/r 46A. The remand report has been received vide letter dated 23.08,2012. The appellant has also filed its rejoinder vide letter dated 10.10.2012. In his remand report, the AO has stated that TP study report was not furnished at time of assessment despite opportunities given to the appellant I have gone through the record and find that in letters dated December 21, 2006 and December 22, 2006, the Appellant had requested the AO that in case he was of the view that the Appellant has a PE in India and wanted to attribute further profits to the PE, then, the Appellant should be provided with an opportunity to explain his case. However, no such opportunity was granted by the AO or any show cause notice issued under section 92C(3) of the Act. Therefore, as far as TP study report is concerned, the appellant was prevented by sufficient cause for not producing it before AO during assessment stage. Given this, I admit the additional evidence under Rule 46A in the interest of justice as it is cardinal Page 24 of 24 principle of International taxation law that profit attributable to PE has to be computed on separate entity basis following arm's length principle.
11.2 I have considered the observations of the Ld. AO contained in the assessment order, the submissions of the appellant and also the remand report of the Ld. AO. I am in agreement with the Appellant that to the extent of functions, assets and risks already captured in the transfer pricing analysis of the Indian associated enterprise, i.e. Vertex India, no further profit can be attributed to such functions, assets and risks in the hands of the Appellant's PE. The Appellant's PE can be taxed only in respect of functions, assets and risks which have not already been captured in the hands of Vertex India. In the facts of Appellant's case, the AO has alleged Vertex India or activities undertaken by Vertex India to be the PE of Appellant in India. The AO has not established that there were any functions, assets or risks other than activities of Vertex India that constitute PE of appellant in India. Hence, no further profits can be attributed in the hands of Appellant's PE in India otherwise it will lead to double taxation of income pertaining to same functions, assets and risks once in the hands of the Indian associated enterprise and again in the hands of the Appellant's PE. This is also in line with the judgment of Supreme Court in the case of Morgan Stanley. It is pertinent to mention that in the Appellant's own case in AY 2006-07, on the basis of TP study of PE, the TPO has held that no further attribution is required in Appellant's hands.
11.3 It is also pertinent to mention that in connection with the work outsourced to Vertex India by the Appellant, the entire amount of revenue was passed on to Vertex India by the Appellant, other than £ 60,5 1 8 which was towards pass through telephony costs incurred by the Appellant in UK and recovered from the end-customer. It means that the appellant has retained only a portion of the contract revenue which pertains to functions performed by it outside India.
1 1.4 The Appellant has pointed 2 errors in the computation made by the AO out of which one of them has been rectified by the AO himself in the subsequent year in the assessment of the Appellant's affiliate. Rectifying both or even one of them related to leasehold improvements as done by AO, the computation results into a loss and therefore nothing is left to be attributed.
Page 24 of 24 1 1.5 In view of the totality of facts of the present case, I hold that no further profits can be attributed to the Appellant's PE in India i.e. profits attributable to PE are Nil. The ground of appeal is decided in favour of the appellant.”
In view of this even if assumed that there is a PE in India of the assessee no profit can be attributed to it as FAR (Functions performed, Assets deployed and Risk Assumed) such PE has already been compensated at arm's length price and therefore nothing more should be attributed to it. Furthermore when in the case of Assessee for AY 2006-07 Ld AO has made no addition and assessment is made at returned income it is apparent that the contention the assessee is accepted by the AO in subsequent year. In view of this we confirm the order of CIT (A) on this count that if there is a PE in India of the assessee, when PE is remunerated at arm‟s length no further attribution of profit can be made.
Whether the reimbursement of Rs Rs.2,45,11,059 (GBP 306,076) is Royalty as per Indo UK DTAA and is chargeable to tax despite there being no income element. Facts of the case is that assessee has claimed reimbursement of expenses from the Indian company of Rs.5,24,52,0147- in the return of income the same was claimed as exempt from taxation on the ground that the reimbursement of expenses is not subject to tax in India in accordance with the provision of DTAA. Ld AO asked to explain the details of reimbursement of expenses and the nature of services provided for against these reimbursement. In reply the AR of the assessee submitted that the reimbursement of GBP 654982 represents the amount spent by company to facilitate Vertex India in delivering its services to the customer in UK including support in treasury, taxation, finance, etc. AO was of the view that it is responsibility of the Indian company to render services to the customer on the behalf of the assessee company therefore the disbursement of above expenses on behalf of Indian Co. does not arise. According to him even otherwise this is taxable as business income pertaining to Indian operation as the reimbursement of expenses has an effect of reducing the service fee payable to the Indian company. As on the basis of assets employed and salary and wages paid, the service fee payable to the Indian company comes out to be 78151587- and service fee actually paid was 7170443/-. Therefore if the reimbursement of expenses is reduced from the services fee actually received by the Indian company, then profit from Indian operation will enhance from the same value i.e. the reimbursement of expenses paid by Indian company to other. In the same logic the royalty and fee for technical services received by the assessee company and its affiliates will have effect of reducing the fee actually paid to Indian company. Therefore without prejudice to Page 24 of 24 the assessee's disclosure, the receipt as royalty and fee for technical services, the same is taxable as business profit. Therefore the profit margin of assessee company and its affiliate for Indian operations will further enhance by reimbursement of expenses and royalty and FTS paid by Indian co.. On appeal before CIT (A) he held that:-
“17.1 I have considered the observations of the Ld. AO contained in the assessment order and the submissions of the appellant. The appellant has put forward three contentions 1) that the reimbursements were on cost to cost basis and hence there is no income, 2) the said amount does not qualify as FTS under the DTAA, and 3) the said amounts are not effectively connected with the PE.
17.2 It has been stated that out of the total reimbursement of £ 654,982 (Rs. 52,452,014), amount aggregating to £ 348,906 (Rs. 27,940,955) pertains to third party costs directly relatable to Vertex India and the balance of £ 306,076 (Rs.24,511,059) pertains to costs that have been allocated to Vertex India, In this regard, the appellant has submitted a declaration along with copy of documentary evidence in the form of invoices. The argument of the appellant that there was no element of income in the entire amount of reimbursements cannot be accepted as it cannot be said with certainty that whether the amount of £ 306,076 allocated by the Appellant was on cost to cost basis or not. However, for the third party costs of £ 348,906 directly relatable to Vertex India which has been demonstrated in the form of documentary evidence also, the argument of the appellant is accepted.
17.3 The next question is whether the amount of £ 306,076 is taxable in India as Royalty/FTS or Business Profits attributable to PE. It is clear that the said amount is not effectively connected to the PE and hence cannot be taxed as Business Profits. Even otherwise, it has already been concluded above that no further profits can be attributed to the PE in the facts of present case. Hence, the only question remains whether the said amount is Royalty or FTS in nature.