Article 7 -
Attribution of
business
profits
Presenters : CA Sanjiv Chaudhary
CA Nidhi Maheshwari
24 May 2013
1
The Journey Ahead……
1
Backdrop- Why attribution?
2
Principles of Attribution under the Act
3
Principles of Attribution under Tax Treaty
4
Force of Attraction Rules
5
Computation principles
6
Landmark Judgments
7
Key Challenges & Takeaways
2
Backdrop- Why Attribution?...
• Residence Country – generally taxation of global profits
• Right of source country to tax profits of foreign enterprise operating in its
jurisdiction – when Permanent Establishment (‘PE’) exists i.e. Source Based
Taxation
- Only those profits which are attributable to PE in the source country
Attribution of profits – the next biggest controversy
3
Attribution of business profits of foreign
enterprises- Governing Provisions
Under Income Tax Act and Rules (‘Domestic Law’):
– Section 9(1)(i) of the Act read with Rule10
Under Tax Treaty:
– Article 7 of Tax Treaties read with the provisions of the Act
Beneficial provisions of the Act or the Tax Treaty can be applied
4
Attribution under the Act
5
Attribution of profits under the Act (1/2)
 Section 9(1)(i) of the Act:
“The following incomes shall be deemed to accrue or arise in India:all income accruing or arising, whether directly or indirectly, through or from
any business connection in India, or through or from any property in India,
or through or from any asset or source of income in India, or through the
transfer of a capital asset situate in India.”
 Explanation 1(a) to section 9(1)(i) of the Act:
“In the case of a business of which all the operations are not carried out in
India, the income of the business deemed under this clause to accrue or arise
in India shall be only such part of the income as is reasonably attributable
to the operations carried out in India”
6
Attribution of profits under the Act (2/2)
• Rule 10 of the Income-tax Rules:
In any case in which the Assessing Officer is of opinion that the actual amount
of the income accruing or arising to any non-resident person whether directly or
indirectly, through or from any business connection in India
…………………………………… cannot be definitely ascertained, the amount of
such income for the purposes of assessment to income-tax may be calculated :
(i) at such percentage of the turnover so accruing or arising as the Assessing Officer
may consider to be reasonable, or
(ii) on any amount which bears the same proportion to the total profits and gains of the
business of such person (such profits and gains being computed in accordance with
the provisions of the Act), as the receipts so accruing or arising bear to the total
receipts of the business, or
(iii) in such other manner as the Assessing Officer may deem suitable.”
7
Methods prescribed under Rule 10
 Rule 10(i) - Presumptive Method
- Income computed at such percentage of the turnover as the AO may consider
reasonable
- Ad hoc profits are estimated as attributable to the operations in India
 Rule 10(ii) - Proportionate Method
- Profits computed in ratio of India receipts to total receipts of the business
- Proportionate profits based on worldwide income is attributed to the operations in India
- Difficult method as worldwide income of the enterprise is to be computed under the Act
before applying proportionate method
- In case of different businesses, relevant business income needs to be considered
 Rule 10(iii) - Discretionary Method
- Such method as is deemed fit by tax authorities – AO may devise any mechanism on
facts and circumstances of the case.
8
Relevant CBDT Circulars (1/2)
• CBDT Circular No. 23 dated 23 July 1969 – Now withdrawn
Non-Resident selling goods from outside India to Indian customers on principal-toprincipal basis through Agents in India
– If the agent’s commission fully represents the value of the profit attributable to his
service; it should prima facie extinguish the assessment.
– This principle is now well established including by Supreme Court in the case of
Morgan Stanley
9
Relevant CBDT Circulars (2/2 )
• CBDT Circular No. 5 dated 28 September 2004 – relevant extracts are
reproduced below:
“Paragraph 2 contains the central directive on which the allocation of profits to a
Permanent Establishment is intended to be based. The paragraph incorporates
the view that the profits to be attributed to a Permanent Establishment are
those which that Permanent Establishment would have made if, instead of
dealing with its Head Office, it had been dealing with an entirely separate
enterprise under conditions and at prices prevailing in the ordinary market.
This corresponds to the “arm’s length principle”. Paragraph 3 only provides
a rule applicable for the determination of the profits of the Permanent
Establishment, while paragraph 2 requires that the profits so determined
correspond to the profit that a separate and independent enterprise would have
made. Hence, in determining the profits attributable to an IT-enabled BPO
unit constituting a Permanent Establishment, it will be necessary to
determine the price of the services rendered by the Permanent
Establishment to the Head office or by the Head office to the Permanent
Establishment on the basis of “arm’s length principle”.
10
Indian scenario: Some key judicial precedents (1/2)
Ad hoc Attribution – A few instances
• Taxability of trading profits where sale is concluded in India
-
10% of supply – Annamalis Timber 41 ITR 781 (Madras HC)
• Taxability of offshore supplies where PE played some role
-
20% of global profits – NETWORKS, OY : 96 TTJ 1 (Delhi ITAT, SB)
• Taxability of offshore supplies where PE was involved in marketing activities
-
35% of the global profits (50% manufacturing, 15% R&D) – Rolls Royce (Delhi HC)
• Taxability of CRS activities where agency PE played marketing activities
-
15% of the total revenues - Galileo International Inc : 114 TTJ 289 (Del. ITAT)
• Taxability of back office operations where PE looks after operations and marketing
activities of overseas affiliates
-
Global adjusted profits x India assets/Global assets : eFunds 42 SOT 165 (Delhi ITAT)
11
Indian scenario: Some key judicial precedents (2/2)
Principles of Attribution - Legal Position
• Ahmedbhai Umarbhai & Co (1950) SCR 335
-
Profit apportionment on the basis of business activities, manufacturing profits taxable in the
jurisdiction where manufacturing takes place
• Morgan Stanley (292 ITR 416) (SC)
-
Profits attribution to PE based on functions assets and risks analysis
• Rolls Royce Singapore Pvt Ltd (ITA No 1278/2010) dt August 30, 2011
-
TP principles should be applied to determine profits attributable to PE
• Hyundai Heavy Industries : 291 ITR 482 (SC)
- Even if supply is considered to be integral part of installation, supply is not attributable to PE
because it is at arm’s length; Direct billing to customer represents arm’s length
• Instruction No. 5 of 2009 (withdrawing Instruction 1829), Para 4
12
Attribution under Tax Treaties
13
Framework of OECD Model - Article 7
Residence State
Enterprise
Source State
Art 5:
Constitution of
PE
Article 7(1) - Charging provision
Article 7(3) - Elimination of double
taxation
Article 7(2) - Basis of profit attribution
Article 7(4) - Limitation
14
Article 7(1) - Scope of taxation
Article 7(1): The profits of an enterprise of a Contracting State shall be taxable only
in that State unless the enterprise carries on business in the other Contracting
State through a permanent establishment situated therein. If the enterprise carries
on business as aforesaid, the profits that are attributable to the permanent
establishment in accordance with the provisions of paragraph 2 may be taxed in
that other State.
Key aspects:
•
PE test for each source of income
•
No guidance on how to interpret the term ‘profits of an enterprise’
•
Existence of PE must for attribution
•
Business should be carried on
- Preparatory activities do not trigger attribution
•
Only profits attributable to such PE is taxable in the source country
•
Applicability of Minimum Alternate Tax
15
Force of Attraction Rule
16
Force of Attraction Rule – UN MC
The profits of an enterprise of a Contracting State shall be taxable only in that State
unless the enterprise carries on business in the other Contracting State through a
permanent establishment situated therein. 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 that 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 that other State of the same or
similar kind as those effected through that permanent establishment
‘Force of attraction’ rule not present in OECD Model Convention
Does exist in the US Model Convention
17
Force of Attraction Rule
International Bureau of Fiscal Documentation - International Tax Glossary
“Principle under which a country may tax a foreign enterprise in respect of
income it derives in that country if the enterprise maintains a permanent
establishment there, irrespective of whether that income is derived through or
otherwise economically connection with the permanent establishment……”
Different kinds of Force of Attraction in context of DTAA’s entered by India
Type 1:
- Once activities are same / similar
- Without specific requirement of role by PE
Type 2:
- Business reasons for not routing the direct business of HO through PE
- Tax avoidance motive need to be established
Comparision vis a vis explanation to section 9(1)(i) – Whether treaty can
create a charge.
18
Force of Attraction…
Examples Type 1:
Article 7(1) of India USA DTAA
“The profits of an enterprise of a Contracting State shall be taxable only in that State unless the
enterprise carries on business in the other Contracting State through a permanent establishment
situated therein. 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.”
Some other countries having similar Force of Attraction rule.
Cyprus
Denmark
Indonesia
New Zealand
Italy
19
‘Directly and indirectly’ - Whether connotes ‘force
of attraction’ rule?
Examples: Type 2
Article7(1) states that profit “directly or indirectly” attributable to the PE…..
Taxable…
• Protocol to Article 7 clarifies, as under:
“………….,it is understood the words directly or indirectly mean, …………., that
where a permanent establishment takes an active part in negotiating, concluding
or fulfilling contracts entered into by the enterprise, then, ………………………,
there shall be attributed to the permanent establishment that proportion of
………………… contribution of the permanent establishment to those
transactions bears to that of the enterprise as a whole. It is also understood
that profits shall be regarded as attributable to the permanent
establishment to the above mentioned extent, even when the contracts in
question are made directly with the head office of the enterprise ………………
20
Force of Attraction Rule - Motive of Tax
Avoidance
Article7(1) as per UN Model Convention
• With an additional para, as under:
“The provisions of sub-paragraphs (b) and (c) above shall not apply if the
enterprise proves that such sale or activity could not have been reasonably
undertaken by the permanent establishment.” or
“may be considered attributable to that permanent establishment if it is proved
that: (i) this transaction has been resorted to in order to avoid taxation in
the Contracting State where the permanent establishment is situated, and (ii) the
permanent establishment in anyway was involved in this transaction.”
21
Force of Attraction under the ITA? (1/2)
Income tax
Act
Provisions of section 5(1) and 5(2) provides that
income is taxable in India if it is received in India
or deemed to be received in India or accrues or
arises in India or is deemed to accrue or arise in
India
Section 9 covers income which is deemed to
accrue or arise in India
22
Force of Attraction under the ITA (2/2)
“9(1) The following incomes shall be deemed to accrue or arise in India:
All income accruing or arising, whether directly or indirectly, through or
from business connection in India, or through or from any property in
India, or through or from any asset or source of income in India, or
through the transfer of a capital asset situated in India.
[Explanation 1]. For the purposes of this clause
(a) In the case of a business of which all the operations are not carried out
in India, the income of the business deemed under this clause to
accrue or arise in India shall be only such part of the income as is
reasonably attributable to the operations carried out in India; …”
Arguably, no force of attraction under the ITA – Do ‘force of attraction’ rules
under the Indian tax treaties become meaningless?
23
Example: Attribution of Profit – Force of Attraction
HO
Sale of
pharmaceuticals in
India
Outside India
In India
Customers in
India
Direct sale of
garments by HO in
India
Customers in
India
PE
PE sells garments manufactured by
HO
Type 1 Force of Attraction
24
Example: Attribution of Profit – Force of Attraction
HO
Conclusion of sale of
pharmaceuticals
Outside India
In India
Negotiating sale of
pharmaceuticals in
India
Customers in
India
PE
Negotiation and conclusion of sale of
garments manufactured by HO
Customers in
India
Type 2 Force of Attraction
25
Similar Goods – Examples
Similar
26
Similar Business activities – Examples
Not Similar
27
Article 7(2): Approaches to determine profit
• Approaches to determine profit:
- relevant business activity; or
- functionally separate entity.
• Recommended approach – OECD report suggest functionally separate
entity approach as preferable
• Profit should be determined by applying the arm’s length principle –
OECD Transfer Pricing Guidelines could be applied
28
Article 7(2)
For the purposes of this Article and Article [23A] [23B], the profits that are
attributable in each Contracting State to the permanent establishment referred to in
paragraph 1 are the profits it might be expected to make, in particular in its
dealings with other parts of the enterprise, if it were a separate and independent
enterprise engaged in the same or similar activities under the same or similar
conditions, taking into account the functions performed, assets used and
risks assumed by the enterprise through the permanent establishment and
through the permanent establishment and through the other parts of the
enterprise
Independent entity approach
29
Authorized OECD Approach: An outline
Determining
the profits
of a PE
Step1: Hypothesising
the PE as a distinct
and separate
enterprise
Step 2:
determining the
profits of the PE
Functional /
factual analysis
to determine
the Activities
and conditions
of the PE
Functions
performed
Comparability
analysis
Assets used
Applying
transfer pricing
methods to
attribute profits
Risk assumed
Capital and
funding
Recognition of
dealings
30
Single v/s Two taxpayer approach - Meaning
Two tax payer approach mooted
Party / Tax Payer
Indian Dependent Agent Co
Residential Status
Resident
Dependent Agent PE
Non-resident
Foreign Co
Non-resident
Transaction between
Indian Dependent Agent Co. and
Foreign Co
Dependent Agent PE and the head
office (Foreign Co)
Applicable provisions requiring
arm’s length payment
Article 9 if both are Associated
Enterprise
Article 7(2)
31
Article 7(3) - Provisions
Where, in accordance with paragraph 2, a Contracting State adjusts the profits
that are attributable to a permanent establishment of an enterprise of one of the
Contracting States and taxes accordingly profits of the enterprise that have been
charged to tax in the other State, the other State shall, to the extent
necessary to eliminate double taxation on theses profits, make an
appropriate adjustment, the competent authorities of the Contracting states shall
if necessary consult each other
32
Article 7(4) - Provisions
Where profits include items of income which are dealt with separately in other
Articles of this Convention, then the provisions of those Articles shall not be
affected by the provisions of this Article
33
Specific Article vs. Attribution to PE
Effective Connection Vs Attribution
Article 12(3) of the OECD Model Convention:
“The provisions of paragraph 1 shall not apply if the beneficial owner of
the royalties, being a resident of a Contracting State, carries on
business in the other Contracting State in which the royalties arise
through a permanent establishment situated therein and the right or
property in respect of which the royalties are paid is effectively
connected with such permanent establishment. In such case the
provisions of Article 7 shall apply.
 Bechtel (AAR) ( 228 ITR 487)
 Ishikawajima-Harima Heavy Industries Ltd. Vs DIT (SC) (288 ITR 408)
 Worley parsons services Pty. Ltd. (AAR ) (313 ITR 273 )
34
Specific Article vs. Attribution to PE
Relevant extracts - Worley Parsons Services Pty. Ltd. In re. AAR ruling:
“…the prerequisite for attracting the exclusion clause is that "the services in
respect of which the royalties are paid are effectively connected with the
PE". It must be noted that the effective connection should be between the
royalty generating services and the PE. The expression 'services' is
significant and should be given due weight. It is not enough that there is a PE
of the non-resident in the source country carrying out some activities in
connection with the project or the work. The PE may be effectively
connected with the project and the contract from a broader perspective but the
connection contemplated by para 4 of art. XII is in respect of the services that
fall within the purview of royalty. The PE or fixed base set up in the source
country should be engaged in the performance of royalty generating
services, irrespective of what other activities it performs. At least, it
should facilitate the performance of such services. The terminology
'effective connection' denotes a real and intimate connection. Clear corelation between the services which give rise to royalty income and the
PE is a key factor for the purpose of exclusion of paras 1 and 2 of art. XII.
35
Basic construct of India Tax Treaties
Article
Art 7(1)
Basic Rule
Art 7(2)
Computation
Hypothesis
Key Provisions
• Income Attributable to PE
• Force of Attraction Rule (if any) or Indirect attribution
As if PE is
• a distinct and independent enterprise
• engaged in same or similar activities
• under same or similar conditions
Art 7(3)
Expense Deduction
• Actual Expense incurred, incl. reasonable allocation of General &
Admin Overheads
• Whether in source state or in HO state
• Subject to domestic law
• No deduction for HO payment (except reimbursement of actual
expenses)
Others (varies from
Treaty to Treaty)
• Applying Apportionment method in case of difficulty (reasonable)
• Methodology applied consistently Y-on-Y
• Exception (Purchase activity)
36
Computation of Profits
Attributable to PE
37
Article 7(3) of Indian DTAA’s
Principles of computation of Income of PE
•
In determining profits of a PE
– Deduction shall be allowed for expenses (including executive & general
administrative)
– Incurred for the PE
– Incurred in or outside the source country
– In accordance with and subject to limitations of domestic law
•
No deduction – amount paid by PE to the HO or to any other offices of the
enterprise, except reimbursement of actual expenses
– For use of patents or other rights in the form of royalties, fees or other similar
payments
– For specific services performed or for management in the form of commission
– For money lent in the form of interest (exception for banking enterprises as explained
by CBDT Circular 740)
•
Similarly, income received by PE from HO for aforesaid purposes shall be
ignored
38
Computation of profits attributable to PE under
the Act
• Attribution of income to the extent of operations / activities carried in
trade
• Nothing attributable if activities are preparatory or auxiliary in nature e.g.
purchasing of goods
• No specific mechanism provided for attribution of profits
–
Transfer pricing rules can be applied
–
Rule 10 of the Income-tax Rules can be applied
Function / Asset / Risk analysis imperative to determine profit
attribution – Morgan Stanley
39
Computation of profits attributable to PE under
the Act
Rule 10 – Method of Attribution under the Act:
• Determination of actual profits if it can be ascertained
• Methods prescribed in Rule 10 are not accurate methods
– These involve estimation and subjectivity
– Hukumchand Mills Ltd. v. CIT, 103 ITR 548 (SC)
• Can be followed only when the AO is of the opinion that profits cannot
be definitely ascertained
– Rule is last in priority list and is to be applied in exceptional
situations
Rule 10(i) - Presumptive Method
• Adhoc profits is estimated as attributable to the PE
40
Computation of profits attributable to PE under
the Act
Rule 10(ii) - Proportionate Method
– Proportionate profits based on world income is attributed to the PE
– Difficult method as World income of the enterprise is to be computed
under the ITA before applying proportionate method
– In case of different businesses relevant business income be
considered
Rule 10(iii) - Discretionary Method
– Attribution in some other method
41
Computation of profits attributable to PE under
the Act
Specific provisions for computing profits:
– All provisions applicable as is applicable to resident
enterprise for e.g. section 32, 40(a), 43B, etc,.
– Section 44C – Branch
– Section 44D and 44DA – Taxability of royalties and FTS
– Section 115JB – MAT provisions
42
Computation of profits attributable to PE under
the Act
Presumptive basis of taxation
– Income is computed on presumptive basis
– Provisions of sections 28 to 44 not applied
– Applied in case of specific types businesses/assesses
– It is not in line with the principles laid down in Article 7(2)
Examples
– Shipping business (u/s 44B) - 7.5% of gross revenue
– Business of Exploration (u/s 44BB) - 10% of gross revenue
– Business of Aircraft (u/s 44BBA) - 5% of gross revenue
– Turnkey Power Projects (u/s 44BBB) - 10% of gross revenue
43
Example: Attribution of Profit – Fixed place PE
F Co.
US
India
Branch
PE sells garments
manufactured by F Co.
Customers in
India
Profit & Loss A/c of Branch as a PE of F Co. for India tax purpose:
Sales
Less: Expenses incurred
-Cost of garments imported (to be on arm’s length basis based on FAR)
-Personnel cost of branch employees
-Rent of branch office premises
-General administrative expenses of HO – Rs. 20,000 (10% allocable to PE)
-Depreciation on branch assets
-Royalty on intangible assets (assuming economic ownership rests with HO)
Total expenses
Profit attributable to PE
Rs. 1,00,000
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
70,000
3,000
5,000
2,000
2,000
3,000
85,000
15,000
44
Example: Attribution of Profit – Service PE
Rendering of legal
services
F Co.
Offshore Activities
US
India
Onshore Activities
Customers in
India
Total man days spent on job
Offshore man days
Onshore man days
Project revenue
Revenue attributable to India (PE only on account of onshore)
Less: Expenses incurred
-Personnel cost
-Depreciation on India assets (Assuming all assets acquired from India)
-Royalty for know-how
Total cost
Profit taxable in India
Service PE
1000 mandays
600 mandays
400 mandays
Rs.1,000,000
Rs. 400,000
Rs. 75,000
Rs. 75,000
Rs. 100,000
Rs. 250,000
Rs. 150,000
45
Example: Attribution of Profit – Agency PE …
Payment of commission
Supply of garments to
agent
F Co.
Dependent Agent
US
India
Sale of garments to final customer
Credit / Inventory risk by HO
Customers in
India
Sales
Less: Cost of goods paid to F Co. (Based on FAR / TNMM)
Less: Commission @ 20% of sales (agent sufficiently remunerated)
Profit attributable to PE
Rs. 100,000
Rs. 80,000
Rs. 20,000
Rs. 20,000
NIL
46
APA route for Permanent Establishment
As per the recently issued APA Guidance with FAQs by the income-tax
department, APA application may be possible in case the applicant
admits PE in India (FAQ no. 23)
47
Landmark Judgements
48
Morgan Stanley and Co – SC Ruling
Supreme Court of India
Facts
 Activities outsourced by MS Co. to
Indian group entity MSAS:
-
Equity / fixed income research
-
Account reconciliation;
-
IT enabled services, etc
 MS Co. staff visited India for
monitoring/quality control (stewardship)
MS Co.
Activities
Outsourced
USA
India
Remunerated
at arms
length price
 MS Co. staff deputed to MSAS
-
-
MSAS reimburses salary cost to MS
Co.
MSAS
Employees deputed continue to be
employed with MS Co., which pays
salary to the deputees outside India
49
Morgan Stanley and Co – SC Ruling

Ruling:

Service PE
was Upheld

Profit
Attribution
NO


PE definition under Section 92F(iii) of the IT Act is
inclusive so as cover various types of PE under
DTAA such as Service PE, Agency PE,
Construction PE, etc.
Profits of PE determined based on what an
independent enterprise under similar
circumstances might be expected to derive
Profits of MS Co. which have economic nexus with
PE attributable
AE that constitutes PE and is remunerated on
arms length basis taking into account all risk taking
functions of the multinational enterprise – no
further attribution
If TP analysis does not adequately reflect
functions performed / risks assumed by the
enterprise – there would be need to attribute
profits for those functions / risks
50
Ishikawajima-Harima Heavy Industries Ltd. v. DIT
158 Taxman 259 (SC)
• All income of turnkey projects not assessable in India merely due to PE
• Only part of income attributable to the operations carried out in India by
PE taxable
• Offshore supply not taxable if property in goods passed outside India
• The fact that the contract signed in India is not material
• If services have been rendered outside India and have nothing to do
with the PE then they cannot be attributable to the PE
• Offshore services – sufficient territorial nexus – apart from utilization in
India, need to be rendered I India or have a live link to fall within Article
12 of the DTAA (This resulted in insertion of an Explanation to Section
9(1) by FA 2007 w.r.e.f. 1.6.1976)
• In Jindal Thermal Power Co. Ltd. v DCIT (2009) 182 Taxman 252 (Kar),
the Court has held that criteria of rendering services in India as laid
down by the Supreme Court has not been done away by the
Explanation
51
Galileo International Inc – Delhi HC
Airlines
Payment
Payment
INDIA
Passengers
approaches
Does not
charge fees
Travel Agent TA
Does not
charge fees

Provides
support services
and Equipments
Distributor

Does not
charge fees

Services of
Distributor
Galileo Inc.
Lines &
Nodes
Fees

Server
Lines &
Nodes

USA
Payment
Telecom Service
Provider
52
Galileo International Inc – Delhi HC
Ruling:
Fixed and
Agency
PE was
Upheld
Profit
Attribution
YES
“…On the basis of such analysis of functions performed, assets
used and risk shared in two different countries, the income can
be attributed. In the present case, we have found that majority of
the assets i.e., host computer which is having very large capacity
which processes information of all the participants is situated
outside India. The CRS as a whole is developed and maintained
outside India. The risk in this regard entirely rests with the
appellant and that is in USA, outside India. However, it is equally
important to note that but for the presence of the assessee in
India and the configuration and connectivity being provided in
India, the income would not have generated. Thus the initial
cause of generation of Income is in India also. On the basis of
above facts we can reasonably attribute 15 per cent of the
revenue accruing to the assessee in respect of bookings made in
India as income accruing or arising in India and chargeable under
section 5(2) read with section 9(1)(i) of the Act.”
53
Galileo International Inc – Delhi HC
Ruling:
Profit
Attribution
YES
“…since the revenue attributable in respect of
the booking made in India is only 0.45 Euro (15
per cent of Euro 3) and commission paid to
Interglobe was Euro 1, there was no income
which was taxable in India.”
Upheld by Delhi High Court
subsequently
54
Rolls Royce Plc – Delhi Tribunal Ruling
Facts





RRIL’s liaison office (‘LO’) carried out activities only in
respect of RR Plc
LO’s key responsibility includes securing orders and
solicit request for quotation/purchase orders for RR
Plc’s products
The employees of RR Plc visit India frequently and
use premises of the LO
Employees of RRIL participate in meetings with
customers where significant matters regarding
contracts with RR Plc are discussed and decisions
are taken
RR Plc on various occasions designated RRIL as sole
contact point in respect of certain customers (eg. to
send orders/quotations/acceptances, etc)

RRIL marketed certain after sales/other services
provided by RR Plc to present/potential customers of
RR Plc

RRIL provided certain advise/recommendations to RR
Plc as regards certain customer proposals
Service
Agreement
RR Plc
Reimbursement
of Cost + Mark
Up
Equipment
Sales
RRIL
Services
UK
India
RRIL
(India LO)
Indian
Customer
55
Rolls Royce Plc – Delhi Tribunal Ruling
Ruling:
 All profits directly and indirectly attributable to the
Fixed
Place &
Agency
PE was
Upheld


Profit
Attribution
YES





PE to be considered
However, under Article 7(4) of the Treaty,
computation could be on proportionate basis
Since no specific P&L provided, computation to
be under Rule 10
50% to be attributed to manufacturing
15% to be attributed to R&D
35% to be attributed to marketing
Only marketing done in India
Hence profits to be attributed to India – 35%
56
Set Satellite (Singapore) Pte Ltd vs. DCIT (Mum
HC)
Sing Co
(Business of creating,
marketing & distributing TV
channels)
Agency
Agreement
Singapore
India
Fee
India Agent
(dependant)
Arms length
remuneration
Customers
(Advertisers)
Existence of an
Agency PE
57
Set Satellite (Singapore) Pte Ltd vs. DCIT (Mum
HC)
 CBDT Circular 23 of 1969 is applicable to SET Singapore since:
Ruling:
Agency
PE was
Upheld
−
it’s business activities in India where wholly channeled
through its agent (SET India);
−
the contracts to sell (the ad slots) are made outside India; and
the sales are made on a principal to principal basis
 Thus, if commission to SET India fully represents the value of the
No further
profit
attributable to
Dependent
agent PE in
India
profit attributable to its service - it should prima facie extinguish
the assessment.
 Under Article 7(2) profit attributable to a PE would be the profit it
since
might be expected to earn it were a separate and independent
entity carrying out similar activities – i.e. the arm’s length profit
 Dependant agent paid commission @ 15% - Circular 742
recognizes that Indian agents of FTCs generally retain 15% as
service charges
 Since, commission paid to SET India is at arm’s length - no further
Whether principle laid
down holds good even
after withdrawal of
Circular 23?
profits can be attributable to its activities in the hands of SET
Singapore’s PE in India in terms of Circular 23 r.w. Article 7(2)
 Considering the Morgan Stanley judgment, if the correct arms
length price is applied then nothing further would be left to be
taxed in the hands of the FCo
58
Convergys Customer Management Group Inc – Delhi Tribunal
Facts
 CCM was a company incorporated in the
USA
 CCM procured services from CIS on
principal to principal basis :
- IT enabled call centre services
- Back office support services ;
- CCM staff visited CIS for supervision/direction
and control
- CCM also provided certain hardware and
software assets on free of cost basis to CIS
CCM
Overseas
Customers
Services
Subcontracted
USA
India
CIS
59
Convergys Customer Management Group Inc – Delhi Tribunal
 Relying on the CBDT Circular No. 5 of 2004, Supreme
Courts decision in case of Morgan Stanley and OECD
Guideline, the Tribunal held that no further profits can be
attributed to a PE once an arm's length price has been
determined
Fixed Place
PE was
Upheld
 However, the taxpayer had submitted that it does not
prepare India specific accounts, therefore the attribution of
profits on the basis as disclosed in the TP study for assets
and software cannot be accepted.
Profit
Attribution
Yes
 Further in the facts and circumstances of the case PSM was
not the correct method for attribution of profits to the
taxpayer’s PE in India.
 Departmental observation that further attribution was
required for entrepreneurial services for managing risk
related to the service delivery performed in India by CCM
was held to be completely without any basis.
60
Convergys Customer Management Group Inc – Delhi Tribunal
 The Tribunal held that department’s methodology was not
acceptable and made the following observations:
Fixed Place
PE was
Upheld
With regard to Revenue’s approach in considering revenue of
CCM as a multi-national enterprise as the starting point, :
 Revenue of taxpayer cannot be considered as revenue of the
PE
Profit
Attribution
Yes
 Department ought to have considered the expenditure incurred
outside India for arriving at the profit of CCM with regard to the
contracts wherein services have been procured from CIS
 Provisions of Section 44C of the Act having been invoked in
attributing income of the taxpayer without allowing the cost
incurred to earn the revenue outside India (thereby attributing
the entire receipts) was incorrect.
61
Convergys Customer Management Group Inc – Delhi Tribunal
 The Tribunal prescribed the correct approach to arrive at attributable
profits as under:
 Computing global operating income percentage of the customer care
business as per annual report
Fixed Place
PE was
Upheld
 Above percentage to be applied to the end-customer revenue with
regard to contracts/projects subcontracted to CIS to arrive at operating
income from Indian operations.
 The operating income from India operations to be reduced by the profit
before tax of CIS to arrive at profit attributable to Indian PE
Profit
Attribution
Yes
 Estimation of profit based on above residual profit
 For the purpose of attribution on residual profits, reliance was placed on
two Supreme Court rulings that had dealt on profit attribution to Indian
PEs. In the case of Anglo French Textile Co, 10% attribution was held
reasonable and in Hukum Chand Mills Ltd., 15% attribution was held
reasonable. The Tribunal held that the adoption of the higher figure of
15% for attribution of the Taxpayer’s PE will meet the ends of justice.
62
Service Providers – Force of Attraction
LLP Fiscally transparent for UK tax
purpose; Partners of LLP are liable
to tax
LLP
Clients
Facts
• LLP, UK based Law firm (fiscally
transparent for UK tax purpose) rendered
legal advisory services to clients having
Indian projects
• LLP did not have Office / branch in India
Provision of legal
advisory services
UK
India
• Personnel of LLP rendered services in
India / overseas
• LLP filed Nil tax return in India
Issues for Consideration
Indian
Projects
• Applicability of ‘Force of attraction’ rule for
offshore services
Partners and Staff members
of LLP visited India for
rendering services
63
Service Providers – Force of Attraction
• Profits indirectly
attributable to PE’
incorporates the
Force of Attraction
rule
Applicability
of Force of
Attraction
• Services rendered not
only in India but also
in UK are taxable
• The same
observations were
also made by the
Mumbai Tribunal in
the case of Linklaters
LLP. Reliance was
placed by the Tribunal
on the provisions of
Article 7(1)(b) and
7(1)(c) of the UN
Model Convention as
well as on the UN
Model Convention
Commentary
Overruled
recently by ITAT
SB in Clifford
Chance; SB
concluded that
reliance on UN
commentary is
not required and
profits shall be
attributed to PE
on the basis of
its contribution;
Article 7(3)
clearly explains
the scope and
ambit of the
profits indirectly
attributable to
the PE.
64
Key takeaways
65
Key takeaways
• PE – a dynamic concept
– Especially with emergence of economic and
technological advancements
• Attribution – very contentious in practice
• Documenting functional analysis – key defense
• Attribution vis-à-vis arm’s length payments
• OECD commentary vs. Indian judicial precedents
Well documented Transfer pricing policyImportant to defend claims from
revenue authorities
66
Q&A
67
Thank You
68