Income from Business
(Article 7)
Vikram Vijayaraghavan, Advocate
M/s Subbaraya Aiyar, Padmanabhan & RAMAMANI
(SAPR) Advocates, Chennai
Agenda
• Introduction to Article 7
• The Model Conventions & Article 7
• Article 7 in the MCs – A Deep Dive
– The Basic Rule (Article 7(1)) [with FoA & case studies]
– PE - Computation Hypothesis (Article 7(2))
– PE – Computation of profits attributable (Article 7(3) and beyond)
– Model Commentary on computation of profits attributable to PE
• India’s DTAAs: Rubber hits the road!
– An Example Indian DTAA’s Article 7
– Indian DTAA’s & Article 7 : Points to Note
• Indian Income Tax Act & Attribution of profits to PE
– S.9(1)(i), Explanation 1(a), Rule 10, Sec. 44C
– Indian cases – Attribution to PE
• Interplay between Article 7 and other Articles
• Summary
Introduction to Article 7
Article 7 : Income from business
The bulwark of a DTAA
• An important Article which is the cornerstone of every DTAA business profits is the engine driving most enterprises today.
• This Article allocates taxing rights with respect to business
profits of a Contracting State to the extent that these profits
are not subject to different rules under other Articles of the
Treaty.
• Incorporates basic principle that unless an enterprise of a
Contracting State has a Permanent Establishment situated in
the other state, the business profits of that enterprise may
not be taxed by that other State
• This Article does not intend to trample upon other kinds of
income such as dividends, immovable property rent etc.
Introduction to Article 7
• Typically, where income is earned is called Source State and
where the person who receives it is normally based is
called Residence State
• Bottomline: It’s a Source vs. Residence country power
struggle i.e., “Where is my portion of the tax pie?”
– Residence country typically has the right to tax the
business profits subject to attribution of said profits to
PE in Source State (Article 7 r.w. Article 5) : A logical
proposition but the devil is in the details!
Residence State?
Source State?
The Model Conventions & Article 7
The Model Conventions & Article 7
• The 3 major Model Conventions – the OECD, the UN and the US have a checkered history on Article 7.
– It has evolved over time as globalization has rapidly increased
• Prior to OECD 2010 MC, the OECD and UN/US differed always on
the Force of Attraction concept; however other things were more
or less on the same lines
• Since the 2010 OECD MC, there is a divergence in the attribution of
profits to PE with OECD very strongly advocating separate entity
approach to arrive at ALP using only TP analysis : a marriage of
Article 7 and 9 by OECD?
• So we really need to study 5 combinations!
– OECD MC 2008, OECD MC 2014
– UN MC 2011
– US MC 1996, US MC 2006
Article 7 in the MC’s – A deep dive
OECD Model Convention
The Basic Rule - Article 7(1)
OECD MC 2008
OECD MC 2014
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 that permanent
establishment.
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.
UN Model Convention
The Basic Rule - Article 7(1)
UN MC 2001 & MC 2011
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.
US Model Convention
The Basic Rule - Article 7(1)
US MC 1996
US MC 2006
The business 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 are attributable to
that permanent establishment.
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 are attributable to
that permanent establishment.
Article 7(1) Underlying principle
• The principle which underlies Paragraph 1 has a long history
and reflects international consensus that, as a general rule,
until an enterprise as a State has a PE in another State, it
should not be regarded as participating in the economic life of
the other State to such an extent that the other State has
taxing rights on its profits
• Many types of PE’s possible (agency PE, supervisory PE,
service PE etc.)
– Exclusions to PE are usually when the operations in other
State are in the nature of ancillary or preparatory activities
(or) use of storage facility solely for delivery of goods (or)
purchasing or info gathering activities (or) stock of goods
maintenance for processing by another enterprise etc.
Article 7(1)
Escaping the Source Axe!
• Two possibilities to escape source taxation
prima facie
#1 “….carries on business in the other
Contracting
State….”
(lets
attack
the
fundamentals!)
#2 Carries on business in the other Contracting
State but there is no PE there (Indian taxpayer’s
usual refrain!)
Article 7(1)
Absence of “business”
• Interesting Belgium case of Sogetra S.A.C.Etat Belge (1974)
– Belgian company entered into JV with Dutch company to carry out
harbour work in Netherlands; another Belgian company was brought
in to raise finance which merely lent money and agreed to share of
profit.
– Lender argued that interest paid on loan was derived from PE and was
therefore taxable only in The Netherlands. Cour de Cassation rejected
this as the lender did not carry on business from a PE in The
Netherlands
• Transvaal Associated Hide & Skin Merchants (Pty) Ltd vs Collector of
Taxes, Botswana (SATC 97)
– Whether purchase of hides from abattoirs in Botswana and their
preparation for sale and delivery constituted a business. Maisels J.A.’s
referred to a dictum: “Anything which occupies the time and attention
and labour of man for the purpose of profit is business”
Article 7(1)
Presence of business…Absence of PE
• Payment to Singapore companies for letting out cranes to
Malaysian company – no PE in Malaysia and not Roaylty –
hence “business profits”– Walter Wright (Singapore) Pte Ltd
vs. DGIR (3 M.L.J 186)
• Per diem payment to Canadian owners of rail road freight cars
for period of time those cars were used in US tracks classified
as “rental income” and not “industrial and commercial
profits” US Revenue Ruling 73-278
• Fees paid to French company for engineering services, the
supply of machinery, erection and commissioning were not
Royalties but “industrial and commercial profits” not taxable
in India in absence of PE – Commr. Vs. Hindustan Paper Corp
(77 Taxman 450 Calcutta HC)
Article 7(1)
“Force of Attraction” Principle
• Principle of Force of Attraction primarily concerned with taxation of
business profits in Source country
– Prevent tax evasion/avoidance through artifical contracts &
business arrangements
– Identification of business txns. – source based taxation
• Three kinds of FoA found in Treaties:
– Pure force of attraction : all profits derived in source state
taxable as profits of PE whether or not through PE
– Limited force of attraction : profits derived through PE as well
as profits from sale of goods/activities same or similar to PE
directly by HO in source country taxable as profits of PE
– No force of attraction : only profits derived through PE taxable
• Article 7(1) of the UN MC includes a limited form of Force of
Attraction principle
Article 7(1)
Pure Force of Attraction
• Classic example of the Pure ‘Force of Attraction’ rule is Article III
of the UK-USA Income-tax Convention, 1945 which read as
follows:
“(1) A UK enterprise shall not be subject to US tax in
respect of its industrial or commercial profits unless it is
engaged in trade or business in the United States through
a PE situated therein. If it is so engaged, United States tax
may be imposed upon the entire income of such
enterprise from sources within the United States…”
• In other words, if an enterprise of a contracting country had a PE
in the other country, it was taxable not only in respect of the
profits attributable to the PE, but in respect of the entire
profits arising from sources in that country!
Article 7(1)
Limited FoA
• The raison-d-etre of the modified ‘Force of Attraction’ principle
is best understood from the Commentary on UN Model
Convention which states thus (paragraph 46):
“This para reproduces art. 7, para 1, of OECD Model Convention,
with the addition of the provisions contained in cls. (b) and (c). In
the discussion preceding the adoption by the Group of Experts of
this para, several members from developing countries expressed
support for the “force of attraction” rule, although they would limit
the application of that rule to business profits covered by art. 7 of
the OECD Model Convention and not extend it to income from
capital (dividends, interest and royalties) covered by other treaty
provisions. The members supporting the application of the “force of
attraction” rule also indicated that neither sales through
independent commission agents nor purchase activities would
become taxable to the principal under that rule.
Article 7(1)
Limited FoA
“Some members from developed countries pointed out that the
“force of attraction” rule had been found unsatisfactory and
abandoned in recent tax treaties concluded by them because of
the undesirability of taxing income from an activity that was
totally unrelated to the establishment and that was in itself not
extensive enough to constitute a PE. They also stressed the
uncertainty that such an approach would create for taxpayers.
Members from developing countries pointed out that the
proposed “force of attraction” approach did remove some
administrative problems in that it made it unnecessary to
determine whether particular activities were or were not related
to the PE or the income involved attributable to it. That was the
case especially with respect to transactions conducted directly by
the home office within the country, but similar in nature to those
conducted by the PE.
Article 7(1)
Limited FoA
• However, after discussion, it was proposed that the “force of
attraction” rule, should be limited so that it would apply to
sales of goods or merchandise and other business activities in
the following manner: if an enterprise has a PE in the other
Contracting State for the purpose of selling goods or
merchandise, sales of the same or a similar kind may be taxed
in that State even if they are not conducted through the PE; a
similar rule will apply if the PE is used for other business
activities and the same or similar activities are performed
without any connection with the PE.”
Article 7(1)
#NoFOA
• Klaus Vogel explains the preference for a system which did not
adopt the ‘Force of Attraction’ rule in (3rd Edition, Vol I, page 410):
“This distribution of taxation according to the economic connection of the
profits concerned is preferable to the principle of ‘attraction force’ because
the former method proceeds from the enterprise’s individual
organizational structure and avoids restricting entrepreneurial freedom of
disposition through fictitiously allocating profits by way of generalizing
standards. While OECD committee on fiscal affairs recognized that such
extensive freedom of entrepreneurial disposition might also involve the
risk of being abused, it thought that this risk should not be given undue
weight and that much more importance should be attached to ensuring,
both for tax purposes and otherwise, that international business contacts
can be shaped according to commercial requirement.”
Article 7(1)
Case Study #1 - FoA
• DCIT vs. Roxon OY (106 ITD 489 Mumbai)
– Finish assessee company entered into contract to
“design, manufacture, deliver, erect, test and
commission certain bulk handling facility at Nava
Sheva Port Trust and to impart training to the NSPT”
– Clearly assessee had PE in India : no dispute there
– AO went one step further and held that assessee was
required to supply the equipment (offshore
equipment supply) and install it in India as part of a
turnkey contract, thus the supply was linked to the
installation and chargeable to tax under the ‘Force of
Attraction’ principle.
Article 7(1)
Case Study #1 - FoA
• Tribunal disagreed with Revenue and ruled in favour of assessee
• Considered in detail the FoA clauses of the relevant Treaty and
gave 3 reasons why profits from supplies did not fall within its
ambit:
– First is PE came into existence after supply transaction
– Second reason was, if anything, PE is deemed to be buying at
market value and selling at same value to customer; billing
was direct with customer and the hypothetical purchase &
sale by PE did not result in any profits to be taxable
– Third reason is in offshore supply of equipments etc in a
turnkey contract what can be taxed is only profits
attributable to the work effectively carried out by PE
Article 7(1)
Case Study #2 - FoA
• SNC-Lavalin vs. ACIT (110 TTJ Del 13)
– Assessee entered into contract with NHPC for Chamera project.
– Assesse claimed it had performed work relating to project even
prior to setting up of PE but bills were raised after PE was
established; claimed that profit not attributable to PE had to be
excluded
– Tribunal held limited FoA under India-Canada DTAA applies and
FoA holds good even for rendering of services
– It was held that as there was a composite contract for rendering
services in connection with setting up of the Hydroelectric project,
the work carried out outside India was deemed to have arisen in
India as it was the same as the services rendered by the PE in India.
– The fact that the invoices for the said off-shore work was raised
through the PE in India and accounted for in the books of project
office set up in India sealed the fate of the assessee.
Article 7(1)
Case Study #3 - FoA
• Sumitomo Corp. vs. DCIT (114 ITD 61 Del.)
– The assessee, a Japanese company, secured several contracts for
supply of various equipment's to Maruti Udyog Ltd for its car project
and also undertook to supervise the installation of the equipment's.
– The contracts were independent and not commercially a coherent
whole.
– The period of supervision in the case of individual contracts did not
exceed 180 days.
– The Department argued that there was a supervisory PE on the basis
that the period of all contracts had to be aggregated.
– It was also argued that as the supervisory services were “effectively
connected” with the PE, Article 12(5) applied and the fees thereof
had to be assessed as business profits and not as fees for technical
services
Article 7(1)
Case Study #3 - FoA
• Tribunal held that as far as Article 12(5) was concerned, the State where
the PE was located was entitled to tax only those profits which were
economically attributable to the PE and arose as a result of activities of
PE
• ITAT held that Article 12(5) adopted the “No Force of Attraction Principle”.
It held that Article 12(5) made a distinction between income which was
the result of activities of the PE and income which arose by reason of
direct dealings by the enterprise from the head office without the aid or
assistance of the PE.
• The term “effectively connected” was held not to be the opposite of
“legally connected” but as being “really connected”. It was held that the
connection had to be seen not in the form but in real substance.
• ITAT also repelled aggregation argument by Department with regard to
FoA rule and held that different contracts were not part of a coherent
whole and aggregating them would violate the FoA rule
Article 7(1)
Case Study #4 – FoA
• ITO vs. LinkLaters LLP (40 SOT 51 Mum.)
– Whether services rendered by UK law firm from outside India to
Indian clients was taxable in India given that assessee had a PE?
– India-UK DTAA does not have standard “Force of Attraction” clause in
the usual format but merely provides that if enterprise of one
Contracting State carries on business in other Contracting State
through PE, “the profits of the enterprise may be taxed in the other
State but only so much of them as is directly or indirectly attributable
to that permanent establishment“
– The Tribunal held that connotation of the phrase “profits indirectly
attributable to permanent establishment” incorporated FoA rule.
– It held that in addition to taxability of income in respect of services
rendered by the PE in India, ANY income in respect of the services
rendered to an Indian project (similar to the services rendered by the
PE) is also taxable in India irrespective of fact whether such services
are rendered through PE or directly by the general enterprise.
Article 7(1)
Case Study #4 - FoA
• Tribunal held that this indirect attribution, in view of the specific
provisions of the India-UK tax treaty, was enough to bring the
income from such services within the ambit of taxability in India.
• The Tribunal emphasized that the twin conditions that had to be
satisfied for taxability of related profits are (i) the services should be
similar or relatable to the services rendered by the PE in India; and
(ii) the services should be ‘directly or indirectly attributable to the
Indian PE’ i.e. rendered to a project or client in India.
• The effect of the judgement is that the entire profits relating to
services rendered by the assessee, whether rendered in India or
outside India, in respect of Indian projects became taxable in
India!!
• This ruling has been struck down (thankfully!) restored by
subsequent Mumbai Special Bench in ADIT vs. Clifford Chance (TS194-ITAT-2013 Mum)
Article 7(1)
FoA - Points to Ponder
• Around 30 of ~85 Indian DTAA’s contain some form of FoA.
– Many DTAA’s Limited FoA (Canada, Belgium, USA, Italy,
Denmark)
– Some DTAA’s limited Limited FoA!! (NZ, Indonesia)
– Some adopt UN Model with “Right to Prove otherwise”
(Sri Lanka, Cyprus, Germany)
– Some adopt OECD Model with variation (directly or
indirectly attributable to PE) (Japan, Singapore, UK, Malta,
Oman)
• Can we take refuge under the Indian Income Tax Act which
has only attribution to PE concept and no FoA?
OECD MC - Article 7(2)
PE : Computation Hypothesis
OECD MC 2008
OECD MC 2014
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 separate enterprise engaged in
the same or similar activities under the
same or similar conditions and dealing
wholly independently with the enterprise
of which it is a permanent establishment.
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 other parts of the enterprise.
UN MC - Article 7(2)
PE : Computation Hypothesis
UN MC 2001
UN MC 2011
Subject to the provisions of
Subject to the provisions
of paragraph
3, an enterprise
Subject toofthe
paragraph
3, where
a provisions of paragraph 3,
StateState
carries where
on business
in the of a Contracting State
where an enterprise ofContracting
a Contracting
an enterprise
Contracting State through
a permanent
carries on business in other
the other
carries on
business in the other
establishment
situated
therein,
there
shall in
Contracting State through
a
permanent
Contracting
State
each Contracting State be attributed to thatthrough a permanent
establishment situatedpermanent
therein, there
shall establishment
situated
therein, there shall
establishment
the profits which
it
in each Contracting State
bebe
attributed
in each
Contracting
might
expectedto
to make
if it were
a distinctState be attributed to
and separate
in the same
that permanent establishment
the enterprise
profits engaged
that permanent
establishment the profits
or similar
activities
the same
or similar
which it might be expected
to make
if it underwhich
it might
be expected to make if it
conditions
and
dealing
wholly
independently
were a distinct and separate enterprise
were a distinct and separate enterprise
with the enterprise of which it is a permanent
engaged in the same or
similar activities
engaged in the same or similar activities
establishment.
under the same or similar conditions and
dealing wholly independently with the
enterprise of which it is a permanent
establishment
under the same or similar conditions and
dealing wholly independently with the
enterprise of which it is a permanent
establishment
US MC – Article 7(2)
PE - Computation Hypothesis
US MC 1996
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 business
profits that 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. For this purpose, the business
profits to be attributed to the permanent
establishment shall include only the profits
derived from the assets or activities of the
permanent establishment.
US MC 2006
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 that 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. For
this purpose, the profits to be attributed to
the permanent establishment shall include
only the profits derived from the assets
used, risks assumed and activities
performed by the permanent establishment
Article 7(2)
PE – Computation Hypothesis
• Approach to determine profit of the PE. Historically two
approaches:
– Relevant business activity (or)
– Functionally separate entity
• OECD recommends “functionally separate entity” approach
• Profit should be determined by applying arm’s-length
principle – OECD TP Guidelines should be applied
– Clear movement towards Article 7(2) and Article 9 being
closely tied together : ALP is fundamental to the mix!
Article 7(2)
Authorized OECD approach
Determining
the profits
of a PE
Functional /
factual analysis
to determine the
Activities and
conditions of the
PE
Step1: Hypothesising
the PE as a distinct and
separate enterprise
Step 2:
determining the
profits of the PE
Functions
performed
Comparability
analysis
Assets used
Applying transfer
pricing methods
to attribute
profits
Risk assumed
Capital and
funding
Recognition of
dealings
Source: ICAI Article 7 Webinar:
24 May 2014
Article 7(2)
PE - Separate Entity Approach
• Difficulty in this approach is simply that PE is
not a separate entity
– It cannot enter into legally binding contracts with
remainder of enterprise of which it is part
– It cannot borrow funds or pay interest or royalties
to the remainder of the enterprise
– Thus to apply these guidelines developed in
context of separate enterprises means creating
functionally separate enterprise as an artificial
construction i.e., a separate enterprise fiction
Article 7(2)
Expenses of a PE: the bird’s-eye view!
• Three kinds of expenses for the PE:
(a) expenses that PE itself incurs in India
(b) expenses that the foreign company incurs at head office
level exclusively for the Indian PE and
(c) expenses that the foreign company incurs at head office
level generally for its business which also benefits the PE
being a part of the legal entity.
• With respect to direct expenditure i.e., clause (a) there is little
dispute; it is always deductible by PE
• Attribution of exclusive expenditure & apportionment (by key)
of general HO expenditure is always contentious – especially
the latter i.e., apportionment .
Article 7(3)….and beyond
Computation of profits attributable to PE
• A bit of history….
– OECD MC 2008 (i.e., prior to 2010), UN MC 2001 & 2011, US MC 1996
& 2006 were all along on the same lines – few differences such as FoA,
– Attribution to Permanent Establishment Report 2008, OECD changed
things!
– OECD MC 2010 made significant differences to Article 7
– In other words, US & UN Model follow the old OECD Model. Indian
treaties typically follow these too
– New OECD Model Article 7 framework reflects the growing trend of
using ALP as the backbone and integrating everything under the TP
umbrella
• What were the changes in OECD Model post 2008 ?
– OECD Model modified Article 7(2) to incorporate F.A.R, removed the
old OECD MC’s Article 7(3), 7(4), 7(5) and 7(6). New Article 7(3)
relating to corresponding adjustment introduced
Article 7(3)….
Computation of profits attributable to PE
OECD MC 2014
Art 7(3) 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
these profits, make an appropriate adjustment to the
amount of the tax charged on those profits. In
determining such adjustment, the competent
authorities of the Contracting States shall if necessary
consult each other.
Article 7(3)….
Computation of profits attributable to PE
OECD MC 2008 (prior to OECD MC 2010)
Art. 7(3) In determining the profits of a permanent establishment, there shall be allowed as
deductions expenses which are incurred for the purposes of the permanent establishment,
including executive and general administrative expenses so incurred, whether in the State in
which the permanent establishment is situated or elsewhere.
Art 7(4) Insofar as it has been customary in a Contracting State to determine the profits to be
attributed to a permanent establishment on the basis of an apportionment of the total
profits of the enterprise to its various parts, nothing in paragraph 2 shall preclude that
Contracting State from determining the profits to be taxed by such an apportionment as may
be customary; the method of apportionment adopted shall, however, be such that the result
shall be in accordance with the principles contained in this Article.
Art 7(5) 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.
Art 7(6) For the purposes of the preceding paragraphs, the profits to be attributed to the
permanent establishment shall be determined by the same method year by year unless
there is good and sufficient reason to the contrary.
Article 7(3)….
Computation of profits attributable to PE
UN MC 2011
Art 7(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 executive and general
administrative expenses so incurred, whether in the State in which the permanent
establishment is situated or elsewhere. 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 or other rights, or by way of commission,
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 permanent
establishment. Likewise, no account shall be taken, in the determination of the
profits of a permanent establishment, for amounts charged (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 or other rights, or by way
of commission 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.
Article 7(3)….
Computation of profits attributable to PE
UN MC 2011
Art 7(4) In so far as it has been customary in a Contracting State to
determine the profits to be attributed to a permanent establishment on the
basis of an apportionment of the total profits of the enterprise to its various
parts, nothing in paragraph 2 shall preclude that Contracting State from
determining the profits to be taxed by such an apportionment as may be
customary; the method of apportionment adopted shall, however, be such
that the result shall be in accordance with the principles contained in this
Article.
Art 7(5) For the purposes of the preceding paragraphs, the profits to be
attributed to the permanent establishment shall be determined by the same
method year by year unless there is good and sufficient reason to the
contrary.
(NOTE: The question of whether profits should be attributed to a
permanent establishment by reason of the mere purchase by that
permanent establishment of goods and merchandise for the enterprise was
not resolved. It should therefore be settled in bilateral negotiations.)
Article 7(3)….
Computation of profits attributable to PE
US MC 2006
Art 7(3) In determining the profits of a permanent establishment, there
shall be allowed as deductions expenses that are incurred for the
purposes of the permanent establishment, including executive and
general administrative expenses so incurred, whether in the State in
which the permanent establishment is situated or elsewhere (∗)
Art 7(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.
Art 7(5) For the purposes of the preceding paragraphs, the profits to be
attributed to the permanent establishment shall be determined by the
same method year by year unless there is good and sufficient reason to
the contrary.
UN Model Commentary on
Computation of expenses attributable to PE
• The UN MC specifically excludes certain deductions by PE in
Art. 7(2), the UN Model Commentary provides the rationale:
“41. The treatment of interest charges raises particular issues. First there might be
amounts which, under the name of interest, are charged by a head office to its
permanent establishment with respect to internal “loans” by the former to the
latter. Except for financial enterprises such as banks, it si generally agreed that
such internal “interest” need not be recognized. This is because:
- From a legal standpoint, the transfer of capital against payment of interest
and an undertaking to repay in full at due date is really a formal act
incompatible with the true legal nature of a PE
- From the economic standpoint, internal debts and receivables may prove to be
non existent, since if an enterprise is solely or predominantly equity funded it
ought not to be allowed to deduct interest charges that it has manifestly not
had to pay….”
42. For these reasons, the ban on deductions for internal debts and receivables
should continue to apply generally, subject to special situation of banks….
OECD Model Commentary 2014 on
Computation of expenses attributable to PE
• OECD MC 2014 Commentary deleted a number of paragraphs from Article
7 of previous versions of its MC. The rationale is explained in detail in its
Model Commentary as follows:
“38. Article 7, as it read before 2010, included the following paragraph 3:
“In determining the profits of a permanent establishment, there shall be
allowed as deductions expenses which are incurred for the purposes of the
permanent establishment, including executive and general administrative
expenses so incurred, whether in the State in which the permanent
establishment is situated or elsewhere.”
Whilst that paragraph was originally intended to clarify that paragraph 2
required expenses incurred directly or indirectly for the benefit of a permanent
establishment to be taken into account in determining the profits of the
permanent establishment even if these expenses had been incurred outside
the State in which the permanent establishment was located, it had
sometimes been read as limiting the deduction of expenses that indirectly
benefited the permanent establishment to the actual amount of the expenses.
OECD Model Commentary 2014 on
Computation of expenses attributable to PE
“39. This was especially the case of general and administrative expenses,
which were expressly mentioned in that paragraph. Under the previous
version of paragraph 2, as interpreted in the Commentary, this was generally
not a problem since a share of the general and administrative expenses of
the enterprise could usually only be allocated to a permanent establishment
on a cost-basis.
40. As now worded, however, paragraph 2 requires the recognition and
arm’s length pricing of the dealings through which one part of the enterprise
performs functions for the benefit of the permanent establishment (e.g.
through the provision of assistance in day-to-day management). The
deduction of an arm’s length charge for these dealings, as opposed to a
deduction limited to the amount of the expenses, is required by paragraph 2.
The previous paragraph 3 has therefore been deleted to prevent it from
being misconstrued as limiting the deduction to the amount of the expenses
themselves.
OECD Model Commentary 2014 on
Computation of expenses attributable to PE
“That deletion does not affect the requirement, under paragraph 2, that in
determining the profits attributable to a permanent establishment, all
relevant expenses of the enterprise, wherever incurred, be taken into account.
Depending on the circumstances, this will be done through the deduction of
all or part of the expenses or through the deduction of an arm’s length
charge in the case of a dealing between the permanent establishment and
another part of the enterprise.
41. Article 7, as it read before 2010, also included a provision that allowed the
attribution of profits to a permanent establishment to be done on the basis of
an apportionment of the total profits of the enterprise to its various parts.
That method, however, was only to be applied to the extent that its
application had been customary in a Contracting State and that the result was
in accordance with the principles of Article 7. For the Committee, methods
other than an apportionment of total profits of an enterprise can be applied
even in the most difficult cases. The Committee therefore decided to delete
that provision because its application had become very exceptional and
because of concerns that it was extremely difficult to ensure that the result of
its application would be in accordance with the arm’s length principle.”
OECD Model Commentary 2014 on
Computation of expenses attributable to PE
“42. At the same time, the Committee also decided to eliminate
another provision that was found in the previous version of the Article
and according to which the profits to be attributed to the permanent
establishment were to be “determined by the same method year by
year unless there is good and sufficient reason to the contrary.” That
provision, which was intended to ensure continuous and consistent
treatment, was appropriate as long as it was accepted that the profits
attributable to a permanent establishment could be determined
through direct or indirect methods or even on the basis of an
apportionment of the total profits of the enterprise to its various parts.
The new approach developed by the Committee, however, does not
allow for the application of such fundamentally different methods
and therefore avoids the need for such a provision”
• Bottomline: OECD has clearly moved to a separate entity model
driven by ALP analysis using its Transfer Pricing Guidelines
India’s DTAA’s
India’s DTAAs
Rubber hits the road!
• We saw the Model Conventions; what do India’s
negotiated DTAAs with various Countries?
• Most of India’s DTAA’s follow the UN MC and the old
OECD MC (2008)
– Have limited Force of Attraction (FoA) rule
– Deductions of expenses allowed for purpose of PE
including executive and general administrative
expenses
– Have clause which subjects allowability of expenses
to domestic laws of the State in which PE is situated
– Allow apportionment wherever necessary/applicable
India’s DTAA’s: An example
India-Belgium DTAA
ARTICLE 7 - BUSINESS PROFITS
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 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.
2. Where an enterprise of a Contracting State carries on business in the other
Contracting State through a permanent establishment situated therein, there
shall be attributed to such permanent establishment the profits which it might
be expected to derive if it were an independent enterprise engaged in the same
or similar activities under the same or similar conditions and dealing at arm's
length with the enterprise of which it is a permanent establishment.
India-Belgium DTAA (contd.)
• 3. (a) 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 executive and general
administrative expenses so incurred, whether in the State in which the permanent
establishment is situated or elsewhere, subject to the limitations of the taxation
laws of that State :
• Provided that where the law of the State in which the permanent establishment is
situated imposes a restriction on the amount of the executive and general
administrative expenses which may be allowed, and that restriction is relaxed or
overridden by any Convention or Agreement between that State and a third State
which is a member of the OECD which enters into force after the date of entry into
force of this Agreement, the competent authority of that State shall notify the
competent authority of the other Contracting State of the terms of the
corresponding paragraph in the Convention or Agreement with that third State
immediately after the entry into force of that Convention or Agreement and, if the
competent authority of the other Contracting State so requests, the provisions of
this sub-paragraph shall be amended by protocol to reflect such terms.
India-Belgium DTAA (contd.)
• (b) 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 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 permanent establishment. Likewise, no account shall be taken,
in the determination of the profits of a permanent establishment, for
amounts charged (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 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.
India-Belgium DTAA (contd.)
4. Insofar as it has been customary in a Contracting State to determine the
profits to be attributed to a permanent establishment on the basis of an
apportionment of the total profits of the enterprise to its various parts,
nothing in paragraph 2 or paragraph 3 shall preclude such Contracting
State from determining the profits to be taxed by such an apportionment
as may be customary; the method of apportionment adopted shall,
however, be such that the result shall be in accordance with the principles
laid down in this Article.
5. 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 purpose of export to the enterprise of which it is the
permanent establishment.
6. For the purposes of the preceding paragraphs, the profits to be attributed
to the permanent establishment shall be determined by the same method
year by year unless there is good and sufficient reason to the contrary.
7. Where profits include items of income which are dealt with separately in
other Articles of this Agreement, then the provisions of those Articles shall
not be affected by the provisions of this Article.
India’s DTAA’s: Points to note
•
•
India-UK DTAA (and India-Oman DTAA) has a paragraph on indirect
attributability to PE
– “3. Where a permanent establishment takes an active part in negotiating,
concluding or fulfilling contracts entered into by the enterprise, then,
notwithstanding that other parts of the enterprise have also participated
in those transactions, that proportion of profits of the enterprise arising
out of those contracts which the contribution of the permanent
establishment to those transactions bears to that of the enterprise as a
whole shall be treated for the purpose of paragraph 1 of this Article as
being the profits indirectly attributable to that permanent
establishment.”
Some DTAA’s like India-USA, India-Canada, India-Germany have an additional
“estimation” provision in Article 7(2)
– Art. 7(2) “... In any case, where the correct amount of profits attributable
to a permanent establishment is incapable of determination or the
ascertainment thereof presents exceptional difficulties, the profits
attributable to the permanent establishment may be estimated on a
reasonable basis provided that the result shall be in accordance with the
principles laid down in this Article.”
India’s DTAAs: Points to Note
• Few DTAA’s such as India-Italy and India-Japan don’t
seem to have provision to subject PE expense
deduction to domestic tax laws
• India-Cyprus DTAA has peculiar FoA exception to Art.
7(1)(b) & (c)
“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”
• India-Sri Lanka, India-Singapore DTAA’s seem to
have no FoA provision
Indian Income Tax Act & Attribution of profits to PE
Indian Income Tax Act & Attribution to PE
• Section 9(1)(i) of the IT 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”
Indian Income Tax Act & Attribution to PE
Taxability of Foreign Agency commission
• Withdrawal of Circular 23 & the whole agency commission fiasco
– Circular withdrawal doesn’t change the underlying statute!
– Assuming foreign agent has no PE here in India; Article 7 of
Treaty empowers Residence country to tax (and) S.9(1)(i)
read with Explanation 1(a) makes it not exigible to tax in
India
– If not exigible to tax in India, no question of TDS (GE India
Technology Centre Pvt. Ltd. Vs. CIT 327 ITR 456 SC)
– Dept.’s lookout is to how to construe the agency agreement
as Fees for Technical Services (FTS) so that PE restriction is
removed by deeming fiction of S.9(1)(vi) r.w its Explanation’s
– CIT vs. Faizan Shoes 48 taxmann.com 48 (Mad)
Indian Income Tax Act & Attribution to PE
Rule 10 of IT Rules
• 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.”
Indian Income Tax Act & Attribution to PE
Rule 10 of IT Rules (contd.)
 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 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.
Indian Income Tax Act & Attribution to PE
CBDT Circular No. 5 - 28th Sept. 2004
“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”.
Ad-hoc attributions: Typical Indian judicial flavour!
Issue
ITAT Ruling
Citation
Taxability of trading profits where
sale is concluded in India
10% of supply
Annamalais 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
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)
S.44C – Deduction of head office expenditure in the case of nonresidents
• In 1976, Indian legislature realized the need of placing some checks and
balances for deductibility of PE expenses that are not incurred in India.
• Section 44C was introduced in the Income tax Act, 1961 (‘the Act’) for this
purpose. Circular no. 202 in July 1976 issued which stated that it is
extremely difficult to scrutinize and verify claims in respect of head
office expenses, particularly in the absence of account books of the head
office which are kept outside India. It added that foreign companies
operating through branches in India sometimes try to reduce the
incidence of tax in India by inflating their claims in respect of head office
expenses. It was with a view to getting over these difficulties section 44C
was introduced.
• Section 44C defines head office expenses and lays down limit to which
such expenses can be claimed as deduction from PE profits.
S.44C – Deduction of head office expenditure in the
case of non-residents
• It covers all executive and general administration expenses including rent,
rates, taxes, insurance, salary, travelling etc. incurred outside India. The
definition in the Act is inclusive and the tax treaties do not provide any
definition.
• Usually, the executive and general administrative expenses include
expenses that are related to the overall management of the enterprise
and in addition to the specifics in the inclusive definition it can encompass
depreciation, expenses related to office equipment, expenses on periodic
meetings, training and skill enhancement, market research and analysis,
expenses on standard operating procedures, marketing costs for the
overall enterprise etc.
• The limit of deduction is restricted to five percent of adjusted total income
even if the expenses actually incurred and attributable to the PE are
higher.
S.44C –Few case laws…
• CIT vs. Emirates Commercial Bank Ltd. (262 ITR 55 Mum. HC)
– Provisions of S.44C cover only those expenses which are
common for various locations and require apportionment; does
not effect expenses incurred exclusively for PE
• John Wyeth & Brother Ltd. vs. CIT (312 ITR 80 Mum. HC)
– HO Allocation of R&D expenses will not fall under S.44C
restriction as it is not general administrative or executive in
nature
• JCIT vs. American Express Bank (ITA 5904/Mum/2000, ITAT Mum.)
– Expenses incurred by HO in relation to solicitation of NRI
deposits and other expenditure incurred for Branch
– AO applied S.44C to restrict the expense deductions claimed by
assessee PE
– ITAT decided in favour of assessee and said expenditure incurred
for PE should be allowable u/s 37(1) and not restricted by S.44C
Indian cases - Attribution of profits to PE
Case #1: Morgan Stanley
• SC delivered a landmark judgment in the case of DIT
(Intl. Tax.), Mumbai v. Morgan Stanley and Co. Inc. (Civil
Appeal 2914 of 2007 SC), ruling that the outsourcing of
services such as back-office operations to a captive
service provider will not per se create a permanent
establishment of the parent in India.
• It has also accepted the single-entity approach for the
attribution of profits to a PE by ruling that the payment
of an arm’s-length price by the nonresident to the PE
extinguishes any further attribution of profits to tax.
And it has reiterated the importance of considering an
economic nexus before taxing a nonresident’s global
profits in India.
Indian cases - Attribution of profits to PE
Case #1: Morgan Stanley
• SC delivered a landmark judgment in the case of DIT
(Intl. Tax.), Mumbai v. Morgan Stanley and Co. Inc. (Civil
Appeal 2914 of 2007 SC), ruling that the outsourcing of
services such as back-office operations to a captive
service provider will not per se create a permanent
establishment of the parent in India.
• It has also accepted the single-entity approach for the
attribution of profits to a PE by ruling that the payment
of an arm’s-length price by the nonresident to the PE
extinguishes any further attribution of profits to tax.
And it has reiterated the importance of considering an
economic nexus before taxing a nonresident’s global
profits in India.
Indian cases - Attribution of profits to PE
Case #2: Ishikawajima-Harima Heavy Industries Ltd. vs. 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 in 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 and
subsequently FA 2010)
Indian cases – Attribution of profits to PE
Case #3: Rolls Royce PLC (ITA No.493/2008)
• Rolls Royce India Ltd. (RRIL) liasion office carried out activities only in
respect of Rolls Royce Plc
• RRIL India key responsibility was securing orders, solicit request for
quotation/orders for RRPlc products
• RRIL, India personnel actively work with RRPlc and are involved in
meetings with clients, where contracts are discussed and decisions
taken
• RRPlc designated on certain occasions RRIL, India as sole point of
contact in respect of some customers
• RRIL India marketed certain after sales/other services provided by
RRPlc to customers and also provided advise/recommendation as
regards cutomer proposals
• ITAT held all profits directly and indirectly attributable to PE to be
considered; profits attributed to India set at 35% using Rule 10 as only
marketing done in India
Indian cases – Attribution of profits to PE
Case #4: Set Satellite DIT vs. Set Satellite (ITA No.944/2007)
• Where the assessee had a ‘Dependent Agency Permanent
Establishment’ (‘DAPE’) (“SET India”) in India and it was
admitted by the Revenue that the assessee had paid ‘arms
length’ remuneration to the said dependent agent but the
Tribunal still held (106 ITD 75) that notwithstanding the
taxability of the said dependent agent in accordance with
domestic law, the assessee had to be assessed in respect of
the
profits
attributable
to
the
said
DAPE,
held, reversing the judgement of the Tribunal
Indian cases – Attribution of profits to PE
Few other cases…
• DIT vs. Set Satellite (Singapore) Pte. Ltd. (ITA No.1676 of 2011
Mum. HC) : Royalty income not taxable in India since there is no link
between payment of Royalties and taxpayer’s PE in India
• Ahmedbhai Umarbhai & Co (1950) SCR 335) : Profit apportionment
on the basis of business activities, manufacturing profits taxable in
the jurisdiction where manufacturing takes place
• 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
• DIT vs. Galileo Advertising 180 Taxman 357 Delhi. HC) : Held that
15% of revenue generated from bookings within India is taxable in
India.
Interplay of Article 7 & other Articles
Interplay of Article 7 & other Articles
Specific Article vs. Article 7
• All Model Conventions agree on this. Phew!
“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.”
• Specific trumps over the General: when the characterization
of payment belongs to one of the types covered by a specific
Article of the convention, that has to apply and not the catchall business profits Article 7.
Interplay of Article 7 & other Articles
Payments “effectively connected” with PE
“6. The provisions of paragraphs 1 and 2 of this Article shall not
apply if the beneficial owner of the royalties or fees for technical
services, being a resident of a Contracting State, carries on business
in the other Contracting State in which the royalties or fees for
technical services arise through a permanent establishment
situated therein, or performs in that other State independent
personal services from a fixed base situated therein, and the right,
property or contract in respect of which the royalties or fees for
technical services are paid is effectively connected with such
permanent establishment or fixed base. In such case, the provisions
of Article 7 (Business profits) or Article 15 (Independent personal
services) of this Convention, as the case may be, shall apply.” (IndiaUK DTAA)
Interplay of Article 7 & other Articles
Payments “attributable to” PE
• “6. The provisions of paragraphs 1 and 2 shall not apply if the
beneficial owner of the royalties or fees for included services,
being a resident of a Contracting State, carries on business in the
other Contracting State, in which the royalties or fees for included
services arise, through a permanent establishment situated
therein, or performs in that other State independent personal
services from a fixed base situated therein, and the royalties or
fees for included services are attributable to such permanent
establishment or fixed base. In such case the provisions of Article 7
(Business Profits) or Article 15 (Independent Personal Services), as
the case may be shall apply.” (India-USA DTAA)
Interplay of Article 7 & other Articles
Few case laws…
• Worley Parsons Pty Ltd. (In re 747 of 2007)
– The services rendered and the work undertaken by the
applicant-Australia n company in terms of the Agreement for
Basic Engineering and Procurement services fall within the
scope of `royalties’ as defined in Article XII(3) of the DTAA
between India and Australia and the receipts are taxable in India
by virtue of Article XII(2); under the Income-tax Act too, they are
so taxable
– The exclusion clause under Article XII (4) of the DTAA is not
attracted in view of the absence of the effective connection
between PE and the services, and therefore, the royalty income
is liable to be taxed under Article XII(2) of the DTAA read with
section 9(1)(vi) and other charging provisions of the Act.
Interplay of Article 7 & other Articles
Few case laws…
• ADIT (IT) 3 (2) v. Bunge Agribusiness Singapore Pte. Ltd. [ITA No 6116 &
6117 (Mum.) of 2008]
• Assessee, a Singapore based company, received service fees from its 100
per cent Indian subsidiary for rendering legal and accounting services and
cost sharing arrangements. AO treated those services to be taxable as fees
for included services under article 12(4) of Indo-Singapore DTAA.
• On Appeal, assessee contended that it had a PE in India to which the
aforementioned receipts belonged in relevant years. Therefore, the
receipts would be assessed under Article 7 of the DTAA as business profits.
CIT (A) upheld the claim and split the consideration as 25% for technical
services and 75% as business receipts. Revenue files Appeal before ITAT.
• Tribunal held: Paragraph 1 & 2 of Article 14 which regulates the taxability
of royalty for fee for technical services in the State in which it arise on the
gross amount at the specified rate will not be applicable if these receipts
are effectively connected with PE or fixed base. Therefore, provisions of
Article 7 will apply
Interplay of Article 7 & other Articles
Few case laws…
• In ACIT vs. Clough Engineering (130 ITD 137 Delhi SB), Special
Bench of Tribunal in ACIT vs. held that interest earned on
income-tax refund is taxable on gross basis at 15% under Article
11 of India-Australia DTAA and not under Article 7 r.w. Article
11(4)
• Tribunal held that even if debt is connected to receipts of PE it
cannot be said to be effectively connected with such receipts
because responsibility to tax lies with assessee foreign company
from the final profit ascertained as on last day of previous year
• Following Clough(supra), Bechtel International Inc. vs. ADIT (ITA
No.5198/Mum/2010) held in favour of assessee that interest on
income-tax refund was not effectively connected with assessee
PE in India
Interplay of Article 7 & other Articles
Points to ponder…
• Spice Telecom vs. ITO (113 TTJ 502 Bang.)
– In absence of FTS clause in India-Mauritius Treaty,
payments will be governed by Article 7 of said tax
treaty
• DCIT vs. TVS
2012(Chny))
Electronics
(TS-421-ITAT-
– Domestic law prevails if no provision exists for
particular head of income under Treaty (??!!)
Summary
• Article 7 r.w. Article 5 forms the cornerstone of any DTAA
• Number of changes made to the Article 7 in the MC’s especially OECD
– Latest OECD MC and UN/US MC’s seem to diverge significantly
• Concept of PE dynamic
– Even more so with advent of electronic commerce!
• Attribution always contentious and complicated
• Move to use ALP and TP as the basis of attribution
• Indian Income Tax Act has its own set of provisions and rules
• Force of Attraction rules
– Not enshrined in OECD Model as they don’t find favour in developed
countries but used by developing nations such as India who follow the
UN Model in this regard
• When payments come under Specific Articles, those Articles get invoked
and not Article 7
– Except for payments effectively connected to/attributable to PE
Thanks!
Presentation By
Vikram Vijayaraghavan, Advocate
vvikram@saprlaw.com / vvikram@gmail.com
c/o M/s Subbaraya Aiyar, Padmanabhan &
RAMAMANI (SAPR) Advocates
New No 114, Royapettah High Road, Chennai – 14
044-28130254, +91-98402-51125
http://www.saprlaw.com / office@saprlaw.com
Acknowledgments:
Ms. Bhavya Rangarajan & Mr.Dhiraj Raman, SAPR Advocates