Case: Assistant Director of Income Tax-I, New Delhi Vs. M/s E-Funds IT Solution Inc

After framing several substantial questions of law, the High Court narrated the undisputed facts as follows:6. Undisputed facts in brief may be first noticed. The assessees are companies incorporated in United States of America (USA, for short) and were residents of the said country. They were assessed and have paid taxes on their global income in USA.Corp. was the holding company having almost 100% shares in IDLX Corporation, another company incorporated in USA. IDLX Corporation held almost 100% shares in IDLX International BV, incorporated in Netherlands and later in turn held almost 100% shares in IDLX Holding BV, which was a subsidiary again incorporated in Netherlands. IDLX Holding BV was almost a 100% shareholder ofIndia Private Limited, a company incorporated and resident of Indiad International India Private Limited has been described asd India). IDLX International BV was also the parent/holding company having almost 100% shares inInc., which as noticed above, was a company incorporated in USACorp. have entered into international transactions withIndia. The details of these transactions have to be examined in depth and have to be referred below.India being a domestic company and resident in India was taxed on the income earned in India as well as its global income in accordance with the provisions of the Act. The international transactions between the assessees andIndia and the income ofIndia, it is accepted, were made subject matter of arms length pricing adjudication by the Transfer Pricing Officer (TPO, for short) and the Assessing Officer (AO, for short) in the returns of income filed byIndia. We are not primarily concerned with the merits of the computation of income declared and assessed in the hands ofIndia in the present appeals, though the factum thatIndia was assessed to tax on its global income as per law or on arms length pricing in relation to associated transactions and the basis of the said computation of income earned byIndia, as noticed below, is a relevant and an important fact. Revenue has not disputed the said legal position. It is the contention of the Revenue that income of the two assessees were attributable to India because the two assessees had PE in India and should be taxed in India, irrespective of whether the said assessees had paid taxes in USA. Income earned and taxed in the hands ofIndia was different from the income attributable to the two assessees. Thus the balance or differential amount, i.e., income attributable to the two assessees, which was not included in income earned and taxed in the hands ofIndia, should be taxed in India8. As a principle what is stated and submitted by the Revenue cannot be contested and in fact not contested by the assessees as it is a principle applicable to international taxation. A foreign or at company can be taxed in the country where it has a subsidiary, which is also a PE on the income attributable to the said PE, even if the subsidiary (in the present case ofIndia) is being taxed in the said country. The principle being that subsidiary being an independent and a distinct entity is taxed for its income, whereas the foreign entity, i.e., holding company is taxed for the income earned by the said independent entity attributable to the PE in the country where subsidiary is situated. The income of the subsidiary is not taxed in the hands of the. Thus, there is no double taxation in the hands of the holding company as income of the subsidiary is not taxed as income of foreign holding assessee. The principle is that a subsidiary constitutes an independent legal entity for the purpose of taxation2. The assessing authority decided that the assessees had a permanent establishment (hereinafter referred to as PE) as they had a fixed place where they carried on their own business in Delhi, and that, consequently, Article 5 of the India U.S. Double Taxation Avoidance Agreement of 1990 (hereinafter referred to as DTAA) was attracted. Consequently, the assessees were liable to pay tax in respect of what they earned from the aforesaid fixed place PE in India. The CIT (Appeals) dismissed the appeals of the assessees holding that Article 5 was attracted, not only because there was a fixed place where the assessees carried on their business, but also because they were service PEs and agency PEs under Article 5. In an appeal to the ITAT, the ITAT held that the CIT (Appeals) was right in holding that a fixed place PE and service PE had been made out under Article 5, but said nothing about the agency PE as that was not argued by the Revenue before the ITAT. However, the ITAT, on a calculation formula different from that of the CIT (Appeals), arrived at a nil figure of income for all the relevant assessment years. The appeal of the assessees to the High Court proved successful and the High Court, by an elaborate judgment, has set aside the findings of all the authorities referred to above, and further dismissed thes of the Revenue. Consequently, the Revenue is before us in these appeals.

Reasoning: Specific and detailed criteria are set out in the aforesaid provisions in order to fulfill the conditions of these PEs existing in India. The burden of proving the fact that a foreign assessee has a PE in India and must, therefore, suffer tax from the business generated from such PE is initially on the Revenue12. Thus, it is clear that there must exist a fixed place of business in India, which is at the disposal of the US companies, through which they carry on their own business. There is, in fact, no specific finding in the assessment order or the appellate orders that applying the aforesaid tests, any fixed place of business has been put at the disposal of these companies. The assessing officer, CIT (Appeals) and the ITAT have essentially adopted a fundamentally erroneous approach in saying that they were contracting with a 100% subsidiary and were outsourcing business to such subsidiary, which resulted in the creation of a PE13. It further went on to hold that the ITATs finding that the assessees were a joint venture or sort of partnership with the Indian subsidiary was wholly incorrect. Also, none of these arguments have been invoked by the Revenue and such a finding would, therefore, be perverse. After citing Klaus Vogel on Double Taxation Conventions, Arvid A. Skaar in Permanent Establishment: Erosion of a Tax Treaty Principle and Bollinger v. Commissioner, 108 S.Ct. 1173, the High Court found against the Revenue, holding that there is no fixed place PE on the facts of the present case. We agree with the findings of the High Court in this regard14. Reliance placed by the Revenue on the United States Securities and Exchange Commission Form 10K Report, as has been correctly pointed out by the High Court, is also misplaced. It is clear that the report speaks of theof companies worldwide as a whole, which is evident not only from going through the said report, but also from the consolidated financial statements appended to the report, which show the assets of the group worldwide16. This report would show that no part of the main business and revenue earning activity of the two American companies is carried on through a fixed business place in India which has been put at their disposal. It is clear from the above that the Indian company only renders support services which enable the assessees in turn to render services to their clients abroad. This outsourcing of work to India would not give rise to a fixed place PE and the High Court judgment is, therefore, correct on this score18. It has already been seen that none of the customers of the assessees are located in India or have received any services in India. This being the case, it is clear that the very first ingredient contained in Article 5(2)(l) is not satisfied. However, the learned Attorney General, relying upon paragraph 42.31 of the OECD Commentary, has argued that services have to be furnished within India, which does not mean that they have to be furnished to customers in India20. We entirely agree with the approach of the High Court in this regard. Article 42.31 of the OECD Commentary does not mean that services need not be rendered by the foreign assessees in India. If any customer is rendered a service in India, whether resident in India or outside India, a service PE would be established in India. As has been noticed by us hereinabove, no customer, resident or otherwise, receives any service in India from the assessees. All its customers receive services only in locations outside India. Only auxiliary operations that facilitate such services are carried out in India. This being so, it is not necessary to advert to the other ground namely, that other personnel would cover personnel employed by the Indian company as well, and that the US companies through such personnel are furnishing services in India. This being the case, it is clear that as the very first part of Article 5(2)(l) is not attracted, the question of going to any other part of the said Article does not arise. It is perhaps for this reason that the assessing officer did not give any finding on this scoreHe is right in this submission as no argument on this score is found before the ITAT. However, for the sake of completeness, it is only necessary to agree with the High Court, that it has never been the case of Revenue thatauthorized to or exercised any authority to conclude contracts on behalf of the US company, nor was any factual foundation laid to attract any of the said clauses contained in Article 5(4) of the DTAA. This aspect of the case, therefore, need not detain us any furtherShri Ganesh is correct in stating that as the arms length principle has been satisfied in the present case, no further profits would be attributable even if there exists a PE in IndiaA perusal of the above would show that a competent authority should engage in discussion with the other competent authority in a principled, fair and objective manner, with each case being decided on its own merits. It is also specifically observed that where an agreement is not otherwise achievable, then both parties should look for appropriate opportunities for compromise in order to eliminate double taxation on the facts of the case, even though a principled approach is important. The learned Attorney General also relied upon Best Practice No.1 of the said OECD Manual, which requires the publication of mutual agreements reached that may apply to a general category of taxpayers which would then improve guidance for the future. Best Practice No.1 has no application on the facts of the present case, as the agreement reached applies only to the respondent companies, and not to any general category of taxpayers. It is clear, therefore, that Shri Ganesh is right in relying upon Article 3.6 of the OECD Manual. It is very clear, therefore, that such agreement cannot be considered as a precedent for subsequent years, and the High Courts conclusion on this aspect is also correctWe are afraid that this argument cannot be countenanced at this stage as it has never been raised before any of the authorities below and has not been raised before the High Court also. This being the case, we do not think it necessary to get into this aspect of the matter29. Having held in favour of the assessees that no permanent establishment in India can possibly be said to exist on the facts of the present case, we do not deem it necessary to go into thes that were filed before the High Court, which were dismissed by the High Court agreeing with the ITAT that the calculation of the ITAT would lead to nil taxation. This point would not arise in view of our decision on the facts of the present case. It is, therefore, unnecessary to go into this aspect of the matter.