CIT v. EFunds IT Solution & Ors.

Case Laws Analysis
Distinguished on Hitachi High Technologies Singapore Pte. Ltd. v. Dy. CIT 2019 TaxPub(DT) 6445 (Del-Trib)
Followed on Aspect Software Inc v. ADIT 2015 TaxPub(DT) 2422 (Del-Trib)
Relied Rolls Royce PLC v. Director of IT (International Taxation) 2012 TaxPub(DT) 0508 (Del-HC)
Set aside Janak Dehydration (P) Ltd. v. Asstt. CIT 2010 TaxPub(DT) 2292 (Ahd-Trib)
Partly affirmed E-Funds Corporation v. Asstt. Director of Income-tax (International Taxation) 2010 TaxPub(DT) 2286 (Del-Trib)
Applied Director of Income-tax (International Taxation) & Anr. v. Morgan Stanley & Co. & Anr. 2007 TaxPub(DT) 1354 (SC)
Relied Ishikawajma-Harima Heavy Industries Ltd. v. Director of Income-tax 2007 TaxPub(DT) 0876 (SC)
Relied Gkn Driveshafts (India) Ltd. v. Income Tax Officer & Ors. 2003 TaxPub(DT) 0734 (SC)
Relied CIT v. Toshoku Ltd. 1980 TaxPub(DT) 1127 (SC)
Relied CIT v. R.D. Aggarwal & Co. & Anr. 1965 TaxPub(DT) 0193 (SC)

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The Tax PublishersIT Appeal Nos. 735, 912 to 920 & 1200 to 1203 of 2011 2014 TaxPub(DT) 1849 (Del-HC) : (2014) 266 CTR 0001 : (2014) 226 TAXMAN 0044 : (2014) 099 DTR 0257 CIT v. eFunds IT Solution & Ors. INCOME TAX ACT, 1961 --Double taxation relief--Agreement between India and USAPermanent establishment (PE)--Merely because the non-resident assessee to protect their interest, for ensuring quality and confidentiality has sent its employees to provide stewardship services, will not make the Indian subsidiary or another entity, a PE of the non-resident company, Thus, on the question of seconded employees by the foreign enterprise/assessee to the Indian enterprise/subsidiary, one has to examine the nature and functions by the said seconded employees and who exercised control and supervised them. When and if the said employees had provided stewardship functions, no PE existed, even if the employees of the non-resident assessee were taken on deputation. The word 'permanent' in the expression PE is of significance and imperial importance. It refers to some degree of permanency and not a mere transitory nature of the business in the other State. Further, the enterprise must have a fixed place of business. [Para 20] The UN Commentary observes that place of business to constitute PE, the enterprise using it must carry on its business wholly or partly 'through' it, though the activity need not be productive in character and need not be permanent in the sense that there is no disruption, but the operations must be carried out on regular basis. Branch, offices and factory mentioned in para 2 are examples of fixed place of business. In para 4.6 of the OECD Commentary, the words 'through which' have been interpreted to have a wide meaning but postulate that the particular location should be at the disposal of the enterprise for that purpose and only then the business is carried through the location where the activity takes place. The word 'through' has been interpreted and read in a manner that the foreign enterprise should have the right to use the location in the second State. The said right may or may not be formalized through legal documentation, but right to use should be established and shown. Then and then alone fixed place PE shall exist. [Para 22] A subsidiary may become dependent or an independent PE agent provided the tests as specified in paras 4 and 5 are satisfied. A dependent agent is deemed to be PE of the principal establishment under para 4, if one of the three conditions specified in sub-clauses (a) to (c) are satisfied. [Para 24] Sub-clause (1) to article 5(2) defines what can be called service PE. Sub-clause (k) is also a type of service PE, but this clause is not relevant for the purpose of the present decision. The sub-clause (1) requires furnishing of services within the second Contracting State by a foreign enterprise through its employees or other personnel. But, a PE is created only if activities of that nature continue for a period or periods aggregating more than 90 days in 12 months period or under clause (ii) services are performed within that State for a related enterprise as defined in article 9 para 1. For application of clause (ii) no time period stipulation is postulated. Sub-clause (1) would apply only if the foreign enterprise or the two assessees had performed services in India through their employees or personnel, i.e., personnel engaged or appointed by the foreign assessee. [Para 26] Thus, the employees and other personal must be of the non-resident assessee to create a service PE. [Para 26] The services must be performed in respect of the activities within India. The distinction being activities 'within India' and activities 'between' the foreign enterprise/assessee and the Indian enterprise, i.e., the resident assessee is relevant. Thus, merely because the non-resident assessee to protect their interest, for ensuring quality and confidentiality has sent its employees to provide stewardship services, will not make the Indian subsidiary or another entity, a PE of the non-resident company. However, in respect of deputationists, the same principle was not applied. [Para 27] Thus, on the question of seconded employees by the foreign enterprise/assessee to the Indian enterprise/subsidiary, Court has to examine the nature and functions performed by the said seconded employees and who exercised control and supervised them. When and if the said employees had provided stewardship function, no PE exists even if the employees of the non-resident assessee were taken on deputation. [Para 29] Transactions between a foreign enterprise and an independent agent do not result in establishment of a PE under para 5 to article. 5 if the independent agent is acting in ordinary course of their business. The expression 'ordinary course of their business' has reference to activity of the agent tested by reference to normal customs in the case in issue. It has reference to normal practice in the line of business in question. However, as per para 5 of article 5, an agent is not considered to be an independent agent if his activities are wholly or mostly wholly on behalf of foreign enterprise and the transactions between the two are not made under arm's length conditions. The twin conditions have to be satisfied to deny an agent character of an independent agent. In case the transactions between an agent and the foreign principal are under arm's length conditions the second stipulation in para 5 of artcile 5 would not be satisfied, even if the said agent is devoted wholly or almost wholly to the foreign enterprise. [Para 35] The MAP procedure and agreement is, no doubt, relevant but cannot be determinative or the primary basis to decide whether the assessee had PE in India. There are several reasons for the same, including communication dt. 7-5-2007 of the Internal Revenue Services, America. [Para 42] 'Double taxation' means taxation of the same subject-matter or income in the hands of one assessee or one person in the two different countries. Double taxation can be avoided by either granting exemption or giving tax credit paid in the third country. As per the MAP procedure, there was decrease in the American taxable income and the tax paid on income in India was credited under the American laws. [Para 42] The AO, CIT(A) and the Tribunal have primarily relied upon the close association between e-Fund India and the two assessees and applied functions performed, assets used and risk assumed, criteria to determine whether or not the assessee has fixed place of business. This is not a proper and appropriate test to determine location PE. The fixed place of business PE test is different. Therefore, the fact that e-Fund India provides various services to the assessee and was dependent for its earning upon the two assessees is not the relevant test to determine and decide location PE. The allegation that e-Fund India did not bear sufficient risk is irrelevant when deciding whether location PE exists. The fact that e-Fund India was reimbursed the cost of the call centre operations plus 16 per cent basis or the basis of margin fixation was not known, is not relevant for determining location or fixed place PE. E-Fund India was/is a separate entity and was/is entitled to provide services to the assessees who were/are independent separate taxpayer. Indian entity, i.e., subsidiary company will not become location PE under article 5(1) merely because there is interaction or cross transactions between the Indian subsidiary and the foreign Principal under article 5(1). Even if the foreign entities have saved and reduced their expenditure by transferring business or back office operations to the Indian subsidiary, it would not, by itself, create a fixed place or location PE. The manner and mode of the payment of royalty or associated transactions is not a test which can be applied to determine, whether fixed place PE exists. [Para 49] The activities specified in article 5, para 3 would not create a PE, even when the conditions specified in paras (1) and (2) of article 5 are satisfied. Paragraph 3 is not a positive provision but a negative list. The said para does not create a PE but has a negative connotation and activities specified when carried on do not create a PE. [Para 50] The subsidiary may also render services to a third party on behalf of the principal. This by itself would not lead to a subsidiary becoming a PE unless requirements of paras 1, 2, 4 or 5 are satisfied. The observations of the Klaus Vogel, in fact, support the assessee as it postulates that partnership PE would be created only when the principal of the foreign enterprise retains the economic risk of contract and other general conditions, i.e., articles 5(1), 5(2), 5(4) and 5(5) of the DTAA are fulfilled. Tax authorities have to be cautious and aware of consequences when they apply joint venture or partnership principle in a case like the present one as it could be argued that substantial or significant part of the income of the joint venture entity should be taxed in the source State. [Para 52] The fact that 40 per cent of the employees of the entire group were in India, i.e., were employees of e-Fund India, will not make the said company agency subsidiary PE or fixed place PE of the assessee. Neither provision of any software, intangible data, etc. whether free of cost or otherwise, make e-Fund India an agency or fixed place PE of the two foreign assessees. Whether or not and on what basis e-Fund India was reimbursed expenses of xerox, courier charges, etc., will not make e-Fund India as PE of the assessee under articles 5(1), 5(4) or 5(5). Conditions and stipulates under articles 5(1), 5(4) or 5(5) will create a PE and not the said facts as highlighted in the impugned orders. [Para 56] Conditions of articles 5(4) are not satisfied in the present case. It is not the case of the Revenue that e-Fund India was authorized and habitually exercised authority to 'conclude' contract or was maintaining stock or merchandise from which it delivered goods or merchandise on behalf of the assessee or secured orders on behalf of the assessee. Therefore, the conditions and requirements of sub-clauses (a), (b) and (c) to article 5(4) are not satisfied. [Para 57] The transactions between the assessees and e-Fund India were at arm's length and were taxed on arm's length principle. There was no allegation or considered finding of the Tribunal that the transactions were not in ordinary course of business. In these circumstances, even otherwise requirements of article 5(5) are not satisfied in the present case. [Para 58] The Tribunal and the authorities have erred in treating employees of e-Fund India as employees of the assessees for determining whether service PE under article 5(2)(1) was created. There are no other factual findings recorded by the Tribunal in respect of service PE under artcile 5(2)(1). The assessment order also does not record any other relevant finding for creation of service PE under article 5(2)(1), other than payment received by e-Fund India for providing management and support service by the President and Sales Team to overseas group entities. Payment by e-Fund Corp on the said account were received for the year ending 31-3-2002, but stopped thereafter. This, no doubt, is a relevant aspect with reference to article 5(2)(a) but the said provision has not been invoked in the assessment order and in the appellate orders, including order of the Tribunal. [Para 59] Services of the nature specified in para 3 of article 5 have to be excluding while in determining and deciding whether or not a PE exists under article 5(2). There is another difficulty if one apply artcile 5(2) (a)â€”Place of management principle;â€” enterprises in UK and Australia were subsidiaries or legal entities and not branches of the assessees. To what extent and when 'place of management' principle will be applicable in such cases, DTAA which will be applicable as the associated enterprise were located in UK and Australia and computation of income attributable to the PE are highly debatable and contentious questions which require findings of facts at the first instance and cannot be made matters to be decided for the first time in an appeal under section 260A. [Para 60] At best, service PE for the year ending 31-3-2002 would have been created under article 5(2) (1) but again there has not been thorough and detailed discussion on the nature and type of services rendered and determination on question of salary and whether the President and employees of regional office could be treated as 'employees or other personnel' of the assessee. [Para 61] The AO has recorded that employees were seconded to e-Fund India but the functions they performed and whether they performed functions and reported to e-Fund Corp/associated enterprise was not known or ascertained. This was not the correct way of determining and deciding whether service PE existed. Whether the seconded employees were performing stewardship services or were directly involved with the working operations was relevant. It is also not known whether the services were performed related to services provided to an associated enterprise in which case clause 5(2)(1)(ii) would be applicable. In the said situation, the question of attribution of income, etc., would also arise. [Para 62] Existence of PE does not depend upon transfer of assignment or sub-contracting work/services to India, with an intent and purpose to save costs and to increase profitability of the assessee resident abroad. This is not the stipulation or requirement in article 5. [Para 67] Similarly, the contention and finding recorded that e-Fund India had provided necessary input or information to e-Fund Corp or e-Fund Inc. to enable them to enter into contracts which were sub-contracted or assigned to e-Fund India, will not make e-Fund India a PE of the assessee. This is not covered under any of the clauses or stipulations of art. 5. It is not the case that employees of e-Fund India had participated and/or were present in the negotiations of the assessee with the third parties, in respect of contracts to be paid/sourced from India or even executed/performed abroad. [Para 69] The AO has recorded incorrectly that majority of the employees of the two assessees operate from India. The said finding is legally untenable and drawn on a wrong legal principle. Employees of e-Fund India were not employees of e-Fund Corp or e-Fund Inc. Seconded employees were only two in number and only in assessment year 2005-06. It is further observed that the two assessees had significant assets in India on wrong legal assumption that assets of e-Fund India were assets of e-Fund Corp and e-Fund Inc. He has held that the assessee and e-fund India did not operate on arm's length basis as in respect of some contracts, e-Fund India had raised bills directly to the customer but for similar contracts/arrangement the entire amount was paid to the two foreign assessees and only a miniscule amount or profit was transferred or paid to e-Fund India. The said finding/conclusion again is not a correct inference. It is not borne out from the record and has not been accepted by the Tribunal as it has accepted attribution of income made by the assessee. [Para 70] SUBSCRIBE FOR FULL CONTENT

The Tax PublishersIT Appeal Nos. 735, 912 to 920 & 1200 to 1203 of 2011
2014 TaxPub(DT) 1849 (Del-HC) : (2014) 266 CTR 0001 : (2014) 226 TAXMAN 0044 : (2014) 099 DTR 0257

CIT v. eFunds IT Solution & Ors.

INCOME TAX ACT, 1961

--Double taxation relief--Agreement between India and USAPermanent establishment (PE)--Merely because the non-resident assessee to protect their interest, for ensuring quality and confidentiality has sent its employees to provide stewardship services, will not make the Indian subsidiary or another entity, a PE of the non-resident company, Thus, on the question of seconded employees by the foreign enterprise/assessee to the Indian enterprise/subsidiary, one has to examine the nature and functions by the said seconded employees and who exercised control and supervised them. When and if the said employees had provided stewardship functions, no PE existed, even if the employees of the non-resident assessee were taken on deputation.

The word 'permanent' in the expression PE is of significance and imperial importance. It refers to some degree of permanency and not a mere transitory nature of the business in the other State. Further, the enterprise must have a fixed place of business. [Para 20] The UN Commentary observes that place of business to constitute PE, the enterprise using it must carry on its business wholly or partly 'through' it, though the activity need not be productive in character and need not be permanent in the sense that there is no disruption, but the operations must be carried out on regular basis. Branch, offices and factory mentioned in para 2 are examples of fixed place of business. In para 4.6 of the OECD Commentary, the words 'through which' have been interpreted to have a wide meaning but postulate that the particular location should be at the disposal of the enterprise for that purpose and only then the business is carried through the location where the activity takes place. The word 'through' has been interpreted and read in a manner that the foreign enterprise should have the right to use the location in the second State. The said right may or may not be formalized through legal documentation, but right to use should be established and shown. Then and then alone fixed place PE shall exist. [Para 22] A subsidiary may become dependent or an independent PE agent provided the tests as specified in paras 4 and 5 are satisfied. A dependent agent is deemed to be PE of the principal establishment under para 4, if one of the three conditions specified in sub-clauses (a) to (c) are satisfied. [Para 24] Sub-clause (1) to article 5(2) defines what can be called service PE. Sub-clause (k) is also a type of service PE, but this clause is not relevant for the purpose of the present decision. The sub-clause (1) requires furnishing of services within the second Contracting State by a foreign enterprise through its employees or other personnel. But, a PE is created only if activities of that nature continue for a period or periods aggregating more than 90 days in 12 months period or under clause (ii) services are performed within that State for a related enterprise as defined in article 9 para 1. For application of clause (ii) no time period stipulation is postulated. Sub-clause (1) would apply only if the foreign enterprise or the two assessees had performed services in India through their employees or personnel, i.e., personnel engaged or appointed by the foreign assessee. [Para 26] Thus, the employees and other personal must be of the non-resident assessee to create a service PE. [Para 26] The services must be performed in respect of the activities within India. The distinction being activities 'within India' and activities 'between' the foreign enterprise/assessee and the Indian enterprise, i.e., the resident assessee is relevant. Thus, merely because the non-resident assessee to protect their interest, for ensuring quality and confidentiality has sent its employees to provide stewardship services, will not make the Indian subsidiary or another entity, a PE of the non-resident company. However, in respect of deputationists, the same principle was not applied. [Para 27] Thus, on the question of seconded employees by the foreign enterprise/assessee to the Indian enterprise/subsidiary, Court has to examine the nature and functions performed by the said seconded employees and who exercised control and supervised them. When and if the said employees had provided stewardship function, no PE exists even if the employees of the non-resident assessee were taken on deputation. [Para 29] Transactions between a foreign enterprise and an independent agent do not result in establishment of a PE under para 5 to article. 5 if the independent agent is acting in ordinary course of their business. The expression 'ordinary course of their business' has reference to activity of the agent tested by reference to normal customs in the case in issue. It has reference to normal practice in the line of business in question. However, as per para 5 of article 5, an agent is not considered to be an independent agent if his activities are wholly or mostly wholly on behalf of foreign enterprise and the transactions between the two are not made under arm's length conditions. The twin conditions have to be satisfied to deny an agent character of an independent agent. In case the transactions between an agent and the foreign principal are under arm's length conditions the second stipulation in para 5 of artcile 5 would not be satisfied, even if the said agent is devoted wholly or almost wholly to the foreign enterprise. [Para 35] The MAP procedure and agreement is, no doubt, relevant but cannot be determinative or the primary basis to decide whether the assessee had PE in India. There are several reasons for the same, including communication dt. 7-5-2007 of the Internal Revenue Services, America. [Para 42] 'Double taxation' means taxation of the same subject-matter or income in the hands of one assessee or one person in the two different countries. Double taxation can be avoided by either granting exemption or giving tax credit paid in the third country. As per the MAP procedure, there was decrease in the American taxable income and the tax paid on income in India was credited under the American laws. [Para 42] The AO, CIT(A) and the Tribunal have primarily relied upon the close association between e-Fund India and the two assessees and applied functions performed, assets used and risk assumed, criteria to determine whether or not the assessee has fixed place of business. This is not a proper and appropriate test to determine location PE. The fixed place of business PE test is different. Therefore, the fact that e-Fund India provides various services to the assessee and was dependent for its earning upon the two assessees is not the relevant test to determine and decide location PE. The allegation that e-Fund India did not bear sufficient risk is irrelevant when deciding whether location PE exists. The fact that e-Fund India was reimbursed the cost of the call centre operations plus 16 per cent basis or the basis of margin fixation was not known, is not relevant for determining location or fixed place PE. E-Fund India was/is a separate entity and was/is entitled to provide services to the assessees who were/are independent separate taxpayer. Indian entity, i.e., subsidiary company will not become location PE under article 5(1) merely because there is interaction or cross transactions between the Indian subsidiary and the foreign Principal under article 5(1). Even if the foreign entities have saved and reduced their expenditure by transferring business or back office operations to the Indian subsidiary, it would not, by itself, create a fixed place or location PE. The manner and mode of the payment of royalty or associated transactions is not a test which can be applied to determine, whether fixed place PE exists. [Para 49] The activities specified in article 5, para 3 would not create a PE, even when the conditions specified in paras (1) and (2) of article 5 are satisfied. Paragraph 3 is not a positive provision but a negative list. The said para does not create a PE but has a negative connotation and activities specified when carried on do not create a PE. [Para 50] The subsidiary may also render services to a third party on behalf of the principal. This by itself would not lead to a subsidiary becoming a PE unless requirements of paras 1, 2, 4 or 5 are satisfied. The observations of the Klaus Vogel, in fact, support the assessee as it postulates that partnership PE would be created only when the principal of the foreign enterprise retains the economic risk of contract and other general conditions, i.e., articles 5(1), 5(2), 5(4) and 5(5) of the DTAA are fulfilled. Tax authorities have to be cautious and aware of consequences when they apply joint venture or partnership principle in a case like the present one as it could be argued that substantial or significant part of the income of the joint venture entity should be taxed in the source State. [Para 52] The fact that 40 per cent of the employees of the entire group were in India, i.e., were employees of e-Fund India, will not make the said company agency subsidiary PE or fixed place PE of the assessee. Neither provision of any software, intangible data, etc. whether free of cost or otherwise, make e-Fund India an agency or fixed place PE of the two foreign assessees. Whether or not and on what basis e-Fund India was reimbursed expenses of xerox, courier charges, etc., will not make e-Fund India as PE of the assessee under articles 5(1), 5(4) or 5(5). Conditions and stipulates under articles 5(1), 5(4) or 5(5) will create a PE and not the said facts as highlighted in the impugned orders. [Para 56] Conditions of articles 5(4) are not satisfied in the present case. It is not the case of the Revenue that e-Fund India was authorized and habitually exercised authority to 'conclude' contract or was maintaining stock or merchandise from which it delivered goods or merchandise on behalf of the assessee or secured orders on behalf of the assessee. Therefore, the conditions and requirements of sub-clauses (a), (b) and (c) to article 5(4) are not satisfied. [Para 57] The transactions between the assessees and e-Fund India were at arm's length and were taxed on arm's length principle. There was no allegation or considered finding of the Tribunal that the transactions were not in ordinary course of business. In these circumstances, even otherwise requirements of article 5(5) are not satisfied in the present case. [Para 58] The Tribunal and the authorities have erred in treating employees of e-Fund India as employees of the assessees for determining whether service PE under article 5(2)(1) was created. There are no other factual findings recorded by the Tribunal in respect of service PE under artcile 5(2)(1). The assessment order also does not record any other relevant finding for creation of service PE under article 5(2)(1), other than payment received by e-Fund India for providing management and support service by the President and Sales Team to overseas group entities. Payment by e-Fund Corp on the said account were received for the year ending 31-3-2002, but stopped thereafter. This, no doubt, is a relevant aspect with reference to article 5(2)(a) but the said provision has not been invoked in the assessment order and in the appellate orders, including order of the Tribunal. [Para 59] Services of the nature specified in para 3 of article 5 have to be excluding while in determining and deciding whether or not a PE exists under article 5(2). There is another difficulty if one apply artcile 5(2) (a)â€”Place of management principle;â€” enterprises in UK and Australia were subsidiaries or legal entities and not branches of the assessees. To what extent and when 'place of management' principle will be applicable in such cases, DTAA which will be applicable as the associated enterprise were located in UK and Australia and computation of income attributable to the PE are highly debatable and contentious questions which require findings of facts at the first instance and cannot be made matters to be decided for the first time in an appeal under section 260A. [Para 60] At best, service PE for the year ending 31-3-2002 would have been created under article 5(2) (1) but again there has not been thorough and detailed discussion on the nature and type of services rendered and determination on question of salary and whether the President and employees of regional office could be treated as 'employees or other personnel' of the assessee. [Para 61] The AO has recorded that employees were seconded to e-Fund India but the functions they performed and whether they performed functions and reported to e-Fund Corp/associated enterprise was not known or ascertained. This was not the correct way of determining and deciding whether service PE existed. Whether the seconded employees were performing stewardship services or were directly involved with the working operations was relevant. It is also not known whether the services were performed related to services provided to an associated enterprise in which case clause 5(2)(1)(ii) would be applicable. In the said situation, the question of attribution of income, etc., would also arise. [Para 62] Existence of PE does not depend upon transfer of assignment or sub-contracting work/services to India, with an intent and purpose to save costs and to increase profitability of the assessee resident abroad. This is not the stipulation or requirement in article 5. [Para 67] Similarly, the contention and finding recorded that e-Fund India had provided necessary input or information to e-Fund Corp or e-Fund Inc. to enable them to enter into contracts which were sub-contracted or assigned to e-Fund India, will not make e-Fund India a PE of the assessee. This is not covered under any of the clauses or stipulations of art. 5. It is not the case that employees of e-Fund India had participated and/or were present in the negotiations of the assessee with the third parties, in respect of contracts to be paid/sourced from India or even executed/performed abroad. [Para 69] The AO has recorded incorrectly that majority of the employees of the two assessees operate from India. The said finding is legally untenable and drawn on a wrong legal principle. Employees of e-Fund India were not employees of e-Fund Corp or e-Fund Inc. Seconded employees were only two in number and only in assessment year 2005-06. It is further observed that the two assessees had significant assets in India on wrong legal assumption that assets of e-Fund India were assets of e-Fund Corp and e-Fund Inc. He has held that the assessee and e-fund India did not operate on arm's length basis as in respect of some contracts, e-Fund India had raised bills directly to the customer but for similar contracts/arrangement the entire amount was paid to the two foreign assessees and only a miniscule amount or profit was transferred or paid to e-Fund India. The said finding/conclusion again is not a correct inference. It is not borne out from the record and has not been accepted by the Tribunal as it has accepted attribution of income made by the assessee. [Para 70]