Section 92CE-Secondary Adjustments- Finer Aspects

Section 92CE – Secondary adjustment- Deciphering Finer aspects

·         Legal enforceability of Rate of Interest prescribed u/s 92CE

Section 92CE relating to Secondary adjustment provides for following:-

a)      Deeming excess money (Excess of Arm’s length Price as a result of Primary adjustment over value of International transaction) as an advance recoverable from Associated Enterprise.

b)      Manner of computation of Interest on such an advance.

c)       Rate of Interest.

In my view, the rate of interest prescribed under rule 10CB in exercise of power u/s 92CE lacks legal enforceability enunciated as under:-

1.       Each section and each chapter of Income Tax Act is meant for specific operation/action as under;-

i)                    Section 2- Defining the meaning of word used in the Act, either extending or curtailing the dictionary or common parlance meaning of the word.

ii)                   Section 4 is charging section

iii)                 Section 5 defines the range of Income

iv)                 Section 14 qualifies the income to various head

v)                  Section 15 to 59 (Chapter IV) quantify the Income

vi)                 Chapter X - Special provisions relating to avoidance of tax - In other words, the said chapter deals with  the Specific Anti Avoidance rules (SAAR) in various scenarios, whereby it provides measures to re-adjust the taxable income quantified under substantive provisions of Chapter IV

2.       Submission as regard non-enforceability of rate of interest prescribed u/s 92CE.

a)      Is every advancement of money by assessee is taxable transaction, mandating him to compute and offer for tax interest thereon, even if no interest is charged by him?  This aspect is possible in either of the two scenarios;-

i)                    Where Interest on such advance is deemed as Income u/s 2(24) or

ii)                   Transaction of advancement of money is made part of SAAR, whereby if prescribed conditions are satisfied, assessee will be liable to offer for tax interest on such advance.

b)      Section 92CE deems that excess money (Excess of Arm’s length Price as a result of Primary adjustment over value of International transaction) is an advance recoverable from Associated Enterprise (deemed debt).

c)       Section 2(24) has not been amended to provide for interest on deemed debts as deemed income.

d)      Section 92B provides that transaction of advance between enterprise and associated enterprise is an international transaction.

e)      Section 92 provides that income arising on international transaction shall be determined as per Arm’s length principle.

f)       Thus in view of afore-said, the interest on deemed debt u/s 92CE is made taxable (i.e charged) by virtue of application of Section 92 i.e SAAR and in this scenario, Interest rate prescribed u/s 92CE has no applicability, explained as under:-

i)                    Assessee will be required to find comparable uncontrolled transaction (CUT) for deemed debt

ii)                   The Income accruing under CUT will be deemed as income from deemed debt.

iii)                 There is no requirement to visit section 92CE to compute interest on deemed debt on the rates prescribed in the section, when the same is computed under ALP mechanism.

g)      At this point, following points also merits attention

                                I.            The role of Chapter X is to prescribe benchmark/milestone/criterion to evaluate whether there is avoidance of tax in different scenarios and then provide the mechanism to recover avoided tax either through enhancement of income or disallowance of loss quantified under chapter IV and other substantive provisions.

                              II.            The quantification/computation of income is a solely domain of chapter IV.

                            III.            Even if definition of income is being amended to deem interest on deemed debt as income, its quantification can be only be provided in Chapter IV and not in Chapter-X

                            IV.            Safe harbor rules u/s 92CB also does not provide for quantification of Income. It only provides that if an income on international transaction is within the range provided under safe harbor rule, it will be deemed that same is as per ALP, even if income under comparable transaction is more than income under international transaction. In other words, safe harbor rule does not provide for quantification of income but only modifies the ALP mechanism by making section 92 subject to section 92CB.

                              V.            To illustrate, section 92B provides that Corporate Guarantee or receivable is International transaction and income/interest thereon shall be computed on ALP basis. Safe harbor rules only provide that in certain situations, if income/interest thereon, quantified under Chapter IV, is at level specified in the safe harbor rules, it shall be deemed that income/interest is at ALP. Thus law has not quantified income/interest on corporate guarantee or receivable under chapter X

                            VI.            For Secondary adjustment, section 92 has not been made subject to section 92CE, similar to safe harbor rules. Thus section 92 will operate independently of section 92CE. Further, when a section provides for chargeability of Income to Tax, then computation machinery relating to that charging section will prevail, over the other computation provision relating to that income.

Thus interest rate prescribes u/s 92CE has no applicability for following reasons:-

a)      The interest on deemed debt is made chargeable by virtue of application of provision of  section 92 and accordingly interest is to be computed as per the ALP mechanism prescribed for section 92, rather than on the basis of rate prescribed u/s 92CE

b)      Section 92 has not been made subject to the provision of section 92CE, similar to section 92CB relating to Safe harbor rules, thus providing for independent operation of section 92.

c)       Further role of Chapter X is not to provide for quantification of Income, which is sole prerogative of Chapter IV.

·         Recovery of deemed debt

1.       Section 92CE provides that till deemed debt is recovered, assessee has to charge interest on deemed debt.

2.       The point for consideration is whether deemed debt should be recovered separately in specie or if the value of International transaction in subsequent years is more than ALP, can it be taken that assessee has recovered deemed debt

3.       If deemed debt is recovered separately, then issues involved will be as under:-

a)      The deemed debt is not an actual debt in the books of assessee.

b)      If the assessee recover such deemed debt, then recovery of same will be either credited in the P&L or be taken as direct credit to reserve.

c)       In the year of recovery, if assessee  is subject to MAT, then whether assessee will be liable to MAT, if such amount is credited to P&L

d)      There is no such exception provided u/s 115JA for exclusion of the same

e)      However MAT is entire code in itself and whether exclusion of such recovery from computation of book profit will be permitted is debatable question

f)       If MAT is not applicable and recovery is credited to P&L, then under normal provision, assessee can exclude the same from Computation of Income, on the principle of double taxation of same income.

4.       If in subsequent years, value of International transaction is more than ALP, then can it be deemed that assessee has recovered deemed debt advanced to associated enterprise. Exemplified

a)      In year 1, AO made primary adjustment to the extent of Rs. 5 Cr, which assessee disputed and but lost the case before ITAT in Year 5

b)      In Year 2 & 3, the assessee facts are as under;-

Year	Income under International Transaction	Income under Comparable Uncontrolled Transaction
2	12 Cr	10 Cr
3	14 Cr	11 Cr

c)       In above case, though assesse international transaction is at ALP, can assessee take stand that since income under international transaction is in excess of income under CUT by Rs. 5 Cr in aggregate, he has recovered the deemed debt relating to Year 1 and as such there is no requirement for secondary adjustment in Year 5, when assessment proceedings for year 1 crystallized.

Transfer Pricing Documentation – Country by Country Report- India landscape

Transfer Pricing Documentation – Country by Country Report- India landscape

1.       BEPS Action Plan 13 advocates Three-tiered approach to transfer pricing documentation as under:-

a)      Master file – Overview Information about MNE group categorized in 5 categories

i)                    MNE group organization Structure

ii)                   Description of MNE’ businesses

iii)                 MNE’s intangibles

iv)                 MNE’s inter-company financial Activities

v)                  MNE’ financial and tax position

b)      Local File – Containing detailed information relating to transaction between local country affiliate and associated enterprise, relevant financial information regarding said transaction, comparability analysis and selection and application of most appropriate transfer pricing method

c)       Country by country Report – Containing the following information

i)                    the aggregate information in respect of the amount of revenue, profit or loss before income-tax, amount of income-tax paid, amount of income-tax accrued, stated capital, accumulated earnings, number of employees and tangible assets not being cash or cash equivalents, with regard to each country or territory in which the group operates

ii)                   the details of each constituent entity of the group including the country or territory in which such constituent entity is incorporated or organised or established and the country or territory where it is resident

iii)                 he nature and details of the main business activity or activities of each constituent entity

2.       BEPS – Annual Submission of Transfer Pricing Documents to relevant Tax Authority

a)      Master and local File – Every constituent entity is required to submit Master and local file with tax authority of the country in which entity is operating, irrespective of Revenue of such entity.

b)      Country by Country Report – Parent entity of the group is required to file country by country report in tax jurisdiction in which such parent entity is resident, provided that annual consolidated group revenue of international group, as reflected in Consolidated Financial statement, in preceding fiscal year is not less than EUR 750 Mn.

3.       India Position

a)       India is signatory Country to the Multilateral Competent Authority agreement on exchange of country by country report.

b)      Accordingly, India is required to share the Country by Country report, furnish by parent entity in India, with other signatory Countries

c)       Accordingly Finance Act, 2016 has institutionalized the legal framework requiring the submission of country by country report by parent entity of MNE group, resident in India, to India’s Tax Authority.

d)      The content of reports and other incidental details are yet to notified through appropriate rules and guidelines

4.       India Legal Frame work

a)      Relevant Definitions – Under Section 286

i)                    Constituent Entity

·         Any separate entity of an international group that is included in the consolidated financial statement of the said group for financial reporting purposes;

·         Any Permanent establishment of separate business entity of International group

ii)                   Parent Entity - Constituent entity, of an international group holding, directly or indirectly, an interest in one or more of the other constituent entities of the international group, such that it is required to prepare Consolidated financial statement under any law for time being in force and no other constituent entity is required to prepare consolidated financial statement

iii)                 Group - includes a parent entity and all the entities in respect of which, for the reason of ownership or control, a consolidated financial statement for financial reporting purposes is required to be prepared

iv)                 International Group means any group  that includes:-

·         Two or more enterprises which are resident of different countries or territories

·         An enterprise, being a resident of one country or territory, which carries on any business through a permanent establishment in other countries or territories

b)      Amendment in Section 92D

i)                    Every Constituent entity, as defined u/s 286, is required to keep and maintain prescribed information & documents in respect of international group, as defined u/s 286. The prescribed information, to be notified through rules, must be relating to Master File and local file.  

ii)                   Every person who has entered into International transaction is required to furnish above-said prescribed information and documents to prescribed Authority. Submission of prescribed information is made mandatory irrespective of any amount of revenue

iii)                As per literal interpretation, it seems that constituent entity, which has not entered into international transaction, is only required to keep and maintain the prescribed information and documents and same is NOT required to be submitted to prescribed authority.

c)       Introduction of section 286 – Furnishing of Report in respect of International Group

Ø  The reporting requirement under this section is applicable only when consolidated group revenue as reflected in consolidated financial statement of International group for the accounting year preceding the reporting accounting year exceeds prescribed amount. This amount, to be specified in rules, must be in the range as specified is BEPS Action Plan-13

Ø  Reporting Requirement

·         When Constituent entity, resident in India,  is not a parent entity

·         When constituent entity, resident in India, is Parent entity

Reporting requirement - When Constituent entity, resident in India, is not a parent entity

i)                    It is require to notify to prescribe Income tax Authority on or before prescribe date, details of parent entity of International group and country or territory of which said parent entity is resident

ii)                   It is required to file country by country report of International group for a reporting accounting year to prescribed tax authority in India, if parent entity is resident of country-

·         With which India does not have an agreement for exchange of Country by Country report

·         There has been systemic failure of the country and said failure has been intimated by prescribed authority to such constituent entity

Systemic failure" with respect to a country or territory means that the country or territory has an agreement with India providing for exchange of report of the nature referred to in sub-section (2), but—

   (i) in violation of the said agreement, it has suspended automatic exchange; or

  (ii) has persistently failed to automatically provide to India the report in its possession in respect of any international group having a constituent entity resident in India.

Reporting requirement - When Constituent entity, resident in India, is not a parent entity.

i)                    Every parent entity , resident in India, shall for every reporting accounting year furnish country by country report in respect of International group  to prescribed Income tax Authority on or before the due date u/s 139(1)

ii)                   Reporting requirement exemplified

S.No.	Parent Entity	Other Constituent Entity	Remarks
1.	Resident In India	Subsidiary resident of foreign Country	Parent entity is required to file country by country report to prescribed tax authority in India
2.	Resident in India	PE in foreign Country	The group is international group, as defined above. So, Parent entity is required to file country by country report to prescribed tax authority in India.
3.	Resident in India	Subsidiary in foreign Country, but treated as resident of India under POEM	Parent entity is NOT required to file country by country report to prescribed tax authority in India, as the requirement of International group is not satisfied.

International Transaction -Receivable in the course of Business-Analysis

International Transaction -Receivable in the course of Business-Analysis

Finance Act 2012 added new wings to the definition of word “international transaction” u/s 92B of Income Tax Act, 1961 by adding an explanation to said section.

Among the various clauses of said explanation, under clause (i) (c ) “ debt arising during the course of business “  (Receivable)is given a recognition of being International Transaction.

·        Does it mean that Receivable was earlier not an International transaction but now made it or it was so previously, but now made it more explicit?

a)      In normal course Receivable arising in the course of business is not a transaction; it is a consequence/cause of transaction of sale of good on credit.

b)      A transaction of sale of goods inter-alia includes arrangement/understanding on the part of seller as regard execution of accompanied functions/risk like transportation of goods, credit terms, after sale services etc.

c)       As per clause (v) of section 92F, transaction includes arrangement, understanding, and action in concert.

d)      It seems that by virtue of afore-said provision u/s 92F, legislature must have assigned to arrangement/understanding on credit terms, the status of international transaction, which was hitherto not an international transaction but rather one of the facet of transaction of sale of good.

e)      The function of Explanation in a statute is to explain the meaning of certain phrases and expressions contained in the statutory provisions.

f)       The “Sale transaction”, already an international transaction by virtue of Substantive provision of section 92B, does not require aid of explanation to explain its meaning, which is an unambiguous in itself.

g)      Can an explanation deem a function/risk associated with Sale transaction as an international transaction without corresponding amendment in the substantive provision of section 92B or do an explanation have power to render anything as international transaction, when the same is not mandated by fundamental provision to which explanation is appended?

h)      Can said explanation be understood in the context of one limb of section 92B , “any other transaction having a bearing on the profit, income, losses or assets of enterprise”  , so as to include within its ambit the transaction of capital financing characterized in the Form of debt arising in the course of business i.e one entity financing its associated enterprise through credit sale of good and not collecting the corresponding Receivable over long period of time.

i)        It seems that true to Interpretation principles, Receivable shall be treated as an international transaction in the latter case only i.e where it is intended as mean of capital financing and not when same originate and collected in normal course of business.

·         If one ignores the afore-said enunciation, treat every Sale transaction and its associated Receivable, as separate International transactions in each and every case, the point of consideration is how to determine the ALP of Receivable:-

a)      Whether to determine ALP of Receivable independently of main transaction (sale of goods) to which it is sub-set or

b)      Whether ALP of Receivable is to be determined in juxtaposition with principal transaction from which it originate?

Ø  Do Receivable merit independent ALP benchmarking

a)      Separate analysis of Receivable dehors the primary sale transaction, do not stand the test of Transfer pricing principles.

b)      For transfer pricing analysis, following are pre-requisites:-

ü  An International Transaction

ü  Income or expenses associated with an International Transaction or expected to arise from an International transaction in Arm’s Length Scenario.

ü  Existence of Comparable transaction.

Now evaluate how Receivable falls into afore-said criterion

1.       Receivable is an international transaction by virtue of Explanation to section 92B.

2.        In ordinary course of business, no separate compensation is intended from Receivable but rather only profit from principal sale transaction is contemplated. However if Receivable extends beyond a threshold level, interest is considered as separate compensation for such Receivable. The threshold level would be dependent upon business exigencies and market trend. Thus in normal course, compensation for Receivable is embedded in Profit from sale transaction.

3.       Comparability

§  Receivable cannot be compared solely with the unsecured loan to determine appropriate rate of interest as compensation for Receivable, as both the transactions are not comparable. In loan transaction, the entire compensation is in the form of Interest and in Receivable, the compensation is incorporated in separate international transaction, being sale of goods.

§  There may be the case, where one person is charging interest on Receivable. Does this transaction (Charging Interest on Receivable) become a comparable case, so that tested party should also charge interest on Receivable? Consider a situation  of following two persons in same line of business, where normal credit period is business is 2 months

i)                    Mr. A Charging Sale price of 1020/unit

ii)                   Mr. B is charging sale Price of Rs. 1000/unit + Rs. 20 as Interest for credit period extended

Can anybody said, on the basis of transaction of Mr. B, that Mr. A should also charge Rs. 20 as Interest on his Receivable, without comparing the Sale price of both the parties.

The obvious answer seems to be NO. On account of cost involved in extending credit period, one person has compensated himself through enhanced sale price, while other person has explicitly charged separate consideration for the same, through Interest

§  Since the compensation for Receivable is inextricably linked with sale price, the appropriate comparable would always be comparable sale transaction but not an unsecured loan transaction.

Conclusion

a)      Though Receivable have been grouped under the category of capital financing in explanation to section 92B, it does not mandate that every Receivable should earn interest to satisfy benchmark of being at ALP.

b)      Enterprise envisages consolidated profit from sale transaction, which is meant to remunerate various associated functions like transportation, extending credit, after sale service etc.  If law deems any of such function as separate international transaction, it does not mean that assessee should charge separate compensation for the same, unless statue overtly provides for reducing the sale price because the recompense for such function (deemed transaction) is already included in principal sale transaction.

c)       The Transfer Provisions are part of anti-abusive measures which seeks to solicit rational behavior on the part of assessee; it cannot force assessee to do business in particular manner.

d)      Since income determination and comparability analysis of Receivable cannot be done in isolation with sale transaction, Arm length benchmarking of Receivable has to be in done in collocation with Primary Sale transaction Discrete Transfer Pricing analysis of Receivable in sequestration and derogation of primary sale transaction, of which it is sub-set, is not true comparability/benchmarking from Transfer pricing perspective in current scenario.

Ø  ALP determination of Receivable in association with Sale Transaction

o   Legal Position

a)      Section 92 requires that income arising from International Transaction should be determined on Arm’s length basis, advocating transaction by transaction approach in application of Arm’s Length Principles.

b)      Rule 10A(d) provides that transaction includes closely linked Transactions, empowering to treat closely linked transactions as single transaction for ALP benchmarking.

c)       The words closely linked transaction has not been defined in the Act or rule.

d)      Para 3.9 OECD Transfer Pricing guidelines provides that where pricing of two transactions are so closely linked that it is impractical to determine price of individual transactions, these transactions should be evaluated on combined basis.

e)       ICAI guidance note on Transfer pricing provides that two or more transactions can be said to be linked when these transactions emanate from a common source being an order or a contract or an agreement or an arrangement and the nature, characteristics and terms of these transactions are substantially flowing from the said common source.

f)       Receivable and Sale transaction not only originate from common contract but also their pricing cannot be determined on individual basis.

g)      Thus literature behind statutory provisions allows the evaluation of Sale Transaction and Receivable on aggregate basis.

o   Modus-operandi

Since the compensation for Receivable is part and parcel of sale transaction, ALP benchmarking of sale transaction in conjunction with the credit terms, will be due compliance of Transfer Pricing study of Sale Transaction and Receivable on aggregate/combined basis, as currently in practice.

a)      In case of CUP method, the adjustment in sale price of comparable to account for different credit terms shall be considered as due benchmarking and evaluation of Sale transaction & Receivable of Tested party

b)      In case of Margin Methods (CPM & TNMM), the margin of tested party duly adjusted for working capital difference shall be deemed as due ALP determination of Sale Transaction & Receivable.

·         Take another case: Suppose as per terms of Contract in international transaction, the credit period is two months, but in actual transaction, credit period is between 2-4 months. Can AO take a stand that compensation associated with 2 months credit period is incorporated in sale price and for balance terms of Receivable, Interest should be charged.

The stand of AO may be counter as under:-

a)      Evaluating credit term in sale transaction is a part of functional analysis establishing the credit risk taken by seller.

b)      In OECD guidelines, it is emphasized that we need to evaluate whether purported allocation of risk is consistent with economic substance of transaction and in this regard the parties’ conduct should generally be taken as best evidence of concerning the true allocation of risk.

c)       So if contract provides for credit period of 2 months, but actual conduct of parties convey credit period of 2-4 months, then seller shall be assumed to taking credit risk of 2-4 months based on actual conduct.

d)      Thus arrangement or understanding in transaction must be gathered from actual conduct of parties, rather than professed by parties.

e)      Thus if cumulative ALP determination of sale transaction in concurrence with actual credit terms is in consonance with Comparable sale transaction, then no separate Interest adjustment is required.

Summary

1.       It is not that compensation associated with Receivable was untaxed before deeming the Receivable as International Transaction. The ALP determination of Sale transaction duly takes into consideration the credit terms, thus compensation for cost associated with Receivable is duly factored into while evaluating the sale transaction. Thus said amendment has not plugged any existing loophole.

2.       On the principle of valuing each and every word of statue and principle of Harmonious Construction, it seem that deeming credit arrangement between associated enterprises, as discrete International Transaction warranting separate charge of interest on the same, should be taken in the sense of Capital financing only, in current setting of statue   

3.       Treating Receivable as international Transaction should not empower assessing authorities to take Interest as appropriate ALP of Receivable in normal course, without statute explicitly providing of reducing the sale price/Margin for compensation for Receivable already rooted therein, because if one goes by literal interpretation and treat every Receivable as International Transaction,  Sale Transaction and Receivable are already evaluated on combined basis

SERVICE PE- Centrica India Offshore- Judgement Crtically Analysed

SERVICE PE- Critical Observations on Judgement in Centrica Offshore India (P) Ltd.

Facts:-

1.       Centrica Plc, a company incorporated in UK, along with foreign subsidiaries in Canada, collectively referred to as “Overseas Entities” were engaged in the business of supplying gas and electricity to consumers across UK and Canada.

2.       The overseas entities outsource their back office support function (Debt collection/consumers billing/monthly jobs) to third party vendors in India.

3.       To ensure that Indian vendors comply with quality guidelines, Centrica Indian Offshore (P) Ltd (CIOP), as subsidiary of Centrica Plc. was established to provide locally based interface between overseas entities and Indian Vendors.

4.       To seek support during initial years, CIOP sought some employees from overseas entities (From UK and Canada) on secondment for some duration.

5.       Employees so seconded worked under direct control and supervision of CIOP. Overseas entities were not responsible for any error or omission of the work of such employees, CIOP bears all risk and rewards associated with work performed by such employee

6.       Seconded employees continued to remain on the payroll of their foreign employer, but CIOP reimburse their salary cost to overseas entities. Thus overseas entities were not generating any profits from the lending their personal to CIOP

7.       Seconded employees were rendering managerial services to CIOP.

Held

1.       It was held by AAR, which was subsequently confirmed by Hon’ble Delhi HC, that if the employees continue on the payroll of the non-resident and have a lien on their jobs in the non-resident multinational, a service PE can emerge if services are rendered in India for specified periods following judgement of Supreme Court in Morgan Stanley (292 ITR 416)

Critical Observations

·         It was simply held that since seconded person are employees of foreign entities, utilisation of their service for specified period in India will amount to PE of foreign Entities, irrespective of other factors critical for determination of PE.

·         Hereinafter below attempt is being made, to understand other important factors which give indication that there is no PE in the instant case and even if there is PE, No amount of profit can be attributed to said PE.

Critical Factors Analysed

1.       Nature of Income from India.

2.       Nature of operations in India.

3.       Amount of profit which can be Attributed to PE

Nature of Income

1.       Article 5(2)(k) of India-UK treaty deal with SERVICE PE, which provide for rendition of service by enterprise of contracting state (R state) in other contracting states (S state)   for more than 90 days in 12 month period, as essential condition for constitution of SERVICE PE.

2.       Article 5(1) is basic/Fixed PE clause, which provides that PE mean fixed place of business through which business of enterprise is wholly or partly carried on. For Fixed place PE, following test needs to satisfied:-

a)      Business Test – Carrying of business.

b)      Power of Disposition (Disposal Test)

c)       Permanence test – Geographically and Tenure

3.       It is well established that article 5(2) is not an article independent of Article 5(1), but rather Article 5(2) has to be read jointly and harmoniously with Article 5(1). For example , branch as provided in Article 5(2) will not become PE simpliciter unless conditions of Article 5(1) are satisfied.

4.       In Article 5(2)(k), the power of disposition test and permanence test has been replaced with a period of 90 days, but BUSINESS TEST is required to be satisfied in order to constitute SERVICE PE.

5.        The crucial point for consideration at this juncture is whether;-

a)      Whether every rendering of service by enterprise of  R State in S state, irrespective of nature of core business of enterprise will constitute PE in S State, thus amounting to carrying on business in S state or

b)      Only when core business of enterprise is in the realm of SERVICE business, then only SERVICE PE will be arise upon rendering of service in S State.

6.    To be more precise, in the instant case:-

a)      Centrica PLC (FE) is engaged in the business of supplying gas and electricity.

b)      In the course of business, FE lends its personals to its subsidiary to assist the subsidiary in the supervision of its works, which is deemed as rendering of service by Judicial authorities.

c)       Will such deemed rendering of service in India satisfied the BUSINESS TEST, as the business of FE is not lending of persons but the supplying gas and electricity i.e whether SERVICE PE is carrying on business of FE in India.

7.    In order to understand satisfaction of BUSINESS TEST of an activity, one of criterion is to determine which article of DTAA governs taxability of income from activity of Enterprise in S State. If it falls under Article 7, then arises the need to evaluate the existence of PE in S state, to which profit from such activities can be attributed.

8.    The words Enterprise is neither defined in treaty not in Income Tax Act. Enterprise can be taken as carrying on business.

9.    It is not the case, that each and every income of enterprise of R Sate from S state is taxable as Business Profit under Article 7. It depends upon the nature of income and accordingly relevant distributive rule will apply as under:-

a)      Income from Immovable Property – Article 6

b)      Business Profits – Article 7

c)       Dividend – Article 11

d)      Interest – Article 12

e)      Royalty and fees of Technical Service – Article 13

f)       Capital gain – Article 14

g)      Other Income – Article 23

8.       Now crucial question is whether any income digressed from main operation will constitute business income (attracting Article 7) or other income (attracting Article 23). In the instant case, lending of personal by FE is one-off activity being carried out without any profit motive, thus all essential of business is lacking in said activity.

9.       So if income from such activity is other income governed by Article 23, then there is no question for evaluation of PE in India, because PE has relevance only when concerned income is business income under Article 7 in S state, which can be attributed to PE.

Nature of Operations

1.       Article 5(3) of India-UK treaty provides that there will not any constitution of PE if activities there at are confined to activities which are solely of a preparatory or auxiliary character in nature.

2.       In instant case FE is engaged in the business of supplying gas and electricity and it has appointed various vendors in India to perform backup office work. In that process, it has established its subsidiary (CIOP) to supervise the work of said vendors.

3.       As per decision of Hon’ble supreme court in DIT Vs Morgan Stanley (292 ITR 416),  if PE is engaged in the business of back up office work, it amount to carrying on activities of auxiliary in nature.

4.       In the facts of the case, CIOP is supervising the auxiliary activities of FE in India.

5.       In performance of function of supervision, CIOP has availed the service of personal of FE, which is adjudicated as SERVICE PE of FE in India.

6.       When whole gamut of activity in India of FE is of auxiliary nature, rendering of supervisory and managerial services by SERVICE PE will too fall under the domain of activities of auxiliary nature.

7.       Thus when activities of FE in India is confined to activities of auxiliary nature, there is no constitution of PE under Article 5.

Attribution of Profit to PE.

1.       Without prejudice to what is said above, even if it assumed that FE has SERVICE PE in India, the big question is how much amount of profit can be attributed to said PE.

2.       Article 7(1) of India –UK treaty provide as under:-

“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 enter price may be taxed in the other State but only so much of them as is directly or indirectly attributable to that permanent establishment”

3.       In the instant case, FE has not earned any profit from the business of lending of personal to CIOP, as it has just recovered the salary cost of those personal from CIOP.

4.       Thus when no profit is being earned on business activity by FE, then despite the carrying on business in S state through PE,  no profit could be attributed to PE.

5.       Thus even in the facts of case, even if there is PE, there is no amount of profit which can be attributed to PE.