Profits Attributable To Permanent Establishment Can't Be Ignored On Basis Of Global Income Or Loss Earned/ Incurred By Cross Border Entity: Delhi HC

Referring to Article 7 of the Double Taxation Avoidance Agreement (DTAA) entered into between the Government of United Arab Emirates and the Republic of India, the Delhi High Court held that the right of the Holding company (source State) to allocate or attribute income to the Permanent Establishment (PE) cannot be restricted on the basis of the global income or loss that may have been earned or incurred by a cross-border entity.

If an enterprise is carrying on business through a PE situated in the other Contracting State, then its profits is liable to be taxed in the other State, subject to the extent of profits attributable to that PE, clarified the Court.

The High Court explained that Article 7(1) of the Indo-UAE DTAA clearly casts a dichotomy between the profits that may be earned by an enterprise on a global scale and those which are attributable to a PE situate in the Contracting State.

Thus, where an enterprise carries on business through a PE in the other Contracting State, profits would be liable to be attributed to that PE as if it were a distinct and separate enterprise engaged in similar activities and independent of the enterprise of which it may be a part, added the High Court.

The Three Judge Bench of Justice Yashwant Varma, Justice Sanjeev Narula and Justice Purushaindra Kumar Kaurav observed that “It would be incorrect to interpret Article 7 as requiring us to ignore the income that may be generated pursuant to activities undertaken by a PE in one of the Contracting States and making the exercise of attribution dependent upon the profits or the income that the enterprise may otherwise earn at an entity level”.

Therefore, the Bench stated that the activities of a PE are liable to be independently evaluated.

Facts of the case:

The Petitioner/ Assessee had approached the Full Bench challenging the correctness of the view expressed by the Division Bench of the Court in Commissioner of Income-tax (international taxation) vs. Nokia Solutions and Networks OY. In the said case, the Division Bench refused to accept the contention of the assessee that profit attribution to a PE would be warranted only if the enterprise as a whole, and the PE constituting merely a component thereof, had earned profits.

The petitioner argued that if the enterprise at an entity level had suffered a loss in the relevant A.Y, then no profit or income attribution would be warranted insofar as the PE is concerned. Refuting such contentions, the Division Bench observed that the profits attributable to the Assessee's PE in India are required to be determined on the footing that the PE is an independent taxable entity. It is, thus, possible that an Assessee makes a net loss at an entity level on account of losses suffered in other jurisdictions, which is partly offset by profits arising from India.

The Division Bench further opined that if it is held that the Assessee has a PE in India, prima facie the Assessee would be liable to pay tax on the income attributable to its PE in India notwithstanding the losses suffered in other jurisdictions.

At the same time, the Division Bench of the High Court disagreed with the decision rendered by a Special Bench of the Tribunal in case of Motorola Inc. Vs. Deputy Commissioner of Income Tax, Non-Resident Circle New Delhi [2005 SCC OnLine ITAT 1], where it was held that global profit or loss would constitute a relevant factor for attributing income to a PE.

Observations of the High Court:

Referring to the Organisation for Economic Co-operation and Development (OECD) Commentary on Article 7 of the India UAE DTAA, the Bench emphasized over the imperatives of viewing the PE as a separate and independent centre for the purposes of fiscal treatment and taxation is necessitated for reasons of attribution and recognition of income generated by it independently.

The Bench explained that the concept of a PE is based upon the undertaking of economic activity in a particular State irrespective of the residence of an enterprise and the same being understood to be in the nature of a conglomerate or an entity which may have many arms or independent functional units situate in various fiscal jurisdictions.

Any entrepreneurial activity which gives rise to income or profit thus becomes liable to be taxed at source (the location which gives rise to the accrual of profits or income) irrespective of the ultimate recipient or owner of that income, added the Bench.

The Bench stated that the PE is a fictional creation of an independent economic centre in a Contracting State which informs the allocation of taxing rights, and once the DTAA confers an independent identity upon the PE, then the question of taxability cannot be decided based on either the activities or profitability of the parent company which sustains the PE.

“The Contracting State in which this imagined entity is domiciled and undertakes business thus becomes identified as an independent profit or revenue earning centre which is liable to be taxed. Once such an entity is found to exist in one of the Contracting State, it is viewed as a unit which contributes to the economic life of that State and thus be liable to tax”, added the Bench.

Referring to the decision of Apex Court in DIT vs. Morgan Stanley [(2007) 7 SCC 1], the Bench reiterated that the identity which attaches to a PE for the purposes of ascertainment of a taxing liability cannot possibly be doubted.

Thus, the Bench clarified that the existence and identity of the PE is separate and distinct and subject to tax to the extent of activities that it may undertake in a State distinct from that of its principal.

“While protecting the right of an enterprise to be subject to tax in the State where it be resident, Article 7 places a negative stipulation in respect of cases where a PE is found to exist coupled with an attribution exercise being undertaken in respect of the domestic enterprise”, added the Bench.

The High Court therefore answered in favour Revenue and concluded that taxability of income earned by a PE existing in a Contracting State is not even remotely linked or coupled to the overall operations of the enterprise of which it may be a part.

Hence, the High Court directed the matter to be placed for disposal before the appropriate Roster Bench, in line with its observations.

Counsel for Petitioner/ Assessee: Senior Advocate S. Ganesh and Advocates U.A. Rana & Himanshu

Counsel for Respondent/ Revenue: Advocates Sanjay Kumar & Easha

Case Title: HYATT INTERNATIONAL SOUTHWEST ASIA vs. ADDITIONAL DIRECTOR OF INCOME TAX

Citation: 2024 LiveLaw (Del) 1040

Case Number: ITAT 216/ 2020

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