The Delhi High Court has held that a Permanent Establishment (PE) is conceived to be an independent taxable entity and cannot possibly be doubted or questioned.
The bench of Justice Yashwant Varma, Justice Sanjeev Narula and Justice Purushaindra Kumar Kaurav has observed that the activities of a PE are liable to be independently evaluated and ascertained in light of the plain language in which Article 7 of the Double Taxation Avoidance Agreement (DTAA) stands couched.
The bench noted that Article 7 does not expand its gaze or reach to the overall operations or profitability of a transnational enterprise. It is concerned solely with the profits or income attributable to the PE. The 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. The argument of world-wide income is thus rendered wholly untenable.
Background
The Full Bench of three judges has been constituted as a consequence of a Division Bench of the Court doubting the correctness of the view expressed in Commissioner of Income-tax (international taxation) vs. Nokia Solutions and Networks OY. The Division Bench, while referring the question for consideration of the full bench had doubted the view expressed in Nokia Solutions that profit attribution to a Permanent Establishment would be warranted only if the enterprise as a whole, and the PE constituting merely a component had earned profits.
The appellants/assessee appear to have argued that in case the enterprise at an entity level had suffered a loss in the relevant Assessment Year, no profit or income attribution would be warranted insofar as the PE is concerned.
The Court proceeded to consider the challenge which stood raised and the issue of applicability of Article 7 of the Double Taxation Avoidance Agreement between India and the United Arab Emirates, in case losses had been suffered at an entity level, was reserved for further consideration.
The Division Bench observed that the issue of attribution of profits to a PE in India would have to be determined on the basis of the latter being considered to be an independent taxable entity. It thus opined that once it is found that the assessee has a PE in India, it would be liable to pay tax on such income in India notwithstanding the losses that the enterprise as a whole may have suffered in other jurisdictions
Nokia Solutions was considering a challenge to a decision rendered by the Tribunal and which in turn had sought to draw sustenance for holding that global profit or loss would constitute a relevant factor for attributing income to a PE on the basis of a decision rendered by a Special Bench of the Tribunal in Motorola Inc. Vs. Deputy Commissioner of Income Tax, Non-Resident Circle New Delhi (and vice-versa).
By the time the issue again arose for consideration of the Tribunal for AY 2010-11, it proceeded on the basis that the question of attribution already stood answered in light of the judgement handed down by the Special Bench pertaining to AYs‘ 1997-98 and 1998-99. The Tribunal observed that since the Special Bench had already held that it would be Nokia’s worldwide net profit margin which was to be applied for determining the quantum of income attributable to the PE, the same principle should apply and govern the issue for AY 2010-11. It thus held that since Nokia on a global scale had suffered a net loss, no profit or income could be attributed to its PEs.
Arguments
The assessee contended that once the department had accepted the formulation of the legal position by the Special Bench of the Tribunal in Motorola Inc. and had restricted its challenge only to the prescription of a profit percentage, it would not be permissible for them to re-agitate those questions.
The assessee argued that on a reading of Article 7 of the DTAA, it would be apparent that the profits of an enterprise based in UAE would ordinarily be taxable only in that State and not in India. It was his submission that if the enterprise based in the UAE were making a loss, the question of taxability either in UAE or in India would not arise at all. Only if an enterprise were making a profit, could a PE through which it carries on business be subjected to tax and that too restricted to so much of the profit as is attributable to that PE. For a foreign enterprise to be taxed in India, the following three conditions precedent would have to be conjunctively satisfied.
Firstly, the foreign enterprise must be making a profit.
Secondly, the foreign enterprises have a PE in India.
Lastly, at least a part of the profit made by that enterprise is attributable to its PE in India and that part alone being liable to be taxed.
The assessee contended that if a foreign enterprise like the appellant were making a loss, the question of attributing any profit to its PE in India would not arise and consequently that enterprise would have no tax liability in India.
The department argued that the Convention clearly contemplates an exercise of attribution being undertaken under Article 7 in light of the PE being treated as a separate and distinct enterprise in itself. Article 7 mandates the attribution of profits to a PE acknowledging it to be a distinct and separate enterprise and thus such an exercise being undertaken independently.
The department argued that the determination of business profit as per Article 7 is mandated to be undertaken on the basis that the PE is a separate enterprise and is operating independently of the enterprise of which it may be a PE. A reading of the provisions of the DTAA would lead one to the irresistible conclusion that the only relevant consideration for answering the question of business profit is the activities undertaken by the PE at its individual level and uninfluenced by the activities of the enterprise of which it may be a part.
The department argued that the taxability of the profit of the PE would have no connection with either the profit or the loss which the assessee earns or suffers at a global level.
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Conclusion
The court held that the profits of an enterprise do not become subject to taxation unless it be found that it functions in the other Contracting State through a PE. Article 7 further postulates that it is only such income which is attributable to the PE which would be subjected to tax in the source State. As is pertinently noted in the OECD and UN Commentaries, it would be wholly incorrect to found taxation on the basis of the overall activities or profitability of an enterprise.
The court opined that the source State is ultimately concerned with the income or profit which arises or accrues within its territorial boundaries and the activities undertaken therein. As those commentaries pertinently observe, the profits attributable to a PE are not liable to be ignored on the basis of the performance of the entity as a whole.
The court ruled that Article 7 cannot possibly be viewed as restricting the right of the source State to allocate or attribute income to the PE based on the global income or loss that may have been earned or incurred by a cross border entity.
“We would thus answer the Reference by holding that the tentative view expressed by the Division Bench in these set of appeals as well as the doubt expressed with respect to the findings rendered in Nokia Solutions was well founded and correct,” the court said.
The court directed that the papers of these appeals may be placed before the appropriate Roster Bench for disposal.
Case Title: Hyatt International Southwest Asia Ltd. Versus Additional Director Of Income Tax
Case No.: ITA 216/2020
Date: 19/09/2024
Counsel For Petitioner: S. Ganesh
Counsel For Respondent: Sanjay Kumar