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Tejas Chandulal Shah B.com(Dist.), Grad. CWA, ACA tejascks@gmail.com +91 9029000575

Analysis of decision of Hyderabad ITAT in case of IJM (India) Infrastructure Ltd vs ACIT (ITA

No.1814/Hyd/2012) relating to non-applicability of transfer pricing provisions to PE of foreign

company:

Recently, Hon’ble Income Tax Appellate Tribunal (“ITAT”) Hyderabad has pronounced one ruling in

the case of IJM (India) Infrastructure Ltd vs ACIT [ITA No. 1814/Hyd/2012] wherein the Hon’ble ITAT

has held that permanent establishment (hereinafter referred to as “PE”) of foreign company is

“resident” in India and transactions of the assessee company with such PE of foreign company are

not liable for compliance with provisions under Chapter X of the Income-tax Act, 1961 (hereinafter

referred to as “the Act”). The said ruling even though being facts specific, has laid down certain

principles which are worth examination and requires second thought. The principles laid down by

Hon’ble ITAT in the said ruling are as under:

Project office of Malaysian company is resident in India as per section 6(3) of the Act

o The project office of IJM Corporation Berhad, Malaysia (“IJM Malaysia” or “Foreign

Company”) is registered under section 592 of the Companies Act, 1956 with the registrar

in India and by virtue of such registration its affairs are controlled and managed in India.

o One of the Directors of the foreign company is nominated as Attorney for the purpose of

project office in India.

o The Director, so nominated, is empowered to manage and operate entire operations in

India and all the decisions relating to operations in India are taken in India.

o The Director who has been entrusted with managing affairs of project office in India is

residing in India.

PE of Malaysian company (which is a project office) should be considered as “resident” in

India applying provisions of Article 24 of Double Taxation Avoidance Agreement (DTAA)

between India and Malaysia.

o As per Article 24 of India – Malaysia, national of Malaysia should not be

discriminated and should be given same tax treatment as national of India under

similar circumstances.

o In view of all decisions relating to operations of project office are being taken in

India similar to any branch of Indian company having operations in India, project

office (which is PE in India) should be considered as resident in India applying Article

24 of DTAA between India and Malaysia.

o Reliance was placed on the ITAT Ahmedabad ruling in the case of Rajeev Sureshbhai

Gajwani vs ACIT (129 ITD 145) (Ahd.) (SB)

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Transfer provisions should not apply where there is no possibility of shifting of profits

outside India

o Transactions of the assessee with its project office are between two tax residents as

mentioned above.

o Project office is being assessed as “PE of foreign company” in India

o No motive to shift the profits or evade the tax in India as business profit is taxable in

separate legal entity in India.

o In connection with the above preposition, ITAT has relied upon following case laws:

Philips Software Centre P Ltd vs ACIT [2008] (26 SOT 226) (Bang)

Dresdner Bank A.G. vs Addl. CIT (108 ITD 375)

ITO vs Zydus Altana Healthcare P Ltd (44 SOT 132) (Mum.)

Cotton Naturals I Pvt. Ltd. vs DCIT (ITA No.5855/Del/2012)

The above ruling has highlighted certain concepts which are interesting to observe and further

examine as it may have catastrophic effect on applicability of transfer pricing provisions more

particularly for years prior to FY 2012-13 (i.e. for years when provisions of chapter X of the Act were

not applicable for transactions between two residents) in relation to international transactions.

Further, for FY 2012-13 and subsequent years also, the ruling is relevant as much as the question of

applicability of provisions of Chapter X of the Act is concerned. Hence, applying the principle laid

down by the Hon’ble ITAT, transfer pricing provisions will still not apply, even after amendment to

provisions of section 40A(2) and Chapter X of the Act vide Finance Act, 2013, unless there exist any

intent to shift profit outside India or there exist erosion of tax base.

In summary the three principles which have been relied upon by the Hon’ble ITAT, for holding that

Project Office in India (“PE” under the DTAA between India and Malaysia) of Malaysian company is

resident in India and provisions of chapter X of the Act are not applicable to transactions of the

assessee company (i.e. Indian company) with such PE of Malaysian company, are as under:

When daily affairs of project office is managed wholly from India, the PO is resident in India

Branch of foreign company should be considered as “resident” otherwise it will result in

violation of Article 24 of India- Malaysia DTAA.

In absence of shifting of profit outside India, provisions of chapter –X of the Act are not

applicable.

Hereunder, each of the above three principal arguments/ contentions based on which the ruling was

rendered has been examined:

1. Project Office of IJM Malaysia is resident in India:

1.1. India follows residence based taxation and hence under the provisions of the Act, taxability

of taxable subject (i.e. tax payer/ person) depends upon the residential status of the tax

payer. Residence under the domestic law (i.e. Income-tax Act, 1961) depends upon the

category of person and compliance with the conditions relating to residential status. In the

captioned matter the issue pertains to determination of the residence of IJM Malaysia which

is a foreign company and having project office (i.e. PE) in India. In view of the fact that IJM

Malaysia is a company, let us examine condition for residential status for a person which is a

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company. The criterion for determination of residential status of a company has been

prescribed under Section 6(3) of the Act and the same has been reproduced hereunder for

ready reference:

(3) A company is said to be resident in India in any previous year, if— (i) it is an Indian company ; or (ii) during that year, the control and management of its affairs is situated wholly in India.

1.2. From above reproduced definition, it is evident that “Indian company” is always resident in

India. Hence, it is important to refer to the definition of “Indian Company” under section

2(22A) of the Act. For ready reference, the same has been reproduced below:

(22A) "domestic company" means an Indian company, or any other company which, in

respect of its income liable to tax under this Act, has made the prescribed arrangements

for the declaration and payment, within India, of the dividends (including dividends on

preference shares) payable out of such income ;

1.3. From above, it is evidently clear that companies incorporated in India or company which has

made arrangement for declaration and payment of dividend in India are resident for the

purpose of the Act. In view of the same, Project Office, Branch, Fixed Place PE, Service PE,

agency PE, liaison office, etc. will never been considered as “resident” under first condition/

criteria.

1.4. Now, let us examine applicability of second condition/ criteria of “control and management

of its affairs is situated wholly in India”. If we divide the content of second condition, second

condition/ criteria has following aspects:

Company’s control and management;

Of company’s affairs; and

Situated wholly in India

1.5. From careful reading of the second condition for determination of residential status of

company, we can make out that it talks about “control and management of the company”.

The requirement to examine company’s control and management come from the definition

of “person” who is “taxable subject” for the purpose of levy of Income-tax under any taxing

statute. As per section 2(31) of the Act, “company” is considered as taxing statue and not

branch/ PE/ Project Office, etc.

1.6. Further, second aspect of the second condition talks about “company’s affairs” and not

about only affairs of the Project Office/ Branch Office/ PE/ Liaison office.

1.7. Last and most important aspect of the second condition is quantum of the situs of control

and management. This is very important as a company can have more than one place of

control and management. However, for being resident in India for a company not

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incorporate in India, the condition is the control and management should be wholly within

India.

1.8. In this regard, we would now discuss, how the Hon’ble ITAT has read the above three criteria

of section 6(3 ) of the Act:

The Hon’ble ITAT has construed “Project office” as taxable unit disregarding its head

office which is foreign company and considered “Project Office” as liable to tax in

India as company falling within the definition of “person” under section 2(31) of the

Act.

“Project Office” is registered under section 592 of the Companies Act, 1956 and

hence should be construed as managed within India.

Day to day affairs of the project office is managed from India. Project director having

authority to take decisions on the activities relating to day to day matters of project

office and his presence in India has been construed as “situated wholly” in India.

1.9. The approach adopted by the Hon’ble ITAT to hold PE as resident in India is debatable and

untenable in light of the statutory provisions.

“Project Office” being a permanent establishment and independent of its head

office (i.e. foreign company) do not fall within the definition of “person” as the

taxable subject must first fall within the definition of “person” under section 2(31) of

the Act if we need to look at PE in India separately. Hence, for determination of

“residential status”, separate legal entity approach cannot be applied. Separate legal

entity approach is applicable for quantification of income and not for determination

of “Residential Status”

Section 6(3) of the Act requires examination of “control and management” of

company which is one of the eligible taxable subject under section 2(31) of the Act

Hence, if we have to ignore foreign company then, PE on its own is not a taxable

subject or at least not taxable as a company. In such event, the condition for

residential status may get changed. Hence, to remove such absurdity in application

of the provisions, if have to consider PE as part of foreign company then taxable

subject is such foreign company and in such circumstances the “control and

management of the company” is required to be examined and not of the project

office”.

The requirement to look for the “company” as a whole can also be understood from

the perspective of section 6(5) of the Act where the statutory provisions specifically

states that the residential status for one source of income is if “resident” than for all

source of income the same should be considered as “resident” only.

Further, determination of “residential status” is the foundation based on which

“scope of income” which is liable to tax is determined and hence it precede

determination of income rather than vis-a-versa.

The requirement of “wholly within India” is most exhaustive requirement and hence

if the “control and management” of the taxable subject if situated even partly or

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fraction of the period or for even some part outside India, the condition will not get

fulfilled.

Considering the conditions required to be meet with respect to “company” under

section 6(3) of the Act and the fact that taxable subject being foreign company and

not only project office, to conclude “residential status” based on merely activities

performed in India would be incorrect as residential status is to be determined with

respect of “entity” as a whole and not for the “activities” in a particular jurisdiction.

This is further established from the fact that India follows “residence based

taxation” and not “jurisdiction based taxation”.

Hence, in my view, reliance placed on the “activities performed in India” to

determination of “residential status” is untenable in light of provisions of section

6(3) and 6(5) of the Act in particular and systems of taxation being adopted in India

in general. Examination of “activities performed in India” is relevant for “scope of

total income” which will be subsequent step to determination of residential status.

1.10. The Hon’ble ITAT has also relied upon the decision of the Calcutta High Court in the case of

CIV vs Bank of China (154 ITR 617) in support of the conclusion that the control and

management is wholly within India.

1.11. Reliance on Calcutta High Court decision in the case of Bank of China by Hon’ble ITAT

The Hon’ble ITAT has interpreted the “control and management of affairs” in the sense of

managing day to day affairs of the project office. Further, to arrive at the said conclusion,

the Hon’ble ITAT has relied upon the decision of the Hon’ble Calcutta High Court in the case

of CIT vs Bank of China (In Liquidation) – (154 ITR 617). However, there are appearant

differences in the facts of Project Office of Malaysian AE in India and Bank of China (In

liquidation). The differences are as under:

Bank of China was under liquidation and by virtue of the order of the Calcutta High

Court all the assets and liabilities of the Bank of China in India were under complete

control and management of the High Court and the official liquidator was appointed

in that connection.

Under liquidation cases when the High Court is having complete control over all the

assets and hence there is no possibility of control or management being existing at

more than one place.

Further, the Calcutta High Court ruling was more specific to the facts of company

under liquidation as against operative company. In case of company under

liquidation (forced liquidation, due to India – China being at war) the activities were

absent and issue was regarding taxability of passive income and in light of the fact

that Indian authorities have exercised special powers in curtailing activities by head

office. These facts are completely missing in the case under consideration. Hence, it

can be argued that Calcutta High Court ruling is not applicable to facts under

consideration before Hon’ble ITAT.

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1.12. Foreign EPC company’s modalities for execution of projects – Industry Practice:

Let us further examine the “control and management situated wholly in India” in context of

the EPC industry’s operative modalities from foreign company perspective:

The definition refers to “Control and management of its affairs is situated wholly in

India”, in case of Project office, it is difficult to envisage complete control and

management within India as in EPC transactions followings are specific

characteristics:

o Foreign company bid for project in India

o On being successful in getting the contract, foreign company will enter into

agreement with Indian Company or State/ Central Government or any other

agencies/ authorities in India. In the event of the contract being complete EPC

i.e. which includes services as well as supplies, generally, four separate

agreements are being entered into being, On-shore supplies, On shore services,

Off-shore supplies and Off shore services.

o Generally, each of the four agreements, if they are separate, should be read

separately unless consideration of one of the agreement is depending upon/

pre-condition to some part of services/ supplies having performed from outside

India (i.e. off shore)

o For taxability, off-shore supplies and services will not be questioned as the same

is not liable to tax in India as per the Supreme Court decision in the case of

Ishikawajima-Harima Heavy Industries Ltd vs DIT (288 ITR 408) (SC).

o For On-shore services, generally Project Office is being established as per RBI

requirements and then the work under on-shore contract will be undertaken by

itself or will be subcontracted to some agency with supervisory activities being

done through such project office.

From above narrated peculiar features of EPC contracts, it can be envisaged that

even for the activities of “Project Office” are concerned, it is not possible to argue

that such project office is “controlled and managed situated wholly within India” as

the basic decision on which activities will be performed by whom and were to have

project office and when to establish project office and what is the activity profile of

project office are being determined by head office i.e. foreign company after being

awarded such contract.

Further, the ownership and responsibility over the work being performed by the

Project Office remains with head office only and hence control or supervision also

remains from the head office. In light of these facts, to hold that even part of the

control and management is not outside India seems too difficult to prove.

However, in the captioned ruling of Hon’ble ITAT, there is no mention of the

reference to such critical aspect of the EPC contracts.

1.13. Requirement of “Control and management of its affairs situated wholly in India”:

In connection with the captioned matter, the Hon’ble ITAT has held that the control and

management of IJMII, Malaysia is wholly situation in India:

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Project director is residing in India.

Project director has authority for the operations/ activities to be performed by

Indian project office

Day to day activities has been managed from India.

1.14. However, the Hon’ble ITAT while deciding the “control and management is situated wholly

in India” based on above aspects, have not touched upon the following points:

How and why Project office has been established – Requirement to execute project

awarded to foreign company requires formation of project office in India.

Who is bearing the risk of activities of project office – Only Indian project office or

even foreign company?

Who has decided what activities should be carried out by Project office itself or it

should be sub-contracted? - Board minutes at Malaysian company could have been

vital to this

Whether activities of Project office were subject to review by Head Office?

Who has granted the authorities and extent of the authorities? Whether seconding

of the decision taken by Project Director is required for any funcition?

Is there any difference in “control and management situated wholly in India” and

“place of effective control and management”?

1.15. Answers to above pointers/ questions may throw more light of certain circumstances and

evidences which could have material impact if brought out or considered in the above ruling

of the Hon’ble Hyderabad ITAT. On perusal of the Delhi ITAT ruling in the case of ITO vs

Tianjin Tianshi India Pvt Ltd in (ITA No. 3991/Del/2010), one may observe that certain

pointers as mentioned above have been raised by the department and Hon’ble ITAT has held

to the effect that PE of foreign company, in cases where such circumstances exists, is non-

resident in India. However, from perusal of the captioned ruling of the Hon’ble ITAT

Hyderabad, one cannot make out whether the Hon’ble ITAT had a chance to examine the

above factors or not. Hence, it could have been enriching and more insightful if the Hon’ble

ITAT had chance to discuss on the above factual aspects and their interplay with the

“residential status” of foreign company. Additionally, it is also interesting to note that in

similar circumstances the Hon’ble AAR (Authority for advance ruling) in the case of P. No. 13

of 1995 (228 ITR 487) (AAR), has narrated how EPC (Engineering, Procurement and

Construction) industry functions more particularly when foreign company entered into or is

awarded any such contract by Indian company. In light of such circumstances the Hon’ble

AAR has ruled that control and management of its affairs are not situated wholly within

India.

1.16. Further, according to Prof. Klaus Vogel, place of management exists where management

directives are given (including opening of project office or accepting or signing of the

contracts or giving authority to someone to undertake certain transactions) and not where

they take effect. One need to understand that even the decision whether to open a project

office or not or whether to sign a contract or not or granting of certain authority to some

person for transacting some business will also be in the nature of management directive

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only and if such decisions are taken at head office, one cannot rule out that not wholly but

at least some part of the control and management has existed outside india.

1.17. Further, in connection with the Hon’ble ITAT’s reliance on the day to day activities being

managed from within India for determination of the residential status of foreign company, it

is relevant to note the Bombay High Court ruling in the case of Narottam & Pereira Ltd vs CIT

(1953) 23 ITR 454 (Bom.) wherein it has been held to the effect that central management

and control of the company is paramount important and not the day to day business.

Further, the Hon’ble High Court has specifically hold that to determine company’s residential

status, it is important to see where controlling and directing powers functions and where is

head and brain of the company.

1.18. Further, it is accepted judicial position that in case of company, there can be more than one

place of management. The fact of the same is also evident and recognized by requirement

of determination of residential status of certain category of tax payers based on “effective

place of management” under various DTAA. Once recognizing the multiple place of

management, it is important to understand that provisions of section 6(3) of the Act require

“control and management to be situated wholly in India” which is far different from

“effective place of management”.

1.19. Hence, if the management and control of the foreign company have been outside India for

even some part of the year or even for some aspect of the activities or decision making, such

foreign company or any form of its presence (be it Project Office or Branch) requires to be

considered as non-resident under the Act.

1.20. Further, as per provisions of section 6(5) of the Act, if a person (as defined under section

2(31) of the Act) is resident for one source of income then the said person will be construed

as resident for all source of income. Considering the said provisions and accepted judiciary

principles in this regard, if PE is held to be resident, foreign company will be considered as

resident in India, as for the purpose of taxability it is the “foreign company” which is liable to

tax and not the PE and it is “foreign company” which is taxable subject as covered with the

in the definition of “person” under section 2(31) of the Act. Hence, in the event of foreign

company being considered resident in India, its global income should be taxed India.

1.21. PE has been considered as separate legal entity, as per section 92F of the Act, only for the

purpose of provisions of chapter X of the Act which deals with the transfer pricing

provisions. Further, taxing PE as person instead of foreign company and considering PE

separate from foreign company as separate person will violate the basic charging provisions

as the definition of “person” does not cover “Permanent Establishment” as oppose to

definition of enterprise as contained in section 92F of the Act.

1.22. Hence, the captioned ruling of the Hon’ble Hyderabad ITAT may lead to an approach

whereby the provisions of section 6(5) of the Act as well as already established principles

regarding “residential status” of a “person” and taxability of such person’s, in respect of

income from other sources, may get violated.

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1.23. To reconcile the statutory provisions on residential status and taxability, one may need to

understand that residential status is for the “person” as defined under section 2(31) of the

Act as a whole. However, taxability will be only for the income which is falling within the

ambit of charging sections. If one follows the said principle, which is almost settled, then

there will not be issues of non-reconciling provisions of the Act as highlighted in above para.

1.24. However, the ruling has given new dimension to the determination of residential status and

consequently taxability of income of non-residents whereby one may re-look at the position

taken for residential status of various permanent establishments of a foreign company in

India for taking benefit of the captioned ruling.

2. PE of Malaysian company should be considered as “resident” as per Article 24 of the

DTAA:

2.1 The Hon’ble ITAT has held that as per Article 24 of the DTAA between India and Malaysia,

the Project office of Malaysian company should be considered at par with project office of

any Indian company and hence should be considered as “resident”. In this regard, the

Hon’ble ITAT has also placed reliance on the decision of ITAT Ahmedabad Special Bench in

the case of Rajeev Sureshbhai Gajwani vs ACIT (129 ITD 145).

2.2 In the Case of Rajeev Sureshbhai Gajwani (supra), the issue was with regard to computation

of total income and in which connection the Hon’ble Special Bench has held that as per

Article 26 of India – US DTAA, both (i.e. resident of India and resident of US) should be

considered at part except to matters covered under para 3 of Article 7 as per the Article

26(2) of India – US DTAA. However, in the captioned matter, the Hon’ble ITAT has implied

approved application of “Non-discrimination” principles even for determination of

“residential status” of the company.

2.3 On perusal of the DTAA between India and Malaysia, one may observe that the said DTAA is

on same principle on which various DTAA are being signed and primarily for the avoidance of

double taxation. Hence, the scope of Article 24 of the DTAA between India and Malaysia

should be construed and restricted for application for determination of the income and not

for determination of the residential status. Hence said ruling of the Special Bench of the

Ahmedabad ITAT is not applicable to the facts of the case before Hon’ble Hyderabad ITAT

and clearly distinguishable.

2.4 In this connection, it is worthwhile to note that the “non-discrimination” article refers to the

discrimination based on “nationality” or “citizenship” and as per internationally accepted

principles practices, differential treatment / requirements based on “residential status” has

not been considered as “discrimination covered with the provisions of Article relating to

“non-discrimination” under the respective DTAA. DTAA between India and Malaysia under

Article 24 has specifically agreement that “same circumstances” will include in particular

with respect to residence. Hence, any differential treatment because of the “residential

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status” with respect to residence will not be considered as “discrimination” which is

prohibited under the captioned Article 24 of the DTAA between India – Malaysia. DTAA

between India and Malaysia has Article 24 which restricts both the contracting states from

discriminating based on certain grounds. Summarily, Article 24 of India – Malaysia deals

with the following circumstances and restricts both the countries from following

discriminations:

a) Discrimination based on nationality of the tax payer

b) Taxation of PE of resident of other Malaysia at rate higher than taxation of resident

of India. Further, India will not be obliged to grant certain additional personal

allowances or benefits which India is granting due to civil status and/ or family

responsibilities.

c) Deductibility of fees for technical services and other payment (other than covered

under Article 9,11 and 12) under the same circumstances.

d) Enterprise which is directly or indirectly controlled by resident of Malaysia should

not be treated differently from other enterprises in similar circumstances.

2.5 In view of above, when the DTAA signed between India and Malaysia has specifically

restricted applicability of the captioned article in relation to “residence”. Hence, Hon’ble

ITAT’s conclusion that treating PE of Malaysian company as non-resident will be violation of

Article 24 is devoid of merits and does not find support under the India – Malaysia DTAA.

2.6 Further, provisions of Article 24 of the DTAA between India and Malaysia also restricting and

not covering the applicability of differential criteria for determination of “residential status”

as the language used in the para – 1 of the Article 24 reads as under:

Nationals of a Contracting State shall not be subjected in the other Contracting State to

any taxation or any requirement connected therewith, which is other or more

burdensome than the taxation and connected requirements to which nationals of that

other State in the same circumstances, in particular with respect to residence, are or

may be subjected. This provision shall, notwithstanding the provisions of Article 1, also

apply to persons who are not residents of one or both of the Contracting States.

(Emphasis supplied)

2.7 Hence, application of differential criteria is not based on the “nationality” of the Malaysian

company but is based on the “place of management and control” of Malaysian company

whose PE is there in India. Hence, following internationally accepted principles and even the

OECD commentary, different treatment based on residential status should not have been

considered as violation of provisions of Article 24 of the DTA between India and Malaysia.

3. Transfer pricing provisions do not apply in absence of shifting of profit outside India:

3.1 Primarily, the Hon’ble ITAT has decided the matter of non-applicability of transfer pricing

provisions based on the conclusion that the PE of Malaysian (Project Office) in India is

resident for tax provisions in India and hence transaction between the Assessee Company

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and PE of Malaysian Company are not falling within the ambit of the “international

transacions”.

3.2 In addition to above and as an independent ground, the Hon’ble ITAT at para 5.17 to 5.19

held to the effect that in absence of shifting of profit outside India and/ or erosion of taxes in

India provisions of chapter X of the Act are not applicable. Further, to arrive at the

conclusion that there is absence of shifting of profit outside India and/ or absence of erosion

of tax base in India, the Hon’ble ITAT has relied upon the fact that the profits of PE are

taxable in the hands of PE and is separately assessed as such.

3.3 However, it is interesting to note that the Hon’ble ITAT has not commented or took the fact

of PE being assessed as foreign company to any further logical conclusion and the said fact

has been merely quoted and restrictive relied upon only to high light that PE is also filing

return and being assessed as non-resident company (i.e. foreign company). It is pertinent to

note that even after holding the PE as resident, the Hon’ble ITAT has not disturbed or

commented on why the PE of Malaysian company has been offering income as “non-

resident” for all such years including year under consideration.

3.4 Further, the Hon’ble ITAT has placed reliance on the following rulings to come to the

conclusion that in absence of shifting of profit outside India, provisions of chapter X of the

Act are not applicable.

Philips Software Centre P Ltd vs ACIT [2008] (26 SOT 226) (Bang)

Dresdner Bank A.G. vs Addl. CIT (108 ITD 375)

ITO vs Zydus Altana Healthcare P Ltd (44 SOT 132) (Mum.)

Cotton Naturals I Pvt. Ltd. vs DCIT (ITA No.5855/Del/2012)

3.5 In this regard, let us examine the facts and the circumstances in light of which each of the

above rulings were delivered and its applicability to the facts of the case before Hon’ble

Hyderabad ITAT in the captioned case:

The facts before the concerned Hon’ble ITATs in the cases of Philips Software Centre

P Ltd vs ACIT [2008] (26 SOT 226) (Bang); ITO vs Zydus Altana Healthcare P Ltd (44

SOT 132) (Mum.) and Cotton Naturals I Pvt Ltd vs DCIT (ITA No. 5855/Del/2012)

were more or less identical. In all these 3 cases, assessee company were entitle to

and claiming profit linked deduction in respect of the income from provisioning of

services from its associated enterprises and hence before Hon’ble ITAT in all the

three cases, the ground was raised regarding “need/ intent/ motive to shift profit

outside India”. Further, considering the said fact, the concerned Hon’ble ITATs have

held that transfer pricing provisions do not apply to that extent. However, in the

case before Hon’ble Hyderabad ITAT is concerned the facts are different as the

assessee nor PE of the foreign company are entitled to profit linked deduction and

hence above three rulings are not applicable.

Further, the reliance on the ruling of Dresdner Bank A.G. vs Addl. CIT (supra) seems

to be misplaces as the issue under consideration was computation of income in the

case of PE in India and taxability of interest paid by branch to head office. However,

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on examination of the facts of the said case law in the case of Dresdner Bank A. G.

(supra), we feel that the said Mumbai ITAT ruling does not have implications on the

case under consideration.

3.6 Hence, in my humble view reliance on the above rulings were not warranted/ misplaced.

However, now we may turn to the reliance placed on the CBDT circular No. 14 of 2001 which

talks about the basic intention of transfer pricing regulations. The relevant para from the

CBDT circular No. 14 of 2001 has been reproduced below:

55.5A The new provision is intended to ensure that profits taxable in India are not

understated (or losses are not overstated) by declaring lower receipts or higher

outgoings than those which would have been declared by persons entering into

similar transactions with unrelated parties in the same or similar circumstances. The

basic intention underlying the new transfer pricing regulations is to prevent shifting

out of profits by manipulating prices charged or paid in international transactions,

thereby eroding the country’s tax base. The new section 92 is, therefore, not

intended to be applied in cases where the adoption of the arm’s length price

determined under the regulations would result in a decrease in the overall tax

incidence in India in respect of the parties involved in the international transaction.

3.7 From above reproduction of relevant para of the CBDT Circular, one may notice that the

CBDT has mentioned that the framework of the statutory provisions is to “prevent” and

“ensure”. For the purpose of such prevention or determination, statutory provisions need

to be applied. Hence, reliance on the said circular to interpret that department has primary

onus to prove “erosion of tax base” or “shifting of profit outside India” is unwarranted.

3.8 Further, the Hon’ble ITAT has held that there is absence of any “intent” to shift the profit

when PE is being taxed in India on its profits. In that regard, one may need to consider the

following facts and circumstance before arriving at such conclusion;

PE of foreign company has got the contracts from Indian companies

PE of foreign company has sub-contracted only certain portion of the work to Indian

companies (i.e. labour contract) and supplies remained non-taxable in India

(Following SC ruling in the case of IHI)

PE of foreign company is taxable at 40% as against indian company at 30%

(excluding surcharge and education cess)

3.9 In view of above circumstances, to hold that there is absence of shifting of profits or erosion

of tax base in India might not be right.

3.10 Without prejudice to above, if we read the provisions of Chapter X of the Act which deals

with and prescribe requirements for computation of income in accordance with the arm’s

length principles. As per the provisions of Chapter X of the Act, compliance with the arm’s

length principles would be requires for every transactions which satisfies following

conditions:

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Two or more associated enterprises, as defined under section 92A of the Act, enter

into any transaction

Such transaction is “international transaction” as per definition prescribed under

section 92B of the Act; and

One or more of such “associated enterprises” entering into transaction is/ are “non-

resident”

3.11 In the event of all the three conditions mentioned above being satisfied, income arising from

such transaction would be required to be computed in light of the provisions of Chapter – X

of the Act.

3.12 Hence, from above it is evidently clear that Indian transfer pricing provisions, as contained in

Chapter – X of the Act, do not require establishing or requirement of existence of intent to

shift profit outside India or requirement to establish or proving erosion of tax base in India.

3.13 Further, to above, Punjab and Haryana High Court in the case of Coca Cola Inc. has

specifically ruled in context of applicability of transfer pricing provisions vis-à-vis establishing

shifting of profit outside India that there is no requirement for the revenue to establish/

show that there is shifting of profit outside India for applicability of provisions of Chapter X

of the Act. However, in that context, the Hon’ble Supreme Court has without commenting

on the merit of the issue has stated that the matters are pending before various authorities

and hence right course for the tax payer would be to through right channel rather than

through writ petition. Hence, the Hon’ble Supreme Court has directed all the judiciary

where such matters are pending to dispose of the relevant matters relating to the tax payer

at the earliest.

3.14 Additionally, the Hon’ble Special bench of Bangalore ITAT in the case of Aztec Software 7

Technology Services Ltd. vs ACIT (107 ITD 141) (SB) has held that as per the mandate of

section 92(1) of the Act, question of tax avoidance is not required to be established by for

following statutory provisions. Further, it has been held that wherever there is an

“international transaction” among “associated enterprises”, income from such transaction is

required to be computed having regard to the arm’s length principles. Further, Hon’ble ITAT

Special Bench has held that when the language of the statute is clear and unambiguous, one

is not required to find intent of the legislature by referring to Budget Speech of Finance

Minister, notes on clauses, etc. Subsequently, the tax payer has filed an appeal before the

Hon’ble Karnataka High Court against the said order. In that regard, the Hon’ble Karnataka

High Court by dismissing appeal filed by the tax payer has confirmed the said order of the

Hon’ble ITAT Special Bench including on the issue of applicability of transfer pricing

provisions in absence of intent or without establishing shifting of profits outside India.

3.15 From above, it is evidently clear that judiciary has already accepted the proposition that it is

not a pre-requisite for tax authorities to establish shifting of profit outside India for

applicability of the transfer pricing regulations in India. Additionally, the provisions of

Chapter X of the Act also indicates that the applicability of profits of transfer pricing does not

require establishing shifting of profit outside India on the part of the tax payer, however, in

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turn the primary onus is put on the tax payer to show compliance when the transaction falls

within the ambit of “international transaction”.

3.16 In view of above, to hold a transaction out of the purview of provisions of chapter X of the

Act only on the ground that the PE is also filing return of income in India and keeping very

low or Nil margin is contrary to the provisions of the Income-tax Act, 1961 in light of

followings:

Income-tax Act, 1961 prescribes applicability of provisions of Chapter X of the Act

irrespective of the fact whether the tax payer has filed return of income or not.

Transfer pricing provisions also apply to determine whether the transactions are at

arm’s length price or not and the primary onus for compliance with the captioned

provisions are with tax payer and not with the tax officials. Hence, there is no

statutory requirement to show that there is shifting of profits outside India/ erosion

of tax base of India for applicability of transfer pricing provisions.

A transaction when entered into between one or more non-resident requires

examination from both the transacting parties’ perspective. Indian tax authorities

have not given recognition to the fact of economic double taxation for transfer

pricing matters. Further, to above, even the statutory provisions provide for only

upward adjustment and restrict application of transfer pricing provisions where such

application results in reduction in taxable income of the tax payer.

Even though the transaction being same, adjustment can be possible in both the

transacting parties’ cases as arm’s length price of the transaction will be examined

from both the transacting parties’ cases separately.

Indian transfer pricing provisions do not allow consequential adjustment in another

party’s (i.e. AE’s) income computation even if both the parties to the transaction are

liable to tax in India as the adjustment to income is restricted only to the upward

adjustment as per the provisions of Section 92 of the Act.

3.17 In view of above, argument of establishing of shifting of profit outside India should not be

taken as basic premise for applicability of transfer pricing provisions in India. Hence, to

delete the transfer pricing adjustment/ approving a transaction which is principally not in

compliance with arm’s length principles only for the reason of apparent “intent/ motive” to

shift profit outside India, will make transfer pricing provisions redundant to great extent.

3.18 Further, absence of requirement to examine “intent/ motive” can also be observed from the

fact that when the provisions of Chapter X of the Act has been amended to expand its scope

to certain specified domestic transactions, the legislation has been worded in such a manner

that for applicability of the transfer pricing provision there is no requirement to prove that

there is “shifting of profit” or “erosion of tax base”. This is more important particularly in

light of the fact that when the amendment is being made in Income-tax Statute at the

instance and recommendation of the Hon’ble Supreme Court. However, while

implementing such recommendation, the legislators have ignored the observation of the

Hon’ble Supreme Court to the fact that transaction between “related parties” will not have

any impact if both the entities are paying taxes on its income at full rate and the transaction

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is tax neutral for revenue. However, the present scheme of transfer pricing provisions as

applicable on the specified domestic transactions, we can observe that the said

recommendation to Hon’ble Supreme Court is absent and transfer pricing provisions are

applicable to all covered Specified domestic transaction whether or not there exists any tax

leakage.

3.19 In view of above, in my view when the statutory provisions are clear and unambiguous, one

may not succeed at higher appellate authority based on the contention of “intention” of the

statutory provisions. Hence, in my view, the Hon’ble ITAT’s view of non-applicability of

transfer pricing provisions to assessee when there is no “intent/ motive” to shift profit

outside India may face review by higher appellate authority in coming time. However, till

then this captioned ruling is surely helpful and may turn out to be savior for many tax

payers.

4. Summarizing:

4.1 The ruling of Hon’ble Hyderabad ITAT in the case of IIJM India Infrastructure Ltd. (supra) has

given certain new dimensions to the interpretation of practical scenarios and hence

important.

This is the remarkable ruling wherein the PE of the operating foreign company

(unlike Bank of China, where cases were far from comparable) is held as “resident”.

However, in my personal opinion, Hon’ble ITAT’s view on certain facts and

characteristics of operations (which are common for execution of such EPC

contracts) of PE could have made some difference.

In this ruling Hon’ble ITAT has held that “residence” can also be considered as one of

the ground on which tax payer can ask for relief under “Non-discrimination” under

DTAA. Considering the cascading effect of the said interpretation, one can assume

that this ruling of the Hon’ble Hyderabad ITAT is going to be savior for many tax

payers in coming days.

This ruling is remarkable when the Hon’ble ITAT has applied principle of “intention

to shift profit OUTSIDE India” in cases where tax payer is not eligible for any income

linked deductions (as cases laws relied upon by the tax payer in support of this

argument were on different facts and circumstances as compared to the facts of the

tax payer. Assessee in respective cases, as relied upon by Assessee Company, were

eligible and claiming income linked deduction in those cases). Further, filing of

return of income in India has been given cognizance which will be very significant

aspect as Hon’ble ITAT has done away with the normally perceived “erosion of tax

base” due to differential tax rate of 40% as against 30% in this case.

In view of above summarized points, the captioned ruling of the Hon’ble Hyderabad ITAT ruling will

have far reaching impact and considering the fact of the ruling being in favour of tax payer, we may

see more reliance on this captioned ruling in time to come by other tax payers too.