Special Bench Ruling On Applicability Of TP Provisions To Transactions Between Foreign Company And Its Branch In India

BACKGROUND

• Recently, Special Bench formed at Ahmedabad ITAT delivered a ruling¹ on the issue of applicability of Transfer Pricing (‘TP') provisions to the transactions between a foreign company and its branch (Permanent Establishment) in India.
• The taxpayer is a Project Office (‘PO') in India of a Company based out of China (‘Foreign Company'), set up to provide onshore services to the customer of foreign company in India. In consideration for these services, the customer made certain payments to the foreign company instead of the taxpayer, since the taxpayer (PO) did not have a bank account. This was regarded as ‘reimbursement' by the Assessing Office (‘AO') and he treated it as international transaction and referred the matter to Transfer Pricing Officer (‘TPO') for determination of arm's length price.
• The TPO was of the view that the services provided by the taxpayer to customer are actually services provided on behalf of the foreign company and hence the act of providing services by the taxpayer on behalf of foreign company constitutes international transaction between the taxpayer and foreign company. The TPO observed that the per unit civil work rate received from customeris less than the rate paid to sub-contractor.
• The matter was presented before the Ahmedabad Tribunal (‘Ahmedabad ITAT'). The Ahmedabad ITAT observed that there were conflicting views expressed by division benches on applicability of TP provisions to the transactions between an enterprise and its Permanent Establishment (‘PE'), hence, the matter was referred to a Special Bench (‘SB'). The following question was referred for consideration before the SB:

“Whether or not the transactions between an enterprise and its foreign permanent establishment can be considered international transactions for the purpose of section 92B and accordingly can be subjected to the ‘arm's length price' adjustment?”

• At the outset, SB observed that the question referred before it did not bring out the exact facts of the case. While the question referred to SB mentioned about Indian enterprise and its foreign PE whereas the in the facts, the subject matter transaction was between foreign enterprise and its PE in India. Hence, SB reframed the question as below:

“Whether or not the transactions between a foreign enterprise outside India and its Indian permanent establishment can be considered as an international transactions for the purpose of section 92B of the Act and accordingly can be subjected to the ‘arm's length price' adjustment?”

Aithent Technologies Pvt. Ltd. (‘Aithent')

• In case of Aithent, there was a transaction between the Indian Head Office (‘Indian HO') and its branch in Canada (‘foreign branch'). There are total three cases of Aithent that dealt with the same issue of applicability of TP provisions.
• In two of the cases, the Delhi ITAT held that for a transaction to be considered an international transaction there should be two or more Associated Enterprise (‘AEs'), and since branch is not a separate entity distinct from the Indian HO, the transaction cannot be an international transaction.
• In the third case of Aithent, the Delhi ITAT referred to sec. 92F (iii) of Income Tax Act, 1961 (‘the Act') wherein the term ‘enterprise' is defined as the person including the PE of such person, and hence foreign branch of Indian HO and Indian HO are separate enterprises for purpose of TP provisions. Further, the Delhi ITAT explained that the section loses its substance in case of Indian HO and foreign branch as the transaction between HO and branch would become tax neutral, since the Indian HO is liable to tax for its global income. However, the above view cannot be applied in case of Foreign HO and Indian Branch, since the non- residents are taxed only on the Indian Income. Hence, the nonresident may resort to under or over invoicing to mitigate the tax in India.

Fujifilm Corporation, Japan (‘Fujifilm')

• In the given case, the taxpayer was a Japanese enterprise having its branch office in India and the taxpayer had contended that the branch in India is just an extension of HO and therefore TP adjustment cannot be made. The Delhi ITAT referring to sec. 92F (iii) of the Act, observed that the PE i.e., the branch in India is a separate enterprise for purpose of TP and hence any transaction between foreign enterprise and its PE in India are subject to TP regulations.
• The Delhi ITAT did not follow the case of Aithent and observed that the transaction between foreign HO and Indian branch are not tax neutral and if they are not at arm's length, it would affect the income chargeable to tax of non-resident.
• The SB in the present case observed that there is no conflict between these decisions. Since, in case of Aithent, the transaction was between the Indian enterprise having foreign branch and the global income of Indian company was taxable in India, and in case of Fujifilm, where the transaction was between foreign enterprise having Indian branch, only the Indian income was taxable.
• The SB further observed that in case of Indian company having foreign branch, both are tax residents in India. Thus, the condition for sec. 92B(1) of the act that there should be at least one non-resident party does not get fulfilled. However, the same condition gets satisfied in case of a foreign enterprise having Indian branch, since both the parties are non-residents in this case..

DECISION OF SPECIAL BENCH ON REFRAMED QUESTION

• The SB analysed the issue under consideration based on the following parameters :
  • Permanent establishment - a separate enterprise;
  • Associated Enterprise as per sec. 92A of the Act;
  • International Transaction as per sec. 92B of the Act; and
  • Double Taxation Avoidance Agreement (‘DTAA') vs. the Income Tax Act.

1. Whether PE a separate enterprise?

• The taxpayer contended that although the definition of enterprise as per sec. 92F (iii) deems PE as an enterprise, but it does not treat PE separate from the foreign company and thus TP provisions cannot apply between PE and its HO or between other units of HO. Further, it also contended that PE is only a subset of foreign company. The taxpayer relied on the decision of Sir Kikabhai Premchand vs. CIT (1993) 24 ITR 506 SC, Betts Huett & Co Ltd vs. CIT (1979) 116 ITR 425 (Cal) & Sumitomo Mitsui Banking Corporation (2012) 19 taxmann.com 364 (Mum SB) for the contention that the transaction with self cannot trigger any income.
• The SB held that the applicability of TP provisions is linked to being qualified as an ‘enterprise' and not a ‘person'. Further, from reading the provisions of the Act, it is clear that the PE is a separate ‘enterprise' and transaction between HO and its PE are between two separate enterprises. It also held that the decisions relied by the assessee that one cannot generate income by dealing with self are not applicable in given context.

2. Associated Enterprises as per sec. 92A

• The taxpayer contended that in order to constitute an ‘associated enterprises', requirements of sec. 92A (1) as well as of sec. 92A (2), both are to be fulfilled. It further submitted that the relationship between PE and HO do not fulfill any of the conditions mentioned in sec. 92A (2) of the Act and thus, there is no AE relationship between foreign company and Indian HO.
• The revenue submitted that the HO and PE are managed and controlled by same set of persons and contributed capital. Further, the revenue contended that few conditions of sec. 92A(2) are met as below:
  • 92A(2)(a) – PE is completely owned by HO,
  • 92A(2)(b) – Promoters of HO holds directly 100% of shares in HO and PE,
  • 92A(2)(c) – Directors of PE are appointed by HO
  • 92A(2)(e) – Funds of PE are advanced to HO,
  • 92A(2)(g) – HO has complete expertise including drawing, specifications for power plant.
• The SB observed that the expression ‘participation in management or control or capital' as specified in sec. 92A(1) of the Act is not a defined expression. To find the meaning of the said expression, sec. 92A(2) of the Act has to be referred and hence the both the sub-sections are required to be read together.
• Further, SB held that the test of holding voting power through shares would not be satisfied as PE has no independent share capital, same approach can be applied for appointment of directors. However, SB noted that in these cases, fulfillment of clauses (g), (h) or (i) of sec. 92A(2)may be a fit check. The SB directed the division bench to analyse if any of the clauses as mentioned in section 92A(2) applies in current case.

3. International Transaction as per sec. 92B of the Act

• The taxpayer contended that there is no income arising out of the international transaction as there was only fund movement between foreign company, PE and third party.
• In this respect, the SB contended that income in context of TP has to be in commercial and business sense and whether an independent party would permit routing its receipts through third party. Further, it also emphasized that there was an arrangement between the foreign company and PE that gave rise to loss in the hands of PE. For the income to be covered under ambit of TP, the transaction has to satisfy the test of 92B(1) or 92B(2) of the Act. Since, both are non –residents, the basic test of sec. 92B is satisfied.
• Further, the SB noted that in case of sec. 92B(2), the transaction between an enterprise and unrelated person should have been influenced by the AE and it can be in the form of prior agreement between the AE and unrelated person, or the terms of the transactions have to be in substance determined by AE and unrelated person. The SB directed division bench to also analyse the applicability of sec. 92B(2) of the Act in present case.

4. DTAA vs the Act

• The taxpayer also contended that the provisions of DTAA override the Act, and it submitted that as per Article -9 (Associated Enterprise) of India China DTAA, the profits derived by one enterprise would be subject to TP only where one of the enterprises is resident of other contracting state i.e., India. Further, it was submitted that neither HO nor the PE can be termed as resident and thus transaction between them shall not be subject to TP considering provisions of Article 9 of DTAA.
• The SB held that the purpose of Article 9 is limited to only confirm that broadly similar rules exist in domestic law and even if the Article 9 override the act, the attribution of profits to PE is to be done as per Article 7(2) of DTAA i.e., in the manner as if the PE were a distinct and separate enterprise.
• It further observed that the intention of Article 7(2) and TP provisions is same wherein both try to analyse as how third parties would have dealt in uncontrolled conditions. Thus, the contention that there is conflict between Article 9 and domestic TP was rejected by SB.

The SB on basis of above, concluded that the transaction between foreign enterprise and its PE in India can be considered as International transaction and be subject to arm's length price determination. Further, the matter has been remanded to divisional bench to give effect to the SB order.

AURTUS COMMENTS

• The applicability of TP provisions to transactions between a branch and HO has been a subject of significant legal debate and interpretation.
• While the first issue i.e. transaction between India HO and foreign branch was largely settled, the SB ruling reinforces the prevailing understanding of provisions.
• On the issue of applicability of TP provisions to transaction between Indian PE and foreign HO, while it has been consistently held that TP provisions shall be applicable considering the branch and the foreign HO as ‘separate enterprise', however, this rulings attempts to test whether the existing definition of ‘Associated Enterprise' covers a company, and its branch is an interesting dimension, which would need to be tested depending on facts of each case. Further, applicability of TP provisions to transactions of branch with third parties from the perspective of section 92B(2) would also warrant careful analysis.
• Lastly, it would be interesting to see the implementation of above order by the division bench, with respect to issue of applicability of section 92A(2) and 92B(2).

Footnote

1. M/s. TBEA Shenyang Transformer Group Company Limited vs. DCIT [TS-508-ITAT-2024Ahd-TP]

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