In 2007, when the Supreme Court of India delivered its landmark ruling in the case, DIT v. Morgan Stanley and Co. [(2007) 292 ITR 416 (SC)], it was wholeheartedly welcomed by foreign companies doing business in India as it gave perceptible clarity to the taxability of such enterprises in India through permanent establishment (PE).
Now, foreign companies have another reason for celebration. The Bombay high court, in its recent ruling in the case of SET Satellite (Singapore) Pte Ltd v. DDIT (2008-TIOL-414-HC-MUM-IT), setting aside the earlier income-tax appellate tribunal (Itat) order, has applied the principles laid down by the Supreme Court in the Morgan Stanley case to PEs other than service PEs (agency PE in this case). This vindicates the position that while the decision of the Supreme Court was in the context of a service PE, the principles were intended to apply to other types of PEs as well. Another important principle laid down is that the withdrawal of income by a taxpayer was permitted, even though offered earlier while claiming it was not taxable.
SET Satellite (Singapore), a foreign telecasting company based in Singapore and engaged in the business of broadcasting various television channels into India from there, appointed SET India (P) Ltd as an agent to carry on marketing activities in India for sale of advertisement air-time slots (ad airtime) to various advertisers in India on its behalf. The agent appointed by the appellant qualified as a “dependent agent permanent establishment” (Dape) and its services were remunerated on an arm’s length basis.
The appellant originally filed nil tax returns in India. Later, it revised the returns, offering its business income to tax in India while at the same time maintaining a position that, since it was remunerating the agent on arm’s length consideration, it had no further tax liability in India.
The commissioner of income tax (appeals), or CIT(A), upheld the above-mentioned contentions of the appellant in principle, while refusing to grant relief on the second contention on the ground that the appellant had itself offered its income to tax in India and, therefore, there was no reason to interfere with the order of the assessing officer. In an appeal filed before Itat, the tribunal—relying on the view expressed by the Organisation of Economic Cooperation and Development, International Fiscal Association and the Australian tax office—held that the mere payment of arm’s length remuneration to a dependent agent did not extinguish the tax liability of the appellant in India. In fairness, this decision was issued by Itat before the Supreme Court decided the Morgan Stanley case. Consequently, an appeal was filed by the appellant before the high court against the Itat order.
The following issues were considered by the high court:
Illustration: Jayachandran / Mint
First, whether having taxed the agent on the fair value of activities in India, the same could be taxed all over again in the hands of the assessee as being income attributable to the deemed PE; and second, whether the assessee was debarred from contending in appeal that there was no income liable to tax as a matter of law solely on account of the fact that it had at some stage surrendered on ad hoc basis a sum for taxation as being liable to tax in India without prejudice to its claim that its income is not liable to tax in India. The appellant contended before the high court that as per Article 7(2) of the India-Singapore tax treaty, the profits attributable to the PE are profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a PE. This corresponds to the arm’s length principle. Accordingly, it was submitted that since the dependent agent has been remunerated on arm’s length basis, it extinguishes the tax liability of the appellant in India.
The appellant also placed reliance on the Morgan Stanley case where the Supreme Court has accepted the principle that payment of arm’s length consideration to an associated enterprise, which also constituted a PE, would extinguish the tax liability of the foreign enterprise in India.
Relying on the Itat decision, the tax department contended that, for one, mere payment of arm’s length remuneration to a dependent agent did not extinguish the tax liability of Dape; consequently, further attribution of profits was required to be made to Dape depending on functions performed, assets used and risks assumed. And two, it held that the decision of the Supreme Court in the Morgan Stanley case did not have the effect of negating the principles adopted in the Itat order.
After considering circulars No. 23 and 742 issued by the Central Board of Direct Taxes, Article 7 of the tax treaty and the decision of the Supreme Court in the Morgan Stanley case, the high court held that:
(a) If a foreign enterprise pays its Indian PE on arm’s length basis for its services, the Indian tax liability of the foreign enterprise on account of such PE is extinguished;
(b) Merely because tax on income was paid for some assessment years, it would not stop the assessee from contending that its income was not liable to tax.
The importance of this ruling is also because despite being delivered in the context of an enterprise having a PE under a double taxation treaty, it can possibly be applied to foreign enterprise taxable under the domestic law on the basis of a business connection in India in the form of an agent or a service provider—more so when the long established treaty concepts such as dependent agent, independent agent, arm’s length pricing, associated enterprises and so on, now find place in the Income-tax Act itself.
Further, in this case, the taxpayer was found to have satisfied the domestic law threshold of taxability. Though it was a treaty protected case, the treaty was not invoked to reduce the taxability imposed by the domestic law. On the basis of settled law, it could be argued in a non-treaty case that a treaty, by itself, cannot create tax liability but can certainly mitigate the liability imposed by the domestic law on an enterprise. Therefore, once the higher threshold under domestic law is shown to have been crossed by the taxpayer, the lower threshold under the treaty can automatically be presumed to have been satisfied.
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This column is contributed by Abhinav Ashwin of AZB & Partners, Advocates & Solicitors.