Court- Delhi Tribunal
Citation: e Funds Corporation Vs. ADIT] (2010-TII-165-ITAT-DEL-INTL
Brief : The back office operations and software development services carried out by an Indian subsidiary are held to be a fixed place permanent establishment of a Foreign Company. It has also been held that the contract entered into by the foreign company with its clients for providing certain IT-enabled services and then assigning or sub-contracting the same contract to Indian Subsidiary for execution can be said to constitute a business connection in India and profits attributed to the permanent establishment are determined based on the global profits in proportion to Indian assets to global assets.
Facts: eFunds Corporation, USA and eFunds IT Solution Group Inc, USA (assessees), were two independent companies incorporated under the laws of Delaware, United States and, were tax residents of USA. eFunds International India (Pvt.) Ltd. (eFunds India), an Indian company, was providing service to the eFunds Corporation, USA by way of providing: (a) call center services; (b) financial shared services and data entry; and (c) software development services. For such services, eFunds India received compensation by way of remuneration, which was assessed to tax in India. The transactions between eFund India and the assessees were claimed to be at arm’s length for all assessment years (AY) other than for the AY 2005-06. As the assessees did not have business in India, the amount of remuneration paid, is not being claimed as a deduction in India, but same was deducted as expenditure while computing their expenditure in USA. The assessees had entered into various agreements with eFunds India, wherein eFunds India was to render services outside India. As the assessees didn’t have any business or presence in India, they never filed return of income in India.
In the first assessment for the AY 2003 -04, the assessing officer (AO) held that the facilities of eFunds India constitutes a fixed place permanent establishment (PE) of the assessees on the basis of the group annual report for year 2002, that the facilities of eFunds India in shape of software development centre and call centre were at disposal of the assessees, the whole of contract in respect of professional services were carried out in India; and all revenues relatable to this segment were derived from activities undertaken in India i.e. the terminals on which database of assessees was constantly and on real time basis available to eFunds India. Accordingly, the AO framed the assessments by adopting the Group Annual Global Balance Sheet prepared by the assessees in USA and estimated the income attributable to the PE in India by allocating global revenues of the assessees in the proportion of alleged assets in India to the global assets.
Based on the orders passed in AY 2003 -04, the AO reopened the assessments for other assessment years. The AO arrived at following observations / conclusions for holding PE in India –(1) as per the annual report of the assessees, they have international sales outlet in all parts of world, including India; (2) as per the group annual report in Form No. 10-K, the activities of the assessees in India are not preparatory or auxiliary activity; but core income generating activities; (3) The purpose for incurring the expenses incurred by eFunds India with regard to traveling expenses, communication charges, courier charges, tape drives, xerox, etc. was not known and if these expenses were incurred in India, then, whether the same should have form the cost base of eFunds India for the purpose of compensation or not, requires to be verified; (4) The of source the information regarding employee strength was the global accounts of assessee and the transfer pricing study report in case of eFunds India; (5) The source of the information is Form No. 3CEB of eFunds India; (6) The purpose of providing the software free of cost to eFunds India is not known. The cost of such software to the assessee is also not known. Had this software provided at charge, the payment could be liable for withholding tax and also such charge will form part of cost base of the eFunds India, which in turn will require more compensation from the assessee ; (7) The effect of the same are required to be seen on the transfer prices between eFunds India and the assessee; (8) The President and sales team of eFunds India were working for the assessees., then, whether they were also concluding the contracts on behalf of the enterprise was required to be seen and this would also create the
PE of the assessees in India.
In the meanwhile assessees invoked Mutual Agreement Procedure (MAP) proceedings in respect of assessment year 2003-04, for which a MAP resolution was arrived at. The assessment in all these years were completed by the AO adopting earlier line of action, and MAP order was also considered while working out the taxable income. The assessees contended that it has no assets in India, no presence in India, no liaison office in India and no business in India and therefore, no PE in India and as such, no income was either received in India or has accrued or arisen in India and as such.
On appeal to the Commissioner of Income tax (Appeals) [CIT (A)], CIT(A) upheld the actions taken by the AO in holding that assessees have PE in India and profits were attributable to tax, however, gave part relief in respect of computation of attribution of profits.
Aggrieved by the order of CIT (A), both assessee and revenue, preferred appeals for all the assessment years before Income Tax Appellate Tribunal (‘Tribunal’) on the reopening of assessment, determination of PE and attribution of profit to such PE in India.
Observation and decision of the Tribunal:
• The AO had the material in the form of assessment order for AY 2003-04, annual accounts, business model and business strategy were same for all these years, business arrangements and strategy among these entities being same thereby the transactions and resultant income had linkage to earlier years. These information and material on record of prudent revenue officers are sufficient to hold a belief that income has escaped assessments in years under appeals and to initiate the proceedings under section 147 / 148 of the Act.
• The AO has mentioned to the fact that assessees had initiated provisions of MAP under Article 27 of the India – USA Double Taxation Avoidance Agreement (DTAA) wherein the USA competent authority also agreed to the negotiations of the issue of taxation of the assessee with Indian competent authority which was pending at that point of time for the AYs 2003- 04 and 2004- 05 in the case of eFunds IT Solutions Inc. Once the AO found out that the assessees had a PE for AYs 2003- 04 and 2004- 05, the reopening of assessment proceedings under section 147 became a logical consequence.
• The assessees entered into contract with its clients for providing certain IT enabled services and then, the same contract was either assigned or sub-contracted to eFunds India for execution. Therefore, both the assessees and eFunds India came under legal obligation to provide services to clients of the assessees.
There are contracts between the assessees and eFunds India, viz., Master Sub-Contractor Agreement, Financial Shared Services Agreement and Call Centre Agreement; and under these agreements, eFunds India provides various services to the assessees. Considering Function performed, Assets used and Risks assumed (FAR analysis) by the assessees and eFunds India, it is clear that eFunds India is not having requisite material assets as the relevant software and database needed for providing IT enabled services so as to perform the requisite functions independently, therefore, to that extent they are made available by eFunds Corporation to eFunds India free of any charges.
The corporate office of eFunds India at Mumbai had an International Division which consisted of a president’s office and a sales team. The president’s office over viewed operations of eFunds group entities globally and the sales team undertook marketing efforts for affiliates of assessee. The overall reporting of President’s office was to the assessees. These activities were carried on continuously over a period which included the years in question.
eFunds India does not bear any significant risk as the ultimate responsibility lies with the assessees.
The above activities are carried on continuously over a period. From this factual matrix, it can be seen that the gamut of activities and relationship clearly constitutes Business Connection (BC) in India and income from such BC is deemed to accrue or arise in India to the assessees.
• It can be seen that there exist a PE even under article 5(1) in respect of the back office operation and software development services being carried out by the subsidiary. Place of business need not be owned, rented or otherwise under possession or control of the enterprise in order to constitute PE. The only requirement is that the place should be fixed in the context of the nature of business being carried out and also no time period test is prescribed for permanence. The permanence of the establishment has to be determined in the context of nature of business being carried on. In view of activities carried out in the present case, there exists a PE of the assessees in India also under article 5 (2) (i) of DTAA between India and USA (in the form of sales outlet). The aforesaid activities can’t be considered to be preparatory and auxiliary as they are the core income generating activities. Also, the assessees have themselves submitted to Indian tax authorities that the business of eFunds India is inextricably linked to the business of the assessees.
• In the present case as the business of development and global deal is carried out through the PE cannot be considered to be preparatory and auxiliary in nature. The activity of supervision or control of the proper performance of a contract can hardly be considered to be of an auxiliary nature, as it is strictly functional to the production of income. Therefore, the decisions of DIT v. Morgan Stanley & Co. Inc. 292 ITR 416 (SC) and Motorola Inc. v. DCIT (95 ITD 269) [ITAT Del (SB)], replied upon by the assessees are not applicable to the present case.
• eFunds India is not bearing the entire risk of business and, it is only very limited risk which is with respect to BPO, call centre, accounting service and software development. Accordingly, the remuneration that, has been paid in accordance with the Transfer Pricing study conducted by eFunds India does not include all the risks of the assessees. Therefore, the in view of the decision of Morgan Stanley(supra) as explained in Rolls Royce Plc v. DDIT 19 SOT 42 (ITAT Del) case will not extinguish the assessment of both the assessees.
• The facts of years under appeal are same as that of MAP years. The assessees have not been able to point out any change in the business model as compared to those in MAP assessment years. The MAP resolution is to be viewed as an application of the DTAA to an e-commerce environment, where the literal application of Article 5 of DTAA may not lead to a correct representation of the taxing rights of the two tax jurisdictions as e-commerce business may be transacted on global basis through various tax jurisdiction and income may be earned in various jurisdictions. The competent authorities have not only provided for computation of income under article 7 in MAP, but also for the tax credit to be provided to the assessee in the home country’s tax jurisdiction. Thus, it is clear that the assessees have a PE in India in accordance with the above analysis and MAP resolution.
• The calculation of attributable profits, i.e., difference between profits attributable to the assessees as reduced by profits of Indian subsidiary, it shall be pertinent here to indicate that the whole exercise is to ascertain the effect of assessees’ business connections in India in terms of profits, which are attributable. Part of the functions and consequent revenue is declared in the hands of subsidiary eFunds India and part has not been attributed to any entity in India, which is to be taxed.
• The proper method for estimating the profits attributable to PE shall be worked out in the following manner/order, which, according to us, gives a fair and is reasonable basis:
(i) Determination of Proportion of Indian assets to Global assets, i.e., including eFunds India assets (written down value of assets, and not the gross value, is to be considered);
(ii) Aggregate of global profits of group (inclusive of eFunds India profits);
(iii) Working of total profits attributable to India out of global profits in same proportion as (i) above;
(iv) Aggregate India attributable profits of group-X;
(v) Less : (-) eFunds India International assessed Profits-Y;
(vi) Balance: Z(X-Y) i.e., Surplus profits attributable to Indian PEs of both assessees.
Surplus profits, i.e., ‘Z’ is to be further distributed in both assessees: 85 % attributable to PE of eFunds Corporation; and 15% attributable to eFunds IT Solution.
• This working is more scientific and equitable. It will take care of the apprehension raised that though e-Funds India income was reduced on first stage in MAP proceedings, corresponding assets are not reduced, while adopting the global assets. This methodology/formula would be more helpful in arriving at the reasonably correct amount of attributable income, being comparatively just, fair and equitable.
This Ruling has dealt with three important aspects, viz., determination of PE, attribution of profit to PE and whether the resolution agreed in MAP proceedings for a particular year is to be followed in other years.
The Tribunal has held that the foreign company constitutes a PE under article 5(1) in respect of back office operations and software development services carried out by the Indian subsidiary and the operations carried out by such Indian subsidiary are integral part of the foreign company’s income generating activity.
As per the analogy drawn from the article 7(2) of India-USA DTAA, the income of the PE should have been determined based on the functions, assets and risk assumed by the permanent establishment in the source country. The said article further provides that where the correct amount of profits attributable to the PE is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the PE may be estimated on a reasonable basis. However, the result derived from such estimation shall be in accordance with the principles contained in Article 7. However, it seems that without applying the principles that are laid down in article 7, the Tribunal felt it proper, on the basis of formula agreed in principle by the assessees in MAP proceedings for other years, to attribute the profits to the PE based on the global profits (including profits earned by the Indian subsidiary) in proportion to the Indian assets to the global assets which then be reduced by the profits earned by the Indian subsidiary.
This Tribunal ruling is one of its kind on attribution of profit, which is determined based on the percentage of global revenue in proportion to the Indian assets to the global assets. This is one of the indirect methods of attribution of profits to the PE, which finds place in the USA-Ukraine DTAA.