A US based company (assessee), engaged in the business of developing and selling hybrid plant seeds around the world had a liaison office in India. The liaison office was converted into a branch office to undertake the two following activities:
- conduct agri-genetic research for the development of new products;
- Production of parent seeds and its sales to the joint venture company under an arrangement.
The agricultural research conducted by the research unit in India results in development of parent breeder / foundation seeds in small quantities and these breeder / foundation seeds are used as inputs as seed for multiplication and sale of parent seeds. The expenses incurred in relation to the research unit are fully reimbursed at cost by the US head office.
The Assessing Officer (AO) held that the research activities created a Permanent Establishment (PE) of the assessee in India and the profits attributable to the research unit were taxable in India. The AO worked out the estimated offshore income that was attributable to the Indian research unit based on the sales and net income of the commercial unit of the Indian branch and expenses of research unit.
Contentions of the Assessee
- The research activity is in-house and exclusive, and the research material and know-how are neither sold nor licensed or otherwise transferred to any third party including production unit of the Indian branch.
- The research activity is preparatory and auxiliary activity to the main business of assessee company and hence covered by exclusionary clause of Article 5(3) (e) of the India-USA Tax Treaty.
- The assessee has not earned income of any nature from sale of research activities per se carried in India.
- ·The Article 7(3) of the India-USA Tax Treaty provides that no estimate of attributable profits shall be made in respect of the information that is shared bilaterally between head office and the PE.
Contentions of the Revenue
- As per the approval letter issued by Reserve Bank of India (RBI), the Indian branch is engaged in the agri-genetic research for development of new products and to make available parent seeds to its Joint Venture Company.
- The research activities are carried out in India but the benefits are reaped outside India. The assessee has earned huge profits from these activities carried out through its branches all over the world.
- The research conducted by the assessee is main core activity which is commercially exploited by the assessee by selling of hybrid/parent seeds. Hence, such activities are not merely preparatory or auxiliary activities.
- The nature of income in the present case is not the same as income referred in Article 7(3) of the India-USA Tax Treaty.
Ruling of the Tribunal
- The assessee carries on agri-genetic research to develop and produce breeder seeds, which are used as inputs and / or seeds for producing parent seeds, which are in turn sold to the joint venture company.
- The sole objective of the assessee in establishing the branch office was not to engage in scientific research or agri-gentic research alone; the assessee also wanted to produce parent seeds for making them available to its Joint Venture Company. The research activity and the sale of parent seeds by the assessee company are inter-linked, inter-lacing and inter-dependent.
- The activities undertaken by the assessee are nothing but one composite integrated activity intended to be carried out by the assessee for the purpose of producing parent seeds, which are being supplied to the joint venture company as per the approval granted by the RBI.
- The activity of developing and producing breeder seeds by doing extensive research is an “essential” and “significant” part of the activity of the branch office in supplying parent seeds to its joint venture company.
- The research activities cannot be held to be the functions of back office supporting the business of the branch carrying on business of production and sale of parent seed.
- Therefore, the activity carried out in India is not covered within the exclusion provision contained in Article 5(3) (e) of the India-USA Tax Treaty.
- The branch office of assessee in India constitutes PE within the meaning of Article 5 of the India-USA Tax Treaty and income of the PE is to be taxed in India as per the provisions of Article 7 of the India-USA Tax Treaty.
- As regards the attribution of profits to the PE, the Tribunal restored the matter to the file of AO for determining the price of the services rendered by the Indian branch to the assessee.
Under the specific facts of the case the research activities were held to be in the nature of core business activities and not preparatory and auxiliary services so as to be covered in the exclusionary Article for Fixed Place PE.
Source: Pioneer Overseas Corporation Vs. DDIT, ITA Nos. 1868, 1869, 1870 and 1871/Del/2005 (Delhi Tribunal) dated 24 December 2009