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DIRECTOR OF INCOME TAX Vs. M/S E FUNDS IT SOLUTION
February, 10th 2014
*            IN THE HIGH COURT OF DELHI AT NEW DELHI

+                       INCOME TAX APPEAL NO. 735/2011

                                         Reserved on: 29th October, 2013
%                                    Date of Decision: 5th February, 2014

        DIRECTOR OF INCOME TAX                    ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION                   ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 736/2011 & 737/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS CROPORATION                   ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 738/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION INC.              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 739/2011 & 740/2011
ITA No. 735/2011+connected appeals                            Page 1 of 102
        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS CORPORATION                ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 802/2011

        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION INC.              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 845/2011

        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS CORPORATION INC              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 912/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus
ITA No. 735/2011+connected appeals                       Page 2 of 102
         DIRECTOR OF INCOME TAX                 ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.


                 INCOME TAX APPEAL NO. 913/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 914/2011& 915/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NO. 916/2011

        E FUNDS IT SOLUTIONS GROUP INC           ..... Appellant
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                          Anand Sukumar, Advocate.

                                     Versus

         DIRECTOR OF INCOME TAX                  ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

ITA No. 735/2011+connected appeals                      Page 3 of 102
                 INCOME TAX APPEAL NO. 917/2011

        E FUNDS CORPORATION                     ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.


                 INCOME TAX APPEAL NOS. 918/2011,919/2011 &
                 920/2011

        E FUNDS IT SOLUTIONS GROUP INC           ..... Appellant
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                          Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 1002/2011

        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         E FUNDS IT SOLUTION INC                    ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 1200/2011 &
                 1201/2011

        E FUNDS IT SOLUTION GROUP INC                 ..... Appellant
ITA No. 735/2011+connected appeals                        Page 4 of 102
                          Through Mr. S. Ganesh, Sr. Advocate with Mr.
                                  Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOMNE TAX..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 1202/2011 &
                 1203/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOMNE TAX..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 1217/2011 &
                 1218/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION INC              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 1219/2011 &
                 1221/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

ITA No. 735/2011+connected appeals                          Page 5 of 102
                                          Versus

         M/S E FUNDS CORPORATION                   ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.


         CORAM:
         HON'BLE MR. JUSTICE SANJIV KHANNA
         HON'BLE MR. JUSTICE SANJEEV SACHDEVA


SANJIV KHANNA, J.:
*            IN THE HIGH COURT OF DELHI AT NEW DELHI

+                       INCOME TAX APPEAL NO. 735/2011

                                         Reserved on: 29th October, 2013
%                                    Date of Decision: 5th February, 2014

        DIRECTOR OF INCOME TAX                    ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION                   ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 736/2011 & 737/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS CROPORATION                   ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 738/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION INC.              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 739/2011 & 740/2011
ITA No. 735/2011+connected appeals                            Page 1 of 102
        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS CORPORATION                ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 802/2011

        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION INC.              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 845/2011

        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS CORPORATION INC              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NO. 912/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus
ITA No. 735/2011+connected appeals                       Page 2 of 102
         DIRECTOR OF INCOME TAX                 ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.


                 INCOME TAX APPEAL NO. 913/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 914/2011& 915/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NO. 916/2011

        E FUNDS IT SOLUTIONS GROUP INC           ..... Appellant
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                          Anand Sukumar, Advocate.

                                     Versus

         DIRECTOR OF INCOME TAX                  ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

ITA No. 735/2011+connected appeals                      Page 3 of 102
                 INCOME TAX APPEAL NO. 917/2011

        E FUNDS CORPORATION                     ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.


                 INCOME TAX APPEAL NOS. 918/2011,919/2011 &
                 920/2011

        E FUNDS IT SOLUTIONS GROUP INC           ..... Appellant
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                          Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 1002/2011

        DIRECTOR OF INCOME TAX                   ..... Appellant
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                         Sr. Standing Counsel.

                                     Versus

         E FUNDS IT SOLUTION INC                    ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 1200/2011 &
                 1201/2011

        E FUNDS IT SOLUTION GROUP INC                 ..... Appellant
ITA No. 735/2011+connected appeals                        Page 4 of 102
                          Through Mr. S. Ganesh, Sr. Advocate with Mr.
                                  Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOMNE TAX..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 1202/2011 &
                 1203/2011

        E FUNDS CORPORATION                    ..... Appellant
                 Through Mr. S. Ganesh, Sr. Advocate with Mr.
                         Anand Sukumar, Advocate.

                                     Versus

         ASSISTANT DIRECTOR OF INCOMNE TAX..... Respondent
                 Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                 Sr. Standing Counsel.

                 INCOME TAX APPEAL NOS. 1217/2011 &
                 1218/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

                                     Versus

         M/S E FUNDS IT SOLUTION INC              ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.

                 INCOME TAX APPEAL NOS. 1219/2011 &
                 1221/2011

        DIT-1 INTERNATIONAL TAXATION               ..... Appellant
                  Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni,
                          Sr. Standing Counsel.

ITA No. 735/2011+connected appeals                          Page 5 of 102
                                          Versus

         M/S E FUNDS CORPORATION                   ..... Respondent
                  Through Mr. S. Ganesh, Sr. Advocate with Mr.
                  Anand Sukumar, Advocate.


         CORAM:
         HON'BLE MR. JUSTICE SANJIV KHANNA
         HON'BLE MR. JUSTICE SANJEEV SACHDEVA


SANJIV KHANNA, J.:


        This common judgment will dispose of these two sets of cross-

appeals        by      the     Director     of     Income   Tax,   International

Taxation and e-Fund Corporation, USA (e-Fund Corp., for short)

relating to Assessment Years 2000-01, 2001-02, 2002-03, 2004-05,

2005-06, 2006-07 and 2007-08 and e-Fund IT Solutions Group

Inc., USA (e-Fund Inc., for short) relating to Assessment Years

2000-01, 2001-02, 2002-03, 2005-06, 2006-07 and 2007-08. The e-

Fund Corp. and e-Fund Inc., when referred together have been

described as the assessee` and the Director of Income Tax,

International Taxation has been referred to as the Revenue`. The

cross-appeals arise out of two common orders passed by the Income

Tax Appellate Tribunal (tribunal, for short). The first order dated 30th

September, 2010 relates to all assessment years, except assessment



ITA No. 735/2011+connected appeals                                  Page 6 of 102
years 2006-07 and 2007-08, which are subject matter of the second

order of the tribunal dated 15th March, 2011.


2.      The assessee are primarily aggrieved by the finding of the

tribunal that they have Permanent Establishment (PE, for short) in

India. They are also aggrieved with the initiation of the assessment

proceedings under Section 147 read with Section 148 of the Income

Tax Act, 1961 (Act, for short), whereas the Revenue is aggrieved by

the finding of the tribunal relating to computation or attribution of the

income earned by the assessee through the PE in India.


3.      By order dated 27th September, 2011, the following substantial

common questions of law were framed in the appeals Nos. 912/2011,

913/2011, 914/2011, 915/2011, 916/2011, 917/2011, 918/2011,

919/2011 and 920/2011 relating to assessment years 2000-01, 2001-02,

2002-03, 2004-05 and 2005-06 filed by the assessee:-

                 1. Whether, on the facts and circumstances of the case
                 and in law, the Assessing Officer was justified in
                 reopening the assessment under Section 147/148 of the
                 Income-Tax Act?
                 2. Whether on the facts and in the circumstances of the
                 case and in law, the Tribunal was justified in holding
                 that Appellant has a business connection in India under
                 Section 9(1) of the Act?
                 3. Whether on the facts and in the circumstances of the
                 case and in law, the Tribunal was justified in holding
                 that the Appellant has a permanent establishment in
                 India under Articles 5(1), 5(2) (1) and 5(4) of the India-
                 US DTAA?
ITA No. 735/2011+connected appeals                                       Page 7 of 102
                 4. Whether on the facts and in the circumstances of the
                 case, and in law, the Tribunal was justified in holding
                 that appellant is liable to interest under Section 234A
                 and 234B of the Act?

4.        By subsequent order dated 2nd March, 2012, two more

questions of law being question Nos. 5 and 6 were framed and read as

under:-

                5. Whether any income of eFunds International India Pvt.
                Ltd. Can be attributed and assessed in the hands of the
                appellant?
                6. In case question no. (5) is answered against the
                appellant, whether the Tribunal was justified and correct
                in adopting the formula mentioned in the order and not
                accepting the stand of the assessee?

4A. By order dated 17th November, 2011, the following substantial

common questions of law were framed in the appeals ITA Nos.

1200/2011, 1201/2011, 1202/2011 and 1203/2011 relating to

assessment years 2006-07 and 2007-08 filed by the assessee:-

                 1. Whether the tribunal is correct in holding that the
                 appellant has business connection in India under
                 Section 9(1)(i) of the IT Act?
                 2. Whether the tribunal was correct in holding that the
                 appellant has a permanent establishment in India under
                 Arts 5(1), 5(2) (1) and 5(4) of the India-US DTAA?
                 3. Whether any income of e-funds international India
                 pvt ltd can be attributed and assessed in the hands of
                 the appellant?
                 4. In case Ques 3. Is answered against the appellant
                 whether the tribunal was justified and correct in
                 adopting the formula mentioned in the order and not
                 accepting the stand of the assessee?




ITA No. 735/2011+connected appeals                                     Page 8 of 102
In ITA Nos. 1201/2011 and 1203/2011 relating to assessment year

2006-07 the following additional substantial questions relating to

initiation of assessment proceedings under section 147/148 of the Act,

was raised:-

                 Whether the action of the Assessing officer in
                 reopening the assessment under Section 147/148 of the
                 IT Act is correct?

5.      The substantial questions of law framed on the appeals being

ITA Nos. 735/2011, 736/2011, 737/2011, 738/2011, 739/2011,

740/2011, 802/2011, 845/2011 and 1002/2011 filed by the Revenue

vide order dated 27th September, 2011 read as under:-

                 1. Whether on the facts and circumstances of the case,
                 the Income Tax Appellate Tribunal has erred in law I
                 not appreciating that the method adopted by the AO for
                 attributing the profit to the PE of the assessee is based
                 on the lines of MAP proceedings based on A.Y. 2003-
                 04?
                 2. Whether on the facts and circumstances of the case,
                 the order of the ITAT is not perverse?

5A.     In ITA Nos. 1217/2011, 1218/2011, 1219/2011 and 1221/2011

for Assessment Years 2006-07 and 2007-08 filed by the Revenue, the

following substantial questions of law were framed vide order dated

21st November, 2011:-

                 (1) Whether the Income Tax Appellate Tribunal has
                 correctly rejected the computation of profit attributed to
                 the Permanent Establishment on the lines of the MAP
                 proceedings?
                 (2) Whether the formula prescribed by Income Tax
                 Appellate Tribunal for computation of profit attributable
                 to a Permanent Establishment is correct and as per law?
ITA No. 735/2011+connected appeals                                       Page 9 of 102
                 (3) Whether the order of the Income Tax Appellate
                 Tribunal is perverse?


6.      Undisputed facts in brief may be first noticed. The assessees are

companies incorporated in United States of America (USA, for short)

and were residents of the said country. They were assessed and have

paid taxes on their global income in USA. e-Fund Corp. was the

holding company having almost 100% shares in IDLX Corporation,

another company incorporated in USA. IDLX Corporation held almost

100% shares in IDLX International BV, incorporated in Netherlands

and later in turn held almost 100% shares in IDLX Holding BV, which

was a subsidiary again incorporated in Netherlands. IDLX Holding

BV was almost a 100% shareholder of e-Funds International India

Private Limited, a company incorporated and resident of India (e-Fund

International India Private Limited has been described as e-Fund

India`). IDLX International BV was also the parent/holding company

having almost 100% shares in e-Fund Inc., which as noticed above,

was a company incorporated in USA.


7.      Both e-Fund Inc. and e-Fund Corp. have entered into

international transactions with e-Fund India.        The details of these

transactions have to be examined in depth and have to be referred

below. e-Fund India being a domestic company and resident in India

ITA No. 735/2011+connected appeals                             Page 10 of 102
was taxed on the income earned in India as well as its global income in

accordance with the provisions of the Act. The international

transactions between the assessees and e-Fund India and the income of

e-Fund India, it is accepted, were made subject matter of arms length

pricing adjudication by the Transfer Pricing Officer (TPO, for short)

and the Assessing Officer (AO, for short) in the returns of income filed

by e-Fund India. We are not primarily concerned with the merits of

the computation of income declared and assessed in the hands of e-

Fund India in the present appeals, though the factum that e-Fund India

was assessed to tax on its global income as per law or on arms length

pricing in relation to associated transactions and the basis of the said

computation of income earned by e-Fund India, as noticed below, is a

relevant and an important fact. Revenue has not disputed the said legal

position. It is the contention of the Revenue that income of the two

assessees were attributable to India because the two assessees had PE

in India and should be taxed in India, irrespective of whether the said

assessees had paid taxes in USA. Income earned and taxed in the

hands of e-Fund India was different from the income attributable to the

two assesses. Thus the balance or differential amount, i.e., income

attributable to the two assesses, which was not included in income




ITA No. 735/2011+connected appeals                           Page 11 of 102
earned and taxed in the hands of e-Fund India, should be taxed in

India.


8.       As a principle what is stated and submitted by the Revenue

cannot be contested and in fact not contested by the assessees as it is a

principle applicable to international taxation. A foreign or a non-

resident company can be taxed in the country where it has a subsidiary,

which is also a PE on the income attributable to the said PE, even if the

subsidiary (in the present case of e-Fund India) is being taxed in the

said country. The principle being that subsidiary being an independent

and a distinct entity is taxed for its income, whereas the foreign entity,

i.e., holding company is taxed for the income earned by the said

independent entity attributable to the PE in the country where

subsidiary is situated. The income of the subsidiary is not taxed in the

hands of the non-resident principal and vice-versa. Thus, there is no

double taxation in the hands of the holding company as income of the

subsidiary is not taxed as income of foreign holding assessee. The

principle is that a subsidiary constitutes an independent legal entity for

the purpose of taxation.


9.       Before we examine whether e-Fund India and its activities

constitute PE of the foreign assessees as under the applicable Double

Taxation Avoidance Agreement between India and USA,                   (The
ITA No. 735/2011+connected appeals                            Page 12 of 102
agreement for the sake of convenience is being referred to as DTAA),

it would be appropriate, at the outset, dispel any doubt or contention

that establishing a subsidiary in the other treaty country would result in

creating or establishing a PE of a foreign holding company in the said

third country. Again to be fair to the Revenue, no such contention has

been raised and the said legal position is clear and luminescent from

paragraph 6 to Article 5 of the DTAA. The said paragraph reads:-

                 6. The fact that a company which is a resident of a
                 Contracting State controls or is controlled by a
                 company which is a resident of the other Contracting
                 State, or which carries on business in that other State
                 (whether through a permanent establishment or
                 otherwise), shall not of itself constitute either company
                 a permanent establishment of the other.



10.     The aforesaid paragraph in categorical terms states that a

holding or a subsidiary company by themselves would not become PE

of each other.          The words used in the said paragraph are equally

important because the term holding or parent company or a

subsidiary company is not used.                  The said paragraph uses the

expression controls or is controlled by a company, which is resident

of the other contracting State.              Use of the word controls or

controlled is significant and defines the scope and ambit of the said

clause. Paragraph 6 states that the company, which controls or is

controlled and carries on business in the other State, would by itself not
ITA No. 735/2011+connected appeals                                       Page 13 of 102
constitute PE of the other company.           Therefore, even carrying on

business in the other country by either the controlled company or the

controlling company, but and though the other company would not

make them, i.e. the two companies, a PE of each other. However, this

does not mean that a subsidiary can never be a PE of the holding

company, though there is opinion that the holding company or the

controlling company possibly may not be a PE of a subsidiary (the

later question is not subject matter of the present decision and we

express no opinion on the said question though it may be a relevant

aspect, which the tax adjudicators, policy makers and the legal

draftsmen in India and abroad may have to deal with). Indeed if this

principle is not applicable it could be argued that the Indian subsidiary,

i.e., eFund India`s income could be taxed in the country from where it

is controlled or managed.            A subsidiary can become a PE of the

holding/controlling company or the related company, if it satisfies the

postulates and requirements of other paragraphs of Article 5,

notwithstanding and negating the protection provided under paragraph

6 of Article 5, which recognizes legal independence of the two entities

for tax purposes. This legal principle that the holding or contracting

company and the subsidiary or the controlled company are two

separate and independent tax entities and must be so treated permeates

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and pervades but will give way to the exceptions carved out and stated

in the DTAA. The legal principle is simple, a subsidiary being a

resident of the State in which it is incorporated and functioning is taxed

for its income. Subsidiary`s income is separately allocated and brought

to tax in the country where it is situated or is a resident of. This clearly

distinguishes a subsidiary form a foreign assessee, which is directly

carrying on business and has residence in another country through their

own branches/offices, personnel, etc.


11.     Klaus Vogel on Double Taxation Conventions, Third Edition,

states the following principle:-

                 40. [Principle] It is generally accepted that the
                 existence of a subsidiary company does not, of itself,
                 constitute that subsidiary company a permanent
                 establishment of its parent company. This follows from
                 the principle that, for the purpose of taxation, such a
                 subsidiary company constitutes an independent legal
                 entity. Even the fact that the trade or business carried
                 on by the subsidiary company is managed by the parent
                 company does not constitute the subsidiary company a
                 permanent establishment of the parent company.

12.     Similarly, in Arvid A. Skaar in Permanent Establishment,

Erosion of Tax Treaty Principle, Second Indian, Reprint, 2008 has

succinctly explained the legal position at page 540 paragraph 36.2.1 as

under:-

                 The treaty-based protection of related companies
                 recognizes the legal independence of related companies
                 for tax purposes as a material reality until the opposite is

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                 proved. This affects both the constitution of PE, and the
                 allocation of income to a separate entity.

13.     It is further clarified and elucidated at pages 541-42 paragraph

36.2.3 as :-

                          36.2.3 POLICY CONSIDERATIONS
                 A neutral tax system would allow a subsidiary PE to be
                 constituted in all cases where the same conclusion
                 would be reached for unrelated companies. This
                 solution is expressly stated for a subsidiary PE under
                 the agency clause. Consequently, the position of some
                 older pre-OECD authors, that a subsidiary can never
                 constitute a PE for the parent, has not been sustained.
                 The conventional position of the OECD-based tax
                 treaty doctrine is that a subsidiary PE can only be based
                 on the agency clause. However, the tax treaties aim at
                 allowing the source state to tax business profits with a
                 certain economic allegiance to the country expressed
                 through the enterprise`s PE. This intention must also
                 apply when the parent company`s business income is
                 earned by the intermediation of a subsidiary. Thus,
                 from a de lege ferenda point of view, PE taxation of the
                 parent company is justified in cases where residence
                 state taxation of the subsidiary does not adequately
                 attribute taxing jurisdiction to the source state. The
                 commentaries to the OECD model treaty do not de lege
                 lata give conclusive reasons for the conventional
                 wisdom with regard to this question.

A part of the above observations are in the nature of justification of

right of taxation in source State and relate to the domain of PE principle

and inter-state neutrality as a theory. Issue of source State in the present

factual matrix has been touched below.


14.     The aforesaid principle is no longer res integra and has been

lucidly elucidated by the Supreme Court in DIT versus Morgan



ITA No. 735/2011+connected appeals                                       Page 16 of 102
Stanley and Co. Inc., (2007) 292 ITR 416 (SC) in the following

words:-

                 32. The object behind enactment of transfer pricing
                 regulations is to prevent shifting of profits outside India.
                 Under Article 7(2) not all profits of MSCO would be
                 taxable in India but only those which have economic
                 nexus with PE in India. A foreign enterprise is liable to
                 be taxed in India on so much of its business profit as is
                 attributable to the PE in India. The quantum of taxable
                 income is to be determined in accordance with the
                 provisions of I.T. Act. All provisions of I.T. Act are
                 applicable, including provisions relating to depreciation,
                 investment losses, deductible expenses, carry-forward
                 and set-off losses etc. However, deviations are made by
                 DTAA in cases of royalty, interest etc. Such deviations
                 are also made under the I.T. Act (for example:
                 Sections 44BB, 44BBA etc.). Under the impugned
                 ruling delivered by the AAR, remuneration to MSAS
                 was justified by a transfer pricing analysis and,
                 therefore, no further income could be attributed to the
                 PE (MSAS). In other words, the said ruling equates an
                 arm's length analysis (ALA) with attribution of profits. It
                 holds that once a transfer pricing analysis is undertaken;
                 there is no further need to attribute profits to a PE. The
                 impugned ruling is correct in principle insofar as an
                 associated enterprise, that also constitutes a PE, has been
                 remunerated on an arm's length basis taking into account
                 all the risk-taking functions of the enterprise. In such
                 cases nothing further would be left to be attributed to the
                 PE. The situation would be different if transfer pricing
                 analysis does not adequately reflect the functions
                 performed and the risks assumed by the enterprise. In
                 such a situation, there would be a need to attribute
                 profits to the PE for those functions/risks that have not
                 been considered. Therefore, in each case the data placed
                 by the taxpayer has to be examined as to whether the
                 transfer pricing analysis placed by the taxpayer is
                 exhaustive of attribution of profits and that would
                 depend on the functional and factual analysis to be
                 undertaken in each case. Lastly, it may be added that
                 taxing corporate on the basis of the concept of Economic
                 Nexus is an important feature of Attributable Profits
                 (profits attributable to the PE).
                                                       (Emphasis supplied)


ITA No. 735/2011+connected appeals                                         Page 17 of 102
15.     ECONOMIC AND SOCIAL COUNCIL in their report dated

17.10.2008 have stated;-


                 "38.1 In relation to the test of legal
                 dependence, it should be noted that the control
                 which a parent company exercises over its
                 subsidiary in its capacity as shareholder is not
                 relevant in a consideration of the dependence or
                 otherwise of the subsidiary in its capacity as an
                 agent for the parent. This is consistent with the
                 rule in paragraph 7 of Article 5. But, as
                 paragraph 41 of the Commentary indicates, the
                 subsidiary may be considered a dependent
                 agent of its parent by application of the same
                 tests which are applied to unrelated
                 companies.

16.     It has been observed below, that subsidiary can constitute PE,

other than dependent agent PE. A write up in Bulletin for International

Taxation, February 2011 titled The                 Subsidiary as a Permanent

Establishment has summarized the true and correct legal position in

the following words;-


                        A PE is, however, not always easy to identify.
                 This is particularly true where a PE is hidden behind a
                 dependent operating company, i.e. if an operating
                 company in addition to its own business also carries on
                 another company`s business as a PE of the latter. In this
                 regard, the 2010 OECD Model Tax Convention (the
                 OECD Model) states in Art. 5(7) that:

                 [t]he fact that a company which is a resident of a
                 Contracting State controls or is controlled by a company
                 which is a resident of the other Contracting State, or
                 which carries on business in that other state (whether
                 through a permanent establishment or otherwise), shall
                 not of itself constitute either company a permanent
                 establishment of the other (emphasis added)
ITA No. 735/2011+connected appeals                                     Page 18 of 102
                 This follows from the principle that, for the purpose of
                 taxation, such a subsidiary constitutes an independent
                 legal entity.7 Accordingly, both companies are subject to
                 unlimited tax liability in the state in which they are
                 resident or where their place of management is located.

                 However, by using the wording not of itself , the
                 provision clarifies that a parent company (parent) can
                 have an (agent) PE in its subsidiary`s state of residence if
                 the general requirements for a PE set out inArt. 5(1) to
                 (5) of the OECD Model are met. Accordingly, any space
                 or premises belonging to the subsidiary that is at the
                 disposal of the parent (the right-to-use test) and that
                 constitutes a fixed place of business (the location test
                 and the duration test) through which the parent carries
                 on its own business (the business activity test), gives
                 rise to a PE of the parent under Art. 5(1), subject to Art.
                 5(3) and (4), of the OECD Model. In addition, under Art.
                 5(5) of the OECD Model, a subsidiary constitutes an
                 agency PE of its parent if the subsidiary has the authority
                 to conclude contracts in the name of its parent and
                 habitually exercises this authority, unless these activities
                 are limited to those referred to in Art. 5(4) or unless the
                 subsidiary does not act in the ordinary course of its
                 business as an independent agent within the meaning of
                 Art. 5(6)........




Subsidiary as a Permanent Establishment

17.     This brings us to paragraphs 1 to 5 of Article 5 of the DTAA and

the exceptions to paragraph 6 to Article 5. Article 7, which relates to

business profit, may be also of some relevance. Paragraphs 1 to 5 of

Article 5 and the entire Article 7 are being reproduced below:-


                 Article5
                 PERMANENT ESTABLISHMENT

                 1. For the purposes of this Convention, the term
                 "permanent establishment" means a fixed place of

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                 business through which the business of an enterprise
                 wholly or partly carried on.

                 2. The term         "permanent    establishment"     includes
                 especially:

                 (a) a place of management;

                 (b) a branch;

                 (c) an office;

                 (d) a factory;

                 (e) a workshop;

                 (f) a mine, an oil or gas well, a quarry or any other place
                 of extraction of natural resources;

                 (g) a warehouse, in relation to a person providing storage
                 facilities for others;

                 (h) a farm, plantation or other place where agriculture,
                 forestry, plantation or related activities are carried on;

                 (i) a store or premises used as a sales outlet;

                 (j) an installation or structure used for the exploration or
                 exploitation of natural resources, but only if so used for a
                 period of more than 120 days in any twelve month
                 period;

                 (k) a building site or construction, installation or
                 assembly project or supervisory activities in connection
                 therewith, where such site, project or activities (together
                 with other such sites, projects- or activities, if any)
                 continue for a period of more than 120 days in any twelve
                 month period;

                 (l) the furnishing of services other than included services
                 as defined in Article 12 (Royalties and Fees for Included
                 Services), within Contracting State by an enterprise
                 through employees or other personnel, but only if;

                 (i) activities of that nature continue within that State for a
                 period or periods aggregating more than 90 within any
                 twelve-month period; or



ITA No. 735/2011+connected appeals                                          Page 20 of 102
                 (ii) the services are performed within that State for a
                 related enterprise (within the meaning of paragraph 1 of
                 Article 9 (Associated Enterprise).

                 3. Notwithstanding the preceding provisions of this
                 Article, the term "permanent establishment" shall be
                 deemed not to include any one or more of the following:

                 (a) the use of facilities solely for the purpose of storage,
                 display or occasional delivery of goods or merchandise
                 belonging to the enterprise;

                 (b) the maintenance of a stock of goods or merchandise
                 belonging to the enterprise solely for the purpose of
                 storage, display, or occasional delivery;

                 (c) the maintenance of a stock of goods, or merchandise
                 belonging to the enterprise solely for the purpose of
                 processing by another enterprise;

                 (d) the maintenance of a fixed place of business solely for
                 the purpose of purchasing goods or merchandise, or of
                 collecting information, for the enterprise;

                 (e) the maintenance of a fixed base of business solely for
                 the purpose of advertising, for the supply of information,
                 for scientific research, or for other activities which have
                 preparatory or auxiliary character, for the enterprise.

                 4. Notwithstanding the provisions of paragraphs 1 and 2,
                 where a person other than an agent of an independent
                 status to whom paragraph 5 applies is acting in a
                 Contracting State on behalf of an enterprise of the other
                 Contracting State other Contracting State, that enterprise
                 shall be deemed to have permanent establishment in the
                 first-mentioned State if:

                 (a) he has an habitually exercises in that first-mentioned
                 State an authority to conclude contracts on behalf of the
                 enterprise, unless his activities are limited to those
                 mentioned in paragraph 3 which, if exercised through a
                 fixed place of business, would not make that fixed place
                 of business, would not make that fixed place of business a
                 permanent establishment under the provisions of that
                 paragraph;

                 (b) he has no such authority but habitually maintains in
                 the first-mentioned State a stock of goods or merchandise
                 from which he regularly delivers goods or merchandise
ITA No. 735/2011+connected appeals                                        Page 21 of 102
                 on behalf of the enterprise, and some additional activities
                 conducted in that State on behalf of the enterprise have
                 contributed to the sale of the goods or merchandise; or

                 (c) he habitually secures orders in the first-mentioned
                 State, wholly or almost wholly for the enterprise.

                 5. An enterprise of a Contracting State shall not be
                 deemed to have a permanent establishment in the other
                 Contracting State merely because it carries on business in
                 that State through a broker, general commission agent or
                 any other agent of an independent status, provided that
                 such persons are acting in the ordinary course of their
                 business. However, when the activities of such an agent
                 are devoted wholly or almost wholly on behalf of that
                 enterprise and the transactions between the agent and the
                 enterprise and the transactions between the agent and the
                 enterprise are not made under arm's length conditions, he
                 shall not be considered an agent of independent status
                 within the meaning of this paragraph.

                 Article7

                 BUSINESS PROFITS

                 1. The profits of an enterprise of a Contracting State shall
                 be taxable only in that State unless the enterprise carries
                 on business in the other Contracting State through a
                 permanent establishment situated therein. If the enterprise
                 carries on business as aforesaid, the profits of the
                 enterprise may be taxed in the other State but only so
                 much of them as is attributable to (a) that permanent
                 establishment; (b) sales in the other State of goods or
                 merchandise of the same or similar kind as those sold
                 through that permanent establishment; or (c) other
                 business activities carried on in the other State of the
                 same or similar kind as those effected through that
                 permanent establishment.

                 2. Subject to the provisions of paragraph 3, where an
                 enterprise of a Contracting State carries on business in the
                 other Contracting State through a permanent
                 establishment situated therein, there shall in each
                 Contracting State be attributed to that permanent
                 establishment the profits which it might be expected to
                 make if it were a distinct and independent enterprise
                 engaged in the same or similar activities under the same
                 or similar conditions and dealing wholly at arm's length
                 with the enterprise of which it is a permanent

ITA No. 735/2011+connected appeals                                        Page 22 of 102
                 establishment and other enterprises controlling,
                 controlled by or subject to the same common control as
                 the enterprise, in any case where the correct amount of
                 profits attributable to a permanent establishment is
                 incapable of determination or the determination thereof
                 presents exceptional difficulties, the profits attributable to
                 the permanent establishment may be estimated on a
                 reasonable basis. The estimate adopted shall, however, be
                 such that the result shall be in accordance with the
                 principles contained in this Article.

                 3. In the determination of the profits of a permanent
                 establishment, there shall be allowed as deductions
                 expenses which are incurred for the purposes of the
                 business of the permanent establishment, including a
                 reasonable allocation of executive and general
                 administrative expenses, research and development
                 expenses, interest and other expenses, incurred for the
                 purposes of the enterprise as a whole (or the part thereof
                 which includes the permanent establishment), whether
                 incurred in the State in which the permanent
                 establishment is situated or elsewhere, in accordance with
                 the provisions of and subject to the limitations of the
                 taxation laws of that State. However, no such deduction
                 shall be allowed in respect of amounts, if any, paid
                 (otherwise than towards reimbursement of actual
                 expenses) by the permanent establishment to the head
                 office of the enterprise or any of its other offices, by way
                 of royalties, fees or other similar payments in return for
                 the use of patents, know-how or other rights, or by way of
                 commission or other charges for specific services
                 performed or for management, or except in the case of
                 banking enterprise, by way of interest on moneys lent to
                 the permanent establishment. Likewise, no account shall
                 be taken, in the determination of the profits of a
                 permanent establishment, for amounts charged (otherwise
                 than toward reimbursement of actual expenses), by the
                 permanent establishment to the head office of the
                 enterprise or any of its other offices, by way of royalties,
                 fees or other similar payments in return for the use of
                 patents, know-how or other rights, or by way of
                 commission or other charges for specific services
                 performed or for management, or, except in the case of a
                 banking enterprise, by way of interest on moneys lent to
                 the head office of the enterprise or any of its other offices.

                 4. No profits shall be attributed to a permanent
                 establishment by reason of the mere purchase by that


ITA No. 735/2011+connected appeals                                          Page 23 of 102
                 permanent establishment of goods or merchandise for the
                 enterprise.

                 5. For the purposes of this Convention, the (sic) to be
                 attributed to the permanent establishment as provided in
                 paragraph 1 (a) of this Article shall include only the
                 profits derived from the assets and activities of the
                 permanent establishment and shall be determined by the
                 same method year by year unless there is good and
                 sufficient reason to the contrary.

                 6. Where profits include items of income which are dealt
                 with separately in other Articles of the Convention, then
                 the provisions of those Articles shall not be affected by
                 the provisions of this Article.

                 7. For the purposes of the Convention, the term "business
                 profits" means income derived from any trade or business
                 including income from the furnishing of services other
                 than included services as defined in Article 12 (Royalties
                 and Fees for Included Services) and including income
                 from the rental of tangible personal properly other than
                 property described in paragraph 3 (b) of Article 12
                 (Royalties and Fees for Included Services).




18.     Article 7 paragraph 1, states that profit of an enterprise of

contracting State shall be taxed only in that State, i.e., in the State

where it is a resident and not in the other State even if its activities

have a business connection in the second State. This ensures that the

same income is not taxed twice in the hands of the same person merely

because there is a business connection between income earned by one

assessee from activities in two States. Income of the said assessee

can be taxed in the second State only if and when the said enterprise

carries on business in the said State through a PE. However, in such

circumstances only such income, which is attributable to the PE, is
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taxable in the PE State of which the assessee is not a resident. Sub-

clauses (b) and (c) to paragraph 1 of Article 7 incorporate a limited

force of attraction principle.       Under sub-clause (b) in addition to

income attributable to the PE, income earned from sale of goods or

merchandise or of same or similar kind sold through the PE in the other

State, which are similar or same as effected through PE, are to be

added. Clause (b) would come into operation only if there is sale of

goods or merchandise in the second State and not otherwise and then

goods or merchandise should be similar or of same kind as are being

sold through the PE. We need not dwell into sub-clause (b) as it is not

the case of the Revenue that the two foreign assessees were selling

merchandise or goods in India or the PE in India, i.e., the subsidiary

was selling goods or the merchandise.          Sub-clause (c) is also not

applicable as it is not the case of the Revenue that the two foreign

assessees were carrying on business activities in India other than those

effected through the PE.             Activities carried on by the foreign

assessees outside India are not covered under sub-clause (c) to

paragraph 1 of Article 7. We shall be referring to other paragraphs of

Article 7 subsequently as at this stage we would first like to examine

Article 5 paragraphs 1 to 5 of the DTAA.


Location or fixed place PE under Article 5(1) and (2) of DTAA.

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19.     Paragraph 1 of Article 5 refers to what can be described as fixed

place PE. Tiiu Albin commentary, Problems with PE; problems in

determining permanent establishment on the basis of Article 5(1) has

stated that the said Article encapsulates three requirements, namely, (i)

the existence of place of business at the disposal of the enterprise; (ii)

the place of business must be of a fixed nature (geographical and

temporal permanence); and (iii) the enterprise being carried on is

required to be carried on through the place of business.


20.     The word permanent in the expression PE is of significance

and imperial importance. It refers to some degree of permanency and

not a mere transitory nature of the business in the other State. Further,

the enterprise must have a fixed place of business. The expression

fixed place of business refers not only to physical location in the

form of immovable property or premises but in certain instances can

mean machinery and equipment. The word fixed refers to a distinct

place with some or certain degree of permanence. The relevant and

important word used in the definition clause for the purpose of the

present case is through and i.e., the carrying on of business should

be through the fixed place of business. In Morgan Stanley (supra),

the Supreme Court has observed that back office operations by the

Indian subsidiary to the parent to support the main office functions and

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equity and fixed income research, account reconciliation and providing

IT enabled services such as data processing and support centre do not

satisfy the second requirement of Article 5(1), i.e., carrying on of

business in India through such fixed place. The Indian subsidiary

was in fact merely supporting the front operations of the principal

company and on functional and factual analysis, Section 5(1) was not

applicable. In Morgan Stanley (supra), the Supreme Court observed:-


                 EXISTENCE OF P.E. IN INDIA

                 6. With globalization, many economic activities spread
                 over to several tax jurisdiction. This is where the concept
                 of P.E. becomes important under Article 5(1). There
                 exists a P.E. if there is a fixed place through which the
                 business of an enterprise, which is multinational
                 enterprise (MNE), is wholly or partly carried on. In the
                 present case MSCO is a multinational entity. As stated
                 above it has outsourced some of its activities to MSAS in
                 India. A general definition of the P.E. in the first part of
                 Article 5(1) postulates the existence of a fixed place of
                 business whereas the second part of Article 5(1)
                 postulates that the business of the MNE is carried out in
                 India through such fixed place. One of the questions
                 which we are called upon to decide is whether the
                 activities to be undertaken by MSAS consists of back
                 office operations of the MSCO and if so whether such
                 operations would fall within the ambit of the expression
                 "the place through which the business of an enterprise is
                 wholly or partly carried out" in Article 5(1).

21.     The aforesaid observations are perhaps more appropriate and

relevant when we will refer to the exclusionary clause, i.e., paragraph 3

of Article 5 of DTAA. For the purpose of present decision, we would

like to reproduce the interpretation in the amended commentary of UN

Model to Article 5, the relevant portion of which reads:
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                 B. COMMENTARY ON THE
                 PARAGRAPHS OF ARTICLE 5
                 Paragraph 1

                 3. This paragraph, which reproduces Article 5(1) of the
                 OECD Model, defines the term permanent
                 establishment, emphasizing its essential nature as a
                 fixed place of business with a specific situs.
                 According to paragraph 2 of the OECD Commentary
                 (the 2005 version of which is cited below), this
                 definition contains the following conditions:
                 - the existence of a place of business, i.e., a facility
                 such as premises or, in certain instances, machinery or
                 equipment;
                 - this place of business must be fixed, i.e., it must be
                 established at a distinct place with a certain degree of
                 permanence;
                 - the carrying on of the business of the enterprise
                 through this fixed place of business. This means usually
                 that persons who, in one way or another, are dependent
                 on the enterprise (personnel) conduct the business of
                 the enterprise in the State in which the fixed place is
                 situated.

                 The OECD Commentary goes on to observe:-

                 "3. It could perhaps be argued that in the general
                 definition some mention should also be made of the
                 other characteristic of a permanent establishment to
                 which some importance has sometimes been attached in
                 the past, namely that the establishment must have a
                 productive character--i.e., contribute to the profits of
                 the enterprise. In the present definition this course has
                 not been taken. Within the framework of a well-run
                 business organisation it is surely axiomatic to assume
                 that each part contributes to the productivity of the
                 whole. It does not, of course, follow in every case that
                 because in the wider context of the whole organisation
                 a particular establishment has a productive character
                 it is consequently a permanent stablishment to which
                 profits can properly be attributed for the purpose of tax
                 in a particular territory.

                 4. The term place of business covers any premises,
                 facilities or installations used for carrying on the
                 business of the enterprise whether or not they are used
                 exclusively for that purpose. A place of business may
                 also exist where no premises are available or required
                 for carrying on the business of the enterprise and it
ITA No. 735/2011+connected appeals                                       Page 28 of 102
                 simply has a certain amount of space at its disposal. It
                 is immaterial whether the premises, facilities or
                 installations are owned or rented by or are otherwise at
                 the disposal of the enterprise. A place of business may
                 thus be constituted by a pitch in a market place, or by a
                 certain permanently used area in a customs depot (e.g.,
                 for the storage of dutiable goods). Again the place of
                 business may be situated in the business facilities of
                 another enterprise. This may be the case, for instance,
                 where the foreign enterprise has at its constant disposal
                 certain premises or a part thereof owned by the other
                 enterprise.

                 4.1 As noted above, the mere fact that an enterprise has
                 a certain amount of space at its disposal which is used
                 for business activities is sufficient to constitute a place
                 of business. No formal legal right to use that place is
                 therefore required. Thus, for instance, a permanent
                 establishment could exist where an enterprise illegally
                 occupied a certain location where it carried on its
                 business.

                 4.2 Whilst no formal legal right to use a particular place
                 is required for that place to constitute a permanent
                 establishment, the mere presence of an enterprise at a
                 particular location does not necessarily mean that that
                 location is at the disposal of that enterprise. These
                 principles are illustrated by the following examples
                 where representatives of one enterprise are present on
                 the premises of another enterprise. A first example is
                 that of a salesman who regularly visits a major
                 customer to take orders and meets the purchasing
                 director in his office to do so. In that case, the
                 customer`s premises are not at the disposal of the
                 enterprise for which the salesman is working and
                 therefore do not constitute a fixed place of business
                 through which the business of that enterprise is carried
                 on (depending on the circumstances, however,
                 paragraph 5 could apply to deem a permanent
                 establishment to exist).

                 4.3 A second example is that of an employee of a
                 company who, for a long period of time, is allowed to
                 use an office in the headquarters of another company
                 (e.g. a newly acquired subsidiary) in order to ensure
                 that the latter company complies with its obligations
                 under contracts concluded with the former company. In
                 that case, the employee is carrying on activities related
                 to the business of the former company and the office
                 that is at his disposal at the headquarters of the other
ITA No. 735/2011+connected appeals                                         Page 29 of 102
                 company will constitute a permanent establishment of
                 his employer, provided that the office is at his disposal
                 for a sufficiently long period of time so as to constitute
                 a fixed place of business (see paragraphs 6 to 6.3)
                 and that the activities that are performed there go
                 beyond the activities referred to in paragraph 4 of the
                 Article.

                 4.4 A third example is that of a road transportation
                 enterprise which would use a delivery dock at a
                 customer`s warehouse every day for a number of years
                 for the purpose of delivering goods purchased by that
                 customer. In that case, the presence of the road
                 transportation enterprise at the delivery dock would be
                 so limited that that enterprise could not consider that
                 place as being at its disposal so as to constitute a
                 permanent establishment of that enterprise. 4.5 A fourth
                 example is that of a painter who, for two years, spends
                 three days a week in the large office building of its
                 main client. In that case, the presence of the painter in
                 that office building where he is performing the most
                 important functions of his business (i.e. painting)
                 constitute a permanent establishment of that painter.

                          XXXXX

                 4.6 The words through which must be given a wide
                 meaning so as to apply to any situation where business
                 activities are carried on at a particular location that is at
                 the disposal of the enterprise for that purpose. Thus, for
                 instance, an enterprise engaged in paving a road will be
                 considered to be carrying on its business through the
                 location where this activity takes place

                 5. According to the definition, the place of business has
                 to be a fixed one. Thus in the normal way there has to
                 be a link between the place of business and a specific
                 geographical point. It is immaterial how long an
                 enterprise of a Contracting State operates in the other
                 Contracting State if it does not do so at a distinct place,
                 but this does not mean that the equipment constituting
                 the place of business has to be actually fixed to the soil
                 on which it stands. It is enough that the equipment
                 remains on a particular site (but cf. the discussion at
                 paragraph 20 below).
                 5.1 Where the nature of the business activities carried
                 on by an enterprise is such that these activities are often
                 moved between neighbouring locations, there may be
                 difficulties in determining whether there is a single
                 place of business (if two places of business are
ITA No. 735/2011+connected appeals                                           Page 30 of 102
                 occupied and the other requirements of Article 5 are
                 met, the enterprise will, of course, have two permanent
                 establishments). As recognised in paragraphs 18 and 20
                 below a single place of business will generally be
                 considered to exist where, in light of the nature of the
                 business, a particular location within which the
                 activities are moved may be identified as constituting a
                 coherent whole commercially and geographically with
                 respect to that business.



22.     The UN Commentary observes that place of business to

constitute PE, the enterprise using it must carry on its business wholly

or partly through it, though the activity need not be productive in

character and need not be permanent in the sense that there is no

disruption, but the operations must be carried out on regular basis.

Branch, offices and factory mentioned in paragraph 2 are examples of

fixed place of business. In paragraph 4.6 of the OECD Commentary,

the words through which have been interpreted to have a wide

meaning but postulate that the particular location should be at the

disposal of the enterprise for that purpose and only then the business is

carried through the location where the activity takes place. The word

through has been interpreted and read in a manner that the foreign

enterprise should have the right to use the location in the second State.

The said right may or may not be formalized through legal

documentation, but right to use should be established and shown. Then

and then alone fixed place PE shall exist.

ITA No. 735/2011+connected appeals                                      Page 31 of 102
23.     Fixed location test may be in form of a legal right or can be

inferred from the facts when the foreign establishment and its

employees are allowed right to use the place of business belonging to a

subsidiary, a third party. Arvid A. Skaar in Permanent Establishment

(supra) has observed:-

                 (at page 155) 11.1 General
                 The definition of the basic-rule PE of the modern tax
                 treaties explicitly requires the enterprise`s objective
                 presence in the other country through the existence of a
                 fixed place of business. It also requires a business
                 activity as a condition for PE. Furthermore it is a clear
                 condition that there must be a connection between the
                 place of business and the activity, i.e. that the activity
                 has to be conducted through the place of business.
                 xxx
                 xxx

                 (at pages 157-8) 11.3 The problem: A factual or a
                 legal approach?
                 xxxxx
                 xxxxx
                 xxxxx
                 xxxxx
                  The present author`s hypothesis concerning tax-treaty
                 law is that the right of use test is met if the taxpayer`s
                 use of the place of business cannot be prevented
                 without his consent. Evidence of the enterprise`s right
                 to use the place of business, according to this
                 hypothesis, can be found in the business arrangements
                 in which the taxpayer is involved.



24.     The term through postulates that the taxpayer should have the

power or liberty to control the place and hence the right to determine

the conditions according to its needs.



ITA No. 735/2011+connected appeals                                        Page 32 of 102
Phillip Baker in his commentary on Double Taxation Conventions and

International Tax Law (Sweet & Maxwell publications, 2nd edition) has

stated that:-

                 requirement of a fixed place of business which is
                 implicit under Article 5(1), is that the place of business
                 must be at the disposal of the enterprise. The right to
                 use` test or the requirement that the place of business
                 must be at the disposal of the enterprise is rationally
                 and logically implicit in Article 5(1) in the expressions
                 fixed place of business and through which the
                 business of enterprise is carried on.           It is not
                 extraneous and the interpretation does not imply adding
                 or substracting words to Article 5(1). The OECD and
                 UN Model Commentaries quoted above adopts a
                 reasonable and a rational approach in the commentaries
                 for interpretation of Article 5(1) to not only include
                 places which are legally at the disposal of an enterprise
                 but also places where the non-resident assessee can as a
                 matter of right claim is right to use. The said right to
                 use can be inferred from the conduct etc.



25.     There is some controversy whether the examples given in

paragraph 2 to Article 5 are per se and ex facie permanent

establishments or the requirements of paragraph 1 should also be

satisfied. This controversy is in respect of building and construction

sites etc. We need not give an affirmative opinion on the said question

in relation building/construction sites etc. Overwhelming international

commentaries, write ups and decisions support the position that for

applying the location test, requirements of paragraph 1 to Article 5

must be independently satisfied. Therefore, to create a location PE,

requirements of paragraph 1 to Article 5 should be satisfied. To some
ITA No. 735/2011+connected appeals                                        Page 33 of 102
extent, the controversy and contention to the contrary is academic in

view of the negative list given in paragraph 3, which is fairly

comprehensive and the restrictive; and postulates of paragraph 1 to

Article 7 and other paragraphs to Article 7. Even otherwise, a mine,

oil or gas fuel etc. or plantation or a factory in most cases would satisfy

requirements of paragraph 1 to Article 5. United Nations Handbook on

Selected issues in Administration of Double Tax Treaties for

Developing Countries states that Article 5(2) lists some examples of

fixed place of business. However, we need not address this issue

further for the purpose of the present decision as the two foreign

assessees did not have any branch office or factory or workshop in

India and merely because they had a subsidiary in India by itself did

not create a fixed place of business/location PE within the meaning of

Article 5, paragraph 2, sub-clauses (b) to (k) thereof.


Service PE under Article 5(2)(l) of the DTAA.

26.     Sub-clause (l) to Article 5(2) defines what can be called service

PE. Sub-clause (k) is also a type of service PE, but this clause is not

relevant for the purpose of the present decision. The sub-clause (l)

requires furnishing of services within the second contracting State by a

foreign enterprise through its employees or other personnel. But a PE

is created only if activities of that nature continue for a period or
ITA No. 735/2011+connected appeals                             Page 34 of 102
periods aggregating more than 90 days in 12 months period or under

clause (ii) services are performed within that State for a related

enterprise as defined in Article 9 paragraph 1. For application of

clause (ii) no time period stipulation is postulated.   Sub-clause (l)

would apply only if the foreign enterprise or the two assessees had

performed services in India through their employees or personnel, i.e.,

personnel engaged or appointed by the foreign assessee. Employees of

E-Fund India were their employees, i.e. employees of an Indian entity

and not employees of the assessee. The employees of e-fund India did

not become other personnel of the two assessee, once and if the said

persons were defacto and dejure employed by the Indian

entity/enterprise, i.e., e-Fund India. The words employees and other

personnel have to be read along with the word through and

furnishing of services by the foreign enterprise within India. Thus the

employees and other personnel must be of the non-resident assessee to

create a service PE. Any other interpretation or treating employees of

the Indian entity, i.e., e-Fund India as other personnel of the foreign

assessee would lead to incongruities and irrational result, for every

subsidiary which engages an employee, would always become a PE of

the controlling foreign company. The said submission of the Revenue

is misconceived and has to be rejected. This would be contrary to the

ITA No. 735/2011+connected appeals                          Page 35 of 102
overriding mandate of Article 5 paragraph 6. Decision in the case of

Morgan Stanley (supra) as suggested and submitted by the Revenue

does not hold or propound to the contrary.                  In the said case, the

Supreme Court has held as under:-


                 13. However, the question which arises for
                 determination in the present case is the nature of
                 activities performed by stewards and deputationists
                 deployed by MSCO to work in India as employees of
                 MSAS. Under Article 5(a)(1) furnishing of services
                 through the fixed place in India can constitute a P.E.
                 The AAR In the impugned ruling has held that the
                 stewards and deputationists are proposed to be sent by
                 the MSCO from U.S. According to the AAR there is a
                 flow of service from the MSCO to the MSAS when the
                 former deputes its own employees to work in India in
                 MSAS. Therefore, according to the AAR the service
                 Agreement between MSCO and MSAS dated 14.4.3005
                 would fall under Article 5(2)(1) and consequently the
                 transfer pricing regulation would apply for evaluating
                 the charges payable by MSCO to MSAS in India for
                 such service contract, This ruling has been challenged
                 by the applicant.

                 14. Article 5(2)(1) of the DTAA applies in cases where
                 the MNE furnishes services within India and those
                 services are furnished through its employees. In the
                 present case we are concerned with two activities
                 namely stewardship activities and the work to be
                 performed by deputationists in India as employees of
                 MSAS. A customer like an MSCO who has world wide
                 operations is entitled to insist on quality control and
                 confidentiality from the service provider. For example
                 in the case of software P.E. a server stores the data
                 which may require confidentiality. A service provider
                 may also be required to act according to the quality
                 control specifications imposed by its customer. It may
                 be required to maintain confidentiality. Stewardship
                 activities involve briefing of the MSAS staff to ensure
                 that the output meets the requirements of the MSCO.
                 These activities include monitoring of the outsourcing
                 operations at MSAS. The object is to protect the interest
                 of the MSCO. These stewards are not involved in day
                 to day management or in any specific services to be
ITA No. 735/2011+connected appeals                                       Page 36 of 102
                 undertaken by MSAS. The stewardship activity is
                 basically to protect the interest of the customer. In the
                 present case as held hereinabove the MSAS is a service
                 P.E. It is in a sense a service provider. A customer is
                 entitled to protect its interest both in terms of
                 confidentiality and in terms of quality control. In such a
                 case it cannot be said that MSCO has been rendering
                 the services to MSAS. In our view MSCO is merely
                 protecting its own interests in the competitive world by
                 ensuring, the quality and confidentiality of MSAS
                 services. We do not agree with the ruling of the AAR
                 that the stewardship activity would fall under Article
                 5(2)(1). To this extent we find merit in the civil appeal
                 filed by the appellant (MSCO) and accordingly its
                 appeal to that extent stands partly allowed.

                 15. As regards the question of deputation, we are of the
                 view that an employee of MSCO when deputed to
                 MSAS does not become an employee of MSAS. A
                 deputationist has a lien on his employment with MSCO.
                 As long as the lien remains with the MSCO the said
                 company retains control over the deputationist's terms
                 and employment. The concept of a service PE finds
                 place in the U.N. Convention. It is constituted if the
                 multinational enterprise renders services through its
                 employees in India provided the services are rendered
                 for a specified period. In this case, it extends to two
                 years on the request of MSAS. It is important to note
                 that where the activities of the multinational enterprise
                 entails it being responsible for the work of
                 deputationists and the employees continue to be on the
                 payroll of "the multinational enterprise or they continue
                 to have their lien on their jobs with the multinational
                 enterprise, a service PE can emerge. Applying the
                 above tests to the facts of this case we find that on
                 request/requisition from MSAS the applicant deputes its
                 staff. The request comes from MSAS depending upon
                 its requirement. Generally, occasions do arise when
                 MSAS needs the expertise of the staff of MSCO. In
                 such circumstances, generally, MSAS makes a request
                 to MSCO. A deputationist under such circumstances is
                 expected to be experienced in banking and finance. On
                 completion of his tenure he is repatriated to his parent
                 job. He retains his lien when he comes to India. He
                 lends his experience to MSAS in India as an employee
                 of MSCO as he retains his lien and in that sense there is
                 a service PE (MSAS) under Article 5(2)(1). We find no
                 infirmity in the ruling of the ARR on this aspect. In the
                 above situation, MSCO is rendering services through its
                 employees to MSAS. Therefore, the Department is right
ITA No. 735/2011+connected appeals                                        Page 37 of 102
                 in its contention that under the above situation there
                 exists a Service PE in India (MSAS). Accordingly, the
                 civil appeal filed by the Department stands partly
                 allowed.

27.     In respect of stewardship activities by employees of the non-

resident assessee, it was observed that the employees were not

involved in any day-to-day management or any specific services

undertaken by the Indian subsidiary and it was basically to protect the

interest of the customers, i.e., the third parties. It was also noticed, as

in the present case, that the Indian subsidiary therein was a service

provider. The aforesaid observations of the Supreme Court affirm our

view that the services must be performed in respect of the activities

within India.         The distinction being activities within India and

activities between the foreign enterprise/assessee and the Indian

enterprise, i.e., the resident assessee is relevant. Thus, merely because

the non-resident assessee to protect their interest, for ensuring quality

and confidentiality has sent its employees to provide stewardship

services, will not make the Indian subsidiary or another entity, a PE of

the non-resident company. However, in respect of deputationists, the

same principle was not applied in Morgan Stanley (supra) as the non-

resident enterprise had retained control over deputationists` terms of

employment, they continued to remain on the pay rolls of the foreign

enterprise and their lien in the foreign enterprise was not disturbed. In

ITA No. 735/2011+connected appeals                                    Page 38 of 102
Morgan Stanley (supra), on completion of the deputation term, the

said deputationists were to revert back and was repatriated to their

parent job. Here, the Supreme Court has placed reliance on substance

rather than form. An important factor and fact, which was noticed by

the Authority on Advance Ruling in Morgan Stanley & Co. Inc., In

re[2006] 284 ITR 260 was:-

                  The staff deputed to MSAS would be on the payroll
                 of the applicant and the remuneration paid by it will be
                 reimbursed by MSAS. Out of a total remuneration of
                 Rs.49,402,704 paid to employees, reimbursement to
                 associate company for deputed staff aggregates to
                 Rs.24,220,631 ; performance appraisal, pro-motion and
                 discipline, etc., would be carried out in consultation
                 with the applicant. Clause (4) of the agreement
                 expressly stipulates that MSAS shall comply with all
                 performance standards as specified by the Morgan
                 group and that it shall comply with all reasonable
                 directions or instructions of the group. Operation
                 manual would be prepared and updated in conformity
                 with the policy, procedures and practices of the Morgan
                 group. Clause 7 enjoins upon MSAS to submit reports
                 or other information concerning the services that the
                 group may require. It further enjoins MSAS to attend
                 all meetings convened for reviewing the services at the
                 appointed time, place and agenda fixed by the group.
                 By virtue of clause 8, MSAS is required to maintain a
                 complete record which would be subject to audit and
                 investi-gation by the applicant. The persons authorized
                 by the Morgan group are provided unrestricted access
                 to the business premises of the MSAS for audit and
                 investigation. While clause 19 of the agreement
                 disables MSAS from disclosing the information
                 contained in the software products to any party except
                 the Morgan group which has the liberty to share the
                 infor-mation with any member of the Morgan group.
                 All this would show that the applicant would be in a
                 position to exercise close control and super-vision on
                 the working of MSAS. Further these features in the
                 agreement vividly bring out that the business of MSAS
                 is inextricably linked with the business of the applicant
                 and the other two entities of the Morgan Stanley group
ITA No. 735/2011+connected appeals                                       Page 39 of 102
                 so as to make activities of MSAS projection of Morgan
                 group.

28.     In Morgan Stanley & Co. Inc., In re (supra) one of the findings

recorded by the Authority for Advanced Ruling was that the salary

payable to the deputed staff from associated enterprises aggregated to

50% of the total remuneration to be paid to the employees of the Indian

subsidiary. Further performance appraisal, promotion and discipline

etc. was to be carried out in consultation with the foreign assessee.


29.     Thus, on the question of seconded employees by the foreign

enterprise/assessee to the Indian enterprise/subsidiary, we have to

examine the nature and functions performed by the said seconded

employees and who exercised control and supervised them. When and

if the said employees had provided stewardship function, no PE exists

even if the employees of the non-resident assesse were taken on

deputation.


Article 5(3) and its over-riding effect and consequences.

30.      Paragraph 3 of Article 5 is a non-obstante provision which

overrides paragraphs 1 and 2. In the said paragraph list of negative

activities, which are deemed not to create PE are stipulated. These

consist of sub-clauses (a) to (e). Clause (e) stipulates that maintenance

of fixed place of business for the purpose of advertising, supply

ITA No. 735/2011+connected appeals                                       Page 40 of 102
information, scientific research or for activities of preparatory or

ancillary character would deem not to create a PE. One clarification

may be made. Paragraph 3 of Article 5 sets out a negative list or

excludes activities performed through a fixed place in India or USA

by a foreign enterprise/assessee, from application of paragraphs 1 and

2 to Article 5. It may also cover and protect service PE cases when

sub-clauses (a) to (c) apply or when sub-clauses (d) and (e) apply and

fixed place or base is created.         Nature of the activities of the

employees and other personnel of the non-resident assessee is

important and relevant. This formed the foundation and basis of the

distinction made by the Supreme Court in Morgan Stanley (supra)

between stewardship activities and primary or core activities.

Therefore, first and foremost, Article 5(1)/(2) should be applicable but

then if the activities fall within parameters of paragraph 3, PE is not

created for imposing tax in the second state. It does not follow that if

activities are not covered in the negative or exclusions set out in

paragraph 3, a PE is established or deemed to be established under

paragraphs 1 or 2 of Article 5. This principle is relevant. As noticed

below, the tribunal has erred and has referred and applied paragraph 3

of Article 5 as if all activities performed and undertaken by the Indian

subsidiary and their employees would still create a PE in India of the

ITA No. 735/2011+connected appeals                           Page 41 of 102
assessees, because the activities of e-funds India were not preparatory

or auxiliary in character. This is not the correct legal position.


Agency PE under Article 5(4) and (5) of DTAA.

31. Paragraphs 4 and 5 of Article 5 relate to creation of agency PE in

the second contracting country. Agency replaces fixed place with

personal connection.                 Arvid K. Skaar in his work Permanent

Establishment` has opined that primacy of location test` of the basic

rule is consistent with the conceptual structure of the PE clause itself.

An agency will constitute a PE only when a PE cannot be found

according to those conditions in the basic rule which are altered or

replaced by the agency clause.                OECD and UN Model Treaties

recognize agency PE. The principle being, that a foreign enterprise

may choose to perform business activities itself or through a third

person in the other States. An agent is a representative who acts on

behalf of another with third persons.              International taxation laws

recognize and accept two distinct types of agency PE, dependent and

independent. Every agent by very nature of principle of agency is to

follow principal`s instructions.            But this principle is not squarely

applicable to DTAAs, as third parties may not be strictly an agent

under the domestic law. Further, the aforesaid dependency cannot be

the distinguishing factor which determines whether the agency is
ITA No. 735/2011+connected appeals                                 Page 42 of 102
dependent or an independent agency for the purpose of Article 5

paragraphs 4 and 5 respectively. A dependent agency is one which is

bound to follow instructions and is personally dependent on the

enterprise he represents. Such dependency must not be isolated or

once in a while transaction but should be of comprehensive nature.


32.     The dependency test` as per Arvid A. Skaar requires

examination and answer whether the business interest of the principal

and the agency have merged. When there is evidence of merging of

interest, then power to instruct the agent exceeds a certain level. In

such cases the Principal regularly participates in the process of settling

current business problems or exercises discretionary power in the said

respects.      OECD Commentary does not accept dependency based on

financial support, supply of patents etc. as itself creating agency PE.

Klaus Vogel on Double Taxation Conventions, Third Edition at page

345 in paragraph 170 states that interdependence must exist in both

legal and economic respects but the independence is the main criteria.

The expression independent agent` is used with the words brokers

and general commission agents` in paragraph 5 o f Article 5 will,

therefore, normally not include agents who have power to conclude

contracts. Paragraph 38.1 of the OECD Commentary has been quoted



ITA No. 735/2011+connected appeals                            Page 43 of 102
above (see paragraph 15).            The commentary elucidates and gives

illustrations and tests.


33.      Earlier U.N. commentary had deviated in some respect from the

OECD commentary and had observed that an agent who was wholly or

almost wholly engaged by one principal shall be considered to be a

dependent agent. This initial position stated in UN commentary has,

however, not been accept in subsequent commentaries. The essential

criteria being arms length relationship though engagement with one or

a group might serve as an indicator of absence of independence of an

agent.


34.      Subsidiary by itself cannot be considered to be a dependent

agent PE of the Principal, otherwise it would negate the overriding

effect of paragraph 6 to Article 5, a provision which precedes and

seeks to give recognition to separate legal entity principle associated

with juristic incorporated enterprises.       However, a subsidiary may

become dependent or an independent PE agent provided the tests as

specified in paragraphs 4 and 5 are satisfied.       A dependent agent is

deemed to be PE of the principal establishment under paragraph 4, if

one of the three conditions specified in sub-clause (a) to (c) are

satisfied.        Under sub-clause (a), a dependent agent should have

authority and should habitually exercise the said authority to conclude
ITA No. 735/2011+connected appeals                             Page 44 of 102
contracts on behalf of the foreign enterprise. What is meant by the

term authority to conclude contract` has been subject matter of

controversy on whether participation in negotiations by the agent is

sufficient or not. However, this is not relevant for the decision of the

present appeals in view of the factual matrix of the present case. Sub-

clause (b) refers to an agent who habitually maintains stock of goods or

merchandise from which he regularly delivers goods or merchandise

on behalf of the principal enterprise. In such cases, the agent should

also perform some additional activities in its country on behalf of the

foreign enterprise which has contributed to the sale of goods or

merchandise. Sub-clause (c) applies when the agent habitually secures

orders in the said country i.e. where he is located, almost wholly or

wholly for the foreign enterprise.


35.     Transactions between a foreign enterprise and an independent

agent, do not result in establishment of a permanent establishment

under paragraph 5 to Article 5 if the independent agent is acting in

ordinary course of their business. The expression ordinary course of

their business has reference to activity of the agent tested by reference

to normal customs in the case in issue. It has reference to normal

practice in the line of business in question. However as per paragraph

5 of Article 5, an agent is not considered to be an independent agent if

ITA No. 735/2011+connected appeals                           Page 45 of 102
his activities are wholly or mostly wholly on behalf of foreign

enterprise and the transactions between the two are not made under

arm`s length conditions.             The twin conditions have to be satisfied to

deny an agent character of an independent agent.                   In case the

transactions between an agent and the foreign principal are under arm`s

length conditions the second stipulation in paragraph 5 of Article 5

would not be satisfied, even if the said agent is devoted wholly or

almost wholly to the foreign enterprise.


36.     In Morgan Stanley (supra) Supreme Court rejected the

contention of the Revenue that dependent agency was created after

recording that Indian subsidiary had no authority to enter into or

conclude contracts on behalf of the foreign establishment/agency. The

contracts were entered into in America and were concluded there.

Only implementation of those contracts to the extent of back office

operations were carried out in India. This legal position is relevant in

the present case.


37.     In TVM Ltd. vs. Commissioner of Income Tax (1999) 237 ITR

230, Authority of Advance Ruling has interpreted the two expression

has` and habitually exercises` in the case of dependent agent. It has

been observed that the expression has` may have reference to the legal

existence of such authority on terms of the contract between the
ITA No. 735/2011+connected appeals                                   Page 46 of 102
Principal and the Agent, the expression habitually exercises` has

certainly reference to systematic course of conduct on the part of the

agent. Reference to OECD Commentary and Klaus Vogel was made

and it has been observed :-

                 .....Para. 4 uses two expressions : has and
                 habitually      exercises an authority to conclude
                 contracts on behalf of the enterprise in question. While
                 the expression has may have reference to the legal
                 exist- ence of such authority on the terms of the
                 contract between the principal          and agent, the
                 expression habitually exercises has certainly
                 reference to a systematic course of conduct on the part
                 of the agent. If, despite the specific provision of the
                 soliciting agreement, it is found, as a matter of fact,
                 that TVI is habitually concluding contracts on behalf of
                 TVM without any protest or dissent, perhaps it could
                 be presumed either that the rele- vant provisions of the
                 agency contract are a dead letter ignored by the parties
                 or that the principal has agreed implicitly to TVI
                 exercising such powers notwithstanding the terms of
                 the contract. If such a situation is found to exist, then
                 perhaps it could be said that TVI constitutes a
                 permanent establishment for TVM despite the clauses
                 of the contract relied upon.



38.     Judgment of the Delhi High Court in the case of Rolls Royce

PLC versus Director of Income Tax (International Taxation) (2011)

339 ITR (Del) is a good authority for the proposition that subsidiary

can constitute and become a PE of the controlling company. The said

decision proceeds on its own peculiar facts and we do not find that any

legal principle and the elucidation in the present decision is contrary to

the legal ratio propounded in the case of Rolls Royce (supra).

ITA No. 735/2011+connected appeals                                       Page 47 of 102
Mutual Agreement Procedure

39.      Before we go on the factual matrix and apply the aforesaid

principles to the facts of present case, we would like to deal with the

contention of the Revenue that the PE issue stands determined as India

and USA had resorted to Mutual Agreement Procedure (MAP, for

short) as envisaged under Article 27 of the DTAA.              Tribunal in the

impugned order has referred to the determination under the MAP and

relied upon the determination and it has been observed that the

competent authorities of the two countries had resorted to the said

procedure and had agreed to taxation of income of the assessee in

India.


40.      MAP procedure as envisaged under Article 27 of the DTAA was

resorted to in the case of e-Fund Corp for the assessment years 2003-

04 and in the case of e-Fund Inc. for the assessment years 2003-04 and

2004-05.        The letter or communication issued by the competent

authority in India dated 23rd April, 2007 vide file No. 480/4/2006-

FTD-1 reads as under:-

              The Acting Director (International) competent authority
              of USA initiated Mutual Agreement Procedure in the case
              of M/s e Funds Corporation and e Funds I.T. Solution.
              Inc., for the previous year ending 31.3.2003 with the
              Competent Authority of India under the Double Taxation
              Avoidance Agreement vide their letter No. SE LM IM: T:
              ? : IN dated 8.5.2006. Subsequently vide letter dated
              16.2.2007 Competent Authority of USA initiated Mutual
ITA No. 735/2011+connected appeals                                  Page 48 of 102
              Agreement Procedure for the previous year ending
              31.3.2004 in the case of the Solutions Group Inc. The
              Competent Authorities of both the countries after
              examined the facts of the case and issues involved have
              arrived at a resolution in terms of Section 90 of Income
              Tax Act, 1961 read with Article 27 of Indo --USA
              Double Taxation Avoidance Agreement and Rule 44 I-I
              of Income Tax Rules, 1962. The Competent Authorities
              of USA and India have reached an agreement as follows
              with          respect          to         the        Tax
              assessment on M/s e Funds Corporation and e Funds IT
              Solution Group Inc:
              Income will be attributed to the Indian PEs based on
              the ratio of certain developed and acquired tangible
              and intangible assets in India and outside India. Out
              of the total assets for the AY 2003-04 , 10.48% of the
              assets      were       located      in      India    and
              accordingly 10.48% of the Income would be
              attributable to India. The percentage attributable to
              India for the AY ending 2005 was arrived of 11.11%
              These percentages will be applied to the base of
              consolidated gross income as reduced by the income
              of subsidiary e Funds India Pvt. Ltd. Already reported
              in India. Thereafter the total income so attributed will
              be apportioned between e Funds and IT solutions in
              the ratio of 85% (to e Funds) and 15% (to IT
              Solutions) for the AY 2003-04 and 87% (to e Funds)
              and 13% (to IT solutions) for the AY 2004-05.

              In view of the above, the income attribution , as
              agreed upon is given below:
                                    AY 2003-04         AY 2004-05
                                    Figures in US $ Figures in US                 $
                                    million            million
              Apportionable base 25.12                 30.71
              income
              Percentage            10.48%             11.11%
              attributed to India
              Income attributed to 2.63                3.14
              India
              Allocation between
              IT Solutions and e 0.39 (15%)            0.45 (13%)
              Funds IT Solutions
              E Funds               2.24 (85%)         2.96 (87%)
              




ITA No. 735/2011+connected appeals                                   Page 49 of 102
41.     The assessee has placed on record communication dated 7th

May, 2005 written by Department of Treasury, Internal Revenue

Services, Washington in which they have stated that they did not agree

on technical merits that e-Fund Corp or e-Fund Inc. had a PE in India

but they had agreed to mutual agreement to divide income to avoid

double taxation. As per the terms of mutual agreement, income of the

two assessees would be attributed to India taxation as per calculations.

In terms of the said determination, there would be decrease in income

of e-Fund Corp and e-Fund Inc. under the USA tax laws and they

would be also entitled to foreign tax credit. The letter states that the

said decision would not be binding on subsequent years. Pursuant to

these letters, the two assessees had written letter dated 14th May, 2007

to the Income Tax authorities in which it was specifically stated that

they did not agree on technical merits that they had PE in India but had

agreed to accept the mutual settlement.


42.     The MAP procedure and agreement, is no doubt relevant but

cannot be determinative or the primary basis to decide whether the

assessee had PE in India. There are several reasons for the same,

including communication dated 7th May, 2007 of the Internal Revenue

Services, America. Whether or not PE exists is a matter of law and

fact, and there has to be determination of the said issue on merits. A

ITA No. 735/2011+connected appeals                           Page 50 of 102
decision on merits will normally be persuasively` conclusive for

subsequent or other assessment years, unless there are good and

sufficient reasons to take a contrary or divergent view. However, a

concession on point of law, is not binding for other assessment years or

a different assessee. It is always open to the competent authorities of

the two countries to enter into an agreement for avoidance of double

taxation and bring a litigation/dispute to an end.     Double taxation

means taxation of the same subject matter or income in the hands of

one assessee or one person in the two different countries.       Double

taxation can be avoided by either granting exemption or giving tax

credit paid in the third country. As per the MAP procedure, there was

decrease in the American taxable income and the tax paid on income in

India was credited under the American laws.


FACTS AND APPLICATION OF AFORESAID PRINCIPLES
TO THE FACTS
43.     Tribunal in the impugned order has held that the assessee had

fixed place PE under Article 5(1) and also service PE under Article

5(2)(l) of the DTAA. The assessment order on the said aspect is rather

ambiguous and unclear. In paragraph 7 of the assessment order, it is

observed that the assessee had permanent establishment in India in

various forms without elucidating any specific paragraph of Article 5

which was invoked and held to be applicable. However, in paragraph
ITA No. 735/2011+connected appeals                           Page 51 of 102
8 reference is made to the assessment order for assessment year 2003-

04 in the case of e-Fund Corp and it was observed that assessee had

fixed place PE as well as dependent agent PE i.e. PE under Article 5(1)

and Article 5(4) of the DTAA.


44.     Commissioner of Income Tax (Appeals) has held that the

assessees had PE in India under paragraph 5(1), 5(2)(l) and both

dependent PE and independent PE under Article 5(4) and 5(5) of the

DTAA.


45.     Tribunal in the impugned order has primarily referred to and

quoted findings of the Assessing Officer. The assessee have placed on

record copies of the written submissions filed before the appellate

authorities i.e. Commissioner (Appeals) and tribunal wherein they have

specifically questioned and challenged the facts recorded by the

Assessing Officer/Commissioner (Appeals). Unfortunately, these have

not been dealt with specifically in the appellate orders and to this

extent we as an appellate court under Section 260A, are handicapped

and faced with rather a difficult task.   Further the assessment orders

are confusing and the expression it is not known`, reflective of

uncertainty and no firm finding, is repeatedly used and finds mention

throughout. In case, the assessee had withheld facts, adverse inference

could have been drawn and accordingly facts recorded but there should
ITA No. 735/2011+connected appeals                          Page 52 of 102
be affirmative or negative factual finding. Use of expression it is not

known` has not helped and has created confusion as the expression

reflects ambiguity and lack of factual finding.


46.     On the question as to the activities of the assessee and the

agreements between the two assessee and e-Fund India, we find there

is elaboration and reference in the order of Commissioner (Appeals).

However, the tribunal has not commented upon the same.

Explanations and details furnished before the Assessing Officer and

observations made in the assessment order have been quoted. In the

assessment order it is mentioned that the two assessees had four main

business lines, namely (a) Electronic Payments; (b) ATM Management

Service; (c) Decision support and risk management; and (d)

Professional Services. Specific details of these activities as stated by

the assessee have been noted in paragraph 6.14 of the order of the

tribunal and for the sake of convenience are reproduced below. These

details have not been questioned in the orders of the Assessing Officer,

Commissioner (Appeals) or the tribunal. These are:-

                 a)      ATM Management Services
                 Those appellants had installed ATM machines and
                 point of sale machines in USA and Canada and, not in
                 India. On the transactions carried out through the
                 ATMs, revenues were generated by the appellants
                 outside India and, therefore no income accrued in India.
                 All the servers processing the transactions were not


ITA No. 735/2011+connected appeals                                      Page 53 of 102
                 installed in India and were located wholly outside
                 India.
                 Electronic Payments
                 That ATM machines installed by other companies not
                 belonging to the appellants outside India were also
                 managed i.e. the transactions for these ATM machines
                 were routed through servers installed by the appellant.
                 These servers contained database of various
                 cardholders for the purpose of verification and,
                 revenues were shared from the ATM machine
                 installers. Here also no activity was carried on by the
                 appellants in India and, therefore no income accrued in
                 India.
                 Decision Support and Risk Management
                 That appellants further provide decision support and,
                 risk management services providing risk management
                 based data and other products to financial institutions,
                 retailers and other businesses that assist in detecting
                 fraud and assessing the risk of opening a new account
                 or accepting a check. These products and services are
                 based on or enhanced by appellant's proprietary
                 databases such as Debit Bureau®, ChexSystems (SM)
                 and SCAN(SM) and other sources. Neither the
                 customers to whom such services are provided are
                 situated in India nor the services are provided from
                 India and, therefore no income accrued to the
                 appellants in India.
                 d)       Professional Services
                 Professional Services include business process
                 management and IT outsourcing services, EFT software
                 sales and software applications development,
                 maintenance and installation services. The appellant's
                 business process management and outsourcing services
                 focus on both back-office and customer support
                 business processes, such as accounting operations, help
                 desk services, account management, and call center
                 operations to customers outside India.



47.     As per the assessment/appellate orders e-Fund India had

performed back office operations in respect of the first three.                  This

included data entry operations etc. in respect of Decision Support and



ITA No. 735/2011+connected appeals                                      Page 54 of 102
Risk Management.                 Reference to the activities in India etc. is

examined in detail below.


48.     We shall first examine whether the assessees had fixed place PE

in India. It was stated by the assessee that they did not have any assets

or presence in India with no licenced office or business activity in

India, consequently no income was chargeable to tax in India under

clause 5(1) i.e. Fixed Place of Business. Neither in the assessment

order nor in the appellate order including order of the tribunal, we find

any material and relevant discussion to hold that the two assessee had a

fixed place of business in India through which business of enterprise

was wholly or partly carried on. None of the authorities including the

tribunal have held that the two assessee had right to use any of the

premises belonging to e-Fund India. It has not been adverted to or

stated that premises of e-Fund India were at the disposal, legally or

otherwise, of the two assessees. The right to use test` or disposal test`

has not been adverted to or applied nor is there any observation or

finding to the said aspect. In the absence of any such finding Article

5(1) cannot be invoked and applied. As elucidated above, Article 5(1)

has to be read with paragraph 6 of Article 5 which relates to subsidiary

companies.



ITA No. 735/2011+connected appeals                                Page 55 of 102
49.     The Assessing Officer, Commissioner (Appeals) and the tribunal

have primarily relied upon the close association between e-Fund India

and the two assessee and applied functions performed, assets used and

risk assumed, criteria to determine whether or not the assessee has

fixed place of business.             This is not a proper and appropriate test to

determine location PE.                The fixed place of business PE test is

different.        Therefore, the fact that e-Fund India provides various

services to the assessee and was dependent for its earning upon the two

assessees is not the relevant test to determine and decide location PE.

The allegation that e-Fund India did not bear sufficient risk is

irrelevant when deciding whether location PE exists. The fact that e-

Fund India was reimbursed the cost of the call centre operations plus 16%

basis or the basis of margin fixation was not known, is not relevant for

determining location or fixed place PE. Similarly what were the direct

or indirect costs and corporate allocations in software development

centre or BPO does not help or determine location PE. Assignment or

sub-contract to e-Fund India is not a factor or rule which is to be

applied to determine applicability of Article 5(1). Further whether or

not any provisions for intangible software was made or had been

supplied free of cost is not the relevant criteria/test. e-Fund India

was/is a separate entity and was/is entitled to provide services to the

ITA No. 735/2011+connected appeals                                    Page 56 of 102
assessees who were/are independent separate taxpayer. Indian entity

i.e. subsidiary company will not become location PE under Article 5(1)

merely because there is interaction or cross transactions between the

Indian subsidiary and the foreign Principal under Article 5(1). Even if

the foreign entities have saved and reduced their expenditure by

transferring business or back office operations to the Indian subsidiary,

it would not by itself create a fixed place or location PE. The manner

and mode of the payment of royalty or associated transactions is not a

test which can be applied to determine, whether fixed place PE exists.


50.     Reference to core of auxiliary or preliminary activity is relevant

when we apply paragraph 3 of Article 5 or when sub-clause (a) to

paragraph 4 to Article 5 is under consideration.        The fact that the

subsidiary company was carrying on core activities as performed by

the foreign assessee does not create a fixed place PE. Paragraph 3 of

Article 5 lists negative activities which when performed from a fixed

placed in the other contracting State would not create a PE. The

activities specified in Article 5, paragraph 3 would not create a PE,

even when the conditions specified in paragraphs (1) and (2) of Article

5 are satisfied. Paragraph 3 is not a positive provision but a negative

list. The said paragraph does not create a PE but has a negative

connotation and activities specified when carried on do not create a PE.

ITA No. 735/2011+connected appeals                             Page 57 of 102
51.     Learned standing counsel for the Revenue submitted that the

facts found by the tribunal and the authorities show that assessee were

a joint venture or in partnership with e-Fund India as the business of

the assessee and the Indian subsidiary were interlinked and closely

connected. Our attention was specifically drawn to the 10K report

which has been quoted by the Assessing Officer, Commissioner

(Appeals) and the tribunal and also observations of Klaus Vogel

quoted by the Commissioner (Appeals)/tribunal in their order, the

relevant portion of which reads :

                 b) Subsidiary as an agent: On the basis of a special
                 parent/subsidiary relationship -- other than one of
                 control under company law a subsidiary may; however,
                 in individual cases be an agent, and consequently, for
                 that reason a permanent establishment, of its parent
                 company. The Mfg: make this clear by using the words
                 'of itself`. Also the transformation of a permanent
                 establishment into a subsidiary does not yet lead,
                 therefore, to the characterization of the subsidiary as a
                 permanent establishment. In such cases, the subsidiary
                 continues to be a separately taxable entity. his its parent
                 company's permanent establishment only to the extent
                 that it satisfies the agency requirement set out in Art.
                 5(5). and (6) MC. Paragraph 41 MC Comm.Art. 5
                 makes express mention of this only in regard to the
                 independent agent within the meaning of Art. 5(5). Like
                 any other unrelated company, however, a
                 subsidiary, if an independent agent, can very well
                 also constitute a permanent establishment of its
                 parent company under, the conditions laid down in
                 Art. 5(6). A subsidiary may, for instance, act as an
                 agent of its parent nd conclude such contracts for the
                 latter on the b as is of a corresponding authority as go
                 beyond the limits of the ordinary course of its business.
                 The independence of the subsidiary under company law
                 also remains authoritative for tax purposes if it
                 subcontracts. entirely or partially to associated enterprises
                 or it acquires the means required for the contract's
ITA No. 735/2011+connected appeals                                           Page 58 of 102
                 execution from associated enterprises. The latter is
                 particularly true ,fir the hiring out of employees as
                 temporary workers. If the parent company makes
                 personnel available to the subsidiary.* remuneration, then
                 the activity of this 'hired labour' is to be attributed to the
                 subsidiary and does not constitute a permanent
                 establishment of the parent doing the hiring-out. This is
                 different, however, as well as in cases of subcontracts
                 if the parent assumes the economic risk of the
                 contract's fulfillment in relation to the main
                 customer. In this situation the parent company and
                 the subsidiary have in fact established a company of
                 which they are partners. This will lead to a
                 permanent establishment for the partners f the
                 general preconditions are fulfilled."



52.     The aforesaid observations are in the context of dependent

agency and not in the context of Article 5(1) or fixed place PE. The

observations of Klaus Vogel have been misread and understood out of

context. The said observations have been made in the context of

independence of subsidiary and it has been observed that such

independence for tax purposes is retained and is not negated, even if

there is a sub-contract or assignment entirely or partially between the

associated enterprises, or the subsidiary acquires means for execution

from associated enterprises including hiring out of employees and

works. It is observed that even hiring of labour by the subsidiary from

the associated enterprise does not constitute permanent establishment

of the parent company. The last portion of the aforesaid quotation

refers to position where two companies or enterprises work as partners

and in this situation permanent establishment of the partners may be a
ITA No. 735/2011+connected appeals                                            Page 59 of 102
PE, if general preconditions are fulfilled.       The last words if general

preconditions are fulfilled` are not superfluous but material and core of

the principle. Permanent establishment of partners or a joint venture

PE, as a concept and principle has not been invoked and applied in the

present case. The said concept itself has been subject matter of

significant debate.            PE cannot be and is not established by mere

transactions between two associated enterprises or the principal sub-

contracting or assigning the contract to the subsidiary. An agency PE

will be established and created if the requirements of paragraphs 4 and

5 of Article 5 are fulfilled and not otherwise. It is not uncommon for

an enterprise to enter into contracts assign or sub-contract works, or

service to their subsidiary. The subsidiary may also render services to

a third party on behalf of the principal. This by itself would not lead to

a subsidiary becoming a PE unless requirements of paragraphs 1, 2, 4

or 5 are satisfied. The observations of the Klaus Vogel in fact support

the assessee as it postulates that partnership PE would be created only

when the principal of the foreign enterprise retains the economic risk

of contract and other general conditions i.e. Articles 5(1), 5(2), 5(4)

and 5(5) of the DTAA are fulfilled. Tax authorities have to be cautious

and aware of consequences when they apply joint venture or

partnership principle in a case like the present one as it could be argued

ITA No. 735/2011+connected appeals                              Page 60 of 102
that substantial or significant part of the income of the joint venture

entity should be taxed in the source State.


53.     This is also the view and opinion of Arvind K. Skaar, wherein he

has referred to the principle of altered ego companies and decision of

American courts in National Carbide Corporation vs. Commissioner

336 US 422; Moline Properties Inc. vs. Commissioner 319 US 436

and Bollinger vs. Commissioner 108 S.Ct. 1173 and has referred to six

point as the National Carbide criteria. These are:

                 (1) The corporation must operate in the name and for
                 the account of the principal,
                 (2) it must bind the principal by its actions,
                 (3) it must transmit money received to the principal,
                 (4) it must be considered whether the receipt of income
                 is attributable to the services of the employees of the
                 principal or to assets belonging to the principal,
                 (5) the relations between the principal and the agent
                 must not depend upon the fact that it is owned by the
                 principal, and
                 (6) the business purpose must be carrying on the
                 normal duties of an agent.



54.     With reference to criteria 5 and 6 in Bollinger (supra),

observations and clarifications were made relying upon separate entity

doctrine. Thereafter the text refers to problem of empty` and slander`

companies which are used to avoid PE taxation. In the summary and

conclusions Arvid A Skaar concludes that related enterprises which

cooperate and join like Joint Venture may constitute subsidiary PE of

ITA No. 735/2011+connected appeals                                     Page 61 of 102
each other i.e. both the principal and subsidiary are PE inter se. It is

further observed that international practice seems to suggest that

subsidiary PE is not constituted for an enterprise which sub-contracts

an assignment, if the enterprise does not take part in the physical work

itself even though it contributes the equipment necessary for the work

(service PE question and physical work has been examined below).


55.     In the present case, we are not concerned with construction PE

or bifurcations of contract or multiple contracts for installation,

execution, supply, manufacture etc.      The considerations and tests

applicable in said cases may be different.


56.     10K report referred to in the orders was filed by the assessee

with the S.E.C. USA. The details submitted in this document not only

pertain to the two assessee incorporated and paying tax in USA but the

entire group companies including e-Fund India. The assets, revenues,

income earned, employees of e-Fund India etc. have to be disclosed

and elucidated in the said report. The report, no doubt, is relevant and

material but has to be examined with due care and caution to determine

and decide whether the two assessees have PE in India. The fact that

business has been transferred or sub contracted or assigned to e-Fund

India is not relevant and material, unless we are determining

applicability of paragraph 3 to paragraph 5 and the question is whether
ITA No. 735/2011+connected appeals                           Page 62 of 102
the Indian company is performing core or auxiliary and preliminary

activities. The fact, the report refers to and give details of or number

of employees of e-Fund India which are part of the e-Fund group is not

relevant. Neither income earned by eFund India nor activities in India

by the Indian subsidiary by itself, relevant in determining whether or

not PE exists under paragraphs 1, 2, 4 and 5 of Article 5. Thus and

therefore, the fact that 40% of the employees of the entire group were

in India i.e. were employees of e-Fund India, will not make the said

company agency subsidiary PE or fixed place PE of the assessee.

Neither provision of any software, intangible data etc. whether free of

cost or otherwise, make e-Fund India an agency or fixed place PE of

the two foreign assessees. Whether or not and on what basis e-Fund

India was reimbursed expenses of xerox, courier charges etc. will not

make e-Fund India as PE of the assessee under Articles 5(1), 5(4) or

5(5). Conditions and stipulates under Articles 5(1), 5(4) or 5(5) will

create a PE and not the said facts as highlighted in the impugned

orders. Therefore, we will now examine the facts found and refer to

Articles 5(4) and 5(5) of DTAA.


57.     Conditions of Articles 5(4) are not satisfied in the present case.

It is not the case of the Revenue that e-Fund India was authorized and

habitually exercised authority to conclude` contract or was

ITA No. 735/2011+connected appeals                             Page 63 of 102
maintaining stock or merchandise from which it delivered goods or

merchandise on behalf of the assessee or secured orders on behalf of

the assessee.         Therefore, the conditions and requirements of sub-

clauses (a), (b) and (c) to Article 5(4) are not satisfied.


58.     The assessment order does not state or mention how and why the

transactions between the assessee and e-Fund India were not at arm`s

length and consequently Article 5(5) was applicable. The assessment

order does mention that software was provided to e-Fund India free of

cost. However, it was not stated that this showed that the transactions

between the assessee and e-Fund India were not at arm`s length basis.

The assessees have submitted that e-Fund India had undertaken and

carried      out     custom application         development,   integration     and

maintenance and management of the software in e-Fund India`s

software development facilities. e-Fund India undertook code

development in accordance with product specifications defined by e-

Fund Corp or Deluxe, (a third company). The code generated was

subsequently tested to ensure that the functions performed by the code

were as per the protocol design and standard specifications. Final

testing was undertaken by e-Fund Corp. The software was owned by

e-Fund Corp or Deluxe and e-Fund India did not have any intangible

right in the software.               This plea has been repeatedly taken by the

ITA No. 735/2011+connected appeals                                   Page 64 of 102
assessee and has not been controverted or found to be incorrect. A

submission or statement by an assessee should be accepted unless there

are good grounds and reasons to reject the statement of fact. In case of

any suspicion and when verification is required, further enquiry or

investigation may be undertaken but the facts stated by the assessee

cannot be rejected without cogent and good reasons. The transactions

between the assessees and e-Fund India were at arm`s length and were

taxed on arm`s length principle.             There was no allegation or

considered finding of the tribunal that the transactions were not in

ordinary course of business.         In these circumstances, even otherwise

requirements of Article 5(5) are not satisfied in the present case.


59.     This brings us to Article 5(2)(l) i.e. service PE.      As already

recorded above, employees of e-Fund India are not to be counted and

treated as employees of the assessees; e-Fund India being a separate

entity and taxable assessee. The tribunal and the authorities have erred

in treating employees of e-Fund India as employees of the assessees for

determining whether service PE under Article 5(2)(l) was created.

There are no other factual findings recorded by the tribunal in respect

of service PE under Article 5(2)(l). The assessment order also does not

record any other relevant finding for creation of service PE under

Article 5(2)(l), other than payment received by e-Fund India for

ITA No. 735/2011+connected appeals                              Page 65 of 102
providing management and support service by the President and Sales

Team to overseas group entities. Payment by e-Fund Corp on the said

account were received for the year ending 31st March, 2002, but

stopped thereafter. This no doubt is a relevant aspect with reference to

Article 5(2)(a) but the said provision has not been invoked in the

assessment order and in the appellate orders including order of the

tribunal. We do not have details with regard to the exact nature and

character of the management services provided to the overseas group

entities.


60.     Before the Commissioner (Appeals), the assessee in their

submission had stated that the President of e-Fund Indian provided

management support services in U.K. and Australia, while certain

personnel of South-east Asia region provided marketing support

services to e-Fund India as well as e-Fund group entities overseas. The

e-Fund India had an international division which consisted of

President`s office and South-east Asia Region office.               Thus services

rendered by e-Fund India personnel comprised of marketing support

provided by President and Sales Team to U.K. and Australia and e-

Fund Group overseas.                 It was further mentioned by the assessee that

the President`s office managed operations of e-Fund Group entities in

U.K. and Australia and accordingly employees of said entities reported

ITA No. 735/2011+connected appeals                                     Page 66 of 102
to the President. The President in turn was reporting to e-Fund Corp.

Aforesaid factual position prima facie indicates that the said activities

may have resulted in a PE under Article 5(2)(a) under the heading

Place of Management` but the said provision has not been invoked.

This court while exercising jurisdiction under Section 260A of the Act

would not like to invoke the said provision as it requires factual

determination as well as computation of the income attributable to the

PE. We do not have any finding on the exact nature of the services

rendered whether it was only relating to accounts, receivables, human

resource management or related to other direct management services.

Services of the nature specified in paragraph 3 of Article 5 have to be

excluding while in determining and deciding whether or not a PE exists

under Article 5(2). There is another difficulty if we apply Article

5(2)(a) ­ Place of Management principle; ­ enterprises in UK and

Australia were subsidiaries or legal entities and not branches of the

assessees. To what extent and when place of management principle

will be applicable in such cases, DTAA which will be applicable as the

associated enterprise were located in UK and Australia and

computation of income attributable to the PE are highly debatable and

contentious questions which require findings of facts at the first




ITA No. 735/2011+connected appeals                           Page 67 of 102
instance and cannot be made matters to be decided for the first time in

an appeal under section 260A of the Act.


61.     The President and international sales division or regional office

may have also constituted service PE in India for the year ending 31 st

March, 2002, if we treat the President and employees whose salary was

reimbursed as other personnel who had performed services within

that State for a related enterprise as defined in paragraph 1 of Article 9.

Thus, at best service PE for the year ending 31st March, 2002 would

have been created under Article 5(2)(l) but again there has not been

thorough and detailed discussion on the nature and type of services

rendered and determination on question of salary and whether the

President and employees of Regional Office could be treated as

employees or other personnel` of the assessee.


62.     The appellants had pleaded before the authorities and the

tribunal that prior to assessment year 2005-06 not even a single

employee of the assessee ever visited India even for a short period and

in 2005-06, two employees of e-Fund were transferred to e-Fund India

and that the entire expenditure for these two employees were borne by

e-Fund India.           No employees were present in India after 2005-06.

Presence of employees in India is relevant under Article 5(2)(l) but the

said employees should furnish services within the contracting State.
ITA No. 735/2011+connected appeals                             Page 68 of 102
These services should not be mere stewardship services.                   The

Assessing Officer has recorded that employees were seconded to e-

Fund India but the functions they performed and whether they

performed functions and reported to e-Fund Corp/associated enterprise

was not known or ascertained.              This was not the correct way of

determining and deciding whether service PE existed. Whether the

seconded employees were performing stewardship services or were

directly involved with the working operations was relevant. It is also

not known whether the services were performed related to services

provided to an associated enterprise in which case clause 5(2)(l)(ii)

would be applicable. In the said situation, the question of attribution

of income etc. would also arise.


63.     Two employees of e-Fund Corp were deputed to e-Fund India in

the assessment years 2005-06. The case of the assessee and e-Fund

India is that they were deputed to look towards development of

domestic work in India.              Payment of these employees as per the

Revenue to the extent of 25% was borne by e-Fund India and balance

75% was borne by e-Fund Corp. The Assessing Officer on this basis

has observed that this reduced cost base of e-Fund India as

remuneration was paid by e-Fund Corp and the said employees were at

liberty to perform functions of e-Fund Corp even while working for e-

ITA No. 735/2011+connected appeals                              Page 69 of 102
Fund India. The response of the assessee as quoted in the assessment

order was that e-Fund India, apart from export activities had also

domestic business in India.          This was evident from the return of

income filed by e-Fund India where domestic income was computed

separately as it was not eligible for deduction under Section 10A of the

Act. Copy of the return was furnished. It was further stated that cost

of personnel seconded in India was fully borne by e-Fund India i.e.

100% of the salary paid to the said employees seconded to India were

debited to profit and loss accounts. 75% of the salary component was

paid abroad by e-Fund Corp but the same was reimbursed by e-Fund

India.      This was in accordance with and permitted under the Indian

Exchange Control Regulations. It was further stated that the Assessing

Officer was wrong in assuming that the two seconded employees were

at liberty to function for e-Fund Corp while they were working for e-

Fund India. The seconded employees were working under the control

and supervision of e-Fund India. The Assessing Officer thereupon has

not commented on the reply of the assessee, though he has recorded

comments in respect of replies to other issues raised by him (see

paragraph 7 of the assessment order). The aforesaid factual assertion

made by the assessee, therefore, was not negated or questioned by the

Assessing Officer.

ITA No. 735/2011+connected appeals                            Page 70 of 102
64.     Commissioner (Appeals) has referred to technical explanation to

DTAA issued by the US Department of Treasury.                                The said

explanation refers to the definition of term PE` including service PE

and states as under:-


                          Subparagraph (1) provides the rule for
                 determining the conditions under which the activity of
                 furnishing services, through employees or other
                 personnel, constitutes a PE. These rules apply only to
                 the provision of services which are not considered to be
                 "included services", as the term is defined in article
                 12 (Royalties and Fees for included Services). Under
                 the subparagraph, the furnishing of services gives
                 rise to a PE if either the activity continues for an
                 aggregate of more than 90 days in a twelve month
                 period, or the services are performed fir a person related
                 to the enterprise providing the services. In the latter case,
                 no time threshold test must be met for a PE to exist. The
                 determination of whether persons are related for purposes of
                 this test is made in accordance with the rules of article 9
                 (Associated Enterprises).

65.     The      aforesaid           explanation   has   been   misunderstood          by

Commissioner (Appeals). Sub-clause (l) to Article 5(2) creates service

PE when the overseas assessee is involved in the activity of furnishing

services within the other contracting State through employees or other

personnel but only if conditions stipulated in clauses (i) or (ii) are

satisfied. Clause (i) stipulates a threshold period or aggregation of the

threshold period which should be satisfied. Clause (ii), however, does

not stipulate any time threshold. Clause (ii), therefore, is much wider

but is applicable when the foreign enterprise through employees or

other personnel performs service within the other contracting State for
ITA No. 735/2011+connected appeals                                         Page 71 of 102
a related enterprise defined in Article 9 paragraph 1. But the said

employees or other personnel of the assessee should have performed

services in India for an associated enterprise. They should not have

performed services for e-fund India`s domestic activities.


66.     Control and supervision of workers is a relevant and important

factor as was noticed by the Authority for Advance Ruling in Tekniskil

(Sendirian) Berhard Vs. Commissioner of Income Tax [1999] 222

ITR 551. In the said case, a Malaysian company had provided skilled

labour to a Korean company, who had worked in India. As the said

labour had worked under the supervision and control of Korean

company, it was held that Malaysian company did not have

permanent establishment in India as per Article 7 of DTAA between

Indian and Malaysia. In P.No.28 of 1999 In Re Authority for Advance

Ruling in its decision reported in [2000] 242 ITR 208 took an opposite

view after noticing that the Indian joint venture did not pay any

remuneration to the foreign employees and the employees continued to

be the employees of the foreign company and were paid by the foreign

company.          Thus, the applicant company was rendering services

through its employees to the Indian company, therefore this created a

PE.



ITA No. 735/2011+connected appeals                           Page 72 of 102
67.     The assessment order refers to the net income or loss of e-Fund

Corp and has come to the conclusion that once operations of e-Fund

India started and grew, the profits of e-Fund Corp also increased. This

is a very simplistic method and manner of analyzing data. Profits or

losses depend upon several factors like, business environment, quality

of business operations etc. including transfer of back office operations

or other operations to a more efficient and cost effective locations.

The said finding can be given after minute and meticulous examination

of the data, reasons and not by a straight forward and simplistic

inference. Further existence of PE does not depend upon transfer of

assignment or sub-contracting work/services to India, with an intent

and purpose to save costs and to increase profitability of the assessee

resident abroad. This is not the stipulation or requirement in Article 5.


68.     The contention of the Revenue is that if rights in the software

had been transferred to e-Fund India, compensation was required to be

paid by e-Fund India and this would have required deduction of tax at

source.       The argument is farfetched. We are not dealing with

assessment or failure of e fund India to deduct tax at source. The

argument cannot be accepted as it would interfere with the working or

business model adopted by the assessee and e-Fund India.        The said



ITA No. 735/2011+connected appeals                            Page 73 of 102
working model is not a sham or a camouflage having no business

character.


69.     Similarly, the contention and finding recorded that e-Fund India

had provided necessary input or information to e-Fund Corp or e-Fund

Inc. to enable them to enter into contracts which were sub-contracted

or assigned to e-Fund India, will not make e-Fund India a permanent

establishment of the assessee. This is not covered under any of the

clauses or stipulations of Article 5. It is not the case that employees of

e-Fund India had participated and/or were present in the negotiations

of the assessee with the third parties, in respect of contracts to be

paid/sourced from India or even executed/performed abroad.


70.     The Assessing Officer has recorded and in our opinion

incorrectly that majority of the employees of the two assessees operate

from India. The said finding is legally untenable and drawn on a

wrong legal principle.               Employees of e-Fund India were not

employees of e-Fund Corp or e-Fund Inc. Seconded employees were

only two in number and only in assessment year 2005-06. It is further

observed that the two assessee had significant assets in India on wrong

legal assumption that assets of e-Fund India were assets of e-Fund

Corp and e-Fund Inc. He has held that the assessee and e-fund India

did not operate on arm`s length basis as in respect of some contracts, e-
ITA No. 735/2011+connected appeals                            Page 74 of 102
Fund India had raised bills directly to the customer but for similar

contracts/ arrangement the entire amount was paid to the two foreign

assessees and only a miniscule amount or profit was transferred or paid

to e-Fund India. The said finding/conclusion again is not a correct

inference. It is not born out from the record and has not been accepted

by the tribunal as it has accepted attribution of income made by the

assessee.


71.     India has expressed reservation on some of the paragraphs in

OECD commentary; primarily on the ground that India as a source

State is entitled to tax services in the form of fee for technical/included

service or royalty payment. The stand of the Indian tax authorities is

that the services need not be rendered physically in India but when the

payment is sourced from India and the services are to be utilized in

India, income of the foreign resident is taxable in the source State i.e.

India. We need not examine the said stand of the tax authorities in the

present case as this is not in dispute or issue in question. The source

State in the present case was USA. It was the State where the contract

of service was performed and utilized, though certain operations took

place in India.         The beneficiaries of the services and the payment of

the services were sourced in USA. Casual examination of India`s

balance for payments in US Dollars available on Reserve Bank of

ITA No. 735/2011+connected appeals                               Page 75 of 102
India`s website from the year 2000-01 to 2010-11, would indicate that

India has substantial inflow under the head invisible i.e. payments

for services and products which do not result in transfer of physical

objects.      A significant portion of India`s services, which contributes

almost 55% to the Indian Gross Domestic Product, are for outbound

and cross borders services. A greater and in-depth study is required to

understand the full tax or revenue implication as far as India is

concerned including study of proposed amendments to the OECD

Model Treaty.

Section 9(1)(i) of the Act

72.     No arguments have been addressed before us on the aspect of

legal connection which justifies taxation of a non-resident under

Section 9(1)(i) of the Act on income which is deemed to be accrue or

arise in India. The tribunal in the impugned order has held that the

assessees had business connection in India for the points noted in

paragraph 18.3. Though the reasons stated in paragraph 18.3 do appear

to be widely and broadly stated, but keeping in view the mandate and

the ratio of the decisions of the Supreme Court in Commissioner of

Income Tax, Punjab Vs. R.D. Aggarwal and Company [1965] 56 ITR

20, Commissioner of Income Tax, Andhra Pradesh Vs. Toshoku Ltd.,

Guntur and Ors. (1980) 125 ITR 525, Ishikawajma-Harima Heavy

ITA No. 735/2011+connected appeals                             Page 76 of 102
Industries Ltd. Vs. Director of Income Tax, Mumbai [2007] 288 ITR

408 and the amendments incorporated and made to Section 9 (1)(i), it

has to be held that business connection did exist, not because the

assessees were associated enterprise or had a subsidiary in India, but

because the e-Funds India was providing information and details to the

assessees in USA for the purpose of entering into contracts with third

parties and subsequently the said contracts were performed fully or

partly by e-Funds India as an assignee or sub-contractee and looking at

the nature of the said transactions and the manner in which contracts

were executed and where the asssessee had assumed and agreed to

third party claims and risks; business connection is established.

However, even when business connection under Section 9(1)(i) stands

established, the provision does not seek to bring to tax, all profits of the

non-resident. Only income reasonably attributed to operations carried

out in India can be taxed under the Act. Real and intimate connection

must exist between operations carried out in India and business by non-

resident outside India, and profits of business outside India attributed

to operations carried out in India, can be only subjected to tax. This is

clear from the explanation to Section 9(1)(i) and only such income

operations carried out in India have to be attributed and taxed. This

would have entailed an intrusive and exhaustive exercise into each

ITA No. 735/2011+connected appeals                              Page 77 of 102
contract executed by E fund India, and on involvement of the assessee

and E fund India. In the present case, attributions of profit to business

connection has not been undertaken/applied keeping in mind the

aforesaid stipulation, but by applying Article 7 of the DTAA.             It

appears and is apparent that the assessee and Revenue felt that

application of DTAA was more beneficial to the assessee.

73.     In Director of Income Tax Vs. Rio Tinto Technical Services

[2012] 340 ITR 507 (Delhi) it has been observed that Section 90 (2)

mandates that where the Central Government has entered into DTAA

and the said agreement applies, the provisions of that Act will apply to

the extent they are more beneficial to the assessee. In other words,

when DTAA and provisions of the Act apply to an assessee, then the

Article of DTAA or the provision of the Act will apply depending

upon, which one of the two is more beneficial or advantageous to the

assessee.


Challenge to the initiation of proceedings under Section 147/148 of

the Act.

74.     Challenge to the initiation of proceedings under Sections

147/148 of the Act by the two assessees is devoid of merits.       In the

present case, the assessee had not filed returns of income and were not

subjected to regular assessment under Section 143(3). Challenge on
ITA No. 735/2011+connected appeals                           Page 78 of 102
the ground of change of opinion etc. is not available. The only ground

on which proceedings can be challenged is that the reasons recorded do

not disclose any rational or relevant nexus with the formation of belief

that income of the two assessees had escaped assessment. At the stage

of issue of notice only a tentative or prima facie view, justifies

initiation of proceedings under Section 147/148 of the Act, though the

reasons or grounds recorded must not be based on gossip, rumour or

mere suspicion. In the present case, reassessment proceedings were

initiated after assessment orders in respect of assessment year 2003-04

were passed by the Assessing Officer. In respect of the said year,

MAP procedure was adopted and income of the two assessees has been

partly taxed in India. We, therefore, do not accept the contention of

the assessee that there was no justification or valid reason to initiate

proceedings under Section 147/148 of the Act.


75.     Learned counsel for the assessees has submitted that reasons

to believe for the assessment year 2000-01 were not communicated

and this was in violation of law. Failure to communicate reasons

to believe,       may       result   in   setting   aside   of   the   assessment

order as an assessee has a right to challenge the proceedings initiated

under Section 147/148 of the Act, after following procedure as

per GKN Driveshafts (India) Limited. vs. Income-tax Officer

ITA No. 735/2011+connected appeals                                     Page 79 of 102
(2003) 259 ITR 19 (SC). However, in the facts of the present case, we

are not inclined to set aside the assessment order for the Assessment

Year 2000-01 and the appellate proceedings for this reason. Reasons

to believe recorded for 2000-01 and subsequent years are identical.

Reasons to believe for all assessment years, other than 2000-01 were

communicated.            The assessees did not object or protest before the

Assessing Officer that they had not been served with the reason to

believe for the assessment year 2000-01.             No doubt, it was the

obligation and duty of the Assessing Officer to furnish the reasons to

believe and mere change in incumbent, did not absolve or wash away

this duty or obligation, but in the facts of the present case, we are of the

firm belief that the assessee was aware of the reasons to believe and

was not prejudiced and in fact in full knowledge and were aware of the

reason to believe for the assessment year 2000-01. They took a

conscious and considered decision not to challenge the proceedings at

the initiation stage. Thus non communication of reasons to believe was

inconsequential and did not prejudice the assessee. Tribunal has on

examining the original records came to a factual finding giving cogent

reasons, why reasons to believe were in fact recorded before issue of

notice. Challenge to the proceedings under Section 147/148 of the Act

is therefore, rejected.

ITA No. 735/2011+connected appeals                              Page 80 of 102
Computation, apportionment or accumulation of income/profit

76.        The assessment order drawing authority from Article 7(2) of the

DTAA and Rule 10 of the Income Tax Rules, holds that profit of the

two assessees attributable to Indian PE should be computed on

reasonable basis. The Assessing Officer took into account the assets of

the two assessees located outside India and located in India, i.e., the

assets of e-Fund India. In proportion to the assets located in and

outside India, income from operations was attributed to the Indian PE.

However, in computing the income from operations, the net profit of e-

Fund India was reduced from the total income and then 2.51% of the

net profit was attributed to India, 2.51% being the percentage of assets

in India. The aforesaid income was divided in the ratio of 15% and

85% towards as income of Indian PE of e-Fund Inc. and e-Fund Corp.

In view of the said computation, the total income of the two assessees

determined for the relevant assessment years is as under:-


For e-Funds Corporation & e-funds IT Solutions Group Inc.

 S.No.       Assessment                            Post AO`s Decision
                Year

      1.     2000-01                 Particulars              Amount (In Million
                                                              USD)

                              Income from operations (10                1.28
                              K)

                              Less; Net profits (eFunds                 0.82

ITA No. 735/2011+connected appeals                                             Page 81 of 102
                              India)

                              Attributable Income (In                 0.46
                              Million of USD) (A)

                              Percentage allocated to India           2.51%
                              (B)

                              Income attributed to the India          0.012
                              PE (A*B)

                              Allocation of revenue between company eFunds IT
                              Solution Group Inc. and eFunds Corporation

                              eFunds IT Solution Group                0.002
                              Inc. (15%)

                              eFunds Corporation (85%)                0.010

                              Exchange Rate                           43.62

                              eFunds IT Solution Group                87,240
                              Inc. (in Rs.)

                              eFunds Corporation (In Rs.)             436,200

2.         2001-02            Particulars                   Amount(In Million USD)

                              Income from operations                     18.99
                              (10 K)

                              Less; Net profits (eFunds                  6.41
                              India)

                              Attributable Income (In                    12.57
                              Million of USD) (A)

                              Percentage allocated to                   5.65%
                              India (B)

                              Income attributed to the                   0.711
                              India PE (A*B)

                                     Allocation of revenue between company eFunds
                              IT Solution Group Inc. and eFunds Corporation

                              eFunds     IT   Solution                   0.107
                              Group Inc. (15%)

                              eFunds        Corporation                  0.604
                              (85%)

                              Exchange Rate                              46.64

ITA No. 735/2011+connected appeals                                           Page 82 of 102
                              eFunds     IT    Solution              4,990,480
                              Group Inc. (in Rs.)

                              eFunds Corporation (In                28,170,560
                              Rs.)

3.         2002-03            Particulars                 Amount (In Million USD)

                              Income from operations                   46.97
                              (10 K)

                              Less; Net profits (eFunds                15.53
                              India)

                              Attributable Income (In                  31.44
                              Million of USD) (A)

                              Percentage allocated to                  9.03%
                              India (B)

                              Income attributed to the                 2.838
                              India PE (A*B)

                              Allocation of revenue between company eFunds IT
                              Solution Group Inc. and eFunds Corporation

                              eFunds     IT   Solution                 0.426
                              Group Inc. (15%)

                              eFunds        Corporation                2.413
                              (85%)

                              Exchange Rate                            48.80

                              eFunds     IT    Solution             20,788,800
                              Group Inc. (in Rs.)

                              eFunds Corporation (In                117,754,400
                              Rs.)

4.         2004-05            Particulars                 Amount (In Million USD)

                              Income from operations                   43.67
                              (10 K)

                              Less; Net profits (eFunds                7.16
                              India)

                              Attributable Income (In                  36.50
                              Million of USD) (A)

                              Percentage allocated to                 12.37%
                              India (B)

ITA No. 735/2011+connected appeals                                      Page 83 of 102
                              Income attributed to the                  4.514
                              India PE (A*B)

                              Allocation of revenue between company eFunds IT
                              Solution Group Inc. and eFunds Corporation

                              eFunds     IT   Solution                  NA
                              Group Inc. (15%)

                              eFunds         Corporation                3.927
                              (85%)

                              Exchange Rate                             43.86

                              eFunds     IT    Solution                 NA
                              Group Inc. (in Rs.)

                              eFunds Corporation (In                172,238,220
                              Rs.)

5.         2005-06                     Particulars         Amount (In Million USD)

                              Income from operations            62.70
                              (10 K)

                              Less; Net profits (eFunds         6.12
                              India)

                              Attributable Income (In           56.57
                              Million of USD) (A)

                              Percentage allocated to           9.02%
                              India (B)

                              Income attributed to the          5.105
                              India PE (A*B)

                              Allocation of revenue between company eFunds IT
                              Solution Group Inc. and eFunds Corporation

                              eFunds     IT   Solution          0.766
                              Group Inc. (15%)

                              eFunds         Corporation        4.339
                              (85%)

                              Exchange Rate                     43.75

                              eFunds     IT    Solution         33,512,500
                              Group Inc. (in Rs.)

                              eFunds Corporation (In            189,831,250
                              Rs.)

ITA No. 735/2011+connected appeals                                       Page 84 of 102
6.         2006-07            Particulars                 Amount (In Million USD)

                              Income from operations                      77.20
                              (10 K)

                              Less; Net profits (eFunds                 6.76
                              India)

                              Attributable Income (In                  70.44
                              Million of USD) (A)

                              Percentage allocated to                  5.74%
                              India (B)

                              Income attributed to the                 4.042
                              India PE (A*B)

                              Allocation of revenue between company eFunds IT
                              Solution Group Inc. and eFunds Corporation

                              eFunds     IT   Solution                 0.606
                              Group Inc. (15%)

                              eFunds        Corporation                3.436
                              (85%)

                              Exchange Rate                            44.61

                              eFunds     IT    Solution             2,70,46,039
                              Group Inc. (in Rs.)

                              eFunds Corporation (In                15,32,60,890
                              Rs.)

7.         2007-08            Particulars                 Amount (In Million USD)

                              Income from operations                   79.03
                              (10 K)

                              Less; Net profits (eFunds                 7.00
                              India)

                              Attributable Income (In                  72.03
                              Million of USD) (A)

                              Percentage allocated to                  5.06%
                              India (B)

                              Income attributed to the                 3.645
                              India PE (A*B)

                              Allocation of revenue between company eFunds IT
                              Solution Group Inc. and eFunds Corporation

ITA No. 735/2011+connected appeals                                      Page 85 of 102
                              eFunds     IT   Solution             0.547
                              Group Inc (15%)

                              eFunds         Corporation           3.098
                              (85%)

                              Exchange Rate                        43.59

                              eFunds     IT    Solution         2,38,33,642
                              Group Inc (in Rs.)

                              eFunds Corporation (In            13,50,57,303
                              Rs.)




77.     Commissioner (Appeals) did not interfere with the aforesaid

computation except that for the purpose of attribution, he held that the

value of assets should be taken at actual cost and not on written down

value. The value of the assets was taken by the Assessing Officer at

written down value.                  The Commissioner (Appeals) observed that

taking written down value could result in different rates of attribution

for various years as depreciation rates might vary for various assets and

without change in business model or assets, business attribution would

also vary.         This probably had resulted in reduction of income

attributable to the two assessees and, therefore, Revenue preferred

appeals. Assessee also preferred appeals before the tribunal.


78.     Tribunal in the impugned order has modified the method of

computation or attribution of profits to Indian PE.               The method

adopted by the tribunal is as under:-

ITA No. 735/2011+connected appeals                                  Page 86 of 102
                 8.36.            In our view, 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.
        (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 I.T.
                 Solutions.
                 8.37. In our view, this working is more scientific and
                 equitable. It will take care of the apprehension raised by
                 the learned counsel that though eFunds India income
                 was reduced on first stage in MAP proceedings,
                 corresponding assets are not reduced, while adopting the
                 global assets. This methodology/formula will be more
                 helpful in arriving at the reasonably correct amount of
                 attributable income, being comparatively just, fair and
                 equitable.

79.     It was further observed that it was desirable to adopt depreciated

cost of assets as the base as held by the Assessing Officer.                         The

tribunal observed that the reasoning of the Commissioner (Appeals)

required interference because computation on the basis of actual cost

would require reference to earlier records and reverse calculations,

which was undesirable. Besides income generating capacity of the

assets would diminish with the lapse of time and depreciation, as
ITA No. 735/2011+connected appeals                                         Page 87 of 102
provided in the respective statutes, should be given due regard. In such

circumstances, it was desirable and expedient to base attribution on

depreciated cost of assets for purpose of apportionment as it would be

fairer, practical and hassle free method. As a result of the direction

given by the tribunal, income of the two assessees has been computed

as under:-


For e-funds Corporation & e-funds IT Solutions Group Inc.


 S.No        Assessment                            Post ITAT Decision
                Year
1.         2000-01                        Particulars       Amount (In Million
                                                                 USD)

                                     Income from                  1.28
                                     operations (10K)
                                     (A)

                                     Percentage allocated         2.51%
                                     to India (B)

                                     Attributable Income          0.032
                                     (In Millions of USD)
                                     (C=A*B)

                                     Less; Net profits            0.82
                                     (eFunds India) (D)

                                     Income attributed to         NIL
                                     the India PE (C-D)

                                     Allocation of revenue between company
                                     eFunds IT Solution Group Inc. and eFunds
                                     Corporation

                                     eFunds IT Solutions          NIL
                                     Group Inc. (15%)

                                     eFunds Corporation           NIL
                                     (85%)


ITA No. 735/2011+connected appeals                                        Page 88 of 102
2.         2001-02                        Particulars       Amount     (In   Million
                                                            USD)

                                     Income from                     18.99
                                     operations (10K)
                                     (A)

                                     Percentage allocated            5.65%
                                     to India (B)

                                     Attributable Income              1.07
                                     (In Millions of USD)
                                     (C=A*B)

                                     Less; Net profits                6.41
                                     (eFunds India) (D)

                                     Income attributed to             NIL
                                     the India PE (C-D)

                                     Allocation of revenue between company
                                     eFunds IT Solution Group Inc. and eFunds
                                     Corporation

                                     eFunds IT Solutions              NIL
                                     Group Inc. (15%)

                                     eFunds Corporation               NIL
                                     (85%)

3.         2002-03                        Particulars        Amount (In Million
                                                                  USD)

                                     Income from                     46.97
                                     operations (10K)
                                     (A)

                                     Percentage allocated            9.03%
                                     to India (B)

                                     Attributable Income             4.24
                                     (In Millions of USD)
                                     (C=A*B)

                                     Less; Net profits               15.53
                                     (eFunds India) (D)

                                     Income attributed to            NIL
                                     the India PE (C-D)

                                     Allocation of revenue between company
                                     eFunds IT Solution Group Inc. and eFunds

ITA No. 735/2011+connected appeals                                           Page 89 of 102
                                     Corporation

                                     eFunds IT Solutions              NIL
                                     Group Inc. (15%)

                                     eFunds Corporation               NIL
                                     (85%)

4.         2004-05                          Particulars          Amount (In Million
                                                                      USD)

                                     Income from operations            43.67
                                     (10K) (A)

                                     Percentage allocated to           12.37%
                                     India (B)

                                     Attributable Income (In            5.40
                                     Millions of USD)
                                     (C=A*B)

                                     Less; Net profits                  7.16
                                     (eFunds India) (D)

                                     Income attributed to the           NIL
                                     India PE (C-D)

                                     Allocation of revenue between company
                                     eFunds IT Solution Group Inc. and eFunds
                                     Corporation

                                     eFunds IT Solutions             NA
                                     Group Inc. (15%)

                                     eFunds Corporation              NIL
                                     (85%)

5.         2005-06                        Particulars           Amount (In Million
                                                                     USD)

                                     Income from                      62.70
                                     operations (10K)
                                     (A)

                                     Percentage allocated             9.02%
                                     to India (B)

                                     Attributable Income               5.66
                                     (In Millions of USD)
                                     (C=A*B)

                                     Less; Net profits                 6.12

ITA No. 735/2011+connected appeals                                             Page 90 of 102
                                     (eFunds India) (D)

                                     Income attributed to            NIL
                                     the India PE (C-D)

                                     Allocation of revenue between company
                                     eFunds IT Solution Group Inc. and eFunds
                                     Corporation

                                     eFunds IT Solutions             NIL
                                     Group Inc. (15%)

                                     eFunds Corporation              NIL
                                     (85%)

6.         2006-07                        Particulars       Amount    (In    Million
                                                            USD)

                                     Income from                     77.20
                                     operations (10K)
                                     (A)

                                     Percentage allocated            5.74%
                                     to India (B)

                                     Attributable Income             4.43
                                     (In Millions of USD)
                                     (C=A*B)

                                     Less; Net profits               6.76
                                     (eFunds India) (D)

                                     Income attributed to            NIL
                                     the India PE (C-D)

                                     Allocation of revenue between company
                                     eFunds IT Solution Group Inc. and eFunds
                                     Corporation

                                     eFunds IT Solutions             NIL
                                     Group Inc. (15%)

                                     eFunds Corporation              NIL
                                     (85%)

7.         2007-08                        Particulars       Amount    (In    Million
                                                            USD)

                                     Income from                     79.03
                                     operations (10K)
                                     (A)


ITA No. 735/2011+connected appeals                                           Page 91 of 102
                                     Percentage allocated          5.06%
                                     to India (B)

                                     Attributable Income            4.00
                                     (In Millions of USD)
                                     (C=A*B)

                                     Less; Net profits              7.00
                                     (eFunds India) (D)

                                     Income attributed to           NIL
                                     the India PE (C-D)

                                     Allocation of revenue between company
                                     eFunds IT Solution Group Inc. and eFunds
                                     Corporation

                                     eFunds IT Solutions            NIL
                                     Group Inc. (15%)

                                     eFunds Corporation             NIL
                                     (85%)

Thus, no tax is payable by the two assessees in any year because e-

Fund India had declared and stands taxed on a higher income.


80.     Learned counsel for the Revenue has raised three contentions.

Firstly, the method adopted by the Assessing Officer was in terms of

the method adopted and accepted in the MAP proceedings and,

therefore, the most reasonable method. Order of the tribunal does not

set out or give reasons why the method adopted in the MAP

proceedings was unreasonable and inappropriate. Secondly, as per

Article 7, method once adopted should be followed from year to year

and can be only altered under paragraph 5 of Article 7 for good and

sufficient reasons.            Lastly and in alternative, the bifurcation or



ITA No. 735/2011+connected appeals                                         Page 92 of 102
appropriation should be based on Rule 10 by applying turnover criteria

and not on the basis of assets criteria.


81.     Article 7 has been quoted above. Paragraph 2 of the said Article

stipulates that business income attributed to permanent establishment

will be calculated as if the permanent establishment in a distinct and

independent enterprise engaged in the same or similar activities under

the same or similar conditions and dealing at arms length` with other

associated enterprises.              In case profits attributable to permanent

establishment are incapable of determination or determination presents

exceptional difficulties, the profits attributable must be estimated on

reasonable basis but in accordance with the principles stated above.

Paragraph 3 postulates deductions in respect of expenses incurred for

business of the PE, including reasonable allocation of executive and

general expenses, research and development expenses whether

incurred in the State where PE is situated or elsewhere, should be

allowed but in accordance with and subject to limitations of taxation

laws of the country in which PE is situated. However, in respect of

royalties, fee or similar payments in return for use of patent, know-how

or other rights etc., only reimbursement of actual expenses can be

allowed.        Paragraph 5 states that profit attributed to permanent

establishment in clause (a) paragraph 1 of Article 7 shall only include

ITA No. 735/2011+connected appeals                                  Page 93 of 102
profits derived from assets and activities of permanent establishment.

The determination should be by the same method from year to year

unless there are good and sufficient reasons.


82.     Paragraph 5 affirms scope of paragraph 1(a) of Article 7 to

profits derived from assets and activities of the PE. In other words,

only assets and activities of PE i.e. e-Fund India can be taken into

consideration for attribution of profits to the two assessee, if it is

assumed that e-Fund India was PE of the assessee. The activities,

which were not undertaken by e-Fund India and the assets of the two

assesses outside India, cannot be taken into account or attributed for

earning/income of the two assessees. This is subject to the limited

force of attraction principle mentioned above, which in the present case

is not applicable.


83.     We have already quoted passages from decision in Morgan

Stanley (supra) on the question of attribution when the Indian

company, i.e., e-Fund India itself was assessed and subjected to tax on

arms length` basis. The Supreme Court has observed that in such

cases when transfer pricing analysis includes and takes into account

risk taking functions of the PE enterprise, nothing further would be

attributable to the foreign or non-resident enterprise. However, if the

transfer pricing order or computation does not adequately reflect the
ITA No. 735/2011+connected appeals                           Page 94 of 102
functions performed and risk assumed by the Indian enterprise, there is

need to attribute profits for those functions or risks which have not

been considered. Data placed by the taxpayer, which is examined and

considered in transfer pricing analysis is, therefore, of importance and

has to be examined in each case.


84.     Apportionment criteria or method is beset with difficulties and

complications.            Recent OECD attempt for application of people

functions tests etc. has been subject matter of unfavourable comments.

The criteria or apportionment principles can be grouped as:-

(i)     Receipt of enterprise based on turnover or commission.

(ii)    Expenses i.e. based upon wages paid.

(iii)     The capital structure i.e. based upon apportionment of total

working capital of the enterprise allocated to each enterprise or part.

Asset can form the basis of apportionment.

(iv)     Amalgamation of one two or more of the above criteria can be

also adopted in different proportions.

85.     As noticed above, Article 7 of the DTAA refers to the asset and

functions method.             Normally, turnover or commission method is

applied in case of enterprise providing service as net profits

significantly depends upon turnover. In Morgan Stanley (supra), the

Supreme Court has also observed that Transactional Net Margin

ITA No. 735/2011+connected appeals                             Page 95 of 102
Method (TNMM, for short) is most appropriate method in case of

service PE. The assessment order itself indicates and states that the

said method was adopted for computing arms length pricing in the case

of e-Fund India.


86.     In the present case, the Assessing Officer, in our opinion, rightly

did not invoke wages method as it would have lead to inequitable and

inappropriate results. In the present case the assessees` activities

though broadly divided into four heads were interconnected and not

independent as the heads/lines were interdependent and had direct

relationship. Assets in form of ATM equipment, location/installation

charges etc. were significant and important for the entire business

including back office operations.        As the Assessing Officer had

applied asset and income method and the Commissioner (Appeals) did

not adversely comment; the tribunal did not interfere or adopt a

different apportionment criteria but corrected an obvious anomaly

noticed and apparent. The anomaly being; that while computing the

proportion of net income attributable to Indian PE, the net income of

the group less income of eFund India was attributed to the group assets

including assets of e-fund India.       Thus, the net income excluded

income earned by e-fund India was divided or attributed to the assets,

including Indian assets, though Indian assets had also contributed in

ITA No. 735/2011+connected appeals                             Page 96 of 102
earning of the net income. This inconsistency was highlighted by the

assessee before the Commissioner (Appeals) and the tribunal.

Commissioner (Appeals) referred to the written submissions; that the

formula adopted was iniquitous and irrational. The said contention was

elucidated by giving a specific example noticed in paragraph 7.7 of the

order of the Commissioner (Appeals). The contention was rejected

stating that the example was a theoretical. Method of apportionment

has to be fair, rational and logical. Assets and net income criteria

applied must collate and refer to the assets which have contributed to

the earning of the net income.            The tribunal, therefore, rightly

interfered and corrected the error, which was apparent.       In the MAP

proceedings a formula was adopted and should be consistently

followed but if the said formula was irrational and inappropriate, it

could be corrected in other and subsequent years. The approach of the

tribunal, therefore, cannot be faulted.

87.     On the question whether depreciated/written down value or the

original cost of assets should be taken as the basis, the tribunal has

accepted the written down value of the assets adopted by the Assessing

Officer. Revenue has not specifically questioned the said finding and

had contested original cost basis adopted by Commissioner (Appeals).

Moreover, the tribunal has given valid and cogent reasons for the same,

ITA No. 735/2011+connected appeals                             Page 97 of 102
though in a given case, adjustments may have to be made when there is

material to show that written down value may lead to irrational or

illogical results due to difference in rate of depreciation or 100%

depreciation was/is allowed under applicable tax laws of one of the

countries. No such contention or issue has been raised by the Revenue

before us.

88.        Noticing the position that turnover method or TNMM is

considered appropriate in case of service industry, while reserving

judgment, the assessee was directed to file a computation of attribution

of income on the basis of turnover method. Thereafter, the assessee

filed a chart working out attribution on turnover basis. The calculation

read:-

    
       Year         Assessment Year   eFunds US        eFunds India    %      of
                    (AY)                                               eFunds
                                                                       India Vs
                                                                       eFunds
                                                                       US
                                                                       Turnover
       1            2                 3                4               5=4/3*100

       31-Mar-00    2000-01           14,448,252,600   435,344,000     3.01

       31-Mar-01    2001-02           20,606,718,000   1,097,752,000   5.33

       31-Mar-02    2002-03           25,289,380,000   1,785,150,000   7.06

       31-Mar-04    2004-05           23,556,109,500   2,084,474,000   8.85

       31-Mar-05    2005-06           23,603,125,000   2,174,630,000   9.21

       31-Mar-06    2006-07           22,957,421,250   2,229,147,000   9.71

       31-Mar-07    2007-08           23,905,497,030   2,146,683,000   8.98

                                                                               
ITA No. 735/2011+connected appeals                                       Page 98 of 102
89.     Accordingly it is stated that in view of the income declared and

taxed in the hands of e-Fund India, nothing remains to be attributed or

taxed in the hands of the two assessee.

90.     In the order dated 29th October, 2013, it was recorded that both

the parties have mentioned the appeals and calculations made by the

assessee had been furnished to the Revenue and in case Revenue

wanted to give counter calculations, the same be filed after examining

their records within 10 days. No calculations have been filed by the

Revenue.         We had directed the said calculations to be filed, as we

were uncertain about our decision. We were concerned that if turnover

method was applied or partly applied, then whether an order of remand

would be justified. Details were asked to be furnished to avoid another

round of litigation with an order of remit, if it was not necessary. We

did not seek details with an intention to get on record new or fresh

facts, which were not elucidated or relied upon by the parties before

the tribunal but in case we found merit in the contention raised by the

learned counsel for the Revenue whether an order of remand would be

justified. For reasons stated above we have not deemed it appropriate

to interfere with the findings of the tribunal on apportionment.




ITA No. 735/2011+connected appeals                            Page 99 of 102
91.     In view of the aforesaid discussion, we answer questions of law

in the following manner:-


                       Whether, on the facts and circumstances
               of the case and in law, the Assessing Officer was
               justified in reopening the assessment under
               Section 147/148 of the Income-Tax Act?
                 Notices under Section 147/148 are valid and as per law.


                        Whether on the facts and in the
                 circumstances of the case and in law, the
                 Tribunal was justified in holding that Appellant
                 has a business connection in India under Section
                 9(1) [or 9(1)(i)] of the Act ?
        The assessees have business connection in India, but the tribunal

has given a wide and broad meaning to the term business connection

and what is attributable and taxable as business connection has not

been adjudicated and decided.         This is because both the Assessing

Officer and the assessees have proceeded that in terms of Section 90(2)

of the Act, provisions of the DTAA were more beneficial to the

assessee. Question No. 2 is accordingly answered.


                        Whether on the facts and in the
                 circumstances of the case and in law, the
                 Tribunal was justified in holding that the
                 Appellant has a permanent establishment in
                 India under Articles 5(1), 5(2) (1) and 5(4) of
                 the India-US DTAA?
        The assessees did not have permanent establishment in India

under Articles 5(1), 5(2)(l) and 5(4) of the DTAA.

ITA No. 735/2011+connected appeals                              Page 100 of 102
                       Whether any income of eFunds
                 International India Pvt. Ltd. Can be attributed
                 and assessed in the hands of the appellant?
        No income of the e-Funds India could be attributed and assessed

in the hands of the assessee/appellants.


                       In case question no. (5) or question
                 No.(3) (i.e. immediately preceding question) is
                 answered against the appellant, whether the
                 Tribunal was justified and correct in adopting
                 the formula mentioned in the order and not
                 accepting the stand of the assessee?
        This question need not be answered in view of answer to the

preceding question . However, this question has been substantially

answered while deciding the appeals of the Revenue.

                 Whether on the facts and in the circumstances
                 of the case, and in law, the Tribunal was justified
                 in holding that appellant is liable to interest
                 under Section 234A and 234B of the Act?
        This question need not be answered in view of the findings that

the assessee did not have income taxable in India/taxable income.


92.     The substantial questions of law raised in the appeals by the
Revenue except appeals relating to Assessment Years 2006-07 and
2007-08 read:-

                 Whether on the facts and circumstances of the
                 case, the Income Tax Appellate Tribunal has
                 erred in law in not appreciating that the method
                 adopted by the AO for attributing the profit to
                 the PE of the assessee is based on the lines of
                 MAP proceedings based on A.Y. 2003-04?
ITA No. 735/2011+connected appeals                                  Page 101 of 102
                 Whether on the facts and circumstances of the
                 case, the order of the ITAT is not perverse?

        The substantial questions of law raised in appeals of the Revenue
relating to Assessment Years 2006-07 and 2007-08 read:-
                 Whether the Income Tax Appellate Tribunal has
                 correctly rejected the computation of profit
                 attributed to the Permanent Establishment on the
                 lines of the MAP proceedings?

                 Whether the formula prescribed by Income Tax
                 Appellate Tribunal for computation of profit
                 attributable to a Permanent Establishment is
                 correct and as per law?

                 Whether the order of the Income Tax Appellate
                 Tribunal is perverse?

        These questions have to be answered against the Revenue and in
favour of the assessees. The findings of the tribunal are not perverse
and the tribunal is justified in not accepting the formula/method
adopted/applied by the Assessing Officer or in the MAP proceedings
to compute purported income attributable to the two assessee.

93.     The appeals are disposed of. In the facts, there will be no order
as to costs.



                                               (SANJIV KHANNA)
                                                   JUDGE



                                              (SANJEEV SACHDEVA)
                                                    JUDGE
FEBRUARY 05th, 2014
VKR/KKB/NA

ITA No. 735/2011+connected appeals                               Page 102 of 102

and 2007-08 and e-Fund IT Solutions Group Inc., USA (e-Fund Inc., for short) relating to Assessment Years 2000-01, 2001-02, 2002-03, 2005-06, 2006-07 and 2007-08. The e- Fund Corp. and e-Fund Inc., when referred together have been described as the assessee` and the Director of Income Tax, International Taxation has been referred to as the Revenue`. The cross-appeals arise out of two common orders passed by the Income Tax Appellate Tribunal (tribunal, for short). The first order dated 30th September, 2010 relates to all assessment years, except assessment ITA No. 735/2011+connected appeals Page 6 of 102 years 2006-07 and 2007-08, which are subject matter of the second order of the tribunal dated 15th March, 2011. 2. The assessee are primarily aggrieved by the finding of the tribunal that they have Permanent Establishment (PE, for short) in India. They are also aggrieved with the initiation of the assessment proceedings under Section 147 read with Section 148 of the Income Tax Act, 1961 (Act, for short), whereas the Revenue is aggrieved by the finding of the tribunal relating to computation or attribution of the income earned by the assessee through the PE in India. 3. By order dated 27th September, 2011, the following substantial common questions of law were framed in the appeals Nos. 912/2011, 913/2011, 914/2011, 915/2011, 916/2011, 917/2011, 918/2011, 919/2011 and 920/2011 relating to assessment years 2000-01, 2001-02, 2002-03, 2004-05 and 2005-06 filed by the assessee:- 1. Whether, on the facts and circumstances of the case and in law, the Assessing Officer was justified in reopening the assessment under Section 147/148 of the Income-Tax Act? 2. Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that Appellant has a business connection in India under Section 9(1) of the Act? 3. Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that the Appellant has a permanent establishment in India under Articles 5(1), 5(2) (1) and 5(4) of the India- US DTAA? ITA No. 735/2011+connected appeals Page 7 of 102  4. Whether on the facts and in the circumstances of the case, and in law, the Tribunal was justified in holding that appellant is liable to interest under Section 234A and 234B of the Act? 4. By subsequent order dated 2nd March, 2012, two more questions of law being question Nos. 5 and 6 were framed and read as under:- 5. Whether any income of eFunds International India Pvt. Ltd. Can be attributed and assessed in the hands of the appellant? 6. In case question no. (5) is answered against the appellant, whether the Tribunal was justified and correct in adopting the formula mentioned in the order and not accepting the stand of the assessee? 4A. By order dated 17th November, 2011, the following substantial common questions of law were framed in the appeals ITA Nos. 1200/2011, 1201/2011, 1202/2011 and 1203/2011 relating to assessment years 2006-07 and 2007-08 filed by the assessee:- 1. Whether the tribunal is correct in holding that the appellant has business connection in India under Section 9(1)(i) of the IT Act? 2. Whether the tribunal was correct in holding that the appellant has a permanent establishment in India under Arts 5(1), 5(2) (1) and 5(4) of the India-US DTAA? 3. Whether any income of e-funds international India pvt ltd can be attributed and assessed in the hands of the appellant? 4. In case Ques 3. Is answered against the appellant whether the tribunal was justified and correct in adopting the formula mentioned in the order and not accepting the stand of the assessee? 


 ITA No. 735/2011+connected appeals Page 8 of 102 In ITA Nos. 1201/2011 and 1203/2011 relating to assessment year 2006-07 the following additional substantial questions relating to initiation of assessment proceedings under section 147/148 of the Act, was raised:- Whether the action of the Assessing officer in reopening the assessment under Section 147/148 of the IT Act is correct? 5. The substantial questions of law framed on the appeals being ITA Nos. 735/2011, 736/2011, 737/2011, 738/2011, 739/2011, 740/2011, 802/2011, 845/2011 and 1002/2011 filed by the Revenue vide order dated 27th September, 2011 read as under:- 1. Whether on the facts and circumstances of the case, the Income Tax Appellate Tribunal has erred in law I not appreciating that the method adopted by the AO for attributing the profit to the PE of the assessee is based on the lines of MAP proceedings based on A.Y. 2003- 04? 2. Whether on the facts and circumstances of the case, the order of the ITAT is not perverse? 5A. In ITA Nos. 1217/2011, 1218/2011, 1219/2011 and 1221/2011 for Assessment Years 2006-07 and 2007-08 filed by the Revenue, the following substantial questions of law were framed vide order dated 21st November, 2011:- (1) Whether the Income Tax Appellate Tribunal has correctly rejected the computation of profit attributed to the Permanent Establishment on the lines of the MAP proceedings? (2) Whether the formula prescribed by Income Tax Appellate Tribunal for computation of profit attributable to a Permanent Establishment is correct and as per law? ITA No. 735/2011+connected appeals Page 9 of 102  (3) Whether the order of the Income Tax Appellate Tribunal is perverse? 6. Undisputed facts in brief may be first noticed. The assessees are companies incorporated in United States of America (USA, for short) and were residents of the said country. They were assessed and have paid taxes on their global income in USA. e-Fund Corp. was the holding company having almost 100% shares in IDLX Corporation, another company incorporated in USA. IDLX Corporation held almost 100% shares in IDLX International BV, incorporated in Netherlands and later in turn held almost 100% shares in IDLX Holding BV, which was a subsidiary again incorporated in Netherlands. IDLX Holding BV was almost a 100% shareholder of e-Funds International India Private Limited, a company incorporated and resident of India (e-Fund International India Private Limited has been described as e-Fund India`). IDLX International BV was also the parent/holding company having almost 100% shares in e-Fund Inc., which as noticed above, was a company incorporated in USA. 7. Both e-Fund Inc. and e-Fund Corp. have entered into international transactions with e-Fund India. The details of these transactions have to be examined in depth and have to be referred below. e-Fund India being a domestic company and resident in India ITA No. 735/2011+connected appeals Page 10 of 102 was taxed on the income earned in India as well as its global income in accordance with the provisions of the Act. The international transactions between the assessees and e-Fund India and the income of e-Fund India, it is accepted, were made subject matter of arms length pricing adjudication by the Transfer Pricing Officer (TPO, for short) and the Assessing Officer (AO, for short) in the returns of income filed by e-Fund India. We are not primarily concerned with the merits of the computation of income declared and assessed in the hands of e- Fund India in the present appeals, though the factum that e-Fund India was assessed to tax on its global income as per law or on arms length pricing in relation to associated transactions and the basis of the said computation of income earned by e-Fund India, as noticed below, is a relevant and an important fact. Revenue has not disputed the said legal position. It is the contention of the Revenue that income of the two assessees were attributable to India because the two assessees had PE in India and should be taxed in India, irrespective of whether the said assessees had paid taxes in USA. Income earned and taxed in the hands of e-Fund India was different from the income attributable to the two assesses. Thus the balance or differential amount, i.e., income attributable to the two assesses, which was not included in income ITA No. 735/2011+connected appeals Page 11 of 102 earned and taxed in the hands of e-Fund India, should be taxed in India. 8. As a principle what is stated and submitted by the Revenue cannot be contested and in fact not contested by the assessees as it is a principle applicable to international taxation. A foreign or a non- resident company can be taxed in the country where it has a subsidiary, which is also a PE on the income attributable to the said PE, even if the subsidiary (in the present case of e-Fund India) is being taxed in the said country. The principle being that subsidiary being an independent and a distinct entity is taxed for its income, whereas the foreign entity, i.e., holding company is taxed for the income earned by the said independent entity attributable to the PE in the country where subsidiary is situated. The income of the subsidiary is not taxed in the hands of the non-resident principal and vice-versa. Thus, there is no double taxation in the hands of the holding company as income of the subsidiary is not taxed as income of foreign holding assessee. The principle is that a subsidiary constitutes an independent legal entity for the purpose of taxation. 9. Before we examine whether e-Fund India and its activities constitute PE of the foreign assessees as under the applicable Double Taxation Avoidance Agreement between India and USA, (The ITA No. 735/2011+connected appeals Page 12 of 102 agreement for the sake of convenience is being referred to as DTAA), it would be appropriate, at the outset, dispel any doubt or contention that establishing a subsidiary in the other treaty country would result in creating or establishing a PE of a foreign holding company in the said third country. Again to be fair to the Revenue, no such contention has been raised and the said legal position is clear and luminescent from paragraph 6 to Article 5 of the DTAA. The said paragraph reads:- 6. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other. 10. The aforesaid paragraph in categorical terms states that a holding or a subsidiary company by themselves would not become PE of each other. The words used in the said paragraph are equally important because the term holding or parent company or a subsidiary company is not used. The said paragraph uses the expression controls or is controlled by a company, which is resident of the other contracting State. Use of the word controls or controlled is significant and defines the scope and ambit of the said clause. Paragraph 6 states that the company, which controls or is controlled and carries on business in the other State, would by itself not ITA No. 735/2011+connected appeals Page 13 of 102 constitute PE of the other company. Therefore, even carrying on business in the other country by either the controlled company or the controlling company, but and though the other company would not make them, i.e. the two companies, a PE of each other. However, this does not mean that a subsidiary can never be a PE of the holding company, though there is opinion that the holding company or the controlling company possibly may not be a PE of a subsidiary (the later question is not subject matter of the present decision and we express no opinion on the said question though it may be a relevant aspect, which the tax adjudicators, policy makers and the legal draftsmen in India and abroad may have to deal with). Indeed if this principle is not applicable it could be argued that the Indian subsidiary, i.e., eFund India`s income could be taxed in the country from where it is controlled or managed. A subsidiary can become a PE of the holding/controlling company or the related company, if it satisfies the postulates and requirements of other paragraphs of Article 5, notwithstanding and negating the protection provided under paragraph 6 of Article 5, which recognizes legal independence of the two entities for tax purposes. This legal principle that the holding or contracting company and the subsidiary or the controlled company are two separate and independent tax entities and must be so treated permeates ITA No. 735/2011+connected appeals Page 14 of 102 and pervades but will give way to the exceptions carved out and stated in the DTAA. The legal principle is simple, a subsidiary being a resident of the State in which it is incorporated and functioning is taxed for its income. Subsidiary`s income is separately allocated and brought to tax in the country where it is situated or is a resident of. This clearly distinguishes a subsidiary form a foreign assessee, which is directly carrying on business and has residence in another country through their own branches/offices, personnel, etc. 11. Klaus Vogel on Double Taxation Conventions, Third Edition, states the following principle:- 40. [Principle] It is generally accepted that the existence of a subsidiary company does not, of itself, constitute that subsidiary company a permanent establishment of its parent company. This follows from the principle that, for the purpose of taxation, such a subsidiary company constitutes an independent legal entity. Even the fact that the trade or business carried on by the subsidiary company is managed by the parent company does not constitute the subsidiary company a permanent establishment of the parent company. 12. Similarly, in Arvid A. Skaar in Permanent Establishment, Erosion of Tax Treaty Principle, Second Indian, Reprint, 2008 has succinctly explained the legal position at page 540 paragraph 36.2.1 as under:- The treaty-based protection of related companies recognizes the legal independence of related companies for tax purposes as a material reality until the opposite is ITA No. 735/2011+connected appeals Page 15 of 102  proved. This affects both the constitution of PE, and the allocation of income to a separate entity. 13. It is further clarified and elucidated at pages 541-42 paragraph 36.2.3 as :- 36.2.3 POLICY CONSIDERATIONS A neutral tax system would allow a subsidiary PE to be constituted in all cases where the same conclusion would be reached for unrelated companies. This solution is expressly stated for a subsidiary PE under the agency clause. Consequently, the position of some older pre-OECD authors, that a subsidiary can never constitute a PE for the parent, has not been sustained. The conventional position of the OECD-based tax treaty doctrine is that a subsidiary PE can only be based on the agency clause. However, the tax treaties aim at allowing the source state to tax business profits with a certain economic allegiance to the country expressed through the enterprise`s PE. This intention must also apply when the parent company`s business income is earned by the intermediation of a subsidiary. Thus, from a de lege ferenda point of view, PE taxation of the parent company is justified in cases where residence state taxation of the subsidiary does not adequately attribute taxing jurisdiction to the source state. The commentaries to the OECD model treaty do not de lege lata give conclusive reasons for the conventional wisdom with regard to this question. A part of the above observations are in the nature of justification of right of taxation in source State and relate to the domain of PE principle and inter-state neutrality as a theory. Issue of source State in the present factual matrix has been touched below. 14. The aforesaid principle is no longer res integra and has been lucidly elucidated by the Supreme Court in DIT versus Morgan ITA No. 735/2011+connected appeals Page 16 of 102 Stanley and Co. Inc., (2007) 292 ITR 416 (SC) in the following words:- 32. The object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. Under Article 7(2) not all profits of MSCO would be taxable in India but only those which have economic nexus with PE in India. A foreign enterprise is liable to be taxed in India on so much of its business profit as is attributable to the PE in India. The quantum of taxable income is to be determined in accordance with the provisions of I.T. Act. All provisions of I.T. Act are applicable, including provisions relating to depreciation, investment losses, deductible expenses, carry-forward and set-off losses etc. However, deviations are made by DTAA in cases of royalty, interest etc. Such deviations are also made under the I.T. Act (for example: Sections 44BB, 44BBA etc.). Under the impugned ruling delivered by the AAR, remuneration to MSAS was justified by a transfer pricing analysis and, therefore, no further income could be attributed to the PE (MSAS). In other words, the said ruling equates an arm's length analysis (ALA) with attribution of profits. It holds that once a transfer pricing analysis is undertaken; there is no further need to attribute profits to a PE. The impugned ruling is correct in principle insofar as an associated enterprise, that also constitutes a PE, has been remunerated on an arm's length basis taking into account all the risk-taking functions of the enterprise. In such cases nothing further would be left to be attributed to the PE. The situation would be different if transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise. In such a situation, there would be a need to attribute profits to the PE for those functions/risks that have not been considered. Therefore, in each case the data placed by the taxpayer has to be examined as to whether the transfer pricing analysis placed by the taxpayer is exhaustive of attribution of profits and that would depend on the functional and factual analysis to be undertaken in each case. Lastly, it may be added that taxing corporate on the basis of the concept of Economic Nexus is an important feature of Attributable Profits (profits attributable to the PE). (Emphasis supplied) ITA No. 735/2011+connected appeals Page 17 of 102 15. ECONOMIC AND SOCIAL COUNCIL in their report dated 17.10.2008 have stated;- "38.1 In relation to the test of legal dependence, it should be noted that the control which a parent company exercises over its subsidiary in its capacity as shareholder is not relevant in a consideration of the dependence or otherwise of the subsidiary in its capacity as an agent for the parent. This is consistent with the rule in paragraph 7 of Article 5. But, as paragraph 41 of the Commentary indicates, the subsidiary may be considered a dependent agent of its parent by application of the same tests which are applied to unrelated companies. 16. It has been observed below, that subsidiary can constitute PE, other than dependent agent PE. A write up in Bulletin for International Taxation, February 2011 titled The Subsidiary as a Permanent Establishment has summarized the true and correct legal position in the following words;- A PE is, however, not always easy to identify. This is particularly true where a PE is hidden behind a dependent operating company, i.e. if an operating company in addition to its own business also carries on another company`s business as a PE of the latter. In this regard, the 2010 OECD Model Tax Convention (the OECD Model) states in Art. 5(7) that: [t]he fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other state (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other (emphasis added) ITA No. 735/2011+connected appeals Page 18 of 102  This follows from the principle that, for the purpose of taxation, such a subsidiary constitutes an independent legal entity.7 Accordingly, both companies are subject to unlimited tax liability in the state in which they are resident or where their place of management is located. However, by using the wording not of itself , the provision clarifies that a parent company (parent) can have an (agent) PE in its subsidiary`s state of residence if the general requirements for a PE set out inArt. 5(1) to (5) of the OECD Model are met. Accordingly, any space or premises belonging to the subsidiary that is at the disposal of the parent (the right-to-use test) and that constitutes a fixed place of business (the location test and the duration test) through which the parent carries on its own business (the business activity test), gives rise to a PE of the parent under Art. 5(1), subject to Art. 5(3) and (4), of the OECD Model. In addition, under Art. 5(5) of the OECD Model, a subsidiary constitutes an agency PE of its parent if the subsidiary has the authority to conclude contracts in the name of its parent and habitually exercises this authority, unless these activities are limited to those referred to in Art. 5(4) or unless the subsidiary does not act in the ordinary course of its business as an independent agent within the meaning of Art. 5(6)........ Subsidiary as a Permanent Establishment 17. This brings us to paragraphs 1 to 5 of Article 5 of the DTAA and the exceptions to paragraph 6 to Article 5. Article 7, which relates to business profit, may be also of some relevance. Paragraphs 1 to 5 of Article 5 and the entire Article 7 are being reproduced below:- Article5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of ITA No. 735/2011+connected appeals Page 19 of 102  business through which the business of an enterprise wholly or partly carried on. 2. The term "permanent establishment" includes especially: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; (g) a warehouse, in relation to a person providing storage facilities for others; (h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on; (i) a store or premises used as a sales outlet; (j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve month period; (k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects- or activities, if any) continue for a period of more than 120 days in any twelve month period; (l) the furnishing of services other than included services as defined in Article 12 (Royalties and Fees for Included Services), within Contracting State by an enterprise through employees or other personnel, but only if; (i) activities of that nature continue within that State for a period or periods aggregating more than 90 within any twelve-month period; or ITA No. 735/2011+connected appeals Page 20 of 102  (ii) the services are performed within that State for a related enterprise (within the meaning of paragraph 1 of Article 9 (Associated Enterprise). 3. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include any one or more of the following: (a) the use of facilities solely for the purpose of storage, display or occasional delivery of goods or merchandise belonging to the enterprise; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or occasional delivery; (c) the maintenance of a stock of goods, or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; (d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise; (e) the maintenance of a fixed base of business solely for the purpose of advertising, for the supply of information, for scientific research, or for other activities which have preparatory or auxiliary character, for the enterprise. 4. Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 5 applies is acting in a Contracting State on behalf of an enterprise of the other Contracting State other Contracting State, that enterprise shall be deemed to have permanent establishment in the first-mentioned State if: (a) he has an habitually exercises in that first-mentioned State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph; (b) he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise ITA No. 735/2011+connected appeals Page 21 of 102  on behalf of the enterprise, and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise. 5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. Article7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arm's length with the enterprise of which it is a permanent ITA No. 735/2011+connected appeals Page 22 of 102  establishment and other enterprises controlling, controlled by or subject to the same common control as the enterprise, in any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article. 3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest and other expenses, incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or except in the case of banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than toward reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices. 4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that ITA No. 735/2011+connected appeals Page 23 of 102  permanent establishment of goods or merchandise for the enterprise. 5. For the purposes of this Convention, the (sic) to be attributed to the permanent establishment as provided in paragraph 1 (a) of this Article shall include only the profits derived from the assets and activities of the permanent establishment and shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 6. Where profits include items of income which are dealt with separately in other Articles of the Convention, then the provisions of those Articles shall not be affected by the provisions of this Article. 7. For the purposes of the Convention, the term "business profits" means income derived from any trade or business including income from the furnishing of services other than included services as defined in Article 12 (Royalties and Fees for Included Services) and including income from the rental of tangible personal properly other than property described in paragraph 3 (b) of Article 12 (Royalties and Fees for Included Services). 18. Article 7 paragraph 1, states that profit of an enterprise of contracting State shall be taxed only in that State, i.e., in the State where it is a resident and not in the other State even if its activities have a business connection in the second State. This ensures that the same income is not taxed twice in the hands of the same person merely because there is a business connection between income earned by one assessee from activities in two States. Income of the said assessee can be taxed in the second State only if and when the said enterprise carries on business in the said State through a PE. However, in such circumstances only such income, which is attributable to the PE, is ITA No. 735/2011+connected appeals Page 24 of 102 taxable in the PE State of which the assessee is not a resident. Sub- clauses (b) and (c) to paragraph 1 of Article 7 incorporate a limited force of attraction principle. Under sub-clause (b) in addition to income attributable to the PE, income earned from sale of goods or merchandise or of same or similar kind sold through the PE in the other State, which are similar or same as effected through PE, are to be added. Clause (b) would come into operation only if there is sale of goods or merchandise in the second State and not otherwise and then goods or merchandise should be similar or of same kind as are being sold through the PE. We need not dwell into sub-clause (b) as it is not the case of the Revenue that the two foreign assessees were selling merchandise or goods in India or the PE in India, i.e., the subsidiary was selling goods or the merchandise. Sub-clause (c) is also not applicable as it is not the case of the Revenue that the two foreign assessees were carrying on business activities in India other than those effected through the PE. Activities carried on by the foreign assessees outside India are not covered under sub-clause (c) to paragraph 1 of Article 7. We shall be referring to other paragraphs of Article 7 subsequently as at this stage we would first like to examine Article 5 paragraphs 1 to 5 of the DTAA. Location or fixed place PE under Article 5(1) and (2) of DTAA. ITA No. 735/2011+connected appeals Page 25 of 102 19. Paragraph 1 of Article 5 refers to what can be described as fixed place PE. Tiiu Albin commentary, Problems with PE; problems in determining permanent establishment on the basis of Article 5(1) has stated that the said Article encapsulates three requirements, namely, (i) the existence of place of business at the disposal of the enterprise; (ii) the place of business must be of a fixed nature (geographical and temporal permanence); and (iii) the enterprise being carried on is required to be carried on through the place of business. 20. The word permanent in the expression PE is of significance and imperial importance. It refers to some degree of permanency and not a mere transitory nature of the business in the other State. Further, the enterprise must have a fixed place of business. The expression fixed place of business refers not only to physical location in the form of immovable property or premises but in certain instances can mean machinery and equipment. The word fixed refers to a distinct place with some or certain degree of permanence. The relevant and important word used in the definition clause for the purpose of the present case is through and i.e., the carrying on of business should be through the fixed place of business. In Morgan Stanley (supra), the Supreme Court has observed that back office operations by the Indian subsidiary to the parent to support the main office functions and ITA No. 735/2011+connected appeals Page 26 of 102 equity and fixed income research, account reconciliation and providing IT enabled services such as data processing and support centre do not satisfy the second requirement of Article 5(1), i.e., carrying on of business in India through such fixed place. The Indian subsidiary was in fact merely supporting the front operations of the principal company and on functional and factual analysis, Section 5(1) was not applicable. In Morgan Stanley (supra), the Supreme Court observed:- EXISTENCE OF P.E. IN INDIA 6. With globalization, many economic activities spread over to several tax jurisdiction. This is where the concept of P.E. becomes important under Article 5(1). There exists a P.E. if there is a fixed place through which the business of an enterprise, which is multinational enterprise (MNE), is wholly or partly carried on. In the present case MSCO is a multinational entity. As stated above it has outsourced some of its activities to MSAS in India. A general definition of the P.E. in the first part of Article 5(1) postulates the existence of a fixed place of business whereas the second part of Article 5(1) postulates that the business of the MNE is carried out in India through such fixed place. One of the questions which we are called upon to decide is whether the activities to be undertaken by MSAS consists of back office operations of the MSCO and if so whether such operations would fall within the ambit of the expression "the place through which the business of an enterprise is wholly or partly carried out" in Article 5(1). 21. The aforesaid observations are perhaps more appropriate and relevant when we will refer to the exclusionary clause, i.e., paragraph 3 of Article 5 of DTAA. For the purpose of present decision, we would like to reproduce the interpretation in the amended commentary of UN Model to Article 5, the relevant portion of which reads: ITA No. 735/2011+connected appeals Page 27 of 102  B. COMMENTARY ON THE PARAGRAPHS OF ARTICLE 5 Paragraph 1 3. This paragraph, which reproduces Article 5(1) of the OECD Model, defines the term permanent establishment, emphasizing its essential nature as a fixed place of business with a specific situs. According to paragraph 2 of the OECD Commentary (the 2005 version of which is cited below), this definition contains the following conditions: - the existence of a place of business, i.e., a facility such as premises or, in certain instances, machinery or equipment; - this place of business must be fixed, i.e., it must be established at a distinct place with a certain degree of permanence; - the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated. The OECD Commentary goes on to observe:- "3. It could perhaps be argued that in the general definition some mention should also be made of the other characteristic of a permanent establishment to which some importance has sometimes been attached in the past, namely that the establishment must have a productive character--i.e., contribute to the profits of the enterprise. In the present definition this course has not been taken. Within the framework of a well-run business organisation it is surely axiomatic to assume that each part contributes to the productivity of the whole. It does not, of course, follow in every case that because in the wider context of the whole organisation a particular establishment has a productive character it is consequently a permanent stablishment to which profits can properly be attributed for the purpose of tax in a particular territory. 4. The term place of business covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it ITA No. 735/2011+connected appeals Page 28 of 102  simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place, or by a certain permanently used area in a customs depot (e.g., for the storage of dutiable goods). Again the place of business may be situated in the business facilities of another enterprise. This may be the case, for instance, where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise. 4.1 As noted above, the mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is therefore required. Thus, for instance, a permanent establishment could exist where an enterprise illegally occupied a certain location where it carried on its business. 4.2 Whilst no formal legal right to use a particular place is required for that place to constitute a permanent establishment, the mere presence of an enterprise at a particular location does not necessarily mean that that location is at the disposal of that enterprise. These principles are illustrated by the following examples where representatives of one enterprise are present on the premises of another enterprise. A first example is that of a salesman who regularly visits a major customer to take orders and meets the purchasing director in his office to do so. In that case, the customer`s premises are not at the disposal of the enterprise for which the salesman is working and therefore do not constitute a fixed place of business through which the business of that enterprise is carried on (depending on the circumstances, however, paragraph 5 could apply to deem a permanent establishment to exist). 4.3 A second example is that of an employee of a company who, for a long period of time, is allowed to use an office in the headquarters of another company (e.g. a newly acquired subsidiary) in order to ensure that the latter company complies with its obligations under contracts concluded with the former company. In that case, the employee is carrying on activities related to the business of the former company and the office that is at his disposal at the headquarters of the other ITA No. 735/2011+connected appeals Page 29 of 102  company will constitute a permanent establishment of his employer, provided that the office is at his disposal for a sufficiently long period of time so as to constitute a fixed place of business (see paragraphs 6 to 6.3) and that the activities that are performed there go beyond the activities referred to in paragraph 4 of the Article. 4.4 A third example is that of a road transportation enterprise which would use a delivery dock at a customer`s warehouse every day for a number of years for the purpose of delivering goods purchased by that customer. In that case, the presence of the road transportation enterprise at the delivery dock would be so limited that that enterprise could not consider that place as being at its disposal so as to constitute a permanent establishment of that enterprise. 4.5 A fourth example is that of a painter who, for two years, spends three days a week in the large office building of its main client. In that case, the presence of the painter in that office building where he is performing the most important functions of his business (i.e. painting) constitute a permanent establishment of that painter. XXXXX 4.6 The words through which must be given a wide meaning so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose. Thus, for instance, an enterprise engaged in paving a road will be considered to be carrying on its business through the location where this activity takes place 5. According to the definition, the place of business has to be a fixed one. Thus in the normal way there has to be a link between the place of business and a specific geographical point. It is immaterial how long an enterprise of a Contracting State operates in the other Contracting State if it does not do so at a distinct place, but this does not mean that the equipment constituting the place of business has to be actually fixed to the soil on which it stands. It is enough that the equipment remains on a particular site (but cf. the discussion at paragraph 20 below). 5.1 Where the nature of the business activities carried on by an enterprise is such that these activities are often moved between neighbouring locations, there may be difficulties in determining whether there is a single place of business (if two places of business are ITA No. 735/2011+connected appeals Page 30 of 102  occupied and the other requirements of Article 5 are met, the enterprise will, of course, have two permanent establishments). As recognised in paragraphs 18 and 20 below a single place of business will generally be considered to exist where, in light of the nature of the business, a particular location within which the activities are moved may be identified as constituting a coherent whole commercially and geographically with respect to that business. 22. The UN Commentary observes that place of business to constitute PE, the enterprise using it must carry on its business wholly or partly through it, though the activity need not be productive in character and need not be permanent in the sense that there is no disruption, but the operations must be carried out on regular basis. Branch, offices and factory mentioned in paragraph 2 are examples of fixed place of business. In paragraph 4.6 of the OECD Commentary, the words through which have been interpreted to have a wide meaning but postulate that the particular location should be at the disposal of the enterprise for that purpose and only then the business is carried through the location where the activity takes place. The word through has been interpreted and read in a manner that the foreign enterprise should have the right to use the location in the second State. The said right may or may not be formalized through legal documentation, but right to use should be established and shown. Then and then alone fixed place PE shall exist. ITA No. 735/2011+connected appeals Page 31 of 102 23. Fixed location test may be in form of a legal right or can be inferred from the facts when the foreign establishment and its employees are allowed right to use the place of business belonging to a subsidiary, a third party. Arvid A. Skaar in Permanent Establishment (supra) has observed:- (at page 155) 11.1 General The definition of the basic-rule PE of the modern tax treaties explicitly requires the enterprise`s objective presence in the other country through the existence of a fixed place of business. It also requires a business activity as a condition for PE. Furthermore it is a clear condition that there must be a connection between the place of business and the activity, i.e. that the activity has to be conducted through the place of business. xxx xxx (at pages 157-8) 11.3 The problem: A factual or a legal approach? xxxxx xxxxx xxxxx xxxxx The present author`s hypothesis concerning tax-treaty law is that the right of use test is met if the taxpayer`s use of the place of business cannot be prevented without his consent. Evidence of the enterprise`s right to use the place of business, according to this hypothesis, can be found in the business arrangements in which the taxpayer is involved. 24. The term through postulates that the taxpayer should have the power or liberty to control the place and hence the right to determine the conditions according to its needs. ITA No. 735/2011+connected appeals Page 32 of 102 Phillip Baker in his commentary on Double Taxation Conventions and International Tax Law (Sweet & Maxwell publications, 2nd edition) has stated that:- requirement of a fixed place of business which is implicit under Article 5(1), is that the place of business must be at the disposal of the enterprise. The right to use` test or the requirement that the place of business must be at the disposal of the enterprise is rationally and logically implicit in Article 5(1) in the expressions fixed place of business and through which the business of enterprise is carried on. It is not extraneous and the interpretation does not imply adding or substracting words to Article 5(1). The OECD and UN Model Commentaries quoted above adopts a reasonable and a rational approach in the commentaries for interpretation of Article 5(1) to not only include places which are legally at the disposal of an enterprise but also places where the non-resident assessee can as a matter of right claim is right to use. The said right to use can be inferred from the conduct etc. 25. There is some controversy whether the examples given in paragraph 2 to Article 5 are per se and ex facie permanent establishments or the requirements of paragraph 1 should also be satisfied. This controversy is in respect of building and construction sites etc. We need not give an affirmative opinion on the said question in relation building/construction sites etc. Overwhelming international commentaries, write ups and decisions support the position that for applying the location test, requirements of paragraph 1 to Article 5 must be independently satisfied. Therefore, to create a location PE, requirements of paragraph 1 to Article 5 should be satisfied. To some ITA No. 735/2011+connected appeals Page 33 of 102 extent, the controversy and contention to the contrary is academic in view of the negative list given in paragraph 3, which is fairly comprehensive and the restrictive; and postulates of paragraph 1 to Article 7 and other paragraphs to Article 7. Even otherwise, a mine, oil or gas fuel etc. or plantation or a factory in most cases would satisfy requirements of paragraph 1 to Article 5. United Nations Handbook on Selected issues in Administration of Double Tax Treaties for Developing Countries states that Article 5(2) lists some examples of fixed place of business. However, we need not address this issue further for the purpose of the present decision as the two foreign assessees did not have any branch office or factory or workshop in India and merely because they had a subsidiary in India by itself did not create a fixed place of business/location PE within the meaning of Article 5, paragraph 2, sub-clauses (b) to (k) thereof. Service PE under Article 5(2)(l) of the DTAA. 26. Sub-clause (l) to Article 5(2) defines what can be called service PE. Sub-clause (k) is also a type of service PE, but this clause is not relevant for the purpose of the present decision. The sub-clause (l) requires furnishing of services within the second contracting State by a foreign enterprise through its employees or other personnel. But a PE is created only if activities of that nature continue for a period or ITA No. 735/2011+connected appeals Page 34 of 102 periods aggregating more than 90 days in 12 months period or under clause (ii) services are performed within that State for a related enterprise as defined in Article 9 paragraph 1. For application of clause (ii) no time period stipulation is postulated. Sub-clause (l) would apply only if the foreign enterprise or the two assessees had performed services in India through their employees or personnel, i.e., personnel engaged or appointed by the foreign assessee. Employees of E-Fund India were their employees, i.e. employees of an Indian entity and not employees of the assessee. The employees of e-fund India did not become other personnel of the two assessee, once and if the said persons were defacto and dejure employed by the Indian entity/enterprise, i.e., e-Fund India. The words employees and other personnel have to be read along with the word through and furnishing of services by the foreign enterprise within India. Thus the employees and other personnel must be of the non-resident assessee to create a service PE. Any other interpretation or treating employees of the Indian entity, i.e., e-Fund India as other personnel of the foreign assessee would lead to incongruities and irrational result, for every subsidiary which engages an employee, would always become a PE of the controlling foreign company. The said submission of the Revenue is misconceived and has to be rejected. This would be contrary to the ITA No. 735/2011+connected appeals Page 35 of 102 overriding mandate of Article 5 paragraph 6. Decision in the case of Morgan Stanley (supra) as suggested and submitted by the Revenue does not hold or propound to the contrary. In the said case, the Supreme Court has held as under:- 13. However, the question which arises for determination in the present case is the nature of activities performed by stewards and deputationists deployed by MSCO to work in India as employees of MSAS. Under Article 5(a)(1) furnishing of services through the fixed place in India can constitute a P.E. The AAR In the impugned ruling has held that the stewards and deputationists are proposed to be sent by the MSCO from U.S. According to the AAR there is a flow of service from the MSCO to the MSAS when the former deputes its own employees to work in India in MSAS. Therefore, according to the AAR the service Agreement between MSCO and MSAS dated 14.4.3005 would fall under Article 5(2)(1) and consequently the transfer pricing regulation would apply for evaluating the charges payable by MSCO to MSAS in India for such service contract, This ruling has been challenged by the applicant. 14. Article 5(2)(1) of the DTAA applies in cases where the MNE furnishes services within India and those services are furnished through its employees. In the present case we are concerned with two activities namely stewardship activities and the work to be performed by deputationists in India as employees of MSAS. A customer like an MSCO who has world wide operations is entitled to insist on quality control and confidentiality from the service provider. For example in the case of software P.E. a server stores the data which may require confidentiality. A service provider may also be required to act according to the quality control specifications imposed by its customer. It may be required to maintain confidentiality. Stewardship activities involve briefing of the MSAS staff to ensure that the output meets the requirements of the MSCO. These activities include monitoring of the outsourcing operations at MSAS. The object is to protect the interest of the MSCO. These stewards are not involved in day to day management or in any specific services to be ITA No. 735/2011+connected appeals Page 36 of 102  undertaken by MSAS. The stewardship activity is basically to protect the interest of the customer. In the present case as held hereinabove the MSAS is a service P.E. It is in a sense a service provider. A customer is entitled to protect its interest both in terms of confidentiality and in terms of quality control. In such a case it cannot be said that MSCO has been rendering the services to MSAS. In our view MSCO is merely protecting its own interests in the competitive world by ensuring, the quality and confidentiality of MSAS services. We do not agree with the ruling of the AAR that the stewardship activity would fall under Article 5(2)(1). To this extent we find merit in the civil appeal filed by the appellant (MSCO) and accordingly its appeal to that extent stands partly allowed. 15. As regards the question of deputation, we are of the view that an employee of MSCO when deputed to MSAS does not become an employee of MSAS. A deputationist has a lien on his employment with MSCO. As long as the lien remains with the MSCO the said company retains control over the deputationist's terms and employment. The concept of a service PE finds place in the U.N. Convention. It is constituted if the multinational enterprise renders services through its employees in India provided the services are rendered for a specified period. In this case, it extends to two years on the request of MSAS. It is important to note that where the activities of the multinational enterprise entails it being responsible for the work of deputationists and the employees continue to be on the payroll of "the multinational enterprise or they continue to have their lien on their jobs with the multinational enterprise, a service PE can emerge. Applying the above tests to the facts of this case we find that on request/requisition from MSAS the applicant deputes its staff. The request comes from MSAS depending upon its requirement. Generally, occasions do arise when MSAS needs the expertise of the staff of MSCO. In such circumstances, generally, MSAS makes a request to MSCO. A deputationist under such circumstances is expected to be experienced in banking and finance. On completion of his tenure he is repatriated to his parent job. He retains his lien when he comes to India. He lends his experience to MSAS in India as an employee of MSCO as he retains his lien and in that sense there is a service PE (MSAS) under Article 5(2)(1). We find no infirmity in the ruling of the ARR on this aspect. In the above situation, MSCO is rendering services through its employees to MSAS. Therefore, the Department is right ITA No. 735/2011+connected appeals Page 37 of 102  in its contention that under the above situation there exists a Service PE in India (MSAS). Accordingly, the civil appeal filed by the Department stands partly allowed. 27. In respect of stewardship activities by employees of the non- resident assessee, it was observed that the employees were not involved in any day-to-day management or any specific services undertaken by the Indian subsidiary and it was basically to protect the interest of the customers, i.e., the third parties. It was also noticed, as in the present case, that the Indian subsidiary therein was a service provider. The aforesaid observations of the Supreme Court affirm our view that the services must be performed in respect of the activities within India. The distinction being activities within India and activities between the foreign enterprise/assessee and the Indian enterprise, i.e., the resident assessee is relevant. Thus, merely because the non-resident assessee to protect their interest, for ensuring quality and confidentiality has sent its employees to provide stewardship services, will not make the Indian subsidiary or another entity, a PE of the non-resident company. However, in respect of deputationists, the same principle was not applied in Morgan Stanley (supra) as the non- resident enterprise had retained control over deputationists` terms of employment, they continued to remain on the pay rolls of the foreign enterprise and their lien in the foreign enterprise was not disturbed. In ITA No. 735/2011+connected appeals Page 38 of 102 Morgan Stanley (supra), on completion of the deputation term, the said deputationists were to revert back and was repatriated to their parent job. Here, the Supreme Court has placed reliance on substance rather than form. An important factor and fact, which was noticed by the Authority on Advance Ruling in Morgan Stanley & Co. Inc., In re[2006] 284 ITR 260 was:- The staff deputed to MSAS would be on the payroll of the applicant and the remuneration paid by it will be reimbursed by MSAS. Out of a total remuneration of Rs.49,402,704 paid to employees, reimbursement to associate company for deputed staff aggregates to Rs.24,220,631 ; performance appraisal, pro-motion and discipline, etc., would be carried out in consultation with the applicant. Clause (4) of the agreement expressly stipulates that MSAS shall comply with all performance standards as specified by the Morgan group and that it shall comply with all reasonable directions or instructions of the group. Operation manual would be prepared and updated in conformity with the policy, procedures and practices of the Morgan group. Clause 7 enjoins upon MSAS to submit reports or other information concerning the services that the group may require. It further enjoins MSAS to attend all meetings convened for reviewing the services at the appointed time, place and agenda fixed by the group. By virtue of clause 8, MSAS is required to maintain a complete record which would be subject to audit and investi-gation by the applicant. The persons authorized by the Morgan group are provided unrestricted access to the business premises of the MSAS for audit and investigation. While clause 19 of the agreement disables MSAS from disclosing the information contained in the software products to any party except the Morgan group which has the liberty to share the infor-mation with any member of the Morgan group. All this would show that the applicant would be in a position to exercise close control and super-vision on the working of MSAS. Further these features in the agreement vividly bring out that the business of MSAS is inextricably linked with the business of the applicant and the other two entities of the Morgan Stanley group ITA No. 735/2011+connected appeals Page 39 of 102  so as to make activities of MSAS projection of Morgan group. 28. In Morgan Stanley & Co. Inc., In re (supra) one of the findings recorded by the Authority for Advanced Ruling was that the salary payable to the deputed staff from associated enterprises aggregated to 50% of the total remuneration to be paid to the employees of the Indian subsidiary. Further performance appraisal, promotion and discipline etc. was to be carried out in consultation with the foreign assessee. 29. Thus, on the question of seconded employees by the foreign enterprise/assessee to the Indian enterprise/subsidiary, we have to examine the nature and functions performed by the said seconded employees and who exercised control and supervised them. When and if the said employees had provided stewardship function, no PE exists even if the employees of the non-resident assesse were taken on deputation. Article 5(3) and its over-riding effect and consequences. 30. Paragraph 3 of Article 5 is a non-obstante provision which overrides paragraphs 1 and 2. In the said paragraph list of negative activities, which are deemed not to create PE are stipulated. These consist of sub-clauses (a) to (e). Clause (e) stipulates that maintenance of fixed place of business for the purpose of advertising, supply ITA No. 735/2011+connected appeals Page 40 of 102 information, scientific research or for activities of preparatory or ancillary character would deem not to create a PE. One clarification may be made. Paragraph 3 of Article 5 sets out a negative list or excludes activities performed through a fixed place in India or USA by a foreign enterprise/assessee, from application of paragraphs 1 and 2 to Article 5. It may also cover and protect service PE cases when sub-clauses (a) to (c) apply or when sub-clauses (d) and (e) apply and fixed place or base is created. Nature of the activities of the employees and other personnel of the non-resident assessee is important and relevant. This formed the foundation and basis of the distinction made by the Supreme Court in Morgan Stanley (supra) between stewardship activities and primary or core activities. Therefore, first and foremost, Article 5(1)/(2) should be applicable but then if the activities fall within parameters of paragraph 3, PE is not created for imposing tax in the second state. It does not follow that if activities are not covered in the negative or exclusions set out in paragraph 3, a PE is established or deemed to be established under paragraphs 1 or 2 of Article 5. This principle is relevant. As noticed below, the tribunal has erred and has referred and applied paragraph 3 of Article 5 as if all activities performed and undertaken by the Indian subsidiary and their employees would still create a PE in India of the ITA No. 735/2011+connected appeals Page 41 of 102 assessees, because the activities of e-funds India were not preparatory or auxiliary in character. This is not the correct legal position. Agency PE under Article 5(4) and (5) of DTAA. 31. Paragraphs 4 and 5 of Article 5 relate to creation of agency PE in the second contracting country. Agency replaces fixed place with personal connection. Arvid K. Skaar in his work Permanent Establishment` has opined that primacy of location test` of the basic rule is consistent with the conceptual structure of the PE clause itself. An agency will constitute a PE only when a PE cannot be found according to those conditions in the basic rule which are altered or replaced by the agency clause. OECD and UN Model Treaties recognize agency PE. The principle being, that a foreign enterprise may choose to perform business activities itself or through a third person in the other States. An agent is a representative who acts on behalf of another with third persons. International taxation laws recognize and accept two distinct types of agency PE, dependent and independent. Every agent by very nature of principle of agency is to follow principal`s instructions. But this principle is not squarely applicable to DTAAs, as third parties may not be strictly an agent under the domestic law. Further, the aforesaid dependency cannot be the distinguishing factor which determines whether the agency is ITA No. 735/2011+connected appeals Page 42 of 102 dependent or an independent agency for the purpose of Article 5 paragraphs 4 and 5 respectively. A dependent agency is one which is bound to follow instructions and is personally dependent on the enterprise he represents. Such dependency must not be isolated or once in a while transaction but should be of comprehensive nature. 32. The dependency test` as per Arvid A. Skaar requires examination and answer whether the business interest of the principal and the agency have merged. When there is evidence of merging of interest, then power to instruct the agent exceeds a certain level. In such cases the Principal regularly participates in the process of settling current business problems or exercises discretionary power in the said respects. OECD Commentary does not accept dependency based on financial support, supply of patents etc. as itself creating agency PE. Klaus Vogel on Double Taxation Conventions, Third Edition at page 345 in paragraph 170 states that interdependence must exist in both legal and economic respects but the independence is the main criteria. The expression independent agent` is used with the words brokers and general commission agents` in paragraph 5 o f Article 5 will, therefore, normally not include agents who have power to conclude contracts. Paragraph 38.1 of the OECD Commentary has been quoted ITA No. 735/2011+connected appeals Page 43 of 102 above (see paragraph 15). The commentary elucidates and gives illustrations and tests. 33. Earlier U.N. commentary had deviated in some respect from the OECD commentary and had observed that an agent who was wholly or almost wholly engaged by one principal shall be considered to be a dependent agent. This initial position stated in UN commentary has, however, not been accept in subsequent commentaries. The essential criteria being arms length relationship though engagement with one or a group might serve as an indicator of absence of independence of an agent. 34. Subsidiary by itself cannot be considered to be a dependent agent PE of the Principal, otherwise it would negate the overriding effect of paragraph 6 to Article 5, a provision which precedes and seeks to give recognition to separate legal entity principle associated with juristic incorporated enterprises. However, a subsidiary may become dependent or an independent PE agent provided the tests as specified in paragraphs 4 and 5 are satisfied. A dependent agent is deemed to be PE of the principal establishment under paragraph 4, if one of the three conditions specified in sub-clause (a) to (c) are satisfied. Under sub-clause (a), a dependent agent should have authority and should habitually exercise the said authority to conclude ITA No. 735/2011+connected appeals Page 44 of 102 contracts on behalf of the foreign enterprise. What is meant by the term authority to conclude contract` has been subject matter of controversy on whether participation in negotiations by the agent is sufficient or not. However, this is not relevant for the decision of the present appeals in view of the factual matrix of the present case. Sub- clause (b) refers to an agent who habitually maintains stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the principal enterprise. In such cases, the agent should also perform some additional activities in its country on behalf of the foreign enterprise which has contributed to the sale of goods or merchandise. Sub-clause (c) applies when the agent habitually secures orders in the said country i.e. where he is located, almost wholly or wholly for the foreign enterprise. 35. Transactions between a foreign enterprise and an independent agent, do not result in establishment of a permanent establishment under paragraph 5 to Article 5 if the independent agent is acting in ordinary course of their business. The expression ordinary course of their business has reference to activity of the agent tested by reference to normal customs in the case in issue. It has reference to normal practice in the line of business in question. However as per paragraph 5 of Article 5, an agent is not considered to be an independent agent if ITA No. 735/2011+connected appeals Page 45 of 102 his activities are wholly or mostly wholly on behalf of foreign enterprise and the transactions between the two are not made under arm`s length conditions. The twin conditions have to be satisfied to deny an agent character of an independent agent. In case the transactions between an agent and the foreign principal are under arm`s length conditions the second stipulation in paragraph 5 of Article 5 would not be satisfied, even if the said agent is devoted wholly or almost wholly to the foreign enterprise. 36. In Morgan Stanley (supra) Supreme Court rejected the contention of the Revenue that dependent agency was created after recording that Indian subsidiary had no authority to enter into or conclude contracts on behalf of the foreign establishment/agency. The contracts were entered into in America and were concluded there. Only implementation of those contracts to the extent of back office operations were carried out in India. This legal position is relevant in the present case. 37. In TVM Ltd. vs. Commissioner of Income Tax (1999) 237 ITR 230, Authority of Advance Ruling has interpreted the two expression has` and habitually exercises` in the case of dependent agent. It has been observed that the expression has` may have reference to the legal existence of such authority on terms of the contract between the ITA No. 735/2011+connected appeals Page 46 of 102 Principal and the Agent, the expression habitually exercises` has certainly reference to systematic course of conduct on the part of the agent. Reference to OECD Commentary and Klaus Vogel was made and it has been observed :- .....Para. 4 uses two expressions : has and habitually exercises an authority to conclude contracts on behalf of the enterprise in question. While the expression has may have reference to the legal exist- ence of such authority on the terms of the contract between the principal and agent, the expression habitually exercises has certainly reference to a systematic course of conduct on the part of the agent. If, despite the specific provision of the soliciting agreement, it is found, as a matter of fact, that TVI is habitually concluding contracts on behalf of TVM without any protest or dissent, perhaps it could be presumed either that the rele- vant provisions of the agency contract are a dead letter ignored by the parties or that the principal has agreed implicitly to TVI exercising such powers notwithstanding the terms of the contract. If such a situation is found to exist, then perhaps it could be said that TVI constitutes a permanent establishment for TVM despite the clauses of the contract relied upon. 38. Judgment of the Delhi High Court in the case of Rolls Royce PLC versus Director of Income Tax (International Taxation) (2011) 339 ITR (Del) is a good authority for the proposition that subsidiary can constitute and become a PE of the controlling company. The said decision proceeds on its own peculiar facts and we do not find that any legal principle and the elucidation in the present decision is contrary to the legal ratio propounded in the case of Rolls Royce (supra). ITA No. 735/2011+connected appeals Page 47 of 102 Mutual Agreement Procedure 39. Before we go on the factual matrix and apply the aforesaid principles to the facts of present case, we would like to deal with the contention of the Revenue that the PE issue stands determined as India and USA had resorted to Mutual Agreement Procedure (MAP, for short) as envisaged under Article 27 of the DTAA. Tribunal in the impugned order has referred to the determination under the MAP and relied upon the determination and it has been observed that the competent authorities of the two countries had resorted to the said procedure and had agreed to taxation of income of the assessee in India. 40. MAP procedure as envisaged under Article 27 of the DTAA was resorted to in the case of e-Fund Corp for the assessment years 2003- 04 and in the case of e-Fund Inc. for the assessment years 2003-04 and 2004-05. The letter or communication issued by the competent authority in India dated 23rd April, 2007 vide file No. 480/4/2006- FTD-1 reads as under:- The Acting Director (International) competent authority of USA initiated Mutual Agreement Procedure in the case of M/s e Funds Corporation and e Funds I.T. Solution. Inc., for the previous year ending 31.3.2003 with the Competent Authority of India under the Double Taxation Avoidance Agreement vide their letter No. SE LM IM: T: ? : IN dated 8.5.2006. Subsequently vide letter dated 16.2.2007 Competent Authority of USA initiated Mutual ITA No. 735/2011+connected appeals Page 48 of 102  Agreement Procedure for the previous year ending 31.3.2004 in the case of the Solutions Group Inc. The Competent Authorities of both the countries after examined the facts of the case and issues involved have arrived at a resolution in terms of Section 90 of Income Tax Act, 1961 read with Article 27 of Indo --USA Double Taxation Avoidance Agreement and Rule 44 I-I of Income Tax Rules, 1962. The Competent Authorities of USA and India have reached an agreement as follows with respect to the Tax assessment on M/s e Funds Corporation and e Funds IT Solution Group Inc: Income will be attributed to the Indian PEs based on the ratio of certain developed and acquired tangible and intangible assets in India and outside India. Out of the total assets for the AY 2003-04 , 10.48% of the assets were located in India and accordingly 10.48% of the Income would be attributable to India. The percentage attributable to India for the AY ending 2005 was arrived of 11.11% These percentages will be applied to the base of consolidated gross income as reduced by the income of subsidiary e Funds India Pvt. Ltd. Already reported in India. Thereafter the total income so attributed will be apportioned between e Funds and IT solutions in the ratio of 85% (to e Funds) and 15% (to IT Solutions) for the AY 2003-04 and 87% (to e Funds) and 13% (to IT solutions) for the AY 2004-05. In view of the above, the income attribution , as agreed upon is given below: AY 2003-04 AY 2004-05 Figures in US $ Figures in US $ million million Apportionable base 25.12 30.71 income Percentage 10.48% 11.11% attributed to India Income attributed to 2.63 3.14 India Allocation between IT Solutions and e 0.39 (15%) 0.45 (13%) Funds IT Solutions E Funds 2.24 (85%) 2.96 (87%) ITA No. 735/2011+connected appeals Page 49 of 102 41. The assessee has placed on record communication dated 7th May, 2005 written by Department of Treasury, Internal Revenue Services, Washington in which they have stated that they did not agree on technical merits that e-Fund Corp or e-Fund Inc. had a PE in India but they had agreed to mutual agreement to divide income to avoid double taxation. As per the terms of mutual agreement, income of the two assessees would be attributed to India taxation as per calculations. In terms of the said determination, there would be decrease in income of e-Fund Corp and e-Fund Inc. under the USA tax laws and they would be also entitled to foreign tax credit. The letter states that the said decision would not be binding on subsequent years. Pursuant to these letters, the two assessees had written letter dated 14th May, 2007 to the Income Tax authorities in which it was specifically stated that they did not agree on technical merits that they had PE in India but had agreed to accept the mutual settlement. 42. The MAP procedure and agreement, is no doubt relevant but cannot be determinative or the primary basis to decide whether the assessee had PE in India. There are several reasons for the same, including communication dated 7th May, 2007 of the Internal Revenue Services, America. Whether or not PE exists is a matter of law and fact, and there has to be determination of the said issue on merits. A ITA No. 735/2011+connected appeals Page 50 of 102 decision on merits will normally be persuasively` conclusive for subsequent or other assessment years, unless there are good and sufficient reasons to take a contrary or divergent view. However, a concession on point of law, is not binding for other assessment years or a different assessee. It is always open to the competent authorities of the two countries to enter into an agreement for avoidance of double taxation and bring a litigation/dispute to an end. Double taxation means taxation of the same subject matter or income in the hands of one assessee or one person in the two different countries. Double taxation can be avoided by either granting exemption or giving tax credit paid in the third country. As per the MAP procedure, there was decrease in the American taxable income and the tax paid on income in India was credited under the American laws. FACTS AND APPLICATION OF AFORESAID PRINCIPLES TO THE FACTS 43. Tribunal in the impugned order has held that the assessee had fixed place PE under Article 5(1) and also service PE under Article 5(2)(l) of the DTAA. The assessment order on the said aspect is rather ambiguous and unclear. In paragraph 7 of the assessment order, it is observed that the assessee had permanent establishment in India in various forms without elucidating any specific paragraph of Article 5 which was invoked and held to be applicable. However, in paragraph ITA No. 735/2011+connected appeals Page 51 of 102 8 reference is made to the assessment order for assessment year 2003- 04 in the case of e-Fund Corp and it was observed that assessee had fixed place PE as well as dependent agent PE i.e. PE under Article 5(1) and Article 5(4) of the DTAA. 44. Commissioner of Income Tax (Appeals) has held that the assessees had PE in India under paragraph 5(1), 5(2)(l) and both dependent PE and independent PE under Article 5(4) and 5(5) of the DTAA. 45. Tribunal in the impugned order has primarily referred to and quoted findings of the Assessing Officer. The assessee have placed on record copies of the written submissions filed before the appellate authorities i.e. Commissioner (Appeals) and tribunal wherein they have specifically questioned and challenged the facts recorded by the Assessing Officer/Commissioner (Appeals). Unfortunately, these have not been dealt with specifically in the appellate orders and to this extent we as an appellate court under Section 260A, are handicapped and faced with rather a difficult task. Further the assessment orders are confusing and the expression it is not known`, reflective of uncertainty and no firm finding, is repeatedly used and finds mention throughout. In case, the assessee had withheld facts, adverse inference could have been drawn and accordingly facts recorded but there should ITA No. 735/2011+connected appeals Page 52 of 102 be affirmative or negative factual finding. Use of expression it is not known` has not helped and has created confusion as the expression reflects ambiguity and lack of factual finding. 46. On the question as to the activities of the assessee and the agreements between the two assessee and e-Fund India, we find there is elaboration and reference in the order of Commissioner (Appeals). However, the tribunal has not commented upon the same. Explanations and details furnished before the Assessing Officer and observations made in the assessment order have been quoted. In the assessment order it is mentioned that the two assessees had four main business lines, namely (a) Electronic Payments; (b) ATM Management Service; (c) Decision support and risk management; and (d) Professional Services. Specific details of these activities as stated by the assessee have been noted in paragraph 6.14 of the order of the tribunal and for the sake of convenience are reproduced below. These details have not been questioned in the orders of the Assessing Officer, Commissioner (Appeals) or the tribunal. These are:- a) ATM Management Services Those appellants had installed ATM machines and point of sale machines in USA and Canada and, not in India. On the transactions carried out through the ATMs, revenues were generated by the appellants outside India and, therefore no income accrued in India. All the servers processing the transactions were not ITA No. 735/2011+connected appeals Page 53 of 102  installed in India and were located wholly outside India. Electronic Payments That ATM machines installed by other companies not belonging to the appellants outside India were also managed i.e. the transactions for these ATM machines were routed through servers installed by the appellant. These servers contained database of various cardholders for the purpose of verification and, revenues were shared from the ATM machine installers. Here also no activity was carried on by the appellants in India and, therefore no income accrued in India. Decision Support and Risk Management That appellants further provide decision support and, risk management services providing risk management based data and other products to financial institutions, retailers and other businesses that assist in detecting fraud and assessing the risk of opening a new account or accepting a check. These products and services are based on or enhanced by appellant's proprietary databases such as Debit Bureau®, ChexSystems (SM) and SCAN(SM) and other sources. Neither the customers to whom such services are provided are situated in India nor the services are provided from India and, therefore no income accrued to the appellants in India. d) Professional Services Professional Services include business process management and IT outsourcing services, EFT software sales and software applications development, maintenance and installation services. The appellant's business process management and outsourcing services focus on both back-office and customer support business processes, such as accounting operations, help desk services, account management, and call center operations to customers outside India. 47. As per the assessment/appellate orders e-Fund India had performed back office operations in respect of the first three. This included data entry operations etc. in respect of Decision Support and ITA No. 735/2011+connected appeals Page 54 of 102 Risk Management. Reference to the activities in India etc. is examined in detail below. 48. We shall first examine whether the assessees had fixed place PE in India. It was stated by the assessee that they did not have any assets or presence in India with no licenced office or business activity in India, consequently no income was chargeable to tax in India under clause 5(1) i.e. Fixed Place of Business. Neither in the assessment order nor in the appellate order including order of the tribunal, we find any material and relevant discussion to hold that the two assessee had a fixed place of business in India through which business of enterprise was wholly or partly carried on. None of the authorities including the tribunal have held that the two assessee had right to use any of the premises belonging to e-Fund India. It has not been adverted to or stated that premises of e-Fund India were at the disposal, legally or otherwise, of the two assessees. The right to use test` or disposal test` has not been adverted to or applied nor is there any observation or finding to the said aspect. In the absence of any such finding Article 5(1) cannot be invoked and applied. As elucidated above, Article 5(1) has to be read with paragraph 6 of Article 5 which relates to subsidiary companies. ITA No. 735/2011+connected appeals Page 55 of 102 49. The Assessing Officer, Commissioner (Appeals) and the tribunal have primarily relied upon the close association between e-Fund India and the two assessee and applied functions performed, assets used and risk assumed, criteria to determine whether or not the assessee has fixed place of business. This is not a proper and appropriate test to determine location PE. The fixed place of business PE test is different. Therefore, the fact that e-Fund India provides various services to the assessee and was dependent for its earning upon the two assessees is not the relevant test to determine and decide location PE. The allegation that e-Fund India did not bear sufficient risk is irrelevant when deciding whether location PE exists. The fact that e- Fund India was reimbursed the cost of the call centre operations plus 16% basis or the basis of margin fixation was not known, is not relevant for determining location or fixed place PE. Similarly what were the direct or indirect costs and corporate allocations in software development centre or BPO does not help or determine location PE. Assignment or sub-contract to e-Fund India is not a factor or rule which is to be applied to determine applicability of Article 5(1). Further whether or not any provisions for intangible software was made or had been supplied free of cost is not the relevant criteria/test. e-Fund India was/is a separate entity and was/is entitled to provide services to the ITA No. 735/2011+connected appeals Page 56 of 102 assessees who were/are independent separate taxpayer. Indian entity i.e. subsidiary company will not become location PE under Article 5(1) merely because there is interaction or cross transactions between the Indian subsidiary and the foreign Principal under Article 5(1). Even if the foreign entities have saved and reduced their expenditure by transferring business or back office operations to the Indian subsidiary, it would not by itself create a fixed place or location PE. The manner and mode of the payment of royalty or associated transactions is not a test which can be applied to determine, whether fixed place PE exists. 50. Reference to core of auxiliary or preliminary activity is relevant when we apply paragraph 3 of Article 5 or when sub-clause (a) to paragraph 4 to Article 5 is under consideration. The fact that the subsidiary company was carrying on core activities as performed by the foreign assessee does not create a fixed place PE. Paragraph 3 of Article 5 lists negative activities which when performed from a fixed placed in the other contracting State would not create a PE. The activities specified in Article 5, paragraph 3 would not create a PE, even when the conditions specified in paragraphs (1) and (2) of Article 5 are satisfied. Paragraph 3 is not a positive provision but a negative list. The said paragraph does not create a PE but has a negative connotation and activities specified when carried on do not create a PE. ITA No. 735/2011+connected appeals Page 57 of 102 51. Learned standing counsel for the Revenue submitted that the facts found by the tribunal and the authorities show that assessee were a joint venture or in partnership with e-Fund India as the business of the assessee and the Indian subsidiary were interlinked and closely connected. Our attention was specifically drawn to the 10K report which has been quoted by the Assessing Officer, Commissioner (Appeals) and the tribunal and also observations of Klaus Vogel quoted by the Commissioner (Appeals)/tribunal in their order, the relevant portion of which reads : b) Subsidiary as an agent: On the basis of a special parent/subsidiary relationship -- other than one of control under company law a subsidiary may; however, in individual cases be an agent, and consequently, for that reason a permanent establishment, of its parent company. The Mfg: make this clear by using the words 'of itself`. Also the transformation of a permanent establishment into a subsidiary does not yet lead, therefore, to the characterization of the subsidiary as a permanent establishment. In such cases, the subsidiary continues to be a separately taxable entity. his its parent company's permanent establishment only to the extent that it satisfies the agency requirement set out in Art. 5(5). and (6) MC. Paragraph 41 MC Comm.Art. 5 makes express mention of this only in regard to the independent agent within the meaning of Art. 5(5). Like any other unrelated company, however, a subsidiary, if an independent agent, can very well also constitute a permanent establishment of its parent company under, the conditions laid down in Art. 5(6). A subsidiary may, for instance, act as an agent of its parent nd conclude such contracts for the latter on the b as is of a corresponding authority as go beyond the limits of the ordinary course of its business. The independence of the subsidiary under company law also remains authoritative for tax purposes if it subcontracts. entirely or partially to associated enterprises or it acquires the means required for the contract's ITA No. 735/2011+connected appeals Page 58 of 102  execution from associated enterprises. The latter is particularly true ,fir the hiring out of employees as temporary workers. If the parent company makes personnel available to the subsidiary.* remuneration, then the activity of this 'hired labour' is to be attributed to the subsidiary and does not constitute a permanent establishment of the parent doing the hiring-out. This is different, however, as well as in cases of subcontracts if the parent assumes the economic risk of the contract's fulfillment in relation to the main customer. In this situation the parent company and the subsidiary have in fact established a company of which they are partners. This will lead to a permanent establishment for the partners f the general preconditions are fulfilled." 52. The aforesaid observations are in the context of dependent agency and not in the context of Article 5(1) or fixed place PE. The observations of Klaus Vogel have been misread and understood out of context. The said observations have been made in the context of independence of subsidiary and it has been observed that such independence for tax purposes is retained and is not negated, even if there is a sub-contract or assignment entirely or partially between the associated enterprises, or the subsidiary acquires means for execution from associated enterprises including hiring out of employees and works. It is observed that even hiring of labour by the subsidiary from the associated enterprise does not constitute permanent establishment of the parent company. The last portion of the aforesaid quotation refers to position where two companies or enterprises work as partners and in this situation permanent establishment of the partners may be a ITA No. 735/2011+connected appeals Page 59 of 102 PE, if general preconditions are fulfilled. The last words if general preconditions are fulfilled` are not superfluous but material and core of the principle. Permanent establishment of partners or a joint venture PE, as a concept and principle has not been invoked and applied in the present case. The said concept itself has been subject matter of significant debate. PE cannot be and is not established by mere transactions between two associated enterprises or the principal sub- contracting or assigning the contract to the subsidiary. An agency PE will be established and created if the requirements of paragraphs 4 and 5 of Article 5 are fulfilled and not otherwise. It is not uncommon for an enterprise to enter into contracts assign or sub-contract works, or service to their subsidiary. The subsidiary may also render services to a third party on behalf of the principal. This by itself would not lead to a subsidiary becoming a PE unless requirements of paragraphs 1, 2, 4 or 5 are satisfied. The observations of the Klaus Vogel in fact support the assessee as it postulates that partnership PE would be created only when the principal of the foreign enterprise retains the economic risk of contract and other general conditions i.e. Articles 5(1), 5(2), 5(4) and 5(5) of the DTAA are fulfilled. Tax authorities have to be cautious and aware of consequences when they apply joint venture or partnership principle in a case like the present one as it could be argued ITA No. 735/2011+connected appeals Page 60 of 102 that substantial or significant part of the income of the joint venture entity should be taxed in the source State. 53. This is also the view and opinion of Arvind K. Skaar, wherein he has referred to the principle of altered ego companies and decision of American courts in National Carbide Corporation vs. Commissioner 336 US 422; Moline Properties Inc. vs. Commissioner 319 US 436 and Bollinger vs. Commissioner 108 S.Ct. 1173 and has referred to six point as the National Carbide criteria. These are: (1) The corporation must operate in the name and for the account of the principal, (2) it must bind the principal by its actions, (3) it must transmit money received to the principal, (4) it must be considered whether the receipt of income is attributable to the services of the employees of the principal or to assets belonging to the principal, (5) the relations between the principal and the agent must not depend upon the fact that it is owned by the principal, and (6) the business purpose must be carrying on the normal duties of an agent. 54. With reference to criteria 5 and 6 in Bollinger (supra), observations and clarifications were made relying upon separate entity doctrine. Thereafter the text refers to problem of empty` and slander` companies which are used to avoid PE taxation. In the summary and conclusions Arvid A Skaar concludes that related enterprises which cooperate and join like Joint Venture may constitute subsidiary PE of ITA No. 735/2011+connected appeals Page 61 of 102 each other i.e. both the principal and subsidiary are PE inter se. It is further observed that international practice seems to suggest that subsidiary PE is not constituted for an enterprise which sub-contracts an assignment, if the enterprise does not take part in the physical work itself even though it contributes the equipment necessary for the work (service PE question and physical work has been examined below). 55. In the present case, we are not concerned with construction PE or bifurcations of contract or multiple contracts for installation, execution, supply, manufacture etc. The considerations and tests applicable in said cases may be different. 56. 10K report referred to in the orders was filed by the assessee with the S.E.C. USA. The details submitted in this document not only pertain to the two assessee incorporated and paying tax in USA but the entire group companies including e-Fund India. The assets, revenues, income earned, employees of e-Fund India etc. have to be disclosed and elucidated in the said report. The report, no doubt, is relevant and material but has to be examined with due care and caution to determine and decide whether the two assessees have PE in India. The fact that business has been transferred or sub contracted or assigned to e-Fund India is not relevant and material, unless we are determining applicability of paragraph 3 to paragraph 5 and the question is whether ITA No. 735/2011+connected appeals Page 62 of 102 the Indian company is performing core or auxiliary and preliminary activities. The fact, the report refers to and give details of or number of employees of e-Fund India which are part of the e-Fund group is not relevant. Neither income earned by eFund India nor activities in India by the Indian subsidiary by itself, relevant in determining whether or not PE exists under paragraphs 1, 2, 4 and 5 of Article 5. Thus and therefore, the fact that 40% of the employees of the entire group were in India i.e. were employees of e-Fund India, will not make the said company agency subsidiary PE or fixed place PE of the assessee. Neither provision of any software, intangible data etc. whether free of cost or otherwise, make e-Fund India an agency or fixed place PE of the two foreign assessees. Whether or not and on what basis e-Fund India was reimbursed expenses of xerox, courier charges etc. will not make e-Fund India as PE of the assessee under Articles 5(1), 5(4) or 5(5). Conditions and stipulates under Articles 5(1), 5(4) or 5(5) will create a PE and not the said facts as highlighted in the impugned orders. Therefore, we will now examine the facts found and refer to Articles 5(4) and 5(5) of DTAA. 57. Conditions of Articles 5(4) are not satisfied in the present case. It is not the case of the Revenue that e-Fund India was authorized and habitually exercised authority to conclude` contract or was ITA No. 735/2011+connected appeals Page 63 of 102 maintaining stock or merchandise from which it delivered goods or merchandise on behalf of the assessee or secured orders on behalf of the assessee. Therefore, the conditions and requirements of sub- clauses (a), (b) and (c) to Article 5(4) are not satisfied. 58. The assessment order does not state or mention how and why the transactions between the assessee and e-Fund India were not at arm`s length and consequently Article 5(5) was applicable. The assessment order does mention that software was provided to e-Fund India free of cost. However, it was not stated that this showed that the transactions between the assessee and e-Fund India were not at arm`s length basis. The assessees have submitted that e-Fund India had undertaken and carried out custom application development, integration and maintenance and management of the software in e-Fund India`s software development facilities. e-Fund India undertook code development in accordance with product specifications defined by e- Fund Corp or Deluxe, (a third company). The code generated was subsequently tested to ensure that the functions performed by the code were as per the protocol design and standard specifications. Final testing was undertaken by e-Fund Corp. The software was owned by e-Fund Corp or Deluxe and e-Fund India did not have any intangible right in the software. This plea has been repeatedly taken by the ITA No. 735/2011+connected appeals Page 64 of 102 assessee and has not been controverted or found to be incorrect. A submission or statement by an assessee should be accepted unless there are good grounds and reasons to reject the statement of fact. In case of any suspicion and when verification is required, further enquiry or investigation may be undertaken but the facts stated by the assessee cannot be rejected without cogent and good reasons. The transactions between the assessees and e-Fund India were at arm`s length and were taxed on arm`s length principle. There was no allegation or considered finding of the tribunal that the transactions were not in ordinary course of business. In these circumstances, even otherwise requirements of Article 5(5) are not satisfied in the present case. 59. This brings us to Article 5(2)(l) i.e. service PE. As already recorded above, employees of e-Fund India are not to be counted and treated as employees of the assessees; e-Fund India being a separate entity and taxable assessee. The tribunal and the authorities have erred in treating employees of e-Fund India as employees of the assessees for determining whether service PE under Article 5(2)(l) was created. There are no other factual findings recorded by the tribunal in respect of service PE under Article 5(2)(l). The assessment order also does not record any other relevant finding for creation of service PE under Article 5(2)(l), other than payment received by e-Fund India for ITA No. 735/2011+connected appeals Page 65 of 102 providing management and support service by the President and Sales Team to overseas group entities. Payment by e-Fund Corp on the said account were received for the year ending 31st March, 2002, but stopped thereafter. This no doubt is a relevant aspect with reference to Article 5(2)(a) but the said provision has not been invoked in the assessment order and in the appellate orders including order of the tribunal. We do not have details with regard to the exact nature and character of the management services provided to the overseas group entities. 60. Before the Commissioner (Appeals), the assessee in their submission had stated that the President of e-Fund Indian provided management support services in U.K. and Australia, while certain personnel of South-east Asia region provided marketing support services to e-Fund India as well as e-Fund group entities overseas. The e-Fund India had an international division which consisted of President`s office and South-east Asia Region office. Thus services rendered by e-Fund India personnel comprised of marketing support provided by President and Sales Team to U.K. and Australia and e- Fund Group overseas. It was further mentioned by the assessee that the President`s office managed operations of e-Fund Group entities in U.K. and Australia and accordingly employees of said entities reported ITA No. 735/2011+connected appeals Page 66 of 102 to the President. The President in turn was reporting to e-Fund Corp. Aforesaid factual position prima facie indicates that the said activities may have resulted in a PE under Article 5(2)(a) under the heading Place of Management` but the said provision has not been invoked. This court while exercising jurisdiction under Section 260A of the Act would not like to invoke the said provision as it requires factual determination as well as computation of the income attributable to the PE. We do not have any finding on the exact nature of the services rendered whether it was only relating to accounts, receivables, human resource management or related to other direct management services. Services of the nature specified in paragraph 3 of Article 5 have to be excluding while in determining and deciding whether or not a PE exists under Article 5(2). There is another difficulty if we apply Article 5(2)(a) ­ Place of Management principle; ­ enterprises in UK and Australia were subsidiaries or legal entities and not branches of the assessees. To what extent and when place of management principle will be applicable in such cases, DTAA which will be applicable as the associated enterprise were located in UK and Australia and computation of income attributable to the PE are highly debatable and contentious questions which require findings of facts at the first ITA No. 735/2011+connected appeals Page 67 of 102 instance and cannot be made matters to be decided for the first time in an appeal under section 260A of the Act. 61. The President and international sales division or regional office may have also constituted service PE in India for the year ending 31 st March, 2002, if we treat the President and employees whose salary was reimbursed as other personnel who had performed services within that State for a related enterprise as defined in paragraph 1 of Article 9. Thus, at best service PE for the year ending 31st March, 2002 would have been created under Article 5(2)(l) but again there has not been thorough and detailed discussion on the nature and type of services rendered and determination on question of salary and whether the President and employees of Regional Office could be treated as employees or other personnel` of the assessee. 62. The appellants had pleaded before the authorities and the tribunal that prior to assessment year 2005-06 not even a single employee of the assessee ever visited India even for a short period and in 2005-06, two employees of e-Fund were transferred to e-Fund India and that the entire expenditure for these two employees were borne by e-Fund India. No employees were present in India after 2005-06. Presence of employees in India is relevant under Article 5(2)(l) but the said employees should furnish services within the contracting State. ITA No. 735/2011+connected appeals Page 68 of 102 These services should not be mere stewardship services. The Assessing Officer has recorded that employees were seconded to e- Fund India but the functions they performed and whether they performed functions and reported to e-Fund Corp/associated enterprise was not known or ascertained. This was not the correct way of determining and deciding whether service PE existed. Whether the seconded employees were performing stewardship services or were directly involved with the working operations was relevant. It is also not known whether the services were performed related to services provided to an associated enterprise in which case clause 5(2)(l)(ii) would be applicable. In the said situation, the question of attribution of income etc. would also arise. 63. Two employees of e-Fund Corp were deputed to e-Fund India in the assessment years 2005-06. The case of the assessee and e-Fund India is that they were deputed to look towards development of domestic work in India. Payment of these employees as per the Revenue to the extent of 25% was borne by e-Fund India and balance 75% was borne by e-Fund Corp. The Assessing Officer on this basis has observed that this reduced cost base of e-Fund India as remuneration was paid by e-Fund Corp and the said employees were at liberty to perform functions of e-Fund Corp even while working for e- ITA No. 735/2011+connected appeals Page 69 of 102 Fund India. The response of the assessee as quoted in the assessment order was that e-Fund India, apart from export activities had also domestic business in India. This was evident from the return of income filed by e-Fund India where domestic income was computed separately as it was not eligible for deduction under Section 10A of the Act. Copy of the return was furnished. It was further stated that cost of personnel seconded in India was fully borne by e-Fund India i.e. 100% of the salary paid to the said employees seconded to India were debited to profit and loss accounts. 75% of the salary component was paid abroad by e-Fund Corp but the same was reimbursed by e-Fund India. This was in accordance with and permitted under the Indian Exchange Control Regulations. It was further stated that the Assessing Officer was wrong in assuming that the two seconded employees were at liberty to function for e-Fund Corp while they were working for e- Fund India. The seconded employees were working under the control and supervision of e-Fund India. The Assessing Officer thereupon has not commented on the reply of the assessee, though he has recorded comments in respect of replies to other issues raised by him (see paragraph 7 of the assessment order). The aforesaid factual assertion made by the assessee, therefore, was not negated or questioned by the Assessing Officer. ITA No. 735/2011+connected appeals Page 70 of 102 64. Commissioner (Appeals) has referred to technical explanation to DTAA issued by the US Department of Treasury. The said explanation refers to the definition of term PE` including service PE and states as under:- Subparagraph (1) provides the rule for determining the conditions under which the activity of furnishing services, through employees or other personnel, constitutes a PE. These rules apply only to the provision of services which are not considered to be "included services", as the term is defined in article 12 (Royalties and Fees for included Services). Under the subparagraph, the furnishing of services gives rise to a PE if either the activity continues for an aggregate of more than 90 days in a twelve month period, or the services are performed fir a person related to the enterprise providing the services. In the latter case, no time threshold test must be met for a PE to exist. The determination of whether persons are related for purposes of this test is made in accordance with the rules of article 9 (Associated Enterprises). 65. The aforesaid explanation has been misunderstood by Commissioner (Appeals). Sub-clause (l) to Article 5(2) creates service PE when the overseas assessee is involved in the activity of furnishing services within the other contracting State through employees or other personnel but only if conditions stipulated in clauses (i) or (ii) are satisfied. Clause (i) stipulates a threshold period or aggregation of the threshold period which should be satisfied. Clause (ii), however, does not stipulate any time threshold. Clause (ii), therefore, is much wider but is applicable when the foreign enterprise through employees or other personnel performs service within the other contracting State for ITA No. 735/2011+connected appeals Page 71 of 102 a related enterprise defined in Article 9 paragraph 1. But the said employees or other personnel of the assessee should have performed services in India for an associated enterprise. They should not have performed services for e-fund India`s domestic activities. 66. Control and supervision of workers is a relevant and important factor as was noticed by the Authority for Advance Ruling in Tekniskil (Sendirian) Berhard Vs. Commissioner of Income Tax [1999] 222 ITR 551. In the said case, a Malaysian company had provided skilled labour to a Korean company, who had worked in India. As the said labour had worked under the supervision and control of Korean company, it was held that Malaysian company did not have permanent establishment in India as per Article 7 of DTAA between Indian and Malaysia. In P.No.28 of 1999 In Re Authority for Advance Ruling in its decision reported in [2000] 242 ITR 208 took an opposite view after noticing that the Indian joint venture did not pay any remuneration to the foreign employees and the employees continued to be the employees of the foreign company and were paid by the foreign company. Thus, the applicant company was rendering services through its employees to the Indian company, therefore this created a PE. ITA No. 735/2011+connected appeals Page 72 of 102 67. The assessment order refers to the net income or loss of e-Fund Corp and has come to the conclusion that once operations of e-Fund India started and grew, the profits of e-Fund Corp also increased. This is a very simplistic method and manner of analyzing data. Profits or losses depend upon several factors like, business environment, quality of business operations etc. including transfer of back office operations or other operations to a more efficient and cost effective locations. The said finding can be given after minute and meticulous examination of the data, reasons and not by a straight forward and simplistic inference. Further existence of PE does not depend upon transfer of assignment or sub-contracting work/services to India, with an intent and purpose to save costs and to increase profitability of the assessee resident abroad. This is not the stipulation or requirement in Article 5. 68. The contention of the Revenue is that if rights in the software had been transferred to e-Fund India, compensation was required to be paid by e-Fund India and this would have required deduction of tax at source. The argument is farfetched. We are not dealing with assessment or failure of e fund India to deduct tax at source. The argument cannot be accepted as it would interfere with the working or business model adopted by the assessee and e-Fund India. The said 


 ITA No. 735/2011+connected appeals Page 73 of 102 working model is not a sham or a camouflage having no business character. 69. Similarly, the contention and finding recorded that e-Fund India had provided necessary input or information to e-Fund Corp or e-Fund Inc. to enable them to enter into contracts which were sub-contracted or assigned to e-Fund India, will not make e-Fund India a permanent establishment of the assessee. This is not covered under any of the clauses or stipulations of Article 5. It is not the case that employees of e-Fund India had participated and/or were present in the negotiations of the assessee with the third parties, in respect of contracts to be paid/sourced from India or even executed/performed abroad. 70. The Assessing Officer has recorded and in our opinion incorrectly that majority of the employees of the two assessees operate from India. The said finding is legally untenable and drawn on a wrong legal principle. Employees of e-Fund India were not employees of e-Fund Corp or e-Fund Inc. Seconded employees were only two in number and only in assessment year 2005-06. It is further observed that the two assessee had significant assets in India on wrong legal assumption that assets of e-Fund India were assets of e-Fund Corp and e-Fund Inc. He has held that the assessee and e-fund India did not operate on arm`s length basis as in respect of some contracts, e- ITA No. 735/2011+connected appeals Page 74 of 102 Fund India had raised bills directly to the customer but for similar contracts/ arrangement the entire amount was paid to the two foreign assessees and only a miniscule amount or profit was transferred or paid to e-Fund India. The said finding/conclusion again is not a correct inference. It is not born out from the record and has not been accepted by the tribunal as it has accepted attribution of income made by the assessee. 71. India has expressed reservation on some of the paragraphs in OECD commentary; primarily on the ground that India as a source State is entitled to tax services in the form of fee for technical/included service or royalty payment. The stand of the Indian tax authorities is that the services need not be rendered physically in India but when the payment is sourced from India and the services are to be utilized in India, income of the foreign resident is taxable in the source State i.e. India. We need not examine the said stand of the tax authorities in the present case as this is not in dispute or issue in question. The source State in the present case was USA. It was the State where the contract of service was performed and utilized, though certain operations took place in India. The beneficiaries of the services and the payment of the services were sourced in USA. Casual examination of India`s balance for payments in US Dollars available on Reserve Bank of ITA No. 735/2011+connected appeals Page 75 of 102 India`s website from the year 2000-01 to 2010-11, would indicate that India has substantial inflow under the head invisible i.e. payments for services and products which do not result in transfer of physical objects. A significant portion of India`s services, which contributes almost 55% to the Indian Gross Domestic Product, are for outbound and cross borders services. A greater and in-depth study is required to understand the full tax or revenue implication as far as India is concerned including study of proposed amendments to the OECD Model Treaty. Section 9(1)(i) of the Act 72. No arguments have been addressed before us on the aspect of legal connection which justifies taxation of a non-resident under Section 9(1)(i) of the Act on income which is deemed to be accrue or arise in India. The tribunal in the impugned order has held that the assessees had business connection in India for the points noted in paragraph 18.3. Though the reasons stated in paragraph 18.3 do appear to be widely and broadly stated, but keeping in view the mandate and the ratio of the decisions of the Supreme Court in Commissioner of Income Tax, Punjab Vs. R.D. Aggarwal and Company [1965] 56 ITR 20, Commissioner of Income Tax, Andhra Pradesh Vs. Toshoku Ltd., Guntur and Ors. (1980) 125 ITR 525, Ishikawajma-Harima Heavy ITA No. 735/2011+connected appeals Page 76 of 102 Industries Ltd. Vs. Director of Income Tax, Mumbai [2007] 288 ITR 408 and the amendments incorporated and made to Section 9 (1)(i), it has to be held that business connection did exist, not because the assessees were associated enterprise or had a subsidiary in India, but because the e-Funds India was providing information and details to the assessees in USA for the purpose of entering into contracts with third parties and subsequently the said contracts were performed fully or partly by e-Funds India as an assignee or sub-contractee and looking at the nature of the said transactions and the manner in which contracts were executed and where the asssessee had assumed and agreed to third party claims and risks; business connection is established. However, even when business connection under Section 9(1)(i) stands established, the provision does not seek to bring to tax, all profits of the non-resident. Only income reasonably attributed to operations carried out in India can be taxed under the Act. Real and intimate connection must exist between operations carried out in India and business by non- resident outside India, and profits of business outside India attributed to operations carried out in India, can be only subjected to tax. This is clear from the explanation to Section 9(1)(i) and only such income operations carried out in India have to be attributed and taxed. This would have entailed an intrusive and exhaustive exercise into each ITA No. 735/2011+connected appeals Page 77 of 102 contract executed by E fund India, and on involvement of the assessee and E fund India. In the present case, attributions of profit to business connection has not been undertaken/applied keeping in mind the aforesaid stipulation, but by applying Article 7 of the DTAA. It appears and is apparent that the assessee and Revenue felt that application of DTAA was more beneficial to the assessee. 73. In Director of Income Tax Vs. Rio Tinto Technical Services [2012] 340 ITR 507 (Delhi) it has been observed that Section 90 (2) mandates that where the Central Government has entered into DTAA and the said agreement applies, the provisions of that Act will apply to the extent they are more beneficial to the assessee. In other words, when DTAA and provisions of the Act apply to an assessee, then the Article of DTAA or the provision of the Act will apply depending upon, which one of the two is more beneficial or advantageous to the assessee. Challenge to the initiation of proceedings under Section 147/148 of the Act. 74. Challenge to the initiation of proceedings under Sections 147/148 of the Act by the two assessees is devoid of merits. In the present case, the assessee had not filed returns of income and were not subjected to regular assessment under Section 143(3). Challenge on ITA No. 735/2011+connected appeals Page 78 of 102 the ground of change of opinion etc. is not available. The only ground on which proceedings can be challenged is that the reasons recorded do not disclose any rational or relevant nexus with the formation of belief that income of the two assessees had escaped assessment. At the stage of issue of notice only a tentative or prima facie view, justifies initiation of proceedings under Section 147/148 of the Act, though the reasons or grounds recorded must not be based on gossip, rumour or mere suspicion. In the present case, reassessment proceedings were initiated after assessment orders in respect of assessment year 2003-04 were passed by the Assessing Officer. In respect of the said year, MAP procedure was adopted and income of the two assessees has been partly taxed in India. We, therefore, do not accept the contention of the assessee that there was no justification or valid reason to initiate proceedings under Section 147/148 of the Act. 75. Learned counsel for the assessees has submitted that reasons to believe for the assessment year 2000-01 were not communicated and this was in violation of law. Failure to communicate reasons to believe, may result in setting aside of the assessment order as an assessee has a right to challenge the proceedings initiated under Section 147/148 of the Act, after following procedure as per GKN Driveshafts (India) Limited. vs. Income-tax Officer ITA No. 735/2011+connected appeals Page 79 of 102 (2003) 259 ITR 19 (SC). However, in the facts of the present case, we are not inclined to set aside the assessment order for the Assessment Year 2000-01 and the appellate proceedings for this reason. Reasons to believe recorded for 2000-01 and subsequent years are identical. Reasons to believe for all assessment years, other than 2000-01 were communicated. The assessees did not object or protest before the Assessing Officer that they had not been served with the reason to believe for the assessment year 2000-01. No doubt, it was the obligation and duty of the Assessing Officer to furnish the reasons to believe and mere change in incumbent, did not absolve or wash away this duty or obligation, but in the facts of the present case, we are of the firm belief that the assessee was aware of the reasons to believe and was not prejudiced and in fact in full knowledge and were aware of the reason to believe for the assessment year 2000-01. They took a conscious and considered decision not to challenge the proceedings at the initiation stage. Thus non communication of reasons to believe was inconsequential and did not prejudice the assessee. Tribunal has on examining the original records came to a factual finding giving cogent reasons, why reasons to believe were in fact recorded before issue of notice. Challenge to the proceedings under Section 147/148 of the Act is therefore, rejected. ITA No. 735/2011+connected appeals Page 80 of 102 Computation, apportionment or accumulation of income/profit 76. The assessment order drawing authority from Article 7(2) of the DTAA and Rule 10 of the Income Tax Rules, holds that profit of the two assessees attributable to Indian PE should be computed on reasonable basis. The Assessing Officer took into account the assets of the two assessees located outside India and located in India, i.e., the assets of e-Fund India. In proportion to the assets located in and outside India, income from operations was attributed to the Indian PE. However, in computing the income from operations, the net profit of e- Fund India was reduced from the total income and then 2.51% of the net profit was attributed to India, 2.51% being the percentage of assets in India. The aforesaid income was divided in the ratio of 15% and 85% towards as income of Indian PE of e-Fund Inc. and e-Fund Corp. In view of the said computation, the total income of the two assessees determined for the relevant assessment years is as under:- For e-Funds Corporation & e-funds IT Solutions Group Inc. S.No. Assessment Post AO`s Decision Year 1. 2000-01 Particulars Amount (In Million USD) Income from operations (10 1.28 K) Less; Net profits (eFunds 0.82 ITA No. 735/2011+connected appeals Page 81 of 102  India) Attributable Income (In 0.46 Million of USD) (A) Percentage allocated to India 2.51% (B) Income attributed to the India 0.012 PE (A*B) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solution Group 0.002 Inc. (15%) eFunds Corporation (85%) 0.010 Exchange Rate 43.62 eFunds IT Solution Group 87,240 Inc. (in Rs.) eFunds Corporation (In Rs.) 436,200 2. 2001-02 Particulars Amount(In Million USD) Income from operations 18.99 (10 K) Less; Net profits (eFunds 6.41 India) Attributable Income (In 12.57 Million of USD) (A) Percentage allocated to 5.65% India (B) Income attributed to the 0.711 India PE (A*B) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solution 0.107 Group Inc. (15%) eFunds Corporation 0.604 (85%) Exchange Rate 46.64 ITA No. 735/2011+connected appeals Page 82 of 102  eFunds IT Solution 4,990,480 Group Inc. (in Rs.) eFunds Corporation (In 28,170,560 Rs.) 3. 2002-03 Particulars Amount (In Million USD) Income from operations 46.97 (10 K) Less; Net profits (eFunds 15.53 India) Attributable Income (In 31.44 Million of USD) (A) Percentage allocated to 9.03% India (B) Income attributed to the 2.838 India PE (A*B) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solution 0.426 Group Inc. (15%) eFunds Corporation 2.413 (85%) Exchange Rate 48.80 eFunds IT Solution 20,788,800 Group Inc. (in Rs.) eFunds Corporation (In 117,754,400 Rs.) 4. 2004-05 Particulars Amount (In Million USD) Income from operations 43.67 (10 K) Less; Net profits (eFunds 7.16 India) Attributable Income (In 36.50 Million of USD) (A) Percentage allocated to 12.37% India (B) ITA No. 735/2011+connected appeals Page 83 of 102  Income attributed to the 4.514 India PE (A*B) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solution NA Group Inc. (15%) eFunds Corporation 3.927 (85%) Exchange Rate 43.86 eFunds IT Solution NA Group Inc. (in Rs.) eFunds Corporation (In 172,238,220 Rs.) 5. 2005-06 Particulars Amount (In Million USD) Income from operations 62.70 (10 K) Less; Net profits (eFunds 6.12 India) Attributable Income (In 56.57 Million of USD) (A) Percentage allocated to 9.02% India (B) Income attributed to the 5.105 India PE (A*B) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solution 0.766 Group Inc. (15%) eFunds Corporation 4.339 (85%) Exchange Rate 43.75 eFunds IT Solution 33,512,500 Group Inc. (in Rs.) eFunds Corporation (In 189,831,250 Rs.) ITA No. 735/2011+connected appeals Page 84 of 102 6. 2006-07 Particulars Amount (In Million USD) Income from operations 77.20 (10 K) Less; Net profits (eFunds 6.76 India) Attributable Income (In 70.44 Million of USD) (A) Percentage allocated to 5.74% India (B) Income attributed to the 4.042 India PE (A*B) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solution 0.606 Group Inc. (15%) eFunds Corporation 3.436 (85%) Exchange Rate 44.61 eFunds IT Solution 2,70,46,039 Group Inc. (in Rs.) eFunds Corporation (In 15,32,60,890 Rs.) 7. 2007-08 Particulars Amount (In Million USD) Income from operations 79.03 (10 K) Less; Net profits (eFunds 7.00 India) Attributable Income (In 72.03 Million of USD) (A) Percentage allocated to 5.06% India (B) Income attributed to the 3.645 India PE (A*B) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation ITA No. 735/2011+connected appeals Page 85 of 102  eFunds IT Solution 0.547 Group Inc (15%) eFunds Corporation 3.098 (85%) Exchange Rate 43.59 eFunds IT Solution 2,38,33,642 Group Inc (in Rs.) eFunds Corporation (In 13,50,57,303 Rs.) 77. Commissioner (Appeals) did not interfere with the aforesaid computation except that for the purpose of attribution, he held that the value of assets should be taken at actual cost and not on written down value. The value of the assets was taken by the Assessing Officer at written down value. The Commissioner (Appeals) observed that taking written down value could result in different rates of attribution for various years as depreciation rates might vary for various assets and without change in business model or assets, business attribution would also vary. This probably had resulted in reduction of income attributable to the two assessees and, therefore, Revenue preferred appeals. Assessee also preferred appeals before the tribunal. 78. Tribunal in the impugned order has modified the method of computation or attribution of profits to Indian PE. The method adopted by the tribunal is as under:- ITA No. 735/2011+connected appeals Page 86 of 102  8.36. In our view, 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. (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 I.T. Solutions. 8.37. In our view, this working is more scientific and equitable. It will take care of the apprehension raised by the learned counsel that though eFunds India income was reduced on first stage in MAP proceedings, corresponding assets are not reduced, while adopting the global assets. This methodology/formula will be more helpful in arriving at the reasonably correct amount of attributable income, being comparatively just, fair and equitable. 79. It was further observed that it was desirable to adopt depreciated cost of assets as the base as held by the Assessing Officer. The tribunal observed that the reasoning of the Commissioner (Appeals) required interference because computation on the basis of actual cost would require reference to earlier records and reverse calculations, which was undesirable. Besides income generating capacity of the assets would diminish with the lapse of time and depreciation, as ITA No. 735/2011+connected appeals Page 87 of 102 provided in the respective statutes, should be given due regard. In such circumstances, it was desirable and expedient to base attribution on depreciated cost of assets for purpose of apportionment as it would be fairer, practical and hassle free method. As a result of the direction given by the tribunal, income of the two assessees has been computed as under:- For e-funds Corporation & e-funds IT Solutions Group Inc. S.No Assessment Post ITAT Decision Year 1. 2000-01 Particulars Amount (In Million USD) Income from 1.28 operations (10K) (A) Percentage allocated 2.51% to India (B) Attributable Income 0.032 (In Millions of USD) (C=A*B) Less; Net profits 0.82 (eFunds India) (D) Income attributed to NIL the India PE (C-D) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solutions NIL Group Inc. (15%) eFunds Corporation NIL (85%) ITA No. 735/2011+connected appeals Page 88 of 102 2. 2001-02 Particulars Amount (In Million USD) Income from 18.99 operations (10K) (A) Percentage allocated 5.65% to India (B) Attributable Income 1.07 (In Millions of USD) (C=A*B) Less; Net profits 6.41 (eFunds India) (D) Income attributed to NIL the India PE (C-D) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solutions NIL Group Inc. (15%) eFunds Corporation NIL (85%) 3. 2002-03 Particulars Amount (In Million USD) Income from 46.97 operations (10K) (A) Percentage allocated 9.03% to India (B) Attributable Income 4.24 (In Millions of USD) (C=A*B) Less; Net profits 15.53 (eFunds India) (D) Income attributed to NIL the India PE (C-D) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds ITA No. 735/2011+connected appeals Page 89 of 102  Corporation eFunds IT Solutions NIL Group Inc. (15%) eFunds Corporation NIL (85%) 4. 2004-05 Particulars Amount (In Million USD) Income from operations 43.67 (10K) (A) Percentage allocated to 12.37% India (B) Attributable Income (In 5.40 Millions of USD) (C=A*B) Less; Net profits 7.16 (eFunds India) (D) Income attributed to the NIL India PE (C-D) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solutions NA Group Inc. (15%) eFunds Corporation NIL (85%) 5. 2005-06 Particulars Amount (In Million USD) Income from 62.70 operations (10K) (A) Percentage allocated 9.02% to India (B) Attributable Income 5.66 (In Millions of USD) (C=A*B) Less; Net profits 6.12 ITA No. 735/2011+connected appeals Page 90 of 102  (eFunds India) (D) Income attributed to NIL the India PE (C-D) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solutions NIL Group Inc. (15%) eFunds Corporation NIL (85%) 6. 2006-07 Particulars Amount (In Million USD) Income from 77.20 operations (10K) (A) Percentage allocated 5.74% to India (B) Attributable Income 4.43 (In Millions of USD) (C=A*B) Less; Net profits 6.76 (eFunds India) (D) Income attributed to NIL the India PE (C-D) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solutions NIL Group Inc. (15%) eFunds Corporation NIL (85%) 7. 2007-08 Particulars Amount (In Million USD) Income from 79.03 operations (10K) (A) ITA No. 735/2011+connected appeals Page 91 of 102  Percentage allocated 5.06% to India (B) Attributable Income 4.00 (In Millions of USD) (C=A*B) Less; Net profits 7.00 (eFunds India) (D) Income attributed to NIL the India PE (C-D) Allocation of revenue between company eFunds IT Solution Group Inc. and eFunds Corporation eFunds IT Solutions NIL Group Inc. (15%) eFunds Corporation NIL (85%) Thus, no tax is payable by the two assessees in any year because e- Fund India had declared and stands taxed on a higher income. 80. Learned counsel for the Revenue has raised three contentions. Firstly, the method adopted by the Assessing Officer was in terms of the method adopted and accepted in the MAP proceedings and, therefore, the most reasonable method. Order of the tribunal does not set out or give reasons why the method adopted in the MAP proceedings was unreasonable and inappropriate. Secondly, as per Article 7, method once adopted should be followed from year to year and can be only altered under paragraph 5 of Article 7 for good and sufficient reasons. Lastly and in alternative, the bifurcation or ITA No. 735/2011+connected appeals Page 92 of 102 appropriation should be based on Rule 10 by applying turnover criteria and not on the basis of assets criteria. 81. Article 7 has been quoted above. Paragraph 2 of the said Article stipulates that business income attributed to permanent establishment will be calculated as if the permanent establishment in a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arms length` with other associated enterprises. In case profits attributable to permanent establishment are incapable of determination or determination presents exceptional difficulties, the profits attributable must be estimated on reasonable basis but in accordance with the principles stated above. Paragraph 3 postulates deductions in respect of expenses incurred for business of the PE, including reasonable allocation of executive and general expenses, research and development expenses whether incurred in the State where PE is situated or elsewhere, should be allowed but in accordance with and subject to limitations of taxation laws of the country in which PE is situated. However, in respect of royalties, fee or similar payments in return for use of patent, know-how or other rights etc., only reimbursement of actual expenses can be allowed. Paragraph 5 states that profit attributed to permanent establishment in clause (a) paragraph 1 of Article 7 shall only include ITA No. 735/2011+connected appeals Page 93 of 102 profits derived from assets and activities of permanent establishment. The determination should be by the same method from year to year unless there are good and sufficient reasons. 82. Paragraph 5 affirms scope of paragraph 1(a) of Article 7 to profits derived from assets and activities of the PE. In other words, only assets and activities of PE i.e. e-Fund India can be taken into consideration for attribution of profits to the two assessee, if it is assumed that e-Fund India was PE of the assessee. The activities, which were not undertaken by e-Fund India and the assets of the two assesses outside India, cannot be taken into account or attributed for earning/income of the two assessees. This is subject to the limited force of attraction principle mentioned above, which in the present case is not applicable. 83. We have already quoted passages from decision in Morgan Stanley (supra) on the question of attribution when the Indian company, i.e., e-Fund India itself was assessed and subjected to tax on arms length` basis. The Supreme Court has observed that in such cases when transfer pricing analysis includes and takes into account risk taking functions of the PE enterprise, nothing further would be attributable to the foreign or non-resident enterprise. However, if the transfer pricing order or computation does not adequately reflect the ITA No. 735/2011+connected appeals Page 94 of 102 functions performed and risk assumed by the Indian enterprise, there is need to attribute profits for those functions or risks which have not been considered. Data placed by the taxpayer, which is examined and considered in transfer pricing analysis is, therefore, of importance and has to be examined in each case. 84. Apportionment criteria or method is beset with difficulties and complications. Recent OECD attempt for application of people functions tests etc. has been subject matter of unfavourable comments. The criteria or apportionment principles can be grouped as:- (i) Receipt of enterprise based on turnover or commission. (ii) Expenses i.e. based upon wages paid. (iii) The capital structure i.e. based upon apportionment of total working capital of the enterprise allocated to each enterprise or part. Asset can form the basis of apportionment. (iv) Amalgamation of one two or more of the above criteria can be also adopted in different proportions. 85. As noticed above, Article 7 of the DTAA refers to the asset and functions method. Normally, turnover or commission method is applied in case of enterprise providing service as net profits significantly depends upon turnover. In Morgan Stanley (supra), the Supreme Court has also observed that Transactional Net Margin ITA No. 735/2011+connected appeals Page 95 of 102 Method (TNMM, for short) is most appropriate method in case of service PE. The assessment order itself indicates and states that the said method was adopted for computing arms length pricing in the case of e-Fund India. 86. In the present case, the Assessing Officer, in our opinion, rightly did not invoke wages method as it would have lead to inequitable and inappropriate results. In the present case the assessees` activities though broadly divided into four heads were interconnected and not independent as the heads/lines were interdependent and had direct relationship. Assets in form of ATM equipment, location/installation charges etc. were significant and important for the entire business including back office operations. As the Assessing Officer had applied asset and income method and the Commissioner (Appeals) did not adversely comment; the tribunal did not interfere or adopt a different apportionment criteria but corrected an obvious anomaly noticed and apparent. The anomaly being; that while computing the proportion of net income attributable to Indian PE, the net income of the group less income of eFund India was attributed to the group assets including assets of e-fund India. Thus, the net income excluded income earned by e-fund India was divided or attributed to the assets, including Indian assets, though Indian assets had also contributed in ITA No. 735/2011+connected appeals Page 96 of 102 earning of the net income. This inconsistency was highlighted by the assessee before the Commissioner (Appeals) and the tribunal. Commissioner (Appeals) referred to the written submissions; that the formula adopted was iniquitous and irrational. The said contention was elucidated by giving a specific example noticed in paragraph 7.7 of the order of the Commissioner (Appeals). The contention was rejected stating that the example was a theoretical. Method of apportionment has to be fair, rational and logical. Assets and net income criteria applied must collate and refer to the assets which have contributed to the earning of the net income. The tribunal, therefore, rightly interfered and corrected the error, which was apparent. In the MAP proceedings a formula was adopted and should be consistently followed but if the said formula was irrational and inappropriate, it could be corrected in other and subsequent years. The approach of the tribunal, therefore, cannot be faulted. 87. On the question whether depreciated/written down value or the original cost of assets should be taken as the basis, the tribunal has accepted the written down value of the assets adopted by the Assessing Officer. Revenue has not specifically questioned the said finding and had contested original cost basis adopted by Commissioner (Appeals). Moreover, the tribunal has given valid and cogent reasons for the same, ITA No. 735/2011+connected appeals Page 97 of 102 though in a given case, adjustments may have to be made when there is material to show that written down value may lead to irrational or illogical results due to difference in rate of depreciation or 100% depreciation was/is allowed under applicable tax laws of one of the countries. No such contention or issue has been raised by the Revenue before us. 88. Noticing the position that turnover method or TNMM is considered appropriate in case of service industry, while reserving judgment, the assessee was directed to file a computation of attribution of income on the basis of turnover method. Thereafter, the assessee filed a chart working out attribution on turnover basis. The calculation read:- Year Assessment Year eFunds US eFunds India % of (AY) eFunds India Vs eFunds US Turnover 1 2 3 4 5=4/3*100 31-Mar-00 2000-01 14,448,252,600 435,344,000 3.01 31-Mar-01 2001-02 20,606,718,000 1,097,752,000 5.33 31-Mar-02 2002-03 25,289,380,000 1,785,150,000 7.06 31-Mar-04 2004-05 23,556,109,500 2,084,474,000 8.85 31-Mar-05 2005-06 23,603,125,000 2,174,630,000 9.21 31-Mar-06 2006-07 22,957,421,250 2,229,147,000 9.71 31-Mar-07 2007-08 23,905,497,030 2,146,683,000 8.98 ITA No. 735/2011+connected appeals Page 98 of 102 89. Accordingly it is stated that in view of the income declared and taxed in the hands of e-Fund India, nothing remains to be attributed or taxed in the hands of the two assessee. 90. In the order dated 29th October, 2013, it was recorded that both the parties have mentioned the appeals and calculations made by the assessee had been furnished to the Revenue and in case Revenue wanted to give counter calculations, the same be filed after examining their records within 10 days. No calculations have been filed by the Revenue. We had directed the said calculations to be filed, as we were uncertain about our decision. We were concerned that if turnover method was applied or partly applied, then whether an order of remand would be justified. Details were asked to be furnished to avoid another round of litigation with an order of remit, if it was not necessary. We did not seek details with an intention to get on record new or fresh facts, which were not elucidated or relied upon by the parties before the tribunal but in case we found merit in the contention raised by the learned counsel for the Revenue whether an order of remand would be justified. For reasons stated above we have not deemed it appropriate to interfere with the findings of the tribunal on apportionment. ITA No. 735/2011+connected appeals Page 99 of 102 91. In view of the aforesaid discussion, we answer questions of law in the following manner:- Whether, on the facts and circumstances of the case and in law, the Assessing Officer was justified in reopening the assessment under Section 147/148 of the Income-Tax Act? Notices under Section 147/148 are valid and as per law. Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that Appellant has a business connection in India under Section 9(1) [or 9(1)(i)] of the Act ? The assessees have business connection in India, but the tribunal has given a wide and broad meaning to the term business connection and what is attributable and taxable as business connection has not been adjudicated and decided. This is because both the Assessing Officer and the assessees have proceeded that in terms of Section 90(2) of the Act, provisions of the DTAA were more beneficial to the assessee. Question No. 2 is accordingly answered. Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that the Appellant has a permanent establishment in India under Articles 5(1), 5(2) (1) and 5(4) of the India-US DTAA? The assessees did not have permanent establishment in India under Articles 5(1), 5(2)(l) and 5(4) of the DTAA. ITA No. 735/2011+connected appeals Page 100 of 102  Whether any income of eFunds International India Pvt. Ltd. Can be attributed and assessed in the hands of the appellant? No income of the e-Funds India could be attributed and assessed in the hands of the assessee/appellants. In case question no. (5) or question No.(3) (i.e. immediately preceding question) is answered against the appellant, whether the Tribunal was justified and correct in adopting the formula mentioned in the order and not accepting the stand of the assessee? This question need not be answered in view of answer to the preceding question . However, this question has been substantially answered while deciding the appeals of the Revenue. Whether on the facts and in the circumstances of the case, and in law, the Tribunal was justified in holding that appellant is liable to interest under Section 234A and 234B of the Act? This question need not be answered in view of the findings that the assessee did not have income taxable in India/taxable income. 92. The substantial questions of law raised in the appeals by the Revenue except appeals relating to Assessment Years 2006-07 and 2007-08 read:- Whether on the facts and circumstances of the case, the Income Tax Appellate Tribunal has erred in law in not appreciating that the method adopted by the AO for attributing the profit to the PE of the assessee is based on the lines of MAP proceedings based on A.Y. 2003-04? ITA No. 735/2011+connected appeals Page 101 of 102  Whether on the facts and circumstances of the case, the order of the ITAT is not perverse? The substantial questions of law raised in appeals of the Revenue relating to Assessment Years 2006-07 and 2007-08 read:- Whether the Income Tax Appellate Tribunal has correctly rejected the computation of profit attributed to the Permanent Establishment on the lines of the MAP proceedings? Whether the formula prescribed by Income Tax Appellate Tribunal for computation of profit attributable to a Permanent Establishment is correct and as per law? Whether the order of the Income Tax Appellate Tribunal is perverse? These questions have to be answered against the Revenue and in favour of the assessees. The findings of the tribunal are not perverse and the tribunal is justified in not accepting the formula/method adopted/applied by the Assessing Officer or in the MAP proceedings to compute purported income attributable to the two assessee. 93. The appeals are disposed of. In the facts, there will be no order as to costs. (SANJIV KHANNA) JUDGE (SANJEEV SACHDEVA) JUDGE FEBRUARY 05th, 2014 VKR/KKB/NA ITA No. 735/2011+connected appeals Page 102 of 102 
 
 
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