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Adobe Systems Incorporated Vs. Assistant Director Of Income Tax And Anr
May, 20th 2016
       IN THE HIGH COURT OF DELHI AT NEW DELHI
%                                            Judgment delivered on: 16.05.2016

+                        W.P.(C) 2384/2013 & CM 4515/2013

ADOBE SYSTEMS INCORPORATED                      ..... Petitioner
                 Through: Mr R.P. Bhat, Senior Advocate with
                 Mr Prakash Kumar, Mr Vishal Kalra and Mr
                 Vivek Bansal, Advocates.

                                  versus

ASSISTANT DIRECTOR OF INCOME TAX
AND ANR                                       ..... Respondents
                 Through: Mr Dileep Shivpuri, Senior Standing
                 Counsel with Mr Sanjay Kumar, Advocate.

                                           WITH

+                        W.P.(C) 2385/2013 & CM 4517/2013

ADOBE SYSTEMS INCORPORATED                      ..... Petitioner
                 Through: Mr R.P. Bhat, Senior Advocate with
                 Mr Prakash Kumar, Mr Vishal Kalra and Mr
                 Vivek Bansal, Advocates.

                                  versus

ASSISTANT DIRECTOR OF INCOME TAX
AND ANR                                      ..... Respondents
                 Through: Mr Dileep Shivpuri, Senior Standing
                 Counsel with Mr Sanjay Kumar, Advocate.

                                           WITH

+                        W.P.(C) 2390/2013 & CM 4523/2013

ADOBE SYSTEMS INCORPORATED                      ..... Petitioner
                 Through: Mr R.P. Bhat, Senior Advocate with
                 Mr Prakash Kumar, Mr Vishal Kalra and Mr
                 Vivek Bansal, Advocates.

W.P.(C) 2384/2013, 2385/2013 & 2390/2013                             Page 1 of 31
                                  versus

ASSISTANT DIRECTOR OF INCOME TAX
AND ANR                                                       ..... Respondents

                                  Through: Mr Dileep Shivpuri, Senior Standing
                                  Counsel with Mr Sanjay Kumar, Advocate.

CORAM:
JUSTICE S.MURALIDHAR
JUSTICE VIBHU BAKHRU

                                           JUDGMENT

VIBHU BAKHRU, J

1.      The Petitioner, Adobe Systems Incorporated (hereafter the

'Assessee'), has preferred the present petitions under Article 226 and 227

of the Constitution of India, impugning three separate notices dated 30 th

March, 2011 (hereafter ,,the impugned notices) issued under Section 148

of the Income Tax Act, 1961 (hereafter the ,,Act) for Assessment Years

(AYs) 2004-05, 2005-06 and 2006-07 respectively. The Assessee further

impugns three separate orders dated 8th March, 2013 (hereafter

,,impugned orders) passed by the Assessing Officer (hereafter ,,the AO)

rejecting the objections raised by the Assessee against the assumption of

jurisdiction under Section 148 of the Act.


2.      Briefly stated, the controversy in these petitions involves the

question whether Adobe Systems India Private Limited (an Indian


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                             Page 2 of 31
subsidiary of the Assessee and hereafter referred to as ,,Adobe India)

could be considered as its Permanent Establishment (PE). And if so,

whether any part of the Assessee's income, could be attributed to such PE

in respect of the activities carried out by Adobe India, income from which

had been subjected to transfer pricing scrutiny/adjustment.


2.1     The Assessee disputes that it has a PE in India. It further contends

that since the income of Adobe India has been assessed at Arm's Length

Prices (ALP), no part of Assessee's income could be attributed to Adobe

India even if it was assumed to be the Assessee's PE in India. On the

other hand, it is the Revenue's case that the activities carried out by the

Adobe India are the core business activities of the Assessee; Adobe India

is the Assessee's PE in India; the cost plus basis on which Adobe India is

remunerated by the Assessee does not capture the fair share of Assessee's

income attributable to its PE; and that a part of the Assessees income,

computed on profit split method, is chargeable to tax under the Act.


2.2     Whilst the Assessee claims that there is no tangible material for the

AO to have any reason to believe that the Assessee's income has escaped

assessment, the Revenue contends that the transfer pricing report as

submitted by Adobe India provides sufficient reason to form a belief that

the Assessee's income had escaped assessment.


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                         Page 3 of 31
Factual Background


3.      The Assessee is a company incorporated under the laws of

Delaware in USA. The Assessee provides software solutions for network

publishing which includes web, print, video, wireless and broadband

applications. The Assessee has a wholly owned subsidiary in India,

namely, Adobe India. It is stated by the Assessee that Adobe India

provides software related Research and Development (R&D) services to

the Assessee and the Assessee does not have any business operations in

India. The R&D services rendered by Adobe India, are paid for by the

Assessee on cost plus basis in terms of an agreement entered into between

the Assessee and Adobe India. Whilst the Assessee claims that such

agreement is on principal to principal basis, the Revenue disputes the

same.


4.      The Assessee claims that during the Previous Years relevant to the

AYs in question, it was not assessable under the Act in respect of any of

its income other than interest on advance fees paid to Adobe India. And

since, Adobe India had withheld the applicable taxes (TDS) on such

interest, the Assessee was not obliged to file its return of income under

the Act by virtue of Section 115A(5) of the Act.




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                       Page 4 of 31
5.      Adobe India is assessed to tax in India in respect of its income. As

stated earlier, Adobe India is mainly engaged in the business of providing

software related R&D services to the Assessee.          It is stated by the

Assessee that R&D activities carried out by Adobe India are on

assignment basis and does not entail end to end software development.

Since Adobe India provides R&D services to its holding company, an

Associated Enterprise (AE), its transaction with the Assessee have been

subjected to examination by the Transfer Pricing Officer (TPO). It is

stated that for AYs 2004-05 and 2005-06, the AO and the TPO accepted

the fees paid by the Assessee on cost plus 15% basis as being on ALP and

Adobe India's assessment was made accordingly. The assessment orders

for AYs 2004-05 and 2005-06 have become final and are not subject

matter of any further proceedings. It is stated that in Adobe Indias

assessment for AY 2006-07, the TPO/AO did not accept the Transfer

Pricing Study submitted by the Assessee therein as he did not accept the

set of comparables used by the Adobe India to determine the ALP.

However, Adobe India succeeded in its appeal before the Income Tax

Appellate Tribunal and this Court is informed that the Revenue has

assailed the Tribunal's order in this Court which as yet is pending. The

Assessee further informs that for AY 2007-08, the Transfer Pricing Study

furnished by Adobe India was not accepted by the TPO, who sought to

W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 5 of 31
apply Profit Split Method (PSM) for determining the ALP instead of

Transactional Net Marginal Method (TNMM) used in the preceding

years. Adobe India successfully challenged the TPO's order for AY

2007-08 before the Dispute Resolution Panel (DRP) and the DRP has

held that ALP be determined by applying TNMM as in the preceding

years.


6.       The AO issued the impugned notices under Section 148 of the Act

on 30th March, 2011. In response to the aforesaid notice for AY 2004-05,

the Assessee sent a letter dated 9th May, 2011 stating that it did not

conduct any business activity in India and had not earned any taxable

income except the interest on advances received from Adobe India, tax on

which was duly withheld and deposited by Adobe India. The Assessee

also referred to Section 115A (5) of the Act to contend that by virtue of

the said provision, it was not liable to file its return of income under

Section 139(1) of the Act, for the relevant year. The Assessee also sought

reasons for reopening of the assessment for the AY's in question.

Thereafter, AO issued show cause notices dated 27th July, 2011 for AY

2004-05 and 1st August, 2011 for AYs 2005-06 and 2006-07 alleging

non-compliance of the impugned notices dated 30th March, 2011. The

Assessee responded to the show cause notice for AY 2004-05 on 9th



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                      Page 6 of 31
August, 2011 and to the show cause notices for AYs 2005-06 and 2006-

07 on 24th August, 2011, by reiterating its earlier stand that it had earned

only interest income from Adobe India in respect of which tax was

withheld by Adobe India in terms of Article 11 of the DTAA between

USA and India.


7.      Reasons recorded for initiation of reassessment proceedings were

furnished by the AO under cover of a letter on 17 th October, 2011. After

the receipt of aforesaid reasons, Assessee requested for inspection of

records in order to file objections against the reasons recorded.


8.      The Assessee filed its objections through a letter dated 23rd August,

2012 while reserving its right to make further objections on inspection of

the files.


9.      On 4th January, 2013, the AO issued notices under Section 142(1)

of the Act directing the Petitioner to submit the returns of income in

response to the impugned notices dated 30th March, 2011. The Assessee,

on 4th February, 2013, without prejudice to its rights and contentions,

filed the returns of income for AYs 2004-05, 2005-06 and 2006-07.


10.     Thereafter, on 22nd February, 2013, the Assessee filed additional

objections after inspecting the records. By an order dated 8th March,



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                            Page 7 of 31
2013, the AO disposed of the objections filed by the Assessee for the

relevant AYs.


11.     In the aforesaid backdrop, the limited controversy to be addressed

is whether the AO had any reason to believe that the Assessee's income

for the AYs in question had escaped assessment. Before proceeding to

address the issues involved, it would be necessary to refer to the reasons

recorded by the AO for forming the belief that the Assessee's income for

the relevant AYs had escaped assessment.

[ad}
Reasons to believe that income had escaped assessment.

12.     In the reasons recorded by the AO for issuance of the impugned

notices, the AO had recorded that: (a) Adobe India develops software for

the Assessee for which Adobe India has been compensated on a 'cost plus

profit basis'; (b) the ownership of the software developed by Adobe India

is the sole property of the Assessee and Adobe India does not retain any

intellectual property rights in respect of the software developed by it; (c)

the Assessee makes substantial profits by selling the software developed

in India abroad for which no taxes have been paid by the Assessee in

India; (d) Adobe India has been working wholly and exclusively for the

Assessee and does not develop software for any other concern; and (e) the

Assessee's transaction with Adobe India are not isolated transactions "but

W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 8 of 31
a continuous business connection as Adobe India is connected to the

Assessee through a network of lease lines and other technological

means".


13.     On the basis of the above, the AO concluded that activities carried

out by Adobe India were a part of the Assessees core business activities

and, consequently, Adobe India constituted the Assessee's PE under

Article 5(1) of the Indo-US Double Taxation Avoidance Agreement

(DTAA). He also observed that in terms of the agreement between Adobe

India and the Assessee, the Assessee was obliged to provide assistance,

specifications and supervision and was further entitled to audit the

facilities of Adobe India for maintenance of the requisite standards. This,

according to the AO, indicated that the Assessee had a Service PE in

India in terms of Article 5(2)(l) of the Indo-US DTAA. According to the

AO, Adobe India was also a dependent agent of the Assessee and thus,

constituted its PE in terms of Article 5(5) of the Indo-US DTAA.


14.     The AO reasoned that since the Assessee had a PE in India, a part

of the profit accruing to the Assessee which is attributable to the activities

in India was chargeable to tax under the Act.




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                          Page 9 of 31
15.     The AO further observed that the transaction between the Assessee

and Adobe India involved transfer of intangibles and multiple inter-

related transactions which could not be evaluated separately for the

purposes of determining ALP by any one transaction. The AO also

recorded that development and customisation of software was a highly

technical job and the same could not be restricted to computation on cost

plus basis. In his view, cost plus basis was not a suitable method for

intangibles like software services and the Profit Split Method was

applicable in terms of Rule 10B of the Income Tax Rules. Finally, the

AO took note of the global profits reported by the Assessee and held that

the same should be apportioned in the ratio of the R&D expenses incurred

by the Assessee. On the aforesaid basis, the AO computed Assessee's

taxable profits for AY 2006-07 as under:


         "From the above facts it's clear that the assessee has business
         connection as well as permanent establishment in India and
         its income has escaped assessment as per the provisions of
         Section 147 r.w.s. 148 of the Income-tax Act, 1961. The total
         value of the transactions is Rs1094766837/-. These are R&D
         expenses of the assessee's Co.
         As per global B/S of the assessee company the total R&D
         expenses are $365328000 and profit is $728434000 applying
         the same ratio the profit attributable to India R&D which is
         Rs.1094766837 come to Rs2080056990 which is more than
         Rs.1 lakh. Although the figures are for calendar year but
         same has been taken on pro-rata basis.



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                         Page 10 of 31
         From the above paras, it is clear that the income of the
         assessee escaping assessment is Rs2080056990/- which is
         more than Rs.1 lacs and therefore I have reason to believe
         that income of the assessee has escape assessment as per
         section 151 r.w.s. 148 of the Income-tax Act, 1961."


The taxable profits for AYs 2004-05 and 2005-06 were also computed in

a similar manner.


Reasoning and Conclusion


16.     It is apparent from the plain reading of the reasons recorded by the

AO that his belief that the income of the Assessee had escaped

assessment stems from his understanding that the activities pertaining to

R&D services rendered by Adobe India were conducted by the Assessee.

He has, therefore, concluded that the Assessee must surrender a part of

his income, which is attributable to those activities in India, to tax under

the Act. It is not disputed that Adobe India has been assessed to tax on the

very same activities priced on Arm's Length basis. In the circumstances,

the first and foremost question to be considered is whether such activities

of a subsidiary company could by itself provide a reason to believe that

any income relating thereto has escaped assessment in the hands of

foreign holding company.




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 11 of 31
17.     Chapter X of the Act contains special provisions relating to

avoidance of tax. Section 92 of the Act, which falls under Chapter X of

the Act, mandates that any income arising from international transactions

shall be computed having regard to the ALP. The purpose of enacting the

transfer pricing regulations is to ensure that income from transactions

between the related parties are not shifted out of India so as to escape or

mitigate the incidence of tax payable under the Act. Thus, the transfer

pricing regulations are to be read as providing the framework, to tax the

real income of an assessee derived from international transactions with a

related party; they cannot be read as provisions to impute any

hypothetical income in the hands of an assessee. Thus, the transfer

pricing scrutiny/adjustments in respect of the activities of Adobe India

must be read to have resulted in capturing the entire income from the said

activities in the net of tax.


18.     In Sony Ericsson Mobile Communications India Pvt. Ltd. and

Ors. v. Commissioner of Income Tax-III and Ors.: (2015) 374 ITR 118

(Del), a Division Bench of this Court explained the context of Chapter X

of the Act in the following words:-


          "77. As a concept and principle Chapter X does not
          artificially broaden, expand or deviate from the concept of
          "real income". "Real income", as held by the Supreme


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 12 of 31
          Court in Poona Electricity Supply Company Limited
          versus CIT, : [1965] 57 ITR 521 (SC), means profits
          arrived at on commercial principles, subject to the
          provisions of the Act. Profits and gains should be true and
          correct profits and gains, neither under nor over stated.
          Arm's length price seeks to correct distortion and shifting
          of profits to tax the actual income earned by a
          resident/domestic AE. The profit which would have
          accrued had arm's length conditions prevailed is brought
          to tax. Misreporting, if any, on account of non-arm's
          length conditions resulting in lower profits, is corrected."



19.     Services provided by Adobe India to the Assessee have been

remunerated by the Assessee on cost plus basis and the same has been

accepted in AYs 2004-05 and 2005-06. The method of determining the

ALP for the said transaction, that is, TNMM, has been accepted for AYs

2004-05, 2005-06, 2006-07; although for AY 2007-08, the TPO has

sought to use the PSM, the same was not upheld by the DRP. Thus,

undisputedly, the real income of Adobe India, which is related to the

activities carried out by Adobe India has been brought to tax in its hands.

And even if there is any dispute relating to the same, it is liable to be

resolved in proceedings relating to Adobe India.


20.     We may now refer to the provisions of Article 7 of the Indo-US

DTAA which read as under:-




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                         Page 13 of 31
        "ARTICLE 7
        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 establishment and other enterprises controlling,
        controlled by or subject to the same common control as that
        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


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                           Page 14 of 31
        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 a banking
        enterprises, 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 permanent
        establishment of goods or merchandise for the enterprise.
        5. For the purposes of this Convention, the profits 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



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                           Page 15 of 31
        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 property other than property described in
        paragraph 3(b) of Article 12 (Royalties and Fees for Included
        Services)."


21.     Paragraph 1 of Article 7 makes it amply clear that only so much of

the profits as are attributable to a PE or could be attributed by using the

principle of Force of Attraction would be taxable in the contracting state

of the PE. In other words, in addition to the business profits attributable

to a PE, profits attributable to sale of goods or merchandise which are

similar to those sold through the PE or other business activities which are

similar to those effected through the PE, can also be taxed in the state

where the PE is situated.


22.     Further, paragraph 2 of Article 7 of the Indo-US DTAA also

stipulates that profits attributable to a PE would be such profits which a

PE might be expected to make if it were a distinct and an independent

enterprise engaged in the same or similar activities and dealing wholly at

arm's length with the enterprise of which it is a PE.




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                       Page 16 of 31
23.     In view of the above, even if the subsidiary of a foreign company is

considered as its PE, only such income as is attributable in terms of

paragraphs 1 and 2 of Article 7 can be brought to tax. In the present case,

there is no dispute that Adobe India - which according to the AO is the

Assessee's PE - has been independently taxed on income from R&D

services and such tax has been computed on the basis that its dealings

with the Assessee are at arm's length ( that is, at ALP). Therefore, even if

Adobe India is considered to be the Assessee's PE, the entire income

which could be brought in the net of tax in the hands of the Assessee has

already been so taxed in the hands of Adobe India. There is no material

that would even remotely suggest that the Assessee has undertaken any

activity in India other than services which have already been subjected to

ALP scrutiny/adjustment in the hands of Adobe India. Thus, in our view,

even if the AO is correct in its assumption that Adobe India constituted

the Assessee's PE in terms of Article 5(1), 5(2)(l) or 5(5) of the Indo-US

DTAA, the facts in this case do not provide the AO any reason to believe

that any part of the Assessee's income had escaped assessment under the

Act.




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 17 of 31
24.     In the case of DIT (International Taxation) v. Morgan Stanley &

Company Inc.: (2007) 292 ITR 416 (SC), the Supreme Court had

explained the above in the following manner:-


          "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


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                           Page 18 of 31
          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)."


25.     We may also mention that according to the AO, the profits

attributable to the activities carried out by Adobe India are to be

ascertained by PSM as, according to him, the Cost Plus method used by

Adobe India for determining the ALP does not fairly capture the profits

which could legitimately be taxed under the Act. In our view, the

question as to which is the correct method of determining the ALP can

only be debated in proceedings relating to the assessment of Adobe India.

The fact that the AO has not succeeded in persuading the DRP to accept

his point of view, cannot possibly provide him a reason to now try and

assess profits calculated on PSM in the hands of the Assessee.


26.     In view of the aforesaid, the impugned notices and the proceedings

initiated by the AO are liable to be set aside.


27.     In view of our above conclusion, it is not necessary for us to

examine whether the Assessee had a PE in India in terms of Article 5(1),

5(2)(l) or Article 5(5) of the Indo-US DTAA. However for the sake of

completeness, we consider it appropriate to also examine the question



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                         Page 19 of 31
whether the AO's opinion that the Assessee has a PE in India is informed

by reason.


28.     A subsidiary company is an independent tax entity and is

separately taxed for its income in the country of its domicile. In the

present case, Adobe India is a separate assessee and is liable to pay tax on

its income. The fact that a holding company in another contracting state

exercises certain control and management over a subsidiary would not

render the subsidiary as a PE of the holding company. This is expressly

spelt out in paragraph 6 of Article 5 of the Indo-US DTAA, which reads

as under:-


         "(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."


29.     The aforesaid principle is also stated in Klaus Vogel on Double

Taxation Conventions, Third Edition in the following words:-


         "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


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                          Page 20 of 31
         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."


30.     Having stated the above, we must also clarify that the fact that a

subsidiary company is a separate tax entity does not mean that it could

never constitute a PE of its holding company. In certain circumstances,

where the specified parameters defining PE - in the present case Article 5

of the Indo-US DTAA - are met, a subsidiary would constitute a PE of its

holding company. However, in determining whether the requisite

parameters are met, it is necessary to bear in mind that a subsidiary is a

separate legal entity and its activities, the income from which are assessed

in its hands at arms length pricing, cannot be the sole basis for the

purposes of imputing the subsidiary to be a PE of its holding company.

This is so because, a subsidiary is liable to pay tax on its income and a

foreign holding company is liable to pay tax on its income and the same

set of activities cannot be construed as that of a holding company through

its PE and that of the subsidiary as its own activity resulting in income

from the same activities being taxed twice over; once in the hands of the

subsidiary and again in the hands of the holding company. In cases where

a subsidiary acts as an agent of its holding company, the income from the


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 21 of 31
activities conducted by the subsidiary for and on behalf of its principal

would be assessed in the hands of the principal - that is, the holding

company - and not in the hands of the subsidiary. The subsidiary would

only be liable to pay tax on the remuneration receivable as an agent and

such remuneration would clearly be deductable while computing the

income in the hands of the holding company.


31.     Keeping the aforesaid principles in mind, we may now examine

whether the AO had any reason to hold that the Assessee has a PE in

India in terms of Article 5(1), 5(2)(l) or Article 5(5) of the Indo-US

DTAA. Article 5 of the Indo-US DTAA which defines Permanent

Establishment reads as under:-


                                           "ARTICLE 5
                        PERMANENT ESTABLISHMENT
         1. For the purposes of this Convention, the term "permanent
         establishment" means a fixed place of business through
         which the business of an enterprise is 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 ;



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                       Page 22 of 31
                     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 a
                        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
                                           days within any twelve-month
                                           period ; or

                                  (ii)     the services are performed within
                                           that State for a related enterprise
                                           [within the meaning of paragraph
                                           1 of Article 9 (Associated
                                           Enterprises)].


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                                 Page 23 of 31
         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 place of business
                        solely for the purpose of advertising, for the
                        supply of information, for scientific research or
                        for other activities which have a 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, that enterprise shall be deemed to have a
         permanent establishment in the first-mentioned State, if:

                     a) he has and habitually exercises in the 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


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                            Page 24 of 31
                         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 on behalf of the
                        enterprise, and some additional activities
                        conducted in the 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 other 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 are not
         made under arm's length conditions, he shall not be
         considered an agent of independent status within the
         meaning of this paragraph.
         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."







W.P.(C) 2384/2013, 2385/2013 & 2390/2013                           Page 25 of 31
32.     Para (1) of Article 5 defines a PE to mean a fixed place of business

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

The term 'fixed place of business' includes premises, facilities, offices

which are used by an enterprise for carrying on its business. The fixed

place must be at the disposal of an enterprise through which it carries on

its business wholly or partly. Although, the word 'through' has been

interpreted liberally but the very least, it indicates that the particular

location should be at the disposal of an Assessee for it to carry on its

business through it. These attributes of a PE under Article 5(1) of the

Indo-US DTAA were elucidated by the Supreme Court in Morgan

Stanley (supra). In a recent decision, a Division Bench of this Court in

Director of Income Tax v. E-Funds IT Solution: [2014] 364 ITR 256

(Delhi) reiterated the above-stated attributes; after quoting from various

authors, this Court held that "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". In the

present case, there is no allegation that the Assessee has any Branch

Office or any other office or establishment through which it is carrying on

any business other than simply stating that Adobe India's constitutes the

Assessee's PE. There is no evidence that the Assessee has any right to use

the premises or any fixed place at its disposal. The AO has simply

W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 26 of 31
proceeded on the basis that the R&D services performed by Adobe India

are an integral part of the business of the Assessee and therefore, the

offices of Adobe India represent the Assessees fixed place of business.

Thus, clearly the right to use test or the disposal test is not satisfied for

holding that the Assessee has a PE in India in terms of Article 5(1) of the

Indo-US DTAA.


33.     In E-Funds IT Solution (supra), this Court had expressly negated

that an assignment or a sub-contract of any work to a subsidiary in India

could be a factor for determining the applicability of Article 5(1) of the

Indo-US DTAA. The Court had further expressly held that :


        "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 permanent establishment. 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 permanent establishment exists.
        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 permanent
        establishment."




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                         Page 27 of 31
34.     Thus, the AO's view that Adobe India constituted the Assessee's

PE in terms of paragraph 1 of Article 5 of the Indo-US DTAA is palpably

erroneous and not sustainable on the basis of the facts as recorded by him.


35.     We also find that there is no material to hold that the Assessee's

employees constitute a Service PE in terms of Article 5(2)(l) of the Indo-

US DTAA. The Assessee has denied that any of its employees has

rendered any service in India. There is no material available with the AO

that would contradict the same. The AO has concluded that the Assessee

has a PE in India in terms of Article 5(2)(l) of the Indo-US DTAA, only

on the basis that the Assessee has a right to audit Adobe India and that the

agreement between the Assessee and Adobe India entails that the

Assessee would provide specifications, assistance and supervision for the

R&D services procured by the Assessee. The said terms of the agreement

do not in any manner indicate that the Assessee has been providing

services in India. Clause 5.5 of the agreement referred to by the AO

indicates that the Assessee is authorized to audit the Indian subsidiary

(Adobe India), so as to ensure that Adobe India adheres to the standards

required by the Assessee. The same cannot possibly lead to the inference

that the Assessee has been rendering services to Adobe India. The

stipulation as to provide specification and further assistance is only for



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                        Page 28 of 31
the purpose of ensuring that the Assessee procures the service that it has

contracted for from Adobe India. Such clauses in the agreement cannot

lead to an inference that the Assessee has a PE in India for rendering

services, that is, a Service PE in terms of Article 5(2)(l) of the Indo-US

DTAA. This has also been authoritatively held by Supreme Court in

Morgan Stanley (supra).


36.     It is also noteworthy that the AO while computing the income that

is alleged to have escaped assessment has also not alluded or attributed

any income to the services alleged to have been rendered by the Assessee

to Adobe India. In terms of Article 7(1) of the Indo-US DTAA, only such

income as is attributable to the PE can be taxed in the State where the PE

is located.


37.     The AO's view that Adobe India constitutes the Assessee's PE

under Article 5(5) of the Indo-US DTAA is also wholly unsustainable.

Article 5(5) of the Indo-US DTAA provides for an exclusion to Article

5(4) of the Indo-US DTAA. In terms of Article 5(4), where a person acts

in a contracting state on behalf of an enterprise of the other contracting

state, the enterprise shall be deemed to have a Permanent Establishment

in the first mentioned state. In other words, a dependent agent of an

enterprise would constitute its PE. In the present case, there is no material


W.P.(C) 2384/2013, 2385/2013 & 2390/2013                         Page 29 of 31
to form a view that Adobe India acts as an agent for and on behalf of the

Assessee. Further, there is no allegation that any of the other conditions

specified under clauses (a), (b) or (c) of paragraph 4 of Article 5 of the

Indo-US DTAA are applicable to Adobe India. One of the necessary

conditions for holding that an agent constitutes a PE of an enterprise is

that the agent must have an authority to conclude contracts or should have

been found to be habitually entering into or concluding contracts on

behalf of the enterprise. In the present case, there is no allegation that

Adobe India is authorised to conclude contracts on behalf of the Assessee

or has been habitually doing so.


38.     Insofar as Article 5(5) of the Indo-US DTAA is concerned, the

same postulates that any business carried through a broker, commission

agent or any other agent of an independent status acting in its normal

course would not constitute a PE of an enterprise. The exception to this

being that if activities of such agent are devoted wholly or almost wholly

on behalf of the enterprise and the transactions between enterprise and the

agent are not made under arm's length conditions. In such case, the agent

would not be considered as an agent of independent status. In the present

case, apart from the AO stating so, there is no reason to assume that

Adobe India is an agent of the Assessee; there is neither any agreement



W.P.(C) 2384/2013, 2385/2013 & 2390/2013                       Page 30 of 31
which states so nor any material which indicates that Adobe India acts as

such. More importantly, it is not disputed that Adobe India is assessed on

its income determined at ALP and, therefore, there is no occasion for the

AO to assume that Adobe India constitutes the Assessee's PE under

Article 5(5) of the Indo-US DTAA.


39.     In view of the aforesaid, the impugned notices and impugned

orders are set aside. The petitions are allowed and the pending

applications are disposed of. However, in the given circumstances, parties

are left to bear their own costs.




                                                   VIBHU BAKHRU, J




                                                   S.MURALIDHAR, J
MAY 16, 2016
RK




W.P.(C) 2384/2013, 2385/2013 & 2390/2013                      Page 31 of 31

 
 
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