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.
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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
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