India: Permanent Establishment Is A Separate Entity For The Purpose Of Transfer Pricing ITAT Hyd
July, 30th 2014
The Income Tax Appellate Tribunal (ITAT), Hyderabad Bench has recently held in the case of DCIT, Hyderabad vs. M/s IJM (India) Infrastructure Ltd, Hyderabad (2014-TII-114-ITAT-HYD-TP) that a permanent establishment (PE) of a foreign company has to be treated as separate entity for the purpose of transfer pricing and that any transaction entered by an Indian resident i.e. a company with such a PE should not be treated as an international transaction. Which means, such a transaction should be treated as a domestic transaction and not as an international transaction under section 92B of the Income-tax Act, 1961 (the Act). One of the main reasons for the ITAT to arrive at such a conclusion is for the fact that there is no Indian base erosion in such a transaction. In the sense, the transaction between the parties is tax neutral and even if the payments between such a PE and the Indian company is not at arm's length price (ALP), it will still not erode tax base in India as it gets neutralized in one taxpayer's hand or the other. The ITAT seems to have given little importance to the fact that a PE is subject to tax at 40% (base rate) and whereas a domestic company is taxed only at 30% (base rate).
The above holding of the ITAT also finds support from the definition of 'enterprise' in section 92F of the Act which includes a PE. Which simply means, a PE can be a standalone enterprise/ separate entity.
However, by this ruling one aspect seems to have become a dead letter law. In section 92B(1) of the Act, international transaction means a transaction between two or more associated enterprises (AE), either or both of whom are non-residents. The analysis of which is dealt in detail in the concluding remarks of this KS Alert with examples. Meanwhile, the brief facts of the case and the arguments of the parties are as under.
Facts of the case
The taxpayer, IJM (India) Infrastructure Ltd, Hyderabad (IJM India) is engaged in the business of works contract, construction and maintenance of roads, bridges, townships, buildings, etc. and is a 99% subsidiary of IJMII Mauritius (IJM Mauritius). IJM Mauritius is a wholly owned subsidiary of IJM Corporation Berhad, Malaysia (IJM Malaysia). IJM Malaysia has an MCD Project Office (PO) in New Delhi, India. This PO is admittedly a PE of IJM Malaysia in India. The various construction projects that were secured by IJM Malaysia and the PE in India were subcontracted to the taxpayer by way of back to back arrangement with a thin margin left with IJM Malaysia and PE in India.
The taxpayer also had various joint ventures (JV) with IJM Malaysia and all the orders that were secured by the JV, which was situated in India, were subcontracted to the taxpayer. Further, IJM Malaysia had separate JVs with many Indian entities and the works secured by such JVs were also subcontracted to the taxpayer. Briefly, the taxpayer had acted as a subcontractor for the PE, the JV with IJM Malaysia and JVs of IJM Malaysia. All the above JVs were residents in India and were filing their tax returns in India including the PE.
The taxpayer filed tax return for the Assessment Year (AY) 2009-10 declaring NIL income. However, the assessing officer (AO) referred the matter to the transfer pricing officer (TPO) under section 92CA of the Act for scrutiny. The TPO made upward adjustment of INR 624.53 million (approx) to the income of the taxpayer and reduced its returned loss to INR 154.54 million (approx). The adjustment by the TPO was based on the international transactions entered by the taxpayer with the above said PE, JV with IJM Malaysia and JVs of IJM Malaysia.
Based on the above observations, the AO passed draft assessment order as per section 144C of the Act. The AO reiterated in its draft assessment order that the transactions between the taxpayer and the PE and JVs were international transactions and therefore, they have to be at arm's length and subject to transfer pricing regulations.
Against the draft assessment order, the taxpayer appealed to the Dispute Resolution Panel (DRP) stating that the transactions between the taxpayer and the PE and JVs were not international transactions as per section 92B of the Act (which defines international transaction) as the said section states that there has to be either two or at least one non-resident (NR) to be treated as an international transaction. Since the PE and JVs were all residents of India, there is no international transaction but only a domestic transaction. Further, the taxpayer argued that there was no transfer of goods or services between the taxpayer and the PE and JVs. The direct services rendered by the taxpayer to the PE and JVs are not covered under section 92B(2) of the Act which deals with international transaction between AEs, since at least one NR is required to attract transfer pricing regulations. The taxpayer submitted that such arguments were already accepted by the same ITAT in taxpayer's own case for the AY 2008-09 and therefore, the DRP needs to follow the same for the current AY as well.
The DRP accepted the arguments of the taxpayer and since the same ITAT has already held that the transaction between the taxpayer and the PE does not fall within the definition of international transaction which requires at least one NR, the DRP allowed the taxpayer's claim.
Against the order of the DRP, the revenue preferred the current appeal to the ITAT.
Arguments of the Revenue
The revenue argued that the transactions between the taxpayer and the PE and JVs are international transactions since the taxpayer himself has admitted to it while filing the report in Form 3CEB. The revenue argued that the PE should not be treated as a separate enterprise but as an extension of IJM Malaysia and therefore, the transactions were between the taxpayer and an NR AE which fulfils the requirement under section 92B.
Arguments of the Taxpayer
The taxpayer reiterated the arguments made before the DRP to the ITAT.
Ruling by the ITAT
The ITAT concurred with the DRP and accepted the arguments of the taxpayer. The ITAT while following its own earlier order passed in taxpayer's own case, held as follows:
PE should be treated as a resident in India
Article 24 of the India-Malaysia tax treaty contains non-discrimination provision which compels the contracting states not to discriminate between its own nationals and foreign nationals. The word 'national' includes both natural and artificial persons. Further, since the PE is controlled and managed from India and pays tax on the income attributed to it in India, it has to be treated as a resident of India. Therefore, the PE has to be treated as a separate enterprise.
Joint Ventures formed by the taxpayer were resident of India
Since all the decisions of the JVs were taken in India and since the JV agreements have been executed in India, the JVs are residents of India. Even otherwise, as per paragraph 3 of the Article 4 of the India-Malaysia tax treaty which deals with Residence, an Association of Persons (AOP) shall be deemed to be resident of the contracting state in which its management and control is situated. Since all the decisions are taken in India, the JVs are Indian residents.
Transfer Pricing regulations are not applicable
The said transactions are between two resident parties and therefore, section 92B which requires at least one NR is not fulfilled and therefore, no transfer pricing regulation is applicable. Further, since the transactions are between resident parties, there is no base erosion in India since the PE and the JVs are subject to tax in India.
The ITAT concluded that since the transactions are between only resident parties and since there cannot be any evasion of Indian taxes, transfer pricing provisions are not applicable.
The interpretation of the ITAT is welcome i.e. a PE is a tax resident in India since it is separately liable to tax in India. The holding that there is no base erosion and there is tax neutrality on the transactions between the taxpayer and the PE and JVs finds merit (barring the difference in tax rates as mentioned in the first paragraph).
The holding of the ITAT that a PE is a separate entity also finds support from section 92F of the Act which defines an 'enterprise'. The opening words of clause (iii) of section 92F which defines 'enterprise' includes a PE of a person, which means that a PE has a separate enterprise status. Section 92B defines international transaction which means a transaction between two AEs either or both of whom are NRs. Now, if a PE has a separate enterprise status and if it is situated in India, then any transactions with it could be treated as domestic transactions.
However, the above judgment and the definition of the term 'enterprise' only seem to be conflicting with the intent behind section 92B. As per section 92B, even a transaction between two NRs can be subject to transfer pricing in India. This is because section 92B contemplates a situation where in a PE of a foreign company situated in India transacts with another foreign company, then such transactions will be treated as international transaction and subject to Indian transfer pricing even though only two NRs are involved (a PE is treated as a foreign company).
Another situation is where two PEs (situated in India) of two foreign companies (having a common foreign parent) transact with each other in India then section 92B will be triggered as the two PEs are treated as extension of respective foreign companies and are therefore, NRs. Now by this judgment, the above two scenarios become non-est i.e. since a PE itself is treated as an Indian resident, there cannot be two NRs.
To conclude, it appears that the ITAT has given importance to the fact that for it to be an 'international transaction' it necessarily has to be a 'cross border transaction'. On the converse, every 'cross border transaction' will necessarily be an 'international transaction'! To give an example of these two scenarios, the current case law is not an international transaction as per the ITAT because it has no cross border transaction. On the second scenario, even if one Indian company transacts with a PE (situated offshore) of another Indian AE, then it will be treated as an international transaction because it involves cross border transaction and the fact that it is only between two Indian entities (a PE being a part of the company itself) will be ignored.