Director Of Income Tax v. M/S E Funds It Solution

* IN THE HIGH COURT OF DELHI AT NEW DELHI + INCOME TAX APPEAL NO. 735/2011 % Reserved on: 29[th] October, 2013 Date of Decision: 5[th] February, 2014 DIRECTOR OF INCOME TAX ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus M/S E FUNDS IT SOLUTION ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NOS. 736/2011 & 737/2011 DIT-1 INTERNATIONAL TAXATION ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus M/S E FUNDS CROPORATION ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NO. 738/2011 DIT-1 INTERNATIONAL TAXATION ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus M/S E FUNDS IT SOLUTION INC. ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NOS. 739/2011 & 740/2011 ITA No. 735/2011+connected appeals Page 1 of 102 DIRECTOR OF INCOME TAX ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus M/S E FUNDS CORPORATION ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NO. 802/2011 DIRECTOR OF INCOME TAX ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus M/S E FUNDS IT SOLUTION INC. ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NO. 845/2011 DIRECTOR OF INCOME TAX ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus M/S E FUNDS CORPORATION INC ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NO. 912/2011 E FUNDS CORPORATION ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus ITA No. 735/2011+connected appeals Page 2 of 102 DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NO. 913/2011 E FUNDS CORPORATION ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NOS. 914/2011& 915/2011 E FUNDS CORPORATION ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NO. 916/2011 E FUNDS IT SOLUTIONS GROUP INC ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. ITA No. 735/2011+connected appeals Page 3 of 102 INCOME TAX APPEAL NO. 917/2011 E FUNDS CORPORATION ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus Versus ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NO. 916/2011 E FUNDS IT SOLUTIONS GROUP INC ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. ITA No. 735/2011+connected appeals Page 3 of 102 INCOME TAX APPEAL NO. 917/2011 E FUNDS CORPORATION ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NOS. 918/2011,919/2011 & 920/2011 E FUNDS IT SOLUTIONS GROUP INC ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus ASSISTANT DIRECTOR OF INCOME TAX ..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NOS. 1002/2011 DIRECTOR OF INCOME TAX ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus E FUNDS IT SOLUTION INC ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NOS. 1200/2011 & 1201/2011 E FUNDS IT SOLUTION GROUP INC ..... Appellant ITA No. 735/2011+connected appeals Page 4 of 102 Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus ASSISTANT DIRECTOR OF INCOMNE TAX..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NOS. 1202/2011 & 1203/2011 E FUNDS CORPORATION ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. Versus ASSISTANT DIRECTOR OF INCOMNE TAX..... Respondent Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. INCOME TAX APPEAL NOS. 1217/2011 & 1218/2011 DIT-1 INTERNATIONAL TAXATION ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. Versus M/S E FUNDS IT SOLUTION INC ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NOS. 1219/2011 & 1221/2011 DIT-1 INTERNATIONAL TAXATION ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. ITA No. 735/2011+connected appeals Page 5 of 102 Versus M/S E FUNDS CORPORATION ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. CORAM: HON'BLE MR. JUSTICE SANJIV KHANNA HON'BLE MR. JUSTICE SANJEEV SACHDEVA SANJIV KHANNA, J.: Versus M/S E FUNDS IT SOLUTION INC ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. INCOME TAX APPEAL NOS. 1219/2011 & 1221/2011 DIT-1 INTERNATIONAL TAXATION ..... Appellant Through Mr. Sanjeev Sabharwal & Mr. N.P. Sahni, Sr. Standing Counsel. ITA No. 735/2011+connected appeals Page 5 of 102 Versus M/S E FUNDS CORPORATION ..... Respondent Through Mr. S. Ganesh, Sr. Advocate with Mr. Anand Sukumar, Advocate. CORAM: HON'BLE MR. JUSTICE SANJIV KHANNA HON'BLE MR. JUSTICE SANJEEV SACHDEVA SANJIV KHANNA, J.: This common judgment will dispose of these two sets of cross-appeals by the Director of Income Tax, International Taxation and e-Fund Corporation, USA (e-Fund Corp., for short) relating to Assessment Years 2000-01, 2001-02, 2002-03, 2004-05, 2005-06, 2006-07 and 2007-08 and e-Fund IT Solutions Group Inc., USA (e-Fund Inc., for short) relating to Assessment Years 2000-01, 2001-02, 2002-03, 2005-06, 2006-07 and 2007-08. The e-Fund Corp. and e-Fund Inc., when referred together have been described as the ‗assessee‘ and the Director of Income Tax, International Taxation has been referred to as the ‗Revenue‘. The cross-appeals arise out of two common orders passed by the Income Tax Appellate Tribunal (tribunal, for short). The first order dated 30[th]September, 2010 relates to all assessment years, except assessment ITA No. 735/2011+connected appeals Page 6 of 102 years 2006-07 and 2007-08, which are subject matter of the second order of the tribunal dated 15[th] March, 2011. 2. The assessee are primarily aggrieved by the finding of the tribunal that they have Permanent Establishment (PE, for short) in India. They are also aggrieved with the initiation of the assessment proceedings under Section 147 read with Section 148 of the Income Tax Act, 1961 (Act, for short), whereas the Revenue is aggrieved by the finding of the tribunal relating to computation or attribution of the income earned by the assessee through the PE in India. 3. By order dated 27[th] September, 2011, the following substantial common questions of law were framed in the appeals Nos. 912/2011, 913/2011, 914/2011, 915/2011, 916/2011, 917/2011, 918/2011, 919/2011 and 920/2011 relating to assessment years 2000-01, 2001-02, 2002-03, 2004-05 and 2005-06 filed by the assessee:- ―1. Whether, on the facts and circumstances of the case and in law, the Assessing Officer was justified in reopening the assessment under Section 147/148 of the Income-Tax Act? 2. Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that Appellant has a business connection in India under Section 9(1) of the Act? 3. Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that the Appellant has a permanent establishment in India under Articles 5(1), 5(2) (1) and 5(4) of the India-US DTAA? ITA No. 735/2011+connected appeals Page 7 of 102 4. Whether on the facts and in the circumstances of the case, and in law, the Tribunal was justified in holding that appellant is liable to interest under Section 234A and 234B of the Act?‖ 4. By subsequent order dated 2[nd] March, 2012, two more questions of law being question Nos. 5 and 6 were framed and read as under:- ―5. Whether any income of eFunds International India Pvt. Ltd. Can be attributed and assessed in the hands of the appellant? 6. In case question no. (5) is answered against the appellant, whether the Tribunal was justified and correct in adopting the formula mentioned in the order and not accepting the stand of the assessee?‖ ITA No. 735/2011+connected appeals Page 7 of 102 4. Whether on the facts and in the circumstances of the case, and in law, the Tribunal was justified in holding that appellant is liable to interest under Section 234A and 234B of the Act?‖ 4. By subsequent order dated 2[nd] March, 2012, two more questions of law being question Nos. 5 and 6 were framed and read as under:- ―5. Whether any income of eFunds International India Pvt. Ltd. Can be attributed and assessed in the hands of the appellant? 6. In case question no. (5) is answered against the appellant, whether the Tribunal was justified and correct in adopting the formula mentioned in the order and not accepting the stand of the assessee?‖ 4A. By order dated 17[th] November, 2011, the following substantial common questions of law were framed in the appeals ITA Nos. 1200/2011, 1201/2011, 1202/2011 and 1203/2011 relating to assessment years 2006-07 and 2007-08 filed by the assessee:- ―1. Whether the tribunal is correct in holding that the appellant has business connection in India under Section 9(1)(i) of the IT Act? 2. Whether the tribunal was correct in holding that the appellant has a permanent establishment in India under Arts 5(1), 5(2) (1) and 5(4) of the India-US DTAA? 3. Whether any income of e-funds international India pvt ltd can be attributed and assessed in the hands of the appellant? 4. In case Ques 3. Is answered against the appellant whether the tribunal was justified and correct in adopting the formula mentioned in the order and not accepting the stand of the assessee?‖ ITA No. 735/2011+connected appeals Page 8 of 102 In ITA Nos. 1201/2011 and 1203/2011 relating to assessment year 2006-07 the following additional substantial questions relating to initiation of assessment proceedings under section 147/148 of the Act, was raised:- ―Whether the action of the Assessing officer in reopening the assessment under Section 147/148 of the IT Act is correct?‖ 5. The substantial questions of law framed on the appeals being ITA Nos. 735/2011, 736/2011, 737/2011, 738/2011, 739/2011, 740/2011, 802/2011, 845/2011 and 1002/2011 filed by the Revenue vide order dated 27[th] September, 2011 read as under:- ―1. Whether on the facts and circumstances of the case, the Income Tax Appellate Tribunal has erred in law I not appreciating that the method adopted by the AO for attributing the profit to the PE of the assessee is based on the lines of MAP proceedings based on A.Y. 2003-04? 2. Whether on the facts and circumstances of the case, the order of the ITAT is not perverse?‖ 5A. In ITA Nos. 1217/2011, 1218/2011, 1219/2011 and 1221/2011 for Assessment Years 2006-07 and 2007-08 filed by the Revenue, the following substantial questions of law were framed vide order dated 21[st] November, 2011:- ―(1) Whether the Income Tax Appellate Tribunal has correctly rejected the computation of profit attributed to the Permanent Establishment on the lines of the MAP proceedings?‖correctly rejected the computation of profit attributed to the Permanent Establishment on the lines of the MAP proceedings?‖ (2) Whether the formula prescribed by Income Tax Appellate Tribunal for computation of profit attributable to a Permanent Establishment is correct and as per law? Appellate Tribunal for computation of profit attributable to a Permanent Establishment is correct and as per law? ITA No. 735/2011+connected appeals Page 9 of 102 (3) Whether the order of the Income Tax Appellate Tribunal is perverse?‖ 21[st] November, 2011:- ―(1) Whether the Income Tax Appellate Tribunal has correctly rejected the computation of profit attributed to the Permanent Establishment on the lines of the MAP proceedings?‖correctly rejected the computation of profit attributed to the Permanent Establishment on the lines of the MAP proceedings?‖ (2) Whether the formula prescribed by Income Tax Appellate Tribunal for computation of profit attributable to a Permanent Establishment is correct and as per law? Appellate Tribunal for computation of profit attributable to a Permanent Establishment is correct and as per law? ITA No. 735/2011+connected appeals Page 9 of 102 (3) Whether the order of the Income Tax Appellate Tribunal is perverse?‖ 6. Undisputed facts in brief may be first noticed. The assessees are companies incorporated in United States of America (USA, for short) and were residents of the said country. They were assessed and have paid taxes on their global income in USA. e-Fund Corp. was the holding company having almost 100% shares in IDLX Corporation, another company incorporated in USA. IDLX Corporation held almost 100% shares in IDLX International BV, incorporated in Netherlands and later in turn held almost 100% shares in IDLX Holding BV, which was a subsidiary again incorporated in Netherlands. IDLX Holding BV was almost a 100% shareholder of e-Funds International India Private Limited, a company incorporated and resident of India (e-Fund International India Private Limited has been described as ‗e-Fund India‘). IDLX International BV was also the parent/holding company having almost 100% shares in e-Fund Inc., which as noticed above, was a company incorporated in USA. 7. Both e-Fund Inc. and e-Fund Corp. have entered into international transactions with e-Fund India. The details of these transactions have to be examined in depth and have to be referred below. e-Fund India being a domestic company and resident in India ITA No. 735/2011+connected appeals Page 10 of 102 was taxed on the income earned in India as well as its global income in accordance with the provisions of the Act. The international transactions between the assessees and e-Fund India and the income of e-Fund India, it is accepted, were made subject matter of ―arms length pricing‖ adjudication by the Transfer Pricing Officer (TPO, for short) and the Assessing Officer (AO, for short) in the returns of income filed by e-Fund India. We are not primarily concerned with the merits of the computation of income declared and assessed in the hands of e-Fund India in the present appeals, though the factum that e-Fund India was assessed to tax on its global income as per law or on ―arms length pricing‖ in relation to associated transactions and the basis of the said computation of income earned by e-Fund India, as noticed below, is a relevant and an important fact. Revenue has not disputed the said legal position. It is the contention of the Revenue that income of the two assessees were attributable to India because the two assessees had PE in India and should be taxed in India, irrespective of whether the said assessees had paid taxes in USA. Income earned and taxed in the hands of e-Fund India was different from the income attributable to the two assesses. Thus the balance or differential amount, i.e., income attributable to the two assesses, which was not included in income ITA No. 735/2011+connected appeals Page 11 of 102 earned and taxed in the hands of e-Fund India, should be taxed in India. ITA No. 735/2011+connected appeals Page 11 of 102 earned and taxed in the hands of e-Fund India, should be taxed in India. 8. As a principle what is stated and submitted by the Revenue cannot be contested and in fact not contested by the assessees as it is a principle applicable to international taxation. A foreign or a non-resident company can be taxed in the country where it has a subsidiary, which is also a PE on the income attributable to the said PE, even if the subsidiary (in the present case of e-Fund India) is being taxed in the said country. The principle being that subsidiary being an independent and a distinct entity is taxed for its income, whereas the foreign entity, i.e., holding company is taxed for the income earned by the said independent entity attributable to the PE in the country where subsidiary is situated. The income of the subsidiary is not taxed in the hands of the non-resident principal and vice-versa. Thus, there is no double taxation in the hands of the holding company as income of the subsidiary is not taxed as income of foreign holding assessee. The principle is that a subsidiary constitutes an independent legal entity for the purpose of taxation. 9. Before we examine whether e-Fund India and its activities constitute PE of the foreign assessees as under the applicable Double Taxation Avoidance Agreement between India and USA, (The ITA No. 735/2011+connected appeals Page 12 of 102 agreement for the sake of convenience is being referred to as DTAA), it would be appropriate, at the outset, dispel any doubt or contention that establishing a subsidiary in the other treaty country would result in creating or establishing a PE of a foreign holding company in the said third country. Again to be fair to the Revenue, no such contention has been raised and the said legal position is clear and luminescent from paragraph 6 to Article 5 of the DTAA. The said paragraph reads:- ―6. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.‖ 10. The aforesaid paragraph in categorical terms states that a holding or a subsidiary company by themselves would not become PE of each other. The words used in the said paragraph are equally important because the term ―holding‖ or ―parent company‖ or a ―subsidiary company‖ is not used. The said paragraph uses the expression ―controls or is controlled by a company‖, which is resident of the other contracting State. Use of the word ―controls‖ or ―controlled‖ is significant and defines the scope and ambit of the said clause. Paragraph 6 states that the company, which controls or is controlled and carries on business in the other State, would by itself not ITA No. 735/2011+connected appeals Page 13 of 102 10. The aforesaid paragraph in categorical terms states that a holding or a subsidiary company by themselves would not become PE of each other. The words used in the said paragraph are equally important because the term ―holding‖ or ―parent company‖ or a ―subsidiary company‖ is not used. The said paragraph uses the expression ―controls or is controlled by a company‖, which is resident of the other contracting State. Use of the word ―controls‖ or ―controlled‖ is significant and defines the scope and ambit of the said clause. Paragraph 6 states that the company, which controls or is controlled and carries on business in the other State, would by itself not ITA No. 735/2011+connected appeals Page 13 of 102 constitute PE of the other company. Therefore, even carrying on business in the other country by either the ―controlled company‖ or the ―controlling company‖, but and though the other company would not make them, i.e. the two companies, a PE of each other. However, this does not mean that a subsidiary can never be a PE of the holding company, though there is opinion that the holding company or the controlling company possibly may not be a PE of a subsidiary (the later question is not subject matter of the present decision and we express no opinion on the said question though it may be a relevant aspect, which the tax adjudicators, policy makers and the legal draftsmen in India and abroad may have to deal with). Indeed if this principle is not applicable it could be argued that the Indian subsidiary, i.e., eFund India‘s income could be taxed in the country from where it is controlled or managed. A subsidiary can become a PE of the holding/controlling company or the related company, if it satisfies the postulates and requirements of other paragraphs of Article 5, notwithstanding and negating the protection provided under paragraph 6 of Article 5, which recognizes legal independence of the two entities for tax purposes. This legal principle that the holding or contracting company and the subsidiary or the controlled company are two separate and independent tax entities and must be so treated permeates ITA No. 735/2011+connected appeals Page 14 of 102 and pervades but will give way to the exceptions carved out and stated in the DTAA. The legal principle is simple, a subsidiary being a resident of the State in which it is incorporated and functioning is taxed for its income. Subsidiary‘s income is separately allocated and brought to tax in the country where it is situated or is a resident of. This clearly distinguishes a subsidiary form a foreign assessee, which is directly carrying on business and has residence in another country through their own branches/offices, personnel, etc. 11. Klaus Vogel on Double Taxation Conventions, Third Edition, states the following principle:- ―40. [Principle] It is generally accepted that the existence of a subsidiary company does not, of itself, constitute that subsidiary company a permanent establishment of its parent company. This follows from the principle that, for the purpose of taxation, such a subsidiary company constitutes an independent legal entity. Even the fact that the trade or business carried on by the subsidiary company is managed by the parent company does not constitute the subsidiary company a permanent establishment of the parent company.‖ 12. Similarly, in Arvid A. Skaar in Permanent Establishment, Erosion of Tax Treaty Principle, Second Indian, Reprint, 2008 has succinctly explained the legal position at page 540 paragraph 36.2.1 as under:- ―The treaty-based protection of related companies recognizes the legal independence of related companies for tax purposes as a material reality until the opposite is 36.2.3 as :- ―36.2.3 POLICY CONSIDERATIONS 12. Similarly, in Arvid A. Skaar in Permanent Establishment, Erosion of Tax Treaty Principle, Second Indian, Reprint, 2008 has succinctly explained the legal position at page 540 paragraph 36.2.1 as under:- ―The treaty-based protection of related companies recognizes the legal independence of related companies for tax purposes as a material reality until the opposite is 36.2.3 as :- ―36.2.3 POLICY CONSIDERATIONS A neutral tax system would allow a subsidiary PE to be constituted in all cases where the same conclusion would be reached for unrelated companies. This solution is expressly stated for a subsidiary PE under the agency clause. Consequently, the position of some older pre-OECD authors, that a subsidiary can never constitute a PE for the parent, has not been sustained. The conventional position of the OECD-based tax treaty doctrine is that a subsidiary PE can only be based on the agency clause. However, the tax treaties aim at allowing the source state to tax business profits with a certain economic allegiance to the country expressed through the enterprise‘s PE. This intention must also apply when the parent company‘s business income is earned by the intermediation of a subsidiary. Thus, from a de lege ferenda point of view, PE taxation of the parent company is justified in cases where residence state taxation of the subsidiary does not adequately attribute taxing jurisdiction to the source state. The commentaries to the OECD model treaty do not de lege lata give conclusive reasons for the conventional wisdom with regard to this question.‖ A part of the above observations are in the nature of justification of right of taxation in source State and relate to the domain of PE principle and inter-state neutrality as a theory. Issue of source State in the present factual matrix has been touched below. 14. The aforesaid principle is no longer res integra and has been lucidly elucidated by the Supreme Court in DIT versus Morgan ITA No. 735/2011+connected appeals Page 16 of 102 words:- A part of the above observations are in the nature of justification of right of taxation in source State and relate to the domain of PE principle and inter-state neutrality as a theory. Issue of source State in the present factual matrix has been touched below. 14. The aforesaid principle is no longer res integra and has been lucidly elucidated by the Supreme Court in DIT versus Morgan ITA No. 735/2011+connected appeals Page 16 of 102 words:- ―32. The object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. Under Article 7(2) not all profits of MSCO would be taxable in India but only those which have economic nexus with PE in India. A foreign enterprise is liable to be taxed in India on so much of its business profit as is attributable to the PE in India. The quantum of taxable income is to be determined in accordance with the provisions of I.T. Act. All provisions of I.T. Act are applicable, including provisions relating to depreciation, investment losses, deductible expenses, carry-forward and set-off losses etc. However, deviations are made by DTAA in cases of royalty, interest etc. Such deviations are also made under the I.T. Act (for example: Sections 44BB, 44BBA etc.). Under the impugned ruling delivered by the AAR, remuneration to MSAS was justified by a transfer pricing analysis and, therefore, no further income could be attributed to the PE (MSAS). In other words, the said ruling equates an arm's length analysis (ALA) with attribution of profits. It holds that once a transfer pricing analysis is undertaken; there is no further need to attribute profits to a PE. The impugned ruling is correct in principle insofar as an associated enterprise, that also constitutes a PE, has been remunerated on an arm's length basis taking into account all the risk-taking functions of the enterprise. In such cases nothing further would be left to be attributed to the PE. The situation would be different if transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise. In such a situation, there would be a need to attribute profits to the PE for those functions/risks that have not been considered. Therefore, in each case the data placed by the taxpayer has to be examined as to whether the transfer pricing analysis placed by the taxpayer is exhaustive of attribution of profits and that would depend on the functional and factual analysis to be undertaken in each case. Lastly, it may be added that taxing corporate on the basis of the concept of Economic Nexus is an important feature of Attributable Profits ‖(profits attributable to the PE). (Emphasis supplied) ITA No. 735/2011+connected appeals Page 17 of 102 15. ECONOMIC AND SOCIAL COUNCIL in their report dated 17.10.2008 have stated;- “38.1 In relation to the test of legal dependence, it should be noted that the control which a parent company exercises over its subsidiary in its capacity as shareholder is not relevant in a consideration of the dependence or otherwise of the subsidiary in its capacity as an agent for the parent. This is consistent with the rule in paragraph 7 of Article 5. But, as paragraph 41 of the Commentary indicates, the subsidiary may be considered a dependent agent of its parent by application of the same tests which are applied to unrelated companies.‖ 16. It has been observed below, that subsidiary can constitute PE, other than dependent agent PE. A write up in Bulletin for International Taxation, February 2011 titled ―The Subsidiary as a Permanent Establishment‖ has summarized the true and correct legal position in the following words;- 16. It has been observed below, that subsidiary can constitute PE, other than dependent agent PE. A write up in Bulletin for International Taxation, February 2011 titled ―The Subsidiary as a Permanent Establishment‖ has summarized the true and correct legal position in the following words;- ―A PE is, however, not always easy to identify. This is particularly true where a PE is hidden behind a dependent operating company, i.e. if an operating company in addition to its own business also carries on another company‘s business as a PE of the latter. In this regard, the 2010 OECD Model Tax Convention (the ―OECD Model‖) states in Art. 5(7) that: [t]he fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other state (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other (emphasis added) ITA No. 735/2011+connected appeals Page 18 of 102 This follows from the principle that, for the purpose of taxation, such a subsidiary constitutes an independent legal entity.7 Accordingly, both companies are subject to unlimited tax liability in the state in which they are resident or where their place of management is located. However, by using the wording ―not of itself ‖, the provision clarifies that a parent company (parent) can have an (agent) PE in its subsidiary‘s state of residence if the general requirements for a PE set out inArt. 5(1) to (5) of the OECD Model are met. Accordingly, any space or premises belonging to the subsidiary that is at the disposal of the parent (the ―right-to-use test‖) and that constitutes a fixed place of business (the ―location test‖ and the ―duration test‖) through which the parent carries on its own business (the ―business activity test‖), gives rise to a PE of the parent under Art. 5(1), subject to Art. 5(3) and (4), of the OECD Model. In addition, under Art. 5(5) of the OECD Model, a subsidiary constitutes an agency PE of its parent if the subsidiary has the authority to conclude contracts in the name of its parent and habitually exercises this authority, unless these activities are limited to those referred to in Art. 5(4) or unless the subsidiary does not act in the ordinary course of its business as an independent agent within the meaning of ‖Art. 5(6)…….. Subsidiary as a Permanent Establishment 17. This brings us to paragraphs 1 to 5 of Article 5 of the DTAA and the exceptions to paragraph 6 to Article 5. Article 7, which relates to business profit, may be also of some relevance. Paragraphs 1 to 5 of Article 5 and the entire Article 7 are being reproduced below:- ―Article5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of ITA No. 735/2011+connected appeals Page 19 of 102 business through which the business of an enterprise wholly or partly carried on. 2. The term "permanent establishment" includes especially: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; (g) a warehouse, in relation to a person providing storage facilities for others; (h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on; (i) a store or premises used as a sales outlet; (j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve month period; business through which the business of an enterprise wholly or partly carried on. 2. The term "permanent establishment" includes especially: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; (g) a warehouse, in relation to a person providing storage facilities for others; (h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on; (i) a store or premises used as a sales outlet; (j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve month period; (k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects- or activities, if any) continue for a period of more than 120 days in any twelve month period; (l) the furnishing of services other than included services as defined in Article 12 (Royalties and Fees for Included Services), within Contracting State by an enterprise through employees or other personnel, but only if; (i) activities of that nature continue within that State for a period or periods aggregating more than 90 within any twelve-month period; or ITA No. 735/2011+connected appeals Page 20 of 102 (ii) the services are performed within that State for a related enterprise (within the meaning of paragraph 1 of Article 9 (Associated Enterprise). 3. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include any one or more of the following: (a) the use of facilities solely for the purpose of storage, display or occasional delivery of goods or merchandise belonging to the enterprise; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or occasional delivery; (c) the maintenance of a stock of goods, or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; (d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise; (e) the maintenance of a fixed base of business solely for the purpose of advertising, for the supply of information, for scientific research, or for other activities which have preparatory or auxiliary character, for the enterprise. 4. Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 5 applies is acting in a Contracting State on behalf of an enterprise of the other Contracting State other Contracting State, that enterprise shall be deemed to have permanent establishment in the first-mentioned State if: (a) he has an habitually exercises in that first-mentioned State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph; (b) he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise ITA No. 735/2011+connected appeals Page 21 of 102 on behalf of the enterprise, and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise. (b) he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise ITA No. 735/2011+connected appeals Page 21 of 102 on behalf of the enterprise, and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise. 5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. Article7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arm's length with the enterprise of which it is a permanent ITA No. 735/2011+connected appeals Page 22 of 102 establishment and other enterprises controlling, controlled by or subject to the same common control as the enterprise, in any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article. ITA No. 735/2011+connected appeals Page 22 of 102 establishment and other enterprises controlling, controlled by or subject to the same common control as the enterprise, in any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article. 3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest and other expenses, incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or except in the case of banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than toward reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a ban