Thursday, January 24, 2013

Must Read: Application of “force of attraction” principle in computation of profits attributable to PE.

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Recently ITAT held that, the categories (b) and (c) in Article 7(1) of UN Model Convention clearly incorporate a force of attraction rule as is embedded in Article 7 of the India-UK treat.



The assessee is seeking rectification of mistake alleged to have crept in the common order of the Tribunal in ITA No. 4896 and 5085 of 2003



Assessee is a partnership firm of solicitors having its head office at London with no branch office or any other form of physical presence in India. During the year under consideration, the assessee carried out certain work on Indian projects, majority of which was done in U.K. and some of the work was done in India by persons who visited for short period of time. He submitted that the main issue involved in the assessee’s case was whether the assessee had a permanent establishment in India and the Tribunal vide its order dated 16th July, 2010 (supra) decided the same against the assessee by upholding the decision of the AO that the assessee had a service PE in India.. He submitted that the AO had brought to tax in India the entire income earned by the assessee from Indian projects although only a part of the services in relation to the said projects was performed in India. He submitted that the learned CIT(Appeals), however, agreed with the stand of the assessee that the income in respect of services rendered in India only was taxable in India being attributable to the PE in India relying inter alia on Article 7(3) of the India-UK DTAA. He submitted that the Tribunal, however, has accepted the stand of the Revenue on this issue that the entire income earned by the assessee from Indian projects is taxable in India in view of the force of attraction principle embedded in Article 7 of the India-UK DTAA and allowed ground No. 2 of the appeal of the Revenue. He invited our attention to the relevant portion of the Tribunal’s order as contained in paragraph No. 139 to 149 on this issue and contended that the Tribunal has referred to the provisions of Article 7(1) and 7(2) of the India-UK DTAA while deciding this issue ignoring entirely the provisions of Article 7(3) of the said treaty. He submitted that the Tribunal has relied on Article 7(1)(b) and 7(1)(c) of the UN Model Convention to decide the issue of attribution of profit holding that the said provisions are akin to the provisions of Article 7(1) and 7(2) of the India-UK DTAA. In this regard, he invited our attention to the comparative chart prepared and furnished by him of the relevant provisions of Article 7 of India-UK DTAA and that of UN Model Convention and submitted that there is no provision in Article 7 of UN Model Convention which is akin to the provision of Article 7(3) of India-UK DTAA. He contended that the Tribunal has applied the force of attraction principle embedded in Article 7(1) of India-UK DTAA which provides that the profits of the enterprise may be taxed in the other state but only so much of them as is directly or indirectly attributable to the PE in that State. He contended that what is meant by profits indirectly attributable to PE has been decided by the Tribunal relying on Article 7 of UN Model Convention ignoring that the same has been explained in Article 7(3) of India-UK DTAA.



The learned counsel for the assessee further submitted that the force of attraction principle contained in the UN Model Convention is completely different from the “direct and indirect attribution” principle contained in India-UK DTAA and the conclusion reached by the Tribunal relying on the force of attraction principle contained in UN Model Convention overlooking Article 7(3) of India-UK DTAA explaining what is indirectly attributable to a PE has given rise to a mistake

apparent from record inasmuch as the entire income from the Indian projects is held to be taxable in India by the Tribunal irrespective of whether the activity is done in India or not which is erroneous being contrary to the scope of indirect income attributable to PE as expressly defined in Article 7(3) of the India-UK Tax Treaty. He also explained how overlooking a statutory provision gives rise to a mistake apparent from record with the help of one example by reference to the provisions of section 2(41) and section 54(2)(vii).



The Tribunal has held the provisions of Article 7(1) of India-UK DTAA and the provisions of Article 7(1)(c) of UN Model Convention to be para material overlooking the vital and relevant provisions of Article 7(3) of India-UK DTAA which has given rise to a mistake apparent from record as the relevant statutory provisions applicable in the case have been ignored. He submitted that Article 7(1) of India-UK DTAA has to be read with Article 7(2) and 7(3) and the decision rendered by the Tribunal reading Article 7(1) in isolation has resulted in a mistake apparent from record as the relevant provision of Article 7(3) has been overlooked.



In the present miscellaneous application, ITAT observed that there cannot be any quarrel with the proposition, which is also supported by various judicial pronouncements cited by the learned counsel for the assessee, that non-consideration of relevant statutory provision constitutes a mistake apparent from record. The question, however, is whether the Tribunal in the present case can be said to have rendered its decision on the issue of computation of profit attributable to the PE of the assessee in India without considering Article 7(3) of the India UK DTAA as alleged by the assessee. In this regard, it is observed that the entire income earned by the assessee from projects in India was brought to tax by the AO in the hands of the assessee being attributable to the PE in India. This action of the AO was disputed by the assessee in an appeal filed before the learned CIT(Appeals) wherein the grievance projected by the assessee in ground No.5 was that the AO erred in including in the total income the amounts invoiced by the assessee that were relatable to the services rendered outside India. As claimed by the assessee in the said ground, the AO ought to have assessed the assessee only in respect of fees which were relatable to work performed in India. In support of this ground, reliance, inter alia, was placed on behalf of the assessee before the learned CIT(Appeals) on Article 7(3). The learned CIT(Appeals) thus had accepted the contention of the assessee that only the income related to the services performed in India was attributable to the permanent establishment in India and only that portion of income ought to be charged to tax in India.



It was observed that, The extension of taxability of profits of PE by including profits directly or indirectly attributable, is akin to the provisions of Article 7(1)(b) and 7(1)(c) of the UN Model Convention which provides that in addition to the “profits attributable to the permanent establishment” the taxability of PE profits will also extend to “(b) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business carried on in that other State of the same or similar kind as those effected through that permanent establishment”. In our considered view, the connotations of “profits indirectly attributable to permanent establishment” will extend to these two categories. These categories clearly incorporates a force of attraction rule. The basic philosophy underlying the force of attraction rule is that when an enterprise sets up a permanent establishment in another country, it brings itself within the jurisdiction of that another country to such a degree that such another country can properly tax all profits that the enterprise derives from that country ‐ whether the transactions are routed and performed through the PE or not.



Held, the connotations of “profits indirectly attributable to permanent establishment” do indeed extend to incorporation of the force of attraction rule being embedded in Article 7(1). In addition to taxability of income in respect of services rendered by the PE in India, any income in respect of the services rendered to an Indian project, which is similar to the services rendered by the permanent establishment, is also to be taxed in India in the hands of the assessee – irrespective of the fact whether such services are rendered through the permanent establishment, or directly by the general enterprise. There cannot be any professional services rendered in India which are not, at least indirectly, attributable to carrying out professional work in India. This indirect attribution, in view of the specific provisions of India UK tax treaty, is enough to bring the income from such services within ambit of taxability in India. The twin conditions to be thus satisfied for taxability of related profits are (i) the services should be similar or relatable to the services rendered by the PE in India; and (ii) the services should be ‘directly or indirectly attributable to the Indian PE’ i.e. rendered to a project or client in India. In effect thus, entire profits relating to services rendered by the assessee, whether rendered in India or outside India, in respect of Indian projects is taxable in India.



ITAT relying on the UN Model Convention commentary on this issue, a considered view was taken by the Tribunal that the connotation of “profits indirectly attributable to permanent establishments” did extend to incorporation of the force of attraction rule being embedded in Article 7(1). Keeping in view this text and context of the order of the Tribunal, we are of the view that it cannot be said that the Tribunal has ignored or overlooked Article 7(3) of India-UK treaty while rendering its decision on this issue and that there is any mistake apparent from record in the order of the Tribunal on account of non consideration of the said article as alleged by the assessee.



As regards the contention raised on behalf of the assessee that the scope of Article 7(1)(c) of U.N. Model Convention is limited to activities carried on in India only, it is observed that the Tribunal has taken a considered view on interpretation of the said Article that the entire profit relating to services rendered by the assessee whether rendered in India or outside India, in respect of Indian Project is taxable in India and it is not permissible to review the decision of the Tribunal in the guise of rectification u/s 254(2) of the Act. We are, therefore, of the view that the order of the Tribunal does not suffer from any mistake apparent from record as alleged by the assessee in the present miscellaneous application.



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